PLAYING THE MARKET
Late in July of last year, the Maricopa County Board of Supervisors held a special meeting. It was time to churn some debt.
Periodically during the previous two years, the county had developed an unfortunate habit of running out of cash to pay its bills. When that happened, the supervisors were called upon to move millions of dollars between funds, patching over the shortfalls.
On July 26, 1993, the supervisors met to shuffle sizable amounts of money.
That day alone, the five-member board would approve $128.8 million in short-term debt--equaling about one-tenth of the county's entire budget--to meet the county's pressing financial needs.
And on that day, the Maricopa County Board of Supervisors, led by former board chairman Jim Bruner, may very well have committed federal securities fraud.
Since New Times reported the full depth of the county's financial crisis four months ago--showing that Maricopa County had racked up nearly $100 million in hidden debt by using short-term credits--the county's financial meltdown has become a public matter.
The bills have come due for three years of county deficit financing. During that time, budget documents show, the county borrowed money it could not repay, using inflated guesses of each year's tax revenues to justify its action.
Most of the appointed county officials who oversaw the debt spree, including former county manager Roy Pederson, have been run off. A new management team is battling to bring the finances back under control.
The cleanup will be painful. A tax increase is likely in the next two years, although the supervisors continue to downplay that possibility. County employees have been laid off. Parks are closing, health services face the ax and the budgets of county departments are being pared to cover the tens of millions of borrowed dollars that must be paid back.
Supervisors have even been forced to consider selling the seat of county government--the downtown County Administration Building--for cash. While that embarrassment has been avoided, the county is planning to effectively take out second mortgages on two of its jails.
And it turns out that part of the financial sleight of hand that sank Maricopa County into this mammoth sea of debt may well have been illegal.
You are deeply in debt. You go to the bank and apply for a loan, saying you want money to buy a house. As you fill out the myriad papers that the bank requires, you neglect to mention that you owe a truckload of money on your credit cards. The bank doesn't catch on, and you get the cash.
Instead of buying a house, you use the money to pay off your other debts.
You have just committed fraud.
Although the mechanics are more complex, Maricopa County essentially played the same deceptive game last summer.
As part of a creative financing package that was taken before the Board of Supervisors last July, county officials asked for permission to sell $25.5 million worth of general obligation bonds. Those bonds had been approved by voters in 1986, but had not been brought to market.
After approving the sale of the bonds, the board promptly turned around and voted to lend the money to the general revenue fund to help cover daily operating expenses. (The money was to be paid back to the general obligation fund later, with interest.)
The bond money, of course, was supposed to be used to build specific projects--parks, jails and the like--that had been approved by the voters. But today, more than a year after the bond issue, none of the $25 million has bought a single brick, board or nail.
Instead, the money has been used as a cash pool for the county to dip into whenever it runs short of money. County officials, in fact, went on to promise one New York bond-rating agency that the county would deliberately not spend any of the money on capital projects for at least one year.
In and of itself, investing money obtained in a bond sale is not illegal. In fact, investing general obligation money so it can earn interest is a common government practice.
But in order to sell bonds, any government--including Maricopa County--must print a lengthy "Official Statement" that explains to potential investors what the borrowed money is going to be used for and what the financial condition of the government is at the time.
The Official Statement approved by the Board of Supervisors that day in July was a lie. It did not reveal that the bond proceeds were going to immediately be used to cover the county's operating deficit, and would be used for that purpose for more than a year.
Nor did it reveal that the county was engaged in a dangerous cycle of short-term credit that had plunged it into debt and threatened the very financial health of county government.
Investors would rely on the Official Statement to decide if the county's bonds looked like a safe place to put their money. But the statement did not tell them the truth about the county's financial situation.
In fact, the statement did not mention at least $100 million in county debt.
"That may be a real problem, between you and me," says a Washington D.C.-based municipal-bond-market insider. "That's the kind of thing that the Securities and Exchange Commission gets real excited about."
Four supervisors--chairman Jim Bruner and board members Ed King, Tom Rawles and Mary Rose Wilcox--voted for the potentially fraudulent bond issue. Board member Betsey Bayless, now chair of the board, abstained, because she is vice president of Peacock, Hislop, Staley & Given, the company that acted as financial adviser for the bond sale.
