DALLAS -- In a surprising move, the Oklahoma City school district board Friday unanimously voted not to pay more than $1 million in arbitrage profits, penalties, and interest to the Internal Revenue Service for its participation in a cash management scheme.

The move could mean that holders of $30 million in tax-exempt bonds issued in the 1990-91 program could now be taxed under IRS regulations and the IRS could blacklist the school district by revoking its ability to certify some other bond issues as tax-exempt in the future.

"I am shocked that the school board ignored a demand by the IRS. To my knowledge, this has not occurred before," said Bob Schaffer, an Atlanta bond attorney who is one of several lawyers suing the district over the cash management program. "I don't expect the IRS to roll over. They have no choice but to declare the bonds taxable."

School district officials and attorneys had few comments on the issue beyond saying that paying the arbitrage rebate violated the Oklahoma Constitution. Legal sources said it could be unconstitutional because paying the rebate would use taxpayer money to benefit the bondholders, not for a public purpose required by state law.

"The details that we discussed are not available at this time," said Cleeta John Rogers, general counsel to the Oklahoma City School District, who made the recommendation to the school board.

Meanwhile, industry observers expressed amazement at the board action, which could threaten the tax-exempt status of future bond issues by the school district and carry a market penalty when the district plans to issue $90 million in general obligation bonds on Nov. 16.

The action is the latest development in a controversy over the 1990-91 cash management program in Oklahoma. Under the program, Oklahoma City schools and about 200 other districts issued $395 million in tax-exempt tax and revenue anticipation notes. The districts maintained they needed the money to cover temporary cash shortfalls, but the IRS later challenged that. The agency said the shortfalls were exaggerated, and as a result, the bonds could become taxable arbitrage bonds.

At least six districts are being investigated by the IRS, including Tulsa public schools, which agreed to settle their bill, and Oklahoma City. The IRS demanded that Oklahoma City pay more than $1 million in arbitrage profits, penalties, and interest for selling $30 million in tax-exempt bonds and collecting $252,000 in profits in the 1990-91 program. The IRS could have demanded rebate for $17 million in bonds floated in the 1992-93 program, and the district also has refused to pay that.

IRS officials declined to comment on the specifics of the case and their future actions. However, David Stell, public affairs officer for the agency's Oklahoma City office, said the IRS has the authority to revoke the issuer's ability to certify future arbitrage bonds as tax-exempt under federal law if it fails to pay the arbitrage profits. The IRS also can declare the bonds taxable.

"We have opinions to the contrary," said L.D. Barney, spokesman for the Oklahoma City school district.

However, industry sources said if the Oklahoma City school district is blacklisted by the IRS, future bond issues will be affected.

"In the interest of the taxpayers and the students, I trust the board will reconsider that action because of the dire consequences ... and the possible imposition of market penalties on future issues," said Larry Patton, one of the attorneys who filed a taxpayer lawsuit last week against the school district.

The lawsuit contends that the bond underwriter, counsel, tax attorney, and others who profited from the 1990-91 cash management program should pay the damages to the IRS, not the taxpayers.

The suit now likely will be withdrawn because the taxpayers will not be damaged if the district does not pay the IRS, Patton said.

The bond underwriter for the program, Stifel, Nicolaus & Co., and the bond attorney, Fagin, Brown, Bush, Tinney & Kiser, declined to comment on the school board's decision. The tax attorney, Hawkins, Delafield & Wood, could not be reached for comment.

Industry sources said they expected bondholders to go after the bond firms involved in the program if the bonds are declared taxable by the IRS.

IRS spokesman Stell said such an action probably would be listed in the Federal Register if the agency decided to declare the bonds taxable.

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