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Orlando Sentinel (Florida), 7/7, editorial

Doubling down on pensions
Tallahassee gambles, and soaks taxpayers for pensions

Facing big deficits in their public-employee pension systems, some cash-strapped local governments in Florida have come to a politically difficult but mathematically inescapable realization: They must pare back generous benefits for their retirees.

Apparently, such basic math isn't taught in Tallahassee. This year legislators rejected even modest cuts in public-pension benefits, despite a growing shortfall in the $114 billion system that covers about a million employees and retirees.

Instead, they raised taxpayers' funding for the system -- a total of $3.3 billion last year for state and local governments by more than 10 percent.

Now the State Board of Administration, the agency that manages the system, has turned to a different strategy: Florida will gamble its way out of the hole.

Whose idea was this -- Jimmy the Greek's?

Last month the agency won approval from its trustees -- Gov. Charlie Crist, Chief Financial Officer Alex Sink and Attorney General Bill McCollum -- for a plan to triple the system's 5 percent stake in "alternative investments." New investments would include hedge funds, which are more-exotic, less-transparent and less-regulated than stocks or bonds.

While hedge funds may yield higher returns, they are also considered riskier. Yet the agency's executive director, Ash Williams, told the trustees that the new strategy would mean higher returns and lower risk.

Investment experts interviewed by the St. Petersburg Times mocked the notion of expecting lower risk when going after higher returns. "It's an absurd investment scenario," said Edward Siedle, a former federal securities lawyer. As a rule, investments with the potential for higher returns carry higher risk.

Florida's pension system was fully funded for years until lower investment returns, and a jump in payouts, opened a $15 billion shortfall last year between its assets and long-term obligations. The system has plenty of money to keep up with current benefits, but its deficit is expected to reach $23 billion this year and keep growing without changes. State taxpayers are on the hook if funds ever run short.

The system, which includes county and some city workers, along with state employees, has features that most private-sector workers would love to have. Members can retire with full benefits after 30 years, regardless of their age. Retirees get 3 percent cost-of-living increases every year, regardless of inflation.

And unlike public employees in 45 other states, Florida's don't have to contribute a dime to their pensions. In this year's legislative session, a bill died that would have required employees to put up a measly one-quarter of 1 percent of their salaries toward their pensions. So did proposals to raise retirement ages and reduce higher payouts for some employees.

Legislators took one small step, dropping the interest rate on payouts for employees in the DROP early retirement incentive program from 6.5 percent to 3 percent a year. But Mr. Crist vetoed even that change.

Meanwhile, some cities in South Florida with their own pension systems have decided to follow the lead of private employers. They're putting new employees in 401(k)-type plans rather than more-expensive guaranteed plans. Some are upping employee contributions to their pensions, or raising retirement ages.

But inaction in Tallahassee, beyond soaking taxpayers, has left higher investment returns as the only way to boost the balance in the state system. Hence the strategy to double down and get into hedge funds.

Legislators should put the brakes on this plan. They need to stop putting off changes to fix the system for the long term. It's a matter of fiscal responsibility for them, and fairness for taxpayers.

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"The State Board of Administration, which manages many of Florida's public investments, has seen its assets plummet by $62-billion, a third of their value, in the last 13 months." (Freedburg, Sydney & Humburg, Connie, "Florida pension fund plummets," St. Petersburg Times, 1/17/08)

"The decline - the steepest in the agency's 65-year history - reflects both big investment losses in the global financial crisis and the decision by hundreds of local and state agencies to withdraw money from shaky SBA accounts."  (Freedburg, Sydney & Humburg, Connie, "Florida pension fund plummets," St. Petersburg Times, 1/17/08)

St. Petersburg Times, 11/8, Times Wire

Florida pension fund plummets

Florida's public investments lose $62-billion amid stock losses and cash withdrawals.

The State Board of Administration, which manages many of Florida's public investments, has seen its assets plummet by $62-billion, a third of their value, in the last 13 months.

The decline - the steepest in the agency's 65-year history - reflects both big investment losses in the global financial crisis and the decision by hundreds of local and state agencies to withdraw money from shaky SBA accounts.

In both cases, the SBA plowed money into higher-risk investments with the potential for bigger profits. But in the ongoing financial meltdown, they generated big losses instead.

Combined, the investment losses and withdrawals slashed SBA assets from a high of $187.5-billion on Sept. 30, 2007, to $125.4-billion as of Oct. 31.

The SBA manages 34 public funds. The largest is the state's retirement system pension plan for almost 1-million public employees, retirees and their family members.

The SBA also handles investment accounts for the Florida Lottery, the state's hurricane catastrophe fund and a local government investment pool where nearly a thousand counties, cities, school districts and other state and local entities keep surplus cash.

In the last 13 months, the state pension plan lost more than a quarter of its value, or $37.9-billion. It peaked at $138.4-billion on Sept. 30, 2007, and was worth $100.5-billion on Oct. 31.

The local government pool, which was once the largest in the country, shrank by $21.2-billion, from $27.3-billion to $6.1-billion, largely because of withdrawals.

Spokesman Dennis MacKee said all SBA funds are built to survive losses in the market, even severe ones, adding that they will recoup those losses over time.

"We remain confident with the long-term soundness of the funds we manage,'' he said.

MacKee also said the benefits of pension plan participants and retirees are guaranteed by the state. Florida is better off than many states, he said, because its pension plan has more than enough money to cover future retirement benefits.

