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Re: Yield Burning, What the heck is it?
Chapman, Spira & Carson - Disscusion

From: City of New Orleans vs. Smith Barney Inc. and BT Alex . Brown Incorporated
Date: 4/25/99
Time: 8:18:18 AM
Remote User:

Comments

The following actual filing gives a crystal clear look at a yield buring law suit. In this instance it was filed by the City of New Orleans against two major brokerage firms. We think it is not complex, readable and interesting. Chapman

THE CITY OF NEW ORLEANS,

Plaintiff, VERSUS

SMITH BARNEY INC. and BT ALEX. BROWN INCORPORATED,

Defendants.

CIVIL ACTION NO.

SECTION

MAGISTRATE DIVISION

COMPLAINT FOR DAMAGES AND FOR DECLARATORY JUDGMENT NOW INTO COURT, through undersigned counsel, comes plaintiff The City of New Orleans, who represents the following to this Honorable Court:

Parties

1. Plaintiff The City of New Orleans ("The City") is a municipality organized under the laws of the State of Louisiana and located in this District.

2. Defendant Smith Barney Inc. ("Smith Barney") is a corporation organized under the laws of the State of Delaware having its principal place of business in the State of New York, which at all material times transacted business in this District.

3. Defendant BT Alex. Brown Incorporated ("Alex Brown") is a corporation organized under the laws of a state other than Louisiana and having its principal place of business in a state other than Louisiana, which at all material times transacted business in this District.

Jurisdiction and Venue

4. Jurisdiction lies in federal court pursuant to 28 U.S.C. 1331 and 1332, because this is a civil action arising under the laws of the United States and because there is complete diversity of citizenship between plaintiff, on the one hand, and defendants, on the other hand. Venue lies in this District pursuant to 28 U.S.C. 1391(a)(2) and/or (b)(2), because a substantial part of the events or omissions giving rise to this action occurred in this District.

General Allegations

5. Pursuant to certain resolutions, contracts and agreements entered into in or about September of 1991, The City issued millions of dollars worth of tax-free bonds under the title: "$179,798,786.65 City of New Orleans, Louisiana General Obligation Refunding Bonds, Series 1991 (the "Bonds")."

6. Defendants Smith Barney and Alex. Brown acted as underwriters and/or escrow providers for the issuance of the Bonds pursuant to contract, and as advisors and fiduciaries to The City by virtue of the responsibilities and obligations they assumed in connection therewith.

7. Defendants Smith Barney and Alex. Brown affirmatively represented to The City in or about September of 1991 that the Open-Market Securities purchased in connection with the issuance of the Bonds were acquired by arms' length transactions and that no amount was paid by The City to reduce their yield. Based on these and other representations, The City believed that it had been fully apprised of all mark-ups, commissions, fees, and transaction costs in connection with the issuance of the Bonds.

8. Defendants Smith Barney and Alex. Brown affirmatively represented to The City in or about September of 1991 that they were performing all acts necessary to insure that the Bonds qualified as tax-free bonds, knowing that the tax-exempt status of the interest component to be paid investors was an essential feature of the Bonds to The City and to the investors therein.

9. On June 16, 1997, The City received an SEC subpoena for certain records concerning the Bonds, which was the first indication of any kind to The City that there were any problems or potential problems with the issuance of the Bonds, although even on that date, The City had no understanding of the purpose of the subpoena or what any potential problems may be.

10. On August 21, 1997, and again on September 15, 1997, the District Director of the Internal Revenue Service issued letters to The City informing it that the IRS had made a "preliminary determination" that the Bonds did not meet the IRS requirements for tax-exempt bonds, based upon the IRS having "concluded that securities purchased for [the Bonds'] defeasance escrow fund were excessively marked-up in a practice commonly known as 'yield burning.'" The IRS further informed The City that Smith Barney, as escrow provider, and Alex. Brown, as lead underwriter, apparently had a private agreement to share these "excessive mark-ups" without The City's knowledge, and therefore that the Bonds were "arbitrage bonds and that the interest paid to bondholders is not likely to be excludable from income." The IRS further notified The City that "if a final determination is made that the interest on the named bond issue is not excludable, it is our responsibility under the law to recover any unpaid tax on the interest from the holder of the bonds."

