Merrill Blames O.C. Leaders in Suit Response

SANTA ANA — In its first detailed response to Orange County’s damage lawsuit, Merrill Lynch & Co. contended Thursday that county leaders and their lawyers--not the brokerage--caused taxpayers to suffer $1.64 billion in losses when they caused a panic among the county’s lenders by imprudently filing for bankruptcy last December.

Lawyers for the Wall Street firm argued that county officials mistakenly believed that the investment banks, which had loaned the county billions to invest in high risk securities, would be barred from selling off the county’s collateral by the “automatic stay” provisions of the U.S. Bankruptcy Code.

Contrary to the county’s belief, the bankruptcy filing triggered a massive sell-off, causing “unnecessary losses [to county taxpayers] due to premature liquidations at unfavorable prices,” Merrill Lynch argues.

Lawyers for the brokerage firm also argued that the county should not have “precipitously forced the resignation of [then-county Treasurer-Tax Collector Robert L.] Citron without a suitable replacement.”

“[T]he bankruptcy filings and the abrupt firing of Citron caused dealers to sell the securities which resulted in the . . . loss suffered by the county and [its investment] pool.” The Wall Street firm’s lawyers said county officials should have followed a “viable workout plan” they had been presented with, which would have enabled the county to meet its immediate cash needs and hold onto its securities until it could sell them later at better prices.

The firm’s arguments were contained in its answer to a $2-billion damage suit the county has filed in U.S. Bankruptcy Court in Santa Ana.

Merrill Lynch sold Orange County most of the securities in the county-run investment pool, and the county blames the brokerage firm for the resulting financial debacle.

For its part, Merrill Lynch denies any wrongdoing and is seeking to place blame on the county in its newly filed response.

Merrill Lynch confronted the county’s arguments that the multibillion-dollar reverse repurchase deals engineered by Merrill Lynch for Citron violated debt limits imposed by the California Constitution.

Reverse repurchase agreements are transactions in which securities are used as collateral for loans, which are then used to buy other securities paying a higher rate of interest. In the case of Orange County, the problem arose when rising interest rates began affecting the short-term, variable-rate loans, and the long-term fixed securities began losing value.

Orange County’s argument that Merrill Lynch should be held responsible for the county’s losses, the firm contends, “threatens the reliability and stability of the federal securities markets,” and if upheld by a court “would cause chaos within the municipal investment community.”

Bruce Bennett, the county’s lead bankruptcy lawyer, disputed the brokerage’s assertion that the county was presented with a workout plan.

“If there was such a plan, neither I nor any of the other professionals representing the county had ever heard of it,” Bennett said.

Instead, Bennett said Merrill Lynch officials recommended to former California State Treasurer Thomas W. Hayes, who was appointed to restructure the collapsed investment pool, that the county liquidate its portfolio.

C. Dana Hobart, a lawyer with the Los Angeles firm of Hennigan, Mercer & Bennett, which is representing the county in its lawsuit against Merrill, described the brokerage’s response as “scare tactics.”

“Any entity, particularly Merrill Lynch, that does business with a municipality, is charged by law with knowing the [debt] limits of that municipality,” Hobart said. “For Merrill Lynch to argue that this is a surprise just doesn’t hold water.”

Hobart added, “It will not cause chaos in the financial community for a conclusion to be reached that Merrill Lynch has to engage in lawful transactions with a municipality.”

The county’s lawsuit alleges that Merrill Lynch duped Citron into borrowing billions of dollars to purchase risky securities. Citron is scheduled to be sentenced Feb. 23 on his guilty plea to interest skimming charges stemming from disclosures following the bankruptcy.

The county’s lawsuit also contends that the transactions, particularly those involving reverse repurchase agreements, forced the county to exceed the amount of debt it could legally incur under the state Constitution.

According to the county’s lawsuit, Merrill Lynch sold Orange County 68% of the securities in the $21-billion investment portfolio, which included $14 billion purchased with borrowed money. The county used virtually all of this borrowed money to buy reverse repurchase agreements.

In previous responses to the county’s damage suit, Merrill Lynch had challenged the county’s right to even bring the lawsuit, arguing that the securities Merrill Lynch sold belonged to the nearly 200 government agencies--cities, school districts and special districts--that had invested in the county-run pool. Any lawsuit for damages thus had to be filed by all of the pool participants, Merrill Lynch had argued.

But U.S. Bankruptcy Judge John E. Ryan ruled earlier this month that the county was the proper party to sue the Wall Street brokerage and could pursue its claim in Bankruptcy Court. The Wall Street firm continues to challenge this point, arguing that the damage suit belongs in a regular federal court, not Bankruptcy Court.

The brokerage’s detailed response was largely routine, containing no new revelations except for its arguments that the county was presented with “a workout plan.”

“The county’s filing for bankruptcy was unnecessary, imprudent and tainted by conflicts of interest,” Merrill Lynch stated.

Timothy Gilles, the brokerage’s spokesman, declined to elaborate on the conflict-of-interest allegations, saying the firm’s lawyers were “prepared to prove them at the appropriate time.”

* REPAYMENT PLAN UNVEILED: Supervisors accepted plans for ending O.C.’s bankruptcy. A47

* EX-OFFICIAL SUES: County is sued for alleged sex harassment, discrimination. B1