Camarillo lost nearly $25 million last year when its city treasurer borrowed funds to finance highly speculative investments that backfired because interest rates rose last spring, an auditor's report released Monday said.
A four-month investigation and audit by the national accounting firm Arthur Andersen & Co. revealed that by March, 1987, City Treasurer Donald F. Tarnow, who was fired in January, had purchased on margin more than $273 million in government securities with less than $25 million in city money.
The value of those margin investments plummeted the following month when interests rates rose, driving down the value of the government-backed bonds and resulting in losses of more than $11 million in April, 1987, the audit said.
In total, the city lost $21.7 million of its $26 million investment fund as a result of speculative bond market trading, the audit report said.
Margin investments involve purchasing securities by paying only a portion of their value. When market conditions are favorable, the bonds can be sold at substantial profit before the bearer has to pay off their balance. But in Camarillo's case, huge losses were sustained because of the falling bond market.
Tarnow invested an additional $3.2 million from city employee benefit funds in two business ventures that auditors say are now worthless.
As of January, 1988, about $1 million remained in the city's investment fund, the audit report said.
"I'm shocked," said Councilwoman Charlotte Craven. "The irony is that everyone, the community, the council, always thought that Camarillo was a thriving city with a healthy reserve and no problems."
Tarnow, 46, was fired from his post as the city's chief investment officer for failing to disclose the investment losses to the City Council. The losses first came to light last November when $16,000 worth of city checks bounced.
Former Finance Director Larry Weaver, Tarnow's boss and another longtime city employee, resigned after a preliminary audit released earlier this year that disclosed investment losses could approach $20 million.
Auditors found no evidence of "any unauthorized direct transfers of city funds to any city employee," the report said. Still ongoing, however, is an investigation by the city attorney's office and a legal firm hired by the city to find out whether any laws were broken in the investment transactions, city officials said.
One of the 15 brokerage firms involved, First Investment Securities, of Little Rock, Ark., is under investigation by the FBI and the Securities and Exchange Commission. The firm is also the target of a federal lawsuit filed on behalf of six Southern California cities and municipal agencies. In that suit, the cities and agencies allege that the investments violated state and federal regulations in transactions that resulted in losses of at least $8.4 million last year.
Camarillo lost about $2.7 million in bond market transactions with First Investment, the audit report said. City Atty. Colin Lennard has said the city will consider filing suits against individuals or brokerage firms to recover some of the investment losses.
Tarnow, in previous interviews, has denied any wrongdoing in the investments and said the losses were caused by an unexpected fall in the bond market. Neither he nor Weaver could be reached for comment on the auditor's report.
Tarnow's speculative trading methods and huge losses were hidden from the City Council because the former treasurer was given complete control over investments and the accounting of those investments, the audit report said. Investment accounting records for the city's 1986-87 fiscal year were incomplete and monthly investment reports to the council were "erroneous, inadequate and misleading," the report said.
In previous years, Tarnow had earned as much as $2 million in annual interest through city investments. But beginning last year, he began dealing heavily in speculative bond market transactions, the audit report said.
In those transactions, Tarnow speculated on changes in the interest rate, hoping to profit on the buying and selling of government-backed long-term bonds, according to the report. As interest rates fell, as they did during much of 1986, the value of the bonds increased. But by the spring of 1987, at the height of the city's bond market investment, interest rates began rising.
At that time, the city had purchased on credit more than $200 million in long-term securities, the audit report said. As the bond market began falling, the city was forced to sell its safe investments, such as certificates of deposit, to cover its bond losses.
While engaging in those highly sophisticated investment strategies, Tarnow, an 18-year city employee, sought no professional advice except that given by securities brokers who earned commissions on more than $1.6 billion in bond market trades he made on behalf of the city between December, 1986, and July, 1987, the audit report said.