Bethany Krajelis Jun. 24, 2014, 6:42pm

The City of Harvey and its comptroller have diverted at least $1.7 million of bond proceeds earmarked for a hotel redevelopment project, according to the U.S. Securities and Exchange Commission.

The SEC filed a lawsuit Tuesday in Chicago’s federal court, accusing the southern Cook County city and its comptroller, Joseph T. Letke, of misusing proceeds raised from investors in bonds issued by the municipality between 2008 and 2010 and providing potential investors false and misleading statements.

Since 2008, the agency asserts, the city and Letke “have engaged in a scheme to divert bond proceeds for improper purposes, including undisclosed payments to Letke,” who has served as the city’s comptroller for at least six years, and to the city to cover its payroll.

Based on the alleged scheme and its belief the city wants to sell bonds as soon as this month for the development of a grocery store, the commission filed an emergency motion with its suit in an attempt to prevent it from doing so.

Its motion seeks a temporary restraining order to prevent the city from selling bonds and a permanent injunction enjoining it from doing so for a period of five years, unless it first retains an independent, court-appointed consultant to review its policies and procedures.

"[T]hrough a pattern of egregious misuse of bond proceeds, Harvey has demonstrated that it cannot be trusted on issues relating to municipal bond issuances," the agency asserts in its emergency motion.

[Updated: Judge issues emergency order blocking bond sales.]

The SEC’s accusations stem from “municipal bond offerings by Harvey to bond investors for approximately $6 million in 2008, for approximately $3 million in 2009 and for approximately $5 million in 2010.”

The purpose of these three years of bond offerings was to provide funding to develop and build a Holiday Inn Hotel in Harvey, according to the suit.

The SEC states these bonds weren’t general obligations funds that would be repaid by the city, but instead, were limited obligation bonds that would be repaid from tax revenue streams, such as the city’s hotel-motel tax, sales tax or tax from the Tax Increment Financing District (TIF) the city created for the hotel redevelopment project.

Because the money used to repay the bonds was set to come from tax revenues that would be directly affected by the hotel project, the suit states “it was important to bond investors that money raised from the bond offerings … was actually used to fund the hotel development.”

“Yet, unbeknownst to bond investors and contrary to representations in official statements and other documents connected to the 2008, 2009 and 2010 Bond Offerings,” the SEC claims “Harvey officials improperly diverted at least $1.7 million of bond proceeds from these offerings into the general operation accounts of Harvey to pay the City’s operation costs, including payroll" between 2009 and 2011.

The agency further alleges Letke “received approximately $269,000 in undisclosed payments derived from bond proceeds and other proceeds earmarked for the Hotel Redevelopment Project. Bond investors were thus materially misled about the purpose and risks of the bonds they purchased from Harvey.”

It appears the $269,000 Letke received was in addition to the slightly more than $1 million Letke & Associates Inc., an auditing firm he owned, got from the city during these years. Letke’s firm served as the city’s financial advisor for the three years of bond offerings at the crux of the complaint.

A 2012 article in The Southtown Star reported that Letke & Associates filed for bankruptcy that June, claiming nearly $10 million in outstanding debts, and Letke declared personal bankruptcy that May, claiming nearly $3 million in assets and $25 million in liabilities.

Letke, according to the SEC, is the principal shareholder of a number of businesses, including Alli Financial, the successor to Letke & Associates, as well as Public Funding Enterprises and Public Funding Group LLC, both of which have provided financial advisor services to the City of Harvey and other municipalities.

From 2008 to 2010, the agency contends that Letke and/or his businesses received at least $1.9 million from the City of Harvey and that from 2011 to the present, Letke's businesses have continued to provide and be compensated for services to the city.

In regards to the bonds issued between 2008 and 2010, the suit states the city sold about $14 million of bonds during those three years intended to go toward a hotel redevelopment project, which was estimated to cost about $23 million and result in a Holiday Inn hotel and conference center.

As part of the offerings, the SEC alleges the city provided potential investors with official statements, signed by the city’s mayor and city clerk, laying out how the money would be used and how the bonds would be repaid.

But, the federal agency claims, the city of Harvey and Letke diverted bond proceeds for purposes unrelated to the hotel project, including undisclosed payments to Letke and to the city to fund its operational costs like payroll.

When it comes to the city’s hotel project, the SEC basically sums it up as a failure.

“As of 2014, as the result of Harvey’s and Letke’s participation in the scheme to divert bond related proceeds, the Hotel Redevelopment Project has turned into a fiasco for bond investors and Harvey residents,” the suit states.

Citing news reports, the agency contends “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.”

Putting aside the alleged bond scheme for the hotel project, the SEC claims the city plans to issue bonds sometime this year to fund the construction of a 43,500-square-foot grocery store.

The agency notes the city distributed a draft memo on its 2014 proposed bond offerings to potential investors. Although the memo lays out the project and its risk factors, the SEC asserts it failures to mention it “misused a portion of the proceeds from three previous bond offerings” related to the hotel project.

“Unlike the prior offerings in 2008, 2009 and 2010, where a third party prepared a feasibility study for the offerings, the feasibility study for the 2014 project was done by Letke through Public Funding Group LLC,” the suit states.

Letke, according to the agency, was involved in drafting the 2014 memo, is serving as the city’s financial advisor through his company and will receive a fee if bonds are issued.

The SEC also mentions the city of Harvey’s financial issues in its suit. Earlier this year, the Illinois State Comptroller’s Office instructed an auditor to bring the city into compliance with laws regarding annual audited financial statements, as its last ones were from 2008.

The federal agency notes that Letke wrote a recent document, in which he described the city’s financial condition as a crisis. In that document, Letke allegedly predicted the city would be unable to pay its bills in July and would not be able to make payments to bondholders by August.

As part of its suit, the SEC wants Chicago’s federal court to order Letke “to disgorge his ill-gotten gains,” pay prejudgment interest and civil damages, and to be restrained and enjoined “from participating in any capacity in a municipal securities offering.”

The agency, which has requested a jury trial in the matter, is being represented by Chicago attorneys Eric M. Phillips, Eric A. Celauro and Sally J. Hewitt with the SEC.

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