MINNEAPOLIS — The Minnesota Orchestral Association’s board of directors is a virtual who’s who of civic elite. The 90-year-old symphony orchestra is just the kind of institution that has long entrusted its financial affairs to Piper Jaffray Cos., a venerable financial-services firm at the pinnacle of Minneapolis’s small, tightly woven business-civic community.
But in the past few months, the cozy relations have been badly frayed as the orchestra watched the value of its derivatives-laden Piper Jaffray investments plunge about $2 million. The orchestra is among thousands of Minnesota charities, government agencies and individuals whose investments have declined sharply in value.
Those losses, which on paper could exceed $700 million, resulted from the decisions of one portfolio manager. Although most of the losses are still unrealized, many of Piper’s investors contend they were misled into believing that they were making a conservative investment, and some are suing for compensation.
“We do not believe we have done anything wrong,” says Addison L. “Tad” Piper, the firm’s 47-year-old chairman and chief executive.
Piper, of course, isn’t the only financial firm to take hits related to derivatives recently. Several others have felt compelled to compensate investors for their losses. But so far, Piper has resisted.
Until the portfolios run by Worth Bruntjen blew up, the 99-year-old firm had a reputation for being, if anything, too conservative.
“Piper was the little old lady of brokerage firms,” says Robert Markman, president of Markman Capital Management, a money-management consultant here. “If they could be faulted for anything, it was that they would bore you to death.”
A similar reaction comes from Walter E. Weyler, a vice president of the orchestral society’s board who also invested personally in one of Mr. Bruntjen’s funds. He says he holds Piper’s managers “in the highest regard for the way they have run their firm and have contributed to the community, but I am very surprised about this investment. This is not a case of `That’s the way it goes.’ The fact that these investments could be so volatile was not understood by investors.”
That many in Minneapolis are dismayed isn’t surprising.
“My grandfather didn’t have a mission statement, but we always had values,” Mr. Piper says. Even after the paper losses, he was saying, during a lengthy interview last week, words that he has been repeating, with obvious sincerity, for years: “We have always cared more about our clients than ourselves.”
Mr. Piper works in a glass-walled office decorated with Indian art. His desk is made from a rosewood piano that belonged to his great-grandfather, the father of the firm’s founder. Slightly built and balding, Mr. Piper is the embodiment of the firm’s culture: He is quick to smile, and he exudes a kind of Midwestern warmth. Employees say he is the sort of boss who tells people they are working too hard and urges them to spend more time with their families.
As a child, Mr. Piper helped his father settle retail brokerage accounts during weekend visits to Piper Jaffray’s offices. Every Christmas, his father would give him and his siblings stock in some of the well-known Minneapolis companies that the firm had taken public. Among those Piper helped launch are Archer-Daniels-Midland Co. and Pillsbury Mills Inc.
“From quite an early age, I was the kid who checked the paper to look up stock quotes,” says Mr. Piper, who lives on a 70-acre farm west of the city. He joined the family business full-time after graduating from Williams College and Stanford business school, and he succeeded his father as chief executive in 1983.
About the same time, regional brokerage firms around the country were facing a common threat: The big local companies that had relied on them for financing needs suddenly began dealing with Wall Street firms offering more-sophisticated financial products. “The New York firms began flying into Minneapolis and taking clients that we had for 20 years,” says Bruce C. Huber, the co-head of Piper Jaffray’s capital-markets group. “Playing golf with the client on Saturday doesn’t matter anymore.”
In response, Piper Jaffray created an investment-banking practice that focused on a handful of industries nationwide rather than just local companies. It also started an investment-management business that, until recently, has been successful by any measure. Begun in 1985, it now handles $12 billion. “We were late getting into it,” Mr. Piper says, “but it has become the fastest-growing part of our business.”
Much of that growth was engineered by Mr. Bruntjen, who joined Piper in 1988 from Alliance Capital Management’s Minneapolis office. At Piper, his biggest success was the Institutional Government Income Portfolio fund. Until this year, the fund seemed a winner: Although investing in government-guaranteed securities, it produced extraordinary returns for a short-term bond fund. Last year, it posted a gain of almost 16% — earning top ratings from both Morningstar Inc. and ValueLine Mutual Fund Survey. And it bolstered Piper’s effort to build its asset-management reputation and attract clients.
