On the morning of Sept. 29, 2008, as the world woke up to unprecedented turmoil in financial markets, the normally placid director of the state Division of Gas and Oil considered a worst-case scenario for the $23 million escrow fund he administered.

The Wachovia Bank branch, at 201 S. Jefferson St. in Roanoke, Va., has been the physical address of the Virginia Gas and Oil Board’s escrow fund since 2006. (Gree Moore/WSLS)

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The millions were compensation for Virginia landowners whose mineral rights the state had leased to private energy corporations, often against owners’ will or without their knowledge. The money waited in escrow for safekeeping until the question of individual ownership could be resolved.

Suddenly, it seemed in jeopardy.

Managing the fund was Wachovia Bank, which by the fall of 2008 had been brought to its knees by its ill-fated acquisition of junk mortgages at the height of the housing bubble. With investor confidence plummeting, the Federal Deposit Insurance Corp. swooped in to facilitate an emergency sale of Wachovia to Citigroup early on Sept. 29.

At 9:06 a.m., DGO Director David Asbury e-mailed his contact at Wachovia and floated a question with a quivering parenthetical: “Under a worst case scenario, assuming Wachovia fails. . . what value (if any) would remain in the Escrow Account?”

It also occurred to Asbury, who had been in the job for just five months, to ask if each sub-account in the fund was FDIC-insured. The answer, it turned out, was that the entire $23 million fund was insured for $250,000.

This particular financial drama unfolded out of the view of thousands of royalty owners, who receive no accounting of their funds in escrow. At the end of the tumultuous week, Wachovia was acquired by Wells Fargo, and the escrow fund did not lose value – at least not immediately.

What the episode reveals is how little members of the Virginia Gas and Oil Board – the state regulatory body with exclusive authority over the escrow fund – know about the fund’s operations, leaving the details to Asbury, according to interviews, hundreds of pages of board hearing transcripts and internal correspondence obtained by the Bristol Herald Courier through a Freedom of Information Act request.

Board members often lack seemingly important information, such as the interest the escrow fund is earning and how its deposits are insured. They do not receive monthly statements from the bank, and some were unaware – as recently as November, when they voted on awarding a new contract for escrow services – that the fund has been losing interest on its deposits for more than half a year.

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A precipitous fall

The man in charge of administering the escrow fund has a quiet, polite manner in person. He is responsive to media inquiries, but speaks only through e-mails; he declined interview requests for this story and others.

As director of the Division of Gas and Oil, David Asbury is also the “principal executive to the staff of the [Virginia Gas and Oil] Board” – a somewhat grand-sounding job title for a staff of just two. Asbury and Diane Davis, programs administrator for the DGO, are the only state employees who handle the escrow fund and the board’s records.

“He’s not a guy who goes home when the clock goes off,” Donnie Ratliff, a board member who represents coal interests and who worked with Asbury at Pittston Coal Co., where the director was an engineer, said in an interview. “There is no one more dedicated and conscientious than David.”

On Oct. 10, 2008, Wachovia representatives traveled to Abingdon, Va., to meet with Asbury at the Division of Gas and Oil’s former office there. After several tense weeks, the bank officials were eager, as one wrote, “to more broadly discuss our mutual relationship and services being provided.”

At the meeting, Wachovia recommended that the board shift its investment policy to a more conservative asset allocation.

Eleven days later, at the board’s October hearing, Asbury advised members to adopt the bank’s suggestion.

“We are giving up about a percent of earnings potential, but it is also reducing our risk to as close to zero risk as we can,” he said.

Bruce Prather, a consulting geologist who represents the gas and oil industry on the board, asked Asbury, “During the upheaval [. . .] did we lose any money?”

Asbury replied, “No, we did not.”

But even as he spoke, the fund’s interest income had begun to flat-line.

The escrow fund started off January 2008 by earning $47,000 in interest. By October, interest had dropped by half to $23,000.

Now, with the fund’s more conservative investment mix, the interest income plunged – to $1,170 in January, and into negative territory in February at a $2,173 loss.

The reason for this, as a bank representative explained to the board six months later, was that interest rates were “very, very compressed” – so much so that the bank’s servicing fees were higher than the interest that escrow deposits were earning.

It is unclear if any board members were aware of this when, in March 2009, they voted to extend Wachovia’s contract through the end of the year. The evidence suggests that they were not.

At the board’s June 16, 2009, hearing, Asbury presented members with the first-quarter report for the escrow fund, which had a net interest income of $5,000 – $118,000 less than what it netted over the same period the previous year.

The first-quarter report masked the worsening situation; by May, the escrow fund had experienced three months of income loss since the beginning of the year. But Asbury did not address this during the hearing, and board members asked no questions. The “investment risk assessment” on the docket was continued.

