ORANGE COUNTY IN BANKRUPTCY : Chance of Recouping Losses Small : Courts: Even if it wins its suit against Merrill Lynch, Orange County probably won't get back its $2 billion, finance experts agree. But action could help shift blame.


Even if it wins its suit against Merrill Lynch & Co., finance and legal experts say Orange County has little hope of recouping the $2.02 billion it lost on Wall Street securities, but may succeed in shifting blame away from county officials as it points the finger of guilt at the only party with deep pockets.

The federal lawsuit argues that Merrill Lynch & Co. is responsible for the county's losses, because its representatives were aware--or should have been aware--that former Orange County Treasurer Robert L. Citron was violating the California Constitution and government codes when he borrowed millions and gambled taxpayers' money on risky investment schemes.

But the same argument is likely to be used--and could be used effectively--in Merrill Lynch's defense, finance and legal experts said Thursday.

"Any time someone says, 'You knew, or you should have known,' you can then turn around and go through the gamut of people who also touched it and say, 'They should have known, too,' " said Chicago attorney James Spiotto, a specialist in Chapter 9 bankruptcy issues.

As if on cue, Merrill Lynch released a statement Thursday echoing that line, denouncing the lawsuit allegations as an attempt to make the giant Wall Street brokerage a "scapegoat" for the county's mistakes, and claiming that there is "overwhelming evidence" that the Orange County Board of Supervisors was aware of Citron's risky investment strategy and its potential pitfalls.

"For the Board of Supervisors to now accuse Merrill Lynch is disingenuous at best, and an abdication of their own responsibilities in this matter," the statement read. "For years they reaped high rewards. Now they want to deny the risks. In effect, they're saying: 'Heads we win, tails you lose.' "

Law professor Jennifer Arlen, who teaches securities law at USC, said parts of the county's lawsuit appear to have merit. If Citron were investing his own money and was personally made aware of the risks involved, Merrill Lynch & Co. would have fulfilled its obligation, Arlen said.

"The question here is whether informing Citron is sufficient," she said after reviewing the lawsuit. "Arguably, they had a duty to go over his head, go straight to the Board of Supervisors and say, 'Hey, there is a problem here.' It seems the county has potentially a good claim here."

But less clear is the county's claim of securities fraud, she said.

"You need to have misleading information or evidence of deceit," Arlen said. "They will have to prove . . . non-public information . . . was somehow withheld from them, when presumably the county could find out what they were doing with the investments at any time."

One thing seems clear: Orange County could face years of complex litigation and staggering legal bills and out-of-pocket expenses. And even if successful, it is unlikely the county would recoup all its losses.

For example, San Jose sued Merrill Lynch and other brokerage firms in the mid-1980s after losing $60 million in securities trading. The lawsuit claimed, among other things, that Merrill Lynch did not follow county guidelines for investing--a claim similar to Orange County's.

Merrill Lynch paid $750,000 to settle its portion of the suit, said New York attorney Patricia M. Hynes, who represented the city.

"No, we didn't get it all back. But I certainly think it was worth it for the City of San Jose to try," she said. Hynes said she could not comment on Orange County's suit, but said she sympathized with their position.

"Merrill Lynch is supposed to know their customer and know whatever guidelines control those investments," she said.

Albert Malanca is a Tacoma, Wash., attorney who handled a case in which Merrill Lynch paid to settle its role in a public utilities lawsuit. Bondholders who lost an estimated $7.5 billion in bond principal and interest were paid only 10 cents to 15 cents on the dollar when the case was settled in the late 1980s.

"Rarely, if ever, will all the money be recouped," he said. "But the county would be derelict in not trying."

In other cases involving Merrill Lynch, two widows filed suit in San Diego last month arguing Merrill Lynch misled them and sold them "extraordinarily high-risk investments suitable only for speculators." Merrill Lynch denies the claim.

But the firm agreed in June to pay $4 million in connection with a company "revenue-generating" idea that went awry, and was censured by the New York Stock Exchange.

Finance and legal experts said they were not surprised that the county's suit did not name Citron as a defendant, because suing the former treasurer could ultimately hurt the county.

"What will the county get suing him?" Malanca said. "He's probably got a house and a car. But he could also become a convenient vehicle for Merrill Lynch to point to and blame for the whole thing. That could confuse a jury, which could find the official liable and not Merrill Lynch. And they're the only party with any money."

James W. Mercer, an attorney representing the county against Merrill Lynch, agreed.

"He doesn't have the money," he said Thursday, adding that he believes the case against Merrill Lynch will be successful. "We have an incredibly strong case."

But others question whether the vagaries of the law might not reveal some troubling loopholes.

Alan Bromberg, a securities law professor at Southern Methodist University in Dallas, noted that savvy attorneys could make a powerful argument that Citron did not borrow money to make the investments, as the county's lawsuit maintains.

"There is an ongoing debate about whether a repurchase agreement is a sale or a loan, and if the alleged borrowing is in the form of repurchase agreements that might make a tough case, as strange as it might sound," Bromberg said.

He also said that if the county is successful at proving there was no authority for the transaction, they must still prove the transactions caused the losses.

"The other side can argue there were intervening and multiple causes that were also at play," he said.

Sam Gruenbaum, a securities lawyer in Los Angeles, said he wanted to reserve judgment until the facts of the case are unearthed, but said he is troubled by the idea that the lawsuit might really be attempting to hold Merrill Lynch responsible for not predicting the rise in interest rates.

"No one has a crystal ball, and is this holding them liable for a prediction--perhaps a wrong one--on where the interest rate will move?"

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