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Michael Riley: 38 Studios Insider Trade and Municipal Fraud

Tuesday, June 10, 2014

 

Perhaps the SEC should set up a permanent office here in Rhode Island because there is plenty for them to discover and prosecute over the next several years.

First, investigating suspicious trading in State issued securities like 38 studios bonds where some lucky investor dumped $1.2 million worth of bonds the day before this ill-fated insider laced company closed its doors and laid off all its employees could produce several leads including the seller and the tipster. For example: Who was the seller? How did they know to sell? A tip perhaps? Was it one of the GA circus of insiders? Was it a government employee from the administration or the EDC? Whoever it was, they probably know something and it may add to current investigations the SEC is already involved in. This could occupy a few investigators over the next year.

While the insider investigation alone is reason enough  to set up a permanent office, we have so much more including  an out of control Municipal Crisis in Rhode Island  that serves as the “poster boy”  for issuing false and misleading statements regarding the economic condition and health of our  municipalities.  When packaged in public statement and bond issuance this is known as fraud. This fraud goes well beyond Providence’s “asset pumping” where that Mayor has deliberately overstated pension assets and has been warned by their own auditor to halt such practices a few months ago. It also extends to the fraudulent practice of shopping for your favorite discount rate from actuaries.  For Providence the fraud is in the $600 million range making “category 5” complaints against Cicilline seem tiny. Inconceivably Projo and the main Street media has given Taveras a complete pass on both items. The SEC may not be so kind.   

In addition to Providence, dozens of Rhode Island Municipalities may be committing fraud on an annual basis as well  and are  encouraged to do so by our States  Municipal finance division and RI Pension Study Commission Chairman Rosemary Booth Gallogly. Consider what Ms. Gallogly just did in West Warwick two weeks ago. To set the stage lets go back to January 2012 when Ms. Gallogly had her first meetings, both she and others on the committee refused to address the issue of actuary shopping. In May 2012 she warned of imminent collapse and demanded action. None came, so 1 year ago in 2013 she personally crafted and negotiated a 5 year plan that doesn’t even contemplate GASB 68. After a presentation of that plan she and town officials tell West Warwick citizens to vote for the fix, budget plus negotiated fixes “all or none”. Town voters are told if this budget is turned down the State will take over operations. Voters representing less than 5% of the population subsequently voted in favor and endorsed her 5 year plan and the new budget. The discount rate she uses for this plan, which is woefully funded at 17.1%, is 7.5%. To understand the SEC view on this action and potential liability our Cities like West Warwick, Johnston and Providence and our State Revenue Director are now exposing all Rhode Island citizens to, please carefully read the comments below of SEC Commissioner Daniel Gallagher. Gallagher’s comments came May 29 at the MSRB’s First Annual Municipal Securities Regulator Summit.

Laying down the gauntlet on pension shenanigans

In a speech last week to the Municipal Securities Rulemaking Board, the U.S. Securities and Exchange commissioner, Daniel Gallagher, took a hard line on the way that public pension fund liabilities are calculated, chiming in on the side of conservative-minded economists who say that funds hide their true liabilities. In particular, he pointed to the now familiar argument about which discount rate to use in calculating a pension’s liability (the higher the discount, or investment, rate of return, the lower the liability).

Gallagher indicated that public pension funds are assuming the pensions will continue to earn what they have earned historically. Gallagher and others say that assumption is not appropriate going forward. Gallagher noted that plans' true unfunded liabilities remain opaque because “many assume a 7.5 to 8 percent return, when a rate in the mid-6 percent range would be more realistic.”

“This lack of transparency,”  he went on to say, “can amount to a fraud on municipal bond investors, and it does a disservice to state and local government workers and retirees by saving elected officials from making the hard choices either to fully fund the pension promises that were made to public employees, or not to make the promises in the first place.” He added the SEC would quickly bring fraud charges against any corporate issuer in the private sector “for playing such numbers games. … We should not treat municipalities any differently.”

