When Thieves Fall Out

by Thomas Brom

Even by the heightened standards of the day, the municipal derivatives scandal is a beaut. It involves a vast bid-rigging and kickback conspiracy, implicating every major Wall Street bank and an assortment of brokers, dealers, and con artists. The perps allegedly manipulated the bidding for short-term investments in the proceeds from the sale of municipal bonds - an arcane but lucrative practice that violated the Sherman Antitrust Act and cheated bond issuers out of billions of dollars.

Official probes abound: The IRS began its investigation in 2005, the FBI in 2006, the Department of Justice (DOJ) Antitrust Division in 2007, two state attorneys general in 2008, and last year California's attorney general and the Securities and Exchange Commission.

In October 2009 the DOJ indicted three executives in CDR Financial Products, a Beverly Hills?based muni derivatives broker, for bid-rigging, receiving illegal kickbacks, and fraud. In May a former director of UBS, the Swiss bank, confessed to bid-rigging, conspiracy, and wire fraud in the elaborate scheme.

And of course the scandal inspired follow-on civil suits - lots of them, coordinated in 2008 before District Judge Victor Marrero of the Southern District of New York (In re Mun. Derivatives Antitrust Litig., No. 08 MDL 1950 (J.P.M.L.)). The suits come in three bunches: a putative class action brought by public entities in multiple states represented by dozens of law firms, and two clusters of individual cases brought by public entities in California.

"The bid-rigging involved a small number of individuals who all knew each other," says Stuart G. Gross, a principal at Burlingame's Cotchett, Pitre & McCarthy who represents individual public entities against multiple defendants. "Their compensation was substantially bonus-based, and tied to the highest level of profits on the transactions. As alleged in our complaint, two muni derivatives traders said at a New York steak house they were glad they weren't 'kicking each other's teeth out' making competitive bids."

But Wall Street fraud isn't exactly news anymore. What's extraordinary about the muni derivatives scandal is how it unraveled. The whistleblower was one of those two traders in New York, an employee of Bank of America (BofA), which was a counterparty to many of the transactions.

According to court documents, an investigation by BofA's outside counsel in 2004 revealed its complicity in muni derivatives bid-rigging. By 2005 the IRS was closing in, and a year later the DOJ had convened a criminal grand jury.

At that point BofA was confronted by the classic "prisoner's dilemma" - whatever the other co-conspirators choose to do, each will be better off confessing than remaining silent. As luck would have it, the DOJ's Antitrust Division had a program built on that game theory. Its corporate leniency policy, promulgated in 1993, had just been expanded under provisions of the Antitrust Criminal Penalty Enhancement and Reform Act (ACPERA) of 2004 (Pub. L. No. 108-237, codified at 15 U.S.C. section 1).

ACPERA permits applicants that admit violating the Sherman Act to avoid the harshest consequences of DOJ enforcement: indictment, joint and several liability, treble damages, and debarment from eligibility for government contracts. It provides leniency for directors, officers, and employees as well as for the corporation. For an applicant to fully benefit, it must be the first to file.

But the cost of admission is steep. Applicants must supply information that is not already known to the DOJ, report wrongdoing "with candor and completeness," make restitution to injured parties, and verify that their corporation was neither the leader nor originator of the activity. And they must cooperate with plaintiffs lawyers, providing "all documents or other items potentially relevant to the civil action that are in the possession, custody, or control of the applicant." (Pub. L. No. 108?237, § 213(b).)

BofA took the plunge in January 2007. It signed a Corporate Conditional Leniency Letter with the DOJ and announced a $14.7 million settlement with the IRS for its role in certain bond deals. The bank then entered settlement negotiations with the plaintiffs class counsel that were overseen by retired Judge Daniel Weinstein of JAMS in San Francisco.

A Long Road to Recovery
The road to taxpayer recovery, however, has been long and bumpy. The first bump was an inconvenient section of ACPERA that permits detrebling of damages by civil claimants "except that the term [claimant] does not include a State or a subdivision of a State with respect to a civil action brought to recover damages sustained by the State or subdivision." (§ 212 (4); emphasis added.)

That exception meant BofA was still on the hook for treble damages for its part in the bid-rigging scheme. But in September 2007, Cohen, Milstein, Hausfeld & Toll - co-lead counsel in the class action - signed an agreement with BofA to not seek treble damages in exchange for a proffer of information and evidence.

