Banks Accused of Rigging Municipal Bond Rates

May 9th, 2008
By Christina Rexrode
Charlotte Observer

In Oakland, Calif., an industrial city on the San Francisco Bay, municipal bonds have helped pay for new soccer fields, renovations to the coliseum where the NFL's Raiders play, and cleaning up the prized Lake Merritt. But the city says those bonds could have paid for more, had it not been cheated by the banks that rigged the interest rates on them.

In a lawsuit filed at the end of last month, Oakland alleges that employees from about three dozen of the country's major financial institutions, including Charlotte's Bank of America Corp. and Wachovia Corp., have illegally rigged the auctions that determine the return that a city or other government entity can get on a bond investment.

Oakland isn't the only government entity that feels cheated: The state of Mississippi, the city of Chicago, Berkeley County in South Carolina, the school district of neighboring Charleston County and a host of others entities have also sued the banks in the past two months, singling out several employees or former employees of Wachovia and Bank of America. Federal agencies have subpoenaed many of the banks, according to the lawsuits.

The lawsuits follow reports of investigations by the IRS, the Department of Justice, and the SEC.

There's no reliable way to gauge how much each entity might be owed if the suits are successful. Oakland estimates that, since 1992, it has been cheated out of about half a million dollars. That's not a lot of money for a big bank, but the potential class of plaintiffs is significant. There are more than 50,000 issuers of municipal securities, according to the Securities and Exchange Commission. Last year, more than $487 billion of new bonds and notes were issued.

John Russo, Oakland's city attorney, paints the allegations as a case of rich bankers cheating struggling governments. "How many cars do you need, how many servants do you need to have, how much is enough? ... For you to make an extra five grand when you're already making 100?" said Russo. "We really needed that money, fixing our schools and playgrounds and redoing Lake Merritt."

The banks say they are cooperating with authorities.

Accused of lowering rates

States, cities and other government entities issue tax-exempt municipal bonds when they need to raise money for public projects like roads or sewer plants. The bonds give the governments a cash payment in exchange for a promise to repay the bond holders, usually over several years.Since bonds usually fund long-term projects, cities don't have to spend their bond money all at once. Instead, they can store the money in investment vehicles called municipal derivatives. Large banks and insurance companies submit bids, through a broker, to provide these contracts. The winning bid carries the highest rate of return.

The lawsuits allege that the underwriting banks and the brokers worked together to rig these bids, thus lowering the interest rates they paid the cities. Employees from Bank of America, Wachovia and other providers and brokers would meet secretly and agree to take turns winning the bids, the lawsuits say. This is against the law; the IRS says that potential providers cannot review each other's bids.

According to the lawsuits, there are only about 20 major derivatives providers in the country; employees from different companies often know each other through trade groups. "A very small, little murky kind of industry," says Mark Schwartz, a Philadelphia-area attorney and former investment banker who is now a critic of the industry. "It's totally incestuous."

The e-mail

Often, a bank that agreed to lose a bid would be compensated under the table by the winning provider, the lawsuits say. For example, in 2001 and 2002, a Bank of America employee on the derivatives desk in Charlotte, Doug Campbell, paid four financial firms a total of $182,393 in nine deals where they officially played no role, according to court records.

In a June 2002 e-mail Campbell wrote to his boss, Phil Murphy, he said the payments were "part of the ongoing attempt to develop a better relationship with our major brokers," meant to help struggling new firms, or a way of "just saying thanks for all the swap business we had been doing," court records show.

Says Schwartz: "This is no different than putting somebody on the payroll when they don't come to work."

The e-mail is part of a lawsuit Murphy filed against Bank of America several years ago, alleging that he was shunned as a whistleblower after reporting the deals.

Murphy is also named in another lawsuit, filed March 12 by Fairfax County, Va., and other government entities. Campbell and another former Bank of America employee, Dean Pinard, as well as Wachovia employees Jay Saunders and Martin McConnell, are named in the Fairfax suit and in another filed in March by Haywood County, Tenn.

The Fairfax suit says the five bankers "engaged in the illegal communications and conduct ... to restrain competition." It also names several individuals from JPMorgan Chase, Bear Stearns and other financial firms.

Saunders and McConnell didn't return calls for comment; Pinard and Campbell could not be reached. Murphy declined to comment, saying, "I don't think it would be in my best interest right now." Pinard, Campbell and Murphy have all left Bank of America.

Wachovia said in its latest annual report that the Department of Justice had notified two of its employees that they are targets of an investigation but did not identify them. In a filing, Wachovia said those two employees are on administrative leave.

Wachovia said in the same filing that it had been subpoenaed by the Department of Justice and the SEC in connection with bidding practices for the municipal contracts. Bank of America does not comment on subpoenas, but the Oakland lawsuit says the bank was subpoenaed in late 2006. In 2007, Bank of America agreed to cooperate with the Justice Department investigation in exchange for amnesty from criminal antitrust charges.

Three months ago, the SEC told Bank of America that it could face civil action.

Wachovia declined to comment on the municipal bond allegations beyond its regulatory filings, where it said it was cooperating fully with the investigations. Bank of America also said it was cooperating fully with the investigations, and had been working with the plaintiffs. `We really needed that money,' says lawyer for city of Oakland.