In July and August of 2007, the state agency that manages billions of dollars in public investments bought at least $2.3-billion in securities from three Wall Street firms.
Within just weeks, financial rating firms began downgrading those investments — a development that diminished their value and touched off a series of aftershocks at the State Board of Administration:
• In February, the U.S. Securities and Exchange Commission asked the SBA to turn over a mountain of records on the investments. The SEC wants to know if the state agency mishandled the investments and the Wall Street firms made improper sales.
• In April, an audit ordered by the SBA's board of trustees found widespread problems in five of the investment funds managed by the agency. Some of the securities' sales were improper, the audit said, and oversight was lax.
• Now, a legal showdown may be near. Lawyers hired by the SBA have concluded they have grounds to sue the Wall Street firms, and the state's Office of Financial Regulation — a watchdog agency that supervises financial institutions — has issued subpoenas.
"The taxpayers should be wondering about a whole array of issues around this situation,'' said Florida Chief Financial Officer Alex Sink, who has pushed for investigations of the debacle.
The SBA manages $159.6-billion in assets in 33 funds. The largest is the state's retirement and pension fund for 1.1-million public employees, retirees and their family members. The agency also handles investment accounts for the Florida Lottery, the state's hurricane catastrophe fund and a local government fund where nearly a thousand counties, cities, school districts and other local entities keep surplus cash.
The agency, which employs about 160 people, is governed by a three-member board of trustees who also make up a majority of Florida's Cabinet — the governor, the attorney general and the chief financial officer.
The SBA's problems came to light last year shortly after the mortgage market hit the skids. Local government agencies began yanking money from the SBA's local government fund amid concerns that it held shaky, mortgage-related securities.
The turmoil left some local agencies struggling to pay salaries and bills and led to the resignation of the SBA's executive director, Coleman Stipanovich.
At the center of the controversy are three Wall Street giants that offer brokerage services to the SBA: JPMorgan Chase, Credit Suisse and Lehman Brothers.
Between December 2006 and December 2007, records show, a bulk of the now-suspect investments — 42 percent — was sold to several SBA funds by Lehman Brothers.
Lehman Brothers hired former Gov. Jeb Bush as a consultant in June 2007 — five months after he left office and the SBA board of trustees. In July and August, Lehman sold many of the securities that were soon downgraded.
Earlier this week, Bush repeated earlier statements that he played no role in the Lehman Brothers sales.
"I was not involved in these investments by the State Board of Administration,'' Bush said in an e-mail. "The decisions were made by the SBA when I was no longer governor. In my role as a consultant to Lehman Brothers, I have absolutely nothing to do with any sales or trading related to the State Board of Administration.
"Markets across the globe have been affected by subprime mortgage issues. The Florida Cabinet and State Board of Administration are doing the right thing by working to protect the remaining local government investment pool participants.''
Stipanovich, the former executive director, was appointed by Bush and the other two trustees in 2002. He did not return three calls for comment. Stipanovich is the brother of J.M. "Mac'' Stipanovich, a prominent GOP lobbyist who advised Bush's 1994 gubernatorial campaign.
The SBA's current trustees have said they were caught off guard by the crisis over the local government fund.
Sink, who became chief financial officer in January 2007, noted that Florida has a longstanding relationship with Lehman Brothers. She said she has no evidence of wrongdoing by the firm or Bush.
But Sink said she wonders if the Wall Street firms dumped tainted securities on Florida and other states.
"I believe I read that Lehman had decided in December of '06 that they wanted to reduce their own firm's exposure to these types of investments,'' Sink said. "It just makes you wonder if they're going to reduce their exposure, then they have to sell off their investments to some other purchasers.''
Gov. Charlie Crist, who has been a trustee since 2003 when he became attorney general, agreed with Sink. He said the state is aggressively pursuing how the investments "were sort of dumped on Florida. ...Who knows, there could have been fraud involved in that.''