But that surplus has been declining for the last eight years - not because of poor performance, the state says, but because government employers were allowed to make smaller contributions to the plan.

If the surplus disappears, the Legislature might have to turn to government employers - and taxpayers - to increase contributions to meet benefit obligations.

The SBA, which employs about 160 people, is governed by a three-member board of trustees who also make up a majority of Florida's Cabinet - the governor, the attorney general and the chief financial officer.

Gov. Charlie Crist did not respond to an interview request. Chief Financial Officer Alex Sink was traveling for two days and unavailable, an aide said.

Attorney General Bill McCollum said Florida is "doing pretty well compared to the market overall."

"It's going to have down years and it's going to have up years, and we've had a lot more up years,'' he said. "The overall result of this pension fund is still very good - better than the norm. Will it be lower this year? Yes. But it has still been beating the market.''

Opaque investments

Florida isn't alone. Across the country, the financial crisis is wreaking havoc on public pension funds and investment agencies. The meltdown is spurring a debate over whether those government agencies are gambling too much.

"In the current environment, we should replace the reach for yield with a return to basics,'' said Thomas Tew, a Miami securities lawyer. Earlier this year, he was hired by the Legislature to review the near-collapse of the SBA's local government investment pool. "That means less aggressive investments and less risks.''

Like big banks and mutual funds, the SBA and other public investment agencies are complex financial institutions. But unlike banks and mutual funds, they face no comparable oversight. There is no requirement that they fully disclose their finances, and they don't have to undergo annual, independent audits.

"It's appalling that those whose public pensions are at risk don't have the same disclosure that a retiree who owns mutual funds would have,'' Tew said.

In September, some members of Congress called for more oversight of public and private pension funds after a federal study found more of them were putting money into higher-risk, lightly regulated investments.
Sen. Charles Grassley of Iowa has long raised concerns about opaque investments creeping up in Americans' pension plans, and whether they pose a danger to workers' retirement security.

"We don't have the facts about these swaps and derivatives and hedge funds and whatever they are,'' said Grassley, the top Republican on the Senate Finance Committee. "It's one thing when a $5-million investor buys these investments. It's quite another when it involves pension funds of your average middle-class person.''

Florida's investment problems came to light late last year after reports that the SBA held billions of dollars of securities tied to bundles of loans that included subprime mortgages, which are loans granted to risky borrowers with poor credit histories.

In November 2007 alone, nervous counties, cities and school districts withdrew $12.2-billion from the local government pool.

Citizens Property Insurance, the state-run insurer of homes and condos, pulled more than $5-billion this year and closed several SBA accounts. It still has about $743-million in the local government pool.

The city of St. Petersburg has withdrawn more than $111-million from the local government pool since mid November 2007.

"We won't make any more investments in the SBA until we have assurances that it's as safe an investment as where we have our dollars now,'' said Tish Elston, the city's first deputy mayor.

The SBA "put whole school systems in jeopardy'' when it temporarily froze the account to prevent it from collapsing, said Jackie Pons, superintendent of Leon County school district. He says he had to call a local banker late at night to get a $10-million loan to meet payroll for school employees.

"Everybody's lost confidence in this account and everybody wants their money back,'' he said.

But bank failures of recent months may be changing things.

Take the Hillsborough County Tax Collector's Office. It decided to reinvest with the SBA in June after commercial banks began struggling.

"The SBA started looking good,'' said Scott McAlister, an auditor in the tax office.

The SBA has not acknowledged losses from the subprime mortgage debacle. MacKee said the information was too difficult to get.

But the agency is still holding about $2-billion in troubled securities. That means the tax collector, the pension plan and many state and local agencies that invest with the SBA face losses.

The SBA also has sustained big losses in the stock market.

With more than half of its assets invested in stocks, Florida's state pension plan lost about 15 percent in value, or $23.9-billion, for the year ended Sept. 30. It lost another $14-billion, or an additional 12 percent of value, in October. That decline roughly parallels the performance of other large public pension funds.

The market turmoil wiped out 22 percent of the value of domestic stocks in Florida's pension plan. Foreign stocks dropped 29 percent.
A riskier strategy

One factor in the sharp decline of the SBA's assets appears to be a recent change in its investment strategy.

In the last few years, the SBA - like many other investment agencies around the country - has invested in complicated, sophisticated tools with the potential for dramatically higher gains.

They have names like structured investment vehicles, 130/30 funds, derivatives, credit default swaps and private equity investments, and they are lightly regulated, unpredictable and not routinely reported to the public.

Instead of big payoffs, however, the new tools have apparently produced big losses for the SBA.

The size of the losses are difficult to determine, partly because some of the investments are traded privately and are notoriously hard to value. In addition, the SBA says it doesn't focus on prices of individual assets. Instead, it tracks the entire fund or asset category and compares the performance to established objectives and other large pension funds.

But congressional committees and the Securities and Exchange Commission are now examining the role some of these higher-risk investment tools have played in the global financial turmoil.

The SBA's executive director, Ash Williams, says he, too, plans to review some of the more aggressive strategies.

"When you're talking about investments that are still in process, you don't know where they will end up,'' said Williams, a former Wall Street investment fund manager who recently joined the SBA. "It's sort of like being at a football game in the second quarter. You don't know who won the game because it's not over.''

