Following up to my last post on systemic fraud at public pension funds, Sydney Freedberg sent me her latest article, Florida investment agency uses smoke, mirrors (added emphasis and notes are mine):
Front and center on its Web site, the agency that invests $118 billion for Floridians showcases its code of ethics: "It's all about … Trust — Performance — Integrity.''
Most people take that as an article of faith, that the state is investing money for retirees and others wisely. But when the agency has fielded inquiries, it has often been about obfuscation, omission and falsehood.
[Note: When you are hiding the truth, remember the three O's: Obfuscate, Obfuscate, Obfuscate!]
When a community college employee asked if his pension money was in risky securities sliding on Wall Street, the answer he got was misleading and false.
When a city official with $26 million invested with the state asked if the money was safe, the people who run the state fund brushed him off.
When another city official asked if a $425 million investment was safe, the agency gave an answer the city considered so misleading that it asked the FBI to investigate.
When the agency's employees privately fretted about losses and shaky investments, their bosses told retirees and state and local officials that everything was fine. They even misled the three people charged with oversight of the agency: the governor, the chief financial officer and the attorney general.
This picture emerges from a St. Petersburg Times review of thousands of e-mails and confidential memos, financial records, transcripts and other reports issued from late 2006 to 2009.
The documents reveal an agency, the State Board of Administration, that often clouds its public statements in complicated language and corporate speak that obscure the truth.
Pressed for answers, the agency's managers sometimes dodged or equivocated. Sometimes they offered assurances that were technically accurate but gave a distorted picture. Sometimes their responses were simply false.
The managers say that they never tried to deceive anyone but acknowledge that they need to be more open. Executive director Ash Williams said the agency offers free, one-on-one investment counseling and is working to improve its disclosure about investments that it makes with the taxpayers' money.
"We want to be as straightforward as we can,'' Williams said. "We're trying to disclose as much as we can in the spirit of openness.''
Tanya Beder, a risk-management expert who audited an SBA fund for the Legislature last year, agreed to review documents for the Times.
When it comes to disclosure, she said, she saw a continuation of the attitude that she found during her audit: Senior managers believe it is up to investors to ask rather than the duty of the agency to disclose.
"This attitude is troubling,'' Beder said. "It places a huge burden on investors to ask exactly the right question."
[Note: Investors can't know what questions to ask because these investments are not always easy to understand. That is why you need to conduct a thorough performance, operational and risk assessment of these large funds by independent experts on an annual basis.]
The SBA invests money for about 1,000 counties, cities, school districts and others, from the state lottery and the hurricane catastrophe fund to the Division of Blind Services and the McKnight Foundation minority scholarships.
It also manages the pension money of 1 million public employees and their families. Among them is Doug Kirby, a 54-year-old Broward Community College administrator with five years until he retires.
In the summer of 2007, articles in Bloomberg Markets and MSN Money alarmed Kirby. The stories said that Wall Street banks were talking public pension funds into investing in collateralized debt obligations — known as CDOs — backed by assets that sometimes included subprime mortgages, which are loans to people with poor credit histories.
CDOs are sold in slices, or "tranches.'' The articles said the riskiest portions, "equity tranches,'' were being peddled to pension funds.
Kirby e-mailed the SBA copies of the two articles. "I would like to know if the pension fund … has exposure to the criminal fraud of Wall Street firms selling collateralized debt obligations?'' he wrote to spokesman Michael McCauley.
Before writing back, McCauley checked with the SBA's top men — then-executive director Coleman Stipanovich and his deputy, Kevin SigRist. "How would you like me to respond?'' he asked.
The answer McCauley e-mailed to Kirby was technically accurate in part, false in part and misleading.
McCauley said Florida did not have any "subprime, equity tranches identified in the two articles.''
That was true. What McCauley did not say was that the pension fund had other arcane and risky investments. On that date, records show, the pension fund held $300 million of Axon and Ottimo, mortgage-related securities that would soon plunge in value.
