Monday, February 13, 2006 | The Securities and Exchange Commission has given targets of its investigation into the city of San Diego their last chance to avoid enforcement actions by the agency, a sign that the SEC’s two-year-long case probing City Hall’s financial dealings has advanced, multiple sources close to the investigation said last week.
Sources said that within the last one or two weeks, the SEC has given people of interest in its investigation a “Wells call.” Such communication is an informal invitation to potential defendants that allows them one last chance to submit information that may put an end to suspicions that they committed securities fraud.
The sources of the update on the SEC’s two-year-long investigation spoke on the condition that they not be named in this story.
They confirmed that former city employees have been invited to point out any errors in the legal theories or holes in the evidence the regulatory agency may be using to build a case. The potential defendant’s response is not required but if he or she does respond – an action known as a “Wells submission” – whatever is submitted can itself be used as evidence in a trial.
It was unclear who received the SEC communications. A number of current and former city officials have run up legal bills as a result of the investigations by the SEC and the U.S. attorney. The city attorney has also accused city employees, former Mayor Dick Murphy and other elected officials of being responsible for the disclosure errors. But Council President Scott Peters – one of those who approved the bond disclosures in question – said Sunday that he had not received a Wells call from the SEC.
Peters did say, however, that his lawyer and attorneys for Murphy, and Council members Toni Atkins, Donna Frye, Jim Madaffer and Brian Maienschein met with the SEC on Friday to discuss the council’s role in the city’s disclosure practices. The City Council has authorized about $1 million to cover legal expenses for the council members as they deal with the SEC and Justice Department, although Frye has not sought public funds to pay for her lawyer.
“We’ve cooperated with any request they’ve wanted,” Peters said. “Anything that will conclude this matter is good, and we look forward to cooperating so that can happen.”
Other council members last week were either unavailable or declined to comment on the investigation.
The SEC probe has been pushed off-stage in recent months as attention focused on the federal and state corruption charges brought down against former officials of the city’s retirement system. If the SEC brings any civil charges, however, the agency could potentially focus on other areas of the city’s management where critics have said illegal acts occurred.
The Wells calls placed by the SEC relate to the city’s disclosure practices in 2002 and 2003, when the municipal government released financial statements and bond offerings that played down the severity of the city’s pension deficit, which is currently estimated to be about $2 billion. According to an investigation by the City Attorney’s Office, the city released seven sets of misleading financial statements between April 2002 and June 2003.
The errors and omissions found in those disclosures have also held up the certification of the city’s financial audits dating back to the 2003 fiscal year. The audit delays have resulted in the downgrading or suspension of the city’s credit ratings, which has essentially barred City Hall from borrowing on the public bond markets for much-needed capital improvement and infrastructure projects.
In addition to its disclosure practices, the SEC subpoenaed information about the city of San Diego’s sewer-user fees and related bond disclosures, although it does not appear to be related to the Wells calls placed in the last few weeks. City Attorney Mike Aguirre has alleged that the city put misleading statements about the way it charged residential users of the sewer system compared to industrial users. The sewer system is also the subject of major lawsuit brought against the city filed by the Utility Consumers’ Action Network.
The U.S. Attorney’s Office, which has charged several former retirement officials for their role in a pension-funding scheme, is also taking an interest in the city’s disclosure gaffes, according to subpoenas. The SEC can only file a civil complaint whereas the U.S. attorney can prosecute securities law violations criminally.
Securities attorneys who are not involved in the investigation said the SEC’s Wells calls signify that the agency’s staff believes a case is close to being filed.
“It’s an indication that this has moved up the ladder of seriousness,” said Bill Sullivan, a securities lawyer with Paul Hastings. “There could still be a fair amount of time before anything really happens, but generally this is an indicator that things have advanced to where a decision is being made by [SEC] staff to go ahead and ask the commission to move forward.”
Normally, the prospective defendant will reply to a call within 30 days, although the window for a Wells filing is up to the discretion of the SEC staff that invites the submission. A Wells submission can change the minds of the SEC staff, leading them to abandon their pursuit, negotiate a settlement or proceed with the charges.
“A Wells letter filed Tuesday could lead to enforcement as soon as Wednesday, or even two years later, or not at all,” Sullivan said.
Penalties assessed against individuals who are found culpable of securities fraud are far-ranging. There are essentially three levels of fraud, spanning from negligent to reckless to intentional. Responsible parties can be ordered to stop engaging in the practice that was found illegal, be forced to step down from their current position as an officer or director at the entity where the wrongdoing occurred, or barred from ever serving as an officer or director of an organization that issues securities publicly.
Elected city officials, just as a board of directors, could be subject to the same penalties corporate overseers face, if they were found culpable of securities fraud, said Ed McIntyre, a securities attorney with Soloman Ward.
“A municipality, when it goes to the public marketplace, is as much a reporting entity as anyone else,” said McIntyre.
In 1996, Orange County faced SEC actions similar to what sources say the city will face along with individuals at the focus of the agency’s probe.
The SEC, that year, determined that Orange County had misled investors about the security of bonds the county had issued. Though the SEC took direct aim at Orange County’s elected Board of Supervisors, its investigation only led to enforcement actions against former Treasurer-Tax Collector Robert Citron, who was elected to his post. Citron pleaded guilty to six felony counts that were brought by the U.S. Attorney’s Office.
But the supervisors were reprimanded by the SEC and ordered to abandon past practices.
“Although the [Board of Supervisors] may delegate certain of these duties to county officers and employees, it is ultimately responsible for the execution of these duties,” the SEC determined.
San Diego’s elected officials have argued repeatedly that relied on the city employees who were advising them to approve bond disclosures. In Orange County, supervisors and the county government itself were not individually penalized, but were ordered to correct its disclosure practices.
San Diego City Council members voted in September to separate themselves and city employees from the city government for the purposes of the SEC probe when they asked City Attorney Mike Aguirre and outside attorney John Hartigan to begin settlement talks on behalf of the city. Sorting the city from its workers who were involved in any securities infractions may enable the city to more quickly conclude the probe of its books, Aguirre said at the time.
Staff Writer Andrew Donohue contributed to this report.
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