WASHINGTON - It is rare for the Securities and Exchange Commission to sue individual public officials for alleged securities fraud and the commission's case against five former San Diego officials is meant to send a strong message: that public officials cannot avoid responsibility for their disclosures just because they are employees of municipalities, securities law experts said yesterday.
"Clearly the point is the SEC is not going to settle out for a minimal amount if you are signing certifications that are untrue," said one securities lawyer who asked for anonymity. "Just because you are an employee or something like that doesn't absolve you, doesn't give you a get-out-of-jail-free card."
The attorney stressed that the situation in San Diego was on the "fringe" and "pretty outrageous" and that the vast majority of issuers practice good disclosure, but he added that there is also "a large number of municipalities that have to be awakened to the fact that this is serious stuff."
But one market participant yesterday noted a legal hurdle that the SEC may have to overcome. They must prove that the San Diego officials acted with scienter, or extreme recklessness, even though they did not appear to personally profit from the city's pension crisis. Scienter refers to intentional wrongdoing.
The source, who asked for anonymity,referenced a recent decision from the U.S. Court of Appeals for the First Circuit in Boston in which the appellate court took into consideration, in determining whether former officials at the now-defunct Bradford College acted with scienter, the fact that the defendants did not profit personally other than perhaps saving their jobs.
The January decision in ACA Financial Guarantee Corp. v. Advest Inc. noted: "In this case there is no allegation of any additional motive other than the defendants' desire to keep the college operating and to deprive creditors of their due in an inevitable bankruptcy proceeding. These are shaky grounds for leaping to the conclusion that there is a strong inferences that the defendants intentionally or recklessly disregarded the facts available to them when quoting financial aid figures in an offering statement accompanying a multimillion-dollar bond offering."
Though the ruling is legally binding in the first circuit, which includes New England and Puerto Rico, it only serves as precedent in the San Diego federal court where the SEC suit was filed and which is part of the Ninth Circuit.
Other lawyers said the SEC lawsuit marks "a tightening of the noose" in terms of the SEC taking incrementally more serious enforcement actions against public officials.
Robert Doty, president of American Governmental Financial Services Co., said the SEC began jawboning municipal officials about disclosure in the 1970s, and in the following decade took regulatory steps that included adoption of its Rule 15c2-12 and other releases on primary market disclosure. In the 1990s, the commission adopted rule amendments on secondary-market disclosure and took its first enforcement actions against individual municipal officials, including Orange County, Calif., obtaining injunctions against two officials. Though during the current decade the SEC has taken enforcement action against a number of issuers, sometimes including issuer officials, the commission typically has done so through administrative proceedings and has not sought civil penalties against issuer officials.
“With this lawsuit, they’re going for a civil penalty, which I think is a more severe step, and they’re doing it through a judicial proceeding rather than an administrative proceeding, which I think is also an incremental step with greater seriousness,” Doty said. “If the commission were to win this action, I think that it would get the attention of officials of all municipal issuers. It would mean that their own personal wealth could be on the line, though we’ll have to see how this particular action will play out.”
The SEC filed securities fraud charges against the five former San Diego officials Monday in the U.S. District Court for the Southern District of California, in San Diego, claiming they made false and misleading statements in connection with $260 million of the city's municipal securities sold in 2002 and 2003 as well as in presentations made to rating agencies and in secondary market disclosures.
The officials are: former city manager Michael T. Uberuaga; former city auditor and comptroller Edward P. Ryan; former deputy city manager of finance Patricia Frazier; former assistant city auditor and comptroller Teresa A. Webster; and former city treasurer Mary E. Vattimo. Webster and Vattimo face separate criminal charges filed by the Justice Department and Webster also faces criminal charges filed by the district attorney for San Diego county, sources said. Attorneys for all five former city officials did not return phone calls by press time.
SEC officials are seeking injunctions against further violations of the commission's antifraud rules as well as unspecified monetary penalties.
The SEC charges were the latest installment in a drama that was first sparked when the city revealed in early 2004 that it had not disclosed to bond investors the extent to which is had underfunded its employee pension plan. The consequences included SEC sanctions against the city, announced in November 2006.
The crisis, and the questions it raised about the city's accounting, made it hard for the city to gain auditor approval of its financial statements. It wasn't until March 2007 - three years and 11 months after the firm was hired - that KPMG LLP certified the city's comprehensive annual financial report for fiscal year 2003, allowing it to return to the public bond market. The city has been forced to privately place bonds during its absence from the market.
In December, the SEC settled securities fraud charges with the outside auditors for the city and its pension system - Thomas J. Saiz and Calderon, Jaham & Osborn, his former accounting firm. Saiz and the company were enjoined by a federal court from engaging in future securities law violations and Saiz paid a civil penalty of $15,000. The accounting firm Caporicci & Larson acquired Saiz's firm in early 2003.
San Diego city attorney Michael Aguirre said yesterday that the SEC's fraud charges should help force the city to get its financial housing in order.
"This hopefully will help to spur a more thorough reform of our financial management," he said. "The SEC coming forward like this really helps to strengthen those of us who are arguing that we need to reform, that we need to get our internal controls in place."
Aguirre, an elected official, also called on Mayor Jerry Sanders to confront municipal unions and clean out the city's finance departments, and said that Sanders continues to preside over the expansion of the city's unfunded pension liabilities.
"We still haven't come back and done the hard work necessary to get that system under control," he said. "Instead of us being financially prudent and paying close attention to arithmetic, we've still been playing the political game of trying to satisfy the insatiable appetites of these unions for benefits."
In a statement late Monday, Sanders said: "Charges such as the ones filed today by the SEC are reminders of our shameful past. But they are also opportunities to reflect on the progress we have made instituting reforms so that these problems can never - and will never - happen again."