After Merrill Debate, Profit Beat Prudence

For two years before Orange County went bankrupt, Merrill Lynch & Co. officials sharply disagreed among themselves whether to let then-Treasurer Robert L. Citron continue an all-or-nothing strategy of betting on the movement of U.S. interest rates, according to thousands of pages of sworn testimony released this week.

But despite the internal debate that raged within Merrill Lynch & Co. about whether the strategy could prove disastrous, the firm’s profit-oriented sales staff, in the end, prevailed over the firm’s risk analysts who were responsible for safeguarding the company’s investments.

Even Merrill’s top salesman, Michael G. Stamenson, believed it was not the firm’s responsibility to police the county’s portfolio--as this exchange between Stamenson and Orange County attorney James W. Mercer Jr. illustrated:

Mercer: What was your understanding of any responsibility you had to determine whether or not [a purchase] was in accordance with the government code?

Stamenson: As long as Mr. Citron was comfortable with it . . . and I saw no glaring disregard for the government code . . . I saw no problem with it.

Mercer: Is it fair to say you didn’t perceive your responsibility to be that of a policeman?

Stamenson: I carry no badge, sir.

The testimony, taken in a deposition for the county’s recently settled lawsuit against Merrill, also shows the brokerage considered a variety of options that might have averted the bankruptcy but none were pursued.

At one point, some Merrill officials questioned the wisdom of granting Citron credit, but then actually extended his credit line $900 million more than the limit it had imposed.

Orange County settled its civil fraud lawsuit against Merrill last month for $420 million. After that announcement, The Times and other news organizations sought the release of depositions and exhibits compiled in the massive lawsuit.

The testimony shows for the first time how Merrill executives actually viewed Citron’s $21-billion investment pool, whose value plummeted in the fall of 1994 as interest rates continued to spiral upward.

Eighteen months before the collapse in December 1994, Merrill Lynch executives looking to minimize the firm’s financial and legal risks wanted Citron to go public about his unorthodox investment strategy to county supervisors and all 200 cities, schools and special districts in the investment pool Citron managed.

But no such warnings were ever issued.

Instead, Merrill Lynch sales staff and other officials quietly helped the treasurer rewrite his annual report to supervisors issued at the end of 1993, which contained more subtle warnings.

In his deposition, Thomas Akin, former managing director of Merrill’s San Francisco office, was asked whether the warning was issued.

“I don’t believe so, no,” he said, adding, “things just moved slower than you’d like them to from all regards.”

Citron, too, recalled that Merrill risk managers wanted him to make a special midyear presentation because they were concerned “that they may have a liability . . . if the type of securities they were selling to Orange County failed,” he testified.

Broker Torn Between Big Sales and Big Risks

Merrill Lynch recognized the importance of keeping a watchful eye on investments by having Daniel T. Napoli, global risk manager for the firm, report to the firm’s chief executive officer. But there was a natural tension between sales professionals seeking lucrative commissions and fees and those cautioning prudence.

In November 1992, top Merrill officials discussed what the firm should do about Citron, whose pool faced the danger of a run on the bank by investors should interest rates suddenly rise.

Merrill decided to require that all dangerously volatile securities be reviewed by risk managers before sales became final.

It is not clear why, but in Orange County’s case, that task was transferred a year later to sales staff in Chicago.

John Breit, the risk manager who held the job of reviewing the sales, testified he had trouble getting answers about the pool from Stamenson.

“My best recollection is that Mike was reluctant to bother Citron with too many requests and that there were just difficulties in finding everything I wanted to know,” Breit said.

But Breit wasn’t too concerned. “Sales has more dealings with clients than I have,” he testified.

Merrill spokesman Bill Halldin acknowledged Thursday that company executives did debate what to do about Orange County’s investment pool.

But he said the firm paid close attention to the warnings from its risk managers and twice tried to buy back the entire portfolio of so-called derivative securities from Citron “at a profit to the county.”

“There were disagreements, but after meetings a consensus was reached and Merrill Lynch management aggressively moved to implement recommendations,” Halldin said.

To those who followed the county’s dealings with Merrill, the relationship had few checks and balances.

