Chicago Interest Rate Swap Legal Analysis
Post on 07-Aug-2018
214 Views
Preview:
Transcript
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 1/29
Daniel J .
C o l l i n s
Dri nker
Biddle
ReathLLP
D a n
C o l l i n s i s an
e x p e r i e n c e d
t r i a l
a t t o r n e y , h a v i n g
t r i e d more
t h a n
20
c a s e s
t o
v e r d i c t
i n
c r i m i n a l
and c i v i l
p r o c e e d i n g s
i n
b o t h
f e d e r a l
and s t a t e c o u r t .
As a
former
f e d e r a l
p r o s e c u t o r ,
D a n
i s
w e l l
p o s i t i o n e d
t o
a d v i s e
c o r p o r a t e
and i n d i v i d u a l
c l i e n t s
i n r e s p o n d i n g t o
government
and r e g u l a t o r y
i n q u i r i e s , c o n d u c t i n g
i n t e r n a l
i n v e s t i g a t i o n s ,
and
h a n d l i n g o t h e r
complex
l i t i g a t i o n m a t t e r s .
B e f o r e
j o i n i n g
D r i n k e r
B i d d l e , D a n s e r v e d a s an A s s i s t a n t
U n i t e d S t a t e s
A t t o r n e y
f o r t h e
N o r t h e r n
D i s t r i c t
of
l l i n o i s
f o r
10 y e a r s , where he i n v e s t i g a t e d and
p r o s e c u t e d a
wide a r r a y
of
w h i t e c o l l a r
c r i m e s ,
n c l u d i n g
commodities and
s e c u r i t i e s
f r a u d ,
bank
f r a u d ,
m a i l
and w i r e
f r a u d ,
computer
a c c e s s f r a u d , h e a l t h
c a r e f r a u d ,
e x p o r t c o n t r o l s
and
s a n c t i o n s ,
p u b l i c
c o r r u p t i o n , t a x
e v a s i o n
and money
l a u n d e r i n g .
I n p a r t i c u l a r , D a n
d e v e l o p e d
s u b s t a n t i a l
e x p e r i e n c e
c o n d u c t i n g
p a r a l l e l
i n v e s t i g a t i o n s w i t h
t h e
S e c u r i t i e s and Exchange
Commission
(SEC),
t h e
Commodity
F u t u r e s
T r a d i n g
Commission
(CFTC),
nd
o t h e r
r e g u l a t o r s .
D a n
h e l d m u l t i p l e s u p e r v i s o r y
p o s i t i o n s
w h i l e
a t
t h e
U n i t e d
S t a t e s A t t o r n e y s
O f f i c e .
Most
r e c e n t l y ,
he was
Deputy
Chief
of
h e F i n a n c i a l Crimes and
S p e c i a l
P r o s e c u t i o n
s e c t i o n , where
he
oversaw
t h e
work
of e v e r a l
s e n i o r
AUSAs
n
t h e
i n v e s t i g a t i o n
of more
c o m p l i c a t e d w h i t e c o l l a r
m a t t e r s .
B e f o r e t h a t ,
D a n
s e r v e d a s
A c t i n g
Chief
and
Deputy
Chief of
t h e
G e n e r a l
Crimes
S e c t i o n ,
where he
s u p e r v i s e d and t r a i n e d AUSAs n f e d e r a l c r i m i n a l p r a c t i c e and r i a l
a d v o c a c y .
James L. Kopec ky
Kopecky
Sc hu m ac h er B l e a k l e y Rosenburg
PC
E a r l y
i n
h i s c a r e e r , Jim
r e p r e s e n t e d d e f e n d a n t s i n commercial d i s p u t e s ,
i n c l u d i n g
complex,
f e d e r a l
c o u r t m u l t i d i s t r i c t l i t i g a t i o n
m a t t e r s .
Jim
j o i n e d t h e
U n i t e d
S t a t e s S e c u r i t i e s and
Exch a n ge
Commission
( SEC )
n
1999,
i s i n g
t o
t h e
l e v e l
of
Branch Chief
n
t h e D i v i s i o n
of
E n f o r c e m e n t .
At
t h e
S E C ,
Jim
l e a d a
team of
a t t o r n e y s and
s t a f f
t h a t
i n v e s t i g a t e d
and
p r o s e c u t e d
s e c u r i t i e s
f r a u d ,
i n c l u d i n g
i n s i d e r
t r a d i n g ,
a c c o u n t i n g
f r a u d ,
c o m p l i c a t e d m a r k e t
m a n i p u l a t i o n
a c t i o n s ,
Ponzi schemes,
f f e r i n g
f r a u d s and
s a l e s p r a c t i c e a c t i o n s .
Jim
l e a d s
h i s f i r m s
r e g u l a t o r y
s e r v i c e s p r a c t i c e , a n d
f r e q u e n t l y
l i t i g a t e s m a t t e r s
on
b e h a l f
of
i n d i v i d u a l s , p u b l i c companies, r o k e r - d e a l e r s , and
hedge
fund managers
i n
b o t h s t a t e and f e d e r a l
c o u r t s
a c r o s s
t h e
c o u n t r y ,
a s w e l l
a s a r b i t r a t i o n s
b e f o r e
t h e
F i n a n c i a l I n d u s t r y
R e g u l a t o r y
A u t h o r i t y
( FINRA ), t h e N a t i o n a l
F u t u r e s
A s s o c i a t i o n ,
and
t h e American
A r b i t r a t i o n
A s s o c i a t i o n .
Jim
a c t s a s an
i n d e p e n d e n t
i n v e s t i g a t o r f o r i n v e s t i g a t i o n s u n d e r
S a r b a n e s
Oxley
and a s an
i n d e p e n d e n t e x p e r t c o n s u l t a n t t o companies d i s c i p l i n e d
by
S e l f R e g u l a t o r y
O r g a n i z a t i o n s . I n
a d d i t i o n , f e d e r a l
d i s t r i c t
c o u r t j u d g e s ,
upon
recommendation
from
t h e
s t a f f
of
t h e
U n i t e d
S t a t e s S e c u r i t i e s and Excha nge Commission, have
a p p o i n t e d Jim
t o
a c t
a s R e c e i v e r
on
b e h a l f
of
v i c t i m s
of
s e c u r i t i e s f r a u d . Jim
a l s o
a c t s a s
a
H e a r i n g O f f i c e r f o r
t h e
I l l i n o i s
S e c u r i t i e s
Department,
p r e s i d i n g o v e r
and
maki ng recommendations r e g a r d i n g a c t i o n s
a g a i n s t
b r o k e r
- d e a l e r s ,
i n v e s t m e n t
a d v i s e r s
and i n d i v i d u a l s .
77779967.2
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 2/29
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 3/29
ANA
LYSIS
OFPOT
ENTIAL
LEGAL
CHA
LLENG
ES
TO
THE
CITY
OF
CHICAG
O S INT
ERESTRA
TESW
AP
TRAN
SACTIO
NS
I
.
EXECUT
IVESU
MMARY
W
e ere
a s k e d t o
i n d e p e n d
e n t l y r e v
i e w
t h e C i
t y
of
h i c a g
o s i n
t e r e s t
r a t e swap
a
g r e e m e n t
s t o
d e t
e r m i n e
w h e t h
e r
t h
e r e
i s
a
ny
e v i d e n
c e
t h
a t
t h
e a g r e e
m e n t s
were
p r o c
u r e d by
f r
a u d and
t o
d
e t e r m i n e
w h e t
h e r
t h e r e
a r e
a
ny
g r o u n d s
f o r
t h e
C i t y t o
c h a l l e n g e
t h o s e
a g
r e e m e n t s
b a s e d
on
f r a
u d , m
i s r e p r e s e n
t a t i o n s ,
o m i s
s i o n s ,
o r u n f a i r
d e a
l i n g t
h r o u g h
a r b i t r
a t i o n
o r
i n c
o u r t .
To
c o m p l e
t e
o u r
r e
v i e w ,
we n a l y z e d
t h e
t r a n
s a c t i o n doc
uments
o r
t h e s e sw
ap
a g
r e e m e n t s ,
co
mmunicat
ions betwe
en t h e C i
t y and
t s sw
ap c o u n t
e r p a r t i e s
,
a
nd o t h e r document
s
e l a t i
n g
t o
t h e
C i t y s
sw a
p t r a n s a c t
i o n s .
I
n
t o t a l w
e e v i e w e d
a p p r o x i m a
t e l y
50 boxes
of
a r d
copy
documen
ts
an
d
a n a l
y z e d
t h o u s a n
d s
of
a g e s
of l e c t r o n i c
docume
nts.
We
l s o i n t
e r v i e w e d
n i n e
c u
r r e n t an d form
er C i t y
empl
oyees i n c l u d
i n g c u
r r e n t
and
former
Chief
i n a n c
i a l
O f f i c e r s ,
C
o m p t r o l l e
r s , an d
D
eputy
C o m p t
r o l l e r s )
who
were r e s p
o n s i b l e f o r
n e g
o t i a t i n g ,
e x e c u t i n
g , an
d
ma
nag ing
t h e s
wap
a g r e e m e
n t s .
Our
n v e s t i g a t i
o n
f
ound no
e v i
d e n c e
t h a
t
would
s u p p o r
t a c l a i
m
t h a t
t h
e C i t y
s swa
p
a g r
e e m e n t s
were
p r
o c u r e d b
y r a
u d
o r
t h a t any of h e
C i t y s
swap c o u n t e r
p a r t i e s
m a
d e any
m a t e
r i a l
m i s r e p r e s
e n t a t i o n s
o r
o m i s s i o n
s
of
a
c t .
N
or
d i d
we i n d
e v i d
e n c e
t o
s u p p o r
t a c l a i
m
t h a t t h e C i t
y s sw
ap
c o u n t e r p
a r t i e s
f a i l
e d
t o
d e a l
f a i r l y
w i t h
t h e
C i t y
w h e n n e g
o t i a t i n g
and
e x e c u t i
n g
t h e
swap a g r e e m e n
t s .
n
s
s e n t i a l
el
ement of any c a
u s e of c
t i o n f o r f r
a u d
i s
a
m a t e
r i a l m
i s r e p r e s e
n t a t i o n o r
an
o m i s s i
o n
of
a t e r i a
l
f a
c t .
We
ou
nd
no
e v i d e n c
e
t h a t
any
o
f
h e
C i t y s
swap c o u n t e r
p a r t i e s
m i s r
e p r e s e n t
e d
o r
o
m i t t e d
m a t e r i a l
f a c t
s r e
l a t i n g t o t h e t r
a n s a c t i o n s
.
Nor
were
an
y
of
h e
i n
d i v i d u a l s
we
n t
e r v i e w e d
aware
of
an
y m a t e r i a
l m i s r e p
r e s e n t a t i
o n
o r o
m i s s i o n .
A l l
o
f h e
i n d i v i d
u a l s
we
n t
e r v i e w e d , i n c l u d i n g t h o s e
r e s p o n s i b l e f o r n e g o t i a t i n g
and
e x e c u t i n g t h e
swap
t r a n s a c t i
o n s , w er
e
w
e l l
i n f
o r m e d an
d aware
o
f
h e
v a r i
o u s
r i s k s a s s o c
i a t e d
w
i t h
swa
ps.
None
o
f
them b e l i e v e d
t h a t
a
ny
s
wap
c o
u n t e r p a r t
y e
ngaged i n
f r a u d u l
e n t
c o n
d u c t ,
and s e v e r a l s
t a t e d
t h e i r
b e l i e f t h a t t h e C i
t y
b e n e f i t t e
d
fro
m
t
h e sw a
ps.
F u r t h
e r ,
we
fou
nd
n
o documen
ts a
u t h o r e d
o
r
p r e s e n t
e d
by
c o u n t e r p a r
t i e s
o r
u n d e r w
r i t e r s ,
o r
o
t h e r co
mmunicat
ions h a t a t t
e m p t e d t o m i s s
t a t e
t h e
r i s k s
a
s s o c i a t e d w i t h
swaps.
Ou
r n v e s
t i g a t i o n
d i
s c l o s ed a
nu m
ber of
a c t s
t h a t
w
ould m ak
e t
c h a l
l e n g i n g ,
f
n o t
i m p o s s i
b l e , t o
c
l a i m
t h a
t
t h e
C i t y s c o u
n t e r p a r t i
e s d i d n o
t
d e
a l f a
i r l y
w i t
h t h e
C i t y
o r t h a t
t h e
C i t y d i d
n o
t u n
d e r s t a n d
t h e
r i s k s
a s s o c i a t e
d
w i t h
swap
r a n s a
c t i o n s .
The C i t y
employe
d a
t a l e n t e d ,
e x
p e r i e n c e
d ,
a
nd
k n o w l e d g
e a b l e
d
e b t mana
ge ment
team a s w e
l l a s o
u t s i d e a d
v i s o r s a
nd
o u t s i d e
c o u n s e l
t o
a d v i s e
on
t h e s e
t r a n s a c t i o n s .
Th e
C i t y
and
t s
c o u n s e l
and
p r o f e s s i o n a l
a d
v i s o r s n e g o t
i a t e d and
docu
mented
e
ac h
of
h e
swap r a n s a
c t i o n s .
More
over n t h e
sw ap
t r a n s a c t i
o n d o c u m e n t
a t i o n i t s
e l f
t
h e
C i t y
makes a num
be r of e
p r e s e n t a t
i o n s
r e g a r d i
n g i t s
kn o
wledge
and
s o p h i s t i c
a t i o n and ac k
nowledge
s t h e l i m i t e
d ,
n
on
- f i d u c i a r y
r o
l e p l a y e d
by
h e
sw ap c
o u n t e r p a r
t y . F i
n a l l y , and
p e r h a
p s mos
t e l l i n g , t h
e C i t y n o t
o n l y ackn
owledged
u t
a l s o
p u b l i c l
y
d i s c
l o s e d t h e
r i s k s a s s o c i
a t e d
w
i t h
swap
a g
r e e m e n t s
i n i t s
Comp
rehensi v
e
An
nual
F i n a n c i a l
R e p
o r t s
CAFR
s)
o i n g back
t
o
2
004
and
i n
i t s
I n t e r
e s t a t e Sw ap
P o l i c y ,
implem
ented
i n 2
004
and
i r s t p o s t e
d o n l i
n e
i
n
2
006.
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 4/29
The C i t y
a l s o would
have
an
e x t r e m e l y d i f f i c u l t time
e s t a b l i s h i n g t h a t
t
r e l i e d on a
r e p r e s e n t a t i o n
m a de by
any swap
o u n t e r p a r t y ,
which
s a
e q u i r e d
element
of
e c u r i t i e s
f r a u d
c l a i m .
I n
a d d i t i o n
t o t h e
d i s c l o s u r e s
i n t h e C i t y ' s CAFRs,
h e
C i t y ' s 2006
SWAP
o l i c y ,
and t h e
C i t y ' s
e x p e r i e n c e d
and knowledgeable
e b t
management
eam
—each
of
which
a l o n e
c r e a t e s
an
o b s t a c l e
t o
e s t a b l i s h r e l i a n c e —the
n t e r n a t i o n a l Swap e a l e r s
A s s o c i a t i o n , n c .
(ISDA) aster
Agreements, which
governed
l l
of
h e
C i t y ' s
swap
g r e e m e n t s ;
o n t a i n e d
a
non
- r e l i a n c e
c l a u s e ,
i n which
h e
C i t y
s t a t ed t h a t
t
had
m ade
t s
own e c i s i o n
t o
e n t e r i n t o
each
r a n s a c t i o n
u s i n g
i t s
own udgment and r e l y i n g
upon
h e
a d v i c e
of
t s own
d v i s o r s . The
i t y
a f f i r m a t i v e l y
acknowledged t h a t t
was
not
e l y i n g on any
r e p r e s e n t a t i o n
by a
swap
o u n t e r p a r t y
and h a t
t h e
c o u n t e r p a r t y
was
o t
a c t i n g
a s t h e
C i t y ' s
f i d u c i a r y o r a s
t h e
C i t y ' s
a d v i s o r w i t h r e s p e c t t o t h e
t r a n s a c t i o n .
As
a r t
of
ur n v e s t i g a t i o n ,
we l s o
reviewed h e
v a r i o u s
a s s e r t i o n s
i n two r e c e n t
l e t t e r s
from
t h r e e
u n i o n s
u r g i n g t h e C i t y t o f i l e
a r b i t r a t i o n
b e f o r e t h e
F i n a n c i a l
I n d u s t r y
R e g u l a t o r y
A u t h o r i t y
(FINR.A) t o seek a e f u n d
of ums
t h a t
t h e C i t y ]
expended
on
r a u d u l e n t i n t e r e s t
r a t e
swaps, s
w e l l
a s
a
e g a l m e m o r a n d u m from
a
New ork law
i r m
t h a t ,
w h i l e
acknowledging
t h a t
i t
cannot
d v i s e
on any p e c i f i c
f i n a n c i n g w i t h o u t c l o s e l y
r e v i e w i n g t h e
f i n a n c i n g and
l l
r e l a t e d
t r a n s a c t i o n s ,
a s w e l l a s
r e p r e s e n t a t i o n s m a de by
n d e r w r i t i n g banks and o t h e r s
t o
i s s u e r
p e r s o n n e l , n e v e r t h e l e s s
s p e c u l a t e s a s t o what
such
a
review might
show
and
t h e
remedies
an
i s s u e r
m a y
have
f
an n d e r w r i t e r d i d
v i o l a t e t h e f a i r
d e a l i n g r u l e s . N o t
n l y
d i d we
i n d no
e v i d e n c e
t h a t
t h e
C i t y
was m i s l e d , d e f r a u d e d ,
o r
d e a l t
w i t h
u n f a i r l y , b u t
t h e
r e l e v a n t
documents
we
eviewed and
t h e
t e s t i m o n y
of
h e
w i t n e s s e s we
n t e r v i e w e d
a f f i r m a t i v e l y
r e f u t e
any
such
c l a i m
and
e s t a b l i s h
t h a t t h e C i t y
was
u l l y
aware
of h e
r i s k s
of
uch r a n s a c t i o n s . Our
review
showed t h a t t h e C i t y
used
swaps s
a
t r a t e g y
t o r e d u c e
t h e c o s t s
of
t s
d e b t
and
hedge h e
i n t e r e s t
r a t e
and
o t h e r
r i s k s
a s s o c i a t e d
w i t h t h a t
d e b t .
A c c o r d i n g l y , even
f
FINRA
r b i t r a t i o n
were e g a l l y a v a i l a b l e
(which, s
we
x p l a i n below,
t
i s n o t ) ,
i l i n g a
l a i m
a l l e g i n g f r a u d
o r
u n f a i r d e a l i n g would be m e r i t l e s s , and
o u l d s e r v e t o
damage
h e
C i t y ' s
c r e d i b i l i t y i n
i t s
c u r r e n t
and u t u r e
d e a l i n g s w i t h
f i n a n c i a l
i n s t i t u t i o n s and
t s
a b i l i t y t o
f i n a n c e t h e
C i t y ' s
needs
going
f o r w a x d .
I I .
BACKGROUND
A.
I n t e r e s t
Rate Swaps
The
Municipal
S e c u r i t i e s
Rulemaking
Board
MSRB)
e f i n e s
an I n t e r e s t
Rate
Swap
C o n t r a c t
o r Agreement s :
A p e c i f i c
d e r i v a t i v e
c o n t r a c t
e n t e r e d
i n t o
by
an i s s u e r
o r
o b l i g o r w i t h a
swap
p r o v i d e r t o exchange
p e r i o d i c
i n t e r e s t
payments.
T y p i c a l l y , one
p a r t y
a g r e e s
t o
m a k e
payments
t o t h e o t h e r
b a s e d
upon
a
f i x e d
r a t e
of
i n t e r e s t
i n
exchange f o r
payments
b a s e d
upon
a v a r i a b l e
r a t e .
The swap
c o n t r a c t
m a y
p r o v i d e
t h a t
t h e
i s s u e r
w i l l pay t o t h e
swap
c o u n t e r
- p a r t y
a
f i x e d r a t e
of
n t e r e s t
i n exchange
f o r t h e
c o u n t e r - p a r t y
m a k i n g v a r i a b l e
payments q u a l t o
t h e amount
a y a b l e
on
h e
v a r i a b l e
r a t e
d e b t .
MSRB, l o s s a r y
of
Terms, v a i l a b l e
a t
h t t p : / / w w w . m s r b . o r g /
l ~ o s s a r
~ ~ a s p x ( l a s t v i s i t e d
October
28, 014). The
MSRB l s o
d e f i n e s
a
F l o a t i n g
- t o - F i x e d Rate
Swap
s :
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 5/29
An
greement whereby
an
i s s u e r s y n t h e t i c a l l y
c o n v e r t s v a r i a b l e r a t e
d e b t
t o
f i x e d
r a t e d e b t
t h r o u g h a n i n t e r e s t r a t e swap o r
s i m i l a r
a g r e e m e n t .
I n
t h i s
p r o c e s s , t h e i s s u e r makes
payments
t o
t h e c o u n t e r p a r t y
a t
a f i x e d
r a t e
a c c o r d i n g
t o
t h e
t e r m s
of h e swap and t h e
c o u n t e r p a r t y
makes
payments
on a
v a r i a b l e
r a t e
o r
r a t e s
a c c o r d i n g
t o
t h e
t e r m s of
h e swap, which
m a y
be
e q u i v a l e n t
t o t h e
r a t e s
p a y a b l e t o b o n d h o l d e r s
u n d e r
t h e
bond
c o n t r a c t .
I d .
I n
a
l o a t i n g
- t o
- f i x e d r a t e swap,
payments m a d e
by
one
c o u n t e r p a r t y
t y p i c a l l y
a r e b a s e d
on
a
f l o a t i n g r a t e
of
n t e r e s t ,
such
a s t h e
L ondo n
I n t e r b a n k
O f f e r e d
R a t e
(LIBOR)
r
t h e
S e c u r i t i e s
I n d u s t r y
and F i n a n c i a l
Markets
A s s o c i a t i o n
(SIFMA)
u n i c i p a l
Swap
I n d e x ,
w h i l e payments
m a d e
b y
h e o t h e r
c o u n t e r p a r t y a r e
b a s e d on
a i x e d
r a t e
of n t e r e s t .
H i s t o r i c a l l y ,
m u n i c i p a l i t i e s
have
u s e d i n t e r e s t
r a t e
swaps
n
c o n n e c t i o n w i t h t h e i s s u a n c e
of
o n d s .
A
wap agreement y p i c a l l y i n v o l v e s
t w o
c o u n t e r p a r t i e s : t h e
m u n i c i p a l i t y
and
a
b a n k .
W h e n
a
m u n i c i p a l i t y i s s u e s a
v a r i a b l e ,
o r f l o a t i n g ,
r a t e
bond,
t
m a y
n t e r
i n t o
a
o n t r a c t
w i t h
a
bank
c o u n t e r p a r t y t o
swap
h e
f l o a t i n g v a r i a b l e )
r a t e of
n t e r e s t
f o r
a
i x e d
r a t e
of
n t e r e s t i n
o r d e r t o , a m o n g
o t h e r
b e n e f i t s ,
r e d u c e i n t e r e s t
r a t e
r i s k . The swap
changes
h e
r i s k p r o f i l e
of
h e
d e b t by
e s s e n t i a l l y
c o n v e r t i n g t h e
f l o a t i n g r a t e d e b t i s s u e i n t o
a i x e d r a t e d e b t ,
r e f e r r e d
t o a s a
s y n t h e t i c f i x e d r a t e .
The m u n i c i p a l i t y p a y s t h e f i x e d r a t e
on
t h e swaps, l u s
t h e d i f f e r e n c e
between t h e
f l o a t i n g
r a t e
on h e
bonds and h e
f l o a t i n g
r a t e
on
h e
swaps, l u s
s u p p o r t
c o s t s .
I f n t e r e s t r a t e s
r i s e a f t e r t h e swap s
e x e c u t e d
such
t h a t t h e
m a r k
- t o- m a r k e t
v a l u e
of h e
swap
r i s e s
f o r
t h e
m u n i c i p a l i t y , t h e m u n i c i p a l i t y m a y
x e r c i s e t h e
o p t i o n
t o
t e r m i n a t e
t h e
agreement
a n d
r e c e i v e a
t e r m i n a t i o n
payment.
