Securities Regulation Daily Court doesn’t vary, again dismisses claims JP Morgan fraudulently reset muni rates
Friday, January 8, 2021

Court doesn’t vary, again dismisses claims JP Morgan fraudulently reset muni rates

By John M. Jascob, J.D., LL.M.

The plaintiff failed for the fourth time to plead that JP Morgan and other defendants violated the California False Claims Act in connection with resetting interest rates for certain variable rate municipal securities.

A California court has again ruled that the relator in a qui tam action under the California False Claims Act failed to plead that JP Morgan Chase & Co. and other defendants defrauded the State of California when resetting the interest rates for certain variable rate municipal debt securities. In sustaining the demurrer to the fifth amended complaint, San Francisco County Superior Court Judge Anne-Christine Massullo held that the plaintiff failed to allege the means by which the defendants inflated California variable rate debt obligation (VRDO) rates in order to benefit by causing investors——including tax-exempt money market funds owned or managed by the defendants—to hold on to the bonds rather than redeem them. The court did, however, grant the plaintiff leave to amend the complaint within 15 days to add detail to the allegations concerning information learned from inside sources (State ex rel. Edelweiss Fund, LLC v. JP Morgan Chase & Co., January 6, 2021, Massullo, A.).

According to the plaintiff-relator, Edelweiss Fund, LLC, the defendants submitted false claims to the State of California by failing to disclose their noncompliance with material requirements in remarketing agreements entered into with the state in connection with the VRDOs at issue. Specifically, the plaintiff alleged that the defendants breached their duties under the contracts and MSRB rules to individually and actively reset each VRDO interest rate to the lowest rate that would enable a defendant to sell that VRDO at par. Instead, the plaintiff contended, the defendants engaged in conduct intended to inflate the VRDO interest rates, allowing the defendants to submit false claims for services not rendered and for inflated interest.

The court held, however, that the plaintiff failed to adequately allege falsity. Although the complaint alleged that four former employees—two from JP Morgan, and one each from Citigroup and Wells Fargo—told the plaintiff that the defendants did not perform individualized rate setting or make a good faith effort to set the interest rates at the lowest possible level, the court found these statements to be vague, especially as to the time period and VRDOs at issue. As such, the statements were insufficiently tethered to the alleged fraud to support the plaintiff’s belief that the defendants submitted false claims to the state knowing that they had not complied with their marketing agreements.

The court also rejected the plaintiff’s comparative analysis of commercial paper rates that was intended to show that VRDO rates were higher than they should have been due to the defendants’ fraud. Stating that investors have historically been willing to accept lower interest rates for VRDOs than for commercial paper because VRDOs are tax advantaged, the plaintiff alleged that interest rates in a properly functioning California VRDO market should not exceed 75 percent of the interest rate on commercial paper, as evidenced by VRDO interest rates on the SIFMA index from 1998 to 2007. By contrast, VRDO interest rates on the SIFMA index were 176 percent of the commercial paper rate from 2008 to 2013, the period at issue.

The court, however, was not persuaded. While noting that the plaintiff’s entire theory of the case depended on the relationship between VRDOs and commercial paper, the court explained that the complaint did not discuss the factors, apart from the alleged wrongdoing and tax treatment, that might impact this relationship. Moreover, the plaintiff failed to explain what a "properly functioning market" for VRDOs and commercial paper looks like and whether the conditions that would give rise to such a market were present absent the defendants’ allegedly fraudulent behavior. Although the inverted relationship between the rates for VRDOs and commercial paper suggested that the market was not functioning properly, this was insufficient to provide standalone support for the claim that the defendants knowingly violated their contractual obligation to secure the lowest possible interest rates on VRDOs, the court reasoned.

Finally, the court rejected the plaintiff’s "bucketing" analysis, which attempted to show that the defendants violated their contractual obligations to determine the rates individually by frequently applying the same absolute rate changes, as opposed to percentage rate changes, to VRDOs with dissimilar characteristics. Although the plaintiff alleged a large percentage of parallel movements, the complaint did not allege particularized facts tethering those parallel movements to noncompliance with an express contractual term. Accordingly, the court found that the plaintiff failed to allege either the means by which the defendants inflated California VRDO rates or any other basis to infer that the conditions in the VRDO market were caused by fraud.

The case is No. CGC-14-540777.

Attorneys: James A. Bloom (Schneider Wallace Cottrell Konecky Wotkyns LLP) for Edelweiss Fund, LLC and the State of California. Jonathan G. Cedarbaum (Wilmer Cutler Pickering Hale and Dorr LLP) for JP Morgan Chase & Co. and Bank of America Corp. Michael P. Conway (Jones Day) for Wells Fargo & Co., Wells Fargo Bank & Co. and Wells Fargo Bank, N.A.

Companies: Edelweiss Fund LLC; JP Morgan Chase & Co.; Bank of America Corp.; Wells Fargo & Co.; Wells Fargo Bank & Co.; Wells Fargo Bank, N.A.

MainStory: TopStory BrokerDealers Enforcement FraudManipulation GCNNews MunicipalSecuritiesNews CaliforniaNews

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