ZUG, Switzerland - The United States had its Orange County disaster. The United Kingdom (and Singapore) had its Barings crisis. Switzerland has its Landis & Gyr scandal.
Landis & Gyr?
Little-known outside the normally placid Swiss pension arena, the Zug-based pension fund of Landis & Gyr AG, a leading manufacturer of building control systems, incurred a net loss of 170 million Swiss francs ($135 million) from 1992 through 1994 through a highly leveraged investment strategy using a variety of derivative instruments.
The scandal not only tarred those involved in running and overseeing the 800 million franc ($634 million) pension fund, but has resulted in new regulatory guidelines clarifying duties of trustees, increasing reporting requirements and restricting use of derivatives for all Swiss pension funds (Pensions & Investments, May 27).
The Landis & Gyr predicament was "even worse than Orange County," said Daniel Wydler, a senior vice president at Pictet & Cie, Zurich, who also served on a six-member panel that devised the new guidelines.
A February 1996 summary from a 350-page report by Revisuisse Price Waterhouse found that a complex, derivative-based strategies resulted in a net loss of 170 million Swiss francs from 1992 through 1994 for the Swiss fund - although it actually lost more than 400 million francs from peak to trough.
The report, which had been commissioned by the canton of Zug's department of the interior, accused the pension fund of: breaching the law's investment limits as well as the fund's investment guidelines; lacking adequate separation of functions between the investment manager and the back office; failing to install effective reporting systems to reflect the fund's true financial position; and wanting independent controls and risk management.
The 350-page report said executives of the Landis & Gyr fund decided in April 1992 to make up an 18 million franc funding shortfall by boosting returns to 6%. By that summer, the fund had dropped much of its Swiss and foreign bond portfolios in favor of Swiss shares and various investment funds, it added.
The fund invested heavily in call options in Swiss equities, the report said. By year end, the fund had exceeded the legal limits on Swiss equity exposure, set at 30%, the report said.
But the fund's true exposure went unnoticed because derivatives positions were accounted at market value, not on the fund's effective market exposure, the report said. This practice fell afoul of best accounting principles and led to underestimating the fund's actual market exposure by "billions of francs," the report said.
Use of derivatives was extended to other asset classes from the beginning of 1993. By the end of 1993, the report said, the pension fund's portfolio hardly contained any physical investments, instead synthetically replicating exposures. Some banks warned the fund of possible risks, the report said.
In August 1993, the fund's general manager, Frederick Haas, informed the finance committee of violations of legal and policy investment limits, the report said. As a result, the fund put in place a 100 million franc equity swap to reduce exposure to Swiss stocks. But Mr. Haas undermined this move by buying stock futures, taking advantage of a rising stock market, the report said.
Still, the strategy worked, resulting in gains of 320 million francs in 1993, of which about 200 million francs were booked. In January 1994, the fund gained a further 100 million francs.
Liquidity crunch hits
But things starting going wrong in February 1994, when the U.S. Federal Reserve starting hiking interest rates, throwing global markets into a tizzy. Interest-rate volatility caused a liquidity crunch for the highly leveraged fund in February and March, leading the fund to unload shares in foreign investment pools and to borrow money.
Also, an "extremely dubious sale of options" and a special investment arrangement with the fund's parent company, which shifted the entire investment risk to the fund, also occurred, the report said.
In May 1994, the fund board, headed by Landis & Gyr Chief Executive Willy Kissling, tried to limit the losses through more regular realization of profits, risk reduction and abandoning the above-average earnings objective, the report said.
Shortly thereafter, Mr. Haas resigned his position, effective six months later. Pension assets were transferred to a new L&G subsidiary, restructured to meet legal requirements, and subsequently were farmed out to external banks.
In November, an interim audit revealed the fund had lost 412.5 million francs as of Sept. 30, 1994, resulting in a net loss of 173.2 million francs.
By the end of 1994, the pension fund had a shortfall of 34 million francs and was 94.6% funded - down 2.5 percentage points from three years earlier when the strategy had started.
In reality, however, the Landis & Gyr fund was that well funded only because of a 92 million franc contribution and an increase in the interest rate used in calculating pension liabilities to 4.5% from 4%, the report said.
"Without these two changes, the shortfall would have been around 104 million (francs) higher and would have been approximately 138 million (francs)" - compared with the 18 million franc deficit at Jan. 1, 1992, the report said.
Pension officials criticized
The Revisuisse Price Waterhouse report said Mr. Haas did not follow either the fund's internal investment guidelines or federal law.
Nor did he seek authorization for use of certain investment instruments or properly account for the derivatives exposure, thus giving an overly rosy picture of the fund's true status, the report said.
The report also said Josef Follpracht, chairman of the fund's finance committee and the company's chief financial officer, failed to put in place adequate controls, although he had told committee members and Mr. Kissling that controls were sufficient.
Mr. Follpracht reportedly was dismissed in November 1994 by the company for providing incorrect information on the pension fund's status.
Mr. Kissling and other members of the fund board also failed to monitor the finance committee properly, instead trusting too much in Mr. Haas and Mr. Follpracht, the report said.
The report also criticized the fund's auditor, Schweizerische Treuhandgesellschaft Coopers & Lybrand, for failing to paint a correct picture of the fund's exposure and not pointing out the fund lacked the internal resources to engage in derivatives investments.
In a statement, STG-Coopers & Lybrand categorically denied the charges, saying the accounts met legal requirements. What's more, in its 1993 report, sent to the pension foundation and to regulatory authorities, the auditor had noted the lack of risk controls at the fund and the weakness of the internal control system. In an interview, Mr. Haas said he has been made the scapegoat unfairly, and that he had acted at the direction and with the full knowledge of his superiors. "They had full insight into what happened," he said.
He said the full report is riddled with contradictions and has been rebutted by the chief players. He also claimed Landis & Gyr has suppressed distribution of the full report. Mr. Haas is in litigation with his former employer over alleged harm to his professional reputation.
Landis & Gyr officials did not respond to numerous requests for comment.
Revisuisse Price Waterhouse, he said, was hired to pin the blame on someone for the losses - but not to investigate the roles of Landis & Gyr executives or regulatory authorities in the losses. "In the end, I am the culprit," he said.
He asserted Swiss authorities want to sweep the true story under the rug.
Beat Moos, a lawyer with the canton of Zug's internal affairs department, said it was not Revisuisse's job to investigate the role of the company or the canton, especially because the canton had commissioned the report.
What's more, he said it is the role of the auditor to spot problems in a pension fund's statements under Switzerland's self-regulatory system. Since the Landis & Gyr crisis emerged, there has been discussion on increasing the role of the government, but he said the canton lacks the resources. "We have no financial analysts," he said.
Meanwhile, Landis & Gyr was acquired earlier this year by Elektrowatt AG, an electricity and technology group based in Zurich. The firm has pumped 120 million francs into the fund to make up a shortfall.
An 18-month-old criminal investigation by the Zug cantonal authority into the Landis & Gyr pension losses was dropped May 17.