O.C. Sues Five Firms in Its Bid to Recover Investment Losses
Broadening a campaign to recover the investment losses that drove it into bankruptcy, Orange County filed five new lawsuits Tuesday, demanding millions in damages from its former bond lawyers, a Wall Street ratings firm and even the federally chartered agency that sells student loans.
Attorneys representing the county filed the suits in U.S. Bankruptcy Court here on the eve of the county’s emergence from the worst municipal bankruptcy in the nation’s history.
“These lawsuits are an attempt to share the responsibility rather than shift it,” said J. Michael Hennigan, the county’s top litigation attorney who is already pursuing multibillion-dollar damage suits against Merrill Lynch & Co., the brokerage firm that sold most of the exotic securities on which Orange County lost $1.64 billion, and KPMG Peat Marwick, the county’s former outside auditor. Both firms have denied any wrongdoing.
The lawsuits filed Tuesday named as defendants the investment banking firm Morgan Stanley; the Wall Street ratings agency Standard & Poor’s Corp.; the law firm of LeBoeuf, Lamb, Greene & MacRae, which gave the county legal advice on its borrowings; Rauscher Pierce Refsnes Inc., a Dallas brokerage the county says it relied on for financial advice; and the Student Loan Marketing Assn., the quasi-governmental agency commonly referred to as Sallie Mae, which indirectly raises money for guaranteed student loans.
Officials for the firms deny any wrongdoing. They said the county’s claims were without merit and that they planned to defend themselves vigorously in court.
The suits focus on actions taken by each of the defendants in 1994, when then-Treasurer-Tax Collector Robert L. Citron, who managed the county’s investment pool, borrowed more than $14 billion to make a series of wrong-way bets on the direction that interest rates would move.
Orange County argues in its suits that Citron’s heavy borrowings from brokerages and investment banks were in violation of the state Constitution, which forbids a county to borrow more money than it has the resources to repay.
The latest group of defendants are accused of failing to disclose or detect the risks that Citron was taking with public funds, and helping him increase his bets in a desperate attempt to recoup losses when interest rates began to rise.
Most of the money-losing investments were pegged to interest rates and declined in value as the Federal Reserve Board began pushing interest rates higher, as it did six times in 1994.
The suits deal at length with attempts by then-candidate for treasurer John M.W. Moorlach to expose Citron’s casino-type bets and the alleged efforts of the new defendants to blunt criticism of the incumbent.
Hennigan, the Los Angeles lawyer who heads the county’s litigation team, said attorneys carefully selected the five defendants because they represented the major causes of action the county plans to pursue.
Roger R. Stanton--the chairman of the county Board of Supervisors, which approved filing the suits Tuesday morning--said they were intended to exact “some accountability from these folks who were hired in good faith by the taxpayers of Orange County to provide advice and counsel . . . and who fell down on the job. They have to be held accountable.”
Samuel M. Sugden, chairman of LeBoeuf, called the suit against his New York law firm an “outrage.”
“The filing of this litigation represents yet another effort by the county to blame others for the losses caused by the county’s failed investment strategy and the . . . improper activities of its own officials,” Sugden said.
Jennifer Driscoll, a spokeswoman for Rauscher Pierce Refsnes, added: “Plainly, Orange County is simply looking for as many deep pockets as it can find.”
County lawyers had planned to name about 20 additional Wall Street firms as defendants in suits on Tuesday, but changed their plans late Monday night when a number of the firms agreed to return more than $65 million of county money that had been held since securities held as collateral were liquidated after the county declared bankruptcy in December 1994. Of that amount, brokerage CS First Boston contributed $55 million, Hennigan said.
Under a so-called tolling agreement, the county and those firms agreed to suspend any contemplated legal action against each other for at least 140 days. The county might sue the firms when that period expires, Hennigan said.
Some Wall Street analysts reacted with disbelief after learning that the county had sued Standard & Poor’s.
“When Citron wins, it was fine. But when Citron loses, it’s everyone else’s fault,” said Joe Mysak, editor of Grant’s Municipal Bond Advisor in New York. “I can see suing your bond counsel. But rating agencies? It’s just bad business.”
Christopher Taylor, executive director of the Municipal Securities Rulemaking Board, a regulatory agency, said even though Orange County will officially emerge from bankruptcy today, “this bankruptcy will have a couple more years to run [as] we go through all these lawsuits. Now the dissection process begins.”
The following are summaries of the new suits, and responses by the defendants:
Standard & Poor’s
Orange County took what appears to be an unprecedented step in filing suit against Standard & Poor’s Corp., the Wall Street credit rating agency that signed off on hundreds of millions of dollars of Orange County bonds.
Major rating agencies scrutinize bond issues and then assign ratings designed to help investors judge the riskiness of such deals. Good ratings can significantly lower the cost of borrowing.
While other rating agencies, such as Moody’s Investors Service, also rated Orange County’s bonds, S&P; rated the bulk of Orange County’s deals and gave stellar ratings to bonds sold in the months before the county filed bankruptcy.
