“A Little Enron Accounting” Leads To SEC Charges Against Municipal Water District And Two Managers

On Wednesday, the SEC charged California’s largest agriculture water district, Westlands Water District, with misleading investors about its financial condition when it issued a $77 million bond offering.  On that same date, Westlands agreed to pay $125,000 to settle the charges, making it only the second municipal issuer in history to pay a financial penalty in an SEC enforcement action.  The SEC also charged Westlands’ General Manager, Thomas Birmingham, and former Assistant General Manager, Louis David Ciapponi.  Birmingham and Ciapponi also agreed to settle the charges against them by paying $50,000 and $20,000 respectively.

At the heart of the case were the SEC’s allegations that Westland made misleading statements about its financial condition through what the SEC described as “extraordinary accounting transactions.”    According to the SEC, Westlands agreed in prior bond offerings to maintain a 1.25 debt service coverage ratio, constituting the measure of an issuer’s ability to make future bond payments.  In 2010, Westlands learned that drought conditions and reduced water supply would prevent the Water District from generating enough revenue to maintain that ratio.  In order to meet the ratio, Westlands reclassified funds from reserve accounts to record additional revenue.  According to the SEC, the general manager, Birmingham, jokingly referred to the reclassification transactions as “a little Enron accounting” when describing the transactions to Westland’s Board of Directors.

Based in part on the extraordinary accounting transactions, when Westlands issued the $77 million bond offering in 2012, it represented to investors that it met or exceeded the 1.25 ratio for each of the prior five years.  Westlands did not disclose that it would not have been possible to meet that ratio without the extraordinary 2010 accounting transactions.  In addition, Westlands omitted separate accounting adjustments made in 2012 that would have negatively affected the ratio had they been done in 2010.  The difference was significant, as the SEC indicated that Westlands coverage ratio for 2010 would have been only 0.11 instead of the 1.25 reported to investors.  The SEC found that Birmingham and Ciapponi improperly certified the accuracy of those bond offering documents.

A complete copy of the SEC’s order settling the charges against Westlands can be found here.