WASHINGTON -- The District of Columbia concluded last week that Lazard Freres & Co. and Merrill Lynch & Co. did not reap undue profits or violate their contracts with the district in connection with two interest rate swap deals the firms managed in 1991 and 1992.

The firms had an agreement to design and market interest rate swaps to the public sector at the time of the district offerings, and they had agreed to split fees on any joint swap deals.

But an investigative report by the district's finance office released Wednesday found the firms' agreement was adequately disclosed, and actions by district officials rejecting any fee-splitting arrangements prevented the firms from profiting unfairly as a result of the agreement.

In particular, the report found no wrondoing by Lazard Freres, the district's financial adviser since 1986, for the role it played in arranging a $331 million debt retirement issue in September 1991 that included an interest rate swap.

Merrill Lynch, which has served as underwriter on dozens of city bond issues since 1984, won a role in the bond offering through competitive bidding and participated in the deal's interest rate swap.

Ellen O'Connor, the district's chief financial officer, said in an interview that Lazard Freres informed the district about its agreement with Merrill Lynch a month before the offering. Also at the time of the transaction, Lazard Freres suggested a fee-splitting arrangement with Merrill Lynch. but the city rejected the proposal. she said.

"The subject was never introduced again." O'connor said. Lazard Freres and Merrill Lynch subsequently participated in another $300 million general obligation bond offering in March 1992 that included an interest rate swap. The report says the two swap deals saved the district $15 million and $13 million, respectively.

O'Connor said neither Lazard Freres which receives a flat $500,000 fee each year for its advisory services, nor Merrill Lynnch, which was paid "in line with industry norms," earned extraordinary fees from the swap deals they participated in.

Based on a review of the firms' swap agreement, the fees the district paid in the deals, and interviews with company officers, the report also concludes that the roles each firm played did not violate their contracts or fiduciary responsibilities to the district.

The report does not address allegations in other states. however. that the underlying arrangement between Merrill Lynch and Lazard Freres might have created conflicts of interest. Appended to the report is a list of 12 deals, all in Massachusetts, in which the firms said they split fees.

The U.S. attorney and state attorneys in Massachusetts have been investigating whether Mark S. Ferber, the Lazard Freres vice president who signed the three-year agreement with Merrill Lynch in June 1990. should have disclosed the arrangement to various state bonding authorities as a possible conflict of interest.

Ferber, who moved from Lazard Freres to First Albany Corp. in February, was fired by his new employer in july for signing the undisclosed retainer agreement.

The district's report says that the state of Wisconsin reviewed its relationships with Ferber, Lazard Freres, and Merrill Lynch in recent weeks and, like the district, came to the conclusion that no specific violations or conflicts arose.

And despite the spate of investigations triggered by the two firms' swap agreement, O'Connor said the district is not requiring Lazard Freres or any other firm doing business with the district to forswear such arrangements in the future.

"The firms on Wall Street can have any kinds of agreements they want to have. Our position is only that the agreements should not represent a breach of responsibility with the district," O'Connor said in an interview. "We are not the cops of Wall Street."

The agreement between Merrill Lynch and Lazard Freres, which is detailed in the district's report, specifically "contemplated that there would be no revenue sharing on transactions with municipalities for whom Lazard served as financial advisor," the report says.

When asked if Lazard Freres nevertheless might have informally steered the September 1991 swap deal to Merrill Lynch as a favor, even though Lazard Freres did not earn extra fees from the transaction, O'Connor responded that the deal was one of the first municipal swaps ever and Merrill had managed 95% of the municipal swap business up to that point.

The deal triggered an outpouring of similar offerings and interest by other jurisdictions, and won the "Deal of the Year" award from Institutional Investor that year, O'Connor said. "If that's not a third party endorsement, I don't know what is," she said.

O'Connor said the city tries to "balance off" any danger that firms will exploit their ties with the district by insisting on competitive bidding of some offerings and selecting an array of regional and national firms to manage all the city's deals.

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