Merrill Lynch Proposed Deal, Documents Show

In a secret effort to settle the county’s bankruptcy-related lawsuit, Wall Street giant Merrill Lynch & Co. last May proposed a deal to pay bondholders $430 million and give the county an $800-million loan to pay off other creditors, according to documents made public Monday.

The proposal called for Merrill Lynch and other Wall Street firms that did business with the county to help the county repay its debts, the documents show.

But the idea was swiftly rejected by then-County Chief Executive Officer William J. Popejoy, who instead was seeking an outright $1.2-billion payment from Merrill Lynch.

An account of the proposed settlement was contained in confidential notes that Popejoy provided to the Board of Supervisors following negotiations in New York last May with Merrill Lynch Chairman Daniel Tully and company executives. Those notes were made public Monday along with other evidence presented to the grand jury in its investigation of the county’s unprecedented bankruptcy.

Popejoy’s notes are the first indication that Merrill Lynch officials were seriously considering ways to reach an out-of-court settlement.

Merrill Lynch spokesman Timothy Gilles confirmed Monday that top executives met with Popejoy in May. But, he said, “we responded in no uncertain terms that Merrill Lynch had done nothing wrong, that Orange County was looking for scapegoats and we did not intend to be held as a scapegoat. Our paying that kind of money [the $1.2-billion demand] was absurd.”

Asked if the brokerage had proposed a deal, Gilles declined to comment.

Gilles said Popejoy did not take notes during the meeting, adding that “as to the accuracy of his notes, we have no comment.”

The county’s $2-billion suit alleges that Merrill Lynch duped former Orange County Treasurer-Tax Collector Robert L. Citron into purchasing risky securities in violation of state law. It also contends 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.

In addition to Merrill, the county has sued its outside auditor, KPMG Peat Marwick, for $3 billion, alleging the firm failed to warn county leaders about the risks in its ill-fated investment pool. County bankruptcy lawyers are also planning a slew of lawsuits against other professionals and Wall Street firms.

But for the last year, the county’s suit against Merrill has drawn the most attention.

According to his notes, Popejoy told Merrill’s top in-house lawyer, Steve Hammerman, who accompanied Tully to the meeting on May 17, 1995, that he thought it would take a $1.2-billion payment to settle the case.

Both Tully and Hammerman expressed “strong feeling[s] that such an amount was not justified,” and that other Wall Street firms “should be brought into the discussions.”

At one point in the meeting, Tully even suggested making a charitable donation to settle the case. Popejoy said that was fine--as long as the charity was the county, the notes show.

When the discussions went nowhere, Popejoy said he was about to leave and thanked the Merrill executives for their time, saying: “I would have felt badly later if I hadn’t at least tried to start settlement negotiations before our disagreement assumed a life of its own and more fully entered the . . . public arena,” the documents show.

Popejoy wrote that his remark “seemed to get their attention.”

According to Popejoy, Hammerman questioned why “a legal disagreement should enter that arena.”

Said Popejoy, “I then picked up a newspaper from the table and said: Orange County news may be on the back pages in [the] New York Times, but in Orange County (a community of some 3 million folks) the bankruptcy was front page stuff in both major newspapers almost every day.”

Both Tully and Hammerman made comments “indicating Merrill Lynch’s interest to be part of a solution--not because they had done anything wrong--rather . . . to avoid further hardships by the community,” according to Popejoy’s notes.

Tully and Hammerman asked Popejoy to meet later in the day with three high-ranking officials, who later discussed the crafting of a $1.2-billion plan to bail the county out of its financial debacle.

One suggestion, according to Popejoy, called for “Wall Street, not just Merrill Lynch” to loan “all or part of the money, even at a sub-market rate (50% of market) with repayment later by the county.”

When Popejoy rejected the offer, the officials responded by proposing that Wall Street pay the $430 million. The remaining $800 million owed county creditors would also be financed--and guaranteed--by Wall Street firms but ultimately repaid by the county.

Popejoy said he was “‘clear and adamant that such would not be acceptable to us.”

