CHICAGO — Five Wisconsin school districts on Monday settled their lawsuit against Stifel Financial Corp. that alleged the firm misled them on a risky investment to help fund their retiree health care benefits. In addition, the districts and firm announced they were joining forces to take aim at RBC Capital Markets LLC, which arranged the now-worthless investment product.
When combined with funds from a previously announced regulatory settlement with RBC, the Stifel settlement brings to $218 million the amount recouped by the districts on their $200 million investment. The districts still have between $20 million to $30 million in unrecovered legal, administrative, interest and other costs, according to their attorney, Stephen Kravit of Milwaukee-based Kravit, Hovel & Krawczyk SC.
The five districts are the 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.
The announcement from Stifel and the school districts marks the latest and one of the more dramatic turns of events in the saga over the districts’ 2006 investment in synthetic collateralized debt obligations. Stifel was the advisor and placement agent for the deal, while RBC put together the investment products.
“Both Stifel and the school districts were victims of a product that we believe was deceptively created by RBC. You need to look no further than the facts of this case to understand how credit default swaps and synthetic CDOs contributed to the financial crisis,” Stifel chief executive officer Ronald J. Kruszewski said in a statement.
RBC fired back, calling Stifel’s claims against the firm “preposterous.”
“We vehemently deny their allegations. Stifel unilaterally designed this investment, represented to us in writing that this investment was suitable in light of the districts’ objectives, and is responsible for misrepresenting and selling the product, whose risk it compared to Treasury notes, to the school districts,” RBC said in a statement. “We are heartened by the fact that the school districts will be the beneficiary of Stifel’s settlement.”
The districts and Stifel went to court Monday to dismiss the districts’ claims against Stifel and its counterclaims. They will seek approval to file an amended claim jointly against RBC seeking $200 million in damages.
“This settlement is a significant step toward recouping our losses. It is the result of cooperation and hard work for the benefit of our district and its taxpayers. We look forward to the day when there will be a final resolution and full damages assessed,” Todd Gray, the Waukesha School District’s superintendent, said in a statement.
The case is being presided over by Milwaukee County Circuit Court Judge William Brash.
The districts filed their lawsuit against Stifel, RBC and others in 2008, accusing them of fraudulently misleading the districts over the safety of the investments purchased by trusts set up by the districts to help fund their unfunded other post-employment benefits. Stifel and RBC also turned against each during the course of litigation, charging each other with misconduct in cross-claim filings.
The districts 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.
As part of the Stifel settlement, the firm must notify the rating agencies that the districts are cleared of the note liability, Kravit said.
The Securities and Exchange Commission began probing the deals in August 2010, according to the districts. Last August, the SEC charged Stifel Nicolaus and a former senior executive in a complaint with fraudulently misleading the districts by steering them into unsuitably risky and complex investment products.
In September, the SEC announced that RBC would 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.
Under terms of the settlement announced Monday, Stifel paid $13 million to the districts and provided a standby letter of credit for an additional $9.5 million, to be paid when Stifel resolves its case with the SEC, among other conditions.
The SEC declined to comment on the settlement. It said the case is still pending and a trial date has not yet been set. Sources said they expect Stifel will argue for leniency in an attempt to settle the case, citing their agreement with the districts.
At the center of the settlement is Stifel’s forgiveness of the remaining $154 million of notes issued by the districts’ OPEB trusts and purchased by Depfa. In a surprise move last summer, Stifel purchased the notes from Depfa, eliminating the threat of legal action by Depfa against the districts. Stifel has relieved the districts of their moral obligation to repay the notes.
The talks leading to the settlement began last July and were aided by Stifel’s purchase of the notes from Depfa. The districts and Stifel will assert 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.
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 unfunded 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.
In its pending complaint against Stifel, the SEC alleges violations of federal securities laws and asserts 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.”