McCauley wrote that the pension fund held CDOs but said none was tied to the subprime portion of the market. He capitalized NONE.
That was false. At the time, the pension fund had at least five CDOs linked to the subprime market.
McCauley says now that he passed on what he was told. SigRist says the agency did hold securities guaranteed by banks, but they were "indirectly'' tied to the subprime mortgage market.
Kirby called the response "disappointing'' and felt he never got a straight answer.
"I thought they were sending me a feel good, trust-us-we-know-what-we're-doing letter,'' he said, "but it didn't give me a warm and fuzzy feeling.''
In 2007, Mike Lombardi headed the SBA's short-term trading desk, which at the time managed $58 billion in investments. The mission was to avoid high-risk bets and invest in vanilla securities that could quickly be converted to cash.
The money had to be liquid in case any of the 1,000 local governments needed to pay for such basics as salaries and road repairs. It had to be available in case agencies like Citizens Property Insurance Corp. or the hurricane fund needed to pay storm and property insurance claims.
In policies, newsletters and public statements, the SBA described two funds it managed as "money market-like'' or "2a-7 like,'' suggesting they followed strict rules for private money market mutual funds regulated by the Securities and Exchange Commission.
But the funds were not regulated by the SEC. They were not subject to federal rules or accredited by any outside evaluator.
At least $1 billion was invested in risky securities that could not be quickly and easily converted to cash.
Billions in additional holdings "weren't appropriate for a public pension fund or for public funds that must fall back on the taxpayers if they get into trouble,'' said Jack Kiefner, a St. Petersburg securities lawyer who formerly worked for the SEC.
Thomas Tew, a Miami securities lawyer who examined the local government fund for the Legislature, said that the use of "money market-like'' and "2a-7 like'' was misleading. Said Tew:
"The term doesn't explain the additional risk that the little word 'like' adds to the equation.''
SigRist, the agency's deputy executive director, says the short-term funds adopted more conservative investment rules and better disclosure. The local government pool got the top rating from credit ratings agency Standard & Poor's.
When zero isn't zero
In late June 2007, the SBA was briefing a panel that advises the agency on its investments. One of the advisers, Roman Martinez, wanted more details.
"What is the exposure vis-a-vis mortgage-backed, you know, all the things we're hearing about, collateralized bonds, etcetera?''
Rob Smith, an SBA senior investment officer, answered that they were "pretty much neutral to mortgage-backeds in the Lehman Aggregate part of the benchmark.''
"How would you characterize our exposure in terms of the subprime lenders?'' Martinez pressed.
"Zero,'' Smith replied.
"Zero?'' Martinez repeated. "Say it so it's recorded.''
"We dodged that bullet,'' interjected Stipanovich, the SBA's executive director. "We'll never get credit for it, but we did dodge that bullet.''
Zero? On that day, records show, the SBA held $929 million of securities issued by Countrywide, the mortgage giant that became the symbol of the subprime debacle.
Dodged that bullet? That day, the SBA held $284.3 million of Washington Mutual, another big subprime lender — until it failed last year.
You weren't warned?
After billions of dollars in securities tanked in 2007, the SBA blamed Wall Street brokers for pushing it into unsuitable investments and credit-rating agencies for not making it aware of the risks.
Gov. Charlie Crist and Chief Financial Officer Alex Sink, both SBA trustees, said they believed firms like JPMorgan Chase and now-defunct Lehman Brothers dumped highly risky securities on Florida and other unsuspecting states.
But documents show that SBA managers were made aware of the risks all along. Before Lombardi's short-term trading desk bought securities, it received confidential memos, e-mails and investor reports from brokers and sponsors that screamed out warnings. Some examples from the reports:
"There is currently no market for the securities.''
"Rating agencies … may not fully reflect the true risks of an investment.''
"The issuer may have insufficient funds to pay the notes as they mature and the holders of the notes may suffer losses.''
"A substantial exposure to nonprime, and in particular subprime, U.S. residential mortgage market may decrease and sales … could … result in losses to investors.''
