MOORLACH UPDATE — LOOK BACKS — Journal Of Accountancy — March 1, 2010

FIVE-YEAR LOOK BACKS

March 1

1995

I guess there is no other higher achievement for a Certified Public Accountant than to be mentioned in the Journal of Accountancy, with photo!  Better yet, this would not be my only time.  It’s such a big deal to be mentioned in the American Institute of Certified Public Accountants (AICPA) monthly magazine, that the California Society of Certified Public Accountants (CSCPA) monthly publication now makes a big deal out of it when a CPA from California does. 

The article is titled “Be Skeptical, Dig For Facts, Orange County CPA Urges.”  The publication does not mention the name of the reporter, and her name is not at my fingertips. 

Since my oldest son is now working for a CPA firm, I’ll include the entire article for his reading pleasure.

"As accountants, we have to play our hunches, exercise our professional skepticism and remember that if something is too good to be true, then it’s not true," said John M. W. Moorlach, the Orange County, California, CPA who sounded the alarm about his county’s dangerous investment practices almost a year ago.

No one seemed to be paying attention when, in the course of his unsuccessful campaign to unseat then County Treasurer Robert L. Citron, Moorlach, who is also a CFP, warned that the treasurer’s high-risk investment philosophy could lead to fiscal disaster. "If you are getting higher returns than anywhere in the country, you’re taking higher risks," he said.

The county’s highly leveraged portfolio of investments, made up of derivatives and reverse repurchase agreements instead of less glamorous but perhaps more prudent investments, left the county bankrupt and unable to meet its budget on December 6, 1994. The county later filed a $2 billion lawsuit against Merrill Lynch, which it claimed sold it unsuitable securities. Press reports said lawsuits might be filed against other brokers and financial advisers.

Moorlach, a partner with Balser, Horowitz, Frank & Wakeling in Costa Mesa, California, and a member of the American Institute of CPAs personal financial planning division, expects to get a chance to put his investment ideas for the county into practice this April. He has a verbal commitment from the county board of supervisors that he will take over the treasurer’s post from Thomas E. Daxon, a CPA with Arthur Andersen & Co., whom the board appointed as interim treasurer just before Christmas. (Citron resigned the day before the county declared bankruptcy.) Late March isn’t the best time to disengage from a CPA’s practice, so Moorlach plans to begin after tax season.

Wide-ranging investment pool. Orange County was the biggest participant in the Orange County Investment Pool, which managed approximately $22 billion on behalf of 187 municipalities, school districts and other agencies–both in and outside the county. The county comprised 32% of the pool’s assets. In the largest bankruptcy by a municipality, the county’s investment in the portfolio lost approximately $600 million and its operating budget was about $172 million short.

As of mid-January 1995, the pool had lost approximately $2.02 billion, Moorlach said, but the discovery of a previously unknown $310 million bank account and the sale of derivatives at better than anticipated prices later reduced losses to an estimated $1.69 billion as of Journal of Accountancy press time.

"We are still trying to sell about $3 billion of derivatives. If we sell for less than 84 cents on the dollar, our losses will increase, and the longer we hold them, the farther their market value will drop if interest rates go up," said Moorlach.

The losses will mean deferred county projects, mainly in road building and repair, and layoffs across the board, he added. "We have to make up between $42 million and $170 million in savings by June 30, the end of the fiscal year, according to recent reports by the county and its financial advisers."

Sweeping changes. Moorlach is ready to address these issues as treasurer:

* Different provisions of the investment policy statements of municipalities contradict each other, allowing for circumvention of the policy’s intent. The statements must be revised, Moorlach said.

* The pool should be marked to market. In a letter to a state legislator this past summer and in an editorial Moorlach submitted to a local paper in October, he said, "This would force the fund participants to take an immediate loss and would give them three choices: keeping their funds in the pool in anticipation that interest rates would fall and, thereby, restore the market value of the portfolio to the participants’ cost basis; removing their investments at a significant loss but only to their individual municipalities; or holding them until market conditions improved to recoup some of their book losses."

* State law requires school districts to keep all their operating funds in the county’s investment pool. Moorlach thinks that law should be modified to allow the districts alternative investment options. Banks, savings and loan institutions, credit unions, treasury notes or money market funds would be safer options than the pool.

Moorlach also believes that:

* The county should not be allowed to issue taxable bonds simply to invest in the pool.

* Municipalities outside the county’s jurisdiction should be prohibited from investing with the county treasurer, since they increase the county’s exposure should the investments perform more poorly than other investment alternatives.

Such changes, he feels could have pare the county’s loss to $1.2 billion or less last June.

A house of cards.  How Moorlach discovered and attempted to blow the whistle on the Orange County investment portfolio underscores the far-reaching role CPAs play.  He advised that those who review or audit financial statements “cannot be complacent or cut corners.  We must be skeptical, scrutinize, ask questions and hold people accountable.  We have a social responsibility to do so.” 

Moorlach, a member of the Orange County Republican Party executive committee, first became involved in the county investment crisis when an assemblyman asked him to run against the incumbent treasurer, a Democrat.  At first he didn’t want to but agreed to “do a little research on the county’s financial practices” and became concerned about the use of arbitrage, purchases of exotic derivatives and the use of reverse repurchase agreements.  He knew these would present problems once interest rates started to go up. 

According to Moorlach, “the county’s pool was a highly leveraged, long-term bond mutual fund, when it should have been a short-term money market fund because of both the liquidity requirements of the participants, which included retirement and trust funds that could remove money at any time from the pool, and the risk from rising interest rates.”  After review the portfolio, Moorlach sent copies to about six brokers in the bond market, asking for their opinions.  They all agreed about the dangers it posed and said it was one portfolio Moorlach “did not want to inherit.”

When Moorlach takes over as treasurer, he will set up an oversight committee and provide full disclosure through monthly financial statements or compilation reports, he said.  He’ll also restructure the office, reviewing each staff member and deciding who will be retained or replaced and which positions will be eliminated.

How will he juggle his public and private responsibilities?  “I have three options as to how I’ll handle this,” he said.  “I can take a leave of absence from the firm, have my partners buy out my practice or try to do both the county work and the firm’s work by getting a manager to oversee most of my client work and trying to spend some time at my CPA practice every day.  I don’t want to be a bureaucrat forever.  I see the position of treasurer as a short-term opportunity to do a turnaround and then go back to real life.”

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