San Francisco judge deals a blow to VRDO case

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A San Francisco judge dismissed a lawsuit brought by a whistleblower accusing major banks of colluding to inflate variable-rate demand obligation interest rates.

This week, Judge Anne-Christine Massullo in the Superior Court of California in the County of San Francisco said the plaintiff, Edelweiss Fund, did not sufficiently allege falsity under the state's false claims act.

Massullo said the theory is that a group of large banks including JP Morgan Chase and Bank of America, among others, colluded to inflate the VRDO interest rates, but said the plaintiff did not sufficiently allege “that the observed conditions were caused by fraud.”

A San Francisco judge dismissed a lawsuit brought by a whistleblower accusing major banks of colluding to inflate VRDO rates.

This comes after an amended complaint from Edelweiss that detailed specific actions to prove widespread fraud in the way banks handled variable-rate debt rate resets.

In its most recent complaint, Edelweiss provided additional information on a bucketing technique and how each bank supposedly separated the debt into “buckets” to have their rates reset in groups without respect to the characteristics of the bonds.

However, Massullo said Edelweiss had not alleged how, procedurally, the defendants reset VRDO rates.

Edelweiss can refile the complaint with more detail within the next 15 days, and is expected to do so. The decision is significant, however, because the court restricted Edelweiss' ability to add additional analysis to its next version of the lawsuit. Massullo left room only for Edelweiss to include additional material from whistleblower sources that might strengthen its allegations.

Edelweiss also alleged that the banks didn’t make a judgment for the appropriate rate for a given bond because they applied the same rate changes to multiple bonds.

“But, as is clear from more particularized allegations elsewhere, the bonds start at different interest rates,” Massullo wrote. “So, if the interest rate change is the same in absolute terms, the rate reset does not treat the VRDOs as if they are the same because the rates remain different. Instead, it treats the VRDOs as if the intervening events between the prior reset and the current reset had the same impact, in absolute terms, on the appropriate rate. Thus, it is not probative of fraud to say that two VRDOs with different characteristics had the same reset in absolute terms because their rates should be different.”

This lawsuit is among many that have been filed throughout the country. The allegations against the accused banks — Bank of America, Barclays, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, Royal Bank of Canada and Wells Fargo — stems from an allegation first raised by Minnesota-based municipal advisor Johan Rosenberg. He filed the whistleblower lawsuits via Edelweiss.

Edelweiss has to say that at minimum two VRDOs with different characteristics had the same rate reset in absolute terms, but due to some real-world conditions at that time, the rates should not have moved together, she said.

Massullo also said that a commercial paper comparison made as part of Edelweiss' analysis cannot by itself support an allegation of falsity because it can’t support, on its own, a reasonable inference that the defendants inflated the interest rates on VRDOs.

The court said central facts such as in a properly functioning market the interest rate on VRDOs should be lower than the interest rate on commercial paper since they are similar but VRDOs have a tax treatment, was true.

However, Edelweiss didn’t note other factors that would impact the relationship between commercial paper rates and VRDO interest rates.

In late December, the New York Supreme Court Appellate Division denied the appeal of those banks, keeping the trial process there in New York going.

VRDO suits are still on track in Baltimore and Philadelphia where those cities sued the banks, claiming that they colluded in the setting of interest rates for VRDOs the plaintiffs issued.

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Variable-rate bonds Washington DC City and County of San Francisco, CA Securities law
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