Setback Dealt to Lincoln Investors in Junk Bonds : Thrifts: The GAO tells Sen. Alan Cranston that there’s no legal reason for the government to reimburse those who bought the now-worthless securities.

The General Accounting Office, concluding an inquiry requested by Sen. Alan Cranston (D-Calif.), has found no legal justification for the government to reimburse 22,000 investors who purchased $200 million in now-worthless junk bonds at offices of Lincoln Savings & Loan, officials said Friday.

The findings are a setback both for Cranston and the investors, many of them elderly Southern Californians who lost all or part of their life savings as a result of the $2-billion collapse of the high-flying Irvine thrift.

“I’m devastated,” said one of the bondholders, Shirley Lampel of Tustin, after hearing about the GAO’s determination. “It breaks my heart. I can only hope that somewhere down the line someone will see the injustice here.”

The debt securities were issued by Lincoln’s parent company, American Continental Corp., which filed for bankruptcy the day before the federal government seized Lincoln last April 14.

Unlike regular savings accounts or certificates of deposit, the bonds were not insured by the government, and the investors have filed lawsuits seeking to recover their losses from American Continental and its chairman, Charles H. Keating Jr.

Last June, Cranston called for the GAO investigation in an effort to demonstrate his concern for the bondholders, many of whom have blamed Cranston for their losses.

Critics have argued that the bonds never would have been sold had Cranston and four other senators not intervened on Lincoln’s behalf when regulators first considered closing Lincoln in 1987.

In their lawsuits, bondholders contend that American Continental sales representatives intentionally led them to believe that the junk bonds were as secure as insured savings accounts, even though the bonds provided a higher yield. In most cases, the bonds were sold at desks located in the lobbies of Lincoln outlets in Southern California.

In discussing the issue with disgruntled bondholders, Cranston has expressed hope that the GAO might find a legal precedent for repaying them from federal deposit insurance funds.

But a Cranston aide acknowledged Friday that the possibility of reimbursing the investors from the Federal Savings and Loan Insurance Corp. always was “a long shot.”

Joseph Cotchett, an attorney for the bondholders, said he believed that the GAO made the right decision and that he never expected the government to reimburse his clients.

“I would be shocked if the GAO would conclude otherwise,” he said. “Its hard to imagine that anyone should ask the American taxpayers to once again shoulder the expense.”

Rather, Cotchett said he is confident that his clients ultimately will recover all of their losses from the savings and loan officials that they have sued for allegedly defrauding them.

In Cranston’s original request to the GAO, the investigative arm of Congress, he asked the agency to determine “whether the federal regulators were responsible, by any action or failure to take action, for events which led to the losses ultimately suffered by the bondholders and whether it would be appropriate to have the federal government indemnify them through FSLIC.”

Craig A. Simmons, the GAO’s director for financial institutions and market issues, said the agency uncovered no legal precedent or justification for the bondholders to be reimbursed by the deposit insurance fund. He said the issue of determining who was responsible for the losses would be best resolved in the courts.

In fact, according to Simmons, the GAO was prohibited from conducting a full-blown investigation of the bond sales because the matter currently is the subject of litigation in state and federal courts in California.

As a result, he said, his agency relied entirely on a legal opinion provided to the GAO by officials at the Office of Thrift Supervision, which oversees the nation’s savings and loans.

Roy F. Greenaway, Cranston’s administrative assistant, said the senator was notified last September that, because of the pending lawsuits, the GAO could not conduct an inquiry to determine whether regulators had failed to fulfill legal obligations to protect the investors.

Without a finding of negligence on the part of the regulators, he said, the government cannot be required to repay the bondholders.

Nevertheless, Greenaway indicated that Cranston has not abandoned his effort to determine whether the regulators were negligent. He said the GAO’s 11-page legal opinion may contain some promising legal options for the bondholders but he declined to discuss the details.

Asked if he still holds out hope of obtaining reimbursement for the bondholders, Greenaway replied: “Clearly, if you can find that the regulators were negligent, there is some government culpability. . . . (But) I don’t want to raise false hopes for anyone.”

Greenaway and Simmons will meet next week to discuss the GAO’s findings, and Greenaway promised that Cranston would make a public announcement of his conclusions after that.

The GAO report, a copy of which was obtained by The Times, recites the regulatory history of American Continental’s bond offerings. The California Department of Savings and Loans, the now-defunct Federal Home Loan Bank Board and the Securities and Exchange Commission shared responsibility for overseeing the sales.

According to the GAO’s findings, the bank board, which was the predecessor agency to the Office of Thrift Supervision, first learned from the California Department of Savings and Loans in December, 1986, that American Continental bonds were being sold at Lincoln offices.

But it was not until June, 1988, that the California agency notified American Continental and Lincoln that sales of the junk bonds from branch offices of the savings and loan were to be discontinued by August of that year.

Several members of Congress have recently proposed legislation to restrict sales of uninsured investments at branches of federally insured savings and loans. In addition, the Office of Thrift Supervision is considering new regulations that would control and monitor such sales.

Cranston and four other senators--John McCain (R-Ariz.), Dennis DeConcini (D-Ariz.), John H. Glenn Jr. (D-Ohio) and Donald W. Riegle Jr. (D-Mich.)--are being investigated by the Senate Ethics Committee to determine whether their intervention on behalf of Lincoln was influenced by campaign contributions they received from Keating and his associates.

Times staff writer Leslie Berkman contributed to this report.