Web of Deceit, Desire Snares Home-Swindle Prosecution : Courts: D.A.’s office is disqualified from fraud case after informant defects, tapes sexual advances by investigator.

In a tale of deception worthy of a spy novel, a big Los Angeles real estate fraud case has been rocked by a sting carried out by a prosecution informant who secretly defected to the defense and videotaped the chief investigator making sexual advances toward her.

The trap was set last year by a former girlfriend and employee of Kevin S. Merritt, who is charged with 32 counts of defrauding poor and elderly clients of his real estate lending and investment business.

After a lengthy hearing on charges of prosecutorial misconduct, then-Municipal Judge Larry Paul Fidler took the unusual step of disqualifying the entire district attorney’s office, ruling that the state attorney general must take over the case to remove the taint of impropriety.

Fidler said the investigator made improper sexual advances and withheld exculpatory information he obtained from the woman, who might have been called as a witness.

The controversy has brought the case to a virtual halt and may increase Merritt’s chance of winning acquittal. It also has embarrassed the district attorney’s office, which has been accused, along with other law enforcement agencies, of doing little to fight real estate fraud.

Merritt, 33, had been sued at least 175 times when he was charged more than two years ago. At the time, prosecutors and public interest lawyers portrayed him as the most notorious of an unscrupulous breed of loan brokers and foreclosure consultants who had cheated inner-city homeowners out of their properties.

Disclosure of the videotaped sting, meanwhile, has spawned a separate investigation of the two central figures in the scandal: Joseph Kay, a senior investigator for the district attorney, and Katrina E. Smith, the former Merritt girlfriend who secretly taped Kay with the help of Merritt’s brother.

The district attorney’s office “has sent all materials dealing with both Joe Kay and Katrina Smith to the attorney general’s office . . . to decide whether charges should be brought against anybody,” said Deputy Dist. Atty. Don Tamura.

Kay, 45, a 10-year veteran of the prosecutor’s office whom colleagues described as an able investigator, testified last year that he had not made a pass at Smith, but he later admitted that was untrue.

He has been reassigned from the major fraud division to a branch that does background checks on prospective employees of the district attorney’s office. He declined to be interviewed, but others, including his lawyer, Dick Shinee, said Kay was the victim of a setup.

“We believe fairly strongly that . . . Katrina Smith was an operative for Merritt,” Shinee said. “This is a very sophisticated con that went on here.”

Smith, 27, said she was a spurned lover who had turned on Merritt at the end of their affair. Seeking revenge, she said in an interview, she lied about his business dealings and falsely claimed that he threatened her and her family if she talked.

“I have to make the situation right,” she said. “I have a lot of tears over what I’ve done to Kevin. . . .

“I’m not going to be responsible for going along with lies, or making up lies for a man just to go to jail.”

Her involvement with Merritt was the stuff of a daytime soap. She was 21 in 1987 when he hired her, and in a few months, Smith said, they were having an affair.

Merritt exerted a powerful influence in other ways too. Smith said that when her deposition was taken in lawsuits involving Merritt’s business dealings, he would sit in and tip his cigar up or down to furtively signal which questions she should answer.

Smith was a notary public, and her duties included witnessing signatures of Merritt’s customers on deeds and loan papers so the documents could be filed with the county recorder.

In June, 1990, investigators searched Merritt’s offices and seized business records. In Merritt’s briefcase they found dozens of pre-signed notary forms and Smith’s notary seal--potential grounds for revoking her notary commission.

Kay sought Smith for questioning but, Smith said, Merritt sent her to Hawaii and “told me to stay put.”

Kay eventually reached Smith by phone and urged her to return to the mainland if she had nothing to hide. Smith did come back and in July, 1990, was interviewed at her lawyer’s office by Kay and Deputy Dist. Atty. Robert Youngdahl.

Youngdahl, who retired from the prosecutor’s office last year and is now a Los Angeles Municipal Court commissioner, said Smith seemed terrified by the prospect of testifying against Merritt.

“She cried-- cried --how afraid she was of Kevin,” Youngdahl said. “I mean, she was very believable about how afraid she was of Kevin and his people--that she would be killed or beaten up or disfigured.”

