CHICAGO — Missouri economic development officials and financial firms failed to conduct adequate due diligence on an artificial sweetener project in Moberly, lawmakers concluded in a report issued last week after a series of hearings probing the now abandoned, bond-financed project.
Reports from two legislative committees attempt to assess what went wrong with the approval process and include recommendations on avoiding similar fiascoes.
The city of Moberly last fall informed the trustee of $39 million of annual appropriation-backed revenue bonds issued for the project that it wouldn’t honor its pledge to repay the debt issued to help finance construction of the artificial sweetener plant, which was abandoned by the Chinese company Mamtek US Inc.
The city also handed over control of the project site to trustee UMB Bank NA. Moberly lost its investment-grade rating from Standard & Poor’s in September after it declined to make good on its appropriation pledge supporting the revenue bonds issued for the plant. The city’s refusal to appropriate led the trustee to dip into reserves for a Sept. 1 debt payment. The city’s decision followed the company’s default in August on a payment to Moberly needed for debt service.
The bonds were rated A-minus when issued in 2010, one notch below the city’s issuer credit rating at the time. S&P has since lowered the bonds’ rating to CC from A-minus and placed it on negative watch. It also downgraded the city’s issuer credit rating to B from A with a stable outlook.
The project received city help from the bonds issued through the Moberly Industrial Development Authority and $17.6 million in state assistance, although the state funds were never turned over. Officials believed the project would spur economic development in the struggling central Missouri community and create hundreds of jobs, but construction halted with the plant half-built.
Missouri Attorney General Chris Koster is jointly investigating the project with local prosecutors and the Securities and Exchange Commission has issued subpoenas in connection with the financing. The trustee has filed a petition seeking an involuntary Chapter 7 bankruptcy filing for the project and is pursuing a federal lawsuit against Mamtek.
After the Missouri House Interim Committee on Government Oversight and Accountability found plenty of blame to spread in its report issued last week.
“The committee found the testimony of third-party professionals engaged in the Mamtek-Moberly bond process less than credible,” its reads. “Not a single third-party professional took responsibility for the failure to properly investigate Mamtek’s claims. Instead, the committee was told it was common industry practice not to look into the viability of the underlying project in a municipal bond offering, and that Moberly’s credit rating was all that mattered.”
“Indeed, third-party professionals involved in municipal or local bond offerings should have a professional duty to investigate the viability of the underlying project — and to include such a report in the official statement,” the report said.
The committee recommended that the General Assembly consider legislation codifying the duty of third-party professionals in the municipal bond process to investigate the viability of the underlying project, and-or to require insurance for muni-funded projects.
The committee spared the city of Moberly of its harshest criticism, instead taking the state — particularly the state’s Department of Economic Development —and financial firms to greater task for the lack of due diligence of the company’s claims and the project’s viability.
“The committee believes that it was reasonable for Moberly officials to rely on third-party professionals and DED, but that neither the third-party professionals nor DED conducted adequate due diligence,” the House report concludes.
The House panel recommended legislation imposing longer grace periods for local government economic development bond issues or that economic development revenue bond issues go before voters.
The Senate Governmental Accountability Committee recommended in its report — also issued last week — the adoption of legislation banning local government industrial development revenue bonds without a public vote. It also recommended that the state DED be required to review more extensively startup projects seeking public incentives and develop a five-star rating system based on their viability.
The House heard testimony at several hearings from representatives of the DED, bond underwriter Morgan Keegan & Co., UMB, the city and its Moberly Area Economic Development Corp., Armstrong Teasdale and S&P.
Mamtek USA first approached the state and others through a consultant regarding construction of a sucralose manufacturing plant in January, 2010. In March, state economic development officials sent out a request for proposals to communities, including Moberly, about the opportunity to host the project, which offered 161 new jobs. The RFP read: “We still have some due diligence to complete but do deem this a legitimate project.”
The state sought background information on the company and conducted internal due diligence over the spring. It was informed by a contractor with Armstrong Teasdale that Mamtek’s plant in Fujian Province never opened. The information, along with published stories, contradicted information from Mamtek US representatives about its Chinese operations.
In May, Moberly guaranteed financing to Mamtek if the company agreed to locate there. The DED during committee testimony said it informed Moberly of its concerns but did not provide specific information from the contractor or other details. City officials said if they had been made aware of the specific information from the contractor they would have proceeded much differently.
The House report concludes that the state failed on several fronts. “Despite the committee’s conclusion that DED did not conduct adequate due diligence on Mamtek, the department still had enough information in its possession to prevent allocation of bonds and authorization of tax credits,” the report reads. Had the department shared details of the information with the city, the report concludes that “it is likely that the bonds would never have been issued and this catastrophe would have been averted.”
The city hired Morgan Keegan as underwriter in May and the firm in turn hired Armstrong to serve as underwriters’ counsel. Morgan Keegan said in testimony it relied on the firm for due diligence.
The city received the due diligence documents in June. They included claims that Mamtek US had $7.2 million in cash or equivalents but no evidence to support the claim. The state told the city in July that it had approved an increase to $28 million from $5 million in its tax-exempt allocation of recovery zone facility bonds.
In preparing the bond issue’s offering statement, Morgan Keegan testified that it devoted its resources solely to assessing Moberly’s ability to pay back the debt based on the city’s backing and that its only concern with Mamtek was to request information. Armstrong representatives said their role in the bond issue was limited to reviewing the transaction details.
That assertion on Armstrong’s part contradicted documents saying it would conduct due diligence in its role as underwriters’ counsel, according to the report. Moberly said it relied on Morgan Keegan and Armstrong Teasdale in addition to Pelligrino & Associates, which it hired to assess Mamtek’s value.
S&P testified that its rating was based solely on Moberly’s credit given the appropriation pledge. While admitting that the rating agency’s criteria is the industry standard, the House report criticized the practice of basing the rating solely on the city.
“The committee finds this practice shocking. A municipality should not get an investor-grade rating to loan a start-up company with little-to-no hard assets for nearly five-and-a-half times as much money as the city’s annual budget when the city is already running at a deficit,” the report reads.
The House committee’s recommendations include consideration of legislation requiring DED to share all information regarding a company seeking local and state economic development incentives. DED should also adopt rules requiring applicants to provide third-party verification of their financial information and require key officers in start-up companies to submit to and cover the cost of basic criminal and financial background checks.
The city issued a statement after the release of the House report saying it agreed with the report’s comments on Standard & Poor’s and that the agency further erred in downgrading the city after its default. The state DED has defended its actions and noted that the project never received any of the pledged state incentives.
Morgan Keegan defended its role in a recent statement, saying it was hired after local and state officials and legal counsel had conducted due diligence and settled on bond terms and that it “reasonably relied on the statements of government officials, including those who originally introduced Mamtek to the city, as well as third-party valuations provided to the city.”
Standard & Poor’s had no comment.
Armstrong Teasdale general counsel Jay Summerville issued a statement, defending the firm’s work as it relates to the traditional duties of an underwriters counsel. “We believe the report, although well-meaning, is based on a fundamental misunderstanding of the role of underwriter’s counsel in a transaction such as this where the entire bond sale was based on the credit worthiness of the city of Moberly,” he said.
“In fact, the bonds were rated for sale by Standard and Poor’s based on the creditworthiness of the city of Moberly, not Mamtek. We are confident that Armstrong Teasedale performed its role as underwriters counsel in keeping with all applicable professional standards,” he added.
Lawmakers also have already begun introducing legislation based on the committees’ recommendations.