Basic Rules of Investing Violated, Experts Agree : Bankruptcy: Many municipal officials failed to follow checklists before putting funds in Orange County pool.


Last February, Laguna Hills City Councilman Randal J. Bressette distinguished himself among Orange County public officials: Before voting whether to let his city leap into the county’s investment pool, he asked Robert L. Citron, then the county’s treasurer-tax collector, to provide documents substantiating that the pool was safe.

Bressette and others had reason to doubt. Citron had publicly warned that the portfolio’s collection of complex financial instruments could be sensitive to interest rate hikes, and rates were on the rise.

When the documents did not arrive in time for the City Council’s vote Feb. 8, Bressette suggested that the decision be postponed a week. But a majority of the council, relying on a recommendation from its financial staff and reassured by Citron’s then-shining reputation, voted 4 to 1 to plunge into the pool.

It goes without saying that Laguna Hills city officials would like to have that one back.


As authorities focus on Citron’s aggressive investment tactics and many point fingers at the once-revered financier, interviews and records also suggest that numerous local officials failed to heed some basic principles of municipal finance in overseeing the billions of dollars they collectively poured into the ill-fated investment pool.

Guidelines promulgated by the Municipal Treasurer’s Assn. of the United States and Canada, the California Society of Municipal Finance Officers and the Government Finance Officers Assn. call for municipal investors to go through an extensive checklist before entering an investment pool, whether it is overseen by a public official or a private firm.

The guidelines recommend that once in the pool, investors regularly analyze financial reports such as cash-flow statements.

In the case of Orange County’s investors, however, it appears that elected officials and government finance officers viewed Citron, himself an elected official, as an extension of themselves, perhaps believing that such vigilance was unnecessary, or unwarranted.


“They should have been asking more questions,” said Rod Rich, chairman of the Municipal Treasurer’s Assn.'s investment policy certification committee. “But everybody was enamored with the returns; everybody was going along for the ride.”

Privately, many elected officials and government finance officers representing the 187 entities in the pool said they may have relied too heavily on Citron’s long record, which showed that he achieved better-than-average returns at a time when public officials were being forced to scrape for dollars.

Many officials contend that they saw no obvious warning signs. They also say it was acceptable to assume that Citron would operate in their best interests. If a climb in interest rates would hurt their investments, they assumed he would make the necessary adjustments--an assurance he had given both verbally and in writing, officials said.

“Most of us felt the fund was a lot safer than it was,” said Gary C. Burton, deputy director of finance and administration for the Orange County Transportation Authority. With more than $1 billion in the pool, the agency was the troubled fund’s single biggest investor. “We didn’t have any indication” there was a problem, Burton said.


But officials acknowledge that it is paramount, when putting public funds in a government pool, to understand exactly how the money is being invested.

When it was announced that Citron’s $7.8-billion pool was heavily leveraged, and much of it in reverse repurchase agreements, inverse floaters and derivatives, investors reacted with shock, saying they were never told Citron had borrowed so much or invested their money and the borrowed funds in exotic securities.

Yet Citron’s monthly statements--which many agencies received--showed the number of reverse repurchase agreements in the pool, and identified securities that were leveraged or pledged as collateral.

In Citron’s September, 1993, annual statement, he wrote: “Our consistently high interest yields are realized from doing Reverse Repurchase Agreements.” He went on: “This is a strategy that utilizes leverage, and also involved in this strategy is the use of structured or floating interest rate securities.”


Spelling out that the pool had been leveraged by a “2-to-1" margin, Citron also hinted that a rise in interest rates would be problematic. “This strategy has been predicated on interest earning rates (remaining) low for a minimum of the next three years,” he wrote.

When interest rates began to edge up in early 1994, problems did indeed occur, eventually leading to the pool’s collapse last month.

“As long as Mr. Citron was doing well and enjoying high rates of return,” said Evelyn L. Radel, president of the Municipal Treasurer’s Assn., “everybody was happy. But the minute there’s a problem, he gets the blame.

“I don’t think that he should be the fall guy,” said Radel, finance director and deputy treasurer for the city of Barstow. “It’s their responsibility to know what was going on.”


Some officials also seemed to have relied heavily on reports in 1994 by Standard & Poor’s and Moody’s financial rating agencies, saying there was nothing in the Orange County fund to cause concern.

Yet, standard practices and procedures of the municipal investment profession, both written and unwritten, would almost certainly have raised red flags if they were followed.

A pamphlet entitled “An Introduction to External Money Management,” available from the Government Finance Officers Assn., recommends that investors in government pools receive monthly account statements, a detailed list of portfolio holdings and a periodic independent audit of the pool. Among the group’s “checklist of controls” is to make sure safety is not being sacrificed for yield.

