Camarillo Profits Soared, Fell With Investment Plan : ‘Forward Contracts’ Strategy Backfired in Bond Market

Camarillo City Treasurer Donald F. Tarnow was accustomed to earning his city $2 million or more a year by buying government bonds and making other low-risk investments.

In transactions that took little more than a telephone call, Tarnow in recent years would occasionally make the city tens of thousands of dollars in profits without having to spend a dime of public money. For the fiscal year ending last June, Tarnow submitted a report showing a record $3 million earned in city investments.

But, after $16,000 in city checks bounced in November, Camarillo officials discovered a far different financial picture. Officials found that Tarnow lost $2.5 million in city investments between April and June last year. Auditors are now trying to total other losses attributable to Tarnow, who was fired last week for allegedly failing to tell anybody directly that the city was losing money.

As city treasurer and investments officer, Tarnow was responsible for investing $14 million to $25 million of city money that would otherwise sit idle before being spent on such expenses as salaries and street repairs.

City officials said that until December, they had no idea that Tarnow, who had wide discretion in making investments during his 18 years with the city, was losing the city money. Tarnow said that, in the last several years, he had earned the city 10% to 12% annually in investments.

“In hindsight, complacency set in,” Camarillo City Manager Thomas W. Oglesby said. “We had made the usual management inquiries and we got the right answers.”

City Council members are withholding comment on Tarnow’s actions until an audit is completed by Arthur Andersen & Co., a nationally known accounting firm. So far, there is no evidence of criminal wrongdoing by Tarnow, City Atty. Colin Lennard said.

Municipal finance experts outside the city say Tarnow apparently fell victim to an investment strategy known as forward contracts or forward purchases. Those investments, although legal, last year lost several other Southern California cities millions of dollars.

“It’s peculiar for a city to be involved in that sort of investment,” said Bruce Cornell, an investment expert with the UCLA Graduate School of Management. “It is a fairly sophisticated strategy used by the nation’s 39 government securities dealers and their largest clients; it’s not for small cities.”

Tarnow, 46, said in an interview that the bulk of investment losses last spring came when a falling bond market turned that previously lucrative investment strategy into a money pit. However, he denied hiding any of the investment losses and said he had done nothing wrong.

Substantial Profits

Before bond prices began falling at the end of March, Tarnow said, he had earned the city substantial profits through forward purchases.

In those investments, Tarnow said, he would agree to buy government securities at a certain price 30 days before the bonds were issued and payment was due. Those purchase agreements were generally in increments of $1 million or more, Tarnow said.

When the bond market rose, with eager buyers bidding up the price of government securities, Tarnow could sell the bonds at a profit when the payment was due without ever having to spend any city cash. Conversely, however, when the market fell, the city was forced to pay the difference between the agreed-upon price and the final purchase price of the bonds, creating a loss, he said.

Last spring, the bond market fell and kept falling. “At first, we held on,” with the expectation that the market would rebound, Tarnow said. But the losses continued. Tarnow said he was forced to sell some bonds at a significant loss, while holding on to others that he believed would become profitable months or years in the future.

The idea of purchasing bonds through forward purchasing was suggested to Tarnow by a securities broker, he said. Tarnow would not name the broker or the broker’s firm. “It appeared to be a prudent way to make money,” he said.

‘Safe and Available’

Tarnow said the investments did not violate the city’s investment policy, which he wrote. The basic guideline for all city investments “is, and shall continue to be, to insure that money is always safe and available, when needed,” the policy said.

The spring investment losses created cash shortages for the city in the fall, when payments on a $5.3-million road project became due, city officials said. Tarnow said he was forced during that time to again sell off city-held securities at losses that are still being tallied by auditors.

Thomas Rupert, past president of the U. S. Municipal Treasurers Assn. and legislative chairman of the state’s Municipal Treasurers Assn., said forward purchasing became popular among several city treasurers about two years ago. But he said the strategy is too risky for municipal investments.

“In the right market, you are a hero and, in the wrong market, you are a dog,” said Rupert, who over the past 20 years has consulted in the drafting of most state laws governing municipal investments.

The cities of San Marino, Lawndale and Palmdale each lost between $1 million and $3 million in similar investment schemes last year, Rupert said. Jim Wood, who served as part-time city treasurer for those cities and is still part-time city treasurer of Westlake Village, was fired after the losses were disclosed.

City Manager Oglesby said Tarnow was not fired for losing city money.

“The fact that trading losses have occurred is not surprising given the economic condition of the marketplace during the period reviewed, and those responsible for the sales transactions are not being criticized for the losses,” Oglesby said in a report to the City Council. “It came as a surprise, however, to learn that they had occurred, but were not recognized and/or disclosed when they occurred.”

If Tarnow had told the City Council of the losses last spring, then the city would have been able to avoid the cash shortages later in the year, Oglesby said.

Tarnow said he filed the monthly council reports required by law, which show the name of the investment, the amount invested and the interest rate. He conceded that those reports do not show losses that were incurred through forward purchase agreements. But he said those losses could have been traced through entries in city ledgers.

“It’s not my problem that the City Council didn’t go through the records,” Tarnow said. “It was all there in the financial records. . . . Had they asked me or come to me, I would have told them.”

Boss Warned

Tarnow said he warned his boss, Finance Director Larry Weaver, of the losses. Weaver, who could not be reached for comment, resigned from his post last week after 23 years with the city. Tarnow was appointed by the City Council, whereas Weaver was hired by the city manager.

A preliminary audit completed in December showed an additional $2.5 million in funds that could not be accounted for. City officials now say those funds were not lost, but were simply accounting entries that were made several months late. Tarnow said those delays were caused by a shortage of employees in the city’s finance department.

Rupert said he was asked last week by members of the state Assembly Committee on Finance and Insurance to suggest changes in the reporting requirements for municipal investments to prevent future losses similar to what happened in Camarillo, he said.

Rupert said the state should require that monthly investment statements show the profit or loss of individual investment transactions, as well as the degree of risk of each investment. “That would help to forestall those sorts of losses in the future,” he said.

In general, state requirements forbid cities from speculating in high-risk investments, such as stocks, but do not address such strategies as forward purchases of bonds.