Auditor Comes Under Harshest Questioning Yet

Orange County Auditor-Controller Steve E. Lewis, already under scrutiny for his role in the county’s fiscal calamity, was summoned before the Board of Supervisors on Wednesday and questioned in the harshest terms yet about his knowledge and actions as the billion-dollar crisis developed.

Supervisor Roger R. Stanton led the attack on Lewis during the board’s meeting Wednesday, seeking to pin down the veteran county official on what he knew of the risky investment practices of former county Treasurer-Tax Collector Robert L. Citron, and what he did to try to warn officials that Citron’s reliance on high-yield investments could ultimately spell danger for the county.

“It’s clear to me that there was a breakdown in the auditor’s office,” Stanton said.

Although Lewis has claimed credit for being among the first to caution supervisors about Citron’s risky investment strategies, Stanton said the auditor never sounded any significant warnings about Citron’s conduct, which has been blamed for the investment losses that sparked the nation’s largest bankruptcy by a city or county in U.S. history.

Lewis, an elected official who has defended himself against increasingly pointed criticism from county supervisors in recent days, again denied wrongdoing Wednesday. His role, he said, was not to question what turned out to be improper transfers to a county account of interest earned by other participants in the county’s ill-fated investment pool, but to ensure that accounting was done properly.

Furthermore, he said, his office was forced to rely on apparently misleading information from Citron, who resigned under pressure two days before the county declared bankruptcy Dec. 6.

“We were never aware of any serious problems,” Lewis told the supervisors.

In other developments Wednesday:

* In Sacramento, State Treasurer Matt Fong released a list of preliminary recommendations for changes in state law in the aftermath of the Orange County crisis, including a requirement for more complete disclosure of profits and losses suffered by investment funds, as well as restrictions on “leveraging” of municipal portfolios--the practice of borrowing from investment bankers to invest in securities that are expected to pay higher interest.

* A major credit rating agency downgraded a $95-million issue of taxable bonds sold by the city of Anaheim in 1994 for the purpose of investing in the county investment pool. In a report updating the impact of the pool losses on bonds issued by the 187 cities, school districts and other public agencies with investments in the pool, Moody’s also warned that other bond ratings could be affected in coming weeks.

* U. S. Bankruptcy Judge John E. Ryan approved a county request to pay about $3.7 million due bondholders. But attorneys representing the county’s creditors and bondholders grew increasingly testy in the Bankruptcy Court hearing, pressing the county to explain its long-range plans to bolster its credit rating.

* Representatives of the two bankruptcy creditors committees met with the Orange County Business Council and reiterated the importance of including tax hikes in the county’s recovery plan. The creditors committees also emphasized their support for hiring a strong chief executive officer to replace ousted County Administrative Officer Ernie Schneider, and pushed for a quick settlement with participants in the investment pool.

* The finance director for the city of Santa Barbara apparently will become the first public official outside Orange County to lose his job over the financial debacle. Santa Barbara City Administrator Sandra Lizarraga and Finance Director Mark Paul have reached “a mutual understanding” that Paul should resign because of his decision to sink $37.5 million of the city’s reserves into the troubled investment pool, without warning City Council members of the strategy’s potential risks, city officials said Wednesday.

* The Federal Reserve’s decision to raise interest rates one half a percentage point--the seventh interest rate hike in less than a year--was for once a bit of good news for investors in the county’s investment pool. Previous interest rate hikes caused a $1.5-billion decline in the pool’s investments, but because of restructuring that has occurred since the county brought in new financial advisers, the latest increase will actually enhance the county’s holdings--although not enough to overcome the county’s financial troubles. Had the restructuring not occurred, the latest rate hike would have caused another $150-million decline in the pool’s value, Thomas W. Hayes, the county’s financial adviser, stated in a letter to supervisors.

The public grilling of Lewis came during a question-and-answer session at Wednesday’s Board of Supervisors meeting, where Stanton angrily pressed the auditor to explain how he could approve transfers of money and securities between investor and county accounts at the behest of the treasurer’s office, without ever questioning the transactions.

“There wasn’t a need to ask,” responded Lewis, who appeared visibly agitated by the tone of the questioning. “We did not have to ask (how) to do our jobs.”

County officials have disclosed in recent weeks that Citron’s office skimmed into a county account at least $85 million in interest due to other investment pool participants, and spread more than $100 million in county losses among other investors by shifting money-losing county investments into commingled accounts.

The auditor appeared before the board Wednesday to get retroactive approval for a funds transfer he made in late December to enable the county’s Environmental Management Agency to cover bond debt payments.

