IRS auditing entrepreneurial Texas jails that improperly used tax-exempt bonds

Finally, the IRS has begun to dig into shady Texas jail schemes where publicly backed bonds were used to enrich private companies, socializing risk while privatizing potential profits. Purchasers of those bonds may soon be on the hook for taxes on their earnings and counties could see their own bond ratings reduced. Turns out, the whole idea of filling entrepreneurial jails with federal inmates should never have qualified for issuance of tax-exempt bonds in the first place.

According to The Bond Buyer (Oct. 17, behind paywall, though you can sign up for a two week trial subscription), "Roughly $23 million of tax-exempt senior lien revenue bonds issued in 2003 to finance a jail may be taxable private activity bonds, an Internal Revenue Service agent has told the West Texas Detention Facility Corp." in Hudspeth County. And they're not the only one:

The jail bond deal is the latest of dozens under audit where the IRS has suggested that significant amounts of federal inmates paid for by the federal government and management contracts with private parties make the bonds taxable private-activity bonds.

Tax-exempt bonds are private-activity bonds if more than 10% of the proceeds are for private use and more than 10% of the payments for debt service are from private parties. Under federal tax laws and rules, the federal government is considered a nongovernmental or private entity. PABs are only tax-exempt if they are issued for a “qualified” purpose, and a jail is not one of these.

For example, in August (8/23), The Bond Buyer reported that:

Bond counsel Jackson Walker LLP, based in Houston, has tentatively agreed to pay $400,000 to settle a tax dispute between Crystal City Public Facility Corp. in Texas and the Internal Revenue Service over $13.94 million of revenue bonds issued to finance prison facilities. The bonds were issued in 2003, but have been under scrutiny by the IRS since 2010 and in default since last year when the U.S. Marshal withdrew inmates because misconduct and security problems, forcing the facilities to close in May 2012 for repairs and improvements.

Their liability would have been greater if they'd succeeded in getting enough federal inmates to pay the bills.

The IRS’ concerns were two-fold, according to bond-related documents. First the IRS took issue with the management contract the city had with BRG, under which the net profits were split between the two. The IRS argued this compensation structure suggested “an equity interest in the operation of the bond-financed facility,” creating a private use and payments problem.

In addition, the IRS claimed the prison had too many federal inmates. Federal inmates are considered private, not public, parties under the tax law. The IRS contended that the economics of the prison would not work without substantial federal, and therefore private, use and payments. The federal government tends to pay more for incarceration of its inmates that state or local governments.

The only reason the Crystal City jail wasn't dinged harder was that the federal inmates never materialized. If they had, "Normally that would cause a problem, but since the bonds are in default, bondholders have not been receiving any tax-exempt interest that the IRS could declare taxable."

Another facility in Burnet County did find federal inmates to fill their extra beds, but as a result may now lose the bonds' tax-exempt status, The Bond Buyer reported Aug. 8:

This week, U.S. Bank N.A. filed event notices for two separate issuers that financed jails saying the IRS had indicated the tax-exempt bonds or COPs were not tax-exempt. The bank was trustee for both sets of bonds.

One notice said the Burnet County, Tex., Public Facility Corp. has received four letters from the IRS, the first on Dec. 12, 2011 and the most recent on April 12 of this year, seeking information about $35.38 million of project revenue bonds that were issued in 2008 to build a jail.

The bank said that, in the most recent IRS letter, the issuer was asked to provide information “regarding a preliminary conclusion by the IRS that the ... bonds ... violate certain Internal Revenue Code rules that cause [them] to be taxable.” The notice said the issuer is cooperating with the IRS and that “it is unknown at this time what the outcome of the IRS examination will be.”

Bill Neve, president of the Burnet County Public Facility Corp., said the county built the 586-bed jail to hold county prisoners but provided for some extra space so it wouldn’t have to expand the jail during the next 20 years or so. The IRS is concerned about the number of federal prisoners in the jail, many of whom were housed for less than 100 days, he said.

The PAB rules contain an exception for short-term private use and define that to be less than 100 days. But Neve and other sources indicated that if the IRS thinks there is a significant number of federal inmates, it does not take that exemption into account.

In yet another instance down in Willacy County, The Bond Buyer reported Aug. 28th that the bond terms actually contemplated the possibility that the tax-exemption would be disallowed, showing they knew up front this was a dicey deal:

Bonds issued for Willacy County, Texas’s $7 million jail in the town of Raymondville are among several being audited by the Internal Revenue Service to determine whether its bonds should lose their tax exemption, according to County Judge John F. Gonzales.

Gonzales disclosed the audit at a meeting of the Willacy County Commissioners Court earlier this month, according to the Valley Morning Star of Harlingen.