“Seven years ago, their money-management business was virtually nonexistent,” says Eugene C. Sit, the chairman of Sit Investment Associates Inc., a Minneapolis money-management firm. “This was their flagship, and it helped them sell the rest of their funds.”
But Mr. Bruntjen’s expertise was in fixed-income securities, with a specialty in bonds backed by residential mortgages. What helped achieve those stunning returns in recent years was his involvement in certain risky mortgage derivatives known as collateralized mortgage obligations. Derivatives are instruments whose returns are linked to, or derived from, some other factor — in this case, the rate at which homeowners repay mortgages. Many of the CMOs favored by Mr. Bruntjen were supersensitive to changes in the pace of mortgage refinancings, a feature that made them behave like leveraged interest-rate options.
A veteran investor in esoteric mortgage bonds, Mr. Bruntjen boasted publicly of his ability to analyze them and use them to boost returns without undue risk. When the CMOs began to fall in value as interest rates declined in 1990 and 1991, Mr. Bruntjen boldly moved his portfolios into increasingly exotic mortgage derivatives.
The level of exotic derivatives in his portfolios started small but accelerated rapidly. From zero in 1990, exotics rose to 4% of net assets in March 1991, to 30% by March 1992 and to an astounding 90% by March 1993, according to John Rekenthaler, the editor of Morningstar Mutual Funds. A Piper spokeswoman disputes Morningstar’s calculation for March 1993; she says the derivatives were then equal to only 47% of the fund’s gross assets.
“The derivatives he used were inverse floaters, interest-only strips and principal-only strips,” Mr. Rekenthaler says. “Those are the most exotic, most dangerous and most volatile of CMOs.”
As the fund’s holdings in exotic derivatives increased, its character changed. Far from being a traditional government bond fund — relatively safe and relatively boring — it became more and more a gamble on declining interest rates. “It was an enormous interest-rate bet,” says Mr. Sit, whose firm handles $4 billion in investments.
Mr. Bruntjen, 58, who declined to be interviewed, was almost certainly motivated by a desire to produce superior returns for his investors. That, in turn, would attract more clients. His pay was based not on the return generated by funds under his management but on the amount of those funds, says Edward J. Kohler, the president of Piper Capital Management.
Mr. Bruntjen’s aggressive strategy was remarkably effective until this year. The Institutional fund returned 13.3% in 1989, 10.3% in 1990, 17.7% in 1991, 12.2% in 1992 and 15.6% in 1993. The 1993 return far exceeded that of any other short-term government fund followed by rating services. And even though the value of the funds has declined this year, investors who went into them some time ago could still be well ahead.
But when interest rates began rising, the earlier outsized gains quickly turned into losses unprecedented among short-term bond funds. While the value of all fixed-income investments, including U.S. Treasurys, declined as rates rose, the derivatives holdings account for most of Mr. Bruntjen’s losses.
The Institutional fund is off 23.3% since the beginning of this year, according to Lipper Analytical Securities Corp. Mr. Kohler says the rest of Mr. Bruntjen’s investments, which totaled $3.5 billion at year end, fell a similar percentage.
After the losses began, mutual-fund executives were astounded to see Mr. Bruntjen continue to purchase the same derivatives that were decimating the value of his portfolios.
“I am perplexed; it must be overconfidence,” says James Snyder, a portfolio manager at IDS Financial Services. “You would not expect someone with that kind of experience to not know what he was betting against or to not realize what kind of liquidity crisis there would be.”
Mr. Kohler says Mr. Bruntjen continued to buy exotic derivatives even after their market value had begun to decline because he wanted all his investors to have basically the same portfolios.
Many investors say they had no idea that they owned such exotic instruments until the value of their investments began to tumble. What they discovered was that the money they thought was in government securities was actually in securities derived from government securities; among them were “inverse floaters,” an especially volatile derivative that rises in value as interest rates fall but fell by as much as 40% as rates rose.