Bayless' company, in fact, had signed off on the Official Statement before it was presented to the board for a formal vote. So had Fred Rosenfeld of the Gust Rosenfeld law firm, the county's longtime bond counsel.
Rosenfeld steadfastly contends that there was nothing illegal about the Official Statement. However, Larry Given, president of Peacock, Hislop, Staley & Given, says it is now clear that the county's operating deficit should have been revealed to investors.
But Given and several others involved in the issue say no crime was committed, because they simply did not know about the debt at the time they drafted and approved the Official Statement.
"If we had known that we had that deficit, then we would have had to disclose it," says Rawles, who had been on the board for six months when the bond issue was approved. "[But] we didn't know it at the time."
Everyone involved in the bond transaction--at least, everyone who responded to New Times' inquiries--believes that nothing illegal was done. (Bruner, who resigned from the board earlier this year to run for Congress, could not be reached for comment. Paul Walker, his spokesman, said the candidate's schedule did not allow time for an interview.)
But other experts and attorneys say the county probably did break one of the commandments of federal securities law--full disclosure.
Generally, the Securities and Exchange Commission polices only private companies, snooping about for market shenanigans that might leave investors fleeced. They look for the Charles Keatings of the business world.
Most of the SEC's rules and regulations, in fact, do not even apply to governments that issue bonds.
"In general, municipal bonds are exempt from our regulations," says Thomas C. Newkirk, associate director of enforcement for the SEC. "They don't need to be registered with us. The [Official Statement] doesn't need to be run through us."
But one crucial SEC law does apply to governments--Rule 10 of the Securities Act of 1933.
It is the SEC's "antifraud" law, and it requires that the prospectus--or Official Statement--for a bond issue be complete and truthful.
"You can't make a material misstatement in connection with the purchase or sale of a security, and you can't omit to state things that are necessary to make the statements not misleading," Newkirk says.
In short, the Official Statement must tell the truth and the whole truth. It cannot lie about, or fail to disclose, any information that is "material."
"What is material has been defined by the Supreme Court as being something that would influence a reasonable investor in deciding whether to buy, sell or hold a particular security," Newkirk says.
Like, perhaps, tens of millions of dollars in debt?
"That could be something," Newkirk says. "I don't want to get involved in giving an opinion on a particular matter."
The Official Statement for Maricopa County's 1993 bond sale is a weighty and detailed document numbering almost 100 pages. It includes a raft of information that county staff and advisers apparently did consider "material."
It lists, for instance, population statistics, the number of hotel rooms in the county, the major employers and the amount of money tourists spend here each year.
The plethora of rosy information about the county's economic base presumably was included to assure investors that Maricopa County bonds were a warm, safe place to put their money.
But two potentially material facts were not included in the otherwise exhaustive document:
The bonds were being issued to cover short-term debt, not to immediately pay for capital-improvement projects, as stated.
The very reason the county needed to borrow the money for operating costs was its awful financial condition.
Fred Rosenfeld, the county's bond counsel, who signed off on the 1993 sale, would broach little discussion of whether the Official Statement was misleading or potentially fraudulent.
"I will not answer any question on materiality under any circumstances," Rosenfeld says. "That would not be helping the county at all if I did that. There is no one who can answer the question you are asking. . . . It would take a court to render that for you."
Rosenfeld did say that a statement summarizing the county's finances was attached to the Official Statement, and the statement provided full information on the county's financial condition. "I have been told that these deficits do appear in those financial statements," the county's bond counsel says.
(After a brief conversation, Rosenfeld insisted that he wanted the interview retroactively considered off the record. Told that that would not be an option, he ended the conversation.)
In fact, the county's financial statements did not reveal the deficit.
Misleading financial statements are among the reasons the county ended up in the mess that it is in, several county officials and advisers agree.
Even Larry Given, president of the financial-advice firm that approved the 1993 statement, now says that the financial information included in it was misleading.
"We were misled, and everybody else in the world was, also," Given says. "If the board can't figure it out, and I can't, how is anyone else supposed to figure it out?"
In defense of issuing the misleading Official Statement, Given and others involved in the sale resort to a circular argument: The county finance staff was lying to them about the financial problems; therefore, it was not fraudulent to include those lies in the Official Statement.
