(Reuters) - In a case that illustrates the mounting risks facing cash-strapped California cities and their lenders, the desert city of Victorville is bracing for possible litigation amid allegations that it improperly shifted funds among different city-controlled entities.

The Victorville city council was told by its attorney last week that it faced "significant exposure to litigation" relating to a little-publicized Securities and Exchange Commission investigation into its financial practices, the city attorney acknowledged in a statement to Reuters.

City attorney Andre de Bortnowsky denied that Victorville had violated any laws, and said "it almost appears as if the SEC is on a fishing expedition."

The exact focus of the SEC investigation is not known. The SEC declined to comment.

In late June, a civil grand jury report alleged that Victorville may have violated state laws by transferring property taxes dedicated to its sanitation department to its general fund budget. Civil grand juries are investigative bodies that are not empowered to bring charges.

Harvey M. Rose Associates, a San Francisco-based public sector management consulting firm, said in its report to the civil grand jury that Victorville had mismanaged projects, made poor decisions on contracts and loaned $38 million to its municipal utility and its local airport. The report said repayment of those loans was "highly questionable."

The report said the utility is insolvent, with $32 million in assets and $108 million in liabilities.

Bortnowsky, in an email to Reuters, said the city "takes issue with respect to many of the statements contained in the Grand Jury report, especially those pertaining to purported violations of state and local laws and resolutions."

He said a full response to the grand jury allegations would be "forthcoming shortly."

Victorville, with a population of about 115,000, had a total of $407 million in bond debt as of June 30, 2011.

The city's auditors said in February that there "was substantial doubt about the city's ability to continue as going concern" due to "recurring losses" in its general fund and lack of liquidity in funds for its utility and the airport.

The city council in late June adopted a $47 million budget for its general fund that included a $74,992 surplus.

Three California cities have filed or said they would file for bankruptcy since June 28, when Stockton filed for Chapter 9 protection to restructure more than $700 million in debt.

On July 2, the city of Mammoth Lakes filed to shield itself from a $43 million court judgment. The San Bernardino city council voted on July 18 to seek bankruptcy protection.

In both Stockton and San Bernardino, poor financial controls and shuffling of money among different city entities appear to have contributed to their respective financial crises.

(Reporting by Jim Christie and Ronald Grover; Editing by Jonathan Weber, Lisa Shumaker andMatthew Lewis)

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