If mayors of small cities and other municipal officials want to issue mountains of debt in the public markets, they had better be able to disclose their financials in a way the financial markets expect.
That was the broader message that the Securities and Exchange Commission felt called upon to deliver in a special report along with its announcement of a settlement of fraud charges it brought against the City of Harrisburg, Pa.
To be sure, the SEC made a strong statement in the allegations themselves, which marked the first time that the commission had charged a municipality for misleading statements made outside of its securities disclosure documents.
Those statements, made from January 2009 through March 2011, “misrepresented and omitted to state material information regarding Harrisburg’s deteriorating financial condition and credit ratings downgrades, thereby violating the antifraud provisions of the [Securities] Exchange Act,” the SEC charged. Without admitting or denying liability — and without having to pay a fine — Harrisburg agreed to settle the charges.
But the commission used the occasion to address a broader point. Based upon information the SEC unearthed during its probe of the city’s financial disclosures, it felt the need “to address the obligations of public officials relating to their secondary market disclosures for municipal securities.”
Such officials should be aware “that their public statements, whether written or oral, may affect the total mix of information available to investors, and [they] should understand that these public statements, if they are materially misleading or omit material information, can lead to potential liability under the antifraud provisions of the federal securities laws,” the commission warned in its report.
That has often not been the case, according to Ivan Knauer, an attorney at Pepper Hamilton LLP in Washington D.C. who represents Harrisburg. “Generally, a public official in a small town is not used to thinking of [the town] as an issuer,” he told CFO, noting that he was constrained by attorney-client privilege and the terms of the settlement from speaking about Harrisburg specifically.
Mayors of small cities or towns are focused on “the policeman on the beat, the fireman on the way to a fire,” rather than on the need to present accurate and timely financials to the securities markets, Knauer said.
Further, “during the last several years, municipalities have been hurting,” he said. “I don’t know that your average mayor and your average public official have the resources … to do a detailed effort” of financial reporting.
In summarizing its allegations, the SEC called Harrisburg, the capital and ninth largest city of Pennsylvania, “a near-bankrupt city under state receivership.” The woes of the city, which has a population of 48,000 and annual revenues of about $55 million, stem largely from the $260 million or so in debt that it had guaranteed for upgrades and repairs to an incinerator, according to the commission.
As of March 15, 2013, Harrisburg has missed about $13.9 million in general obligation debt-service payments, according to the SEC.
The SEC charged the city with a failure “to comply with requirements to provide certain ongoing financial information and audited financial statements for the benefit of investors,” according to the SEC’s press release.
Because the financial reporting was so scanty, investors “had to seek out Harrisburg’s other public statements in order to obtain current information about the city’s finances,” according to the release. But those also included “misleading statements … in the city’s budget report, annual and mid-year financial statements, and a State of the City address,” the SEC charged.
In its broader report, the SEC said that statements made by public officials that reach the secondary bond market “may not be subject to the same comprehensive review” as those of private issuers. But public officials still “may have liability under the antifraud provisions of the federal securities laws for such statements,” the commission warned.
The message to municipalities, says Knauer, is that “an official needs to be aware of what is disclosed and, in effect, not paint too rosy a picture.”