Latest VRDO filing details 'staggering' inflation

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The latest complaint filed in California alleging fraud in the variable-rate market includes a comprehensive analysis of how much Wall Street banks allegedly inflated VRDO reset rates, hoping the increased detail will satisfy the presiding judge.

Lawyers representing Edelweiss Fund LLC filed the latest complaint in California Superior Court in San Francisco Friday, in response to the judge’s request for more details about the supposedly artificially inflated rates. The fifth amended complaint shows how often different banks acting as remarketing agents in California set rates at levels exceeding a benchmark derived from commercial paper rates.

“There is no economic justification or market explanation for the interest rates of VRDOs to be higher than that of commercial paper at all, no less for an entire five-to-six-year period,” the complaint states. “Such inflated rates can only be explained by defendants’ robo-resetting scheme and their collective and coordinated violation of their obligation to actively and individually set and remarket the VRDOs at the lowest possible interest rates.”

At the heart of not only this lawsuit but others which have been filed in Illinois, Massachusetts, New York, and in federal court in New York City, is an allegation first raised by Minnesota-based municipal advisor Johan Rosenberg based on what his attorneys have said were his own analysis of VRDO rate resets over several years.

Rosenberg filed the state-level whistleblower lawsuits via Edelweiss Fund LLC, a corporate entity created for that purpose. The federal lawsuit, which is an antitrust action, is being pursued by the cities of Philadelphia and Baltimore.

The accused banks, many of which are or are subsidiaries of the largest Wall Street banks, have denied wrongdoing in court filings seeking dismissal of the suit, which have been unsuccessful in every state but Massachusetts.

Johan Rosenberg is the man behind the lawsuits alleging inflated VRDO reset rates.

Rosenberg’s lawsuits allege the banks universally used a bucketing and “robo-resetting” practice in violation of their remarketing agreements, and also colluded to keep VRDO interest rates high so that investors would not exercise their rights to tender the bonds back to the banks. The banks could then collect fees for serving as RMAs and for providing letter of credit services without having to actually remarket the bonds, according to the lawsuits.

The high rates the firms allegedly set ensured the VRDOs would remain as holdings of tax-exempt money market funds, some of which were owned or managed by these same firms, according to the suits.

The complaint set a benchmark at 75% of the interest rate on taxable 7-day AA-rated non-financial commercial paper, to account for the tax exemption that VRDOs enjoy.

Some market participants told The Bond Buyer that mark was too conservative, while others worried that such a benchmark wouldn’t account for expenses that tax-exempt money market funds have to cover that purchasers of commercial paper may not.

The complaint highlights the conduct of individual banks, contending that BofA, for example, exceeded the CP benchmark on more than 79% of the over 44,000 rate resets it conducted in California between 2009 and 2019.

The complaint details similar percentages for Barclays, Citigroup, JPMorgan, Piper Jaffray, Morgan Stanley, Wells Fargo, and RBC, in each instance calling the magnitude of the alleged inflation “staggering.”

If the complaint stands, the case will continue to move toward trial, barring a settlement agreement.

As a whistleblower, Rosenberg stands to reap a personal windfall of millions of dollars if his action successfully recovers money on behalf of California taxpayers.

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