CHICAGO — The efforts of five Wisconsin school districts to recoup their ill-fated $200 million investment in collateralized debt obligations have received reinforcement in the form of possible Securities and Exchange Commission action against an investment bank for its role in the transaction.
Stifel, Nicolaus & Co. disclosed in a regulatory filing that it had received a Wells Notice from the SEC advising it that agency staff intends to recommend the filing of a civil or administrative enforcement against the firm for possible violations of securities laws relating to its role in the investment.
“Stifel Nicolaus intends to respond and explain why it believes enforcement action is not warranted,” the firm said in its regulatory filing late last week.
The commission generally gives recipients of a Wells Notice 30 days to respond, though exceptions can be made.
The SEC launched its probe last spring into the transactions undertaken by the school districts to fund their non-pension retiree health care liabilities. The risky CDO investment scheme involved credit default swaps.
Stifel previously reported that it has provided information and testimony on the subject to both the SEC and state regulators.
The five districts invested a total of $200 million — $165 million from the issuance of asset-backed notes by trusts to fund their other post-employment benefits, and $35 million in cash — to help cover their collective $432 million of unfunded OPEB liabilities. The districts put their moral obligation pledge behind the trust notes.
The five districts are the Kenosha Unified School District, the Kimberly Area School District, the Waukesha School District, the West Allis/West Milwaukee School District, and the Whitefish Bay School District.
The districts filed a lawsuit in 2008 against Stifel and Royal Bank of Canada Europe Ltd. in Milwaukee County Circuit Court alleging the firms misled them over the safety of their investments.
“For the SEC to consider filing a parallel lawsuit is a significant indication that the districts are following a just path and are ever closer to recovering their losses from this fraud,” said Stephen Kravit, an attorney for the districts.
A pre-trial hearing is set for September.
The districts said they believed they were investing in highly rated securities that were not exposed to subprime or other market risks. They were not told the underlying assets backing the CDOs included subprime mortgages. They expected to benefit financially by capturing the spread between the low rate they paid on the notes and the higher rate of return expected on the CDO investments.
When the subprime real estate market collapsed and the value of other structured securities fell, the value of the trusts dwindled. The market’s ongoing problems and the recession further cut into the value of the trusts, triggering a default by the districts in late 2007. The districts were required under the loan agreements to cure the default but they did not, and last year note-holder Depfa Bank Plc demanded repayment.
The districts have refused to repay the notes with their lawsuit pending. Moody’s Investors Service downgraded all five districts as a result but all the ratings remain solidly in investment-grade territory.
The districts contend the firms violated state securities laws by either knowingly or negligently misrepresenting details of the transactions.
The suit further alleges that the firms violated Wisconsin’s trade and fraud statutes because of their statements about the safety of the transactions and their compliance with state laws.
Stifel and RBC have filed cross-claims.
“The company believes the plaintiffs reviewed and understood the relevant offering materials and that the investments were suitable based upon, among other things, our receipt of written acknowledgement of risks from each of the plaintiffs,” Stifel wrote in its filings.
Stifel and RBC officials first presented the investment opportunity in 2006 to the school districts in the form of Stifel’s Government OPEB Asset and Liability program, which involved investing in synthetic CDOs.
The districts had a long-standing relationship with former Stifel banker David Noack, who was referred to in the lawsuit as a “trusted financial adviser.”
RBC formally served as the arranger for the CDO and Stifel served as the placement agency-broker.