C o n v e r s e l y , i f
i n t e r e s t r a t e s
f a l l a f t e r
e x e c u t i o n of
h e swap
agreement an d
t h e c o u n t e r p a r t y e x e r c i s e s
i t s o p t i o n
t o t e r m i n a t e t h e
a g r e e m e n t ,
h e
m u n i c i p a l i t y w i l l
pay a
t e r m i n a t i o n payment.
T e r m i n a t i o n payments a k e p l a c e
o n l y
w h e n
h e
agreement
s
t e r m i n a t e d
b e f o r e
i t s
e x p i r a t i o n
d a t e .
Where
a n agreement
x p i r e s
on t h e d a t e
a g r e e d
upon,
n o
t e r m i n a t i o n
pay ment s m a d e b y e i t h e r s i d e .
C o r p o r a t i o n s ,
n o n p r o f i t
o r g a n i z a t i o n s , and
u n i t s
of t a t e
and
l o c a l
go ve r n m e n t
have
u s e d
i n t e r e s t r a t e swaps
w i d e l y
f o r d e c a d e s .
For example ,
h e
c i t i e s
o r
c i t y
a g e n c i e s
of Mi ami,
B a l t i m o r e , P h i l a d e l p h i a ,
Los A n g e l e s ,
Houston,
New
ork
C i t y ,
Albuquerque, a n d
P i t t s b u r g h
a l l
have
u s e d i n t e r e s t
r a t e swaps s
f a r
back
a s
t h e 1 9 9 0 s .
So
have
h e
s t a t e s
a n d / o r
s t a t e
b o r r o w i n g
a g e n c i e s of a s s a c h u s e t t s ,
I n d i a n a ,New
ork,
o n n e c t i c u t ,
Texas,
North C a r o l i n a ,
M i c h i g a n ,
W i s c o n s i n ,
Oregon , Kentucky, and l l i n o i s .
L o c a l l y ,
t h e C i t y
of
h i c a g o ,
Chicago P u b l i c
S c h o o l s , Chicago T r a n s i t A u t h o r i t y , S t a t e
of
l l i n o i s
R e g i o n a l
T r a n s p o r t a t i o n A u t h o r i t y ,
a n d
I l l i n o i s
Tollway l l have
u s e d
i n t e r e s t r a t e swaps.
M a n y
m u n i c i p a l i t i e s have
i s s u e d v a r i a b l e r a t e bonds
n s t e a d
of
i x e d r a t e
b o n d s , a n d
t h e n
e n t e r e d
i n t o
a f l o a t i n g - t o - f i x e d
r a t e swap
o
m a n a g e
t h e
i n t e r e s t
r a t e r i s k
of
h e
v a r i a b l e r a t e
bonds
and t o
lower
c o s t s .
W h e n
a
m u n i c i p a l i t y i s s u e s a
v a r i a b l e r a t e
bond
a n d
t h e n e n t e r s
i n t o a
swap
a g r e e m e n t , h e
s y n t h e t i c a l l y
- c r e a t e d f i x e d r a t e t h a t
r e s u l t s
t y p i c a l l y i s l e s s
t h a n t h e
i n t e r e s t
r a t e t h a t would have
been p a i d had t h e
m u n i c i p a l i t y
s i m p l y
i s s u e d a i x e d
r a t e
bond.
Over h e
t e r m of
h e bond, h e m u n i c i p a l i t y m a y
e n e f i t
from c o s t s
s a v i n g s
t h a t r e s u l t
from
e a c h
pay ment
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 6/29
of h e lower
n t e r e s t r a t e .
These
o s t s s a v i n g s
a r e
r e a l i z e d
over
time,
and can
be
u b s t a n t i a l
depending on
h e
term of
h e
bond and
subsequent changes
n
i n t e r e s t
r a t e s .
Th e
C i t y
of hicago e n t e r e d i n t o
i t s f i r s t
i n t e r e s t r a t e
s wa p
agreement
more than
20 e a r s
ago.
Th e
C i t y
Council of hicago, by
w a y
of h e
C i t y ' s
o r d i n a n c e
p r o c e s s , g r a n t s t h e CFO
r
Comptroller
h e
a u t h o r i t y t o e n t e r i n t o
such swaps.
I f h e
CFO
r Comptroller wishes
o e n t e r
i n t o a
s wa p
o r which
h e o r d i n a n c e
a u t h o r i z i n g
t h e
i s s u a n c e of h e
u n d e r l y i n g bonds i d
not
a u t h o r i z e
a s wa p r a n s a c t i o n , then u t h o r i t y m u s t be g r a n t e d
through t h e passage of
new
o r d i n a n c e . In
each
n s t a n c e
t h a t we
eviewed,
h e
C i t y
p r o p e r l y
o b t a i n e d
a u t h o r i z a t i o n by
ordinance
from t h e
C i t y
C o u n c i l .
T y p i c a l l y ,
t h e C i t y
e n t e r e d i n t o i n t e r e s t
r a t e
swaps
n c o n n e c t i o n
w i t h
an
u n d e r l y i n g
v a r i a b l e
r a t e
d e m a nd
o b l i g a t i o n
bond
o f f e r i n g .
Often,
t
t h e
s a m e
time, h e
C i t y a l s o
i s s u e d
f i x e d r a t e bonds. Th e C i t y used t h e combination of
i x e d
r a t e
and
v a r i a b l e r a t e o f f e r i n g s a s
a
i s k
m a n a g e m e n t
o o l .
Th e
C i t y
used i n t e r e s t r a t e swaps
n
c o n n e c t i o n w i t h
t h e
v a r i a b l e r a t e
o f f e r i n g s t o
s y n t h e t i c a l l y
c o n v e r t
f l o a t i n g r a t e s
t o f i x e d
r a t e s
t o
reduce
n t e r e s t r a t e r i s k s .
These
swaps
e s u l t e d
i n
s y n t h e t i c a l l y f i x e d c o s t s
(or f i n a n c i n g
c o s t s )
h a t were
lower than
t h e
comparable e v e l of i x e d r a t e s a v a i l a b l e
i n
t h e primary
municipal
bond market
t t h e
t i m e .
I n
a d d i t i o n
t o
t h e f l o a t i n g - t o- f i x e d r a t e s wa p agreements, h e C i t y a l s o has
n t e r e d
i n t o
swaps o
c o n v e r t
t h e b a s i s
upon
which
h e
i n t e r e s t r a t e s
were
a l c u l a t e d , c a l l e d
b a s i s swaps.
T h e
C i t y
has n t e r e d
i n t o
t h e s e b a s i s swaps
n
exchange
o r
s u b s t a n t i a l
u p f r o n t payments o
t h e
C i t y .
C e r t a i n b a s i s swaps
i d
not
extend
f o r
t h e e n t i r e l i f e
of h e
u n d e r l y i n g
v a r i a b l e r a t e d e b t .
T h e C i t y l a t e r extended
so m e
a s i s swaps o m o r e
l o s e l y
match
h e m a t u r i t y of h e
u n d e r l y i n g
v a r i a b l e r a t e
bonds, r
a l t e r e d
t h e
d u r a t i o n
of
h e
s wa p
o
f u r t h e r
m a n a g e
i s k .
Th e
swaps
c o n v e r t e d
t h e i n t e r e s t
b a s i s ,
f o r example, rom
SIFMA o LIBOR
T h e C i t y used t h e s e b a s i s
swaps
o
o b t a i n
funds from c o u n t e r p a r t i e s
and
as o o l s
t o
f u r t h e r
m a n a g e
h e C i t y ' s r i s k
exposure:
Th e
C i t y
e n t e r e d
i n t o
i t s
s w a p
agreements through e i t h e r
a
o m p e t i t i v e
o r n e g o t i a t e d
p r o c e s s .
In
a
o m p e t i t i v e p r o c e s s , t h e C i t y
o r
i t s
f i n a n c i a l a d v i s o r i s s u e d a s wa p b i d
form and
term
s h e e t
t o m u l t i p l e
f i n a n c i a l
i n s t i t u t i o n s
s e t t i n g
f o r t h
t h e
g e n e r a l
s p e c i f i c a t i o n s
and
terms of
t h e a n t i c i p a t e d
s wa p
r a n s a c t i o n .
For example,
h e
form
and
term s h e e t
o f t e n
e x p l a i n e d
t h a t
while
c o u n t e r p a r t i e s
were o b l i g a t e d t o p o s t
c o l l a t e r a l
i n
connection with
t h e
swap,
h e
C i t y
would not
be
e q u i r e d
t o
p o s t c o l l a t e r a l . In
a
e g o t i a t e d p r o c e s s ,
t h e
C i t y n e g o t i a t e d
d i r e c t l y
w i t h
one,
r
m u l t i p l e ,
p o te n t i a l c o u n t e r p a r t i e s .
T h e d v i s o r ' s
r o l e
i n a
e g o t i a t e d
p r o c e s s w a s
o
e n s u r e t h a t
t h e p r i c i n g
r e c e i v e d
by h e
C i t y
w as
a i r
and
c o n s i s t e n t
with p r e v a i l i n g
market
c o n d i t i o n s . T h e d v i s o r a l s o
n e g o t i a t e d
s w a p
e l a t e d
c r e d i t
terms,
analyzed
i s k
v e r s u s
reward,
and
m a d e p e c i f i c
recommendations.
B. C i t y ' s Comprehens ive Ann u a l
Financial
Reports
Th e
C i t y ' s
a c c o u n t i n g
p o l i c i e s a r e
based
upon c c o u n t i n g p r i n c i p l e s
p r e s c r i b e d
by h e
Governmental
Accounting Standards Board GA SB).
In
2008, h e
GASB s s u e d
GASB
Statement No.
3, i t l e d
Accounting a n d
Financial
Reporting
or e r i v a t i v e
I n s t r u m e n t s ,
which
r e q u i r e d
t h a t
t h e C i t y ' s
f i n a n c i a l
r e p o r t s i n c l u d e
s p e c i f i c
d i s c l o s u r e s on
e r i v a t i v e s ,
n c l u d i n g t h e
v a r i o u s
r i s k s
a s s o c i a t e d w i t h s wa p
r a n s a c t i o n s .
These
i s k s
i n c l u d e t h e
f o l l o w i n g :
~
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 7/29
C r
e d i t
r i s k
—th
e
o s s i b i l
i t y t h a t
t h e
swap
c o u n t e r
p a r t y
w i l l n o t make
good on
t s
p r
o m i s e
t
o
pay
t h e
l o c
a l gove
rnment;
2 .
I
n t e r e s t r a
t e
r i s k —the
i s k t h a
t changes n t h e
i n t e r
e s t r a t e
c o u l d
r e d u c e t h e
v a l u e
o
f
h e
s
wap a g r e e m e n
t ;
3
.
B a s i s
r i
s k
—the
o s s i
b i l i t y t h a t
t h e
l o c a l
governm
ent o u l d hav
e
o
pay
h
i g h e r
amou
nts
b e c a u s e
o
f
i f f
e r e n c e s
i n
t h e i
n d e x e s
u
pon
which
t h e
swap
a
g r e e m e n t
s
a r e b a s e d
; and
4 .
T e r m i n a t i
o n r
i s k
—t
he o s
s i b i l i t y t h a
t
a swap
agre
ement ma
y end
a r
l i e r t h a n
e x p e c t e
d an d t h u s
p
o t e n t i a l l y
r e q u i r e
t h e
l o c a l
govern
ment o make a
i g n i f i
c a n t
t e r m i n
a t i o n paym
ent.
A
lthough G SB
3
we
nt n t o
e f f
e c t
i n
June
200
9, h e
C i t y
had been
maki
ng
h e s e
d i s
c l o s u r e s
p
u b l i c l y
s i n
c e
200
4.
T
he C i t y , i n
f a c t ,
h a s i n c l u d e d
a
e t a i l e d
s
t a t e m e n t
of
h e
r i s k s
a s s o c i a t
e d w i t h
i t s
sw
ap a g r e e m e
n t s
i n
e v e r
y
C
FR
i n c e
t h
e
2 0
03 i s c a l
y e
a r
( p u b l i s h
e d
i
n
2 0 0 4
) .
Althoug
h i r s t
p u b
l i c l y
d i s c l o s e
d
i n
2004,
u r
i n t e r v i e w
s r e v e a
l e d
t h a t
t h e C i t y
o f f i c i
a l s
w
h o
e
g o t i a t e d
and
e x e c u t e d
t h e
swa
p
a g r e e m e
n t s on t
s
b e h a l
f
were aware
of h
e r i s k s
mu c h
e a
r l i e r , i n
c l u d i n g
a t t h e t
i m e t h a t
t h e C i t y
e x e
c u t e d
i t s
e x i s t i n g
swap r a n s a
c t i o n s .
I n
t
h e CA
FRs,
t
h e C i t y
d i s c l o s e d
: 1) r
e d i t
r i s k
( e . g . ,
c o u n t e
r p a r t y r i
s k ) ; 2)
n t e r e s t
r a t e r i s k
;
3) a s
i s
r i s k
( i
n c l u d i n g r
i s k s
t i e d
t o
c
hanges
n
m a r g i n a
l
t a x
r a t e s ,
t a x
- e x e m p t
s t a t u
s
of
o
n d s an d
s u p
p l y
and
dema
nd f o r v
a r i a b l e
r
a t e
b o n d
s ) ; 4 ) a x
r i s k
;
a
nd
5
)
e r m i n a t
i o n
r i s k ( i n c l u d i
n g r i s k s
t i e d t o
r a t i
n g s downgr
ades,
o v e n a n t
v i o l
a t i o n s ,
b a n k r
u p t c y , paymen
t e f a
u l t an
d
o t h e r
e
v e n t s
of
d e f a u l
t ) .
The
C
FRs l s
o h i g h l
i g h t e d any
m a
t e r i a l
c h a n
g e s
t o
t h e
swap
a g r e e m e n
t s i n c l u d i n
g
c
o u n t e r p a r
t y d
owngrade
s)
n d / o r
t
e r m i n a t i o
n s .
A c c o
r d i n g l y ,
e
v e r y y
e a r
f o r
more
h a n 10
y
e a r s t h e
C i t y
h a
s
been
d i s
c l o s i n g t h e v e r y
r i s k s
t h e
Septemb er and
O c t o b e r u n i o n
l t t r s
a l l e g e
t h e
C i t y s
swap
c o u n t e r p a r t i e s
may
hav e
m i s r e
p r e s e n t e d
, f a
i l e d
t o
d i s c l o
s e , o r downpl
ayed.
The C i t y s
d i s c
l o s u r e s
a f f i r m
a t i v e l y
e x p l a i n
e d t h e
r i s k
of
n t e
r e s t r a t e mov em
ents,
h e
r i s k
t h a t a
r e d i t
e v e n t
a f f e c t i n g
t h e
c r e d i
t
r a t i
n g s
of
h e
C i
t y
woul d
o c c u r ,
a
nd
t h e
r i s k t h a t
a
swap
c
o u l d
be e r m i n a t
e d
a s a
e s u l t
of
e r
t a i n
e v e n t s ,
i n c l u d i n g
a
a t i n g s downgra
de
of
h
e
C i t y .
The
C
i t y s
d i s c l o
s u r e s d e
m o n s t r a t e
i t s
knowled
ge
and
u n
d e r s t a n d
i n g of
h e v a r i o
u s r i s k s
t h a t c o u l d
imp
ac t
t s
swaps
r a n s
a c t i o n s .
C.
I n t e r
e s t
Ra
te Swa
p
o l i c y
The
C
i t y a l
s o d
i s c l o s e d t h e v
a r i o u s r i
s k s
a s s o c i a t
e d w i t h
swap
r
a n s a c t i o n
s i
n
i t s
I n t
e r e s t
R a t e S wap
P o
l i c y ,
whi
ch i r s t
was implem
ented
i
n
2
0 0 4 and
l a t e r
p u b l
i s h e d
i n
2
006.
The
I n t e r e s t
R a t e
S wap
P o l i c y 2 0 0 6
S wap
o l i c y )
s t a b l i s h e d
g u i d e l i n e s
f o r
e x e c u t i o n
and
managem
ent
of
h e
C i t y
s i n t e r e
s t r a t e swaps
, d
e n t i f i e d
e l e v e n
s e p a r a t e
an
d
s
p e c i f i c
r i s
k
f a c t o r s
t h a
t
t h e
C
i t y
w
ould examin
e b e f
o r e
e n t e r i n g
i n t o
a
sw
ap a g r e e
m e n t
an
d
p
r o p o s e d
w
ays o
m i
t i g a t e
each
of h
e s e r
i s k s :
T
e o f R i s k
D e s c r
i t
i o n o f
R
i s k
W
a t o
M i t i a t
e
R i s
k
B a s i s
r i s k
B
a s i s
r i s k
r e f e r s
t o
t
h e
m
ismatch
T
he
i t y an d t s
f i n a n c i a
l
a d v i s o r s
w i l l
b
etween
t h e
v a r i a b l e r a t e
pay
ments r e v i e
w
h i s
t o r i c a l
t r a d i n
g
d i f f e r e n t
i a l s
r e c e i v e d on a swa
c o n t r a c t
an d
between
t h e
v a
r i a b l e
r a t e
b
onds
and
t h e
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 8/29
T
e
of
Risk
Descri t i o n of Risk
Wa o
M i t i
a t e
Risk
t h e i n t e r e s t payment
c t u a l l y
owed i n d e x .
The C i t y
w i l l s e e k t o
minimize b a s i s
on
t h e b o n d s .
The
two i g n i f i c a n t r i s k
by
t r u c t u r i n g swaps
i t h s m a l l
components d r i v i n g
t h i s r i s k
a r e d e v i a t i o n s between
c a s h
i n f l o w s and
c r e d i t
and
SIFMA/LIBOR
a t i o s . o u t f l o w s .
The
C i t y
w i l l
n o t
s e e k t o
maximize
u p f r o n t
b e n e f i t
by
t r u c t u r i n g
swa
s w i t h u n d u l
h i
h
b a s i s
r i s k
embedded.
Tax i s k
The
i s k
of
a
change i n U.S.
a x
The
i t y
and
t s
c o u n s e l
w i l l
r e v i e w
t h e
t a x
law s u c h
t h a t t h e
f e d e r a l
t a x
e v e n t s i n p r o p o s e d
swap
a g r e e m e n t s . The
exemption
on m u n i c i p a l
d e b t s C i t y w i l l
e v a l u a t e
t h e
i m p a c t
of o t e n t i a l
e l i m i n a t e d
o r
i t s
v a l u e i s
r e d u c e d .
changes
i n t a x
law
on LI OR n d e x e d
The C i t y
i s
n e g a t i v e l y
i m p a c t e d by swaps.
r e d u c t i o n s
i n t a x r a t e s .
C o u n t e r p a r t y r i s k
The
i s k t h a t
a
o u n t e r p a r t y
w i l l
The
i t y w i l l m o n i t o r
e x p o s u r e
l e v e l s ,
n o t
p e r f o r m
p u r s u a n t t o
t h e
r a t i n g s
t h r e s h o l d s ,
and
c o l l a t e r a l i z a t i o n
c o n t r a c t s t e r m s t h u s e x p o s i n g t h e
r e q u i r e m e n t s
on a p o r t f o l i o wide b a s i s . The
C i t y
t o
t h e
r i s k
of
unwinding
h e C i t y w i l l o f t e n r e q u i r e two
o u n t e r p a r t i e s on
swap
a n d / o r
a
e r m i n a t i o n
swaps
o
m i t i g a t e
c o u n t e r p a r t y
r i s k .
a ment.
T e r m i n a t i o n
r i s k
The
i s k
t h a t
t h e swap o u l d
be
The C i t y
w i l l
compute
t s
C o u n t e r p a r l y
t e r m i n a t e d
a s a
e s u l t
of e r t a i n
mark- t o
- m a r k e t
e x p o s u r e . The C i t y
always
e v e n t s i n c l u d i n g
a
a t i n g s
r e t a i n s
t h e
r i g h t
t o t e r m i n a t e swaps t m a r k e t
downgrade o r
t h e
i s s u e r o r
swap
r a t e s .
The
C i t y does n o t
a l l o w c o u n t e r p a r t i e s
c o u n t e r p a r t y , c o v e n a n t v i o l a t i o n ,
t o
t e r m i n a t e u n i l a t e r a l l y ,
e x c e p t
i n
t h e
e v e n t
b a n k r u p t c y ,
payment e f a u l t o r of weakening of
h e
C i t y s c r e d i t
o r i f
o t h e r
o t h e r d e f i n e d e v e n t s of e f a u l t .
t e r m i n a t i o n
e v e n t s
have
o c c u r r e d .
R o l l o v e r r i s k
The i t y m a y be exposed
t o
The i t y
w i l l d e t e r m i n e ,
i n
a c c o r d a n c e
w i t h
r o l l o v e r
r i s k
i f h e
swap e r m i n a t e s
i t s
Debt
o l i c y ,
t s
c a p i t a l
s t r u c t u r e
i n
l i g h t
e a r l y
o r i f
t h e
t e r m of
h e
swap
s
of swap e r m i n a t i n g e a r l y .
The
C i t y w i l l
s h o r t e r t h a n
t h a t
of h e b o n d s .
a l s o
e v a l u a t e e n t e r i n i n t o
a n o t h e r
swa
L i q u i d i t y
r i s k
The
n a b i l i t y
t o c o n t i n u e
o r
renew
The
i t y
w i l l e v a l u a t e t h e
e x p e c t e d
a i q u i d i t y f a c i l i t y a v a i l a b i l i t y
of
i q u i d i t y
s u p p o r t f o r
swapped
and
unhed ed
v a r i a b l e
r a t e
d e b t .
R a t i n g s
R i s k
The
i s k t h a t
t h e C i t y s c r e d i t The i t y
w i l l c o n t i n u e an open d i a l o g u e w i t h
r a t i n g
would
b e
a d v e r s e l y
a f f e c t e d
t h e r a t i n g
a g e n c i e s
s o
t h a t
a l l t h e b e n e f i t s
and
by
e n t e r i n g
i n t o a
swap r i s k s
of
a swap
a r e
u n d e r s t o o d . I n
a d d i t i o n ,
t r a n s a c t i o n .
t h e
C i t y w i l l
s e e k
c o n f i r m a t i o n
t h a t
t h e
swap
w i l l
n o t
a d v e r s e l y a f f e c t
t h e
u n d e r l y i n g
c r e d i t
r a t i n
s .
R i s k of For
C i t y p u r p o s e s , swaps
m a ke
h e
The
C i t y and t s f i n a n c i a l a d v i s o r s
w i l l
R e s t r u c t u r i n g u n d e r l y i n g
bonds non- c a l l a b l e e v a l u a t e t h e
b e n e f i t s of
swap
n
r e l a t i o n
t o
F l e x i b i l i t y
b e c a u s e
t h e C i t y
w i l l
n o t
have
a
t h e
l o s t b e n e f i t
of
u t u r e
s a v i n g s
and
swap w i t h o u t
an
u n d e r l y i n g
b o n d .
r e s t r u c t u r i n g o p p o r t u n i t i e s .
This a c t o r
n o t o n l y
e l i m i n a t e s
t h e
o p p o r t u n i t y
t o r e f u n d t h e s e bonds
f o r s a v i n g s ,
b u t
a l s o e l i m i n a t e s t h e
a b i l i
t o
r e s t r u c t u r e t h i s d e b t .
A m o r t i z a t i o n
Risk h a t
t h e
swap a m o r t i z a t i o n
The C i t y
matches
h e
a m o r t i z a t i o n s c h e d u l e s
R i s k
s c h e d u l e
w i l l
n o t
match
t h e
of bonds and swaps.
The
C i t y and
t s
a m o r t i z a t i o n s c h e d u l e of
h e
f i n a n c i a l a dv i s o r s :
i l l c o n t i n u e t o a s s e s s t h e
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 9/29
T
e
of Risk Descri t i o n of
Risk
Wa
o
Miti
a t e
Risk
b o n d s .
