WASHINGTON - Chapman and Cutler, one of the oldest and most prestigious law firms in the nation, may be the latest bad boy of the municipal bond industry.

A growing number of lawyers say the Chicago-based firm, which historically has been viewed as conservative if not stodgy, now takes more aggressive stances in controversial financings that some say are creative but others say skirt the edge of tax law.

One lawyer in Washington said that until recently, "you weren't considered to be taking a risk with a Chapman opinion. And rarely, if ever, would the firm get in a big disagreement with the government on bond or tax issues."

But now, he added, "some of the top-tier firms are becoming concerned about the aggressive positions they take. They seem to be playing the edge a lot."

"I think they've crossed the edge on some deals," said a lawyer from one of those top-tier firms. While others share this view, he added, "I don't think any of us will want to be quoted by name because we all have to work with them."

The concerns stem from Chapman's involvement in a series of controversial financings such as a window refunding for a Camden County, N.J., authority, two tax-increment financings in Illinois, an interstate health-care pool for an Arkansas authority, asset sales, and call-waiver deals. Chapman also is one of only three firms that have shown a willingness to give opinions on so-called gray boxes.

Both the Camden and Arkansas deals grabbed the attention of law-makers makers and federal regulators, sending shudders through bond officials who worried that such controversies would shatter the fragile legislative and regulatory gains made by the industry during the past two years.

These deals have led some to complain, as one New York lawyer did, "They're the firm that's causing us the most grief on [Capitol] Hill."

No one is accusing Chapman of violating tax laws, however. The firm's toughest critics concede that its lawyers do not give opinions on bond issues without having carefully thought through the issues to develop a detailed rationale for their position.

Instead, their complaint is that Chapman has gotten too liberal -- or too literal -- with its reading of the tax laws. "They take the view that unless the regulations address their specific transaction and prohibit it, anything goes," said the lawyer in New York.

"Let's face it," said a regulatory official in Washington. "Bond lawyers are really the gatekeepers of the system. Issuers just do what bond counsel tells them they can do. The self-restraint of the system largely depends on the standards set by bond counsel.

"Traditionally, the big national firms, firms like Orrick, Herrington & Sutcliffe; Mudge Rose Guthrie Alexander & Ferdon; Brown & Wood; Chapman and Cutler; and O'Melveny & Myers, have held the line," the official continued. "But when you see one of these firms break ranks and get aggressive, you wonder whether the self-restraint of the industry is beginning to break down."

Chapman's lawyers take offense at the notion that they may sometimes be pushing the envelope of tax law. "That is absolutely wrong," said David Nelson during a recent interview with several lawyers of the firm.

The lawyers said that when they analyze transactions or tax issues, they consider the facts involved, the spirit as well as the letter of the law, and the views of lawmakers and regulatory officials. They reject labels like "conservative" or "aggressive."

"I don't think that [these deals] represent a major movement from other deals that we have done previously or that other people have been doing," said David Cholst, another lawyer with the firm.

Mr. Nelson attributed some of the criticism to the fact that Chapman does not shy away from complex and innovative deals. "In this business more than in most other areas of the law, anything new is first greeted with apprehension. People are aghast," he said.

A lawyer outside the firm said that is not the case with broker-dealers. Any story that suggested Chapman was becoming more aggressive would simply bring the firm more business from underwriters, he said.

Not everyone believes Chapman is pushing the limits. "They're aggressive, but they always have solid technical arguments for whatever they do," an investment banker said.

Several lawyers agreed.

"I think that they are innovative and creative. They are not cowboys. They try to find solutions for their clients' problems," said C. Willis Ritter, a lawyer with Ritter & Einchner in Washington, D. C. "There are plenty of Camdens and Arkansases dotting the landscape of this industry over the last 20 years with plenty of other firms responsible for them," Mr. Ritter said, adding, "Let the law firm that is without sin cast the first stone."

Most lawyers agree that Chapman is not the only law firm to have attracted criticism for controversial deals.

But many are concerned about the firm because of the influence it has over the bond market at a time when the growing complexity of the tax laws and rules, increased competition, and the lack of Internal Revenue Service enforcement have made it more tempting for bond firms to be aggressive.

Deals and double takes: They started with Camden

It was Chapman's involvement as bond counsel in the Camden deal, which led the Treasury to adopt new refunding curbs, that first made some lawyers do a double take. "I think it sort of astonished a lot of people that they not only did it, but had no regrets about it later," said a lawyer in the Midwest.

In the 1990 deal, which featured both zero coupon refunding bonds and a forward supply contract, the Camden County, N.J., Municipal Utilities Authority created a window during which revenues ear-marked for debt service were freed up and invested at a profit.

The deal created a stir, with lawyers divided over whether it was permissible under the tax laws. Some applauded it for saving the authority money and said Chapman was correct in opining that the bonds were tax-exempt. "We would have rendered the same opinion had we been given the opportunity," said John Kraft, a lawyer with Kraft & McManimon in New Jersey.

