Louisiana Insurer Seeks $10M in ARS Suit vs. JPM, Bear

BRADENTON, Fla. — The ­Louisiana Citizens Property Insurance Corp. is seeking more than $10 million in damages in a federal suit against JPMorgan and Bear, Stearns & Co. over failed auction-rate securities that the state-run, nonprofit insurer was forced to refinance.

The eight-count suit, filed in U. S. District Court in the Eastern District of Louisiana Dec. 22, claims JPMorgan and Bear Stearns manipulated the ARS market until it collapsed. When the underwriters failed to support the market, Citizens sustained “tens of millions of dollars of damages in increased interest charges and other funding costs,” the suit said.

Citizens, which is Louisiana’s property insurer of last resort, sold nearly $1 billion of debt in early 2006, which included $300 million of auction-rate securities.

Proceeds were used to pay claims from hurricanes Katrina and Rita, which devastated the southern portions of the Bayou State in 2005.

After the auction-rate market collapsed in February 2008, Citizens was unable to obtain a letter of credit in order to reissue the ARS as variable-rate bonds. In April 2009, Citizens remarketed the debt as fixed-rate bonds at 6.125%, according to the suit.

The recompense being sought by Citizens in the suit is the difference between the cash flow under the original transaction sold to Citizens by the underwriters, and what Citizens is paying under the new financing as well as the cost of refinancing, said James Swanson, a partner at Fishman Haygood Phelps Walmsley Willis & Swanson LLP, who is representing Citizens in the suit.

“It’s a significant amount of money,” said Swanson, who also is representing the ­Louisiana Stadium and Exposition ­District and the state in a similar suit against ­Merrill Lynch & Co. and Financial ­Guaranty Insurance Co.

“The basic idea of our suits is pretty simple and that is that the underwriters knew that the auction market was not functioning in such a way that it could be depended on to provide low interest rates without continued support from the underwriters,” Swanson said. “I think [these] are good cases.”

In early 2008, amidst the credit crunch, JPMorgan acquired Bear Stearns.

JPMorgan spokesman Brian Marchiony declined to comment on the suit filed by Citizens.

The insurer’s eight-count lawsuit is demanding a jury trial. Charges include breach of fiduciary duty, intentional and negligent misrepresentation, fraud, breach of contract, and breach of warranties.

“JPMorgan and Bear Stearns represented to Citizens that the ARS structure (together with recommended interest rate cap transactions) would provide Citizens the lowest cost of funds by allowing Citizens to issue long-term bonds at short-term borrowing rates that would be reset every 35 days,” the suit charges.

The ARS were structured to mature in 21 years and included a 6% interest rate cap for the first 10 years.

“Unbeknownst to Citizens, the co-lead underwriters were manipulating the auction-rate market by placing blanket bids for the entire notional amount of the bonds in every auction for which the co-lead underwriters were lead or sole broker-dealer,” the suit said.

Citizens claims that the underwriters failed to disclose that they needed to support the auctions with blanket bids to maintain low interest rates, that they routinely manipulated the ARS market to conceal the inadequate investor demand, that the auctions would fail without their support, and that the interest rate cap was “entirely dependent” on their willingness to place blanket bids.

“Approximately two years after Citizens issued the ARS bonds, JPMorgan and Bear Stearns stopped their manipulative blanket-bid practice, the auctions failed, and the interest rate caps did not cap the debt service on the ARS bonds,” the suit said, noting that penalty interest rates rose as high as 14%.

Swanson also filed for arbitration of Citizens’ claims with the Financial Industry Regulatory Authority. The lawsuit was filed to protect Citizens’ right to take legal action in the event that arbitration is not successful, he said.

A similar request for arbitration has been filed with FINRA on behalf of the Louisiana Stadium and Exposition District, which issued $294.3 million of auction-rate securities in 2006.

The district asked the state to purchase $225.8 million of the ARS when the interest rate went to more than 12% from 4% due to failed auctions. Last month, the Louisiana Bond Commission gave its approval to the state holding onto the ARS for another year.

Swanson said the two cases could take years to conclude.

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