A m o r t i z a t i o n
mismatches
C i t y ' s
o v e r a l l
bond
p o r t f o l i o t o
d e t e r m i n e t h e
c o u l d
a l s o
r e s u l t
i n
t e r m i n a t i o n s
of
b e s t
p r a c t i c e
i n
e a c h
p a r t i c u l a r
i n s t a n c e .
p o r t i o n s
of
h e
swap
p r i o r
t o
m a t u r i t y
and
u n d e r
u n f a v o r a b l e
c o n d i t i o n s
t o
t h e
C i t y .
I n t e r e s t R a t e R i s k
R i s k
t h a t m ov e me n t
of
n t e r e s t
The
b s o l u t e l e v e l
of
n t e r e s t
r a t e s
and t h e i r
r a t e s
o v e r
t i m e
c o u l d a f f e c t t h e
e f f e c t on
t h e
m a r k e t
w i l l
be
a k e n i n t o
v a l u e of
n
o u t s t a n d i n i n s t r u m e n t . a c c o u n t
b e f o r e t h e
Ci e n t e r s
i n t o
a
sw a
C r e d i t
R i s k
Risk
h a t a r e d i t e v e n t
c o u l d The
C i t y
w i l l
m o n i t o r
t h e
r a t i n g s of t s
o c c u r t h a t would a f f e c t
t h e
c r e d i t
c o u n t e r p a r t i e s and
i n s u r e r s .
r a t i n g s of h e C i t y o r
of
ne
of t s
c o u n t e r
a r t i e s .
S i m i l a r
t o
t h e C i t y ' s
r i s k
d i s c l o s u r e s i n i t s
CAFRs, h e C i t y ' s
2006 Sw ap o l i c y
d e m o n s t r a t e s t h e
C i t y ' s
knowledge and
u n d e r s t a n d i n g
of
h e
r i s k s
a s s o c i a t e d
w i t h
swap
t r a n s a c t i o n s .
I t
a l s o
a d o p t s
c e r t a i n p o l i c i e s
a nd
p r o c e d u r e s t o a d d r e s s
and minimize
t h e s e
r i s k s ,
and
p r o h i b i t s
t h e
C i t y
from e n t e r i n g
i n t o
swaps
h a t
were
viewed
a s t o o
r i s k y o r
l a c k i n g i n
t r a n s p a r e n c y .
D .
T h e
n t e r e s t
Rate
Swap
greements
The
2006
Swap P o l i c y
a l s o s e t s
f o r t h
t h a t
t h e
C i t y ' s
c o n t r a c t u a l r e l a t i o n s h i p s
w i t h
i t s
swap c o u n t e r p a r t i e s be g o v e r n e d , o t h e
e x t e n t p o s s i b l e ,
by h e
t e r m s
and c o n d i t i o n s
s e t f o r t h i n
t h e
I n t e r n a t i o n a l
Sw ap
D e a l e r s A s s o c i a t i o n , n c .
(ISDA)
a s t e r Agreement.
The
y p i c a l C i t y
swap r a n s a c t i o n
a l s o
i n c l u d e d
t h e
f o l l o w i n g
a d d i t i o n a l documents:
a
S c h e d u l e
t o
t h e
M a s t e r
Agreement,
r e d i t
S u p p o r t
Annex,
Swap
C o n f i r m a t i o n ,
l e g a l
o p i n i o n s , and
a i r n e s s o p i n i o n s .
T he
ISDA M a s t e r Agreement,
l o n g w i t h
t h e
S c h e d u l e and
C o n f i r m a t i o n ,
i d e n t i f y t h e
swap
c o u n t e r p a r t i e s i . t h e
C i t y and a
b a n k ) ,
and
s p e c i f y t h e
p a r t i c u l a r i n t e r e st
r a t e s
b e i n g
swapped,
payment e r m s , and
t h e
o t h e r
m a t e r i a l
t e r m s
of h e
t r a n s a c t i o n .
The ISDA
M a s t e r
Agreements, s s e t
f o r t h
i n
t h e
S c h e d u l e s
t h e r e t o ,
c o n t a i n a
n on-
r e l i a n c e c l a u s e
p u r s u a n t t o which t h e C i t y
a g r e e s
t h a t
t
h a s
m a d e
t s
o w n
d e c i s i o n t o e n t e r i n t o
each
t r a n s a c t i o n u s i n g i t s o w n udg men t and
r e l y i n g
upon
a d v i c e
from
a d v i s o r s
of
t s
c h o o s i n g .
T he C i t y a l s o
a f f i r m a t i v e l y
acknowledges
h a t
t
i s n o t
r e l y i n g o n
any
communication o r
recommendation
r e p r e s e n t a t i o n s ) by h e
swap
c o u n t e r p a r t y , and
t h a t
t h e swap
c o u n t e r p a r t y
i s
n o t
recommending t h e t r a n s a c t i o n .
I n
a d d i t i o n ,
e a c h
T r a n s a c t i o n
C o n f i r m a t i o n
c o n t a i n s
t h e
f o l l o w i n g a d d i t i o n a l
r e p r e s e n t a t i o n s by
h e C i t y :
[ t h e
C i t y ' s ]
c o u n s e l , a c c o u n t a n t s and
t a x
a d v i s o r s
a r e
f a m i l i a r
w i t h
t h i s
T r a n s a c t i o n ...and
r e l y i n g on h e a d v i c e
of
uch
p r o f e s s i o n a l s and
a d v i s o r s t h e
[ C i t y ] h a s
m a d e a n
i n d e p e n d e n t a n a l y s i s
a nd
d e c i s i o n
r e g a r d i n g
t h i s
T r a n s a c t i o n ;
a nd
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 10/29
[ t
h e
C i t y ]
h a s
d e t
e r m i n
e d t h e
econ
omic
i s k s and
m e
r i t s ,
a s
w e
l l a s
l e
g a l , t a x ,
and
a c c
o u n t i
n g
c h a r a c
t e r i z
a t i o n s
a
nd c o
n s e q u
e n c e s
...a
nd
i s c a p a b l
e
of
ssu
ming
such
i s k s
w i t
h o u t
r
e l y i n
g on
t
h e a d v i c
e
of
c o u n
t e r p a r
t y
b a n k
] .
Th
e
C
i t y
a l s o
a
cknow
ledge
s
h r o u
g h
t h e
ISD
a s t e r
A
gree
ment
h
a t
t h e
c o
u n t e r
p a r t y bank
s
n o t
a c t i n g
a s t h e
C i t y ' s f i d u c i a r y
o r a s
t h e
C i t y ' s
a d v i s o r
w i t h
r e s p e c t t o
t h e
t r a n s a c t i o n .
I n
a
d d i t i
o n
t
o t h e
no n- r e l
i a n c e
c l a u
s e s , t h e
ISD
a s t
e r Agree
ments
, s s
e t
f o r
t h
i
n
t h e
S c h
e d u l e
s t h
e r e t o ,
c o n
t a i n
e x c l u s
i v e
d i s p u
t e
r e s o l u
t i o n
c l
a u s e s
r e q
u i r i n
g
t h e
p a r
t i e s t o
sub
mit
any e g a l
c l a i m
s o r
d i
s p u t e s
t o t h e e x c
l u s i v e
j
u r i s d i
c t i o n of
h e C
o u r t s
of
h e
S t a t e
of
l l
i n o i s
o r
t h e
U n i
t e d
S t
a t e s
D i s t r i
c t Co
urt
o r
t h e
N o r t h
e r n
D i
s t r i c t
of
l l i n o
i s
T
h e I
SD M
aster
Ag ree
ment
l s
o p r
o v i d e
s
t
h a t t h e C
i t y
may
e r m i n
a t e
t h e
i n t e r
e s t r
a t e
s wa
ps
t
any
t i m e
f
o r
marke
t
v a l u e
, o r
u p
on
t
h e o c c u
r r e n c
e of
e r t
a i n
e v e n t s
. Wh
ile t h e
C i t y
m a
i n t a i
n s an u n
l i m i t e
d
r i g h t of
a r l y
t e r
m i n a t
i o n ,
t h
e
ban
k
c
o u n t e r
p a r t i
e s ' t e r m
i n a t i
o n r
i g h t s
a r e
l i m i t
e d . T
h e
s
w ap a
g r e e m
e n t s a l s o
e s t a
b l i s h
c e r t a i
n e a r l y
t e
r m i n a
t i o n
e
v e n t s .
Th e
C i
t y ' s
s w a p
a g r e
e m e n t
s
c
o n t a i n
c r e d i t
r a t i n
g s t h r
e s h o l d
s t h a
t
r e q u i
r e
b o t
h
t h e
C
i t y and
t s
c o
u n t e r p
a r t i e
s t o
m a i n
t a i n
c e r t a
i n c r e
d i t
r a t i n
g s .
n
a r l
y t e r m
i n a t i o
n e v
e n t
i s
t
r i g g e
r e d
i
f t h e
c r e d i
t r a t i
n g
of
h e
C i
t y o r a
o u n t
e r p a r
t y
i s downg
raded
below
suc
h
a g r e e
d u po
n
h r e s h
o l d .
On
c e
r i g g
e r e d ,
t h e
o t h e r
c o
u n t e r
p a r t y
h
a s t h e
r i g h t
t o
t e r m i n
a t e
t
h e s wa
p.
Up o
n
e r m
i n a t i
o n , o
ne
p a r t y ma
y o w e
h e
o t h
e r
a
e r m i
n a t i o
n
payme
nt.
E. E x i
s t i n g
Swa
p r a
n s a c t
i o n s
A s
of
h e
d a t
e
of
h i s r e p
o r t ,
t h e
C i t y
r e m a
i n s
i
n v o l v e
d i
n
s w a p
a
g r e e m
e n t s
r e l a t
i n g
t o
n i n e b
ond
d e
a l s .
Th e
C i t y
c e
a s e d
i s s u i
n g n e w
v a r i
a b l e r a
t e
d e m a
nd
b
onds
n
2
007.
Th
e
a
s t
s w a
p m a d
e n
c o n n
e c t i o
n w i t h
t h
e i s s
u a n c e o
f
n
u n d e r
l y i n g
bon
d
w a s
e x e
c u t e d
i
n 2008.
Ea c
h
of
h
e s e d e
a l s
i n
v o l v e
d t h e
i s s
u a n c e of
a r i
a b l e r a
t e
d e
m a n d
b o n
d s .
Th e
C i
t y r
e m a i n
s
i n v o
l v e d
i n
16 s wa ps
h a t
were
e n t e r e d
i n t o
i n
c o n n e c t i o n w i t h
one
of
h e s e
n i n e u n d e r l y i n g
v a r i a b l e
r a t e
d
e m a n
d
bo
nd s
u n
d e r l y
i n g
s w
a p s )
, and
i n n i n e
s wa
ps n
t e r e d
i n t o
a f t
e r
t h
e
u
n d e r l
y i n g bo
nd
d e a l s
t o
c
o n v e r
t t
h e
b a s i s
u
pon w
hich
t h e
i n t
e r e s t r a t
e s w
ere c a l c
u l a t e d
(
b a s i s
s w a p
s ) .
Th e
C i t y
r
e c e n t
l y
h a s r e n
e g o t i a
t e d t h e
t e
r m s
o
f
e r t a i
n
of
t s s w a p
a g r
e e m e n
t s
t
o (1)
e d u c e
t h e
c r e d i t
r a
t i n g
t h r e s
h o l d s
t h a t a l l o
w t h e
C i t y
' s c o u n
t e r p a r
t i e s t
o t e r m i
n a t e
t h e s w a p
s
f
t h e
C i t y
e x p e r
i e n c e
s
f u r
t h e r
down
grade
s
n
i t s
c r
e d i t
r a
t i n g ,
and
(2) od
ify t h e
m a
t u r i t y
of
h e
s w a
p
a g r e e
m e n t s
. See
C i t y
of
Ch
icag
o
R e o f
f e r i n
g C i r c
u l a r
f o r
i t s
G
e n e r a
l O b l i g
a t i o n
V a r i a
b l e
R a t
e
De
m a n d
Bo
n d s r
o j e c t
and
Ref
undin
g S e
r i e s
2
003B
,
S
epte
mber
2014
.
Th e
f
o l l o w
i n g
c h a r
t s h o
w s
h e C i t y ' s
e x
i s t i n g
s w
a p
a g r
e e m e n
t s ,
h e
u n d e
r l y i n
g
o f f e
r i n g s
t o
wh i
ch e a
c h s
w a p a
greem
ent e l a
t e s t h e
s w
a p c o u n t e
r p a r t
i e s o
n
e
ach t r a
n s a c t i
o n ,
w h e t h
e r
t h e
s w a p
r e l a t e s
t o
t h e u n d e r l y i n g
bond
t r a n s a c t i o n
( U )
r
w a s a
a s i s
s w a p
B ),
h e
n o t i o n a l
a mo
u nt
of
h e
s wa p
, n
d t
s
t r a d
e a
nd e f f e
c t i v e
d a t e s
:
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 11/29
Bond
s s u e
Name
Par
Amount)
I s s u e D a t e d
Swap Counterparty
Bond S e n i o r
Manager
U/ B
N o t i o n a l
Amount
Trade Date
E f f e c t i v e
Date
Lehman B r o t h e r s
202,500,000 e n e r a
O b l i g a t i o n S p e c i a l
F i n a n c i n g
I n c .
V a r i a b l e
R a t e
Demand
Bonds,
r o j e c t ( C o u n t e r p a r t y i s
no w
W i l l i a m
B l a i r
U
]
1 , 8 7 5 , 0 0 0
8 / 6 / 2 0 0 3 8 / 7 / 2 0 0 3
and
Refunding
e r i e s
2 0 0 3 B
Well s Fargo
Bank,
Company,
LLC
[ 8 / 7 / 2 0 0 3 ]
N a t i o n a l A s s o c i a t i o n )
Bear Steams
F i n a n c i a l
P r o j e c t s I n c .
( C o u n t e r p a r t y i s now U $ 5 0 , 6 2 5 , 0 0 0 8 / 6 / 2 0 0 3
8 / 7 / 2 0 0 3
JPMorgan Chase
Bank,
.A.)
The
Bank of
B 1 44,570,000 1 / 3 0 / 2 0 1 3 1 1 / 1 / 2 0 1 4
New ork Mellon
PNC
ank,
B
$ 4 8 , 1 9 5 , 0 0 0
1 / 3 0 / 2 0 1 3
3 / 1 / 2 0 1 4
N a t i o n a l
A s s o c i a t i o n
PNC
ank,
N a t i o n a l A s s o c i a t i o n
B
1 44,570,000
2 / 9 / 2 0 1 2 3 / 1 / 2 0 1 4
222,790,000 G e n e r a l O b l i g a t i o n
V a r i a b l e Rate Demand
Bonds,
r o j e c t
and
Refunding
S e r i e s
2 0 0 5 D
[ 8 / 1 7 / 2 0 0 5 ]
Goldman
Sachs
Bank
USA
Loop
i n a n c i a l
P r o d u c t s
I I
LLC
( C o u n t e r p a r t y
i s
no w
Bank of
o n t r e a l )
Loop
F i n a n c i a l
P r o d u c t s
I I I
LLC
( C o u n t e r p a r t y
i s
no w
Deutsche Bank
AG
New
ork
Branch)
RFPC
a p i t a l
S e r v i c e s ,
LLC
( C o u n t e r p a r t y i s now
The Bank
of
New
York
Mellon)
J e f f r i e s
Funding LLC
( C o u n t e r p a r t y i s
no w
Deutsche Bank
AG
New
ork
Branch)
PNC ank,
N a t i o n a l
A s s o c i a t i o n
Loop
a p i t a l
U 155,953,000 8 / 2 / 2 0 0 5
8 / 7 / 2 0 0 5
M a r k e t s , LLC
U
$ 6 6 , 8 3 7 , 0 0 0
8 / 2 / 2 0 0 5 8 / 1 7 / 2 0 0 5
B $ 6 1 , 3 9 5 , 0 0 0
1 2 / 1 7 / 2 0 1 0
1 / 1 / 2 0 1 4
1 2 / 1 6 / 2 0 1 0
B
100,000,000 (Amended
1 / 1 / 2 0 1 4
4 / 3 0 / 2 0 1 4 )
B $ 6 1 , 3 9 5 , 0 0 0
1 2 / 1 7 / 2 0 1 0
1 / 1 / 2 0 1 4
B 207,880,000 2 / 9 / 2 0 1 2 1 / 1 / 2 0 3 1
200,000,000 e n e r a l O b l i g a t i o n
Loop
F i n a n c i a l
V a r i a b l e
R a t e
Demand
Bonds, efunding
P r o d u c t s I I LLC
Loop
a p i t a l
( C o u n t e r p a r t y
i s
no w
U
150,000,000
1 0 / 2 4 / 2 0 0 7 1 1 / 8 / 2 0 0 7
S e r i e s
2 0 0 7 E F G
M a r k e t s , LLC
Deutsche Bank
AG
[ 1 1 / 8 / 2 0 0 7 ]
New
ork
Branch)
Morgan S t a n l e y
U
$ 5 0 , 0 0 0 , 0 0 0
1 0 / 2 4 / 2 0 0 7
1 1 / 8 / 2 0 0 7
C a p i t a l S e r v i c e s
I n c .
W e l l s Fargo
Bank,
B
100,000,000 1 / 3 0 / 2 0 1 0
1 / 1 / 2 0 1 4
N.A.
W e l l s Fargo Bank,
N.A.
B
100,000,000 1 2 / 2 / 2 0 1 0
1 / 1 / 2 0 1 4
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 12/29
332,230,000
Second
Lien
Wastewater
V a r i a b l e
Rate
Revenue
Refunding
Bonds, e r i e s
2004A
r e f u n d e d
by
Lehm an
B r o t h e r s
332,230,000
Second
Lien
Wastewater
S p e c i a l
F i n a n c i n g I n c .
Lehm an
B r o t h e r s ,
V a r i a b l e
Rate
Revenue Refunding
( C o u n t e r p a r t y s
n o w
I n c .
U
232,560,000
7/22/2004
7/29/2004
Bonds,
e r i e s
2008C on 1 0 / 1 6 / 2 0 0 8 ; Deutsche
Bank AG,
.1PMorgan w a s
o l e u n d e r w r i t e r ;
s w ap s
New
ork
Branch
remained
i n
p l a c e )
[7/29/2004]
JPMo r g a n Chase
Bank
U
49,835,000
7/22/2004 7/29/2004
Bank
of
America,
N.A.
U
49,835,000
7/22/2004
7/29/2004
500,000,000
Second
Lien
Water
Revenue
P r o j e c t and
Refunding Bonds,
UBS AG,
M o rgan
S t a n l e y
U 300,000,000
7/29/2004 8/5/2004
S e r i e s
2 0 04 Stamford
Branch Co. n c o r p o r a t e d
[8/24/2004]
Royal
Ba nk
of
Canada
U
200,000,000
7/29/2004 8/5/2004
100,000,000
Second
L i e n
Water
Revenue
P r o j e c t Bonds, e r i e s
2 0 0 0
UBSAG,
Mo r g a n S t a n l e y
U
100,000,000
4/10/2008 4/16/2008
[
2 / 2 2 /
1999]
Stamford
Branch
Co.
n c o r p o r a t e d
16,595,000
S a l e s Tax
Revenue
Refunding Bonds, a r i a b l e
Rate
S e r i e s
S i e b e r t
Brandford
2 0 0 2
JPMo r g a n
Chase
Bank
Shank
o.,
LC
U I
6 , 5 9 5 , 0 0 0
6/21/2002
6/27/2002
[6/27/2002]
152,150,000
Chicago
M i d w a y A i r p o r t
J . P .
Mo r g a n Chase
Second
Lien Revenue
Refunding Bonds,
The
Goldman
Sachs
S e c u r i t i e s , I n c .
U
91,290,000
1 2 / 9 / 2 0 0 4
12/14/2004
S e r i e s 2 0 0 4C D Auction
Rate
S e c u r i t i e s y
Group,
n c .
[ 2 J
14/2004]
JPMorgan
Chase
Bank,
N.A.
( C o u n t e r p a r t y
s n o w
U
60,860,000
1 2 / 9 / 2 0 0 4
12/14/2004
Wells
Fargo
Bank,
N.A.)
44,900,000
S e n i o r Lien
T a ~ c
Increment
A l l o c a t i o n Bond s
Near
North
Bank
of America N.A.
M e s i ro w F i n a n c i a l ,
U
44,900,000
8/5/1999
9/1/1999
Redevelopment r o j e c t ) , S e r i e s
1 9 9 9 A
I n c .
[ 8 / 5 /
999]
The
c h a r t
demonstrates t h a t of h e
C i t y s
2 5
e x i s t i n g s w a p
agreements, t
e n t e r e d
i n t o
2 1
of hem a f t e r
t
p u b l i c l y acknowledged
t s
u n d e r s t a n d i n g
of h e
r i s k s
p r e s e n t e d by s w a p
t r a n s a c t i o n s
i n
t h e
C i t y s
CAFR
o r
f i s c a l
y e a r
2 0 0 3
p u b l i s h e d
on
June
18,
004).
F u r t h e r ,
a s
mentioned
above,
l t h o u g h t h e C i t y f i r s t
p u b l i c i z e d
t s
u n d e r s t a n d i n g of
h e r i s k s
i n
2004,
h e
C i t y
o f f i c i a l s
who ere
involved i n
n e g o t i a t i n g and
e x e c u t i n g
t h e s e
s w a p
agreements t o l d us t h a t
they
we re
w e l l
aware
of
h e
r i s k s
p r e s e n t e d
by s w a p
t r a n s a c t i o n s
long
b e f o r e
t h e C i t y s p u b l i c
acknowledgement
and,
more
s p e c i f i c a l l y , a t
t h e
time they
e n t e r e d i n t o
agreements on
t h e C i t y s
behalf n
1999,
002, and 2 0 0 3 t wo
s w a p s
n
2003).
~
On pril
16,
2008 , he City refunded a
portion o f he Series
2004 a t e r
bond s ,
t
which
time
a )
he swap
ith
UBS
AG, tamford
Branch
r e l a t i n g
to
the Series
2004
a te r
bo n d s
w a s
am e n d e d to
l o w e r the
notional
am o un t
to
2 0 0 , 0 0 0 , 0 0 0 , as amortized;
an d (b) he City
entered i n t o a
new
swap
ith
a
notional
am o un t o f 1 0 0 , 0 0 0 , 0 0 0
r e l a t e d to the
Series 2000
a t e r b o n d s
r e f l e c t e d i n the chart
above).
1 0
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 13/29
Our
n
t e r v i e w
s a l s o
c o n f
i r m e d
t h a t t
h e s e C i t y
o f
f i c i a l s
e n t e
r e d i n t
o v a r i
a b l e
r a t e
deman
d
bo
nds and
r e l a t e
d
i n t e r e s t
r a t e sw
ap a g r e e m e
n t s
i n
an
f f o r t
t
o
s a v e
t
h e
C i t
y m
o ney v e r s u s
i s s
u i n g
compar
able
i x e
d
r a t e
d e
b t , and
a s a
n o
v e r a l l
d
e b t
r i s
k
m
anagem
ent
o o l .
I
n
e a
c h
c a
s e ,
t
c o
s t t h e
C i t y
l e
s s t o i s s u e
v a r i
a b l e
r a t e de
mand bonds
t
t
h e
t
i m e of s s u
a n c e
t h a n
i t
d i d
t o i s s
u e
f
i x e d r
a t e
d e
b t . T
he C i t
y
t h
e n
e n t e r
e d i n t o an
n t e r
e s t r
a t e sw
ap o
e s
t a b l i s h
a
y n t h e t i
c f i x e d
r a t e ,
l o c k
i n
m a r k e t
c o n d i t i o n s
a t
t h e
t i m e ,
an d
hedge
a g a i n s t
i n t e r e s t r a t e r i s k .
The
p e r f o
r m a n c e
o
f
h e
C
i t y ' s swa
ps
s
an
d h a
s bee
n a
u n
c t i o n
of a r i o u
s
f a c t o
r s .