"The issuer is subject to a potential lack of diversity, illiquidity, interest rate volatility, credit risks associated with the underlying investments, embedded leverage in derivative instruments and other investment risks.''
Take Axon Financial Funding, a complex financial product registered in the Cayman Islands. At least two of Axon's dealers, JPMorgan Chase and Credit Suisse, sent a confidential memo to Lombardi's unit that listed 20 pages of risks, including potential "losses due to defaults'' in mortgages backing the securities.
Lombardi's unit bought Axon anyway, $225 million for Citizens Property Insurance, $425 million for other SBA funds. Citizens took a loss of $111 million. The SBA still has $380 million of Axon; its current value is $176 million.
Freaking out — in private
Aug. 8, 2007: For 48 minutes of a public meeting of the audit committee, Stipanovich trumpeted the SBA's accomplishments.
"We do things in the open,'' he declared. "We're in good shape. … We're a team and we work together.''
Privately, SBA employees and their advisers worked in an alternate universe.
"Now I am freaking out!'' the SBA's Carmen Fisher wrote in an e-mail two days before Stipanovich's reassurances to the audit committee. Fisher, an assistant portfolio manager, had just learned that turmoil in the markets had spread to a security called Luminent. The agency held more than $240 million of it.
As other investments went south, SBA managers met with advisers and held conference calls with lawyers to discuss an "orderly liquidation'' and confidential agreements.
Still, the agency kept its customers in the dark. In late August 2007, Lombardi told an investment banker not to publicize a list that included potentially tainted securities. "This list does need to be shared with discretion, despite our open Sunshine Laws,'' Lombardi said in an e-mail to Tim Smollen.
"Understood, Mike,'' Smollen replied, "info will not go outside our small group.''
Trouble masked by smiles
On Oct. 2, 2007, Gov. Crist and Sink heaped praise on Stipanovich.
"I do want to compliment Coleman …on the performance,'' Sink said. "I just returned from the National Association of State Treasurers, where the treasurer of Connecticut was bemoaning the fact that their retirement fund is funded at all of 80 percent … and it was nice to sit there with a smile on my face.''
Crist chimed in: "We're more blessed than we know in the Sunshine State. …Coleman, how are you doing that, man? What's going on over there?''
"I've got good people,'' Stipanovich replied. "This is why the state of Florida is the envy of the country of public pension funds. … It's because of the leadership we get from the trustees. … We're just, you know, an outstanding organization.''
At that time, the SBA was aware that it held about $2 billion of securities in trouble. But nobody said anything publicly … which is why a Bloomberg News story on Nov. 14 hit like an atomic bomb.
The headline: "Florida Holds $2.2 billion of Debt Cut to Junk Status.''
Crist downplayed the story. "It's always easier to be a Monday morning quarterback,'' he said at the trustees meeting that day. "We all know that.
"But I just want to thank you for your diligence and for your staff's work. And sometimes these things do get blown out and sensationalized, and we have confidence in you.''
The next day, Bloomberg followed up with a story that started with Hal Wilson, the chief financial officer of the four schools in sparsely populated Jefferson County, in the Florida Panhandle.
Wilson told Bloomberg that the county had little investment expertise and was thrilled with how the SBA had managed its $2.7 million.
The story noted what Wilson had not been told: His school district money had been put into securities that contained the risky stuff, what Bloomberg called "some of the most confusing, opaque and illiquid debt investments ever devised.''
Tales of two cities
The stories sparked a rush of withdrawals from the local government investment pool. City and county officials from across Florida called, e-mailed and demanded explanations. The SBA went into damage-control overdrive.
"It has been very crazy around here!'' Carmen Fisher e-mailed to a bank executive. "My boss (Michael Lombardi — mentioned in the article) is fielding calls left and right from the participants in the pool and assuring them that everything is OK.''
But everything was not okay.
As SBA managers frantically tried to prevent a run on their funds, demands for withdrawals kept coming.