Kay later debriefed Smith repeatedly in person and by phone. At his request, she once wore a wire to lunch with Merritt at a hotel near Los Angeles International Airport.

Smith also gave evidence against Merritt in a civil fraud suit. In a sworn declaration and deposition testimony, Smith said Merritt once “stated that I was to never appear in court and if I did I would have to wear a bag over my face.” She said that another time when they were fighting over money, Merritt threatened to kill her niece.

In March, 1991, the district attorney charged Merritt with forgery, fraud and grand theft involving transactions with 20 people.

All told, Kay conferred with Smith about 30 times, seeking information about Merritt’s operation and about the intricacies of real estate transactions.

But at the start of 1992, Smith secretly returned to Merritt’s fold.

On Jan. 15, 1992, she gave a remarkable interview to Merritt’s attorneys in which she recanted her sworn statements against him.

“Kevin and I had a personal relationship for a few years. And it did not turn out and I literally hated the man. I wanted to hurt him very badly. And so I did whatever was possible,” Smith said.

She said she had lied about Merritt threatening her, and she confessed to stealing $60,000 and four properties from him.

But Merritt’s lawyers were most interested in what Smith said about Kay.

Smith said that when she told Kay why Merritt was not at fault in certain of the suspect transactions, Kay did not want to hear it and urged her to stick by her previous stories. And when Kay learned of Smith’s dishonest acts, she said, his main concern was preserving her credibility as a witness.

Smith claimed that Kay even suggested that she say Merritt gave her the properties “in bed one night,” so it would not appear that she had stolen them.

She also said that Kay had asked her out and once invited her to fly to San Francisco to join him at a conference.

Plans for the sting were quickly set in motion. Smith said it was her idea--that she “contacted Kevin and I told him I wanted to videotape Mr. Kay at my home.”

Merritt’s brother, James C. Merritt, took over from there. At a surveillance store, he and an associate bought a micro video camera concealed in a stereo speaker, James Merritt said. Then they set up the equipment in the Orange County home where Smith was staying.

The camera was rolling when Kay entered the house on the evening of Jan. 27.

The rendezvous came at a crucial stage in Merritt’s legal battles.

He was a few weeks from his preliminary hearing. And he was days from the start of a major civil fraud trial in which he was the main defendant.

That case involved the late Roland Henry, an 85-year-old Watts man with a sixth-grade education who went to Merritt for a loan and allegedly was tricked into deeding away his home.

Henry’s family was seeking heavy monetary damages. And since the trial involved transactions that also figured in the criminal case, it would be a sort of dry run.

Smith would be a witness. Although her name and notary seal appeared on key documents, she said in her deposition that she neither had met Henry nor notarized his signature--damaging testimony she was expected to repeat in court.

But over dinner with Kay that night, Smith said she now remembered meeting Henry and notarizing his signature.

When Smith asked Kay’s advice on how to testify, he told her “to go with the truth.”

But when she suggested she might lie about the properties she had stolen from Merritt--if Merritt’s lawyers raised the issue to discredit her--Kay did not try to dissuade her.

“On the property situation, let’s say I go up there and say that . . . Kevin gave them to me in bed,” Smith said. “If they find out that I’ve perjured myself . . . “

“How would they know?” Kay responded.

“I’m just saying, what if there is some way they found out. . . . I’m just worried about, you know, perjury. You know, like jail?”

“How can someone ever know, OK, what happened between you and Kevin in the intimate moments in bed . . . unless Kevin was recording it,” Kay said.

Toward the end of the chicken and steak dinner, Smith and Kay wandered off camera, and it was then that he tried to kiss her, according to the audio portion of the tape.

“No,” Smith said.

“No? Why?” Kay asked.

“Don’t do that because we’re friends,” Smith said.

“Yeah, but that’s something, I think, I’ve wanted to do . . . “ Kay replied.

“Don’t tell me that,” said Smith. “We’re pals. It’s our first date.”

Moments later, Kay asked Smith if he would have “an exclusive to get into bed.”

Smith laughed and replied: “Don’t ask me that right now. Eat your dinner.”

She later apologized, telling Kay, “I’m sorry if I gave you the wrong impression. . . .”

