POINTING THE FINGER
The dispute could determine who is to blame for increased debt load when market conditions head south
Tri-City Medical Center exited the auction-rate bond market earlier this year, following many not-for-profit hospitals that fled the market after its 2008 collapse. But unlike other hospitals, Tri-City Medical Center has sued its bank and bond insurer over the nowlargely defunct financing vehicle.
The district-owned hospital in Oceanside, Calif., last month filed a lawsuit in the Superior Court of Orange County against Citigroup and MBIA, alleging the bank and insurer misled the hospital directors with claims the auction-rate market bore low risk and were negligent in failing to disclose bank intervention in the market, including bids to prevent failed auctions.
The lawsuit appears to be one of the first brought by a healthcare bond issuer against banks that marketed auction-rate bonds before the market seized in February 2008 amid investor panic and mounting bank distress. It has not returned.
Alex Samuelson, a Citigroup spokesman, declined to comment on the lawsuit. MBIA spokesman Kevin Brown declined to comment on the litigation.
Tri-City’s legal argument boils down to this: No one advised the hospital of the risks, despite an obligation to do so.
The lawsuit alleges Citigroup wrongly claimed auction markets were open and fair and the bonds were relatively low risk, but failed to adequately disclose activity to support and manipulate markets that was the subject of an inquiry by the Securities and Exchange Commission in 2006. The SEC fined 15 banks $13 million in May 2006 for failing to disclose intervention in the auction market, including Citigroup. The banks neither admitted nor denied the claims, but were also ordered to generally disclose potential market activity.
By 2006 “the entire auction-rate securities market was not a free-market operation matching willing investors with willing issuers, but instead was an engineered, artificial market sup- ported by the activities of the investment bankers designed to postpone a collapse, and such support could not continue indefinitely,” the lawsuit said.
In July 2007, eight months before the nation’s emerging credit crisis paralyzed the $330 billion auction market, the hospital went to market to refinance roughly $68 million of long-term debt to auction-rate bonds.
At the time Tri-City moved its debt to the auction market, the hospital’s seven-member board, elected by the district, was nearly all medical or healthcare professionals, including a retired registered nurse and a retired pharmacist. The one member not working in healthcare was a certified public accountant.
The hospital paid roughly $3.2 million— going to underwriters for the insurance premium; fees for attorneys, trustees and ratings agencies; and miscellaneous costs to refinance the debt, bond documents show.
The lawsuit also names the hospital’s attorneys and financial advisers and alleges they were negligent in failing to alert the directors that the 2007 bond deal could violate California law that sets a limit on interest paid for hospital district debt.
Soaring interest on the bonds exceeded the 12% limit for auction-rate securities issued by hospital districts, the lawsuit said. Interest in TriCity’s auction bonds climbed above the state limit in multiple auctions between November 2008 and December 2009, repeatedly reaching 14.5%, according to the complaint.
The interest rate hikes cost Tri-City Medical Center $15 million beyond what it would have paid had debt not been refinanced.
Larry Anderson, CEO of the 330-bed hospital, who dubbed the bonds “heinous,” said the hospital also paid roughly $6 million when it terminated its hedge against interest rates on the debt, known as a swap, two months after his arrival in January 2009. Anderson said the
Anderson called the bonds “heinous.”