The SEC Wins First Jury Trial in a Muni Case: SEC v. City of Miami and Michael Boudreaux

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In what the SEC called “the first federal jury trial by the SEC against a municipality or one of its officers for violations of the federal securities laws,” a jury in the U.S. District Court for the Southern District of Florida found the City of Miami and its former budget director, Michael Boudreaux, guilty of securities fraud for misrepresentations related to three municipal bond offerings in 2009. Both Defendants are expected to appeal the jury decision.

The Allegations

The SEC alleged that the city and Boudreaux misled bond investors and ratings agencies about inter-fund transfers designed to hide an increasing General Fund deficit in fiscal years 2007 and 2008. Specifically, SEC argued the following 10 misrepresentations in an earlier Motion for Partial Summary Judgment.

  1. Omitting to disclose in the City’s fiscal year 2007 Comprehensive Annual Financial Reports (”2007 CAFR”) that the City transferred $13.1 million from its Capital Projects Funds to its General Fund to mask increasing deficits in the General Fund;
  2. Describing in the 2007 CAFR the money transferred in fiscal year 2007 as funds “not expended” that were being “returned to the General Fund,” but omitting to disclose that these funds were in fact allocated to certain projects that still needed this money and that the City was only able to meet its General Fund balance target[1] with these funds;
  3. Omitting to disclose in the City’s fiscal year 2008 CAFR (“2008 CAFR”) and the Official Statements for the 2009 bond offerings (collectively “Official Statements”) that the City transferred approximately $24.4 million from the Capital Projects Funds and a Special Revenue Fund to the General Fund to mask increasing deficits in the General Fund;
  4. Misleadingly claiming in the 2008 CAFR and Official Statements that $21.3 million of the $24.4 million transferred from the City’s Capital Projects Funds in fiscal year 2008 were ”unused” appropriations that were “initially funded from the General Fund;”
  5. Omitting to disclose in the 2008 CAFR and Official Statements that the funds transferred in fiscal years 2007 and 2008 were in fact allocated to certain projects that still needed those funds and that some of these projects had already incurred or continued to incur expenditures resulting in unfunded expenditures and deficits in the Capital Projects Funds;
  6. Omitting to disclose in the 2008 CAFR and Official Statements that the funds transferred in fiscal year 2008 included $16.4 million in funds that were restricted by City Code for designated purposes and that were never initially funded from the General Fund;
  7. Omitting to disclose in the 2008 CAFR and Official Statements that the General Fund balance included restricted funds and funds transferred from projects that still needed the funds;
  8. Materially misstating the City’s fiscal year 2008 General Fund financial statements included in the 2008 CAFR and Official Statements because of the improper transfer of $16.4 million of restricted dollars to the General Fund;
  9. Falsely representing to credit rating agencies that the funds taken from the Capital Projects Funds in fiscal year 2008 were the return of prior year General Fund contributions; and
  10. Omitting to disclose to credit rating agencies that funds transferred to the General Fund in fiscal year 2008 included money restricted by City Code for designated purposes and in 2007 and 2008, money taken from specific capital projects that had already incurred expenditures against those funds or still needed them.

Boudreaux’s Alleged Involvement

The Complaint calls Boudreaux “the architect of the scheme to defraud.” Indeed, the SEC alleged he was a key contributor of the misleading (and omitted) information that was used in the CAFRs and the presentations to credit rating agencies.

For example, $13.1 million transferred in April 2008, was made from two funding awards to the city’s Capital Project Funds ($5.1 million and $8.9 million, respectively). The SEC alleged that at Boudreaux’s direction, the city’s Assistant Capital Improvement Projects Director researched the $5.1 million award and determined that only $900,000 of that award was in fact unused and no longer needed for future expenditures.  Boudreaux allegedly ignored this report and requested the transfer of $4.2 million of this award to the General Fund.  Moreover, at Boudreaux’s request, the transfer was manually recorded after the closing of the city’s books on September 30, 2007.  As a result of this transfer, the city was able to report a yearend balance of approximately balance $100.5 million in the General Fund.  However, the budgets for the affected projects were not adjusted to remove the funding from the projects and the affected projects began to incur unfunded expenditures.

Later, during a public hearing with the City Commission to close out the city’s 2007 Operating Budget, Boudreaux described the transfer as “unallocated” General Fund money that was being moved back to the General Fund. The SEC alleged this misrepresentation was repeated in the 2007 CAFR.

The Complaint identifies other transfers that Boudreaux orchestrated through misrepresentations, including: $3.1 million in October 2008, transferred from a Special Revenue Fund restricted to expenditures relating to specific economic development and planning purposes; $8 million in November 2008, transferred from the Capital Projects Funds guised as the return of an “advanced allocation” from the General Fund; and $13.3 million in December 2008, transferred from multiple Capital Projects Funds that were funded by revenue from restricted fees that legally could not be transferred to the General Fund.  Indeed, the city began to question the propriety of some of Boudreaux’s requested transfers in 2008 and did not approve them all.

The City’s Unjust Benefit

The SEC alleged the principal benefit to the city from these misrepresentations was the padding of the General Fund. In 2007, this padding prevented the city from dropping below its publicly stated goal of maintaining $100 million in the General Fund.  It also kept the reserves above the 20% required by city law.  In 2008, had the city transferred all of the money requested by Boudreaux, it would have had a yearend balance in the General Fund of $100 million.  While the yearend balance ultimately was less than $100 million because some of the transfer requests were denied, the city still transferred enough money into the General Fund to keep the reserves above 20%, thus not triggering the city law that would have required the city to adopt a plan to replenish the reserves back to the required threshold within two fiscal years.

Moreover, because the General Fund is used by rating and bond insurers to assess the financial condition of municipalities, the SEC alleged the city benefitted from the misrepresentations by fraudulently inducing a higher rating that allowed it to receive better interest rates and more favorable terms on the bonds it issued. Notably, when the misrepresented transfers were identified and reversed from the General Fund back to the Capital Projects Funds, the rating agencies cited this as a reason for downgrading the city’s bond offerings.

The Verdict

The SEC brought claims against the city and Boudreaux under Section 17(a)(1) of the Securities Act (15 U.S.C. § 77q(a)(1)); Section 17(a)(2) and (3) of the Securities Act (15 U.S.C. §§ 77q(a)(2) and 77q(a)(3)); Fraud in violation of Section 10(b) of the Exchange Act (15 U.S.C. § 78j(b)) and Rule 10b-5(a), (b), and (c) (17 C.F.R. § 240.10b-5). The SEC also brought a claim against Boudreaux for aiding and abetting the city’s violations of Section 10(b) of the Exchange Act and Rule 10b-5.

The jury, after only a few hours of deliberation, returned guilty verdicts against the city on all counts, and against Boudreaux on all counts but the 17(a)(1) claim. It is unclear why the jury found Boudreaux not guilty on the 17(a)(1) claim given that the jury went on to find that he acted “knowingly” or with “severe recklessness” with respect to that claim.  See Jury Verdict Form.

The jury also rejected the defendants’ “reliance on auditors” affirmative defense.

[1] Two facts were principal to the SEC’s claims in this regard: (1) the city’s publicly stated goal of maintaining $100 million in its General Fund and (2) a city law that prohibited the City’s General Fund reserves from falling below 20% of its average general revenues for the prior three fiscal years.