SEC: Municipal Bond Investors Misled


In a warning to local governments nationwide, federal regulators accused Irvine, Anaheim and four Orange County school agencies Tuesday of misleading investors about the risks of municipal bonds issued in the years before the county’s fiscal collapse.

The securities, issued in 1993 and 1994, later became infamous as “casino bonds"--financing to provide funds to speculate with rather than to help pay for streets, sewers or classrooms.

The cities and schools failed to disclose that the $508 million in bond funds was pumped straight into Orange County’s treasury in hopes of a quick profit, the Securities and Exchange Commission said.

The SEC also said bond investors were never warned of the risks taken by then-county Treasurer Robert L. Citron, or of the treasury’s losses as 1994 wore on.


After years of high returns, Citron’s bets on low interest rates lost $1.64 billion by December 1994, plunging the county into the nation’s biggest municipal bankruptcy. Bond investors eventually were repaid, but the county and 200 cities, schools and local agencies have yet to fully recoup their losses.

The cases are the latest in a series brought by the SEC, which said its Orange County investigation is nearly complete but could still yield additional charges.

The SEC is seeking a cease-and-desist order barring the cities and school agencies from future securities violations. But the commission is not seeking financial penalties.

One school system facing SEC charges--the Newport-Mesa Unified School District--settled by promising to make full disclosures in the future. The district admitted no wrongdoing. The district settled the case to escape a protracted and costly legal battle, Supt. Robert Barbot said.


“We are happy to be able to put this matter behind us and . . . focus on the educational goals of the district,” he said.

The others in the case--Irvine Unified School District, North Orange County Community College District, Orange County Board of Education and the two cities--said they will contest the charges.

A lawyer for the schools said officials had trusted their financial and legal advisors to ensure investors were informed about risks.

"[The school officials] were required to act reasonably,” said attorney James Sanders. “It’s our position that they have acted reasonably by hiring outside people to prepare the disclosure documents.”

Anaheim City Atty. Jack L. White also said city officials acted properly in hiring highly regarded advisors.

But Elaine Cacheris, former regional SEC head in Los Angeles, said that hiring professional advisors “isn’t necessarily enough. An issuer has a responsibility to review the disclosure to determine whether it provides investors enough information to make an informed decision,” Cacheris said. “These issuers should have realized that the information in the disclosure documents did not square with what they knew.”

Irvine City Atty. Joel Kuperberg promised that his city “will defend itself vigorously.” He said that while bond investors were repaid in full, Irvine and other cities “were victims of Orange County investment policies.”

Cacheris said one of the SEC’s top priorities in recent years has been to hold municipalities to the same standards in issuing securities as private companies.


“The anti-fraud provisions are going to apply to any issuer who borrows money from the public,” Cacheris said. “Put simply, they are required to tell the truth.”

The Orange County cities and schools failed to do so, she said. Instead of revealing that the bond funds would be used to speculate on interest rates, Cacheris said, the disclosures contained a “laundry list” of possible uses including ongoing expenses and capital expenditures.

Other recent targets of SEC bond disclosure actions include Arizona’s Maricopa County, which includes Phoenix, and the Northern California municipalities of Wheatland and Nevada County.

The SEC action against the cities and school agencies is not likely to hamper their ability to issue conventional bonds, experts said.

The borrowings before the county’s fiscal collapse were a highly unusual “example of greed,” said Zane Mann, publisher of the Municipal Bond Advisor in Palm Springs. “At the time it was done, all knowledgeable professionals knew it was an outrageous thing to do--to gamble with bond money.”

The Orange County cities and schools are charged with negligence, rather than more serious charges of intentional fraud and recklessness that the SEC has brought against others who issued bonds prior to the 1994 bankruptcy.

Indeed, the SEC brought an intentional fraud suit against Dain Rauscher Inc., the firm that acted as advisor and underwriter for the cities and schools that were charged Tuesday. The firm is contesting the suit.

A lawyer for the county Department of Education said Dain Rauscher had suggested issuing the bonds, never billing the investments as risky. “I don’t think it’s appropriate for any municipality to engage in speculative investments, but that’s not the way this investment was explained,” attorney Robert Beall said.


The county closed yet another chapter in the bankruptcy on Tuesday, saying it has agreed to pay $803,000 to the Internal Revenue Service in a dispute over the issuance of tax and revenue notes.

In 1994, Citron issued $200 million worth of government notes and claimed all the money collected to be tax-exempt. When the bankruptcy hit late that year, the IRS began investigating and concluded that the county borrowed more than tax-exemption laws allowed.

County and IRS officials debated the issue for two years before reaching agreement, said Gary Burton, the county’s chief financial officer.

“We agreed to settle, but we didn’t agree anything was wrong,” Burton said. “We just wanted to get this behind us.”

The money will likely come from a fund for bankruptcy-related claims, he said.


Times staff writer Lorenza Munoz and Reuters contributed to this story.


Borrowing to Invest

A look at the Securities and Exchange Commission charges and the agencies involved:


Four Orange County school agencies and two cities issued

$500 million in municipal securities in 1993 and 1994 for the stated purpose of paying expenses and debts. The proceeds were invested in the Orange County Investment Pool, which subsequently collapsed. The SEC accuses the issuers of negligent conduct for not properly disclosing to investors:

* Purpose of bond offerings was to raise investment money

* Proceeds would be invested in the Orange County Investment Pool

* Information about pool’s investment strategy

* Information about pool’s declining results in 1994


* Seeking a cease-and-desist order to prevent future fraudulent conduct

* No monetary fines are being sought

* Newport-Mesa Unified School District has settled, agreeing to the order without admitting or denying SEC findings



Notes Issued


April 8, 1993: $66 million

July 8, 1993: $25 million

April 5, 1994: $95 million


May 6, 1993: $60 million

July 27, 1994: $62 million


Notes issued

Irvine Unified School District

June 14, 1994: $55 million

Newport-Mesa Unified

School District

June 14, 1994: $47 million

North Orange County Community College District

June 14, 1994: $56 million

Orange County Board of Education

June 14, 1994: $42 million

Source: U.S. Securities and Exchange Commission; Researched by JANICE JONES DODDS / Los Angeles Times