When E. F. Hutton talks, Rancho Palos Verdes listens--very carefully.
Last January, the city's new treasurer discovered that his predecessor had invested about $1 million with a Hutton broker in a speculative securities deal. The amount represented about one-fifth of the city's total investment funds.
Several months later, the value of the investment plunged by half and city officials threatened to sue Hutton, alleging that the company failed to inform the city about the risk. According to sources in city government, the two sides made a deal:
Hutton would give the city its $1 million back, plus some interest, and both sides agreed to keep quiet about the settlement.
Same Kind of Investment
Lawndale has not been as fortunate. In late September and early October, the city learned during a routine audit that its part-time treasurer, Ray Wood, had made the same kind of investment with the same Hutton broker. City officials decided to pull out of the deal, and Lawndale was scorched to the tune of more than $1.6 million--about half of the city's general fund reserve.
"We were out of our league," Lawndale Assistant City Manager Paula Cone said in a recent interview. "Way out of our league."
If there is comfort in numbers, Lawndale found plenty of it. The cities of San Marino and Palmdale, which shared the same treasurer as Lawndale, disclosed that they had lost about $6 million altogether in the same type of investment. The Three Valleys Municipal Water District in the San Gabriel Valley later reported it lost $1.5 million in a carbon-copy deal. Bellflower lost $290,000.
In La Verne, city officials invested $630,000, later realized the risk and bailed out just in time. City Manager Martin Lomeli said the city even made a small profit.
"We just got lucky," Lomeli said.
Hutton declined to comment except to say that the losses were caused by the fall in the bond market earlier this year. Hutton was initially involved in all the transactions until its broker, William E. Parodi, moved to another firm and took three of the city accounts with him.
Parodi, who initiated contact with all the cities and put together the deals, defended the investments and said in an interview that he made sure that officials in each city understood the risks. He contended that if the cities had not terminated their investments when the bond market was at a low ebb, they may not have lost any money.
Wood, who also was fired as San Marino treasurer and resigned as finance director in Palmdale, has declined to comment specifically about the investments except to say he made "an error in judgment."
"I didn't realize what was happening until I was trapped," Wood said in an interview shortly after audits uncovered the investments.
The losses came before the recent stock market crash and were not caused by problems in the market. Instead, it appears that the municipalities' losses occurred when interest rates climbed earlier this year. When interest rates rise, the value of existing bonds tends to drop because investors can get a higher return by buying new bonds.
Buying on Margin
What got Lawndale into trouble, city officials say, was that it purchased the securities on margin. In a margin account, an investor puts down only a fraction of the price of the security, hoping the market will rise. If it does, the investor can sell the securities and make a profit without ever paying the full price. But if the price of the security falls more than the amount invested, the investor has to put up more money or lose everything.
Here are the key dates in the Lawndale debacle, based on interviews and a chronology released this week by City Atty. David Aleshire:
Sept. 29-30, 1986--Wood wires $300,000 to an E. F. Hutton brokerage to open an account after initially being contacted by Parodi during the summer. On Lawndale's behalf, Hutton purchases $6 million in government bonds on margin. Lawndale contends that Wood was not told that the bonds were bought on margin.
March 20, 1987--The city's account is transferred, with Wood's approval, from Hutton to another brokerage company, First Investment Securities Inc. The transfer occurs after Parodi resigns from Hutton and joins First Investment.
April 9--Lawndale's accounting supervisor gets a phone call from First Investment instructing the city to wire $253,646 to the company to meet a margin call. Wood approves wiring the funds. According to the city, the margin call is Wood's "first indication" from Parodi that the city's investment involves margin trading, and he instructs Parodi to close the account once Lawndale's investment is recouped.
April 13 and 21--The city receives two additional margin calls for a total of $485,000. Wood authorizes payment.