ORANGE COUNTY IN BANKRUPTCY : SEC Could Have Averted Crisis, Supervisors Say : Bankruptcy: Orange County officials blame federal agency for not sounding alarm after April meeting with ex-treasurer, and for refusing to freeze troubled fund.

By MARK PLATTE and MATT LAIT

Dec. 17, 1994 12 AM PT

TIMES STAFF WRITERS

SANTA ANA —

Orange County supervisors, blindsided this week by a slew of subpoenas from the Securities and Exchange Commission, struck back at the federal agency Friday, charging that the SEC could have prevented the county’s financial debacle.

Some board members questioned why the SEC failed to step in last spring, after questioning the county’s treasurer. And they are angry that the agency refused to freeze the county’s investment fund earlier this month before the county was forced into bankruptcy.

“We asked them for help and they said, ‘No, hands off, we’re not going to do anything,’ ” said Supervisor Roger R. Stanton. “Now the only thing they have done, from the lips of the chairman, is to start throwing rocks.”

SEC Chairman Arthur Levitt Jr. criticized the board this week in a Los Angeles speech, suggesting that Orange County taxpayers “throw out the whole bunch” for placing the public’s savings in such speculative investments. SEC officials have launched a broad investigation of county leaders and the brokerages that underwrote county bonds and sold investments to the now-bankrupt fund.

Supervisors complained that SEC investigators met with then-Treasurer-Tax Collector Robert L. Citron earlier this year to discuss the once-$20-billion fund’s high-risk investment strategy--which involved short-term borrowing to buy long-term bonds and complex “derivative” securities--but failed to alert the board to any trouble.

“Given the fact that they were looking at Citron’s investments in April, what responsibility do they, as a regulatory agency, have to make the public aware?” asked Supervisor William G. Steiner.

In other developments Friday:

* Supervisors approved a plan to start distributing cash to schools, cities and other agencies in danger of not making payroll and other crucial payments. The board’s action, subject to approval by a bankruptcy judge, would release up to $153 million in now-frozen funds for “urgent and essential needs” among investors.

* Santa Ana city officials lobbied furiously for the right to withdraw $9.8 million from the fund, one day after defaulting on a debt service payment for the city’s massive jail construction project. City Manager David N. Ream said that if the city does not get the $5.3 million it was supposed to pay Thursday, plus $4.5 million to pay December contractors’ fees, officials will be forced to halt the project.

* San Diego County’s treasurer announced a $357-million “paper loss” in that county’s investment fund, blaming risky investments similar to those Citron purchased. The treasurer asked local agencies not to pull money out of the fund for fear of starting a run.

* Salomon Bros., the investment house now assisting Orange County, auctioned another $1 billion in fund-owned securities on the market, part of the court-approved liquidation of the county’s remaining portfolio, which stood at $7.96 billion early in the week.

* Citron has been called to testify at an SEC hearing in Los Angeles on Jan. 20, sources said. He is expected to be quizzed about his relationship with various brokers who did business with the county.

* The family of Laura Small--a 13-year-old-girl who received a $1.6-million settlement from the county after she was mauled by a mountain lion in a much-publicized attack at a county park in 1986--sued county officials Friday. The Smalls had $90,000 in the county fund.

* The Tustin Unified School District board approved $1 million in cutbacks--the amount the district has frozen in the county pool. The board imposed a hiring freeze on substitute teachers and teacher aides and delayed buying new textbooks and other instructional materials until June.

* School officials said Foothill Ranch Elementary would open as scheduled Jan. 3, despite an announcement earlier in the week that the bankruptcy had put the school’s opening on indefinite hold.

Other good news came as the supervisors announced that money would be made available as soon as Monday for public agencies that have been struggling since Dec. 6, when the county became the nation’s largest municipality ever to file for bankruptcy.

Under the plan, fund investors initially would receive up to 30% of their original investment in the county fund for emergency needs. That allotment eventually would be deducted from their total share, which will depend on the money recovered from the fund’s ill-fated investments, said Bruce Bennett, the county’s bankruptcy attorney.

Emergency Funds

According to the agreement--which must be approved by a federal judge--agencies would each receive a designated amount to cover specific expenses.

Schools would receive the largest amount, $115 million, to meet payroll and pay vendors. The Transportation Corridor Agency would get $20.6 million by Dec. 22 for contract work on the Foothill and San Joaquin Hills toll roads. The county intends to withdraw $25.6 million.

Other creditors also would be given funds to meet payroll and bills, with the city of Anaheim receiving $8.5 million, the Orange County Water District $4.6 million, the Orange County Transportation Authority $3 million and the Orange County Sanitation District $900,000.

Supt. Paul Possemato of the Laguna Beach Unified School District said Friday he was “very pleased” to hear that the supervisors had taken action toward meeting the pressing needs of schools.

