DIRE STRAITS : Orange County Bankruptcy Spurs SEC to Crack Down on Small Communities

TIMES STAFF WRITER

Not since 1913 have times been so dark in Wheatland. On a hot August day that year, four men were killed when 4,000 angry hops pickers rioted and the state militia had to be called in.

Now, the hulking brown kilns that once roasted hops for beer stand silent as this Northern California town of 2,000 battles a much greater threat: the U.S. Securities and Exchange Commission.

Wheatland is caught up in a sweep by the SEC, the agency that generally regulates stock exchanges and corporations. The town is one of 11 local governments in California, including six in Orange County, being investigated by the SEC as part of a crackdown on abuses in municipal finance.

Sparked by Orange County's massive bankruptcy filing 15 months ago and the SEC's new get-tough policy on municipal bonds, investigations into California's local governments are at an unprecedented high.

Small governments such as Wheatland claim they are being unfairly targeted by the SEC. Although all the SEC investigations involve bad bond deals, the local governments say any bond problems are due to an ignorance of municipal finance and overreliance on bond lawyers and bankers hired as experts. It isn't a case of outright fraud, elected officials say.

In Wheatland's case, it was the town's only bond deal in 30 years--a $2-million bond sold in 1990 to expand a sewer system and build 700 homes--that sparked the SEC probe.

"We say, 'No way.' We didn't do anything wrong," said Clay Castleberry, Wheatland's part-time city administrator.

But he acknowledges that when word of the probe got out, it caused a panic in town.

Residents clamored for answers at a town meeting. The only full-time city employee rounded up volunteers to make copies of bond documents and drive them 125 miles to the SEC's office in San Francisco. And now, Wheatland is trying to hire a securities lawyer.

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"They say it takes $100,000 in legal fees to defend against an SEC notice," said Castleberry, noting that the city's annual budget is only $350,000.

"If the SEC gets tough with us," he said, "we're going to hand them the key to City Hall and say 'Turn out the lights when you're done.' "

The SEC's clampdown has sent shock waves throughout the state. In some city council chambers and county board rooms, public officials are becoming afraid to approve even the simplest of bond deals because of concerns the financings may go bust later.

"If I were a public official right now, I'd be freaked. They are being required by the SEC to know things they can't know--even with good effort," said Dean Misczynski, a bond expert for California. "It has the potential of chilling the climate of public finance in California."

Eventually, small cities that rely on the $1.2-trillion municipal bond market to borrow tax-free money for roads, schools and other projects could be shut out, much the same way very small companies find it too expensive or complicated to raise money on the New York Stock Exchange.

This could hamper economic growth in California and limit government's ability to function, some experts say. Such concerns prompted the National League of Cities this month to urge the SEC to focus on fraud and negligence in its municipal bond investigations rather than lack of disclosure or missing information in bond documents.

The SEC's investigations "appear to have been particularly targeted against smaller cities with inadequate resources to defend themselves," the league said.

Which is exactly Wheatland's predicament, said Juanita Neyens, the town's 74-year-old mayor who lives less than a block from City Hall in the house once occupied by her great-grandmother. Neyens also manages the cemetery and runs the historical society in this town that doesn't yet have a stoplight.

"There are no Bob Citrons [the former Orange County treasurer-tax collector indicted for fraud] here in Wheatland," Neyens said. "We haven't done anything wrong, but we can't afford to fight back."

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Once a place of comfort for any investor who could balance a checkbook, the municipal bond market has become increasingly risky and complex.

Although still a place where local governments go to raise money for infrastructure projects, the market's new complexity has prompted a greater reliance by public officials on outside lawyers, bankers and advisors for assistance on the deals. And with that comes the possibility for more abuses.

Now, the SEC, which has traditionally focused on corporate finance, is doing some badly needed housecleaning in the municipal bond world.

In a statement to The Times, SEC Chairman Arthur Levitt said the scrutiny over municipal bonds is necessary because they are so popular.

"It is one of the SEC's top priorities to make sure that investors and taxpayers alike get accurate and complete information about their investments."

But because municipal bonds have become as complex as the ones sold by major Fortune 500 corporations, city officials say the SEC's expectations are unrealistic. A part-time council member in a rural community is unlikely to be able to spot securities violations, especially a lack of disclosure, some say.

"You're talking about a tree farmer, a day-care operator, who is also on the city council. Ask those people to read bond documents in a meaningful way," said Robert Doty, an advisor hired by cities such as Wheatland to help fight the SEC.

"You mention the word 'arbitrage' and they don't understand it. They can't scrutinize the documents for errors," he said.

But William R. McLucas, the SEC's enforcement chief in Washington, said the SEC is not requiring public officials to be municipal bond experts.

"Borrowing money from the public in a market that is critical to the whole country does require some attention," McLucas said. "We're not suggesting you have to be an MBA to perform your responsibilities."

