MTA Probes Transactions With Ex-Adviser : Finance: Inquiry focuses on whether Lazard Freres & Co. sold securities to agency at inflated prices while its financial consultant. Firm denies any wrongdoing.

The Los Angeles County Metropolitan Transportation Authority has begun an inquiry into transactions with its former financial adviser, Lazard Freres & Co., to determine if the firm substantially overcharged it for U.S. Treasury securities in 1992 and 1993.

MTA officials said in interviews that Lazard persuaded the agency to forgo competitive bidding and instead buy the securities from Lazard. Ronny J. Goldsmith, who joined the agency in May as its chief financial officer, declined to specifically characterize those transactions, but said she considers it “a major conflict of interest” for a financial adviser to have sold securities to a municipal agency.

Data obtained by The Times shows that Lazard appears to have charged the MTA more than $7.5 million above the market price for the treasury securities as shown in daily newspaper financial tables. The apparent overpayments came to light after an individual who was familiar with the transactions brought them to the attention of The Times.

Lazard executives turned down numerous requests for interviews. In written responses to questions, Robert E. Poll, managing director in charge of Lazard’s municipal division, strongly denied that the firm had overcharged the agency or done anything wrong. He said that based in part on the risks the firm took in holding the large quantity of securities for several days before delivering them to the agency, “Lazard’s markup for the [treasury] securities sold to the LAMTA was fair.”

But Poll declined to disclose how much of a markup, or profit above its own cost for the securities, the firm had charged the agency. He said it is against Lazard’s policy to disclose such “proprietary information.”

The MTA bought the treasury securities--U.S. government notes and related securities known as “strips” that had a total face value of more than $1 billion--as a crucial step in three complex deals in which the agency took advantage of lower interest rates to reduce its debt on municipal bonds.

Although minuscule in comparison to the value of the securities, the apparent overpayments would have represented significant profits for Lazard.

Possible overcharges involving the MTA are the latest in a series of problems for the firm, one of Wall Street’s most prestigious. For more than two years, Lazard has tried to deflect accusations of improprieties in its municipal finance business and is the subject of pending federal investigations, including a criminal investigation by the U.S. attorney’s office in Boston. That investigation centers on allegations that Lazard had a secret contract with Merrill Lynch to use its influence as financial adviser to municipal agencies to funnel business to Merrill.

Lazard and Merrill deny any wrongdoing.

Goldsmith said in an interview that she is looking hard at the agency’s past financial practices, and has asked the MTA’s new financial adviser, Public Financial Management, to investigate whether the agency was overcharged on the treasury securities. She said she expects an answer within several days. She said she also has asked it to review the pricing of municipal bonds sold as part of the same transactions. Steven Chesser, an MTA spokesman, said the agency probably will begin legal action if it finds that it was overcharged on the treasury securities.

Goldsmith said she had begun looking into the transactions independent of the inquiries by The Times.

Leslie V. Porter, MTA’s treasurer, who now reports to Goldsmith, and the agency’s bond counsel, O’Melveny & Myers, acknowledged in interviews that they never made independent efforts to check the prices paid for the treasury securities. Porter and Dean M. Weiner, a partner at O’Melveny, said that no one on MTA’s financial staff or at the law firm looked at the tables in the Wall Street Journal to see if the prices paid seemed reasonable. As bond counsel, one of O’Melveny’s responsibilities was to certify that fair market prices had been paid.

Instead, they said, they relied on written assurances from Lazard and independent Wall Street firms stating that Lazard had charged market prices. In an interview, Weiner said he now regrets not having independently checked the prices, particularly in view of recent public allegations by a former Wall Street municipal bond executive, Michael Lissack, that Wall Street firms frequently overcharged municipal governments and that the firms often accommodated each other by falsely certifying that fair prices had been paid.

“In retrospect, we should have been much more skeptical,” Weiner said.

*

The overpayments would have compounded the MTA’s financial difficulties. It announced in April that it expects to lay off 234 employees to help close a $97.6-million budget deficit. Its subway construction program is over budget and behind schedule, and there have been charges of shoddy work by contractors. But the apparent overpayment for treasury securities is the first indication of possible problems involving the agency’s municipal bond financing arrangements.

Records supplied by the MTA show that Lazard charged it prices that were significantly above the quoted “asked” price in the daily table of treasury security prices in the Wall Street Journal. The asked price is the price at which dealers offer to sell the securities.

The exact amount of the apparent overcharges is impossible to determine. The newspaper tables do not show price variations during the trading day. But on the limited number of securities the MTA bought for which such so-called intra-day data is available from Bloomberg Analytics, the records show that Lazard consistently charged well above the day’s highest quoted price.

Raymond Day, chief investment officer for the city of San Diego, said that in such deals, municipal agencies normally pay no more than the quoted asked price and frequently less.

By convention, bond prices are quoted in increments of 1/32 of a percentage point, or about 31 cents per $1,000 of bonds. George A. Nielsen, head of American Money Management Assn. in Denver, a private firm that advises public agencies on financing, said that except in unusual circumstances, a markup of a full 1/32 would be “pressing the limit” of reasonableness. In big deals, municipalities usually pay less than that, he said.

But records show that the prices that Lazard charged the MTA exceeded the quoted prices on the bigger purchases by 12/32s and more, ranging up to more than a full percentage point.

