Merrill Uses Citron’s Words for Defense in County’s Suit

In a bid to undermine Orange County’s arguments for $2 billion in damages, Merrill Lynch & Co. on Wednesday disclosed correspondence from state and local officials defending the investments that plunged the county into bankruptcy.

In court documents filed in U. S. Bankruptcy Court here, Merrill Lynch officials contend that letters and memos from former Treasurer-Tax Collector Robert L. Citron, the county’s in-house attorneys and a former state attorney general bolster their position that the county’s $2.4-billion lawsuit should be dismissed.

“Merrill Lynch relied on the repeated representations of the Treasurer, the Board of Supervisors and others regarding the Treasurer’s legal authority to enter into the investment transactions the County now seeks to repudiate,” Merrill stated in its court filing.

County officials and their attorneys dismissed the brokerage’s arguments and say they believe that U.S. Bankruptcy Judge John E. Ryan will reject them when both sides return to court next Thursday to argue Merrill Lynch’s motion to dismiss the county’s complaint.

“They’re grasping at straws,” Supervisor William G. Steiner said.

The county filed suit shortly after declaring bankruptcy Dec. 6, blaming the Wall Street firm for selling the county risky investments that led to the worst municipal bankruptcy in U.S. history.

The county’s suit alleges that Merrill Lynch entered into illegal transactions with the county in violation of state law. It also contends that the transactions, particularly so-called reverse repurchase agreements, forced the county to exceed the amount of debt that it could legally incur under the state’s Constitution.

According to the county’s lawsuit, Merrill Lynch sold Orange County 68% of the securities in its $21-billion investment portfolio, which included $14 billion bought with borrowed money.

The county used virtually all of this borrowed money to buy reverse repurchase agreements, a transaction in which the seller often provides both the funds and the securities.

In its legal papers, Merrill Lynch addressed the county’s arguments head on for the first time, stating that its dealings with Citron did not violate state law.

“Neither the county nor anyone else interpreted the California statutes as the county now interprets them in its effort to avoid responsibility for its prior acts,” the Merrill filing states.

Merrill Lynch cited a 1977 opinion by then-California Atty. Gen. Evelle Younger that “a municipality may enter into repurchase and reverse repurchase agreements for the sale and purchase of treasury bills.”

Also included in Merrill Lynch’s filing Wednesday was a letter written by Citron to another Wall Street firm expressing his opinion that reverse repurchase agreements and other risky transactions were legal.

“I can think of no instance where the County of Orange government could file suit against a dealer or dealers, where the dealer sold illegal or risky securities, unless they be securities not enumerated in the California Government Code,” Citron wrote in an Aug. 30, 1994, letter to the investment firm Smith Barney.

“Since this treasurer [Citron himself] wrote most of the code regarding what securities are legal purchases, I do not see how we would buy securities that are not legal investments,” Citron added.

Another document was a Nov. 2, 1993, opinion letter from the Orange County counsel’s office assuring First Trust National Association of St. Paul, Minn., that the county’s use of repurchase agreements “constitutes a lawful, valid and binding transaction.”

The letter also seems to contradict the county’s lawsuit claim that securities dealers knowingly gave the county too much credit, in violation of the state Constitution, by arranging reverse repurchase transactions. The letter, sent by County Counsel Terry C. Andrus, said “it is our opinion . . . that the transactions entered into under the repurchase agreement will be sales and purchases, not loans,” so the issue of credit does not arise.

Merrill also included a confidential memo from Auditor-Controller Steve E. Lewis to then-County Administrative Officer Ernie Schneider that addressed the county’s investment risks. The auditor did not question the legality of the county’s investments, but expressed concern that top county officials be aware of the risks of Citron’s investment strategies.

J. Michael Hennigan, the Los Angeles lawyer who is the lead litigator in the county’s lawsuit against Merrill Lynch, said all the letters and memos in Merrill’s filing were either irrelevant or taken out of context.

Hennigan said county lawyers have never challenged the legality of reverse repurchase agreements, but they have contended that “it was illegal to use reverse repurchase agreements to speculate on the reversal of interest rates.”

“Where is the attorney general’s opinion that says you can make a wild speculative bet on the movement of interest rates?” Hennigan asked. “It is clear that what you cannot do is turn a conservative, risk-free investment into a casino bet.”

Hennigan said Merrill Lynch was simply trying to undermine the county’s bid to have Judge Ryan rule on the legality of the brokerage firm’s loans to Citron.

“I don’t see any other argument from Merrill Lynch other than, ‘Please, don’t rule on these issues,’ ” Hennigan said.

Hennigan added that the attorney general’s 1977 opinion, cited by Merrill Lynch’s lawyers in their latest filing, made it clear that a county treasurer could not gamble with public funds.

The opinion states, in part: “In our view, the Legislature . . . intended to limit local agencies to investments which are considered to be safe and prudent and which impose minimal risks of financial loss.”

“This whole framework of law is designed to prohibit one person or one group of people from speculating with public funds,’ Hennigan said.

Bruce Bennett, the county’s bankruptcy attorney, said the Citron letter “doesn’t impress me at all. This borders on insignificance.”

John Amsden, another county attorney agreed, saying Citron’s letter was not relevant.

“A bookie’s bet isn’t legal, even if the bookie says it is,” Amsden said.