T
wo
f
a c t o r s a r e
of
a r t i
c u l a r
i m p o r t
a n c e
f
o r
f u t u r e p
e r f o r m
a n c e : t
h e
C i t
y ' s c
r e d i t
r a t i
n g and h e
s u p p o r
t
c
o s t s a s
s o c i a t e
d
w i
t h t h
e i s s u a
n c e o
f h e u n
d e r l y i
n g
v a r i a b l
e r a t e
d e b t .
As
e s c r i b e
d
a b o
v e , h e C i t
y ' s
swap a
g r e e m e
n t s
g e n e r a
l l y c o n t a i n
p
r o v i s i o
n s t h
a t
p e r
m i t ,
b u t do
n o
t r
e q u i r e ,
t
h e
swa
p
c o u n t
e r p a r t
y
t o
t e r
m i n a t e
t h e
agree
ment
f
t h e
C i t y
' s c r e d
i t
r a t i n g
f a l
l s
belo
w
a
s p e c i
f i e d t h r e s h
o l d
l e v e l .
Under
u r r
e n t
m
arket
a t
e
c o n d i
t i o n s ,
i f h e C i
t y ' s r
a t i n g s
were
r e
d u c e d
below
h r
e s h o l d l
e v e l s and
t s c o u n
t e r p a r t
i e s
e x e r c i
s e d
t h e i r
r i g
h t s t o
t e r m
i n a t e t
h e
s
waps,
h e
C
i t y
would
be
i a b l
e
f
o r
t e
r m i n a t
i o n
p a y m
e n t s .
The r
o b a b i l i
t y
t h a t
t h i s
r i s k
c o
u l d
o c c
u r , a t
l e a
s t
a
s t o s o me
of h e
C i t y ' s
swaps,
a s
i n c r e a
s e d
i n
t h e
l a
s t
two
y e a
r s
due o
downgrades
n
t h e
C i t y ' s
c r e d i t r a t i n g ,
a s d i s c u s s e d
i n
g r e a t e r
d e t a i l
i n
t h e
C i t y ' s r e c e n t
r e o
f f e r i n g
c i r
c u l a r f o r t h e G
e n e r a l
O
b l i g a t i
o n V a r
i a b l e
R a t
e
De
mand
Bon
ds,
r o j e c
t
R
efundi
ng
S e r i
e s 2
003B,
s s u e
d
on
Sep
tember
25,
01
4.
I n
p a r t i c u l
a r , i n t h e
l s t
18
month
s
h e
C i t y h a
s
e x p e r
i e n c e d
t h
r e e c r
e d i t do
wngrad
es: 1)
n
J
u l y 1 7
, 2013
, M
oody's
e d u
c e d t h e
r a t i
n g s
on
h e
C i t y ' s
g e
n e r a l
o b l i g a t
i o n
b
onds
from
A
a3
o
A3 ,
2
)
n March
4,
014,
Moody
's e d u c e d
t
h e
r
a t i n g s of
h e C i t y
' s g e n e r a
l o b l i g
a t i o n
bonds fr
om A
3 o
Baal
,
an
d
(3)
n No v
ember
,
2013,
i t
c h
r e d
u c e d t h e
r a t i
n g on
h e
C i t y ' s
g e n
e r a l o
b l i g a t i
o n bon
ds
fr
om
AA- o
A- .
These
downg
rades
d i d n o t
b r i n
g
t h e
C i t
y ' s
c r e d i
t r a t i n g
below t h e
t h
r e s h o l d
s
i n
t
h e a g r e
e m e n t s ,
and
d i
d n o t
t
r i g g e r
c o u n t e r
p a r t i e s
' o p t i o
n s t o
t
e r m i n a t
e .
Th
e
r e d i t
downg
rades,
h
owever
,
have
c a
u s e d t h e
s
u p p o r t
c o s t s ,
. e .
t h e
l e t t e
r of r
e d i t f e e s ,
a s s o c i
a t e d
w
i t h t
h e
u n d
e r l y i n
g v a r
i a b l e
r a t e
d e b
t
t o
i n
c r e a s e .
F. T
he
Uni
on
L e t
t e r s ,
the
R o o s e v
e l t
I
n s t i t u t
e
Bl o
g
P o
s t ,
an
d t h e
Grais
E l l
s w o r t h
Legal
Mem
oran
dum
On epte
mber 1
5 , 20
14, h e
C i t y r e c e i
v e d
a e t t e r
from t h r e
e
u n i o
n
l e a d e
r s
u r g i n
g t h e
C i t y
t o
i m
m e d i a t
e l y
f i l e
f o
r a r
b i t r a t i o
n
t o
s e e k
a
e f u n
d of
ums e
xpende
d
on
r a u
d u l e n t
i n
t e r e s t
r a t e swaps
h a t
a r e
c o s t
i n g
t
h e C i
t y of
hi c
ago and h e
Ch
icago
u b
l i c
Scho
ol Sys te
m o v e r
a
hundre
d
m i l l i o n
d o l
l a r s
e
v e r y y
e a r , an
d
o d a t e ,
have
e s u
l t e d
i
n
a o s s
of
v e r $80
0
i l l i o
n
d o l l a r
s .
(Septe
mber e
t t e r . The
Sep
tembe
r
L e t t e r
d i d
n o t
i d e
n t i f y a
p e c i f i c
f
r a u d u l
e n t
swa
p
a g
r e e m e n
t , i d n o t
e x p
l a i n
how
h e
swap
a g r
e e m e n t
s
wer
e
f r a u d u
l e n t ,
d i d n o t
i d e n t
i f y
a
m
a t e r i a l
m i s r e
p r e s e n t
a t i o n
o
r
o m i s s i
o n of
a c t r e l a
t e d t o a
ny
a
r t i c u l a
r s wa
p a g r e e
m e n t ,
and
d
i d
n
o t
p r o v i d
e a
ny b a
s i s ,
o r
u n
d e r l y i n
g f
a c t s ,
f o r
t h e
a l l e g e d
$800
i l
l i o n
l o s s .
R a
t h e r t h a
n
p o i n t i n
g
t o
s p
e c i f i c
f a
c t s
r e
l a t i n g
t o
t h
e
C i t y ' s
s
wap
a g r
e e m e n t s
, h
e
Septem
ber
L e t t e
r
r e f e
r e n c e d
p u r p o
r t e d
e f f o
r t s
by t h e
r c i t i e
s t o g e
t
o u t
of
u c h
b o r r
o w i n g
d e a
l s
and
t o
r e v i e w
[
]
t h e
i r ]
o p
t i o n s
f o r
r e c o u p
i n g l o
s s e s
on
t h e i r ]
i n t e r
e s t r a t
e s w a p s
. Th
e
Sep
tember
L
e t t e r a l s o r e f
e r e n c e d
a
e c e
n t
Ameri
can
A r b i
t r a t i o n
A s s o c i
a t i o n
awar
d
e n t e
r e d
i
n
f a v o
r o
f ald
win County
Se
wer e r v i c
e , L
L
B C S S )
,
r i v a
t e
sewe
r
t
i l i t y
h e
a d q u a r t
e r e d
i n
Summer
dale,
Alaba
ma, a
s e d
on
a b a n k
' s
s p e
c i f i c
m i s r
e p r e s e n
t a t i o n
t h a t t h e
r a t e
t i e d
t o
B
C S S ' s
v a r i a
b l e r a
t e dem
and
n
o t e
was a
L
IBOR
a
t e
w
hen
t
i
n
f a c t ,
w
as
o
t , and
h
e
b
a n k ' s
f a i
l u r e
t
o
1 1
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 14/29
d i s c l o s e b a s i s
r i s k .
The
September e t t e r r e a s o n e d t h a t b e c a u s e
t h e CSS
i l l
r e c o u p i t s
l o s s e s , t h e C i t y h a s a
chance
o r e c o u p
[ i t s u n i d e n t i f i e d ]
swap o s s e s
t o o .
The s s e r t i o n s
of
h e
September
e t t e r
c l o s e l y
r e s e m b l e d
t h o s e
of
l o g
p o s t
w r i t t e n
b y
S a q i b
B h a t t i
of
h e
R o o s e v e l t
I n s t i t u t e . I n t h e b l o g ,
Mr. h a t t i
a s s e r t s
t h a t [ a ] s
a
u l e , b a n k e r s
h i g h l i g h t e d t h e
u p s i d e and
minimized
h e p o t e n t i a l downside n
p i t c h i n g
t h e s e
d e a l s . T h i s
was
n
v i o l a t i o n
ofMSR
ule G-17. The b l o g
a r g u e s t h a t c i t i e s can
p o t e n t i a l l y
win back
h u n d r e d s
of
i l l i o n s
of
o l l a r s from Wall
S t r e e t ,
and s u g g e s t s t h a t t h e y
p u r s u e
l e g a l
c l a i m s by
i l i n g
f o r
a r b i t r a t i o n w i t h FINRA. O t h e r t h a n
t h e
a s s e r t i o n t h a t banks a c t e d as a
u l e ,
t h e
b l o g p r o v i d e d
n o
a c t s s p e c i f i c
t o
t h e C i t y ' s
swap g r e e m e n t s o r swap
o u n t e r p a r t i e s ,
d i d
n o t
i d e n t i f y
any
p a r t i c u l a r m i s r e p r e s e n t a t i o n o r o m i s s i o n , and
d i d
n o t a d d r e s s
t h e f a c t
t h a t
t h e C i t y had
acknowledged p u b l i c l y
i t s
u n d e r s t a n d i n g
of
h e r i s k s
f o r
more
h a n
1 0 y e a r s .
On
eptember 1 8 , 2014, h e C i t y r e q u e s t e d
from
h e
u n i o n l e a d e r s
f a c t s
s u p p o r t i n g
t h e i r
a l l e g a t i o n s
of r a u d
and
o s s e s r e l a t e d
t o t h e C i t y ' s swap
a g r e e m e n t s . The C i t y h a s
n o t r e c e i v e d
a
e s p o n s e
t o
t h i s
r e q u e s t .
I n s t e a d ,
on
O c t o b e r
9,
014,
h e
u n i o n l e a d e r s s e n t t h e C i t y a
second
l e t t e r
(October e t t e r ) a g a i n u r g i n g t h e C i t y t o f i l e
an r b i t r a t i o n c l a i m
under
MS RB's Rule
G - 1 7
t o c h a l l e n g e t h e f i n a n c i a l i nd u s t r y ' s q u e s t i o n a b l e p r a c t i c e s t h a t
were p e r v a s i v e
w i t h m u n i c i p a l
swap e a l s — i n c l u d i n g
t h e
w i d e s p r e a d f a i l u r e
t o
a d e q u a t e l y
d i s c l o s e
r i s k s —an d h a t have
r e s u l t e d
i n
s t a t e s , i t i e s and s c h o o l d i s t r i c t s a c r o s s
t h e
c o u n t r y g e t t i n g
s t u c k
i n
t h e s e
g r o s s l y
u n f a i r
a r r a n g e m e n t s .
The
O c t o b e r L e t t e r , l i k e
t h e
September
e t t e r , p r o v i d e s
n o
a c t s s p e c i f i c
t o t h e C i t y ' s swap
a g r e e m e n t s ,
h e
C i t y ' s swap
o u n t e r p a r t i e s ,
o r t h e a l l e g e d
f a i l u r e t o
a d e q u a t e l y
d i s c l o s e
r i s k s a s s o c i a t e d
w i t h
t h e C i t y ' s
swap
a g r e e m e n t s . The
O c t o b e r l e t t e r
however, i s c l o s e d
t h e
u n i o n l e a d e r s ' p u r p o r t e d
l e g a l
b a s i s
f o r
f i l i n g
a
r a u d
o r u n f a i r
d e a l i n g
c l a i m
a g a i n s t t h e C i t y ' s
swap
o u n t e r p a r t i e s :
a
m e m o r a n d u m from h e
law i r m G r a i s
E l l s w o r t h LLP o S a q i b
B h a t t i
t i t l e d
P o t e n t i a l Claims by u b l i c
I s s u e r s
of y n t h e t i c
Fixed
- R a t e
Debt,
a t e d
O c t o b e r
9,
014. As
i s c u s s e d
i n
f u r t h e r d e t a i l
below,
h e
G r a i s
&Ellsworth
LLP
m e m o r a n d u m i k e w i s e p r o v i d e s n o a c t s
o r a l l e g a t i o n s s p e c i f i c t o
t h e
C i t y , t h e C i t y ' s
swap
a g r e e m e n t s , o r
t h e C i t y ' s
c o u n t e r p a r t i e s .
To
a t e , t h e C i t y
h a s
r e c e i v e d
n o
a d d i t i o n a l
i n f o r m a t i o n from
h e
u n i o n s r e l a t i n g
t o
t h e i r a l l e g a t i o n s
of r a u d
o r l o s s e s r e l a t e d t o
t h e C i t y ' s
i n t e r e s t
r a t e
swaps.
1 2
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 15/29
I I I .
THE
NVESTIG TION
A.
Scope
of
Review
The i t y r e t a i n e d
D r i n k e r
B i d d l e
and
Kopecky
Schumacher
o
c o n d u c t
an n d e p e n d e n t
a n a l y s i s
of
o t e n t i a l
c h a l l e n g e s
t o
t h e
C i t y s
e x i s t i n g
i n t e r e s t r a t e
swap
g r e e m e n t s
b a s e d
on
f r a u d ,
m i s r e p r e s e n t a t i o n s ,
o m i s s i o n s , o r u n f a i r
d e a l i n g t h r o u g h
a r b i t r a t i o n
o r t h e
c o u r t s . The
r e v i e w a l s o a n a l y z e d t h e a l l e g a ti o n s s e t
f o r t h
i n t h e
September
1 5 ,
2014 and
O c t o b e r 9, 014
l t t r s and
h e G r a i s
Ellsworth Memorandum , o d e t e r m i n e
w h e t h e r t h e
C i t y
h a s
any v i a b l e
c l a i m
t h a t
t h e
swap
c o u n t e r p a r t i e s
d e f r a u d e d
o r
f a i l e d
t o
d e a l
f a i r l y w i t h t h e C i t y .
B. Documents
Reviewed
We e q u e s t e d , r e c e i v e d , and
e v i e w e d
a p p r o x i m a t e l y
50
boxes
of
a r d - c o p y
documents
and
t h o u s a n d s of
a g e s
of
l e c t r o n i c
documents e l a t i n g t o
t h e C i t y s swap
r a n s a c t i o n s .
We
r e q u e s t e d
i n f o r m a t i o n
from
m u l t i p l e
s o u r c e s ,
i n c l u d i n g t h e
C i t y ,
and
t h e c u r r e n t
and
former
employees
d e n t i f i e d
b e l o w .
I n
a d d i t i o n
t o
t h e
m a t e r i a l s
w e
p e c i f i c a l l y
r e q u e s t e d ,
w e
e n c o u r a g e d t h e
C i t y
and
w i t n e s s e s t o
f u r n i s h any
t h e r documents r
i n f o r m a t i o n t h a t might be
r e l e v a n t t o t h i s r e v i e w .
A l l
of
u r r e q u e s t s
f o r i n f o r m a t i o n
were
m e t . We
l s o
r e v i e w e d
t h e
h u n d r e d s
of
ocuments e l a t i n g
t o t h e C i t y s bond
o f f e r i n g s
and swap
g r e e m e n t s a v a i l a b l e
t h r o u g h
t h e C i t y
of
h i c a g o s
w e b s i t e
and
h e
M u n i c i p a l S e c u r i t i e s
Rulemaking
B o a r d s
w e b s i t e .
Our
e v i e w i n c l ud e d t h e
documents
e l a t i n g
t o t h e
C i t y s
e x i s t i n g swap
r a n s a c t i o n s :
t h e
I n t e r e s t R a t e S w a p
o n f i r m a t i o n s ,
Amendments o I n t e r e s t R a t e
S w a p
o n f i r m a t i o n s ,
ISDA
Master
Agreements,
c h e d u l e s
t o t h e
M a s t e r
Agreements,
nd
C r e d i t
S u p p o r t
Annexes.We l s o
r e v i e w e d , t o t h e
e x t e n t t h e s e m a t e r i a l s
e x i s t e d ,
communications
between h e C i t y
and t s
swap
c o u n t e r p a r t i e s .
C.
Witness n t e r v i e w s
I n a d d i t i o n
t o t h e
a n a l y s i s of e c o r d s
d e s c r i b e d
above, w e
n t e r v i e w e d
n i n e
i n d i v i d u a l s .
These n t e r v i e w s a r e
summarized
b r i e f l y b e l o w . The
p u r p o s e of
h e s e
i n t e r v i e w s
i n c l u d e d
i d e n t i f y i n g
t h e
key
n d i v i d u a l s i n v o l v e d
i n t h e
n e g o t i a t i o n , e x e c u t i o n , and
management
of h e
C i t y s
i n t e r e s t r a t e
swap
g r e e m e n t s ,
u n d e r s t a n d i n g
t h e
C i t y s
p o l i c i e s
and p r o c e d u r e s
f o r u s i n g
i n t e r e s t r a t e swaps,
n d e r s t a n d i n g
t h e
r e p r e s e n t a t i o n s
m ade o t h e C i t y
b y t s
c o u n t e r p a r t i e s (and
p o t e n t i a l c o u n t e r p a r t i e s )
p r i o r t o and
o l l o w i n g t h e e x e c u t i o n
of
h e
swap
g r e e m e n t s ,
d e t e r m i n i n g
t h e C i t y s
u n d e r s t a n d i n g of
t s
swap
g r e e m e n t s and
h e
v a r i o u s r i s k s
and
b e n e f i t s
a s s o c i a t e d
w i t h
t h e s e
a g r e e m e n t s ,
u n d e r s t a n d i n g t h e C i t y s
e x p e r i e n c e and
x p e r t i s e
i n
e n t e r i n g
i n t o
complex
i n a n c i a l
a r r a n g e m e n t s , d e t e r m i n i n g t h e
C i t y s
d e b t
m a n a g e m e n t
o a l s
and
o b j e c t i v e s , and
i d e n t i f y i n g
any
m i s r e p r e s e n t a t i o n s o r
o m i s s i o n s of a c t
r e l a t e d t o
t h e
C i t y s swap
a g r e e m e n t s .
I f t h e C i t y
were
o
f i l
a
l a i m
a g a i n s t one
o r more
of
t s swap
c o u n t e r p a r t i e s ,
anum ber
of
h e s e
i n d i v i d u a l s
l i k e l y
would be
a l l e d
a s
w i t n e s s e s .
Each
n d i v i d u a l
d i s p l a y e d a
i g h l e v e l
of nowledge
and
u n d e r s t a n d i n g
of
h e swap
r a n s a c t i o n s .
None
e l i e v e t h a t
t h e C i t y was
d e f r a u d e d .
I n a d d i t i o n , t h e swap
r a n s a c t i o n
documents h e m s e l v e s
acknowledge h e l i m i t e d ,
13
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 16/29
non- f i d u c i a r y
r o l e of h e
banks t h e c o u n t e r p a r t i e s ) , and
make a f f i r m a t i v e
r e p r e s e n t a t i o n s
r e g a r d i n g t h e
C i t y s
u n d e r s t a n d i n g of h e t r a n s a c t i o n s .
As we i s c u s s
i n
g r e a t e r
d e t a i l
below
i n
t h e
A n a l y s i s
S e c t i o n ,
t h e
knowledge,
x p e r i e n c e ,
s o p h i s t i c a t i o n
and
a n t i c i p a t e d
t e s t i m o n y of
c u r r e n t and
former
members
of
h e C i t y s
d e b t
management
team,
l o n g
w i t h t h e
w r i t t e n
r e p r e s e n t a t i o n s made
n
t h e
swap
agreements and t h e
r i s k d i s c l o s u r e s
i n
t h e CAFRs
nd
2006
Swap
o l i c y ,
would
make
r o v i n g or
even
a l l e g Y n g
i n
good
a i t h )
a
r a u d u l e n t
m i s r e p r e s e n t a t i o n
o r omission
c l a i m e x t r e m e l y
c h a l l e n g i n g .
L o i s
S c o t t
Chief
i n a n c i a l O f f i c e r )
Lois
S c o t t
i s t h e
Chief i n a n c i a l O f f i c e r f o r t h e C i t y .
I n t h a t
r o l e , she
s
r e s p o n s i b l e
f o r
t h e l o n g - t e r m
f i n a n c i a l s t r a t e g y
f o r
t h e C i t y ,
i n c l u d i n g d e b t
management,
n v e s t o r o u t r e a c h and
d i s c l o s u r e ,
i n t e r e s t
r a t e
r i s k management, nd
a n a l y s i s of e n s i o n l i b i l i t y
and
funding s s u e s .
Before o i n i n g t h e C i t y
i n
2011,
Ms.
c o t t
w a s
o - f o u n d e r
and
P r e s i d e n t
of
h e
f i r m
S c o t t
B a l i c e
S t r a t e g i e s ,
LLC
h ic h
became
one
of h e
l a r g e s t
p u b l i c
f i n a n c e
a d v i s o r y
f i r m s
i n t h e c o u n t r y
and
s p e c i a l i z e d
i n
p u b l i c
f i n a n c e . Ms. c o t t
e a r n e d
h e r b a c h e l o r s
d e g r e e
and
M.B.A. t
C o r n e l l
U n i v e r s i t y .
Ms. c o t t
c u r r e n t l y o v e r s e e s t h e i s s u a n c e
of
h e
C i t y s
bonds
and
n o t e s
and
o v e r s e e s
t h e
C i t y s d e b t management
team.
Ms.
c o t t
e x p l a i n e d t h a t one
of e r
primary
r e s p o n s i b i l i t i e s
i s t o
r e g u l a r l y and
p r o a c t i v e l y
monitor t h e
C i t y s
o u t s t a n d i n g
bonds and swap
d e a l s
f o r any
o p p o r t u n i t y t o
produce s a v i n g s and r e d u c e
r i s k s . To
h a t
end, Ms.
c o t t
and
h e r
s t a f f
c o n s u l t
r e g u l a r l y
w i t h f i n a n c i a l
a d v i s o r s
t o
manage
h e
C i t y s
d e b t
p o r t f o l i o . That
ongoing r eview
has
r e s u l t e d
i n t h e C i t y e n t e r i n g
i n t o f i v e
b a s i s-swap
d e a l s i n
which
t h e
C i t y
r e n e g o t i a t e d
t h e
terms
of t s
p r e - e x i s t i n g
s w ap a g r e e m e n t s .
The
C i t y
a l s o
has
1) e r m i n a t e d
two
swaps;
2)
r e n e g o t i a t e d t h e terms
of
e r t a i n
of
t s
s w ap
agreements
t o
lower
h e c r e d i t
r a t i n g
l e v e l s
t h a t
c o u l d
t r i g g e r t e r m i n a t i o n payments
o
c o u n t e r a c t t h e C i t y s
r e c e n t
c r e d i t
downgrades, and
3)
r e n e g o t i a t e d
t h e
m a t u r i t y of
e r t a i n of h e
C i t y s
s w ap
agreements
o
r e d u c e i t s
c o u n t e r p a r t y
e x p o s u r e .
According
t o
Ms.
c o t t ,
t h e C i t y
remains committed t o
m i t i g a t i n g t h e r i s k s
a s s o c i a t e d
w i t h i t s
sw aps
and
g e n e r a t i n g
c o s t s
s a v i n g s where
p o s s i b l e ) on h o s e
swaps.
Ms. c o t t
b e l i e v e s t h a t t h e C i t y had
i n
t h e p a s t ,
and
c u r r e n t l y has
n p l a c e ,
a
o p h i s t i c a t e d
and
e x p e r i e n c e d
f i n a n c i a l
and d e b t management
team t h a t
u n d e r s t a n d s
t h e
r i s k s a s s o c i a t e d
w i t h
swaps,
n c l u d i n g t h e
c r e d i t
r a t i n g ,
i n t e r e s t ,
t e r m i n a t i o n ,
and
c o u n t e r p a r t y
r i s k s . Ms.
c o t t wa s
n o t
aware
of any m i s r e p r e s e n t a t i o n s
o r
o m i s s i o n s
of
a t e r i a l
f a c t
r e l a t e d
t o
t h e
C i t y s s w a p
a g r e e m e n t s . She b e l i e v e d
t h a t
t h e C i t y w a s
w e l l informed about
h e r i s k
f a c t o r s a s s o c i a t e d
w i t h
t h e
swaps
r e f e r e n c i n g
t h e
C i t y s 2006 Swap
o l i c y and
t h e
r i s k
d i s c l o s u r e s i n i t s
CAFRs).