In response to concern by elected officials, Assemblyman Jan Goldsmith (R-Poway) has proposed that every local government in California have a compliance officer, a kind of super-savvy finance cop who would monitor bond deals to make sure no securities rules are violated.

"Since when is the mayor of a city, a volunteer in some cases, as responsible under the law as the chief executive of General Motors? We need to put responsibility in the hands of people who are really qualified," said Goldsmith, who recently held a state hearing on this issue.

"The SEC has already nailed Orange County's hide to the shed and now they are hunting 11 other California communities," he said.

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In Nevada County, a growing rural area in the Sierra foothills, officials now understand how complex municipal finance is.

In December, the county opted to reject a settlement offer from the SEC that would have ended a federal probe into a $9-million development bond designed to provide sewers and other infrastructure for a housing development.

Unlike Orange County and its elected officials who settled with the SEC, elected officials in Nevada County decided to fight back. In an unusual move, they have filed a 150-page response to an SEC "Wells notice'--a formal warning from the SEC that civil charges are about to be filed.

The supervisors, none of whom were in office when the bond deal was done, feared a settlement would affect the county's bond rating and force it to pay higher interest rates. Now, they are waiting for the SEC's response.

"The board feels the county did nothing wrong, and any settlement would be a capitulation--an admission of wrongdoing," said David Brennan, county administrator in Nevada City, a former gold mining town.

Brennan argues that the city did not hire finance people and "go to the beach." It hired a financial advisor, stopped the bond sale when questions came up and quizzed bond lawyers about the deal.

"There is nothing more we could have done. We may not do any bond deals ever again," Brennan said.

Nevada County officials say they are being held responsible for information they did not control, such as facts about the developer or appraisers hired to do a job.

"The SEC has jumped all over the people in Nevada County and they are the most innocent," said Zane Mann, publisher of the California Municipal Bond Advisor. "It does seem like the SEC is picking on innocent but naive issuers who relied on professionals."

The agencies being investigated in Northern California all hired the same firm to sell bonds--First California Capital Markets of San Francisco, which has also reportedly received a Wells notice from the SEC. (The Wells notice is named after John A. Wells, who headed an advisory commission in 1972 recommending that firms or people targeted in an SEC investigation be given time to respond.)

The firm sold bonds in Wheatland, Nevada County and for the tiny Central Valley cities of Wasco and Avenal, which are both being investigated by the SEC.

While some Northern California officials blame the firm for their bond woes, others don't. Officials at First California Capital would not comment.

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In Orange County, four school agencies are fighting notices from the SEC that each district violated securities laws when they sold nearly $500 million of bonds to reap returns in former Orange County Treasurer-Tax Collector Citron's failed investment pool.

The cities of Irvine and Anaheim are also fighting notices from the SEC.

The North Orange County Community College District, the Orange County Board of Education, Newport-Mesa Unified School District and the Irvine Unified School District have filed lengthy responses to the SEC Wells notices that say the schools and certain individuals committed fraud by selling bonds without sufficient information to bondholders on the Orange County investment pool.

"In our bond deal, we had bond counsel do what the SEC seems to be saying we should have done," said one school official who did not want to be named. "We also had another set of lawyers, the underwriters' counsel, look over the documents. What else could we have done?"

But the SEC's McLucas said public officials bear some responsibility even if they hire lawyers. He noted that the securities market would be in big trouble if everyone who hired a lawyer assumed it resolved them of any liability.

"May public officials rely on lawyers? . . . Absolutely," McLucas said. "That reliance must be reasonable."

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Like the schools and Nevada County, Wheatland is waiting for the SEC's next move.

In the town's two-room City Hall, a portrait of a cowboy in a white hat and red bandanna hangs in a frame over the copy machine.

Under it are the words: "There were a helluva lot of things they didn't tell me when I hired on with this outfit."

That's how Mayor Neyens, a fifth-generation Wheatlander, feels.

"I didn't know I needed to read bond deals--you have people do that for you," she said. "And I'm not gonna read that stuff, no way."

Although Wheatland still has not received an SEC Wells notice, the bond issue causing all the trouble is near default. Sold to finance new infrastructure for a housing development, some property owners in the district have been foreclosed on and the homes were never built.

In the special tax district, called Mello-Roos, developers make payments to bondholders until home-buyers move in and begin making the payments themselves. But if homes aren't built and developers can't make the payments, then the property goes into foreclosure.

The city recently tried to sell 45 acres of foreclosed property in its troubled Mello-Roos district for $327,000, but no buyers came forward during an auction on a windy day in front of the Yuba County Courthouse.

"We were disappointed," said Castleberry, who was not in office when the bond deal was transacted. "We're not sure what happens next."