The south Texas county, which has invested heavily in the prison industry, has a large stake in the tax-exempt status of the prisons. The county seat of Raymondville has earned the nickname “Prisonville” because of its heavy concentration of private lockups, most housing federal inmates on immigration violations.

Refinancing the $3 million of outstanding bonds as taxable would cost the county about $200,000, Gonzales said. The jail was built using 2004 bonds bearing 7.5% coupons on maturities of 2029 with yields of 7.75%, according to the Municipal Securities Rulemaking Board’s Emma Web site.

The original $7.65 million of unrated bonds were issued in the name of the County Jail Public Facility Corp. of Willacy County. ...

According to the official statement for the 2004 deal, interest rates would rise to 140% of the original issue rate if the deal were found to be taxable, or the issuer could redeem the tax-exempt bonds at a price equal to 105% of principal, plus accrued interest.

For barely populated Willacy County, it should be noted, $200K is real money.

The facility in Jones County that the Legislature refused to bail out last spring was another example of a failed "public-private partnership" whose bonds would lose their tax exemption if it were filled with federal inmates. The Bond Buyer reported May 2: 

The prison was pitched as an economic stimulus measure that would provide 200 jobs and annual economic impact of $5 million.  County commissioners promised county taxpayers that the for-profit prison would rely on lease payments from the state and never require local tax support. ...

The bonds used to build the prison carried junk ratings of BB from Standard & Poor’s.  Original coupons ranged from 7.25% to 9%. That rating fell to D when the default occurred. ...

The bonds were issued by the Midwest Public Facility Corp., a conduit issuer overseen by the county commissioners.  The bonds were issued as tax-exempt debt.  The issuer failed to make its $2.23 million interest and principal payment due on Oct. 1, 2011.

Meanwhile, The Bond Buyer reported Aug. 16, "Zapata County, Texas, may pay a settlement or refund bonds after an audit of $9.97 million of its debt by the Internal Revenue Service."

Lots of Texas counties have entered into these sorts of entrepreneurial jail deals and many of them have gone bust because federal inmates they counted on to pay the bills never materialized. These stories, though, show these were ill-considered and likely illegal schemes from the get-go - even if they "worked" and federal inmates were found to cover costs. Many Texas counties, like McLennan (Waco), already have had to raise taxes to cover costs for empty, never-should-have-been-built lockups. Now, it's clear their problems won't subside even if those much-touted federal inmates ever do arrive.

Anthony Graves: Innocent and free 16 years after unfounded death sentence

Anthony Graves was convicted of capital murder in 1994 and 12 years on death row and the last four in the Burleson County jail, but today walked out of the courthouse an innocent man. From the Houston Chronicle:

Washington-Burleson County District Attorney Bill Parham dismissed the case after he and his team investigated the case for five months.

"He’s an innocent man," Parham said today. "There is nothing that connects Anthony Graves to this crime." He said the dismissal was just.

"I did what I did because that’s the right thing to do, and I’m fine with it," he said.

An attorney for Graves, Jimmy Phillips, Jr. said his client was released about 5:30 p.m. "The first place he wanted to go is to go hug his mama," Phillips said. "He is a free man and he’s home."

Kelly Siegler, a prosecutor hired to re-try Graves, agreed with Parham.

"After months of investigation and talking to every witness who’s ever been involved in this case and people who’ve never been talked to before, after looking under every rock we could find, we found not one piece of credible evidence that links Anthony Graves to the commission of this capital murder," Siegler said.

"This is not a case where the evidence went south with time or witnesses passed away or we just couldn’t make the case anymore. He is an innocent man."

The only witness against Graves was the actual killer in the incident, a man who recanted his testimony to prosecutors the night before Graves' trial, but was threatened with prosecution of his wife if he did not go ahead and accuse Graves of being his accomplice. Students from the innocence clinic at the University of Houston Innocence Network at the University of St. Thomas first discovered the prosecutorial misconduct five years ago, leading the US 5th Circuit Court of Appeals to later throw out the conviction because the prosecution did not disclose this exculpatory evidence to the defense. As far as I'm concerned, the original prosecutor in the case, Charles Sebesta, should be immediately disbarred and lose any prosecutorial immunity for his willful failure to disclose the recantation. What a disgrace to his profession.

It's interesting to note the language used by the prosecutors in the story, declaring they could find "not one piece of credible evidence." That's particularly significant because Deputy Keith Pikett's infamous dogs reportedly picked out Graves in a "scent lineup," but clearly prosecutors, to their credit, don't consider that evidence "credible."

Congratulations to Graves and his attorneys and kudos especially to the students whose research led to this jaw-dropping turn of events, not to mention the latter-day prosecutors who finally admitted (better late than never) that Graves is actually innocent. For more background on the case, check out Jeff Blackburn's guest post on Grits published while I was on vacation and an excellent Texas Monthly feature by Pam Colloff.

