VRDO lawsuits multiply

WASHINGTON - The number of lawsuits accusing banks and broker-dealers of widespread fraud in the variable-rate demand obligation market has grown to three, though the actual complaints remain under seal in two of those cases

Cases have now been made public, though not fully unsealed in both Massachusetts and California. Those proceedings join the case in Cook County, Illinois, that was fully unsealed last year. While the list of defendants differs from case to case, the lawsuits all allege the same wrongdoing in the remarketing of VRDOs and all are due for important rulings in the next few weeks

VRDOs are variable-rate bonds that are nominally long-term with 20- or 30-year maturities, but are considered short-term because their interest rates are reset periodically, typically weekly. They contain a “put” feature that allows investors to tender them back to tender agents or remarketing agents. The RMAs will then market the VRDOs at a par rate that is 100% of the face value of the security as well as accrued interest.

The suits charge some of the nation’s largest dealer firms with using a “Robo Resetting” device to fraudulently impose artificially high interest rates on the VRDOs so they would not have to be remarketed.

All of the suits were filed in 2014 and came to light more recently. The Illinois suit was unsealed in April 2018, while the Massachusetts and California suits remain mostly under seal. All three suits are filed as a whistleblower actions by Edelweiss Fund LLC, a Delaware-registered limited liability company that was incorporated on April 29, 2014, specifically to pursue this litigation. The individual behind the fund stands to share in any damages recovered on behalf of the state through the lawsuits.

Edelweiss’ consulting expert is Michael Lissack, the former Smith Barney banker who helped the government win hundreds of millions of dollars — and reaped tens of millions of dollars himself in the process — from filing whistleblower lawsuits against Wall Street and other firms in 1995 over charges that they engaged in yield-burning.

The Massachusetts case is filed in Suffolk County Superior Court in Boston, and names as defendants JPMorgan Chase & Co., Citigroup Inc., Merrill Lynch & Co., and Morgan Stanley Smith Barney.

The California case is being handled in the Superior Court of California, County of San Francisco. That case names as defendants JPMorgan, Merrill, Morgan Stanley and Citi as well as Wells Fargo, Barclays, Piper Jaffray, Stifel Nicolaus, Royal Bank of Canada, Piper Jaffray, Westhoff Cone & Holmstedt, Red Capital Markets, Gates Capital Corp., and Stern Brothers & Co.

Many of those same firms have been named in the Illinois complaint, and have declined to comment on the matter. The complaints are civil lawsuits and to date no regulatory or law enforcement agency has publicly accused any of the firms involved in any wrongdoing regarding VRDOs. The firms involved in the Illinois suit, including JPMorgan and Citi, have asked the court to dismiss the suit.

There have been some indications that regulators are at least investigating the issue, though. Sources told The Bond Buyer in September of last year that the Securities and Exchange Commission had sent letters to a number of firms requesting information on their VRDO rate-resetting practices.

All of the VRDO cases are now awaiting court decisions that are not long away. The Illinois suit is due for a ruling on the defendants’ motion to dismiss Jan. 29. The Massachusetts case has a hearing scheduled for Jan. 31, at which time the judge may unseal the complaint. In California, the judge could unseal the complaint at any time and must do so by Feb. 27, according to a source familiar with the proceedings.