(Freedburg, Sydney & Humburg, Connie, "Florida pension fund plummets," St. Petersburg Times, 1/17/08)

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St. Petersburg Times (Florida), 9/19, national section, South Pinellas Edition

Risk Won; taxpayers Lost

HIGHLIGHT: State money managers skirted legal advice and gambled on securities that lost hundreds of millions in value.

Three years ago, the state of Florida made bad investments that lost hundreds of millions in value. State leaders blamed the sharks of Wall Street, who they said duped Florida money managers into buying way-too-risky securities.

Chief Financial Officer Alex Sink pushed the state to sue big banks, which she said dumped tainted investments on Florida.

Gov. Charlie Crist demanded a no-holds-barred investigation and named four Wall Street firms that he suspected took advantage of the state.

Attorney General Bill McCollum wondered if there had been fraud and promised help with an investigation.

But no bank was prosecuted, no lawsuit was filed and there was never a full accounting of a financial debacle that could cost Florida governments and taxpayers hundreds of millions of dollars.

Now the St. Petersburg Times has obtained e-mails and internal memos that document a story at odds with the one told by Crist, Sink and McCollum, the elected officials responsible for oversight of the state's money managers.

The securities Wall Street "dumped" on Florida? The records show the state was anything but an innocent dupe; it was an eager partner.

Going back at least seven years, state money managers had been trying to find a way around rules that restricted them from buying certain risky securities. Time and again they asked, time and again lawyers told them no.

But so eager were Florida's money managers for higher yields, they bought them anyway. In two months at the brink of the housing market meltdown in 2007, the state invested at least $9.5 billion in securities it was not authorized to buy, a review of confidential memos shows.

''Florida can't say it got snookered," said Peter Henning, a Wayne State University law professor and securities law expert, when told what the documents said.

"They were chomping at the bit to buy risky securities. ... These weren't lambs being led to the slaughter. They weren't fooled. ... They seemed to go along quite happily."

What happened?

The State Board of Administration invests more than $140 billion of public money, most of it for the state retirement system. It also manages a fund that pools money from hundreds of Florida towns, counties and school districts.

As of June 30, 2007, the local pool totaled $31 billion, making Florida's the country's largest such fund.

But with the collapse of financial markets and revelations of troubled investments, hundreds of the local clients withdrew billions from the pool. Today it holds less than $6 billion.

Beyond the lost dollars, beyond eroding trust in government, the state's perilous investing aggravated already-strained budgets and put holds on construction of schools, roads, sewers and firehouses across the state. It forced school districts to take out loans to pay teachers.

"I would never invest in the SBA again," said Marcia Dedert, finance director of Port St. Lucie, which had to borrow money to finish some roads. "In my mind, they robbed the citizens of my city."

It's hard to calculate the costs of the risky deals that went awry. The SBA refuses to recognize any loss for local governments. The agency says it has made many positive changes and its goal is to make its clients "whole." But if the bad securities were sold today, taxpayers could be out more than $300 million.

Ashbel C. Williams Jr., who replaced the SBA director who presided over the fiasco, said the agency and its employees did not violate federal securities laws.

"There was never any effort to circumvent either the law or our investment guidelines," he said last year in a letter to the U.S. Securities and Exchange Commission, which was investigating Florida's investment mess.

Williams was out of the office last week and unavailable to be interviewed, his spokesman said.

In a statement to the Times on Wednesday, an SBA attorney said money managers always operated under the belief that a legal exemption - different from the one the lawyers focused on - allowed them to buy the unregistered securities.

Crist, Sink and McCollum, responsible for oversight of the SBA, have given no public explanation about what happened.

What did these elected officials know about the agency's repeated efforts to get around the rules? All of them declined to be interviewed.

The lingo

To follow what happened, it helps to speak the language, a mix of acronyms and subsections of obscure rules.

Three are key: the LGIP, Rule 144A and QIBs.

The LGIP. The Local Government Investment Pool. Hundreds of governments and organizations use this short-term investment fund like a money market. They need access to their money in emergencies and count on the LGIP for investments that are safe and easily converted to cash.

Rule 144A. In 1933, after the Great Depression crushed investors and banks, Congress passed the "truth in securities" law to restore public confidence in the markets and protect mom-and-pop investors from fraud.

Sellers had to register with the SEC and disclose the risks. The SEC created exemptions that allowed experienced, wealthy individuals and institutions to trade securities privately.

In 1990, the SEC adopted Rule 144A, which allows sophisticated investors to trade in unregistered securities, which tend to have higher potential returns, higher risk and less disclosure than securities sold on the public market.

QIBs. Rule 144A creates a specific designation that defines a sophisticated investor as a "qualified institutional buyer," or QIB. A QIB usually must own or invest at least $100 million in securities and be on a list of allowed entities, including insurance companies, investment firms and pension funds. Local governments are not on the list.

First try

The newly released documents show that SBA money managers were frustrated that they could not chase higher yields for the local government pool and other funds that were not on the Rule 144A list.

In 2000, senior investment officer Barbara Jarriel wrote to the SBA's general counsel that the federal rule was "restrictive" and "illogical."

Why should an SBA money manager qualified to buy 144A securities for the pension fund not be qualified to buy them for other SBA funds?

In August 2000, Jarriel hired Steven B. Boehm, a partner in the Washington, D.C., office of Sutherland Asbill & Brennan to seek clarification from the SEC. She asked that Boehm leave the SBA's name out of it.

