SAN FRANCISCO — A federal judge in California has ruled that the city of Alameda did not commit securities fraud in a deal with Nuveen Investments even if it may have intentionally misled bondholders.
U.S. District Court Judge Susan Illston ruled in a summary judgment in the case of Nuveen Funds versus Alameda that according to California securities law the city is not liable for negligent or intentional misrepresentation by an employee.
“Although the court is troubled by the policy implications of holding a public entity immune from state claims of securities fraud,” Illston wrote in her decision in the Northern District of California court May 16. “The weight of authority strongly indicates that California courts would hold that Alameda is immune.”
She also found that the plaintiff didn’t meet the threshold in federal law to show that the city’s particular practices that were claimed to be fraudulent are what caused the loss.
The ruling may have wider implications in the muni bond industry. “We are hearing everyday about municipalities defaulting in droves, but we haven’t seen that happen yet,” said Richard Elder, a lawyer for Alameda in the case from Wulfsberg Reese Colvig & Firstman. “To the extent that defaults do occur, we think this [ruling] is going to be an important part of the playbook.”
Elder said few cases on the books deal with municipal securities fraud.
The case stems from Alameda’s failed foray into operating a telecommunications company, funded partly by tax-exempt bonds. The utility laid fiber optic lines for cable and high-speed Internet service.
The city of 75,000 residents on the San Francisco Bay pulled the plug on the enterprise and sold out to Comcast in 2008, at a price that forced bondholders take a serious haircut. It paid the holders of the unrated 2004 bond anticipation notes, which financed the completion of the system and refinanced outstanding debt, $15 million even though the outstanding principal on the notes was $33 million.
The city said high construction and labor costs and stiff competition from Comcast caused it to sell.
Nuveen, which held the bonds in two high-yield tax-exempt funds, sued Alameda in federal court for $11 million in October 2008, alleging the it and underwriter Stone & Youngberg committed securities fraud by concealing information about the true state of the city’s cable business.
Nuveen alleged Alameda failed to disclose that city officials already believed the system was economically unfeasible, could not compete with Comcast and satellite TV providers, and the city was unwilling to raise rates. The firm also alleged the city issued the 2004 notes, which were tied only to cable revenue, because it feared the terms of the $16 million in certificates of participation the city incurred in 2000 for the system would allow the lender, Citibank, to take assets from the city’s electric utility to satisfy the debt. Those COPs were taken out with proceeds of the 2004 Bans. Nuveen’s suit further alleged that Stone & Youngberg was aware of Alameda’s fraud and provided substantial assistance to advance the fraud.
“While it is our policy not to comment on ongoing litigation, we would point out that our claims against the underwriter were not dismissed. We plan to continue to pursue recovery on behalf of the affected Nuveen-sponsored funds in the courts,” Nuveen spokeswoman Kristyna Sujata said in an e-mailed statement.
Another investor, well-known businessman Bernard Osher, who owned almost $9 million of the debt, also later sued.
The Bernard A. Osher Trust’s case against the city was also dismissed. But Nuveen and Osher’s cases against Stone & Youngberg will go to trial in October.
The city launched the cable system in 1998 after city voters approved a charter amendment allowing the utility to offer telecommunication services. It completed construction in 2005, but trouble started early, and the city hired a consultant in 2006 to review the cable system’s operations. The resulting cost cuts helped it earn a small operating surplus in 2007.
That small surplus did not come close to providing the revenue the system needed to successfully refinance the Bans in 2009, according to a report by a financial adviser to the city.
The deal with Comcast, which closed in November 2008, received consent from 95% of noteholders, including Nuveen, with the stipulation that they retained the right to sue the city to recover their losses. The holders of the other 5% got paid in full.