L.A. sues financial firms, alleging fraud in bond issues

Bid-rigging and other alleged fraud by investment banks and insurance companies allegedly cost Los Angeles taxpayers tens of millions of dollars, according to a pair of lawsuits filed Wednesday by L.A. City Atty. Rocky Delgadillo.

One of the suits alleges that such Wall Street heavyweights as Merrill Lynch & Co., Morgan Stanley and Bank of America Corp. conspired with more than three dozen other financial firms to defraud the city and other public entities in a long-running scheme that’s also the focus of federal criminal investigations.

“Today we’re sending the message that if you cheat the city, we will come at you with everything we’ve got, whether you’re a gang banger or a Wall Street titan,” Delgadillo said in a statement announcing the suits, which were filed in Los Angeles Superior Court and seek unspecified damages.

Both complaints deal with the city’s issuance of municipal bonds. Such securities are sold by cities, counties and states to finance public projects such as the construction of roads, mass transit systems, schools and power plants.

The money raised from selling the bonds is often placed in investments known as municipal derivatives until it’s spent on the projects. Investment firms seeking to sell those instruments to municipalities are supposed to place competitive bids so that public entities receive the best possible rate of return.

But according to the city’s lawsuit against the Wall Street firms, they and other defendants conspired to rig the process by deciding among themselves which firm would win each contract.

“Other defendants would then either submit no bid at all or ‘courtesy bids’ that gave the bidding process the veneer of legitimacy,” the suit says.

The alleged conspiracy resulted in artificially low returns on the investments, costing the city “tens of millions of dollars it should have earned,” Delgadillo said.

A federal grand jury in New York is hearing evidence in the case, according to the lawsuit, which says subpoenas have been issued to more than 30 commercial and investment banks, insurance companies and brokers.

In February 2007, Bank of America Corp. said it was cooperating with the Justice Department to avoid criminal liability for its part in the alleged fraud.

The Internal Revenue Service and the Securities and Exchange Commission also are investigating, according to the lawsuit. The city of Oakland and other municipalities have filed similar lawsuits.

A second suit filed by Delgadillo on Wednesday targets a number of bond insurers. It alleges that the city needlessly bought insurance from the companies for holders of L.A.-issued bonds in the event of a default by the city.

Cities and other issuers of municipal bonds typically buy such insurance to boost the credit ratings on their bonds, making them more attractive to investors and lowering the interest rate the issuers need to pay. But in recent years, municipal bond insurers began insuring bonds backed by subprime mortgages. As those mortgages have gone bad, the insurers’ own credit ratings have fallen, causing a drop in ratings on insured municipal bonds.

According to Delgadillo’s suit, bond insurers never told the city that they had exposure to subprime mortgages. Had the city known that, it wouldn’t have purchased the insurance, the complaint says.

The suit also alleges that the bond insurers conspired to keep in place a credit rating system that gives uninsured municipal bonds lower ratings than they are entitled to.

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kim.christensen@latimes.com