Crist singled out the three Wall Street firms and KKR Financial, an affiliate of Kohlberg Kravis Roberts & Co., the giant buyout firm. KKR Financial issued huge amounts of risky, short-term debt that the three Wall Street firms sold to the SBA.
The governor said he understands that the Wall Street firms tried unsuccessfully to sell some of the "investments that went south'' to other states. So why did the SBA buy them? he asked.
Crist also said that Bush was an honorable person and that he couldn't believe he would ever be "involved in anything nefarious.'' But he suggested that Lehman Brothers may have hired Bush to try to gain influence with the SBA.
"I hope that he wasn't sort of used,'' Crist said.
Attorney General Bill McCollum, who became an SBA trustee in January 2007, declined to comment. His press secretary, Sandi Copes, said that the trustees "do not directly oversee day-to-day management'' of the SBA. That's the job of SBA managers, she said.
No one knows how much investors will lose or recover from the problem securities. But state Rep. Carl Domino, R-Jupiter, who led a House inquiry on the SBA, said the losses may be less than $100-million.
"It's a lot of money, but relative to the losses suffered by other participants in the capital markets, it's not exceptional,'' Domino said.
SBA officials say that, given time, they are optimistic the problem securities will regain their value.
Despite the current woes, they say they have one of the nation's best public investment management teams, with a pension fund that is fully funded, unlike most public pension funds in the United States.
They say they bought the troubled securities, known as "asset-backed commercial paper," because they were top-rated and considered safe, low-risk investments.
Yet to some in the investment world, asset-backed commercial paper — a type of short-term loan backed by something valuable like a home mortgage — is considered extremely complex.
"Bankers talk about them as neutron bomb products,'' said Charles Grice, a former Federal Reserve official who advises companies on financial regulatory issues. "This is like passing out a grenade at a cocktail party, and Florida got caught holding the grenade.''
According to the four-page document request the SEC sent to the SBA, the federal agency is focusing on at least 10 securities, including those that were purchased from Lehman Brothers, Credit Suisse and JPMorgan Chase for three state investment funds.
Jack Kiefner, a securities lawyer in St. Petersburg who formerly worked for the SEC, said the broad scope of the documents requested suggests that the federal investigation is serious.
Meanwhile, the SBA's lawyers have concluded that the Wall Street firms improperly sold three securities to the SBA. Litigation "may be imminent,'' Robert F. Milligan, the SBA's acting executive director, told the SBA's trustees Wednesday.
Lehman Brothers denied making improper sales to the SBA. Credit Suisse and KKR Financial declined to comment. JPMorgan Chase did not respond to requests for comment.
The SBA's internal audit, conducted by the Clifton Gunderson accounting firm and released last month, found dozens of instances where brokers like the Wall Street firms made improper sales of securities to several SBA-managed funds.
The auditors also uncovered conflicts of interest because some of the SBA employees handling investments also monitored their own trades.
In addition, the audit said, SBA managers ignored their own rules and purchased securities through unapproved brokers.
They also failed to notify their bosses when investments fell below purchase guidelines, the audit said.
For example, the audit found five instances where securities in Florida's catastrophic hurricane fund were downgraded between August and October 2007. But it was not until February 2008 that hurricane fund staff became aware of the problem, according to the audit.
The audit attributed much of the SBA's problems to weak oversight. It noted that seven comparable states have boards of directors with nine to 17 members, including financial professionals and investors or retirees with a stake in the system. The Florida board of trustees has only three members — the statewide elected officials.
In his response to the audit, Milligan, the acting SBA chief, said the agency has already made key changes. It has reorganized jobs to eliminate potential conflicts of interest and plans to hire a consultant to re-examine investment policies.
This isn't the first time SBA has faced charges of unwise investments. In 2002, the agency lost $280-million on Enron stock, some of it bought while other investors were unloading it.
Last year, before problems with the local government fund emerged, another audit found the SBA was not adequately supervising risky investments.