Botched investments broke federal rules

Palm Beach Post--April 24, 2008

By MICHAEL C. BENDER
Palm Beach Post Capital Bureau

TALLAHASSEE — The State Board of Administration did not have the proper federal credentials to purchase nearly one of every three securities analyzed in an audit obtained Thursday by The Palm Beach Post.

The finding, the head of a legislative auditing panel said, opens the door for state officials to pursue refunds of some of the $1.2 billion in local taxes they invested in mortgage-backed securities that were downgraded within days of the sale.

What’s being said in Tallahassee

Rep. Carl Domino

R-Jupiter

‘If you’re not a qualified investor, they have to give your money back.’

Alex Sink

State CFO

‘Somebody knew something. I’m certainly hopeful that the investigation … might lead us to figuring out who it was who knew what.’

Charlie Crist

Governor

Says he wants an ‘explanation as to what in the world happened here, and why it happened, and why Florida was, in my view, maybe taken advantage of.’

"If you’re not a qualified investor, they have to give your money back," said Rep. Carl Domino, R-Jupiter, chairman of the Joint Legislative Auditing Committee.

Domino, an investment manager, said that even though board investors didn’t have a special certification from the Securities and Exchange Commission, it is the seller who has the obligation to confirm that investors are authorized to make the deal.

Drafts of the audit, performed by the accounting firm Clifton Gunderson LLP, were provided last week to Gov. Charlie Crist and other board trustees. The trustees then pressed state Financial Regulation Office Director Don Saxon to investigate possible legal action against JPMorgan Chase & Co. and Lehman Bros, which sold the state the troubled securities.

Florida Chief Financial Officer Alex Sink, a State Board of Administration trustee, said it "reeked" that some securities were downgraded so soon after the sales.

"Somebody knew something," Sink said. "I’m certainly hopeful that the investigation … might lead us to figuring out who it was who knew what. That is very suspicious to me."

Officials from JPMorgan and Lehman Bros. declined to comment.

The audit criticized the board for "significant management deficiencies" and a lack of oversight.

The audit also took aim at the board for letting the individuals who made investment transactions also keep an eye on whether those investments were compliant with board rules.

Auditors found the board made purchases through unapproved broker-dealers at least three times and, in three particular funds, failed to properly square more than 70 percent of their investments with state investment rules.

"There are certainly weaknesses in our compliance," board interim Director Bob Milligan said. "And to the extent those weaknesses exist, we need to fix them."

Milligan, who took over the board after purchases of mortgage-backed securities led to a financial crisis for at least one state fund, has withheld almost $50,000 in bonuses for four executives.

He approved $28,000 in bonuses during the first quarter of this year for fund managers and the support team that worked extra hours during the financial crisis, according to public records requested by The Palm Beach Post.

The audit obtained Thursday showed that three State Board of Administration funds are not considered "qualified institutional buyers," a certification the SEC requires before investors can participate in a restricted "144a" market.

The three funds made at least 58 unqualified "144a" purchases, including securities quickly downgraded.

Funds that made improper purchases were the Local Government Investment Pool; the state Hurricane Catastrophe Fund; and the Commingled Asset Management Program, whose investors include the Lawton Chiles Endowment and fire and police departments.

In his response to the audit, Milligan wrote that short-term investments are now subjected to legal reviews and other oversight.

Crist and other board trustees ordered the audit in December. Last week, the governor encouraged Saxon to use his subpoena power if Lehman Bros. or JPMorgan failed to cooperate.

Crist said he wanted an "explanation as to what in the world happened here, and why it happened, and why Florida was, in my view, maybe taken advantage of."

Attorney General Bill McCollum pointed out that the audit showed that the state did not purchase any subprime mortgage securities. However, the mortgage-backed securities it did buy were downgraded because of the subprime meltdown.

"We could have done better around the margins," McCollum said. "But the idea that there was some action on the part of SBA to go out and buy something extraordinarily risky didn’t seem to be revealed."

State officials have spent five months trying to sort out the November crisis, which put billions of dollars in the Local Government Investment Pool at risk.

When word spread that the board had invested in mortgage-backed securities in the midst of the subprime meltdown, local governments withdrew $13.5 billion from the $30 billion pool within two weeks.

The board temporarily shut down the fund. It currently sits at about $8.5 billion, which is subject to withdrawal fees. Local governments have paid about $7 million in redemption fees in the past five months, according to board officials.