The First Settlements Imposing a Penalty on City Officials

The First Settlements Imposing a Penalty on City Officials

The SEC settled with four of five former City of San Diego officials in its action centered on fraud in connection with the sale of municipal bonds. SEC v. Uberuaga, Civil Action No. 08 CV 0621 (S.D. Cal. April 7 2008) (previously discussed here). The settlements are the first to impose a civil penalty against a City official. They may also reflect a new trend.

In 2002 and 2003, the City of San Diego raised over $260 million in municipal securities offerings. The five defendants participated in the offerings and presentations. Those settling are former San Diego City Manager Michael Uberuaga, former Auditor and Comptroller Edward Ryan, the former Deputy City Manager for Finance Patricia Frazier and the former City Treasurer Mary Vattimo. Former Deputy City Manager for Finance, Teresa Webster did not settle.

The false and misleading statements were made regarding the continuing bond offerings and to rating agencies. According to the Commission's complaint, the defendants knew the City had intentionally under-funded its pension obligations to increase benefits and defer costs. The SEC also claimed that the defendants knew the City faced severe difficulty funding its future pension and health care obligations unless new revenues were obtained or cuts were made in pension and health benefits or services. The complaint alleged violations of Securities Act Section 17(a) and Exchange Act Section 10(b).

To settle with the four defendants, the Commission dropped its Section 17(a) and 10(b) claims. Rather, each settling defendant consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a)(2). In addition, each settling defendant agreed to pay a civil penalty: Messrs. Uberuaga and Ryan and Ms. Frazier each agreed to pay $25,000 while Ms. Vattimo will pay $5,000.

Previously, the Commission brought an administrative proceeding against the City and a civil action against its auditors based on essentially the same conduct. The City resolved proceeding against it in 2006 by agreeing to implement a series of detailed undertakings keyed to the underlying conduct. The City also consented to the entry of an order requiring it to cease and desist from committing or causing any violations and any future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). In the Matter of City of San Diego, California, Adm. Proc. File No. 3-12478 (Filed Nov. 14, 2006).

Outside auditor Thomas Saiz and his firm, Calderon, Jaham & Osborn, also settled in 2007. Mr. Saiz and the firm consented to the entry of a permanent injunction prohibiting future violations of Securities Act Section 17(a) and Exchange Act Section 10(b). Mr. Saiz also agreed to pay a civil penalty of $15,000. SEC v. Saiz, Civil Action No. 07 CV 2308 (S.D. Cal. Filed Dec. 10, 2007).

The settlements with the four former City officials contrast sharply with the allegations in the complaint and the earlier settlements. Each settlement with a former City official dropped the scienter-based fraud charges in favor of a claim centered on negligence. In contrast, the settlements with the City and the independent auditors are predicated on scienter-based fraud charges.

The settlements in Uberuaga are, however, similar to the Commission's recent settled action against the State of New Jersey. In the Matter of State of New Jersey, Adm. Proc. File No. 3-14009 (Aug. 18, 2010) (here). That case is based on alleged false statements made in connection with 79 municipal bond offerings. Like the settlements in Uberuaga, the consent injunction is based on negligence rather than scienter-based fraud. Like the settlements in Uberuaga, New Jersey is a "first" - the former are the first settlements imposing a civil penalty on City officials, while the latter was the first action brought against a State. In New Jersey, however, Section 17(a) and Section 10(b) charges were not dropped, they were never brought.

Uberuaga is not the first financial fraud case based on years old conduct where scienter based fraud charges were dropped in favor of Section 17(a)(2) & (3) claims. SEC v. Fisher, Case No. 07-cv-4483 (N.D. Ill. Filed Aug. 9, 2007) also centered on a financial fraud which alleged to have occurred from 1999 through 2002. In settling with the former CEO in July 2010 (here) the Commission dropped Section 17(a) and 10(b) claims and a demand for a penalty in favor of an injunction based on Sections 17(a)(2) & (3) and the payment of disgorgement.

For more cutting edge commentary on developing securities issues, visit SEC Actions, a blog by Thomas Gorman.