BRADENTON, Fla. — Citi, the investment bank selected to lead Jefferson County, Ala., out of bankruptcy, violated municipal securities rules, a former financial advisor for the county alleges.
The claim surfaced in an amended complaint by three sewer system ratepayers, whose suit is known as the Wilson case. They object to the county’s Chapter 9 exit plan, which is contingent on refunding $2 billion in sewer warrants to pay off creditors in December.
The plan “violates current securities law and specifically Rule G-23 of the Municipal Securities Rulemaking Board by virtue [of] the county’s selection of Citibank as managing underwriter for the proposed sewer warrant refinancing,” the complaint said.
Citi declined to comment for this story.
Linking a violation of G-23 to the bankruptcy code appears to be novel, but it won’t stop Jefferson County from selling the debt as planned in December with Citi as the lead underwriter, according to one attorney who asked not to be identified.
However, if regulators find that there is a violation, the investment bank could be fined and forced to forfeit lucrative fees to be made from the deal, he said.
“You can’t have a bankruptcy plan with actions that are forbidden by law and Dodd-Frank made that the law,” said Joshua Firth, an attorney with Birmingham-based Hollis, Wright, Clay & Vail PC, who represents the Wilson ratepayers. “Our position is if it’s not legal for Citi to do, then it’s not legal for the plan to go forward.”
When asked for a comment, Jefferson County’s bankruptcy attorney Kenneth Klee said, “No need to debate this in the press. The votes are in and we will file a pleading and handle this in court.”
County Commission President David Carrington said during Tuesday’s commission meeting that most creditors approved the county’s plan of adjustment in voting, which ended Monday.
The allegation about Citi’s alleged G-23 violation and failure to notify the county in writing that it was acting as an underwriter was made by James White, chairman of the municipal advisory firm Porter, White Capital Advisors Inc. in Birmingham. White, also board chairman of the broker-dealer firm Porter, White & Co., was hired as a municipal finance consultant by attorneys for the Wilson ratepayers.
MSRB Rule G-23, amended in November 2011, prohibits a dealer that acts as an issuer’s financial advisor from being the underwriter for that issuer on the same transaction. The rule did not grandfather any financial advisory relationships established before that.
In early 2008, Citi managing director David Brownstein began advising White, Jefferson County’s financial advisor, about restructuring more than $3 billion of variable- and auction-rate sewer warrants that failed during the collapse of liquidity in the bond market.
“Mr. Brownstein stated that he wanted to help, stating no other motive and at no time did Mr. Brownstein indicate, either orally or in writing, that he was seeking an underwriting relationship or indeed any other relationship,” White wrote in portions of his report for the Wilson case.
White said discussions with Brownstein did not lead to concrete financing proposals, and both stopped working for the county in July 2008.
In May 2010, White said he reviewed a financing plan at the request of former County Commission Jim Carns that was prepared by Citi. Some of the schedules prepared for that plan are “very close” to the financing plan the county is currently contemplating, he said.
The 2010 plan constitutes financial advice, alleged White, who also said it would be “highly ironic for the underwriting of the refunding warrants to be handled in a way that violates a rule adopted for the purpose of preventing the sort of abuses that helped get Jefferson County in trouble in the first place.”
Citi should have sent a G-23 letter in November 2011, according to an attorney who reviewed the complaint.
It does not matter if the bank advised the county under the old G-23 rule between 2008 and 2010, and did not continuously advise the county through the years since, because the amended rule didn’t grandfather underwriters that had prior relationships with issuers.
“In order to clear the deck,” the attorney said, “Citi should have written a letter saying we are your underwriter, not your financial advisor. It looks like there’s evidence that they did not do that. It’s not a huge burden to do, but it’s a huge oversight if they didn’t.”
The Wilson ratepayers’ complaint argues that in order for the county’s plan to be confirmed under the bankruptcy code, it must be proposed in good faith and not by any means forbidden by law.
“They are asking to interpret the bankruptcy code in such a way that if there’s a violation of G-23, you are violating the bankruptcy code,” the attorney said. “I do think it’s probably novel.”
Firth said the G-23 issue arose during legal planning for the Wilson case because the refinancing plan Citi proposed in early 2010 is “eerily similar” to the upcoming deal proposed in the county’s plan of adjustment.
He does not believe it’s a stretch to link G-23 to the Bankruptcy Code because the county’s plan is contingent on issuing refunding debt later this year.
“It really goes to if the bond issuance is valid and legally binding,” he said. “If not, there will be problems at the confirmation stage.”
Firth said he didn’t know for certain if Citi provided the county with the required written notice that it was performing as an underwriter because the judge overseeing Jefferson County’s bankruptcy has not allowed discovery to take place for the Wilson case.
“Do we want to taint the [refunding] deal? Yes.” Firth said. “We think it’s a bad deal for the county, ratepayers and customers.”
Firth said the Wilson legal team has discussed notifying securities regulators about the potential violation, but no determination had been made as of Tuesday.
He also said there are other issues in the complaint that may seem local in nature, but could impact Jefferson County’s ability to pay debt service in the future. One issue is that some portions of the existing sewer system are nearing the end of useful life, and necessary capital expenditures have not been properly factored into refinancing structure.
The refinancing will leave the county with a shortfall of $1.2 billion over 40 years for capital expenses, said Firth, and it’s uncertain if the county will have capacity to go to the bond market for additional funding if needed.
“For potential investors out there, all the things we allege may impact their ability to pay the bonds,” he said. “Any potential investor should at least consider the fact that there are all these outstanding issues.”
The Wilson legal team is already investigating the possibility of an appeal should their objections be struck down by U.S. Bankruptcy Judge Thomas Bennett during the county’s confirmation hearing. If there is an appeal, and it’s successful, Firth said there could be a retroactive impact that affects the county’s ability to pay off the bonds.
The Wilson case claims that Jefferson County’s plan is not feasible, in part because it lacks recent financial detail and relies on financial data from the county’s 2011 audit. Their complaint also reviews Alabama law for issuing new debt, and delves into constitutional issues as well as the county’s plan to issue back-loaded warrants later this year and its impact on paying down the debt.
Objections from the Wilson case, and others, will be heard by Bennett at the confirmation hearing on the county’s plan of adjustment Nov. 12, which could take as long as three days.
In addition to the Wilson ratepayers, three residents objected to the county’s plan. One is a claimant who is legally challenging the removal of ad valorem and homestead property exemptions, and another complained about legal notices provided by the county about the plan, and said they were “non-comprehensive to me, an average reader.”
Another objector on the county’s sewer system said she was “robbed and extorted” by the Jefferson water and sewer department because she was improperly charged $120 for a surety bond to open the sewer account for her home, and she paid “inflated” costs for water service.