Firm May Have Violated Law to Get O.C. Bonds : Probe: Securities official looks askance at Merrill Lynch campaign and main O.C. contact. Firm denies wrongdoing.

A fierce campaign last summer by Merrill Lynch & Co. to sell $600 million in bonds for Orange County may have violated laws governing political contributions by municipal bond firms, according to a securities official.

In addition, new evidence about Merrill Lynch’s efforts to steal that bond underwriting business away from a competitor contradicts sworn testimony by Michael G. Stamenson, ace salesman and the firm’s primary contact with Orange County.

Stamenson testified before a special state Senate committee in January that county bond issues were outside the scope of his work, which was selling investment securities to local governments.

But as a rival Wall Street firm was offering the bonds to investors last June 30, Stamenson was told by his employers to call then-County Treasurer-Tax Collector Robert L. Citron, and tell him that Merrill could offer a better deal than the rival firm.

That telephone call, confirmed by Merrill Lynch officials, made Stamenson a “municipal finance professional,” according to the head of the Municipal Securities Rulemaking Board, and may have made it illegal for Merrill Lynch take the lucrative $600-million deal away from PaineWebber Inc.

Rules of the MSRB, the agency that oversees the giant $1.3-trillion municipal bond market, bar a brokerage for two years from having anything to do with negotiated bond deals if any of their municipal finance professionals have made political contributions exceeding $250 to officials of the issuing government agency--unless the giver lives in the same county and can vote for the official.

Only 17 days earlier, Stamenson, his wife and two junior partners--all of whom live in the San Francisco area--had given Citron $1,000 each.

“If Stamenson indeed made that call, he would be considered a municipal finance professional under Rule G-37, therefore his contribution prior to that would have precluded Merrill from doing the deal,” said Christopher A. Taylor, executive director of the Municipal Securities Rulemaking Board.

“That phone call would be clear evidence that Merrill violated rule G-37,” Taylor added.

That allegation, however, is disputed by officials of Merrill Lynch, who say the rule didn’t apply in this case.

Under the MSRB’s rule, “no broker, dealer or municipal securities dealer shall engage in municipal securities business with an issuer within two years after an contribution to an official of such issuers made by . . . any municipal finance professional, associated with such broker.”

Even though Stamenson has repeatedly insisted that he worked in a completely different division of Merrill Lynch and had nothing to do with municipal bond issues, the MSRB’s rule book defines a municipal finance professional as any person who “solicits municipal securities business . . . even if an associated person is not ‘primarily engaged in municipal representative activities.’ ”

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And while reported violations of that rule are investigated by the U.S. Securities and Exchange Commission, Jennifer Kimball, an SEC spokeswoman, said that “generally, as an MSRB rule, the decision about what is applicable under that rule would lie with the MSRB.”

But Harvey Pitt, a lawyer for Merrill and former general counsel for the SEC, insists that no violation of rule G-37 took place. Stamenson, Pitt said, does not meet the definition of a “municipal finance professional” and thus was not subject to the rule, even though he involved himself in the deal.

“His role was to get ahold of Citron,” said Pitt, and “tell him what Merrill was willing to do. He was doing interface.”

Reached at his home in the Northern California town of Moraga, Stamenson refused all comment and referred all questions to corporate higher-ups.

Pointing out that the restriction applies only to negotiated deals, Pitt also contends that the $600-million issue was competitively bid--an issue that is strongly disputed by several people involved in the deal.

The $600-million deal has come under the scrutiny of state and federal investigators, who want to know whether the money was raised merely to prop up Citron’s teetering investment pool and meet collateral calls from investment banks that had lent Citron billions for his highly speculative investments. The county’s first venture into the municipal bond market to raise money for Citron’s investments occurred in June, 1993. Citron’s longtime financial adviser, Jeffrey R. Leifer, oversaw that $400-million issue and selected PaineWebber Inc. to sell it.

So as the county prepared to borrow the $600 million last June, Leifer examined the proposals of other firms, and PaineWebber was picked again by Citron.

Although proposals of other underwriting firms were taken into consideration, this was not considered a competitively bid issuance, where bonds are offered on the day of sale to any underwriting firm willing to bid on them. Negotiated deals are usually arranged weeks in advance of the sale with a single underwriter, which in turn sells the bonds at the best price.

Although the $600-million deal may have started out as a negotiated financing, Merrill Lynch’s Pitt insists that it became a competitive deal eventually, and so the firm did not violate the rule.

“The rule doesn’t apply to competitive transactions,” Pitt said. “It started out as a negotiated transaction and wound up being reported as a competitively negotiated transaction.” Pitt said a major bond information service, Securities Data Co., lists the deal as a competitive sale.

But the California Debt Advisory Commission, the state agency that tracks government debt sales, records the deal as a negotiated sale, and both Leifer and other sources involved in the deal say it was well understood that the transaction was negotiated.

That June 30, PaineWebber started taking orders from prospective buyers, sources said. Three hours after the market opened, the firm had taken orders for about $400 million but was having trouble placing the remaining $200 million of bonds, the sources added.

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“They didn’t want to get caught with these bonds over the July 4th weekend and were debating whether to go back to the county and tell them they couldn’t quite close the deal at the price they had arranged,” said a source familiar with the transaction.

When market buzz about the $600 million reached the ears of Merrill Lynch’s Robert M. Simonson, it gave him an idea: Merrill could move in on the deal. Simonson, a top securities trader, asked Stamenson to intervene, Pitt said.

The salesman told a special California Senate Committee in January that he had nothing to do with the county’s debt issues. “My scope of activity with the Orange County treasurer was not in the issuance of Orange County debt,” Stamenson said. “I have very, very little, if any, knowledge about the whys and what fors on how that debt was issued or any of the sets of circumstances revolving it.”

Once Merrill decided to make its move, Simonson called the county, proposing to take the issue and save the county $300,000. PaineWebber had agreed to sell the county’s debt for a rate of “LIBOR (the London Interbank Offered Rate) plus 5 basis points,” said Merrill spokesman Timothy Gilles. Merrill thought that was “an above-market price,” and offered to sell the deal at LIBOR flat, saving the county 1/20th of a percent on the sale.

Merrill Lynch said the events surrounding the deal “demonstrate the highly competitive nature of the underwriting business.”

But stealing away a negotiated deal is very unusual, bond traders, underwriters and market experts said.

“I would say it’s very unusual in a negotiated sale because the issuer usually has a contract with the underwriter,” said Taylor of the MSRB. “If I’ve ever seen it, it’s very rare.”

Zane Mann, publisher of the California Municipal Bond Advisor, a trade publication, called the move unheard of, because in a negotiated deal the underwriter typically helps determine the type and maturity of the bonds being offered for sale.

“It’s pretty unusual,” Mann said.

Not so, said Merrill’s Gilles. The investment firm just wanted to help the county. “Not only would the excessively high price have cost the county $300,000 in fees, it most likely would have affected the market for all future Orange County borrowings.

“We felt that as a member of the county’s underwriting group, we did not want that effect,” Gilles said.

Publicly, PaineWebber won’t talk about the deal. But privately, the firm’s bankers were delighted having avoided the subsequent taint of the county’s bankruptcy.

“We dodged a bullet,” one PaineWebber banker said. “I still wonder why Merrill stepped up--it’s the $64,000 question.”

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