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Court Sustains New York Qui Tam Action Involving Alleged Scheme to Reset Interest Rates for Municipal Bonds

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  • Posted on: Apr 27 2020

In past articles, this Blog has written about qui tam actions under the federal False Claims Act (“FCA”). Typically, the whistleblower (known as the “relator”) adds a claim under the state analogue to the FCA. In today’s article, this Blog examines a claim under New York’s qui tam statute. State of N.Y. ex rel. Edelweiss Fund, LLC v. JPMorgan Chase & Co., 2020 N.Y. Slip Op. 50380(U) (Sup. Ct., N.Y. County (Mar. 27, 2020) (here).


Edelweiss involved a claim under the New York False Claims Act (“NYFCA”) by Edelweiss Fund, LLC (“Relator”) on behalf of the State of New York. Relator alleged that defendants — financial institutions and their subsidiaries — collectively engaged in a decade’s-long fraudulent scheme to reset interest rates for certain municipal bonds, known as Variable Rate Demand Obligations (“VRDOs”). New York issues VRDOs to raise money to fund various long-term projects and infrastructure, such as airport, port, transportation, and affordable housing facilities. New York engaged defendants as remarketing agents (“RMAs”) to market and price the VRDOs at the lowest possible interest rates and paid them fees to perform said services. Defendants allegedly represented that they would (i) reset interest rates for VRDOs at the lowest possible rate, and (ii) do so “actively and individually” based on an assessment of each bond’s unique “characteristics.”

According to Relator, however, defendants did not perform the services as promised and instead engaged in “robo-resetting” the interest rates by using an “algorithm or some other mechanical basis” to reset the rates by placing the bonds with different characteristics in the same buckets and applying the algorithm without considering the individual bond characteristics, the associated market conditions, or investor demand, and, thus, breached their obligations to set the rate at the lowest possible rate to trade at par. Relator further alleged that defendants “robo-reset” these rates in the manner they did in order to keep the bonds in the hands of their holders and therefore alleviate the need for defendants to remarket the bonds so as to collect tens of millions of dollars in annual remarketing fees without providing the remarketing services for which New York allegedly paid them.

In addition, Relator alleged that defendants failed to set the rates at the lowest possible interest rates, as their agreements with the State of New York allegedly required, and instead employed the “robo-resetting” algorithm to collectively impose artificially high interest rates on the VRDOs, which was the opposite of what New York hired them to do. Relator claimed that defendants benefited from keeping the VRDO interest rates artificially high because it caused VRDO investors — who are typically tax-exempt money market funds, which defendants in many instances own or manage — to hold the bonds rather than redeem them at face value plus interest. This “put” option is one of the defining features of a VRDO, and it is the responsibility of the remarketing agent to find another investor when the “put” option has been exercised. If the remarketing agent is unable to find another investor, a liquidity provider (who is often the remarketing agent itself) must step in and purchase the VRDO from the redeeming investor. Thus, Relator alleged, by setting the rates for VRDOs artificially high, defendants assured that the holders of the bond would not exercise the “put” option and defendants would not have to find other investors to purchase the bonds or buy the bond themselves. 

The Complaint asserted a single claim against all defendants for violation of the NYFCA (NYSFL § 187 et seq.), alleging that defendants (i) “knowingly present[ed], or cause[d] to be presented a false or fraudulent claim for payment” to a government entity, (ii) knowingly [made], use[d], or cause[d] to be made or used, a false record or statement material to a false or fraudulent claims,” and (iii) conspire[d] to commit a[n] [NYFCA] violation” (NYSFL §§ 189[1][a]-[c]).

Defendants jointly moved to dismiss, arguing that the Complaint (1) failed to allege the elements of a NYFCA claim with the requisite particularity, (2) should be dismissed pursuant to the public disclosure bar, and (3) with respect to the conduit bonds, should be dismissed because the State had no payment obligations. 

With respect to the public disclosure bar, the NYFCA permits the State of New York to oppose a dismissal on public disclosure grounds (NYSFL § 190[9][b]). The Attorney General of the State of New York notified the Court that pursuant to NYSFL § 190 (9)(b), and as required in part by 13 NYCRR § 440.5(b), the State of New York would be exercising its right to object to dismissal of the Complaint on the basis of the public disclosure bar. As a consequence, the Court declined to rule on this aspect of the motion with defendants reserving their rights with respect thereto.

M & T also separately moved to dismiss, arguing that it did not submit a “false claim” because virtually all of its VRDOs are conduit bonds in which the costs were paid by private-equity borrowers, and, therefore, no government funds were at risk in these transactions.

The Court’s Decision

As an initial matter, the Court considered whether Relator satisfied the particularity pleading requirement for a claim under the NYFCA and concluded that Relator met this standard.