Anthony Barone, an SEC attorney, told Boehm: A money manager who buys unregistered securities for a fund that is a qualified institutional buyer is not allowed to buy them for a fund that is not a qualified institutional buyer.

"We read very strictly Rule 144A and what entities qualify as qualified institutions or buyers," Barone told Boehm.

Boehm, himself a former SEC lawyer, relayed the answer to Jarriel and told her the same: Local governments are not QIBs.

That meant the SBA could not certify itself as a QIB to buy unregistered securities on its behalf.

Boehm suggested a solution: The SBA could push for a change in the federal rule.
Jarriel said she didn't have the resources or the time for that.

Second try

Less than a year later, in May 2001, SBA assistant general counsel Ray Petty again hired Boehm's law firm. The SBA wanted Boehm to ask the SEC if the state could gain QIB status partly by relying on another federal rule that defined an ''accredited investor."

It ''uses almost identical language to the QIB definition," Petty said.

The SBA wanted a "no action letter," which a person or entity commonly files to get the SEC's assurance that it won't recommend civil or criminal action.

The SEC, however, did not grant Florida's request for no action.

Third try

At least as far back as July 2002, the SBA's own policy did not allow the purchase of Rule 144A securities for the local pool.

As the housing bubble inflated, Wall Street relied more on Rule 144A products, including mortgage-backed securities. In good times they were a money machine - for the investment firms that sold them and the investors who bought them.

In February 2007, Mike Lombardi, the head of short-term investments for the SBA, again raised the Rule 144A issue. Lombardi wrote deputy executive director Kevin SigRist that Florida seemed behind.

"I have spoken to various plans and (local government investment pools) across the country that simply declared themselves QIBs and operated as such," Lombardi wrote. "Fraught with QIB envy, can you ask our legal staff to revisit Rule 144A?"

SigRist asked and on March 15, 2007, assistant general counsel Maureen Hazen replied: "SBA staff spent a lot of time and about $20,000 on this issue back in 2000-2001 with no true finality. ... I would like to meet with you at your convenience to discuss the law and history of the issue and what, if any, next step you would like to take."

That next step

The next day, a portfolio manager in Lombardi's unit was contemplating the purchase of a risky 144A security called Axon Financial Funding.

"I was just wondering if you had an update on when Axon is expecting to launch," Carmen Fisher wrote to a contact at Credit Suisse, a financial services company.

Axon's offering documents stated that the purchaser must be a qualified institutional buyer under Rule 144A. Multiple lawyers had said the LGIP was not a QIB, and the SBA's own guidelines also precluded an investment.

On April 4, 2007, the SBA bought $90 million of Axon for the local government pool.

On April 6, Lombardi talked to a Wall Street colleague who worked for the credit rating agency Standard & Poor's. Lombardi asked if he knew of local government pools that were certified as QIBs.

He'd not gotten an answer by April 25, when assistant portfolio manager Mary Barry e-mailed her SBA colleagues about a new product called Ottimo, Italian for excellent.

Ottimo's offering documents stated that the purchaser had to be a qualified institutional buyer under Rule 144A.

On May 3, the SBA bought $134 million of Ottimo for the local government pool, which was not eligible to buy those securities.

Ottimo and Axon matured with good return on investment - that time.

Fourth try

The same day the SBA bought securities it was not qualified to buy, Lombardi e-mailed SigRist about a way around the QIB requirement.

Lombardi said the local government pool met the standard of a "qualified purchaser" under a subsection of the Investment Company Act of 1940.

"This particular section is one of the policies used frequently by hedge fund companies to avoid certain SEC requirements," Lombardi wrote.

The problem: Some unregistered securities required that buyers be not only "qualified purchasers," they had to be qualified institutional buyers.

On June 14, 2007, Lombardi again wrote his colleague at Standard & Poor's. "Were you able to pursue the QIB issue? The question repeatedly comes up from different people throughout my organization."

In another e-mail, Lombardi acknowledged that he didn't think the local government fund was a qualified institutional buyer. Of the "laundry list" of types of QIBs, Lombardi wrote his colleague, the "closest" category was "any plan established and maintained by a state ... for the benefit of its employees."

"But that refers to employee benefit plans," Lombardi wrote. "Nowhere is there a state or municipal fund used for non-pension assets."

"(Local government pools) that consider themselves a QIB are reaching," he wrote.
"It certainly would make my life easier if the SEC would address this issue, but they have refused to do so in the past."

Burned

By July 2007, many sophisticated investors worried about subprime mortgages had stopped buying mortgage-related products. The SBA, however, remained in overdrive.

In July and August 2007, with the market for mortgage-backed investments drying up and their value starting to drop, SBA money managers, without proper certification, bought at least $9.5 billion of securities for the local pool, records show. Most matured with good returns.

But the good run was about to end. Over the next few months more than $2 billion in securities the SBA bought for the local pool and other funds were downgraded by credit-rating agencies or lost much of their value.

Many local governments found out about the troubled investments on Nov. 14, 2007, when Bloomberg News reported that some of them had been downgraded to junk status.

In one of the biggest bank runs since the Great Depression, panicked city, county and school officials pulled about $13 billion from the pool. Crist, Sink and McCollum froze the fund.

On Dec. 21, 2007, in a conference call with SBA managers, federal securities investigators requested the names and account numbers of qualified institutional buyers.