2 .
Jeremy
F i n e
De~ut~ptroller)
Jeremy
F i n e j o i n e d t h e
C i t y i n
2003
s
an a s s i s t a n t
c o m p t r o l l e r
i n
t h e
d e b t management
group
and
became
Deputy
C o m p t r o l l e r i n
2007.
Mr.
i n e
c u r r e n t l y
r e p o r t s
d i r e c t l y t o
Lois S c o t t ,
t h e C i t y s
CFO
nd
C o m p t r o l l e r Dan
Widawsky.
P r i o r
t o
j o i n i n g t h e
C i t y , Mr. i n e
worked n
p u b l i c f i n a n c e ,
and
c o n c e n t r a t e d on
m u n i c i p a l
u n d e r w r i t i n g a t
L a S a l l e
Bank.
Mr. Fine e a r n e d
an
u n d e r g r a d u a t e d e g r e e
from
t h e
U n i t e d
S t a t e s
M i l i t a r y
Academy West
o i n t )
and
a
Masters n
B u s i n e s s
A d m i n i s t r a t i o n Finance)
rom
t h e
U n i v e r s i t y
of
otre
Dame.
14
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 17/29
A c c o r d i n g t o Mr.
i n e , h e C i t y
e n t e r e d i n t o swap a g r e e m e n t s
t h r o u g h
two methods:
1)
c o m p e t i t i v e
b i d a g r e e m e n t s
i n
which
h e C i t y
s o l i c i t e d s i m u l t a n e o u s
b i d s from
s e v e r a l f i n a n c i a l
i n s t i t u t i o n s a t one
i m e ) ,
and
2) e g o t i a t e d
a g r e e m e n t s . T h e m a j o r i t y
of
h e
C i t y ' s swaps were
p r o c u r e d t h r o u g h
a o m p e t i t i v e b i d p r o c e s s .
I f h e
C i t y e l e c t e d t o
u s e a
n e g o t i a t e d
p r o c u r e m e n t p r o c e s s ,
h e C i t y o b t a i n e d a t h i r d - p a r t y
o p i n i o n r e g a rd i n g t h e v a l u e
of h e swap
p r i c e d
on a
n e g o t i a t e d
b a s i s .
Mr.
i n e e x p l a i n e d
t h a t
u n d e r w r i t e r s
on
h e u n d e r l y i n g
bond
d e a l s
t y p i c a l l y would c o n t a c t t h e C i t y a b o u t
e n t e r i n g i n t o swap a g r e e m e n t s . T h e C i t y
g e n e r a l l y
r e t a i n e d
a
i n a n c i a l a d v i s o r t o
a d v i s e
on h e
u n d e r l y i n g bond o f f e r i n g and o
a s s e s s
t h e
swap
i d s
o r
n e g o t i a t e
t h e t e r m s
of
h e swap agreement
on
e h a l f
of h e
C i t y , and
i s s u e an
o p i n i o n on
h e
f a i r n e s s
of
h e p r o p o s e d swap
a g r e e m e n t .
Mr.
i n e
b e l i e v e s t h e
C i t y ' s
d e b t
management
team
was
e l l
i n f o r m e d a b o u t
t h e
r i s k
f a c t o r s a s s o c i a t e d
w i t h
swap a g r e e m e n t s .
B e f o r e
e n t e r i n g
i n t o
a
swap
a g r e e m e n t , h e C i t y
a n a l y z e d
t h e
t e r m s of
h e p r o p o s e d
a g r e e m e n t , h e
h i s t o r i c a l p e r f o r m a n c e
ofLIBOR
nd
SIFM
and
o t h e r i n t e r e s t r a t e
i n d e x e s ) , h e impact
of h e swap a g r e e m e n t s
on
h e
a v a i l a b i l i t y and c o s t
of
i q u i d i t y s u p p o r t
f o r o t h e r
C i t y
v a r i a b l e
r a t e p r o g r a m s , h e
c a l l
o p t i on v a l u e , h e
c o u n t e r p a r t y
r i s k ,
t h e
C i t y ' s
e x p o s u r e
t o
v a r i a b l e r a t e s
of
n t e r e s t ,
and
o t h e r
f a c t o r s
r e l a t i n g
t o
t h e
C i t y ' s
d e b t
p o r t f o l i o .
Mr.
i n e e x p l a i n e d t h a t
t h e
C i t y
h a s d i s cl o s e d p u b l i c l y
i n
i t s
C FR s i n c e
2004) nd
i n
i t s
2006 Swap o l i c y t h e
r i s k f a c t o r s t h a t t c o n s i d e r e d and h e
m eans
u s e d
t o m i t i g a t e t h o s e
r i s k s b e f o r e e n t e r i n g i n t o a swap
r a n s a c t i o n .
Mr.
i n e c o u l d
n o t
r e c a l l any i n s t a n c e i n which
a
swap
c o u n t e r p a r t y
o r
t h e C i t y ' s swap
a d v i s o r
f a i l e d
t o
d i s c l o s e
a
m a t e r i a l
f a c t ,
m i s r e p r e s e n t e d a
m a t e r i a l f a c t ,
a i l e d
t o
e x p l a i n
t h e
p r o d u c t o r
t h e
t e r m s
of h e
swap,
r w i t h h e l d any
n f o r m a t i o n re q u e s t e d by h e C i t y
o r
t h e
C i t y ' s f i n a n c i a l a d v i s o r s ) . While Mr. i n e
b e l i e v e s
t h a t
c o u n t e r p a r t y
d i s c l o s u r e s
r e l a t i n g
t o
t h e
swap a g r e e m e n t s have i n c r e a s e d
o v e r
t h e y e a r s , h e does n o t
b e l i e v e o r have
r e a s o n t o
b e l i e v e
t h a t
any
i n f o r m a t i o n
o r
r i s k
f a c t o r s were
m i s s t a t e d o r w i t h h e l d
from h e C i t y b e f o r e
i t
e n t e r e d
i n t o
t h e
swap
a g r e e m e n t s . Nor was Mr. i n e aware
of ny r a u d u l e n t
o r r e c k l e s s c o n d u c t
by
h e
swap c o u n t e r p a r t i e s .
Mr.
i n e
b e l i e v e s
t h a t
t h e
C i t y ' s
swaps
e n e f i t t e d
t a x p a y e r s and
t h a t
t h e
C i t y
o b t a i n e d
t h e
b e s t d e a l s
t
c o u l d b a s e d on
h e
m a r k e t
c o n d i t i o n s
e x i s t i n g a t t h e t i m e
t
e n t e r e d
i n t o
t h e
swap a g r e e m e n t s .
Michele
C u r r a n A s s i s t a n t
C o m p t r o l l e r )
Michele
C u r r a n became an A s s i s t a n t
C o m p t r o l l e r i n 2007.
P r i o r t o
t h a t , s h e
was
employed by h e C i t y
a s
a
e s e a r c h
a n a l y s t
s t a r t i n g
i n 2000.
Ms.
u r r a n
e a r n e d an u n d e r g r a d u a t e
d e g r e e
B.S.
i n a n c e )
from
t h e
U n i v e r s i t y
of
l l i n o i s a t
Chicago
and
a
M a s t e r s
i n
B u s i n e s s
A d m i n i s t r a t i o n
from DePaul n i v e r s i t y
( F i n a n c e ) . Ms.
u r r a n c u r r e n t l y
r e p o r t s
d i r e c t l y t o
Deputy
C o m p t r o l l e r Jeremy F i n e and
CFO
o i s
S c o t t .
Ms. u r r a n h a s
been i n v o l v e d i n t h e C i t y ' s
swap a g r e e m e n t s s i n c e
2003,
nd
h a s p l a y e d
an a c t i v e r o l e
i n t h e
p r o c u r e m e n t and
a d m i n i s t r a t i o n
of
h e
a g r e e m e n t s
s i n c e 2007. Ms.
u r r a n
e x p l a i n e d t h a t t h e C i t y
was e l l i n f o r m e d a b o u t
t h e
r i s k s a s s o c i a t e d
w i t h swap
a g r e e m e n t s .
Th e
C i t y worked
w i t h
s o p h i s t i c a t e d
f i n a n c i a l a d v i s o r s w h o
p e c i a l i z e d
i n
swap
d e a l s .
These
a d v i s o r s
would
a n a l y z e swap e r m s
s h e e t s , a t t e n d
m e e t i n g s w i t h
f i n a n c i a l s e r v i c e
companies h a t
p r o p o s e d
f i n a n c i n g
s t r u c t u r e s
i n c l u d i n g
s w a p s ) , n e g o t i a t e t h e
t e r m s
of h e swap
a g r e e m e n t s ,
i d e n t i f y and communicate
r i s k
f a c t o r s
t o
t h e
C i t y , and i s s u e
o p i n i o n s
r e g a r d i ng t h e
f a i r n e s s
of
h e
15
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 18/29
p r o p o
s e d t r a n
s a c t i o n s .
The i t y
a l s o
u n d e
r s t o o d
t h e imp
act
h a t
v a r i
o u s
r i s
k f a c t o
r s
c o u l
d
have
on h e
p e r f
o r m a n c e
of h e
swa p a g r e e m
e n t s .
T h i s i
n c l u d e d t h e
r i s k
t
h a t t h e i
n t e r e s t
d
ue u
n d e r a
v a r i a b l
e
-
r a t e agreeme
nt o u l d
f l
l
be
low
h
e
s y n t h e t i
c f
i x e d
r a t e p aym
ent a i d
t o
t h
e b
ank
c o u n t
e r p a r t i e s
.
Ms.
u r r a n
b e l i e v e s
t h a t
t h e C i t y
g o t
t h e
b e s t
d e a l
t h a t
t
c o u l d b a s e d
on
market
c o n d
i t i o n s
a t
t h e
t i m e
t
e n t e r e d
i n t o
t h e
sw
a p
a g r
e e m e n t s .
Ms.
u
r r a n
wa s
n o t
awa
re
of
ny
f
r a u d u l e n t
c o n d u c t
, m a t e r i
a l m i s
r e p r e s e n t
a t i o n s of
a c t ,
o r
m a t e r
i a l o m i s s
i o n s
o
f
a c t
r e l a t e d
t
o
t h e
C i
t y s
swa
ps.
4 . B r i a n
Ki
ng f o r
m e r
De
puty
C o m p t r
o l l e r )
B r i
a n
King s e
r v e d a s Deput
y
C
o m p t r o l l e
r from
1999
o
2006.
C
u r r e n t l y ,
Mr. King
s
a
Managi
ng
D i r e c t o
r
of
u b l i c
F i n a n c e
a t
Mesi r o
w
i n
a n c i a l .
Mr.
K
ing ha s
o v e
r
2
0
e a r s
of
p u b l
i c
f i n a
n c e
e x p e r i
e n c e .
Mr.
Ki
ng
e a r
n e d h i s
b a c h
e l o r s d e g
r e e
from Knox
C o l
l e g e
and a
M a s t e r
s
o
f
Managem e
nt
fro
m N o r t
h w e s t e r n
U n i v e r s i
t y .
s
Dep uty C o m p t r
o l l e r ,
Mr.
King
work
ed on
l l
of
h e C i t y
s
swa p a g r e e
m e n t s
from
1
999
h r o
u g h 20
06.
Mr .
K
ing
e x p
l a i n e d
t h a t
t
h e m a j o r i
t y
o
f
h e
C i t y s swaps
were
p r o c u r
e d
t h r o u g
h
c o m p
e t i t i v e b i d
p r o c e s
s e s . For
h o s e swaps r o
c u r e d
t
h r o u g h n
e g o t i a t i o n
, Mr
.
Ki
ng
b e l i
e v e d t h a t t h e c o
u n t e r p a r t i
e s d
e a l t
w i t h
t h e C i
t y
i n
g
ood
a i t h .
Mr. King
e
x p l a i n e d
t h a t swa p
c o u n t e r p
a r t i e s
ha d
an
n c e
n t i v e t o d e a l
w i t h t h e
C i t y
i n
good
a
i t h
b
e c a u s e t h e
banks
wanted o
conduc
t
u t u r e
b u s i n e s
s
w i t h
t h e C
i t y .
A c c o r d i
n g
t o
Mr. Ki
ng, h e C i
t y would n o
t do b u s i n e s s
w i t h a
o u n t e r p a r
t y
i t b e l
i e v e d t o be
i
s h o n e s t .
Mr.
King b e l i e v e d
t h a t
t h e
C i t y
was
w e l l i n f o r m
e d
a
b o u t t h
e
r i
s k s a s s o c i a
t e d
w i t h
swap
a g
r e e m e n t s .
m
ong t s e
mployees
and
i n a n c
i a l
a d v i s
o r s ,
t
h e
C i t y
f r e q u e
n t l y
d i
s c u s s e d
c o u n t e r p
a r t y
r i s k s ,
c r e d
i t r i
s k s , b a s i s
r i s k s ,
t a x
r
i s k s ,
and
t e r m
i n a t i o n
r
i s k s .
Mr .
Ki
ng b e l i e
v e d
t h a t t h e C i t y
g o t
t h e
b e s t
d
e a l t c o u
l d b a s
e d on
marke
t o
n d i t i o n s
a t
t
h e
t i m e
t
e n t e r e d
i n t o
t h
e
swa p a g r e e m
e n t s .
Mr.
Ki
ng
wa s o t
awar e
of n
y
r
a u d u l e n t
c o n d u c t ,
m a t e r i a
l
m i s r
e p r e s e n t a
t i o n s of
a c t ,
o r
m a t e r i
a l o m i s s i o
n s
of
a c t r e l a t e d
t o
t h e C i t
y s
s
waps.
5 .
D a n a
Leve
nson fo
rmer CFO
D a n
a L
ev enson
s e
r v e d
a s
Chie
f
i n a n c
i a l O f f i c e r
fr
om
a
p p r o x i m a
t e l y S
eptember
2 0
0 4 o
Ma r ch
2007.
Mr.
L
evenson
g r a d u
a t e d from
Brown
n i v e r s i
t y i
n
1979
and o b t a i n e d
a
M a s t e r
s
i
n
B u s
i n e s s
A d m
i n i s t r a t i
o n fr om
Ne
w
or k
n i v e r s
i t y .
P r i o r
t o
j o i
n i n g t
h e C i t
y ,
Mr.
ev
enson
wo
rked
i n i n v
e s t m e n t
b a n k
i n g f o r more
h a
n
2 5
y e
a r s ,
p e r f o r
m i n g n
umerous
o r p o r a
t e
an
d
m u n i
c i p a l d e b
t
f i n
a n c i n g s
and
n t
e r e s t
r
a t e
swaps.
Mr .
ev e
nson
b e l i e
v e d t h a t
t h e
d e b t
m a nagem
ent
team
a
t
t h e C
i t y
d u r i n
g h i s
t
e n u r e
wa s
b o t h
e
x p e r i e n c e
d
and k n o w l
e d g e a b l e
.
F u r t h e r
,
b e c a u s e
of
i s
own x p
e r i e n c e ,
he wa s
n v o l v e d
i n
t h e
C
i t y s
bon
d
i s
s u a n c e s ,
i
n c l u d i n g
v a r i a b l e
r
a t e
de m a nd o b l i g a t
i o n s
and n t e
r e s t
r a t e s
wa ps.
He
nd t h e d e b t
m a n a ge
m ent team
u
n d e r s t o o d
t h e
r i
s k s
o
f
uch
r a n s a
c t i o n s . I n d e e d ,
he
p
a r t i c i p a t e
d i n i d e n t i f y
i n g
and r a f t
i n g t h e r i s k s
a s s
o c i a t e d w i t h
t h e
swap
r a n s a c t i o n
s
f o r
t h e
C i t y s
C FR
s nd h e C i t y
s 2 0 0 6
n
t e r e s t
R
a t e S wa p
o l i c y .
Mr .
Leven
son n o t e d
t h a t
a t t h e
t
i m e
of
h e s
e t r a n s a
c t i o n s ,
t
h e C i t y
s c r e
d i t
r
a t i n g w
a s t
a
2 0
- y e a r
h i g h , b u t
f u r t h e
r
n
o t e d
t h a t he
16
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 19/29
f u l
l y
u n
d e r s
t o o d
t h a t down
grad
es
n t h e
C i
t y s
c
r e d i
t r a t
i n g s
c
o u l d
imp
act h e
c o s t of
a p i
t a l .
Wh
ile he d
i d
n
o t e
x p e c
t
t h a t
r i s k t o
be
e a l i z
e d ,
he
u n
d e r s
t o o d
t h i s
r i s k
a t
t h e
t i
m e
t h
e C i
t y
e n t
e r e d
i n t
o
t h
e
sw a
p
a g r e e
m e n t
s .
Mr
. Lev
enso
n
d
i d n
o t b e
l i e v
e t
h a t any
a c
t u a l o r
p
o t e n t
i a l
c o u
n t e r p
a r t i e
s
m
i s r e
p r e s e
n t e d
t h
a t
r i s k
t
o t h e
C i t y ,
a
nd h
e
b e
l i e v
e d
t h a
t t h e
r e s t
of
h e C
i t y
s d e b
t
m a
n age
m ent
tea
m
l i
k e w i
s e u n d
e r s t
o o d
t h
a t r i s k .
Du
ring
M
r.
e v e
n s o n
s
t e
n u r e ,
t h
e C i
t y u
s e d
f i n a
n c i a l
a d v
i s o r s
and
s
wap a d v
i s o r s
t o
c o n s
u l t on
t h
e
t r a n
s a c t i
o n s . e
i d
n o t
b e l i e
v e
t h a
t
a
ny of
h
e s e a d
v i s o r
s , bo
nd u n d e
r w r i t
e r s
o r
s
w ap
o u n t
e r p a
r t i e s
down
play
ed o r
t
r i e d
t o
min
imiz
e t h e
r i s
k s of
h e
t r a n
s a c t i
o n s .
M
r. L
even
son
wa s
n o t awa
re
o
f a
ny
m i s
r e p r e
s e n t
a t i o n
o r
o m
i s s i o
n m
a d e
n
c
o n n e
c t i o n
w i t h
an
y of
h e
C i t y
s
s w
a p
r a n s a
c t i o n
s .
6 .
T
a r i q
Malh
anc
e
f o r
m e r Com
ptro
ller
T a r
i q
M
alha
nce t a r t
e d a t
t h e
C i t
y i n
1
981
a s
a
n
A
c c o u n
t a n t
f o r t h
e C i t
y C o m
p t r o l
l e r
s
O f f i c
e . I n
200
2
he
be
c am e
t h e
C o m p t
r o l l
e r
an
d
r
emai
ned
i n
t h i s
p o s
i t i o n
u n t i
l D e c
e m b
e r
2005
.
Mr.
Malhance
h o l d s
a
B a c h e l o r
of
c i e n c e
and
a
M a s t e r s
i n
B u s i n e s s
A d m i n i s t r a t i o n
from
R
o o s e
v e l t
U n
i v e r
s i t y ,
an
M.A
.
n
Ec
onom
ics
fr
om
t h e U n i
v e r s
i t y
o f l l
i n o i s
a t
C h i
c a g o
, and
f
i n i s h
e d
t
h e
co
urse
work
f
o r
a
Ph.D
.
n
P u b l i
c P o l i
c y A n a l
y s i s a t
t
h e U n
i v e r
s i t y
of
l
l i n o i
s a t
C h
i c a g
o .
C u r r
e n t l y
,
Mr.
M
alha
nce
s e r v e
s
i n
t h
e
P u
b l i c
F
i n a n
c e
Grou
p
a t
H i
l l i a r
d
Lyon
s.
I n
h i s
r o l e s
a
t
t h e
C i t
y ,
Mr.
M
alha
nce
ove
rsaw
t
h e i
s s u a n
c e
o
f e b t ,
i n c l
u d i n
g d e b t
t r a n
s a c t
i o n s
w i
t h i n t e r
e s t
r a t e
swap
s.
Mr
.
Ma
lhan
ce
c u
r r e n
t l y
h a s
i t t l
r e c
o l l e c
t i o n of
h e
d e t
a i l s
of
any
s p
e c i f i
c sw
ap
r a n s a
c t i o
n .
e
i d
r e
m em
be r
h e
t e r
m i n a t
i o n
of
an
i n t e r
e s t
r a t e
s
w a p
w i
t h
Bea
r
S t e a r
n s
t h
a t r e
s u l t
e d i n a
r o
f i t
t o t h
e
C i
t y .
A c
c o r d
i n g
t o
Mr.
Malh
ance
Bea
r
S
t e a r n
s p a
i d
t h e
C i t
y
a
s u b s t
a n t i a
l t e r m i
n a t i
o n
f e e
.
e
x p l a
i n e d
h i
s
kno
wled
ge
and
u n d e
r s t a
n d i n g
o f
wap
t r a n
s a c t
i o n s ,
and
u
s e d t
h e exa
mple
of
h e
B e a
r s S t e a r
n s
s wa
p
a
s a
i t u a t
i o n
t h a
t
t
u r n e d
a
r o
f i t
f o r
t h e
C i t y .
Mr.
Malhance
s t a t e d t h a t
t h e C i t
y c
o n s i s
t e n t
l y t r i e
d
t
o k
eep
t s c o s t
o
f
a
p i t a l
l
ow
an
d
u s e
d a
c o m b
i n a t
i o n o f
i x e d
and
v a r i a
b l e
r a t e d e b t
i n a
n
f f o r
t t o d o
s o .
Th
e C i t y
u s e d
f i n
a n c i
a l
a
d v i s o
r s
and
s wa
p
a d v i s
o r s
t o
a s
s i s t i t
M
r.
Mal
hanc
e
doe
s
n o t
b e
l i e v e
t
h a t
a
ban
k c o u
n t e r
p a r t y
o r u
n d e r
w r i t e
r
m i
s l e d
t h e
C i
t y ,
o r
t h a t
t h e
C i
t y d i d
n o t
u n d e r
s t a n
d t h e
r i s k s
i
n v o l
v e d
i
n
t h
e
t r a n s
a c t i o
n s . e
s
n o
t a
waxe
of
any
m i
s r e p
r e s e n
t a t i
o n o r
o m i s
s i o n
m a
d e
n
c o
n n e c
t i o n
w i t h
any
of
h e
C i t y
s s
w a p
r a n s a
c t i o n
s .
7 .
S t
e v e
L u
x
f
o r m e
r
C
ompt
rol
ler
S t
e v e
L u x
s e r v e
d t h e
C i t y
i n
v a
r i o u s
p o s
i t i o
n s
fr
om 1
996
o
2
011.
e
r a d u
a t e d
fro
m
t h
e
U n i v e
r s i t
y
o f
l l i n
o i s
w i t h
a
B a c
h e l o
r of
c i e n c
e
i n A
c c o u
n t i n
g i n 1
9 86 an
d i
s
a
C e
r t i f i
e d
P u b
l i c
A c
c o u n
t a n t
. e
o i n e d
Tou che
Ross where he
s p e n t
e a r s a s
an
a u d i t o r ,
w i t h
t h e C i t y
a s
a
c l i e n
t .
I
n
1996
h
e
o i
n e d
t h e
C i
t y a
s
a
d e
p u t y
c
o m p t
r o l l e
r f o
r
g
e n e r a
l
a
c c o u n
t i n g
.
e
b
e c a
m e
t
h e
C i t y
s C o m
p t r o
l l e r
i n
2 00
6 and
f t
t
h e
C
i t y
i n
J u l
y
20
11. e
a t e
r be c a
m e t h
e
Ch
ief
F i
n a n c
i a l O
f f i c
e r
a t t h
e Ch
ica
go
Park
D
i s t r i
c t ,
a
o s i t i
o n
t h a t
he
c o n t
i n u e
s t o h o
l d .
I n h i s r
o l e a t t
h e C
i t y ,
Mr.
