In Fund Crash, Schools Could Be Big Losers

Local schools could be the biggest losers in the crisis crippling the Orange County treasurer’s investment fund, because of a state law that requires them to keep virtually all their money in the county pool, officials said Monday.

As some agencies took steps toward withdrawing funds from the pool, which announced a stunning $1.5-billion plunge last week, school administrators urged a wait-and-see attitude and expressed hope that cities and special districts would consider the impact on the school system before making decisions.

“It’s a very serious and grave situation,” Capistrano Unified School District Supt. James A. Fleming said. “The main thought I have is one of Angst .”

Added Rita Newman, assistant superintendent for business services in the Anaheim Union High School District: “We’re stuck.”

The County Department of Education fielded anxious phone calls from school administrators all day and planned a meeting Thursday for the 27 district superintendents and their finance experts to discuss the situation. Attorneys are researching whether schools have any option other than to stay in the pool, officials said.

Newport-Mesa Unified School District Supt. Mac Bernd, whose district is one of four facing the greatest potential damage because they placed huge sums of borrowed money into the pool in hopes of raising badly needed revenue, said the key now is “sticking together.”

“All of the advice we get from all of our sources is that if the agencies involved stay in the pool, these will remain paper losses,” said Bernd, whose district has $80 million invested with the treasurer’s office. “This is a perfect example of when governmental agencies need to cooperate because we’re all serving the same public.”

Newport-Mesa, Irvine Unified, North Orange County Community College District and the Orange County Department of Education each borrowed amounts equivalent to about half their annual budgets, investing $200 million with County Treasurer-Tax Collector Robert L. Citron’s office in a special deal for the sole purpose of reaping profits through arbitrage.

Unlike other investments in the fund, this $200 million cannot be withdrawn until June under terms of the deal.

While the treasurer’s office gave the districts written and oral guarantees at the start of the special deal in 1993 that the overall county pool would back their investments so not a penny of the principal could be lost, county officials outside the treasurer’s office said Monday they never authorized such a special guarantee. Several attorneys also questioned the legality of the arrangement.

Further complicating the situation, officials representing the four investors said Monday that they were assured the guarantee remained for the investment’s second year, which began in June, 1994, but never received a letter expressing that.

“We asked if the same guarantee applied and were given a positive response,” said Michael Fine, Newport-Mesa’s director of fiscal services. “We asked if we would get another letter of guarantee and they said yes we would. But I don’t have one in the file.”

John Nelson, assistant superintendent of the County Department of Education, and Paul Reed, Irvine Unified’s deputy superintendent for business, both also said they understood the guarantee to continue into the second year but never got it confirmed on paper.

But several attorneys raised concerns about the validity of either a verbal or written promise from the treasurer backing some investors’ funds with other investors’ money.

“I think it would have to be in writing and authorized by the county. I find it difficult to believe that a verbal promise would be enforceable,” said Bill Lerach, a San Diego lawyer who specializes in securities fraud. “I’ve never heard of a pooled investment arrangement where certain participants were guaranteed against loss while others were not. If I was an unguaranteed participant I don’t think I’d be too happy.”

Joseph R. Symkowick, general counsel for the State Department of Education, agreed that the prospects for enforcing the guarantee are uncertain.

“In theory, you can enter into contractual obligations that are like guarantees or warranties. You can buy an insurance policy for anything,” he said. “But legally, how good is that guarantee? I don’t know.”

Newport-Mesa school board President Edward H. Decker said Monday he voted against the investment deal last spring partly because he did not believe the guarantee could hold up.

“Even if it was in writing, what would Citron use to guarantee our funds? Did he have a stash somewhere?” Decker quipped Monday. “I never believed he could ultimately guarantee that, anyway, because it would just be a matter of taking money away from somewhere else.”

There is no mention of the special guarantee in a 22-page prospectus describing each district’s investment plan to prospective buyers of the securities.

The prospectus lists the reason for the large loan as meeting expenses, makes no distinction between the special deal and routine borrowing by school districts throughout the state, and never mentions that the loans will be used for high-risk investments.

“The marketplace doesn’t care whether we’re using it to get through the first week of December to meet our cash needs or to build up our reserves,” Fine said.

Newport-Mesa borrowed nearly $47 million for the investment. Irvine Unified borrowed about $54.5 million; the college district borrowed more than $56 million; and the county department borrowed $42 million.

In its first year, the agencies each earned about $1 million for the deal, which they reinvested with the pool. The investment also has made money during the first half of this year.

As an added precaution during the second year of the investment deal, the four agencies bought an “insurance cap” that kicked in to cover losses when interest on their variable-rate loans rose above 5%. The cap cost each district between $200,000 and $300,000, and is now paying some of the interest on the districts’ loans.

“One can certainly sit in the Monday-morning quarterback chair and criticize . . . but I think you have to look at the way things appeared when we made the investment,” said Reed, the Irvine Unified financial manager.

“Our feeling has been that our money is safer (in the county pool) than everywhere else we could place it,” added Nelson. “I obviously trusted something I shouldn’t have.”