Opinion ID: 787091
Heading Depth: 2
Heading Rank: 2

Heading: The Alleged Yield Burning Scheme In This Case

Text: 19 In the present case, the alleged fraud arises from Sakura's sale of forward supply agreements to municipal bond issuers. Lissack claims that Sakura fraudulently mispriced forward supply agreements by rigging the bidding process for the agreements. According to Lissack, Sakura arranged for noncompetitive bidders to make bids well below market value, thus ensuring that Sakura's similarly below-market-value bid would be selected by the municipalities. The Second Amended Complaint alleges the following conduct: 20 Sakura and its co-conspirators also corrupted, and conspired to corrupt, the bid selection process by, inter alia, selecting non-competitive bidders to participate in the bid process; communicating not to exceed bid amounts to losing bidders; selecting fewer than three disinterested bidders to participate in the bid process; providing false or misleading information in order to cause legitimate bidders to submit artificially low bids; diverting portions of anticipated profits to pay off co-conspirators that solicited non-competitive bids or otherwise ensured Sakura's selection as forward supply provider. 21 Lissack claims that Sakura concealed the sham bidding process from the involved municipalities and made false statements and misrepresentations in writing that the transactions complied with federal law and that the forward supply agreements would not cause the advance refunding bonds to run afoul of the IRS's arbitrage restrictions. Sakura's representations allegedly induced municipal issuers and bond counsel to issue certifications that their bonds complied with the yield restrictions of federal law and thus qualified for tax-exempt status. 4 22 Sakura's alleged fraud decreased the price paid to the municipal bond issuers for forward supply agreements below market value and consequently reduced the ultimate yields of the municipalities' escrow accounts below what the yields would have been in the absence of Sakura's fraud, a phenomenon known as yield burning, so named because the yield on the escrow account is artificially lowered (and thus burned) through the mispricing of the forward supply agreement. Yield burning creates a significant profit for the forward supply agreement provider since it allows the provider to pay less for the right to reinvest the escrow account cash flows during the float periods than the provider can expect to earn on reinvestment of those cash flows. Yield burning also causes the municipal bond issuers effectively (and unknowingly) to engage in bond arbitrage, thereby jeopardizing the tax-free status of their advance refunding bonds. The arbitrage arises from the fact that if the forward supply agreement were correctly priced, the total yield derived from the municipality's escrow account would be greater than the yield paid to bondholders. 5 23 The events alleged in the complaint are connected to an investigation launched in late 1993 by the Department of Justice (DOJ), the Securities and Exchange Commission (SEC), and the IRS examining the practice of yield burning in the municipal bonds industry. This investigation focused on whether IRS fair market pricing rules were violated during transactions involving advance refunding bonds. Lissack filed his original complaint in this action in February of 1995, in which he named multiple defendants, all of whom were municipal bond issuers or securities dealers, but did not include Sakura. The Government elected to intervene in that action, which related to the existing investigation, and reached settlement agreements with twenty-seven financial institutions in which the institutions paid the Government approximately $200 million in penalties and disgorgement. 24 In May 1996, Lissack filed an amended complaint, in which he included allegations against Sakura based on ten allegedly fraudulent forward supply agreements. In the complaint, Lissack asserts that Sakura's yield-burning scheme resulted in two distinct, though related, harms to the Government. According to Lissack, had Sakura correctly priced the forward supply agreements, municipalities would have purchased fewer interest-bearing Treasury securities and more zero-interest SLGS bonds in their escrow accounts so as to calibrate the total escrow yield to match the yield payable to the bondholders and to ensure the tax-exempt status of the bonds. Because municipal bond issuers purchased fewer zero-interest SLGS bonds than they otherwise would have purchased, Lissack asserts that the Government was deprived of the benefit of no-cost borrowing on the zero-interest SLGS bonds not purchased. Correspondingly, because municipalities unwittingly purchased more interest-bearing Treasury securities for their escrow accounts than they were entitled to purchase, Lissack claims that the Government paid out more in interest on Treasury securities than the Government would have paid had Sakura properly priced the forward supply agreements. These alleged harms are identical in amount; the value of the excess interest the Government paid on escrowed interest-bearing Treasury securities is identical to value of no-cost borrowing the Government was denied. Importantly for the present case, these alleged harms are also equal to the amount of the positive arbitrage — that is, the amount by which the yield on the municipality's escrow account (if properly priced) exceeded the yield paid on their tax-exempt advance refunding bonds. 25 The Government declined to intervene in the case against Sakura. In March 2001, Lissack filed a second amended complaint, listing five additional allegedly fraudulent forward supply agreements provided by Sakura. On August 19, 2003, the District Court granted Sakura's motion to dismiss, concluding, as is relevant here, that Lissack's case is barred by the clear language of the FCA's Tax Bar. This appeal followed.