A claim under the NYFCA (i.e., New York State Finance Law §§ 189 (a)-(c)) sounds in fraud and therefore is subject to a heightened pleading standard under CPLR § 3016(b). State of New York ex rel. Seiden v. Utica First Ins. Co., 96 A.D.3d 67, 72 (1st Dept. 2012). However, in contrast to traditional fraud claims, to satisfy CPLR § 3016(b), a qui tam plaintiff:

shall not be required to identify specific claims that result from an alleged source of misconduct, or any specific records or statements used, if the facts alleged in the complaint, if ultimately proven true, would provide a reasonable indication that one of more violations of [§ 189] are likely to have occurred, and if the allegations in the pleading provide adequate notice of the specific nature of the alleged misconduct to permit the state or local government effectively to investigate and defendants fairly to defend the allegations made.

NYSFL § 192(1-a).

In other words, a heightened pleading standard applies to a relator’s claims, but as modified by NYSFL § 192(1)(a). As the court in Total Asset Recovery Servs., LLC v. Metlife, Inc. explained, “§ 192 (1-a) does not relieve a qui tam plaintiff of an obligation to plead facts with particularity it only relieves the plaintiff of an obligation to ‘identify specific claims that result from an alleged course of misconduct.’” 2019 WL 1470203, *9 (Sup. Ct., N.Y. County Apr. 3, 2019) (citation omitted). 

Turning to the failure to state a claim argument, the Court denied the motions.

To state a claim under NYSFL §§ 189 (1)(a)-(c), the relator must allege that each defendant (1) made a statement or claim to the State, (2) which was fraudulent, (3) with knowledge of its falsity, (4) that was material to the State’s payment decision, and (5) that each defendant knew was material. New York ex rel. Khurana v. Spherion Corp., 246 F. Supp. 3d 995, 998 (S.D.N.Y. 2017). 

As discussed above, Relator’s claims were primarily based on its allegations that defendants (i) agreed to set the lowest possible interest rate for the VRDOs, and (ii) misrepresented that they would be doing so individually for each VRDO. The Court held that “the Complaint sufficiently allege[d] that the defendants bucketed VRDOs that had different characteristics and applied the algorithm without taking into account the differences between the VRDOs in the buckets. And, as a a result, the defendants violated their obligations by (i) misrepresenting that they were setting the lowest possible interest rate in remarketing agreements and other documents and by (ii) misrepresenting the performance of their remarketing and letter of credit services.” Slip Op. at *8.

The Court rejected defendants’ contention that Relator did not sufficiently allege the falsity of their representations to individually price each VRDO at the lowest possible rate. The Court concluded that “Relator’s forensic analysis of VRDO rates and market data [was] sufficient at this point to withstand a motion to dismiss.” Id. 

As noted above, Relator compared VRDO rates to interest rates for 7-day AA non-financial commercial paper, a security that it contends is closely analogous to VRDOs. Whereas historically VRDO rates have been significantly lower than commercial paper rates because VRDOs are tax-exempt and commercial paper is not (and, thus, investors expected a lower yield in return for the stability and tax exempt status of VRDOs), Relator’s analysis found that, during the time period examined, average VRDO rates climbed statistically higher than commercial paper rates. Inasmuch as the defendants argue that Relator “cherry-picked” the time period for its analysis and that all rates were informed by the 2008 financial crisis, this is an analysis that is better suited for a motion for summary judgment, following discovery, not a motion to dismiss.


“Assuming these allegations to be true,” said the court, “this is sufficient to allege a claim under the NYFCA as, if proven, such allegations would show that the defendants failed to set the lowest possible rates for at least some of these VRDOs.” Id.

With regard to the conspiracy claim, the Court held that Relator adequately plead one. 

To state a conspiracy claim under the NYFCA, a relator must allege that (1) the defendants conspired with each other to get a false or fraudulent claim allowed or paid by the government, and (2) that one or more of the conspirators performed any act to effect the object of the conspiracy. United States ex rel. Grubea v. Rosicki, Rosicki & Assocs., P.C., 318 F. Supp. 3d 680, 705 (S.D.N.Y. 2018). The Court found that Relator satisfied these elements:

Here, Relator adequately alleges conspiracy on the part of the defendants by pleading that (i) interest rates for hundreds of different VRDOs managed by multiple different defendants all moved in lockstep, (ii) the defendants had a joint response to certain key events such as a sudden VRDO interest rate move following a December 15, 2015 Federal Reserve rate hike, (iii) overlap by defendants in coordinating same (e.g., where one defendant serves as RMA for a VRDO where another defendant is the LOC provider or a significant investor), and (iv) that the defendants used third-party pricing services such as the J.J. Kenny Index to coordinate their rate-setting activity. 

