The Orange County Grand Jury’s findings on Mello-Roos bonds are not shocking because government can always use more accounting and oversight, said Lewis Feldman, a partner in law firm Goodwin Procter’s Los Angeles office.

LOS ANGELES — An Orange County, Calif. civil grand jury report criticized the oversight of $2.7 billion of debt issued by community facilities districts in the county.

The report has resonance for hundreds of so-called Mello-Roos districts throughout the Golden State.

The Mello-Roos Community Facilities Act creates somewhat of a public-private partnership between developers and cities to get backbone infrastructure such as streets, sewer and water into new developments. It also helps fund construction of new schools in areas where large single-family developments are planned.

The Orange County civil Grand Jury in its June 29 report described a "lack of transparency, a lack of oversight and auditing, and the lack of an end date [for special district taxes]," said Lewis Feldman, a partner in Goodwin Procter's Real Estate Capital Markets Group.

California civil grand juries are made up of volunteer citizens charged with investigating local governments to recommend improvements.

"Bonds can't be issued for more than 40 years, but the tax might not sunset," Feldman said. "I tend to think the oversight wasn't very well developed when the legislation was created."

No statewide entity appears to be contemplating the issues of transparency and oversight raised in the Orange County grand jury report, which would also apply elsewhere in the state.

In fiscal 2013, 891 California CFDs had $16.1 billion in Mello-Roos bonds outstanding, according to an annual report the California Debt and Investment Advisory Commission issued in September 2014.

Mello-Roos debt landed in an unwelcome spotlight this year after $1.3 million in Mello-Roos bond proceeds were embezzled from a San Francisco conduit issuer.

The Task Force on Bond Accountability State Treasurer John Chiang formed after the embezzlement "will undoubtedly deal with some of the issues mentioned in the OC Grand Jury report, but the work of the Task Force is not yet complete and it has not been tasked with responding to the OC Grand Jury's findings," said treasurer's office spokesman Drew Mendelson.

The task force was expected to have a draft report out by the end of this month.

The Mello-Roos Community Facilities Act was enacted in 1982 as a way for developers and cities to share the cost of building infrastructure such as streets, sewer and water lines.

A local government issues bonds for the special district to finance initial infrastructure costs that are repaid by special taxes assessed on homeowners and commercial property owners after the development is built.

To create a CFD, a two-third vote of property owners is required, but since such districts are created prior to construction of a development, the only vote ends up being that of the original developers.

"The vast majority of the CFD's in Orange Country are created and debt incurred before any of the ultimate taxpayers acquire their property," according to the grand jury report. "There is little oversight of CFD's revenue, expenditures, and debt management by the public."

The jurists contend that funding "is not readily transparent and therefore not generally understood and its consequences are not appreciated by the general public."

The Mello-Roos law was developed after 1978's Proposition 13 cut local property tax revenue, making it hard to finance infrastructure for new development.

Land developers saw the opportunity to use CFD funding to relieve them of the expense of building infrastructure improvements, according to the grand jury. It also allows developers to reduce the prices on homes, because they do not have to include the cost of infrastructure in the prices of homes. Cities and school districts saw the opportunity to use CFDs to obtain an additional funding source for infrastructure and schools in newly developed areas.

Southern California-based CFDs "remain the top issuers of land-based debt, accounting for more than 67%, or $10.8 billion, of all outstanding Mello Roos bonds," according to CDIAC.

The counties with the highest totals of Mello-Roos bonds outstanding are: Riverside County with $3.8 billion, or 24%; Orange County with $2.7 billion, or 17%; and San Diego County with $1.7 billion, or 10%, according to the CDIAC report.

There is no requirement that the special property tax imposed by a Mello-Roos district be apportioned based on benefit to any property owner. In addition, there is no requirement the financed facilities be physically located within the CFD.

After bonds are paid off, the grand jury wrote, the CFD tax may continue to be collected for maintenance of the facilities. In many instances, CFDs can refund bonds to take advantage of lower bond interest rates and then use the interest rate savings to create revenue to be used for other purposes. That proviso will reset the 40-year period and potentially the CFD will continue in perpetuity, according to the grand jury.

The district's taxing authority, which is supposed to expire when the debt is repaid, often continues in perpetuity, according to the grand jury report.

"The bottom line is that there is a lot of confusion and the consumer/homeowner doesn't quite understand the features of Mello-Roos," Feldman said. "There isn't a lot of oversight - and there isn't an understanding by homeowners as to why these are used in some places, and not in others."

The State Controller's office has conducted audits on specific CFDs, but is constrained from conducting a comprehensive audit covering all of the state's CFDs, according to John Hill, a spokesman for Controller Betty Yee.

"The State Controller is certainly a public advocate for transparency and informing the public on all things fiscal," Hill said. But when it comes to audits of government entities, Hill said the controller is "very constrained" by authority and personnel.

"Almost all of our auditors are dedicated to audits required by statute, as opposed to discretionary audits," he said. "And, we must have a statutory basis for launching an audit - the entity, for instance, must receive state funds, which I understand not to be the case with many of these CFDs."

The Orange County Grand Jury also took CDIAC to task for not including bond payment amounts, interest rates or administrative costs in its reports.

The grand jury also reported that the state does not require a complete accounting of the use of the bonds.

"CDIAC collects data on debt issues (taken in the aggregate, not on individual maturities within the issue), thus it does not have granular interest rate data," according to the State Treasurer's Office.

"Bond payment amounts are available in several places, including the official statement, Bloomberg, The Bond Buyer report of sale, Thomson Reuters, and several other data agencies," Mendelson said. "Administration costs are subject to change as circumstances dictate. Even if CDIAC did collect them, they would necessarily be presented in "static" form," he said.

"Orange County does not require a complete accounting of the use of CFD funds so that the homeowner can determine if the funds are being properly used," the grand jury wrote. "There also is no requirement to publically reveal maintenance or administrative costs."

While the report raised some telling questions, Feldman found it short on specific examples of items the grand jury took issue with in the report.

"They just surveyed the major cities and districts and came out with a report totaling long term debt, and how the debt is all out there," Feldman said. "It is long on language, but short on specifics.

"In many respects, it leaves open a lot of questions they went in there to understand," Feldman said. "Without specifics, it is hard to say how they support their conclusions."

Feldman said the conclusions are not shocking, because government can always use more accounting and oversight.

But Feldman acknowledged that the application of Mello-Roos is better understood by the development community than by much of the public that has to assume the payments and repay the debt.



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