ORANGE COUNTY IN BANKRUPTCY : NEWS ANALYSIS : Suits Target Many, but Deepest Pockets May Be Merrill Lynch’s
Where are the deep pockets?
That is the key question for investors, government agencies and others seeking to recover losses stemming from the collapse of Orange County’s investment pool.
Already, several parties have been sued for fraud and other misdeeds. Some of the defendants--Robert L. Citron, the former Orange County treasurer who directed the county’s unusually aggressive investment fund, Assistant Treasurer Matthew R. Raabe and Orange County auditor Steven E. Lewis--appear unlikely to yield the billions of dollars needed to make the county and its creditors whole.
And then there’s Wall Street behemoth Merrill Lynch, the largest underwriter of Orange County’s bonds and the nation’s biggest brokerage, with 1993 revenues of $13.4 billion.
“At the moment, Merrill Lynch looks like the deepest pocket,” said USC law professor Jennifer Arlen, a securities regulation expert.
The firm has reaped fees in excess of $100 million on Citron’s Orange County trades, according to a lawsuit filed Friday by two investors in Orange County bonds. During the past two years alone, Citron purchased from Merrill Lynch almost $6 billion in bonds issued by the Federal National Mortgage Assn.
Another defendant in many of the lawsuits is Michael G. Stamenson, a $1-million-a-year San Francisco-based Merrill Lynch salesman who played a key role in brokering and underwriting securities for Orange County since at least 1988, according to the suits.
*
The basic theory of most of the cases filed thus far is that the defendants either lied about the financial health of the Orange County investment fund or failed to disclose critical information about the fund’s precarious condition, thus misleading investors into thinking their money was safe with Orange County.
“The defendants had actual knowledge of the misrepresentations . . . or acted with reckless disregard for the truth,” according to a federal class-action suit filed this week by Lieff, Cabraser & Heiman, a San Francisco law firm. The suit contends that the investments in Orange County bonds of David and Rosalyn Bare, two Los Angeles County residents, lost value because of the county’s fiscal debacle.
A suit filed Friday also contends that Orange County’s lack of meaningful oversight over Citron’s activities allowed Merrill Lynch and Stamenson “to take virtual control over the investment decisions of defendant Citron for the investment pools, and to materially influence the nature” of the public debt financings and disclosures of the county.
County supervisors repeatedly approved Citron’s activities without discussion, and officials said they were unaware of audits that called the treasurer’s conduct into question.
Thus far, Orange County itself is insulated from suits because of its bankruptcy filing.
But the county’s lawyers have indicated that they, too, are preparing to sue Merrill Lynch on the grounds that the brokerage should have advised the Board of Supervisors that Citron was making unsuitably risky investments.
The county is likely to contend that Merrill Lynch owed a fiduciary duty to the supervisors, its ultimate clients. Its suit also may contend that Citron was not as sophisticated an investor as he was hailed as prior to the recent crisis.
In turn, Merrill Lynch’s likely defense, legal experts say, would be that Citron was a knowledgeable, sophisticated investor who--with the firm’s assistance--was very successful for years and had been fully authorized to act by the supervisors. Merrill’s lawyers aren’t commenting; a company spokesman said the firm has done nothing wrong.
Any suit by the county is likely to make new law, according to Columbia University law professor John C. Coffee, a securities law specialist.
“The case may well decide what the professional responsibility of a securities firm is when faced with a sophisticated and insistent client who demands to pursue a course of action that the securities firm knows, or should have known, is positively reckless,” Coffee said.
Even if the county were to win such a suit, damages may be limited by the fact that, before the recent debacle, the county’s rate of return on its investments was considerably higher than that of other public investment pools.
Such a defense was used successfully by brokerages seeking to reduce their liability after San Jose lost $60 million in somewhat similar circumstances a decade ago.
Merrill Lynch was one of the defendants in that case; the firm settled with the city for $750,000, although San Jose attributed $3 million of its losses to Merrill Lynch, according to City Atty. Joan R. Gallo. The city garnered a total of $24.8 million in settlements.
Other possible targets of lawsuits are some of the professionals--lawyers, accountants and outside auditors--who advised Orange County, as well as firms that aided the county in its bond offerings.
Already, KPMG Peat Marwick, the county’s auditor, is under fire for lax review of the investment pool’s operations.
Taylor Briggs, a partner in LeBouef, Lamb, Greene & MacRae, the New York law firm that served as bond counsel on a $600-million Orange County offering last June, acknowledged the risk of a suit, but said he was not concerned about any liability.
“I don’t see any basis for a suit,” he said.
*
Stephen Gillers, a New York University law professor, said a U.S. Supreme Court decision rendered last April makes it more difficult to sue lawyers or accountants as the “aiders and abetters” of a fraud.
Still, he said, “in a situation like this, the temptation to sue lawyers is almost irresistible.” Among the reasons: Suits against lawyers can be used to put them at odds against their client, thereby aiding a plaintiff; law firms have large insurance policies, and they usually settle, “because they don’t want information about how they practice law to be revealed in public forum,” Gillers said.
Indeed, the prospect of suits against law firms was foreshadowed Friday when the latest class-action suit against Merrill Lynch, Stamenson and Citron was filed in U.S. District Court in Santa Ana by attorney Joseph W. Cotchett, who won multimillion-dollar settlements from two large law firms he sued in connection with the Lincoln Savings & Loan scandal.
*
The complaint alleges that all the defendants “sought and received substantial assistance” in issuing bonds and filing official statements from law firms and other professionals.
All the defendants have denied any wrongdoing. And legal experts say they have lots of possible defenses. A key one is that the risks of Citron’s investment strategy were widely known, particularly after mid-April, when media coverage of his election foe’s criticisms increased. Arguably, that controversy put investors and Orange County on notice about the trouble that emerged full-blown this fall.
At the time, Citron and Raabe defended their tactics. In late April, Citron told reporters that despite rising interest rates, the assets in Orange County’s investment pool were safe. He said there was $700 million available to use as collateral for the county’s loans if interest rates continued to rise--which Citron did not expect--and maintained that the investment pool had enough cash available to cover anticipated withdrawals by the municipal agencies that were its biggest investors.
Those remarks and others have been cited in the lawsuits as false and misleading.
“Here we have a fascinating situation”--with a politician being sued for allegedly false statements made during an election campaign, said Joseph A. Grundfest, a Stanford University law professor who previously served on the Securities and Exchange Commission.
Both Grundfest and Arlen said they did not believe there was any “safe harbor” exempting statements from fraud charges because they were made during a campaign. But they acknowledged that a 1st Amendment defense might be raised.
