Judge Dismisses Lawsuit Filed by O.C. Against Merrill Lynch : Courts: Ruling, viewed as a temporary setback, hinged on whether pool’s funds belonged to county or were held in trust.

A U. S. Bankruptcy Court judge on Tuesday dismissed Orange County’s $2.4-billion lawsuit against Merrill Lynch & Co., ruling that the county had not proven that it was the proper party to bring a claim against the Wall Street firm.

But the ruling by Judge John E. Ryan may represent only a temporary setback for the county in its bitter battle to recover its massive investment losses. The county has until next week to refile its lawsuit, showing that it was the actual owner of the securities in the investment pool and thus the rightful plaintiff in the suit against Merrill Lynch.

J. Michael Hennigan, the county’s lead lawyer in the case, said he accepted Ryan’s ruling, but was disappointed. He said the judge’s decision could cause another lengthy delay in getting the county’s lawsuit before a jury.

“Every day [this case is prolonged] is a golden day for Merrill Lynch,” Hennigan said.

Merrill Lynch’s lawyers were exultant.

“A nice day’s work,” said Ronald L. Olson, the Los Angeles lawyer who is defending the lawsuit. “Right now, there is no claim against Merrill Lynch.”

Ryan issued his ruling after an intense 3 1/2-hour legal debate between lawyers for both parties.

In the end, he sided with Olson, who had argued California law was clear that the funds in the ill-fated Orange County Investment Pool “are trust funds and not the property of the county.” Therefore, county officials cannot sue over them, Olson said.

“What we have here is a dispute between two non-debtors,” Olson said, “because it is not the debtor’s property at issue.”

Merrill Lynch’s lawyers have repeatedly argued that the securities it sold to the pool belonged to about 180 government agencies--not just the county--so any lawsuit for damages must be filed on behalf of all the agencies.

Olson said the investment pool was akin to a money market fund, with depositors having the right to withdraw their money on 30 days’ notice.

“The real question here is: Whose property is at issue?” Olson asked.

He answered the question he posed by citing a state law that forbids counties from claiming ownership of funds in county-run investment pools.

Olson accused the county of “trying to manipulate this case into this court.”

Olson was referring to an April ruling by Ryan that bankruptcy and federal laws barred him from ruling on the overwhelming majority of the issues raised in the county’s initial damage suit against Merrill Lynch.

Since that ruling, the county has sought to keep the case in Bankruptcy Court by contending that Merrill Lynch had no right to liquidate $1.6 billion worth of county securities once held in the pool’s brokerage account.

*

Orange County filed suit against Merrill Lynch 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 transactions with former Orange County Treasurer-Tax Collector Robert L. Citron 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 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 the $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 credit and the securities being purchased.

On Monday, Hennigan argued that Citron indebted the county when he borrowed money from Merrill Lynch, and therefore the county was the injured party in the case.

“We believe this trust disappeared and was commingled out of existence,” Hennigan said.

But Ryan said that, under state law, assets in an investment pool managed by a county treasurer are held in trust.

He said to prove its case, the county must show how state law did not apply to the Orange County situation. “I don’t think that the [existing] complaint has done that sufficiently,” Ryan said.

After the judge’s ruling, Hennigan said the county will amend its new complaint, detailing why the county-run pool was not a trust. And even if that claim fails, the county plans to show that it is the appropriate party to file a lawsuit against Merrill Lynch.