CHICAGO - Five southeastern Wisconsin school districts this week filed a lawsuit against Stifel Nicolaus & Co. and the Royal Bank of Canada, alleging that the firms fraudulently misrepresented the safety of an investment transaction involving synthetic collateralized debt obligations, resulting in about $150 million in losses.

The five - Kenosha Unified School District, Kimberly Area School District, Waukesha School District, West Allis/West Milwaukee School District, and Whitefish Bay School District - collectively invested about $200 million in the transaction that was tied to funding their other post-employment benefits. They now estimate the value has dropped by about $150 million.

The lawsuit, filed Monday in Milwaukee County Circuit Court, contends that the firms violated state securities laws by either knowingly or negligently misrepresenting details of the transaction. The suit further alleges that the firms violated the state's trade and fraud statutes because of their statements about the safety of the transactions and its compliance with state laws.

"In 2006, the plaintiffs collectively invested $200 million in three synthetic CDOs created and marketed by the defendants as a safe and secure method of funding the plaintiff's' ever-increasing OPEB liabilities, without increasing the burden on Wisconsin taxpayers ... the nature, character, and risks of the investments were intentionally or negligently misrepresented, or omitted by the defendants," the lawsuit asserts.

The districts are represented by Shepherd, Smith, Edwards & Kantas LLP and Kravit, Hovel & Krawczyk, which have established a Web site at with information on the lawsuit and background on the transactions.

Stifel has in past interviews strongly countered the districts' assertions, providing copies of acknowledgment letters signed by the districts that did at least generically discuss the investment risks and Stifel's role as a placement agent, not a financial adviser, and that independent advice be sought. Neither Stifel nor RBC commented yesterday on the filing of the lawsuit.

The districts collectively face unfunded OPEB liabilities of $432 million: West Allis with $136 million, Kenosha with $136.5 million, Waukesha with $95 million, Whitefish Bay with $43.4 million, and Kimberly with $21.4 million. New Governmental Accounting Standards Board rules require governments to shift from reporting their non pension-related retiree benefits on an annual basis to an accrued one.

The districts decided to establish trusts to help cover their annual required contributions and to move towards fully funding the liability over time as the trusts' holding grew, believing such a step would positively impact their credit ratings and stabilize operating costs.

The investment saga began in 2006 after Gov. Jim Doyle signed Act 99 into law permitting the districts to establish trusts. It relaxed existing investment requirements, permitting the districts to take on more risk with the ability to earn greater returns. Prior to the act, districts were limited to investment in government securities and short-term corporate investments with Standard & Poor's ratings of at least AA.

In 2006, Stifel and RBC officials presented an investment opportunity to the school districts in the form of Stifel's Government OPEB Asset and Liability program, which involved investing in synthetic CDOs. The districts had a long-standing relationship with former Stifel banker David W. Noack, who was referred to in the lawsuit as a "trusted financial adviser."

"The proposed solution was complex, convoluted, and opaque, and as Stifel and RBC well knew, beyond the investment knowledge or experience of the school districts, the trusts, their school board members, and their administrators," the lawsuit reads.

Under the terms of the transaction, the districts' trusts borrowed money from Depfa Bank to invest in the synthetic CDOs created by RBC Europe, which along with additional money contributed by the districts collateralized the loan. Under the program, the trusts would receive the spread, or the difference between the interest rate on their loan from Depfa and the interest rate the trusts received on their CDO investments. The districts were told several million dollars would be generated over the seven-year term of the CDO investments.

The districts' trusts borrowed some form of taxable debt totaling about $165 million from Depfa and the districts an additional $35 million. The debt typically carried some form of moral obligation pledge from the districts that requires them to post the amount necessary to cover any deficiency in the trust's asset ratio as defined by the value of the district's CDO investment.

The districts content they were not told that the underlying assets backing the CDO included a "mixture of some of RBC's most toxic debt," including subprime mortgage securities, the lawsuit alleges. The districts contend they were led to believe that Stifel and Noack were acting in advisory capacities and that the program's materials incorrectly stated that investment in the synthetic CDOs would have been permitted under "old" state statutes. Those statements led the districts to believe their investments were being made in securities rated at least double-A, the minimum threshold set under state law prior to Act 99.

Moody's Investors Service recently assigned negative outlooks to Kenosha and Waukesha's A1 ratings due to the fiscal strains posed by the loss of value in the investments.

"Should the district's exposure prove to materially strain budgetary options, or willingness to honor its obligations perceptibly erode, overall credit quality could face downward pressure," Moody's analysts wrote in both reports.

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