A $21 million investment at the center of a legal debate in Baltimore County government was downgraded to junk status less than a month after the county purchased it in 2007, according to county documents.

Details of the investment loss were included in a November 2007 letter sent to members of the former County Council and other county officials. The county is now considering suing Merrill Lynch, and has since stopped making similar investments.

The letter, from County Administrative Officer Fred Homan, said the county bought commercial paper issued by Mainsail II LLC through Merrill Lynch on July 31, 2007. At the time, the investment was highly rated by Standard & Poor's and Moody's, he wrote.

But Mainsail's commercial paper — a term used to describe certain types of short-term debt — was tied to subprime mortgages, and downgraded to "non-investment grade," according to the letter.

On Aug. 24, 2007, the commercial paper "failed to pay off at maturity," Homan wrote.

Six days later, the county asked Merrill Lynch to repurchase the Mainsail commercial paper, and Merrill Lynch later declined, according to the document. The county later transferred the investment to a special county pension fund.

Last week, County Council Chairwoman Vicki Almond said she believed the county had lost all $21 million of the investment.

Merrill Lynch spokesman Bill Halldin declined to comment Tuesday, saying the company does not comment on client matters.

At a meeting scheduled for May 1, the County Council is set to discuss a proposed contract with outside legal firms. The contract could be approved the following week.

Under a proposal from County Executive Kevin Kamenetz's office, the county would contract with two firms to pursue a lawsuit: Scott, Douglass & McConnico LLP, which is based in Austin, Texas, and Themis PLLC, which has locations in Washington, D.C., and Chevy Chase. Representatives of the law firms couldn't be reached for comment Tuesday.

The lawyers would receive one-third of any potential recovery after litigation expenses, according to a contract request submitted to the County Council by Budget Director Keith Dorsey.

According to people who attended a private legal briefing for council members last week, the county was approached by outside attorneys seeking to file the lawsuit on behalf of Baltimore County, as they had done for other municipalities.

At the time of Homan's letter, the county was planning a revised investment policy that would "emphasize safety and diversification, but … also increase oversight through an investment committee and prohibit the purchase of asset-backed commercial paper and derivatives."

"The revised policy is designed to prevent a reoccurrence of another 'Mainsail' situation," Homan wrote.

The County Council approved such a policy in January 2008.

In 2007, the county also sold off $40 million in other commercial paper "as a precaution," Homan wrote.

Kamenetz's chief of staff, Don Mohler, said Tuesday he could not comment in detail on the matter because of possible litigation. The county executive discussed the issue briefly during a weekend interview with WBAL-TV.

"We, like many other jurisdictions, were misled as to the security of the financing," he said on television.

Former County Executive James T. Smith Jr. said Tuesday that the Mainsail purchase was part of the county's general investments, and that the county took what it believed was the proper action at the time.

"We handled it as best we could under the circumstances," Smith said.

According to Homan's letter, the county transferred the Mainsail commercial paper in November 2007 to its Police, Fire and Widows' Pension Fund. That account was funded in 1988 to pay for previously unfunded pension obligations to police officers and firefighters hired before Oct. 1, 1959, as well as their surviving spouses, according to the letter.

In 2007, that pension fund was over-funded by 12 percent and "fiscally healthy enough to support any potential revaluation of the Mainsail security," Homan wrote in the letter.

Read the letter below: