JOINT SPECIAL COM. REP. NO.
Honolulu, Hawaii
S.D. 1
H.D. 1
President of the Senate
Twenty-Sixth State Legislature
State of Hawaii
Speaker, House of Representatives
Twenty-Sixth State Legislature
Regular Session of 2011
State of Hawaii
Mr. President and Mr. Speaker:
The Joint Legislative Investigating Committee created and by Senate Concurrent Resolution No. 18, S.D. 1, H.D. 1, entitled:
"ESTABLISHING A JOINT LEGISLATIVE INVESTIGATING COMMITTEE TO OVERSEE THE INVESTIGATION OF THE DEPARTMENT OF BUDGET AND FINANCE'S HANDLING OF THE STATE'S INVESTMENT IN STUDENT LOAN AUCTION RATE SECURITIES,"
begs leave to report as follows:
BACKGROUND
The need for this Joint Legislative Investigating Committee (Committee) arose from the State's purchase of $1,100,000,000 in student loan auction rate securities (SLARS) from Salomon Smith Barney, representing nearly 25 percent of the State's total investment in securities. Due to the financial collapse of the securities market, the assets have been frozen, leaving the State unable to utilize the $1,100,000,000 in SLARS. As a result, the Auditor required the State to revalue the SLARS at $114,000,000 less than the amount that the State actually paid, and other subsequent revaluations of the SLARS have estimated the loss at $254,000,000. It has been asserted by the Auditor in the Auditor's Financial Examination of the Department of Budget and Finance, Report No. 10-03, dated March 2010, that a portion of the SLARS was purchased in violation of state laws that specify the maximum period of maturity and the minimum financial rating for state investment purchases. In this respect, the Auditor's overall conclusion was that the Department of Budget and Finance's lack of leadership and accountability puts the State's funds at risk. There has been widespread disagreement between the Auditor, the Director of Finance, and the Administration regarding the legality and fiscal integrity of the SLARS investments.
In response, the Legislature adopted Senate Concurrent Resolution No. 18, S.D. 1, H.D. 1, which tasks your Committee with:
(1) Overseeing the investigation of the Department of Budget and Finance's handling of the State's investment in student loan auction rate securities; and
(2) Assisting the independent attorney in charge of the investigation by holding meetings and hearings as requested, receiving all information from the investigation, and submitting a final report to the Legislature.
COMMITTEE MEMBERSHIP, PROCEEDINGS, AND WORK
Pursuant to Senate Concurrent Resolution No. 18, S.D. 1, H.D. 1, your Committee comprised six members, including Senators Donna Mercado Kim, Shan S. Tsutsui, and Sam Slom; and Representatives Marcus R. Oshiro, James K. Tokioka, and Gene Ward.
Your Committee met in one hearing on Monday, October 11, 2010. At this hearing, your Committee laid the organizational and procedural ground work for further hearings, including adopting committee rules and designating Senator Donna Mercado Kim and Representative Marcus R. Oshiro as the Committee's co-chairs.
Pursuant to your Committee's recommendation at the hearing co-chairs Kim and Oshiro submitted a letter, dated October 12, 2010, to the Attorney General inquiring whether litigation regarding the State's SLARS had been undertaken by the State, and, if not, whether such litigation is reasonably likely.
By letter also dated October 12, 2010, the Attorney General informed your Committee that litigation had not been undertaken. The Attorney General also stated that he had been engaged for some months in settlement negotiations with Citigroup Inc., Citigroup Global Markets Inc., and Citigroup Global Markets Holdings Inc. concerning the settlement of claims that could be asserted by the State. Additionally, the Attorney General informed your Committee that it was his belief that "it is more likely than not that these negotiations will result in a settlement (which will mean there will be no litigation), there is no certainty that such a settlement will occur, and I believe there is more than a possibility that such settlement will not occur. I also believe that if such a settlement does not occur, there will unquestionably be litigation against CITI." Based on the foregoing, the Attorney General concluded that litigation regarding the State's SLARS is reasonably likely.
SETTLEMENT AGREEMENT BETWEEN THE STATE
AND CITIGROUP GLOBAL MARKETS, INC.
By letter dated November 23, 2010, the Attorney General informed your Committee that a settlement agreement had been reached that day between the State and Citigroup Global Markets, Inc. (CGMI). A copy of the settlement agreement was provided to your Committee and it is attached hereto.
