The recent news of the city of Detroit, Michigan filing for Chapter 9 bankruptcy highlights just one troubling example of the state of affairs for many municipalities across the nation, and with rising debt and pension obligations, many are struggling to stay afloat. Detroit is not the first city to file for bankruptcy, although it is the largest, according to numerous media articles. Jefferson County, Alabama; the cities of Stockton and San Bernardino, California; and the city of Central Falls, Rhode Island have all filed for Chapter 9 bankruptcy since 2010.
The city of Harrisburg, Pennsylvania attempted to file for Chapter 9 bankruptcy in 2011 due in part to a $300 million debt from a failed incinerator project that would have turned trash into energy. The bankruptcy filing was eventually blocked by state lawmakers.
As the economies of these municipalities continue to deteriorate, allegations of corruption and fraud have started to appear. In recent years, the Securities and Exchange Commission (SEC) has been intensifying its investigations and charging several cities, counties, and states with fraud:
- On July 19, 2013, the SEC charged the city of Miami, Florida and a former budget director, Michael Boudreaux, with securities fraud and with violating an existing cease-and-desist order. According to the SEC, in 2009 the city and Boudreaux made materially false and misleading statements and omissions about the financial health of the city’s General Fund, the city’s operating budget, in order to receive favorable terms on three municipal bond offerings that totaled $153 million. The agency accused the city of playing “shell games,” by transferring $37.5 million from its Capital Improvement Fund to the General Fund in order to conceal mounting deficits. This is the second occurrence of similar misconduct, after the SEC issued a cease-and-desist against the city in 2003. Additionally, Miami is the first municipality to be charged with violating an existing SEC cease-and-desist order.
- On May 6, 2013, the SEC charged the city of Harrisburg, Pennsylvania with securities fraud for failing to provide accurate information about its deteriorating financial condition to the city’s municipal bond investors. According to the SEC, between 2009 and 2011, the city failed to comply with requirements to provide certain ongoing financial information and audited financial statements. In what the agency called an “information vacuum,” municipal bond investors had to obtain current information on the city’s finances from other sources; however, that information was seldom publicly available elsewhere. The SEC stated that this was the first instance that the agency had charged a municipality for misleading statements outside of its securities disclosure documents.
- On March 11, 2013, the SEC charged the state of Illinois with securities fraud and was accused of misleading its municipal bond investors of the condition of the state’s pension obligations. The SEC claimed that between 2005 and early 2009, a period in which Illinois issued more than $2.2 billion in municipal bonds, the state failed to make proper disclosures that its statutory plans underfunded its pension system and increasingly raised the risk over time that pension obligations would not be met. This was only the second instance that the SEC has ever charged a U.S. state for violating federal securities laws in their public pension disclosures; the state of New Jersey was the first U.S. state to be charged in 2010.
In 2012, the 17 SEC enforcements in the municipal securities market was more than twice the amount filed in 2011. Whether the SEC is simply increasing their focus on municipal securities fraud or if municipal officials are more willing to conceal troubling economic conditions, it is a growing concern for investors. In a recent statement, SEC Commissioner, Luis A. Aguilar, declared “that a greater focus on this market is needed in order to protect investors.”
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