The Dangers of Relying on a Legal List: West Virginia Consolidated Investment Fund - Book Report/Review Example

A Review of the Article “The Dangers of Relying on a Legal List: A Case Study of the West Virginia Consolidated Investment Fund” by Vernon Hayes The primary objective of the article “The Dangers of Relying on a Legal List: A Case Study of the West Virginia Consolidated Investment Fund” by Vernon Hayes is to use the example and cautionary tale of the West Virginia Consolidated Investment Fund and the financial and political scandal that it had undergone to demonstrate the pitfalls of relying on a “Legal List” of permissible investment instruments, rather than operating under the “Prudent Person Rule”. To quote the author, “this article is a case study of what happened in West Virginia; how its reliance on the legal list fiduciary standard might have contributed to the losses that still affect the financial picture of the state today; and how it is important for govemmental units to implement cash management strategies, and to hire qualified people, in order to adequately protect the public’s money from financial disaster.” (Hayes, 1999: 51). The story began in 1978, when local governments were encouraged to pool in their investment money with the West Virginia State in the Consolidated Investment Fund, managed by the West Virginia Investment Management Board. At first, the local governments were reaping massive returns. In 1984, James Manchin became State Treasurer. The guidelines imposed on the Consolidated Investment Fund were at first very strict: only investments with a maturity date of no longer than ninety days can be entered into by the Fund to protect against market fluctuations. However, because Manchin and his deputy, Margolin wanted to make more aggressive investment strategies, the maturity was extended to ten years. The investment strategy became bolder and the fund engaged in heavy-volume, short-term treasury securities trading (ibid at 52). There was also heavy reliance on futures contracts. This was a strategy that paid off in the beginning, but only a year later, because of an embargo imposed by then President Ronald Reagan on Japan (ibid, at 53) the bond market fell down sharply and continued on a steady decline for months. A series of stopgap measures only heightened the problem – entering the reverse repurchase agreement market only exacerbated the losses. Paying the local governments interests when the fund was no longer making profits but was operating on a loss cost the fund several millions of dollars. Manchin allegedly tried to conceal the losses at first but the hiring of an independent auditor revealed a $160 million imbalance in the account books. There was great public outcry surrounding the revelations of the auditors, exacerbated by Manchin’s apparent ignorance of basic accounting and financial procedures. Manchin was then impeached by the House of Delegates, with a finding that he knew about the hemorrhage since 1987 but did not do anything to stop it. He then resigned to avert any more political scandal and save the future political careers of his relatives. The central argument posed by Hayes in this article is that the “legal list” may have contributed to the losses incurred by the State of West Virginia. To quote the author himself, “By limiting the investment instruments available to Manchin's office, the state forced him to invest in riskier investments within the list, rather than allowing for investment in instruments that might have presented less of a risk to the state.” (ibid, at 58). His conclusion therefore is that the state of West Virginia might have been better served by an application of the “Prudent Person Rule” rather than by the “legal list” rule. Credit must indeed be given to the author for giving us an opportunity to revisit one of the examples of State investment strategies gone bad and the political fall-out arising from it. The author’s contribution lies in a thorough and compelling analysis of the chain of events that has led to the collapse of the Consolidated Investment Fund in West Virginia, and the series of bad decisions that had only exacerbated the crisis and perhaps led to the West Virginia’s current less-than-ideal economic conditions. His conclusion, however, that legal lists were ultimately to blame for the economic woes befalling the State of West Virginia could have been better argued and corroborated by supporting evidence. It is true that the “Prudent Person Rule” has reaped more benefits from the states applying it than states applying the “Legal List” rule. As one analyst has written, as early as 1952 – In practice, trustees who have been able to utilize the Massachusetts Rule and include common stocks in their investment portfolios have fared far better than their legal-list cousins. The average yield in recent years has never greatly exceeded 2% for this latter group, while trustees operating under the Prudent Man Rule have averaged at least 4% .30 It is a hollow victory for "prudence" when one considers the countless wealth that might have gone to life tenants but for the legal-list. (Murray, 1952: 113). However, given the fact that the West Virginia case was riddled with allegations of non-disclosure and perjury, i.e., that Manchin had known of the shortfalls but had concealed it, the Prudent Person Rule would only have made the task of subsequently prosecuting Manchin easier, but it would not have been able to protect the State investment fund from the hemorrhage. In the first place, there had been no problem in the prosecution of Manchin – as can clearly be seen, despite his initial popularity, he was impeached by the House of Delegates. The main problem was the series of bad decisions that had been made. It is entirely plausible to imagine a situation where there was no legal list in place, and in a state of panic, then treasury department of West Virginia would engage in haphazard trading and investing in more risky investments, all in a desperate attempt to arrest the hemorrhage, thus intensifying the crisis and putting the State in greater compromise. The author Hayes had argued that the legal list had prevented the officials of West Virginia from engaging in the investment of instruments that might have been presented less of a risk to the State. However, the converse is as valid – the absence of a legal list would have allowed the State to gamble in investment in riskier instruments. Given the political mess that the Treasury Department was in and the finger-pointing resulting from the fall-out, as graphically illustrated by Hayes, it is all too easy to imagine ill-conceived decisions being made – at best, the result of haste; at worst, prompted by personal interest and the need to cover one’s back. There is of course mainstream support for the Prudent Man rule, and this is something that this Review will not dispute. It is economically more viable, and offers more freedom as long as prudence is not sacrificed. But what this Article by Hayes misses is a direct correlation to persuade the reader that indeed, the legal list is complicit in the economic woes of West Virginia and the application of the Prudent Person Rule might have saved the day. At the end of the day, however, it remains a compelling and sharp analysis of the events leading to the fiasco in West Virginia and the immediate aftermath. There is still much to learn and reflect from this incident. It is not simply an issue of accounting, but an issue of politics as well – and ultimately the greater lesson is that power unchecked can lead to disastrous, irreparable consequences. REFERENCES Hayes, V. R. (1999). The Dangers of Relying on a Legal List: A Case Study of the West Virginia Consolidated Investment Fund. Public Budgeting and Finance, Winter: 49-64  Murray, G. C. (1952) “Economic Consequences of the Virginia Legal Investment Statute 1 Wm. & Mary Rev. Va. L. 106. Available at http://scholarship.law.wm.edu/cgi/viewcontent.cgi?article=1034&context=wmrval&sei-redir=1#search=%22virginia%20legal%20list%20prudent%20person%20rule%22 Read More