Others complained, however, that the deal was arbitrage-driven and violated the spirit, if not the letter, of the tax law. They worried that even the appearance of abuse would lead Congress to enact new legislative bond curbs.

House Ways and Means Committee member Rep. Beryl Anthony, D-Ark., and Treasury officials concluded after meeting with Chapman's lawyers that the deal was legitimate. But they also expressed concern that its structure invited abuse, and so proposed curbs. Rep. Anthony's legislation was never enacted, but the Treasury has included curbs on so-called window refundings in recent rules.

While some lawyers have said the firm showed political naivete in doing that deal, Mr. Nelson said the negative publicity was unwarranted and caused mostly by "people who were disgruntled" at being left out.

In the end, Chapman's lawyers got high marks for their willingness to discuss the deal with tax aides and federal regulators. But they also won the bond law community's "Typhoid Mary" award, a tongue-in-cheek award usually presented annually by members of the National Association of Bond Lawyers for the deal that most hurts the industry.

Some of Chapman's peers raised their eyebrows again when, several months later, the firm was bond counsel on the first of two tax-increment revenue deals for Hoffman Estates, Ill., that helped finance the development of a new headquarters for Sears, Roebuck and Co.'s merchandise group.

Chapman's lawyers insisted that the two deals, done a year apart, did not violate any tax laws. But other lawyers said the two transactions, one of which results in private use and the other in private payments, could have been viewed as a single transaction that exceeded the 10% private use and private payments tests. In that case, the bonds would be private-activity bonds and probably taxable.

"What they were really doing was one big transaction that they were trying to hide by splitting it up into two parts. I thought it was incredibly aggressive," said a federal official. He was particularly troubled that Sears got what was supposed to be an outright grant of bond proceeds from the village in the first deal, and then turned around in the second deal and used bond proceeds to build a municipal center, a fire station, and other village facilities.

Chapman also has been criticized by bond lawyers for taking part in, or advocating, transactions that have generated either outright opposition or tax-law concerns from Treasury and IRS officials. These include asset sales, gray boxes, call-waiver deals, and certain kinds of refundings.

The firm's lawyers acknowledged that they sometimes give opinions on such deals, but said they do so only if certain conditions and all applicable laws and regulations are met.

But many critics complain about the firm's practice of giving opinions on asset sales deals, pointing out that Treasury and IRS officials have urged issuers not to do them. In asset sales deals, an issuer sells tax-exempt bonds, loans the proceeds to another issuer, and then sells the loan note to investors, using the proceeds from the sale to defease the old bonds. Treasury and IRS officials say these deals put two bond issues in the market for the same purpose and appear to be nothing more than refundings in disguise, designed to avoid refunding restrictions.

"Let's be candid," said a lawyer in the Midwest. "One of the restraints firms have is, ~Would Chapman or Orrick do it?' And once Chapman is doing it, it's pretty hard to say you can't do it, so it just moves the whole industry to a more aggressive footing."

Indeed, last year one of the participants in a taxable refunding of some tax-exempt pool bonds justified his role after it was widely criticized by suggesting that Chapman's involvement in it meant the deal was above reproach. Mr. Cholst then defended Chapman's role in the deal by saying it was limited, as bond counsel, to simply opining that the taxable bonds were taxable.

In the deal, done for the Utah School District Finance Cooperative, underwriting firms purchased tax-exempt bonds from a 1988 hedge pool that had made almost no loans, increased the bonds' value through a taxable refunding, and then sold them for a profit. Treasury officials and some lawyers thought the deal may have changed the terms of the underlying tax-exempt bond issue so it could be considered reissued and no longer tax-exempt.

Some lawyers were also surprised that Chapman was willing to give opinions on gray box deals at a time when the IRS was trying to determine whether the deals were designed to help save troubled housing projects or to avoid arbitrage restrictions. In these deals, the credit enhancer sells the mortgage note to investors. The sale of the note allows the credit enhancer to pass on risk to the investors, but also produces money that it invests without regard to arbitrage restrictions.

Perhaps the most serious criticisms of Chapman, however, stem from its involvement in a proposed interstate financing for health-care facilities. Under that deal, proposed last year to reduce financing costs for such facilities, the Arkansas Development Finance Authority was to issue tax-exempt 501(c)(3) bonds, pool the proceeds, and then loan them outside the state to non-profit hospital systems affiliated with American Healthcare Systems.

But the deal immediately drew fire from the National Council of Health Facilities Finance Authorities, a group of 26 bond-issuing agencies, and sparked a debate over whether interstate financing of health-care facilities was appropriate or within state and federal laws.

Industry officials worried the controversy would embarrass or cause problems for two key Arkansans: Rep. Anthony, who was pushing legislative proposals to ease bond curbs; and Gov. Bill Clinton, who was facing an uphill struggle at the start of his presidential campaign.

The officials also feared it might lead to new onerous legislative restrictions on bonds. Rep. Brian Donnelly, D-Mass., had already helped push legislation through Congress prohibiting interstate financing of multifamily housing projects. He also had a history of sponsoring legislative proposals to curb the use of 501(c)(3) bonds to finance nonprofit health-care facilities.

