The trial in the Securities and Exchange Commission’s suit against the City of Victorville alleging city officials and its bond underwriter defrauded bond investors has been delayed at the city’s behest. Proceedings were to have begun more than two weeks ago but the city succeeded in convincing the court to postpone them at least until February 27.
City officials have long maintained that they are anxious for proceedings to get under way so it can be demonstrated that the Southern California Logistics Airport Authority did not, as the federal government contends, engage in a Ponzi-like scheme. According to the original Securities and Exchange Commission (SEC) filing made on April 29, 2013 in U.S. District Court in Los Angeles, the Southern California Logistics Airport Authority used its capacity as a governmental entity to make a cascade of bond offerings and borrowings, with each succeeding issuance or loan being used to debt service previous ones, the final one of which was collateralized by hangars that were knowingly substantially overvalued.
Despite the city’s claim that it wants to see the matter put behind it, the lion’s share of delays in the case have come about as a result of requests by the city, which is the parent agency of the Southern California Logistics Agency and the employer of Keith Meltzler, who is the one individual affiliated with the city who is actually named in the complaint.
Just before the trial was to commence on January 23, the start was moved to January 30. Terree Bowers, the former US Attorney for the Central District of California and member of the international team of prosecutors who presented the cases against Radovan Karadzic and Ratko Mladic before the Yugoslavia War Crimes Tribunal, is currently in private practice and representing the city and the airport authority. Bowers has asked for and was granted an extension so he might receive treatment for an undisclosed medical condition, so that now the trial will, again tentatively, begin on February 27. The defense, collectively, had asked for a longer extension, until June. But the SEC’s lawyers objected, and the judge hearing the case, U.S, District Judge John A. Kronstadt consented to a delay only until February 27, at which time Bowers is expected to be available along with the lawyer representing the bond underwriting firm, Shaun Murphy, whose involvement with a trial now ongoing in Riverside County Superior Court should be concluded by then.
The SEC’s 2013 complaint names the City of Victorville; the Southern California Logistics Airport Authority; Carlsbad-based Kinsell, Newcomb & DeDios; KND Affiliates; J. Jeffrey Kinsell, president of Kinsell, Newcomb & DeDios; Janees L. Williams, vice president of Kinsell, Newcomb & DeDios; and Keith C. Metzler, who at that time was the assistant city manager of Victorville. KND Holdings Inc., parent company of KND Affiliates, also was named as a relief defendant.
According to the complaint, “The Southern California Logistics Airport Authority used tax increment bond offerings to finance a number of ill-conceived redevelopment projects, including the construction of a power plant and four new airplane hangars on the former George Air Force base. By late 2007, it needed $50 million to pay a deposit on a turbine for the power plant, and planned to finance that payment with a new $68 million tax increment bond offering. However, given the tightening credit market and the subordinate nature of the bonds, prospective bond purchasers demanded that the debt service ratio for this offering be increased to 1.25 (from the 1.10 ratio governing prior bond offerings). As a result, the authority was forced to downsize its December 2007 bond offering from $68 million to $42 million. This left the authority with few resources to continue its redevelopment activities. Indeed, by this time, nearly all of the tax increment available to the authority had been used to secure its prior bond issuances.”
Tax increment refers to property tax on property that is committed by a government agency with jurisdiction over that property to pay for public improvements related to that property or to provide debt service to cover bond financing or loans taken out with that property as the security for the bonds or loans. In most cases the proceeds from the bonds are used to make improvements to the property or to provide infrastructure to spur development.
The SEC complaint continues, “In February 2008, in an effort to escape from this financial constraint, the authority borrowed $35 million in short-term financing. It then publicly offered $13.3 million of subordinate tax increment bonds in April 2008 to repay part of that short-term debt. This April 2008 financing was premised, in part, on an assessed value of $65 million for the four hangars. This $65 million valuation was used to determine the all-important tax increment for the April 2008 bond offering, and allowed the authority to satisfy the minimum 1.25 annual debt service ratio for the offering. However, the hangars’ $65 million assessed value was vastly inflated, resulting in the disclosure of false tax increment and debt service ratios in the official statement provided to investors in the April 2008 bond offering. Defendant Keith Metzler, the director of economic development for the city and an agent for the authority, and the two Kinsell, Newcomb & DeDios investment bankers – defendant Jeffrey Kinsell, the owner of Kinsell, Newcomb & DeDios, and defendant Janees Williams – all knew that the assessed value of the hangars was inflated, and, as a result, that the tax increment and debt service ratios disclosed to investors were false. Yet they each withheld this information, resulting in materially misleading disclosures and a substantially oversized bond offering.”
The lawsuit further states, “Kinsell and Kinsell, Newcomb & DeDios also engaged in an additional fraudulent scheme to take undisclosed construction and management fees collected on the airport hangar project. In 2006, the authority retained defendant Kinsell, Newcomb & DeDios Affiliates, LLC (Affiliates), an entity partially-owned by Kinsell, to manage this project. The authority agreed to compensate Affiliates and its contractor under a ‘cost plus 10% construction management fee’ contract. However, Affiliates exploited this fee arrangement by paying itself at least $450,000 more in fees than it was owed. Affiliates further misappropriated $2.3 million of bond proceeds through a fictitious 15% monthly ‘property management fee.’ Affiliates transferred over $1 million of unauthorized property management fees to relief defendant Kinsell, Newcomb & DeDios Holdings, the parent of Kinsell, Newcomb & DeDios. Kinsell, Newcomb & DeDios then used the majority of these fees to finance Kinsell, Newcomb & DeDios’s operating expenses, including payroll. The authority never authorized Affiliates to collect these excessive fees, which Affiliates took from bond proceeds intended to complete construction of the hangars. As a result of the unauthorized construction management fees and property management fees, affiliates misappropriated a total of approximately $2.7 million in bond proceeds.
