Court Reverses on California’s Excessive LC Fees Claim

An appellate court has reversed a trial decision, determining that an “overly burdensome” pleading requirement was applied to the amended complaint of a municipal bond advisor. The municipal advisor brought the qui tam action on behalf of California alleging violation of the False Claims Act, specifically that a group of financial institutions and subsidiaries serving as remarketing agents (RMAs) managing California’s variable rate demand obligations (VRDOs) submitted false claims for payment for their remarketing services and conspired to inflate interest rates on the VRDOs.

In State of California ex rel. Edelweiss Fund, LLC v. JPMorgan Chase & Co., 90 Cal.App.5th 1119 (2023), Edelweiss brought action against a group of banks, contending, among other claims, that they had failed to reset the interest rate for the California VRDOs at the lowest possible rate, and instead regularly grouped VRDOs with “vastly different” characteristics into “buckets”, thereby applying the same absolute rate change to each bucket. Edelweiss identified eight factors that it argued made these bonds dissimilar, including the credit quality of the letter of credit provider.

The group of banks include J.P. Morgan Chase, Wells Fargo, Bank of America, Citibank, RBC Capital Markets, Morgan Stanley Bank, and Barclays Bank.

In its complaint, Edelweiss alleged that California was harmed because it paid for remarketing services it did not receive, paid higher interest on its VRDOs, and paid for “’letter of credit’ services—where the provider must purchase the VRDO from a redeeming investor if the RMA is unable to find another investor—that were ‘rarely called upon’ because of these inflated interest rates.” Among estimated damages of more than USD 641 million, Edelweiss contends that California was unfairly charged USD 136 million in LC fees from 2009 to 2013.

Edelweiss alleges that the “significant differences” in the credit quality of the LC providers and other factors it identified “should have led to differences in their interest rate changes over time,” and that the banks could not have complied with their rate resetting obligation given that they applied matching rate resets for a months-long period across California VRDOs. In support of its conspiracy claims, Edelweiss maintained that the banks “have opportunity and incentive to inflate VRDO rates because they serve as a letter of credit provider on VRDOs where another defendant was the RMA, and defendant RMAs own money market funds that invest in the same VRDOs.”

In its 27 April 2023 decision, the Court of Appeals of California reversed and remanded the case for further proceedings.