Treasurer's Investment Strategy Was Excessively Risky and Violated the Public Trust
- Violated the basic principles of prudent investing.
- Made investments that were unsafe, highly risky, and extremely volatile.
- Leveraged the portfolio more than 2.7 times and invested more than 40 percent in inverse floaters and other structured securities.
- Violated his trust responsibilities by altering accounting records and misallocating earnings and losses.
The Orange County (county) treasurer is responsible for receiving
and keeping safe all funds belonging to the county and other monies
deposited with the treasurer. However, we found that the former
treasurer pursued an investment strategy that violated the basic
principles of prudent investing, which are safety, liquidity,
and yield, in that order. In fact, his investment strategies were
diametrically opposed to these principles. The former treasurer's
investments were unsafe, highly risky, and extremely volatile,
and they lacked the liquidity needed to meet the portfolio's objectives.
Further, he sacrificed safety and liquidity in a failed strategy
to capture higher yields. The former treasurer did this by leveraging
the portfolio more than 2.7 times and purchasing highly volatile
inverse floaters and other structured securities that comprised
more than 40 percent of his investments.
According to our investment consultants, the former treasurer's
investment practices were inappropriate for the county's short-term
investment pool and exposed the pool participants to unnecessary
risks. As a result of the former treasurer's imprudent and reckless
investment strategies, the county and other participants in the
treasurer's portfolio incurred losses of $1.69 billion, which
caused the county's bankruptcy. Ultimately, these losses will
have far-reaching effects, including the loss of jobs and the
reduction of critical local government services.
Furthermore, we found the following:
- The former treasurer violated his trust responsibilities to
participants in the investment pool. When the county and other
public entities deposit their funds into the county treasury,
a trust relationship is established between the treasurer and
- The treasurer's office altered county accounting records for
investment pool interest earnings. As a result, the county's general
fund received approximately $93 million more interest earnings
than it was entitled to receive from the investment portfolio;
- The treasurer's office inappropriately transferred securities
from the county's specific investment account. At the time of
the transfers, the county's securities had accumulated a $271
million loss that was shared by all pool participants;
- Eight of the 14 brokerage firms that we surveyed reported
that they had revenues of at least $21.3 million in 1994 and $46.3
million in 1993 from financial transactions with the county. The
remaining 6 did not provide compensation information. Further,
we believe that most of the firms did not disclose all their compensation
earned on investment transactions with the county; and
- The county estimated that approximately $23.7 million will
be spent for bankruptcy-related costs through June 30, 1995. The
county retained ten firms to provide various services, including
legal services for the bankruptcy, litigation services, and advisory
To improve the operations of the Orange County treasurer's office,
we recommend that the board of supervisors direct the treasurer's
office to prepare a comprehensive investment policy. In part,
the policy should do the following:
- Establish guidelines to achieve safety, liquidity, and yield
while diversifying the portfolio, preserving capital, and maintaining
- Limit the use of reverse repurchase agreements and ensure
that they are in accordance with existing statutes and restrict
the purchase of derivatives and other structured instruments;
- Specify authority and accountability over investment practices
by defining prudence and detailing fiduciary responsibilities
for the treasurer;
- Require a competitive bidding process for brokers and dealers;
- Create an investment advisory committee independent of the
treasurer's office; and
- Require the treasurer to report, at least quarterly, on the
investment activities and holdings to the board of supervisors,
the advisory committee, and pool participants.
In addition, we recommend that the board of supervisors establish
strict rules regarding ethics, conflict of interest, and asset
safekeeping for all the county's investment activities, and adopt
and approve the treasurer's comprehensive investment policies.
Furthermore, the board should rectify the inequities caused by
inappropriate interest allocations and the transfer of the county's
losses to other pool participants and ensure that future allocations
of interest earnings are accurate. Finally, the board should restore
the $73 million to the Teeter Plan taxable note repayment fund
that was inappropriately transferred to the county's general fund.
To improve the investment practices of local governments, we recommend
that the Legislature amend the California Government Code. A few
of our key recommendations are to:
- Require written investment policies for all local governing
bodies to ensure that safety and liquidity are paramount to yield;
- Limit the use of reverse repurchase agreements to 20 percent
of the portfolio and only for specified purposes, and restrict
the purchase of derivatives or other structured instruments;
- Establish and define a prudent person rule for local investment
- Require investment reports, at least quarterly, to the governing
body and investment participants; and
- Prohibit the issuance of taxable or nontaxable debt for speculation
or risk arbitrage investment purposes.
In its response, the county states that it generally concurs with
the findings and recommendations and discusses the actions that
have already been taken to address the deficiencies. However,
the county's auditor-controller disagrees with the appendix to
the report concerning the transfer of restricted funds. The county
states that its staff is researching this and will advise us of
the outcome later.