IRS Auditing $361M of Bonds From Troubled Vernon, Calif.

WASHINGTON — The Internal Revenue Service has opened an audit of $360.7 million of bonds issued in 2009 by Vernon, Calif., which has been roiled by political scandals and could be disincorporated pending the outcome of state legislation.

A material event notice posted by the city Tuesday on the Municipal Securities Rulemaking Board's EMMA system, said the IRS will examine Vernon's 2009 electric system revenue bonds.

The IRS said in an Aug. 10 letter to the city that the bonds were selected based on information received "from external sources," as well as information developed internally by the service, according to the disclosure notice.

"The city believes that the bonds complied with all applicable provisions" of the tax code and it will "cooperate with the IRS" in its examination, according to an event notice signed by Rory Burnett, Vernon's finance director and treasurer. City officials did not respond to calls for comment. Sources said there are $360.7 million of the 2009 bonds outstanding.

Founded in 1905, the city has become a business and financial magnet. In just a 5.2-square-mile area within Los Angeles County, Vernon has about 115 residents but its businesses generated $1.1 billion in taxable sales annually as of 2008, according to an independent ethics report dated July 29, 2011.

Vernon also has a history of paying city officials exorbitant salaries. Similar to those of its neighbor, Bell, Vernon officials have received hundreds of thousands of dollars in salary and pension payments.

The city is now facing political scrutiny. There are two bills pending in the California Legislature that would affect Vernon: one would disincorporate any city with fewer than 150 residents, and the second would offer protection to Vernon's businesses if the city is forced to disband.

Orrick, Herrington & Sutcliffe LLP, bond counsel on the 2009 deal, is representing Vernon for the audit proceedings.

"We are in the process of analyzing the information and document request and will respond to it in due course," an Orrick spokesperson said Tuesday.

The July independent ethics report was led by John Van de Kamp, a former California attorney general. It recommended ethics training, campaign disclosure requirements, and other controls for government employees.

Van de Kamp said in an interview Tuesday that Vernon's bond financings were "outside our purview" for the investigation. He said he was not aware of the audit and did not have any conversations with the IRS as part of his investigation.

"Our job was not to run a financial audit, but to look at their governance procedures, and salaries of city officials, which they have now reduced very substantially," he said. Van de Kamp said the legislation to disincorporate Vernon will likely "go down to the wire" before the Legislature adjourns in mid-September.

Citi and De La Rosa & Co. co-underwrote the 2009 bonds. The underwriters were represented by Stradling Yocca Carlson & Rauth. The bonds were initially rated A3 by Moody's Investors Service and A-minus by Standard & Poor's.

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