MADISON, Wis. - A bill pending in the Wisconsin Legislature would increase auditing, add a chief investment officer and increase the amount of allowed outside managers at the State of Wisconsin Investment Board.
One provision limits the use of derivatives - except for hedging - in the state investment fund, the state's pooled cash fund for governments, agencies and its retirement system. (Hedging is defined as the reduction of the risk of price changes, or of interest rate or currency exchange rate fluctuations, with respect to investments held or to be held by the board, according to a copy of the preliminary bill).
The changes are being made to prevent future losses like the $95 million loss the investment fund suffered through interest rate bets on various foreign currencies and interest rates using over-the-counter swaps.
But, the proposed law, as it stood in early December, also excludes several investments from its definition of derivatives, meaning the state investment fund can use them, provided they are used for hedging.
The list of securities not considered to be derivatives includes:
Forward contracts with a maturity less than 270 days;
Collateralized mortgage obligations with one of the two highest ratings from nationally recognized ratings agencies;
Certain types of swaps, if counterparty creditworthiness requirements are met, if the transaction is used only for risk reduction, and if payment obligations of the agreement are backed by identified state assets of the fund, according to an analysis of the bill by a state bureau;
The sale of futures contracts or options on futures contracts, traded on regulated exchanges; and
Any financial contract or instrument that the board determines by rule is not a derivative.
Heinz Binggeli, managing director with Emcor, an Irvington, N.Y., derivatives consultant, said the restrictions in the bill appear to be appropriate for a longer term fund, not a cash type of fund that needs liquidity.
Typically, a cash fund will not need to hedge currency risk out that far, if at all.
CMOs are what burned a lot of money market funds in 1994 when interest rates unexpectedly shot higher. The market risk in CMOs is not measured by credit ratings, Mr. Binggeli said.
As this story went to press, Mary Lazich, a state representative who is a co-sponsor of the bill, said she would look into why it appears the bill is worded to limit derivatives in just the state investment fund, and why there are exceptions to certain types of derivatives. State Sen. Peggy Rosenzweig, the bill's other sponsor, was unavailable for comment.
Kenneth Johnson, executive assistant to SWIB Executive Director Patricia Lipton, said he would do the same. (SWIB assisted with the preparation of the bill.) He said the board doesn't plan on using derivatives, and when it does so will do it only for hedging.
A public hearing was scheduled for Dec. 11.
The actions on the legislative level follow a squabble among legislators and the board over who was responsible for the losses in the cash fund.
Trustees for the board eventually terminated two employees, Richard V. "Skip" Gibson and Katherine A. Mack, in September. Both worked in the liquid asset divisions at SWIB - Mr. Gibson as an investment director and Ms. Mack as an investment officer. A third unidentified employee was reprimanded.
The liquid assets division managed the fund that took losses through over-the-counter swaps, giving the cash fund exposure to various world interest rates and currencies. The losses were first disclosed in March, and have been renegotiated so payment will be spread out over five to 10 years (Pensions & Investments, April 3).
The terminations followed an investigation of SWIB by Carroll D. "Buzz" Besadny, a former Department of Natural Resources head hired to investigate the personnel aspects of the losses.
According to a prepared statement, SWIB's trustees voted unanimously to terminate the two, based on what Mr. Besadny found to be "misconduct, insubordination and incompetence."
Mr. Besadny delivered the report orally to trustees, and no written record of his recommendations exists.
The investigation by Mr. Besadny was the third in a series, and was anticipated to clear up the issues as to how the losses were taken and who was responsible.
While the first two investigations were primarily based on disclosure of facts, they did not come to strong conclusions; information released regarding Mr. Besadny's investigation is mostly conclusion, with little disclosure. The two initial reviews were conducted by Price Waterhouse L.L.P., New York, and the Wisconsin Legislative Audit Bureau.
People involved in the action by SWIB don't want to talk about the terminations.
Staff at the investment board are not commenting, Mr. Johnson of SWIB said.
Philip Gelatt, chairman of the board of trustees overseeing SWIB, did not return phone calls. But according to a prepared statement for a session with the Wisconsin Joint Committee on Audit, Mr. Gelatt said Mr. Gibson concealed a particularly damaging Mexican interest rate swap from SWIB, and "he lied....about management knowledge of the trades."
Mr. Gibson said he had no comment, through a spokeswoman, in September, and later could not be reached. Mr. Gibson's lawyer, Larry Menke, said Mr. Gibson "did not lie, he was upfront" about the transactions.