4 O.C. School Agencies Get SEC Notices

The staff of the U.S. Securities and Exchange Commission is recommending that at least four Orange County school agencies be charged with fraud and deceptive practices for raising nearly half a billion dollars purely to boost their stakes in the county’s high-flying investment pool.

Irvine Unified School District, the Newport-Mesa Unified School District, the North Orange County Community College District and the Orange County Department of Education have all received so-called “Wells notices” from the SEC staff.

The notice is an official alert that the staff of the regulatory agency intends to recommend to the securities commission that an action be filed, and gives the agencies and individuals receiving them a chance to argue against charges before they are filed.

Starting in 1993, the four school agencies each earned about $1 million extra a year by borrowing roughly $50 million apiece through the issuance of taxable municipal bonds and then investing the proceeds in the ill-fated investment pool operated by then-county Treasurer-Tax Collector Robert L. Citron.

Each gambled that Citron’s pool was safe, and would continue to generate approximately 2% more in interest than the cost of issuing and repaying the bonds.

But the SEC has apparently concluded that the school agencies failed to properly disclose to bond investors that they intended to use the money solely to reap arbitrage gains in the county’s pool.

“Basically, the issue with the SEC appears to be one of disclosure and the specific disclosure they seemed most concerned about was the non-disclosure, if you will, [with] the taxable notes,” said Marc Winthrop, an attorney who represents Irvine, the community college district and the county Department of Education.

“The taxable notes did not disclose in their disclosure documents that they were basically arbitrage bonds,” Winthrop added. “The SEC feels they should have put that on the first page of the disclosure documents.”

SEC enforcement actions may range from formal complaints filed in U.S. District Court to administrative proceedings aimed at getting cease and desist orders, said officials who have been notified.

The letter sent to the Newport-Mesa School District specifically said that the SEC staff was recommending to the full commission that fraud and deceptive practices charges be filed in U.S. District Court.

Some SEC officials have said privately that filing the charges in federal court would enable them to seek significant fines, while administrative actions before the commission does not.

Newport-Mesa school officials said they have been told that the threatened actions are minor, and should not result in fines.

The notices received by the Newport-Mesa school district, its finance officer and a former district official--disclosed Tuesday by the Daily Pilot--said the agency’s proposed charges are based on alleged violations of two federal securities laws and an agency rule prohibiting fraud and requiring proper disclosure of risks to investors.

The SEC cites the taxable notes issued by the school agencies in 1993 and again in 1994, officials said.

The controversial practice of issuing bonds to generate funds for investments was investigated by the California Senate Special Committee on Local Government Investments.

In a hearing last February, Ken Ough, senior vice president of Rauscher Pierce Refsnes, the financial firm that served as the underwriter of the bonds in question and earlier as financial adviser to the school agencies that issued the bonds, told senators, “I brought the idea that they could issue a taxable note and put the proceeds in the Orange County treasurer’s pool in 1993.”

Ough’s firm has also received a Wells notice, a spokesman said Tuesday.

Ough went on to testify that former Assistant Treasurer Matthew R. Raabe attended school board meetings to reassure the agencies the county’s pool was safe.

“Mr. Raabe specifically attended a Newport-Mesa . . . meeting where he went into great detail on how safe that investment was,” Ough testified, adding: “The school districts had a written guarantee by the county on their investment . . . that guaranteed them [an interest] rate of 6.5%.”

At the time, Ough testified, the school agencies were paying “around 4%” on the bonds they had issued, leaving a spread of around 2.5% in profit.

The school officials said they began receiving the SEC notices this week.

Of the five Orange County school agencies to issue bonds purely for investment purposes, only the Placentia-Yorba Linda School District said it has not been notified of an impending action by the SEC.

“We did receive one, and we’re just one of a series of entities across the county that did,” said Irvine Supt. Dennis Smith.

“I was told today,” said Thomas Harris, chancellor of the North Orange County Community College District, adding that the district’s lawyer had planned to meet with the SEC on Tuesday.

Harris said he too was told the matter involves his district’s taxable note issues.

The Newport-Mesa district and the two officials received letters Monday that were mailed late Friday by the SEC’s staff in Los Angeles, said Katherine Butts Warwick, who represents the district.

“We are preparing to meet with the SEC and preparing a response,” Warwick said. “It is our position that because all of the bonds were paid on time and in full that there’s absolutely no harm to any purchaser.”

Said Newport-Mesa Supt. Mac Bernd: “We want the community to know that all bonds connected with the district’s investment or the pool have been paid on time and in full.”

John Nelson, assistant superintendent of the Orange County Department of Education, did not return numerous calls for comment Tuesday.

SEC officials have said repeatedly that the agency will not comment on ongoing investigations.

Last month, a Wells notice was sent to the current and former members of the county Board of Supervisors who presided over the $1.7-billion financial collapse, former board Chairman Thomas F. Riley said.

Gerald Boltz, who represents the supervisors, asked that SEC chairman Arthur Levitt remove himself from an investigation of their role in the county’s bankruptcy because they felt he was too biased, sources have said. But the SEC has rejected that request, Bloomberg News Service reported Tuesday.

In a letter to Boltz, the SEC’s general counsel, Simon Lorne, said “the Commission has not commenced any adjudication involving your clients.” But he added that if formal charges are filed, the SEC would reconsider asking Levitt to recuse himself.

Several financial firms also acknowledged receiving notification, including C.S. First Boston Corp., the underwriter of pension bonds issued by the county last September.

Winthrop, meanwhile, downplayed the seriousness of the SEC action against the school agencies.

“I hate to sound cynical about this whole thing, but there were only two purchasers of our [Irvine’s and the county Department of Education’s] notes, both of whom were institutional purchasers,” Winthrop said.

“The principal purchaser, 85%, was Schwab, so you didn’t exactly have the unsophisticated investor buying these things.”