Bellflower Might Sue E.F. Hutton to Recover $290,000 Bonds Loss

After losing $290,000 in a speculative investment deal, city officials say they were misled by E.F. Hutton and are considering legal action against the investment firm to recover the lost money.

“We are in the process of negotiating with E.F. Hutton,” City Atty. Maurice O’Shea told the City Council on Monday night. “However, if (this) approach does not work, we are prepared to go forward with litigation.”

O’Shea said he is considering joining a cooperative legal effort with Lawndale, Palmdale and San Marino, which together lost more than $9.5 million in municipal funds invested through E.F. Hutton. Like those cities, Bellflower made investments with William Parodi, an account representative with the firm’s Universal City office.

Bellflower officials say Parodi made an unauthorized purchase of government bonds on margin or, with borrowed money, apparently violating state law and the city’s own investment policy. “I think the city was misled to believe this was a proper investment,” O’Shea said. “We will proceed with any and all necessary steps to recover our losses.”

O’Shea said that in addition to the city’s internal investigation, he is also working with an investigator for the U.S. Securities and Exchange Commission and has contacted the Los Angeles County district attorney’s office.

Lori Richards, a branch chief with the SEC’s enforcement division, would not confirm or deny that an investigation is under way, saying only that the matter is confidential. The enforcement division investigates possible violations of federal securities laws.

City Council members said they were surprised and angry when they learned of the loss early last month.

“We should never have been in this market,” Mayor Pro Tem Ken Cleveland said.

“My reaction was ‘Oh damn,’ ” Councilman William Pendelton said. “Whether we made money or didn’t, it was an improper investment. As far as I’m concerned, it was E.F Hutton’s mistake.”

However, Steve Nelson, a spokesman for E.F Hutton’s headquarters in New York, said the firm is not responsible and attributed the loss to “the dramatic drop in the fixed-income market in 1987.”

In December, 1986, Bellflower began purchasing zero coupon U.S. Treasury notes through E.F. Hutton. The investment totaled $717,827. On Oct. 26, the city sold the bonds for $425,000, City Treasurer Mike Sakamoto said. The bonds were to have a yield of 8.25% over 25 years.

(Zero coupon bonds pay all their accumulated interest at maturity instead of at regular intervals such as every six months. That makes their prices sensitive to interest rates. They are known as one of the more volatile types of bond issues.)

Although the state government code allows cities to invest in Treasury notes, using public money for speculative investments in hopes that the market will rise or fall is forbidden, said Zenda James, president of the California Municipal Treasurers Assn.

Smaller cities such as Bellflower, whose investment portfolio stands at about $4.1 million, usually invest in low-risk certificates of deposit or in the state treasurer’s Local Agency Investment Pool, James said.

Margin accounts are risky, she explained, because the investor puts down a portion of the price of a security, hoping prices will rise. But if the market falls more than the amount invested, the entire investment is wiped out unless additional money is put in.

“There is no place in a city’s (investment) portfolio to be playing speculation games with taxpayer’s money,” James said. “I couldn’t do that and sleep at night.”

However, Sakamoto maintains that he was misled.

“There are many areas I cannot get into because of potential litigation,” he said. “But our office’s understanding was that this was a proper investment.”

As city treasurer, Sakamoto has sole authority to invest city money and review investment policy, O’Shea said. “The City Council does not have knowledge of these specific types of investments,” he said.

City Administrator Jack Simpson said it is usual procedure for the city treasurer to invest without consulting the council.

When asked if he was aware that the bonds were bought on margin, Sakamoto said: “It’s almost impossible to read what’s on those confirmation slips.”

Confirmation slips describe the amount and type of investment made and are sent to investors one to two days after each transaction, in addition to a monthly statement “that reiterates the information on the slips,” Nelson said.

“The statements are there so the authorized representative (making the investment) knows exactly what’s going on in the account,” Nelson said.

Although officials in Lawndale, Palmdale and San Marino fired part-time City Treasurer Ray Wood, who made investments for the three cities, Bellflower officials have expressed support for Sakamoto.

Sakamoto, 43, who also serves as assistant city administrator, was appointed to the post of treasurer by the City Council in 1980. In 1983, he was also appointed assistant city administrator. Before joining Bellflower, Sakamoto was a grants consultant for several Southern California cities, including Bellflower, Paramount and Culver City.

“I am not sure Mr. Sakamoto did anything wrong, so until I find out who did, I am not for firing anyone,” Cleveland said.

Pendelton said that taking any action against Sakamoto could jeopardize the city’s negotiations with E.F. Hutton.

“If we do anything that shows a staff person screwed up, what’s that going to do to our position with E.F. Hutton?” he said.