Conspiracy of Banks Rigging States Came With Crash

by Martin Z Braun and William Selway

www.bloomberg.com (May 20 2010)


A telephone call between a financial adviser in Beverly Hills and a trader in New York was all it took to fleece taxpayers on a water-and-sewer financing deal in West Virginia. The secret conversation was part of a conspiracy stretching across the US by Wall Street banks in the $2.8 trillion municipal bond market.

The call came less than two hours before bids were due for contracts to manage $90 million raised with the sale of West Virginia bonds. On one end of the line was Steven Goldberg, a trader with Financial Security Assurance Holdings Ltd. On the other was Zevi Wolmark, of advisory firm CDR Financial Products Inc. Goldberg arranged to pay a kickback to CDR to land the deal, according to government records filed in connection with a US Justice Department indictment of CDR and Wolmark.

West Virginia was just one stop in a nationwide conspiracy in which financial advisers to municipalities colluded with Bank of America Corporation, Citigroup Incorporated, JPMorgan Chase & Company, Lehman Brothers Holdings Incorporated, Wachovia Corporation and eleven other banks.

They rigged bids on auctions for so-called guaranteed investment contracts, known as GICs, according to a Justice Department list that was filed in US District Court in Manhattan on March 24 and then put under seal. Those contracts hold tens of billions of taxpayer money.

California to Pennsylvania

The workings of the conspiracy - which stretched from California to Pennsylvania and included more than 200 deals involving about 160 state agencies, local governments and non-profits - can be pieced together from the Justice Department's indictment of CDR, civil lawsuits by governments around the country, e-mails obtained by Bloomberg News and interviews with current and former bankers and public officials.

"The whole investment process was rigged across the board", said Charlie Anderson, who retired in 2007 as head of field operations for the Internal Revenue Service's tax-exempt bond division. "It was so commonplace that people talked about it on the phones of their employers and ignored the fact that they were being recorded".

Anderson said he referred scores of cases to the Justice Department when he was with the IRS. He estimates that bid rigging cost taxpayers billions of dollars. Anderson said prosecutors are lining up conspirators to plead guilty and name names.

"This will go on for a long time and a lot of people will be indicted", he said in a telephone interview.

Bidding Encouraged

The US Treasury Department encourages public bidding for GIC contracts to ensure that localities are paid proper market rates. Banks that conspired in the bid rigging for GICs paid kickbacks to CDR ranging from $4,500 to $475,000 per deal in at least ten different transactions, government court-filed documents say.

A GIC is similar to a certificate of deposit, but its rates aren't advertised publicly. Instead, towns rely on advisory firms such as CDR to solicit competing offers.

In the bid-rigging deals, CDR gave false information to municipalities and fed information to bankers allowing them to win with lower interest rates than they were otherwise willing to pay, the indictment says. Banks took their illegal gains from the additional returns and paid CDR kickbacks, according to the indictment.

Not Guilty Plea

Wolmark, 54, who was indicted by a federal grand jury in Manhattan on antitrust, conspiracy and wire fraud charges, to which he pleaded not guilty, declined to comment when reached by telephone at CDR's office. Goldberg, who hasn't been charged, declined to comment, says his attorney, John Siffert.

Court records in the broadest-ever criminal investigation of public finance shed new light on how Wall Street's biggest banks were cheating cities and towns during the same decade in which they were setting the stage for a global economic collapse.

As the banks were steering the world's financial system to the brink of catastrophe by loading more than $1 trillion of subprime mortgage loans into opaque debt investments, they were also duping public officials across the US.

Many of the same bankers and advisers who sold public officials interest-rate swap deals that backfired for taxpayers are now subjects of the criminal antitrust investigation involving GICs.

The swaps are derivatives designed to keep monthly interest payments low as lending rates change. Municipal- derivative units of the largest US banks also sold the contracts, public records across the nation show.

