Credit Crunch Digest -- December 2012

This issue of the Credit Crunch Digest focuses on lawsuits involving developments into Libor rate-fixing lawsuits and investigations; JP Morgan Chase & Co.; a $210 million settlement reached with investors in Madoff funds; a possible insider trading case against SAC Capital; actions against accounting firms in connection with U.S. offerings of China-based companies; new U.K. regulatory plans for failing international banks; and a Dodd-Frank loophole helping banks’ offshore clients.

Libor & Other Financial Institution Liability Matters

Litigation and Regulatory Investigations

Fraud and Ponzi Schemes

Government and Regulatory Intervention


Libor & Other Financial Institution Liability Matters

UBS Facing Potential $1.6 Billion Fine in Libor Fixing Probe

UBS, Switzerland’s largest bank, is set to become the second financial institution to enter into a settlement arising out of the Libor rate-fixing scandal.  The potential agreement would reportedly allow UBS to pay up to $1.6 billion to settle allegations that it attempted to rig various interbank interest rates to increase trading profits.  The deal would resolve investigations conducted by certain U.S., British and Swiss regulators, including the U.S. Department of Justice, the U.S. Commodities Futures Trading Commission, and the U.K. Financial Services Authority.  As part of the deal, UBS’ banking subsidiary in Japan, UBS Securities Japan Ltd., will plead guilty to a criminal charge, and UBS will admit that several of its traders manipulated the Japanese yen Libor rate from 2005 to 2010.  It has also been reported that U.S. prosecutors will file criminal charges against certain individuals as part of the settlement process, although UBS, the parent company, will avoid any criminal charges in exchange for paying the large fine. 

Although UBS was granted leniency for cooperating with investigators, this fine is more than triple the $450 million paid by Barclays earlier this year to settle its role in the Libor scandal. The Libor rate is used to set borrowing rates for more than $350 trillion worth of lending contracts worldwide.  The Libor probe has involved approximately 20 of the biggest banks across three continents, involving regulators from the United States, Canada, Europe and Japan.  Recently, British prosecutors arrested several individuals as part of a criminal investigation into rate manipulation.  One of these individuals, Thomas Hayes, is a former UBS trader employed with the bank from 2006 to 2009.  UBS is also facing investigations from the Canadian Competition Bureau, the Attorneys General of Connecticut and New York, and the Monetary Authority of Singapore.  It was not immediately clear whether the Canadian Libor probe would be part of the imminent settlement.

The Libor settlement is just one of the problems encountered by UBS over the past year.  Earlier this year, a rogue UBS trader cost the company $377 million before being jailed, and UBS reportedly had some involvement in issues arising out of the Facebook IPO.  More recently, the company announced that it would lay off 10,000 employees as part of its efforts to wind down a significant part of the investment bank.

(“UBS Said to Face $1.6B Libor Penalty This Week,” Bloomberg, December 16, 2012s; “A Shadow Over Banks as UBS Nears Deal,” The Wall Street Journal, December 16, 2012; “UBS faces $1.6 billion fine over Libor rigging: paper,” Reuters, December 15, 2012)

Litigation and Regulatory Investigations

Dodd-Frank Author: JP Morgan Should Not be Prosecuted for Bear Stearns Acquisition

Former U.S. Congressman Barney Frank, the co-author of the Dodd-Frank Reform and Consumer Protection Act (Dodd-Frank) and former chair of the House Financial Services Committee, has noted that the recent suit brought by the New York State Attorney General against JP Morgan Chase & Co. for widespread mortgage related misconduct at Bear Sterns & Company should not go forward. JP Morgan acquired Bear Sterns & Company following its collapse in 2008, which was, according to Frank, “at the strong request of the Federal Reserve and the Secretary of the Treasury during the Bush administration.”

Congressman Frank further noted that “federal officials involved believed that the failure of Bear Stearns would have terribly negative consequences for the economy, and they urged JP Morgan Chase to do a good deed by taking over an institution which, I believe, the bank would never have sought to acquire absent that urging. The decision now to prosecute JP Morgan Chase because of activities undertaken by Bear Stearns before the takeover unfortunately fits the description of allowing no good deed to go unpunished.” 

