ORANGE COUNTY IN BANKRUPTCY : Key Excerpts From Testimony by Citron, Stamenson
Here are excerpts from the opening statements presented Tuesday by Robert L. Citron and Michael Stamenson, key witnesses testifying before the state Senate Special Committee on Local Government Investments:
ROBERT L. CITRON
“First, and foremost, let me express my deep sorrow to the people of Orange County for the financial crisis that has arisen. As treasurer, I followed an investment course that I believed was prudent and suitable to meet the county’s growing financial needs. In following that path, I relied on the expert advice of financial professionals. In retrospect, it is clear that I followed the wrong course. I will carry that burden the rest of my life. I am not here seeking to place blame or shirk responsibility--I am here simply to tell the truth.”
“I am 69 years old and a third-generation native Californian. My wife, Terry, and I have been married almost 40 years. My parents raised me during the Great Depression. I was ineligible for military service due to an asthmatic condition and therefore entered the University of Southern California. During my first two years at USC, I studied a pre-med curriculum as I wanted to follow in my father’s footsteps. I switched in my third year to general business courses and left during my fourth year due to financial circumstances. I never received a college degree. I attended Loyola University for a semester in the early ‘50s to learn about government finance.
“Between 1948 and 1960, I was employed primarily in the area of consumer finance. In 1960, a friend encouraged me to seek employment with Orange County as a deputy tax collector. I was hired in that year and held that position until 1970 when I was elected to the position of tax collector for Orange County.”
“I was an inexperienced investor. I had never, nor have I ever, owned a share of stock. My primary training was on-the-job. Due to my inexperience, I placed a great deal of reliance on the advice of market professionals. This reliance increased as the number and types of investments permitted by the Government Code were liberalized, and as financial instruments became more complex. This is not to say that by the time derivatives were first sold to the county, almost four years ago, that I didn’t consider myself to be an experienced and successful treasurer. The county achieved many years of extremely high returns during my tenure. However, in retrospect, I wish I had more education and training in complex government securities.”
“I first met Mr. Stamenson in 1975 and I started doing business with him on behalf of the county in 1988 when he took over from Mr. Fred Walker as the county’s Merrill Lynch representative. Merrill Lynch was the primary investment firm selling securities to the county in the late ‘80s and ‘90s. . . . I have heard the figure that Merrill Lynch sold the county about 70% of the approximately $20 billion of securities in the county’s portfolio at the time of the bankruptcy. This figure is consistent with my recollection that Merrill Lynch was the predominant seller of securities to the county. . . . At least to this lay person, Merrill Lynch acted as a financial adviser to Orange County.”
Merrill Lynch Advice
“In late 1992 and early 1993, Merrill Lynch recommended, after an analysis of Orange County’s portfolio, that the county lower its risk profile in the area of derivatives. The county followed this advice by purchasing predominantly fixed callable instruments in mid-1993. Merrill Lynch also offered to buy back certain derivatives on March 31, 1993. These derivatives represented some of the most profitable instruments in the portfolio as they were paying some of the greatest returns. The treasurer’s office decided not to accept Merrill Lynch’s proposal due in great part on its reliance on the economic analysis of Merrill Lynch chief investment analyst Charles Clough. Clough stated that a period of low interest rates would last for three to five years, and perhaps for a decade. This would enhance the value of the county’s derivatives.”
When Rates Rose
“On Feb. 23, 1994, Assistant Treasurer Matt Raabe and I met with Merrill Lynch representatives, including Mike Stamenson, to discuss a lengthy ‘Presentation to Orange County’ of the same date. . . . In this document, Merrill Lynch made a number of investment suggestions that the county strived to implement. There was no sense of doom or gloom at this meeting. In fact, six days later, on March 1, 1994, I had a breakfast meeting with Mike and Mr. Clough. Mr. Clough reiterated that interest rate increases were not sustainable. . . . During the spring and summer of 1994, the county’s portfolio was the subject of numerous reviews by Merrill Lynch and others. In April, 1994, representatives of the Securities and Exchange Commission interviewed Matt Raabe and me about the county’s investments. . . .
“Also in April of 1994, representatives of Moody’s and Standard and Poor’s inquired about the county’s investments. After the inquiries both services continued to rate highly the county’s debt offerings.”
