CHICAGO -- A recent lawsuit in Michigan involving capital appreciation bonds has led state lawmakers to consider a ban on the use of those bonds by school districts.

State Sen. Joanne Emmons, R-Big Rapids, plans to introduce legislation banning school district issuance of capital appreciation bonds as an amendment to an existing school bill tomorrow, according to Peter Jaskoski, her administrative assistant.

Jaskoski said the amendment would end the use of the zero-coupon bonds on May 1, 1995, to allow districts time to complete bond issues that may be in the works.

While similar legislation failed in the Michigan legislature last year, Jaskoski said the current push is being fueled by the Pontiac school district's recent victory in court against its bond counsel Miller, Canfield, Paddock and Stone. The lawsuit, which involved the school district's 1991 issuance of $54.6 million of bonds, including about $35 million of capital appreciation bonds, dealt with "the real problems of how [capital appreciation bonds] are presented and used," Jaskoski said.

Last month, an Oakland County Circuit Court jury found the Detroit-based law firm liable on three counts of legal malpractice, including conflict of interest, and awarded the school district damages of $22 million to $28 million.

The attorney for the Pontiac district has said the inclusion of noncallable capital appreciation bonds in the 1991 issue will cost the district $104 million in debt service over 25 years. Dennis Pollard, the attorney, also said the school board looked to experts like Miller Canfield to fully explain the implication of issuing that type of debt.

Jaskoski said that Emmons' amendment has received support from Gov. John Engler and Senate Majority Leader Dick Posthumus, R-Alto. The amendment has a good chance of passing, even though that would require a three-fourths vote of the legislature, because of its relationship to school funding issues, he said.

"I think with the recent Pontiac situation, there may not be a lot of sympathy out there [for capital appreciation bonds]," Jaskoski said.

Under a new school funding system approved by Michigan voters in March, any bills dealing with funding for school operations require a three-fourths vote of the legislature for passage.

Last fall, legislation calling for a similar prohibition against the use of capital appreciation bonds by schools passed the Senate as part of a package of school reforms related to the new school funding system. However, the bill died in the House.

Nick Khouri, Michigan's chief deputy treasurer, said the Engler Administration has supported past efforts to end the use of the bonding technique by schools.

"Although [capital appreciation bonds], like any financial instrument, have their place, there have been abuses by school districts in the state of Michigan and that is important," he said.

Khouri pointed to "some isolated instances" where capital appreciation bonds "put an undue burden on future taxpayers by backloading debt service."

Critics of the bonds in Michigan have charged that districts and their underwriters use the practice to sidestep unpopular tax increases by telling voters they can push debt service payments into the future and not see their property taxes increase. However, if assessed valuation growth is not enough to meet those future debt service payments, taxes have to be increased because the debt carries a district's general obligation pledge, critics said.

In addition, critics contend interest costs on the bonds can be three to four times higher than on a normal issue because debt service payments are deferred for several years.

Municipal bond executives at Kemper Securities Inc. and A.G. Edwards & Sons, which underwrite much of the school debt in Michigan, defended the practice.

"I think all municipalities, including school districts, ought to have all the financial tools available to them," said Richard Allen, a managing director at Kemper.

"I think it's unnecessary," said Don Elliott, a vice president and manager at A.G. Edwards, referring to the proposed ban. "It's an emotional reaction to some misinformation."

Elliott said he hopes lawmakers will hold hearings on the matter so bond firms can explain their views.

Emmons intends to hold discussions on the matter, which would involve all affected parties, but not until the fall, Jaskoski said. If the amendment passes this month, the state would have a year to determine if schools could still use the bonds, but under certain circumstances, he said.

"Our thought is that there may or may not be certain instances where [capital appreciation bonds] may or may not be useful," Jaskoski said.

Meanwhile, Miller Canfield plans to appeal the circuit court decision in the Pontiac case once the judge makes a final determination on the size of the award, according to Thomas Linn, a principal at the law firm.

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