MTA documents show that in a refunding in June, 1992, Lazard charged the agency $963,000 above the market price quoted in a table in the Wall Street Journal (with the published price of the strips adjusted to reflect the number of days between execution of the trade and actual delivery of the securities to the MTA). In an April, 1993, deal, the amount paid was more than $2.5 million higher than the prices in the Journal table.

In a June, 1993, transaction, the prices paid were nearly $2.7 million above the quoted prices. Then, 13 days later, for reasons that are not entirely clear, Lazard bought back nearly all of the securities it had sold in that transaction. The price it paid the MTA: $1.6 million less than the quoted market price for that day.

*

The MTA’s need for treasury securities arose because, from 1991 through 1993, the agency and its predecessor, the Los Angeles County Transportation Commission, like many other municipal agencies nationwide, sought to take advantage of falling interest rates. The agencies did this by issuing new municipal bonds to lock in lower interest rates and retire older bonds on which it had to pay more. The idea was the same as for homeowners who refinanced their mortgages to take advantage of lower interest rates.

The main difference was that unlike most mortgages, the old municipal bonds had conditions written into them forbidding the issuer to “call,” or pay off, the bonds before a certain date. To get around this, the MTA sold new bonds, then used the proceeds to set up an interest-bearing escrow account to pay off the old bonds until they could be retired.

*

The money put into these escrow accounts was required to be invested in safe U.S. government securities such as treasury notes and strips. It was on these that the MTA appears to have been overcharged. Strips represent treasury notes that have been divided into separate portions representing principal and interest.

Goldsmith, the former chief financial officer for Alameda County Transit in Oakland and a former Berkeley city treasurer, said she would never allow treasury securities to be bought without competitive bidding. She also said she considers it a major conflict for a financial adviser--whose main role is to counsel the MTA on how to get the most favorable deal--to sell such securities to its client.

Porter and Weiner said that at the time they felt comfortable that the charges paid were reasonable because in each instance other, independent Wall Street firms provided letters vouching that Lazard had charged fair market prices.

But after being asked to supply copies of the three letters, Porter changed his explanation. He acknowledged that for the June, 1993, deal, in which Lazard sold treasury securities to the county and then bought them back 13 days later, no such letter had been obtained.

In another instance, there are questions about Lazard’s account that it had received approval of the prices it charged before it made the sale to the MTA. In the MTA’s April, 1993, deal, Lazard got an independent price verification from the Wall Street firm Paine Webber. In justifying the prices that Lazard charged the agency, Poll said in a letter to The Times that the firm obtained Paine Webber’s approval of the prices on April 22, 1993, which he stated was before the MTA accepted Lazard’s offer.

But trade confirmation slips obtained by The Times show that the sales to the MTA took place the day before, on April 21. And MTA spokesman Chesser said Paine Webber’s approval was only received by the agency more than a week after they had taken place.

Asked about the apparent discrepancy, Poll said he had been mistaken about the dates. But he insisted that Lazard received approval from Paine Webber before executing the trades.

Municipal finance experts said that from 1991 through 1993, while many municipal agencies insisted on competitive bidding in buying treasury securities in refunding deals, many others, such as the MTA, did not. However, experts said it was rare for a municipal agency’s financial adviser to also sell the treasury securities itself.

*

In the wake of allegations by Lissack, the self-described whistle-blower who is a former municipal finance executive at Smith Barney, the IRS and other federal agencies have begun scrutinizing the purchases of treasury securities in refunding deals.

Lazard was hired in 1991 under a three-year contract signed with the MTA’s predecessor, the county Transportation Commission, even though it was not the low bidder, MTA officials said.

Lazard’s pitch to the agency was made by Grover L. McKean, a senior vice president and head of the firm’s Los Angeles office. Before he moved into investment banking, McKean had been a top aide to Jesse Unruh, the California state treasurer who died in 1987.

Porter said it was McKean who persuaded the agency to forgo competitive bidding on the securities.

But Porter said McKean made a persuasive case that the firm was uniquely equipped to acquire exactly the right mix of treasury securities on the day the new municipal bonds were being priced.

McKean declined repeated requests from The Times for an interview. In a letter, he did not address questions about the treasury securities. But he said he knew of no reason why the MTA would look into the pricing of its municipal bonds and said the bonds were “priced well within the market.”

The controversy over the amount that Lazard charged the MTA on treasury securities is not without precedent. In October, 1992, Joseph W. Prather, then head of Kentucky’s finance and administration cabinet, sent a blistering letter to Felix G. Rohatyn, senior partner at the firm. In it, Prather said the state was seriously disappointed in Lazard’s performance in a Kentucky Turnpike Authority refunding bond issue on which Lazard had been financial adviser.

A memo by Prather’s staff that was leaked to the press includes allegations that Lazard executives persuaded them not to hold competitive bidding for treasury securities bought for the escrow account, and then tried to overcharge the state by more than $1 million. It contends that “many false statements were made to us [by Lazard] about the escrow account.”

Lazard has strongly denied any wrongdoing in the Kentucky transaction. A letter shows that an investigation conducted by the National Assn. of Securities Dealers was closed with no action taken against Lazard.

Times staff writer Carla Rivera in Los Angeles contributed to this story.