CDR Financial Products Inc., a financial adviser to states and cities, and its founder, David Rubin, pleaded guilty to federal fraud and conspiracy charges last month in New York.
Prosecutors accused them of rigging municipal- bond sales so taxpayers in New York and other unnamed states paid extra to raise billions for government projects.
CDR faces fines of up to $100 million; Rubin faces up to 35 years in prison.
Rubin's firm is based in Beverly Hills, Calif., but in the early 2000s, it had clients across the United States, including Democratic-run states such as California, New Mexico, New York, and, at the time, Pennsylvania.
Like other government financial contractors in those days, Rubin was a contributor to leading politicians - in his case, prominent Democrats such as then-Gov. Ed Rendell and then-Philadelphia Mayor John F. Street.
Rubin served on Rendell's gubernatorial transition team. His firm advised Philadelphia on interest-rates swaps, complex financial contracts designed, for example, to let borrowers raise money at slightly lower interest rates and protect them from the risk of rising rates, in exchange for agreeing to pay banks and in- vestors compensation if rates fell.
Swaps and other "derivative" financial contracts became legal for Pennsylvania towns and school districts under a law Rendell signed in 2003. Wall Street swaps salesmen swarmed the state and signed hundreds of deals. But in the 2008 financial crisis, as interest rates spiked high, then collapsed to nearly nothing, swaps costs rose, prompting governments to pay to get out of the contracts and refinance their debt.
Lawyers at Klehr, Harrison, Harvey, Branzburg L.L.P. and accountants at ParenteBeard L.L.C., both based in Philadelphia, spent 10 months writing a 130-page "forensic audit" for the Harrisburg Authority on how that city's incinerator turned into a $300 million financial disaster.
The audit, released last week, said Harrisburg's troubles included elected officials' failure to make sure the project could pay for itself; conflicts of interest by public officials who worked for contractors; and a string of financial swaps agreements that "added complexity, risk," and "potentially" millions in costs.
None of the government officials or their hired experts "adequately evaluated or assessed the potential risks," the auditors wrote. The audit said this resulted in, for example, millions in payments to Royal Bank of Canada for setting up swaps contracts of questionable value, and in decisions not challenged by paid pros such as Philadelphia-based Public Financial Management Inc. (PFM), the nation's largest muni-bond adviser; or Milt Lopus, a former PFM official who set up his own advisory business; or Pottstown- based Investment Management Advisory Group Inc., which advised the authority on swaps deals.
"The swaps are not the reason for the authority's financial difficulties," Royal Bank of Canada spokesman Kevin Foster told me. "The swaps have worked as expected and have reduced the interest expense
of the authority's debt."
But Harrisburg City Council- man Brad Koplinski wants "a federal investigation," he says. "This entire process has been about greed."
The nonprofit Pennsylvania Budget and Policy Center and the Fight for Philly group last week estimated at more than a half- billion dollars the cost of ending swaps agreements for the city and its public agencies, plus the cost of entering into swaps deals in the first place, instead of just selling bonds. Center head Sharon Ward called on JPMorgan Chase & Co., Wells Fargo & Co., and other banks to return the money.
"We understand people are angry. But their report is really wrong," Philadelphia City Treasurer Nancy Winkler told me.
A former head of PFM's municipal-bond unit, Winkler and her deputy, fellow PFM alumnus James M. Lanham, along with Water Department finance chief Joseph S. Clare III, say the center's report exaggerates the cost of swaps because it compares the city's actual costs over multiyear financial contracts to hypothetical costs at today's record-low rates.
The city officials were unable to give more precise numbers representing actual costs and benefits of swaps. "It would take an extraordinary amount of work," Winkler said.
Still at it
Two years ago, state Auditor General Jack Wagner called on Pennsylvania to ban swaps sales to towns, citing losses in Bethlehem and other cities.
"It upset me, to paint us with the same brush," Christina Ward, a senior finance official at the Philadelphia School District, told me. "We were much more conservative." The district had a negative $39 million swaps position in its last financial report, after paying $60 million- plus to replace previous swaps.
Pennsylvania towns continue to enter what the state calls "qualified interest-rate-manage- ment agreements." In the last three months, state records show, 22 towns and school districts have bought swaps and other "qualified" agreements.
Contact Joseph N. DiStefano at 215-854-5194, JoeD@phillynews.com, or @PhillyJoeD on Twitter.