How Deceit, Blunders Triggered O.C. Disaster : Bankruptcy: Grand jury testimony shows trail of secrecy, incompetence that led to financial meltdown.

It was just before dawn when Orange County’s leaders, frazzled and frightened, turned on one another.

In hours, one of America’s wealthiest counties would declare bankruptcy. But in the cold, empty Hall of Administration that morning, years of deceit, incompetence and arrogance were about to catch up with the county.

Supervisor Roger R. Stanton, flushed with rage, stood toe-to-toe screaming at the county’s chief administrator, top auditor, and the assistant treasurer who two days earlier had helped oust his disgraced boss.

“You, you and you. You’re all in big trouble over this,” snarled Stanton, pointing and jabbing with his finger, according to still secret grand jury testimony obtained by The Times.

On that Dec. 6 morning a year ago, last-ditch efforts to rescue the county’s fast collapsing investment pool were failing. The governor refused to help, as did the state treasurer. A call was placed to President Clinton, to no avail.

Arthur Levitt, chairman of the U. S. Securities and Exchange Commission, tried to force reality on the county’s leadership. You created the problem. You fix it, he told them.

But grand jury transcripts show that the county’s five elected supervisors and its ranking officials were either ill-equipped or unwilling to come up with their own solution.

Milling around the hallways that morning, county officials were gripped by a sickening realization: “If we try to solve it, the argument could be made we were responsible, and we don’t want any indication we were culpable,” then-Finance Director Eileen T. Walsh recalled Stanton saying.

That sentiment seized county government, and revealed that the seemingly tightknit “Orange County family” that worked side by side for years was a dysfunctional mess.

Over almost 50 days of secret testimony before the grand jury investigating the county’s financial collapse, witnesses told the story of a government riddled with cronyism, career-driven politicians, and bureaucrats obsessed with protecting their backs.

It was a government of fiefdoms ruled by elected officials whose underlings had learned not to question decisions.

This was a bankruptcy that was years in the making.

Officials Plead Ignorance

It started with a big lie.

It was the fable of Robert L. Citron, the county’s quirky treasurer with a penchant for oversized turquoise baubles and garish neckties. A man revered as some sort of financial wizard. Seemingly by magic, the arrogant USC fanatic parlayed the idle millions of the county, its schools and cities, and obscure special districts into billions.

To the delight of county officials, Citron came up with yet another way of producing cash at a time when the Legislature was taking it away. While other counties dealt with the harsh budgetary realities of the early 1990s, Orange County officials didn’t question their good fortune or the “genius” who supplied it.

By late 1993, the county’s general fund--its principal checking account--was fat and about $100 million in newly tapped interest earnings would soon be pouring in.

Although many of the county’s top officials later told the grand jury that the mushrooming interest payments were a mystery to them, some employees acknowledged that they found them highly curious.

While their bosses pleaded ignorance, midlevel accountants told the grand jury of schemes to pump up the amount of money available to the county through a creative shell game that enabled the county to constantly borrow and reinvest new money.

The goal was to feed the general fund, jokingly referred to by county insiders as the “retarded sister” for its failure to produce the same high interest earnings as other, less active county accounts.

But prosecutors told the grand jury there was no magic being performed in the treasurer’s office. There was just a plain, old-fashioned scam.

It began in July 1993, when then-Budget Director Ronald S. Rubino went searching for ways to patch the hole left by the loss of state funds, prosecutors alleged. He hatched a plan with his old buddy Citron and then-Assistant Treasurer Matthew R. Raabe, prosecutors maintained, to siphon off the interest earnings of investors in the county pool and stash them in a rainy day fund that would one day grow to about $150 million.

“[Rubino] said that Mr. Citron had been doing a tremendous job earning interest over the last 20 years, and that the [other] people who were in the fund were being very well rewarded,” Raabe testified.

Besides, it wasn’t really stealing, Citron was quoted as saying in testimony read to the jurors. After all, the pool’s investors were still reaping a healthy 7.85% in interest on money entrusted to him, a rate they should be “very happy” with, Citron reasoned.

“I didn’t use the . . . term ‘skimmed’ because I felt in my own mind,” Citron was quoted as telling investigators, “there was nothing wrong with it.”

What’s more, Citron said, “I remember Mr. Rubino saying, ‘If the state doesn’t come through, Bob, this money will certainly save us.’ ”

Raabe testified that he was told to keep the scheme to himself.

“They told me they didn’t want department heads informed,” Raabe said, “because [they] were greedy, particularly the people . . . responsible for social welfare programs, the sheriff, people in health care.”

And they didn’t want the pool participants to know, either, Raabe continued, “because they had the general view that people didn’t always know what was best for them.”

Citron said “that he had checked it out with county counsel and everything was fine.”

But Assistant Dist. Atty. Jan Nolan told the grand jury that what the trio was doing amounted to stealing.