Key Witness

Derivatives are financial instruments used to hedge risks or for speculation. They're derived from stocks, bonds, loans, currencies and commodities, or linked to specific events like changes in the weather or interest rates. Options and futures are the most common types of derivatives.

A key witness in the government's case is a former banker whom the government hasn't named, according to a civil lawsuit filed by Baltimore, Maryland, and six other municipal borrowers against Bank of America, JPMorgan and nine other banks. The banker is providing evidence against his peers.

The witness, who was employed by Bank of America Corporation starting in 1999, has laid out the inner workings of the scheme in confidential meetings with investigators, according to the civil lawsuit.

Bank of America, based in Charlotte, North Carolina, has also been providing prosecutors with evidence since at least 2007. The bank voluntarily reported its own illegal activity and agreed to cooperate with the Justice Department's antitrust division, according to a press release from the company.

Amnesty Agreement

In exchange, the government promised in an amnesty agreement not to prosecute the bank. Bank of America spokeswoman Shirley Norton in San Francisco said in an e-mail the firm is continuing to cooperate.

The banker who has been cooperating with the Justice Department said he overheard his colleagues change Bank of America's bids after coaching from brokers or other banks bidding on the same deal, according to information that the firm provided to plaintiffs in the civil case filed by seven municipalities.

At least five former bankers with New York-based JPMorgan, the second-biggest US bank by assets, conspired with CDR to rig bidding on investment deals sold to local governments, according to the Justice Department list now under seal.

At least three other former JPMorgan bankers are targets of the investigation, according to filings with the Financial Industry Regulatory Authority. Six bankers with Bank of America, the biggest US lender, are also named in the sealed Justice Department list as participants.

Sixteen Companies

Eighteen employees at sixteen other companies, including units of General Electric Company, UBS AG and FSA, then a unit of Brussels lender Dexia SA, are also cited as co-conspirators by the Justice Department, according to the list under seal. None have been charged in the case.

Citigroup spokesman Alex Samuelson, Dexia spokesman Thierry Martiny, GE spokesman Ned Reynolds, JPMorgan spokesman Brian Marchiony, UBS spokesman Doug Morris, and Ferris Morrison, a spokeswoman for Wells Fargo & Company, which acquired Wachovia in 2008, declined to comment.

Former CDR employees Douglas Goldberg, Daniel Naeh and Matthew Rothman, pleaded guilty in federal court in Manhattan in February and March to wire fraud and conspiracy to rig bids.

In October, CDR was charged with criminal conspiracy and fraud, along with Chief Executive Officer David Rubin, 48, vice president Evan Zarefsky and Wolmark. They pleaded not guilty. Rubin, who was also charged with making fraudulent bank transactions, faces as much as $3 million in fines and more than thirty years in jail if convicted.

No Law Broken

Rubin declined to comment in a telephone call.

"Mr Rubin doesn't think that CDR broke the law in any of these transactions", said Laura Hoguet, his attorney in New York.

Daniel Zelenko, a lawyer for Zarefsky in New York, said he was confident his client will prevail at trial.

"The government continues to show that it simply doesn't understand how this market operated", Zelenko said in an e- mail.

During more than three years of investigation, federal prosecutors amassed nearly 700,000 tape recordings and 125 million pages of documents and e-mails regarding public finance deals.

$400 Billion

Municipalities and states raise $400 billion a year by selling bonds. They invest much of those proceeds in GICs, sold by banks or insurance companies. Those accounts hold taxpayer money and earn interest before public agencies spend it.

Banks and advising firms illegally siphoned money from taxpayers by paying artificially low interest rates in the GICs, the CDR indictment says. The money was intended to build schools, hospitals, roads and sewers and refinance higher-cost debt.

The bid-rigging schemes were orchestrated by CDR and other advisory firms, according to the indictment and the civil suits. Advisers are unregulated private firms hired by local governments to consult on public finance deals - and are almost always paid by the banks that arrange the transactions or manage the GICs.