Dorothy Zaharako, the financial officer for the city of Stuart, had been asking questions about the SBA's investments for two weeks.
"Right now, we have 100 percent of our excess cash entrusted to your organization,'' she wrote on Nov. 15, 2007. "$26 million, I know, is a small piece of your total holdings (but) … please provide … us with an understandable written explanation.''
No satisfactory response was forthcoming, said Zaharako's deputy, Louis Boglioli.
"In layman's terms, they blew us off … dismissed us as a small fish in the pond,'' Boglioli said. "So we withdrew the money. The next day, the pool was frozen.''
Next door, the city of Port St. Lucie wasn't so lucky. It had $291 million invested in the pool, and the morning Stuart took out its money, Port St. Lucie deposited another $134.3 million, money from a bond deal to pay for water pipes and sewers.
Marcia Dedert, Port St. Lucie's finance director, had second thoughts about the deposit after Bloomberg had another story on Nov. 28, this one headlined: "Florida School Fund Rocked By $8 Billion Pullout.''
That day, Dedert called and left a message for Mike Lombardi, who got back to her after 5 p.m.
"I was told, if they had anything in mortgages, it was good paper and I didn't have to worry,'' Dedert said. "And I was pretty well assured my money was perfectly safe.''
Dedert said Lombardi told her the SBA had a five-point plan to correct the misunderstandings. The next morning, SBA trustees met to discuss the five-point plan. Dedert listened in via the Internet.
"Stipanovich presented the first point, and before he was finished — that's when the governor and the board froze the fund,'' Dedert recalled.
"You can't print what I said,'' Dedert said, referring to profanities. "We started calling the SBA. The mayor was calling. Everybody was telling us to calm down.''
Today Port St. Lucie has about $17.3 million in tainted assets left in the fund and off-limits.
City officials pressed the FBI to investigate what they say was outright deception in the advice Dedert got. Here's how city attorney Roger G. Orr spelled it out in a letter to the FBI:
"The city views the representations, or better stated, the misrepresentations of Mr. Lombardi on the evening of the 28th, were at best in bad faith or worse fraud.''
Dedert said it was for naught, the FBI did not investigate. Lombardi declined comment. Stipanovich, who resigned in December 2007, did not return messages.
High and dry
Remember Hal Wilson, who had told Bloomberg that the Jefferson County School District was thrilled with the SBA?
Now, with the fund frozen, Wilson's four schools were broke. They had no money to pay 220 teachers and staff, to cover food deliveries or to pay for paper and pencils.
On Nov. 29, 2007, Wilson sent the SBA an e-mail. The subject line: "Can you help me?''
"I have supported you guys from the get-go and I never said anything negative to Bloomberg about the pool. I also did not withdraw our money from the pool. Problem is — I have an $850,000 payroll tomorrow and I need the money.
"I phoned in a request for the funds … but no one can tell me whether or not I will get the funds. Can you help me with this? I don't have any funds on hand locally to cover the payroll and if my payroll is going to bounce tomorrow, I need to start a contingency plan now.
Rob Smith wrote back: "Sorry for the late response, I just got back in the office from the board meeting. … Unfortunately, the board took control out of our hands, so there is really nothing I can do. We have relayed your and others plight to the board members but they have re-affirmed that as of now the pool is closed to withdrawals.''
Twenty minutes later, Wilson wrote back to Smith: "Thanks for your help anyway. Bloomberg is sending another crew from New York and L.A. to interview me this weekend. I can assure you I will not be as supportive as I have been. I cannot believe this is happening. What about our innocent employees who can't get paid tomorrow? What do I tell them?''
Jefferson County was one of five school districts that needed to get short-term loans to cover their payrolls. Today, the cash-strapped district has about $164,800 in distressed assets that can't be redeemed.
Wilson says the experience soured him and hastened his retirement. It was "shocking,'' he said, "the worst experience in my 34 years as a finance officer.''
"I remember thinking what a good job they were doing when all the time they were just screwing us over. … We were betrayed by a state agency. …They deceived us. They lied to us. They violated the trust that we placed in them with our taxpayersers' money.''
