In 2015, Johan Rosenberg was granted U.S. Patent No. 8,935,181 on an unusual invention: software that he claimed could ferret out Wall Street chicanery.
With the help of MuniPriceTracker, Rosenberg combed through thousands of deals in the vast U.S. municipal-bond market.
Now, after working for years under a cloak of anonymity, Rosenberg has finally stepped forward -- and put his name to some startling allegations. He says 16 banks colluded to set the interest rates artificially high on a certain kind of municipal debt, potentially profiting at taxpayers’ expense.
The claims are all the more remarkable because they’re coming from Rosenberg, whose former muni advisory firm in Minnesota had its own brush with trouble.
Three false-claims lawsuits, in Illinois, Massachusetts, and California, are demanding $3.6 billion in damages. They were filed by an entity called Edelweiss Fund LLC, which was revealed March 8 for the first time to be Rosenberg. He stands to get millions of dollars if he wins the suits. The Bond Buyer was first to identify him. Rosenberg confirmed to Bloomberg News that he is behind the litigation.
“These are very serious allegations that are being made, and it creates very significant exposure for the defendants,” said Lane Vines, senior counsel at Berger Montague who specializes in securities fraud and isn’t involved in the lawsuits.
The allegations that banks colluded to keep interest rates high could upend a $150 billion corner of the municipal-bond market. They come after findings of manipulation in the global foreign-exchange market and in setting Libor, the London interbank offered rate. Those scandals cost dozens of traders their jobs and banks billions in fines and penalties.
The Illinois complaint, originally filed in 2014 and refiled in 2017, alleges eight banks cost debt issuers in the state $349 million between 2009 and 2013. It asks for the banks named to pay triple that amount.
The city of Philadelphia in February sued seven banks over similar allegations that they colluded to fix prices on the debt. The lawsuit says that a whistle-blower in 2015 and 2016 began meeting with the federal authorities such as the U.S. Department of Justice’s Antitrust Division, which it says opened a preliminary criminal investigation that is “ongoing.”
In February, a judge refused a request from the banks, including JPMorgan Chase & Co. and Citigroup Inc., to dismiss the case. The banks argued that Edelweiss’ analysis was “subjective and arbitrary” and that it used “cherry-picked” data. The banks declined to comment further.
The Massachusetts lawsuit, filed in 2014, alleges four of the banks overcharged more than $100 million and asks for them to pay triple that amount. The California lawsuit, which was filed against 13 banks and unsealed in December, asks for the banks to pay about $2 billion.
Edelweiss spent “significant resources” over multiple years to analyze variable-rate muni debt and expose the banks’ alleged fraud, according to a September filing as part of the Illinois suit.
Rosenberg is no stranger to controversy. In 2006, federal investigators executed a search warrant at his firm, the Eden Prairie, Minn.-based Sound Capital Management, as part of a criminal investigation of whether banks and financial firms conspired to rig bids for investment deals with local governments.
More than a dozen people from companies including Bank of America Corp., JPMorgan and UBS Group AG pleaded guilty in the investigation by the Justice Department’s Antitrust Division. Rosenberg was never charged.
A former JPMorgan banker, James Hertz, admitted to fraud and conspiracy in 2010. In his plea hearing, Hertz said Rosenberg’s Sound Capital Management told him how to change his bids in order to win deals.
At the time, Rosenberg disputed Hertz’s characterization.
“Every situation can be interpreted two ways,” he told Bloomberg News. “Sound Capital continues to stand by its practices.”
A class action complaint brought by states and municipalities in 2009 against a group of banks and brokers that included Sound Capital alleged that Rosenberg advised a Bank of America employee who served as a confidential witness in the case about the bid levels of other banks.
Sound Capital was dissolved in 2013, according to the Minnesota Secretary of State’s Office. Blue Rose Capital Advisors was formed at the same address, according to the office.
The fraud Rosenberg alleges in the muni market centers on what’s called variable-rate demand obligations, or VRDO.
Banks reset the interest rates periodically, walking a fine line between satisfying investors with high rates and keeping government issuers happy with low ones. If investors decide to bail, it’s up to the bank to find a new buyer. That gives them incentive to keep rates high, the Illinois lawsuit says.
According to the lawsuit, banks are supposed to consider rates individually for each security, but instead sorted the bonds into buckets and set interest rates by group without considering market conditions. The lawsuits note Municipal Securities Rulemaking Board regulations require dealers and brokers to make an effort to get a “fair and reasonable” price for municipal clients that reflects the market.
Proving the banks worked together to inflate interest rates on the debt will be tough, said Robert Brooks, a University of Alabama finance professor. He compared the situation to four gas stations located on the same corner all charging the same price.
“That doesn’t necessarily prove collusion,” he said.
In the case of variable-rate muni debt, interest rates stayed historically low during the time Rosenberg examined them, so it’s unlikely there would be major differences in the resets by the banks, Brooks said. From 2009 through 2015, the main gauge of variable-rate municipal yields averaged about 0.17 percent, according to data compiled by Bloomberg.
Neither Illinois, Massachusetts nor California has joined Rosenberg’s lawsuit. That doesn’t necessarily cast doubt on his allegations, said Randall Fox, a partner at Kirby McInerney LLP who focuses on whistle-blower claims and isn’t involved in the lawsuits brought by Rosenberg. States don’t intervene in such cases for a variety of reasons that may be unrelated to the strength of the argument, such as the resources or priorities of the state attorneys general offices, Fox said.
Though it deals with the complicated world of municipal financing, the underlying premise would be easy to explain to a jury, Fox said.
“What this case is about is that the banks made a promise, a couple of promises, about how it would conduct itself in handling these bonds for the municipalities and the state,” he said. “And they didn’t live up to those promises.”
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