But Stanton seized the opportunity to skewer Lewis on his office’s auditing procedures and practices. The exchange quickly escalated, with Stanton charging that Lewis was never concerned about Citron’s practices and had actually assured the board and the public that there were no problems in the treasurer’s office.

“You know Roger, he went for the jugular,” Supervisor William G. Steiner said later. “With the line of questioning, it might have been better for (Lewis) to have his lawyer standing next to him instead of his chief deputy.”

Stanton asked Lewis to explain an April 28 political endorsement letter Citron used in his reelection campaign literature. The letter affirmed Lewis’ “confidence for (Citron’s) long proven ability to manage the entire Treasurer-Tax Collector Office.”

Lewis replied that he had sent the letter merely to express his political support for Citron, who was then engaged in a heated election fight with opponent John M. W. Moorlach, a Costa Mesa accountant who warned publicly that Citron’s investment practices were risky.

“I supported Bob in the campaign,” an increasingly uncomfortable Lewis told the supervisor. “I thought things were OK.”

“And if you did not think they were OK, I guess you would have come and told the Board of Supervisors?” Stanton asked.

“That is true,” Lewis responded.

“Well, I’m sorry you didn’t tell the Board of Supervisors, Mr. Lewis, and I hope you don’t represent to the people that you did in the future,” Stanton retorted.

Shortly after the county filed for bankruptcy Dec. 6, Lewis disclosed that his office’s 1991 audit of Citron’s operations had revealed some illegal and financially risky investments--irregularities that were clearly spelled out in copies of the audit he addressed to the district attorney and to the supervisors.

After Lewis’ warnings of improper investments were made public, several supervisors complained that they had never received the audit, even though the transmittal letter indicated that copies had been sent to their offices.

More recently, Lewis made public a June 8 letter he had written to Ernie Schneider, the recently ousted county administrative officer, warning about Citron’s risky investments. In an open letter Lewis addressed to the public last Friday, he complained that the supervisors never reacted to this communication either, even though they had been sent copies of the June 8 letter as well.

Late in the day, an exhausted Lewis said he thought the supervisor’s attack was “unfair.” He said his office was more vigilant than most in raising concerns about Citron’s investment practices.

“We never foresaw the bankruptcy,” Lewis said. “Obviously, if we had, we would have told everyone. What we did was raise reasonable concerns about the amount of borrowing the county was doing.”

Lewis said he had no reason to suspect that there was anything improper about the investment pool transfers that Citron submitted to the auditor’s office for routine approval.

But Stanton justified his grilling of Lewis. “Clearly there has been a myth that the auditor raised red flags. Under my questioning today he admitted that he raised no red flags,” Stanton said. “If you can’t rely on an auditor as a watchdog, who can you rely on?”

In Sacramento, meanwhile, state Treasurer Fong issued a list of four recommendations, which echoed suggestions he voiced a month ago when he convened a task force to study the county’s bankruptcy.

Fong’s suggestions were in sharp contrast with those of a special state Senate committee that is studying more far-reaching changes in the way California regulates municipal investments.

Several lawmakers on the Senate committee have recommended limiting municipal portfolios to just five or six prudent investments, a proposal that has alarmed government financial officials.

Even with the two panels on decidedly different tracks, officials with the Senate committee commended Fong’s task force for its efforts.

“I think the four points he recommends are prudent and well reasoned and an excellent first step,” said Scott Johnson, the Senate special committee’s chief counsel. “Like the treasurer, we’ve tried to avoid a rush to judgment. I would say his is a good foundation that we’ll undoubtedly be supplementing.”

Gov. Pete Wilson, who asked Fong to establish the panel of experts, said the treasurer’s report should prove valuable as state officials “sort through the issues” surrounding the bankruptcy.

Noting that Citron was required to report only once a year to the Board of Supervisors, Fong’s task force recommended an annual written statement of investment policy and quarterly reports detailing the current market values of securities.

The report also suggested that local governments often lack the sophistication to grasp complex investment strategies and reports. Given that, some local agencies should be willing to set up an oversight committee of financial experts to offer advice, the task force said.

The group also called for restrictions on “leveraging,” limiting repurchase agreements to no more than 20% of a portfolio’s worth. While there are “legitimate and useful reasons” for using such investments, the panel said, reasonable limits would prohibit “high-risk gambling” that could jeopardize taxpayer dollars.

Fong’s group also recommended that state lawmakers refrain from restricting certain types of investments until after the state auditor offers advice in an upcoming report and law enforcement agencies conclude their investigations of the Orange County situation.

