A few net economic losses in bond investments by the Arkansas treasurer’s office didn’t alarm legislative auditors as much as the lack of documented reasons for selling bonds before they matured, one auditor said Tuesday.
In a special report last year, the state Legislative Audit Division questioned the treasurer’s office decision to abandon its long-standing policy of holding bonds to maturity and prohibiting speculation on future rates of return.
That audit prompted a federal investigation and led last week to the resignation of Martha Shoffner from the treasurer’s post she had held for six years. Shoffner quit her elected position after her May 18 arrest by federal agents on a charge of extortion.
It’s not illegal to sell bonds early, Deputy Legislative Auditor Jon Moore said Tuesday, but when the treasurer’s office changed its policy, “it’s common sense that there would be some sort of analysis when you sell these[bonds], what they were [scheduled] to earn.
“We could find no evidence of that analysis,” Moore said. “So that was a real big red flag to us.”
In a criminal complaint made public after Shoffner’s arrest, the FBI alleged that she received six payments of $6,000 each from one broker, who became a confidential source to the FBI. The broker was given immunity for cooperating in the case.
The largest net economic loss on a single bond acquired by the state was $788,239 on a $25 million bond bought through St. Bernard Financial Services of Russellville in July 2008, the Legislative Audit Division reported in December. The bond was guaranteed to pay 4.25 percent interest if kept through June 2013.
But St. Bernard sold the bond on Jan. 22, 2010, and kept funds in a money-market account for 79 days, earning much less than half a percent annual interest, according to the audit division’s special report.
The rate of interest on the next bond St. Bernard acquired for the state was only 2 percent initially, 2.25 percentage points less than the original bond paid, the report said.
St. Bernard never noted the decrease in earnings, which is not the correct practice under generally accepted accounting procedures, Moore said.
Robert Keenan, chief executive officer for St. Bernard, insists there was a profit of about $1.7 million on the sale of the original bond. And the firm provided documentation to the treasurer in the form of summaries of the accounts and a spreadsheet of the activity on the bonds, Keenan said.
After selling the $25 million bond, the bond that was bought next was a step-up bond with a beginning interest rate of 2 percent and a five-year maturity, Keenan said. The bond was scheduled to step up the interest rate at regular intervals to gradually higher interest rates.
If it had been kept until the June 2013 maturity date of the original bond, the second bond would have earned about $590,000 more than the original bond, including the interest earned before the first bond was sold, Keenan said.
Instead, the issuer of the second bond called it - or bought it back before maturity. That left the totals of the first and second bonds earning about $2.7 million, or about $788,000 less than would have been earned if the original bond had never been sold, according to the audit.
The Legislative Audit Division was looking at the overall transactions with the luxury of hindsight, Keenan said.
“It was a good sale that they twisted around and made look like it was a loss,” Keenan said.
Moore acknowledges that there was a $1.67 million profit on the sale of the first bond, but argues that had it been held to maturity, it would have made almost $3.5 million.
Under normal circumstances, a broker would document the reasons for selling a bond before it had matured, Moore said.
“If they miscalculated on what they thought subsequent interest earnings were going to be - if they thought, for instance, that they were going to go way up and would free the stream of income for greater earnings - that would have been one thing,” Moore said. “But there was no evidence of that.”
Bond prices move higher as interest rates fall and fall when interest rates rise.
St. Bernard wasn’t the only firm that failed to provide documentation outlining reasons for selling bonds, Moore said. None of the others handling bonds for the state did either, he said. Those firms include Bank of Oklahoma, Crews &Associates, Delta Trust Investments and Morgan Keegan.
The investment portfolio overseen by the Arkansas treasurer’s office had grown from $2.22 billion when Shoffner took office in January 2007 to almost $2.64 billion when she resigned last week, an office spokesman said last week.
But it is inaccurate to assume that the investments have had a return of almost 19 percent over the six-year period, said Andy Terry, chairman of the department of economics and finance at the University of Arkansas at Little Rock.
“They could have just added [funds] to the portfolio,” Terry said. “A four- or five-year bond will go up in price when [interest] rates go down, but I wouldn’t expect that kind of capital gains.”
To analyze the performance of the portfolio would take significant research into every transaction made over the six years, Moore said.
Front Section, Pages 1 on 05/29/2013