The Securities and Exchange Commission has charged South Miami, Fla. with defrauding investors by negligently making misstatements and failing to disclose actions it took that jeopardized the tax-exempt status of $12 million of bonds.
The SEC said the city of 11,000 used the bonds to finance a mixed-use retail and public parking structure at tax-exempt rates in two-pooled conduit deals, the first in 2002 and the second in 2006. The bonds were issued by the Florida Municipal Loan Council.
The city represented the project was eligible for tax-exempt status in bond documents, which bond counsel relied on in rendering its tax opinion, the SEC said.
But the city did not reveal that it had impermissibly loaned $2.5 million of proceeds from the 2002 offering to a private developer and restructured a lease agreement with the developer before the 2006 deal, actions that threatened the tax-exempt status of all the bonds. The city did not disclose either action to investors or other key transaction participants.
The city loaned the bond proceeds to the developer just one month after the 2002 offering, despite having signed a tax certificate stating it would not make available any bond proceeds borrowed from FMLC for private use in violation of tax requirements.
In the 2002 lease agreement, the city only leased the retail space to the developer, while it maintained and operated the parking garage. But in a revised lease negotiated in 2005, the city leased the entire structure to the developer and shared the parking garage revenues with the company. The revised lease was approved by the city commissioners and executed by the city attorney, who did not understand the ramifications on the bonds, the SEC said.
Under tax law requirements, for private activity bonds to be tax-exempt, no more than 10% of the bond proceeds can be used by private parties and no more than 10% of the debt service payments can be paid for, or secured by, private parties. In addition, loans to private parties must not exceed the lesser of 5% or $5 million of the proceeds.
“South Miami’s fraudulent conduct put bondholders in danger of incurring significant additional costs associated with their investments,” said Elaine Greenberg, chief of the SEC enforcement division’s municipal securities and public pensions unit. “The tax-exempt status of municipal bonds is vitally important to bond investors, and we will closely scrutinize any conduct by issuers or others that threatens that tax exemption.”
The city’s finance department was a revolving door during that time. The SEC said that at least four different finance directors signed annual certifications between 2005 and 2009, falsely asserting the city was complying with the 2002 and 2006 loan agreements, even though the 2009 finance director had been informed by bond counsel that the 2005 lease could lead to the loss of the bonds’ tax exempt status.
The city’s finance directors had no experience or training in reviewing, completing, or assessing disclosure requirements or tax issues connected with bond financing, the SEC said.
“Municipalities in South Florida and elsewhere cannot rely on a lack of internal procedures or experience in debt offerings to excuse fraudulent disclosures made to investors,” said Eric Bustillo, director of the SEC’s Miami office,
The city eventually filed a material event notice on the Municipal Securities Rulemaking Board’s EMMA system in July 2010 acknowledging that the bonds’ tax-exempt status could be in jeopardy.
In August 2011, the city entered into two closing agreements with the Internal Revenue Service to settle tax law violations without jeopardizing the tax-exempt status of the bonds. Under those agreements, the city paid $260,345 and defeased a portion of the two prior bond offerings at a cost of $1.16 million, the SEC said.
In its settlement with the SEC, South Miami agreed to a cease and desist order barring it from any future securities fraud violations. It also agreed to retain an independent, third-party consultant to conduct annual reviews over three years of its policies, procedures, and internal controls for municipal bond disclosures. The city is supposed to follow through and implement all recommendations made by the consultant. The city neither admitted nor denied the SEC’s findings.
The charges against South Miami come after the SEC staff, in July 2012, sent nearby Miami a Wells Notice warning they planned to recommend the commission file securities fraud charges against the city for failing to disclose serious budget problems in 2007 and 2008 in bond-related documents. Wells Notices give the recipients a chance to talk SEC officials out of taking enforcement action, either through written responses or meetings.
The city responded to the notice in August, offering to settle the charges by improving budget and disclosure practices, including restructuring the finance department. The city also asked the SEC to issue an investigative Section 21(a) report, which lays out the problems without attaching sanctions or fines. The case has not been resolved.
If Miami is charged, it would be the first time an issuer has been involved in two SEC enforcement actions. In 2003, Miami signed a cease and desist order promising not to commit any future securities fraud violations after failing to disclose in bond-related documents material information about its deteriorating finances.