By Any Other Name, A Shell Game

William C. Ayres remembers all too well the call he received in early 1991 from a broker with Rickel & Associates Inc. in Millburn, N.J. The broker was hyping a hefty 10.5% coupon rate on some bonds for Florida retirement homes-a full point higher than the rates on similar tax-free bonds. Ayres, a retired Air Force fighter pilot, checked out the bonds' official statement (in effect the prospectus for a muni bond) and studied some additional financial information. The bonds seemed worth the risk, so he sprang for $250,000 worth. Today, his securities are worthless, and Ayres is livid. "I've learned that if it sounds too good to be true, it probably is," he says. "I got lied to" by the home operators.

"Caveat emptor" should have been stamped on the bonds. The official statement said that the securities carried a high degree of risk and outlined numerous factors that could reduce the profitability of the retirement homes that were backing them. Although issued by the city of North Miami, they were backed only by revenues from the retirement homes. Beyond that, the bonds had not been rated by a credit agency.

RED FLAGS. But the risks may have extended further, perhaps even involving fraud. Four mutual funds run by Allstate Insurance, Dreyfus, and Merrill Lynch, which were also investors, have sued many of those involved in the deal, though not the city of North Miami, alleging that the homes were poorly managed and that their financial condition was concealed. Scott L. Warfman, a lawyer for the retirement-home operator, Meadowcroft Management Group, replies that allegations of fraud "are completely untrue."

Most revenue bonds, secured by such facilities as toll roads, perform without a hitch. But this deal had red flags from the start. The sad saga began in 1987, when, along with other investors, Meadowcroft--a Toronto nursing-home developer headed by George Kuhl--started buying three Miami-area retirement centers for a total of $5.8 million. Warfman says his client spent an additional $6 million on renovations--a claim bondholders disputed. By 1990, though, the retirement homes, which still needed major improvements, were making little if any profit.

CREDIT CRUNCH? Warfman says Kuhl decided to sell "because he was not happy with the project." Bondholders allege, and Warfman denies, that Kuhl's group needed money fast because of pressure from Royal Bank of Canada to repay loans. The bank declined to comment.

The best way to cash out, Kuhl figured, was the municipal-bond market. Armed with audits, appraisals, and other expert opinions, he persuaded the North Miami Health Facilities Authority, a city agency, to help sponsor bond issues totaling $20 million. Says David M. Wolpin, North Miami's attorney: "Our interest was in seeing [the retirement homes] continue as a resource in the area."

The arithmetic did not make much sense. Annual interest payments on the bonds would start at $1.7 million and would rise in subsequent years--but during the three years that Meadowcroft had operated the three facilities, they had never generated more than $380,000 in annual operating income. And the retirement homes were on average half empty, according to the offering document.

But Kuhl's group argued that it could increase occupancy to 95% within 18 months--all the while charging patients top dollar. And the bonds were issued on Aug. 31, 1990, by the North Miami authority, which did not have any financial risk. Kuhl's group netted $12.3 million from the proceeds. But Meadowcroft wanted an additional $4 million. So the underwriter, Van Kampen Merritt Inc. in Philadelphia, issued subordinated bonds with a face value of $4 million and gave them to Meadowcroft.

Instead of holding the bonds, as the city and bond funds expected, Kuhl's group unloaded them at a deep discount for about $1.6 million to Rickel & Associates. By early 1991, Rickel's brokers had resold the bonds to the 19 individuals at a 25% profit.

GRIM SMILES. The bondholders' suits allege that Kuhl's group knew the homes had little likelihood of succeeding. "The homes were already crumbling physically and financially by the fall of 1990," alleges J. Michael Rediker, the individual bondholders' attorney. Warfman denies the charge, though he concedes "some marketing problems" existed. Since issuers are not required to disclose information once bonds have been issued, investors were in the dark about the performance of the retirement homes.

The bonds defaulted in October, 1991--little more than a year after they were issued--and a bank trustee began liquidating in May, 1992. The bond mutual funds will be lucky to get 25 on the dollar. But the subordinated bonds are worth zero.

Not everyone has been a loser. A dozen lawyers, underwriters, and other financial advisers pocketed close to $2 million in fees, according to Warfman. He maintains, though, that Kuhl's investment group lost $1.5 million. If so, it may be the only thing about this deal to make investors happy.

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