SEC’s Gallagher wants to add More Staff to oversee Pension and Municipal Activities, IRS and Arizona County may Settle over Prison Bonds…plus our Editor Analysis: For Whom the Bell, CA (Fraud/Audit) Tolls – a Closer Look
CURRENT EVENTS
SEC News this Week…
Issuers Expected to be Scrambling to Meet MCDC Deadline (B Buyer, December 1, 12014)
After months of preparation, questions, angst and increasing frustration, bond issuers were scrambling to get their voluntary MCDC Initiative documents filed with the SEC…nearly two months AFTER the bond underwriter deadline.
The Municipalities Continuing Disclosure Cooperation initiative, as part of Rule 15c2-12 under the SEC Securities Exchange Act of 1934, provided for leniency toward municipal bond underwriters and issuers who voluntarily disclosed misstatements and omissions regarding required continuing disclosure in their official statements.
The SEC stated that many underwriters participated, but declined to say how many issuers had submitted documents. At least two issuers, possibly mistakenly, posted their MCDC documents on EMMA.
The City of Fort Lupton, CO and the Stroudsburg Area School District in Stroudsville, PA both posted their documents on EMMA. This move caused concern to bond counsel, as EMMA is public and therefore, could open the issuer up to litigation from bondholders.
Gallagher: Focus on Pension Disclosure, Add More Muni Staff (B Buyer, December 3, 2014)
On the same day that Issuers were scrambling to meet the MCDC Initiative Deadline, SEC Commissioner Gallagher discussed increasing focus on muni pension liabilities as well as adding more staffing at the SEC to focus on municipal bond offerings and disclosures.
Gallagher has long been a proponent of increased enforcement to protect the huge majority of retail investors in the bond market, many of whom are not overly sophisticated.
Another area of frustration is the fact that not all muni bond issuers are required to follow GASB accounting standards, which means that there can be inconsistencies in reporting and disclosure.
Although there have been unprecedented enforcement efforts in the last two years, including a first ever financial penalty against an issuer as well as charges filed directly against public officials for fraud, the sentiment is that more needs to be done.
SEC Enforcement Chief Andrew Ceresney has publicly promised to ramp up muni enforcement even more. Gallagher said such a move will be beneficial for market behavior, stating “once every ten years doing a couple muni cases I don’t think is going to send the right message to the community,”
While he acknowledges that pursuing public officials for their roles in fraudulent offerings is tricky, it is more effective than a cease-and-desist order…which means we will likely see more of these types of actions.
Gallagher further went on to explain his point for additional staffing: They (the SEC) have 5 1/2 people to cover a roughly $15 trillion combined muni and corporate bond market, which is largely retail – whereas there are 150 people covering equities and options markets – every day.
“At the end of the day, the commission needs to devote more staff to munis”, Gallagher said.
More IRS Audit News…
Arizona County May Settle With IRS Over COPs Used for Detention Facilities (B Buyer, December 1, 2014)
Last week, Pinal County, AZ disclosed that tax issues with $71.62 million in Certificates of Participation Notes (COPs) may be close to being settled with the IRS.
The audit, which began in 2012, was part of what appeared to be a nationwide review of detention facility financing bonds.
In the audit, the IRS has taken the position that certain arrangements for locally-owned jails to house federal detainees may result in private business use of the facilities.
The private business use (PBU) could endanger the tax-exempt status of obligations issued to finance the jails, the county said.
The federal government is treated as a private party under the federal tax laws.
A contract with U.S. Immigration and Customs Enforcement to house people awaiting deportation appears to be triggering the PBU. On the County website, it states, “This contractual agreement provides essential funding to offset the cost of jail operation to Pinal County taxpayers,”
A settlement could ultimately involve the redemption and refinancing of some of the COPs on a taxable basis, as well as making a payment to the IRS. “The county currently cannot predict the outcome of the audit or ultimate settlement terms,” it said.
OUT & ABOUT
Conferences/Events for the rest of 2014: No conferences or events in December 2014
Conferences in early 2015:
The Bond Buyer’s National Outlook 2015 Conference, January 27, 2015
Metropolitan Club, New York, NY
The Bond Buyer’s Texas Public Finance Conference, February 9-11, 2015
Omni Barton Creek Resort & Spa, Austin, TX
The Bond Buyer and BDA’s National Municipal Bond Summit March 1-3, 2015
The Westin Beach Resort & Spa, Fort Lauderdale, FL
Editor Analysis: For Whom the Bell, California (Fraud Audit) Tolls…A Closer, Look at the Twisted Tale
Ding, ding, ding….Why are muni compliance rules tightening…and seemingly from all directions?
