Bankruptcy May Spur New U.S. Regulations : Investments: Official predicts tough controls on sales practices regarding securities that led to Orange County’s financial woes.

Signaling a more activist federal response to problems underscored by Orange County’s financial collapse, Deputy Treasury Secretary Frank N. Newman said Tuesday that regulators are likely to adopt tough new controls on the sales practices of the brokers and bankers who market the complex financial instruments that contributed to the county’s woes.

Newman said federal agencies are particularly concerned about whether public agencies are being sold investments that are inappropriate for their investment portfolios.

“You will see more coming out about sales practices and suitability,” Newman told a meeting of the Government Finance Officers Assn.

Top federal officials had previously declared the Orange County bankruptcy filing a local problem with little impact on the nation’s financial markets.

In other developments Tuesday:

* About 200 parents and students gathered in Santa Ana, cheering and applauding as one speaker after another demanded that the county return 100% of the school districts’ funds frozen in the depleted county investment pool.

“We have one, single message,” said Fran Williams, a parent and teacher at Rancho Santiago Community College. “Dinero! Ahora!”

“I’d rather have bad roads than crowded classrooms,” said Mark Perew, a Santa Ana parent who helped organize the rally. “I’d rather have libraries open for our kids to be in than more cops to arrest our kids.”

* Gov. Pete Wilson, in Washington, vowed that California will not allow any Orange County schools to close. But Wilson said any money redirected to county school districts that have been financially crippled by their investments in the county pool would be in the form of loans that would have to be repaid.

“We have to assure that the kids are educated,” Wilson said, noting a 1992 state Supreme Court decision that declared the state responsible for providing students with an education.

* Former Rep. William E. Dannemeyer held a news conference to demand that the county immediately float new bonds to resolve its nearly 2-month-old bankruptcy with their repayment to be financed by slashing the salaries of all public employees 10% to 15%.

Accompanied by a loose coalition of conservative county organizations calling themselves Californians for America, Dannemeyer said that any elected county official who sought to raise taxes, fees or assessments would promptly be targeted for removal from office.

“We’re putting any elected public official on notice that if any of them vote to raise taxes or fees of any kind whatsoever . . . we will assist in recalling them,” Dannemeyer said, “whether they serve on a school board, a water district or a city council.”

* Labor leaders, who have been meeting with county officials to discuss the status of 152 fired employees, said the county had agreed to honor seniority in at least some cases. Some senior employees will be reinstated, and others with less seniority will be laid off, the labor officials said.

U.S. Bankruptcy Judge John E. Ryan had ordered labor and county representatives to reassess the layoffs and determine whether seniority provisions in employee contracts could be honored.

In Washington, Deputy Treasury Secretary Newman urged local government officials to acquire a better understanding of the products being marketed by the nation’s investment houses. He also endorsed the idea of a voluntary model investment code for cities and counties.

“You need to understand the instruments you are using,” Newman told an audience that included state and local investment officers.

Newman heads a special working group of federal agencies--created after the 1987 stock market crash--that is scrutinizing how derivative securities and other complicated financial instruments are marketed.

The participating agencies include the Securities and Exchange Commission and the Commodity Futures Trading Commission, which are expected to develop rules for brokerage and trading firms. Three bank regulatory agencies--the Federal Reserve Board, the Comptroller of the Currency and the Federal Deposit Insurance Corp.--could develop restrictions on the conduct of banks involved in selling complex financial instruments to local governments.

Federal officials emphasize that they have no blanket objection to the use of derivatives--instruments whose value is linked to changes in interest rates or other economic indicators. Nor are they upset with leveraging--that is, borrowing money to take a larger position in the market. Both are acceptable and routine tools of money managers in corporations as well as governments.

But former Orange County Treasurer Robert L. Citron has been blamed for betting too heavily on one side of the ledger, investing in derivatives whose value was linked to declining interest rates. And he leveraged a $7-billion portfolio of public funds into what became a $20-billion bet on interest rates. When interest rates began rising last year, Orange County suffered a loss of $1.69 billion on the value of its portfolio.

The federal government continues to steer clear of any legislative proposals that would deeply involve Washington in the issuance of securities by thousands of cities, counties, school district and other local agencies.

That would interfere with the roles of state and local governments, Newman said, and would require adding thousands of federal workers if, for instance, the SEC were to review the prospectuses for local bond offerings.

“It is not the role of the federal government to protect market participants from the prospect they might lose money,” Newman told the finance officers.

Rosenblatt reported from Washington and Wilgoren from Orange County. Times staff writers Mark Platte, J.R. Moehringer, Lee Romney and Susan Marquez Owen in Orange County and Dave Lesher in Washington contributed to this report.