Officials from many of the cities, schools and special districts in Orange County’s pool appear to have monitored Citron’s fund via monthly statements that showed little more than the interest earned.


Some officials did obtain a listing of the securities in the portfolio, but said they did not understand what it meant. Many acknowledge that they did not seek clarification or further documentation.

“We didn’t do any in-depth analysis of their investment portfolio,” said Vicki Baker, finance director for the city of Yorba Linda. “I think you’ll find that most places didn’t get documents.

“You really had to be on top of the pool all the time to see what they were doing,” Baker added. “It all seems clear now that we should have had that information.”

A document put out by the California Society of Municipal Finance Officers titled “Before Entering a Government Pool” provides a detailed list of issues to investigate.


Among them are the nature of the securities in which the pool is invested, the pool’s safekeeping practices, how the pool operates and what types of financial records to seek on a regular basis.

“Government pools may have a broader range of securities than your agency invests in,” it cautions. “It is important that you are aware of, and are comfortable with, the securities the pool buys.”

Among the issues to consider, the document says, is whether the pool distributes detailed financial reports voluntarily or on request only. Citron and Assistant Treasurer Matthew R. Raabe provided only monthly yield statements, and other documents, according to their official policy, were available on request only. At times, municipal finance officials acknowledge, it took repeated requests to get a response.

It took months before Citron’s office released records to John M. W. Moorlach, who ran against Citron in 1994 and who argued that the longtime treasurer’s investment practices had become too risky--a criticism that caused Citron to bristle.


The transportation authority’s Burton said he had never seen such detailed checklists, but acknowledged that “there are a lot of good questions in here.”

An article in the May, 1994, issue of Treasury Notes, an industry newsletter, emphasized the connection between safety and the free flow of information. “The real test of a safe cash management service is whether or not you have to seek answers to (such) questions at all. A true investment partner, whose goal is to concentrate on the safety, security and liquidity of your deposits, will have the answers to these questions ready and waiting for you.”

“Their role should be one of definitely overseeing what’s going on,” M. Corinne Larson, of the Government Finance Officers Assn., said of public officials whose agencies had money in the pool. “They can’t be involved in the day-to-day management of the pool, but they can certainly keep close tabs.

“I know that Bob was a well-respected person,” Larson said. “But you still need to do your homework.”


Municipal officials’ level of vigilance, both before they joined the Orange County pool and while they were in it, varied considerably.

In a December, 1990, analysis, Huntington Beach’s staff recommended that its City Council join the pool, saying it “is returning slightly higher yield than (a state-run pool), due to lower administrative costs.”

But officials in Orange, Westminster, La Palma and Tustin became concerned enough last year to begin withdrawing some of their money. San Juan Capistrano and Garden Grove rejected the county pool’s tempting returns outright, saying a review of the fund’s portfolio made them uncertain about the risk.

“Those who had the good sense to pull out should be admired and advertised,” said Zane Mann, publisher of the California Municipal Bond Advisor. “My biggest concern is the treasurers and finance officers who borrowed money to invest in the pool. It is that group that I think should be held completely responsible for the losses incurred by their communities.”


Others note that the Orange County crisis is not the first of its kind. Similar fiscal calamities in San Jose, Texas, Ohio and Maryland were thought to have led to a heightened state of awareness of how important it is to know exactly where public funds are invested.

Nine days before the Laguna Hills City Council brushed off the concerns voiced by Bressette, a securities broker, and voted to enter the pool, an article in Derivatives Week, a financial newsletter, quoted a municipal bond expert saying the Orange County situation was “a scandal waiting to happen.”

“I don’t take any pleasure in being right,” Bressette said. “I just thought we should have asked more questions.”

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Some Investment Guidelines

Among the questions and issues for public finance officials to consider before joining a government investment pool:

Types of Securities:


Does the pool provide a written statement of investment policy and objectives?

Does the statement contain:

* a description of eligible investment instruments?

* the credit standards of investments?


* the allowable maturity range of investments?

* the policy on reverse repurchase agreements, options, short sales and futures?

Are changes in the policies communicated to the pool participants?

Does the pool contain only the types of securities that are permitted by your investment policy?


Amount of Interest

Is the yield generally in line with market yields for securities in which you usually invest?


Does the pool disclose safekeeping practices?


Is the pool subject to audit by an independent auditor?

Is the copy of the audit available to participants?

Who makes the portfolio decisions?

How does the manager monitor the credit risk of the securities in the pool?


Is the pool monitored by someone on the board or by a separate, neutral party to ensure compliance with written policies?

Does the pool reveal the portfolio’s current market value?


Are the funds 100% withdrawable at any time?


Financial Statements

Are statements for each account sent to participants?

Do statements show balances, transactions and yield?

Does the pool distribute detailed reports of its holdings?


Are the reports given out regularly or by request only?

Source: California Society of Municipal Finance Officers