Local Government Investors Face Higher Risks in a Slumping Economy : Fraud: Officials in smaller towns might not have the background to spot a scam, investment experts warn.
While cities in California, Iowa and other states reel from an alleged fraud involving at least $75.4 million by an Irvine investment adviser, investment experts warn that municipalities and government agencies anxious for big returns on their money are increasingly vulnerable to being cheated in today’s environment of low interest rates.
What’s more, in many smaller towns and government bodies, the investment officers frequently don’t have the background needed by a savvy institutional investor. But government investors can avoid being taken if proper precautions are taken, they say.
“We run into this pattern from time to time,” said Girard Miller, senior vice president of Fidelity Investments, a large mutual fund manager based in Boston. “It’s a cyclical phenomenon in periods of declining interest rates.”
The latest scandal involves surplus funds from scores of governmental agencies that were invested by Steven D. Wymer and his two companies, Institutional Treasury Management and Denman & Co. The Securities and Exchange Commission has charged that at least $75.4 million is missing from three trusts, and a federal judge in Los Angeles has frozen an estimated $1.2 billion in assets that were invested in U.S. Treasury notes and other securities.
The SEC charged in a civil suit that Wymer transferred funds among clients’ accounts to cover discrepancies that resulted from unauthorized transactions that were unsuccessful. In some cases, Institutional Treasury promised returns as high as 30%, even though U.S. Treasury securities yield less than 10%.
Governmental investors are much like individuals: They can invest wherever they please in whatever they want, for the most part. Some rely on old-line firms and conservative investments, while others are lured by the promise of big returns sometimes made by companies with little or no track record.
“The little fly-by-nighters are the ones with the high yields,” said Relmond P. Van Daniker, executive director of the National Assn. of State Auditors, Comptrollers & Treasurers. “If I have the same rates as Merrill Lynch, why invest with me? I have to come in a few points higher than Merrill Lynch.”
Despite the increasing temptation to chase higher yields, Miller noted that losses of the magnitude suspected in this case still are not an everyday occurrence.
“Although these sorts of incidents capture headlines, 95% to 98% of the funds that are invested by governmental investors around the country are well secured,” he said. “It’s not fair to think that billions of dollars are at risk.”
And yet the danger exists, and it is growing, Van Daniker said.
“Times are tough out there for governments,” he said. “The stress is greater. These small towns have got to make the money so that they don’t raise taxes.”
“As the stress comes, you may be willing to take a higher risk to take a higher reward,” Van Daniker said. “If I’m the mayor of a small town, and I tell the finance director, ‘We need to bring in $100,000 in interest,’ and he says, ‘No way’--well, this is the way. If everything pays off, you’re a hero. If it doesn’t, well that’s it.”
In many cases, the investment officers of small cities and government agencies are not sophisticated in the ways of Wall Street.
“There are 80,000 local government units throughout the country, and there aren’t 80,000 MBAs out there,” Miller said. “There are, in some cases, a lack of training and knowledge and skill.”
“I can see how it happens, but I don’t condone it,” Van Daniker said. Small government entities “don’t want to pay an investment firm $10,000 to do it, and you’re being paid to do something anyway, and they say, ‘Aw, you can handle it, can’t you, Joe?’ ”
Many governmental bodies adopted investment policies after scandals in the late 1970s to mid-1980s, including the collapses of ESM Government Securities of Florida and Bevill, Bresler & Schulman Asset Management of New Jersey.