“Had the bankruptcy not occurred, this would never have been discovered [and] this scheme ever brought to light,” she said shortly before Rubino was indicted on two felony counts of aiding and abetting Citron’s interest skimming.

Citron, 70, pleaded guilty last April to six counts of securities fraud and misappropriation of funds, and agreed to assist in the grand jury’s continuing criminal probe. He will be sentenced in February.

But prosecutors said skimming wasn’t enough to feed the county’s appetite for revenues. As a result, Citron cooked up other ways to borrow more money to invest in increasingly exotic and supposedly higher-paying securities, they said. Along the way, he attracted praise instead of scrutiny.

If there were suspicions about the county’s interest windfall or investment risks, none of the supervisors ever expressed them, former county Counsel Terry Andrus testified.

Even if ranking officials had expressed concerns, Citron would have resisted any efforts to oversee his operations, former county Administrative Officer Ernie Schneider testified.

Two members of the county budget staff testified that when they did raise questions about the interest earnings, their boss, Rubino, gave them only cryptic answers.

“This is the kind of thing [that] if a grand jury ever asks, you don’t want to know,” Budget Manager Steve Franks testified that Rubino told him.

The first public questioning of Citron occurred during a contentious election campaign in the spring of 1994. John M. W. Moorlach, the first challenger for treasurer in 20 years, expressed doubts about the safety of Citron’s investments.

It was Moorlach’s campaign against Citron that began to expose Orange County’s big secret.

In April, Citron received a call from an attorney on the staff of the U. S. Securities and Exchange Commission in Los Angeles. After the SEC attorney’s phone call, Citron “was very concerned and he was nervous,” testified lobbyist Lyle A. Overby, who advised Citron on how to handle attacks from Moorlach.

At Overby’s urging, Citron called Andrus.

“Mr. Citron began by stating that he was in a campaign with some people who weren’t nice, and they were playing dirty politics,” Andrus testified. “He didn’t really think it was the SEC. He thought it was dirty tricks or something.”

The SEC inquiry provoked panic among Citron’s inner circle. A decision was quickly made to meet with the regulators outside Orange County, “where somebody from the press might get wind of the meeting,” Deputy County Counsel Robert Austin testified.

A game plan was devised to prevent damage to the county and its investments.

On May 5, 1994, shortly after the meeting with the SEC, Andrus testified, there was a conference call involving Austin and the Wall Street rating agencies that advise prospective buyers about the relative safety of bonds and notes.

While reading notes made during that call, Andrus said he noticed that Austin’s account differed from that of Jean Costanza, a Los Angeles lawyer retained for many years as the county’s bond counsel.

“In Miss Costanza’s [account],” Andrus said, “it appeared that the consequences [of rising interest rates] would be very drastic, and according to Mr. Austin’s notes, it appeared that the consequences would be serious but not as drastic.”

Both Austin and Costanza had been talking to the rating agencies about the vulnerability of Citron’s county investment pool. If interest rates set by the Federal Reserve Board continued their upward spiral, a 2% rise in the rates would wipe out the pool’s liquidity. A 3% rise might sink it altogether.

Andrus testified: “The word ‘disaster’ was used in Costanza’s notes.”

Disaster Warning Proves Prophetic

Seven months later, Costanza’s scribbled memo would turn out to be prophetic.

But with Citron’s election on the line and a $1.3-billion slate of summer borrowings at stake, county officials embarked on a plan to keep the SEC inquiry secret, according to grand jury testimony.

On the advice of outside attorneys, the county deliberately delayed a request by SEC investigators for financial documents for four to five weeks, Austin testified.

“There was a feeling that if [the SEC] didn’t get the documents until after the election, that the matter would be kept more confidential,” Austin said.

Andrus decided not to reveal the SEC inquiry to the Board of Supervisors for fear the county’s ranking officials would blab and trigger a run on the troubled pool, Austin testified.

Later, Schneider testified, Andrus told him he didn’t inform the supervisors “because if I told one I might have to tell them all. If I told [Supervisor] Harriett [Wieder] it would be everywhere.”

When Schneider asked why Andrus kept him--the county’s highest-ranking officer--in the dark about the SEC inquiry, Andrus replied: “Because you didn’t need to know.”

Having successfully kept the SEC’s inquiry under wraps, Citron went on to win reelection. And the county continued its dicey investing, issuing more than $1 billion in new bonds and notes that summer.

Costanza, who was assuming the leadership role in the crisis, maintained the secrecy. Raabe testified that he had begun to fear Citron’s seeming inability to resist risky investments. Especially after the increasingly frail and timid treasurer told him in May or June that he had been consulting a psychic and an astrologer to make financial decisions and that the psychic had already predicted his election win, Raabe testified.

In June 1994, after the county issued $600 million in taxable notes--purely to redouble some of its investments--Raabe made Citron promise “that would be the very last time he would leverage any securities.”

A month later, Citron’s favored brokerage, Merrill Lynch & Co., expressed new doubts.