“This just shows that money talks,” said Fred Smoller, an associate professor of political science at Chapman University who tracks county government. “It’s pretty clear that the incentive system [at Merrill Lynch] was to reward bringing in business, not necessarily doing the right thing.”

Current Treasurer-Tax Collector John M.W. Moorlach, who while running against Citron earlier in 1994 expressed concern about the investment pool, on Thursday expressed a similar view, calling Merrill’s reluctance to more forcefully express its concerns to other county officials a failure.

“It gets back to greed. Greed overrode good internal oversight,” said Moorlach, who recently suggested that the county consider rehiring Merrill for investment advice but wants the company to rebuild its credibility with the county first.

Until the bankruptcy, Citron was such a big revenue producer for Merrill that officials were acutely sensitive about what they could even discuss with him, lest they make him unhappy and risk losing Orange County’s business.

“The big discussion around the office was how much can we tell Mr. Citron what to do,” according to Akin, Stamenson’s boss.

Even though executives met several times to discuss what they considered Citron’s foolhardy strategy, Akin said he was never instructed to tell Stamenson to chart a less-risky path for the treasurer.

“The best of my recollection was that we did make an effort to sell securities to Orange County that would reduce leverage in the portfolio,” Akin said, adding, “I believe that point had been discussed quite extensively.”

But at the time of the pool’s collapse, Citron had leveraged with Merrill’s help the pool’s $7.5 billion in assets, borrowing and investing another $14 billion.

And the testimony indicates that when Citron wanted credit to make more investments, he got it.

Gary Rupert, who headed Merrill’s repurchase desk, said he helped set credit limits for clients such as Orange County.

Rupert testified he wasn’t aware Orange County had exceeded its credit limit at one point by $900 million. He said he later told Napoli but he couldn’t remember how the risk manager responded to the news.

“I gave him the data and asked him if he had any questions,” Rupert testified. “He said no and then basically left.”

No One Wanted O.C. Supervisors to Know

Had Merrill’s risk managers insisted Citron disclose his risky strategy in mid-1993, county supervisors might have been compelled to take action to prevent a collapse.

Asked why the firm didn’t just tell the board itself, Richard M. Fuscone, managing director of Merrill’s fixed income securities group, testified that would have been “an extraordinary event” that would unnecessarily alarm the Board of Supervisors.

For his part, Citron testified that he adamantly opposed the idea of Merrill Lynch officials talking directly to the Board of Supervisors about the risks he was running.

Citing a previously disclosed tape-recorded conversation with Stamenson, Citron recalled he told the Merrill salesman that he wouldn’t permit such a direct meeting because “when Merrill Lynch sold me these securities, they . . . said they were suitable for my portfolio and that they were an excellent investment . . . they made very high returns.”

Citron continued, “And Mr. Stamenson’s reply to that statement . . . was, ‘Bob, I knew you would say that, and I agree with you completely.’ ”

When questioned by county lawyers about what was suitable and legal for Merrill to have sold Citron, Stamenson said it wasn’t his responsibility to know.

“As long as Mr. Citron was comfortable with it . . . and I saw no glaring disregard for the government code . . . I saw no problem with it,” Stamenson said.

Times staff writers Davan Maharaj, Ray F. Herndon, Lorenza Munoz and Jean O. Pasco contributed to this report.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Voices from the Bankruptcy

“I did not perceive myself to be ‘master of the universe’ in reality. It was a term that I used, again, for theatrical effect, to make a point.”

--Michael G. Stamenson, acknowledging that he used the term to describe himself.

*

“My best recollection is that Mike [Stamenson] was reluctant to bother Citron with too many requests and that there were just difficulties in finding everything I wanted to know.”

--John Breit, Merrill Lynch risk manager who reviewed sales, on trouble he had getting answers from salesman Michael G. Stamenson about the Orange County investment pool.

*

“It gets back to greed. Greed overrode good internal oversight. ... It’s a failure that Merrill Lynch will have to live with.”

--Orange County Treasurer-Tax Collector John M. W. Moorlach.

*

“They are kind of a paparazzi with pens.”

