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Commonwealth ex rel. Rosenberg v. JPMorgan Chase & Co.

Superior Court of Massachusetts, Suffolk

July 23, 2019

COMMONWEALTH ex rel. JOHAN ROSENBERG
v.
JPMORGAN CHASE & CO. & others[1]

          MEMORANDUM OF DECISION AND ORDER ON DEFENDANTS’ JOINT MOTION TO DISMISS THE SECOND AMENDED COMPLAINT

          Mitchell H. Kaplan Justice

         The plaintiff and relator, Johan Rosenberg, filed this qui tam action on behalf of the Commonwealth against the defendants, JPMorgan Chase & Co.; JPMorgan Chase Bank, NA; J.P. Morgan Securities LLC; JPMorgan Securities, Inc.; Citigroup, Inc.; Citigroup Global Markets Inc.; Citibank NA; Citigroup Financial Products Inc.; Citigroup Global Markets Holdings Inc.; Bank of America Corporation; Bank of America NA; Merrill Lynch, Pierce, Fenner & Smith Incorporated; Morgan Stanley; Morgan Stanley Smith Barney LLC; Morgan Stanley & Co. LLC; Morgan Stanley Bank, N.A.; Morgan Stanley Capital Services Inc.; and Morgan Stanley Capital Group Inc., asserting a violation of the Massachusetts False Claims Act, G.L. c. 12, § § 5A-5O (the Act).[2] The relator alleges that the defendants engaged in fraud and collusion in connection with their obligations as "remarketing agents" (RMAs) for variable rate, tax exempt bonds, commonly referred to as Variable Rate Demand Obligations (VRDOs), issued by the Commonwealth or one of its cities, towns, counties, or government agencies. More specifically, he alleges that the defendants made false representations to the Commonwealth regarding their conduct in respect of their alleged obligation "to actively and individually reset and remarket VRDOs at the lowest possible [interest] rates." The relator contends that as a result of this fraudulent rate-setting conduct, the Commonwealth paid hundreds of millions of dollars in excess interest and fees since at least April of 2009. The relator’s Second Amended Complaint (complaint) pleads a single count asserting a violation of the Act, premised upon this alleged fraudulent activity.

         The case is presently before the court on a joint motion to dismiss filed by defendants JPMorgan, Citigroup, Merrill Lynch, and Morgan Stanley for failure to state a claim upon which relief can be granted. See Mass. R. Civ. P. 12(b)(6).[3]

         While the defendants argue that the complaint should be dismissed for a number of reasons, including that the relator fails to allege a fraudulent claim actually made to any governmental body, or at least alleged it with the specificity required by Mass. R. Civ. P. 9(b), the court finds that one of the grounds for dismissal on which the defendants rest their motion is squarely applicable to the "facts" alleged by the relator. As will be seen, all of the factual allegations in the complaint are based upon information generally available to the public on websites maintained by the government, self-regulatory agencies established by the securities industry, or news media. The allegations of fraud are based upon the relator’s individual analysis of this public data, and the conclusions that his analysis led him to are also based on this public data. While the issue is one of first impression under the Massachusetts version of the Federal False Claims Act, this court joins the majority of federal courts in holding that, under these circumstances, the factual allegations in the complaint are substantially the same as publicly disclosed transactions, and the relator is not the original source of the information alleged. In consequence, the Relator’s qui tam complaint fails to state a claim based on the Act’s public disclosure bar, and the motion to dismiss is ALLOWED .

         BACKGROUND

         The following facts are drawn from the allegations in the forty-page complaint and assumed to be true for the purposes of this motion. Because the motion turns on the question of public disclosure and original source, details concerning the relator’s analysis of the data and why, in his opinion, that demonstrates fraud are only generally described.

         The Parties

         The relator, Rosenberg, is a Minnesota resident. He has over twenty years of experience advising municipalities and other clients on issuing securities, particularly VRDOs and other types of municipal bonds. Through his work in the industry, Rosenberg became suspicious that the defendants and other VRDO-RMAs were colluding to systematically reset the VRDO interest rates on an algorithmic or some other kind of mechanical basis, a practice he refers to as "Robo-Resetting."[4] According to the relator, this caused artificially high interest rates to be set for these securities and resulted in the Commonwealth paying fees for services that the RMAs were not actually providing. Rosenberg "confirmed his suspicions after performing an extensive forensic analysis of the interest rates and other market data- for the April 1, 2009 through November 14, 2013 period- for the Massachusetts VRDOs ... for which [d]efendants have served as the RMA." Complaint at para. 8.

