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School districts reach $22.5 million settlement in failed-investments case

Stifel also waives $154 million debt, joins in claims pursuit on Royal Bank of Canada

March 19, 2012

Five Wisconsin school districts that invested in $200 million worth of risky financial instruments that subsequently tanked in the economic collapse reached a settlement with a financial firm they sued for leading them astray, the district's lawyers announced Monday.

Under the terms of the settlement, St. Louis-based Stifel Nicolaus & Co. Inc. on Monday paid $13 million to the districts - Waukesha, West Allis-West Milwaukee, Whitefish Bay, Kenosha and Kimberly - and provided a letter of credit for an additional $9.5 million to be paid when Stifel resolves a related case with the U.S. Securities and Exchange Commission, according to details released by Milwaukee-based Kravit, Hovel & Krawczyk law firm.

The financial provisions for the districts under the latest settlement, coupled with money that came to them through an administrative settlement last fall between the SEC and a different financial institution involved in the transactions, means that almost $218 million has been recovered or will be restored to the districts, attorney Stephen Kravit said.

"At $217.9 million, this is the second-largest reported settlement of civil litigation in Wisconsin history, behind the State of Wisconsin's $1.3 billion share of the national tobacco settlement in 1998," Kravit said.

The complicated case had national implications because some believed the Wisconsin districts were the test markets for using such financial instruments to fund future post-retirement benefits for employees, a matter of concern for districts across the country.

The Wisconsin districts borrowed much of the money for the investments - either on their own or through trusts - with the expectation that what had been billed as safe investments would generate enough money to pay interest and benefits costs.

Stifel sent out a news release Monday saying that it will now work with the school districts and the districts' trusts to pursue respective claims against the Royal Bank of Canada, which manufactured the investments. Stifel and the districts aim to recover more than $200 million from the company.

"We are pleased to be able to settle this case and join together with the districts in the case against RBC," Stifel Chairman and CEO Ronald J. Kruszewski said in a statement. "Both Stifel and the school districts were victims of a product that we believe was deceptively created by RBC."

The school districts sued both financial institutions in 2008 after bankers with Stifel helped sell them complex financial instruments known as collateralized debt obligations in 2006. The Royal Bank of Canada marketed and sold to trusts created by the districts the $200 million worth of CDOs, for which the districts contributed $37.3 million of their own funds and borrowed the rest.

But the CDOs became worthless after global markets collapsed in 2008.

In most cases involving average citizens who make poor investments, people usually just lose their money. But the districts argued that they invested taxpayer money based on what they thought was sound financial advice from professionals, and were defrauded.

The financial institutions had maintained that the districts knew the risks of the investment. But that didn't keep Stifel from filing a cross-claim against the Royal Bank of Canada last summer. In June, Stifel added new information to that claim by accusing the Royal Bank of Canada of hiding how much it was going to earn on the CDOs, which made the financial instruments look safer than they really were.

Then in September, the U.S. Securities and Exchange Commission stepped in. The federal agency charged RBC Capital Markets LLC with misconduct in the sale of unsuitable investments to the districts, and with inadequate disclosures about the risk of those investments.

That SEC action brought the districts a total of $30.4 million.

Settlement highlights

Important components of the latest settlement publicized Monday, according to law firm Kravit, Hovel & Krawczyk, include:

Stifel paying the districts $13 million cash on closing and a letter of credit for an additional $9.5 million.

Stifel fully releasing the districts from their moral obligation to repay the $154 million in notes originally issued by a European bank - Depfa Bank - to trusts the districts established as part of the investment transactions. That step could improve the districts' credit ratings. However, the districts' trusts, which are a separate entity, still owe the money borrowed. In a strategic move, Stifel bought that debt from Depfa, and is now seeking to recoup that money plus damages by teaming up with the districts to bring a stronger case against RBC.

Stifel continuing its case against RBC and guaranteeing the districts will recover at least an additional $11 million.

Stifel and the districts splitting 50/50 any damages recovered from RBC in the ongoing litigation, after the $11 million payment to the districts is satisfied.

Stifel paying all the districts' attorneys fees and expenses going forward, up to $67,000 per month.

The districts owe their lawyers no more than 9% of the overall settlement of $217.9 million, or no more than $19.6 million. Split evenly among the districts, that would mean $4 million or less each, but fees owed will likely vary based on factors such as how much money each district invested.

Kravit said districts are still poised to recover 99.6% of the original $200 million that was invested, even if more money isn't recovered through the pending litigation, and even after they make all the necessary payments to their lawyers.

Reaction from the administrators of the five districts Monday was positive.

"In these challenging times financially for school districts, we are delighted to be in a position to achieve return of our invested funds," Mary Gavigan, superintendent of Whitefish Bay Schools, said in a statement.

On Tuesday, RBC issued a statement denying Stifel's allegtions, calling the "preposterous."

"We vehemently deny their allegations," spokeswoman Elisa Barsotti said in an email.

"Stifel unilaterally designed this investment, represented to us in writing that this investment was suitable in light of the districts’ objectives, and is responsible for misrepresenting and selling the product, whose risk it compared to treasury notes, to the school districts," Barsotti said.

"We are heartened by the fact that the school districts will be the beneficiary of Stifel's settlement."

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