Small Cities Fear Regulatory Fallout of O.C. Bankruptcy

SACRAMENTO —  Leaders of a gaggle of small municipalities told state lawmakers Wednesday they fear the Securities and Exchange Commission is threatening to unfairly cast them as scapegoats in a heightened enforcement effort prompted by the Orange County financial debacle.

Buffeted by the new get-tough tack by federal regulators, small town elected leaders are concerned they could face personal financial liability for approving municipal bond deals that subsequently turned sour.

“We’re bewildered to find ourselves included in the company of Orange County,” Clay Castleberry, interim city administrator of Wheatland, told the Assembly Banking and Finance Committee.

The tiny berg just north of Sacramento has a population of 2,000 and a $350,000 annual budget, but faces hefty defense costs and potential fines as the SEC pries into a troubled bond deal the City Council approved to help finance roads and sidewalks for a new development.

Small town officials contend they lack the expertise to understand the intricacies of high finance, relying instead on financial experts hired to review a given bond deal.

Larry Pennell, city manager of rural Wasco, said his council includes a hardware store owner, a contractor and the owner of a firm that grows rosebushes. “They admit they’re unsophisticated and inexperienced” in municipal finance, Pennell said. But the council attempts “to act in a responsible manner.”

Robert Doty, president of a Sacramento financial advisory firm that caters to municipalities, ventured that 95% of the elected municipal leaders in the country never bother to read the bond prospectuses produced for each sale, relying instead on their staffs to ferret out potential problems.

Doty and other financial experts also told the Assembly panel that heightened enforcement by the SEC--which in recent months has said it intends to press charges against a dozen California school districts, cities and counties for securities problems--could put a damper on the ability of local entities to raise money.

“I think the implications are very far-reaching,” Doty said, adding that the SEC, which until last month had never taken similar enforcement actions, seems intent on “stretching” existing rules to give municipal lawmakers financial oversight responsibilities “they didn’t know they had.”

But one state official said it is far too soon to determine whether the SEC has gone too far. “We feel its too early to say that the SEC has exceeded its limits,” said Peter Schaafsma, California Debt Advisory Board executive director.

Schaafsma’s agency is in the midst of searching for new guidelines for municipal bond deals and is developing a curriculum for a continuing education program to get local elected leaders boned up on some of the intricacies of high finance. Seminars as well as an educational video are planned.

Seven of the local governments under SEC scrutiny are cities or school boards in Orange County that borrowed money to reinvest in the county’s failed bond pool, which lost $1.64 billion in 1994 and brought on the biggest municipal bankruptcy in U.S. history.

Those given notice by the SEC are the cities of Anaheim and Irvine, as well as the Placentia-Yorba Linda, Newport-Mesa and Irvine school districts, the Orange County Department of Education, and the North Orange County Community College District.

The only Orange County official to appear was Assistant Supt. John Nelson, of the Education Department, who read a short statement and declined to take questions because of the investigation.

While the Orange County entities have been criticized for borrowing money for risky investments, that is not the case with the five other small government entities that have received SEC notices of potential penalties. Under investigation are Nevada County and the cities of Avenal, Ione, Wasco and Wheatland.

Jan Goldsmith, banking committee chairman, expressed concern the SEC enforcement effort could cause officials in other small municipalities to avoid the bond market for fear they might be unwittingly subjected to harsh federal penalties.

“We don’t want to go overboard,” Goldsmith said. “We don’t want to deter local governments from issuing bonds. If we don’t have bonds, we don’t have roads, we don’t have schools.”

Arthur Levitt, SEC chairman, declined an invitation from the committee to participate in the hearing and did not send another commission official because of the ongoing investigations.

But one state lawmaker expressed dismay that anyone would frown on the pumped up oversight in light of what occurred in Orange County.

“I’m shocked that anyone would believe elected individuals who sought the public trust should be able to pass the buck,” Assemblyman Louis Caldera (D-Los Angeles) said. “Some of this is obviously a response to the Orange County disaster, and therefore long overdue to ensure we have high standards.”