L u
x
w
a s n v o
l v e d
w i
t h
r u n
n i n g
h i
s t o r i
c a l d a t a
a
nd
c a l
c u l a t
i n g
f
i n a n c
i a l
p r o
j e c t i
o n s
t o b
e i n c
l u d e d
i n
t h
e
o f f e
r i n g
d
ocum
ents
o r
t h
e
C i
t y s b
ond
i s s u a
n c e s
,
i n c
l u d i n
g
v
a r i a b
l e
r a t e
d e
m a n d
o b l i
g a t i
o n s w i
t h
i
n t e r e
s t
r a t e
sw
aps.
e
e
l i e v
e d
t h a t
t h e
C i
t y
1 7
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 20/29
f u l l y
u n d e r s t o o d
t h e
r i s k s
i n v o l v e d
i n
t h e s e
t r a n s a c t i o n s ,
and
he
was
n v o l v e d
i n
p r e p a r i n g
d i s c l o s u r e s of h o s e r i s k s .
Mr.
Lux
c o n f i r m e d t h a t
a t t h e t i m e
of n t e r i n g i n t o
t h e
swap
a g r e e m e n t s ,
he
u n d e r s t o o d
t h e
r i s k t h a t
t h e
C i t y s
c r e d i t
r a t i n g s
c o u l d
be
downgraded l t h o u g h
he d i d
n o t
b e l i e v e t h a t
t h e
downgrades would
happen
t o
t h e
e x t e n t
t h a t
t h e y h a v e . He
b e l i e v e d
t h a t
t h e
u s e of
n t e r e s t
r a t e
swaps s a v e d t h e
C i t y
s u b s t a n t i a l c a p i t a l c o s t s a s
compared
t o
i s s u i n g
c o n v e n t i o n a l ,
i x e d - r a t e
d e b t
a t
t h e t i m e ,
t h a t
t h e
swaps
r e
s t i l l working
i n
t h e
C i t y s
f a v o r
t o d a y , and t h a t
t h e swaps m ay
l t i m a t e l y s a v e
a d d i t i o n a l t a x p a y e r f u n d s .
F i n a l l y ,
Mr. Lux s t a t e d
t h a t
t h e C i t y
r e t a i n e d s o p h i s t i c a t e d
c o u n s e l
and
a d v i s o r s
on
t h e
t r a n s a c t i o n s ,
and
he d i d
n o t
b e l i e v e t h e
swap
c o u n t e r p a r t i e s
o r b r o k e r- d e a l e r s and
a d v i s o r s m i s l e d t h e
C i t y .
Mr. Lux s
n o t
aware
of
any m i s r e p r e s e n t a t i o n s
o r o m i s s i o n s m a d e n
c o n n e c t i o n w i t h
any
of h e C i t y s
swap
t r a n s a c t i o n s .
8 .
P a u l Volpeformer CFO)
P a u l
Volpe
g r a d u a t e d
from N o r t h e a s t e r n
U n i v e r s i t y
w i t h
a
L i b e r a l A r t s
d e g r e e i n
1 9 9 1 .
A f t e r g r a d u a t i o n ,
he worked i n r e t a i l
b a n k i n g u n t i l
j o i n i n g t h e
F i n a n c e
D i v i s i o n of h e C i t y s
A v i a t i o n
Department
n
1 9 9 5 .
He
orked
on
m a ny
d e b t
- r e l a t e d
t r a n s a c t i o n s
w h i l e w i t h t h e
A v i a t i o n
D e p a r t m e n t , and mov e d
t o t h e C i t y s
budget
o f f i c e
i n June 2005
where he b e c a m e
t h e
C i t y s
b u d g e t
d i r e c t o r . I n
June 2007
Mr. Volpe
b e c a m e t h e
C i t y s
Chief
i n a n c i a l O f f i c e r,
and
s e r v e d a s CFO
n t i l
he
was
n a m e d
former Mayor D a l e y s
Chief of t a f f
n
D e c e m b er
2008. He
i s
n o w
t h e V i l l a g e Manager of h e V i l l a g e
of
Elmwoo d
P a r k ,
l l i n o i s
Mr.
Volpe
d i d
n o t have
any s p e c i f i c
r e c o l l e c t i o n of any
p a r t i c u l a r
bond
o r
swap
t r a n s a c t i o n . He t a t e d ,
however
h a t t h e C i t y
u s e d i n t e r e s t r a t e swaps
n
a n
e f f o r t
t o
s a v e
on
h e
c o s t
of
a p i t a l
and m i t i g a t e t h e r i s k s
of
a r i a b l e
r a t e bond s s u e s .
Mr. Volpe
r e p o r t e d t h a t
t h e
C i t y
g e n e r a l l y
r e t a i n e d l a w y e r s and
o u t s i d e a d v i s o r s and
had an
e x p e r i e n c e d , k n o w l e d g e a b l e
t eam
w i t h i n t h e
C i t y t o r e v i e w and n e g o t i a t e
t r a n s a c t i o n s .
I f
anyone
d e t e c t e d
a
m i s r e p r e s e n t a t i o n
o r o m i s s i o n ,
he
b e l i e v e d
i t
would
have been
v o i c e d . He
u r t h e r
b e l i e v e d
t h a t
g i v e n
t h e
number
of
banks
n v o l v e d
and t h e
number
of r e s e n t a t i o n s t h e
C i t y a t t e n d e d ,
i f any
one
bank
a t t e m p t e d t o m i s r e p r e s e n t a
m a t e r i a l f a c t ,
t h e
C i t y
would
have
r e c o g n i z e d i t o r
i d e n t i f i e d
i t a s a r e d f l a g , o r a competing
bank
would
have
d i s c o v e r e d
i t
and
b r o u g h t
t
t o
t h e
C i t y s
a t t e n t i o n .
Mr.
Volpe b e l i e v e d
t h a t t h e
C i t y u n d e r s t o o d t h e
r i s k s i n v o l v e d
i n swap
t r a n s a c t i o n s .
W hi l e he d i d
n o t p e r s o n a l l y
b e l i e v e
t h a t
t h e C i t y s
c r e d i t
r a t i n g
would
be
downgraded h e
u n d e r s t o o d and was d v i s e d
of
h e
r i s k
of
such a downgrade and
t h e
impact
t would
have u n d e r
t h e
swap
a g r e e m e n t s a t t h e t i m e t h e C i t y
e n t e r e d
i n t o
t h e s e
t r a n s a c t i o n s . I n t h a t
r e g a r d , h e
s t a t e d
t h a t he
k n e w
more a b o u t
t h e C i t y s c r e d i t
w o r t h i n e s s
t h a n
t h e
swap c o u n t e r p a r t i e s
and
b r o k e r
-
d e a l e r s .
Mr.
Volpe
was
n o t
aware
of any
m i s r e p r e s e n t a t i o n s
o r
o m i s s i o n s m a d e
n c o n n e c t i o n
w i t h
any
of
h e
C i t y s
swap
t r a n s a c t i o n s .
9 .
W a l t e r
Knorr
f o r m e r
CFO)
W a l t e r
Knorr
g r a d u a t e d
from
W i t t e n b e r g
U n i v e r s i t y i n
1971 and
b e c a m e a C e r t i f i e d
P u b l i c A c c o u n t a n t a t
A r t h u r
Youn g
Company n t h e
a u d i t
d e p a r t m e n t .
He
o i n e d
t h e C i t y
i n
1 9 8 2
s A s s i s t a n t
Deputy
C o n t r o l l e r , and remained
w i t h t h e C i t y ,
r i s i n g t o
Comptroller/CFO
18
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 21/29
b e f o
r e he
e f t t h e
C i t y
i n
2002.
Mr
. Knorr
went
o n
t o
w
ork
f o r C i t i
b a n k
and
s
c u r r e n
t l y
t
h e Vic
e
P r e s i d e
n t , Chie
f i n
a n c i a l
O f f i
c e r , and
C o m p t r
o l l e r
f
o r
t
h e U n i v e r s
i t y
of
l l i n
o i s
M
r. Kno
rr s t a t e
d
t h
a t t h e C i t y
t
o o k
a c o n
s e r v a t i
v e
a
p p r o a c
h
t o
i
n t e r e s t
r a t e
sw
ap
t r a n s
a c t i o n s
.
I n
t
h e
m
i d- 1 9 9 0
s , ban
ks be
gan t o
p r e s e n
t swaps
a s
r i
s k
ma
n ageme
nt
o o l s
.
Mr
.
Knorr
d i d
n o t
want
h e C i t y
t o
be
one
of
h e
f i r s t
m u n i c i p a l i t i e s t o e n t e r
i n t o
su ch
t r a n s a c t i o n s
a n d ,
h e r e f o r
e ,
t
h e
C i t y m
o n i t o r
e d
t h e
sw
a p
ma r
ket p r i o r t o
e n t e r i
n g i n t
o
swap
s
o n
t s
own
b e h a
l f .
Mr.
Knorr
a l s o
rem
embe r
e d
s i t
t i n g t h
r o u g h a
n umbe
r of r
e s e n t a t
i o n s
t h a
t
d i s c u s
s e d t h e
r i s k s a
s s o c i a t
e d
w
i t h
s
wa p t r a n
s a c t i o n
s ,
i n c l u
d i n g
i n
t e r e s t
r a t e
r i s k
c r
e d i t
r
i s k
t h
e
r i s k
o
f a
c o u
n t e r p a
r t y ' s c r e d
i t
r a t i
n g
s u f f e r i
n g a down
grade ,
a
nd
b a s i s
r i s k .
e
oes
n o
t
b e l i
e v e any
c o u n
t e r p a r t
y
downpl
a yed
r i s k
s
o r
t r i
e d t o m i s l e a
d t h e
C i t y
b y
m i s r e p r
e s e n t i n
g o r o
m i t t i n g
a
m
a t e r i a l
f a c
t . Nor
s
h
e a
ware
o
f an
y a c t
s t h
a t
s u p p o r
t a
r a u d
o r
o t h e
r
c l a i
m
b y
t h e C i
t y
a g
a i n s t
i t s
c o
u n t e r p a
r t i e s
r e l
a t i n g t o
t h e
swa p
r a n
s a c t i o n
s e
n t e r e d
i n t o
d u r
i n g
h i s
t i m e a t t h e
C i t y .
IV .
N
LYSIS
We
ave
c o n c l u d e d
t h a t
t h e C i t y
does n o t
have
a
go od
a i t h
l e
g a l b a s i s
upon
w
hich
t o
a
l l e g e u
n f a i r o r f r a u d u
l e n t
c o
n d u c t
b y
t h
e ba
nk
c
o u n t e r p
a r t i e s
t o t h e
C i t y ' s
swap t r
a n s a c t i
o n s .
We
n a l y z e
d
t h e C i t y '
s
e x i s t
i n g
swa
p
t
r a n s a c t
i o n s
u
n d e r
t h e
f e d e r a
l s
e c u r i t i
e s
l a w s
, h e
I l l i
n o i s
s e
c u r i t i e
s
l a w s ,
and
FINR
r b i
t r a t i o n
r u l e s .
A
.
Fr
a u d
Bas
e d
C la i
ms
-
n
xami na
ti on o
f h e
C i t y
' s Sw
ap
Deals
Unc
ov ere d
No v i
de nc e
of
a
Ma t
erial
M i s r e
p r e s e n
t a t i o n or
O
missi
on
of
Fa
ct
1 .
Feder
al e c u r
i t i e s Law
s laim
s
We
ound
no e v i d e n c
e
t h a
t
would
s
u p p o r t
a goo
d f
a i t h
c
l a i m
a g a i n
s t
t h
e
C i t y '
s
c o u
n t e r p a r
t i e s
f o r
a
v i
o l a t i o n
of
h e f e d e
r a l
s e c u
r i t i e s
l a
w s .
S e
c t i o n
1 0 b )
o f
h e
S e c u r i t
i e s
E
xch an
ge Ac
t
ma
kes
t
u
n l a w f u
l f o r
any p e r s
o n
t o use o r
employ
, n
c o n n e c t
i o n w i t
h t h e
p u
r c h a s e
o r
s a l e of a
ny s
e c u r i t y
an
y m
a n i p u l a
t i v e o r d e
c e p t i v e
d e v
i c e
o r c o n t r
i v a n c e
i n
c o n t r a v
e n t i o n o
f
such
r u l e s
and
r
e g u l a t i
o n s a s t h
e
C o
mmiss
ion
ma y
p
r e s c r i b
e a s
n e c e
s s a r y o r
a p p r o p r
i a t e i n
t h e p u
b l i c
i
n t e r e s t
o r
f
o r
t
h e
p r o t
e c t i o n
o
f
n v e s t
o r s . 15
U.S
.C. §
8 j ( b
) . SEC
Rule
l O b - 5
i
mpleme
nts
h i s p r o
v i s i o n b y
ma ki n
g t
u n l a
w f u l ,
a m o n g
o t h e r t h i n
g s , t
o ma k
e
any
u n t r
u e
s t a t
e m e n t
of
a
m a t e
r i a l
f a c t
o
r
t o omi
t o s t a t
e
a
m a t e r i
a l
f a c t
n e
c e s s a r y
i n o r d e
r t o
m ake
t h e
s t a t e
m e n t s ma
de ,
n
l i g h t
of
h e c i r c
u m s t a n c
e s
u n d e r
whic
h
t h e y
w
ere ma de ,
o t m i s l e a
d i n g .
1 7
CF
R
4 0 . 1 O b -
5 ( b ) .
T h e
U n i
t e d
S t a t e
s
S upre
me
C o u r t
h a
s
r e c o g
n i z e d
an
i m p l
i e d
p r i v a
t e
c a u s
e
o
f c t
i o n fr
om t h e
t e
x t
and p u r
p o s e
of
§ 1 0 ( b ) .
See
T e l l a b
s ,
I n
c .
v
M
akor s s u
e s
&Right
s,
L t d
. ,
5 5 1 U.S. 308,
3
1 8 2 0 0
7 ) .
For
t h e C i t y
t o
p r e v a i l
o n a
l a i m
t h a t
a
o u n t e r p a r t y
ma d e
a
m a t e r i a l m i s r e p r e s e n t a t i o n
o r
o m i s
s i o n i
n v i o l a
t i o n
o
f §
1 0 b )
an
d
Ru
le l O b - 5
,
t mu
st l l
e g e and
p r o v e
(1)
a
m a t e r i
a l
m i s
r e p r e s
e n t a t i o
n
o
r
o m i s s
i o n
b y
t h
e d e
f e n d a n t
;
(
2 ) c i e
n t e r ;
( 3 )
c
o n n e c t i
o n b
etween
t h e
m
i s r e p r e
s e n t a t i
o n
o r
o m
i s s i o n
and
t h e p
u r c h a s
e
o r s a l e
o
f
a s e c u r i
t y ;
( 4)
e l i a n c
e
upon
t h e
m i s r e p r
e s e n t a t
i o n
o r
o m i s
s i o n ;
5 ) c
onomic
l o s s ;
and ( 6)
o s s
c a
u s a t i o n
.
S t o n
e r i d g e
I
n v e s t m
e n t P a r
t n e r s ,
LLC
S c i e n t i
f i c - A t l a
n t a ,
I
n c . ,
5 5 2
U
.S.
148,
1 5 7
2 0 0 8 )
.
1 9
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 22/29
i s r e p r e s e n t a t i o n o r o m i s s i o n i s
m a t e r i a l
when
h e r e
i s a
u b s t a n t i a l l i k e l i h o o d
t h a t
t h e
d i s c l o s u r e
of
h e o m i t t e d f a c t
would
have been
viewed b y h e
r e a s o n a b l e
i n v e s t o r a s
h a v i n g
s i g n i f i c a n t l y
a l t e r e d
t h e
` t o t a l
mix'
of
n f o r m a t i o n made
v a i l a b l e . Basic
n c . v
L e v i n s o n ,
485
U.S.
224, 31-32 1 9 8 8 ) . The
i t y
a l s o must
s t a b l i s h
t h a t
t h e swap
o u n t e r p a r t y
a c t e d w i t h a
m e n t a l
s t a t e
embracing
n t e n t
t o d e c e i v e ,
m a n i p u l a t e ,
o r
d e f r a u d .
T e l l a b s ,
551 U.S. t 319,
.
3 .
o m p l a i n t a d e q u a t e l y p l e a d s f r a u d u l e n t
i n t e n t
only
f
a
e a s o n a b l e p e r s o n
would
deem
h e
i n f e r e n c e
of
c i e n t e r c o g e n t and a t
l e a s t
a s
c o m p e l l i n g a s
any
p p o s i n g i n f e r e n c e
one
o u l d
draw
from
t h e
f a c t s
a l l e g e d . I d . a t 324.
A c c o r d i n g l y ,
h e
c r i t i c a l e l e m e n t
of any
a u s e
of
c t i o n f o r
s e c u r i t i e s f r a u d ,
o r
any
r a u d
c l a i m f o r
t h a t
m a t t e r ,
s a a t e r i a l
m i s r e p r e s e n t a t i o n o r o m i s s i o n . H e r e ,
we
found no
v i d e n c e
of
a
i s r e p r e s e n t a t i o n o r
o m i s s i o n
b y h e C i t y ' s
c o u n t e r p a r t i e s
on
any of
h e swap
g r e e m e n t s .
Nor was
any
n d i v i d u a l i n v o l v e d
i n
t h e
t r a n s a c t i o n s
on e h a l f
of
h e C i t y
aware
of
a
m i s r e p r e s e n t a t i o n o r o m i s s i o n .
A l l of
h e
i n d i v i d u a l s
we
n t e r v i e w e d ,
i n c l u d i n g t h e
i n d i v i d u a l s
r e s p o n s i b l e f o r n e g o t i a t i n g
and
e x e c u t i n g
t h e
C i t y ' s
swap g r e e m e n t s ,
were w e l l i n f o r m e d
and
aware
of
h e
v a r i o u s r i s k s a s s o c i a t e d
w i t h
swaps.
No
ne
was aware
of
any
r a u d u l e n t
o r
r e c k l e s s
c o n d u c t
b y a swap
o u n t e r p a r t y ,
and
e v e r a l i n d i v i d u a l s
v o l u n t e e r e d
t h e i r
b e l i e f t h a t
t h e
swaps have e n e f i t t e d t h e C i t y .
I n d e e d ,
l l
a g r e e d
t h a t t h e C i t y
o b t a i n e d t h e
b e s t
p o s s i b l e d e a l
t h a t
i t
c o u l d
have
made a s e d on
market o n d i t i o n s a t
t h e
t i m e i t e n t e r e d
i n t o
t h e swap
a g r e e m e n t s .
F u r t h e r , we
found
no
documents
r
communications o
t h e
C i t y
a u t h o r e d
b y
c o u n t e r p a r t i e s
o r u n d e r w r i t e r s
t h a t a t t e m p t e d t o
m i s s t a t e t h e
r i s k s a s s o c i a t e d
w i t h
t h e
swap
a g r e e m e n t s . Moreover,
h e
C i t y
would
be a r d
p r e s s e d
t o
c l a i m t h a t
i t
d i d
n o t
u n d e r s t a n d t h o s e
r i s k s . The
i t y employed
a a l e n t e d ,
e x p e r i e n c e d , and
k n o w l e d g e a b l e
d e b t
management
team
a s
w e l l
a s o u t s i d e
a d v i s o r s
and
o u t s i d e
c o u n s e l t o
a d v i s e
on h e
t r a n s a c t i o n s .
I n
so me
n s t a n c e s ,
t h e
C i t y r e v i e w e d m u l t i p l e
p r e s e n t a t i o n s
from m u l t i p l e i n v e s t m e n t
banks
r i o r t o
e n t e r i n g i n t o swap
t r a n s a c t i o n s .
The
C i t y
and t s
a d v i s o r s n e g o t i a t e d and
documented h e
swap
r a n s a c t i o n s .
I n
t h e
swap
r a n s a c t i o n a g r e e m e n t s ,
h e C i t y
made
a
number
of
e p r e s e n t a t i o n s r e g a r d i n g
i t s
knowledge
and
s o p h i s t i c a t i o n and
acknowledged
h e
l i m i t e d ,
non- f i d u c i a r y
r o l e p l a y e d b y h e
swap
c o u n t e r p a r t y .
The n t e r v i e w s and
r e v i e w
of
ocuments
make
l e a r
t h a t
t h e C i t y
knowingl y and
s t r a t e g i c a l l y
u s e d t h e
swap
r a n s a c t i o n s
a s a i s k
management
o o l , and
swaps
o n s t i t u t e d
o n l y
a
p o r t i o n
of h e
C i t y ' s d e b t p o r t f o l i o .
F i n a l l y ,
t h e
C i t y
p u b l i s h e d t h e
r i s k s a s s o c i a t e d
w i t h swap
a g r e e m e n t s i n i t s C FRs nd
t s 2006 Swap o l i c y .
I t would be
v i r t u a l l y i m p o s s i b l e
f o r t h e C i t y t o
a r g u e
now
h a t
a o u n t e r p a r t y
made
a
m a t e r i a l m i s r e p r e s e n t a t i o n
o r o m i s s i o n g i v e n t h e
C i t y ' s
r e p r e s e n t a t i o n s
t o
t h e
c o u n t e r p a r t i e s , t s
u n d e r s t a n d i n g of h e r i s k s i n
t h e s e swap
r a n s a c t i o n s ,
and
t s
u s e of d v i s o r s
and
o u t s i d e
c o u n s e l
t o
a s s i s t
These
same a c t s
would
undermine
any
l a i m
b y
h e C i t y
t h a t i t r e l i e d
on a
m i s r e p r e s e n t a t i o n
made
b y
one of
h e C i t y ' s swap
o u n t e r p a r t i e s .
R e l i a n c e i s
an
s s e n t i a l
element
e q u i r e d t o e s t a b l i s h a
§
0 ( b )
and
Rule l O b - 5
v i o l a t i o n . S t o n e r i d g e
I n v e s t m e n t
P a r t n e r s ,
LLC
S c i e n t i f i c - A t l a n t a ,
I n c . ,
552
U.S.
4 8 , 157
2 0 0 8 ) .
I n a d d i t i o n
t o
t h e
d i s c l o s u r e s
i n t h e C i t y ' s
C FRs
nd
h e C i t y ' s
2006
Swap
o l i c y ,
and
h e
C i t y ' s
e x p e r i e n c e d
d e b t
management
team—each
of
which a l o n e
would r e a t e
an
b s t a c l e
i n
e s t a b l i s h i n g
r e l i a n c e — t h e
ISD
a s t e r Agreements h a t
g o v e r n e d
a l l
of
h e
C i t y ' s swap
g r e e m e n t s
c o n t a i n e d
a
non-
2 0
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 23/29
r e l i a n c e c l a u s e , i n
which
h e C i t y s t a t e d t h a t
t had made
t s
own e c i s i o n t o
e n t e r i n t o
e a c h
t r a n s a c t i o n
u s i n g
i t s own udgment and t h e
a d v i c e of
t s
a d v i s o r s .
The
C i t y
a f f i r m a t i v e l y
acknowledged
t h a t
t
was
n o t
r e l y i n g
on
any
r e p r e s e n t a t i o n s by
a
swap
c o u n t e r p a r t y ,
and t h a t
t h e
c o u n t e r p a r t y
was o t
a c t i n g a s
t h e
C i t y ' s
f i d u c i a r y o r
a s
t h e C i t y ' s
a d v i s o r w i t h r e s p e c t
t o
t h e
t r a n s a c t i o n . The ISDA M a s t e r
Agreements u r t h e r
p r o v i d e d t h a t
[ t h e
C i t y ] h a s
d e t e r m i n e d
t h e
economic
r i s k s and
m e r i t s ,
a s
w e l l
a s
l e g a l , t a x , and
a c c o u n t i n g
c h a r a c t e r i z a t i o n s and
c o n s e q u e n c e s
..
.
and
i s
c a p a b l e
of
assuming
s u c h
r i s k s , w i t h o u t
r e l y i n g on
t h e
a d v i c e
of
c o u n t e r p a r t y
b a n k ] .
