The Securities and Exchange Commission obtained an emergency court order against a Chicago suburb and its comptroller to stop a fraudulent bond offering that the city has been marketing to potential investors.
The SEC has filed fraud charges in U.S. District Court for the Northern District of Illinois against the city of Harvey, Ill., and Joseph T. Letke alleging that they have been engaging in a scheme for the past several years to divert bond proceeds for improper, undisclosed uses. The SEC’s complaint alleges that the purported purpose of prior bond offerings was to fund the development and construction of a Holiday Inn hotel in Harvey. However without informing investors, Harvey officials diverted at least $1.7 million of bond proceeds from these offerings to pay the city’s operational costs such as its payroll, and Letke received approximately $269,000 in undisclosed payments derived from bond proceeds. While investigating Harvey’s past bond offerings to investors, the SEC learned that the city is intending to issue new limited obligation bonds as early as this week, and draft offering documents make materially misleading statements about the purpose and risks of those bonds while omitting that past bond proceeds have been misused.
In response to the SEC’s request for emergency relief, the Hon. Judge Rebecca Pallmeyer conducted an emergency hearing today and issued a temporary restraining order preventing Harvey from offering or selling any bonds through July 14. At the hearing, Harvey agreed to this restriction. Additionally, to prevent dissipation of Letke’s ill-gotten gains, the court order prohibits Letke from incurring any extraordinary expenses beyond reasonable and customary personal and business expenses. The court scheduled an additional hearing for July 8.
“We moved quickly to stop this city and its comptroller from issuing more bonds under false pretenses,” said Andrew J. Ceresney, director of the SEC’s Division of Enforcement. “We will continue to aggressively pursue municipalities and public officials who raise money through fraudulent bond transactions that harm both investors and residents.”
David Glockner, director of SEC’s Chicago Regional Office, added, “Harvey’s bond investors were misled into believing their money would go toward construction of a Holiday Inn when instead the bulk of it was diverted into Harvey’s general coffers and Letke’s pocket. Our action has stopped their scheme in its tracks, and we will continue our investigation to determine additional facts surrounding the misconduct.”
According to the SEC’s complaint, instead of general obligations bonds that are repaid from the general coffers of a municipality, Harvey’s bond offerings in 2008, 2009, and 2010 were limited obligations bonds that were to be repaid from dedicated tax revenue streams such as Harvey’s hotel-motel tax, sales tax, or incremental tax from the Tax Increment Financing District that the city created for the development and construction of the Holiday Inn project. Therefore, it was important to bond investors that the bond offerings were consistent with the stated purpose and the money raised was actually used to fund the hotel development, because the amount of funds available to repay the bonds derived from tax revenues would be materially affected by the funding and progress of the project.
However, the SEC alleges that Harvey’s bond investors were materially misled about the purpose and risks of the bonds they purchased from the city. As Harvey and Letke perpetrated the scheme to divert bond-related proceeds, the hotel redevelopment project turned into a fiasco for bond investors and city residents. According to news reports, the proposed Holiday Inn hotel and conference center stands as a decrepit shell. The hotel’s façade has many holes in it, and the interior of the hotel appears gutted in places with dangling wires and exposed studs.
The SEC’s complaint alleges that Harvey and Letke violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5.
The SEC’s investigation, which is continuing, has been conducted by staff in the Chicago Regional Office and the Municipal Securities and Public Pensions Unit, including Eric A. Celauro, Sally J. Hewitt, and Scott Hlavacek. The litigation will be led by Eric M. Phillips. The case is being supervised by Peter K.M. Chan.