Id. at *8-*9.

“In addition,” explained the Court, “the Complaint alleges that a ‘senior’ Bank of America employee confirmed that the defendants had met and coordinated their response to an April 2012 Bank of America credit downgrade by agreeing to keep buying Bank of America backed bonds so as to protect Bank of America from an investor run on those bonds which would result in Bank of America having to draw down the letter of credit it committed to supposed the bond.” Id. at *9. The Court concluded that “taken as a whole and assumed as true for purposes of this motion to dismiss,” these allegations were “sufficient to allege that the defendants conspired to artificially create a market for municipal bonds with a higher rate than would otherwise exist.” Id. 

Finally, the Court held that Relator stated a claim against M & T. 

M & T claimed that substantially all its VRDOs were conduit bonds. Conduit bonds are a “subset of municipal bonds used to finance projects by private entities.” E.g., Department of Revenue of KY v. Davis, 553 U.S. 328, 333, n.2 (2008). While the government is the issuer of the bonds, the actual borrower is a private entity. Thus, it is the conduit borrower that is liable for making debt service payments on the bonds, not the government issuer. The same holds for related fees and interest, which are also generally paid by the private entity borrower.

M & T argued that it did not submit a “false claim” because “virtually” all of its VRDOs were conduit bonds in which costs were paid by private-entity borrowers, and not the government. The Court held that “[t]his argument misses the point.”

In the case of conduit VRDOs, New York issues bonds to conduit borrowers (i.e., non governmental entities who advance certain key state interests) to develop various critical infrastructure using tax-exempt financing. Conduit borrowers typically agree to repay the government issuer who pays the interest and principal on the bonds. Importantly, conduit VRDO borrowers obtain funds from New York, and thus, necessarily, some portion of New York’s funds is included in the payments conduit VRDO borrowers made to M & T.

Conduit borrowers made payments in response to demands for payment that M & T submitted, which, according to the Complaint, were tainted by false claims and statements. Moreover, under the NYFCA, M & T may be liable for making false claims or statements to an “agent of the state,” which M & T may have done when it submitted invoices for RMA and LOC services to the bond trustees and/or paying agents (see NYSFL §188[1][ii]).


The Court explained that “Relator allege[d] that New York provided the funds to the conduit VRDO borrower and therefore at least some portion of New York’s funds was necessarily included in the payments that the conduit VRDO borrowers made to M & T in response to the allegedly false claims for payment that M & T submitted.” Id. at *10. The Court reasoned that the “purpose of the False Claims Act supports such a ‘broad interpretation.’” Id. (citation omitted). “The fact that, here, New York’s money passed to M & T through private VRDO borrower entities,” said the Court, “does not make the government any less its source.” Id. (internal quotation marks and citation omitted).

The Court also denied M & T’s motion to dismiss the conspiracy claim on the same grounds as it did with respect to the other defendants. Additionally, the Court addressed M & T’s argument that there could be no conspiracy because M & T did not actually receive the funds, holding that receipt of the money was “simply irrelevant to the analysis if M & T ha[d] conspired with the other defendants to commit a violation of either NYSFL §§ 189 (1)(a) or (1)(b).” Id. The Court explained that “[p]ayment by New York to M & T [was] not necessary if M & T colluded with the other defendants to defraud New York by automatically resetting the VRDO rates without regard to their individual characteristics at rates higher than the lowest possible rate and by acting in concert to prop up Bank of America VRDOs, as the Complaint alleges.” Id. (citing Allison Engine Co., Inc. v. United States ex rel. Sanders, 563 U.S. 662 (2008)). 


Edelweiss shows that “what” and “how” a plaintiff pleads his/her cause of action makes the difference as to whether the court will sustain the complaint. The Edelweiss Fund has filed multiple lawsuits around the country under state false claims acts analogous to the NYFCA, each containing nearly identical allegations to the complaint before Justice Andrew Borrok of the Supreme Court, New York County Commercial Division. As Justice Borrok noted, these courts reached differing conclusions as to the sustainability of its claims. 

Edelweiss is notable because of the difference in application of the particularity pleading requirement. As readers of this Blog know, in a fraud action, CPLR § 3016(b) requires the plaintiff to allege sufficient facts to support a “reasonable inference” that the allegations of fraud are true. Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y.3d 553, 559-60 (2009). In the context of a claim under the NYFCA, the standard is modified by relieving the plaintiff of the obligation to “identify specific claims that result from an alleged course of misconduct.” Total Asset Recovery Servs., 2019 WL 1470203, at *9; NYSFL § 192(1)(a). 

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