ORANGE COUNTY IN BANKRUPTCY : Brokerage Urged More Authority for County Treasurers : Bankruptcy: Legislature, backed by Orange County lawmakers and Merrill Lynch, steadily gave local officials added leeway to put tax money into complex investments.

Merrill Lynch, the Wall Street firm most closely tied to Orange County’s failed investment strategy, was a driving force in the state Legislature on at least five bills approved since 1987 that widened counties’ authority to put local tax money into more exotic investments.

Led by Orange County lawmakers and spurred on by Wall Street political contributions, the Legislature repeatedly has expanded the fiscal authority of counties and steadily moved toward deregulating the investment practices of local treasurers.

Robert L. Citron, the Orange County treasurer who quit this week as the county plunged into bankruptcy because of his investment schemes, pushed hard for passage of many of the bills. Citron then used the newfound freedom to invest tax money in securities offered by Merrill Lynch.

Since 1987, Merrill Lynch has employed the law firm of Orrick, Herrington & Sutcliff as its Sacramento lobbyist. As a law firm, Orrick, Herrington is a major player in government finances and served as a bond counsel on at least 15 Orange County bond deals since 1989.

Orrick, Herrington sponsored bills expanding counties’ investment power, and its lead lobbyist, James Bruner, helped shepherd them through the legislative maze.

“He’s there all the time, all the time,” said state Sen. Quentin L. Kopp (I-San Francisco). He consistently pushed “two, three of those bills every year,” Kopp said.

Bruner did not return phone calls this week and Merrill Lynch has declined comment beyond a statement saying that it did nothing irregular with regard to the Orange County fiscal situation.

No statute specifically permitted Citron to use tax money, as he did, to borrow more money, then gamble that cash based on the direction of British or German interest rates. But the way lawmakers wrote the codes, local treasurers became increasingly deregulated.

The deregulation came through a series of bills--at least 16 since 1979--broadening the authority of counties and other local agencies to invest their cash.

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The Legislature began allowing counties to enter the new world of Wall Street with complex investments such as reverse repurchase agreements and various derivatives as local treasurers demanded more freedom to make up revenue shortfalls after Proposition 13 passed in 1978.

Most Orange County lawmakers were happy to oblige because of their view that local government should have more autonomy and that government should be more businesslike. In most instances, warnings about associated risks were overlooked.

In the state Senate, many of the bills were heard in the Local Government Committee, of which Kopp is a member. Sen. Marian Bergeson (R-Newport Beach) is the longtime chairwoman, but she is leaving the Senate next month to take office as an Orange County supervisor.

“I’ve been skeptical,” Kopp said, “and Marian let them all go through. I was a thorn. But on most of them, I finally relented.”

Bergeson sponsored at least three bills dealing with local investment authority. One permitted local governments to invest in securities that were A-rated, rather than far-safer AAA-rated securities. The measure, which now is law, was sponsored by Orrick, Herrington and backed by Merrill Lynch and Citron.

Bergeson characterized her legislation as “non-controversial” and said it was fueled by a feeling that local governments needed more tools to finance services in the aftermath of the tax-cutting Proposition 13.

“There has been an effort throughout government to try to give greater local autonomy,” Bergeson said. “I’m a believer in that, as long as accountability is established.”

Orange County lawmakers--including former Assembly members Tom Umberg, Richard Robinson and Chester (Chet) Wray--were instrumental in winning such law changes. They not only got plaudits from Citron, but many also received thousands of dollars in campaign contributions from Merrill Lynch and Orrick, Herrington.

Since 1987, Merrill Lynch and Orrick, Herrington have given at least $80,000 to the Orange County delegation in Sacramento and local Orange County officials. Bergeson has received $8,000 since 1987.

All five sitting Orange County supervisors have received contributions from Orrick, Herrington and Merrill Lynch. Contributions also went to Orange County school board members, council members from various cities, and Irvine Ranch Water District trustees. Merrill Lynch also donated to local ballot measures to build an Orange County jail and to increase the sales tax to finance roads.

In his reelection race this year, Citron received $1,000 from Orrick, Herrington and $1,000 from Michael Stamenson, the Merrill Lynch broker most heavily involved in the firm’s dealings with Orange County.

Merrill Lynch and Orrick, Herrington long have been major donors to statewide candidates, including treasurer and governor, and have given to other state legislators.

Lawmakers from outside Orange County also played a role in changing the laws to open up new ways for local governments to invest their money. Most of the bills passed easily.

Former Assemblyman Gil Ferguson (R-Newport Beach) was one of a handful of Orange County lawmakers who received no campaign money from Orrick, Herrington or Merrill Lynch since 1987, campaign records show.

“The blame starts with legislators who are carrying the bills knowing absolutely nothing about what they were doing,” said Ferguson, who is running for the Senate seat Bergeson is vacating.

Orrick, Herrington and Merrill Lynch also exercised their power by killing bills, as Assemblyman Byron Sher (D-Palo Alto) discovered in 1987. Sher’s bill, backed by Citibank, proposed allowing local governments to invest in relatively low-risk, bank-generated securities. These securities would have offered stable interest rates, unlike the complex derivatives that Citron favored.

Stamenson, Merrill Lynch’s lead broker on municipal investments in California, took a personal role in killing Sher’s bill. Stamenson became so enraged over the arcane measure that he physically charged the lobbyist who was trying to get the bill passed, witnesses said. Stamenson ended up bloodied. Shortly after, Citron, who also opposed the bill, sent a scathing letter to Citibank taking Stamenson’s side and attacking the lobbyist.

“Merrill didn’t handle these (types of investments); banks did,” Sher said Friday. “You can draw your own conclusion. Merrill didn’t want the competition.”

As the depth of Orange County’s problems became apparent this week, legislative staffers were combing law books to determine how it was that Orange County was able to make such complex investments on such a huge scale. At least three lawmakers were preparing to introduce bills to stop such investment practices.

In the aftermath of the city of San Jose’s $60-million financial debacle in 1984, the Legislature sought to rein in local officials. Like Orange County, San Jose fiscal officers invested cash using reverse repurchase agreements, betting on the direction of interest rates to help their money grow.

Assemblyman Dominic Cortese (D-San Jose), who carried the bill, first sought to prevent local government from dabbling in reverse repurchase agreements.

“I actually lost sleep contemplating what a terrible impact this loss had on (San Jose)--the number of police officers they could have hired, the number of parks they could have bought,” Cortese said.

But Cortese said the bill met fierce opposition from San Jose officials and other treasurers, as well as the brokerage industry. In the end, the bill required only that local treasurers make monthly reports detailing the health of their investment portfolios to boards of supervisors.

“They just beat me down with regard to this bill,” Cortese said.

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Even that provision fell by the wayside because written into the law was a provision that the reporting requirement would end in 1991. By 1991, the San Jose fiasco had become a dim memory in the Capitol, and the reporting requirement no longer is part of the statute. Cortese acknowledged that he “missed the boat” by not seeking to extend it.

One reporting requirement did remain on the books requiring local treasurers to report quarterly. But as part of three successive budgets in the 1990s, the Legislature removed the requirement, along with other state mandates on local governments. The reason: Local governments did not want to spend the money on such reports.

The most recent expansion of local investment authority became law last year. Then-Assemblyman Umberg (D-Garden Grove) carried the bill, which was backed by Citron, Orange County and Merrill Lynch, through Orrick, Herrington.

The measure permits county treasurers to invest in derivatives based on mortgage interest rates, among others. In themselves, the securities listed by Umberg’s measure are relatively conventional. But Citron used some of those investments in risky ways.

Umberg said the bill “wasn’t very controversial” and was assured by legislative committee consultants that it would be an effective tool for county treasurers.

“I’m not a bond expert,” Umberg said. “I was assured these were safe instruments. All it did was provide them with a broader range of investments. I would assume county treasurers would use their own discretion in their use.”

Bergeson said, “Hindsight is always great. I’m sure anyone could look 10 years back and find that in solving one problem they’ve created another problem.”

One of the few people who added a cautionary note to the Umberg bill was Inyo County Treasurer John Tracy. In a letter to Umberg, Tracy warned that the investment vehicles were “unsafe and unsound.” As it turned out, Tracy was the lone voice warning against the bill, and other county treasurers criticized him for trying to block them from gaining the extra authority.

This week, Tracy said he was hesitant to take an I-told-you-so posture, given the Orange County bankruptcy and the resignation of Citron, whom he counts as a friend.

“I hoped this wouldn’t come up,” Tracy said. “But I felt this was a danger. . . . It seems to me (the 1992 legislation) does have a bearing, certainly because for the first time it allowed us to invest in items we couldn’t invest in before.”