Peat Marwick Added to O.C. Bond Suit : Bankruptcy: The accounting firm knew about the risky investments but failed to take action, the county alleges. The company denies any culpability.

Attorneys for investors suing Merrill Lynch and other brokerage firms in a class action added accounting powerhouse KPMG Peat Marwick to the suit Thursday, alleging the county’s auditor knew about the risky investments that led to the county’s bankruptcy.

The suit alleges that “Peat Marwick knew or recklessly disregarded material facts . . . about the highly risky and unsuitable investment strategy being used by [former County Treasurer-Tax Collector Robert L.] Citron at the urging of certain defendants, including Merrill Lynch and other underwriter defendants, which exposed the county and pool participants to enormous losses when interest rates increased.”

For example, when Peat Marwick began its initial audit for the county, for fiscal year 1992-93, “the county’s portfolio already reflected a high degree of market risk,” the suit said. “A deadly pattern was occurring right before Peat Marwick’s professional eyes,” the suit said.

Kirk Hulett, one of several attorneys representing the plaintiffs, said, “Basically we found out that Peat Marwick knew of the risk of the portfolio and knew exactly what Citron was doing and chose to ignore it, chose to blind itself to what was going on instead of taking appropriate action, which is the role of the auditor.”

The county’s auditor was not included in the original suit, Hulett said, because attorney’s had not finished investigating its role until now.

“It was obvious from the get go that Merrill Lynch was responsible in many regards. But it takes a little bit more effort and investigation to find out was Peat Marwick’s involvement,” Hulett said.

Officials for Peat Marwick said the company had not been served with the suit and could not comment on the specific charges in it, but they denied any culpability in the county’s $1.7-billion loss in investments.

“We do, however, stand by our past statement, that the [county’s] financial statements were presented fairly, and the disclosures were appropriate,” said Peat Marwick spokesman Kevin Kelly. Kelly then pointed to Peat Marwick’s testimony before the California Senate Subcommittee on Orange County.

At that time, John Miller, director of the firm’s government insurance division said: “We are not investment advisers, nor do we provide investment strategy or legal advice to our clients. KPMG’s contract with the county was to perform a financial statement audit.”

The original class-action lawsuit was filed in federal court. Some aspects of that suit, however, were more suited to state court and so were filed Thursday in Orange County Superior Court. There, bondholders will have a lower burden of proof to meet. In state court, for example, the plaintiffs are allowed to prove negligent misrepresentation rather than intentional wrongdoing, as is required in federal court.

Also, in state court, a jury is not required to reach a unanimous verdict. Rather, a verdict requires agreement of at least nine of the 12 jurors. Cases also must be adjudicated within one year.