Probe Centers on Whether Citron Warned Investors : Orange County: Criminal investigators want to determine if risks, possible safeguards were explained. ‘Pain at all levels’ predicted as layoffs loom.

The criminal inquiry into former Orange County Treasurer-Tax Collector Robert L. Citron’s office focuses on whether he warned investors that the county’s portfolio was losing value and on how he planned to guard against losses, according to search warrants served this week.

The search warrants say that investigators are seeking to determine “whether a felony has been committed or a particular person has committed a felony” and requests the personal calendars of Citron and acting Treasurer Matthew R. Raabe.

The contents of the search warrants--disclosed to The Times Wednesday--provide the first official indication of the direction the criminal investigation is taking. Other government agencies, including the U.S. Securities and Exchange Commission and the state Department of Corporations, have launched their own investigations into Citron’s risky investment practices.

As talk of expected layoffs swept through county government offices, investigators with the district attorney’s office pressed ahead Wednesday, interviewing County Administrative Officer Ernie Schneider. Schneider said later that he would cooperate and agreed to provide necessary documents. Although Schneider would not say what had been requested, sources close to the investigation said he was asked to turn over paperwork related to his dealings with the treasurer’s office.

The items requested in the search warrants indicate that authorities are interested in what Citron or Raabe told pool participants about the safety of their investments and whether the risks were adequately explained. Attorneys for Citron and Raabe did not return phone calls from The Times Wednesday.

Specifically, authorities requested correspondence in which cities, school districts and other investors may have been notified “of any trouble or potential risk” or offered assurances regarding “the safety of the investment.” Investigators also demanded access to any contingency plans the county had to “extricate” itself from potential problems.

While the probe continued Wednesday:

* Talk of layoffs consumed the Hall of Administration as a 14-year executive secretary in Supervisor Roger R. Stanton’s office learned that she was one of the first workers to lose her job. “It just stinks,” said Ruth Allison, 56.

The county’s management team met with each of the county’s employee unions and told them there would be “pain at all levels,” union leaders said. No specifics were revealed, but the team is expected to unveil budget reduction targets for all county departments today.

* The county has informed cities and other public entities that because of the fiscal crisis, it will withhold millions of dollars in property tax revenues they were due to receive today--cutting their payouts from 32% to 22% of the taxes collected. City managers expressed surprise and disappointment at the decision.

“This is one most of us don’t quite understand,” said Laguna Niguel City Manager Tim Casey. “Most of us feel the full amount is owed.”

* County officials said that Tuesday’s auction of securities with $1.21 billion in face value brought in $1.12 billion, $597 million of which will go to pay off existing loans to brokerages such as Merrill Lynch.

* In a bid to prevent a run on San Diego County’s investment fund, county Treasurer Paul Boland said he will impose penalties of up to 11% on cities and districts that withdraw their funds. The $3.3-billion fund has lost about 10% of its market value because of rising interest rates and withdrawals.

* Many school districts and other governmental agencies that have funds frozen in the county’s pool are scrambling to make bond payments due the first of the year. Most are raiding other pots of money to cover their payments, according to a report Wednesday from Moody’s Investors Service, the bond rating agency.

The Laguna Beach Unified School District voted to go forward with hiring a contractor for the reconstruction of Thurston Middle School, which was badly damaged in the Laguna Beach firestorm. District officials announced earlier this month that the $2.6-million project had been placed on hold.

* Gerald Boltz, a criminal defense attorney who headed the SEC’s Los Angeles regional office in the 1970s, has been retained to represent the Board of Supervisors and other county officials in the SEC investigation. Boltz could not be reached for comment Wednesday.

* Rep. Christopher Cox (R-Newport Beach) met with SEC Chairman Arthur Levitt Jr. to discuss the Republicans’ proposed “securities reform” bill, which raises the standard of proof in civil fraud cases by requiring an investor to prove a defendant had “actual knowledge” of a fraud.

Cox’s office said the House Commerce subcommittee on telecommunications and finance is expected to begin hearings on the legislation in mid-January.

* Two more congressional committees announced that they would hold hearings next month on the Orange County financial debacle or related issues. The Senate Banking Committee will focus on risky “derivative” securities and highly leveraged investment strategies. A third panel, the House Banking Committee, also plans to hold a hearing on the financial calamity.

In Santa Ana, district attorney’s investigators began poring over 50 boxes of documents seized from the treasurer’s and auditor’s offices this week. Some of the information is contained on computer disks, which authorities have also seized.

City officials from Irvine, Huntington Beach, Santa Ana, Seal Beach and Anaheim said district attorney’s investigators have interviewed them about their investments in the portfolio Citron managed. Several said they were asked whether Citron or Raabe offered them any oral or written representation on the risk to the fund.

Citron and his staff had maintained that the funds of 187 public investors were safe and invested in high-yield reverse repurchase agreements, which allowed the county to pledge securities as collateral against short-term borrowing to buy securities at a higher interest rate. But when interest rates rose, the fund lost money--so far more than $2 billion.

