The Ghost of Scandals Past

Previous "creative financing" debacles should haunt city officials who've approved a risky $1 billion lease of Muni streetcars

He went on the lam for two years before he was arrested in Southern California for trying to obtain a phony passport. He was subsequently sentenced to state prison on securities fraud charges related to his collapsed limited partnerships.

In 1995 the SEC notified Nevada County officials and other deal participants that it was considering filing securities fraud charges against the county and its entire financing team. Following a three-year probe, the SEC reached a negotiated settlement with the county that resulted in a "cease and desist" order specifying that, even though Nevada County hired lawyers and experts, it violated U.S. securities law by failing to adequately supervise the creative-financing bond deal itself.

The San Francisco investment banking firm that underwrote the bonds agreed to pay $700,000 in penalties to settle a federal civil suit connected with the Montross deal.


If Nevada County tied its fate to that of Michael Montross, San Francisco is marrying its interests with those of a group of investors and trustees. In the case of Nevada County, sound city finances relied on the promise of a successful real estate deal. In San Francisco, our partners must build the perfect tax shelter.

The deal is supposed to work like this: Muni will lease 118 of the city's Breda rail cars to a group of private investors, mostly foreign firms. For the right to deduct the value of the cars' annual wear and tear from their federal taxes, the investors will lease the cars back to Muni -- at a $43 million discount. Muni will pay $10 million to lawyers and financial consultants, and keep $33 million for itself.

If the IRS somehow determines that the investors can't take the tax deduction they had hoped for, however, it becomes S.F. Muni's responsibility to make it whole, according to the Tax Indemnification Agreement Muni is entering into with CIBC, one of the investors. According to this agreement, the taxpayers of the City and County of San Francisco are liable for helping create the Breda tax break (or sham, depending on your point of view). If the IRS gets wise, and disallows the tax break, the agreement provides a laundry list of ways the decision might be considered Muni's fault. In such an event, the citizens of San Francisco must pay the investors what they say we have to pay, in taxes, because of the loss of the tax shelter -- and we won't even be allowed to inspect the investors' records to make sure they're telling us the truth. Theoretically, the city could be liable for millions, or even tens of millions, of dollars.

It would seem important, therefore, that Muni officials and their advisers achieve a solid understanding of how, exactly, the tax shelter is supposed to work, and who, exactly, we're dealing with.

Harrington, for one, did not seem conversant with these details during our meeting in the conference room, or in a subsequent half-hour conversation. To answer my questions, she looked up documents and read from them; she gave incomplete, misleading descriptions; she obfuscated in other ways. At the same time, however, she insisted that this tax shelter, which Muni has sold to the Board of Supervisors as a tax shelter, not be referred to in the press as a tax shelter.

Harrington told me she would take my request to speak with attorneys from Orrick, Herrington & Sutcliffe LLP, who advised the city on the Breda leaseback deal, "under advisement." In other words, she refused.

The city's financial adviser, Peter Ross, a principal of Ross Financial, seemed more knowledgeable about the transaction. Still, he parried questions about the tax shelter's details. "These are quite complicated, and the questions you raise are the ones you are very much aware of," he said. "It's a complicated aspect, and counsel for the investors have concluded that the transactions do comply with the tax code, and our counsel is satisfied that the tax risk is borne by the equity investor rather than Muni."

For Walter Borny, who during the early 1990s spent months poring over court and financial records trying to determine what, precisely, Montross had done with investors' money, the evasions and temporizing sound all too familiar: "Anybody who says, '"Everybody's doing this' -- those are buzzwords for '"Don't look into what we're doing.'"


Having scrutinized spirits past, I thought I'd visit ones from a possible future of lease-leaseback deals. I traveled by phone to Ontario, Canada, where the provincial government is drawing up municipal leasing guidelines after a lease-leaseback deal for a proposed sports complex in the city of Waterloo blew up into a series of lawsuits when a journalist determined last year that the deal would cost the city $228 million over 31 years, twice what officials first thought. As it happened, the tax shelter part of the deal fell through, and the city of Waterloo was liable for the money lost to investors.

Since then, several other government entities in Ontario have launched inquiries into troublesome lease-leaseback transactions similar to the Muni-Breda leaseback. The city of Toronto has hired leasing expert Greg Dorbeck to conduct a detailed review of a lease agreement involving $68 million of computer equipment.

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