Given
t h e non- r e l i a n c e c l a u s e i n t h e
M a s t e r
Agreement and t h e
o t h e r
f a c t o r s
i d e n t i f i e d a b o v e ,
w e have c o n c l u d e d
t h a t
t h e C i t y
does
n o t have
a
b a s i s t o e s t a b l i s h r e l i a n c e .
As o t h e b a s i s swap r a n s a c t i o n s t h e
C i t y e n t e r e d
i n t o ,
t h e s e t r a n s a c t i o n s
were
o r
t h e
p u r p o s e
of e c e i v i n g
a
u b s t a n t i a l
up
- f r o n t payment,
r
t o
s h o r t e n
o r
l e n g t h e n
t h e
d u r a t i o n
of h e
swap.
The
b a s i s
swap
t r a n s a c t i o n s
s e r v e d
t h e
C i t y ' s
s t a t e d
p u r p o s e .
We i k e w i s e
found
no
e v i d e n c e
t h a t t h e
C i t y ' s swap
c o u n t e r p a r t i e s
m i s r e p r e s e n t e d t h e
r i s k s
of
h e s e
t r a n s a c t i o n s .
R a t h e r ,
t h e
C i t y
s t r a t e g i c a l l y n e g o t i a t e d
t h e
t e r m s
of h e s e
swap
r a n s a c t i o n s t o
manage
t s
d e b t
p o r t f o l i o and r e c e i v e up- f r o n t
c a s h
p a y m e n t s .
The
C i t y
does n o t have
a
r e d i b l e
c l a i m f o r f r a u d
o r
m i s r e p r e s e n t a t i o n
u n d e r
t h e f e d e r a l
s e c u r i t i e s
law
r e l a t i n g
t o t h e s e
b a s i s swap
r a n s a c t i o n s .
One
d d i t i o n a l f a c t
t h a t
would make t
e x t r e m e l y d i f f i c u l t
f o r
t h e
C i t y
t o
a s s e r t a
good
f a i t h
c l a i m
a g a i n s t t s swap
c o u n t e r p a r t i e s
f o r a
v i o l a t i o n of
h e
f e d e r a l
s e c u r i t i e s
laws s t h a t t h e
C i t y ' s c u r r e n t and former employees
n v o l v e d i n
n e g o t i a t i n g
and
e x e c u t i n g t h e swap
a g r e e m e n t s
a r e n o t aware
of
any
m i s r e p r e s e n t a t i o n o r
o m i s s i o n
made
n
c o n n e c t i o n w i t h any of
h e swaps. I f
t h e C i t y
were
o
f i l e
a c l a i m a g a i n s t one
o r more of
t s c o u n t e r p a r t i e s , a
number of h e s e
i n d i v i d u a l s
l i k e l y
would
be c a l l e d
a s w i t n e s s e s
t o
a d d r e s s
t h a t
c l a i m . But none
w i l l
t e s t i f y
t h a t
t h e
c o u n t e r p a r t i e s d e f r a u d e d t h e
C i t y ,
and
none
w i l l
t e s t i f y
t h a t
t h e
c o u n t e r p a r t i e s
f a i l e d
t o
d e a l
f a i r l y w i t h
t h e
C i t y .
Based
on our r e v i e w of
h e
a v a i l a b l e e v i d e n c e ,
w e
recommend
t h a t
t h e C i t y n o t p u r s u e a
c a u s e
of c t i o n
a g a i n s t any
of
t s
c o u n t e r p a r t i e s f o r
a
v i o l a t i o n
of
h e
f e d e r a l s e c u r i t i e s
l a w s .
2 .
I l l i n o i s
S e c u r i t i e s
Law f 953
I l l i n o i s
S e c u r i t i e s Act )
We
l s o
found
no
e v i d e n c e t h a t would
s u p p o r t
a good
a i t h
c l a i m
a g a i n s t t h e
C i t y ' s
c o u n t e r p a r t i e s f o r a
v i o l a t i o n
of h e
l l i n o i s S e c u r i t i e s
A c t .
The l l i n o i s
S e c u r i t i e s Act r o v i d e s
r e s c i s s i o n
a s
a
remedy
o r u n l a w f u l
conduct
n
c o n n e c t i o n w i t h t h e
s a l e of
a
e c u r i t y .
S p e c i f i c a l l y ,
t h e
I l l i n o i s
S e c u r i t i e s
Act
r o v i d e s
t h a t
[ e ] v e r y
s a l e
of
e c u r i t y
made
n
v i o l a t i o n
of h e p r o v i s i o n s
of
h i s Act
h a l l
be v o i d a b l e
a t
t h e
e l e c t i o n
of h e
p u r c h a s e r . 815 ILCS
5 / 1 3 ( A ) . To
n v o k e t h i s
p r o v i s i o n ,
t h e p u r c h a s e r
must
i v e
n o t i c e
of
ny
l e c t i o n
t o
v o i d
w i t h i n
onths
f t e r t h e
p u r c h a s e r
s h a l l have
knowledge
h a t
t h e
s a l e
of h e
s e c u r i t i e s
t o him
o r h e r
i s
v o i d a b l e . See 815 ILCS
5 / 1 3 ( B ) .
21
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 24/29
S e c t i o n
12
of
h e I l l i n o i s S e c u r i t i e s
Act
r o v i d e s :
I t
s h a l l
be
a
i o l a t i o n
of
h e
p r o v i s i o n s
of
h i s Act o r
any
p e r s o n :
F . To engage n any r a n s a c t i o n , p r a c t i c e
o r c o u r s e
of
u s i n e s s
i n
c o n n e c t i o n
w i t h
t h e
s a l e
o r
p u r c h a s e
of e c u r i t i e s which works
o r
t e n d s
t o
work
a
r a u d
o r
d e c e i t
upon
h e
p u r c h a s e r o r s e l l e r
t h e r e o f .
G.
To
b t a i n
money
o r p r o p e r t y t h r o u g h t h e s a l e
of
e c u r i t i e s b y
means of ny
u n t r u e s t a t e m e n t
of
a
m a t e r i a l
f a c t
I
To employ
any
d e v i c e , scheme
o r
a r t i f i c e
t o d e f r a u d
i n c o n n e c t i o n w i t h t h e
s a l e
o r
p u r c h a s e of
ny
e c u r i t y ,
d i r e c t l y
o r
i n d i r e c t l y .
815
ILCS 5 / 1 2
(West
1 9 9 8 ) .
Because e c t i o n s
1 2 ( F ) ,
1 2 ( G ) , and
1 2 ( I )
of
h e
I l l i n o i s
S e c u r i t i e s
Act
r e
modeled
f t e r
s e c t i o n s 1 7 ( a ) ( 1 ) t h r o u g h
a ) ( 3 )
of
h e
f e d e r a l S e c u r i t i e s Act of
1933
S e c u r i t i e s
Act)
15 U . S . C .
§
7 7 q ( a ) ( 1 )
h r o u g h
a ) ( 3 )
2 0 0 0 ) ) ,
l l i n o i s c o u r t s
l o o k
t o
f e d e r a l
s e c u r i t i e s
f r a u d
c a s e
law i n
i n t e r p r e t i n g
t h o s e
s e c t i o n s . People W h i t l o w , 89 1 1 2 d
322,
33-34
1 9 8 2 ) ;
F o s t e r v
A l e x ,
213
I l l
App.
3d
1001,
1005 5 t h
D i s t .
1 9 9 1 ) .
S e c t i o n s
1 7 ( a ) ( 1 )
h r o u g h
a ) ( 3 )
of h e
S e c u r i t i e s Act
r e q u i r e n e a r l y
t h e
same l e m e n t s a s s e c t i o n
1 0 ( b )
of h e S e c u r i t i e s
Exchange Act
15
U.S.C.
§
8 j ( b ) 2 0 0 0 ) ) ,
and
Rule
l O b - 5
(17
. F . R . § 2 4 0 . 1 O b - 5
2 0 0 0 ) ) .
Moreover, r e a s o n a b l e
r e l i a n c e
i s
an
e l e m e n t of
e c t i o n s
1 2 ( F ) ,
1 2 ( G ) ,
and
1 2 ( I )
of
h e
I l l i n o i s
S e c u r i t i e s
Law.
T i r a p e l l i v Advanced q u i t i e s , I n c .
351
l l
App. 3d
4 5 0 1 s t D i s t .
2 0 0 4 ) .
I f
h e C i t y were
o
a t t e m p t
t o
p u r s u e c l a i m s
u n d e r
t h e
I l l i n o i s
S e c u r i t i e s A c t ,
t would
f a c e s i m i l a r h u r d l e s
t o
t h o s e r e l a t i n g
t o
t h e
f e d e r a l
s e c u r i t i e s
l a w s .
F i r s t , a s
d i s c u s s e d
a b o v e , w e
have
found no e v i d e n c e of a
m i s r e p r e s e n t a t i o n
o r
o m i s s i o n r e l a t e d
t o
t h e C i t y ' s swap
a g r e e m e n t s . Second,
h e C i t y
w a s
a
o p h i s t i c a t e d and
k n o w l e d g e a b l e
market a r t i c i p a n t
t h a t
was
d v i s e d
b y
p r o f e s s i o n a l a d v i s o r s . Moreover, w h e n h e C i t y e n t e r e d
i n t o
e a c h
of
h e
swap
a g r e e m e n t s
i n
q u e s t i o n ,
t
e x p r e s s l y
acknowledged
t h a t i t had n o t r e l i e d
on
any
e p r e s e n t a t i o n s
made
b y h e c o u n t e r p a r t y
b a n k s . R a t h e r , t h e
C i t y
e n t e r e d
i n t o
each
agreement
f t e r
i t s
o w n
r e v i e w and a s s e s s m e n t of h e p r o p o s e d
t r a n s a c t i o n
and
w i t h t h e
p r o f e s s i o n a l i n p u t
and a d v i c e
of
o u t s i d e
f i n a n c i a l
a d v i s o r s ,
t a x
a d v i s o r s , and
c o u n s e l . Und e r h e s e
c i r c u m s t a n c e s ,
t
would
be
e x t r e m e l y d i f f i c u l t f o r t h e
C i t y
t o
e s t a b l i s h
t h e ke y
element
of
e l i a n c e .
A c c o r d i n g l y ,
b a s e d
on
o u r r e v i e w of
h e
e v i d e n c e and t h e f a c t s
and
c i r c u m s t a n c e s w e
recommend
t h a t
t h e
C i t y
n o t
p u r s u e a a u s e of
c t i o n a g a i n s t any
of
t s
c o u n t e r p a r t i e s
f o r
a
v i o l a t i o n
of h e
I l l i n o i s S e c u r i t i e s
A c t .
22
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 25/29
3.
Cla
ims
Under
t h
e I l l i n o
i s
Cons
umer
Fra
ud and
eceptive
P r a c t i c e s
Ac t
Th
e
G r a i s
&Ellsw
orth
memora
ndum a l s o
s u
g g e s t s
t h a t
i t i
e s m
ay
h
ave
c l
a i m s u n d e r
s t a t e
u n f a i r
t r a d e
p r a c t i c e s a c t s .
However, h e C i t y
l a c k s s t a n d i n g t o
a s s e r t
a l a i m
u n d e r
t h e
I l l i n
o i s
Con
sum er
F r a u
d
a
nd D e c e
p t i v e
P r a c t i c e s
Act
CFA). To
t a t e a
c l a i m
u n d e r t h e
CFA
,
person
a s
s p e c
i f i c a l l y d e f i n e d by t h
e CF
A
us
t
s
how: a
n
u n f a i r
o r d e c e
p t i v e a c t
o r
p r
a c t i c e
by t h
e
d e f
e n d a n t ;
t h e
d
e f e n d a n t '
s
i n t e n
t t h a t
p l a i n
t i f f r e l y on t
h e
d e c e p t i
o n ; t h e o c c u r
r e n c e of
h e
d
e c e p t i o n
d u r i n
g
a c o u
r s e of
o n d u
c t i n v o l v i
n g
t r
a d e
o r comme
rc e;
and
a c t
u a l
d
amage o
t h e
p l a i n t
i f f
p r
o x i m a t e l y
c a u s
e d by h e
d e
c e p t i o n .
See 815 IL
CS
5 0 5
/ 1
e t s e q .
;
s e e a l s o
M a n t i s
v .
P
e k i n Mem'l
Hosp.
n c . ,
395
l l
App. 3d
943,
949
I l l . Ap p .
t .
3d
D i s t . 2 0 0 9 ) .
U
nder
h e
CFA,
a m u n
i c i p a l i t y
i s
n o
t
a
perso
n a p a b l e of
r i n g i n g
s u i t .
See 815 l l
Comp .
t a t .
§
0 5 / 1 ( c ) ;
Board
of
d u c
a t i o n of i r y
of
hic
ago . A,
n
d
,
I n c
. ,
1
3 1 I l
l
2d 428,
6
9
19
89)
[ T ] h
e
l e g i s l a t u
r e i s aware of how
o
i n c l u d e
a
body p o l i t i
c
w i t h
i n
t h
e
d e f i n i t i
o n
of
p e r s o
n ' o r
` c o r p o
r a t i o n , '
and we e l
i e v e t h a t
i t s
f a i l u
r e
t o
do
so i
n
t h
e
C
onsumer
Fr
aud
Act s
how s an
i n t e n t
n o t
t o
i n c l u d e them w i t h i n
t h e
d e f i n i t i o n
of
e r s o n s
w ho may
s u e b a s e d
on
t h e
A c t . ) .
H e r e , b e c a u s
e t h e C i t y
i s n o t
a
per
son
l i g i b
l e
t o
f i l
e
a
l a i
m
u n d e r t h e
s t a t u t e ,
t l a c
k s
s t a n d i n g
t
o a s s e r t
a c l a i m
u n d e r
t h
e
CFA. Mo
re
m p o r t a n t l
y ,
a
goo
d f a i t h
c l a i m
u n d e
r
t h e
CFA
s u f f
e r s from
t h e
sam
e
d i s p o s i t i
v e
d e f
e c t s a s
t
h e o t h e r c
l a i m s d i s
c u s s e d
a b o v e : t h e r e
i s
no
e v i
d e n c e
o
f
a
d e c e p t i
v e a c t
o r
p r a c t i c
e
by
one
o
f
h
e swap
c o u n t e r
p a r t i e s .
Th
ere
s
, t h
e r e f o r e ,
no
go
od
f a i t h
b
a s i s u
pon
w
hich t h e C i t
y may
u r s
u e
a
l a i m
u n d e r
t h e
CFA.
4
.
Claim
s
or
V i o l a t i o
n s
o f
MS
RB nd
FINR
A
ul
es
The
C i t
y
h a s
n
o
p r i v a t e r i g
h t
of
c t i o n
a g a i n s
t
any of
t s
swap
o u n t e r p a r
t i e s
u n
d e r
r u l e s
p r o m u l g a t e d
by t h e
M u n i c i p a l
S e c u r i t i e s
Rule
Making
Board
MSRB),
r
t h e F i n a n c i a l I n d u s t r y
R e g u l a
t o r y
A u t h o r i t
y
(FINR
A).
C
ongress
r e a t e d t h
e
MS
RB
n 1975,
a
nd expand
ed t s
m i s s i o n
w i t h
p a s
s a g e
of
h e D od
d- F r a
n k Ac t
n
2010.
The
MS
RB
r e a t
e s r u l e s
t h a t
s e c u r i t i
e s
f i r m s
,
b a n k s ,
and
m u n i c i
p a l
a d v i
s o r s mu
st
o l
l o w wh
en
e n g a g
i n g
i
n m u n i c
i p a l
s e c u r i t i e s
t r a n s a c t i
o n s
and
a d v i s i n g
i
n v e s t o r s
and
s t a t
e and l
o c a l g o v e r n m
e n t s .
The
U n i t e d S t a t e
s
S e c u r i
t i e s and
E
xchange Comm
ission
(SE
C),
F
INRA,
nd
f e
d e r a l b a n k i n
g
r
e g u l a t o r s
e n f o r
c e
MSRB
u l
e s ,
d
e p e n d i n g
on t h e
s t a t u s
of h e
e n t i t y a g a i
n s t
w
hom
h
e
r u l e s
a r e
b
e i n g e n f o r c
e d . There
s no
e x p r e s s
p r i v a t e r i g
h t
o
f c t
i o n
u n d e r
t h e
MSR
B u
l e s ,
and
c o u r t s
t
h u s
f a r have
r e j e c t e d
a t t e m p
t s
t o imply
a
r
i v a t e r i g h t
o
f
c t i o n .
See
.
g . ,
Prager
.
F
MS
o
nds,
n c . , 20 1
0
WL 9
50065
(
S.D.
F l a .
2 0 1 0 )
;
C h a r t e r
Hou
se
. F
i r s t T e n n e s s
e e Bank
,693
F . S
upp. 593
,
59
8 M . D .
Tenn
1 9 8 8
) .
I n
a d d i t i o n
t o
t h e
e n f o r c e m e n t
of MSRB u l e s ,
F
INR
r o m u l g a t e s
i t s own
u l e s f o r
memb
er i r m s , i n
c l u d i n g
Rule
2010,
whic
h
r
e q u i r e s
me
mbers o o
b s e r v e
h i g
h
s t
a n d a r d s of
comme
rcial
hon
or an
d e q u i t a
b l e p r i n c i
p l e s
of
r a d
e . C o u r t s
a l s o
have
r e j e c t e d a
r i v a t e c a u s e
of
a c
t i o n f o
r
a
v i o l a
t i o n
of F
INR
u
l e s
o r
r e g u
l a t i o n s . Se
e
S a
l d e r v .
R e t a i l P r o p e
r t i e s
o
fAm., n c . ,
N
o. 1 2
- 5 8 8 2 , 20
14
WL
5988
04, *2
4
N
. D. l l
Ju
ne
1 0
,
2 0 1 4 ) ;
Richman
.
Goldman
S
achs
Gro
up, n c . ,
8
68
F .
S
upp.
2d
26
1,
275
n .
5
S.D.N.Y
. 0 1 2 ) .
A c c o r d
i n g l y ,
t h e
M
SRB
nd
FINRA
u l e s
do n o t
c r e a t e
a
a u s e
of c t i o n
t h e C i t y
c
o u l d p u r
s u e
i n
c o u r t .
23
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 26/29
B.
FINRA
r b i t r a t i o n
Even f
t h e
C i t y
c o u l d
a s s e r t
a g o o d - f a i t h c l a i m
grounded
n
f r a u d
a g a i n s t a
swap
c o u n t e r p a r t y , an r b i t r a t i o n
b e f o r e
FINRA, hich h e
September
1 5 ,
2014
and
O c t o b e r
1 0 , 2014
l e t t e r s u r g e t h e
C i t y
t o
i m m e d i a t e l y f i l e , i s
a l m o s t
c e r t a i n l y u n a v a i l a b l e t o t h e
C i t y .
FINRA s
a s e l f - r e g u l a t o r y
o r g a n i z a t i o n r e g u l a t e d
by
h e
SEC
h a t p r o v i d e s
an
l t e r n a t i v e
d i s p u t e
r e s o l u t i o n
fo r u m
o
i t s
m e m b e r i r m s and
c u s t o m e r s
o f t s
m e m b e r i r m s .
Under
FINRA
r u l e s , m e m b e r i r m s a r e r e q u i r e d t o a r b i t r a t e
c u s t o m e r d i s p u t e s
b e f o r e
a
FINRA p p o i n t e d
a r b i t r a t i o n
p a n e l .
FINRA
e m b e r i r m s a l s o a r e
r e q u i r e d t o
i n c l u d e
i n t h e i r a g r e e m e n t s
w i t h
c u s t o m e r s a
r o v i s i o n
t h a t a l l o w s
d i s p u t e s t o be
r b i t r a t e d . None
o f
h e
C i t y ' s swap
c o u n t e r p a r t i e s
a r e
FINRA
e m b e r i r m s .
Nor
does t
a p p e a r t h a t
i n
most
n s t a n c e s
t h e swap
c o u n t e r p a r t i e s
c o u l d
be c o n s i d e r e d
b r o k e r - d e a l e r s
e n g a g i n g i n
m u n i c i p a l s e c u r i t i e s
a c t i v i t i e s o r
u n d e r w r i t e r s s u b j e c t t o
an
a r b i t r a t i o n
r e q u i r e m e n t
u n d e r
Rule G-35
o f h e
MSRB
a t h e r ,
t h e
c o u n t e r p a r t i e s
a r e
banks
h a t s u b m i t t e d
b i d s
t o ,
o r
n e g o t i a t e d
w i t h , t h e C i t y
o n h e swap
t r a n s a c t i o n s and
n t e r e d
i n t o
ISDA Master Agreements
o r each swap
r a n s a c t i o n . I t i s u n l i k e l y
t h a t
t h e C i t y c o u l d
compel
h e s e
non-FINRA
m e m b e r
i r m s
t o
a r b i t r a t e
b e f o r e
FINRA.
I f
a i a b l e
c a u s e
o f c t i o n
e x i s t e d , t h e
C i t y might
be
a b l e
t o ,
i n so me
n s t a n c e s , b r i n g
FINRA
r b i t r a t i o n c l a i m s a g a i n s t t h e
b r o k e r
- d e a l e r
bond
managers and
u n d e r w r i t e r s . I f t h e
swap
c o u n t e r p a r t y and
e n i o r bond manager,
r
u n d e r w r i t e r ,
a r e
a f f i l i a t e s
o f
h e
same n v e s t m e n t
bank,
h e C i t y
c o u l d a r g u e t h a t t h e
FINRA
e m b e r o l d
t h e
i n t e r e s t r a t e
swaps
w i t h
t h e
u n d e r l y i n g v a x i a b l e
r a t e
bonds
s
a package
and h a t ,
i n d o i n g s o ,
t h e
bond
manager r
u n d e r w r i t e r
m i s l e d
t h e C i t y .
I n
many
n s t a n c e s ,
however,
h e
C i t y
i s s u e d t h e
v a r i a b l e
r a t e bonds
and
c o m p e t i t i v e l y
b i d t h e a s s o c i a t e d
i n t e r e s t
r a t e swap.
C o n s e q u e n t l y ,
t h e swap
o u n t e r p a r t y
and
t h e
bond
manager
r
u n d e r w r i t e r
were
n o t
a f f i l i a t e s
o f h e
same
n v e s t m e n t
b a n k .
These
f a c t s
p r e s e n t s i g n i f i c a n t
c h a l l e n g e s
t o
c o m p e l l i n g
FINRA
r b i t r a t i o n , even
u n d e r t h i s a l t e r n a t i v e
t h e o r y .
Moreover, h e ISDA M a s t e r Agreements
h a t
t h e
C i t y
e n t e r e d
i n t o
w i t h t h e swap
c o u n t e r p a r t i e s
c o n t a i n
e x c l u s i v e
fo r u m
e l e c t i o n c l a u s e s . These c l a u s e s
r e q u i r e t h e
p a r t i e s
t o
submit
any i s p u t e t o
t h e
e x c l u s i v e
j u r i s d i c t i o n
o f
h e c o u r t s
o f
h e
S t a t e
o f l l i n o i s
and
h e
U n i t e d
S t a t e s D i s t r i c t Court
n
t h e
N o r t h e r n D i s t r i c t
o f l l i n o i s .
R e c e n t l y , t h e Second
C i r c u i t
h e l d
t h a t
a fo r u m
s e l e c t i o n
c l a u s e
s u p e r s e d e s
FINRA
u l e s
r e q u i r i n g
a r b i t r a t i o n .
Goldman,
Sachs
o.
.
Golden
Empire
c h .
F i n . A u t h . ,
No.
13
-797-CV,
014
WL
099289,
t *6
2d
C i r .
Aug.
1,
0 1 4 ) ;
C i t g r o u p
Global
a r k e t s , I n c . ,
v . N.
C
s t .
Muni.
Power Agency,No. 3 -
2247
-CV, 014
WL 099289,
t
*6
2d
C i r .
Aug.
21, 0 1 4 ) .
The
September
1 5 ,
2014
e t t e r ' s
r e f e r e n c e
t h a t
t h e C i t y
had
u n t i l o n l y e a r l y
O c t o b e r
t o
i n i t i a t e
a
FINRA
r b i t r a t i o n
i s
l i k e l y
a
e f e r e n c e
t o
FINRA's
i x
- y e a r
a r b i t r a t i o n
e l i g i b i l i t y r u l e s .
