Federal authorities investigating Merrill Lynch & Co.'s public finance work in New Jersey are looking into the bond verification services of a politically connected financial advisory firm, according to sources familiar with the probe.

Agents of the Federal Bureau of Investigation are asking why Merrill Lynch recommended that issuers use the verification services of Consolidated Financial Management, a financial advisory firm that is owned by Nicholas A. Rudi, a close friend of New Jersey Gov. Jim Florio, according to sources.

Verification services are used to determine whether there is enough money to cover the redemption of refunding bond issues.

As a matter of policy, the FBI does no comment on or confirm investigations in progress.

It is not clear what the FBI is looking for, but the probe is another indication of the strong ties between Merrill Lynch and Armacon.

An investigation by the U.S. Attorneys Office for the Southern District of New York so far has centered on a joint trading account Merrill Lynch maintained with Armacon Securities, a New Jersey brokerage owned by Rudi and the governor's chief of staff, Joseph C. Salema. The Securities and Exchange Commission is also investigating the matter, according to sources.

Investigators now are questioning whether the verification-services tie is part of a larger effort by Merrill and other firms to win bond business in the state by courting top Florio aides. In particular, authorities have been examining the New Jersey Turnpike Authority's 1991 and 1992 refundings. Merrill underwrote the largest of the turnpike's five refunding issues, $1.6 billion.

Investigators, according to the sources, have questioned bankers familiar with the business relationship as to when and why Merrill began suggesting to issuers that they use Consolidated for verification work.

Issuers, and sometimes underwriters, use verification firms, which are usually accounting firms, to review and verify whether the escrowed proceeds from a refunding bond issue and the investments made with the proceeds will be enough to cover the redemption of the bonds, according to municipal bond professionals.

After the review of the escrow and the repayment schedule, the verification firm provides an opinion on whether there will be enough money to redeem the bonds and pay investors.

James Wiggins, a spokesman for Merrill Lynch, yesterday said, "We don't speak for the U.S. Attorney. It would not be appropriate for us to characterize the direction of his investigation. It would not surprise us if he was looking into all aspects of Consolidated Financial Management's business relationships, given the close ties between Consolidated Financial Management and Armacon.

"And finally, we do want to reiterate a fact that is getting lost in all this, which is that all aspects of the U.S. Attorney's investigation were prompted by information initially discovered and turned over voluntarily Merrill Lynch," Wiggins said.

Thomas Puccio, a lawyer representing Rudi, Armacon, and Consolidated, yesterday said, "No practice by Rudi, Armacon, and Consolidated that I am aware of is either unethical or illegal."

Typically, issuers pay verification firms $2,000 to $11,000 for their services, according to municipal bond professionals. The fees for bigger and more complex deals may be higher.

The opinion is an assurance to investors of repayment, said one financial adviser. "It is a very specialized field, an important cog in the wheel." said the financial adviser. "It is very important."

This adviser, however, said he had never heard of Consolidated Financial Management.

But an official with the Baton Rogue, La., firm of CitiState Advisors Inc., a reinvestment broker and financial adviser, said he had worked with Consolidated Financial Management.

Walter Monsour, president of the CitiState, said that his firm has worked with Consolidated for the last three years on bond issues. CitiState brokers bond reinvestment services, and Consolidated did the verification work on refunding issues.

Issuers, bond firms, or Consolidated Financial Management would recommend CitiState for the investment brokering, Monsour said, but he said that he did not recommend Consolidated Financial Management for work. Monsour also serves as of counsel to the bond counsel firm of Kutak Rock.

The federal investigation into the New Jersey Turnpike Authority's refundings last month led Merrill Lynch to suspend three high-level company officials, after finding "apparent irregularities" in the way they managed the joint trading account with Armacon. The company has said it found no evidence of criminal wrongdoing by any of the three managing directors: Michael A. Baumrin, Dennis J. Boyle, and Marsha L. Eisenberg.

First Boston Corp., another turnpike underwriter, has also been subpoenaed in the case. The firm served as senior manager on a $135.6 million Hudson County, N.J., bond issue that included Armacon as a co-manager in April 1992.

Officials at Lazard Freres & Co., which was paid $2.3 million as the turnpike's financial adviser, previously said the firm had not received any subpoenas. But last week, Lazard officials began declining to comment about their status in the investigation. And sources at the firm implied that Richard Poirier, the senior banker on the turnpike refunding, had received a subpoena. Poirier's lawyer declined to comment.

Armacon served as a co-manager in a syndicate led by Lazard Freres for a $122.7 million Hudson County, N.J., Improvement Authority bond sale in December 1992.

Federal investigators are also asking subjects of the investigation whether they knew or met with Rudi, Salema, or Gov. Florio.

Salema reportedly sold his stake in Consolidated in 1991 upon joining the governor's staff. He retained a 50% stake in Armacon, but put the ownership interest into a blind trust a few months after joining the administration.

Consolidated ranked third among New Jersey financial advisers last year, with 23 issues totaling $638 million.

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