In addition, Congressman Frank further added that buyers of distressed firms at the government’s request should not face prosecution. This would include Bank of America’s acquisition of Merrill Lynch, but not in connection with its purchase of mortgage giant Countrywide Financial. ("Barney Frank: JPMorgan Doesn't Deserve To Be Sued,” Forbes, October 22, 2012).

JP Morgan Sues Supervisor of “London Whale”

JP Morgan disclosed that it filed an October 22, 2012 lawsuit in the United Kingdom against Javier Martin-Artajo, the former supervisor of trader Bruno Iksil. Nicknamed the “London Whale,” Iskil is allegedly responsible for the trades in JP Morgan’s chief investment division that resulted in losses in excess of $6.2 billion for the bank.  The matter is pending in the High Court of Justice, Queen’s Bench Division.

JPMorgan previously admitted to “egregious” failures in failing to manage its positions on synthetic credit securities. Both Iskil and Martin-Artajo are no longer employed by the bank.

JPMorgan’s internal investigation determined that Martin-Artajo encouraged Iksil to place artificially higher values on trades than what would have been received on the market. As a result of these trading losses, the bank is facing regulatory scrutiny and criminal probes as well as civil lawsuits from investors. (“London Whale’s Boss Martin-Artajo Sued by JPMorgan,” Bloomberg, October 31, 2012).

Fraud and Ponzi Schemes

A Bank of New York Mellon Subsidiary Reaches $210 Million Madoff Investor Settlement

A $210 million settlement has been reached in a civil lawsuit filed in 2010 by then-New York Attorney General Andrew Cuomo against a Bank of New York Mellon subsidiary, Ivy Asset Management.  The litigation arose out of losses sustained by investors that were fraudulently advised to invest in the Madoff Ponzi scheme.  According to Eric Schneiderman, New York Attorney General, “Ivy deliberately concealed negative facts it uncovered in its due diligence of Madoff in order to keep earning millions of dollars in fees.”  Ivy was paid more than $40 million to perform due diligence and give advice to its clients regarding their Madoff investments.  Despite discovering information that Madoff was not investing funds as represented, Ivy allegedly failed to disclose this information to its clients for fear of losing the fees it received from the investments in the Madoff funds.    

As a result of Ivy’s allegedly fraudulent conduct, its clients lost more than $236 million when Madoff’s Ponzi scheme collapsed.  Ivy’s clients were made up of dozens of New York union pension plans, as well as hundreds of individual investors.  In addition to the $210 million to be contributed by Ivy, an additional approximately $9 million will be funded by other defendants to the litigation.

When combined with the money expected to be paid from the liquidation of Madoff’s estate by trustee Irving Picard, this settlement is expected to compensate the defrauded Ivy Asset Management investors of nearly all of the money lost in the investment scheme.  (“A.G. Schneiderman Obtains $210 Million Settlement With IVY Asset Management In Connection With Madoff Ponzi Scheme,”, Press Release, November 13, 2012).        

SEC Considers Insider Trading Lawsuit Against Hedge Fund Giant SAC Capital

SAC Capital Advisors, a $14 billion hedge fund, announced in a client conference call that federal securities regulators are preparing to file a civil lawsuit against the firm. The anticipated lawsuit arises from another criminal insider trading prosecution against a former SAC portfolio manager for allegedly corrupting a doctor who provided confidential information on a drug trial. According to prosecutors, the data provided allowed SAC to garner gains and avoid losses of $276 million, which was described by the authorities as the most lucrative insider trading scheme ever unearthed.

SAC, which has been the subject of improper trading investigations for years, received notice of the possible enforcement action by the Securities and Exchange Commission (SEC) on November 20, which is the same date the former portfolio manager was arrested.  

