SEC drags Harvey, Illinois, back to court for alleged settlement violations
Harvey’s alleged lax compliance with management reforms required under a 2014 consent judgment that settled charges of fraudulent bond proceed use prompted the Securities and Exchange Commission to file an enforcement action this week.
The SEC on Wednesday filed a motion in the U.S. District Court for the Northern District of Illinois Eastern Division asking the court to order the city to implement recommendations laid out by an independent consultant aimed at strengthening the “city’s weak and ineffective system of internal controls.”
The impoverished south suburb of Chicago was required to hire an independent consultant under the December 2014 and to implement its recommendations.
The city adopted the consultant’s recommendations relating to payroll and human resources internal controls but “nearly five years after the Independent Consultant first made recommendations for the city to strengthen its internal controls, the city still has not implemented the independent consultant’s core recommendations,” the filing charges.
The city has also failed to implement recommendations relating to accounts payable and cash disbursement functions. “Therefore, the city has violated the consent judgment,” the filing reads. “The court should require the city to implement all of these open recommendations reflected in the final report.”
A March 2019 report from ICL LLC accountant James Hill concluded the “internal control environment within the city of Harvey is still unreliable and informal and most likely will remain so unless forced by external regulatory bodies or a renewed commitment by the new administration to remediate undocumented controls and policies and procedures as a top priority in 2019.”
The city’s attorney Robert Fioretti sent a letter to SEC attorney Eric Phillips in June of this year saying “the great majority of formerly open items” from the consultants’ report “have been remediated.”
“Moreover, Harvey's next independent public audit for fiscal year 2019, which is on track to be completed by September, will likewise investigate the continued integrity and any potential remaining shortcomings of the internal control environment,” the letter read. “Thus, we trust that the SEC shares Harvey’s view that rehiring the IC is unnecessary. Moreover, it is not feasible to do so in the present environment given the severe and increasing budget and personnel/time constraints that Harvey faces. These have been exacerbated by the COVID-19 pandemic that has caused a precipitous drop in revenues as experienced by all levels of government statewide.”
The city could not immediately be reached to comment, but the filing comes amid city efforts to restructure its debt under a pact struck earlier this year with bondholders who sued to intercept tax collections amid ongoing general obligation bond defaults.
The city earlier this month hired Meristem Advisors LLC to devise a debt restructuring. The city hopes to wrap the GO, overdue water bills to Chicago, and possibly other debt into the transaction.
It’s too early to say whether the action will complicate any borrowing and it could even be helpful, said Brian Battle, director of trading at Chicago-based Performance Trust Capital Partners.
“This might be the SEC firing a shot across the bow to say to the city that as it’s getting reorganized and restructured ‘we are watching,’” he said. “They are going on the record saying that they are still watching the city and won’t accept any shortcuts.”
It’s not a “scale-tilter” type of action, but Battle still believes the city’s best route on its restructuring is through a direct placement.
As Harvey was preparing to go to market in June 2014, the SEC acted. It filed a complaint and request to block the deal, marking the first instance in which the agency sought an emergency court order to halt a municipal bond offering amid an ongoing investigation. The court granted the temporary injunction.
SEC investigators alleged Harvey had diverted about $1.7 million over the course of 2008, 2009 and 2010 from offerings that were supposed to finance a hotel and conference center. The unfinished project was abandoned. The official statements made no mention of proceeds being diverted.
The SEC accused Harvey and the former comptroller Joseph Letke of engaging "in a scheme to divert bond proceeds for improper purposes, including undisclosed payments to Letke,” fraudulently misleading bond investors.
In the settlement, the city agreed, without admitting or denying the SEC's allegations, to cease violating federal securities laws and to hire an independent consultant and audit firm.
The city’s restructuring efforts are being pursued by Mayor Christopher Clark who took office last year. The consent decree struck with 2007 bondholders in June gives the city two years to complete a restructuring.
Under the agreement approved by a Cook County Circuit Court judge, the city gets to keep 90% of pledged tax revenues and bondholders will receive 10%. The pact runs to June 2, 2022, as long as the city honors terms of the agreement that call for it to continue negotiations and move toward a debt restructuring.
The dwindling tax base of the impoverished south Chicago suburb can’t support its pension liabilities, bonds and other debts. At the time of the GO bondholder pact, the city owed $4.5 million in defaulted debt service that was due in December 2018, June and December 2019 and June 2020 on a $31 million 2007 issue.
Harvey has been mired in litigation with various other creditors. In 2018, it settled a dispute with its public safety pension funds that sought to garnish tax revenues that flow through the state to make up for overdue contributions.
Chicago took Harvey to court after the city fell behind on payments for Chicago-treated water from Lake Michigan. The two cities agreed to a consent decree in 2015, but Harvey violated it and the court stripped Harvey of control over its water operations in 2017. Harvey is seeking to regain control of the water operations arguing the receiver is diverting an excessive amount of revenue and extracting high fees for its services.
The case SEC v. Harvey 1:14-cv-04744 was assigned Thursday to U.S. District Court Judge Joan H. Lefkow.