11. Despite efforts to resolve these issues since August of 1997, The City has been unable to obtain agreements from the defendants either to resolve and terminate these issues directly with the IRS or to indemnify, hold harmless, and defend The City from the potential claims of the bondholders should the Bonds' tax-exempt status be denied.

Count One

Declaratory Judgment

12. Plaintiff The City of New Orleans reaffirms and realleges all of the foregoing allegations.

13. There is an actual and existing dispute as a result of the foregoing between The City and the defendants as to whether the defendants have committed any wrongdoing and/or have any obligation to resolve these issues with the IRS or indemnify The City. Therefore, pursuant to the Federal Declaratory Judgment Act, 28 U.S.C. 2201, The City seeks a declaratory judgment that the defendants are 100% responsible for any determination by the IRS to deny the Bonds' tax-exempt status and, therefore, should be ordered to indemnify, hold harmless, and defend The City from any and all potential claims occasioned thereby.

Count Two

Violations of Section 10(b) of the Exchange Act

14. Paragraphs 1 through 13 are repeated and realleged as if fully set forth herein.

15. Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder prohibits any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange, from employing any device, scheme or artifice to defraud, or from making any untrue statement of a material fact or omitting to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or from engaging in any act, practice or course of business which operates or would operate as a fraud or deceit on any person, in connection with the purchase or sale of any security.

16. By reason of the foregoing conduct, defendants Smith Barney and Alex. Brown each violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and The City seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Three

Violations of Section 17(a) of the Securities Act

17. Paragraph 1 through 16 are repeated and realleged as if fully set forth herein.

18. Section 17(a) of the Securities Act makes it unlawful for any person in the offer or sale of any securities by the use of any means or instrumentalities of transportation or communication in interstate commerce or by use of the mails, directly or indirectly, to employ any device, scheme or artifice to defraud, or to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or to engage in any transaction, practice or course of business which operates or would operate as fraud or deceit upon the purchaser.

19. By reason of the foregoing conduct, defendants Smith Barney and Alex. Brown each violated Section 17(a) of the Securities Act, and The City seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Four

Violations of Section 206(1), (2) and (3) of the Advisers Act

20. Paragraphs 1 through 19 are repeated and realleged as if fully set forth herein.

21. Sections 206(1), (2) and (3) of the Advisers Act, respectively, make it unlawful for any investment adviser, by the use of the mails or any means or instrumentality of interstate commerce, directly or indirectly: (1) to employ any device, scheme or artifice to defraud any client or prospective client; (2) to engage in any transaction, practice or course of business which operates as a fraud or deceit upon any client or prospective client; or (3) acting as a principal for its own account, knowingly to sell any security to or purchase any security from a client, or acting as a broker for a person other than such client, knowingly to effect any sale or purchase of any security for the account of such client, without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction.

22. By reason of the foregoing, defendants Smith Barney and Alex. Brown violated Sections 206(1), (2) and (3) of the Advisers Act, and/or aided and abetted violations thereof by knowingly and substantially assisting in such violative conduct, and The City seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Five

Violations of Louisiana Securities Law >

23. Paragraphs 1 through 22 are repeated and realleged as if fully set forth herein.

24. By virtue of the foregoing acts, defendants Smith Barney and Alex. Brown violated the Louisiana Securities Law, La. R.S. 51:701 et. seq., and plaintiff seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Six

Breach of Fiduciary Duty

25. Paragraphs 1 through 24 are repeated and realleged as if fully set forth herein.

26. At all relevant times, defendants Smith Barney and Alex. Brown served as investment providers and financial advisors to The City, providing the defeasance escrow with Treasury securities, reviewing the financing arrangements, advising the issuer as to the reasonableness of the refunding bond prices and the defeasance investments, and otherwise operating as a fiduciary to The City.