By engaging in this conduct, the authority, Kinsell, Newcomb & DeDios, Affiliates and Kinsell violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and Section 17(a) of the Securities Act of 1933, and the city, Metzler, Kinsell, Newcomb & DeDios, Kinsell and Williams aided and abetted violations of these antifraud provisions of the federal securities laws.”
In the more than four-and-a-half years since the action was filed, Victorville and the airport authority have been represented by Terree A. Bowers, Adam Bentley, Collin Seals and Karen Van Essen of Arent Fox LLP. Metzler has been represented by Michael D. Torpey, James N. Kramer, James A. Meyers, Kevin M. Askew, Judy Kwan and Blake L. Osborn of Herrington & Sutcliffe LLP. Kinsell, Newcomb & DeDios have been represented by attorneys Shaun Murphy, Mark A. Maasch and Randall S. Polycn.
Early in the case, attorneys for the defense asserted in motions that the hangars were indeed worth what the city said they were worth. If that tactic had worked, it would have greatly compromised the central tenet of the government’s case. Kronstadt in November 2013 ruled that the combined defenses’ overall rationale for dismissing the case against the three defendants was “unpersuasive,” and that the bulk of the matter should go forward.
Kronstadt has ruled that the SEC has not yet presented any convincing evidence to show the city or Metzler improperly gained from their alleged misconduct, which is the basis of the SEC’s prayer for disgorgement, a form of relief seeking restitution of ill-gotten profits from security law violators.
By 2015, Herrington & Sutcliffe were proving to be more aggressive than Arent Fox in propounding that much of what was at the basis of the SEC’s case was action by Kinsell, Newcomb & DeDios.
In a July 2015 filing, however, the SEC asserted Metzler could not logically or credibly lay responsibility for what had occurred at the feet of Kinsell, Newcomb & DeDios or other agents of the city, including city staff assigned to the airport.
The SEC’s lawyers, consisting of Robert Conrad, Theresa Melson, Todd Brilliant, Sam S. Puathasanon, John W. Berry, Kristin S. Escalante, Amy Jane Longo and David J. Vanhavermaat, asserted Metzler was the “point person” most fully focused on the situation at the airport, including the value of its various assets. Metzler played “a significant role” in the bond offerings, according to the SEC, communicating with the bond rating agencies and giving presentations to potential investors. Evidence shows he knew the county assessor valued the hangars at roughly half the amount he represented, the SEC contends.
“Metzler, in his motion, attempts to characterize this case as one about simple ‘mistakes’ that he made while surrounded by a team of professionals who should have fixed the errors instead of him,” according to the SEC. “What he ignores, however, is the compelling evidence of his intentional conduct to hide serious problems regarding the millions of dollars of tax increment that was needed to repay back the authority’s ever-increasing debt load.”
After incurring more than $269 million in debt, the city and the authority in 2008 had exhausted all options involving leveraging available tax revenues. It sought a bridge loan from Deutsche Bank. Deutsche Bank, however, insisted that any possible repayment schedule with it would require the backing of additional bond issuances. When Deutsche Bank requested from the city that it perform a calculation of the property value escalation that would come from new development, the record clearly demonstrates Metzler leapt into the breach, according to the SEC. “Metzler was heavily involved,” the SEC asserted. Though Metzler had documentation clearly indicating substantially lower property values, he hid that reality and conveyed to Deutsche Bank a $65 million estimate on the value which referenced construction costs he knew to be inflated, the SEC said. There were no sales of comparable hangar properties to support that price and there were no pending offers for the purchases of the hangars in question. Thus, the SEC maintains that Metzler knew, or was reckless in not knowing, that there were material misrepresentations in connection to the April 2008 airport bond offering.
There has been a less-than-subtle sundering of the once solid monolithic defense initially put up by the defendants in which the city, the authority, Metzler and Kinsell, Newcomb & DeDios uniformly maintained nothing wrong had occurred such that the city, the authority and Metzler are now suggesting that if the misappropriation of $2.7 million in bond proceeds as alleged by the SEC actually occurred, it was a matter of Kinsell, Newcomb & DeDios pulling the wool over Metzler’s eyes and those of the bond investors. Still, if Metzler proves able to establish that he was not involved, knowledgeable or culpable in Kinsell, Newcombe & DeDios’s diversion of the bond proceeds, this would yet raise questions about his level of competence and the degree to which he failed to live up to his responsibility of providing proper oversight of Kinsell, Necombe & DeDios’s activities.
Despite the SEC’s allegations with regard to Metzler in particular, the Victorville City Council has not lost faith in him. While he had occupied the position of economic development director with the city and had been the agent for the airport authority at the time of the 2008 bond issuance that is at the heart of the lawsuit, Metzler had been elevated to the position of assistant city manager in 2011. The suit did not trigger his firing or even a demotion. Rather, at the end of November 2017, when Victorville City Manager Doug Robertson accepted an offer from the Town of Apple Valley to become town manager there and announced his departure as Victorville city manager effective January 1, the City of Victorville moved in December to appoint Metzler acting city manager.
To date, the City of Victorville has paid Arent Fox and Herrington & Sutcliffe $11 million in preparing the defense of itself, the airport authority and Metzler.