New York VRDO rate-rigging case against Wall Street banks advances

A mediation session is set for Tuesday as a long-standing lawsuit charging Wall Street banks with rigging New York’s variable-rate bonds inches forward.

The New York case is one of four state-level lawsuits brought by Minnesota-based municipal advisor Johan Rosenberg, who filed them under the name of a Delaware-incorporated entity called Edelweiss Fund LLC. Edelweiss sued on behalf of the states and their entities that issued variable-rate debt and entered into contracts with banks as remarketing agents and liquidity providers.

The Illinois case was settled last October for $70 million deal, of which $48 million went to the state and $14.4 million to Edelweiss. The California case remains in discovery and a judge in the New Jersey case recently ruled in favor of Edelweiss on a public disclosure question, which the banks have appealed.

The New York mediation session comes after the parties filed summary judgement motions and expert reports to support their cases. The lawsuit charges the banks, JPMorgan Chase & Co., Citigroup, Inc., M & T Bank Corporation, Morgan Stanley Smith Barney LLC., and Bank of America Merrill Lynch & Co., Inc., under the New York False Claims Act.

Edelweiss accuses the banks of conspiring to keep VRDO interest rates high so investors would not exercise their rights to tender the VRDOs back to the banks serving as remarketing agents, thus allowing the banks to collect fees for serving RMAs and for providing letter of credit services for a fee without having to actually remarket the bonds. Employees at the banks responsible for re-setting the rates talked with each other about the rates ahead of time and often spent mere seconds resetting rates en masse instead of individually, Edelweiss alleges.

The banks deny all wrongdoing. JPMorgan, in its summary judgement motion, said no city or state has offered its own allegations to back up Edelweiss, known in the case as the relator. “In the many years since relator went public with its allegations of long-running fraud and breach of contract, not one issuer has stepped forward to endorse those allegations; nor has a single issuer testified that it believes that JPMorgan or any other defendant breached its contracts,” the bank said.

The expert reports presented by Edelweiss lay out evidence for the charges of rate-rigging, collusion as well as estimated damages. S. Ilan Guedj, partner and chair of the Finance Practice at economic consulting firm Bates White, LLC., estimates damages from 2009 through 2019 at $615 million. The damages stem from remarketing and liquidity service fees and the cost of inflated reset rates. The complaint asks for the state to recoup treble damages and penalties.

Bradley Wendt, a consultant at Charles River Associates who formerly worked in munis at Goldman Sachs and Merrill Lynch and was senior advisor to the Under Secretary of the U.S. Treasury, where he led Treasury’s oversight of Puerto Rico’s bankruptcy, provided testimony on the rate-setting allegations, comparing the reset VRDO rates with seven-day AA non-financial taxable commercial paper.

Wendt said his analysis, spanning 2009 to 2020, showed the banks “regularly reset tax-free VRDO nominal interest rates higher than taxable CP interest rates. In 8 of 12 years, [the banks’] tax-free VRDO nominal interest rates equaled or exceeded taxable CP interest rates,” Wendt said. “My analysis shows that no other sector in the municipal market exhibits the anomaly of tax-free nominal interest rates, on average, equaling or exceeding taxable interest rates for comparable securities for prolonged time periods,” he said. The pattern demonstrates the “VRDO interest rates were inflated and not reset at the lowest interest rate.”

Harvard law professor Einer R. Elhauge offered support for the charges that the banks were colluding to set the inflated rates by comparing

“Citi and the other alleged wrongdoers could collectively, but not individually, increase profits by elevating VRDO interest rates above competitive levels,” Elhauge said. “Thus, evidence that Citi and the other alleged wrongdoers did in fact elevate VRDO interest rates above competitive levels and in ways that did not take competitive factors into account supports a conclusion that the Citi and the other alleged wrongdoers were either coordinating or colluding with respect to resetting.”

The banks, in their own expert report, hired former Municipal Securities Rulemaking Board president Lynette Kelly to review Geudj’s data and determine whether the CUSIPs cited were in fact conduit bonds and therefore the state and its political subdivisions carried no financial responsibility to cover payments, remarketing or liquidity fees associated with the debt.

In her report, Kelly said 450 CUSIPs cited in the Guedj report were conduit bonds. “With respect to each of the 450 CUSIPs, the private obligor, as opposed to the public authority issuer, was financially responsible to pay principal and interest, remarketing fees, and liquidity facility fees,” Kelly said.

In an August brief opposing Edelweiss’ summary judgement motion, BAML attorneys called Edelweiss’ allegations rife with error and a “fictional universe of facts.”

Among other things, the bank argued it is not required to reset the VRDOs at the lowest possible rate but only “the lowest rate which ‘in its judgment’ would permit the bonds to be resold at par when their rates later became effective.” The bank contends it reset rates individually, and not en masse as Edelweiss alleges, and that the whistleblower lacks evidence to prove collusion.

“Given this devastating absence of evidence, Relator relies on hired experts to try to establish what the record cannot,” BofA said.

If Tuesday’s mediation session does not led to a settlement, the parties are set to meet for oral arguments on Feb. 6, according to the docket.

Bank of America, Morgan Stanley and JPMorgan declined to comment. Citi and M&T Bank
did not respond to requests for comment.