Judge Marrero blessed the deal, finding in August 2008 that the agreement "merely reduces the amount of damages that plaintiffs may seek directly from BofA, a reduction that is already contemplated by ACPERA as an incentive to encourage cooperation with the government."

Lieff, Cabraser, Heimann & Bernstein refused to participate. "ACPERA is clear there is no civil reduction of damages to state entities that are victims of antitrust violations," says Eric B. Fastiff, a San Francisco partner at Lieff Cabraser who represents Oakland, Alameda County, Fresno, and Fresno County in individual suits. "Class counsel and BofA said, 'Let's pretend the Act does permit detrebling' - and the court went along."

Cotchett Pitre also filed individual actions against the defendants on behalf of some 20 cities, counties, and public agencies - including Los Angeles, Riverside, and Stockton; and San Mateo, Contra Costa, and San Diego counties. Its clients have entered separate cooperation agreements with BofA.

The second bump to recovery was even bigger. In April 2009, Judge Marrero dismissed the consolidated class complaint as insufficient to "raise a right to relief above the speculative level" (citing Bell Atl. Corp. v. Twombly, 550 U.S. 544 (2007)), or to make the asserted claim plausible on its face (citing Iqbal v. Hasty, 490 F.3d 143 (2d Cir. 2007)). How embarrassing! However, the court did allow certain plaintiffs to file a more precise pleading.

"To protect its criminal investigations, the DOJ limited the amount of information it permitted the BofA to release," explains Michael P. Lehmann, co-lead class counsel and a partner in the San Francisco office of Hausfeld.

Adds Fastiff at Lieff Cabraser, "You have to understand that this is a very, very complex case. There were thousands of individual transactions made over a period of ten to twelve years. You have multiple layers of conspiracy involving banks, brokers, and dealers. The evidence is still with the defendants."

So in June 2009 the plaintiffs filed a second consolidated amended complaint, this time with more details from BofA and information gleaned from regulatory filings. With its own amended complaints, the Cotchett Pitre firm submitted a statistical analysis of alleged sham bidding and other collusive practices by several of the defendants.

The revised civil pleadings arrived about the same time Judge Marrero was assigned criminal cases related to the alleged bid-rigging. In February he received the first of three guilty pleas from lower-level employees at CDR Financial. By late April Marrero had changed direction, denying a motion to dismiss filed by dozens of defendants, including JP Morgan Chase, Morgan Stanley, Citigroup, Wells Fargo, and Goldman Sachs Group.

"The criminal pleas confirmed the allegations in our clients' complaints," Fastiff says. "Judge Marrero's second opinion was influenced by the parallel criminal proceedings."

The DOJ immediately filed a motion to stay discovery, but a month later the court ruled that all three plaintiffs groups should have access to documents and more than 600,000 audiotapes recorded at muni derivative trading desks.

So does the prisoner's dilemma work as a public policy? Congress, with the support of the American Bar Association, thought so in 2009, when it extended ACPERA for an additional year (Pub. L. No. 111-30). The ABA's letter to the House and Senate judiciary committees, however, pointed out that "there is no case law or academic study that addresses the effectiveness of the damages limitation in encouraging companies to report conduct ... [n]or are there any reported cases discussing the implications of the leniency applicant's requirement to cooperate with the civil claimants." No matter. In late May, Congress extended ACPERA by another ten years.

Plaintiffs lawyers certainly aren't complaining about the corporate leniency program. "ACPERA has proven its success in many ways," says Cotchett Pitre's Gross. "It made the civil cases a whole lot easier. In our Tulare County complaint, for instance, the BofA proffered information on 64 transactions."

Robert W. Tarun, a senior trial lawyer in the San Francisco office of Baker & McKenzie who specializes in white-collar criminal defense, says the ACPERA model has proved so successful that a similar corporate leniency program should be offered in Foreign Corrupt Practices Act cases. "It has created a carrot system for companies that uncover wrongdoing and are first through the door," Tarun says. "It's not just a matter of detrebling damages in civil litigation. Companies can avoid debarment, and the felony tag."

The felony tag, of course, is what provokes the prisoner's dilemma.

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