Advisory Group Calls for Limits on Treasurers

Concluding that Orange County’s financial fall resulted from a “reckless abuse” of the public trust, a private sector panel Thursday recommended that the Legislature conduct a wholesale revision of state laws governing municipal treasurers.

The 12-member group, which is advising a special Senate committee investigating Orange County’s bankruptcy, called for prohibitions on excessive borrowing for investment purposes, criminal penalties for violators and a restriction on the use of derivatives, the complex financial instruments that got former Orange County Treasurer Robert L. Citron into trouble when interest rates climbed last year.

The advisory group--composed of leaders in business, education, labor and finance--suggested that local agencies be considered “unsophisticated investors” in dealing with brokers, putting the onus on Wall Street to make sure municipal investments are sound.

The panel also called for annual audits of county investment funds and the establishment of three-member review committees to help shepherd county investment decisions.

“We do not believe the losses should have occurred or would have occurred if there was appropriate legislation and all parties acted in a responsible manner,” said Eli Broad, the advisory board chairman and chief executive of SunAmerica Inc., a Los Angeles-based financial services firm.

The recommendations come as some officials are calling on local agencies to guard against financial disasters by limiting the amount of funds that they borrow for investment purposes and being more vigilant about disclosing risks to investors in municipal securities.

At the same time, various regulatory bodies are weighing whether to place controls on the sales practices of brokers and bankers who market the kind of complex financial packages that have proved troublesome to Orange County and other local governments.

Lawmakers generally applauded the advisory committee’s findings, with Senate President Pro Tem Bill Lockyer (D-Hayward) calling the proposals “good ideas presented by credible people.”

Sen. Lucy Killea (I-San Diego), who co-chairs the Senate Special Committee on Local Government Investments, said the private sector panel had provided a balanced view that was “very ambitious in scope.”

A special legislative session on the Orange County bankruptcy, called by Gov. Pete Wilson, begins today.

The advisory group unveiled its blueprint shortly before the Senate committee convened its third hearing Thursday to examine the problems that led to the largest municipal bankruptcy filing in U.S. history.

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During the afternoon session, committee members slammed the Orange County supervisors, who were not at the hearing, and blamed county staff members for shielding information from the board.

“Nobody is responsible for anything,” said Sen. Quentin L. Kopp (I-San Francisco) in exasperation. “It’s anarchy.”

In his first extensive public comments since being demoted three weeks ago, former County Administrative Officer Ernie Schneider blamed the crisis on other county officials and his powerless administrative position.

His job “had all the responsibility and no authority,” said Schneider, who complained that he had no oversight over elected or nonelected department heads. He complained to the committee that he often found county officials circumventing his authority and going directly to the Board of Supervisors.

But he also admitted that he was occasionally out of the loop, had no financial background and was professionally ill-equipped to handle the complexities of the county’s investment problems.

“To be perfectly honest with you, I’m not really a finance person,” he told senators, who pressed him about his role in the collapse.

Schneider said he was not involved in the decision to declare bankruptcy.

“I’m sorry to say nobody asked me for my opinion,” he said. “Not a soul.”

Already under fire from county supervisors, Orange County Auditor-Controller Steve E. Lewis was sharply questioned about whether he was aware of Citron’s irregular accounting practices.

Specifically, the senators wanted to know why he did not become alarmed about the large infusion of cash being pumped into the county’s economic uncertainty fund--money that belonged to other pool participants--and why he did not better monitor improper security transfers between county-held accounts and the county’s investment pool.

“These were everyday normal transactions that were initiated by the treasurer’s office,” Lewis said, adding that he was not given enough information by Citron to discover any impropriety.

Sen. Rob Hurtt (R-Garden Grove), frustrated by some of Lewis’ answers, asked: “Is there anybody who can terminate your service?”

“The people can,” Lewis said. “We believe we did our job. We did more than many.”

Lawmakers also quizzed county counsel Terry C. Andrus about the days leading up to Orange County’s bankruptcy filing and asked him why he never told the Board of Supervisors about a 3 1/2-hour meeting that he, Citron and his assistant Matthew Raabe had with the Securities and Exchange Commission in April.

“When I came back from that meeting I was convinced that the controversy was political, based on everything they said,” Andrus said. “Everything I took away led me to believe (it had) . . . nothing to do with the integrity of the (investment) pool.”

Andrus defended the county’s decision to file for bankruptcy protection as its only option after it failed to get the SEC to step in and arrange a deal with a potential buyer for the county’s investment portfolio.

During their morning session, lawmakers grilled representatives of Merrill Lynch, the giant brokerage house that sold Citron many of the interest-sensitive securities that caused the investment fund to collapse in December amid investment losses of $1.69 billion.

The brokerage, which earned $62.4 million in 1993 and 1994 on its dealings with Orange County, continued to defend itself against allegations that it kept selling Citron inappropriate securities while warning him that the county’s investment pool was getting into deeper trouble.

Of particular concern to the Senate committee was Merrill’s failure to inform the Orange County Board of Supervisors of the risks, despite warning Citron at least nine times since 1992 and once offering to buy the county’s portfolio outright.

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Richard M. Fuscone, 43, director of Merrill’s fixed income securities group, defended the firm’s disclosures in bond offerings for the county and said Merrill encouraged Citron to be more forthcoming with the board about the pool and its exposure to interest rate swings.

“We did persist,” Fuscone said in the face of intense questioning. “We had advised the county treasurer that he should disclose more fully or more comprehensively about his strategy, the current market, the risks and rewards of the strategy. And we had suggested that one opportunity to accomplish this was to meet with the board, and we offered our willingness to meet with him (and) with the board to explain the current market environment.

“Mr. Citron declined and had offered to send us a letter verifying his authorization to carry on the business that he was (doing) and the fact that there had been sufficient disclosure to the Board of Supervisors,” Fuscone said.

At Merrill’s urging, Fuscone said, Citron rewrote parts of his 1993 annual report to the board that described the risks of the investment fund.

Lawmakers questioned Fuscone and two bankers who helped underwrite a $600-million bond sale by the county in July about whether there had been sufficient disclosure of the condition of the county’s investment pool when Merrill underwrote the offering of taxable notes issued solely to reinvest the proceeds in the pool.

Most troubling, committee members said in their questioning, was Merrill’s acknowledgment that it knew of the precarious nature of Orange County’s fund, and, in a 29-page report, warned Citron of the dangers of his strategy should interest rates rise. Merrill Lynch officials told Citron that each 1% rise in interest rates would shave $270 million off the pool’s market value.

But Fuscone replied that what Merrill Lynch sold the county was not a problem. Instead, he insisted, what caused the county trouble was Citron’s insistence that interest rates would resume their fall when they were steadily rising.

But some committee members did not buy Fuscone’s explanation.

“I’ve got to tell you that I think your explanation is a dog that just won’t hunt,” said Sen. John R. Lewis (R-Orange).

Times staff writers Matt Lait and Tracy Weber in Sacramento and Lee Romney and correspondent Shelby Grad in Orange County contributed to this report.