Merrill Lynch & Co. agreed Tuesday to pay $437 million to settle its role in Orange County's financial collapse, ending a bitter legal battle by making one of the biggest payouts in Wall Street history.
The settlement equals about 11 weeks of 1997 profits for Merrill, the nation's largest 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 separate suit by the Irvine Ranch Water District.
Including six previous settlements, investors in the county's investment pools have recovered $638.7 million--about 39% of their $1.64 billion in bankruptcy-related losses.
The settlement was spurred by a federal judge who last week signaled that although the county sought $2 billion in its lawsuit, its losses were offset by nearly $800 million in unusually high profits it made before its high risk investments failed.
County Treasurer-Tax Collector John M.W. Moorlach, who as a private citizen first sounded alarms over the county's investments nine months before the December 1994 bankruptcy, said Tuesday that he believes another $200 million or more can be recovered from lawsuits pending against 20 other brokerage, legal and financial firms.
"We're hopeful that we may be able to announce more settlements soon," said county attorney James Mercer Jr.
While the bankruptcy caused a political and financial earthquake in 1994, resulting in hundreds of layoffs and cuts in social services, it has had little effect on most residents of the county, one of the nation's most affluent. The region's economy has created tens of thousands of jobs, boosting incomes and home prices along the way.
Experts said the size of the legal recoveries shows that the defendants were highly concerned about how juries 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 then-county Treasurer Robert L. Citron into placing casino-style bets on interest rates by borrowing billions of dollars to invest in risky securities. They alleged the investments reaped Merrill millions of dollars in extra commissions.
Merrill officials continued to deny culpability for the losses even as they settled the case, maintaining 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.
As part of the settlement, the county also will drop its claims against the Student Loan Marketing Assn., the Federal Home Loan Bank system and several other federally sponsored agencies that issued the derivative securities that Merrill sold to Citron.
A Non-Event on Wall Street
Merrill isn't yet completely clear of the Orange County mess, having said it expects the Securities and Exchange Commission to charge it with negligence in the case. "We're still talking to the SEC," spokesman Bill Halldin said.
On Wall Street, the settlement was a virtual non-event.
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 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 year. In 1997, Merrill reported profits of more than $1.9 billion on revenue 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."
Hayes' agreement with the pool investors called for him to be paid 1.5% of any amount recovered over $200 million, making his cut about $6 million so far.
The settlements, which must be approved in federal court, have increased schools' recovery of losses to 95 cents on the dollar. Most cities and special districts will have recovered more than 90 cents on the dollar, except for a handful that opted out of the county lawsuit to pursue their own claims.
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.
In a statement, the county stressed that the settlement with Merrill "ends their adversarial relationship" and suggested that Merrill, the county and the other investors in the treasury might be able to have "constructive relationships" in the future.
Citron, in an interview Tuesday, expressed no surprise at the settlement, saying he believes Merrill was motivated 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."
High Profits Turned to High Toll
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 following 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 a total of $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." 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 and others 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 $880 million it borrowed to emerge from bankruptcy.
Orange County Supervisor Todd Spitzer, too, called it "an excellent settlement, especially when you consider that 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.
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Orange County's suit against Wall Street giant Merrill Lynch ended Tuesday with a $432.1-million settlement agreement. Impact of the county bankruptcy and settlement details:
Unrecovered loss: about $1 billion
Recovered Tuesday: $437.1 million
Previously Recovered: $201.6 million
Total Recovered: $638.7 million
County Investment Pool Loss: $1.64 billion
Source: Time reports