CHICAGO – State and federal judges in Wisconsin have approved final settlement agreements to conclude an eight-year effort by five school districts to recoup $200 million lost on a risky investment product.
The final settlement pacts in both
"Today's announcement marks the end of an eight-year long legal fight. The school districts have been made whole – all of their investment losses from the transactions have been restored," the districts' lawyers at Kravit Hovel & Krawczyk SC said in a statement Tuesday. The settlements also cover legal fees.
The districts had previously resolved their litigation against Stifel while the SEC had previously settled its case against RBC. Stifel advised the districts and served as placement agent on their 2006 investment in synthetic collateralized debt obligations while RBC put together and arranged the investment products.
"We are obviously very proud of the result," said C. J. Krawczyk of Kravit Hovel & Krawczyk. "The odds of school districts prevailing in a complex piece of securities litigation against a $90 billion bank aren't particularly good, and they get worse the longer a case stretches on."
The litigation generated 3 million pages of documents, 75 depositions, and 30 motions. "To emerge victorious on the other side is no small thing," he said.
The districts filed their lawsuit in 2008 against Stifel and its parent Stifel Financial Corp. , RBC, and others accusing the firms of fraudulently misleading them about the safety of the investments purchased by trusts set up by the districts to help fund other post-employment benefits. Their case was bolstered by the SEC's later filing of fraud charges against the two firms.
On Tuesday, Milwaukee County Circuit Court Judge John J. DiMotto signed off on the district's final settlement with RBC while U.S. District Court Judge Charles N. Clevert Jr. approved a final judgment and settlement in the Securities and Exchange Commission's case against Stifel.
RBC said in a statement: “We are pleased to resolve this matter. The settlement is in the best interests of our clients and shareholders.”
The settlements bring to a close a saga that saw several twists. Stifel and RBC turned against each other during the course of litigation, charging each other with misconduct in cross-claim filings.
The districts expressed relief that the case was finally closed in their favor and some had praise for Stifel for its cooperation in recent years. “This was a complicated case and the decisions that had to be made along the way were far from obvious. I commend the members of each board for their willingness to make some tough calls that ultimately led to this very successful outcome. I’d also like to thank Stifel Nicolaus, who stepped up early on to make things right with us in 2012 and who has been a good partner to the districts over the past four years,” said Joseph Como, chairman of the Waukesha Board of Education.
The districts believed they were investing in securities rated double-A-minus or better. In fact, they were linked to the performance of synthetic collateralized debt obligations that included non-investment-grade credits.
The difference between the earnings from the investment and the costs of borrowing were to be used to reduce the underfunding of retiree benefits, but the value of the trusts dwindled after the subprime real estate market collapsed and the value of the structured securities fell. The market's ongoing woes and the recession further cut into the value of the trusts, triggering a default in late 2007.
The districts were hit hard when the investment soured because they had put their moral obligation pledge behind $165 million of notes issued by their respective trusts to fund their investments in the CDO products. The districts borrowed to cover the remaining costs.
As the value of the product shrunk, the lender that purchased the notes, Depfa Bank, demanded repayment. The districts refused to make good on their moral obligation pledge, and as a result their ratings from Moody's Investors Service deteriorated.
The Securities and Exchange Commission began probing the deals in August 2010 and in August 2011 the SEC charged Stifel and a former senior executive David Noack with fraudulently misleading the districts by steering them into unsuitably risky and complex investment products.
A month later, the SEC brought a complaint against RBC and a simultaneous settlement was announced in which RBC agreed to pay $30.4 million to settle charges accusing the firm of misconduct for its role in the sale of unsuitably risky investment products. RBC neither confirmed nor denied the charges in an order.
The districts -- Kenosha Unified School District, the Kimberly School District, the Waukesha School District, the West Allis/West Milwaukee School District and the Whitefish Bay School District – settled with Stifel in March 2012 and in a surprise move the two sides joined forces against RBC.
The districts and Stifel asserted in their litigation that RBC misrepresented and omitted material information regarding the default risks and value of the investment product in its creation and marketing, how it was priced, and associated fees in order to maximize its profit.
"Both Stifel and the school districts were victims of a product that we believe was deceptively created by RBC," Stifel chairman Ronald J. Kruszewski said at the time.
RBC called Stifel's claims against the firm "preposterous."
Pieces of the Stifel settlement were tied to its resolution of the SEC case. At the center of the settlement was Stifel's forgiveness of the remaining $154 million of notes issued by the districts' OPEB trusts and purchased by Depfa. In a surprise move, Stifel purchased the notes from Depfa in 2011, eliminating the threat of legal action by Depfa against the districts. Stifel relieved the districts of their moral obligation to repay the notes.
Stifel also paid $13 million to the districts and provided a standby letter of credit for an additional $9.5 million, to be paid when its regulatory case with the SEC was resolved. Tuesday's resolution of that case freed up those funds.
Settlement of the SEC's Stifel case took several additional years to reach and came as a trial was set to begin. In its complaint, the SEC alleged violations of federal securities laws and asserted that Stifel "induced the school districts to invest in complex financial instruments through a series of falsehoods and misrepresentations," knowing that the districts "were risk-averse."
In the order entered by the federal judge Tuesday, Stifel and Noack agreed to disgorge of $1.66 million in profits gained as a result of their actions in addition to $840,000 of interest. Stifel must pay a civil penalty of $22 million – including $11.2 million to the commission and $10.8 million to the districts -- while Noack must pay a penalty of $100,000.
Under the final judgment order and settlement, Stifel and Noack admit that they made certain material misstatements to the school districts that overstated the safety and downplayed the risks of investing in CDOs.
"Stifel and Noack acted negligently by making material misstatements and omissions to the School Districts and by failing adequately to investigate the appropriateness of the CDO investments. By engaging in the acts and omissions described above, Stifel and Noack violated the federal securities laws," the judgment reads.
Under the districts' finalized agreements approved by the court Tuesday, neither the school districts nor their trusts will have any further obligation under the notes, which are finally and irrevocably cancelled.
Under the now-final settlement agreements from RBC and Stifel as well as the regulatory cases, the districts are to receive a total of $63.9 million in cash as well as the note forgiveness. Most of the $20.5 million added to the final settlement recovery came from RBC.
The districts originally invested $35 million in cash and their trusts borrowed $165 million of notes for the failed investment. "This is the second largest civil settlement in state history," the districts' attorney said.
