Depositions Shed Light on O.C. Bankruptcy

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 they 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 Robert L. Citron testified that he had begun to suspect his brain had been deteriorating throughout the period during which 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.

“My brain is unable to audit all the information necessary to make executive decisions,” he testified.

The provocative admissions are among the highlights 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.

Ironically, the revelations come at a time when current county Treasurer John M.W. Moorlach has said he wants to consider once again hiring Merrill Lynch to help the county invest its idle cash.

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 of the investment fund had been wiped out, the county filed for bankruptcy.

But fully two years before the 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 the problem came from 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 probably be “a negative outcome” for the county.

How much of one? he was asked.

“Greater than a billion dollars,” Broeksmit testified.

Despite his professed ignorance of municipal finance, Stamenson amassed a personal fortune selling derivative 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?” he was asked.

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

The testimony had been sought by The Times and other news organizations who urged the court to make it public after the $420-million settlement last month of the county’s lawsuit and a $17-million settlement of a similar suit 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, Merrill told Citron of its profound concern about the strategy he had chosen to pursue--one based on the presumption that U.S. interest rates would remain low indefinitely.

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

The executive who called on Citron in 1992 was Daniel T. Napoli, a senior vice president and member 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 time it loaned him billions to buy them.

Napoli, who reported directly to Merrill’s chairman at the time, 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.

Broeksmit, who left Merrill and now works for Deutschebank in London, urged the firm to sell the entire $2.8-billion Orange County portfolio at one point. Broeksmit’s fateful warning was contained in a three-page memo to Edson V. Mitchell, then head of Merrill’s fixed-income group, 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.

The testimony released Wednesday provided the first real look at Merrill Lynch’s side of the bankruptcy story. Until now, the investment giant has simply read from a terse, carefully worded script that “it acted properly and professionally” in its dealings with Citron and the county.

For example, Merrill Lynch super-salesman Stamenson was seen in 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 before 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.

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.