--Former Supervisor Roger R. Stanton, on newspaper reporters covering the county bankruptcy.

*

“Yes. And--it’s gone downhill ever since.”

--Supervisor William G. Steiner, confirming for a Merrill Lynch attorney his 1993 appointment to the Board of Supervisors by Gov. Pete Wilson.

*

“I had no familiarity with the board or any of the supervisors and would have been unable to determine how I would initiate such a call or how the firm would initiate such a call.”

--Richard M. Fuscone, a Merrill Lynch managing director, on why he didn’t tell county supervisors his concerns about the investment pool.

*

“It was just a fun thing--a fun thing to watch, that based upon certain dates during the year, whether there was a major change in the market.”

--Robert L. Citron, former county treasurer-tax collector, discussing astrological charts he regularly bought from an Indianapolis astrologer for $4.50.

*

“Bob Citron has continued his wizardry with solid investments even during a time when interests [rates] have continued to fall.”

--Rob Richardson, in a 1993 letter to his boss, former supervisor Roger R. Stanton.

Key County Players Update

Documents released this week in Orange County’s civil case against Merrill Lynch revived memories of a saga that affected the careers of six county officials. How they have fared since the bankruptcy:

Matthew R. Raabe

* Title: Former assistant treasurer; appointed treasurer after Robert L. Citron was forced to resign in December 1994; fired a few months later after discovery of interest skimming.

* Accusations: Five felony counts of misappropriating public funds, lying to investors and keeping false county records.

* Faced: 13 years in prison, $10 million in fines

* Outcome: Convicted on all five counts; sentenced to three years in prison and fined $10,000. On bail pending appeal of his conviction.

*

Robert L. Citron

* Title: Former treasurer-tax collector

* Accusations: Six felony counts of misappropriating public funds, lying to investors and keeping false county records

* Faced: 14 years in prison, $10 million in fines

* Outcome: Sentenced to a year in jail and fined $100,000; qualified for work-release program, so instead of a conventional jail term he did clerical work at the county jail during the day and spent nights at his Santa Ana home. Completed his sentence last October.

*

Ronald S. Rubino

* Title: Former county budget director; resigned months before bankruptcy to work for Leifer Capital in Santa Monica

* Accusations: Two felony counts of aiding and abetting misappropriation of more than $60 million in public funds

* Faced: Possible nine years in prison

* Outcome: After jury deadlocked 9 to 3 last year in favor of acquittal, Rubino pleaded no contest to a single felony charge of violating a public records law. Trial judge found him guilty and sentenced him to two years of unsupervised probation and 100 hours of community service. Record was wiped clean after he completed probation. Has since worked as financial consultant for Orange County Transportation Authority and is offering consulting services to cities.

*

Steve E. Lewis

* Title: Auditor-controller since 1984; joined county government in 1965

* Accusations: Civil charges of willful misconduct for alleged failure to oversee and keep a check on Citron’s operations

* Faced: Removal from office

* Outcome: 4th District Court of Appeal removed district attorney from prosecution, ruling he had obvious conflicts of interest. State attorney general’s office dropped the charges “in the furtherance of justice.”

*

Roger R. Stanton

* Title: County supervisor for 16 years

* Accusations: Civil charges of willful misconduct for failure to oversee and keep a check on Citron’s operations

* Faced: Removal from office

* Outcome: 4th District Court of Appeal in Santa Ana dismissed charges against him, saying district attorney had overstepped authority; ruling was upheld by state Supreme Court. Stanton, who did not run for reelection last year, has since returned to his job as a business professor at Cal State Long Beach.

*

William G. Steiner

* Title: County supervisor, appointed 1993

* Accusations: Civil charges of willful misconduct for failure to oversee and keep a check on Citron’s operations

* Faced: Removal from office

* Outcome: 4th District Court of Appeal in Santa Ana dismissed charges against him, saying district attorney had overstepped authority; ruling was upheld by state Supreme Court.

Steiner did not run for reelection this year. He plans to work for a children’s services organization in Arizona after his term expires in December.

Source: Times reports; Researched by DAVAN MAHARAJ / Los Angeles Times