$117.5 Million More to O.C. in New Settlements

In another major victory in Orange County’s war to recover bankruptcy losses, two more brokerages agreed Tuesday to pay $117.5 million to settle their share of the blame for the 1994 financial fiasco.

Morgan Stanley Dean Witter & Co. and Nomura Securities International Inc. both denied wrongdoing and said they had settled because of the uncertainty of legal action.

Their payments will bring recoveries to nearly half of what the county says it lost, and about 80% of what defendants claim was lost if earlier investment gains are factored. With lawsuits against 17 defendants still unresolved, some county officials are privately expressing hope of recouping $1 billion of what the county calculated was its total loss of $1.64 billion.

Suits still are pending against 14 brokerages, a former legal advisor and a former financial advisor on the county’s municipal bonds, and Standard & Poor’s Corp., a major bond-rating service. All have been told that the county will fast-track the cases against them.

“The latest settlements give us tremendous momentum,” said James W. Mercer Jr., one of the county’s lead attorneys.

Legal experts said the settlements are far greater than usual in investment loss suits. But then, Orange County’s debacle was far from a run-of-the-mill case.

The vast loss shook the financial world. Overnight, one of America’s richest counties had become its biggest bankruptcy case, rocking the sleepy municipal bond market with the threat of default. And Wall Street’s biggest firms stood accused of furthering an investment scheme so risky it was illegal.

Now, the bondholders have been made whole. The county has largely repaid the 200 school districts, cities and local agencies burned in its financial meltdown. And the large settlements have fast-tracked recovery for the county itself, which issued more than $1 billion in long-term bonds to pay its debts.

Perils of Litigation

In Tuesday’s settlements, Morgan Stanley Dean Witter agreed to pay $69.6 million. The deal actually settles claims against two brokerages originally sued by the county--Morgan Stanley and Dean Witter--that merged after the suits were filed.

Morgan Stanley maintained its dealings with the county had been “exemplary,” saying it settled because litigation is always uncertain. “We’re glad to put the matter behind us,” a spokeswoman said.

Nomura issued a similar statement, citing the “considerable costs and diversion of management’s time and the uncertainty” of legal proceedings. It will pay the county $47.9 million.

The settlements bring the total recovered by the county’s legal team to $739 million. By far the biggest share is from Merrill Lynch & Co., the nation’s largest brokerage and once the chief investment house for the county.

Merrill agreed last month to pay the county $400 million, return $20 million in frozen county funds, and pay the Irvine Ranch Water District $17 million to settle a separate lawsuit. It previously paid local prosecutors $30 million, $27 million of which went to the county, to end a criminal investigation.

Like Merrill Lynch, Nomura and Morgan Stanley lent the county huge sums of money that it reinvested in search of high returns. To a lesser extent than Merrill, they also supplied the risky securities favored by then-county Treasurer-Tax Collector Robert L. Citron--securities that plunged in value when interest rates rose sharply in 1994.

Citron’s strategies had racked up huge returns in the years leading up to the bankruptcy. By offsetting the losses with those earlier excess profits, the defendants argued that the county’s loss was actually $900 million, not the $1.64 million or more that it claimed.

There has been no court ruling on the loss. If the lower figure is used, the latest settlements brings Orange County’s recovery to 82% of its losses. The higher figure works out to a 45% recovery so far.

John C. Coffee Jr., a financial litigation expert at Columbia Law School, said investors who file fraud suits typically recover 15% of their losses. The recoveries by the county are extraordinary by comparison, Coffee said, especially because it must share blame for the debacle.

Merrill’s in-depth knowledge of the county’s investments, its dominant role in selling Citron volatile securities and its role in underwriting key bonds for the county all made the case much stronger against it, Coffee said.

“Everyone else was in a much better position to say, ‘We’re not the financial advisors. We’re just supplying the needs of a sophisticated investor,’ ” he said.

Large Legal Questions

Coffee said two large legal question marks have helped to propel the string of settlements by brokerages.

The first is the county’s contention--as yet undecided in court--that Citron’s heavy borrowing to invest in volatile securities was so risky that it was illegal under California law.

The county maintains the brokers had a legal duty to know this and to preserve taxpayers’ funds. And it contends that because Citron acted “ultra vires”--beyond his authority--all the lending transactions must be reversed and the money returned in full.

A similar lawsuit in Britain a few years ago ended with a ruling that municipalities had no authority to buy certain risky securities. The Orange County defendants no doubt are keenly aware of that precedent, Coffee said.

The other major uncertainty is less complicated, he said: the unpredictable nature of juries.

“This kind of very celebrated case, which jurors will know about even though the venue has been moved to Los Angeles, is likely to evoke some sympathy for the plaintiffs,” Coffee said. “If you’re sitting on a jury, you might think, ‘Here’s a way to put teachers back to work in Orange County.’ ”

Major remaining brokerage defendants in the bankruptcy lawsuits include Fuji Securities Inc.; PaineWebber Inc.; Bear, Stearns & Co. Inc.; Prudential Securities Inc.; Kidder, Peabody & Co.; Smith Barney Inc.; Cantor Fitzgerald Securities Corp.; and Sanwa Securities (USA) Co. LP.

Applying legal liability formulas in proportion to the settlements so far, the remaining defendants would pay $211 million, according to the county. That would bring the total of the settlements to $950 million.

That would leave the county $50 million short of the $1 billion mark in recoveries, with suits remaining against Standard & Poor’s Corp.; Rauscher Pierce Refsnes Inc., a financial advisor on county municipal bonds; and Brown & Wood, a law firm that advised the county on the disclosures it was supposed to make in selling the bonds.

Standard & Poor’s, which rated the county’s bonds highly, has said it will go to trial rather than settle the county’s claims that it failed in its duty to warn of the risks Citron was running.

It’s possible that some of the brokerages will decide to fight in court as well, officials said.

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Bankruptcy Payback So Far

Tuesday’s agreement by Orange County with Morgan Stanley Dean Witter & Co. and Nomura Securities International Inc. brings the county’s total amount recovered since the 1994 bankruptcy to more than $739 million. Who has paid what, so far:

Amount: Source

$420 million: Merrill Lynch settlement and return of $20 million in excess collateral

$75 million: KPMG Peat Marwick LLP

$52.5 million: Credit Suisse First Boston Corp.

$45 million: LeBoeuf, Lamb, Green & McRae LLP

$27 million: Merrill Lynch payment to terminate criminal action

$1.05 million: Recovery on taxable note claim

$1 million: Recovery on fidelity bond

Tuesday’s settlements

$69.6 million: Morgan Stanley Dean Witter & Co.

$47.9 million: Nomura Securities International Inc.

STILL PENDING

Targets of other lawsuits filed by the county that remain unresolved:

* Standard & Poor’s Corp.: County rating agency and advisor

* Rauscher Pierce Refsnes Inc.: County financial advisors

* Brown & Wood: Attorneys

* Fourteen additional brokers: PaineWebber, Fuji Securities, Smith Barney, Sanwa Securities, Citicorp Securities, Bear, Stearns & Co., Cantor Fitzgerald Securities Corp., Daiwa Securities, Donaldson Lufkin & Jenrette, Kidder Peabody & Co., Lehman Brothers, Prudential Securities, BA Securities and Paribas Corp.

Source: Orange County Litigation Fund