By Tim Dulaney, PhD and Tim Husson, PhD
Yesterday the Securities and Exchange Commission (SEC) charged the City of South Miami with defrauding investors over the tax-exempt status of some municipal offerings.
In 2002, the City of South Florida obtained access to tax-exempt financing through a pooled conduit municipal bond issued by the Florida Municipal Loan Council (FMLC) to fund the construction of a mixed-use retail and parking structure in the city's commercial district.* The 2002 FMLC bond offering can be found here (PDF). The funding was meant to cover the portion of the construction costs attributable to the parking structure in which the city would remain full control and receive all parking revenues. The city's access to tax-exempt financing depended critically on the limited role of the for-profit developer.
City officials became concerned with the municipality's ability to pay the debt service on the bonds and subsequently cancelled the project. Litigation with the developer followed and a settlement was reached in which the developer would lease the entire project (including the parking structure), jeopardizing the tax-exempt status of the bonds.
The City of South Miami sought additional funding from FMLC in 2006 to continue the project. However, in seeking this new funding the city omitted information concerning the new lease with the developer. FMLC issued pooled municipal bonds (PDF) in 2007 based on this omission and other material misrepresentations. City officials were reportedly aware of the failure to comply with IRS rules for tax-exempt financing and continued to issue certifications that the city was in compliance with the terms of the loan agreements.
It was not until July 2010 that the city formally recognized the adverse impact of the renegotiated lease with the developer on the tax-exempt status of the 2002 and 2007 bonds. The City of South Miami has settled with the IRS resulting in nearly $1.5 million in additional costs. From the viewpoint of the bondholders, the settlement effectively preserved the tax-exempt status of the bonds.
The City of South Miami has agreed to retain an independent third-party consultant to review financial disclosures and ensure compliance. The SEC order instituting cease-and-desist proceedings can be found here (PDF).
* A pooled municipal bond offering is one in which an issuer uses the proceeds from a bond issuance to make loans to a set of municipalities. A conduit municipal bond is issued by a municipality that then loans the proceeds to a private entity. The private entity then repays the loan to the issuer and the issuer pays bond investors from the proceeds. Typically the municipality is not responsible for making up shortfalls on loan-repayments and as such these bonds are considered more risky than vanilla/non-conduit bonds. For more information about the basics of municipal bonds, see the Municipal Securities Rulemaking Board's website.
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