A lawsuit filed by five southeastern Wisconsin school districts against several financial firms the districts charge misled them over the safety of a $200 million investment involving synthetic CDOs will be heard at the state court level, a federal judge has ruled.
The ruling from Rudolph T. Randa, chief judge of U.S. District Court for the Eastern District of Wisconsin, on Friday marked a victory for the schools, which believe state securities and fraud laws are stricter and the penalties tougher.
The districts originally filed the lawsuit last year against Stifel, Nicolaus & Co., James Zemlyak, an executive vice president at the firm, and the Royal Bank of Canada Europe. with the Milwaukee County Circuit Court.
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.
The defendants, who have countered that the districts signed documents notifying them of the investment risks, argued that the case should fall under federal jurisdiction under "diversity jurisdiction" standards because the firms are based outside of Wisconsin. Any request for a transfer of venue is automatically heard by a federal judge."This is the school districts' first victory on the way to righting the wrongs done to their taxpayers, schools, and teachers by Stifel Nicolaus and the Royal Bank of Canada, which promoted, packaged, and sold these toxic investments," said Stephen E. Kravit, an attorney representing the district from the firm Kravit, Hovel & Krawczyk.
Attorneys for the defendants could not be reached immediately to comment on whether the firms would appeal the ruling.
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 fund their collective $432 million of other post-employment benefits. They now estimate the value has dropped by more than $150 million.
Moody's Investors Service earlier this year downgraded the West Allis district's rating by one notch to 'A1' and assigned it a negative outlook, and downgraded the Waukesha district by 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, although the latter received a negative outlook.
The districts' trusts issued asset-backed notes totaling $165 million, which are held by Depfa Bank. 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.