Strong warnings from three departments within Merrill Lynch & Co. that Orange County's investment strategy was dangerous and getting more so were ignored by others in the firm who continued to encourage the risky borrowing and interest-rate gambling by former County Treasurer-Tax Collector Robert L. Citron, according to a published report Wednesday.
The new disclosures portray the investment giant as a company at war with itself over its contradictory involvement in Orange County's finances.
Merrill's concerns reached all the way to its 17-man executive committee nearly three years before $1.7 billion in trading losses plunged the county into bankruptcy.
On Feb. 6, 1992, for example, Daniel T. Napoli, senior vice president for risk management and an executive committee member, made an unprecedented personal visit to Citron to caution the treasurer about so heavily borrowing against public funds to boost his investment earnings.
"You have 10 times the leverage in your portfolio that we allow in ours," Napoli warned Citron on Feb. 6, 1992, a Merrill Lynch spokesman quoted Napoli as saying.
The revelations, contained in internal Merrill Lynch documents, were reported Wednesday by the Wall Street Journal. Merrill Lynch, in a news release, dismissed the Journal's disclosures as "nonsense."
"This article misrepresents selected internal documents, misstates statistics, and relies on anonymous sources in distorting the basic facts of how Merrill Lynch determined to conduct its relationship with the Orange County Treasurer's Office," the statement said.
A Merrill Lynch spokesman said he had reviewed the memos cited by the newspaper but refused to release them.
In addition to Napoli's risk management analysis, the Wall Street Journal reported that Gary Rupert, the head of Merrill's "repurchase" desk complained in a Feb. 26, 1992, memo that the firm "is pushing the high end of a prudent target range with respect to any client" in selling Orange County risky securities while loaning large amounts of money to the county.
As a result of Rupert's complaint, Merrill began charging the county a higher interest rate on borrowed funds.
"What do you do in a situation where you are in so deep?" Thomas Akin, a now retired Merrill manager was quoted by the newspaper as saying. "You don't agree with it, but you can't walk away."
Reached at his Tiburon home in Northern California, Akin referred calls to Merrill's spokesmen.
According to the Wall Street Journal account, Merrill's concerns about Orange County surfaced in early 1992, eight months earlier than the firm has previously said.
Napoli, who reported directly to Merrill Chief Executive Daniel P. Tully, had his risk-management group closely analyze Citron's portfolio in July, 1992. On Aug. 17, 1992, that analysis showed Citron's pool, with $4 billion in derivatives and $2.5 billion in loans, had become supersensitive to interest rate fluctuations. The higher interest rates rose, the less the pool earned.
This information was critical to Citron, who attracted investors seeking to supplement the taxes of their cities, school districts or other agencies with extra interest income. Nearly three years before the pool collapsed, Merrill's analysts realized, a sudden drop in Citron's yields could start a run on the investment pool.
Armed with data detailing just how precarious the pool's footing was, Napoli told Michael G. Stamenson, the salesman who sold Citron most of his investments, to share Merrill's detailed findings with the treasurer.
The next month, as Merrill has previously disclosed, Stamenson wrote Citron, saying the firm's research showed "substantially more price volatility" and that the county "should constantly review the volatility."
At the time, Citron firmly believed that interest rates would remain low for several years, and he structured his investments accordingly to maximize yields.
But Stamenson's warning letter to Citron, according to the Wall Street Journal, failed to discuss a $1.4-billion limit on borrowing by the county that Merrill had imposed on Citron, or that Orange County's cost of borrowing would increase significantly and the pool's earnings would plummet if interest rates rose.
Merrill spokesman Tim Gilles( disagreed with the newspaper's account, saying that Stamenson fully disclosed all of the concerns raised by Napoli.
"There were no omissions in Mr. Stamenson's letter," Gilles said. "It fully covered the analysis that had been done."
In a second, 3 1/2-page response to the Wall Street Journal article, Merrill Lynch noted that Stamenson's letter "had been preceded and was followed by numerous oral discussions . . . where these issues were discussed in greater detail."