An even greater concern was whether the deal would meet federal tax-law requirements. Lawyers from Chapman would not discuss the deal, saying it was a client matter. But sources familiar with it said Chapman advised the deal's participants that public hearings would not be needed in the states where facilities would be financed with loans from the pool.

That view was disputed by federal regulators, tax aides, and several bond lawyers. They said that under the tax laws and rules, the bonds would be tax-exempt only if they were issued after public hearings were held and approvals from elected officials were obtained in the facilities' host states.

One federal regulator said the Joint Tax Committee's so-called blue book, which explains provisions of the Tax Reform Act of 1986, states that certain pooled financings' facilities need not be identified before bonds are issued. But, the regulator added, "To say that something in the blue book overrides existing regulations would be pretty bold."

A Washington lawyer complained, "Once again you have a highly visible transaction, and Chapman has come to a conclusion based on a highly technical reading of the detail in the regulations."

Authority officials have since said they will not issue the bonds without holding public hearings in the host states. That turnaround may be due to Rep. Anthony, who did not want to be invloved in the deal but was concerned that it meet state health requirements and federal tax laws. The Arkansas representative, however, will not be returning to Congress next year after losing a primary election on June 9.

Eight decades of history: the firm's heritage

Chapman and Cutler was organized in 1913 when N.W. Harris, of N.W. Harris & Co., a Chicago-based bank and underwriting firm, persuaded one of his lawyers, T.S. Chapman, to set up a firm to write bond opinions. Henry Cutler later joined the firm, which is still housed in the same building as the bank, now called the Harris Trust & Savings Bank.

For several decades, Chapman dominated the bond law business in the South and most states west of Ohio. The firm served as a training ground for many bond lawyers and also set standards for bond documents still in use today. In addition, it helped finance such landmarks as Candlestick Park in San Francisco, Chicago's O'Hare International Airport, and the marine terminal in Valdez, Alaska.

As the bond business grew in size and complexity, Chapman lost much of its hold over the South and West except in Arizona and Utah, where it set up regional offices. Chapman also had to give up ground in its home state of Illinois, but is still the top-ranked bond counsel firm there. Chapman had 63.5% of the bond counsel business in the state last year, compared to 75.6% in 1981, the earliest year for which such statistics are available, according to Securities Data Co.

Despite the increased competition, Chapman typically has been the nation's top-ranked bond counsel firm based on the number of bond issues reported annually and has continued to rank among the top-five bond counsel firms in terms of dollar volume for the past 12 years.

In 1991, for example, Chapman ranked fourth, serving as bond counsel for $6.8 billion, or 4% of bond issues by dollar volume, according to Securities Data Co. But it was bond counsel for 619 issues, more than twice the issues of most other firms.

"About 70% or 80% of the transactions that Chapman does are no-brainer, plain-vanilla general obligation and revenue deals" for small issuers in Illinois, said a lawyer who has worked with the firm on many deals.

"To the city treasurer in southern Illinois, they are a conservative bond counsel firm who never leads him astray," the lawyer said. "They are the same people who have given good advice for 30 years. But the other transactions are more creative and it's some of these deals that have caused some of the lawyers at the firm to get a reputation of being cowboys. The city treasurer never sees these deals. But professionals in the industry do."

A lawyer in Washington agreed, saying, "When you say Chapman and Cutler, you paint with a very broad brush. Their reputation of being conservative was based more on the bond counsel side than on the tax counsel side, but the bond lawyers and the tax lawyers are worlds apart."

Typically, tax lawyers deal with more complicated federal tax-law issues than bond lawyers.

Chapman, which has developed a broad financial practice with municipal bonds accounting for only about 20% of its business today, has almost 250 lawyers. Of these, 27 are in its municipal section and 12 are in its tax section. But lawyers from other departments, such as the health and education group and the banking group, also become involved in bond issues.

Chapman's critics claim the firm developed its reputation of being conservative years ago when Manly W. Mumford, one of the most respected lawyers in the industry, was at Chapman. Mr. Mumford retired from the firm in 1990 and is now a consultant. These critics say Chapman has become more creative and aggressive under the influence of the new Young Turks in the tax department, principally Jeffrey Berry and Mr. Cholst.

But Chapman's lawyers dismiss this line of thinking as a lot nonsense. They say that Mr. Berry and Mr. Cholst are not viewed as aggressive by their peers at the firm and that thorny tax issues typically are settled only after a spirited debate among several of the firm's lawyers. "What never comes to you is all of the things we turn down or modify," said Mr. Nelson.

They also say that Mr. Mumford, who was as comfortable doing arbitrage calculations on an abacus as on a computer, was certainly not conservative or stodgy. "Manly Mumford was a preacher on this point: ~Try to figure out a way to do it,'" said Mr. Nelson.

What does Mr. Mumford say about the debate over Chapman? "I suspect that conservatism or aggressiveness may lie in the eyes of the beholder," he said. "We like to think we're doing it right."

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