Broker to Settle With O.C. for $437 Million

By E. SCOTT RECKARD and MICHAEL WAGNER

June 3, 1998 12 AM PT

TIMES STAFF WRITERS

Merrill Lynch & Co. agreed Tuesday to pay $437 million to settle its role in Orange County’s financial collapse, the largest municipal bankruptcy in U.S. history.

The payout--the equivalent of about 11 weeks of Merrill’s 1997 profits--is the largest settlement ever by Wall Street’s biggest brokerage.

It includes $400 million to settle the county’s lawsuit, the return of $20 million in county funds that had been frozen and $17 million to settle a suit by an Irvine water district.

Including six previous settlements, the county has recovered $638.7 million--about 39% of its $1.64 billion in bankruptcy losses.

County Treasurer John M.W. Moorlach, who first raised concerns about the county’s investments about nine months before the 1994 bankruptcy, said Tuesday that another $200 million or more can be recovered from lawsuits pending against 20 other brokerage, legal and financial firms.

While the bankruptcy caused a political and financial earthquake in 1994, it has had little meaningful effect on most county residents since then. The region’s economy has created tens of thousands of jobs, boosting everything from incomes to home prices along the way.

Still, the recoveries are far more than many observers had expected, and white-collar fraud experts said their size shows that the defendants were highly concerned about how a jury might apportion blame for the debacle.

“You can say a $10-million or $20-million settlement is designed to spare the expense and bad publicity of a trial,” said John Coffee, a New York University law professor. “But you can’t say that about a $400-million settlement.”

For Merrill, the payout simply may have been rooted in wanting to boost its business in California, said Zane B. Mann, publisher of the California Municipal Bond Advisor.

Merrill “probably determined that it will cost $400 million to get back in the good graces of Southern California governments and begin doing underwriting again,” he said.

The county contended that Merrill duped former county Treasurer Robert L. Citron into placing casino-style bets on interest rates by borrowing billions of dollars to invest in risky securities.

Merrill Lynch officials continued to deny culpability for the losses even as they settled the case, maintaining that they had acted properly and that Citron was a sophisticated investor who charted his own course.

The brokerage said it was settling because of the “substantial costs and distraction of continuing to litigate” the case. “Both the county and we acknowledged there is uncertainty in any legal case,” said Timothy Gilles, a Merrill spokesman.

On Wall Street, the settlement was a virtual nonevent.

News of the settlement leaked out before trading concluded, and Merrill’s shares rose 31 cents, to $80.06, in New York Stock Exchange trading.

The company said that it had set aside reserves for the settlement and that the payment “will have no financial impact” on earnings either in the second quarter or for the year. In 1997, Merrill reported profits of more than $1.9 billion on revenues of nearly $32 billion.

Thomas W. Hayes, the former state treasurer hired by the county to oversee the lawsuit, said Tuesday that he was pleased with the settlement.

“This has been a long and difficult period for the people of Orange County,” Hayes said at an Irvine news conference. “We are very pleased that in a spirit of mutual cooperation we were able to negotiate an end to this lengthy and contentious litigation.”

The first $54 million of the recent settlements will go to school districts that invested with the county, bringing their recovery to 95% of their losses. Most of the rest goes to cities and local agencies that also lost money in the debacle.

Other issues beyond the large sums are involved in the Merrill settlement, namely millions of pages of documents, testimony and other evidence gathered by the county that will be destroyed. That could mean the full story of the events that led up to Orange County’s bankruptcy will never be made public.

Citron said Tuesday that he was not surprised by the settlement. He said that he believes that Merrill was motivated to try to keep its actions secret. He said that grand jury testimony in the case was effectively sealed when Merrill agreed to pay a separate $30-million settlement to end the criminal investigation of the brokerage.

“We don’t think Merrill wanted released the multi-thousand pages of depositions--not only mine but literally hundreds of other people--for the same reason they settled with the district attorney,” Citron said. “They didn’t want the testimony released.”

