Bond Investors Await Reckoning Day : WPPSS

Not long ago, about two dozen well-tailored attorneys piled into a pair of federal marshal’s vans outside the U.S. District Court here for a most unusual tour of this desert city.

Here were some of the nation’s best securities lawyers in search of a courtroom--specifically, one big enough to accommodate the mammoth securities litigation surrounding the ill-fated Washington Public Power Supply System.

Accompanied by trial Judge William D. Browning, they checked out an abandoned church, a Shriners temple, the defunct Rialto theater and a pair of office building auditoriums. An asbestos-filled school was dropped from the schedule, the judge quipped, because “we don’t want to foster any satellite litigation.”

By the time the tour was over, the lawyers still hadn’t agreed on a site for the huge securities fraud trial, which is expected to last up to two years and feature more than 100 defendants.

Still, the Tucson excursion illustrates that a day of reckoning may be approaching for the Pacific Northwest utilities, Wall Street brokerage houses and others that helped market $2.25 billion in Washington Public Power Supply System bonds that went into default in 1983.

In February, the Securities and Exchange Commission completed its own three-year investigation into the default--the largest in municipal bond history--and is expected to take enforcement action in the near future.

Congressional sources say the SEC is planning to bring fraud charges against the supply system itself rather than the Wall Street brokerage firms that marketed the bonds.

However, Rep. John D. Dingell (D-Mich.), an arch-foe of the SEC, is urging the agency to pursue “members of the investment community” who were involved in WPPSS bond offerings. Blyth Eastman was the supply system’s financial adviser, while Merrill Lynch, Smith Barney, Salomon Bros. and Bache underwrote the bonds.

Dingell has been particularly harsh on Merrill Lynch, charging in a letter to the SEC that the firm’s sales staff “aggressively marketed (WPPSS) bonds” even after the release of a July, 1981, research report by its own bond analysts that was “critical” of the supply system.

The agency also looked into charges that institutional investors and brokerage firm’s “dumped” WPPSS bonds on unsuspecting retail buyers after the professional investors realized that something was amiss at the supply system. Such “dumping,” if it occurred, could be construed by the courts as insider trading.

Merrill Lynch and the other underwriters strongly deny any impropriety or wrongdoing in connection with the sale of the bonds. The firm, says a spokesman, “believes there is no basis for SEC action with respect to Merrill Lynch and the other underwriters.”

If the legal fallout seems massive, it is keeping in character with the Washington Public Power Supply System. Not much about the public power agency, which has generated more controversy than electricity, has been small.

The agency--whose initials, appropriately, are pronounced “whoops”--once planned to build 20 nuclear power plants, began work on five and completed only one.

Two partially built plants were abandoned, two are in mothballs, and now there is talk of converting one of the mothballed nuclear plants into a facility to make weapons-grade plutonium.

70,000 Investors Affected

As a result of the construction debacle, the agency--whose board of trustees included a muffler shop owner and an apple orchardist--left an estimated 70,000 investors around the country holding the bag on the $2.25 billion in bonds that went into default.

Now those bondholders are getting their day--or, rather, days and weeks and months--in court. They contend that they were defrauded, and they are suing everyone from Main Street to Wall Street.

Defendants in the case to be tried in Tucson range from tiny municipal utilities in the Pacific Northwest that contracted to buy power from the now scrapped power plants to the lawyers, investment bankers and bond rating agencies that helped market the bonds even as construction delays and cost overruns at WPPSS mounted.

The trial, which is scheduled to begin in September, 1988, was moved to Tucson from Seattle in order to find impartial jurors. WPPSS has aroused such passions in the Pacific Northwest that the chance of a fair trial there was ruled virtually nil.

If some or all of the 91 utility defendants lose and the judgment can be enforced, electricity rates could double or triple in cities and towns across Washington, Oregon and Idaho.

The stage for the current litigation was set in 1983, when the Washington state Supreme Court ruled that the utilities lacked legal authority to enter into contracts under which they agreed to pay all project costs even if the projects failed.

Thus excused from their agreements to pay back the bonds, which had been known as “come hell or high water” securities, the utilities stopped making payments to WPPSS, and the supply system defaulted.

The case, known as Multi-District Litigation No. 551, combines litigation brought by New York’s Chemical Bank, the trustee for the defaulted bonds, with class-action lawsuits filed by individual bondholders.

Multi-district litigation was created by Congress 17 years ago for gargantuan cases that sprawl beyond a single judicial district. Other examples of multi-district litigation include lawsuits surrounding the use of asbestos and Agent Orange.

The WPPSS case involves holders of bonds issued to build the supply system’s nuclear power plants No. 4 and 5. The bonds, which were issued beginning in the late 1970s and haven’t paid interest since 1983, currently trade for about 15 cents on the dollar.

About $6 billion in bonds issued to build plants No. 1, 2 and 3 aren’t involved in the litigation. Bonds for these plants have the backing of the Bonneville Power Administration, a federal agency that generates and transmits electricity in the Pacific Northwest.

