ORANGE COUNTY IN BANKRUPTCY : Huntington Files Suit Against Merrill Lynch : Crisis: The city says it has a better chance than the county of winning legal challenge against the brokerage. It invites other agencies to join in.

Saying they have a stronger chance than the county to win a lawsuit against Merrill Lynch & Co., Huntington Beach officials have mounted a legal challenge against the Wall Street giant and are urging other cities to join them.

Huntington Beach has filed a class action lawsuit on behalf of 31 cities that put their money in Orange County’s bankrupt investment pool and is seeking to recover more than $870 million from the brokerage firm, which was the largest underwriter of the county’s bonds.

Attorneys for Costa Mesa and Anaheim have approached Huntington Beach attorneys to discuss joining the suit and Huntington Beach Deputy City Atty. Arthur De La Loza has also discussed the possibility with Newport Beach City Atty. Robert Burnham, city officials say.

Meanwhile, Huntington Beach City Atty. Gail C. Hutton is talking about broadening the class action lawsuit to include most of the 186 government agencies that invested with the county.

“I feel we have been put in a position of having to take a stand and let the world know that we have been injured by Merrill Lynch,” said Hutton, the only elected city attorney in the county. “And I hope others also will recognize that it is necessary to take a stand.

“I feel a direct responsibility to the voters. I want to get the best return possible for Huntington Beach.”

Orange County has filed a separate lawsuit against Merrill Lynch, and county bankruptcy attorneys say their efforts on behalf of all pool investors is the best way to hold the brokerage responsible for the pool’s collapse.

The county’s and city’s lawsuits are similar on key points. Both allege that Merrill Lynch and its senior broker Michael Stamenson acted not only as the county’s chief broker, but also as financial advisers. Both accuse the firm of breaching federal and state laws governing municipal investments by advising former county Treasurer Robert L. Citron to make speculative and highly risky investments.

Merrill Lynch officials have denied any wrongdoing in their dealing with the pool investments and also deny that the firm ever served as an architect of the county’s investment strategy.

They say they fulfilled their legal fiduciary duties as broker by keeping Citron informed of the risks of his investment decisions. The brokerage blames him and other county officials for the collapse of the investment pool, which lost $1.69 billion and forced the county to declare bankruptcy Dec. 6.

An attorney for Merrill Lynch said the brokerage house is prepared to deal with Huntington Beach’s lawsuit, as well as the county’s lawsuit and a dozen other consolidated class action lawsuits filed in U.S. District Court.

“I don’t think the allegations will meet the test,” said Merrill Lynch attorney Ronald Olson. “They are all unsubstantiated and internally inconsistent. We are intent on pursuing our defense in a vigorous way and making sure the court knows what the facts are.”

De La Loza said he believes Huntington Beach’s class action lawsuit is stronger than the county’s. While Merrill Lynch officials can claim they kept the county informed about the risks through Citron, they never informed the cities that their investments were at risk, he said.

“Our position is that Merrill Lynch had a duty to fully disclose the nature and extent of the portfolio” to the cities, he said.

Olson and Peter Dolan, another attorney representing Merrill Lynch, declined to respond to specific allegations by Huntington Beach, saying they were not yet familiar with the suit.

But in the past, the firm has argued that Citron was a knowledgeable, sophisticated investor who was authorized to act on behalf of pool investors by the Board of Supervisors.

A decision by other cities to join Huntington Beach would strengthen the city’s suit, said Chris Heffelfinger, a San Francisco attorney whose firm is helping represent Huntington Beach.

“It makes the suit more legally compelling and it would send a strong signal to Merrill Lynch that Huntington Beach isn’t out there on its own, that other cities are serious about this, committed to litigation and to pushing ahead,” he said.

But while some cities have expressed interest in the suit, Irvine City Manager Paul O. Brady Jr. called the filing premature because the county has not yet devised a final settlement plan for investors.

The county offered a tentative plan last month and has been working with the Official Pool Participants Committee on a revision scheduled for release Friday.

“Then if parties are not happy with what they see and no settlement is in the offing, then and only then, should investors look at taking separate action,” Brady said. “The best way to settle the pool part of the case is to negotiate it and not litigate it.”

Newport Beach Mayor John W. Hedges said his City Council is waiting to see the new settlement plan before deciding whether to join the suit.

“Huntington Beach has made the value judgment that now is the time to go off on their own,” Hedges said. “We haven’t reached that point.

“Nevertheless, we’re keeping our powder dry. It doesn’t mean we’re not ready to do battle.”

In the earlier settlement proposal, the county asked investors to sign over their rights to sue Merrill Lynch or anyone else involved in the bankruptcy. In exchange the county offered 77 cents for every dollar invested in the pool, plus additional cash notes and IOUs for the balance, De La Loza said.

Hutton said she is against turning over any rights to the county to sue Merrill Lynch or any other firms involved in the bankruptcy because Huntington Beach’s suit is the only way to ensure that the city’s $43.6 million would be returned in full.

“Judging from the county’s past actions, we have to act for ourselves,” Hutton said. “Orange County wants it (money from Merrill Lynch) for itself, not for the cities and others in the pool.”

Hutton said the county has already proven itself untrustworthy, first by losing 23% of the money the cities invested in the pool and then by refusing since the bankruptcy to return it. She and other pool investors contend that the money they gave to the county to invest was turned over to the county in trust, not as a loan, and so should be repaid in full.

“The county has been more than dragging their feet on this--their feet are on the desk,” said Stanley Grossman, a New York attorney who is also representing the city.

County bankruptcy attorney Bruce Bennett said the county would act fairly in disbursing funds it might win from Merrill Lynch. He pointed to its earlier proposed settlement plan that would allow the county and other pool investors to keep winnings in proportion to the amount it invested in the pool.

Bennett and Lee Bogdanoff, another county bankruptcy attorney, said the county and its investors should wage a united attack against Merrill Lynch.

“There’s strength in numbers,” Bogdanoff said. “By consolidating claims, you also consolidate potential damages. It’s certainly better to work together against a common defendant than having multiple parties.”

Huntington Beach’s legal team disagrees.

The city’s attorneys say their lawsuit differs from the county’s because they have accused the brokerage of working in concert with the county to mislead the cities and other pool participants into thinking their investments were safe.

The suit alleges that Merrill Lynch and Stamenson even helped Citron prepare annual reports about the pool’s status that assured cities that their money “continued to be safe and liquid.”

“There were continual assurances that the fund was safe,” Heffelfinger said. “They (Merrill Lynch) were assisting the county in its breach to us as trust beneficiaries.”

Olson and Dolan have declined to comment about the allegations involving the brokerage’s role in the annual reports to investors. But Olson said the city’s argument that the county and Merrill Lynch both share primary responsibility for the bankruptcy is flawed.

Ultimately, he said, pool participants will have to choose their primary target for recovering losses in order to make a consistent, logical argument.

“They can’t have it both ways,” Olson said. “They can only recover their money once.”

De La Loza said it poses no legal problem to level equal blame on Merrill Lynch and the county.

“They (Merrill Lynch and the county) were acting in concert,” De La Loza said. “They were aiding and abetting one another. We may not get double recovery, but we will be able to recover all of our money from both the county and/or Merrill Lynch.”