A Milwaukee County Circuit Court judge ruled yesterday that a lawsuit filed by five southeastern Wisconsin school districts against several financial firms over the safety of an investment involving synthetic CDOs can proceed.
The ruling comes as the districts’ $200 million investment — partially financed with bond proceeds in an effort to bring down the districts’ unfunded liabilities for their other post-employment benefits, or OPEBs — has lost about $190 million of its value, according to court documents.
Judge William Brash’s oral ruling Thursday rejecting the defendants’ motion to dismiss the case marked the latest victory for the districts, which previously won a fight over whether the case would be heard in state or federal court.
The defendants — Stifel, Nicolaus & Co., James Zemlyak, an executive vice president at the firm, and the Royal Bank of Canada Europe — preferred federal court while the districts preferred state court, believing state securities and fraud laws are stricter and the penalties tougher.
“Our clients are very pleased that we can now proceed with discovery and hopefully go to trial within the year,” said Stephen Kravit, an attorney for the districts. “The judge rejected all motions to dismiss and said all claims can go forward.”
“The litigation is still in its early stages, and the denial of RBC’s and Stifel’s motions simply means that the defendants will now formally respond to the second amended complaint once it is re-filed,” Stifel said in a statement.
The five districts involved are the Kenosha Unified School District, the Kimberly Area School District, the Waukesha School District, the West Allis/West Milwaukee School District, and the Whitefish Bay School District. They collectively invested about $200 million in the transaction that was tied to funding newly established trusts to better pay for their collective $432 million of OPEBs.
The lawsuit contends that the firms violated state securities laws by either knowingly or negligently misrepresenting details of the transaction. The suit further alleges that the firms violated the state’s trade and fraud statutes because of their statements about the safety of the transactions and its compliance with state laws.
Moody’s Investors Service last year downgraded the West Allis district’s rating one notch to 'A1' and assigned it a negative outlook, and downgraded the Waukesha district one notch to 'A2' and assigned a negative outlook, over both their financial exposures to the deal. Moody’s affirmed Kimberly’s A1 rating, Whitefish Bay’s 'Aa2' rating, and Kenosha’s A1 rating, though the latter received a negative outlook.
The districts’ trusts issued asset-backed notes totaling $165 million, which are held by Depfa Bank Plc. Those funds and another $35 million were invested in the synthetic CDOs created by RBC Europe in 2006.
Under the program, the trusts would receive the spread, or the difference between the interest rate on their loan from Depfa and the interest rate the trusts received on their CDO investments. The districts were told several million dollars would be generated over the seven-year term of the CDO investments. However, CDO defaults have resulted in sharp losses and a deficiency in the trusts’ asset ratios.
The districts are under pressure by Depfa to repay the loans. Depfa has so far rejected the districts’ efforts to get the bank to join with them in pursuing relief from the defendants in the lawsuit.
“There were many parties involved in the creation and review of the investments, many of whom the districts have chosen not to sue, including the districts’ legal advisers and school board members,” Stifel said in its statement. “Stifel was placement agent and had no role in creating the investment, monitoring it, or recommending changes to the investment.
“The investment, which was created by Royal Bank of Canada, was 'AA'-minus rated at the time of purchase and was operating as expected at the time Stifel terminated its relationship with the districts more than two years ago,” the statement read. “The districts and the trusts also signed documents in which they acknowledged the risks of the investments and promised to review them with financial and legal advisers … The worldwide financial crisis has caused the problems the districts are now experiencing.”