WASHINGTON - The Internal Revenue Service has charged that the Riverside County, Calif., Housing Authority issued more bonds than authorized, approved a blank arbitrage certificate, and failed to investigate the feasibility of the housing project that the 1985 Whitewater Garden bond issue was to finance.
The allegations are made in a document filed by the IRS last week in the first U.S. Tax Court case brought by a bondholder challenging the IRS' right to collect taxes on interest from bonds that have become taxable because of tax law violations.
Harbor Bancorp & Subsidiaries, of Long Beach, Calif., brought the tax court case against the IRS last year after the agency tried to collect $19,763 of taxes on interest earned from $250,000 of Whitewater Garden bonds the bank held from 1988 through 1990.
The IRS has charged that the Whitewater Garden black box bonds, which were rushed to market on Dec. 31, 1985, were subject to and violated arbitrage rebate requirements because they were not validly issued until after those requirements took effect in 1986.
The IRS details its allegations and reveals new information in a "Request for Admissions" document filed with the tax court that presents the agency's view of the facts in the case. Harbor Bancorp has 30 days to either agree to or deny the facts. If it does not respond by Aug. 28, the facts are considered proven, a federal lawyer said.
The IRS charges in the document that the Riverside County authority approved issuance of only up to $17.2 million of bonds for the Whitewater Garden housing project. Instead, $17.5 million of bonds were issued.
William Rosenberger, the executive director of the authority, said yesterday that it is "not unusual" for the authority to approve a bond issue and then actually issue bonds of a slightly different amount.
The IRS also contends that Rosenberger, acting for the authority, on Dec. 17, 1985, signed a "no-arbitrage certificate" that was dated Dec. 31, 1985, but not actually prepared until February 1986. Issuers are supposed to sign such certificates at the time they issue bonds.
Rosenberger confirmed that he signed the certificate in December 1985, but said he was "not aware" that it was blank.
The IRS also charges that the housing authority, before issuing the bonds, "did not make any inquiry into the nature or feasibility of the project, the experience or competence of SBE Development Inc., or the financing structure for the development of the project."
SBE was to develop the housing project.
Rosenberger agreed the authority did not investigate the project or bond issue, but said it was only acting as a conduit issuer and had been asked to do the financing by the county's economic development agency.
"They brought the project to us, Rosenberger said, adding that the project and financing were supposed to have been scrutinized by officials who are no longer at the county agency.
The IRS charges that the housing authority failed to file a notice of a public hearing on the bond issue. Rosenberger said that while the authority has been unable to find any such notice, it did hold a public hearing.
The IRS document also reveals that Donaldson, Lufkin & Jenrette Securities Corp. and Drexel Burnham Lambert Inc. were supposed to have underwritten the bond issue but assigned the underwriting to Matthews & Wright Inc. in 1986. The authority had no knowledge of the switch, according to the IRS and Rosenberger.
The document provides the first comprehensive look at the transaction, which was one of 22 bond issues totaling almost $800 million that Matthews & Wright closed without cash and rushed to market to beat new tax laws.
The IRS said the checks that Matthews & Wright used to "buy" these bonds were returned to the firm without ever having entered normal banking channels, so that the firm incurred no obligation or detriment and received no assets or benefit at the bond closings.
"The Whitewater check was never deposited into regular banking channels and if it had been, it would have been dishonored," the IRS said.
According to the IRS, Matthews & Wright "purchased" the Whitewater Garden bonds on New Year's Eve with a check for $17.61 million from the New American Federal Credit Union. The check was presented to InterFirst Bank Houston, trustee for the bonds. But at that time, the credit union had a balance of only $45,128.12 in its clearing account at Chase Manhattan Bank.
Matthews & Wright directed the trustee to "invest" the bond proceeds in an investment agreement issued by Commercial Bank of the Americas, an unlicensed bank that had no place of business and no assets other than $5,011 in an account at the Bank of Guam, according to the IRS.
The trustee "endorsed" the check to the order of the Commercial Bank of the Americas and received, in return, an investment agreement from that offshore bank, the IRS said. The offshore bank then "paid" for the bonds by endorsing the uncashed cheek back to Matthews & Wright. The offshore bank became the "owner" of the bonds and the trustee because the "owner" of the investment agreement.
The IRS says Matthews & Wright did not really purchase the Whitewater Garden bonds with cash from its accounts until Feb. 20, 1986, so the bonds were not actually issued until that day.
On Feb. 20, the black box structure of the financing for the project was put into place. The structure was devised by Steven Tetrich and James J. Keefe, two owners of Unified Capital Corp., a mortgage lender and broker, according to the IRS.
The IRS said about $17.78 million was deposited into an account for the Whitewater Limited Partnership, the developer partnership for the project, an account controlled by Unified Capital. Roughly $16 million of that was disbursed to Mercantile Capital Finance Corp. #47, a single-purpose Delaware corporation that was supposed to provide a letter of credit for the deal but that had only $500 in initial capital and shareholders' equity.
Unified disbursed the $16 million, rather than using another source of money from third-party investors, to buy a reimbursement note from Mercantile, under which the developer promised to pay for draws from the letter of credit. Mercantile used the money to buy an annuity or guaranteed investment contract from Crown Life Insurance Co.
The project was never built. Since Feb. 20, 1986, debt service on the bonds has been paid solely by draws from the letter of credit. The sole security for the letter of credit is the GIC. The IRS said the GIC yield is 9.5515% and is much higher than the yield of the bonds, which is 7.3750%.