Some residents, including John Ferguson, whose late mother-in-law owned property in the Mello-Roos district, thinks the bond deal never should have been done. He said he hopes the SEC will shut Wheatland down, asserting that officials don't know what they are doing.

"What's the point of a city like this one? I don't want my taxpayer money spent on defending a city that is guilty," he said.

A payment of $80,000 is due to bondholders in May and another $145,000 is due in November. While the city can make the first payment, there is fear it won't be able to make the second one.

And, officials predict, once the bonds actually default, the SEC will step in and levy fines against Wheatland. Such an action could cause the town to unincorporate and cease to exist.

"Evidently the SEC is trying to establish some new policies," Neyens said. "But they are going to destroy our town."

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Bond Issue Investigations

The Securities and Exchange Commission is investigating several California city, county and school district bond issues for possible security laws violations.

1. Nevada County

* Issue: $9 million in Mello-Roos bonds in 1990 to build housing development infrastructure.

* What went wrong: Bonds sold with the intent developer would make payments to bondholders until home buyers began paying Mello-Roos taxes. Developer failed to complete subdivision, filed bankruptcy, left county with no way to repay bonds.

* SEC concern: County officials failed to provide bond buyers with adequate information about bonds and developer. Even though county hired lawyers and experts, it did not adequately supervise bond issue, SEC says.

* Status: County officials have filed a 150-page explanation of why they are rejecting SEC's offer of a settlement.

2. Wheatland

* Issue: $2 million in bonds in 1990 to expand a sewer system and build 700 homes.

* What went wrong: Bonds sold with intent developer would make payments to bondholders until home buyers began paying Mello-Roos taxes. Developer failed to complete subdivision, leaving county with no way to repay bonds.

* SEC concern: Insufficient disclosure to bond buyers

* Status: Under SEC investigation

3. Ione

* Issue: $14.5 million in Mello-Roos bonds in 1991 for construction of housing development

* What went wrong: City alleges developer misappropriated bond-sale funds, forcing issue into default

* SEC concern: City failed to adequately supervise bond issue and did not provide enough disclosure to bond buyers.

* Status: City has received Wells notice (1)

4. Avenal

* Issue: $11 million in bonds issued in 1989 for city improvement projects.

* What went wrong: Bond funds were used for other things, including purchase of Ione and Nevada County bonds

* SEC concern: Inadequate supervision of bond issue and buyer information

* Status: City has responded to Wells notice (1)

5. Wasco

* Issue: $35 million Mello-Roos bonds in 1989 for housing development infrastructure

* What went wrong: Developers failed to pay property assessments on bonds forcing city to dip into reserves

* SEC concern: Bond proceeds used in ways not adequately disclosed to bond buyers

* Status: City has received Wells notice (1)

6. North Orange County

Community College District

* Issue: $56.3 million in taxable bonds to invest in the Orange County investment pool

* What went wrong: County filed for bankruptcy in 1994 and pool collapsed

* SEC concern: Not enough disclosure about investment pool's condition to bondholders

* Status: District has responded to Wells notice (1)

7. Anaheim

* Issue: $95 million in taxable bonds to invest in the Orange County investment pool

* What went wrong: County filed for bankruptcy in 1994 and pool collapsed

* SEC concern: Not enough disclosure about investment pool's condition to bondholders

* Status: City has responded to Wells notice (1)

8. Newport-Mesa Unified School District

* Issue: $47 million in taxable bonds in 1994 to invest in the Orange County investment pool

* What went wrong: County filed for bankruptcy in 1994 and pool collapsed

* SEC concern: Not enough disclosure about investment pool's condition to bondholders

* Status: District has responded to Wells notice (1)

9. Orange County Department of Education

* Issue: $42.2 million in taxable bonds in 1994 to invest in the Orange County investment pool

* What went wrong: County filed bankruptcy in 1994 and pool collapsed

* SEC concern: Not enough disclosure about investment pool's condition to bondholders

* Status: Department has responded to Wells notice (1)

10. Irvine

* Issue: $62.5 million in taxable bonds in 1994 to invest in Orange County investment pool

* What went wrong: County filed bankruptcy in 1994 and pool collapsed

* SEC concern: Not enough disclosure to bond buyers about investment pool's condition

* Status: Responding to SEC has cost the city $40,000 to date

11. Irvine Unified School District

* Issue: $54.5 million in taxable bonds in 1994 to raise funds for Orange County investment pool

* What went wrong: County filed bankruptcy in 1994 and pool collapsed

* SEC concern: Not enough disclosure about investment pool's condition to bondholders

* Status: District has responded to Wells notice (1)

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(1) Notice issued by SEC informing recipient of intent to charge with security law violations

Source: California Assembly Committee on Banking and Finance, individual public agencies; Times reports;

Researched by JANICE L. JONES / Los Angeles Times

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