County treasury officials assured investors earlier this year that they did not expect interest rates to rise drastically, and even if the rates climbed, they would simply liquidate some securities. But the prospects of liquidation were remote, they said, and “we do have several strategies in mind that would counter such an occurrence,” Raabe wrote to one investor in late April. Specific remedies were not mentioned.

The SEC has subpoenaed Citron, Raabe, the five county supervisors, the county’s top administrator, and top brokers with Merrill Lynch, the county’s top bond underwriter. The federal agency is seeking to determine whether the brokerage gave campaign contributions or provided kickbacks to county officials in exchange for business, sources familiar with the investigation said.

The SEC and the Department of Corporations also are trying to determine whether Citron plunged the county an additional $600 million into debt during the summer to cover mounting losses in the investment pool.

Sources said the district attorney’s request for records is even more encompassing.

“To some extent, the D.A.’s search warrant is broader than the SEC’s,” said one source familiar with the investigation. “Clearly, the D.A. is looking at what representations were made to pool participants by anyone in the treasurer’s office and how the investment pool was run. On the other side, (investigators) are looking at the relationship the investment bankers had with the county.”

Chief Assistant Dist. Atty. Maury Evans declined to comment Wednesday on any individuals being targeted in the probe, nor would he say whether more search warrants are planned.

“We’re just working hard,” Evans said.

Evans was uncertain how long it will take to review the items seized this week, but he noted that prosecutors have rarely handled such a massive collection of documents in a search warrant. “This would be one of the largest since I’ve been here in 20 years,” he said.

San Diego Deputy Dist. Atty. Anthony Samson, in charge of the major fraud unit, said Orange County prosecutors will likely want to follow the money in search of “undue influence, bribery, those types of things” in the county’s financial dealings with Wall Street.

The wide range of government records sought this week would provide only a framework for that search; if prosecutors hope to pursue criminal allegations, he said, they will likely have to subpoena bank records and other financial documents from government officials and private business people that might show a pattern of unexplained income.

Samson cautioned against a rush to judgment.

“I see a lot of financial failings (in Orange County), but that’s not always caused by skulduggery,” he said. “A lot of it’s not criminal in nature--it’s just the market.”

Paul S. Meyer, a former Orange County prosecutor who now works as a defense attorney, said the district attorney clearly has a broader mandate in the case than other regulatory agencies such as the SEC, whose investigations are targeted at securities law violations.

Legal experts said the district attorney’s investigation could cover a wide range of possible misconduct, from allegations of improper acceptance of gifts, donations or other financial favors by public officials to a failure by the county and its financial advisers to adequately disclose the risks of the investment fund, or even a broad conspiracy to defraud investors.

Thomas M. Goethals, a private defense attorney who worked in the district attorney’s office for a dozen years, said actual payoffs to government officials appear to be least likely, based on what has emerged publicly.

While the criminal investigation continued Wednesday, county workers worried about their jobs.

The county’s operations management council of Dist. Atty. Michael R. Capizzi, Sheriff Brad Gates and Health Care Agency Director Tom Uram prepared to unveil recommendations for budget cuts and staff layoffs today, but union leaders were offered few details at Wednesday’s meetings.

The unions--which include everyone from firefighters to deputy sheriffs, custodians and social workers--have formed a coalition of bargaining units for the first time in Orange County history to deal with the crisis, said Bill Fogarty, executive secretary-treasurer of the Orange County Central Labor Council, AFL-CIO. All together, the unions represent about 14,000 employees, he said.

Fogarty said employee morale is at “an all-time low,” in part because of the paucity of information. He faulted county management for not including the unions in discussions of cutbacks.

Meanwhile, financial experts Wednesday confirmed that Citron definitely managed two separate investment pools--a highly leveraged pool and a safer pool earning less interest. But they remain uncertain whether securities in the so-called safer pool had also been invested in higher-risk investments. It has emerged as an issue because the agencies that had specifically given Citron more than $1 billion to place in routine securities--as opposed to reverse repurchase agreements and other exotic arrangements--believe they should receive a higher percentage of their money back.

Sources say internal documentation exists to show that Citron and his staff treated the two funds differently, keeping track of each pool’s somewhat different investment standards through internal record-keeping. The money for both funds, however, was kept in a single bank account, a practice that other municipal treasurers say is not unusual.

Yet to be determined, according to the sources, is whether the two funds were “cross-collateralized”--that is, whether securities in one fund were used to borrow money to buy securities for the other fund. If funds in the “bond pool” were used as collateral for either pool, that could undercut arguments by “bond pool” investors that they should take less of a hit.

Times staff writers Matt Lait, Greg Hernandez, Jeff Brazil and Rebecca Trounson and correspondents Shelby Grad and Leslie Earnest in Orange County; Gebe Martinez in Washington; and Michael A. Hiltzik in Los Angeles contributed to this report.