Transcripts Show Genesis of Bankruptcy as Early as ’92

The two central figures in the Orange County bankruptcy who saddled the county with billions of dollars in risky securities admitted in lengthy depositions released Wednesday that each knew little about municipal finance.

In fact, Merrill Lynch super-salesman Michael G. Stamenson, who received daily reports of how much cash was available for investment from the county, told attorneys flatly, “I’m not an expert in municipal finance.”

And former county Treasurer- Tax Collector Robert L. Citron testified he had begun to suspect

his brain had been deteriorating throughout the period Stamenson had sold him billions of dollars in speculative investments, eventually triggering America’s largest municipal bankruptcy.

Citron said he sensed his brain functions had been waning since 1989, five years before the bankruptcy. “My brain is unable to audit all the information necessary to make executive decisions,” he testified.

Merrill Lynch officials insisted that Citron was fully aware of what he was doing and purchasing.

“Mr. Citron’s testimony clearly shows that Mike Stamenson was able to explain clearly, accurately every single security that Citron purchased from Merrill Lynch,” brokerage spokesman James Wiggins said.

The provocative admissions by Stamenson and Citron are among the highlights of tens of thousands of pages of sworn testimony taken in the county’s recently settled lawsuit against Merrill Lynch & Co. The documents were released late Wednesday at the urging of The Times and other news organizations. The Times was able to review only a small portion of the testimony late Wednesday evening. Large sections of the transcripts were redacted at the request of attorneys for the county and Merrill.

The newly released testimony by some brokerage executives supports the county’s position that Merrill Lynch knew years before the bankruptcy that Citron’s strategy was badly flawed and could trigger massive losses.

In December 1994, after $1.64 billion had been wiped out of the investment fund, the county filed for bankruptcy. In settlements concerning dozens of investments, the county has since recovered about half of its losses. Last week, current county Treasurer-Tax Collector John M.W. Moorlach has said he wants to consider once again hiring Merrill Lynch to help the county invest its idle cash.

But fully two years before the county’s bankruptcy, a debate raged within the Wall Street investment behemoth over the prudence of aiding Citron’s gamble with billions of dollars in public money.

Top executives, including Merrill’s current chief executive, David Komansky, attended a meeting in late 1992 about Citron’s investment scheme and the county’s dangerous exposure.

Among the clearest warnings that a downfall awaited Orange County if the brokerage did nothing to correct it were made by William S. Broeksmit, the man who helped pioneer the exquisitely complex “derivative” securities sold to Citron.

Broeksmit testified that he walked away from a discussion with a colleague about Citron’s strategy knowing that if the interest rates suddenly reversed, there would likely be “a negative outcome” to the county.

How much of one? he was asked.

“Greater than a billion dollars,” Broeksmit testified.

Broeksmit took his concerns to his boss, Edson V. Mitchell, then co-director of Merrill’s fixed-income group. He was asked, “Did you believe that people senior to you . . . should be fully informed about the Orange County investment strategy?”

“Yes,” Mitchell responded, including Komansky.

Star Salesman Doing a ‘War Dance’

Despite his professed ignorance of municipal finance, Stamenson amassed a personal fortune selling such instruments to Orange County and took relish in every trade.

“Mr. Stamenson, have you ever been known to do a war dance around the trading room when you completed a trade?”

Stamenson responded, “I became very pleased when a trade was executed, yes. I’m probably guilty of that.”

Some Merrill executives testified they had no idea what sort of money Citron was investing.

For example, Amery Dunn, a Merrill Lynch trader who worked under Stamenson, said he wasn’t aware that Citron’s pool contained money for school districts.

“Did anyone discuss with you, prior to Feb. 23, 1994, that some of the monies that were involved with Mr. Citron were school funds?”

“Not that I recall,” Dunn testified.

Stamenson too said that even if he had thought about money intended for schoolchildren being funneled into exotic securities, it didn’t matter to him.

“First of all, I did not think of the Orange County pool as school money,” Stamenson testified. “I thought of it as a pool of money run by Mr. Citron, by the most professional, successful investor that I’ve ever encountered in my professional life.

“So . . . emotional attachment to school money has no weight with me, because I didn’t think of it in that context,” Stamenson said.

The testimony was sought by The Times and other news organizations who urged the court to make it public following the $420-million settlement last month of the county’s lawsuit, and a $17-million settlement to a similar one brought by the Irvine Ranch Water District.

It had become clear by 1992 that Citron was assuming a level of risk that would have been extraordinary for a Wall Street insider, let alone a municipal treasurer.

As early as Feb. 6, 1992, a senior Merrill executive told Citron face to face of the brokerage’s profound concern for the one-way strategy he had chosen to pursue--that U.S. interest rates would remain low indefinitely.

In 1994, six unprecedented increases in the interest rate wiped out $1.64 billion from the county’s pool, triggering the bankruptcy.

Too Leveraged by a Factor of 10

The executive who called on Citron in 1992 was Daniel T. Napoli, a senior vice president of Merrill’s 17-member executive committee.

“You have 10 times the amount of leverage in your portfolio that we allow in ours,” Napoli warned Citron then.

