A state appeals panel is allowing an investment firm to revive a class action on behalf of the state of California, accusing JP Morgan and other financial institutions of deploying an automated system they claim artificially inflated municipal bond interest rates, costing taxpayers big money in interest to finance the bonds.
Edelweiss Fund, which initiated the complaint on behalf of taxpayers, could claim a portion of any financial damages that may be awarded to the state.
San Francisco Superior County Court Judge Anne-Christine Massullo dismissed Edelweiss’ seventh amended complaint with prejudice, prompting an appeal to the California First District Appellate Court, which issued its order April 27. Justice Jeremy Goldman wrote the opinion; Justice Jon Streeter concurred, as did Judge Jenna Whitman, an Alameda County Superior Court judge assigned to the panel for this case.
Edelweiss aimed its complaint at financial institutions it alleges serve as remarketing agents managing variable rate demand obligations. The agents set interest rates for tax-exempt municipal bonds and typically adjust those rates weekly, according to the allegations. The root issue is Edelweiss’ allegation the bank defendants violated the California False Claims Act by submitting false claims for their services because they knew they didn’t set the rates as low as possible, instead colluding to inflate rates.
The complaint alleged defendants “engaged in a coordinated ‘Robo-Resetting’ scheme where they mechanically set the rates en masse without any consideration of the individual characteristics of the bonds or the associated market conditions or investor demand” and “impose(d) artificially high interest rates on California VRDOs, the exact opposite of what California hires them to accomplish.”
Judge Massullo said the allegations “may be consistent with fraud,” but ultimately said Edelweiss’ complaint didn’t offer sufficient details regarding how defendants set VRDO rates and couldn’t support a reasonable inference “the observed conditions were caused by fraud, as opposed to any other factors that may have influenced the relevant financial markets during the relevant time period.”
The appeals panel noted claims under the False Claims Act must carry a degree of particularity to survive dismissal, but Massullo “required too much to satisfy this standard,” Goldman wrote. The appellate judges said California law doesn’t support the federal plausibility standard. The panel also rejected the financial institutions’ alternative argument, a contention the law’s public disclosure clause forecloses Edelweiss’ allegations.
Edelweiss is pursuing similar litigation on behalf of taxpayers in Illinois, New York, New Jersey and Massachusetts, the panel said, and has survived motions to dismiss in each jurisdiction. Goldman noted the Illinois court specifically addressed the particularity of allegations, as well as the public disclosure bar.
The panel didn’t fully accept Edelweiss’ allegations, rejecting its position the institutions implied certified compliance with contracts when they submitted invoices. However, it said Edelweiss’ allegations could survive dismissal because of claims the defendants didn’t consider relevant factors for individual bond rates and adequate allegations the rates weren’t reset at the lowest possible levels, which was the contractual obligation.
“Edelweiss alleges that the interest rate change applied by a defendant to every VRDO in a given bucket was ‘calibrated to ensure the lowest quality, riskiest VRDO in the bucket’ would trade at par, increasing the likelihood that lockstep adjustments would result in an interest rate that was higher than necessary for some of the VRDOs in the bucket,” Goldman wrote. “Edelweiss need not allege defendants’ exact rate resetting procedure if the allegations it does offer support the inference that defendants were knowingly failing to reset rates on some VRDOs at the lowest possible level, as we believe they do.”
The complaint included allegations from former employees of the defendant institutions, and the panel said Judge Massullo held their testimony to too high a standard of specificity.
“Taken together,” Goldman wrote, “these statements add support for the inference from the rate-resetting data that defendants did not evaluate, for each VRDO, the factors that Edelweiss alleges it is necessary to consider in order to reset rates at the lowest possible level that would allow the series to be sold at par, and that their failure to do so resulted in rates that were too high.”
Finally, the panel rejected the argument the complaint should fail because of its reliance on public data, including interest rate figures disclosed in real time. The panel said the central issue to this argument was the Electronic Municipal Market Access website, and rejected the defendants’ argument that site qualified as “news media.”
The panel compared EMMA to the online database of the U.S. Securities and Exchange Commission. Goldman said both are automated information collections “entities are required to submit, and its purpose is to accelerate the receipt, dissemination and analysis of this time-sensitive information for the benefit of investors, corporations and the market.” While acknowledging the modern information age expanded common understanding of “news media,” the panel said, EMMA doesn’t quaify as such, making the public disclosure bar inapplicable.
The case was sent back to Superior Court for further proceedings, and the panel said Edelweiss is entitled to compensation for the costs of its appeal.
Representing plaintiffs in the matter are attorneys with the firms of Steyer Lowenthal Boodrookas Alvarez & Smith; the Lawrence Law Firm; Schneider Wallace Cottrell Konecky; and Constantine Cannon.
JP Morgan Chase has been represented by Greenberg Traurig.
Wells Fargo is represented by Jones Day.
Bank of America is represented by Williams Cutler Pickering Hale and Dorr.
Citibank is represented by Keesal, Young & Logan, which also is representing Piper Jaffray.
Morgan Stanley is represented by Sidley Austin.
Barclays is represented by Skadden, Arps, Slate, Meagher & Flom.
King & Spalding filed friend-of-the-court briefs on behalf of the U.S. Chamber of Commerce, California Chamber of Commerce and American Bankers Association, none of whom were parties in the case.