SEC Complaint Charges Victorville With Defrauding Airport Bond Investors

(May 3) Los Angeles—The Securities and Exchange Commission on April 29 charged the city of Victorville, the Southern California Logistics Airport Authority, assistant city manager and former director of economic development Keith C. Metzler, the airport authority’s bond underwriter and the bond underwriter’s owner and vice president with defrauding investors by inflating valuations of property securing an April 2008 $13.3 million municipal bond offering.
Metzler, the Carlsbad-based bond underwriting firm of  Kinsell, Newcomb & DeDios, the firm’s owner J. Jeffrey Kinsell, and the firm’s vice president Janees L. Williams were responsible for false and misleading statements made in the airport authority’s 2008 bond offering, the SEC alleged. It also charged that the bond underwriting firm, working through a related party, misused more than $2.7 million of bond proceeds to keep itself afloat.
“Financing redevelopment projects by selling municipal bonds based on inflated valuations violates the public trust as well as the antifraud provisions of the federal securities laws,” said George S. Canellos, co-director of the Securities & Exchange Commission’s Division of Enforcement. “Public officials have the same obligation as corporate officials to tell the truth to their investors.”
Elaine C. Greenberg, chief of the SEC’s Municipal Securities and Public Pensions Unit, said, “Investors are entitled to full disclosure of material financial arrangements entered into by related parties. Underwriters who secretly line their own pockets by taking unauthorized fees will be held accountable.”
The Securities & Exchange Commission (SEC) alleges the airport authority, which is controlled by the city of Victorville, undertook a variety of redevelopment projects, including the construction of four airplane hangars at the former George Air Force Base, which was being converted to civilian use as Southern California Logistics Airport. The airport authority financed the projects by issuing tax increment bonds, which are solely secured by and repaid from property-tax increases attributable to increases in the assessed value of property in the redevelopment project area.
According to the SEC’s complaint filed in U.S. District Court for the Central District of California in Los Angeles, by April 2008, the airport authority was forced to refinance part of the debt incurred to construct the hangars, and other projects, by issuing additional bonds. The principal amount of the new bond issue was partly based on Metzler, Williams, and Kinsell using a $65 million valuation for the airplane hangars even though they knew the county assessor valued the hangars at less than half that amount, according to the SEC.
“The 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 Air Force base,” according to the SEC complaint. “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.
“In February 2008, in an effort to escape from this financial constraint, the authority borrowed $35 million in short-term financing,” the complaint continues. “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 KND [Kinsell, Newcomb & DeDios] investment bankers —defendant Jeffrey Kinsell, the owner of KND, 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.”
According to the SEC complaint, “On January 18, 2008, Metzler forwarded an email he received from the assessor’s office to Williams showing it had assessed the values of hangar Nos. 1 and 2 at an aggregate value of only $8,779,000 for the 2007-2008 fiscal year, and $8,955,000 for the 2008-2009 fiscal year. The assessor’s office also informed Williams that it had not yet assessed the value of Hangar Nos. 3 and 4. These assessment figures undermined the $65 million estimate for all four hangars. Under this assessment, the remaining two hangars (Nos. 3 and 4) would have to be valued at approximately $56 million alone for the previously provided estimate for all four hangars of $65 million to have any validity. But the remaining two hangars could not be assessed at over $56 million. The four hangars were too similar for such a disparate valuation to be possible. Nevertheless, Williams and Metzler used the $65 million assessed value for all four hangars. Metzler included the $65 million value in a draft of the spreadsheet he prepared in advance of a conference call with the bank, Williams, the authority’s counsel and others. Williams emailed the Metzler spreadsheet to the meeting participants, as well as to Kinsell. The Metzler spreadsheet reflected: (1) the estimated $65 million assessed value for all four hangars for the 2008-2009 fiscal year; and (2) the $56,221,000 hangar valuation available for bonding in 2008-2009 (i.e., the $65 million estimated assessed value for the hangars in 2008-2009 minus the $8.779 million assessed value for Hangars No. 1 and 2 in 2007-2008 ).  The consultant relied on the $65 million estimated assessed value  Metzler provided for the hangars when it conducted its tax increment analysis.”
The inflated figure allowed the airport authority to issue substantially more bonds and raise more money than it otherwise would have, the SEC maintains, such that  a consequence of the city’s inflated valuation of the hangars was that  investors were given false information about the value of the security available to repay them.
