Cities Hit as Funds From Bonds Pay Other Bills
By IANTHE JEANNE DUGAN, JUSTIN SCHECK and BOBBY WHITE
When the recession squeezed Miami's budget in recent years, officials reached into funds raised for road repairs and other projects to plug the shortfall.Now, the city is paying a price. The moves triggered lawsuits and a federal investigation, in a brouhaha that holds ramifications for how municipalities nationwide maneuver around unprecedented money problems.
Cash Flow
In Miami, the Securities and Exchange Commission is wrapping up an investigation into whether the city used funds intended for roads and other purposes to fill budget gaps elsewhere, according to people close to the probe. Bondholders are suing, saying the moves obscured the city's true finances. The city's former budget director is also suing, claiming he was fired for cooperating with the SEC and the Federal Bureau of Investigation.
Then, in late October, the city's former auditor sued, alleging in the suit that he lost his job because he flagged problems then "participated, at the request of the Securities and Exchange Commission, in an investigation into whether the City of Miami was engaging in behavior tantamount to stock fraud in the marketing of its municipal bonds." Both so-called whistleblower cases are filed in a circuit court in Miami-Dade County.
"If I had looked the other way, I'd still have my job," said Victor Igwe, who had worked as Miami's internal auditor for 12 years until late June, after his contract wasn't renewed.
City officials declined to comment on the departure of the two officials.
"The city is cooperating fully with the investigation," said Ivan Harris, an attorney at Morgan Lewis & Bockius LLP who is representing Miami in the SEC matter. He said the city "stands by the accounting for the transfers" because some of the funds had been unused for their designated purposes and other funds were replaced.
The SEC declined to comment.
For municipalities, the legality and potential penalties of moving money around range widely. Misusing money raised by publicly sold infrastructure bonds, for example, could violate civil laws protecting bond buyers. Other cases could violate federal or state public-finance disclosure laws, accounting rules, or regulations governing how agencies spend federal funds.
Some cases are being handled on a local level.
In Modoc County, Calif., officials were ordered last year by the state controller to repay more than $13 million they moved, including state and federal tax dollars earmarked for schools, roads, welfare programs and other projects. The county, as late as 2008, channeled some of those restricted funds into its main hospital.
"Modoc's unlawful use of funds to mask its deep budget deficits was a disturbing finding," said state controller John Chiang in an email. "The misuse of public dollars, poor bookkeeping and substandard financial audits are not isolated to this county."
Modoc officials said they learned the transfers were illegal during recent audits by Mr. Chiang. The alternative, they say, was to possibly close the hospital—the county's biggest employer. "We just have to keep tightening our belts," said County Supervisor Jeff Bullock.
The county so far has been unable to repay, and officials declined to comment on whether further action will be taken.
The shuffles, public officials say, have picked up steam during the recession.
When Ecorse, Mich., ran into a financial crunch in 2008 and 2009, the city used more than $2 million intended for schools and other areas to fill budget shortfalls, according to a state audit. The city's mayor says that the issues are in the past.
Portland, Ore., over the past five years used money raised for water and sewers to pay for other purposes, including remodeling a building for the nonprofit foundation that runs the city's Rose Festival, according to a March report by the city auditor.
The project may have helped the public, wrote city auditor LaVonne Griffin-Valade, but state law, city code and bond covenants require that utility ratepayer money be spent for utilities. Misusing the funds could reclassify the money as an unauthorized tax.
A Portland city council member who oversees sewers, Dan Saltzman, said the council "has been getting more lax about how we're allowing ratepayer dollars to be spent." He has proposed an independent utility commission.
Elaine Greenberg, who runs the SEC municipal unit, said the agency is looking for cases where governments might use money from a bond offering for purposes not specified in the offering documents.
"You can't float a bond for one thing and use the money for another," she said. The agency also is on the hunt for governments moving money reserved for specific purposes.
Ms. Greenberg wouldn't confirm or deny the existence of any investigation.
A municipal borrower that misleads investors in borrowing documents or uses money raised for other purposes could violate antifraud provisions. Municipalities deemed at higher risk of default typically pay higher interest rates on bonds. By obscuring financial problems, they may underpay bondholders.
Historically, the SEC has avoided financially penalizing municipalities, since taxpayers ultimately pay the penalty. So last year the agency tried a new approach—it fined individual officials in San Diego to settle allegations the city had misled bond investors.
In Miami, any new case would be a second offense. In 2003, the SEC ordered Miami to cease and desist from future violations of antifraud provisions after concluding the city had misled bond buyers by moving money among agencies to mask a deficit. The city maintained it did nothing wrong.
The SEC began re-examining Miami in late 2009. Regulators have investigated transfers into the general fund. They also have questioned the use of gas taxes paid by drivers, which Mr. Igwe's audit report said was supposed to be used for transportation-related projects but was instead used to operate street lights and decorative lights in parks.
Among those in Miami questioned by the SEC was Michael Boudreaux, who was fired as budget director in 2010. In his pending lawsuit against Miami, Mr. Boudreaux said city officials discovered a "major budget shortfall" and directed him to locate funds. Those officials declined to comment.
"There was no deception on my part," Mr. Boudreaux said in an interview. He says others implemented the ideas and that he was fired after speaking to federal investigators.
Marc Sarnoff, a city commissioner, said that he and others weren't aware that moving the funds was a potential violation of rules.
Write to Ianthe Jeanne Dugan at ianthe.dugan@wsj.com, Justin Scheck at justin.scheck@wsj.com and Bobby White at bobby.white@wsj.com
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