SEC Accuses First Boston of Fraud in O.C. Collapse

In its first strike against one of Orange County’s financial advisors, the Securities and Exchange Commission on Wednesday sued CS First Boston, accusing it of fraud and deceptive practices that hastened the county’s fiscal downfall two years ago.

The federal regulator charged that First Boston and two of its investment bankers misrepresented or omitted crucial information about the county’s shaky financial condition in documents offering to sell $110 million in county bonds. The company and the bankers denied any wrongdoing.

The bonds were sold only months before the county collapsed into the nation’s worst municipal bankruptcy.

The agency’s lawsuit, filed in federal court in Santa Ana, raises the specter of other suits, including one against the nation’s largest investment banker, Merrill Lynch & Co., the county’s main investment advisor.

The SEC investigation is wide-ranging and continuing, said Elaine Cacheris, the agency’s regional director in Los Angeles, but she would not elaborate.

The suit against First Boston and its two former brokers--Douglas S. Montague, 39, of La Canada and Jerry L. Nowlin, 53, of Park City, Utah--seeks an unspecified amount in penalties. The firm is liable for $500,000 per violation and each individual faces a penalty of $100,000 per violation, but the SEC would not detail how many violations occurred.

The agency alleges that while preparing documents for the bond sale, the defendants “knew, or were reckless in not knowing, significant negative information” about the county’s beleaguered investment pools. They either misrepresented the information or omitted it from the official offering statement, the suit alleges.

First Boston asserted that “there is no basis for a fraud charge” and that it will defend its position “vigorously.”

“The county provided CS First Boston with misleading information,” said Andrew MacMillan, a spokesman for the brokerage. First Boston, he said, was “clearly victimized” by the now disgraced and convicted former county treasurer, Robert L. Citron, who was sentenced Tuesday to a year in jail.

The individual defendants also blamed Citron and the county.

“Mr. Nowlin denies the charges and expects to be cleared at trial,” said his lawyer, Jan Lawrence Handzlik. “He played by the rules and did his job properly at all times. Even the SEC was hoodwinked by certain officials in Orange County.”

Montague said through his lawyer, Robert S. Brewer Jr., that he maintained the highest ethical standards and complied with all laws and rules. “I am confident it ultimately will be demonstrated that my conduct in this transaction was above reproach,” he said.

The bonds were issued in September, 1994, to help fund the county’s obligation to the Orange County Employees Retirement System. But the sale came as the county’s $20.6-billion investment portfolio was teetering under the weight of repeated hikes in interest rates, which was gutting the value of some highly risky securities it held. The investment pools crashed, losing $1.64 billion, and the county went into bankruptcy in December 1994.

The SEC charges that First Boston and its brokers couldn’t help but know that increases in interest rates through 1994 had been destroying about a third of the county’s portfolio.

What made the offering particularly worrisome to county officials was that it offered short-term notes that investors could cash in with only seven days’ notice.

The seven-day feature hastened the county’s collapse, officials have said. Already losing $1.5 billion, the pools couldn’t withstand a call by bondholders for refunds. But news leaked out, and they demanded their money.

The county responded by filing for bankruptcy, making the $110-million bond issue the only one to default and adding to the county’s problems.

First Boston pointed out that it had nothing to do with the securities the county bought for its investment pools, in which numerous cities and agencies also participated.

In selling county pension bonds to the public, however, First Boston had a duty to examine the county’s financial condition, including the investment pools, and disclose any risks to potential investors. That, the SEC charges, is what the brokerage failed to do.