Bringing lawsuits over Orange County's financial collapse nearly to a close, a dozen Wall Street firms agreed to pay Orange County $20.8 million Monday for their roles in the nation's largest municipal bankruptcy.
The settlements increase the county's total recovery to $860.6 million--about half of what it lost in 1994 on investments that backfired.
The firms that settled Monday were accused of contributing to the debacle by providing credit or risky securities to then-Treasurer Robert L. Citron to further his heavy betting on low interest rates. They admitted no wrongdoing.
The county treasury, with $7 billion in funds from the county and 200 cities, schools and public agencies, lost more than $1.6 billion when the Federal Reserve forced rates up sharply.
The settlements close out the county's lawsuits accusing brokerage, accounting and legal firms of wrongdoing in connection with its bankruptcy.
Its sole remaining suit, which its lawyers acknowledge will be a difficult one, attempts to blame the bond rating firm Standard & Poor's for failing to sound alarms as the county skidded toward insolvency. A judge has ruled that to recover damages, the county must show S&P knew it was publishing falsehoods by assigning its highest ratings to the county's 1994 bonds.
The $860.6 million includes $26 million in interest on settlements awaiting distribution, $1 million from an insurance policy protecting the county against financial gaffes by its officers, and several other minor bankruptcy-related matters.
But the settlements come mainly from former professional advisors to the county, notably Merrill Lynch & Co., Citron's chief investment house. Merrill paid more than $450 million to settle civil claims and a criminal investigation of its role in the debacle.
Merrill attorneys, noting that huge investment gains had made Citron a hero before rates shot up, argued that the county's net loss was only $900 million when the gains were considered. By that standard, the $860.6 million recovered so far is much more than most observers had predicted.
Alan Bromberg, a securities law expert at Southern Methodist University, said the county has done well considering the complex legal issues and the fact that Citron pleaded guilty to financial fraud after the bankruptcy.
"After all, the county's own financial policies led to the problems," Bromberg said. "It would be surprising if they recover anything close to 100%."
The firms that settled Monday were minor players in the Orange County drama, compared with previous defendants who settled, such as Merrill Lynch, and the county's top lawyers and accountants.
The latest settlements were with BA Securities; Cantor Fitzgerald Securities Corp.; Citicorp Securities Inc.; Daiwa Securities America Inc.; Donaldson, Lufkin & Jenrette Securities Corp.; Fuji Securities Inc.; Kidder Peabody & Co. Inc.; Lehman Bros. Inc.; PaineWebber Inc.; Prudential Securities Inc.; Sanwa Securities (USA) Co. LP; and Smith Barney Inc.
Those dozen firms benefited from a recent court ruling that Citron's heavy use of borrowed funds to increase his bets on interest rates was permitted under California law. In the end, they paid "relatively modest sums," Bromberg said, adding that "$20.8 million spread around a dozen big firms is small potatoes."
The Orange County debacle and other recent municipal finance scandals focused the attention of regulators and politicians on Wall Street's relationship with counties and cities, which previously had been a little-scrutinized--though lucrative--backwater of the brokerage business.
The lesson that more care must be taken in handling municipal funds has been made especially clear for companies that, like Merrill, promote themselves as offering investment advice, brokerage services and bond underwriting in one package, Bromberg said.
"The industry has paid a high price for its dealing with the county and has learned to be more circumspect in dealing with municipalities," Bromberg said. "This is the end of an era." The lone remaining defendant, S&P, is owned by New York's McGraw Hill Cos. Inc. S&P gave its highest rating to billions of dollars' worth of county bonds in 1993 and 1994 despite having discussed Citron's investments at length with county officials.
The county contends that if S&P had warned of the risks, it would never have issued the bonds and would have put its financial house in order, limiting its losses.
U.S. District Judge Gary Taylor has set a high legal bar, ruling the county must prove that S&P acted with "actual malice"--meaning it intentionally issued false ratings or recklessly disregarded facts in determining the ratings. That standard is a tough one, and Taylor ruled there is too little evidence for it to apply in connection with the 1993 ratings.
The judge ruled, though, that there is sufficient evidence for a jury to hear the case involving the bonds in 1994, when criticisms of Citron's investments surfaced publicly.