That same day, SBA managers revised the agency policy that barred the local pool from purchasing 144A securities. The agency changed the words ''restricted from purchasing" to ''generally restricted."

In February 2008, federal regulators asked the SBA for documents relating to Axon, Ottimo and eight other securities. They also sought background information about the state's money managers and "all documents related to ... the (local pool's) ability to acquire Rule 144A securities ... and status as a qualified purchaser or qualified institutional buyer."

In April 2008, an audit commissioned by the SBA documented that Florida did not meet the qualified institutional buyer requirement in about one-third of the securities purchases that the auditors examined in the local pool and two other funds. The audit found 168 questionable purchases of Rule 144A securities.

The audit found a troubling combination: weak internal controls and a lack of external oversight by the trustees - Crist, Sink and McCollum.

The auditors said they were not hired to do a criminal investigation, and it was ''outside the scope" to determine if the problems were the result of fraud or illegal acts.

Misled?

Sink said Lehman Brothers and JPMorgan Chase might have offloaded tainted securities on Florida and other states to keep them off their balance sheets.

In March 2008, she called a news conference to unveil 10 proposed reforms of the SBA. No. 1: determine if Florida has a lawsuit against Wall Street.

"The people of Florida deserve to know if there was wrongdoing with the sale of these investments to the LGIP," she said. ''If so, we must hold those companies that sold the investments accountable."

Echoing Sink, Crist said: ''I think it reeks."

The governor said Florida may have been ''taken advantage of" and singled out four firms - Lehman, JPMorgan, Credit Suisse and an affiliate of Kohlberg Kravis Roberts & Co. - that might have ''dumped" investments on the state.

"Who knows," he said, "there could have been fraud involved in that."

At a meeting of the SBA trustees in April 2008, McCollum promised his office's assistance in an investigation. "I think there were judgments and controls that weren't appropriate, and we could have done better around the margins," he 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."

In May 2008, the SBA announced it had a legal case against Wall Street for peddling unregistered securities and a lawsuit could be ''imminent." Instead, the agency extended the deadline for going to court.

In July 2008, the SEC ordered a full-scale fraud investigation, not only of the three banks that sold the tainted securities but also of Florida's SBA.

SEC investigators came to Tallahassee that October to take testimony from four SBA managers.

In January 2009, the SBA filed a $682 million claim in bankruptcy court against Lehman Brothers, which sold the state a big chunk of the troubled securities.

The SBA made many of the bad purchases around the time Lehman hired former Gov. Jeb Bush as a consultant. Bush has said he played no role in the sale of securities to the SBA.
In April 2009, the SEC subpoenaed documents relating to complaints by local governments about the SBA's management and investment strategy for the local pool.

More than a year after the federal regulators started their formal fraud investigation, the public found out about it from the newspaper.

Williams, the SBA director, chastised the Times for reporting old news. "We have no indication whatsoever from the ... SEC that they are looking at fraud at the SBA," he said.

The newly released documents show that just the day before, Williams sent a five-page letter to the SEC in which he said that "neither the SBA nor any of its employees engaged in any violations of the federal securities laws."

He wrote that his staff had made "every effort" to gain and follow "expert advice and guidance" on buying securities, and the SBA thought it was eligible to buy everything it bought.

Williams urged federal regulators to close their investigation and "publicly remove this cloud."

Four months later, they did. In a one-paragraph letter March 3, 2010, Eric R. Busto, an assistant director of the SEC'S Miami office, said the agency was ending its investigation into the SBA with no enforcement action.

He included an SEC statement that said the termination letter "must in no way be construed as indicating that the party has been exonerated or that no action may ultimately result from the staff's investigation of that particular matter."

Crist, Sink and McCollum praised Williams. Said McCollum:

"Sounds like we were cleared to me."

Duped?

Michael J. Pucillo, an attorney representing the SBA, said in a statement to the Times on Wednesday that the agency did not ignore its own lawyer's advice. To buy the securities, he said state money managers relied on a different exemption, which allows purchases directly from firms that issue securities.

Pucillo said the SBA traders got assurances from various brokers that the state was purchasing directly and had a legal exemption. But those brokers gave incorrect information, Pucillo said, adding that the SBA never would have made the buys had the banks given accurate information.

"The only liability for selling these securities to the SBA without an exemption rests with the seller," he said.

Pucillo also said the SBA did not ease its guidelines for purchasing Rule 144A securities to "justify prior conduct or in response to an SEC inquiry."

Three former securities regulators and a nationally known expert said the investment misfortune may be a case of ''unclean hands" - the legal doctrine that a party in a lawsuit who has done wrong should not recover from another who may have done wrong as well.

Adam Pritchard, a University of Michigan Law School professor, said Florida's explanation of how it purchased the securities is plausible, but if the state sued, the banks might argue, "You knowingly participated in the violation of these rules, and you did it because you thought the rules didn't make sense, and now you're trying to get out of these transactions."

James D. Cox, a Duke Law School professor, said it's odd that state money managers went out on a limb.

"It's one thing for Wall Street to go down dark alleys and through speed traps when they're not satisfied with the securities laws," Cox said. "But it's another thing to find government blowing through the securities law with the same belief as Wall Street."

Jack Kiefner, a St. Petersburg securities lawyer, reviewed documents obtained by the Times. He said they show the SBA asked the same questions over and over, refused to take no for an answer, tried to come at it from different directions and relied on technical arguments to buy highly risky products it should never have bought.