According to the Attorney General's summarization of the settlement agreement, the principal terms of the agreement are as follows:
(1) In June 2015, the State will have the option to require CGMI to purchase some or all of the State's remaining auction rate securities portfolio at par value, as well as to have CGMI make up the difference between the liquidation price and par value on any of the State's auction rate securities which have been previously involuntarily liquidated below par value. This means that the State's taxpayers will lose no principal on any of the State's auction rate securities investments;
(2) Starting in July 2012, the State will have the ability to obtain interim liquidity on its auction rate securities portfolio of up to $150 million worth of the securities, at market value, with the difference between that market value and par value to be paid by CGMI by July 2015; and
(3) The State releases potential claims against CGMI and any affiliated entities and individuals in connection with the State's investments in auction rate securities, and CGMI admits no wrongdoing.
In his media statement, attached to his November 23, 2010 letter, the Attorney General stated his belief that "this settlement is in the best interests of the State, and provides substantial value to the State. The State will essentially get back what it paid for these securities, plus interest collected on them. The alternative – lengthy, expensive litigation — would have provided no certainty, and might, in the end, have been unsuccessful. Bottom line—taxpayers will not lose out on the principal value of these securities, and that is a good result for Hawaii and its citizens."
FINDINGS AND RECOMMENDATIONS OF THE JOINT LEGISLATIVE INVESTIGATING COMMITTEE
Your Joint Legislative Investigating Committee finds that the State's investment in the auction rate securities was fiscally imprudent, based on the Auditor's Report No. 10-03, which stated in pertinent part:
Our examination revealed a lack of proper leadership and accountability in the Department of Budget and Finance and resulting deficiencies in its execution of statutorily mandated fiscal responsibilities. We found that the department is not efficiently and effectively managing the State's $3.8 billion treasury. Its investment policy, which is meant to delineate investment procedures and requirements, has neither been formally updated since 1999, nor reviewed in detail since 2002. Management of state cash and investments is governed by the 1999 policy and general statutory guidance and is carried out via informal, manual procedures that increase risk and hamper efficiency. Neither the director of finance nor the Financial Administration Division (FAD) administrator has exercised proper oversight of investment decisions and activities.
As a result, the state treasury now holds approximately $1 billion of illiquid auction-rate securities (ARS). We found that the department significantly increased ARS holdings to more than $1 billion in FY2008, shortly before the ARS market froze. Although the investment policy states that yield is of secondary importance to safety and liquidity, we found the department continued investing in ARS primarily based on their high yields, which generally indicate greater risk. However, the department did not perform a risk assessment or cost-benefit analysis prior to purchase, nor did it obtain and review the securities' offering documents that disclose related risks.
Your Joint Legislative Investigating Committee recommends that the State recover its principal investments from CGMI and related entities. Additionally, your Committee has continuing concerns over the management and supervision of state funds and investments by the Department of Budget and Finance. Your Committee recommends that the Legislature further review the Department's management and supervision of the State's funds and investments.
Respectfully submitted on behalf of the members of the Joint Legislative Investigating Committee,
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DONNA MERCADO KIM, Co-Chair |
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MARCUS R. OSHIRO, Co-Chair |
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LIST OF APPENDICES
A. S.C.R. 18 SD1 HD1 (2010)
B. Senate Appointment Letter dated August 16, 2010
C. House Appointment Letter dated June 25, 2010
D. Letter dated October 12, 2010, to Attorney General Mark Bennett from Co-Chairs Kim and Oshiro Re: Student Loan Auction Rate Securities; Legal Actions
E. Letter dated October 12, 2010, to Co-Chairs Kim and Oshiro from Attorney General Mark Bennett Re: Student Loan Auction Rate Securities; Legal Actions
F. Letter dated November 23, 2010, to Co-Chairs Kim and Oshiro from Attorney General Mark Bennett Re: Settlement Agreement; News Release
G. Settlement Agreement dated November 23, 2010
H. Rules of the Joint Senate-House Investigative Committee
I. October 11, 2010, Hearing Notice
J. Agenda for October 11, 2010, hearing
K. Vote Sheets for October 11, 2010
L. January 4, 2011, Hearing Notice
M. Auditor's Report No. 10-03, March 2010, Financial Examination of the Department of Budget and Finance
N. Vote Sheet for January 4, 2011