Local superintendents “have been waiting for a cash flow response (from the county) for about a week now,” Possemato said. “This will give more assurance to our employees that while the solutions are difficult, there’s an attempt to meet our needs.”

Some attorneys representing cities, schools and special districts have suggested that state law defines the county pool as a simple trust fund, requiring the county to repay investing agencies in full before withdrawing any money for itself.

“The fund itself was essentially a bank account,” said Ronald Rus, who represents three cities and three water districts in the case.

The trust fund provision of the law states that “when any public entity or any public official . . . who is required or authorized by law to deposit funds in the county treasury, makes a deposit, those funds shall be deemed to be held in trust. . . . The funds shall not be deemed funds or assets of the county.”

U.S. Trustee Marcy J.K. Tiffany acknowledged Friday that state law describes the county treasury as a trust fund, but dismissed as “shortsighted” and “very dangerous” the idea that this law means other investors should get 100% before the county takes a penny.

“There is certainly a California code section that provides that these are trust funds,” said Tiffany, who is overseeing the case for the federal Bankruptcy Court. “That’s all it does. It says nothing about recovering money first. This is an argument that somebody’s been throwing out there, and I think it’s a terrible idea. It’s self-defeating and contrary to the whole goal of what we’re doing here.”

If all other investors were repaid in full, the county could lose about three-quarters of the nearly $3 billion it has tied up in the fund. The market value of the fund’s remaining investments, minus loans yet to be repaid, was estimated at $5.4 billion this week--a 27% decline from what investors originally put in.

“What it would amount to is suicide. It’s like choking yourself with your own hand,” Tiffany said. “How can entities within the county (survive) if the county isn’t functioning? The county has to be viable. The county has to be able to sell bonds. The county has to be able to raise money. If the county can’t do that, the county will wither and die.”

While a plan was put in place to distribute the money, Orange County continued its efforts Friday to sell off its troubled portfolio and garner cash for its investors.

The county on Friday sold longer-term U.S. government agency bonds with a principal value of $566 million at prices ranging from 96 cents to 98.75 cents on the dollar. Salomon also sold $440 million in foreign bank-issued “derivative” securities--the first of the more complex securities that are to be liquidated.

Including the $483 million in bonds sold on Thursday, Salomon now has unloaded $1.49 billion in securities.

Salomon executives concede that they are racing the clock to sell the rest of the portfolio, as the holidays thin the ranks of investment professionals willing to take time to look at the securities.

The brokerage’s ability to unload the derivatives at fair prices is key to assuring that fund investors get back 73 cents for each $1 they invested--the recovery estimate Salomon gave earlier this week.

“I’m very pleased with the results” of the auctions, said Thomas W. Hayes, the former state treasurer who is advising the county. “However, we are still in a very risky position and will move prudently to continue to remove those risks.”

County supervisors were optimistic about the sales, but they smoldered Friday over the SEC’s handling of the county’s fiscal crisis.

SEC Involvement

The SEC first looked at the Orange County pool last April, when Citron’s investment practices became an issue in his reelection campaign. At the time, Citron was locked in a contentious battle and his opponent accused him of unwisely gambling with the public’s money as interest rates shot up.

After speaking with Citron, SEC officials reported that they found his strategies risky, though not illegal, sources told The Times this week. But the officials also said they had assurances that there was government oversight of the fund.

Earlier this month, when Citron announced the initial “paper loss” to his fund, SEC investigators were back at the Hall of Administration, spending the weekend before the county declared bankruptcy poring over documents relating to the portfolio. In the days since the bankruptcy, the SEC has widened its probe of the county’s financial dealings, serving subpoenas on all five supervisors Wednesday, seeking bank statements, diaries and other personal records. Citron also was subpoenaed.

The relationship has been contentious from the start.

Last week, Steiner accused the SEC of refusing the county’s pleas for help so it could use the fund’s failure as a lobbying argument to increase its regulatory powers. The SEC’s William McLucas decried the allegation as “absolutely absurd,” saying: “Somebody must have been smoking something or dropped in from planet Mars.”

Supervisors Chairman Thomas F. Riley was still upset Friday after hearing about Levitt’s speech.

“When I read this I felt maybe we should challenge his qualifications for what he is doing,” Riley said.

Riley lashed out about implications that board members may have taken kickbacks from bond dealers. “It’s a complete insult,” he said.

Times staff writers Jodi Wilgoren, Dan Weikel, Chris Woodyard, Greg Johnson, Julie Marquis, Lee Romney and Tom Petruno, and correspondents Jeff Bean and Hope Hamashige in Orange County, contributed to this report.

ORANGE COUNTY IN BANKRUPTCY : SEC Could Have Averted Crisis, Supervisors Say : Bankruptcy: Orange County officials blame federal agency for not sounding alarm after April meeting with ex-treasurer, and for refusing to freeze troubled fund.

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