ORANGE COUNTY IN BANKRUPTCY : Fund Debacle Reveals Gaps in Campaign Donation Ban : Regulation: Even supporters say tighter curbs are needed on financial firms’ gifts to municipal officials.

It was supposed to shut down the campaign contribution pipeline from Wall Street to City Hall. It was supposed to end the days when savvy executives “paid to play” in the government bond business.

But eight months after the federal government imposed an eagerly awaited control on the municipal bond industry, the Orange County bankruptcy disaster has revealed more loopholes than leverage in the law.

The new regulation “is turning out be loose as a sieve,” said Zane Mann, publisher of the California Municipal Bond Adviser, a Palm Springs publication that advises private investors. “It’s a joke, and I think that’s the consensus in the industry.”

Spurred by a series of public financing scandals across the nation, the Securities and Exchange Commission earlier this year prohibited municipal finance firms from doing business with officials to whom they had given campaign contributions in the previous two years.

Federal regulators are not quite as discouraged in their assessment of the impact of their work, saying that the regulation marked an important first step toward cleaning up the process for awarding bond work.

“I can’t tell you the number of people (in the bond industry) who have come up to me and said ‘Thank you, thank you--you’ve saved me so much money. I don’t have to be held up anymore by the politicians,’ ” said Christopher Taylor, executive director of the Municipal Securities Rulemaking Board, which drafted the measure.

But even federal officials acknowledge that the rules they imposed may have to be tightened to close gaps that allow some finance professionals to evade them. If not, players in the bond industry will continue to influence the awarding of contracts through gifts and donations, critics say.

Bond underwriters and dealers are covered by the ban but investment brokers are not. Neither are bond lawyers. Financial advisers are--but only if they are registered as bond dealers. And Wall Street underwriting firms can still give corporate contributions--but only if their municipal finance professionals were not involved in donations.

Mann says the sense of bewilderment has become common in the finance industry, and it has led to many donations that may or may not be legal.

“Seems like everyone can get around the technicalities by just changing their (professional) title. . . . Wives are making donations, back room clerks, everyone.”

SEC General Counsel Simon M. Lorne agrees that “there are certainly some loopholes. I think the Orange County situation is likely to prompt reconsideration of municipal finance issues across the board . . . and certainly the contribution issue is one that’s likely to be looked at.”

A review of donations to Orange County officials shows that six firms active in the county’s troubled bond business made contributions totaling more than $7,000 to former Treasurer-Tax Collector Robert L. Citron in the first six weeks after the donation ban went into effect April 25. More recent data is not available because most elected officials have not yet reported contributions for the second half of the year.

An investigative arm of the SEC is examining three donations from Merrill Lynch employees to Citron. But federal officials say these and other contributions made after the ban was imposed could be considered legal under the law’s provisions.

The $1.2-trillion municipal finance industry has proved a growing source of funding for politicians nationwide in the last decade, public records show. Its participants give municipal officials hundreds of thousands of dollars each year in campaign donations, meals, sports tickets and other gifts. The SEC regulation was aimed at drying up that source, but records show that the financial connections between Orange County politicians and key bond players have continued.

That is why BankAmerica Corp. and a subsidiary could donate $1,750 to Citron in May, federal officials say. The bank does not appear to be covered by the ban in its role as Orange County’s bond trustee.

Neither is Leifer Capital, a Santa Monica firm that has earned more than $1 million in recent years as financial adviser on Orange County’s bond deals. The firm donated $1,000 to Citron’s campaign fund in June.

Also outside the ban are bond attorneys and private auditors who routinely earned tens of thousands of dollars from county bond contracts and who donated a total of more than $500 to Citron’s campaign after the ban took effect.

Critics complain that they are left with an uneven playing field tilted toward bond lawyers, advisers and other financial professionals who are not covered by the ban. The Orange County bankruptcy, SEC Commissioner Rick Roberts said, “is another incident that has called into question some parts of (the regulation)--primarily its breadth or lack thereof.”

Even if a firm is involved in underwriting business--which is covered by the ban--contributions by top Wall Street executives may still be allowed. As a result, a senior vice president at Dean Witter could donate $100 to Supervisor William G. Steiner earlier this year without running into the ban--if it is clear the executive had no direct involvement with municipal finance issues, federal officials say.

Even in the case of the Merrill Lynch contributions, which have drawn the most scrutiny, federal officials say it is still unclear whether regulations were violated.