27. The City's reposed trust and confidence in defendants' competence, integrity and fidelity. Defendants sought and accepted this reposing of trust and confidence and accepted the responsibility to act with competence, integrity and fidelity in advising The City regarding financial transactions. The defendants therefore owed a fiduciary duty to The City. As described above, the defendants breached their fiduciary duties to The City and The City seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Seven

Breach of Contract

28. Paragraphs 1 through 27 are repeated and realleged as if fully set forth herein.

29. The City and the defendants entered into contractual agreements in or about September of 1991, the terms of which governed the parties' actions at applicable times; which defendants breached as set forth above, and for which plaintiff seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Eight

Recovery of Payment of Things Not Due

30. Paragraphs 1 through 29 are repeated and realleged as if fully set forth herein.

31. As set forth above, defendants by their actions received payments of things not due which under Louisiana law must be disgorged pursuant to La. C.C. Arts. 2301 and 2302, and plaintiff The City of New Orleans seeks all such payments due to it thereunder, plus interest, costs, and attorney's fees.

Count Nine

Unfair and Deceptive Trade Practices

32. Paragraphs 1 through 31 are repeated and realleged as if fully set forth herein.

33. As set forth above, defendants' actions constitute unfair and deceptive trade practices in violations of La. R.S. 51:1405 et. seq., for which The City seeks all damages due it thereunder, including interest, costs, and attorney's fees.

Count Ten

Negligent and/or Intentional Misrepresentations or Other Tortious Conduct

34. Paragraphs 1 through 33 are repeated and realleged as if fully set forth herein.

35. As set forth above, the defendants made negligent and/or intentional misrepresentations or committed other tortious acts in violation of Louisiana law, for which plaintiff seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Eleven

Breach of Duty of Full Disclosure

36. Paragraphs 1 through 35 are repeated and realleged as if fully set forth herein.

37. At all times relevant hereto, the defendants acted as agents for The City in conducting purchases and sales of securities on behalf of The City.

38. As agents for The City, the defendants owed a duty of full disclosure to The City.

39. The defendants breached their mandatory duties in failing to disclose fully the details about payments received in connection with handling The City's transactions herein, and The City seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Twelve

Breach of Duty to Avoid Self Dealing

40. Paragraphs 1 through 39 are repeated and realleged as if fully set forth herein.

41. As agents for The City, the defendants owed a duty to The City to avoid self-dealing, which they breached by arranging payments from each other and/or third parties to perform services on behalf of The City, for which plaintiff seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Count Thirteen

Breach of Duty to Turn Over and Account for Funds

42. Paragraphs 1 through 41 are repeated and realleged as if fully set forth herein.

43. As agents for plaintiff, the defendants owed a duty to turn over and account for all funds received as a result of their agency relationship, which they breached as set forth above, for which The City seeks all damages, interest, costs, and attorney's fees caused to it thereby.

Relief

44. WHEREFORE, plaintiff The City of New Orleans prays that, after all due proceedings, judgment be granted in its favor and against defendants Smith Barney Inc. and BT Alex. Brown Incorporated, as follows:

1. For a declaratory judgment finding that the defendants are 100% responsible for any determination by the IRS to deny the Bonds' tax-exempt status and ordering them to indemnify, hold harmless, and defend The City from any and all potential claims occasioned thereby;

2. For all damages caused to The City as a proximate result of defendants' wrongful actions or inactions, plus legal interest due thereon; and

3. For any and all other and further relief to which The City may be entitled by law or equity, including all costs and reasonable attorney's fees incurred in fact and any statutory or exemplary damages or penalties permitted by law.

Respectfully submitted,

RANDALL A. SMITH, T.A. (#2117) Of SMITH, JONES & FAWER, L.L.P. 201 St. Charles Avenue, Suite 3702 New Orleans, Louisiana 70170 Telephone: (504) 525-2200

Counsel for The City of New Orleans


Last changed: March 17, 2000