Gary Rupert, head of Merrill’s “repurchase” desk at the time, had complained in a memo on Feb. 26, 1992, that the brokerage was “pushing the high end of a prudent target range with respect to any client” in selling Citron volatile securities at the same it lent him billions to buy them.

Napoli, who reported directly to then-Merrill Chairman Daniel P. Tully, had his staff analyze Citron’s investments.

By August 1992, Napoli’s staff knew just how supersensitive to interest rates Citron’s pool really was.

The testimony was expected to provide the first detailed portrait of the side of the Orange County bankruptcy story that has never been told--Merrill Lynch’s.

For 43 months, the investment giant has read from a terse, carefully worded script that “it acted properly and professionally” in its dealing with Citron and the county.

Those familiar with the testimony have said for weeks that it contained some surprisingly candid details.

For example, Stamenson was seen on a 1992 training video exhorting colleagues to emulate his “master of the universe” performance in selling securities to Citron.

By then, Orange County was Merrill Lynch’s largest customer, and the account brought Stamenson millions in commissions and accolades from the firm.

Virtually all the top county officials, many of whom have previously testified by the Orange County Grand Jury, were deposed, including Sheriff Brad Gates.

Gates became a pivotal player in the months after the bankruptcy, grabbing power over day-to-day operations as county supervisors ducked a barrage of public criticism for their failure to avert the fund’s collapse. Gates emerged as a key contact for financial lawyers, bankers and consultants attempting to unwind the incredibly complex fiscal mess, and as a crisis cop for managers within a nearly paralyzed government.

‘There Wasn’t Anybody in Charge’

The sheriff testified he was on vacation and didn’t learn of the bankruptcy until after it had occurred. When he returned, he said, “the county was in complete disarray.”

“There was a lot of confusion,” he continued. “There wasn’t anybody in charge. . . . We were in the middle of a disaster. I didn’t know much about financial issues and disasters of that type, but I do know what disasters are.”

In his testimony, Gates acknowledged for the first time that he ordered a shredder after the bankruptcy and participated in the shredding of documents, although he would not describe exactly what was destroyed.

The sheriff testified that he told then-Assistant Sheriff Walt Fath to obtain the shredder that only he and Fath would have access to.

“I was dealing with a lot of documents on sensitive issues in my department and I wanted to be able to shred those documents and not leave them laying around and also was involved in negotiations on various items for the county with a lot of people,” Gates explained.

He said he didn’t keep a log of what was destroyed and didn’t know if Fath did.

Asked specifically if any files relating to the county’s investment pool had been shredded, Gates said, “I have no way of knowing.”

The testimony also highlights divisions within Merrill Lynch in the months before the bankruptcy as the problems with the pool were becoming clearer.

Samuel Corliss Jr., a Merrill Lynch broker, testified that Stamenson was unhappy after a April 1994 meeting with the Irvine Ranch Water District--one of the largest investors in the county pool--at which he discussed how harmful higher interest rates would be to the county’s investors.

Corliss said he didn’t actually recommend that the water district pull its money out of the county pool, although the IRWD had chosen to do just that.

Following the meeting, Merrill Lynch officials told Corliss that Stamenson was very unhappy, and that such actions went against the needed “teamwork” to keep the pool intact--eight months before the bankruptcy.

The depositions shed light on questions that have dogged Merrill since the December 1994 bankruptcy filing.

Never completely revealed to Citron, nor to those who invested in the county’s debt issues, was Broeksmit’s warning that “hot money” would desert the county’s pool and hasten its collapse if interest rates suddenly spiked up.

Broeksmit, who left Merrill and now works for Deutschebank in London, at one point urged the firm to sell the entire $2.8-billion Orange County portfolio.

Broeksmit’s fateful warning was contained in a three-page memo to Mitchell, who shared the concern throughout the firm.

Between 1990 and February 1993, the amount of money in the county’s investment pool shot up dramatically, from $2.5 billion to $5.5 billion, as word of Citron’s apparent investment acumen spread.

Even though depositors were required to give the county a 30-day notice before pulling their funds out, Merrill executives correctly foresaw the calamity awaiting Citron should he hit a bad patch and be unable to sustain his high yields.

That many among the 200 schools, agencies and municipalities investing with Citron were doing so solely to take advantage of those yields was not lost on Broeksmit.

“While I’m not an expert in municipal finance, it would seem to me that dramatic growth . . . has been driven by the extraordinary yields being offered,” his warning read.

For the past year, The Times and other news organizations have also sought the release of the 9,500 pages of testimony by Merrill executives before the Orange County Grand Jury.

An appellate court ruled earlier this year that the transcripts should be released. Merrill has said it will appeal the ruling to the state Supreme Court.

The release of the civil lawsuit testimony resulted when a coalition of media organizations said it would go to federal court to get access to virtually all of the documents surrendered and depositions taken in preparation for a jury trial that never took place.

Times staff writers Ray F. Herndon, Shelby Grad and Jean O. Pasco contributed to this report.

* CITRON CITED CONDITION: Ex-county treasurer testified his “cognitive deficits” led to bad investment decisions. A17

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The Bankruptcy Papers

Large portions of the thousands of pages of transcripts of sworn testimony taken in the county’s recently settled lawsuit against Merrill Lynch were blocked out by attorneys fo the individuals testifying.