The city of Philadelphia filed a lawsuit Wednesday accusing Bank of America Corp, Barclays Plc, Citigroup Inc, Goldman Sachs Group Inc, JPMorgan Chase & Co, Royal Bank of Canada and Wells Fargo & Co of defrauding the city and public entities out of millions of dollars. The antitrust action claims the banks conspired to inflate the interest rates of tax exempt bonds known as Variable Rate Demand Obligations (VRDOs).
VDROs are issued by public entities as fundraisers for infrastructure and public services like water, public education and transportation. With VDROs, investors receive long term borrowing for short term rates. The banks then “remarket” the bonds to investors and charge the municipality for that service. The city accuses the banks of conspiring to not compete with each other by keeping rates artificially high and not remarketing the bonds. Philadelphia has issued $1.6 billion of VRDOs, therefore the banks may have profited significantly from the accused scheme.
The Antitrust Division of the US Department of Justice has an ongoing a preliminary criminal investigation into defendants’ remarketing practices in connection with VRDOs.
Variable Rate Demand Obligations (VRDO) or “floaters;”
VRDOs (also known as VRDNs) are debt instruments that generally allow issuers to receive financing at short-term rates when borrowing long-term. Making up approximately three-quarters of the total U.S. municipal money market, VRDOs can be a vital tool for municipal bond issuers seeking to diversify their debt structure and take advantage of the natural demand from tax-exempt money market funds. Their appeal to investors lies in their maturity-shortening features and variable interest rates that can offer potential stability of principal.
VRDOs are typically supported by either an irrevocable direct-pay letter of credit (LOC) issued by a financial institution or a conditional standby purchase agreement (SPA) from a financial institution (a “Standby Purchaser”). The mechanics of the LOC and SPA differ, but each is intended to provide a mechanism for holders to be able to sell their bonds after a requisite notice period. In some instances, issuers of high credit quality with substantial liquid resources provide liquidity themselves.