Wilshire Boulevard

CDR, which was located on Wilshire Boulevard in Beverly Hills, California, during the transactions under investigation, has provided advice on more than $158 billion in public transactions since it was founded in 1986, according to its website.

CDR helped arrange deals in which financial firms took millions of dollars in profits from GICs, Bloomberg News reported in October 2006. Almost all of the deals were shams: As much as $7 billion in bond-issue proceeds were invested in GICs but never spent for the intended purpose of providing services to taxpayers.

CDR signed off on interest-rate swaps to municipalities, as banks took hidden fees sometimes ten times as much as they charged on fixed-rate bond deals, according to data compiled by Bloomberg. For the public, the swaps were fraught with risks.

In the past decade, banks have peddled swaps the world over, from Jefferson County, Alabama - which was forced to the brink of bankruptcy - to the hill towns of the Umbria region of Italy. Many of these swaps soured when the credit crisis began in 2007.

Getting Out

Dozens of municipalities have paid banks billions to get out of swap contracts. The agency that oversees the San Francisco-Oakland Bay Bridge said it spent $105 million to escape its deal in July 2009.

"They were gouging the municipalities", said retired IRS investigator Anderson, 59. "Beside the excessive fees, some of the swap deals just didn't work. It was just awful. The same people were involved in the GIC end of the market."

Bid rigging not only cheated cities and towns, it also illegally denied the IRS required taxes from GIC income, Anderson said. The evidence is clear in telephone recordings made on GIC desks, he said. "We could hear people talking about how everyone knew who was going to win the bid. You could tell it was just everyday business."

The Securities and Exchange Commission is conducting a probe of bid rigging from its Philadelphia office that's parallel to the Justice Department investigation.

More Probes

State attorneys general in California, Connecticut and Florida are also investigating. Bank of America, JPMorgan, Fairfield, Connecticut-based GE, and Zurich-based UBS have disclosed in regulatory filings that they may be sued by the SEC.

The Federal Bureau of Investigation has raided at least two of CDR's competitors, Pottstown, Pennsylvania-based Investment Management Advisory Group Incorporated, known as Image, and Eden Prairie, Minnesota-based Sound Capital Management. Neither has been charged.

Robert Jones, a managing director of Image, declined to comment, after answering a call to the firm's office. Johan Rosenberg of Sound Capital didn't return calls seeking comment.

Tape recordings cited in a letter by Justice Department prosecutor Rebecca Meiklejohn show how those deals worked. In two GIC bids for the Utah Housing Corporation, CDR's Zarefsky advised an unidentified trader that his firm could lower its offer by "a dime", or ten basis points (a basis point is 0.01 percentage point).

'A Couple Bucks'

The West Valley City-based housing agency accepted contracts with GE's FGIC Capital Market Services division for 5.15 percent and 3.41 percent in 2001, public records show. Zarefsky didn't return calls seeking comment.

"I can actually probably save you a couple bucks here", Zarefsky told the trader, according to the letter citing the tape recording.

The Utah agency, which finances mortgages for low-income residents, didn't know that financial firms were cheating it out of money that could have been used to help home buyers, said Grant Whitaker, who runs the agency. "It sounds like somebody got a better deal than we did", he said in a telephone interview.

Such deals could produce large illegal profits by banks, said Bartley Hildreth, public finance professor at the Andrew Young School of Policy Studies at Georgia State University in Atlanta.

A New Wrinkle

"Just a basis point on many of these deals is tens to hundreds of thousands of dollars", he said.

This isn't the first time Wall Street has faced accusations of reaping excessive fees on investment deals with public officials. Goldman Sachs Group Incorporated, Lehman Brothers, which filed for bankruptcy in 2008, Merrill Lynch & Company and other securities firms agreed by 2000 to pay more than $170 million to settle SEC charges that they had sold overpriced Treasury bonds to municipalities.

The so-called yield burning drove down the returns that local governments earned and trimmed required payments to the IRS. The firms neither admitted nor denied wrongdoing.

