WASHINGTON - Two District of Columbia council members are moving to bar Merrill Lynch & Co. from underwriting any district bond offerings until an independent investigation is conducted on the firm's side deal with Lazard Freres & Co. to generate interest rate swaps.
Merrill Lynch served as the counterparty in two district swaps in September 1991 and March 1992, when the firm's swap marketing and fee-splitting agreement with Lazard Freres & Co., the district's financial adviser, was in effect.
Merrill Lynch has served as senior manager on seven district bond deals in the past five years, totaling $948 million, according to Securities Data Co. The firm co-managed 11 transactions totaling $1.6 billion during the same period.
Council members John Ray and William Lightfoot are sponsoring the prohibition against doing further business with Merrill Lynch as an amendment to a $243 million general obligation bond authorization bill that the 13-member council is scheduled to consider on Jan. 4, council aides said.
Council aides said other members at a council meeting Tuesday appeared to support the amendment and the idea of an independent investigation of the two companies' relationship.
The amendment is aimed in part at putting pressure on Mayor Sharon Pratt Kelly to request an investigation by the city's independent inspector general into whether Mark S. Ferber, former partner at Lazard Freres, steered the district's swap business to Merrill Lynch as part of the side agreement, the aides said.
"I don't believe under any conditions a financial adviser that we're, paying should be under any agreement with anyone," said Ray, a political opponent of the mayor, at the Tuesday meeting.
Only the mayor, who named Ferber as the city's lead adviser when she renewed Lazard Freres' advisory contract in July 1991, can request such an investigation under the city bylaws, the aides said.
Separately, Ray has asked the city auditor to look into the matter.
"The mayor has no intent of requesting a review by the inspector general" at this time, said Cheryl Crowell, a spokeswoman for the D. C. finance office.
"The mayor is satisfied that the executive branch conducted a thorough review with an eye toward looking for harm to the district and found none," Crowell said, referring to the office's internal review of the firms' agreement last month.
Federal and state attorneys in Massachusetts are separately investigating allegations that Ferber illegally exploited Lazard Freres' ties as financial adviser to state authorities to generate business for Merrill Lynch. Lazard Freres received $2 million from Merrill Lynch for helping the firm promote interest rate swaps during 1991 and 1992.
Merill Lynch and Lazard Freres have denied my wrongdoing in both jurisdictions.
"Merrill Lynch did not compensate Lazard in respect of the interest rate swap transactions that were executed with the District of Columbia in 1991 and 1992. Indeed, Merrill Lynch did not receive services from or share fees with Lazard" in connection with the transactions, said Barry J. Mandel, Merrill Lynch's general counsel, in response to the internal inquiry.
Similarly, Lazard Freres partner Michacle DelGiudice told district finance officials that "none of the compensation Lazard received from Merrill Lynch pursuant to the contractual relationship was related in any way to services provided to the District of Columbia."
According to the results of the internal investigation announced last month by Ellen O'Connor, the deputy mayor for finance, the two firms were largely exonerated based on those assurances. In addition, O'Connor said she specifically vetoed a suggestion by Lazard Freres that it split the fees generated by the 1991 swap deal with Merrill Lynch.
But Ray is charging that the internal investigation sidestepped the principal issue, which is whether Lazard Freres used its position to steer the district's business to Merrill Lynch. "On the face of it, the swaps were exactly the sorts of transactions for which the agreement was created," he said in a Dec. 1 letter to the mayor.
"Once Lazard Freres had made [the fee-splitting] suggestion, who did Ms. O'Connor think they were going to recommend for the swap?" Ray asked in the letter. "Why did such a suggestion not on its face raise the specter of impropriety, coming from a firm under obligation to advise the district on the best financial deals?"
At Ray's insistence, the letter says, the council required competitive bidding on the 1991 deal, which was part of a larger $331 million debt retirement issue, because of "rumors that Merrill Lynch had been selected as the underwriter for that issue before the council had . . . authorized it."
In a later meeting with O'Connor in May 1993, Ray said, he questioned whether the selection of Merrill Lynch to do the 1991 swap had comported with the council's directive to bid the issue competitively. The swap accounted for $230 million of the $331 million issue.
Ray also questioned in the letter whether the 1992 swap deal handled by Merrill, which totaled $300 million, "had really produced the best results for the city.
"So widespread was the talk about the Merrill Lynch profit on the swap, that it was commonly referred to in financial circles as Merrill Lynch's hit on the ~mother lode,'" the letter says.
Nevertheless, O'Connor assured Ray at the meeting that both deals were in the city's best interest, and "offered as evidence the fact that Lazard Freres had recommended both that the swap method be utilized and that Merrill Lynch be chosen as the counterparty for the swap," the letter says.
O'Connor did not disclose to Ray at the time that the two firms had a swap marketing agreement, it says.
As soon as she learned of the agreement, O'Connor should have "sent both firms packing," said Ray's letter, which questioned the impartiality of O'Connor's investigation.
Crowell, O'Connor's spokeswoman, said Ray's charge that the district hired Merrill Lynch on Lazard Freres' recommendation is "not true."
"Our financial advisers don't recommend anything. An internal team selects" all the underwriters for district issues, she said.
In addition to calling for an independent investigation and a ban on any further business with Merrill Lynch, Ray is urging O'Connor's resignation and the severance of the district's contract with Lazard Freres.
Crowell said that Ray's charges are "politically motivated," and that "in all candor, the mayor decided not to dignify Ray's letter with a response."
Ray aide Sharon Ambrose said other council members appear to agree with Ray that an independent investigation, at least, is warranted. "The majority of the members seemed to indicate, if only in body language, that they would be more comfortable if a less involved party were to do another look at it," Ambrose said.
