Communications with Auditors and Audit Committees in these troubled

times…A case study: Investing in Corporate Note….Bankruptcies?

Presenter:Presenter: Marc Puckett, Director of Finance/City Treasurer, City of Costa MesaMarc Puckett, Director of Finance/City Treasurer, City of Costa Mesa

What a year!

As it was described to me by one of our brokers, “This is definitely a 100-year happening.”

Indy Mac Bank, the Pasadena-based thrift failed. Indy Mac Bank, the Pasadena-based thrift failed. Washington Mutual Bank failed in the largest Washington Mutual Bank failed in the largest

bank failure in U.S. history. bank failure in U.S. history. Firms that were considered Wall Street titans Firms that were considered Wall Street titans

have disappeared.have disappeared. Bear Sterns, Wachovia, AG Edwards, Merrill Bear Sterns, Wachovia, AG Edwards, Merrill

Lynch and Countrywide were all purchased by Lynch and Countrywide were all purchased by other financial institutions. other financial institutions.

“This is definitely a 100-year happening.”

158 year old Lehman Brothers, the fourth largest 158 year old Lehman Brothers, the fourth largest investment bank on Wall Street failed. investment bank on Wall Street failed.

Lehman Brothers filed for Chapter 7 (liquidation) Lehman Brothers filed for Chapter 7 (liquidation) bankruptcy protection on September 15. bankruptcy protection on September 15.

The City of Costa Mesa has two Lehman Brothers The City of Costa Mesa has two Lehman Brothers Corporate Note Securities in its investment Corporate Note Securities in its investment portfolio purchased in Dec. 2007 at a total cost of portfolio purchased in Dec. 2007 at a total cost of $5,049,700.$5,049,700.

What now? PANIC?!?!

Securities dropped in value to $0.10-$0.13 Securities dropped in value to $0.10-$0.13 on the dollar on the dollar and have a current market and have a current market value of roughly $500k –650kvalue of roughly $500k –650k. .

After the bankruptcy filing, the City has After the bankruptcy filing, the City has over $4.5 million in potential lossesover $4.5 million in potential losses

Need to report potential loss….Need to report potential loss….

Communications with Audit Committees and Auditors in these troubled times

Identify the specific details to be communicated.Identify the specific details to be communicated. Determine the timing of the communication.Determine the timing of the communication. Determine the form in which the communication Determine the form in which the communication

will be made.will be made. Determine relevant persons to communicate Determine relevant persons to communicate

information to.information to. Identify the potential effect on the financial Identify the potential effect on the financial

statements, determine whether audit adjustments statements, determine whether audit adjustments are necessary and fully disclose in footnotes. are necessary and fully disclose in footnotes.

Identify the specific details to be communicated - Take stock: Overview of Costa Mesa’s investment portfolio

Safety, Liquidity, Yield always overriding investment Safety, Liquidity, Yield always overriding investment objectives.objectives. $111 million portfolio.$111 million portfolio. Investment Policy more conservative than State law.Investment Policy more conservative than State law. Updated and approved annually by governing body. Updated and approved annually by governing body. Investment Oversight Committee reviews investment Investment Oversight Committee reviews investment

policy annually and treasurer’s reports monthly.policy annually and treasurer’s reports monthly.

Take stock: Investment decisions

Reassess basis for making original Reassess basis for making original investment purchases.investment purchases.

Investments complied with State law and Investments complied with State law and were rated “A” or better when purchased were rated “A” or better when purchased and up until Lehman filed for bankruptcy and up until Lehman filed for bankruptcy on September 15. on September 15.

Take Stock: Investment Policy Limitations

Investments complied Investments complied with State law and with State law and were rated “A” or were rated “A” or better when purchased better when purchased and up until Lehman and up until Lehman filed for bankruptcy filed for bankruptcy on September 15.on September 15.

Investment decisions Investment decisions reviewed with IOC.reviewed with IOC.

Determine the timing of the communication

““When you have bad news to tell, get it all out When you have bad news to tell, get it all out and position yourself to move forward”and position yourself to move forward”

Determine the form in which the communication will be made.

Begin preparing memo to communicate the loss –Begin preparing memo to communicate the loss – Surveyed CMTA and CSMFO via group list for Surveyed CMTA and CSMFO via group list for

other public agencies with Lehman loss other public agencies with Lehman loss exposures. exposures.

Identified 56 California agencies with loss Identified 56 California agencies with loss exposures totaling $350 million. exposures totaling $350 million.

Formed Lehman Brothers Working Group.Formed Lehman Brothers Working Group. Your not alone! There is strength in numbers.Your not alone! There is strength in numbers.

Determine relevant persons to communicate information to - Wrote draft memo to City Council and City Wrote draft memo to City Council and City

Manager fully disclosing what had happened and Manager fully disclosing what had happened and the potential loss.the potential loss.

Met with City Manager, reviewed draft memo and Met with City Manager, reviewed draft memo and asked for his input.asked for his input.

Met with Auditors, discussed impact on financials Met with Auditors, discussed impact on financials and how information should be disclosed. and how information should be disclosed.

Released memo to City Council and the Public Released memo to City Council and the Public (Press).(Press).

Identify the potential effect on the financial statements, determine whether audit adjustments are necessary and fully disclose in footnotes.