“It was my investment strategy to use the county’s large cash reserves in periods of rising rates to cover the increased cost of borrowing. It was also my philosophy to hold the county’s securities to maturity to avoid sustaining any loss in the principal value of the securities. Before the bankruptcy, I sincerely believed that these philosophies were sound. My adherence to these philosophies is a matter of public record. In retrospect, they were unable to weather the fastest interest rate hikes in history.”
“Since 1986, I have been Merrill Lynch’s account executive for the Orange County treasurer’s office. Let me say first that I, like everyone here, very much regret the burdens and anxiety imposed on the people of Orange County by this calamity. I cannot lose sight of the enormous personal pain that this situation has produced.”
On Assigning Blame
“When a financial disaster like this strikes, it is important both to minimize the adverse effects on the citizens, and to consider whether corrective legislation should be enacted to preclude a recurrence: Sadly, some may also find it tempting in the emotional aftermath to point fingers and assign blame--oftentimes where it does not belong.”
“Neither I nor anyone else at Merrill Lynch designed or structured the county’s investment strategy or controlled the county’s investments--Mr. Citron did. Neither I nor Merrill Lynch had any discretionary authority whatsoever over the Orange County account. . . . Mr. Citron had a relationship with most major financial institutions, and he actively sought competitive bids.”
Merrill Not Alone
“Merrill Lynch has been the No. 1-ranked firm in underwriting debt and equity securities for the past six years. Because of our presence and position in the capital markets, on many transactions Merrill Lynch was able to offer the best price, and therefore was able to execute a significant portion--perhaps 60% or 70%--of Orange County’s desired securities purchases. Please keep in mind that the balance of the purchases--also a significant percentage of the county’s business--was purchased by the treasurer’s office from other brokers.”
Dealings With Citron
“For my part, I made recommendations to Mr. Citron about what he might buy, with an eye toward achieving his stated investment objectives of holding until maturity and increasing the county’s interest income. Often he solicited these recommendations. Sometimes he accepted our recommendations, sometimes he did not. But one thing should be clear--Bob Citron controlled the Orange County portfolio. Merrill Lynch did not--I did not.”
“Bob Citron was highly qualified to make these decisions for Orange County. I have known him since 1975, and there is no doubt that he was and is a highly sophisticated, experienced and knowledgeable investor, fully versed in the advantages and risks associated with the securities that he purchased from brokerage firms, including Merrill Lynch. I learned a lot from him, since he was doing reverse repurchase transactions before I even knew what that term meant.”
“He disclosed this investment strategy fully and frequently to the Board of Supervisors. In fact, the citizens of Orange County reelected Bob Citron in 1994, after his investment strategy had become the sole issue in the campaign.”
Disclosure by Merrill
“The types of structured securities that Merrill Lynch sold to Orange County were not ‘exotic derivatives.’ They were primarily U.S. government agency obligations with relatively simple interest rate structures.
“Some have suggested that although Merrill Lynch understood the risks associated with the investments Orange County made, we did not disclose them. That is not true. In fact, we gave him an analysis that showed him what would happen if interest rates continue to rise. We explained the risks of each security the county treasurer’s office purchased, whether we were first to suggest the investment or, as was the case on many occasions, he had discussed a proposed investment structure with other dealers and requested our input.
“Moreover, beginning in 1992, I and others from Merrill Lynch met with, and wrote to, Mr. Citron on many occasions to inform him of the risk exposure that the investment pool would face if-- if --interest rates were to rise. There was no doubt in anyone’s mind that Mr. Citron fully understood this risk exposure. We also provided Mr. Citron with information reflecting the range of views held by Merrill Lynch economists about the direction of interest rates, not only the views of Chuck Clough, whom Mr. Citron mentioned in his testimony this morning. I should also note that I understand Mr. Clough told Mr. Citron that he should position himself to be more defensive against an increase in interest rates.”
“I want to emphasize that we offered to repurchase every derivative security Mr. Citron had purchased through our firm. We did not select out those that were profitable.
“Mr. Citron declined the offer, because he believed he could continue to achieve high yields by holding his investments to maturity. Nonetheless, he was fully aware of the risks associated with his strategy. His investment strategy was not irrational. In fact, Mr. Citron had enjoyed unprecedented success with his investment strategy. Based upon our relationship, and his track record, I respected his judgment, his understanding of his investment objectives, and his understanding of the potential risks of his investment strategies.”