WASHINGTON -- A new controversy has erupted over an issuer's attempt to call bonds that were escrowed to maturity, only this time the dispute is headed for court.
The dispute centers around the Jefferson Memorial Hospital Association in Crystal City, Mo., which wants to call $9.75 million of bonds that it issued in 1975 and 1982 and defeased to maturity with its own cash in 1988 and 1989.
The hospital is planning to refund the bonds next Thursday, but says in the refunding bond documents that it will delay calling the bonds until a state or federal court affirms its right to do so.
The hospital must seek a court opinion because Commerce Bank of St. Louis, the trustee, is unwilling to call the bonds without one, according to Thomas K. Vandiver, a lawyer with Sonnenschein Nath & Rosenthal in St. Louis, which is representing the hospital. Bank officials would not comment oil the matter. "What we're trying to do is to take a very conservative approach to this," Vandiver said. "If there's an issue out there in connection with this, we'd like to get it resolved."
Meanwhile, Emmet & Co., a broker-dealer in Far Hills, N.J., that trades escrowed-to-maturity bonds and holds some of the hospital's bonds, has warned that bondholders may bring legal action against the hospital if it calls the bonds before their stated maturity date of March 1, 1999.
Emmet issued the warning in a letter sent Wednesday to Commerce Bank, copies of which were also sent to the Securities and Exchange Commission, the Public Securities Association, the hospital, and other market participants.
In the letter, Dennis C. Darling, a vice president at Emmet, told Venetta Garnett, a corporate trust official at the trustee bank, that the rights of bondholders "would be violated if the bonds were called...."
"Considering the amount of money at stake in this issue and the contentious nature of this matter, there is certain to be legal action should the issuer and legal counsel proceed with the intention of calling these bonds," Darling said.
He told Garnett the bondholders must be represented in any court action brought by the hospital regarding the call.
The dispute is the latest in a series of controversies over attempts by issuers to call bonds that have been escrowed to maturity. It is similar to the controversy in October 1992 that surrounded Memorial Health Services' redemption of bonds that had been issued in 1974 and cash-defeased in 1984.
Both Memorial Health Services, a nonprofit medical center in Long Beach. Calif., and Jefferson Memorial defeased their bonds to maturity with cash on hand rather than by issuing refunding bonds. Emmet complained in both cases.
"We trade escrowed-to-maturity bonds," Darling said in an interview this week. "If you let someone get away with this, every investment banker and lawyer is going to try to do the same thing."
Emmet contends that Jefferson Memorial never reserved its right to call the bonds when it escrowed them to maturity.
Vandiver admits the language in the escrow agreement "is not as clear as it could be," but insists it gives the hospital the right to call the bonds.
The escrow agreement says that if the bonds are paid, the indenture will terminate and the rights under the indenture will "be void except as to ... rights under the indenture of holders to receive payments of principal and interest on the bonds when due (whether at maturity, upon redemption as provided in the indenture or otherwise)...."
Emmet says that one of its traders and an official at Kenny S & P Information Services were told this year by Donald Mueller, a lawyer with Armstrong, Teasdale, Schlafly & Davis in St. Louis that had been advising the hospital, that the call rights had been defeased.
"Earlier in 1993 we traded some substantial blocks of Jefferson Memorial escrowed bonds relying on a close reading of the escrow agreement and information supplied to us by Donald Mueller of Armstrong, Teasdale of St. Louis ... that the original calls were defeased," Darling told Garnett.
Mueller could not be reached for comment. But Vandiver said Mueller told him that while he may have said the bonds had been defeased to maturity, there was never any discussion of whether the calls were defeased. "It could be they interpreted the conversation beyond what [Mueller] said," Vandiver said.
Emmet believed, based on the escrow agreement and the information from Mueller, that the bonds would remain outstanding until March 1, 1999.
Kenny officials confirmed yesterday that they listed the 1982 bonds as "optional call defeased" until May 28 on the basis of what they had been told by someone at the Armstrong Teasdale firm, but would not say if it was Mueller. On June 1, Kenny changed the bonds' description to indicate the bonds could be called after conferring with Armstrong Teasdale again. Kenny officials were checking on the descriptions of the 1975 bonds at press time.
Darling contends in the letter that the description of the bonds was changed after PaineWebber Inc., which is to underwrite the hospital's refunding bonds along with Stifel, Nicolaus & Co., said it was incorrect. Officials from PaineWebber could not be reached for comment.
Several traders said the bonds have been trading at premiums in the market because of confusion over their status. On Wednesday, a block of the 1982 bonds were being offered at a premium of 120% of their principal amount by Drizos Investments Inc., a dealer in Morristown, N.J., according to J.J. Kenny's "Blue List" of prerefunded bonds. Drizos described the bonds as having been escrowed to maturity.
Nick Drizos, president of Drizos, said he was told by someone connected with the bond issue that the calls had been defeased, but said he could not remember the name of the person.
Emmet contends that the call would run counter to guidelines issued by the Securities and Exchange Commission, the Municipal Securities Rulemaking Board, and the Public Securities Association. Under those guidelines, issuers are supposed to call escrowed-to-maturity bonds only if they disclosed that they were retaining their call rights in the defeasance notice and official statement for the refunding bonds.
Vandiver says the SEC, MSRB, and PSA guidelines only address situations in which the bonds were escrowed to maturity through refundings. In Jefferson Memorial's case, he says, the hospital defeased its bonds with cash to get out from under its "on behalf of" issuer status. It did not issue any notices to bondholders. No bond firms were involved. Therefore, the SEC, MSRB, and PSA do not have any jurisdiction in this matter, he said.
SEC and MSRB officials said this week that they are not sure whether cash defeasances are covered by their guidelines on escrow-to-maturity bonds.
At the same time, however, they disputed the notion that the guidelines only cover bond firms. The guidelines, which appear in an SEC letter that was sent to the MSRB on June 24, 1988, represent the SEC's opinion of the responsibilities of bond firms and issuers under the antifraud provisions of the securities laws, they said.
"The antifraud provisions apply to any person," said Robert Colby, deputy director of the agency's market regulation division.
If there is a securities law issue in this case. Colby said, it should be heard in federal rather than state court.