As you can see we could support several federal investigators here, maybe even enough to fill the Superman building. Isn’t it time we listen to SEC commissioners or GASB about how we account for our pensions? Isn’t it almost criminal that Chafee and Gallogly have done so little to address this crisis?

At the very least let’s find out which insider sold those bonds May 23, 2012 and who tipped him/her off? Demand action by your officials. We don’t have to sit back and take this. Let’s halt the $12.5 bond payment and find out what’s going on. 

Michael G. Riley is vice chair at Rhode Island Center for Freedom and Prosperity, and is managing member and founder of Coastal Management Group, LLC. Riley has 35 years of experience in the financial industry, having managed divisions of PaineWebber, LETCO, and TD Securities (TD Bank). He has been quoted in Barron’s, Wall Street Transcript, NY Post, and various other print media and also appeared on NBC news, Yahoo TV, and CNBC.

 

Related Slideshow: Who Wants to Pay and Who Wants to Default on the 38 Studios’ Bonds

GoLocalProv showcases which Rhode Island politicians and organizations want to pay or default on the 38 Studios' Bonds.

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CON

Allan Fung

Republican candidate for Governor

“I am repeating my opposition to the 38 Studios loan guaranty and to the use of taxpayer dollars to repay those moral obligation bonds.”

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CON

Ken Block

Republican candidate for Governor

“38 Studios was a bad deal and a bad investment from the very beginning and now Rhode Island taxpayers are being asked to take the hit for bondholders who should have known better...As long as there are serious legal questions still to be decided, we need to stop the repayment process."

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PRO

RIPEC

John Simmons, executive director of the Rhode Island Public Expenditure Council

“We’re not going to punish anybody but ourselves if we don’t pay."

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PRO

Greater Providence Chamber of Commerce

Laurie White, President of Chamber of Commerce

“I think it’s important that action occur quickly. Our view is that economic development in Rhode Island has to be the main event. … We need a very dramatic, aggressive effort to change the path that we’re on.”

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PRO

Gina Raimondo

Democratic candidate for Governor

“Despite my frustration with everything surrounding this transaction, I believe it is in the best long-term interest of the state and all taxpayers to repay these bonds."

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PRO

Clay Pell

Democratic candidate for Governor

“Clay does not believe Rhode Island should default on its moral obligation bonds when they come due. 38 Studios was a terrible mistake — and another example of why we need to change the culture of politics in Rhode Island"-Devin Driscol.

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PRO

Angel Taveras

Democratic candidate for Governor

“While I share the frustration of many Rhode Islanders, I believe that not paying back 38 Studios bondholders would have a detrimental impact on the state’s bond rating that would far outweigh any short-term benefit we might gain. We cannot afford to default on our obligations.”

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PRO

Lincoln Chafee

Governor of Rhode Island

“The candidates who can’t understand these two obvious truths are unfit to be Governor. The consequences of default would place Rhode Island as one of the lowest state bond ratings in the nation, and the industry would reduce Rhode Island to ‘junk bond’ status. We have been told in no uncertain terms that the reaction to not paying our debt obligations will be severe and have an adverse impact on Rhode Island. In addition, failure to honor our obligations could have harmful effects on the pending lawsuit.”

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CON

Mike Stenhouse, CEO of RI Center for Freedom and Prosperity

"It's not just about not paying off bondholders.  Bondholders are adults, they knew the risk.  It's not just a question of the credit agencies.  It's a question of what would payment crowd out, what reforms could we achieve with that money, such as sales tax reform, which would enable us to create jobs."

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CON

Mike Riley

2012 Republican candidate for the 2nd Congressional District of Rhode Island.

"If we had a real Governor, he would stand up for the Taxpayers and the State of Rhode Island and stand up against threats by rating agencies."

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PRO

Professor Ed Mazze

Professor of business at University of Rhode Island

"Even though this is a moral obligation in terms of the way the financial deal is set up I still feel the state has an obligation to the bondholders, to make good on their payments."

 
 

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