Illinois State Comptroller candidate Clint Krislov’s analysis of the Illinois’ Bright Start Program and its experience with Oppenheimer
Statement of Clint Krislov:
It is time for Raja Krishnamoorthi to answer some tough questions about his management and oversight of Illinois’ Bright Start program. Raja claims credit for supervising the Bright Start program, but who was actually watching the investments?
Raja claims Bright Start program is one of top College Savings programs, yet all but one of Illinois funds lost 50 – to- 400% more than their benchmarks?
Who’s going to compensate the 185,000 Bright Start families for the rest of the 40% of their tuition money lost in Oppenheimer’s derivative swaps trading in its Core Bond and Fixed Income funds?
Raja welcomed parents into the program and promptly switched the plan sponsor – his choice, Oppenheimer.
Raja left when most of the funds cratered, performing vastly worse than their benchmarks. Instead of staying with the office to fix what he broke, Raja left, to run for the next political office.
Raja has turned into the typical Illinois politician: Ducking responsibility for mistakes made, and leaving Illinoisans to pick up the pieces.
We don’t need a new generation of the same old talk. As the Daily Herald said, we need more than just talk.
I’ve taken on battles with the City and State, and stayed with them, even when it’s taken years to win. As our Comptroller, we need someone who’s going to stay with this until it’s fixed. I’ll pledge that.
Illinois needs someone who sees the Comptroller office as the opportunity to fix Illinois’ finances, now, more than ever.
Where will Raja and David Miller be, what will they do, when the next political opportunity presents itself?
There is no dispute that the state’s Bright Start experience with Oppenheimer has been a disaster for 185,000 families who lost some 40% of their savings for their children’s tuitions.
OK, so the Treasurer’s office is getting them back half of their losses; where do they get the rest of their college savings back? Don’t you think Illinois owes them more? I do.
When the heat was on, instead sticking around to fix the problem, Raja decided to run for Comptroller.
Who in Illinois government is going to get the rest of their money back? Don’t we owe it to them to hang around and fight for those families?
We need a comptroller who’s there for Illinois families when times get tough. A taxpayer’s watchdog who understands complex financial transaction and documents.
The following is Clint Krislov’s analysis for Illinois’ Bright Start program
1) What is Bright Start?
Bright Start is Illinois’ version of the so-called “529” investment funds. These are investment options for parents of children to save for college. The State’s endorsement of these portfolios means an investment in the funds will be free of state and federal tax on any growth or income, as long as the proceeds are used for college expenses.
The State selects the investment portfolio managers, and the programs. Some are automatic. Parents can select portfolios based on their children’s ages (0-6 years old, 7-9. 10-11, 12-14, 15-17, and age 18 portfolio) which automatically shift the child’s investment as the child ages, presumably favoring growth for youngest ages (in the view that over long time spans, growth will make up for risk and volatility), moving towards more conservative investments as the child approaches college age, and will need to use the money very soon.
There are other portfolios available (an Equity Portfolio, A “Balanced” Portfolio, and a “Fixed Income” Portfolio, plus a “Principal Protection Income” Portfolio, so-named for their being, respectively, devoted to growth, balanced growth and income, solely interest income, and most conservative protection against loss.)
2) What did our Treasurer do?
Shortly after Mr. Krishnamoorthi came to work for the Treasurer’s office, the entity charged with overseeing the program, the office replaced the Legg Mason funds with Oppenheimer-managed funds.
3) What happened?
Virtually all Bright Start portfolios lost large amounts, notably greater than their benchmark indices.
Over the period through June 30, 2009, all but one of the Bright Start Fund portfolios “underperformed” their benchmarks. That is, they performed worse—in many cases, much worse—than the indexes (indices) they were to be measured against.
For example, the Direct Sold-Blended portfolio for 7-9 year old children lost 25.64% over the previous year, 50% more than the 17.11 percent loss in the benchmark.
The 10-11 year olds’ portfolio lost 25.95%, nearly 100% greater loss than the benchmark’s 13.79%loss.
The 12-14 year olds’ portfolio lost 23.35%, more than 100% greater loss than the benchmark’s 10.47% loss.
The 15-17 year olds’ portfolio’s loss of 20.68%, was approximately five times the benchmark index’ loss of 4.5%.
And the portfolio for 18 year olds (remember, 18 year olds’ money needs to be very conservatively invested, since it will begin being needed for expenses in less than a year) lost 13.14%, compared to the benchmark’s gain of 2.6%.
Only the Equity Portfolio’s Loss of 25.31% was slightly better than its benchmark loss of 27.10%.
The “Balanced Portfolio” lost 32.38%, three times the benchmark’s loss of 10.61%. But the worst –the Fixed Income Portfolio-supposed to be all investment grade bonds, lost a whopping 40.48 percent of its value in the one year, while its benchmark index increased 5.77%. (Source-Office of the Illinois Auditor General, Management Discussion and Analysis portion of Bright Start Audit Report for Year ended June 30, 2009, at page 2.)
These are startling differences which could not have been ignored.
4) Why did this happen?