Attorneys for holders of the defaulted bonds allege that their clients were misled. They assert that the utilities never intended to pay off the debt if the projects failed. “The lack of disclosure concerning the utilities’ unwillingness to pay constituted fraud,” argues James Irwin, a Seattle lawyer representing the bond holders.

Further, the plaintiffs allege that the supply system and its advisers concealed material facts from investors: that costs for the plants were far outrunning projections and that construction schedules were hopelessly delayed.

The supply system’s consultants, lawyers and bond underwriters have been dragged into the litigation as well. “Face it,” says Cyrus Noe, who publishes a weekly newsletter on WPPSS litigation called Clearing Up, “a bunch of muffler shop owners and apple orchardists cannot go out on their own and borrow $2.25 billion.”

The case, whose discovery phase will be wrapped up by this summer, has generated thousands of documents and hundreds of depositions. Judge Browning is considering appointing a special magistrate just to verify transcriptions of hundreds of hours of taped meetings.

So far, according to bondholder lawyers, no “smoking guns” have emerged. “It’s more like building a house brick by brick,” attorney Irwin says.

Still, bondholder lawyers seem certain to introduce a memo by a supply system financial official bemoaning a “lack of candor” about construction problems.

Had Early Warning

And, according to court records, participating utilities were informed by the supply system as early as January, 1978, that the system had “studies forecasting a range of completion dates” but always used the “optimistic schedule.”

And as early as 1977, participating utilities realized they wouldn’t need all the power that they had contracted to buy. These forecasts were crucial to representations in the offering’s official statement concerning both the need for the nuclear plants and their economic feasibility.

Underwriters also swept away their doubts about the plants’ viability in marketing the bonds, some evidence shows.

As early as 1975, for example, Smith Barney rewrote a study of the supply system and removed several unfavorable conclusions “in response to criticism and pressure” from financial adviser Blyth Eastman and bond counsel Wood & Dawson, the bondholders charge.

But the defendants deny that they misled anyone. “Problems with the nuclear power industry were so widespread and well known that any idiot who didn’t know about them had to have his head in the sand,” says Albert R. Malanca, a lawyers for several utility defendants.

“And who could have known that good-faith forecasts for future power needs wouldn’t be borne out?” Malanca adds.

Dennis K. Bromley, who is representing several Wall Street underwriters, echoes the thought. “The heart of the plaintiffs’ case is that there was a fraud on the market,” he says.

“We say the market knew everything about the WPPSS problems,” he adds. “It was in the Wall Street Journal. It was in Barron’s. It was in court proceedings around the country.”

Perhaps one of the few things that lawyers from all sides agree on is that Tucson--Judge Browning’s home--isn’t terribly convenient for the trial.

“With all due respect, as I sat in the Denver airport at 11 o’clock last night waiting for a connecting flight arriving here at 1 a.m., I had some misgivings about your honor’s decision to hold the trial in Tucson,” Malanca said at a hearing last month.

“Let me remind you,” the judge shot back, “that it is the same distance whether you go from Seattle to Tucson or Tucson to Seattle.” The judge has held many pretrial hearings in Seattle.

And lawyers for the Wall Street bond underwriters, not surprisingly, thought they would get the best shake in New York.

Concerned About Location

Malanca says he’s particularly concerned about the choice of this Arizona Sun Belt town because of its heavy concentration of retired people, “the kind of people who would own bonds.”

In any case, one wag recently surveyed the 60 lawyers--most from out of town--in Judge Browning’s regular courtroom and predicted that the judge would likely be named “man of the year” by Tucson’s Chamber of Commerce.

To be sure, some free-spending lawyers at last month’s hearing were checking out more than potential courtrooms. Judge Browning thoughtfully provided each lawyer with a copy of the Southern Arizona Restaurant Assn. pamphlet titled “Dining in the Desert.”

And the lawyers themselves could be overheard comparing notes on Tucson’s hotels. Some stayed downtown, while others preferred the posh Ventana Canyon Resort, where rooms start at $180 a night.

The judge, clearly relishing the prospect of presiding over the massive trial, has already picked out the “state of the art” computer system he wants to equip whatever building is finally selected for the courtroom.

The government will pick up the tab for the basic courtroom and associated construction, but individual lawyers must pay for their own office space. “I suggest we lease the property until September of 1990, to be on the safe side, with periodic escape clauses,” the judge says.

The escape clauses could be exercised if the trial moves quickly or if the case somehow gets settled.

What are the prospects of a settlement, and what might be its terms? Defendants, in aggregate, have about $300 million in insurance available to them if they are held liable in the case, one source says.

Any bondholder who wanted to participate in any recovery in the class-action litigation must have filed a claim showing proof of loss by earlier this year.

“You really can’t speculate on a settlement,” says bondholder attorney Irwin. “At this point, it is an unknown. All I can say now is that we are preparing for trial.”