Broker Michael G. Stamenson asked Raabe to meet him in Newport Beach, Raabe testified. “He said that he and Merrill Lynch were concerned . . . about the amount of leverage Mr. Citron was continuing to increase in the investment fund.” But Citron brushed aside Stamenson’s cautions, Raabe testified, and continued to leverage the pool even more.

By September 1994, Raabe said, he was concerned enough to call Stamenson and ask the broker to have Merrill Lynch “put pressure on [Citron] to curtail some of the investment activities.”

A month later, Raabe testified, he was near panic. Risking Citron’s wrath, he shared his concerns with Schneider and Lewis. On Costanza’s advice, the officials decided to hire a New York firm to analyze the pool.

Raabe said he ordered a senior employee in the treasurer’s office not to execute any securities trades without his approval. “She asked me if that included Mr. Citron, and I said yes,” Raabe testified.

Led by Schneider, an emergency committee of former finance director Walsh, Andrus, Lewis and Raabe “would meet regularly after Mr. Citron went home.”

For weeks, the New York firm analyzed the pool, Raabe testified, and at first it appeared that the county faced a half-billion dollar trading loss.

But on Nov. 3, Raabe gathered a group including Deputy County Counsel John Abbott to explain that the county’s loss would be $2 billion if it had to sell off its securities.

The same day, the county’s troubles began to multiply. Irvine Water District Chairman Peer Swan came in demanding to withdraw $400 million from the pool. The pool’s problems were downplayed, Abbott testified, for fear Swan would leak the county’s troubles to others.

During the meeting, someone from the county suggested continuing to keep the financial troubles secret from the elected supervisors, Abbott said. Swan agreed, saying, “We absolutely don’t want them knowing; all hell would break loose,” Abbott recalled.

On Nov. 8, with the supervisors still out of the loop, the possibility of declaring bankruptcy first came up during a meeting in Andrus’ office, Abbott recalled.

That same day, Abbott, Austin and Raabe received what Abbott called the “Angel of Death call.”

The county’s hired SEC specialist “explained in graphic and somewhat gory terms, frightening terms, what he perceived to be the possible worst-case, or doomsday, scenario with respect to the pool. . . . He went through what a $2-billion loss would mean nationally, not only to the municipal market, but to the treasury market,” Abbott recalled in his testimony.

A series of increasingly panicked conference calls and meetings followed. Andrus brought up whether Merrill Lynch and Citron could be held liable for the debacle, testimony revealed.

On Nov. 10, Raabe and other county officials finally alerted supervisors in a series of individual meetings.

On Dec. 1, the county held a news conference to announce that its investments had had a so-called “paper loss” of $1.5 billion.

Two days later, the New York firm analyzing the county’s investments predicted a meltdown if the pool wasn’t liquidated by the time Wall Street opened Monday morning, Dec. 5.

Costanza called an emergency meeting of top county officials--excluding Citron and the supervisors--at the Prego restaurant. The mood was tense, Abbott testified. Increasingly alarmed, someone suggested using cash in the Economic Uncertainty Fund--Rubino’s secret rainy day fund--to bail out the county, Abbott recalled.

But Raabe quickly responded, “Well, we really can’t use all that money because it’s not all ours,” according to Abbott’s testimony.

Abbott said Lewis told the group that Austin had approved the shift of other participants’ interest earnings into the fund. Abbott said he was shocked by the revelation, adding, “It seemed fairly clear what was going on was illegal.”

After the meeting Abbott and Andrus returned to the Hall of Administration and spent the next couple of hours researching what responsibility the supervisors had over Citron and if or how they could oust him, Abbott and Andrus testified.

The next morning, Sunday, Dec. 4, Andrus, Schneider and Costanza drafted a resignation letter and drove with Raabe and Lewis to the treasurer’s home. After a distraught Citron was persuaded to resign, Andrus called Walsh to have a psychiatrist tend to the county’s once-vaunted financial wizard, Walsh testified.

Later that day, the supervisors finally were summoned to the Hall of Administration to be briefed on the dismal condition of the county’s finances. In order to avoid violating public meeting laws, the supervisors had to be told individually.

Throughout that day and into the night, county officials, consultants and attorneys tried to piece together a deal to liquidate the portfolio. In a frantic search for help, county officials turned to Gov. Pete Wilson, U. S. senators and others, but were rebuffed. Supervisor Wieder suggested that the county simply ask the Federal Reserve Board to lower interest rates, Walsh recalled to the grand jury.

When all their ideas failed, Raabe proposed selling the entire portfolio to Wall Street investors and swallowing a $1.3-billion to $1.7-billion loss.

The proposed sale sparked a huge debate among county officials over the fiscal and political fallout of such a move, Raabe said.

By the time they finally agreed to dump the portfolio, Wall Street investors had lost interest and prepared for a fire sale. In the end, bankruptcy seemed the only option.

Times staff writers Rene Lynch, Ken Ellingwood and Dexter Filkins also contributed to this story.