Addressing concerns over transparency and accountability for fees paid by school and community college districts to bond services professionals, the California Attorney General has opined that certain contract structures for work on general obligation bonds and their related elections may be unlawful. At the request of California State Treasurer John Chiang, the Attorney General considered a variety of contract types that have been used in California for the provision of bond-related services by underwriting firms, independent financial advisory firms, and bond counsel law firms on school and community college district general obligation bond measures. The opinion considers the legality of contingent fee payment structures that motivate firms to support campaigns and/or may indirectly result in the use of district funds for campaign purposes. The Attorney General concludes in significant part that where a district enters into a contingent fee arrangement for the purpose of inducing or incentivizing a firm to promote election passage, or if the fee amount is inflated to account for the value of campaign donations or other in-kind services provided to the district or a campaign committee, the contract may violate the law. (__ Ops.Cal.Atty.Gen. __(January 26, 2016).)
School and community college districts typically contract for bond services professionals on a contingent fee basis, i.e., where the consultant is only paid if a bond measure is successful and bonds are issued thereafter. Fees for the work performed by each firm are usually paid at the time of a bond closing. Most of these professionals provide necessary services that commence prior to a bond election, such as investigating finance options, sizing a bond measure in accordance with facility needs and community support, devising repayment structures that fit within legal parameters, preparing the bond measure and legal documentation, and advising and assisting the governing board in understanding how the financing works (“pre-election services”). After a successful election, the same firms convene to issue bonds (“bond issuance services”), and upon issuance of the bonds, each is paid a fee for services rendered. Those costs are paid from bond proceeds. These professional services firms, and other district vendors, are typically solicited by campaign committees to make contributions to the bond campaign during the course of the service period.
The Attorney General opinion considers five interrelated questions about bond services contracts, but focuses most critically on contracts in which a firm provides pre-election services at a reduced rate or without charge, in exchange for the right to provide bond issuance services for a “lucrative” fee paid at the end of the transaction from bond proceeds. Nothing is legally wrong with compensating bond professionals for both legitimate pre-election services and bond issuance services; however, the Attorney General suggests that such arrangements can run afoul of the prohibition on the use of district funds to “campaign” for bond measures. Violations may occur when a district enters into a contingent fee arrangement for the purpose of inducing or incentivizing a firm to promote election passage through measure contributions or in-kind services to the campaign effort, or where the fee amount is inflated to account for the value of campaign donations or in-kind services provided to a campaign committee, and the district has not taken “reasonable steps” to ensure that the fee is not inflated.
The opinion does not explain how to determine whether a district entered into such an agreement for the sole or partial purpose of inducing support for a campaign. However, reasonable steps to ensure that a fee is not inflated could include competitive comparative pricing of fees, even though competitive procurement of these services is not otherwise legally required.
The Attorney General opinion also importantly concludes that expenses a district incurs for pre-election services, while lawful, are not a permissible cost of issuance or expenditure of bond proceeds, and thus presumably must be paid from the general fund. While law firms may disagree on this point, until a court considers the issue, the safer practice will be to pay pre-election costs from the general fund rather than from bond funds.
The opinion does not reach new or surprising conclusions about the legality of paying for campaign services or contributions out of district revenues. The use of public funds of any kind to advocate for the support of a bond measure is never lawful. However, the opinion applies this law to certain fee practices in the bond industry about which districts are sometimes confused or under-informed, and finds that some contracts create the potential for indirect use of public funds to support bond campaigns.
As many districts undertake efforts to call bond elections in 2016, this opinion impresses upon all that a district should make “reasonable efforts” to ensure that fees charged by bond professionals are market rate for the work performed, and to ensure that campaign services and bond campaign contributions play no part, express or implied, in the selection process for bond services firms or the way a contract is structured. A competitive selection process for underwriters, independent financial advisors and bond firms may avoid any implication that campaign contributions have impacted the selection and may also constitute the suggested “reasonable efforts” to avoid inflation of fees to offset campaign support. We believe the most defensible selection process is one conducted by the district, and not a member of the finance team, to ensure that proposals or quotes are not subject to outside influence. Fee proposals should detail the costs of both pre-election services separately from bond issuance services to ensure that they can be segregated for payment from different sources.
Given the Attorney General’s scrutiny of contingent compensation arrangements in this opinion, bond services firms may become reticent to offer their pre-election services on a contingent fee basis, instead seeking payment for pre-election services whether or not a bond election is successful. Districts will need to build into their general fund budgets these and all election-related costs.
Attorney General opinions are not binding legal authority, but they are considered persuasive authority to courts in California. If you have questions about this opinion or the impact of this opinion on your existing or future contracts, please do not hesitate to contact us.