The alleged use of fake documents to defraud investors in municipal bonds sold for an Arizona sports complex puts a spotlight on due diligence, an area where some say practices may need rethinking as artificial intelligence expands the toolkit of potential fraudsters.
"I think there just needs to be better thinking on due diligence in this modern-day era because nowadays creating a credible false document is much easier than before," said Peter Chan, a partner at the law firm of Baker McKenzie who previously served as assistant regional director in the Securities and Exchange Commission's Chicago regional office.
"But even that is dated," said Chan, adding that these days "if you can have someone on a Zoom creating a false image and voice of who they are so that they can assume someone else's identity, the idea of due diligence is evolving."
Indeed, while the alleged fraudulent scheme involving bonds issued for the Arizona sports complex included fake letters – some with misspelled names – news reports last year
On April 1, the SEC announced that it had charged Randall "Randy" Miller, Chad Miller, and Jeffrey De Laveaga in connection with a fraudulent scheme to sell approximately $284 million of municipal bonds, now defaulted.
In a parallel action the same day, the U.S. Attorney's Office for the Southern District of New York announced the unsealing of a criminal indictment against the Millers.
According to the SEC's complaint, the bonds were issued for the benefit of Legacy Cares, an Arizona nonprofit corporation, in August 2020 and June 2021. Legacy Cares issued the bonds via the Arizona Industrial Development Authority, a conduit issuer.
Both the $250.8 million of bonds issued in 2020 and the $33 million of bonds issued in 2021 were revenue bonds, which meant that the cash needed to pay interest and principal back to the bondholders was to be from revenue generated by the sports complex, the complaint said.
While the limited offering memorandum for the 2020 bonds included financial projections that anticipated revenue as being multiple times the amount necessary to cover the payments to investors, the financial projections "were false and misleading," the SEC's complaint said.
Attached to the 2020 offering memorandum and referenced throughout the document were "letters of intent," purported to be from sports clubs, leagues and other entities signaling intent to move their events or operations to the sports complex, the complaint said.
"However, the majority of the more than 50 letters of intent were either totally fabricated or materially altered in some fashion, including the forging of signatures, by Randy Miller, Chad Miller, and De Laveaga in the months leading up to the 2020 bond offering," according to the SEC's complaint, which alleged that at least two of the letters misspelled the names of purported signatories.
In addition to the phony letters of intent, the defendants – knowingly or recklessly – worked together to create a set of so-called "pre-contracts," which were also referenced throughout the 2020 offering memorandum as supporting the revenue projections, the SEC's complaint alleged.
"Like the fabricated letters of intent, however, most of the pre-contracts were fake," the complaint said.
The limited offering memorandum pertaining to the 2021 bond offering incorporated the same false projections, letters of intent and pre-contracts from the 2020 offering document, the SEC's complaint said.
In January 2022, the sports complex opened with far fewer events and significantly lower attendance than had been projected in the offering documents, the complaint said. In October 2022, Legacy Cares defaulted on both the 2020 and 2021 bonds. Legacy Cares filed bankruptcy proceedings in May 2023, the SEC's complaint said.
Burned bondholders filed
The lawsuits, one of which was brought by Vanguard, Voyageur, AllianceBernstein and PIMCO and the other by Saybrook Fund Advisors, have since been consolidated into one complaint, and are now in discovery. Oral arguments relating to a motion to compel discovery responses from Ziegler are currently set for May 15.
Chan said while he didn't know enough about the underlying facts to comment specifically on who may or may not be at fault the Legacy Cares situation, his general observation was that when the extensiveness of a fraud gets to the point where someone is creating false data and documents "it is tough to blame gatekeepers applying traditional due diligence."
While he stressed the importance of understanding the risk profile of an issuer – particularly one with a limited history – "due diligence has historically not been equated as a forensic investigation," Chan said.
"I do think there needs to be an ongoing rethinking as to what is effective due diligence in the new technological landscape where creating false stuff is pretty easy," he said. "And I don't mean just false documents."
While fraud has a history dating back "to the beginning of human kind," clearly AI "has gotten and it will get even more sophisticated," said David Dubrow, a partner at ArentFox Schiff.
"It expands the possibilities of how fraud can be committed," Dubrow said, adding that AI expands the toolkit "materially." The potential for AI-enabled fraud "is something that the market is going to have to really start to confront and think about as this evolves," he said.
"I don't know that anyone has a clear solution to that," Dubrow said.
