Edelweiss lawsuit alleges bank fraud cost California at least $719 million

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WASHINGTON — A conspiracy by banks to hold variable-rate demand obligation interest rates artificially high cost California issuers $719 million dollars over five years, alleges the newly-unsealed whistleblower lawsuit filed there by Johan Rosenberg.

The second amended complaint now unveiled in California Superior Court for the County of San Francisco charges that JPMorgan, Merrill, Morgan Stanley and Citi as well as Wells Fargo, Barclays, Piper Jaffray, Stifel Nicolaus, Royal Bank of Canada, Piper Jaffray, Westhoff Cone & Holmstedt, Red Capital Markets, Fitzgerald Public Finance Gates Capital Corp., and Stern Brothers & Co. cost California issuers of variable-rate debt more than the issuers in Illinois and Massachusetts combined.

The banks employed a “robo-resetting” scheme and colluded with each other in order to keep interest rates high so that investors would not exercise their rights to tender the VRDOs back to the banks serving as remarketing agents (RMAs), thus allowing the banks to collect fees for serving RMAs and for providing letter of credit services without having to actually remarket the bonds.

“This amounts to minimum, pre-trebled estimated damages to California of $719 million from defendants' robo-resetting scheme — $177 million that California has paid defendants for RMA services it never received; $406 million that California has paid in inflated VRDO interest rates; and $136 million that California has paid defendants in improper and excessive letter of credit fees,” according to the lawsuit.

Rosenberg, a Minnesota-based municipal advisor who filed suits in at least California, Illinois, Massachusetts and New York via an entity he formed called Edelweiss Fund LLC, is seeking treble damages and stands to win many millions of dollars for himself if any of the lawsuits succeed. His attorneys have said that Rosenberg discovered the alleged fraud based on his own analysis of VRDO interest rates.

In the Edelweiss complaints so far made public, Rosenberg has alleged damages of well over $1 billion $719 million in California, $349 million in Illinois, and $134 million in Massachusetts.

The California suit alleges collusion directly by leading figures in the public finance departments of many of the defendants, and quotes marketing promises allegedly made by the banks to the municipalities issuing the VRDOs. The statements include promises to "focus individually on each variable rate program on which we serve as remarketing agent and provide superior pricing performance” and "leverage the vast experience and expertise of our firm's banking team and our local marketing and pricing capabilities to deliver the lowest interest cost possible."

Those representations fly in the face of what Rosenberg alleges the banks actually did, which was to “bucket” large groups of VRDOs and set their rates en masse without regard to the characteristics of the securities.

The accused banks have not commented publicly on the allegations, but did file motions in an Illinois courtroom in which many of them denied any wrongdoing.

In addition to the Edelweiss suits brought by Rosenberg, both Philadelphia and Baltimore have filed their own complaints against many of the same large banks, alleging the same conduct. More lawsuits may emerge in the coming months.

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Variable-rate bonds Securities law Lawsuits Secondary bond market JPMorgan Chase Wells Fargo State of California Barclays Washington DC California