WASHINGTON -- Charles County, Md., is trying to recover millions of dollars from nine securities firms that sold the county's former deputy treasurer derivatives and other risky longterm investments that were prohibited under a state-enacted local law.
The county sued the firms in a U.S. District Court earlier this month to recover almost $30 million -- its entire portfolio -- that had been invested in taxable inverse floaters, collateralized mortgage obligations, and other medium- and long-term derivatives and structured notes.
Five of the firms have since agreed to settle the dispute by repaying the county about $10 million to $15 million in exchange for the derivatives and structured notes, Howard Goldberg, the county's lawyer, said yesterday.
Goldberg, a partner with the law firm of Smith, Somerville & Case in Baltimore, would not name the firms involved in the settlements.
Three other firms, he said, have agreed to allow the county's financial consultant, A. Webster Dougherty & Co. in Baltimore, to sell the obligations they sold the county, with the county getting the proceeds but retaining its right to litigate over any remaining losses, he said.
Goldberg also declined to identify these firms, but sources said one of them is Liberty Capital Markets of Irvine, Calif., which sold the county almost two-thirds of the risky investments in its portfolio. Officials from Liberty Capital did not return phone calls.
Goldberg and county officials hope the settlements will prevent Standard and Poor's Corp. from lowering its AA-minus rating on the county's outstanding $78 million of unenhanced general obligation bonds.
The rating agency placed the bonds on CreditWatch with "negative implications" last week after becoming concerned that the county would not be able to meet cashflow needs and debt service requirements because its investment portfolio was tied up in derivatives and structured notes.
But Goldberg said yesterday that the money coming in from the settlements should alleviate the rating agency's concerns.
"The county's immediate financial problem is over. The money has already started flowing back into its treasury," he said.
Meanwhile, the county is planning to amend its lawsuit to recover millions of additional dollars in county funds that the deputy treasurer used for similar past transactions. in which the derivatives and structured notes were either sold or redeemed, Goldberg said.
That amount of money could exceed the funds being sought in the current complaint, sources said.
The county is determined to continue to "vigorously pursue" legally any firms that do not fully repay the county funds that were tied up in these transactions, Goldberg said yesterday.
The securities firms named in the suit, in addition to Liberty Capital, are Prudential Securities Inc.; Donaldson, Lufkin & Jenrette Securities Corp.; Smith Barney Inc.; Lehman Government Securities Inc.; Ernst & Co.; Meridian Capital Markets; Mabon Securities Corp.; and Murchison Investment Bankers.
The county's troubles began in early July when former deputy treasurer Stephen R. Johnson reported a $1.3 million loss from the county's investment portfolio for the fiscal year ending on June 30.
County auditors and officials began investigating and discovered that Johnson, over an 18-month period, had invested the county's entire investment portfolio in risky medium- and long-term derivatives and structured notes.
The obligations included inverse floaters, two-tiered index notes, and collateralized mortgage obligations issued by government-sponsored agencies such as the Federal National Mortgage Association or the Federal Home Loan Mortgage Corp. These instruments are extremely sensitive to changes in interest rates and produced losses when interest rates rose.
"They were well beyond what would be a prudent investment for a municipality," said Samuel Ketterman, a senior vice president at A. Webster Dougherty. "The county had no liquidity whatsoever" as a result of these investments, he said.
Under a so-called public local law -- a local law enacted by the Maryland General Assembly -- Charles County can invest only in short-term U.S. government obligations. Short-term generally means 270 days or less, county officials said.
The derivatives and structured notes purchased by Johnson were not government securities and had maturities up to 29 years, Ketterman and others said.
The county filed its lawsuit on Aug. 5 against the nine out-of-state securities firms that had sold these obligations to the county through Johnson.
The suit, which was filed in the U.S. District Court of the District of Maryland in Baltimore, sought an immediate return of the county's money from the transactions.
The county contended in the suit that since the transactions violated a state-enacted local law, they should be rendered void and the county should be repaid.
"The county did not have authority to enter into them," Roger Fink, a county attorney, said this week. "Our legal position has been that we don't own them, so all of the transactions are void."
Although the county asked the court to take immediate action, several of the scheduled court hearings have been postponed, including one set for today, as the county continues to work toward settling its disputes with the securities firms.
Goldberg said he is hopeful the county will settle all of the disputes.
County officials say they do not know why Johnson, who had announced he would be a candidate for county treasurer, invested in medium- and long-term derivatives and structured notes.
Johnson took responsibility for the county's investments and purchased these obligations after Thelma Bowie, then treasurer, suffered a series of health problems starting in 1991.
Johnson was fired as deputy treasurer on July 12, after county officials learned about the investments. When contacted earlier this week, Johnson refused to comment on the controversy or on his previously announced plans to run for county treasurer.
Asked whether the county plans to take any action against Johnson over the investment controversy, Fink said, "We're continuing to investigate every possibility in order to recover the money and completely make the county whole."
County sources said this week that state attorneys are also investigating the county investments.
But deputy state attorney Frank Jones said he could not confirm or deny the existence of any investigation.
Bowie formally resigned as county treasurer on Aug. 17 for health reasons. County officials immediately appointed Harry H. Foxwell to replace her. Foxwell retired from the Navy in July after serving 30 years with the U.S. Office of Naval Intelligence.
