VRDO lawsuit must be dismissed, major banks say

WASHINGTON — A lawsuit accusing eight banks and broker-dealers of “widespread fraud and collusion” in connection with remarketing the variable-rate demand obligations in Illinois should be thrown out because it is based purely on conjecture, the banks' lawyers said.

Attorneys representing several of the accused banks — JPMorgan Chase & Co., Citigroup Inc., Bank of America Corp., Barclays PLC, Morgan Stanley, William Blair & Co., BMO Financial Group, and Fifth Third Bancorp — filed a joint motion Monday asking a Cook County, Ill.,Circuit Court judge to dismiss the suit for a laundry list of reasons.

The suit was filed in January 2017 by Edelweiss Fund LLC on behalf of Illinois under the Illinois False Claims Act, but kept under seal until April of this year when it was unsealed. It claims the firms used a “Robo Resetting” device to fraudulently impose “artificially high interest rates” on the VRDOs so they would not have to be remarketed.

Edelweiss is a Delaware-registered limited liability company formed specifically to pursue the litigation but is not identified beyond that in the suit. An expert consulting witness for Edelweiss is Michael Lissack, the former Smith Barney banker who helped the government win hundreds of millions of dollars — and reaped tens of millions of dollars himself in the process — from filing whistleblower lawsuits against Wall Street and other firms in 1995 over charges they engaged in yield-burning.

cook county circuit court

While Lissack has prevailed in the past, the defendants in this lawsuit say that Edelweiss fails to adequately stake a claim under the law. The suit “does not identify a single false statement or claim by any defendant,” the defense lawyers told the court. Under the Illinois False Claims Act, the defense argued, the complaining party (relator) must point to specific false statements a defendant made and show that the false statements were material to the state’s payment decision.

The suit charges that the firms set VRDO rates artificially high in order to be paid for remarketing services without having to remarket them, in violation of remarketing agreements that generally commit remarketing agents to try their best to set the rates at the level necessary to market the bonds at par. But those agreements are not representations that a firm is promising to hand-reset every VRDO at the lowest possible rate, the defense wrote.

Further, lawyers for the defendants told the court, judges have previously held that such lawsuits must be dismissed if based entirely on information that was publicly disclosed prior to the suit being filed and if the relator is not the original source of the information. The suit is based entirely on publicly available VRDO reset information, the defense wrote. Edelweiss is not the original source of the information, they argued.

Even if it was the original source of information, the banks’ lawyers continued, as an LLC formed in 2014 it could claim such status only on information it obtained in the four months between when it was incorporated and when it filed its original lawsuit in 2014. That original suit was voluntarily dismissed before being refiled in 2017.

Finally, the suit must be dismissed at least for bonds for which Illinois was not on the hook, the defense lawyers wrote. Many of the VRDOs cited in the suit were conduit issuances, the defense lawyers pointed out, meaning that a conduit borrower and not the state were liable for making such payments. The case is a qui tam suit, meaning it was brought by a private party on behalf of the government, in this case, Illinois.

The defense asked the court to dismiss the suit with prejudice, meaning that it could not be brought again.

A successful outcome for Edelweiss could pave the way for more lawsuits in other locations, as the rate-setting behavior alleged in the suit is not unique to Illinois. The outcome could also be significant in that it could dampen demand for VRDOs, which market experts have expected to make a strong comeback thanks to new federal tax law provisions that discourage banks from holding muni bonds. The VRDO market crashed in 2009 when the financial crisis caused banks to stop issuing letters of credit for them.

Lawyers and investment bankers generally have been skeptical about the idea of widespread fraud in the VRDO market, noting the transparency of the rates. Those rates are based on the Securities Industry and Financial Markets Association Municipal Swap Index, a seven-day index calculated and published by Bloomberg based on resets reported to the Municipal Securities Rulemaking Board’s SHORT system and overseen by SIFMA’s Municipal Swap Index Committee.

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Securities law Variable-rate bonds Enforcement Lawsuits Court cases Citigroup Morgan Stanley Goldman Sachs Fifth Third Bancorp SIFMA MSRB Illinois Washington DC
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