WASHINGTON — In a closely watched case that has major implications for bond lawyers, a three-judge federal appeals court panel ruled against bond attorney Ira Weiss yesterday and agreed with the Securities and Exchange Commission that he misled investors about the tax-exempt status of $9.6 million of three-year notes issued by the Neshannock Township, Pa., School District in mid-2000.
The panel of judges from the U.S. Court of Appeals for the District of Columbia Circuit said the evidence in the case supported the SEC’s Dec. 2, 2005, ruling that the Pittsburgh-based Weiss was “at least negligent” and “departed from the standard of reasonable prudence” by failing to perform the work needed to form the basis for his unqualified opinion that the notes were tax-exempt.
“Substantial evidence … supports the SEC’s conclusion that ‘Weiss was responsible for misrepresentations and omissions in the official statement and in his legal opinions,’ which failed to provide investors with ‘full information concerning the substantial risk that the Internal Revenue Service would find the notes to be taxable,’ ” Judge Raymond Randolph said in the 13-page opinion he wrote for the panel.
The underwriter, the now-defunct Queastor Municipal Group, had proposed the note issue as an arbitrage-driven deal, telling school board members they did not have to spend the proceeds and could instead invest them for three years to earn $225,000, the panel noted in its ruling.
Weiss never explicitly contradicted the underwriter during a meeting with the school board, except to say this “wasn’t exactly the case” and that the school board had to reasonably expect to spend the proceeds within three years, the panel said. Weiss only obtained a “wish list” of projects with no specific schedules or cost estimates, and he left school board members with the impression that they did not have to actually spend the money, the panel said.
In addition, he failed to tell the board about two of three tax law restrictions they had to meet for the notes to be tax-exempt — that it had to enter into a binding contract to spend at least 5% of the proceeds within six months and proceed with due diligence to complete the projects.
The board took no action on the projects for a year but earned $150,000 in arbitrage profits. The IRS eventually concluded the notes were taxable, but the school board settled the tax dispute with the IRS so that the notes would remain tax-exempt.
David Hickton, a partner at the law firm of Burns White & Hickton who is representing Weiss, said yesterday, “We’re disappointed with the decision. We believe that the judge who heard the evidence and saw the witnesses live reached the correct result. We’re studying the opinion and planning our next step in the process.”
Hickton was referring to the initial decision of SEC administrative law judge Lillian McEwen, who ruled in favor of Weiss in early 2005, only to be later overturned by the commission.
Weiss has 45 days to petition to appeals court panel for a rehearing or to ask the full appeals court to consider the panel’s ruling. Alternatively, Weiss could ask the Supreme Court to take up the case, but he would have to show that the circuits have split on some of the issues.
Mark Zehner, the Philadelphia-based regional municipal securities counsel in the SEC’s enforcement division, said yesterday, “I’m gratified that the DC Court of Appeals upheld the SEC decision and think there’s much language in the opinion that will provide guidance to bond lawyers for the future.”
Zehner pointed out that this is the first circuit court ruling regarding a bond lawyer. “No one can ignore this now,” he said. “There are few circuit court-level decisions relating to the municipal bond industry. This provides a roadmap for bond counsel across the country.”
“For the vast majority of bond lawyers that have been doing the right things, the Ira Weiss decision doesn’t change how they are practicing law,” Zehner said. “But for those who have been aggressive and operating on the edges of what constitutes an unqualified opinion, this should make them much more cautious.”
Charles Anderson, field operations manger for the IRS tax-exempt bond office, agreed. “This ruling should give comfort to the majority of bond counsel who exercise due diligence and should also give indigestion to those who have a habit of being special tax counsel on abusive arbitrage transactions.”
“Judge Randolph appears to have followed the same logic used in arguments we have been making on a number of recent [Section] 6700 pre-assessment letters to tax counsel,” Anderson said. The IRS has been able to get some bond counsel to disgorge their fees to settle 6700 charges after arguing that they did not conduct adequate due diligence, he said. Section 6700 of the tax code allows the IRS to impose monetary penalties on participants in abusive transactions.
Anderson also said the panel’s logic “can be applied to potential referrals to our Office of Professional Responsibility … of a number of Section 6700 cases. We have been awaiting this important ruling which, admittedly, does not have direct precedence in our cases, but certainly affirms and impacts greatly on the common sense aspects of our 6700 cases.”
In its ruling, the appeals court panel said Weiss claimed he was not liable for the official statement, arguing it was the school board’s document. But the panel said, “Weiss reviewed the official statement and approved the portion of it containing his opinion that the [notes] would be tax-exempt. He knew his statement would reach potential investors. Therefore, Weiss could incur liability for his misrepresentations even when he did not communicate them directly to investors.”
The panel said that Weiss “seems to think that the tax opinions he expressed in his opinion letters were simply that — opinions containing no statements of fact on which to predicate liability for misrepresentation or deceit.”
“Under the securities laws, a statement of opinion includes an implied representation that the speaker rendered the opinion in good faith and with a reasonable basis,” the panel said. But “good faith alone is not enough. An opinion must have a reasonable basis and there can be no reasonable basis for an opinion without a reasonable investigation into the facts underlying the opinion.”
The panel said “Weiss also seeks to avoid liability on the basis that he conducted a reasonably sufficient examination by relying on his client’s certified representations that he had no reason to believe were false.”
However, “there is ample evidence to support the SEC’s rejection of this defense on the ground that the representations Weiss cites were too ‘vague’ for him reasonably to rely upon them. Consider the non-arbitrage certificate. Treasury regulations require non-arbitrage certificates to ‘state the facts and estimates that form the basis for the issuer’s expectations’ of meeting the three tests,” the panel said. “Yet the school district’s certification — which Weiss drafted — is wholly conclusory, stating only that the issuer ‘reasonably expects’ to satisfy each of the three tests.”
“Weiss wrongly gave the board the impression that it merely had to ‘intend to do the projects,’ rather than have a reasonable need for the funds before issuing the [notes],” the panel said. “Therefore the question is not whether the board intended to do the projects, but whether a reasonable person would have expected the board to follow through on those projects in a manner that would satisfy the three tests.”
“The bond transaction in this case was promoter-induced. [The underwriter] used the prospect of arbitrage to sell the transaction,” the panel said. “Weiss was at the presentation, Weiss knew that the board had not contracted for any of the projects or even sought bids. He could not have been unaware of the substantial likelihood that the board would fail to satisfy these tests. Yet Weiss never asked the board to confirm that it was committed to specific projects or was ready to proceed with them.”
