Sacramento Utility Company Sues Wall Street Firms Over Alleged Bid Rigging

The Sacramento Municipal Utility District (SMUD) sued Goldman Sachs, Morgan Stanley and 45 other financial firms Thursday in Sacramento, California, federal court for allegedly rigging bids in bond-derivatives markets and defrauding the utility.

SMUD joined at least six city and county governments in California that already have filed similar lawsuits arising from a federal investigation made public in 2006. Many other public entities around the country have joined in lawsuits seeking class-action status.

The SMUD filing is the first to name Goldman Sachs as a defendant, according to lawyers working with the utility.

The litigation deals with bond-related financial instruments often used by local and state governments and other public entities when financing projects such as power plants.

After money is raised through a bond sale, but before it is spent on a project, it is often invested in municipal derivatives to earn a return. Another type of derivative is used to help public entities hedge against shifts in interest rates on variable-rate bonds. In both cases, competitive bidding is supposed to ensure the best possible return.

SMUD's suit - like those filed elsewhere - alleges that brokers, banks and insurance companies agreed to fix bids on municipal derivative contracts so public entities received lower rates of return than they would have in a truly competitive market.

"These are very sophisticated investment vehicles, but the scheme was very simple," said Nanci Nishimura, a partner at Cotchett, Pitre and McCarthy, a Burlingame-based law firm working with SMUD on the suit.

Court documents indicate SMUD entered into municipal derivative contracts worth at least $1.16 billion from 1999 through 2008. The deals detailed in the suit were struck with three firms: Goldman Sachs, $490 million; Merrill Lynch, $357 million; and Morgan Stanley, $312 million.

The Bee contacted six of the defendants named in the suit, including Goldman Sachs and Morgan Stanley. All either had no comment or did not respond to a request for comment.

The suit does not specify how much the alleged bid-rigging scheme may have cost the utility. Financial experts contacted by The Bee said the case is too complex to speculate on damages incurred by any particular entity.

The nation's municipal bond market is so large - roughly $2.6 trillion - that the total sums involved in the broader case could be huge.

"Even a fairly small difference in the funding cost would be an enormous amount of money," said Craig M. McCann, an economist with the Securities Litigation and Consulting Group, based in the Washington, D.C., area.

The related lawsuits filed around the country have been transferred to federal court in the Southern District of New York. A federal judge there has been assigned to oversee pretrial matters. Each case will likely then be transferred back to the court where the suit was filed, said Nishimura. SMUD's case will likely follow a similar path and be heard in Sacramento.

Arlen Orchard, SMUD's general counsel, said it's not clear what path the litigation will take. It could drag on, he said. Or, depending on what evidence emerges, some defendants may choose to settle early.

"This is a very, very complicated litigation. … It really could be years before it's resolved," he said.

In late October, the U.S. Department of Justice indicted three current and former officials at Beverly Hills-based CDR Fiancial Products Inc., one of the defendants in the SMUD suit. The officials are charged with participating in the type of bid-rigging alleged in the SMUD suit. A statement on CDR's Web site calls the charges "completely baseless."

Bank of America, which purchased Merrill Lynch last year, announced in 2007 that it had agreed to cooperate with the ongoing federal investigation in exchange for amnesty concerning its role in the municipal derivatives markets.