Municipalities and states are finally beginning to take legal action to protect taxpayers. Many local governments sustained huge investment losses in the recent market turmoil. In certain cases, relatively unsophisticated government servants were induced to make toxic investments by savvy Wall Street financial advisers. As a result of relying on these advisers, state and local governments have ended up owning some of the riskiest junk imaginable and have sustained critical losses.
Recently, the city of St. Petersburg, Fla., filed suit against Wachovia Bank NA and other entities to recover $15 million in losses related to investments in securities issued by Lehman Brothers. The action is for breach of contract, breach of fiduciary duty, negligence, and violations of state securities and trade regulation statutes. The claims arose out of a securities lending program administered by Defendants, as a fiduciary and agent for Plaintiff. The City engaged Wachovia as its agent to lend out its portfolio of securities to various borrowers in exchange for cash collateral. Wachovia then invested the City’s cash collateral in various investments including those issued by Lehman. In making the investments, Wachovia acted with discretion limited only by an agreed-upon conservative investment guidelines.
The core allegation of the suit is Wachovia failed to warn St. Petersburg that Lehman securities had become too risky for its conservative investment guidelines as required by its fiduciary and contractual obligations. Indeed, Wachovia continued to advise St. Petersburg not to sell any of its collateral investments, including the Lehman bonds, before they came to maturity, and failed to tell city officials about rating agencies’ downgrades of the Lehman securities. Had it done so, the city could have sold them with a small loss, the suit says.
Lehman filed for Chapter 11 in September 2008, listing assets of $639 billion and debts of $613 billion. It was not until after Lehman’s collapse that Wachovia first disclosed its concerns about the Lehman bonds to the city, according to the complaint. By that time, the bonds were relatively illiquid and nearly worthless.
“When the loaned securities corresponding to the Lehman bonds were returned, the city had to pay $15 million in cash … to pay back those borrowers because the Lehman bonds were illiquid and nearly worthless, pending bankruptcy proceedings that are still in progress
today,” the suit said.
J. Boyd Page, an Atlanta attorney that represents investors, observed, “I’m glad that some of these victimized state and local governments are acting to protect their residents. With due respect to government servants, in most cases, they simply did not have the expertise or resources to investigate and understand some of the high-risk securities they were sold. In many situations, they had to trust the honesty and integrity of their financial advisers. Unfortunately, that trust was misplaced in certain cases.”
The case is City of St. Petersburg, Florida v. Wachovia Bank, National Association et al., case number 10-cv-00693, in the U.S. District Court for the Middle District of Florida.