The City of Los Angeles recently filed two separate lawsuits in California state court concerning substantial losses it allegedly suffered as a result of municipal bonds it previously issued.

The first lawsuit, entitled City of Los Angeles v. Ambac Financial Group, Inc. et al., accuses six bond insurers and two insurance executives of colluding with ratings agencies to establish a discriminatory two-track rating system that forced municipalities and other public bond issuers to pay hundreds of millions of dollars in unnecessary premiums for bond insurance. The bond insurers named in the Complaint are Ambac Financial Group Inc., MBIA Inc., XL Capital Assurance Ltd., ACA Financial Guaranty Corp., Financial Guaranty Insurance Co., and CIFG Assurance NA.

According to the Complaint, a copy of which is available here, those bond insurers colluded with ratings agencies so that the ratings agencies would maintain two separate credit rating schemes: one for corporate issuers and one for public issuers. Under the alleged separate credit rating schemes, public issuers (namely municipalities like Los Angeles) were systematically given lower bond ratings than corporate issuers with the same or worse credit worthiness . Therefore, the municipalities were allegedly forced either to pay bond purchasers higher rates than their corporate counterparts or to buy bond insurance to increase their bond ratings. The Complaint alleges that the municpalities paid hundreds of millions of dollars in premiums for bond insurance to offset the alleged discriminatory dual rating schemes.

The Complaint also accuses the bond insurers of misleading the City of Los Angeles and other municipalities about the bond insurers’ exposures to subprime debt. According to the Complaint, the bond insurers failed to disclose that, while they were collecting hundreds of millions of dollars in premiums from municipal bond insurers, bond insurers were also exposing themselves to over $100 billion in risk from bonds backed by subprime debt. The Complaint further alleges that when the subprime loans backing that debt began to default, the bond insurers’ own credit ratings began to slip, leading to downgrades for the municipal bonds they insured. According to the Complaint, “[t]he insurer Defendants’ highly risky involvement in subprime markets was never disclosed by the Defendants to Plaintiff Los Angeles and other California cities and municipalities.”

Based on these allegations, the City of Los Angeles accuses the six insurance defendants of fraud and deceit, breach of contract, breach of their covenants of good faith and fair dealing and negligence. The city also accuses all of the defendants of negligent misrepresentation and violation of the California business code.

The second suit, entitled City of Los Angeles v. Bank of America, et al., also involves the city’s bond issuances. In that action, however, the City of Los Angeles accuses over 40 financial institutions of conspiring to manipulate the municipal derivative market through bid rigging and market allocation agreements. According to the Complaint, a copy of which is available here, the municipal derivatives at issue are investment vehicles used by Los Angeles and other municipalities to hold unused funds raised through the sale of bonds. The most common of these derivative instruments is a Guaranteed Investment Contract, but municipalities also often purchase a variety of other derivative instruments, including swaps and options.

The lawsuit accuses various financial institutions of conspiring to manipulate the sale of those municipal derivatives by agreeing to allocate the contracts among the different financial institutions. The institutions then allegedly rigged the bidding process to ensure that the pre-selected winner would in fact win the bid. According to the Complaint, the other financial institutions either chose not to submit bids or submitted only “courtesy bids” to give the bidding process “a veneer of legitimacy.”

The conspiracy, according to the Complaint, was widespread. The City of Los Angeles claims that it first came to light in February of 2007 when Bank of America announced that the United States Department of Justice (“DOJ”) had granted its amnesty application in exchange for full cooperation into the DOJ Anitrust Division’s investigation of market manipulation for municipal derivatives. The conspiracy uncovered by the DOJ, according to the City of Los Angeles, caused municipalities to purchase municipal derivatives that paid depressed interest rates. The city also says that it forced municipalities to engage counterparties who carried “increased credit risks not reflected in the terms of the transactions” and to pay those counterparties inflated fees and costs. Based on these allegations, the City of Los Angeles accuses the defendants of fraud and deceit and of violation of California’s business code.