Schooling Banks and Brokers

What Stephen E. Kravit and C.J. Krawczyk found in three million pages of discovery

Published in 2013 Wisconsin Super Lawyers — December 2013

When C.J. Krawczyk was a teenager spending summers on Blue Lake in Minocqua, attorney Stephen E. Kravit noticed him—but not for his intelligence or dedication. He saw him fooling around with a chainsaw.

Years later, when Krawczyk interviewed to be a summer clerk at Kravit’s firm, Kravit sprung it on him: “Alright, now what the hell were you doing with that chainsaw cutting down trees randomly on that property in Minocqua?”

“I stunned him speechless; then we both broke up laughing,” Kravit says.

“That story’s kind of morphed over the years,” Krawczyk, 39, insists. But having his adolescent shenanigans brought up in a job interview, he says, “prepared me, in a way, for being in law practice. When somebody drops the bomb on you [that] you don’t see coming, you have to … turn and parry and stay on your feet.”

Krawczyk and Kravit, now partners at Kravit, Hovel & Krawczyk in downtown Milwaukee, are still on their feet after the Royal Bank of Canada (RBC) and brokerage firm Stifel Nicolaus & Co. dropped a bomb on them: three million pages of discovery in a complicated, lengthy case in which the two represented, and still represent, five Wisconsin school districts.

In 2006, the districts—West Allis/West Milwaukee, Whitefish Bay, Waukesha, Kenosha and Kimberly—invested $200 million to finance their pension liabilities, buying up synthetic collateralized debt obligations (CDOs), a type of asset-backed security with varying layers of risk, or tranches, bought from Royal Bank of Canada and brokered by Stifel Nicolaus. Unbeknownst to the districts, they had purchased risky investments inconsistent with their conservative investment policies. According to Kravit, no one had sold derivatives like these to schools before.

Eighteen months after the purchase, the CDOs became worthless. The trusts set up by the districts had borrowed more than $150 million to make the investments because Stifel and RBC marketed them to be “as safe as a CD,” according to Kravit. The school districts were told that it would take the equivalent of 15 Enron debacles for the investments to fail. 

“I really think there was a naiveté on [the] part of the investment professionals thinking that, ‘Well, this stuff isn’t going to blow up and we’ll be OK,’” says Krawczyk. “But they were whistling past a graveyard while they did that.”

RBC, Canada’s largest bank, packaged the CDOs for the schools to buy. In discovery, Kravit, Krawczyk and their team found that when RBC employees reviewed the idea of selling these CDOs to the districts, they determined that it was unsuitable for the schools, communicating this conclusion in internal documents. RBC went ahead and sold the CDOs to Stifel so that the brokerage firm had the responsibility to decide whether this type of investment was suitable for its clients. However, after an initial $25 million investment, according to Kravit, Stifel refused to take sole responsibility for suitability. “RBC agreed to that, ignoring [a managing director’s] view that this was an unsuitable investment, and directly sold $175 million more to the school districts,” says Kravit. “Those are pretty good liability-creating facts.”

Sifting through three million pages to eventually find this intelligence in one seven-page memo is a career highlight for Krawczyk. “When that document came to my attention, it was a game changer,” he says.

Several years into the case, the Securities and Exchange Commission began investigating both RBC and Stifel. RBC settled with the SEC for $30.4 million, which was turned over to the school districts; however, a provision of the settlement stated that $22 million of the money couldn’t be considered damages in the school districts’ civil case. So the case is still ongoing.

“These regulator brokerages and banks are a lot more afraid of the SEC than they are of a couple of Wisconsin school districts. … The SEC is the gorilla in the room,” says Kravit. “For an $80 billion bank, what is [$30] million? Pocket change. They did the smart thing. Stifel did the opposite.”

Stifel and the SEC are still in litigation, but the brokerage firm settled with the school districts on March 19, 2012, Krawczyk’s birthday, for $13 million; a standby letter of credit for nearly $10 million to be paid when their case with the SEC is resolved, among other stipulations; and forgiveness of the $154 million debt created to finance the purchase of the CDOs in 2006. Stifel controls the debt after purchasing the notes for a large discount from Depfa Bank. Going forward, the school districts and Stifel are both pursuing recovery claims from RBC. 

To date, Kravit and Krawczyk have procured $217.9 million between their settlement with Stifel and the SEC’s settlement with RBC. Kravit says it’s the second largest civil settlement in Wisconsin history.

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