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Stifel to Buy $162.5 Million of School Notes

CHICAGO — One day after being accused of fraud by the Securities and Exchange Commission for its role in advising five Wisconsin school districts on a risky investment scheme, Stifel Financial Corp. said it has finalized an agreement to purchase $162.5 million of school district-supported notes from Depfa Bank Plc.

The notes were sold by trusts set up by the districts to begin funding their other post-employment retiree health care obligations. They used the proceeds to invest in risky and complex products involving synthetic collateralized debt obligations.

The districts’ put their moral obligation behind the notes and when the investments soured, Depfa called on the districts to make good on their pledge. The districts refused as they pursued litigation against firms and others involved in the transaction including Stifel Nicolaus & Co. and RBC Capital Markets Corp.

In its announcement Thursday, Stifel reported that it purchased the notes at “substantial discount,” but did not disclose the price it paid. The news release noted the firm was a defendant in the school district litigation filed Sept. 29, 2008, stemming from the districts and their trusts’ $200 million investment in the CDOs. In addition to the trust notes, the districts contributed another $37.5 million towards the transactions.

After their purchase, Stifel said the notes were immediately written down, and are carried at a zero value on the company’s balance sheet, suggesting that the firm, like the school districts, considers them worthless.

“The write-down of the notes plus additional litigation-related provisions relating to the Wisconsin school district matters and other charges resulted in a $27.9 million after tax or $0.45 charge per diluted share” for the quarter ending June 30, the release read.

Stifel’s move does not settle the school districts’ lawsuit, but it suggests that it is moving in that direction. The districts, Stifel, and RBC recently held mediated discussions in an attempt to reach a settlement, but failed.

“There is no settlement, much to our disappointment at this time,” Stephen Kravit, an attorney for the districts, said Thursday.

The districts are the Kenosha Unified School District, the Kimberly Area School District, the Waukesha School District, the West Allis/West Milwaukee School District, and the Whitefish Bay School District. Their lawsuit is before Milwaukee County Circuit Court Judge William Brash.

Several sources said it was likely that the districts sought to clear the note obligation as part of the settlement talks. Kravit said he could not comment on the terms discussed during mediation, citing confidentiality agreements, but he did say that the notes are only one piece of the financial pie the districts are seeking to recoup. The districts’ loss, including the trust notes, their own $37.5 million contribution, interest, and attorney fees, adds up to about $240 million.

Stifel’s ownership of the notes gives it some leverage in future settlement talks with the districts and RBC. Stifel served as the placement agent and broker on the transactions. RBC acted as the arranger for the CDOs. Depfa acted as the lender on the districts’ trust on the note sale.

In the school districts’ lawsuit, Stifel has charged RBC hid its true profits, concealed the products’ risks, and misrepresented its ability to provide daily pricing of the CDOs. RBC has countered that Stifel’s claims are an attempt to deflect blame.

RBC reported in its second-quarter report to shareholders last May that it was subject to regulatory investigation and was cooperating with the regulatory investigation and vigorously defending the lawsuit, according to published reports.

On Wednesday, the SEC filed a lawsuit accusing Stifel and a former company executive, David Noack, who now works for Robert W. Baird & Co., of fraud for steering the districts into unsuitably risk and complex investments.

The now-worthless investment products were linked to the performance of synthetic CDOs that included non-investment-grade credits, information concealed from the districts, which were told the investments were sound, the SEC charged.

The SEC alleges that the heavy use of leverage and the structure of the synthetic CDOs exposed the school districts to a heightened risk of catastrophic loss. The 44-page complaint alleging violations of federal securities laws was filed in the U.S. District Court for the Eastern District of Wisconsin in Milwaukee. Stifel expressed its disappointment in the SEC’s action it called “misplaced” and said it would fight the charges.

After the subprime real estate market collapsed and the value of structured securities fell, the value of the trusts dwindled. The market’s ongoing woes and the recession further cut into the value of the trusts, triggering a default in late 2007.

The districts were required under the loan agreements with Depfa to cure the default but refused. The districts’ decision not to cure the default prompted Depfa in early 2010 to take possession of the remaining assets and demand repayment from the districts.

The strain of the investment losses and the decision to renege on the moral obligation pledge led to downgrades, though the districts’ ratings remain in solid investment-grade territory.

Stifel ranked 18th nationally in 2009 and rose to 13th last year, senior managing 242 deals worth $3.1 billion, according to Thomson Reuters.

The firm ranks 17th so far this year as a senior manager on 147 deals totaling $1.7 billion.

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