See prior, related Grits posts:

• Progress and its Discontents, or what I learned from an article in Texas Monthly
• 'Scent lineup' evidence may be used in Anthony Graves capital murder case
• Tales from death row: Passion and intrigue marked two capital murder trials
• Blog: Four of 10 worst US prosecutors in Texas
• Prosecutors improperly withheld confession in death penalty case

Breakout! Burnet jail escape ill-timed for Grayson jail builders

In love and in politics, timing is often everything, and for jail builders in Grayson County, the timing of last week's jail break in Burnet County couldn't be worse.

The Burnet County Jail is the only one in Texas currently operated by Southwestern Correctional LLC, which is based in Louisiana and operates eight facilities there (mostly for the state prison system) under the name La Salle Corrections. (Hundreds of inmates from the Harris County Jail diaspora ended up in a La Salle facility in Urania, La). They also manage a federal facility for immigration and US Marshall's service prisoners in Crystal City, TX.

Grayson County Judge Drue Bynum and three other members of the commissioners court would like to hire Southwestern Correctional to run an oversized jail in Grayson County with an eye toward contracting out extra space to other jurisdictions. The Commission on Jail Standards boosted their estimate of Grayson's jail capacity needs after the private company and county officials lobbied them to change their methodology.

Now, the ill-timed escape and the apparent culpability of Southwestern Correctional employees may give voters a new reason to reject jail bonds scheduled to go to the voters in November. Here's an excerpt from a blandly titled piece on the topic in the Sherman Herald-Democrat:

Charles Ryan Boisseau, editor of the Burnet Bulletin and writer for the related Highland Lakes Newspapers, said he had spoken with Adan Munoz, executive director of the Texas Commission on Jail Standards, about the incident. Boisseau said Friday that Munoz confirmed that his office had officially deemed the [Burnet] jail non-compliant.

"The best way to describe it is a lack of diligence, a lack of professionalism," Munoz said.

Boisseau said the account he got of how the escape happened was that guards were rushing to process inmates back into the jail after a recreation break outside in a secure area. He said each inmate was supposed to be searched before and after going outside.

"One of the guards walked ahead of the inmates, and just basically let them close the door behind themselves," Boisseau said. That's when the man escaped by going back into the recreation yard, climbing onto a roof and sliding down a drain pipe.

Boisseau, in a copyrighted story Friday, said that Billy McConnell of Southwestern Correctional LLC confirmed that the jailer responsible for supervising the inmates coming in and out of the jail had resigned and two others face disciplinary action. Boisseau added in a telephone conversation that Burnet County Sheriff W.T. Smith's staff said he was worn out by the events since Sunday and could only be reached by e-mail.

Southwestern has 30 days to show Texas Commission on Jail Standards how it plans to correct the noncompliance issues. The inmate, Nuana Antonio Fuentes-Sanchez, was in jail awaiting trial on accusations he violently attacked a couple in their home during a robbery.

Boisseau said that privatization of building and operating the jail in Burnet County was a controversial issue. Burnet County Judge Donna Klaeger also serves as chairwoman of the Texas Commission on Jail Standards.

Reacting to these revelations, the blog Texas Prison Bidness asks, "Southwestern Correctional has major problems in Burnet; Are Grayson Commissioners watching?"

One wonders what might be discovered by searching further into La Salle Corrections in Louisiana? A quick Google search revealed an anecdote from 2003 about a La Salle-run facility where

For $3, inmates and visitors to the Claiborne Parish Detention Center in Homer [could] buy pirated copies of recordings by a wide array of performers, according to a lawsuit filed on behalf of the music industry. The jail's computers were used to illegally copy recordings by performers ranging from rapper Eminen to country music's George Strait to New Age instrumentalist John Tesh, Baton Rouge-based Utopia Entertainment Inc. charged in the copyright-infringement case ... in U.S. District Court in Shreveport.

That also sounds like a situation exhibiting a lack of "diligence" and "professionalism." One suspects this incident and the recent escape won't be the only lapses reporters or jail critics in Sherman might find if they dig into La Salle Corrections too hard.

According to TCJS chief Adan Munoz, in Burnet County Southwestern Correctional/La Salle convinced local officials to go with an outsized facility, just as they've been pushing in Grayson. "Our recommendation was 432" beds, he told me last week, but "They went with a private company’s own needs analysis and built 587, after initialing wanting 700 beds."

Some locals in Grayson County are already pushing back hard against plans that rely on TCJS' most recent, higher needs assessment, which relies on a methodology provided by Southwestern Correctional. That overreach by jail builders, combined with likely blowback from this recent escape episode, bode ill, one would think, for a jail vote that's now less than two months away.

I've seen no polling, but one suspects that if there's any organized local opposition at all it could easily vanquish the bonds at the ballot box, spoiling for now Judge Bynum's long-cherished dream of a jail so big it pays for itself.