WASHINGTON -- Clearfield, Utah, officials are trying to negotiate a settlement with some of the participants of the $6.8 million Heather Estates black-box bond deal that was sold for the city's housing authority five years ago and declared taxable by the Internal Revenue Service in June.

"We're talking about the idea of a possible settlement with some of the participants," said Harold Stephens, a lawyer representing the city in its lawsuit against the parties to the deal and its talks with the IRS.

Mr. Stephens made the remarks yesterday after the IRS met with Clearfield officials and agreed to give them time to try to a reach a settlement with the deal's participants. He would not name the participants that are negotiating with the city, but he said they do not include Matthews & Wright Inc., the underwriter of the issue.

The IRS notified Clearfield officials in June that the bonds violated federal tax laws and demanded $638,064 from the city in return for not taxing the interest earnings of the bondholders. The amount is roughly equivalent to the arbitrage that was earned from the deal, Mr. Stephens said.

Clearfield officials told the IRS they could not pay that amount, but they might be able to come up with all or some of the money from a settlement with the deal's participants, Mr. Stephens said.

Some of the bond firms involved in the deal approached the city about a settlement after realizing the amount being sought by the IRS is far less than they would spend in legal fees trying to fight the city's lawsuit, Mr. Stephens said.

Clearfield and Residential Mortgage Inc., the company that was to develop the Heather Estates project, filed the lawsuit in a U.S. District Court in Salt Lake City earlier this year. The suit alleges that Matthews & Wright and other parties to the Heather Estates deal violated securities and tax laws, committed fraud, breached fiduciary duty, and were guilty of racketeering.

Lawyers for Matthews & Wright have been trying to convince a panel of judges in Washington to transfer the suit to a U.S. District Court for the Eastern District of Pennsylvania, where seven other lawsuits pending against Matthews & Wright and others have been transferred and temporarily put on hold.

Matthews & Wright's lawyers have contended that all the suits are similar and should be consolidated. But Clearfield officials opposed the request for a transfer in court documents filed with the Judicial Panel on Multidistrict Litigation earlier this month. The panel of judges has agreed to hold a hearing on the jurisdictional dispute next month, Mr. Stephens said.

The Heather Estates issue was one of 26 deals totaling $1.3 billion that were rushed to market and closed without cash by Matthews & Wright in the mid-1980s. The firm, which was barred from the underwriting business by the Securities and Exchange Commission, purchased the bonds with checks from an undercapitalized credit union and then temporarily warehoused them with an unlicensed, offshore shell bank. The bonds were not sold to public investors for cash until months later.

The Heather Estates bonds were first sold for the Housing Authority of Clearfield City, Utah, as a $7.5 million issue on Dec. 31, 1985, and then resold as a $6.8 million issue in July 1986.

The IRS has treated the Heather Estates issue differently from the other 26 issues that were closed without cash by Matthews & Wright. The agency has contended the Heather Estates bonds are not tax-exempt because there was no reasonable expectation at the time of issuance that the proceeds would be used for housing.

In the cases of the other deals Matthews & Wright closed without cash, the IRS has said the bonds were subject to arbitrage rebate requirements because they were not validly issued until after those requirements took effect. In those deals, the IRS has demanded the arbitrage be rebated and warned that the bonds will no longer be tax-exempt if the arbitrage payment is not made.

Heather Estates was a black-box deal--so named because the deals have a complicated structure and the bond proceeds seems to disappear--in which participation interests in the mortgage note to the property being financed are supposed to be sold to third-party investors for cash to buy credit enhancement.

In the Heather Estates deal, however, as with many of the black-box deals done in the mid-1980s, the mortgage note was never sold. The bond proceeds were locked into a long-term guaranteed investment contract and were not available for the project. The GIC, held by Mutual Life Insurance Co., is not due to mature until December 1993.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

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