There has been a tremendous amount of publicity, focus and (consequently) grumbling about increasing scrutiny, accountability and transparency for public funds over the last two years.
In reviewing news for this weeks’ edition, I stumbled across a closing article on the IRS audit for the Bell, CA Bonds…and then I remembered…
Oh yeah, Bell, California. A small town of about 35,000 people near Los Angeles that hit the financial scandal spotlight in 2010 – and in a big, ugly way. Do you remember why?
It started with an IRS Audit of $35 million of their general obligation bonds which were issued in 2007 for a proposed sports complex. It was never built, although some of the bonds were used for minor park repairs. So what happened to the rest?
The IRS issued the audit notice in 2010 as they were concerned the issue was a hedge bond – whereby the city had failed to spend 85% of the bond proceeds on qualifying expenditures within the required three-year spend down period under federal tax law. Ding….
What quickly came to light is that the City Manager, Robert Rizzo, was collecting a salary of $800,000 per year, plus lucrative benefits, which padded his total compensation to $1.18 million. Additionally, the assistant manager, Angela Spaccia, was raking in a neat $564,000. Pretty cushy salaries for managing a town of only 35,000 people.
However, the icing on the cake was to find that five of six council members – all very part-time, were each earning over $100,000 in annual compensation. Interestingly enough, there were no council minute approvals for any of these lucrative salary amounts. Ding, Ding….
When looking at the bond and accounting records, it was evident that funds were being misappropriated to phony agencies and loans were being made without proper approvals. The citizen’s property tax rates kept escalating (2nd only to Beverly Hills) while the infrastructure and services kept declining.
So, how could this happen when nothing unusual came up during the annual audit of the city’s finances?
State Controller John Chiang in December 2010, issued a scathing report of Bell’s audit firm, Mayer Hoffman McCann(MHM)regarding their June 2009 audit as follows:
“MHM appears to have been a rubberstamp rather than a responsible auditor committed to providing the public with the transparency and accountability that could have prevented the mismanagement of the city’s finances by Bell officials,”
He further went on to state, that “Had MHM fully complied with the 17 applicable fieldwork standards, it would have led them to identify some—if not all—of the problems my office has uncovered since August.”
Chiang noted that the firm had relied primarily on comparisons to prior-year financial statements, and failed to review the age and collectability of a loan that showed no repayment – nor had required City Council approval.
The California Board of Accountancy also reviewed the file and found eight specific criticisms, which focused primarily on audit documentation issues, rather than audit procedures. MHM was subsequently fined $300,000 in penalties, $50,000 in audit fees, placed on probation for two years and will be subject to quarterly peer reviews. Ding, Ding, Ding….
Then the plot thickens…this is starting to sound like something from the Twilight Zone, isn’t it?
Enter IRS Criminal Investigations and the FBI to go along with the original IRS bond audit. Rizzo would be indicted and convicted on 69 counts along with tax evasion of $300,000, Spaccia would be found guilty on 11 of 13 counts and the five council members would be indicted for multiple counts each of misappropriation of public funds. Robert J. Melcher, Rizzo’s tax preparer, has pleaded guilty to aiding and abetting the filing of a false tax return.
District Attorney Jackie Lacey said in a prepared statement. “Their reign of fraud left the working-class city of 35,000 nearly bankrupt.” Rizzo received 12 years, which is the longest prison term for public corruption since the Public Integrity Division was founded in 2000.
Given that many municipalities continue to struggle with financial woes, decreased revenues, increasing pension fund costs
and demands for services, (then add scandals like Bell) it is little wonder that bondholders, taxpayers and legislators are worried about wrongdoing…
In closing, you and I, while diligently doing our job to be a great public servant and provide the best value to our communities, need to understand that sensational, criminal events like these make us look bad too.
That is why we need to band together to make sure our compliance programs are up to snuff…
While we shake our heads at how Bell’s twisted web of collusion, corruption and crisis occurred, it should also make us realize that, as stewards of public funds, the IRS, SEC and other financial oversight agencies will be wielding the sword of protection and enforcement to look out after the investor, the taxpayer and the laws that protect them. That is their mission.
Oh, and as a final note, the city of Bell did resolve the tax standing (saved by the bell…) of their bonds. They paid a fine of $287,000 and retained the tax exempt status of their bonds.
We hope you enjoyed this week’s edition of the Monday Muni Minutes. As always your comments are welcome…
To your compliance success,
Debbie
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P.S. For Issuer 2 Issuer members who said “yes” to the Next Steps Survey Training, watch your e-mail later this week for important information…
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