The most flagrant problem appears to have been in Oppenheimer’s Core Bond Fund and Fixed Income Strategy. Rather than merely investing parents’ money in investment grade fixed income (i.e., bonds), Oppenheimer apparently attempted to “juice” the earnings and commissions, by instead selling so-called “Swaps” in these portfolios. Swaps are transactions, similar to short-selling, in which the purchaser gets paid if other investments go down. This is akin to a bond fund selling bets against bonds. These are the same type of “deals” that hemorrhaged Lehman, Bear Stearns and AIG into bankruptcy or federal rescue, in order to survive.
5) Was this wrong to do?
Absolutely. For a fund that is represented to be solely in investment grade bonds, it is like taking family’s food budget to the track, and getting off-balance on the wrong side of a hugely risky gamble.
6) Who discovered the problem? Could or Should someone have discovered this earlier?
According to the complaints filed in other Oppenheimer cases, it was uncovered by Morningstar, not the State of Illinois.
While some argue that it could have been uncovered by actually checking to see what the Oppenheimer funds were invested in, there are also allegations that the swaps were concealed.
What is certain is that there were two significant drops in the funds. Someone should have been on notice with the first drop.
7) What efforts have been made to recover the losses?
Some investors brought class actions, and Oregon sued Oppenheimer for its 529 funds. All of the cases brought in federal courts have been “centralized” and coordinated in the Colorado U.S. District Court.
Instead of suing, Illinois and four other states chose instead to negotiate a settlement.
8) What are the terms of the settlement?
Although the Treasurer’s office has not publicly posted the settlement, and offers only summary descriptions, we obtained a copy by a Freedom of Information Act request, and have it posted on our website www.ClintforIllinois.com.
Oppenheimer will pay $77,230,000, which will be divided among the Bright Start investors whose Bright Start portfolio lost money in Oppenheimer’s Core Bond Fund and Core Plus Fixed Income Strategy. Originally boasted as an 80-90% recovery, it appears that the potential claimants was at some point “expanded” to include many more affected people; so the recovery is now estimated at approximately 50% of the Oppenheimer losses from those two funds.
The actual amount that anyone is entitled to is determinable only by a complex calculation of daily losses attributable to the Core Bond Fund and Core Plus Fixed Income Strategy losses. Class members will eventually receive a written report of their share of the recovery before having 180 days to accept the amount and release any claims. Any unclaimed amounts will be eventually transferred to the State Treasurer as unclaimed property, rather than the more normal procedure of adding the unclaimed proceeds to increase the recoveries for those who do make claims.
What is wrong with the settlement?
Although it will be a significant amount of money, obtainable relatively sooner than the class actions are likely to be resolved, we think there are some problems that should have been addressed differently.
Questions:
What happened to transparency and truthfulness?
How can portfolios that lost 50% to 400% more than their benchmarks be called acceptable?
How come no one actually looked at what the families’ money was being invested in?
Why was the settlement not promptly placed on the web, for all 185,000 affected families to evaluate?
Why no objection opportunity? Our class action settlements routinely give notice to affected class members, with opportunity to object. We’ve objected to, and improved, other settlements in the past.
Where the State Treasurer’s office failed, and needs improvement:
1) There seems little reason why the Bright Start investors should not recover 100% of their “swaps-based” losses in the Oppenheimer Core Bond Fund and Core Plus Fixed Income Strategy. For funds that were presented to be investment grade bonds and securities, this was like engaging in a bait and switch that was entirely inappropriate. Since no litigation was filed, and no discovery occurred, there is, of course no information available on the commissions that Oppenheimer earned on these swap deals, and whether Oppenheimer is actually net profitable on all this, even after the $77 million repayment.
2) When the State wraps its label on an investment and solicits families to invest, it has a duty to patrol those investments to make sure that they are really being invested in what the state represents them to be in. If the state is going to represent to parents that this is the easiest way to invest for children’s college expenses, with television advertising to induce people to invest in Bright Start, the state owes these parents the guarantee that they are what they purport to be.
So the state has to either guarantee that the investment is what it presents itself as, or have the plan sponsor guarantee that its investments will be in what they advertise. This is entirely different from guaranteeing a return or a profit.
The State’s decision to let Oppenheimer off at a 50% payback might well leave some families justifiably looking for a way to make the State come up with the rest of what they lost by investing in reliance on the State’s solicitation. The State’s sovereign immunity ought not shield it from liability for soliciting unsophisticated families to invest their children’s college savings in state programs, without adequately supervising to ensure that they are truthfully advertised and operated.
3) The Bright Start families should be made whole for their Oppenheimer Core Fund and Strategy swaps losses. 100% in full, and the state should have held out for that full recovery. Sometimes, you just have to sue. Our justice system may not be perfect, but negotiation without discovery is often deluding ourselves to think we know what was going on, when we don’t. In the securities fraud area, negotiations with insufficient information is a certain ticket to inadequate recovery.
4) Illinois needs Debar legislation, that would presumptively bar a vendor who defrauded Illinois government entities, like the Bright Start program, but lots of others, from eligibility for any government contracting for five years. Certainly there could be good cause shown for limited exceptions. But, the idea that contractors can defraud Illinois governments and citizens, yet keep coming back to the trough—simply has to end.
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