Ex-employees give evidence in fraud case against financial institutions

In a case before the California Court of Appeal, seven former employees of certain financial institutions allegedly corroborated a complaint that their ex-employers shirked their contractual and regulatory obligations and engaged in rate-setting misconduct.

In the case of State of California ex rel. Edelweiss Fund LLC et al. v. JPMorgan Chase & Company et al., Edelweiss Fund, LLC sued JPMorgan, Citigroup, Wells Fargo, Bank of America, Merrill Lynch, Morgan Stanley, Barclays, Royal Bank of Canada, and Piper Jaffray.

Read more: Wells Fargo employee accused of being racist cyberbully

The complaint alleged that the defendants:

• conspired to violate the California False Claims Act by colluding to inflate interest rates on California variable rate demand obligations (VRDOs)
• engaged in a coordinated “robo-resetting” scheme where they would mechanically set the rates as a whole without considering the bonds’ individual characteristics, the associated market conditions, or investor demand and would impose artificially high rates
• failed to fulfill their obligations as remarketing agents to reset the interest rates at the lowest possible rates that would enable them to sell the series at face value
• submitted false claims for payment for remarketing services between 2009 and 2013.

Certain past employees of the defendants provided statements supporting the claim of a robo-resetting scheme, Edelweiss said.

Employees 1 and 2, who worked at JPMorgan during the 1998 to 2007 period, alleged that the defendants engaged in the robo-resetting practices and inflated VRDO rates during this time. Employee 2

said that JPMorgan did not consider particular VRDOs when setting rates and that the business unit joked that “the whole remarketing desk could be replaced with three monkeys.”

Employee 3, who worked at Citigroup from the early 1990s to 2008, alleged that Citi and other remarketing agents generally did not consider VRDOs on an individualized basis and instead reset rates en masse.

Employee 4, who worked at Wells Fargo’s remarketing desk from around 2008 to 2015, monitored the other defendants’ rate resetting practices and believed that they had a substantially similar process as Wells Fargo’s. This process, as the employee described, did not result in the lowest rates and instead sought to ensure that VRDOs would not be “put” back to Wells Fargo as the remarketing agent, which would require undertaking inventory risk.

Employee 5, a senior employee who worked on Barclays’s remarketing function from around 2008 to 2012, alleged his former employer did not devote enough resources to staff the remarketing function in a way that would have ensured the lowest rates. Allegedly, management regularly yelled at the employee when rates were reset too low.

Employee 7, who worked at Citigroup for two decades, said remarketing agents failed to consider prevailing market conditions and operated the VRDO market as the “biggest joke of a market of all time.”

The defendants filed a demurrer, which the trial court granted. The trial court found that Edelweiss failed to include particularized allegations about how the defendants set their VRDO rates and failed to establish that fraud was the factor causing the observed conditions.

Case against financial institutions should proceed

The California Court of Appeal for the First District reversed the judgment and returned the case to the trial court for further proceedings.

Edelweiss sufficiently pleaded its claims under the California False Claims Act based on the defendants’ alleged breaches of contractual obligations and alleged conspiracy to commit such violations, the appellate court said.

Regarding the former employees’ statements, the appellate court noted the following:

• Employees 1, 2, and 3 supported the inference from the rate-resetting data that the defendants set rates that were too high because they failed to evaluate, for each VRDO, the factors that they allegedly had to consider to reset rates at the lowest possible level for selling the series at par
• Employee 4 supported the allegation that the defendants used robo-resetting on California VRDO rates and the inference that the defendants violated their rate-resetting obligations
• Employees 5 and 7 added allegations about the feasibility of the defendants’ compliance with their rate resetting obligations

Lastly, the court found the evidence of Employee 6 insufficient and lacking in anything meaningful.