Auditor Called O.C. Fund Safe, Tape Discloses

An executive at KPMG Peat Marwick, Orange County’s outside auditors, reassured a local government agency last spring about the safety of the county’s now-bankrupt investment pool, saying an expert brought in by the firm had given the pool a stamp of approval.

The executive’s remarks, captured by an unobtrusive tape recorder at a meeting of the public agency, diverge from Peat Marwick’s repeated insistence in the wake of the county’s bankruptcy filing that the firm never reviewed the pool or the practices of the treasurer’s office because it was never asked to do so.

According to a transcript obtained by The Times under the California Public Records Act, Peat Marwick partner Margaret J. (Peggy) McBride told members of the Orange County Water District’s investment committee that the giant accounting firm had reviewed the investment pool and that she thought it was “a good place to have your money.”

The tape and a transcript of the March 29, 1994, meeting has been turned over to the Orange County district attorney’s office, which is investigating the county’s financial debacle.

McBride’s remarks came after several investment committee members raised questions about the way the county kept its books, in particular its practice of valuing the pool’s holdings at cost rather than market value.

“Since we are the auditors for the county, I’ll give you a little bit of assurance,” said McBride. “We think they’re at very little risk of . . . having to sell any significant amount of investments, or maybe any, at a discount that would cause you a problem.”

The water district, which had $116.5 million invested in the pool when the county filed for bankruptcy Dec. 6, stands to lose more than $20 million--depending on what the county recovers in litigation and whether voters approve a half-cent sales tax hike June 27.

McBride, who was the district’s auditor as well as the county’s, routinely sat in on meetings of the investment committee, which had discussed for two years whether to pull the agency’s funds out of the county pool.

Her statements could bolster efforts by the county and its bondholders to pursue civil litigation against the Big Six accounting firm, one of several potential “deep pockets” targeted for failing to disclose the risks associated with the county’s investment pool, which suffered a staggering $1.7-billion loss last year.

“That judgment, if made, was obviously incorrect at a minimum,” county bankruptcy attorney Bruce Bennett said when told of McBride’s comments. “Obviously, they ignored the volatility, which should have been obvious to an expert. It’s obviously something the county would want to look into.”

In the wake of the county’s financial crisis, Peat Marwick came under attack for failing to spot trouble looming for the county-run investment pool.

County Auditor-Controller Steve E. Lewis said in January that he had twice asked the accounting firm--in 1993, and again in early 1994--to pay special attention to the treasurer’s office and the $7.4-billion portfolio it ran for 200 local government agencies.

At the time, Peat Marwick officials insisted they had never done so.

“KPMG was not asked and did not second-guess the county’s investment strategy,” the firm’s national director for government assurance services, John R. Miller, told The Times earlier this year. “What got Orange County into trouble was its investments, not its accounting.”

But at the water district meeting, McBride pointed to the expert’s visit as evidence that Peat Marwick had done a thorough job of looking at the investments.

“We brought in our, quote, ‘expert’ on investment securities from, actually, Ohio, and he sat down with [ex-Assistant Treasurer] Matt Raabe, spent about an hour going through their practices, their structure, their leveraging, market conditions, the whole thing,” McBride said, according to the transcript.

“And I think they both walked away very happy with the exercise. I think Matt was pleased to have somebody who understood what he was doing look at what he was doing. And I was extremely pleased that we came away as comfortable and happy as [we] were.

“I don’t claim to understand all of his strategies,” she said then, “but I am comfortable that . . . he’s OK. It’s a good place to have your money. . . .”

In a prepared statement Miller submitted to a state Senate committee investigating the Orange County bankruptcy, he also referred to the outside expert, but downplayed the level of analysis.

“We were not engaged to provide any services with respect to the treasurer’s office or the investment funds other than those that were summarized in the county’s financial statements and encompassed by the financial statement audit,” Miller wrote in his prepared remarks.

“To assist the local engagement team in performing their audit procedure, one of KPMG’s specialists from its capital markets group was asked to look at the investment portfolio and to discuss any issues with the treasurer’s office. The conclusion reached as a result of these discussions was that Orange County was aware in 1993 of the investment risks posed to the fund by leverage and by fluctuations in interest rates.”

McBride, a Peat Marwick partner for public services in the firm’s Costa Mesa office, did not answer calls for comment last week.

But Miller, a top-ranking executive based in New York, defended McBride’s statements to the water district, saying that she was not providing investment advice and that her assessment of the pool was accurate at the time.

“By attending meetings like these, we can give the investment committee and its investment advisers factual information that we learned through our professional reading of financial statements,” Miller said.

“As part of our financial statement audit, we used the specialized knowledge of a professional who could review with client management certain aspects of their investment portfolio,” he continued. “The purpose of this review was to determine if it was appropriate for Orange County to report in its financial statements the value of the portfolio at cost.”

Miller also emphasized that KPMG never finished its audit for fiscal year 1993-94. But at the investment committee meeting, McBride never mentioned how up-to-date her information was, and several people who attended said they took her comments as an endorsement of the pool’s current condition.

Phil Anthony, a Costa Mesa developer who presides over the water district board, said McBride’s comments “did support what most of us believed at the time, which was that it was a safe place to have our money.”

“I’m very disappointed that a lot of the experts didn’t figure it out. There are all of these financial experts of different sizes and shapes and colors, and virtually none of them raised the alarm flag until much too late.”

Alan Adelman, who attended the session in his former capacity as chief investment officer of First Interstate Bank, an adviser to the district, agreed.

“It’s a situation where, hindsight being 20-20, the assurances that were given . . . were not accurate,” Adelman said.

“The water district and their professional staff, as well as their board members, relied upon the comments rendered by Matt himself and they put reliance on their outside professionals, be it their auditors or their investment bankers,” he added.

“They did rely on professionals, and I think there’s a responsibility these professionals have. You need to be sure of what you say and stand by it.”

Lawyers representing bondholders in a class-action lawsuit and those handling the county’s litigation against private companies declined to comment, other than to acknowledge that Peat Marwick remains on their list of potential targets.

“It certainly lends credence to any effort to pin them in the litigation,” said a source familiar with the case, speaking on the condition that he not be named. “It’s certainly an important factor as far as Peat Marwick is concerned and their liability in assuring investors.”