School districts consider lawsuit in investment downturn

By Amy Hetzner
Milwaukee Journal Sentinel

Five Wisconsin school districts, including Kimberly, could face combined losses of tens of millions of dollars in a complex investment scheme to help fund employee retirement benefits, according to investigators hired by the districts.

The value of district investments has declined by $120 million — or 60 percent — since the transactions were undertaken within the last two years, according to a news release from a public relations firm for the attorneys who examined the deals.

School district officials released statements accompanying the news release Wednesday, saying they were misled by a financial adviser, and that the investments were much riskier than they had been told.

"There were no documents signed by the districts or even presented to the districts prior to closing that disclosed the true risk of the deal," said Shawn Yde, director of business services for the Whitefish Bay School District. "There is no way the districts knew or could have known that they were being victimized."

School boards for the five districts — Kimberly, Kenosha, Waukesha, West Allis–West Milwaukee and Whitefish Bay — plan to vote over the next few weeks on whether to file a lawsuit to recoup their losses, said Craig Peterson, president and CEO of Milwaukee public relations firm Zigman Joseph Stephenson Inc.

"The school districts feel as though they were intentionally misled, that they were buying at least AA-rated investment products," Peterson said. An AA rating usually means that an investment is safer, although it does not earn as much money as riskier deals.

The five districts recently hired two law firms — one in Milwaukee and a Houston-based firm that specializes in securities fraud litigation — to look into their investment in complex financial instruments known as collateralized debt obligations. A chartered financial analyst also was retained.

CDOs are bundles of debt that can range from corporate bonds to subprime mortgages. They have been at the center of the global financial turmoil that has brought down some major companies over the last year.

The five districts made the investments in 2006 using borrowed money and, in some cases, district assets to help seed trusts they established to borrow more money to funnel into the CDOs. According to Wednesday's news release, the deals also involved a credit default swap, another fairly recent financial vehicle designed to transfer risk from one investing party to another.

The value of the investments has plummeted over the last year, triggering calls for millions of dollars more in collateral to avoid a drop in income from quarterly dividends.

But until recently, school officials had continued to insist that their investments were safe and that district funds were protected. Until the last fiscal quarter, they all also had been receiving surplus payments from the investments that they could use to pay non-pension retirement benefits for their employees.

Representatives from all of the districts said in statements released Wednesday that they had been sold investments far riskier than they had been led to believe by the investment banks involved in the deal.

Officials with Royal Bank of Canada, which devised the CDOs and determines their value, and Stifel, Nicolaus & Co., the original broker on the deal, could not be reached Wednesday night.

"At all times we believed we were acting in the best interest of our citizens, and in accordance with Wisconsin state statutes," said Deborah Rouse, director of business services for West Allis–West Milwaukee, in her written statement. "We were victimized by these sophisticated financial institutions and we are recommending action."

Said Jason Demerath, interim executive director of business services for Waukesha: "We were unknowingly sold a risky and expensive plan . . . We are shocked and angry, and Waukesha will do everything in its power to get our money back."