Whistleblower Lazard settles federal yield-burning case for $11 million

Settlement sets the framework for other yield-burning qui tam cases

April 22, 1999 -- Lazard Freres & Co. has agreed to pay the federal government a total of $11 million to settle allegations that the firm improperly overcharged municipalities for U.S. Treasury securities, a practice known as "yield-burning."

With the resolution of this case, Lazard will have paid a total of $20 million in the past six months to settle yield-burning charges.

"This is a significant milestone in the government's enforcement action against yield-burning," said Erika A. Kelton, a Washington, D.C., attorney whose firm, Phillips & Cohen, represents the whistleblower in the case. "The settlement establishes a framework for settling similar yield-burning charges pending against other Wall Street investment banks."

The federal investigation of illegal yield-burning practices has dogged many banks for several years. The investigation was sparked by Michael Lissack, a former managing director of Smith Barney, who first brought public attention to the fraud perpetrated by Wall Street and filed the "qui tam" lawsuit against Lazard that resulted in today's settlement.

On the eve of trial last November, Lazard settled a separate yield-burning lawsuit brought under the California False Claims Act. Lazard agreed to pay the Los Angeles County Metropolitan Transportation Authority (LAMTA) $9 million to settle charges that the investment bank fraudulently overpriced securities by $3 million on a single municipal refinancing transaction.

"As the LAMTA settlement made clear, when these matters are litigated, the government's ultimate recovery is greatly increased," said attorney John R. Phillips of Phillips & Cohen. "Given that, we expect other investment firms will take advantage of the opportunity to settle yield-burning charges.

"If the cases aren't settled," Phillips added, "we are fully prepared to litigate each and every case."

Phillips & Cohen represented Lissack in both cases against Lazard and served as counsel to the LAMTA.

Yield burning occurs when banks improperly inflate the price of securities above their fair market value. The inflated price improperly lowers, i.e., "burns," the securities' yield. The practice is prohibited by federal law.

In the case of municipal debt refinancings known as "advance refundings," investment banks improperly pocketed the profits made by overpricing securities rather than giving the profits to the federal Treasury as required.

The federal settlement covers related cases brought against Lazard by the Justice Department and the Securities and Exchange Commission (SEC): $7.45 million will go to Justice to settle Lissack's federal whistleblower lawsuit; the remaining $3.55 million will go to the SEC, which will return the money to state and local issuers that lost money as a result of Lazard's yield-burning practices. Lazard closed its muni finance department in 1996.

A separate qui tam case brought by Lissack resulted in Meridian Securities (now CoreStates Financial Corp.) paying the Justice Department $3.8 million in April 1998 to settle yield-burning charges.

Phillips & Cohen's empirical study of Wall Street's pricing practices showed that when banks sold securities competitively, they charged average mark-ups of just 25 cents per $1,000 bond. But when they sold clients the same securities on a sole-source basis, the banks added about a $5 mark-up per bond. The profits made on non-competitive sales were on average 20 times higher than those made on competitive deals.

"Deal by deal, year after year, Wall Street raked in hundreds of millions in improper profits," Kelton said.

The Justice Department's settlement with Lazard covers five refinancing transactions in which the firm sold U.S. Treasury securities to municipal agencies in connection with those bond issues. These "advance refunding" bond transactions were for the LAMTA, the Kentucky Turnpike Authority, the New Jersey Highway Authority and the Nashville Davidson Electric System.

Lissack's federal false claims lawsuit against Lazard was filed in 1995 in the southern district of New York (Manhattan). It was brought under the False Claims Act, which permits individuals with knowledge of fraud against government entities to file suit on their behalf.

"Wall Street made hundreds of millions of dollars illegally from yield-burning at the taxpayer's expense, and those profits should be returned to the U.S. Treasury," Lissack said.

Lazard's settlement clearly demonstrates the effectiveness of the False Claims Act in recovering damages in yield-burning cases, said attorney Phillips. Companies liable under the False Claims Act can be required to pay as much as three times damages and $5,000 to $10,000 for each false claims. The "relator," as the whistleblower is known, is entitled to a share of whatever money the government recovers as a result of the lawsuit.

"The day of reckoning for the rest of Wall Street is coming," Phillips said. "Lazard did not get away with yield-burning, and neither will other investment banks."

For more information about this case, see the following news stories:

  • "Lazard to pay $11 million to settle federal charges," Joseph B. Treaster, The New York Times, 4/23/99.
  • "Lazard to pay $11 million in settlement with the U.S. in 'yield-burning' case," Charles Gasparino and John Connor, The Wall Street Journal, 4/23/99.
  • "11M Lazard hit for muni fraud," Amy Feldman, New York Daily News, 4/23/99.