First of Two Parts
WASHINGTON — Fluvanna County, Va., and Davenport & Co., its financial advisor for 15 years, are battling each other in a circuit county court over whether the firm misled the county about $67.5 million of bonds sold in December 2008 to finance construction of a new high school.
The county’s Board of Supervisors filed a seven-count complaint against Davenport in the Fluvanna County Circuit Court in September, claiming the firm gave them “deceptive, false and misleading advice,” which led them to issue standalone bonds through the Virginia Public School Authority instead of participating in a less-costly pool bond issue the VPSA had closed three weeks earlier.
The authority issues pool bonds twice a year and uses the proceeds to buy a pool of general obligation bonds from local governments that have little access to the markets. The localities then use the proceeds to finance capital projects for public schools.
Fluvana’s board claims Davenport recommended the standalone deal because, as FA, it would receive more compensation than for the pool deal, where it was one of four underwriters. The board claims Davenport began pushing for a refunding even before the issuance, a transaction from which it would also make money.
The Fluvanna County board has charged the firm with breach of fiduciary duty, two separate counts of fraud, gross negligence, unjust enrichment and disgorgement, breach of contract and violation of state securities laws.
It is asking for a jury trial and is seeking $18.5 million in compensatory damages, $350,000 in punitive damages, disgorgement of all fees it paid Davenport, interest, and recovery of attorneys’ fees and other costs, according to its complaint.
The $18.5 million is the amount of “excess interest payments” the county claims it will be paying over the life of the bonds, the complaint says. But Davenport is fighting back. In its response to the complaint, it maintains it acted professionally and “always in the best interests” of the county.
The firm said it “did not mislead the board in any way ... nor did it breach any duty owed the board. If the board suffered any damage as a result of the issuance of the bonds, which Davenport denies, it did not result from any act or omission on Davenport’s part.”
“The county was seeking to finance a new high school during a time of interest-rate volatility, just after the 2008 financial collapse,” said Kathleen Holman, Davenport’s executive vice president and chief administrative officer. “The record will reflect that Davenport presented several options, carefully explaining every aspect of each option. The contention that Davenport recommended one option over another to enhance its fees is absurd.”
Davenport has also suggested politics are at play. “Nearly three years later, after an election changed its makeup, the board now says that voting for the 2008 bond legislation was a mistake,” Davenport told the court. Today, only one of the four supervisors who voted for the new high school and bonds remains on the board — Mozell H. Booker.
The firm is asking the court to dismiss the charges, claiming it cannot reconsider a decision made by the county Board of Supervisors under the Virginia Constitution’s separation of powers doctrine and that most of the charges were not filed within a two-year statute of limitations.
The court has scheduled a hearing for Feb. 23 to consider Davenport’s move to dismiss the lawsuit. Meanwhile, the new high school — one of the most expensive in the state — is expected to be completed soon so that it can open in September, according to school board officials.
The bonds, along with the aftermath of the financial crisis, have had a major impact on the finances of the county, which has a population of about 27,000.
“It’s massive, it’s absolutely tremendous,” said Shaun Kenney, the current chairman of the Board of Supervisors. “For a tiny little county like Fluvanna … to pay $7.4 million in debt service per year.”
The county’s general fund is about $36 million per year, according to finance dirctor Renee Hoover. Annual debt service payments total about $7.4 million, of which about $5.2 million is tied to the school bonds. As a result, the total debt-service payments make up about 20.5% of the general fund and the payments related to the school bonds, about 14.4% of the fund.
A year ago, the accountants at Robinson, Farmer, Cox Associates completed a five-year forecast that found if the county stayed on its current course, its expenditures would exceed revenues by $2.3 million in fiscal 2016.
The firm estimated property taxes might have to rise to $1.36 per $100 of assessed property values by then — much higher than the 48-cent per $100 rate that was in place in 2008 when the bonds were issued. The 48-cent rate was one of the lowest in central Virginia and that had not been raised in roughly 30 years.
“The county’s financial condition is being negatively impacted by a 'perfect storm’ comprised of: significant increases in obligated debt-service payments, real estate market conditions, decreases from state and federal funding sources, and increasing fringe-benefit costs,” the accounting firm warned in its report.
For fiscal 2013, the county administrator has recommended a property-tax rate increase of 11 cents — 4 cents of which would be attributable to the high school debt — from the current 57 cents per $100, according to Kenney.
Some market participants contend the dispute illustrates the differences between dealer and independent financial advisors, as well as the need for key reforms provided by the Dodd-Frank Act, which imposed a clear fiduciary duty on dealer and independent financial advisors, requiring them to act in the best interests of issuers and other clients beginning on Oct. 1, 2010. Many states, including Virginia, impose a fiduciary duty on FAs.
John White, chief executive of the PFM Group, parent company of Public Financial Management Inc., the largest independent FA for competitive and negotiated muni securities in the nation, according to Thomson Reuters data, brought the lawsuit to the attention of Securities and Exchange Commission member Elisse Walter. She has been conducting a review of the municipal market and is expected to issue a report containing legislative and other recommendations for improving the market later this year.
“We do not know what the evidence will show,” White told Alicia Goldin, an SEC lawyer working with Walter on the muni review, in a Nov. 8 letter released after a meeting between PFM and SEC officials. “But PFM could not have conceived of an episode which better would illustrate the reality of the universal tension, in various forms, between the interests of the broker and the interests of the municipal entity in the design of a financing vehicle,” White said.
PFM officials could not be reached for comment. Sandra Sosinski, a spokesman for the firm, said PFM “didn’t think it would be appropriate to weigh in on a competitor’s litigation.”
Critics of the 2008 bond deal complain that when two county board members and 13 citizens — who were worried about the unfolding financial crisis and market volatility in November 2008 — urged the board to hire an independent consultant and get a second opinion on the bond issue and its timing, the board voted the proposal down 4 to 2.
“I generally don’t pick on financial advisors for market-timing issues,” said Eric Johansen, Portland, Ore.’s treasurer and the chairof the Government Finance Officers Association’s debt management panel. “There was a lot of volatility out there.”
But Johansen said the complaint, which he read, could highlight potential conflicts of interest when issuers work with dealer FAs who might have an interest in future underwritings, rather than independent FAs, whose firms do not engage in underwriting business. “I think the situation would be a little simpler to understand if the financial advisor making the decision were not a broker-dealer,” he said. “That’s why we [Portland] don’t use broker-dealers as financial advisors, because we don’t want an FA to have that motivation.”
“That’s why I use PFM most of the time, because they’re independent,” said Timothy Firestine, chief administrative officer of Montgomery County, Md., and a member of GFOA’s debt committee. “I think there’s always that potential for a conflict.”Besides the ongoing litigation, the Financial Industry Regulatory Authority has initiated an inquiry into the transaction, Davenport disclosed in court documents.q
An attorney for the board, Douglas Palais at Eckert Seamans Cherin & Mellott LLC in Richmond, did not respond to requests for comment. Most of the county’s board members and its attorney, Frederick Payne, declined to comment on the lawsuit.