“Orange County’s losses stemmed from a flawed investment strategy and lack of common sense,” the panel concluded. “It would be inappropriate to penalize the state and all other local governments for Orange County’s losses and that is exactly what we would do if we narrowed the list of permitted state and local investments. . . . Common sense cannot be legislated.”

Meanwhile, Moody’s Investors Service issued a lengthy report Wednesday downgrading a $95-million bond issue of the city of Anaheim, warning that similar actions could soon befall other agencies. Many of Orange County’s cities, school districts and other agencies have thousands of dollars of principal and interest payments coming due, Moody’s said.

In its action, the credit rating agency said most of the funds originally set aside by Anaheim for the April 4 bond payments are still frozen in the county’s investment pool, and the city will be forced to tap other funds to meet its obligations.

Also, Moody’s said, while Orange County has signaled that it plans to make good on its debt payments due Feb. 1, there was still a possibility for bond defaults because the county is deciding whether to make its debt payments on a month-by-month basis, rather than committing to a long-term plan.

“Each time, they come to the edge of the cliff before they make the decision,” said Barbara Flickinger, an assistant director with Moody’s in New York.

In bankruptcy court Wednesday, county bond holders and creditors supported a $37.5-million payment to bondholders, but their attorneys stressed that the county needs to develop a clear plan for handling the county’s remaining interest and principal payments.

Bennett Murphy, an attorney representing Orange County bond holders, warned county officials to avoid taking a short-term view of its obligations that could come back to haunt it when the county returns to Wall Street to borrow funds.

Also Wednesday, representatives of the two creditors committees met with the Business Council, which includes more than 2,000 local companies, and stressed the need for an quick decision to refund the investments of the other pool investors.

The 186 local agencies with money frozen in the pool are becoming increasingly desperate for funds to be released, since many have short-term debt payments due this summer, said John Schotz of Saybrook Capital, financial adviser to the pool participants committee.

“The supervisors ought to resign, or do the right thing. They have to consider increased taxes and fees, have to. Otherwise, they should find another line of work,” Schotz said. “So far we’ve been told by (county officials) that they’re not going to. That’s not right.”

Schotz presented several recovery concepts to the business leaders, including selling or swapping county assets, privatization or sales of landfills, new debt issuances and higher taxes. He promised a more detailed plan from the pool participants committee next week.

“There’s a whole menu of things,” he said. “With a $2-billion hole, it almost doesn’t matter what you do because it’s so big. You could cut the county budget down to nothing, it’s not going to solve it.”

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Pay-Back Time

Several Orange County bond issuers have interest payments due within the next month. Many also must also pay principal amounts at the same time. A look at what’s coming due:

Issuer Principal* Interest DUE TUESDAY O.C. Water District (commercial paper) $14,700 $107,129 DUE FEB. 15 Fullerton Parking Authority -- 3,000 City of Laguna Beach -- 627,963 Los Alamitos Unified School District -- 416,000 O.C. Transportation Authority 12,790 8,896,365 O.C. Water District (issued 1989) -- 814,988 O.C. Water District (issued 1993) -- 3,740,629 Placentia Unified School District n/a DUE MARCH 1 Buena Park Water Revenue 145 2,900 Fullerton Library Building Authority 60 17,106 City of Huntington Beach 445 n/a Huntington Beach Public Facilities Corp. 340 32,550 Huntington Beach Redevelopment Agency 80 188,529 O.C. Pension Obligations -- 8,207,160 O.C.-Calif. Financial Services -- n/a O.C. Development Agency -- 1,705,154 Yorba Linda Co. Water District n/a n/a

Total outstanding Issuer debt* DUE TUESDAY O.C. Water District (commercial paper) $25,000 DUE FEB. 15 Fullerton Parking Authority 75 City of Laguna Beach 20,000 Los Alamitos Unified School District 11,920 O.C. Transportation Authority 262,930 O.C. Water District (issued 1989) 26,760 O.C. Water District (issued 1993) 141,545 Placentia Unified School District 470 DUE MARCH 1 Buena Park Water Revenue 260 Fullerton Library Building Authority 620 City of Huntington Beach 939 Huntington Beach Public Facilities Corp. 1,085 Huntington Beach Redevelopment Agency 5,555 O.C. Pension Obligations 209,840 O.C.-Calif. Financial Services 11,975 O.C. Development Agency 57,435 Yorba Linda Co. Water District n/a

* In thousands

Source: Moody’s Investors Service