CHICAGO -- Illinois Development Finance Authority Board members took Chapman & Cutler officials to task yesterday for not fully disclosing to them potential tax law problems with a transaction for Chicago that resembled a call waiver and interest rate swap.

Officials from the bond counsel firm had been asked to appear at yesterday's meeting of the board after panel members demanded an explanation of why Chapman declined to give a legal opinion for the deal. Although Chapman sent a written statement explaining its reasons to the board in March, Ron Bean, the authority's executive director, said board members wanted an opportunity to ask "follow-up questions."

The deal, which the authority board approved at its Dec. 16 meeting, was killed on Dec. 23 by Chicago officials because Chapman, the bond counsel on the transaction, declined to give a legal opinion.

The authority was to have acted as a conduit in the deal, obtaining a short-term floating-rate bank loan to finance the purchase of up to $105 million of outstanding general obligation bonds that Chicago issued in 1982 and advance refunded in 1985 and 1986.

Board members said yesterday that were not made aware by Chapman of potential tax law problems concerning the deal at the authority's Dec. 16 meeting, when the board voted in favor of going ahead with the deal.

Some board members took issue with an explanatory statement that Chapman sent to the board in March. It said that all parties to the transaction -- the authority, the city of Chicago and First Chicago Capital Markets, which was structuring the deal -- were advised of "a number of business, statutory and tax-law questions which would have to be addressed and resolved in order for the transaction to be completed."

Kenneth Solomon, a board member and senior partner at Shefsky & Froelich Ltd., said he could not recall any of those issues being brought to the board's attention at the December meeting.

"It seemed like everything was rosy and ducky about this transaction and that there were no concerns," he said.

Charles Jarik, a partner at Chapman, said that authority staff members were informed about "various tax implications" when meetings on the deal began in November. He pointed out that the staff report that board members received in December indicated that "one of the most significant aspects of the transaction was the market value of the collateral -- the city of Chicago bonds." He added that "negative publicity" about the deal caused concern on the part of the law firm over that market value, a concern that Chapman officials said led to their decision not to issue a bond opinion.

According to the bond documents, if the market value of the bonds dropped below a certain point, the bonds would have to be remarketed.

In its March statement to the board, Chapman pointed to a Dec. 18 article in The Bond Buyer and the refusal of Moody's Investors Service to rate the bonds because of tax law concerns as evidence of "a lack of market confidence in the transaction," which could have adversely affected the value of the bonds.

The Bond Buyer had reported that federal regulatory officials and other bond lawyers said the deal appeared to violate tax laws and regulations. They pointed out that the bonds might be taxable because the deal appeared to be an "artifice and device" that was arbitrage-driven and would leave the bonds outstanding longer than necessary. They also said the deal appeared to violate a refunding rule that took effect last summer that prohibits replacing previously established escrows.

Michael Malone, vice chairman of the authority and secretary-treasurer of Jake's Tire Co., asked the Chapman officials why they did not let the board know at its Dec. 16 meeting that the deal "would not work," given the fact that Chapman admitted receiving phone calls from the Bond Buyer before the meeting about potential federal tax law violations in the deal.

Jarik said that at that time Chapman "fully expected to go forward with the transaction." David Williams, another Chapman partner, said that the decision to halt the transaction was triggered by "a combination" of the Dec. 18 article in The Bond Buyer and the decision by Moody's not to rate the bonds, which took place subsequent to the Dec. 16 meeting.

Solomon said Chapman should learn a lesson from this experience.

"The lesson for you all is the authority includes the board and not just the staff," he stated. "Various issues that need to be on the table ought to be on the table and when something is presented to the board, irrespective of what has been presented in writing, it is incumbent on you to have a dialogue with the board to let us know there is a relevant issue and not to leave it to our staff."

Jarik responded, saying, "That is a fair comment. We appreciate that."

Peter Gidwitz, the authority's chairman, said after the meeting that he felt the board "will be better informed next time" by Chapman or anyone that brings a deal to its attention.

Gidwitz and other board members called Chapman a reputable and respected firm with which the authority has had a long relationship. Both Malone and Ron Bean, the authority's executive director, said they do not expect that relationshipto change because of the d


In the deal, the bonds that were due to be called on Jan. 1, 1993, would have instead been escrowed to maturity and redeemed in 2003 and 2013. Chicago could have made between $3 million and $7 million a year in return for waiving its right to call the bonds, according to participants in the deal. The city's profit would have resulted from the spread between the low floating rates on the loan and the higher fixed rate on the securities put in escrow to pay off the bonds.

At the January board meeting, some authority board members demanded an explanation from Chapman as to why it dropped out of the deal.

In March, Chapman sent a statement to the board, explaining it had pulled out of the deal after a senior tax partner at the firm suggested the bond opinion be reconsidered after "questions" were raised that could have led to "market hostility" and a "possible regulatory review." However, the firm said it "continues to believe that its legal conclusions with regard to the transaction were correct."

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