LOS ANGELES — Attorneys representing Victorville, Calif. and city officials argued in court Monday that the judge should dismiss a fraud case brought by the U.S. Securities and Exchange Commission.

The SEC alleges the city and its officials defrauded investors by inflating valuations of property in connection with a 2008 bond offering.

Defense attorneys argued in U.S. District Court, Central District of California, in downtown Los Angeles that even with the inflated values listed in the offering documents, the debt service ratio still would have met the 1.25 percent debt service ratio required by the refinanced bonds original indenture.

The SEC filed the lawsuit on April 29 against Victorville, city official Keith C. Metzler, the Southern California Logistics Airport Authority, underwriter Kinsell, Newcomb & De Dios, and KND investment banker Janees Williams, charging them with defrauding investors by inflating valuations of property in connection with a 2008 bond offering.

The SEC alleged that officials were responsible for misleading statements made in the airport authority’s bond offering. The authority was using tax-increment bonds secured solely by increases in property tax values, including for four new aircraft hangars, for a variety of projects.

According to the complaint, the SCLAA in April 2008 was forced to refinance part of the debt incurred to construct aircraft hangars and other projects by issuing additional bonds.

The principal amount of the new bond issue was partly based on a $65 million valuation for the airplane hangars, even though deal participants knew the county assessor valued the hangars at about $27 million, the SEC alleged.

In its complaint, the SEC alleges that the value of the property was inflated in order to meet the 1.25 times required for the bond indenture.

Defense attorneys representing Metzler, Victorville, and the Southern California Logistics Airport Authority argue in motions filed to dismiss the case that even if valuations for its airport hangars were inflated, they still met the market’s required benchmark.

Defense attorneys argued in court documents that even at the lesser value on the hangar the debt service ratio of 1.25% is met.

SEC Attorney Sam Puathasnanon argued that federal authorities agreed the debt service ratio of 1.25% is met in 2008, but that it falls below those levels every year after until the bonds reach maturity.

James Kramer, a partner in the San Francisco office of Orrick, Herrington & Sutcliffe, who represents Metzler, said in court that documents being used in the fraud allegations do not show that Metzler was aware that inaccurate numbers made it into the bond documents.

Kramer argued that the documents provided by Metzler to a bank when the city was contemplating a direct placement with the bank in February 2008, two months prior to the bond offering included the higher amounts. But in that document Metzler said the amounts were construction estimates and could change after the assessor’s office evaluated the four hangars, Kramer said.

Metzler, who was the city’s director of economic development when the alleged fraud occurred, forwarded the lower valuation of the hangars that came out of the assessor’s office to KND Holdings in an email to be used in the bond documents that were released in April, Kramer said.

Kramer argued that in order to prove securities fraud the SEC attorneys have to show that Metzler substantially participated in attempts to defraud investors, which means they must show specific facts that they knew fraud was being committed.

“There is no allegation that he was ever given a draft of the debt service schedules by KND Holdings and the consultant,” Kramer said. “There is no allegation from the consultant that he ever read the report or was given a draft.  There is no allegation that KND asked him to look at it and make sure the math was correct.”

If Mr. Metzler missed it, there may have been negligence, but “we are here today to talk about securities fraud,” not negligence, Kramer said.

He argued that Metzler was not aware that the incorrect amounts ended up in the bond offering documents.

U.S. District Court Judge John Kronstadt asked the SEC attorneys if they have proof that Metzler reviewed the page that included the debt service schedules.

Puathasnanon told the judge that federal authorities have documents that show that Metzler was asked to review the bond documents.

“Is it your position that present allegations are sufficient to a finding of fact that Mr. Metzler reviewed this page or was aware of this disparity,” Krondstadt asked.

It’s the SEC’s view “that Metzler’s participation in drafting and review of the bond documents and his failure to correct misstatements constitutes substantial assistance,” Puathasnanon said.

The SEC attorney added that they will amend the complaint to make Metzler’s role clearer.

“He was given a copy and did give comments back to drafters on this document,” Puathasnanon said.

Kronstadt said at the outset of the hearing that his tentative view was to deny the motion to dismiss.

“I think there are times when the complaint refers to actual notice and recklessness in support of the claims,” Kronstadt said. “I think as pleaded there is sufficient actual knowledge.”

But he did not rule on the motions to dismiss during the hearing.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.