A two-day hearing on a long-running lawsuit over top Wall Street banks' alleged rate-rigging of variable-rate demand bonds dug deep into banks' rate-setting practices during oral arguments on dueling summary judgment motions to avoid a potential trial.
The New York case is one of several state-level False Claims Act lawsuits brought by
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Edelweiss accuses the banks of conspiring to keep VRDO interest rates high in a "robo-resetting" scheme 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 as 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. One rate-resetting employee at Citi spent between 20 to 60 minutes a week resetting rates on 600 to 900 VRDOs, Edelweiss attorney Frank Amanat, with Motley Rice LLC, told New York Judge Andrew Borrok during the hearing, which lasted all day Monday and Tuesday.
Borrok peppered attorneys from both sides with dozens of specific questions about how their rate-resetting processes worked, as well as the investor networks for VRDOs and the communications among various rate-setters that would suggest collusion. He also asked for additional documentation related to the banks' liquidity and remarketing invoices, which Edelweiss argues prove the banks submitted false claims for payment.
Edelweiss attorneys outlined their arguments that the banks were knowingly inflating the rates, falsely telling the issuers that they would use their best judgment to try to secure the lowest rates, and failing to make best efforts to widen their investor reach — for example, by reaching more retail investors — to get the lowest rates.
The banks were frequently motivated more by moving their inventory than securing the lowest rates for issuers, Edelweiss attorneys said. In the case of Citi, its inventory "is irrelevant to the rate, yet repeatedly we see that whenever Citi's inventory accumulated to a point that was larger than it was comfortable with … they would raise rates across the board of all the VRDOs they remarketed to get rid of inventory," Amanat said.
"JPMorgan put their own interests before the issuers," said Edelweiss counsel Seth Greenstein with Constantine Cannon LLP. "They needed to move inventory and they increased their rates to get them out the door," he said. "It's a plain violation of their obligation to get the lowest rate."
The banks' collusion was "a give-to-get conspiracy," Greenstein said. "You give information concerning your own rate, and what you get back is information about all your major competitors' rates that they were about to set for their best bonds that week."
The Edelweiss attorneys repeatedly referred to an
Despite their differences, the rates applied to the bonds would move "in lockstep week after week," the Edelweiss attorneys said. "The only logical explanation is they weren't actually considering the individual characteristics of these bonds but were taking a shortcut for their own benefit to limit the time they spent resetting rates," Amanat said.
"No other municipal bond sector exhibited the kind of anomalies you're seeing in the VRDO sector," Greenstein said. "It goes against all tenants of municipal finance."
In support of their arguments against the false claims, the banks noted that no issuers have ever stepped forward to join the lawsuit or halt VRDO business with the firms.
"The issuers here have not complained and in fact since the lawsuit was filed in 2014 not one issuer has terminated its remarketing agreement with Bank of America," said BofA counsel Matthew Benedetto with Wilmer Cutler Pickering Hale & Dorr, LLP. "The governments' continued payment is strong evidence they don't view the particular violation as material."
The banks argued that Edelweiss, five years after filing an amended complaint and after millions of pages of discovery, have failed to establish that employees were knowingly submitting false rates or colluding with one another to do so.
Bank attorneys also disputed specifics over when the banks were required to make "best efforts" to find low rates and that invoices that charged for remarketing services were not false because in fact the rates were reset.
Citi's counsel Susanna Buergel, with Paul, Weiss, Rifkind, Wharton & Garrison LLP, outlined the bank's "three-step process" for its rate resetters: gathering information — which they spent most of their time on — determining the impact of that information on the rates, and then actually setting the rates.
"This was a time-consuming process," Buergel said. "Citi's rate resetters spent 50% to 70% of their work week gathering information to determine the rate," she said. "This was their job; this is what they did full time. They're very familiar with their bonds," she said. The resetter would go into the VRDO spreadsheet and "go CUSIP by CUSIP to take into account how the market environment would impact the rate," she said.
Morgan Stanley's counsel Joan Loughnane, with Sidley Austin LLP, said Edelweiss has not "identified a significant issuer who believes Morgan Stanley breached its duties or who stopped doing business with Morgan Stanley."
Loughnane showed the judge an email between a Morgan Stanley rate setter and Patrick McCoy, former finance director at New York's Metropolitan Transportation Authority, in which McCoy seeks "color" on how the firm had determined some of its recent rates. In response, the Morgan Stanley employee pointed to several factors, including fund flows, the bank's inventory and competitors' rates, that influenced their decision.
"That's a real-time example of [the Morgan Stanley employee] spelling out the application of some of the factors we were talking about," Loughnane said. "The MTA is in a dialogue with the rate resetters about what's going on."
The judge disagreed.
"I don't think it illustrates that. It's an explanation that's offered as to why the rate was set — that's all it was," Borrok said. "It isn't evidence as to how the rate was set or whether it was set appropriately," he said. "It's insignificant as it relates to the issues that I have to think about."
Edelweiss attorney Amanat said the email shows the importance of the bank's internal inventory to the rates. "When an issuer complained, they knew how to reduce the rates and they did it in a targeted way to get the issuer off their back, and they did it here," he said.
The stakes for the banks are high. An expert report for Edelweiss from Ilan Guedj, partner and chair of the Finance Practice at economic consulting firm Bates White, LLC.,
Borrok questioned Edelweiss attorneys about why they should be allowed to seek damages from VRDO deals issued through conduit issuers that were paid by private borrowers. As one of their experts, the banks hired former Municipal Securities Rulemaking Board president Lynette Kelly to review Guedj'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.
The judge appeared to be considering the various categories of damages.
"The record has borne out that the damages on conduit bonds are paid by the private borrowers — so no damages," Borrok told Edelweiss, adding that "respectfully, you haven't developed the record on the conduit bonds."
He later added that the "damages may be the most interesting issue in this case that may find itself elsewhere but it doesn't look like a court has yet adjudicated this issue."
Borrok said he would likely render a decision on the summary judgments by April 20. "I think this case deserves a lot of 'me time,' sitting and writing and thinking," he said.
He noted that the parties may reconvene mediation ahead of his decision, as they consider hedging their bets by settling ahead of a potential adverse ruling.
"My questions give you indications of the points of the case that I think are more evocative than other points, and may give you some thoughts on how to approach a potential resolution to the case," Borrok said.
