(October 30) LOS ANGELES—U.S. District Court Judge John A. Kronstadt on October 28 heard oral arguments over whether the Securities and Exchange Commission complaint alleging investor fraud by the city of Victorville and assistant city manager Keith Metzler should be dismissed.
On April 29, the Securities and Exchange Commission (SEC) alleged that fraud was committed by the city, the airport authority and Metzler, who fills the dual roles of assistant city manager and executive director of the airport authority, when misrepresentations were made to the purchasers of bonds, the proceeds from which were intended to assist in the development of Southern California Logistics Airport, specifically with regard to bonds issued in April 2008.
The airport authority was formed by the city of Victorville to facilitate the conversion of the former George Air Force Base, which was shuttered by the Department of Defense in 1992, into a civilian airport. The Southern California Logistics Airport Authority, which has as its board of directors all five members of the Victorville City Council, issued bonds which were sold to investors to generate revenue to be used in making the base’s civilian use conversion.
Fundamental to the SEC complaint is the allegation that the defendants made misrepresentations with regard to the value of four airport hangars that Victorville referenced in its official statement for an April 2008 bond offering. The value of all four hangars was listed at $65 million. The county assessor later valued the hangars at $27.7 million. The SEC alleges that the authority used the inflated estimated values to mislead bond investors.
Two separate responses to the SEC complaint  were filed on August 30, one from attorneys with the law firm of Arent Fox, which represents Victorville and the airport authority and another from the law firm of Orrick, Herrington & Sutcliffe, representing Metzler.
Arent Fox maintains that even if the hangar valuations were overstated, they were not material misrepresentations by which the financing of the bonds in terms of the city’s and airport authority’s ability to continue to make payments to the bondholders was threatened.
Also charged in the SEC’s April complaint were  Kinsell, Newcomb & DeDios Inc., the underwriter for the bond offerings, that company’s owner, Jeffrey Kinsell, and Kinsell, Newcomb and DeDios investment banker Janees Williams.
The SEC complaint consists of nine claims for relief and one prayer for disgorgement. The authority is named in the first two claims for relief. Kinsell, Newcomb and DeDios [KND] is named in the third, fourth and eighth claims for relief. KND and Jeffrey Kinsell are named in the fifth and sixth claims for relief. Victorville, Jeffrey Kinsell, Williams and Metzler are named in the seventh claim for relief.  Jeffrey Kinsell and Williams are named in the ninth claim for relief.
In the prayer for disgorgement, which is a request for restitution of ill-gotten profits from security law violators, all the parties are named.
Orrick, Herrington & Sutcliffe’s James Kramer told Kronstadt that responsibility for any misrepresentations with regard to the value of the assets securing the bonds fell to the bond underwriters. “Metzler provided the correct information to KND in March and April 2008,” Kramer said in presenting a timeline of the bond offering.
Kramer took issue with Metzler having been included in the case altogether. According to Orrick, Herrington & Sutcliffe, “the SEC itself alleges that Mr. Metzler provided the correct hangar valuation information, twice, to KND. In light of this admitted fact, the SEC’s theory of recklessness boils down to the notion that Mr. Metzler engaged in ‘an extreme departure from the standards of ordinary care’ by, in essence, not assuming that KND ignored the updated valuation and failed to pass it along to the [bond marketing] consultant and by not taking it upon himself to check KND’s, and the consultant’s, math. This is not a plausible theory of recklessness, and the SEC points to no case on such facts that says it is. The SEC now tries to distance itself from its own allegations by claiming that it is ‘meaningless’ that Mr. Metzler, on two separate occasions before the April 2008 bond issuance, provided accurate updated hangar values to KND. According to the SEC, Mr. Metzler ‘did not provide this information to the consultant, which he knew needed that information to calculate the important tax increment.’ But in attempting to downplay the importance of its own admissions that Mr. Metzler provided the updated values to KND (and in attempting to overstate the role of the consultant), the SEC ignores its own allegation that ‘KND, as the underwriter, had ultimate authority over the portions of the official statements it prepared, including the false and misleading debt service schedule in the April 2008 official statement.”
Arent Fox maintains that even if the hangar valuations were overstated, they were not material misrepresentations by which the financing of the bonds in terms of the city’s and airport authority’s ability to continue to make payments to the bondholders was threatened.
“Unfortunately for the SEC, the conclusions in the complaint are inconsistent with the mathematical analysis that the SEC had to perform to bring the action in the first instance,” Arent Fox’s reply brief on behalf of the city and the airport authority states. “As a matter of mathematical fact, regardless of whether the alleged misstated hangar value is used ($65 million), or whether the alleged correct hangar value is used ($27.7 million), the debt service ratio remains above 1.25 in either case.”
The SEC stated in its complaint that the market required the 1.25 debt service ratio, and that the issuing agency was required to meet such a debt service burden on an annual basis throughout the life of the bonds. “The credit rating agencies focused on the debt service ratio, and a ratio below 1.25 would have affected the credit quality of the April 2008 bonds,” the SEC complaint states. Had the quality of the bonds been downgraded, the issuing agency, under the standards dictated by the market, would have needed to pay bondholders a higher yield.
The team of defense attorneys representing the city and the airport authority seized upon the standard the SEC cited in its complaint in constructing a legal shield for their clients.  “[T]he SEC’s allegations — taken on their own terms and accepted as true — do not rise to the level of alleged materiality necessary to survive a motion to dismiss,” the defense team, consisting of Terree Bowers, Jerrold Abeles and Adam Bentley, wrote.
The SEC is improperly seeking to delay a consideration of the materiality of the alleged misrepresentation, Bowers, Abeles and Bentley maintain. “[T]he SEC’s opposition attempts to shift the battleground, arguing that the court ‘need not’ consider it now, or that the basic arithmetic supporting it requires a ‘complicated calculus’ of ‘19 pages of complex math,’ as if to suggest that it is too hard to understand,” the defense brief states. “Both of these premises are false. The court should—indeed, it must—decide whether the facts alleged by the SEC satisfy its burden to demonstrate materiality in the complaint. And it must consider the calculations, because that is the only way to determine whether the SEC’s allegations indeed state a claim. In short, the court is both legally and intellectually capable of determining whether the SEC’s complaint adequately alleges materiality. The determination is possible and proper at this stage in the case.”
Arent Fox maintains the inability of the SEC to sustain that material misrepresentations were made to the bond buyers undermines the entire case against the city and the authority.
According to the SEC’s complaint, 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 Elaine C. Greenberg, chief of the SEC’s Municipal Securities and Public Pensions Unit. “The inflated figure allowed the airport authority to issue substantially more bonds and raise more money than it otherwise would have. It also meant that investors were given false information about the value of the security available to repay them.”
SEC investigators say that Jeffrey Kinsell, KND, 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.
Knonstadt is to rule on motions filed jointly on behalf of the city, airport authority and Metzler  to dismiss the first, second, and seventh claims for relief in the SEC’s April 29 lawsuit before the case, with or without those claims intact, goes forward.