Key decision looms for New York VRDO lawsuit

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A New York judge is weighing dismissal of the second-biggest of the state-level whistleblower lawsuits filed around the country that accuse Wall Street firms and other banks of defrauding issuers of variable-rate debt.

Edelweiss Fund, the corporate entity created by Rosenberg to pursue litigation, filed Tuesday with the Supreme Court of the State of New York its answer to the banks' joint motion to dismiss the complaint. Whether the court allows the suit to move forward may hinge on if the court decides the information on which the suit is based was "public" or not, a finding that allowed the banks to successfully dismiss a similar suit in Massachusetts earlier this year.

Another key question that the court may address is whether or not conduit variable-rate bonds, issued by state government agencies but repaid by non-government borrowers, can fall within the scope of the complaint. The question has been raised in other courts, but has yet to be decided.
At the heart of the accusations raised by the suit in New York as well as similar suits elsewhere is that the banks “bucketed” large groups of VRDOs and set their rates en masse, without regard to the characteristics of the securities, which Rosenberg’s lawsuits argue is a violation of the remarketing agreements binding those banks. Those agreements generally commit remarketing agents to try their best to set the rates at the level necessary to market the bonds at par.

The defendant banks, which are or are subsidiaries of JPMorgan Chase & Co., Wells Fargo, Citigroup, M&T Bank Corp., Merrill Lynch & Co. and Morgan Stanley Smith Barney, are asking for dismissal on the same arguments they have raised in Illinois, Massachusetts, and California. So far the argument succeeded only in Massachusetts.

The banks assert that the complaint does not sufficiently state any false claims made to issuers, and that the suit is subject to a public disclosure bar under New York law because it is based on information such as reset rated publicly disclosed through EMMA and other means. Public disclosure bars exist to prevent whistleblower lawsuits based purely on information that was not secret.

Rosenberg's legal team maintains, however, that the essential facts were not "publicly disclosed" under the narrow definition in New York law, which specifies that disclosure must be through either "news media" or a government report in order for the bar to apply. Further, Rosenberg is an "original source" of information whose own analysis reveals the fraud alleged, according to the brief filed Tuesday.

The conduit bonds issue is important because the damages alleged under the suit, some $374 million in New York, would be lessened if the court accepts the banks' argument that the state is not a party to the remarketing agreements in conduit deals. The damages being sought trail only the $719 million claimed in California. Rosenberg's legal team has asserted that banks are still liable with respect to conduit deals, because they made "false claims" to the paying agents involved, who are "agents of the state."

The banks are expected to file another reply next month, and then the court may decide to schedule oral argument or may decide to make a decision on the motion. The earliest a decision is likely to come is in the first two months of 2020.

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Lawsuits Variable-rate bonds Securities law Munis Merrill Lynch Wells Fargo Citigroup Washington DC New York