New California VRDO complaint is far more detailed

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An amended complaint filed in a California court late last week is the most detailed set of allegations yet revealed in a series of lawsuits against major banks in the variable-rate demand obligation market.

The revised complaint, filed in Superior Court of the State of California in and for the County of San Francisco, is in answer to Judge Anne-Christine Massullo’s August ruling that the lawsuit needed more specificity before she could consider allowing it to move forward. The 171-page document goes beyond any previous VRDO lawsuit yet made public in listing specific actions alleged to prove widespread fraud in the way the banks handle variable-rate debt rate resets.


The previous California complaint was 128 pages and included a broader analysis of the VRDO practices of each of several defendant banks, setting out the number of VRDOs that each was serving as remarketing agent for and the total value of that debt, then detailing how each supposedly separated the debt into “buckets” to have their rates reset in groups without respect to the characteristics of each bond.

The newer complaint walks through specific issuances in great detail, citing language from the remarketing agreement. For example, it details the agreement on an Oct. 21, 2004, issuance of $600 million worth of Kindergarten-University Public Education Facilities Bonds Series 2004A for which J.P. Morgan has been remarketing agent.

“The daily rate shall be the rate determined by the remarketing agent to be the lowest rate which would enable the remarketing agent to sell the [Series 2004A2 Bonds] for delivery on the effective date of such rate at a price (without regard to accrued interest) equal to 100% of the principal amount thereof,” that agreement said.

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 a corporate entity he created for that purpose, Edelweiss Fund LLC. The federal lawsuit, which is an antitrust action, is being pursued by the cities of Philadelphia and Baltimore.

The amended California complaint also contains some additional detail on the alleged “bucketing” of the VRDOs. Citigroup, the suit alleges, bucketed together a $1 billion California GO issuance, a $334 million issuance by the Los Angeles Department of Water and Power, a $39 million issuance of conduit bonds to borrower Bay Apartment Communities related to the development of multifamily rental housing in Campbell, California, and a $26 million issuance of bonds by the Oakland Joint Powers Financing Authority.

Citigroup set the interest rates for all of those bonds “in lock-step fashion,” according to the suit.

Rosenberg’s lawsuits allege that the banks universally used this 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 accused banks, many of which are or are subsidiaries of the largest Wall Street banks, have fought back with varying levels of success to date. While a Massachusetts judge ruled that the suit was barred from continuing because Rosenberg’s analysis was based on publicly available information, multiple attempts to quash the Illinois proceeding have failed.

Another development revealed in the amended complaint is that Rosenberg has added Perry Israel to his legal team, apparently as an expert witness. The longtime National Association of Bond Lawyers member submitted with the amended complaint a declaration stating his expertise in the field, his willingness to be sworn as a witness, and his opinion of how VRDO rates must be particularized to the bond in question.

“The pricing of each VRDO, like any bond issue, should vary depending upon the particular credit characteristics of the bonds, such as the issuer, the conduit borrower, letters of credit, and similar matters,” Israel wrote.

Israel, who has his own practice, also stated that he has been on the NABL board a record three times and spent "more than half" his time between 1980 and 2007 working on financings involving VRDOs.

The decision is now again in Massullo’s hands, as she must decide whether the amended complaint is sufficiently specific to clear the legal hurdle noted in her previous ruling.

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Variable-rate bonds Lawsuits Securities law Munis Citigroup J.P. Morgan Securities Washington DC California
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