SAN FRANCISCO — A small California school district said its financial advisor "duped" it into overpaying hundreds of thousands of dollars for services in a lawsuit that is playing out amid controversy in the state over school bond election and borrowing practices.
Advisory firm Caldwell Flores Winters, Inc. sued Willits Unified School District for breach of contract, resulting in a counter-complaint from the Mendocino County district with 1,800 students.
Critics say the legal dispute has uncovered questionable, if not illegal, practices.
"To me it is just outrageous, forget about fiduciary duties, that any advisor would ask to be compensated in this manner," said Timothy Schaefer, owner of Magis Advisors, an independent municipal financial adviser in Newport Beach, Calif. "I am struggling to find words because it is so over the top."
In April 2012, Caldwell Flores Winters sued Willits Unified for failing to pay the financial advisor $278,961.
The district in December filed a cross-complaint against CFW that alleged violation of state conflict of interest laws, the state political reform act and breach of fiduciary duty.
Willits Board of Trustees members said they felt "duped" by CFW as the district teetered on insolvency, according to meeting minutes.
Neither school district officials nor their lawyer returned calls for comment.
The advisory firm convinced district officials to seek a bond authorization well beyond what the district would legally be able to issue because the larger figure would generate more fees for Caldwell Flores Winters, the district argues in its lawsuit.
CFW was hired in 2009 to advise the school district on the bond program that led to the issuance of four series of bonds totaling $18.87 million in July 2010, which will cost $38.6 million in debt service. The sale included $3.78 million of capital appreciation bonds that will cost $21.9 million at maturity, the official statement said.
That series also included a $4.97 million bond anticipation note with 5% interest due July 2014, which the district has been scrambling to figure out how to pay. It has considered further borrowing to pay off the debt.
Willits alleges in the suit that CFW recommended the highest amount of bond authorization for which to ask district voters out of four options, with the lowest being $28 million.
This, Willits Unified argues, represented a conflict of interest because CFW influenced a decision that directly affected its compensation, which is generally banned by state law. The contract also represented a breach of fiduciary duty.
The district's complaint said CFW initially assumed a $29 tax rate per $100,000 of assessed valuation in the district, which would have supported $23 million of bonding. Even though it was aware that assessed values had dropped in the district after the election, CFW charged Willits a 2.5% fee for the $43 million capital program it advised the district to adopt even though only $18 million was available to fund school construction, according to the cross-complaint.
That fee — $1.075 million — was due in 36 monthly installments after the bond election passed. CFW sued after Willits cancelled the contract, seeking six months of payments plus a $108,993 cancellation fee for a total of $278,961, according to CFW's complaint.
Neither CFW nor its lawyers returned calls for comment.
Even if the district eventually can issue the full $43 million authorization for its construction projects, it would be long after the contract with CFW would have expired, the district argued.
The fee for advising on the capital program was based on a $43 million program that was impossible to achieve, the district argues in its cross-complaint, the district is not obligated to pay the full sum. "CFW knew it could perform program implementation services for only approximately $18 million of the bond projects during the five year term of the contract," the cross-complaint said.
CFW was paid more than $200,000 for financial advisory services and another $185,000 for the implementation of bond projects, the district said.
CFW was also paid $15,000 for conducting voter surveys.
The complaint also alleged that CFW did not advise that the district needed to hold competitive process to select CFW to provide construction management project services.
"CFW performed acts herein alleged with the intent to deceive the district so as to engage in self-dealing and to generate extraordinary and unwarranted fees," the district's lawyer, William Ayres, said in its complaint.
Mendocino County Superintendent of Schools Paul Tichinin, who has advised the Willits district on its troubled finances, said in a phone interview that Willits has suffered from declining assessed valuations, lower property values and a terrible economy.
Tichinin said the district is trying to find ways to pay for bond anticipation notes that are due next year amid falling tax revenues.
"The fiscal status of the district is independent from the bonds other than causing worry and concern," Tichinin said.
In March, the Willits district was one of 117 in the state to receive a "qualified certification" from the California Department of Education" meaning that based upon current projections, the district is in danger of failing to meet its financial obligations in the next three fiscal years. An additional seven districts received the more serious "negative certification."
California Treasurer Bill Lockyer's office said he is troubled because CFW had a financial interest in recommending the highest bond authorization.
"If that doesn't violate conflict of interest laws, it should," said Tom Dresslar, Lockyer's spokesman. "This is the kind of stuff that is giving school bond finance a bad name."
Lockyer has been trying to limit schools' ability to issue capital appreciation bonds, arguing that they cost taxpayers too much for too long.
According to the treasurer, from 2007 to November 2012, CFW made far more money from California school bond sales that included capital appreciation bonds than any other financial advisor firm.
Dresslar also pointed out that it was questionable that the district paid CFW $15,000 for pre-election voter surveys.
Lockyer sent letters in March to Attorney General Kamala Harris asking her to give an opinion on the roles of underwriters, financial advisors and bond counsels in school bond elections.
The SEC's office of compliance inspections and examinations is also conducting an investigation that may be looking at the involvement of some muni advisors in bond ballot campaigns that could violate the fiduciary duty standard and fair-dealing rule.
Caldwell Flores Winters was also paid thousands of dollars as a campaign consultant by the election committee in support of the $43 million of bond authorization. The committee also received donations from the underwriter on the bond sale, Stone & Youngberg, and the bond counsel Jones Hall, according to county election filings.
CFW also negotiated the bond sale fees with the underwriter, as outlined in the contract included in court documents.
Last year The Bond Buyer reported some advisors were helping California school districts by serving as consultants to bond ballot campaigns, and then as financial advisors on the bond deals approved by voters.
State Assemblyman Don Wagner, R-Irvine, has proposed legislation that would prohibit a local agency from working with an individual or firm on any bond deal if they provide services to the bond election campaign.
Similar bills have been put forward and failed in the last few years. Wagner said he hopes the new attention on the subject will help get more support this year. Maybe this is the year.