Even as the banks were settling with regulators, they devised another way to burn yield, this time by skimming money from GICs, according to the indictment, which said the conspiracy went from 1998 to at least 2006.

In the lawsuit against Bank of America and JPMorgan filed in New York in June 2009, the city of Baltimore, two Mississippi universities and four other municipal borrowers say that bankers from those two companies colluded in bidding for GIC contracts in Pennsylvania.

Holiday Party

At a holiday party sponsored by advising firm Image at Sparks Steak House in Manhattan early in the past decade, the Pennsylvania deals were discussed by the Bank of America trader who is cooperating with prosecutors and Sam Gruer of JPMorgan, the civil antitrust lawsuit says.

The Bank of America trader told Gruer that he was happy that the two banks weren't "kicking each other's teeth out" on bidding for certificates of deposits for bond proceeds, the suit says. That information was provided by Bank of America to the plaintiffs.

Gruer, who was informed by prosecutors in 2007 that he was a target of the investigation, declined to comment.

Coaching a Bidder

The trader who is now a federal witness joined Bank of America after being recommended by Image, according to information that the bank turned over to the Baltimore-led plaintiffs. He was assigned by Phil Murphy, who headed the municipal trading desk, to be Bank of America's point person for investment contracts bid by Image, the lawsuit says.

Image coached Bank of America in winning an investment contract in Pennsylvania, according to an internal e-mail exchange in May 2001 between Bank of America trader Dean Pinard and Image's Peter Loughhead that was obtained by Bloomberg News. The e-mail was provided to Bloomberg by a person who got it from Bank of America and asked to remain unidentified.

Loughead, who ran bids for Image, advised Pinard on how much to offer for managing the cash fund for a $10 million bond issued by the sewer authority of Springfield Township, York County, 100 miles (161 kilometers) west of Philadelphia.

'Don't Fall on Any Swords'

Pinard said in the e-mail to Loughead that Bank of America was willing to pay the town as much as $40,000 upfront to win the deal. Loughead wrote that the bank didn't need to pay that much.

"Don't fall on any swords", Loughead wrote to Pinard the day before bids were submitted. He suggested that the bank could win the contract with a bid of slightly more than $30,000. The next day, Bank of America offered $31,000. It won the bidding, authority records show.

Loughead didn't return calls seeking comment. Pinard didn't respond to telephone requests for an interview and no one responded to a knock on the door at his Charlotte home.

Image ensured that Bank of America would dominate GIC deals in Pennsylvania by soliciting sham bids from other banks to make the process look legitimate, according to testimony from the trader cooperating with the Justice Department.

Bank of America would return the favor to Image by submitting so-called courtesy bids at the adviser's request, allowing JPMorgan to win some of the deals, according to information that Bank of America gave plaintiffs' attorneys.

Switching Jobs

Bank of America has cooperated with the municipalities that were suing the bank as part of its 2007 amnesty agreement with the Justice Department.

Traders such as FSA's Goldberg often had worked for several banks and insurance companies that had a role in GIC contracts, according to employment records with Finra, the self-regulator of US securities firms. CDR employees went on to work in the derivative departments of Deutsche Bank AG and UBS, the records show.

Before joining Bank of America, Pinard, forty, worked at Wheat, First Securities Incorporated in Philadelphia with two bankers who would later join Image, according to broker registration records.

"Few people understand this part of public finance", Georgia State's Hildreth said. "It is a very small band of brothers who know the market. So, of course, they are going to reap the benefits."

34 States

For nearly a decade, CDR founder Rubin, Wolmark, and Zarefsky helped fix prices on investment deals that cheated taxpayers in at least 34 states, according to their indictments and records filed in the case.

FSA's Goldberg, who received a bachelor's degree in accounting from Saint John's University in Queens, New York, worked with CDR employees on GIC deals, according to the indictment and public records. Goldberg worked from 1999 to 2001 at GE, which gets 35 percent of its revenue from financial services.

