SEC Files First Lawsuit in Muni Bond Probe
In the first major action of a three-year investigation that shook up the California public finance market, the Securities and Exchange Commission sued a San Diego securities firm Monday for allegedly defrauding investors who bought $69 million worth of bonds sold by local governments.
Filed in U.S. District Court in San Francisco, the suit alleges that First California Capital Markets Group and two of its executives, principal H. Michael Richardson, 56, and manager Derrick Dumont, 36, lied to investors and did not tell them important information about their investments.
“These defendants were at the heart of all these bond deals,” said David Bayless, district administrator for the SEC in San Francisco, who said the investigation into the $69 million worth of bond deals will continue. “This is part of the SEC’s ongoing efforts to clean up the municipal market and to make sure bond investors receive information that is accurate.”
Richardson denied any wrongdoing and vowed to contest the suit.
“I’m going to fight this right up to the end,” said Richardson, now the only investment banker at First California, which once had more than 70 employees in its San Francisco office. Richardson moved the firm to San Diego. Dumont has left the securities business and lives in Calistoga, Calif.
The SEC alleges that there were omissions and fraud in documents for five bond deals sold from 1989 to 1991 for local governments in the Central Valley and Sierra foothills. Bond proceeds were used to fund real estate developments and other projects, some of which never came to fruition. First California was the underwriter on the five deals, selling the bonds to investors on behalf of the municipalities.
The SEC’s three-year investigation, one of the first to target local governments, has sparked controversy throughout the municipal bond industry about whether lawyers, investment bankers or municipal officials are most at fault when it comes to lack of disclosure and other problems on bond deals.
So far, no local governments have been charged in the investigation, though some officials have said the governments may be negotiating settlements with the SEC. Some state lawmakers have argued that municipal officials don’t have the financial expertise to discover errors in complicated securities documents.
Cities, counties and agencies rely on the nation’s $1.3-trillion municipal bond market to borrow tax-free for roads, schools, hospitals and other infrastructure projects. The financings in this case were mostly land-backed bonds, meaning the bonds were secured by land for the projects being built by private developers.
Specifically, the SEC’s suit centers on $9 million worth of bonds sold by Nevada County; $14 million by the city of Ione, a Northern California town with a population of 2,500; $11 million worth of bonds sold by the Avenal Public Financing Authority in the Central Valley; and $35 million worth of bonds sold by the Wasco Public Financing Authority in the Central Valley.
“It’s about time,” said Zane B. Mann, publisher of the California Municipal Bond Advisor newsletter in Palm Springs. “Attention now is being paid to these land-backed bond deals in California. The bankers and the issuers can’t just sell any type of junk they want to.”
In Nevada County, the suit alleges that the defendants overstated the value of the property and misrepresented the developer’s experience and financial condition. In the Ione bond deals, the SEC alleges that the defendants misrepresented the improvements that could be built with the bond proceeds and failed to disclose that the developer did not have the capital to complete the development.
The suit also alleges that First California and Richardson advised the Wasco agency to purchase several low-quality securities, including one for which First California was the underwriter, an act violating federal laws requiring brokers to recommend suitable investments.
The six-count complaint asks the court to order the defendants to “return all ill-gotten gains plus interest, and impose civil penalties.”
“This helps send a message that good disclosure is important and local agencies have to rely on reputable brokers,” said Peter Schaafsma, executive director of the California Debt and Investment Advisory Commission, a state agency that tracks debt.