Three Merrill Lynch brokers in Northern California, active in executing derivative investments for Citron, each donated $1,000 to him June 13--a day before the Board of Supervisors approved a $600-million bond issue that Merrill Lynch underwrote. The wife of Michael Stamenson, the lead broker in the deal, also contributed $1,000, records show.

The Teamsters Union has charged that these contributions violated the SEC regulations, but Taylor of the Municipal Securities Rulemaking Board said investment brokers would not necessarily be considered municipal finance professionals under the terms of the rules. Only if Stamenson or the other two contributors played a role in issuing the bonds would there be a legal problem, he said.

“The question is, did Michael Stamenson attend any meetings where the (Orange County) notes and bonds were discussed?” Taylor said. “I have heard from other dealers--who are always anxious to pile on in these situations--that Stamenson was involved in financing in the County of Orange. . . . The minute you find him attending (finance) meetings, the jig is up.”

Merrill Lynch, however, denies any suggestion of wrongdoing, saying that the contributions fell within the limits of the SEC law.

“If you come to work for Merrill Lynch, you don’t necessarily check your constitutional rights (to support a candidate) at the door,” said company spokesman James Wiggins. “Our view is that we have made every good-faith effort to follow both the letter and the spirit of the law. . . . We were not looking for loopholes.”

Merrill Lynch was one of the first Wall Street firms to back the move for a contribution ban last year.

The new regulation grew out of a recent series of scandals in New Jersey, New York, Kentucky and elsewhere, all of which involved large payments from municipal finance firms to the officials who helped award them contracts.

In New York City, for instance, Comptroller Elizabeth Holtzman drew sharp criticism last year when her office recommended Fleet Securities as an underwriter on city bonds after Holtzman took a loan of nearly half a million dollars from Fleet to bolster her U.S. Senate campaign. In New Jersey, a top aide to then-Gov. Jim Florio was forced to quit last year after it was disclosed that Merrill Lynch had hired his tiny brokerage firm to take part in municipal underwriting for the state.

After publicity on the cases highlighted the “pay to play” problem, the industry moved last year to curb donations. Merrill Lynch and several dozen other leading underwriters pledged to begin a voluntary moratorium on contributions to local and state candidates.

The move did not satisfy federal regulators, however, and SEC Chairman Arthur Levitt delivered a stinging speech in March, warning a group of state treasurers that conflicts inevitably arise when politicians accept money from those seeking municipal bond business.

That conflict, he said, threatens to erode investors’ confidence in the system “if there is a perception that business is bought, that low cost and quality are not the chief criterion (in awarding bond contracts), that fraud is part of the deal,” Levitt said.

With Levitt leading the way, the SEC approved the ban.

The imposition of an April 25 deadline opened up a flood of eleventh-hour contributions, with Citron receiving $3,750 in securities industry contributions in the three weeks before the ban took effect, records show.

Part of the problem stems from the fact that the SEC has only limited control over the players in the municipal finance business. Its jurisdiction centers on bond dealers.

For now, the gaps in the SEC ban will probably mean that other investigating agencies with broader mandates--such as the Orange County district attorney’s office--may have to take the lead in investigating possible wrongdoing in the county’s financial debacle. But in the long term, the case may produce further changes in federal regulations, as officials seek to work out kinks in the system.

Lorne, the SEC lawyer, came out publicly last month in support of efforts by government and the U.S. Bar to curb donations from bond attorneys to politicians and help improve the image of an industry that “has been infested with some of the most odious of practices.”

The National Assn. of Bond Lawyers has resisted such a moratorium on its own contributions, voting instead to encourage bond lawyers to fully disclose their financial donations. Some bond lawyers still deny any connection between donations and bond work, said Andrew Kintzinger, the association’s president, but they appear to be in the minority.

“Over time, we have become sensitized to the very significant perception that ‘pay to play’ is going on, and it is a problem that needs to be addressed,” he said.

Other industry reforms appear likely, observers say. But the best hope for solving the “pay to play” phenomenon, said Robert M. Stern, co-author of California’s political ethics act, may come only with campaign reform efforts aimed at limiting how much money candidates can accept and spend.

The cozy relationship between Wall Street underwriters and Orange County politicians only points up the need for such reforms, he said.

“You’re talking about people who are really giving contributions only because they want to have influence,” he said. “You can make all the little rules you want, but as long as the big rule is that you have to raise money to win a campaign, that’s all that really matters.”