"The state merely decided to knowingly circumvent these rules because it apparently believed the hype of Wall Street that these products were as safe as the gold in Fort Knox and the products paid premium rates. Time has proven the truth.

"Why would the state so desperately want to find a way or mechanism to avoid the protection that securities laws were intended to provide?"

- - -

The local pool has been renamed Florida Prime and is managed now by an outside investment adviser. The SBA says the pool has removed about 80 percent of its bad holdings, tightened investment guidelines and secured a top rating from Standard & Poor's.

Williams concluded: "Clearly lessons have been learned, behaviors changed and investment policies and processes improved."

The SBA gives managers incentives of up to 8 percent of their salaries if they increase returns for the state's pension fund. The SBA said the plan is not related to the local pool and does not encourage "excessive risk taking."

Though steadfast in saying the SBA did not knowingly do anything wrong in the blowup of the local government pool, Williams said three men still with the agency were held accountable: SigRist, Lombardi and his boss, Rob Smith.

How were they punished? They had their bonuses withheld that year.

Computer assisted reporting specialist Connie Humburg, staff writer Kris Hundley and researchers Shirl Kennedy and Carolyn Edds contributed to this report.

* * *

$9.5 billion Securities state money managers purchased that they were not authorized to buy
$160 million Loss to taxpayers, if sold today, of two securities that managers were not authorized to buy

* * *

Questions stay unanswered

None of the three elected officials responsible for oversight of the State Board of Administration or its executive director agreed to be interviewed. The St. Petersburg Times submitted written questions, which none of the elected officials answered. Instead, each issued a brief statement.

Here are two of the questions they chose not to answer, followed by their statements.

QUESTION 1: Without proper federal certification, the SBA bought billions of dollars of prohibited securities for local governments in 2007. ...

Did you know about these prohibited investments and the scope of the unauthorized trading? If you knew, how do you justify making investments that violated the rules? If you didn't know, why not?

QUESTION 2: You and others blamed Wall Street, saying the bad securities were "dumped'' on Florida or some companies doing business with the SBA may have committed fraud. ...

Did you know the SBA had been told repeatedly it was not qualified to buy securities for local governments like those that went bad - but the agency went ahead and bought them anyway?

Gov. Charlie Crist Spokesman Sterling Ivey wrote: "I understand that you have been provided a letter from the attorney representing the SBA and due to the ongoing litigation surrounding the LGIP (Local Government Investment Pool) issue, it is not appropriate for the Governor to comment directly at this time.''

Chief Financial Officer Alex Sink

Communications director Jerri Franz wrote: "It's important to point out again that Trustees are not involved in the day-to-day investment process of the SBA. I understand that you have been provided a letter from the attorney representing the SBA that outlines the state's position and it is not appropriate for the CFO to comment directly at this time.

"... CFO Sink led the process in 2007 to immediately mitigate the damages to LGIP participants by taking appropriate action to temporarily suspend withdrawals and hire an experienced, independent financial firm to develop a plan of action with the input of the pool's investors. The LGIP today benefits from stronger oversight, transparency and accountability as led by CFO Sink.''

Attorney General Bill McCollum

Communications director Ryan Wiggins wrote: "As it relates to the broker dealers, we are assisting the OFR (Office of Financial Regulation) in their investigation and it would be inappropriate for us to discuss any further.''

The SBA

Spokesman Dennis MacKee said executive director Ashbel C. Williams Jr. was out of the office and unavailable to be interviewed. Attorney Michael Pucillo sent a two-page statement that is available, along with other documents, at links.tampabay.com

* * *

Not qualified, and down $62 million

As the housing bubble burst in 2007 and investments tied to real estate plummeted, state money managers bought mortgage-related securities they were not qualified to buy. Here's how one such deal unfolded, with local governments losing on paper about one-third of their $175 million investment.

Feb. 21, 2007: Mike Lombardi, director of short-term investments, asks his boss and the SBA's legal staff to revisit the finding that the Local Government Investment Pool is not a qualified institutional buyer and therefore not eligible to purchase many Rule 144A securities.

March 2, 2007: JPMorgan Chase sends the SBA a confidential offering memo for Axon Financial Funding, a structured credit product incorporated in the Cayman Islands. The memo says Axon is an unregistered product; purchasers are required to meet the federal definition of qualified institutional buyer. The local pool does not meet that requirement.

March 16, 2007: An assistant of Lombardi's contemplates the purchase of Axon.

June 15, 2007: Lombardi acknowledges to a Wall Street colleague that the local pool does not meet SEC requirements of a qualified institutional buyer.

July 27, 2007: Lombardi buys $175 million of Axon from JPMorgan Chase.

Sept. 13-17: Wall Street puts Axon on credit "watch.''

Oct. 23, 2007: Axon credit rating falls below state guidelines.

Nov. 27, 2007: Axon defaults

June 8, 2010: Axon renamed Florida Funding II. Local governments stand to lose $62 million of their original $175 million investment.

