Popejoy Meets With CEO of Merrill Lynch : Bankruptcy: Sources say the officials discussed possible settlement of Orange County’s lawsuit against the brokerage firm. But the sides are reportedly far apart.

Orange County’s top executive flew to New York last week and secretly met with the chairman of Merrill Lynch & Co. to discuss a possible settlement of the county’s $2-billion lawsuit against the firm the county blames for its bankruptcy, sources disclosed Tuesday.

Chief Executive Officer William J. Popejoy, who had been scheduled to meet with legislators in Sacramento at the time, instead went to New York Tuesday so he could meet face-to-face with Merrill Lynch Chairman and Chief Executive Officer Daniel P. Tully on Wednesday morning.

Both county and Merrill Lynch officials declined to discuss the meeting or what, if any, progress was made to settle the county’s legal action against the firm.

The meeting signaled a breakthrough in the standoff between county and Merrill Lynch officials, who have repeatedly blamed each other for the largest municipal bankruptcy in U.S. history. Most of the securities on which Orange County lost nearly $1.7 billion had been offered to the county by Merrill Lynch.

Sources familiar with the situation cautioned against reading too much into the meeting and said the parties are still very far apart on a possible settlement deal.

It was unclear Tuesday whether the county or Merrill Lynch initiated the meeting, but one source said it was the county’s idea.

Paul S. Nussbaum, a top adviser to Popejoy, declined to discuss the meeting and said Popejoy also would not comment. Attorney James W. Mercer, who represents the county in its lawsuit against Merrill Lynch, also declined to comment.

Merrill Lynch spokesman Timothy Gilles said Tuesday evening: “We will have no comment.”

Orange County filed for bankruptcy Dec. 6 after suffering trading losses of $1.7 billion in its investment pool.

On Jan. 12, the county sued Merrill Lynch for $2.4 billion, blaming the giant brokerage firm for perpetrating a “massive investment scheme” that involved “the illegal extension of billions in credit” to former county Treasurer-Tax Collector Robert L. Citron so that he could “buy exotic debt obligations” that ultimately caused the collapse of a county-run investment pool.

At one point, the county had roughly $14 billion in borrowed money invested in securities whose values plummeted as interest rates increased last year.

Merrill Lynch’s willingness to lend money to Citron, to sell him risky securities and to participate in the sale of hundreds of millions of dollars of county bonds issued solely to leverage greater investments, figured prominently in the collapse of the investment pool and the county’s subsequent decision to declare bankruptcy.

Among other things, the county claimed Merrill Lynch “permitted and encouraged” Citron to make investments that the firm knew violated California law and “were contrary to the county’s investment objectives of safety and liquidity, and preservation of capital.”

The suit also claimed the brokerage firm “wantonly and callously abused the trust and confidence” of the county by allowing Citron to invest public funds in volatile and risky securities.

Merrill Lynch denies that it misled Citron.

In January, the firm publicly released letters it sent to Citron offering to buy back the entire portfolio of exotic securities. But the offers were spurned by the former treasurer. And last week, Merrill Lynch gave a special California Senate committee investigating the bankruptcy internal memos showing that some of the firm’s executives were concerned as early as 1992 about Citron’s dangerous investment strategy.

The likelihood of collecting damages from Merrill Lynch played a key role in the county’s negotiations with the schools, cities and other pool investors, who agreed to accept IOUs backed partly by expected lawsuit proceeds in a bankruptcy court settlement adopted May 2.

Last month, Popejoy boasted about the strength of the county’s case against Merrill Lynch, pointing to press accounts describing struggles within the company about its dealings with Orange County and Citron.

News accounts portrayed an investment giant at war with itself over its involvement with Orange County nearly three years before the county declared bankruptcy.

“I think we’ve made a lot of progress in the Merrill Lynch litigation and I think evidence of that are the articles . . . on Merrill Lynch’s behavior and their involvement with Mr. Citron,” Popejoy said in April.

From its published financial statements, Merrill Lynch might well be able to afford a large settlement. It earned more than $1 billion last year on revenues of $18.2 billion.

“These accomplishments were achieved for our clients in a market environment that was difficult and indeed treacherous for many,” Tully and Merrill Lynch President David Komansky told stockholders in the annual report. “One of the most publicized casualties of 1994 was the fixed-income portfolio managed by the treasurer of Orange County, California; the county declared bankruptcy in December following the unprecedented turbulence in the bond market.”

Tully and Komansky continued, “Subsequently, allegations were made the Merrill Lynch was responsible for the county treasurer’s investment policy. We believe the facts, when fully aired and understood, will make it clear that our company acted properly and professionally in our dealings with the Orange County treasurer, with whom we had a 20-year relationship.”

Times staff writer Mark Platte contributed to this story.

* SHORT-TERM NOTES: State’s counties, schools will soon discover how costly Orange County’s debacle is. D1