Citron won a reputation as a financial genius in the early 1990s, earning huge returns for the county and more than 200 schools, cities and local agencies that poured money into its investment pools.

That success turned to disaster in 1994 when the Federal Reserve Board raised interest rates sharply and Citron’s investments--essentially huge bets on low rates--plummeted in value. The losses ultimately totaled $1.64 billion.

The bankruptcy caused the county to lay off 580 employees and cut some department budgets by as much as 30%, with social services and health programs being hardest hit.

One county supervisor resigned, and two others faced civil charges for failing to prevent the financial collapse. An appeals court eventually tossed out those charges as well as similar charges against the county auditor-controller. Only two county officials--Citron and his assistant, Matthew Raabe--spent any time behind bars.

All told, Merrill grossed $100 million on the Orange County account from 1992 to 1994, county attorney James Mercer said Tuesday, making the county Merrill’s single largest customer.

The settlement could make other brokerages more cautious in their municipal bond business, said Schroder Wertheim analyst James P. Hanbury. “People will say, ‘If it happened to Merrill, it could happen to anybody,’ ” he said.

William J. Popejoy, the banker called in as an emergency county chief executive in the months after the 1994 bankruptcy, said the settlement appeared to be a good one for the county.

Popejoy said he had tried to negotiate a settlement with top Merrill executives.

During those talks, which foundered when their existence leaked out, Popejoy said he had been seeking $800 million from Merrill and other firms.

“So as far as how the county is doing, it looks like they’re well on their way to achieving or exceeding what we were seeking four years ago,” Popejoy said.

The size of the settlement met with mixed reaction in the legal and financial communities.

“This is so much less than what the county has been asking for, and it shows that for the most part, it was Citron and the five supervisors who were at fault here,” said Mann, the bond newsletter publisher.

“They were daydreaming to think they were going to get $1 billion, but they said it for political reasons,” Mann said.

Christopher Taylor, executive director of the Municipal Securities Rulemaking Board, called the settlement “kind of piddly. They were asking for $2 billion.”

But county officials applauded the settlement.

“That’s a pretty good result, it’s a big number,” said Orange County Dist. Atty. Mike Capizzi, who engineered a $30-million settlement from Merrill last year to end the county’s criminal investigation.

With more than $600 million in hand and 20 suits still pending, Capizzi said the county appeared well on its way to recovering the nearly $1 billion it borrowed to emerge from bankruptcy.

Supervisor Todd Spitzer called it “an excellent settlement, especially when you consider that the county had unclean hands in all of this.”

Moorlach said it would have been nice to collect more. “But putting it in perspective, based on the other lawsuits out there and the total amount lost by the county, it’s probably as good as we were going to get,” he said.

Times staff writers Thomas Mulligan in New York and Shelby Grad in Orange County contributed to this report.

* JUST BUSINESS: Analysts say the payout is unlikely to hurt Merrill Lynch. D4

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Total Settlements

Bankruptcy-related settlements now total more than $600 million. The tally, in millions:

Amount: $400

Source: Merrill Lynch & Co., primary broker to the county prior to the bankruptcy (plus $20,000 return of excess collateral)

Amount: $75

Source: KPMG Peat Marwick LLPP, accountants for the county, Orange County Transportation Authority, city of Orange and the Orange County Water District

Amount: $53

Source: Credit Suisse First Boston Corp., one of the county’s brokers that entered into reverse repurchase agreements and sold securities

Amount: $45

Source: LeBoeuf, Lamb, Green & McRae LLP, attorneys for the county and numerous school districts

Amount: $27

Source: Merrill Lynch payment to terminate criminal investigation

Amount: $1

Source: Recovery on taxable note claim

Amount: $1

Source: Recovery on fidelity bond

****

* Amount Merrill Lynch made off county investments: $100 million between 1992-1994