Sedona resident Rick Normand (above) at a Special Meeting convened by the City Council to address concerns raised by Mr. Normand and other residents about whether the City of Sedona is improperly using "other funds" to repay a bond issue; along with other alleged technical defaults.

Bond lawyer defends city’s use of reserves to pay back bond debt

Citizens question legality and possibility of default

By Tommy Acosta, Associate Editor

SEDONA, AZ - March 26, 2009 - Members of the now defunct Mayor’s Economic Advisory Committee and legal representatives for the City of Sedona faced off Wednesday, March 25 during a special meeting of the council called to clarify confusion concerning the city’s legal right to pay off its 2007 Series, $18,000,000 bond with funds other than excise tax revenues.

Citizens at the meeting claimed the city might be in technical default of its Series 2007 Bond Issue.

Presently, the city’s Wastewater Enterprise Fund reserves are being tapped to pay off the debt.

Representing the city, the city's bond counsel, Mr. Michael Cafiso of Greenberg Taurig LLP; and Kurt M. Fruend, managing director of the city’s underwriter, RBC Dain Rauscher, argued the city may pay back the debt from any other source.

The bond attorney and underwriter claimed the stipulation that the city must pay back the bond debt solely from excise-tax revenues applies only if the city were to default on its payments. In other words, a portion of the city's excise tax revenues is effectively pledged as collateral to secure repayment of the bond debt.

“The use of [other] moneys in no way violates any rules talked about tonight,” Mr. Cafiso said. “The things we heard tonight were taken out of context. If Sedona doesn’t make payment, then the bond holder can take over and collect out of the excise taxes.”

Mr. Cafiso had previously answered questions raised by Mr. Normand on this issue in a letter sent to City Attorney Michael Goimarac, dated Feb. 19, 2009.

Mr. Normand said his claim the bond debt must be paid back from excise tax revenue was backed by the City of Sedona's Independent Auditor, Cronstrom, Osuch & Company.

“It's prominently posted on this City's own Web site within the Comprehensive Annual Financial Report-Notes to the Basic Financial Statements For the Fiscal Year Ended June 30, 2008, Sec. C entitled Long-Term Obligations (Pg 56), wherein it is stated categorically ‘The City has pledged future excise taxes to repay $9.1 million in business-type excise tax revenue obligations issued in 2007. Proceeds of the bonds provided financing of drainage and sewer improvements within the City. The bonds are payable solely from excise taxes and are payable through 2027.’ This is what most of the Series 2007 bond investors believed to be true.” (Written transcript provided by Rick Normand of his comments at the March 25, 2009 Special Meeting)

Mr. Cafiso said to check with the city’s auditor to make sure the right language was being used.

“Get in touch with your auditor who will tell you the same things we said,” Mr. Cafiso said.

He said it was possible the auditor’s report failed to include language that allows the use of other funds to pay back the debt.

Mr. Normand said the city also failed to file a “Material Event Notice” when the rating of its bond insurer, MBIA was downgraded in December 2007, shortly after the closing of the subject Series 2007 bond obligation.

“The City should have right then and there issued a “Material Event Notice,” he said.

Mr. Fruend said the downgrade does not affect the city’s payments.

“I’m not sure you would want to promote a downgrade in the rating of your bond insurer,” Mr. Fruend said. “It does not change your interest rate.”

Terry Nash, who did not serve on the Mayor’s Economic Committee, cited a recently city staff-generated five-year-plan for the Wastewater Fund, as further cause of alarm.

“It evidences that the Wastewater Fund will be broke by 2013,” he said. “It also evidences that the 2007 Sedona Bond Series payments are being made out of bond proceeds. Once the Wastewater Fund is depleted, how will the payment of $1.5 million be made?”

He noted the title of the bond agreement reads “Excise Tax Revenue Obligations, Series 2007 to bolster his opinion the debt can only be repaid through excise tax revenues.

He also warned the council the city is facing financial catastrophe in the future if action is not taken.

“I want this council to understand that the city is in a very serious financial situation and a potentially disastrous legal position relative to the bonds,” he said. “I want the council to do something about the problem now or face consequences.” he said.

Mr. Cafiso insisted there was nothing wrong with the way the city is paying back its debt and that the city was in much better financial shape than others.

“I commend these gentlemen for the research they have done but they do not understand,” he said. “There are differences in the way we look at things. It’s different the way the bond world looks at them. There is a big difference by what these gentlemen define as default to what default means to us… In terms of what you [the city] are doing, you are in better shape than 90 percent of other municipalities.”

He alluded there might be other reasons the citizens were questioning the way the city is paying back the bond debt.

“The context being given tonight is not just correct,” he said. “There must be some ulterior motive. I just don’t get it.”

Mr. Cafiso’s statement was echoed by Councilwoman Pud Colquitt, who was mayor at the time of the bond was issued and said she signed the agreement.

“I’m beginning to think there is something else afoot here,” she said. “To me, it is about the integrity of the city and council.”

Mr. Normand took exception to the statements.

“This is the kind of treatment well-meaning unpaid citizen volunteers get when they don't tow the official-party line,” he said after the council meeting. “In other words, it's ‘do as you're told, or don't bother us with your volunteer efforts.’ Considering this statement, one has to wonder why anyone should volunteer his time and honest efforts to improve this city, which is obviously falling apart.”

Mr. Fagan, a member of the Mayor’s Economic Advisory Committee, questioned the possible intermingling of reserve funds and bond moneys and labeling the sum as reserves.

“My definition of reserve money is money sitting there for purposes that develop projects,” he said. “This bond money is borrowed money. The proceeds from the bond sale were added to the reserve. We have borrowed money sitting in reserves to be expended in projects over five years. What was $32 million a while ago is $20 million now and it is going down, down, down.”

Assistant City manager Allison Zelms said no borrowed money was put into the reserves.

“I’m not aware of borrowed money in the Wastewater Fund,” she said.

“That’s not true,” Mr. Fagan said after the meeting. “I have city documents that prove so.”

Mr. Nash said the city’s use of paying back the bond with borrowed money constitutes a Ponzi scheme.

“Utilizing the proceeds of the bond to pay back the debt is nothing more than an elaborate Ponzi scheme,” he said.

Mr. Fruend reiterated their position that the city was doing nothing wrong and that the citizens testifying were misinformed.

“I don’t appreciate these allegations,” he said. “They are factually incorrect. My recollection, as a planned approach, it is a common practice to pay back from reserves. I am not convinced the city has done anything wrong, is in default or is part of a Ponzi scheme.”

Councilor Bradshaw asked what would happen if the city defaulted on the loan.

“If someone came after us, who would handle it,” he asked.

“If that occurs the city would defend it,” Mr. Cafiso replied. “You are insured and are covered.”

He noted ultimately, the city would have to pay back the debt from its excise-tax revenues.

Mr. Ancis, a member of the Mayor’s Economic Advisory Committee, called for an independent audit to determine if the city is sound in using other sources of revenue to pay back the 2007 Series debt.

“Here tonight I am asking the city council on this matter,” he said. “I spent six months investigating this issue as a member of the mayor’s committee. I am quite concerned about issues of appropriate disclosure and the city’s ability to meet expenditures. I would demand a third-party audit outside of the same people who participated in getting the bond.”

The council moved into the next agenda item without taking any action or giving staff direction on Mr. Ancis’s request.