"We did not know at the time that there was this crisis going on," Given says. "We couldn't divine by telepathy what was happening. If all that is known now was known then, there would have been something in the Official Statement."
Rawles, one of the supervisors who voted for the bond issue, acknowledges that an operating deficit would have been "material" if he and other board members had known what was really going on with the county's finances.
"If we had known that we had that deficit, then we would have had to disclose it," Rawles says. The ignorance defense has been a common refuge for board members ever since the full scale of the county's financial problems came to light. Bruner, the former board chairman, has repeatedly insisted that he did not know that the county's financial staff was cooking the books to hide deficits.
But if board members were in the dark about the exact size of their budget woes, then they missed or ignored plenty of warning signs that had cropped up before they approved the 1993 bond sale.
Jim Bruner, a financial and estate planner for the state's largest law firm, served for five years on the Board of Supervisors, including two one-year stints as chairman. In January 1993, he took the helm for the second time.
He lauded county administrators for their performance, particularly then-county manager Roy Pederson, whom Bruner had hand-picked in 1990 for the top appointive post.
"The county has instituted a strategic plan for the first time," Bruner said in his speech marking the beginning of his second stint as chairman. "As Mark Twain said, 'How do you know where you are going if you don't have a map?' We know where we are going as a government, and we now have a plan for getting there."
Six months later, the map would be in tatters, and the county was headed for the poorhouse.
Indeed, for the previous two years, the county seems to have been walking a financial tightrope that Bruner and others say they didn't notice.
Multimillion-dollar operating shortfalls would crop up and then be covered quickly by borrowing from funds meant for other purposes, like highways or the flood-control district. Budgets would suddenly have to be slashed at the end of fiscal years, because there wasn't enough revenue coming in.
The revenue projections by the county finance office, then led by Ray Smith, kept turning out to be too high, sparking frequent scrambles to get the budget back in balance.
In February 1993, one month after reascending to the chairmanship, Bruner himself was forced to rush to Governor Fife Symington to ask for money. The county was on the verge of bouncing checks, a crisis averted only when Symington agreed to an emergency release of $60 million in state funds.
The constant scrambles for cash were making some people nervous, especially newly elected County Treasurer Doug Todd, who took office in January 1993.
After looking at the books, Todd began a crusade to convince anyone who would listen that the county was, in fact, running up debts that it couldn't pay and that were being obscured in the county's financial books.
Todd told Pederson, Bayless and others that the county's books were cooked months before the board voted on the 1993 bond issue.
Clearly, board members were at least suspicious of problems. The week before the bond issue was approved, finance director Smith resigned under pressure after an audit showed problems in the finance department.
Taken together, here is what any interested supervisor could have known on July 26, 1993, the day the board sat down to approve the bond sale:
The county treasurer had discovered that the finance staff was cooking the books, and that tens of millions of dollars of debt had built up.
The county's finance chief had been run off because of problems with his office.
Repeatedly, the board had been asked to move funds around to cover operating shortfalls.
That very day, the board was being asked to approve a staggering $128.8 million in short-term debt, including $25.5 million in bond sales, so the cash could be used to loan money to the general fund.
What the supervisors claim eluded them--that the county was running a deficit at the time--did not long elude the bond-rating agencies that pass judgment on the county's financial strength.
Within weeks, analysts from Standard & Poor's and Moody's Investor Services were in town to look over the situation, and they did not like what they saw.
Both agencies subsequently downgraded the county's bonds because of the financial problems.
After the bond sale was approved, Todd says, he again tried to tell officials that the Official Statement was misleading, because it contained phony numbers on the county's financial health.
"At that time, we mentioned to a number of people that the deficit was considerably more than they were even talking about," Todd says. "We told them that some of the numbers in the [Official Statement] were phony, but that was not acceptable to them."
Todd says he was scheduled to meet with the visiting bond raters, and planned to tell them his concerns about the Official Statement. But the scheduled encounter never took place.
After meeting with other county finance officials, Todd says, the bond raters never quite made it by his office. "We were expecting a visit from them, and they never got here," Todd says.
Chris Mushell, Moody's assistant vice president for the Southwest region, says he remembers that he and others were scheduled to meet with Todd, but does not recall why the meeting was canceled.