SAC head Steven A. Cohen, who is not personally accused of any wrongdoing, stated in an investor call that “[w]e take these matters very seriously, and I am confident that I acted appropriately.” (“S.E.C. Weighs Suit Against SAC Capital,” New York Times Dealbook, November 28, 2012)

SEC Targets Accounting Firms for China Audits

The SEC has filed an administrative complaint against the China-based branches of the “Big 4” U.S. accounting firms and another accounting firm as a result of their refusal to release documents in connection with the SEC’s investigation of China-based companies that are listed on U.S. trading exchanges. The accounting firms targeted are: BDO China Dahua Co. Ltd; Deloitte Touche Tohmatsu Certified Public Accountants Ltd; Ernst & Young Hua Ming LLP; KPMG Huazhen (Special General Partnership); and PricewaterhouseCoopers Zhong Tian CPAs Limited.

According to a statement released by the SEC, “SEC investigators have been making efforts for the past several months to obtain documents from these firms.” In addition, the SEC stated that “[t]he audit materials are being sought as part of SEC investigations into potential wrongdoing by nine China-based companies whose securities are publicly traded in the U.S. The audit firms have refused to cooperate in the investigations.”  The SEC expects that administrative hearing will be scheduled to determine the remedial sanctions against the firms. (“The SEC is Going After the China Branches of Big Four Accounting Firms for Failing to Turn Over Documents," Business Insider, December 3, 2012).

Government and Regulatory Intervention

Holding Management Responsible for Failing Banks

Regulators for banks within the United States and United Kingdom recently disclosed a plan for dealing with failing international banks.  This new strategy attempts to shield general taxpayers from bank losses by allowing regulators to fire senior executives, as well as force losses upon shareholders and unsecured creditors.

While the United States developed the Dodd-Frank legislation to address and prevent financial crises, the United Kingdom adopted a similar strategy under the Banking Act of 2009.  Both plans were, in part, based on recommendations published by the Financial Stability Board, and the U.K. plan also incorporates European Union proposals.  Both the FDIC and Bank of England are aiming to ensure financial stability of banks’ critical services through this strategy.

The U.K. legislation would allow the FDIC to reach a resolution with the American banks operating in the United Kingdom without U.K. governmental interference.  Upon being implemented, nobody would be “off the hook” should a big bank fail, and it is expected that bondholders and other creditors will now inspect a bank’s risky behavior in much greater detail than before, creating a self-governing structure.  However, it still remains undetermined whether the FDIC would conversely allow U.K. regulators to oversee the dissolving a U.K. bank operating within the United States.  (“Failing Banks’ Shareholders to Take Losses in U.S.-U.K. Plan,” Businessweek, December 10, 2012).

Bank Subsidiaries Offer Refuge to Offshore Clients in Avoiding Dodd-Frank Regulations

Due to an exemption in the Dodd-Frank Act, offshore bank clients may not be held to the same regulatory requirements for over-the-counter (OTC) derivatives market trading.  By routing clients’ trades through a bank’s overseas subsidiaries, offshore clients may still trade without having to register with the U.S. Commodity Futures Trading Commission and subscribe the regulatory capital and margin requirements that could potentially make it very costly to trade.

Dodd-Frank reforms were enacted to regulate the OTC market by requiring banks to set aside capital against trading risks, execute trades on electronic platforms, and report them to regulatory authorities.  Opponents of such regulation argue that these additional measures may increase costs and cause offshore clients to cease doing business with U.S. banks.  However, the Dodd-Frank requirements only require a “U.S. person” to comply.  The definition of a “U.S. person” currently remains unclear.  Therefore, banks may be using this ambiguity to allow offshore clients to continue to trade in the OTC market by routing their trades through subsidiary banks not operating within the United States, which are not subject to Dodd-Frank regulations.  Until foreign regulators adopt similar trading and reporting requirements, non-U.S. financial institutions can continue to trade with an ancillary division of a U.S. bank without a risk of being considered a U.S. person.  However, this exemption may disappear shortly if foreign jurisdictions begin to adopt rules similar to those in the Dodd-Frank Act.  (“Wall Street Finds a Foreign Detour around U.S. Derivatives Rules,” Reuters, December 2, 2012).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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