Smith Barney Investigating L.A. County Deal : Securities: A former brokerage employee alleges the firm secretly took a $1.3-million fee it had promised to forgo.
Smith Barney Inc. has launched an internal investigation into allegations by a former employee that the giant Wall Street brokerage deceived Los Angeles County in 1993, costing the county as much as $1.3 million by secretly taking a fee the firm had promised to forgo.
Smith Barney has denied that it broke its agreement with the county in connection with a complicated $461-million transaction involving derivatives in October, 1993.
The deal was meant to help the county close a budget gap by getting it a better interest rate on borrowings for its pension plan.
Smith Barney confirmed that it has hired an outside law firm to investigate the employee’s charges, which include allegations that a phony invoice was drawn up to hide the fee.
In a written statement, Smith Barney said that if it finds evidence of improper conduct, it “will work with the county to address what remedial action, if any, is appropriate.”
The allegations were made to federal investigators by Michael R. Lissack, who until Feb. 17 was a managing director in Smith Barney’s municipal finance department and who was directly involved in the transaction. It could not be learned immediately if the Justice Department or the Securities and Exchange Commission are following up on Lissack’s charges.
Smith Barney, after acting as the county’s representative, allegedly received the $1.3-million fee from AIG Financial Products, a firm Smith Barney had negotiated with to provide an interest rate swap to the county as the main part of the deal.
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However, Sharon Yonashiro, the county’s director of public finance, said the county has for now accepted Smith Barney’s and AIG’s assurances that no fee was paid for the deal.
“Smith Barney said it wasn’t true, AIG said it wasn’t true, and there was no reason not to believe them,” she said.
Joe Norton, a spokesman for American International Group, parent company of AIG Financial Products, declined to comment or answer any questions about the transaction. “As a matter of policy, AIG does not discuss individual client matters publicly,” he said.
In an interest rate swap, two sides agree to exchange the streams of interest payments each has to make, usually trading a series of fixed-rate payments for ones with variable interest rates.
The deal was structured so that it would immediately provide more than $20.6 million in cash to the county, with another $10 million to come in 1996.
In a July 20, 1993, letter to the county, Smith Barney said it agreed to the county’s request that the firm take no fee from AIG. The letter stated that Smith Barney “will receive no compensation from AIG in any form” for the deal. Lissack and another source involved with the deal said the county almost certainly would have received all or part of the $1.3 million--either in the form of a lower interest rate on the swap or more cash--had AIG not paid a fee to Smith Barney.
Maureen Sicotte, a county finance manager who worked on the deal, said the county asked Smith Barney to forgo the fee because the firm was merely acting as a “facilitator.” She said that by doing so, Smith Barney, a frequent adviser to the county on financial transactions, was “showing that we have your continued interest at heart.”
County officials insist there is no evidence the county lost money to Smith Barney in the deal. However, Sicotte said an AIG representative will be in Los Angeles today and that the county plans to review documents and billing statements the firm agreed to make available.
Lissack, a self-described whistle-blower, was fired by Smith Barney after he wrote internal memos questioning the ethics of certain transactions. He has since gone public with allegations of wrongdoing at Smith Barney and other firms in deals involving municipal bonds and the way cities and counties invested the proceeds from bond issues. Lissack has filed an arbitration case against the firm, claiming wrongful termination.
Smith Barney denies any wrongdoing. In a document filed with the National Assn. of Securities Dealers, the firm said it fired Lissack because he “engaged in conduct injurious to Smith Barney Inc. and its reputation.”
The transaction, known as a “forward swap,” was meant to let the county receive cash immediately in expectation that it could borrow at a lower interest rate in 1996, when it would be able to retire outstanding pension bonds and issue new ones.
At the time, Smith Barney’s investment bankers were trying hard to win a piece of the county’s huge municipal bond underwriting business.
Smith Barney offered to arrange the initial swap transaction with AIG, hoping that the county would eventually reward it with a lucrative agreement to underwrite the new pension bonds. Smith Barney was to receive no fee from the county initially, only the hope of a large underwriting fee later. And although Smith Barney routinely received a fee from AIG in other similar deals, the county insisted that Smith Barney forgo such fee in this one.
However, Lissack has told investigators that Smith Barney and AIG secretly agreed that AIG would pay the fee anyway. He said that within weeks after the deal was completed, Smith Barney drew up a fictitious invoice for “marketing services” on behalf of AIG to provide Smith Barney with a cover story in case it was eventually questioned about the payment. He said the bill included several smaller items unrelated to Los Angeles County but that the bulk of it was the $1.3-million fee.
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Another source, interviewed separately, who was involved in the transaction between Smith Barney and AIG, gave an account identical to Lissack’s. He said AIG told Smith Barney, “We’re just going to pay you the fee anyway, but we’ll call it a reimbursement for marketing.”
Lissack confirmed that he signed the invoice he contends was fictitious. He said the invoice was presented to him by superiors at Smith Barney just after he had returned to work after recovering from a nervous breakdown. “Needless to say, at that time I signed whatever they put in front of me,” he said. “I wanted to keep my job.”
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Paltrow reported from New York, Rivera from Los Angeles.