Although the Institutional fund’s prospectuses disclose that derivatives would be used, many investors say they had not understood that from their reading of the prospectuses and sales materials. As a result, many investors are accusing Piper of distributing inadequate information and depicting the fund as a rock-solid investment rather than what it turned out to be: a souped-up bet on interest rates.
Mr. Kohler acknowledges knowing that a rise in rates would hurt Mr. Bruntjen’s portfolios but declares: “We were not trying to make a huge interest-rate bet.” Mr. Piper adds: “We did not view it as risky. My own view is that we were doing the best job that we could. We got caught in a market that we thought we understood.”
Piper hasn’t reimbursed investors for losses, but it did invest $10 million of its own money in the Institutional fund as a show of confidence. Mr. Kohler still voices confidence the fund will recoup its losses: “These securities have recuperative powers. Bond markets always rally.”
Although many of Piper’s retail brokers blame its woes on Mr. Bruntjen, its executives continue to support him publicly. “Worth is a very knowledgeable and very sophisticated manager,” Mr. Piper says.
But others suggest that the firm may be standing behind Mr. Bruntjen at least partly because he could be a damaging witness against it in the lawsuits that investors are filing in federal court here. “I think he has a lifetime contract,” says a money manager at another local firm.
Lawyers for angry investors are seeking class-action status for several pending suits. “The sales materials were consistent with the oral representations: that this was a safe fund, just like a money-market fund,” says Gregg M. Fishbein, an attorney for the plaintiffs. Vernon J. Vander Weide, another plaintiffs’ attorney, says: “The business about derivatives is buried in the prospectus. Even there they never say this is unsafe as hell.”
These lawyers, not surprisingly, contend that their case is strong. The only flaw, they say, is that Piper may not have the resources to cover what they believe a court will eventually award. “I want to get as much as I possibly can, but I am not sure I want to be the lawyer who puts Piper out of business,” says Richard A. Lockridge, another attorney. Piper shareholders’ equity was $168.9 million at June 30, and its total potential resources also include its insurance coverage, potential borrowings and claims that it might bring against other parties.
But regardless of the legal outcome, many rival fund managers believe that Piper eventually will have to reimburse investors for some of their losses.
“Piper’s public stance is that everything was disclosed; that’s just ridiculous,” says Mr. Markman of Markman Capital Management. “This fund was not a risk-oriented vehicle. You could tell by the people who bought the fund: municipalities, widows and orphans. It was marketed as the safest product on their shelf.”
Piper’s employees, who own about 60% of its stock, have ample reason for dismay. Like other securities firms’ stocks, Piper shares have been declining in recent months. Yesterday, on unusually heavy volume, the stock plunged $2 a share to close at $11.625 in composite New York Stock Exchange trading.
Even if Piper avoids any legal liability, the loss of confidence in the firm will hurt it. The more than 30 municipalities that invested in the Institutional fund could take their bond-underwriting business elsewhere — a serious threat because Piper has handled about 40% of Minnesota’s municipal underwriting. In addition, the company’s 1,001 retail brokers “are feeling the pressure,” says Dan L. Lastavich, who heads its retail brokerage operation. And Piper isn’t launching several mutual funds that it had planned to start this year.
Piper says few investors have withdrawn their money from its management. But the orchestral association, for one, is said to be already shopping for another money-manager; a spokesman declines to comment.
For Piper, the distress at local charities may be especially embarrassing. Mr. Piper, who is chairman of the local public-radio station and about to become chairman of a hospital that his family helped endow, says he devotes about six hours a week to charitable work. While admittedly good for business, such work also is a family tradition. Piper Jaffray was one of the first to adopt what has become standard for many Minnesota companies: giving 5% of pretax profits to charity.
Mr. Piper says the firm undoubtedly will survive. Recalling that it weathered the Depression “only because of the good graces of some local banks,” he feels sure that it will surmount this crisis. In a conversation last week, in fact, he talked about his hope that some of his five children — the oldest is 25 — will go into the family business.