Every year, Florida helps more than 50,000 blind people live independently. About $2 million for the Division of Blind Services is kept in funds managed by the SBA, including $13,000 in a short-term account.
"We're a small program — a rounding error in the budget,'' said Kurt Ponchak, operations chief at the Division of Blind Services.
In that same pot is money for the prepaid college tuition program as well as money for the McKnight Fellowship Fund, which gives scholarships to minority doctoral students.
In all, the CAMP fund — short for a gobbledygook of a name, the Commingled Asset Management Program Money Market Pool — has about three dozen accounts totaling $290 million.
In July 2008, with the markets tumbling, the SBA sold three securities in the CAMP fund — at a loss of $508,185.
Instead of reporting the loss for that month, the SBA used a stroke of the keyboard to spread the loss over six months, making it appear smaller.
[Note: Ah, those accounting shenanigans are alive and well at public pension funds!]
On Aug. 13, 2008, an SBA manager named Lori McKnight told the agency's inspector general that employees were concerned that the groups with money in the fund were not being told of the losses and that the losses were being minimized by accounting for them across six months.
"She indicated that staff concerns were heightened as a result of criticisms made of the SBA's lack of communications regarding securities downgrades that led to the run on the (local government pool) in November 2007,'' the inspector general wrote in his report.
Top managers overruled the staff. They decided it was not their duty to disclose the accounting change or the losses because they were small. The inspector general agreed.
Until contacted by the Times, several investors said that they didn't know about the July loss. Said Dr. Lawrence Morehouse, who runs the McKnight Fellowship Fund: "It's our money. We should have been told.''
The SBA says it sent the investors a packet of information that July detailing recent changes to the fund. The packet included information about key securities and a cover letter that said that new managers were "actively buying and selling securities.''
What the letter did not say was that sales had resulted in losses.
On the computer, he goes by the screen name buffycat. On Feb. 14, 2009, saying he was relying on his Florida pension to "survive in my retirement years,'' he wrote to the SBA. He asked if any pension money was "invested in subprime mortgage investment vehicles, and other less than stellar investments … and, if so, how much of a loss did the fund sustain?''
"There is no time like the present to provide both the taxpayers and members of the … system with a full financial accounting of the Florida Pension Fund,'' buffycat wrote.
The agency responded to buffycat with a classic example of SBA-speak:
SBA-speak: "The SBA provides detailed information on the FRS pension fund regularly via our Web site www.sbafla.com on a monthly, quarterly, and annual basis.''
What it should have said: The SBA provides outdated and confusing financial data that is over the head of the average person. The last press statement was released four months ago.
SBA-speak: "As with any highly diversified fund, the FRS pension fund was certainly impacted over recent months by the types of investments you described.''
What it should have said: The agency is bleeding like all public pension funds. It has taken a $716 million hit from 100 troubled financial companies and, as of Jan. 30, it stood to lose $473 million on troubled securities. In addition, Citizens Property Insurance, Florida's hurricane catastrophe fund and two pooled funds managed by the SBA have lost at least $484 million.
As of April 16, $727 million in the local government pool remained frozen, and governments could lose $396 million if tainted securities were sold today.
SBA-speak: "Via a link on the Web site, taxpayers and participants can look at the fund's individual 14000+ holdings.''
What it should have said: Through a hidden, broken link, Internet users can look at a list of holdings that is out of date, incomplete and missing information about losses.
SBA spokesman Dennis MacKee says now, "The link we provided … is the most complete listing of securities we had available at the time.''
The broken link was fixed — nearly six weeks after the SBA told buffycat to use it.
I commend Sydney for writing this solid piece of investigative journalism. She took the time to go over a lot of emails and she highlights some serious governance gaps at the Florida's SBA.
This is one reason why I am not a huge proponent of pension consolidation. If you consolidate without first fixing the governance gaps at these large funds, you are just creating a giant disaster that will require another federal bailout down the road.