By Mark Gutglueck
Prognosticators are offering varying predictions of the outcome of the upcoming trial to settle the accusation made by the Securities and Exchange Commission in 2013 that the City of Victorville and its bond underwriter defrauded the purchasers of bonds the city issued and marketed to investors.
The matter is set to go to trial on January 23.
Virtually everyone connected with the city maintains that there is no substance to the case, and that in short order the commission’s attorneys will need to dismiss the matter before subjecting the federal government to unbearable embarrassment. The city’s attorneys, however, have not been terribly expansive with regard to what pegs the city’s defense will hang upon. Those attorneys, so far, have been paid $10.87 million in legal fees to engage in legal sparring with the federal government’s lawyers preparatory to the trial. That $10.87 million has purchased a series of legal filings which hinge on relatively arcane interpretations of the law, while circumscribing a set of factual disputes with the federal government, the actual validity of which are hard to discern. For their part, the commission’s lawyers appear determined to proceed, insisting they can establish with far more than a preponderance of the evidence that misrepresentations were made and both city officials and the firm of Kinsell, Newcomb, & DeDios fully appreciated the depth and implication of those falsifications.
Named in the lawsuit are the City of Victorville as well as the entity which controls the airport, the Southern California Logistics Airport Authority, the governing board for which is the Victorville City council; the bond underwriting firm of Kinsell, Newcomb, & DeDios along with the firm’s employees J. Jeffrey Kinsell and Janees L. Williams; and Keith Metzler, who at the time of the Securities and Exchange Commission filing was Victorville’s assistant city manager and who is due to become Victorville’s acting city manager upon the departure of current city manager Doug Robertson, who will become Apple Valley town manager as of January 1.
According to the complaint filed by the U.S. Securities and Exchange Commission [SEC] on April 29, 2013 in U.S. District Court, “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 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 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 , 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, represented by Terree A. Bowers, Adam Bentley, Collin Seals and Karen Van Essen of Arent Fox LLP, and Metzler, represented by Michael D. Torpey, James N. Kramer, James A. Meyers, Kevin M. Askew, Judy Kwan and Blake L. Osborn of Herrington & Sutcliffe LLP, have made more than two dozen motions, a few of which have been granted and more of which have been rejected by U.S. District Judge John A. Kronstadt. Among those coordinated motions was a relatively modest effort to have what Bowers insisted were redundified charges reduced to a single issue. They also entailed a far more substantive appeal very early on to have the entire complaint dismissed before any of the defendants were required to file their answers. Also relatively early in the matter, much of the legal wrangling in the case consisted of the defense asserting 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, however, 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.
One bone Kronstadt threw the defense was his finding that the SEC has not presented any convincing evidence to show the defendants 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, the Herrignton & 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.
Metzler was the “point person” most fully focused on the situation at the airport, including the value of its various assets, 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 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, however, insisted that any possible repayment schedule with it would require the backing of additional bond issuances. When Deutsche 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.
The city and Metzler are going down swinging – if they go down at all. The nearly $11 million that has been spent on Arent Fox and Herrington & Sutcliffe is more than four fifths the proceeds received through the bond issuance at issue in the lawsuit.
One difficulty Metzler faces is that if Herrington and Sutcliffe are able to convince the jury hearing the matter that it was Kinsell, Newcomb & DeDios which perpetrated the violations and pulled the wool over his eyes in effectuating the misappropriation of $2.7 million in bond proceeds as alleged by the SEC, this will establish, or at the very least strongly suggest, that Metzler was negligent in his supervision of the airport operations and its financial affairs.
City manager Doug Robertson recently told the Sentinel, “The SEC case has been arduous, simply because of the time it takes to get to trial. I have said from day one that based on the evidence, I see no wrongdoing by anyone at the city. I believe when we finally get to the courtroom, the SEC case will amount to nothing because there was no wrongdoing and no ill-gotten gains. Obviously, nothing before a jury is a sure thing, but I am absolutely confident the city will prevail.”
By Mark Gutglueck