A federal judge in New York has
Erie cannot assert a securities fraud claim because the fixed-to-floating rate swap does not meet the definition of a "security-based swap agreement," Judge Loretta A. Preska of the Southern District of New York said in a hearing held Jan. 21, the transcript of which was entered with an order signed Friday.
"The floating interest rate and, thus, for the purpose of the swap, the only material term, is not based on the price, yield, value, or volatility of any security, or any group, or index of securities, but, rather, is based up on the [London Interbank Offered Rate], that is, an interest rate," the judge said, according to the transcript.
The swap is considered a separate transaction even though the fixed-rate interest payment was the same as the interest payment on the bonds the district had issued, she said.
The judge also said the school district failed to adequately plead the fraud allegations in the complaint. In the complaint filed last September, the school district had alleged JPMorgan had charged fees in excess of a fair rate and that the bank colluded with the district's financial adviser, Investment Management Advisory Group Inc., to overlook the fees.
Preska said the school district could have some time to amend the complaint. It will decide at a board meeting later this week how it wants to proceed.
JPMorgan declined to comment.
The judge's decision could have implications for a similar case the Erie district filed against JPMorgan - along with IMAG - in federal court in the western district of Pennsylvania. If the district decides not to challenge the judge's decision in New York, it will also resolve the issue in the case in Pennsylvania. However, that would leave the complaint against the financial adviser open.
JPMorgan has been one of the firms at the center of parallel Justice Department and Securities and Exchange Commission probes regarding alleged anticompetitive behavior in the municipal derivatives and investments market. JPMorgan's tax-exempt capital markets unit said in an internal memo last September that it would no longer structure interest-rate derivative transactions for municipal issuers, because the "risk/return profile of the business no longer justified the resources we have allotted to."
In the Erie lawsuit, the school district said a JPMorgan employee recommended it hire IMAG to serve as an independent financial adviser on a 2003 swaption transaction it entered to synthetically refund a 2000 issue and take advantage of low interest rates. The school district alleged that IMAG overlooked JPMorgan's excessive fees in return for the recommendation.
In her decision dismissing the school district's suit, the judge said many of its claims lacked necessary details and were "not alleged with sufficient particularity." The judge also noted that the complaint failed to detail how JPMorgan calculated its fees and how the school district determined they were above fair value.
JPMorgan collected $1,227,415 on the transaction, when a fair fee would have been no more than $128,000 based on market conditions at the time, Erie alleged.
The issue of the definition of security-based swaps, as compared to interest-rate based swaps, came up in another recent municipal swap case. In a case involving Jefferson County, Ala., muni bond and interest-rate swap deals that touches upon the definition of a securities-based swap, the Securities and Exchange Commission and Wall Street's leading lobbying group - the Securities Industry and Financial Markets Association - last year engaged in a heated legal battle over the extent to which the SEC has enforcement authority over interest-rate based swap transactions. The case revolves around Birmingham mayor Larry Langford and two other individuals and involves swaps based on SIFMA's municipal swap index.
In that case, SIFMA argued that the commission's case represents an "inappropriate expansion" of the SEC's antifraud regulations to non-securities-based swaps because the swaps are based on an index of interest rates, not securities.
The SEC disputed that claim, arguing that the index was created as an index of activity in the variable-rate demand obligation segment of the municipal bond market. VRDOs are bonds, "which are obviously securities," the commission said.
Though a judge was set to hold a hearing on the matter last week, it was postponed while separate criminal charges in the case go forward.