         Defendants JPMorgan, Citigroup, Merrill Lynch, and Morgan Stanley are financial services companies that do business in the Commonwealth and throughout the United States. Since April 1, 2009, the defendants served as the RMAs for approximately 242 VRDOs issued by the Commonwealth or its government subdivisions, which had an aggregate value on issue of approximately $11.8 billion.

         VRDOs

         VRDOs are tax-exempt, variable rate municipal bonds with interest rates that are set on a periodic basis, typically weekly. Although VRDOs are long-term bonds, they are attractive to issuers like Massachusetts and its municipalities, authorities, and agencies[5] because, even though these bonds permit the issuers to borrow money for long periods of time, the interest rates they pay are reset, typically weekly, by RMAs. In consequence, issuers of VRDOs are able to borrow money for extended periods at short-term interest rates.

         Purchasers of VRDOs have a "put" option, which allows them to tender the VRDOs for repurchase, generally on a weekly basis, at their face value ("par") plus any accrued interest. Additionally, VRDOs are secured by letters of credit provided by highly-rated commercial banks to protect investors in the event that the RMA is unable to find new investors to purchase the bonds tendered pursuant to the put. If that happens, the obligation to purchase the tendered bond falls on the provider of the letter of credit, and often, this is the RMA itself. The holder of the letter of credit then must look to the issuer for repayment. Investors are, therefore, attracted to VRDOs because they are low-risk, high-liquidity, and tax-free investments.

         Currently, issuers pay letter of credit providers an annual fee of between 50 and 150 basis points of the VRDO debt balance for this liquidity and credit enhancement feature. Several defendants in this case serve as both the RMA and letter of credit provider for a number of their Massachusetts VRDOs. The largest holders of VRDOs are tax-exempt money market funds, which the defendants also often own or manage.

         The VRDOs in this case are primarily issued by state and local public entities, such as municipalities, agencies, public universities, and hospitals, to raise money to fund various long-term projects or infrastructure. However, some of the VRDOs are issued by public entities on behalf of non-governmental entities (so-called conduit borrowers) to finance qualified projects and programs. The Commonwealth issues conduit bonds to provide tax-exempt financing for conduit borrowers who need low-cost capital to develop infrastructure like airports and affordable housing facilities.[6]

         The Responsibilities of RMAs

         Each issuer contracts with an RMA to manage each VRDO that it issues. RMAs have two basic jobs for which issuers like the Commonwealth pay an average annual fee of approximately 10 basis points of the VRDO debt balance. First, RMAs are required to set, typically on a weekly basis, the VRDO interest rate at the lowest rate that will clear the market. The relator contends that this rate reset must be based on an individual determination of what rate the specific VRDO will require considering the unique characteristics of the bond, the relevant market conditions, and the particular investor demand for the specific bond at issue. Second, RMAs are required to actively "remarket" the VRDOs to replacement investors when the existing investor "puts" the bond back to the RMA such that the VRDO will be repurchased at its par value plus any accrued interest.

         The relator points to three sources setting forth these two responsibilities of RMAs. First, the Municipal Securities Rulemaking Board (MSRB) promulgates rules that cover RMA duties to VRDO issuers. MSRB rules are enforceable by regulatory agencies, including the U.S. Securities and Exchange Commission and the Financial Industry Regulatory Authority. MSRB Rule G-17 requires RMAs to deal fairly and honestly with VRDO issuers. MSRB Rule G-18 requires RMAs to secure a fair and reasonable interest rate for VRDO issuers based on prevailing market conditions.

         The second source of RMAs’ responsibilities is the Securities Industry Financial Markets Association (SIFMA) Model Disclosures promulgated pursuant to MSRB Rule G-17. These are disclosures that SIFMA advises RMAs to make to VRDO issuers to comply with their MSRB Rule G-17 obligations to deal fairly and honestly with issuers. The SIFMA Model Disclosures provide that an RMA is: "required to set the interest rate at the rate necessary, in its judgment, as the lowest rate that permits the sale of the VRDOs at 100% of their principal amount (par) on the interest reset date." Complaint at para. 32.