During the meeting, Smith continued to present herself as Merritt’s enemy. When Kay mentioned an upcoming television report on Merritt, Smith said she wanted to go on the air.

“To upset him? Oh, heck yeah,” Smith said. “In a minute.”

But Smith had no intention of upsetting Merritt.

A few days later, when she took the stand in the Henry case, Smith stunned the Henry family lawyers by recanting her prior testimony.

Smith said she had met Roland Henry and had notarized his signature; that her previous statements were false; that her whole purpose before was ruining Merritt, but that she now was telling the truth.

“Obviously, she had rattlesnaked me,” said Henry’s attorney, Steve Owens.

But Smith’s appearance did not help Merritt.

Owens confronted her with her prior testimony. And Superior Court Judge Dion G. Morrow asked Smith why anyone should believe her latest story.

“You didn’t mind lying under oath on the declaration,” Morrow said. “It didn’t bother you lying at the deposition. . . . So why have we decided to get religion today?”

Merritt and his co-defendants were found liable for civil fraud, and they were assessed $2.3 million in damages and legal fees.

But Smith’s impact on the criminal case was profound.

A week after the secret taping, Merritt’s lawyer, Donald Marks, filed a motion for dismissal, accusing Kay of “gross misconduct” that was “sufficiently flagrant” to throw out the case. Marks said Kay had tried to become sexually involved with a witness, had coached Smith to lie and had withheld her exculpatory statements about Merritt.

At a court hearing, prosecutors claimed that the allegations were a sideshow--that they never intended to call Smith as a witness and that she was not the key figure that Marks portrayed. “This case was put together prior to ever knowing Katrina Smith existed,” Youngdahl said.

Before the district attorney’s office knew of the secret videotape, Kay denied having made a pass at Smith. “No, counsel. You have got it all wrong,” Kay told Marks, “Katrina approached me.”

Later in the hearing, Kay admitted “that answer was not truthful.”

As for encouraging Smith to lie, Kay claimed he merely played along with Smith’s changing stories. “I listened and I patronized her . . . because she was a source of information that I wouldn’t have obtained otherwise.”

Smith was questioned about her motive for taping Kay.

Tamura asked if she knew when she invited Kay to dinner that “he had feelings . . . that were sexual or, perhaps, of an amorous nature.”

“I knew he liked me,” Smith replied.

Tamura: “You hoped to get some admissions or something you could use to help Kevin Merritt at that time?”

Smith: “That is correct.”

At other times, she said her aim was not to sabotage the case but simply to prove Kay had encouraged her to lie.

Marks and Tamura argued over the admissibility of the videotape and a tape of four telephone conversations that Smith also had secretly recorded. Fidler agreed to view the videotape but refused to admit the telephone recordings. With few exceptions, it is illegal in California to record telephone conversations without the consent of both parties.

Ruling last fall, Fidler, now a Superior Court judge, refused to dismiss the criminal charges against Merritt. But he disqualified the district attorney’s office, saying the attorney general must take over to remove the taint of impropriety and assure a fair trial. Disqualification of individual prosecutors or investigators is not unusual, but the wholesale removal of a large prosecutorial agency is exceedingly rare.

The attorney general has appealed the ruling, claiming that Fidler was wrong on points of law. But the attorney general also “would prefer not to take” the case, said a source in the district attorney’s office, because it has less manpower and experience in handling such cases.

Meanwhile, Smith is running a foreclosure business in Orange County.

And Merritt, free on bail, continues in the real estate business. Through his attorney, he has declined to discuss the case.

For him, delay may prove a useful ally. Delays mean that witnesses may forget or move away, become ill or die. And some witnesses against Merritt are elderly.

Moreover, when the case comes to trial, Merritt’s lawyers are expected to use the episode with Kay to attack the credibility of the prosecution’s case.

In the only recent activity in the case, Merritt last month sought a reduction in his $400,000 bail--a request that was denied after the district attorney’s office opposed it.

Merritt “preyed on the poor and elderly in this community, and took their homes,” Deputy Dist. Atty. Richard Rosenthal argued to the court. “That’s the worst kind of white-collar crime I’ve ever seen.”