Four more California school districts have disclosed that they have received preliminary adverse determinations from the Internal Revenue Service for alleged arbitrage violations in advance refundings.
The flurry of disclosures, from six school districts last week, revealed at least nine California issuers are under examination in audits that cover at least $340 million of general obligation refunding bonds sold between 1997 and 2003.
The Centinela Valley Union High School District, the Jefferson Union High School District, and the Pleasant Valley School District said late Tuesday that the IRS had issued them preliminary adverse determinations for one bond issue each, while the Fresno Unified School District said two of its transactions are also under scrutiny.
Preliminary letters precede proposed adverse determinations, which become final 90 days after they are issued if not appealed to the IRS’ office of appeals. Kinsell Newcomb & De Dios Inc., an investment bank with offices in California and Texas, underwrote the deals.
Now-defunct Miller Schroeder Financial Inc. acted as co-managing underwriter on the Jefferson transaction and one of the Fresno deals. Best Best & Krieger LLP of Riverside, Calif., was bond counsel in all of the transactions, rendering the opinion that the transactions complied with tax code restrictions.
Jones Hall PLC of San Francisco served as counsel to the school districts. Jeff Kinsell, the head banker onthe transactions, said Wednesday, that the firm did not earn arbitrage profits and was told years ago by IRS and other regulators "every time to go ahead and do the deals."
"We went through the bidding process and followed their safe harbor regulations. We delivered the Treasuries to [the school districts], to the penny, at the price we won the bids," he said.
IRS officials, firm representatives, and attorneys representing the school districts either could not be reached Wednesday or declined to comment. The four districts’ announcements, made in material event notices filed with the nationally recognized municipal securities information repositories, came on the heels of similar notices from the Delano Joint Union High School District and the Oxnard School District, both of whom a day earlier said they had received preliminary determinations.
Oxnard also said the IRS had opened a separate audit of an earlier refunding deal because it was structured much like the 2001 deal that had been preliminarily declared taxable.
In all of the cases, the IRS is alleging that escrow securities obtained with proceeds from the school districts’ advance refundings were not purchased at fair market value.
The agency also is alleging that the bonds’ yields were computed based on incorrect issue prices, artificially raising the bonds’ yield. Bond yield calculations are important in advance refundings because the tax code requires an issuer to structure its escrow so that the yield is within a certain percentage of the yield on the refunded bonds — otherwise, the escrow earns illegal profits called arbitrage.
Sources with knowledge of the audits speculated Wednesday that the IRS’ tax-exempt bond office could be pushing the group of cases along in audit channels so that they are all at the same point, procedurally speaking. Enforcement agents also could be trying to communicate to deal participants that they are taking the cases seriously, sources said.
The $342.335 million of refunding bonds issued by California school districts that are under IRS examination are as follows, with all but one issue having been the subject of a preliminary adverse determination:
