55 Pa. Districts Victimized by Alleged Financial Scheme
Dozens of Pennsylvania school districts are reeling from an unfolding scandal in which a financial adviser to whom they entrusted hundreds of millions of dollars in public funds is accused of defrauding them of at least $71 million.
The alleged fraud involves proceeds of municipal-bond issues invested by 55 small and medium-size school districts in central and western Pennsylvania with a firm controlled by John Gardner Black, a 53-year-old investment adviser based in Tyrone, Pa., who once worked as a consultant to the state education department.
The federal Securities and Exchange Commission charges in a lawsuit that Mr. Black and two firms he controlled, Devon Capital Management Inc. and Financial Management Sciences Inc., sought to hide investment losses by providing the districts with falsified financial statements assuring them that their investments were fully backed by a pool of collateral securities.
In fact, the SEC charges, Mr. Black was overstating the value of the assets in the collateral pool by $71 million.
Furthermore, the commission says, Mr. Black sought new clients to ensure a steady stream of new assets so that existing investment clients could be paid off when their securities became due.
"He was misleading new investors by failing to disclose that on the day they handed over their money, it was immediately diluted by the undisclosed losses in the pool," Merri Jo Gillette, the assistant administrator for enforcement in the SEC's Philadelphia office, said in a recent interview.
Federal officials say the arrangement amounted to a "Ponzi scheme," in which new investors must be brought into a scheme to pay off old ones.
The suit, filed Sept. 27 in U.S. District Court in Pittsburgh, also alleges that Mr. Black and his companies benefited from the alleged fraud by using at least $2 million in school district funds for personal and business expenses.
During a brief appearance in federal court in Johnstown, Pa., late last month, Mr. Black acknowledged that his actions are also the subject of a separate criminal investigation. A judge rejected his request for $525,000 from his frozen assets to pay his lawyers and $127,000 for living expenses for the next six months.
Michael Nussbaum, Mr. Black's lawyer, did not return phone calls seeking comment last week.
Meanwhile, state and school district officials in Pennsylvania have been wondering how so much public money could have been put at risk.
"This was an absolute shock," said Jay Himes, the executive director of the Pennsylvania Association of School Business Officials. "This firm was well known. I don't think anybody suspected anything of this magnitude."
Mr. Black reportedly built up a business serving as an investment adviser to school districts after his experience more than two decades ago in the Pennsylvania education department and through a partnership with a one-time state revenue secretary.
Mr. Black and Devon Capital Management developed creative bond-investment strategies for school districts and other public agencies that resulted in higher rates of return, and thus, financial benefits for the districts. The alleged fraud also involves seven districts in Michigan and Kentucky and a handful of other governmental agencies.
"The company came highly recommended," said Coleen Heistand, the acting superintendent of the 2,400-student Northern Lebanon school district in Pennsylvania. The district has one of the largest amounts of money invested with Devon, some $25 million.
She said district officials did not even realize that Mr. Black had invested the funds in an unusual vehicle called a collateralized investment agreement, or CIA. The SEC says that Mr. Black told districts their money would receive a specified rate of return and be backed up by a 100 percent collateral pool. If that had been the case, the investment wasn't especially risky, experts said.
But unknown to his clients, the SEC says, Mr. Black made some unwise trades and began to incur losses in January 1995 of at least $50 million. That is when he allegedly began making misrepresentations to hide the losses.
Some Money Available
A federal judge froze the assets of Mr. Black and his two firms and appointed former Pennsylvania Gov. Richard L. Thornburgh as a trustee to sort through the financial mess.
In a report to the judge and in an interview last week, Mr. Thornburgh, who is also a former U.S. attorney general, was pessimistic about school districts' prospects for recovering all of their investments.
"I think it is highly unlikely that every claimant is going to recover 100 cents on the dollar," he said in the interview.
The freeze has created difficulties for some districts, a few of which even had operating funds invested through Mr. Black. Late last month, a judge agreed to Mr. Thornburgh's request to unfreeze 50 percent of the current market value of districts' funds. Mr. Thornburgh said returning that money to the districts would help them meet current obligations.
But some districts are refusing the offer out of a fear they will give up other legal claims.
"It's blackmail," said David Hall, the business manager of the 5,000-student North Hills school district near Pittsburgh. "They should release our money, and if they find that we owe money, then bill us. We're not going to Brazil."
But Mr. Thornburgh said districts will not give up any claims by taking 50 percent of their money now. And it would be unwise to refund 100 percent of any single district's money when so much about the alleged fraud has yet to be untangled, he said.
State officials have begun to examine whether the scandal could have been avoided. State Treasurer Barbara Hafer has been appointed to chair a task force to examine school districts' investment practices.
State Auditor General Robert P. Casey Jr. told a state legislative panel that he believed the CIA arrangement offered by Mr. Black was not authorized for public funds under state law. He recommended more frequent audits of district investments by state officials.
But he said it would be difficult to completely guard against "misrepresentation and fraud," which "can potentially occur regardless of the riskiness of the underlying investment."