San Diego Slapped with SEC Sanctions for Bond Sale Fraud

November 14, 2006 ( - Federal securities regulators on Tuesday sanctioned the city of San Diego for committing securities fraud by lying about the true financial status of its pension and retiree health obligations when selling municipal bonds.

A   Securities and Exchange Commission (SEC) news release said that the city did not disclose to investors during the bond sales in 2002 and 2003 that the city’s unfunded liability to its pension plan was projected to dramatically increase – growing from $284 million at the beginning of fiscal year 2002 to an estimated $2 billion by 2009 (See  SEC Demands San Diego Pension Testimony, Documents ). City officials also misled investors about the fact that the city’s liability for retiree health care was another estimated $1.1 billion, according to the announcement.

The SEC said the city kept under wraps that it had been intentionally underfunding its pension obligations “so that it could increase pension benefits but defer the costs and that it would face severe difficulty funding its future pension and retiree health care obligations unless new revenues were obtained, pension and health care benefits were reduced, or city services were cut,” the regulators wrote in Tuesday’s statement (See  2003 San Diego Memo Critical of Pension Underfunding Decision ).

The city’s “enormous” pension and retiree health liabilities and its failure to disclose those liabilities placed the city in “serious financial straits,” according to  the panel’s order . When the city eventually disclosed its pension and retiree health care issue in fiscal year 2004, the credit rating agencies lowered the city’s credit rating, the SEC pointed out.

The commission’s order declared that the city made misleading statements:

  • in the offering documents for five municipal offerings in 2002 and 2003 that raised over $260 million from investors. The offering documents containing the misleading statements included the “official statements,” which were intended to disclose material information to investors, and the “preliminary official statements,” which were used to gauge investors’ interest in a bond issuance.
  • to the agencies that gave the city its credit rating for its municipal bonds.
  • in its “continuing disclosure statements,” which described the city’s financial condition and were provided by the city to the municipal securities market with respect to prior city bond offerings.

As part of the settlement with the city, San Diego officials agreed:

  • not to repeat their fraudulent activities
  • to hire an independent consultant to assess their policies, procedures, and internal controls about their disclosures relating to municipal bond offerings
  • to conduct annual reviews for a three-year period of the city's policies, procedures, and internal controls and to make recommendations with a view to assuring compliance with the city's disclosure obligations under the federal securities laws
  • to assess the city's compliance with its policies, procedures, and internal controls, and its adoption of the consultant's recommendations.

The city also agreed to adopt the independent consultant's recommendations.

In deciding to accept the city's offer to settle the matter, the commission said it "considered various remedial measures that the city has already taken to detect and prevent future securities law violations as well as the city's agreement to retain an independent consultant. "

The SEC said in the Tuesday statement that its investigation is ongoing as to individuals and other entities that may have violated the federal securities laws.