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SEC Accuses Illinois City of Securities Violations, Blocks Bond Sale

JUN 25, 2014 3:45pm ET
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CHICAGO - Harvey, Ill., and its comptroller, Joseph T. Letke, misused bond proceeds and misrepresented investment risks, the Securities and Exchange Commission alleged in a civil complaint that supported a successful request to block a planned debt issue by the Chicago suburb.

The SEC said the bonds were being fraudulently marketed to investors and a federal judge Wednesday granted the SEC's request to block the deal, which had been expected as soon as this week.

The injunction follows the civil complaint the SEC filed Tuesday accusing Harvey, and Letke of violating securities laws for allegedly misusing bond proceeds and misrepresenting investment risks.

Judge Rebecca Pallmeyer of the U.S. District Court for the Northern District of Illinois, Eastern Division, issued an order blocking any issuance until July 14, according to a statement from the SEC. Harvey agreed to the restriction and a court hearing was set for July 8.

"We moved quickly to stop this city and its comptroller from issuing more bonds under false pretenses," said Andrew J. Ceresney, director of the SEC's Division of Enforcement. "We will continue to aggressively pursue municipalities and public officials who raise money through fraudulent bond transactions that harm both investors and residents."

The SEC learned of the pending bond issue during a probe of the city's past issues. Its complaint accuses the city and Letke of engaging in a "fraudulent scheme" that included "materially misleading statements about the intended use of bond proceeds and the risks of investing in Harvey's municipal bonds" and omitting the misuse of proceeds from offerings in 2008, 2009, and 2010.

The SEC accuses Harvey and Letke, 55, of engaging "in a scheme to divert bond proceeds for improper purposes, including undisclosed payments to Letke." The SEC requested a jury trial.

The allegations center on a $6 million 2008 offering, a $3 million 2009 issue, and a $5 million 2010 sale. Proceeds were to fund a Holiday Inn hotel and conference center.

The bonds were sold with a limited obligation backing. Depending on the issue, supporting dedicated revenue streams included a hotel-motel tax, sales tax revenue, or revenue generated within the project's tax-increment financing district.

The complaint alleges that Harvey officials improperly diverted at least $1.7 million of bond proceeds from the offerings into general operation accounts to pay city operating expenses including payroll.

Letke, a certified public accountant, also received about $269,000 in undisclosed payments from the bond proceeds and other proceeds earmarked for the hotel projects.

"Bond investors were thus materially misled about the purpose and risks of the bonds they purchased from Harvey," the complaint alleges.

Letke also owned private firms that benefitted from city work and the bond sales. In addition to serving as comptroller, Letke operated a firm, Letke & Associates, Inc., and he is a principal shareholder in Alli Financial and Public Funding Enterprises, the SEC complaint says.

Letke and his firm served as a financial advisor to Harvey in connection with the 2008, 2009 and 2010 financings. Letke also serves as comptroller to other municipalities.

In total, the SEC said, Letke and his businesses received at least $1.9 million between 2008 and 2010 relating to work for the city. He also received "undisclosed" fees that added to his compensation and were not reported in offering statements.

"Harvey's bond investors were misled into believing their money would go toward construction of a Holiday Inn when instead the bulk of it was diverted into Harvey's general coffers and Letke's pocket," said David Glockner, director of SEC's Chicago Regional Office. The investigation is ongoing.

The diversion of bond proceeds led to the failure of the hotel project which "has turned into a fiasco for bond investors and Harvey residents," according to the complaint, citing news reports that describe it as a "decrepit shell."

Letke was also in line to receive fees tied to the proposed 2014 bond issue for his work as advisor to the city and preparing a feasibility study on the projects through a private company. The 2014 issue was also structured as a limited obligation of the city payable from TIF revenues. Proceeds would fund construction of a grocery store.

The lawsuit represents a major action by the SEC's enforcement arm, which has signaled that it will be aggressive in ferreting out wrongdoing in the muni space.

While it is not unusual in the context of an offering fraud for the commission to seek emergency action from a court to restrain a party from making a fraudulent offering, sources said this may be the first such time it has happened in the municipal bond market.

The Harvey complaint accuses the city of fraudulently omitting in the new offering statement its misuse of past proceeds tied to the hotel TIF project and failing to adequately share the risks of the project with investors. The city did not disclose that a third party consultant was not hired to examine the feasibility of the project. Instead the Letke-linked firm Public Funding Group conducted the study.

The Illinois comptroller early this year asked an auditor to bring the city of 25,000 into compliance with reporting requirements. Letke reported in recent documents that the city's "current financial condition is grave" and could as soon as July fall short of funds needed to pay bills and in August would not be able to make bond payments.

The city is represented by attorneys Tiffany Mary Ferguson and Rachel Steiner at Pugh Jones & Johnson PC. Neither were immediately available for comment.

The complaint seeks civil penalties against Letke and orders for him to disgorge his alleged ill-gotten gains. It seeks an order restraining and enjoining Harvey, its officers, agents, etc. from directly or indirectly engaging in the offer or sale of municipal securities for five years.

The ban could be avoided if an independent consultant is appointed by the court to overhaul Harvey's municipal security disclosure policies and procedures, and its procedures, controls, and personnel for the proper use of bond proceeds. The complaint also asks that Letke and his related companies be enjoined from participating in bond sales and seeks a freeze on Letke's assets.

The SEC's investigation was conducted by the Chicago Regional Office and the Municipal Securities and Public Pensions Unit, including Eric A. Celauro, Sally J. Hewitt, and Scott Hlavacek. Eric M. Phillips will lead the litigation and the case is being supervised by Peter K.M. Chan.

Kyle Glazier contributed to this story

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