The Morning Report
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So the Kroll report found that eight former top staff members acted with either recklessly or intentionally when allowing inaccurate information about the city’s finances to be disclosed to investors.
The report states:
With regard to the City’s unlawful financial disclosures, we believe the evidence supports the determination that the following City representatives acted with wrongful intent, i.e., scientor as defined pursuant to Section 10(b) of the Securities Exchange Act of 1934:
It then lists the individuals.
But when it comes to council members, there is no statute or act mentioned. The report only says this:
As to members of the City Council, we believe the evidence supports a determination that the following Council members were negligent in fulfillment of their bond offering disclosure responsibilities:
And then it lists the batch of current and former council members. Let’s play a little Q & A here.
Q: So, if both the council members and the staff members knew about the financial problems that weren’t disclosed, why is there a difference between how they were judged by the audit committee?
A: Benito Romano, an audit committee’s attorney, explained it like this: The individuals who were found to act with wrongful intent were actively involved in the preparation of the city’s financial disclosures. The City Council, on the other hand, was only asked to approve the disclosures.
“We concluded that the council members were not sufficiently involved in the disclosure process,” he said. “The council members get presented to them a draft of the disclosure document and it’s already been reviewed by several professionals and they’ve been basically told to sign it.”
He said it is the council members’ duty to ask questions, but that if the City Council had been given greater responsibility under the city structure over the disclosure process, the ruling could have been harsher. (For example, under the new structure recommended by the audit committee, the council would have more responsibility, as it would posses the disclosure documents for two weeks in order to be able to fully study them. They would be expected to understand the financial disclosures.)
Q: Why is the statutory reference so specific in the passage regarding the city representatives and vague in the passage regarding the City Council?
A: There is a statute that deals with negligence (sections 17(a)(2) and 17(a)(3) of the Securities Exchange Act of 1933).
And although negligence can still be determined to be securities fraud – it would be the bottom of the three rungs of securities fraud – the lawyers for the audit committee said that for the purposes of their investigation, they were only asked to identify those who had violated specific antifraud provisions in question.
Therefore, audit committee attorney Michael Young said that because it was determined that negligence didn’t violate the specific antifraud provision in question, a further analysis of what, if any, securities laws were violated by the council was unnecessary for the purposes of the report (i.e. what was requested by outside auditor KMPG).
Romano said it was found that the council members’ behavior did not rise to the top two levels of securities fraud (wrongful or reckless). He said evidence did support a violation of 17a, but the audit committee didn’t come to an ultimate conclusion.
“We didn’t find it necessary to say they violated it,” Romano said.