Mushell, whose job is to take the financial pulse of Maricopa County, says he is not concerned about the Official Statement that was issued in 1993. The money will eventually be spent for capital projects, he says, and the bondholders will be paid off in time.
He describes the situation, effectively, as no harm, no foul.
But Mushell's counterpart at Standard & Poor's, David Hitchcock, is not as sanguine about the 1993 statement. Although he would not pass judgment on whether the bond issue was fraudulent, Hitchcock says it doesn't look good in retrospect.
"An Official Statement should say if money from the bond proceeds is going to ultimately end up in operations," Hitchcock says. "If the ultimate goal is to use deficit financing for operations, that should be disclosed. And the [county's] financial condition should always be adequately disclosed in the Official Statement."
If the Official Statement were deemed to be misleading, the Securities and Exchange Commission has the authority to halt trading of the bonds. The federal government could pursue civil or criminal charges against the county, although SEC officials would not discuss the likelihood of such a prosecution.
The county could also be sued by investors who purchased the bonds, and who now feel the county's deception cost them money.
And the county's failure to disclose the truth in 1993 may well have caused some financial damage. Although no one doubts that the bonds will be paid back eventually, bondholders might have lost money in two ways.
First, bonds typically must pay higher interest rates to attract investors if they receive a low bond rating. People who bought the 1993 bonds bought them at the going interest rates for double-A-rated bonds.
Now, however, the bonds are rated single-A. Had they known the rating might drop because of the county's ongoing financial problems, investors could have demanded higher rates in 1993 or stayed away from the bonds altogether.
Second, a drop in bond ratings causes the actual value of the bonds to go down. Investors who wish to resell the county bonds might not get the price they paid for them.
Lawyers and experts would have to determine the possible damages caused by the incomplete Official Statement.
What is more clear are the county's moves to avoid repeating the deception.
The next time you drive by the Estrella Jail on West Durango Street, or the county's juvenile court and jail in Mesa, appreciate them.
Maricopa County taxpayers will pay for the buildings twice.
As the county tries to work its way out of the hole, it must continue to juggle debt against immediate cash, and also must continue to turn to capital-bond funds and other credit tricks for help.
Because the county's financial problems are so well-known, however, the financial shell games are now being conducted in the open.
This week, for instance, the county was scheduled to raise $30 million in cash by taking out the equivalent of second mortgages on the two jails. The loans will be paid back over ten years, with interest.
At the same time, taxpayers will continue to pay off, with interest, the general obligation bonds that were issued to build the two facilities in the first place.
The board initially considered selling the County Administration Building to raise money, but mortgaging the jails proved to be a more attractive option, says Deborah Larson, the new finance czarina brought in to clean up the county's fiscal mess.
By borrowing money elsewhere, Larson says, the county should be able to free up the $25 million in bond money that was siphoned off in 1993, so that the capital-improvement projects the money was supposed to pay for can finally get under way.
In early June, the county again had to monkey with outstanding general obligation bonds to ease its cash-flow problems.
This time, the board refinanced $26.4 million worth of bonds that had already been sold. Some of the notes were coming due for payment, and the refinancing will allow the county to put off paying principal on the notes for two years.
The money saved can then be used in the ongoing efforts to float the county's budget off the rocks.
Like all bond sales or refinancings, the June 1994 refinancing required the county to issue an Official Statement for possible investors to read.
It is a strikingly different document from the Official Statement written in 1993, before the departures of Bruner, Pederson and Smith.
First, it clearly states that the purpose of the refinancing is to help out with debt problems. One section, titled "The County's Operating Deficit," clearly outlines the budget problems and explains how the new county finance staff hopes to work its way out of them.
An accompanying chart details operating budgets dating back to 1992, long before the potentially fraudulent 1993 bond issue was approved.
In effect, experts say, the county admits in the more recent statement the information that should have been disclosed much earlier.
Mushell and Hitchcock, the two bond raters who watch Maricopa County's finances most closely, say they are mildly encouraged by the county's newfound financial openness.
But digging out of the hole, unfortunately, will require more debt up front.
"I think they're on the right track," Mushell says. "The hard part is, it's a long track. When you don't have money, it costs much more to get money than when you do have money.
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