Ramapo, N.Y., Town Supervisor Christopher St. Lawrence is in the middle of a multi-week trial on two dozen securities fraud charges stemming from municipal bond issuances and accounting practices in Ramapo, a Rockland County hamlet. The star witness against St. Lawrence is former town attorney and leader of the town-owned Ramapo Local Development Corporation (RLDC), N. Aaron Troodler, who pled guilty to securities fraud charges in March. Though the trial has yet to conclude and Mr. St. Lawrence may yet be acquitted, the focus on bond issuances in the St. Lawrence trial shows the federal government’s continued interest in policing securities fraud in the public sector. It also highlights the importance of outside scrutiny of municipalities’ revenue generation (and other indicators of fiscal health) early and often in the life cycle of a bond issuance.
With the St. Lawrence case as a backdrop, public sector securities issuers should consider developing more fulsome oversight efforts as to accounting and bond issuance and repayment documentation, including making sure outside counsel and, where appropriate, auditors, have an opportunity to probe major transactions and relevant ledgers. Given the massive size of the municipal bond market (almost $4 trillion), the St. Lawrence case is not likely to be the last example of criminal securities charges flowing from municipal bond accounting issues.
When former U.S. Attorney Preet Bharara’s office trumpeted the U.S. v. St. Lawrence indictment and Troodler conviction, it did so by stating that the case saw the first securities fraud conviction based on municipal bond issuances. This may be true, but municipal bond finance issues have been of interest to local and federal prosecutors and regulators for years. In California, for example, the SEC and the FBI looked into West Contra Costa school board bond financing and allegations of corruption by school board leadership. No one was charged criminally or otherwise in that case, but the investigations (and related whistleblower allegations) have resulted in further controls being instituted by the District including, recently, a full forensic audit of its bond program and the formation of a task force to implement a lengthy set of recommendations for controls improvements.
Five years ago, Bharara’s office also secured multiple convictions against banking and finance executives in U.S. v. Carrolo, in which the defendants were charged with designing (and carrying out) a rate-fixing effort on public municipal finance bidding. Some of the convictions were later overturned on the grounds that the government had waited too long bring charges in the case.
The criminal prosecution in Ramapo, however, shows that securities fraud charges for individuals (and negative publicity associated with such cases) are a new risk area. These risks can only be mitigated by carefully designing internal controls and ensuring individual municipal leaders do not maintain complete discretion over revenue generation efforts or the representations made to rating agencies, and ultimately, to bondholders, about the financial health of the municipality.
The government’s theory of the case in St. Lawrence is that St. Lawrence and Troodler worked together to provide investors with a false sense of the town’s financial health so that they would positively rate and invest in the town’s bond offerings. In addition to allegedly lying to investors, the indictment and testimony at trial focused on a variety of problematic accounting practices.
The Ramapo financial saga began when the town built a $60 million baseball stadium, and issued approximately $30 million in bonds to pay towards the construction cost. The town’s general fund could not support the required principal and interest payments, and St. Lawrence allegedly lied about revenue sources and the fund balance by propping it up with money from other town funds and with fake receivables to keep the general fund (falsely) in the black. The allegedly fraudulent receivables accounting make the bonds look much more solid than they are. Troodler, who pleaded guilty, borrowed money to make scheduled payments instead of financing the payments via the town’s reserve cash. The government has put on evidence at trial that the fake receivables totaled nearly $10 million over approximately five years. Both investors and bond raters received the allegedly false information and made bond investment decisions on that basis.
The government has called numerous other town employees as witnesses who have testified to a culture of secrecy around the general fund balance. One witness testified that the fund balance was only shown to town officials, and that St. Lawrence was maniacal about controlling information regarding town finances and sought to be the ‘go-to guy’ on town finance. There are allegations of accounting issues as well false information flow; St. Lawrence allegedly made numerous improper transfers across town accounts and orchestrated a buy-back of property to make the town coffers look more full than they really were. This type of individual-level decision-making can lead to obviously problematic practices; public entities should view the St. Lawrence case as an opportunity to implement internal controls that avoid bottlenecking financial information with a single official.
The St. Lawrence trial may also be novel to the extent it reveals prosecutorial willingness to pursue criminal charges where there has been no private financial gain to the individuals themselves. Public sector employees can be just as vulnerable to criminal liability as more conventional white collar defendants have long been in the private sector. Municipal revenue generation efforts can be a risky area, and city governments should be sure to scrutinize—and invite outside scrutiny of—bond issuance and accounting practices as they work to generate funds for key projects.
Small towns and struggling municipalities are particularly vulnerable to accounting issues and frauds like the ones we are seeing in the St. Lawrence trial, and making sure disinterested parties are engaged early on can help avoid a mountain of problems later. As cities look to obtain financing for new projects, it is also critical to continue managing and scrutinizing the accounting throughout the entirety of a bond term. Where bond accounting touches other city funds and ledgers, city employees should take extra care to take into account the whole ecosystem of municipal ledgers. Engaging auditors and outside counsel up front can help protect the revenue generation for the life of a bond. Ensuring that these disinterested parties have an eye on internal controls and on the revenue generation accounting is one key to avoiding some of Ramapo’s problems and help maintain municipal financial health in both the short and long term.