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"The State Board of Administration, which manages many of Florida's public investments, has seen its assets plummet by $62-billion, a third of their value, in the last 13 months." (Freedburg, Sydney & Humburg, Connie, "Florida pension fund plummets," St. Petersburg Times, 1/17/08)

"The decline - the steepest in the agency's 65-year history - reflects both big investment losses in the global financial crisis and the decision by hundreds of local and state agencies to withdraw money from shaky SBA accounts."  (Freedburg, Sydney & Humburg, Connie, "Florida pension fund plummets," St. Petersburg Times, 1/17/08)

St. Petersburg Times, 11/16/08

Florida pension fund plummets; Florida's public investments lose $62-billion amid stock losses and cash withdrawals

The State Board of Administration, which manages many of Florida's public investments, has seen its assets plummet by $62-billion, a third of their value, in the last 13 months.

The decline - the steepest in the agency's 65-year history - reflects both big investment losses in the global financial crisis and the decision by hundreds of local and state agencies to withdraw money from shaky SBA accounts.

In both cases, the SBA plowed money into higher-risk investments with the potential for bigger profits. But in the ongoing financial meltdown, they generated big losses instead.
Combined, the investment losses and withdrawals slashed SBA assets from a high of $187.5-billion on Sept. 30, 2007, to $125.4-billion as of Oct. 31.

The SBA manages 34 public funds. The largest is the state's retirement system pension plan for almost 1-million public employees, retirees and their family members.

The SBA also handles investment accounts for the Florida Lottery, the state's hurricane catastrophe fund and a local government investment pool where nearly a thousand counties, cities, school districts and other state and local entities keep surplus cash.

In the last 13 months, the state pension plan lost more than a quarter of its value, or $37.9-billion. It peaked at $138.4-billion on Sept. 30, 2007, and was worth $100.5-billion on Oct. 31.

The local government pool, which was once the largest in the country, shrank by $21.2-billion, from $27.3-billion to $6.1-billion, largely because of withdrawals.

Spokesman Dennis MacKee said all SBA funds are built to survive losses in the market, even severe ones, adding that they will recoup those losses over time. "We remain confident with the long-term soundness of the funds we manage,'' he said.

MacKee also said the benefits of pension plan participants and retirees are guaranteed by the state. Florida is better off than many states, he said, because its pension plan has more than enough money to cover future retirement benefits.

But that surplus has been declining for the last eight years - not because of poor performance, the state says, but because government employers were allowed to make smaller contributions to the plan.

If the surplus disappears, the Legislature might have to turn to government employers - and taxpayers - to increase contributions to meet benefit obligations.

The SBA, which employs about 160 people, is governed by a three-member board of trustees who also make up a majority of Florida's Cabinet - the governor, the attorney general and the chief financial officer.

Gov. Charlie Crist did not respond to an interview request. Chief Financial Officer Alex Sink was traveling for two days and unavailable, an aide said.

Attorney General Bill McCollum said Florida is "doing pretty well compared to the market overall."

"It's going to have down years and it's going to have up years, and we've had a lot more up years,'' he said. "The overall result of this pension fund is still very good - better than the norm. Will it be lower this year? Yes. But it has still been beating the market.''
Opaque investments

Florida isn't alone. Across the country, the financial crisis is wreaking havoc on public pension funds and investment agencies. The meltdown is spurring a debate over whether those government agencies are gambling too much.

"In the current environment, we should replace the reach for yield with a return to basics,'' said Thomas Tew, a Miami securities lawyer. Earlier this year, he was hired by the Legislature to review the near-collapse of the SBA's local government investment pool. "That means less aggressive investments and less risks.''

Like big banks and mutual funds, the SBA and other public investment agencies are complex financial institutions. But unlike banks and mutual funds, they face no comparable oversight. There is no requirement that they fully disclose their finances, and they don't have to undergo annual, independent audits.

"It's appalling that those whose public pensions are at risk don't have the same disclosure that a retiree who owns mutual funds would have,'' Tew said.

In September, some members of Congress called for more oversight of public and private pension funds after a federal study found more of them were putting money into higher-risk, lightly regulated investments.

Sen. Charles Grassley of Iowa has long raised concerns about opaque investments creeping up in Americans' pension plans, and whether they pose a danger to workers' retirement security.

"We don't have the facts about these swaps and derivatives and hedge funds and whatever they are,'' said Grassley, the top Republican on the Senate Finance Committee. "It's one thing when a $5-million investor buys these investments. It's quite another when it involves pension funds of your average middle-class person.''

Florida's investment problems came to light late last year after reports that the SBA held billions of dollars of securities tied to bundles of loans that included subprime mortgages, which are loans granted to risky borrowers with poor credit histories.

In November 2007 alone, nervous counties, cities and school districts withdrew $12.2-billion from the local government pool.

Citizens Property Insurance, the state-run insurer of homes and condos, pulled more than $5-billion this year and closed several SBA accounts. It still has about $743-million in the local government pool.

The city of St. Petersburg has withdrawn more than $111-million from the local government pool since mid November 2007.

"We won't make any more investments in the SBA until we have assurances that it's as safe an investment as where we have our dollars now,'' said Tish Elston, the city's first deputy mayor.

The SBA "put whole school systems in jeopardy'' when it temporarily froze the account to prevent it from collapsing, said Jackie Pons, superintendent of Leon County school district. He says he had to call a local banker late at night to get a $10-million loan to meet payroll for school employees.

"Everybody's lost confidence in this account and everybody wants their money back,'' he said.

But bank failures of recent months may be changing things.

Take the Hillsborough County Tax Collector's Office. It decided to reinvest with the SBA in June after commercial banks began struggling.

"The SBA started looking good,'' said Scott McAlister, an auditor in the tax office.

