O.C. Auditors Didn’t Understand Investments, Grand Jury Told : Bankruptcy: They also relied on outside lawyers for advice on municipal finance, transcripts show.

Despite the auditor-controller’s duty as Orange County’s chief fiscal regulator, top officials in the office little understood the county’s ill-fated investment strategy and relied on outside lawyers for approval of questionable financial dealings, according to testimony before the Orange County Grand Jury.

Top officials said they lacked the staff and expertise to keep a close eye on the risky investment program of former Treasurer Robert L. Citron and did not fully understand basic federal and state laws governing municipal finance, according to grand jury transcripts released this week.

“We presumed [Citron] had the ability since he was--had been a treasurer for a long time, and he had an outstanding reputation,” Deputy Chief Controller Charles Hulse said.

Accounting chief James M. McConnell told the grand jury that outside lawyers eased officials’ misgivings about a series of financial transactions that may have violated federal tax laws.

*

“I guess I didn’t feel that great about it, but I didn’t think it was deceptive, no,” McConnell said. “We assumed that bond counsel knew what they were doing, and they had done this for other agencies, and that they knew their business.”

Prosecutor Jan Nolan retorted: “And don’t the county taxpayers pay you to know your business?”

“Yes,” McConnell replied.

The grand jury has filed a civil charge against Auditor-Controller Steven E. Lewis, accusing him of official misconduct for his role in the largest municipal bankruptcy in U.S. history. He is the only one in the office to be charged. Lewis declined to testify before the grand jury, but he sent it a lengthy memorandum detailing his actions. He denied any wrongdoing.

Together, the combined annual salaries of Lewis, Hulse and McConnell top $275,000.

Brian Sun, Lewis’ defense attorney, said his client did everything he could to monitor Citron and the county’s financial practices. He said Lewis urged KPMG Peat Marwick, an outside auditing firm, in mid-1993 to evaluate Citron’s investments.

“At least Steve Lewis had the good sense and wherewithal to ask Peat Marwick to take a look,” Sun said.

*

Sun said the county auditor’s duties are narrowly defined and do not include finding fraud in every instance and gauging the soundness of county investments.

“The auditor’s office is not the sort of fraud watchdog the public perceives,” Sun said.

Testimony before the grand jury shows that from the outset, staffers in the auditor-controller’s office were largely in the dark about how Citron was borrowing and investing hundreds of millions of dollars in public money. Hulse told grand jurors that his office simply did not have the ability to make sense of the exotic investments of Citron, who is awaiting sentencing on six felony charges.

“We felt like we did not have the expertise within the auditor’s office to, you know, double-check their calculations,” Hulse told the grand jury. “We couldn’t afford to have a group of staff become experts in the treasurer operations because they were spread kind of thin.”

*

So while the auditor’s office scrutinized every other county department, Citron’s operation was left largely alone, according to Hulse and McConnell. In four years, Hulse’s office performed one audit of Citron, and it contained mild warnings about his financial practices.

Hulse said his office came to rely on assurances from county Budget Director Ronald Rubino that Citron’s strategies were sound. Hulse said that at one point, Auditor-Controller Lewis considered sending a memo to then-Chief Administrative Officer Ernie Schneider to raise concerns about Citron’s investments. Rubino, he said, talked Lewis out of it.

“We were surprised that Rubino was so up on what was going on, and he gave that--gave us a little additional comfort,” Hulse said.

McConnell and Hulse said the auditor’s office relied on outside bond lawyers to relieve any concerns that the county was acting illegally during a series of complicated financial transactions.

*

Some of the transactions involved transfers of millions of dollars from the county’s general fund to allow more tax-exempt borrowing for Citron’s investments--a possible violation of federal tax laws. Prosecutors contend that other borrowing may have violated the law by dodging the requirement that certain debt issues be paid off within a year of being issued.

McConnell said staff members were aware of legal limits but that they relied on an outside bond lawyer, Jean Costanza, to convince them that the transactions were legal. An accountant hired to make sense of the county’s finances told the grand jury that the auditor’s office never acknowledged deepening problems and was mired in denial to the very end.

KPMG Peat Marwick partner Margaret McBride said her auditing firm was hired to audit the county’s finances in 1993, a study that was to include a review of the investment pool that Citron managed for the county and scores of school districts and local governments.

Although Lewis noted the fund was producing unusually high yields and relied heavily on borrowing, he did not seem worried, McBride said. McBride said no one in the county auditor’s office mentioned a 1991 internal audit that had spotlighted irregularities in the county’s investment strategies. And she said a senior manager brought in to examine the complex investment pool was assured by then-Assistant Treasurer Matthew R. Raabe that the county had taken steps to safeguard against a collapse. Peat Marwick saw no need to look further into the pool’s management, she said.

County officials vigorously disputed McBride’s characterization of events and testified that they had asked her firm repeatedly for a close look at Citron’s investments. The county sued the auditing firm last week, contending that Peat Marwick failed to warn of the impending financial meltdown.