Tulsa schools might have to pay IRS millions for part in arbitrage plan.

The Tulsa school district could owe the Internal Revenue Service more than $3 million in arbitrage profits, penalties, and interest for its participation in alleged cash management schemes, and its representatives are expected to proposed tonight that general funds be used to settle at least part of the bill.

The move comes in the wake of reports prepared by Dallas-based First Southwest Co. that calculate that the school district could have to pay $2.084 million in arbitrage rebates for its involvement in cash management programs in fiscal years 1990-91, 1991-92, and 1992-93.

Those calculations do not include the usual 50% IRS penalty, which could add another $1 million plus interest.

The school district commissioned the reports as part of its efforts to settle with the IRS, which has investigated the Tulsa district and several other Oklahoma school districts for taking arbitrage profits and allegedly violating tax laws in the 1990-91 program.

"We are hopeful to reach a settlement soon" said David Fist, an attorney for the Tulsa school district. "If there is a settlement, it would be paid out of the school's general fund."

Fist said a proposal would be presented to the Tulsa school board tonight for approval, although he would release few details.

"If it is not handled expeditiously, the IRS will attempt to assess the bondholders" by revoking the tax-exempt status of the notes sold as part of the cash management program, he said.

The proposed settlement is one of the latest developments in a cash management controversy that started several years ago when about 200 Oklahoma school districts participated in a $396 million borrowing program in 1990-91 that generated millions in alleged arbitrage profits.

Under the state program, school districts issued tax-exempt tax and revenue anticipation notes in transactions that IRS officials said appear to violate arbitrage restrictions.

Tax law allows districts to issue tax-exempt notes to cover temporary cash shortages, but it bans them from issuing tax-exempt bonds based on exaggerated budget deficits to earn arbitrage profits. The IRS has maintained that school districts, including the Tulsa and Oklahoma City districts, overstated their deficits, and the bonds appear to be taxable. As a result, the districts now owe arbitrage rebates, penalties, and interest for the 1990-91 cash management program.

In addition, Tulsa officials also believe that the IRS could assess them for the two following years, when the same concepts were used, Fist said. As a result, First Southwest was asked to calculate rebates for all three years.

"It was my feeling that we shouldn't settle one year and then have the IRS come back and ask about two other years. We wanted to settle any obligation we might have for the open years," he said.

Fist said the district wanted to avoid having the IRS demand that bondholders shell out the money.

However, others maintain that the district should not use money from the general fund and obligate the taxpayers to pay the bill for underwriters, bond counsel, and others who profited from the deal.

"We shouldn't take this out of the hide of Oklahoma taxpayers," said Bob Schaffer, an Atlanta bond attorney.

Schaffer is part of a group that has threatened to sue the bond underwriter and others who profited from the alleged arbitrage scheme in the Oklahoma City school district. The group maintains that taxpayers should not be responsible for the bill. The four-attorney group also is making itself available to other districts that are being investigated by the IRS.

Schaffer said the Tulsa district should be guided by a recent case involving the Hemet, Calif., Housing Authority. In that case, the underwriting firms and lawyers involved in two disputed multifamily housing deals are being called on to pay the IRS $1.1 million, and in return, the IRS will not revoke the tax-exempt status of the bonds.

Fist would not disclose whether the district would go after the bond underwriter, financial adviser, or others who profited from the deal. "I can't discuss it," he said, "I can't confirm or deny it."

Information provided in First Southwest reports indicates that the expected rebate owed well exceeds the arbitrage profits that went to the school district. The Tulsa school district earned $588,658 in arbitrage profits for all three years on the issuance of $137 million in tax and revenue anticipation notes.

However, First Southwest calculations show the district owes a total rebate of $2.084 million, or $923,940 for 1990-91, $806,257 for 1991-92, and $354,684 for 1992-93.

Under IRS regulations, the rebate calculations are based on the profits that went to the school district as well as the money that paid fees for underwriters, letters of credit and other cost of bond issuance.

St. Louis-based Stifel, Nicolaus & Co. was the underwriter, and the financial advisers to the Tulsa district in the 1990-91 program were Stephen L. Smith Inc. and Evan L. Davis.

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