         The third source of the RMAs’ obligations is the remarketing agreements between the defendants and the Commonwealth. According to the relator, each agreement contains provisions requiring the defendants to set and actively remarket the VRDOs they manage at the lowest possible rate based on an individual determination. For instance, an offering statement dated May 24, 2010 concerning $1.1 billion in VRDOs issued by the Massachusetts Department of Transportation and remarketed by JPMorgan states: "Pursuant to the Remarketing Agreement, the Remarketing Agent is required to determine the applicable rate of interest that, in its judgment, is the lowest rate that would permit the sale of the [VRDOs] bearing interest at the applicable interest rate at par plus accrued interest, if any, on and as of the applicable Rate Determination Date. The interest rate will reflect, among other factors, the level of market demand for the [VRDOs] ...." Complaint at para. 34. In response to various solicitations for VRDO remarketing services by the Commonwealth and consistent with their contractual and regulatory obligations, the defendants represented that they would secure the lowest VRDO interest rates. The relator, however, alleges that the defendants failed to do this, and instead, "set interest rates at sufficiently high levels to minimize the need for the remarketing and other services they agreed to provide." Complaint at para. 37. The relator asserts that:

In short, Defendants have not complied with their obligation to actively and individually[7] reset and remarket Massachusetts’s VRDOs at the lowest possible rate. Instead, they have collectively engaged in their Robo-Resetting scheme to minimize their need to provide remarketing services, secure artificially high VRDO rates, extract from Massachusetts improper and excessive remarketing and letter of credit fees, and ultimately cause[d] Massachusetts to pay more than one hundred million dollars in VRDO-related overcharges.

         Complaint at para. 38.

         Robo-Resetting & Relator’s Forensic Analysis

         As discussed above, the relator contends that the defendants "have engaged in a practice of setting their VRDO rates mechanically and collectively, without any consideration of the unique attributes of each particular bond," i.e. "Robo-Resetting." Complaint at para. 39. The relator opines that Robo-Resetting leads to higher than necessary interest rates and this, in turn, causes existing bond holders not to exercise their put options, so that the defendants do not have to remarket the VRDOs to other investors who are willing to hold the same bond at a lower interest rate.

         The relator performed a forensic analysis of the defendants’ rate-setting practices over a four-and-a-half-year period from April 1, 2009 through November 14, 2013. The forensic analysis covers more than 20, 000 Committee on Uniform Securities Identification Procedures (CUSIPs)[8] and almost five million data points and took more than 1, 000 hours.[9]

         The relator explains this forensic analysis on pages eleven through thirty-four of the complaint. According to the relator, the forensic analysis reveals that for likely all of the VRDOs that the defendants manage, the defendants group a collection of unrelated bonds into "buckets" and set their interest rates collectively.[10] This opinion is based upon the relator’s conclusion that, as to each VRDO in a particular bucket, there exists an identical pricing spread that moves the interest rate of each bond in the bucket up or down in lock-step fashion. The relator therefore infers that the defendants did not make an individual determination of what the appropriate interest rate should be for a particular bond and did not make an effort to secure the lowest possible interest rate for the bond. In his view, it is statistically impossible that any bucketing would have occurred if the defendants actively and individually priced the VRDOs they managed as they were obligated to do.

         The relator analyzed the VRDOs for JPMorgan, Citigroup, Bank of America, and Morgan Stanley. For example, relator’s analysis of JPMorgan is alleged, in part, as follows:

45. Relator’s JPMorgan analysis included 1, 377 VRDOs, which had a collective value at issuance of $49.3 billion. Massachusetts has been the issuer of 38 of these bonds (with a collective value at issuance of $2.6 billion). The analysis shows JPMorgan used bucketing to set the VRDO interest rates for at least 95 percent of the JPMorgan portfolio studied, including at least 37 of the 38 Massachusetts VRDOs in the study.
46. JPMorgan’s pricing for these VRDOs can be broken down into four buckets, with the vast majority of the bonds- 1, 083 of them- residing in a single bucket. 27 of the bonds in this single bucket were issued by Massachusetts, representing roughly 71 percent of the Massachusetts VRDOs in the JPMorgan study. Attached hereto as Exhibit A is a listing of JPMorgan’s entire Massachusetts VRDO portfolio which identifies for each VRDO: the issuer, CUSIP number, letter of credit provider, and whether it fell into a bucket under Relator’s pricing analysis.
47. While each of the VRDOs in these JPMorgan buckets had the identical interest rate change as the other bonds in the bucket for at least twenty-six weeks, 80 percent of the time, the majority of the bonds were in their respective buckets for significantly longer than twenty-six weeks ...

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