The SBA has not acknowledged losses from the subprime mortgage debacle. MacKee said the information was too difficult to get.

But the agency is still holding about $2-billion in troubled securities. That means the tax collector, the pension plan and many state and local agencies that invest with the SBA face losses.

The SBA also has sustained big losses in the stock market.
'
With more than half of its assets invested in stocks, Florida's state pension plan lost about 15 percent in value, or $23.9-billion, for the year ended Sept. 30. It lost another $14-billion, or an additional 12 percent of value, in October. That decline roughly parallels the performance of other large public pension funds.

The market turmoil wiped out 22 percent of the value of domestic stocks in Florida's pension plan. Foreign stocks dropped 29 percent.
A riskier strategy

One factor in the sharp decline of the SBA's assets appears to be a recent change in its investment strategy.

In the last few years, the SBA - like many other investment agencies around the country - has invested in complicated, sophisticated tools with the potential for dramatically higher gains.

They have names like structured investment vehicles, 130/30 funds, derivatives, credit default swaps and private equity investments, and they are lightly regulated, unpredictable and not routinely reported to the public.
Instead of big payoffs, however, the new tools have apparently produced big losses for the SBA.

The size of the losses are difficult to determine, partly because some of the investments are traded privately and are notoriously hard to value. In addition, the SBA says it doesn't focus on prices of individual assets. Instead, it tracks the entire fund or asset category and compares the performance to established objectives and other large pension funds.

But congressional committees and the Securities and Exchange Commission are now examining the role some of these higher-risk investment tools have played in the global financial turmoil.

The SBA's executive director, Ash Williams, says he, too, plans to review some of the more aggressive strategies.

"When you're talking about investments that are still in process, you don't know where they will end up,'' said Williams, a former Wall Street investment fund manager who recently joined the SBA. "It's sort of like being at a football game in the second quarter. You don't know who won the game because it's not over.''

(Freedburg, Sydney & Humburg, Connie, "Florida pension fund plummets," St. Petersburg Times, 1/17/08)

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St. Petersburg Times (Editorial), 9/24

Full accounting needed at State Board of Administration

It's possible the Florida State Board of Administration wasn't fully informed by Wall Street brokers three years ago when it cavalierly bought exotic mortgage-related securities just weeks before the credit markets crashed. But newly disclosed e-mails and internal documents show SBA staff members were just as eager to buy the securities as Wall Street was to sell. It was a reckless pursuit of higher returns that disregarded federal regulations, and those SBA staffers involved should have been fired.

The latest revelations cast a far different light on the official version of events offered by the SBA after the securities were given junk status in late 2007, prompting local governments to make a run on the SBA's Local Government Investment Pool. It suggests that SBA trustees - Gov. Charlie Crist, Attorney General Bill McCollum and Chief Financial Officer Alex Sink - either are clueless regarding the facts or are shamefully willing to misrepresent them. Once again the agency, which invests about $140 billion in government assets, has broken faith with Floridians.

St. Petersburg Times' Sydney Freedberg reported this week that SBA money managers sought for years to circumvent decades-old federal regulation [http://www.tampabay.com/specials/2010/reports/florida-state-board-of-administration-pensions] specifically aimed at protecting less-sophisticated investors, such as local municipalities or school boards, from dabbling in risky, unregistered securities.

In 2007, the principal manager of the LGIP, Mike Lombardi, raised the issue again. He repeatedly sought to have the LGIP declared a "qualified institutional buyer" so he could invest its money in mortgage-related securities as he did for the state's pension account.

SBA managers never succeeded in changing the LGIP's classification. Yet Lombardi still invested hundreds of millions of dollars of the LGIP's assets, then $31 billion, in unregistered securities. By November 2007, many of the investments tied to the mortgage industry had been downgraded to junk status, prompting local governments to withdraw $13 billion before the trustees froze the fund.

When an outside consultant months later noted that such buys had violated federal rules as well as the agency's guidelines, the SBA claimed that they were legal under another federal code that would allow the LGIP to purchase the securities as long as they were buying from a "primary issuer." At best, that is exploiting a loophole - and some purchases didn't even qualify under that scenario.

There have been changes at the SBA since this debacle. Executive director Coleman Stipanovich quit under fire. New executive director Ash Williams insists internal controls have been tightened. The Local Government Investment Pool, now called Florida Prime, has moved to an outside money manger, tightened investment guidelines and secured a top rating from Standard & Poor's.

Trustees Crist, McCollum and Sink now meet four times a year solely to discuss the SBA and its operations in public. But that is inadequate for an agency that manages investments totaling nearly twice the state's annual budget. Crist and McCollum have summarily rejected Sink's prudent proposal to expand the SBA board of trustees to include individuals with financial backgrounds who would have more time than busy, statewide elected officials to run herd on the agency.

Besides Stipanovich, no one at SBA has been held to account. Lombardi and his two superiors forfeited annual bonuses but remain in their well-paying posts in Tallahassee. They should have been fired.

National embarrassment may succeed where old-fashioned accountability hasn't. Just this week, Congress' Financial Crisis Inquiry Commission sought documents aimed at understanding the forces at play when the SBA bought the tainted securities. That should force Crist, McCollum and Sink to provide a full public explanation of what happened inside the SBA in 2007 rather than place all of the blame on Wall Street. Such accounting is long overdue to the people of Florida.

 

 

 

 

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