In its suit, Orange County claims that S&P; should have discovered the problems in the county’s investment pool. Instead, the rating agency made public assurances that the county’s investment strategy was sound, and that the county would be able to pay off bonds sold for the sole purpose of raising money to put in its investment pool, the suit charges.
Michael Dorfsman, a spokesman for S&P;, said agency officials could not comment because they had not yet seen the suit. “But earlier this year, the SEC already determined that we were repeatedly misled by county officials at the time about the condition of the pool and the county’s finances,” Dorfsman said.
Student Loan Marketing Assn.
Orange County sued the Student Loan Marketing Assn., commonly known as Sallie Mae, for $58.7 million for selling volatile securities to Orange County for its troubled investment pool.
Although a publicly traded stock corporation, Sallie Mae operates under a federal charter. According to the suit, Orange County paid $2.6 billion for 19 Sallie Mae securities sold from 1991 to 1994. In four of those securities issues, for which Orange County paid $913 million, the documents contained material misrepresentations and omissions by Sallie Mae, the suit charges.
Specifically, the suit charges that Sallie Mae misrepresented the amount that was paid to Merrill Lynch & Co. under a complicated swap agreement with the brokerage firm, and that Merrill was the real issuer of the notes to the county.
The county charges in its suit that Merrill and Sallie Mae have “a history of secretly extending favors to each other that are undisclosed to the market.”
“It’s inconceivable to us that any liability could be attached to the Sallie Mae debt obligations that ultimately ended up in the Orange County portfolio,” said Gisela Vallandigham, a spokeswoman for Sallie Mae.
LeBoeuf, Lamb, Greene and MacRae
The county accused LeBoeuf, Lamb, Greene and MacRae, its bond counsel on more than $975 million in borrowings, of “deceptive and incompetent services.” Because of the law firm’s “misinformation,” the county made “high-risk” transactions that led to massive financial losses, the suit contends.
The suit further alleges that LeBoeuf “restructured the county’s internal finances in unusual ways to provide Citron with a justification” for his risky strategy. The firm then offered opinions “attesting to the legality” of the transactions, according to the lawsuit.
Jean Costanza, a partner in LeBoeuf, was singled out for much of the blame in the county’s lawsuit.
The county alleges that Costanza knew of the enormous risks inherent in the investment pool, including the potentially “disastrous consequences of a rise in interest rates,” but never disclosed that information to the public and the Board of Supervisors. And when the investment pool sustained financial losses, she did not disclose that either, the suit states.
According to Costanza’s handwritten notes during a telephone conversation with county officials and Standard & Poor’s, Costanza noted that former Assistant Treasurer Matt Raabe told S&P; officials that it would be a “DISASTER” to the county’s investment pool if interest rates rose 3%. She further noted that an interest rate increase of 2% would spell “danger.”
Sugden, chairman of LeBoeuf, said the firm acted only as bond counsel, while other firms were responsible for disclosure issues.
“LeBoeuf had nothing to do with the creation of the investment strategy which led to the county’s losses, was never asked to examine the safety of the investments in the Orange County Investment Pools and was not called upon to give an opinion with respect to the disclosure concerning the pools,” Sugden said.
Rauscher Pierce Refsnes Inc.
The suit accuses Rauscher Pierce Refsnes Inc, a Dallas-based firm, of breach of contract and professional negligence. According to the suit, Rauscher served as “financial advisor” on several note offerings during the summer of 1994.
Rauscher officials participated in the drafting of the official statements for the county’s 1994 note offering. These officials, the suits state, should have known that Citron and Raabe were making potentially disastrous bets on the movement of interest rates.
The lawsuit alleges that in one official statement, Rauscher stated that “from time to time, a significant portion of these securities are pledged with respect to reverse repurchase agreements authorized by law.”
But the lawsuit states that Rauscher knew or should have known that Citron’s portfolio was “approximately 150% leveraged and naked to the risk of a rise in interest rates. “
Jennifer Driscoll, a Rauscher spokeswoman, responded that the company plans to defend itself vigorously.
“This [suit] is based on mistaken identity,” Driscoll said. “Rauscher Pierce Refsnes was never a financial advisor to Orange County as the suit alleges. As the official statements of the offerings clearly show, other firms had that role in each instance. . . . We had nothing to do with evaluating the makeup of the investment pool.”
Morgan Stanley and Co.
Morgan Stanley and Co. “facilitated” Citron’s speculative investment scheme by “engaging in illegal reverse repurchase transactions with the county” and selling the county exotic and risky securities, the lawsuit contends.
“This firm reaped enormous profits as a result of its failure to adhere to a regulatory framework that was specifically designed to protect taxpayers and residents from unauthorized acts of public officials,” county Chief Executive Officer Jan Mittermeier said in a prepared statement.
Jeanmarie McFadden, a spokeswoman for Morgan Stanley, declined comment, saying the firm had not had a chance to review the lawsuit.
Correspondent Shelby Grad contributed to this report.
* BERATING THE RATERS: Major bond rating firms face increasing challenges. D1