In addition, the SEC’s investigation found that Kinsell and another of his companies misappropriated more than $2.7 million in bond proceeds that were supposed to be used to build airplane hangars for the airport authority. According to the SEC’s complaint, the scheme began when Kinsell learned of allegations that the contractor building the hangars had likely diverted bond proceeds for his own personal use. When the contractor was removed, Kinsell stepped in to oversee the hangar project through another company he owned, KND Affiliates, LLC, even though Kinsell had no construction experience.
The SEC alleges that the airport authority loaned KND Affiliates more than $60 million in bond proceeds for the hangar project and agreed that as compensation for the project, KND Affiliates would receive a construction management fee of two percent of the remaining cost of construction. However, Kinsell and KND Affiliates took an additional $450,000 in unauthorized fees to oversee the construction and took $2.3 million in fees that the airport authority was unaware of and never agreed to, purportedly as compensation to “manage” the hangars, the SEC alleges.
“By mid-2006, the authority and Kinsell learned of allegations that the developer for the hangars project had not been paying the subcontractors and that the developer’s principal had likely diverted some of the bond proceeds from the project for his own personal use,” the complaint states. “Kinsell reached a ‘handshake deal’ in June or July 2006 with the executive director of the authority whereby Kinsell, through Affiliates, would oversee the project.  Although that “handshake deal” was never reduced to a written contract, all of the parties understood that it was a ‘cost plus 10% construction management fee’ arrangement. In July 2006, the authority approved Affiliates’ new role, and, over the next two years, made five separate loans totaling $60.38 million to Affiliates.
These loans included $22.2 million lent in August 2006, which was used: (1) to immediately pay over $12 million to disgruntled subcontractors and $6 million to the original developer to resolve various claims; and (2) to pay a portion of the remaining costs necessary to complete the hangars.”
The SEC complaint continues, “Periodically throughout the construction of the hangars, Affiliates paid the new contractor the 10% construction management fee that had been earned as of that date. The contractor retained its 8% share of the fee and “rebated” back to Affiliates the 2% fee owed to Affiliates, totaling not more than $865,990 from October 2006 through October 2010. However, Affiliates actually took at least $1,316,524 as the 2% construction management fee, or at least $450,534 more than the amount that was ‘rebated’ back to it by the contractor. Affiliates simply took this excess – and unauthorized – construction management fee directly from the bond proceeds the authority loaned Affiliates to construct the hangars. Affiliates collected the unauthorized 2% construction management fee based on expenses incurred in August 2006 that had nothing to do with the remaining costs of construction, such as the payments to subcontractors for prior work and the payment to the original developer to settle claims. Thus, before KND underwrote bonds for the authority in November 2006, Kinsell and KND knew, or were reckless in not knowing, that Affiliates planned to charge more than the authorized 2% construction management fee and did not disclose this information to investors.”
The SEC alleges that Kinsell and KND Affiliates hid these fees from the airport authority representatives and from the auditors who reviewed KND Affiliates’ books and records.
The SEC’s complaint alleges that the airport authority, Kinsell, KND, and KND Affiliates violated the antifraud provisions of U.S. securities laws and various Exchange Act and Municipal Securities Board rules. The complaint also alleges that Victorville, Metzler, KND, Kinsell, and Williams aided and abetted various violations. The SEC is seeking the return of ill-gotten gains with prejudgment interest, financial penalties, and permanent injunctions against all of the defendants, as well as the return of ill-gotten gains from relief defendant KND Holdings, the parent company of KND.
Terree Bowers, the attorney representing Victorville, this week told the Sentinel, “It is our position that there are both legal and factual issues [in the complaint] that need to evaluated to put the city’s actions  in proper context to determine if the action described  was actually material.”
Bowers would not comment on whether the actions of Kinsell, Newcomb & DeDios or any of its agents or principals were improper and had victimized the city.
“We’re not going to comment on their conduct,” Bowers said. “We are devoting ourselves to showing the city and its employees did nothing wrong.  We are now evaluating whether we will file a moton for dismissal. I cannot give you anything more substantive  until such time as we file a motion  to dismiss or for summary judgment.
The SEC’s investigation was conducted by Robert H. Conrrad and Theresa M. Melson in the Municipal Securities and Public Pensions Unit, and Lorraine B. Echavarria, Todd S. Brilliant, and Dora M. Zaldivar of the Los Angeles Regional Office. Sam S. Puathasnanon will lead the SEC’s litigation.

Leave a Reply