Variable Rate Demand Obligations


A FINRA arbitration panel denied all claims in their entirety.

An investment bank, the respondent in a FINRA arbitration, retained Cornerstone Research. The investment bank had served as an investment advisor, underwriter, and re-marketing agent for a healthcare debt issuer of tax-exempt variable rate demand obligations (VRDOs).

The claimant argued that in late 2007 the investment bank had recommended financing through a synthetic fixed-rate debt instrument by issuing $300 million in variable rate debt. The debt was paired with interest rate swaps, and backed by monoline bond insurance. In mid-2008, the insurers were downgraded, leading to high refinancing costs for the claimant.

In arbitration, the claimant alleged that the investment bank had not disclosed material information concerning the instability and potential downgrades of monoline bond insurers. In responding to these allegations, our expert opined that as of late 2007, both the claimant and respondent had access to the same publicly available information on monoline insurers, the municipal bond market, and interest rate swaps.

Our expert demonstrated that the insurers’ rating downgrades and the mark-to-market losses on the swaps were consequences of the unanticipated financial crisis and not due to information withholding by the respondent.

In addition, our expert examined whether the VRDO bond structure was appropriate in light of the issuer’s objectives and the information available at the time of the financing. He analyzed the structure and performance of this VRDO versus alternative debt structures. His analysis showed that alternate financing structures would not have led to a significantly better performance, and that the opposing expert’s opinion relied heavily on the benefit of hindsight.

Finally, our expert was able to show that damages calculations by the opposing expert were inaccurate and unreliable.

The arbitration panel denied all claims in their entirety.

For additional information on this case, contact Greg Leonard.