Pennsylvania School District Files Suit Against JPMorgan Over Swap

Pennsylvania's Erie School District last week filed a lawsuit in U.S. federal court against JPMorgan, one of the bank's former brokers, and Investment Management Advisory Group Inc., alleging that collusion by the defendants cost the district more than $1 million on an interest-rate swap transaction.

The lawsuit represents added legal troubles for the investment bank, which already finds itself as one of the firms at the center of parallel civil and criminal investigations by the Justice Department and Securities Exchange Commission regarding alleged anticompetitive behavior in the municipal derivatives and investments market. A number of other issuers have also sued JPMorgan, along with other banks, brokers, investment advisers, and insurance companies, alleging similar wrongdoing.

JPMorgan said Wednesday its tax-exempt capital markets unit would no longer structure interest-rate derivative transactions for municipal issuers, writing in an internal memo the "risk/return profile of the business no longer justified the resources we have allotted to it."

In Erie's lawsuit, it says that its long-time JPMorgan broker, David DiCarlo, encouraged the school district to hire IMAG as an independent financial adviser on a 2003 swaption transaction to synthetically refund a 2000 issue and take advantage of low interest rates. As part of a collusive agreement, IMAG overlooked JPMorgan's fees and told the board JPMorgan's fees were "based upon a fair market price," knowing the board members had "only rudimentary, laymen's understanding" of the swap market and planned to rely on IMAG for advice, the lawsuit says.

Erie received $755,000 for giving JPMorgan the right to exercise the swaption that allowed it to enter a fixed-to-floating rate swap. JPMorgan collected $1,227,415 on the transaction, according to the lawsuit filed in U.S. District Court for the Western District of Pennsylvania and first reported by the Erie Times-News. Erie believes a fair fee or market spread would have been no more than $128,000 based on market conditions at the time.

"Based on information and belief under the collusive arrangement, JPMorgan intended to procure for itself and did procure for itself in many instances, excessive transaction fees and/or market spreads on transactions of the type at issue in this matter, specifically including the transaction at issue," the lawsuit says. "Based on information and belief, the IMAG and the individual defendants had knowledge of the foregoing anticompetitive collusive conduct and participated in it."

A JPMorgan spokeswoman declined to comment on the case. A JPMorgan spokesman said "the deal gave the school district immediate debt savings and protected it against unpredictable interest rate risk in the future," according to an article published in February in Bloomberg Markets magazine.

Erie did not discover what it believes are excessive fees until Bloomberg contacted it in October 2007, the lawsuit said. It did not become aware of the alleged collusion until this March.

DiCarlo told the Erie Times-News he retired from JPMorgan on July 31. A JPMorgan spokeswoman confirmed his departure.

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