Investors Maneuver for Winning Edge in Game With No Rules : Fund: Chapter 9 law draws no distinction between large and small creditors. It’s unclear how what’s left will be divided.

What has become crystal clear in the nation’s largest municipal bankruptcy is that many investors in Orange County’s ill-fated investment portfolio are going to lose money, lots of it. What is unclear is whose ox is going to be gored.

Will the billions of dollars lost by departed Treasurer-Tax Collector Robert L. Citron be divided evenly among those with money in the fund, or will some end up far down a pecking order, shouldering more of the financial loss than others?

In an ordinary business bankruptcy, there is a firm division between secured creditors, those who extended credit against a guarantee or collateral, and unsecured creditors, generally suppliers of goods and services. Secured creditors are the ones most likely to get their money.

But in the case of Orange County’s investment pool, municipal bankruptcy law sets no priority between the competing claims of the Newport-Mesa Unified School District with almost $80 million in the fund, Judge Margaret R. Anderson’s retirement nest egg and the special $8-million fund that had been set aside to replace the county Fire Department’s aging fleet of firetrucks.

Nor does it distinguish between the managers of the $1.3-million fund to protect gnatcatcher habitat, Operation Santa Claus, which has $10,000 tied up in the pool, and the Orange County Transportation Authority with $1 billion on the line.

All must fend for themselves with few hard and fast rules in an emerging battle over the $5.4 billion that remains in the investment pool.

Already, scores of investors are staking out their positions and exploring legal arguments in an attempt to show they deserve to recover more from the fund than other individuals and institutions who placed money with the county treasurer.

“There are lots of competing parties with competing demands. Unwieldy is perhaps too mild a term to describe what’s happening,” said Prof. Dan Schechter, a bankruptcy expert at Loyola Law School in Los Angeles. “There is a strong argument that there will be a hierarchy of creditors. But this is an area of new law. There is no set priority on anything. I mean the county could end up giving everyone a 27% haircut.”

There are 187 governmental entities that have funds in the investment portfolio that Citron managed, as well as thousands of individuals who invested retirement funds and court settlements.

Who eventually recovers money and in what amount will be determined largely by the U.S. Bankruptcy Court and the county creditors committee, which was picked Wednesday by bankruptcy Trustee Marcy J.K. Tiffany.

The panel is made up of representatives from the fund’s major institutional investors, including the Orange County Department of Education, the Orange County Transportation Authority, the Orange County Sanitation Districts, the Transportation Corridor Agencies, the city of Irvine representing all county cities, and the city of Mountain View, representing municipalities outside the county.

The creditors committee is responsible for developing a disbursement and recovery plan that is acceptable to the competing interests that sit on the committee, as well as a host of subcommittees chaired by each representative.

In addition, investors and creditors can ask the bankruptcy court to order the county to release funds or grant them priority for recovering their original investments.

Bankruptcy lawyers anticipate that many of those involved will make their pitch to the creditors committee or the Bankruptcy Court in the months ahead. Complex negotiations to work out compromises among the many interests also will occur, they say.

“Circling the wagons is part of the game,” said Richard Levin, who was a bankruptcy attorney for 16 years with Stutman, Treister & Glatt, the Los Angeles law firm now representing the county. “You have a lot of people who have lost money or stand to lose lots of money. Of course, they are going to fight.”

Among those jockeying for a high position in the pecking order are the county’s 27 school districts and four community college districts, which have about $1.5 billion tied up in the fund. About $500 million is borrowed money placed with Citron voluntarily.

School officials across the county contend they should at least recover 100% of their operating funds from the pool, because state law requires school districts to put those funds in the county treasurer’s accounts. They are also looking into whether the money, in effect, was held in trust.

School district officials argue that they had no control over the way Citron was using their money, hence they were at his mercy. They also maintain that if the county does not pay them back in full, the state is legally obligated to make up the difference.

“We in the schools feel we have a case for 100 cents on the dollar, and we intend to aggressively pursue that case,” said Supt. James A. Fleming of the Capistrano Unified School District.

The borrowed money could be more problematic. For example, Newport-Mesa Unified, Irvine Unified, the Orange County Department of Education and the North Orange County Community College District took out loans of $200 million for the sole purpose of investing in the fund voluntarily.

“We had discretion on that one,” acknowledged Supt. Mac Bernd of Newport-Mesa Unified. “We were not mandated to place that money with Citron. We are in that pickle with other school districts and cities.”

For the first year at least, Citron gave the districts guarantees against risk if they placed the money with him, but there were no guarantees in writing at the time the fund collapsed.

Another $1 billion invested in the pool belonged to all the cities in the county, except for San Juan Capistrano and Garden Grove. Unlike school districts, municipalities are not required by law to place their funds with the county treasurer.

Whether the money was placed voluntarily or involuntary should not matter that much, some city officials contend. Municipalities may be just as deserving of full reimbursement as the school districts, they say.

“We were led to believe that this investment would be made in good faith and that the funds were safe and secure,” said one Anaheim official, who requested anonymity.

Anaheim invested about $169 million with the county, the third-largest amount among cities with money in the fund.

“We are in the same boat as everyone else,” said Santa Ana City Manager David N. Ream. “We want an equitable distribution based on what is left in the fund. We have $150 million in the account. We would like all that, but there is not all that to get out. Right now it’s 73 cents on the dollar. Our main interest now is getting that out as soon as possible.”

Representatives of some of the largest institutions that put money in the investment pool, such as the Orange County Transportation Authority and the Transportation Corridor Agencies, say it is too early in the proceedings to formulate a position for recovering funds.

“Basically, we don’t have enough information to determine what our arguments will be,” said Lisa Telles, a spokesperson for the TCA, which is building the county’s toll roads. “We are working with the creditors committee to obtain the information we will need.”

Under Chapter 9 of the bankruptcy statutes, all parties involved are supposed to be treated equitably, bankruptcy lawyers say. No one can be granted priority for removing funds or being paid unless the creditors committee or a bankruptcy judge agrees to it.

“Bankruptcy does not look at deservedness or whether you invested voluntarily or involuntarily,” Levin said. “The fundamental principal of distribution is equality. If you have no collateral, you are part of the great unwashed.”

Bankruptcy lawyers say it could very well turn out that the losses are shared pro rata--that is, everyone will lose a percentage equal to what they had in the fund. If that is the case, it would be a relief to Municipal Judge Margaret R. Anderson in Newport Beach, who has saved money for almost 20 years in the Orange County Deferred Compensation Fund.

The retirement account, which Citron invested, contains about $88 million from more than 2,000 county employees. Under the plan’s contract, the money is the county’s until the employee retires, resigns or is fired, and can be used to pay creditors.

Anderson says her financial adviser told her she and other participants in the fund have little standing in an attempt to recover their contributions to the retirement plan.

“All the money belongs to the county,” Anderson said. “I don’t know whether I am going to get any money back. I can’t do anything about it. I have no options at this point.”