Two days later, on June 18, Asbury and Diane Davis traveled to Roanoke to discuss the escrow fund with the Wells Fargo-Wachovia investment team.

Late that night, Asbury sent an e-mail to Butch Lambert, chairman of the Gas and Oil Board, and copied Sharon Pigeon, the senior assistant attorney general who advises the board, on what he learned.

“Recent analysis of the Escrow reflects a significant decline in monthly interest income,” Asbury e-mailed at 10:57 p.m.. “For the second time in the account’s history, monthly expenses have exceeded monthly interest income.”

In conclusion, Asbury wrote, “We were very pleased with today’s focused but productive meeting and have a high level of confidence in the new Wells Fargo-Wachovia.”

June would be the fourth month of the year that the escrow fund lost interest. But Asbury’s e-mail was the first written acknowledgment to a board member of the negative income.

“He handles this account”

In July 2009, with the escrow balance now at nearly $25 million, board members received the fund’s second-quarter report from a Wachovia official, who broke the bad news this way.

“Income from investments and then netted from expenses of servicing the account were negative $6,793,” Patrick Dixon, a senior vice president for Wachovia, told the board.

Board members also learned that although the bank charged a service fee of $8 per sub-account – nearly $6,000 a month – the entire fund was FDIC-insured for only $250,000. For the other $24.5 million, Wachovia pledged collateral to a third-party trustee, the Bank of New York.

This was in fact a substantial improvement in the security of the fund, thanks to a February change adopted by the Treasury Board of Virginia to require banks holding more than $250 million in public funds to pledge 100 percent collateral for every dollar not insured by the FDIC. As of September, Wachovia held $487 million in public deposits, according to treasury records, making it the second-largest such holder in the state.

In September 2008, Wachovia had collateralized only half of the assets it held for the board.

“With the instability last fall, there was concern that possibly that requirement was not adequate,” Kristin Reiter, director of operations for the Virginia Department of Treasury, said in explaining the new regulation.

The escrow fund’s negative income, in particular, caught board members by surprise.

“Do you let somebody know when you think that we’re going to run a deficit on these costs?” Bruce Prather asked Dixon, the Wachovia vice president. “It’s rather a surprise to us that we find out we’re running in the deficit because we’ve got a lot of money in there.”

The ensuing discussion focused on whether to shift assets into a higher-earning combination; only one board member, Katie Dye, asked the bank if it was “negotiable” on the $8 charge per account.

Dixon, noting that the board soon would solicit bids for a new contract to manage the escrow fund, said Wachovia would wait to negotiate until submitting a bid.

As the discussion wore on, Asbury’s central role in handling the fund emerged.

“See, we as a board, we never have access to the information that you’re talking about because it comes through David,” Prather said to the bank representatives. “In other words, he handles this account.”

Asbury defended the investment policy.

“I think the board made a smart decision last fall during turbulent times to place them in the very lowest-risk potential that there was,” he told board members. “And although we are showing negative income during the second quarter, I believe there is a potential to reverse that by the calendar year end.”

Seeking to staunch the bleeding, the board voted to move half of its funds invested in AAA-rated U.S. government obligations into a higher-earning Wachovia money market fund.

The escrow fund lost $4,000 in July, and it has lost money every month since April, for a nearly $17,000 loss for the first 10 months of the year.

Asked by a reporter about the losses that are eroding the fund’s value, Asbury noted that the fund has not lost its principal – meaning that royalty deposits from gas operators are still higher than the losses of interest income.

“The negative interest income for 2009 is disappointing but is a result of financial market conditions,” Asbury e-mailed the newspaper. “Losses may have been worse but for the safe investment posture required for public accounts and adopted by the Board.”

Prather, asked the same question, said: “We’re trying to resolve that.” He would not elaborate.

Bill Harris, a public board member from Wise County, said it was “not a good situation to be in.”

It was worse than he knew.

When informed of the total losses so far this year, he said, “No, I was not aware we were losing like that.”

Neither was Donnie Ratliff, the board member who represents the coal industry and who was not present at the July 2009 meeting when Wachovia officials explained the negative income.

“I don’t see those numbers,” Ratliff said when asked at the Nov. 17 board hearing, hours before the board voted on awarding a new contract for escrow services. “I don’t know how that happened.”

At that meeting, board members had to choose between Wells Fargo-Wachovia or First Bank & Trust, an Abingdon-based bank.

An evaluation team of five state employees – including Asbury and Diane Davis – ranked Wachovia higher in every category. First Bank, though, offered less expensive services.

The board voted to award the contract to First Bank, beginning in January.