SAN FRANCISCO - California has sued San Francisco-based underwriter Pacific Genesis Group and two of its controlling shareholders for alleged fraud in connection with a number of land-secured bond deals.
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The state Department of Corporations' lawsuit, filed last Thursday, is a first for this agency in connection with a municipal bond offering. The DOC's chief enforcement officer added that the case has prompted greater state oversight of the underwriter and broker-dealer industries, but would not comment on whether other firms are under investigation.
Acting corporations commissioner Brian A. Thompson said in a prepared statement that PGG, its executives, and two land developers allegedly deceived investors by understating and inadequately disclosing the true risks of securities that bankrolled financially distressed developers to build on raw land.
Named in the suit are: PGG president David E. Fitzgerald and his associate Arch V. Zellick; developers Dennes Coombs and Robert Zuckerman; and lawyer William Gnass.
The complaint alleged an "elaborate scheme" to defraud bond investors by failing to disclose developers' true financial condition, their lack of experience, bankruptcies, legal judgments, and encumbrances. Aside from injunctive relief, it seeks unspecified civil penalties under state fraud and securities statutes.
Filed in Sacramento County Superior Court, the suit also questioned whether the Marks-Roos bonds were suitable for the investors who bought them. The state argued investors believed they were buying safe, low-risk bonds when in fact, the debt is precarious because of developers' shaky finances.
Late last week, the DOC tried get a Sacramento County judge to block a $20 million deal PGG was scheduled to sell Friday. But the judge refused to stop the Four Corners Public Financing Authority.
The DOC wants a judge to enjoin PGG from further alleged violations, and for a state-appointed monitor to review the firm's upcoming land- secured deals. A hearing on those motions is set for Dec. 5.
"These revenue bond offerings were mass-marketed to investors who thought they were investing in conservative municipal bonds, and for whom inadequately secured investments in speculative real estate developments masquerading as municipal bonds were wholly unsuitable," Thompson said. "To market these risky and unrated securities, as if they were safe and fully secured municipal bonds, was a misuse and a travesty of the public purpose requirements for municipal securities."
In a press release Thursday, PGG contended that none of the California municipal bonds it has underwritten have harmed any investors, and that the state's case is flawed.
The company noted that at least one of the investors, Hoyt Wheeler, used as an example in the lawsuit as supposedly unsuitable, has retracted his statement in a filing. Fitzgerald in a prepared statement said he expected another to do the same Friday. PGG also accused the DOC of attempting to try the case in the press by releasing misleading statements to the media.
"Pacific Genesis and the other individuals identified in the lawsuit wish to remind the public that this lawsuit is no different than any other claim in litigation," PGG officers said in prepared statement. "The filing of a complaint does not mean that the allegations therein are true."
California Treasurer Matt Fong, who a year ago urged the state and the Securities and Exchange Commission to investigate certain PGG deals, praised the DOC's action. In addition to allegedly defrauding bond investors, he said, the "schemes" could open the door to even more abuses of the Marks-Roos law.
"This lawsuit confirms what I have heard from public officials and citizens throughout the state," Fong said in a press release. "These deals threaten the integrity of local financing practices in general, so I applaud the Department of Corporations for having the courage to file this lawsuit."
SEC officials refused to comment. However, knowledgeable sources said the SEC probably views the PGG matter as particular to California law and won't follow up with any enforcement action of its own. Earlier this year, the SEC concluded an investigation into a PGG deal on a separate issue, and took no action.
G. W. McDonald, assistant commissioner of the DOC's enforcement division, said Thursday he could not comment on whether any other municipal bond firms are currently a target of what he called "a massive fraud investigation." He said the SEC had not asked for the results of the year- long investigation, but said the department would turn information over if requested.
"This is a new set of issues for us because we have always assumed that the reason that municipal securities were exempt securities was because there were inherent checks and balances involved in the way they were offered and sold and packaged," McDonald said. "What we found was that those checks and balances don't work, so we have had to commence a massive fraud investigation in connection with this case, and we are going to have to keep a greater eye on this industry."
Other regional brokers and underwriters who deal in land-secured debt said they were not surprised about the legal action, saying this is an appropriate role for government. They do not expect any backlash from the suit in the market for this type of debt.
