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WASHINGTON, June 24 (Reuters) - The Securities and Exchange Commission is seeking an emergency restraining order to prevent a Chicago suburb from selling bonds this month, alleging in court documents filed on Tuesday that the city and its comptroller misused bond proceeds and schemed to defraud investors.
In a complaint filed against the town of Harvey, Illinois, and the comptroller, Joseph Letke, in the U.S. District Court for the Northern District of Illinois, the SEC also demanded a jury trial - an unusual request in the SEC's current crackdown on the $3.7 trillion municipal bond market.
Harvey is "exploring a new issuance of bonds as soon as late June 2014," the SEC said.
"Through a pattern of egregious misuse of bond proceeds, Harvey has demonstrated that it cannot be trusted," the SEC said in the restraining order request.
By law, the city does not have to inform federal regulators of planned sales.
The commission is seeking to freeze Letke's assets and ban him from bond issuance as well as to bar Harvey from selling debt until a court-appointed consultant reviews its practices.
The commission also wants Letke to disgorge any "ill-gotten gains and pay prejudgment interest."
Starting in 2008, the city sold $14 million in bonds for constructing a Holiday Inn to be repaid from dedicated hotel-motel and sales tax revenues.
It then diverted at least $1.7 million to fund its daily operations and also made $269,000 in undisclosed payments to Letke, the SEC alleges. Letke, who serves as comptroller for a number of municipalities, also benefited from the deals by acting as financial adviser, with compensation topping $500,000, it said.
The SEC described the city of 30,197 people as "in a desperate financial condition," where it will soon not be able to pay its bills. It added that the hotel project has turned into a "fiasco."
Both Harvey's mayor and Letke could not be reached by phone and did not immediately respond to an emailed request for comment.
The commission's regulatory reach into the municipal market is limited and so its complaint rests largely on the city not properly notifying bondholders or potential investors of the alleged misused funds, Letke payouts, and conflicts of interest.
"If Harvey is able to raise additional bond proceeds without any reforms in its policies and procedures, Harvey likely will misuse additional investor funds, especially since its precarious current financial situation gives it ample incentive to do so," it said. "Moreover, Letke remains as comptroller as Harvey and continues to act as a financial adviser to Harvey on bond issuances, putting him in a position to continue his participation in a scheme to divert bond proceeds."
Over the last 18 months, the SEC has ramped up enforcement in the largely unregulated municipal market, but it settled almost all the cases it brought and mostly demanded promises of change from the municipalities and individuals it charged. (Additional reporting by Jonathan Stempel in New York, editing by G Crosse)