Goldberg was referred to only as "Marketer A" in the CDR indictment. "Marketer A" was then later identified as FSA's Steven Goldberg in the Justice Department list of co- conspirators.

At GE, Goldberg worked with Dominick Carollo, a senior investment officer for FGIC, and Peter Grimm, who worked there from 2000 until at least 2006, according to court documents and public records. GE sold FGIC in 2003 to a group led by mortgage insurer PMI Group Incorporated.

Funneling Kickbacks

Goldberg and Grimm worked with CDR to increase their gains on GIC deals, according to the CDR indictment and conspirator list. Carollo left GE in 2003, joining the derivatives unit of Royal Bank of Canada. Grimm and Carollo didn't respond to telephone calls and e-mails seeking comment.

Goldberg continued to participate in the conspiracy after he left for FSA in 2001 and used swap deals with Toronto-based Royal Bank of Canada and UBS to funnel kickbacks to CDR, according to the indictments and the Justice Department list of conspirators. Royal spokesman Kevin Foster said the company is cooperating the government.

FSA, Royal Bank of Canada and UBS all worked on public finance deals in West Virginia that prosecutors say involved bid rigging.

At least three times, Goldberg conspired with CDR to pick up deals with West Virginia agencies, according to a guilty plea by former CDR employee Rothman and other records filed in federal court in Manhattan. Among them was a $147 million investment contract with the West Virginia School Building Authority.

'Raw Greed'

That state's schools need every penny they can get, said Mark Manchin, executive director of the school authority. With seventeen percent of West Virginians below the poverty line in 2008, the state was 45th among the fifty US states, according to a 2009 Census Bureau report. Manchin said some students study in dilapidated, century-old buildings.

"It's just raw greed at the expense of the most vulnerable", he said in a telephone interview. "With deteriorating facilities all over the state, that money is what we use to build schools".

Bank of America's municipal derivatives division, which was formed in 1998, worked on the fourteenth floor of the Hearst Tower in Charlotte. The space was so tight that the banker who's cooperating with the Justice Department said he could hear others in the office change their bids when they got word from financial advisers, according to information Bank of America gave Baltimore.

Bank of America's Murphy told the banker helping prosecutors that Image would use sham auctions to steer deals to Bank of America if the employee told Image that he "wanted to win" and "would work with" Image, according to the civil suit filed by Baltimore. Murphy declined to comment.

Verbal Cues

They would use verbal cues to communicate. The banker would ask whether the bid was a "good fit" to get information on competing bids from Image. Sometimes Image's Martin Stallone said Bank of America's bids were "aggressive", or too high, and had to be reworked.

At other times, Stallone would ask the banker to bid a specific number, according to the civil suit.

Stallone didn't respond to messages left for him at work or to a list of questions faxed and e-mailed to Image.

Like Financial Security Assurance, Bank of America also paid kickbacks to brokers for their help in getting deals, according to the Baltimore lawsuit, which based its allegations on information provided by Bank of America.

On June 28 2002, Douglas Campbell, a former municipal derivatives salesman at Bank of America, wrote in an e-mail to his boss, then managing director Murphy, that he had paid $182,393 to banks and brokers not tied to any particular deals.

'Better Relationship'

Three payments totaling $57,393 went to CDR, which played no role in any transaction connected to that amount. A copy of the e-mail was contained in a North Carolina lawsuit filed by Murphy against Bank of America in 2003.

"The CDR fees have been part of the ongoing attempt to develop a better relationship with our major brokers", Campbell wrote.

The bid rigging in GIC contracts has reduced public funding for schools and housing across the US.

"If this was going on in a small state like West Virginia, it must have been huge elsewhere", the state's Assistant Attorney General Doug Davis said.

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To contact the reporters on this story: William Selway in San Francisco at wselway@bloomberg.net; Martin Z Braun in New York at mbraun6@bloomberg.net

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