Louisiana state officials claim Merrill Lynch steered them into shoddy securities deal [New Orleans CityBusiness (LA)]

State officials and attorneys for the Louisiana Stadium and Exposition District, which oversees the Mercedes-Benz Superdome and the New Orleans Arena, claim Merrill Lynch duped them and other municipalities into a securities market that was artificially propped up by the investment bank.

And now, attorneys are anxious for the case to make its way through federal court in New York, as they express confidence that they can be the first to win litigation similar to other cases judges already have dismissed.

"We feel very good about the case we have," said Jim Swanson, an attorney with New Orleans-based Fishman, Haygood, Phelps, Walmsley, Willis and Swanson.

In 2005 and 2006, the LSED, which is funded by a hotel/motel occupancy tax in New Orleans, was receiving millions from the state to improve the Superdome, but there was a gap of some tens of millions of dollars still needed to complete the project.

At the same time, there was very little revenue coming from the hotel/motel tax as tourists avoided the city after Hurricane Katrina.

The LSED then turned to the bond market for capital. In March 2006, the district issued about $240 million in auction rate security bonds with Merrill Lynch as its underwriter.

The district used ARS bonds, as opposed to a fixed-rate or traditional financial product, because they historically have carried lower interest rates.

ARS bond auctions typically were held in weekly or monthly increments. The more bids the securities received, the lower the interest rate would be.

Unbeknownst to bond issuers, Merrill Lynch was bidding heavily at every auction. In early 2006, the U.S. Securities and Exchange Commission found that Merrill Lynch had failed to disclose its role in ARS auctions to several clients.

Merrill Lynch issued a statement on its website disclosing its role in August 2006 as part of its settlement with the SEC.

Still, the LSED continued with the ARS auctions. Everything appeared to be going fine, with enough bidders on the securities to keep interest rates low, until the global financial crisis struck in August 2007.

"Bond insurers lost their credit rating, the credit markets were in a state of some turmoil," Swanson said. "But really the thing that caused all the problems is Merrill Lynch and the other broker dealers stopped bidding in the auction. If we had known that there weren't enough bidders in the auction, if we had known that, we would have used something different."

When Merrill Lynch stopped supporting the market, the auctions failed, and the LSED's interest rates shot up to 12 to 14 percent.

Swanson said the LSED lost about $10 million in the first year following the financial crisis. After that, he said it has been difficult to calculate the total damage, but he considers it substantial.

"Really, it was never OK," Swanson said. "Merrill Lynch was supporting the auctions."

In court documents, Merrill Lynch's attorneys said it bid on the auctions for the very reason that they not fail because it, too, had a vested interest in the securities.

"(Merrill Lynch's) willingness to purchase ARS with its own funds also demonstrated its own strong belief in the continued viability in the ARS market," court documents say.

The documents state that the bank did try to notify its investment partners about the SEC's action.

A representative for the company, William Halldin, sent the documents to CityBusinesss but could not be reached for comment.

"Plaintiffs were put on notice no later than May 31, 2006, the date the SEC published its settlement agreement with (Merrill Lynch) and other broker-dealers regarding auction rate securities practices," the documents read. "In addition, the 2006 SEC order directed Merrill Lynch to place a description of its auction rate practices procedures on its website, which was done in August 2006. Thus, since August 2006, Merrill Lynch's website plainly disclosed its practice of routinely bidding at actions to prevent auction failures."

Auction rate securities are at the center of the case, but other financial products, such as bond insurance and derivative swaps, are also involved in the litigation.

Several similar cases with Merrill Lynch and other investment banks have been dismissed, but Swanson said he's confident this one will survive.

Aside from the LSED, the New Orleans firm is representing about seven clients throughout the country, including hospital systems in West Virginia and a handful of cities Swanson said could not yet be named.

The state of Louisiana is named as a plaintiff in the lawsuit, as it has since taken over the bonds from LSED to alleviate the interest rates.

Swanson's firm also represents Louisiana Citizens Property Insurance Corp. in a similar case against JP Morgan Chase but said he did not have approval from clients to discuss the case.

The LSED case has been centralized as part of a multi-district litigation in New York's federal court district.

"We really sort of have been waiting for resolution of appeals, so now we're back to getting the case in discovery," Swanson said, referring to a legal term for when the opposing sides of the litigation disclose information.

"Ultimately, the case will be sent back to Louisiana and tried in Louisiana," Swanson said.