LOS ANGELES -- The bond lawyer serving as an expert witness for the government in the Whitewater Garden and Ironwood trial testified Wednesday that he believed the bond issuer did not establish reasonable expectations in its no-arbitrage certificates.
After hearing all of the evidence presented in the eight-day trial, Neil Arkuss, a partner in the Boston law firm of Palmer & Dodge, said he stood by his written conclusion submitted in April. In his report, Arkuss wrote that "the issuer's conduct was such that its no-arbitrage certifications were not reasonable."
Furthermore, to the extent the issuer wished to establish those expectations "derivatively [by relying on the bond counsel on these two transactions], it is my opinion that bond counsel did not meet minimally acceptable practice standards," Arkuss wrote.
During questioning Wednesday by a lawyer representing the Internal Revenue Service, Arkuss said the evidence presented during the trial had changed his views on a couple of facts that he relied upon in expressing his opinion. But these changes did not affect his conclusion, which was based on the overall evidence presented in the case and other documents he used in preparing his opinion, Arkuss testified.
Arkuss, the current president of the National Association of Bond Lawyers, ended up being the last witness in the eight-day trial.
The IRS called Arkuss to help underpin its argument for declaring the bond issues taxable.
The Riverside County Housing Authority in California issued $17.5 million of Whitewater Garden bonds and $13 million of Ironwood bonds to build separate apartment projects.
But the IRS contends the Dec. 31, 1985, sale date for the bonds was a "sham" because it involved a cashless closing scheme used by the now-defunct underwriter, Matthews & Wright.
The IRS claims the debt was actually issued in 1986 during a remarketing. This date would qualify the debt as "arbitrage bonds" subject to arbitrage rebate requirements for tax-exempt multifamily housing bonds issued after 1985.
Even if the judge finds that the debt was validly issued in 1985, the IRS argues the bonds are taxable on grounds the issuer did not establish a reasonable expectation that bond proceeds would be used for housing rather than to earn arbitrage.
Harbor Bancorp, a bank based in Long Beach, Calif., and Edward and Elena Keith, residents of Pebble Beach, Calif., initiated the case before U.S. Tax Court Judge Julian I. Jacobs to fight the IRS' decision to revoke the bonds' tax-exempt status.
Jeffrey Christopher, whose firm of Camfield & Christopher served as bond counsel on the transactions, appeared at the trial last week as a witness called by the bondholders.
Lawyers at Bryan Cave, the law firm representing the bondholders, consistently tried during the trial to show that neither Christopher nor officials at Riverside County knew about a scheme that eventually diverted bond proceeds into long-term guaranteed investment contracts.
During questioning by Juan Keller, a partner of Bryan Cave, Christopher testified that he "would not have authorized release of my opinion" if he had had knowledge about plans to divert the bond proceeds from funding construction of the projects.
When Keller asked if the bond lawyer had possessed any "suspicions, inklings, [or] misgivings" about some of the private parties who arranged the financing structure, Christopher replied, "None whatsoever."
On Wednesday, however, Arkuss testified that factors surrounding the deals' closings would have made him apprehensive.
In response to a question by Clifton B. Cates 3d, a lawyer for the IRS, Arkuss said these factors "would have caused red flags to occur to me." After a brief pause, he added: "Crimson."
On cross-examination, Keller repeatedly questioned Arkuss about what else officials at the housing authority or the county could have done to establish their expectations for the projects.
"They did good due diligence with respect to these projects," Arkuss said, remarking later that "I do not question the good faith" of the government officials who were reviewing the projects and the financings.
But in some of the sharper exchanges during Keller's cross-examination, Arkuss repeatedly stressed that expectations alone are not enough. The issue of law, he testified, is "whether or not they were reasonable."
The lawyers also mixed it up at times during Arkuss' testimony. Keller particularly objected to Cates' persistent questioning regarding the actions of Christopher, the bond counsel. At one point, Keller objected and asked the judge, "What does [this] have to do" with the reasonable expectations of the issuer?
Cates retorted that the bond counsel's actions meant "a great deal," especially to the extent that the bond counsel's knowledge is ascribed to the issuer in reaching the reasonable expectation standard.
"The buck has to stop somewhere," Cates said. "The issuer can't just shut its eyes."
Judge Jacobs let Cates pursue many of his questions regarding the bond counsel's actions, but he also sustained some of Keller's objections. At one point, Jacobs observed that Christopher is not on trial in the case.
Regarding the two bond deals themselves, Arkuss testified that certain details struck him as odd, compared with the practices he considers standard for closing tax-exempt bond deals.
Arkuss observed, for example, that the then-executive director of the housing authority, William Rosenberger, signed the signature page to the no-arbitrage certificates roughly two weeks before the alleged closing on Dec. 31, 1985.
In his experience, Arkuss testified, such certificates are "signed late rather than early," primarily because "facts tend to change" right up until the closing date.
From the testimony presented in the case, Arkuss said he could not conclude that Rosenberger had signed no-arbitrage certificates that were blank. But even if that were not the case, Arkuss said it still appeared Rosenberger signed certificates that were "different" from the ones that ended up in the closing binders for the two transactions.
During cross-examination, Arkuss said "there is no question" Rosenberger believed he was signing a true and correct document, but that still does not make the issuer's expectations "reasonable."
Arkuss also testified it was "highly unusual" that Christopher did not attend the bond closings in New York City, especially given the two weeks that elapsed between the pre-closing and the closing dates.
Christopher testified last week that he did not attend the closings because Stubbeman, McRae, Sealy, Laughlin & Browder, the underwriter 's counsel and special tax counsel, "was to handle" a number of closings.
Christopher said "that was acceptable to me" because Stubbeman McRae issued the special tax opinion on the Whitewater Garden and Ironwood bonds.
But Arkuss said that reasoning "appears to me to be a non sequitur." Arkuss said he did not see the link between Christopher's not attending the closings and Stubbeman's issuance of the special tax opinion.
Arkuss also expressed serious concern about the way the bond counsel "confirmed" its opinion and back-dated it after learning in early 1986 that Matthews & Wright had been substituted as the underwriter at the last minute in late 1985.
In addition, he questioned the validity of the closing process, given the unusual way in which the underwriter's checks were eventually endorsed back to the underwriter and not deposited.
"I would characterize it as not happening," Arkuss testified about the closings.
Jacobs' view on whether or not the bonds closed on Dec. 31, 1985--just prior to when the Tax Reform Act of 1986 took effect--could be a key factor in which whether he finds that the bonds are in fact taxable.
The judge's decision is not expected for several months.