Added footnote disclosure: Added footnote disclosure: Fully disclosed bankruptcy filing on Fully disclosed bankruptcy filing on

September 15, andSeptember 15, and Impact of bankruptcy on fair value of Impact of bankruptcy on fair value of

Lehman securities, and Lehman securities, and Fair value of Lehman securities as of Fair value of Lehman securities as of

issuance date of financials. issuance date of financials.

Next Steps…

Established weekly conference calls with Established weekly conference calls with LBWG each Wednesday to discuss possible LBWG each Wednesday to discuss possible courses of action and opportunities to courses of action and opportunities to collaborate with these agencies on potential collaborate with these agencies on potential means of loss recoveries.means of loss recoveries. Hiring of bankruptcy attorney and Hiring of bankruptcy attorney and

sharing of costs.sharing of costs. Seeking legislative reliefSeeking legislative relief

Next Steps…

Approached federal delegation from California and asked forApproached federal delegation from California and asked forrelief to be included in the federal rescue plan being relief to be included in the federal rescue plan being developed.developed. Ultimately successful:Ultimately successful: H.R. 1424, ‘‘Emergency Economic Stabilization Act of 2008’’ is in H.R. 1424, ‘‘Emergency Economic Stabilization Act of 2008’’ is in

Section 103(7) which reads “the need to ensure stability for United States Section 103(7) which reads “the need to ensure stability for United States public instrumentalities, such as counties and cities, that may have suffered public instrumentalities, such as counties and cities, that may have suffered significant increased costs or losses in the current market turmoil.significant increased costs or losses in the current market turmoil.

This language authorized the Secretary of Treasury, HenryThis language authorized the Secretary of Treasury, HenryPaulson, to use funds from the Troubled Asset ReliefPaulson, to use funds from the Troubled Asset ReliefProgram (TARP) to purchase troubled assets from cities and Program (TARP) to purchase troubled assets from cities and counties. counties.

After passage of HR 1424

Members of working Members of working

group sent joint letter group sent joint letter

to Secretary Paulsonto Secretary Paulson

reinforcing that citiesreinforcing that cities

and counties wereand counties were

unintended victims andunintended victims and

asking that he buy theasking that he buy the

troubled assets fromtroubled assets from

cities and counties.cities and counties.

After passage of HR 1424

Members of Members of California California delegation delegation including Feinstein, including Feinstein, Boxer, and Pelosi Boxer, and Pelosi sent letters to sent letters to Paulson supporting Paulson supporting our efforts. our efforts.

After passage of HR 1424

Next Steps…

Secretary Paulson intimated to Secretary Paulson intimated to congressional staffers that “no way, no congressional staffers that “no way, no how” were cities and counties going to gain how” were cities and counties going to gain access to the TARP funds. access to the TARP funds.

LBWG asked Senator Feinstein to support a LBWG asked Senator Feinstein to support a bill that would specifically direct or allocate bill that would specifically direct or allocate funds from the TARP program to purchase funds from the TARP program to purchase troubled assets from local agencies.troubled assets from local agencies.

Next Steps…

Met with Senator Feinstein in San Francisco on Met with Senator Feinstein in San Francisco on December 18.December 18. She wrote follow-up letter to Paulson asking for She wrote follow-up letter to Paulson asking for

a response to her first letter and that the TARP a response to her first letter and that the TARP funds be used to purchase troubled assets from funds be used to purchase troubled assets from cities and counties.cities and counties.

Indicated that she would be introducing a bill to Indicated that she would be introducing a bill to specifically authorize $10 billion from the specifically authorize $10 billion from the TARP funds to purchase troubled assets from TARP funds to purchase troubled assets from cities and counties. cities and counties.

Next Steps…

SB 116 introduced by SB 116 introduced by Senator Feinstein at Senator Feinstein at the opening of the the opening of the 111111thth session of session of Congress.Congress.

Next Steps…

Companion bill (HR 467) introduced in the Companion bill (HR 467) introduced in the House by Rep. Jackie Speier.House by Rep. Jackie Speier.

Had hoped to tie-bar bills to Economic Had hoped to tie-bar bills to Economic Stimulus bill moving through House and Stimulus bill moving through House and Senate. Senate.

Next Steps…

Also have requested support letters from national Also have requested support letters from national organizations including NACO, APTUS&C organizations including NACO, APTUS&C among others. (These two associations have among others. (These two associations have agreed to write letters of support.)agreed to write letters of support.)

Requested the GFOA to place ads in the GFOA Requested the GFOA to place ads in the GFOA newsletter to solicit input from members in other newsletter to solicit input from members in other states that Lehman loss exposures. states that Lehman loss exposures.

Next Steps…

To date, have identified To date, have identified loss exposures totaling loss exposures totaling over $2 billion in 18 over $2 billion in 18 states including Alaska, states including Alaska, Florida, Minnesota, Florida, Minnesota, Delaware, Texas, Delaware, Texas, Illinois, Massachusetts, Illinois, Massachusetts, New York and New York and California.California.

Possible outcomes

Secretary of Treasury will purchase Secretary of Treasury will purchase troubled assets from Cities, Counties and troubled assets from Cities, Counties and Special Districts through TARP program.Special Districts through TARP program.

Cities, Counties and Special Districts will Cities, Counties and Special Districts will wait until the conclusion of the bankruptcy wait until the conclusion of the bankruptcy liquidation and receive a portion of their liquidation and receive a portion of their principal investment from the trust. principal investment from the trust.

Communications with Auditors and Audit Committees in these troubled

times…A case study: Investing in Corporate Note….Bankruptcies?

Questions?