See
FINRA
o d e
o f
r b i t r a t i o n ,
Rule
12206. Under
FINRA's
i s p u t e
r e s o l u t i o n r u l e s ,
t h e
o c c u r r e n c e o r e v e n t g i v i n g r i s e t o
t h e
d i s p u t e
must have
c c u r r e d
w i t h i n s i x
y e a r s
f o r
t h e
c l a i m
t o be l i g i b l e
f o r
s u b m i s s i o n t o
a r b i t r a t i o n . Here,
h e
C i t y e n t e r e d
i n t o
a l l o f h e
u n d e r l y i n g
v a r i a b l e r a t e bond
o f f e r i n g s
w i t h c o n n e c t e d
i n t e r e s t r a t e swap
r a n s a c t i o n s m o r e
h a n
s i x
y e a r s
a g o .
T he v e n t o r o c c u r r e n c e
g i v i n g
r i s e t o
t h e
d i s p u t e would be h e
m i s r e p r e s e n t a t i o n ,
o m i s s i o n ,
o r
l a c k o f
a i r d e a l i n g a t
t h e
t i m e
o f
n t e r i n g
i n t o
t h e
u n d e r l y i n g
v a r i a b l e
r a t e
bond
o f f e r i n g
and
c o n n e c t e d
swap. T h e r e f o r e ,
even f
FINRA
r b i t r a t i o n were
an
a v a i l a b l e forum
o r
24
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 27/29
t h
e C i
t y t
o
f i l e
a
l a i m
r e
l a t i n
g t o
i
t s
s
wap
a
g r e e
m e n t
s ,
d i
s p u t
e s
r e l a t
i n g t o f r
a u d
o r u n f a i
r
d e a l
i n g
i n
t h e
indu
ceme
nt of
h o s e
swap
r a n s a
c t i o n
s
l i k e l
y
wou
ld n o
t b
e l i
g i b l e
f o r
s u b m
i s s i
o n
t o
F
INR
r b i t
r a t i o
n .
C.
T
he Ba
ldw
i n
C
ou n t
y S
e we r
S e r v
i c e
A r
b i t r a
t i o n
,
The
R o
o s e v
e l t
I n s t i
t u t e
Blog
P o s
t ,
an d
t h e
Grais
&Ellsworth
LLP
Memorandum
I
t i s o
u r
u n
d e r s t
a n d i
n g
t
h a t t h
e a l l
e g a t i
o n s
s e t
f
o r t h
i n t
h e S
epte
mber
an
d
O c t o
b e r
L e t
t e r s
t h e C
i t y
r
e c e i v
e d
fr
om
u n i o
n
l e
a d e r s
we
re b a s
e d on
o u
r
s
o u r c
e s :
(
1)
n Opi n
ion
a
nd
Awa
rd
i s s u
e d by
h e
Ame
rica
n
A r b i
t r a t
i o n
A
s s o c
i a t i
o n o
n Ma
rch
20
,
01
4,
n t h e
m a t t
e r c a
p t i o
n e d
I n
t h e M
a t t e
r
o f
r b i t
r a t i
o n b e
t w e e
n Ba
ldwi
n Co
unty
S
ewe
r
e r v i
c e L
. L . C
.
an d
Regi
ons
Bank
;
2)
p o s
t
b
y S
a q i b
B h a
t t i on
t h e
R o o s
e v e l
t I n s
t i t u t
e b l o g
N
e xt
Ne
w
e a l
,
i t l
e d
W a l l
S t
r e e t
Sw
indl
ed
L
ocal
Go
vern
ment
s, T o o .
H
e r e '
s
o
w
The
y
C
an
Ge t
T
h e i r
Mon e
y Ba
ck,
a t
e d
S
ept e
mber
1
7 , 20
14;
3
) m
e m or
an d
u m fro
m
t h e
la
w
f
i r m
G r
a i s
&E
llsw
orth
L L P
,
a
t e d
Au
gust
25,
0
14,
o
S
a q i b
B h
a t t i ;
and (4
)
m e m
ora
n d u m
f
rom t h
e la
w
f
i r m
G
r a i s
l l
w s o r
t h L
L P,
d a t
e d
O c t o
b e r 9,
01
4.
Be
caus
e t h e
O c
t o b e r
9,
014
and
Au
gust
2
5,
014
G r
a i s
&El
lswo
rth
m e m oran d a
r e
i d e n t i c a l ,
w i t h
t h e
e x c e p t i o n
of
ne
p a r a g r a p h
t h a t
acknowledges
h a t
an
s s u e r s
d
i s c l o
s u r e
s m
a y
v a r y
b
a s e d
upon
h e
i r
know
ledg
e
and e x
p e r i e
n c e ,
we
e
f e r
t o
b o t h
m
e m or
an d
a
c o l l
e c t i v
e l y a s t
h e
Me
m ora
n d u
m .
T
he s s
e r t i o
n s a
nd
a l l
e g a t i
o n s r
a i s e d
by
h e s e
m a
t e r i a
l s
w
ere n o t
s u b s
t a n t i
a t e d
b y
ou
r
n
a l y s
i s of
h e
C i t y
s s
wap
a g r
e e m e
n t s .
T
he R o o
s e v e
l t
I
n s t i t
u t e
b l o
g
p o s t
a p p
e a r s
t
o be
a l m o
s t
e
n t i r e
l y
b
a s e d
on h
e
Me
m or
a n d u
m .
O u r
e v i
e w of
M
r.
h a t
t i s q u
a l i f i
c a t i o
n s r e v e
a l e d
t
h a t h
e
h o l
d s
an
u
n d e r
g r a d
u a t e
d e
g r e e
i n
P o l i t
i c a l S c
i e n c
e . He
o l d s
n o
p o
s t
-
g r a d u
a t e
d e g
r e e s
, a
nd h a s
n o
s p e
c i a l i
z e d
t r a
i n i n g
i n
f i n a
n c e ,
e t
a l o n
e m
u n i c
i p a l
f i n a n
c e .
e
d
oes n o t
h
o l d a
i n a n
c e ,
econ
omic
s,
c
c o u n
t i n g ,
o
r
l
aw d e g
r e e .
He
o m p l e
t e d
aone
-ye a
r
e
l l o w s
h i p w i
t h a n o t -
f o r -
p r o f i
t
gro u
p wo
rk in
g w i t h
l a
b o r
u
n i o n
s t o
r e v
i e w t h e
r o l e
m
u n i c
i p a l
f i n a
n c e
d e
a l s
p
l a y e
d
i n
t h e
p u
b l i c
b u d g e t
r i s i s
N e i t h e r
h i s
b l o g
p o s t
n o r
t h e
Me m ora n d u m
p r o v i d e
any
e t a i l
o r
any
p e c i f i c
m i s
r e p r
e s e n t
a t i o
n s
o r
o m
i s s i
o n s
r e l e
v a n t t o
t h e
C i t y
s
swa
p
a g r
e e m e n
t s . I
n a
d d i t i
o n ,
Mr.
h a t t
i
a p p
e a r e d
a t t h
e
Sept
embe
r 24,
0 14
m e e
t i n g
of
h e
Chi
cago
B
oard
of
d u c
a t i o
n
t
o
u r g
e
t h a
t
t h
e
Boa
rd
p
u r s u
e c l a
i m s
a g a
i n s t
i t s ban
k
o u n
t e r p a
r t i e s
.
T
he
Bo
ard
o
f
d u c a
t i o n
a s k e
d Mr
. h a t
t i
f o r
s
p e c i f
i c s ,
b u
t he
was
n a b
l e
t o
i d e
n t i f y
any
a l l
e g e d
m
i s r e
p r e s e
n t a t
i o n s
o
r
o m
i s s i o
n s .
The
Me m o
ran
d u m
p u
r p o r
t s
t o a n a l
y z e
p o t
e n t i
a l c l a i m
s by
p u b l
i c
i s s
u e r s
o
f
y n
t h e t i
c
f i x e d
- r a t e
d e
b t
a g
a i n s t
t h e i
r
swa
p o
u n t e r
p a r t
i e s .
Howe
v er,
n
t h e
v e
r y
f i r
s t
p a r
a g r a
p h o
f
h e
M
e m o
ran d
u m ,
r a i s
&E
llsw
ort h
a
ckno
wled
ge h e
l i m i
t a t i
o n
o
f
h e i
r
l e g a l
a n
a l y s
i s a
nd
re c
omme
ndat
ions
:
We a n n o t
a d v i s e
on
any
p e c i f i c
f i n a n c i n g
w i t h o u t
c l o s e l y
r e v i e w i n g
t h e
f i
n a n c i
n g
and
l l
r e
l a t e
d t r
a n s a
c t i o n
s , a s w e
l l a
s
t
h e
r e p
r e s e
n t a t i
o n s
m ad
e
by
u n d e
r w r i t
i n g b
anks
a
nd o t h
e r s t
o
i s s u
e r
p
e r s o
n n e l
. . . .
IJf
n
u n d e
r w r i
t e r
d i d v i o l
a t e
t h e
f a i r
d
e a l i
n g
r u
l e ,
t h
e
i s s u
e r m ay
hav
e
a
re m e
dy
i n a r b i t
r a t i o
n
b e
f o r e
FI
N R A
.
(emp
hasi
s
a d
d e d )
.
T
he M
e m or
an d
u m t h
e n
c o
n c e d
e s t h a
t G r a i
s
l l w o
r t h
d i
d n o t
r e v i
e w any
s p
e c i f i
c
f i
n a n c
i n g o r
swap
r a
n s a c t
i o n d
ocum
ents
and
t h a t t
was
awar
e
of
o
p e
c i f i c
u n d e
r w r i
t e r
t h a
t a c t
u a l l y
v i o l
a t e d
t h e
f a i r
d e
a l i n
g
r u l
e .
I
n s t e
a d ,
t h e
Me m
ora
n d u
m o f
f e r s
t h e
25
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 28/29
c o n c l u s o
r y
s t a t e
m e n t t
h a t
[ i ] n g e n e r a
l , howeve
r,
u r
[
G r a i s
l l s w o r t h
' s ]
r e s e a r c h s t
r o n g l y
t h a t u n d e r w r
i t e r s
f r e q u e n
t l y
f a i l e d
t o p r o v i d e
t h e
d i s c l o s u r
e s t
o
p u b l i c
i s s u
e r s by t h e f a i
r
d e
a l i n g
r u l e , and
m i s r e
p r e s e n t e d
m
a t e r i a l r i s k s .
(Emp
hasis a d d e d )
. No
u c h
r e
s e a r c h
h a s
b
een
p r e s e n t
e d t o
t h e C i t y by
G r a i s
Ell
sworth o r anyone
e l
s e .
G r a i s l l w o r t h ' s
Me m o r a n d um
p r e s u p p o s e s
t h e
most
r i t i c l
and
n e c e s s a r y
r e q u i r e m
e n t f o r a
r a u d
c l a i m :
t h a t
t
h e
u n d e r w r i
t e r s
m
i s r e p r e s e
n t e d
m a t e r
i a l
f a c t s t o
t
h e
i s s u e r .
Th e e n
t i r e
a n a
l y s i s
t h a t
f o l
l o w s
i n t h e
Me m o r
a n d u m , nd
which w
a s
s u b s e q u e n
t l y
a d o p t e
d
by
t
h e
R o o s e
v e l t I n s
t i t u t e b l o g
p o s t
and
t h e
Septe
mber
and O c t o b
e r
L e t t e r s ,
assumes
h a t t h e r e w
ere
m i s
r e p r e s e n t
a t i o n s
o
f a t e
r i a l f
a c t s
r e l a t
e d
t o
t
h e C i t y
' s
i
n t e r e s t
r a t e
swap
s.
Based
o n
h i s
a s s u m
p t i o n ,
h
e Me m
o r a n d um
d i s c u s
s e s h
ow
r b i t r a t i o n
c o u
l d be
i n i
t i a t e d
and
c l a i m
s c o
u l d be
m
ad e a g a
i n s t t h e
s w a p
c o u n t e r p
a r t i e s . T
h e
a s s
u m p t i o n
t h a t t h e r e
were
m a t e r i a
l
r e p r e s e n
t a t i o n s i s
a
i g n i f i
c a n t
one
a n d ,
b a s
e d
o n
our n v e s t i g
a t i o n ,
unfo
un ded
i n
t h e
c o n t e x
t
of
h e C i
t y an
d t s
s
w a p
a g
r e e m e n t s .
F
u r t h e r ,
t h e
Me m o r a n
d um
c i t e s a
2
012
n t e r p r e t a
t i v e
N o t i c
e
r e l a t i n g t o
M
SR
ul e
G-
1 7 ,
which
r e q u i r e s
t h e
d i s c l o s u r e
of
e r t a i n r i s k s
t o
i s s u e r s
of complex
m u n i c i p a l
s e c u r i t i e s .
Th e
C i t
y ,
how
ever,
a s
p u
b l i c l y a
cknowle
dged t s u n
d e r s t a n d i
n g
of
h e r
i s k s
i d e n t i f i e
d
i n t h e
I n t e r p r e t
a t i v e Guidance
o r
m
o r e
t h a n
t e n y e a r s ,
and
our i n t e r v
i e w s
r
e v e a l e d
t h a t
t h e
C i t y
o f f i c i a
l s r e s p
o n s i b l e
f o r e x e c u t i n
g
t h e
sw
aps
u n
d e r s t o o d
t h o s e
r i s k s
l o n g
b e
f o r e
t h e n . Becau
se
o
u r i n v e s
t i g a t i o n u
n c o v e r e d
no
e v
i d e n c e
of
i s r e
p r e s e n t a t
i o n s
o r
o m i s
s i o n s
o n
t h e
p a
r t
of
h e
C
i t y ' s sw
ap c o u n t e r p
a r t i e s
o r
u n
d e r w r i t e r
s
a n d ,
n
f
a c t ,
f
ound
t h
a t
t h e
C i t y
p u b l i
c l y
ack
nowledge
d t s
u n d e r s t
a n d i n g of
h
e
r i s k s ,
t h
e
Me m o r a
n d um
and t h e R o o
s e v e l t
I n s t
i t u t e b l o g
p o s t
were n o t
h e l p f u l
t o o u r a n
a l y s i s .
R e l i a n c e
o n
t
h e b l o g
p o s t , t h e
Septemb
er and
O c t o b e r
L
e t t e r s ,
a
nd
t h e M
e m o r a n
d um t o
a s s e r t a
c l a
i m
a l s
o woul
d be m i s p l a c e
d
f o r
a n o
t h e r r e a s o n
:
m a n y
of
h e
c l a i m
s and
recommendations
i n
t h e s e
documents
a r e
grounded
a l m o s t ,
f
n o t
e n t i r e l y ,
o n a
i n g l e
a r b i t r a t i o n
d e c i s i o n
i n v
o l v i n g Bald
win
C
oun ty S e w e r
S e r v i c
e
LL
C B C
S S) ,
r i v a t
e
sew
er
t i l i t y
h e a d q u a r
t e r e d
i n Summerda
le,
Ala
bama.
I n
t h i s d e c i
s i o n , a - 1
p a n e l fou
nd t h a t A m
S out h Ba
nk,
w h
i l e a
c t i n g b o t h
a s a
r e d i t o r
and
an
a d
v i s o r , m i s r e
p r e s e n t e d
t
h e
r a t e
s o n
v a r i a b l e r a
t e
d e m
an d
n o t e
s s o
l d t o B
CSS. S p e c i f i
c a l l y , bank
emplo
yees r e p e
a t e d l y t o l
d
i n d i
v i d u a l s
a t BCSS
h a t
t
h e
v a r i a
b l e
r
a t e s
were
L
IBOR
a t e s w h en,
n
f a c t ,
t
h e y
were
n o
t .
F
u r t h e r ,
t h
e
p a n e l d e t e r m
i n e d
t h a t
w h e n
t h e bank
l a t e r s o l
d s
w a p a g r e e
m e n t s t o
BCSS
t
f a i l e
d
t o
d i s c l o s e
t
h e b a s
i s
r i s k
a s s o c
i a t e d w i t h
t h e
swap
.
Th e
p a n e l r e j e c t e d
t h e b
a n k s
c
l a i m
t h a
t
t
had
d i s c l o
s e d t h i s
r i s k ,
n o t i n
g
t h a t
t
h e o n l y
p r e s e n t a t
i o n a l l e g e
d l y m a d
e w
a s o
a
2
3- y e
a r- o l d
l o w
l e v e l t e m p o r
a r y
e
mployee
a t
BCSS
h ose
r
e s p o n s i b i l
i t i e s
i n c
l u d e d
s u p e r v i s i
n g
t
h e
s e
c r e t a r i e s
,
b u t n o t
f i n a n c e
.
F u
r t h e r , t h e p a n e
l
n o t e d
t h a t
t h i s
p
r e s e n t a t i
o n w
as h r e e
y e a r s b e f o r e
t h e ba
nk e
ven
s
o l d a
swap
agreement
o
BCSS.
Beca
use t h e f
a c t s and c i r c u m s
t a n c e s
i n
t h e BCS
S
r b i t r a t i o
n
d
e c i s i o n
a r e so
d i f f e r e n t
t h a n
t h o s
e
r e
l a t i n g
t o t h e C i t y
an
d
t s
e x i s t i n
g s w a p a g r e e m e n
t s ,
h a t
d e c i s i
o n
o
f f e r s no
s u p p o r t
f o r
t
h e i d e a t
h a t
t h e
C i t y s h o u
l d f i l e a
r a u d
o r u n f
a i r d e a l i n g
c l a i m
a g a i
n s t
i t s
c o u n t
e r p a r t i e s
.
F i r s t ,
wh
ereas
t h e
B
CSS
r b i t r
a t i o n
i n v o
l v e d a
p
e c i f i c
m i s r e p r e
s e n t a t i o n
—sayi
ng
t h e
r a t e
a t
i s s u e
w a s
a
LI
BOR
a t e
w h e n
t
w a
s
n o t
—
o ur r e v i e w foun
d
n
o
e v i d e n c
e t o s
u g g e s t
t h a t any
of
t h e
C i t y ' s
bank
c o u n
t e r p a r t i e
s
m
i s r e p r e s
e n t e d t h e
t e r m
s
of
h e s w
ap
a g r e
e m e n t s .
Secon
d, n l i k e
8/20/2019 Chicago Interest Rate Swap Legal Analysis
http://slidepdf.com/reader/full/chicago-interest-rate-swap-legal-analysis 29/29
BCSS
h
e C i
t y has
d
ecade
s
of
x p
e r i e n
c e
i n e n
t e r i n g
s wa p
r a
n s a c t
i o n s .
Th
e
C i t y
d i d not
e l
y
up
on
t s
ow
n o u n t e r
p a r t y
a
s
an
a d
v i s o r .
I n s
t e a d , our
re
view
o
f h e
d
ocume
n t s an d
i n t e r v
i e w s
of
i n d i v
i d u a l s
i
nvolv
ed
i n e x e
c u t i n g
t
h e C i
t y ' s swap
agr
eeme
nts r
e v e a l
e d t h a t
each t r
a n s a c
t i o n
wa s
thor
oughl
y exami
ne d,
e t t e
d , a
n d
n e
g o t i a t
e d
b
y t s
ow
n i g h l
y s o p h i
s t i c a t
e d
p r o f
e s s i o n
a l s ,
f
i n a n c i
a l
a d v
i s o r s
,
t a x
a
d v i s o
r s , an d
c o
u n s e l .
In
man
y
a s e
s ,
t h e
C i t y
c o m
p e t i t
i v e l y
b i d t h
e
swaps
an d
r e c e i v e d
m u l t i p l e p r e s e n t a t i o n s
from
d i f f e r e n t
banks
p r i o r t o
a g r e e i n g
on
t h e
lowest
i n
t e r e s t
r a t e
b i d .
T h i r
d ,
w
e
ou
nd
n o ev
idenc
e
t
o s u g g
e s t
t h
a t
bank
c
o u n t e
r p a r t i
e s m
i s s t a
t e d t h e
r i
s k s
a s s
o c i a t
e d
w i t
h
t h e sw
aps ,
n
c l u d i
n g
t h
e b
a s i s r i s
k .
To h e
c o n t
r a r y ,
o r mor
e
tha
n
t e n
y
e a r s ,
t h e C i t
y
h
as
d i s
c l o s e
d
p u b l i c
l y t s
u n d e r
s t a n d
i n g of
h
e
r i
s k s
a s
s o c i a t
e d
with
s
wa p
agre
ements
.
F i
n a l l y ,
we a ve
not
unc
ov er
ed a
n y supp
ort o
r t h e
a l l e g
a t i o n
i n
t h e
uni
on l
e a d e r s
'
Sep
temb
er
a n d O
ctobe
r L e t t e r
s t h a t
t h e
C i t y ' s
i
n t e r e s
t r a t e
swap
s a
r e
c o s
t i n g t h e
C i t y an
d
t h e
C
hicag
o
P u b
l i c S
chool
s
ov er
100
m i
l l i o n every
y e a r
,
a n
d hav
e caus
ed
l o s s e s
of o
ver 80
0
m
i l l i o
n t o d a t e .
T
h e
Octo
ber L e
t t e r a
s s e r t s
t h a t
t h e C
i t y ha
s made
e t
i n t e
r e s t
s wa p
pa y m
en t s
of
approx
imate
l y
70
i l l i o
n .
T
hat
h e C
i t y
has m
ade
e t
s w
a p paym
ents,
howe v
er, do
es not
m e a
n
t h a t t h e
C i t y
has
s u f f e r e d
d amag e s
as
a
e s u l t
of
r a u d
o r
u n f a i r d e a l i n g .
Th e
n o t i o n
t h a t
n e t
i n t e r e
s t s
wap pa
ymen
ts eq
uate
t o d a m
a g e s
pres
uppos
es
t h
a t
s
uch pa
y men
t s a
r e t h e r e
s u l t
of r a u
d
o r
u n
f a i r
d e a l i
n g
an
d i g
n o r e s
t
h e f a c
t t h a t
t h e C i t y
rem
ains
o b l i
g a t e d
t o
s e r v i
c e
t
s
debt
( r e
g a r d l e
s s of wh e
ther t
i s s u e
d
a
v a
r i a b l
e r a t
e
or
a i
x e d
r
a t e b
ond).
V.
ON
LUS
ION
O
ur n v e s
t i g a t i
o n f
ound
n o ev
idenc
e t h a t
wo
ul d
s
u p p o r t
a
go
od a i t
h cl
aim t h a t
t h e
C i t y '
s
s
wap
agr
eemen
ts
w
ere
p
rocur
ed by
r a u d
o r
t h a
t
a n y
of
h e
C i t y '
s
s w
a p
c o u n t e
r p a r t
i e s ma
de a
n y
m a t e r
i a l
m i s r e
p r e s e n
t a t i o
n s
or
om
issio
ns of a c t .
Nor
d i d
t h e
i n v e s
t i g a t i
o n d i
s c o v e
r an
y
evi
dence
t o
sup
port
a
clai
m
t h
a t
t h e
C i
t y ' s s
wap c o
u n t e r
p a r t i e
s
f a i
l e d
t o
d e a
l
f a
i r l y
wi
th t h e
C i t y
when
e g o t i a t i n g
and
e x e c u t i n g t h e
s wa p
agreements.
Indeed,
h e
f a c t s t h a t a f f i r m a t i v e l y r e f u t e
a n y
s
uch
cl
aim h
e r e
a r e
c l
e a r
an d
c o m p
e l l i n
g . F
i l i n g
suc h
a
cla
im
not
on l
y
wo u
l d be
a
wa s
te
of
t h e
C i t y ' s
m
on e y
, but
cou
ld
d a ma
g e t h e
C i t
y ' s c r e d i b i
l i t y ,
an
d
we a k
e n t s
p o
s i t i o
n i
n c u r r e
n t an d
f u
t u r e bon
d an
d
o
t h e r
f
i n a n c i
a l d e
a l i n ~ s
a t ~ i d t
r a n s a c
t i o n s .
s
L
.
Kop
e c k y
D
aniel
. o
i n s
top related