ORANGE COUNTY IN BANKRUPTCY : Lewis Expressed Doubts in Memo, Then Nixed It : Crisis: County auditor-controller never sent mid-1993 letter with concerns about safety of investment practices.

Orange County Auditor-Controller Steve E. Lewis said Friday that he wrote but did not send a confidential memo to top county officials in which he expressed doubts about then-Treasurer-Tax Collector Robert L. Citron’s investment practices in May, 1993--19 months before the county filed for bankruptcy.

In the memo to former County Administrative Officer Ernie Schneider, with copies to then-Board of Supervisors Chairman Harriett M. Wieder and Citron, Lewis wrote that Citron would “earn significantly more interest” for the county that year than in previous years and that the interest would result from “investment techniques.”

“It is my understanding that the treasurer has discussed these techniques with you and your staff and you understand them and believe the involved risk is acceptable and appropriate,” he wrote. “However, a fundamental investment principle is that it is necessary to increase one’s risk if one is to significantly increase the rate of return.”

Instead of sending that warning, however, Lewis said he discussed Citron’s investment strategy with the treasurer and with then-county budget director Ronald Rubino, and came away satisfied with their explanations.

At that point in 1993, Lewis said, it was too early to forecast the problems that ultimately caused the county’s investment pool to suffer $1.7 billion in trading losses and forced the county into bankruptcy in December.

“That memo was never signed and never sent,” Lewis said. “It was released under a subpoena that called for all the information we had in this office. We came across this piece of correspondence and submitted it along with everything else.”

The memo was obtained Thursday by the special state Senate committee investigating the Orange County bankruptcy. It was among tens of thousands of pages of county records released to opposing lawyers in the lawsuits brought by the county against Merrill Lynch & Co. and by bondholders suing Merrill Lynch and other financial firms in U.S. District Court in Santa Ana.

The county blames Merrill Lynch and others for the investment pool’s $1.7-billion loss and seeks to collect $2.5 billion from the brokerage firm in the lawsuit filed in U.S. Bankruptcy Court.

Lewis said that before the county released information in the Merrill Lynch lawsuits, “we built master files with all of the sub-fields and I’m sure they pored over all that stuff looking for evidence that the county knew more about the risk that Citron was taking” than county officials have admitted.

But Lewis said “the reality at that time” was that nobody had enough information about Citron’s activities to foretell the enormous trading losses.

Lewis met with Citron and Rubino after raising questions about how Citron expected to generate more interest income than in previous years.

“There was more of a discussion about how he was doing reverse repos and they were saying that there is more interest coming in,” Lewis said. “I wanted to make sure the CAO [Schneider] knew what was coming in.”

Schneider could not be reached for comment.

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Lewis said he was also told in that discussion about the pool’s liquidity and Citron’s philosophy of holding securities until they matured. “But I don’t think any of us ever understood the volatility” of Citron’s investments,” he said.

Back then, “we had just started to learn more about reverse repos and leveraging,” Lewis said. Before 1993, the treasurer was reluctant to discuss his risky investments in detail, Lewis said.

Later, Lewis said he asked the county’s outside auditors, KPMG Peat Marwick, to take a look at the treasurer’s investments and received no indications from them of serious problems. Within weeks of the time the firm was scheduled to complete its audit of the county’s books for the fiscal year that ended June 30, 1994, the county filed for bankruptcy and never received the final audit.

Acknowledging that he did not send the warning is a candid admission for Lewis, who has been publicly castigated by supervisors for not warning them more forcefully of the county’s impending crisis. He recently survived an attempt to oust him by Orange County Chief Executive Officer William J. Popejoy, after agreeing to give up the auditing function of his office.

Lewis has maintained that he gave appropriate warnings about Citron’s activities to county officials, and that it was not his responsibility to oversee individual transfers of money within accounts at the treasurer’s office but rather to make sure the accounting was done properly.

Shortly after the bankruptcy filing, Lewis released a 1991 audit--two years before he wrote the memo--that revealed irregularities in the treasurer’s office. Supervisors complained they had not received that audit even though transmittal letters show it had been sent.

Earlier this year, Lewis made public a June 8, 1994 letter he sent to Schneider--and copied to the supervisors--warning about Citron’s risky investments. After he was attacked by supervisors in February, Lewis said he had never received a response from the board to his earlier warnings.

Citron pleaded guilty April 27 to six counts of securities fraud and misappropriation of funds, including illegally diverting interest from other pool investors to the county. He faces up to 14 years in prison and a $10-million fine.

Scott Johnson, counsel to the special Senate committee, said two Merrill Lynch lawyers who met with him Thursday strongly hinted that there is evidence other officials in the county knew of Citron’s risky practices well before the pool collapsed.