Although anyone with money can go onto a stock market website, throw a dart, and invest into a company they know nothing about, smart investors are unlikely to do that. Smart investors research the venture, they look into the risks that their investment will face, and they gather evidence that grows their confidence in the opportunity. However, what happens when the leaders of a business opportunity fail to disclose the risks involved in an investment to their potential holders?
This is the question Cinco Ranch Bond investors face today.
In the Texas Constitution, there is a section that permits the creation of municipal utility districts (MUDs). MUDs are made up of landowners within a district of Texas that turn their land into habitable communities. For your convenience, we have created a diluted list of phases for how MUDs form and how they create investment opportunities in Texas:*
- Majority landowners in an area in Texas request that their city recognize their district as a MUD.
- The MUD is created, giving landowners voting power to enact bond sales in their district.
- Landowners (MUD owners now) hire a financial adviser to help in the creation, marketing, and sale of their bonds (financial advisors for MUDs are typically security firms).
- MUD hires bond counsel that determines if the bonds are sold for a lawful purpose and qualify for tax-exempt status. (Bond counsel is usually a law firm.)
- MUD turns in their bond proposal to the Texas Commission on Environmental Quality.
- The bonds are approved by the Texas Commission on Environmental Quality.
- The bonds are sold to investors.
- The MUD uses bond money to pay for development of new sewage systems for homes.
- The MUD taxes (with interest) homeowners who live on the MUD’s land.
- Taxes from homeowners compensate bond payouts. MUDs are also paid from these taxes.
*This list is not inclusive of every phase that the creation of a MUD goes through, nor does it list every responsibility a MUD has to their investors.
Clearly there is a lot that goes into how a MUD creates and sells bonds. Typically, the system works with little to no hitches. Money is taken from the homeowners to pay back investors who paid for the sewage and draining systems of the homeowners, all while the MUD takes some money off the top. However, Hurricane Harvey threw a wrench into the operations of Cinco Ranch MUDs and this bad news will likely trickle down to bond investors.
How Harvey Could Cause Cinco Ranch Investor Loss
Cinco Ranch was one of the various Texas communities that was flooded by the rainfall of Hurricane Harvey. As talk about flood plans, dam releases, and liability claims circulate throughout Houston, Cinco Ranch investors are looking for answers. When Cinco Ranch investors were educated on the inherent risks of investing into Cinco Ranch, they were never clearly told that Cinco Ranch was at risk for flooding.
In fact, of the 74 bond sales in the Cinco Ranch communities since 1991, only 1 of the bond statements disclosed that the nearby reservoir could flood nearby subdivisions.
This exception was given in a bond statement by the MUD “Willow Fork Drainage District” in 1992. Willow Fork Drainage District has had 17 more bond statements since 1992 that have withheld declarations to bond investors that the properties they are investing in are at risk for flooding.
What Material Information” Is &Why It Matters
When investors buy federal securities (such as bonds), federal securities law states that a governing body must disclose any “material information” that would be pertinent to the final decision of an investor. Material information is knowledge considered important to know when a reasonable shareholder’s decides to make an “informed investment.”
As a metaphor, a gym must disclose the inherent risks that its members face when working out. The inherent risks would fall under the category of material information. Although this information is worth considering, it does not necessarily change a member’s mind concerning their decision to work out at the gym. The gym has fulfilled its legal obligation to share material information, and the members have now made an educated decision to continue to work out despite the risks.
In a lawsuit scenario concerning this situation, a lawyer representing Cinco Ranch bondholders would not have to prove that Cinco Ranch bondholders would have changed their minds if they had known about the risk of inundation. An attorney would only have to prove that the knowledge of the flood risk of the property was something worth considering in the Cinco Ranch bondholders decision to invest.
Were Cinco Ranch bond investors ill-informed of information concerning their investment?
This is the question concerning the law surrounding the Cinco Ranch controversy, and one that may go unanswered. At this point in time, Hurricane Harvey has not affected any of the Cinco Ranch’s MUDs from paying their bond dues. However, these bonds can have up to a 40-year contractual lifespan. That is plenty of time for Cinco Ranch property values to decrease because of the now public knowledge that Cinco Ranch can flood.