In his grand jury testimony, Popejoy said Merrill Lynch executives were more agreeable to working out a deal as their discussions continued that day, according to transcripts.

“They were talking settlement, and they wanted all of the other potential defendants, the other Wall Street firms, the auditors, anyone else” to be part of the deal, Popejoy testified Sept. 13. “They meant ‘global’ because they didn’t feel that they were the only ones that were involved in this thing.”

Popejoy returned from New York and briefed the Board of Supervisors in closed session a few days later. He was so concerned that the meeting be kept confidential that he collected the memos he had handed out to the supervisors before they left the briefing, his notes and testimony show.

Nonetheless, word of the county’s negotiations with Merrill Lynch was disclosed in The Times within days. Popejoy testified that Merrill Lynch officials were concerned about the county’s breach of confidentiality.

Weeks later, the negotiations were broken off for good after Supervisor Roger R. Stanton released a plan of options to avert a sales tax increase, Popejoy testified. One option in Stanton’s plan mentioned the possibility of settling the county’s bankruptcy litigation for $500 million.

Popejoy testified that Stanton’s proposal undermined his negotiations with Merrill Lynch. He was so upset with Stanton that he went to the grand jury to ask that it investigate the supervisor for disclosing confidential information.

Stanton has denied he did anything to scuttle the county’s settlement with Merrill Lynch. He has insisted the $500-million figure was gleaned from public documents and was not a satisfactory amount.

In an interview Monday, Popejoy reiterated his position.

“Stanton blew the whole thing out of the water,” Popejoy said. “I don’t think there was any doubt that they wanted to get something accomplished.”

But Popejoy said Merrill Lynch’s proposal was “not an offer. It was a discussion. They were interested in a global settlement. These were serious discussions.”

In separate testimony to the Securities and Exchange Commission also released Monday, Auditor-Controller Steve E. Lewis told the agency’s attorneys he began to worry about the county’s excessive borrowing months before the bankruptcy. But he said he relied on outside auditors to monitor the county’s investments.

Lewis also testified that he depended on outside lawyers to assure him of the legality of some of the county’s complex financial transactions.

“We had concerns, but I mean nothing major,” Lewis said about a $400-million borrowing in 1993. “I mean, [it was] something that we wanted to watch--and we didn’t feel like we understood it. . . . I’d say we had concerns.”

Lewis testified last May in response to a subpoena from the SEC, which is investigating possible violations of securities laws leading up to the county’s December 1994 bankruptcy. As early as 1993, Lewis said he worried that elected officials and administrators relied too heavily on interest earnings to balance the county budget. Lewis said he urged county officials to set aside some of the earnings for the future.

“The county seemed to have an attitude that . . . if it had a problem, all it needed to do was go borrow some money and we’ll make some more money,” Lewis testified. “That was my concern.”

Lewis said he had little idea how serious the county’s financial problems would later become.

“It wasn’t that we saw the problem with the treasury going bankrupt,” Lewis said. “It was this idea that the county was becoming so dependent upon . . . this revenue source.”

Yet Lewis said when he took his concerns to Citron and then-Assistant Treasurer Matthew Raabe, the two assured him the county’s investments were safe.

“Bob had a way of saying he knew where interest rates were going to go and . . . even if they did go up, they wouldn’t go up for long,” Lewis said.

Lewis said he didn’t press Citron for detailed explanations. He said he didn’t have a full grasp of Citron’s investment strategy. He said he relied on outside auditors for help.

“This wasn’t an area we understood, the investment side of the treasury,” Lewis testified. “And we still don’t.”

When county administrators shifted money in the budget to qualify for more borrowings, Lewis said he relied on the assurances of outside lawyers that it was all legal.

Documents released Monday show that Lewis apparently was nervous about shifting the funds. On a July 14, 1994 memo that outlined the shift, a scrawled note to bond counsel Jean Costanza reads:

“Steve was hoping you would send him a ‘comfort’ letter so it wouldn’t look like he dreamed up some crazy investment scheme.”

* IN CONTROL: Judge in O.C. misconduct cases says he will keep tight reins. B1