Detroit Seeks Legal Relief over Interest Rate Swaps

(February 3, 2014) — Detroit’s state-appointed emergency manager Kevyn Orr has applied to a bankruptcy judge to negate the city’s payment obligations on $1.44 billion of debt.

The lawsuit, filed on Friday, contends that the city and its retirement systems violated Michigan law when they set up what Orr refers to as “sham” service corporations and funding trusts to facilitate the debt sales in 2005 and 2006, according to documents seen by aiCIO.

All other contracts or obligations connected to the debt are also void, the lawsuit claimed.

The suit has called on bankruptcy judge Steven Rhodes to issue a judgment declaring that the city is not obligated to continue making payments on the pension certificates of participation (COPs) that were issued during the term of former mayor Kwame Kilpatrick, who is now in prison on federal corruption charges.

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“This deal was bad for the city from its onset, despite reassurances it would adequately resolve the city’s pension issues,” Orr said in a statement.

If Orr is successful, the ruling could invalidate the interest-rate swap contracts that Detroit reached with investment banks UBS and Merrill Lynch Capital Services, a part of Bank of America.

The swaps were meant to hedge interest-rate risk arising on variable-rate COPs. In the suit, Detroit claimed that any contract arising from the COPs would be invalid from the start since “all other obligations incurred by the city in connection with the COPs transactions are unenforceable and void”.

Like all other municipalities in Michigan, Detroit was subject to a strict limitation on the amount of indebtedness it could incur. In particular, Section 4a of the Home Rule City Act (HRCA) set maximum limits on a city’s net indebtedness. This would be the greatest of either 10% of the assessed value of all the real and personal property in the city or 15% of this assessed value if money that exceeded the original 10% was or had been used solely for the construction or renovation of hospital facilities.

At the time the $1.44 billion of COPs were issued in 2005, the city had only approximately $660 million remaining under its HRCA debt limit, and therefore could not issue traditional debt to cover the $1.70 billion pension shortfall, the lawsuit explained.

The swap deals, valued at $400 million in 2011, began to cause two public sector pension funds problems as interest rates fell at the same time as Detroit’s credit ratings. The money owed to the banks was a key element that drove Detroit to file for municipal bankruptcy in July.

Orr was appointed in March 2013 to oversee bankruptcy operations of Detroit. A veteran bankruptcy lawyer, Orr was a partner at the Jones Day firm, and worked on some of the US’s most notable bankruptcy cases, including that of Chrysler in 2009.

Last year, Detroit attempted to be awarded bank redress over other debt investments of its pension funds.

In September 2013, an arbitration panel from the Financial Industry Regulatory Authority, an independent regulator of US securities firms, dismissed claims brought by Detroit’s Police and Fire Retirement System.

The system had brought claims against Citigroup, Morgan Stanley, and several other smaller institutions in 2010, claiming the banks had defrauded and breached both contracts and their fiduciary duty when recommending the system invest in various collateralised debt obligation funds.

(February 3, 2014) – Ben & Jerry’s Foundation, the Russell Family Foundation, and Google founder Eric Schmidt’s foundation have joined 14 other charities in divesting from fossil fuel investments.

The group, which represents $1.8 billion in assets, has argued that as long-term investors they have a fiduciary responsibility to battle climate change by supporting only clean energy companies.

Furthermore, they said divesting protects portfolios from the “carbon bubble”—a theory that oil, gas, and coal-related securities are overvalued because reserves cannot be fully exploited while maintaining a livable climate.

“Foundations can divest and achieve superior returns for their endowment,” the organizations stated, encouraging their peers to join the “Divest-Invest Philanthropy” initiative.

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“All portfolios can be readily structured around themes of climate-related strategic asset allocation, carbon risk mitigation, sustainability solutions, and positive environmental impact,” they said.

The John Merck Fund, Park Foundation, Educational Foundation of America, Compton Foundation, and Wallace Global Fund have all signed on to the initiative. Some members, such as the Sierra Club Foundation, have explicitly environmentalist mandates. Others do not, including the Quaker-led Joseph Rowntree Charitable Trust, which “seeks to transform the world by supporting people who address the root causes of conflict and injustice” via grants from its $300 million fund.

The announcement of the initiative came days after a $67 billion Norwegian pension provider said it had sold its holdings of 10 coal-fueled power producers in a bid to reduce its carbon footprint. Other Scandinavian asset owners have recently funded renewable energy projects via the Danish Climate Investment Fund.

Student groups at many leading universities have petitioned their endowments to divest of fossil fuels with middling success. Nine small colleges and universities have thus far agreed to do so, including Hampshire College in Massachusetts and San Francisco State University.

Harvard University denied a strong campaign for divestment in 2013, stating that “funds in the endowment have been given to us by generous benefactors over many years to advance academic aims, not to serve other purposes, however worthy.”

The 18 foundations that have signed on to the “Divest-Invest Philanthropy” initiative compare it to the widespread selloff of South African securities in the 1970s and 1980s. However, a 1999 study of the campaign’s impact found that “the South African boycott had little effect on the financial sector… despite the prominence and publicity of the boycott and the multitude of divesting companies.”