Wisconsin seeks transparency with Clarity's VRDO bid platform

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Wisconsin intends to use the Clarity Bidrate Alternative Trading System to competitively remarket $60 million of floating-rate paper, a decision cemented by recent lawsuits accusing banks and broker-dealers of widespread fraud in the variable-rate demand obligation market.

The lawsuits highlight how “rates are being established behind the curtain and with the Clarity platform everyone will see how the rate is determined based on orders from investors,” said Wisconsin’s capital finance director, David Erdman.


Erdman said he’s been interested in the Clarity platform for some time, with his eye on the platform’s development and performance since its first and so far only issuer deal for Ohio in 2016.

“We liked Clarity since the first we heard about it. It’s a transparent trading platform. The lawsuits have accelerated our interest,” Erdman said. Erdman declined to offer his thoughts on the lawsuits but suggested that using Clarity “sends a message" to the market.

The $60 million general obligation VRDO would initially be placed by Siebert Cisneros Shank & Co. LLC, possibly with a weekly reset, in March. Subsequent bidding would be conducted on Clarity. Quarles & Brady LLP is bond counsel.

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 when the resets came up.

All of the suits were filed in 2014 but only came to light over the last year.

An Illinois suit was unsealed in April 2018, while litigation filed in Massachusetts and California remains mostly under seal. They were filed as 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.

The list of major banks named as defendants differs from case to case. The defendants have declined to comment and those in the Illinois case have asked the court to dismiss the litigation.

Clarity, a division of Arbor Research & Trading LLC, launched its first issuer deal in November 2016 when Ohio sold $32.3 million of variable rate bonds. After the initial underwriting by Key Bank, the bonds began trading on Clarity.

Clarity "creates a new opportunity in the variable-rate securities market that is designed to level the playing field for issuers, investors, banks and broker-dealers. The common thread for issues pricing on Clarity is that they are priced through a competitive bid process and are traded exclusively on Clarity,” the firm’s website says.

The firm’s aim is to rejuvenate the variable-rate municipal market that collapsed during the 2008 financial crisis.

If long-term rates rise, floating-rate products with their short-term interest rates stand to attract more issuer interest, said Clarity’s chief executive and president, Robert Novembre.

Novembre said the firm has spent much of the last two years working on data collection and establishing strategic alliances. For example Siebert is an originations partner, and building a “critical mass” on the investor side with clients now on board from hedge funds to money market funds.

The firm is now working to build supply and hopes to add multiple issuers this year.

“It was a slightly longer road than anticipated but we are at long last at tipping point” with respect to adding issuers, Novembre said.

The costs of using the Clarity platform is comparable to the spread tacked on to a deal, according to the firm, and there can be savings over the longer term if the competitively bid rates are lower than what would have been set during a traditional remarketing managed by a bank.

Issuers can opt to use a liquidity provider for their VRDOs or provide self-liquidity as Ohio does. On Clarity, the provider is referred to as a contractual bidder that steps up if buyers don’t. Ohio has always found buyers on Clarity. “In essence the bank's role is the same, they are the buyer of last resort,” Novembre said. Clarity has banking relationships but the choice of a bank, if an issuer wants a liquidity facility, is part of the negotiations.

Traditional remarketing banks may argue that Clarity lacks a backstop in that they have typically been willing to hold an issuer’s bonds for a short time, but market participants note those pledges are no guarantee and point to the collapse of the auction rate securities market in 2008.

In addition to biddable VRDOs, the firm offers several other products such as biddable tender option bonds — three series from Dexia Bank used the platform until late last year — and biddable floating rate notes.

The three 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.

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

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Primary bond market Variable-rate bonds Lawsuits State of Wisconsin Wisconsin Ohio
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