This issue of the Credit Crunch Digest focuses on fines against Royal Bank of Scotland for alleged Libor rate rigging; the Department of Justice’s lawsuit against Standard & Poors; developments in a mortgage-backed securities lawsuit between the SEC and Citigroup; developments in the Stanford and Madoff financial frauds; and a lawsuit challenging the constitutionality of Dodd-Frank financial reforms.
Litigation and Regulatory Investigations
Fraud and Ponzi Schemes
Government and Regulatory Intervention
Royal Bank of Scotland Handed Massive Fine Over Libor Rate Rigging Scandal
On February 6, 2013, Royal Bank of Scotland (RBS) was fined for “widespread misconduct” in connection with the Libor rate-rigging scandal. There were at least 21 wrongdoers involved, all of whom have either already left RBS or have been disciplined. According to regulators, RBS engaged in improper behavior as late as November 2010, two years after RBS was bailed out by the U.K. government. The massive fine was imposed on RBS by multiple regulators in both the U.S. and the U.K. In the U.S., the Commodity Futures Trading Commission and the U.S. Department of Justice fined RBS $325 million and $150 million, respectively, while the U.K. Financial Services Authority fined the bank approximately $133 million. Regulators say the fine imposed on RBS could have been significantly higher if not for RBS’ cooperation in their investigation. The bonus pool available to RBS employees is reportedly being reduced to cover the cost of the fine, and many bankers will reportedly be facing bonus clawbacks by the bank. “RBS fined for ‘widespread misconduct’ in Libor-rigging scandal,” The Guardian, February 6, 2013.
U.K. Regulators Convince Banks to Not Leave Libor
Certain executives from major banks privately informed the British Bankers’ Association that they were considering withdrawing from the rate-setting panel for Libor. The Financial Services Authority (FSA), the regulatory agency responsible for monitoring Libor, became afraid that a major exodus would continue to damage Libor’s credibility after the recent manipulation scandal. Consequently, the FSA sent letters to the major banks warning them not to leave.
Lenders have become concerned of a perception that staying involved in setting Libor is still tantamount to manipulating the rate. Although wanting to leave, certain bank executives reacted negatively to the tone of the FSA letters, saying they were coercive in nature, and as result decided to remain on the panel. The FSA’s letter to one bank reportedly implied that leaving the panel would negatively impact the current investigation into that bank’s role in the Libor manipulation scandal. In response to criticism about the letters, the FSA alleges its correspondence was merely an attempt to fulfill its obligation to ensure market stability.
According to persons familiar with the letters, they stated that the FSA expects all banks to continue participating with rate-setting, and noted that the FSA assumes it has enforcement power to require banks to remain involved, as least for a temporary period. After receiving an initial letter, any bank that still considered withdrawing from the panel supposedly received another strongly worded letter from the FSA warning it to stay. Currently, no banks have left Libor since the issuance of these FSA letters. “Banks Warned Not to Leave Libor,” Wall Street Journal, February 13, 2013.
Litigation and Regulatory Investigations
U.S. DOJ Commences Civil Fraud Lawsuit Against Ratings Giant
U.S. Department of Justice (DOJ) prosecutors have filed a civil fraud lawsuit against Standard & Poor’s (S&P) alleging that that nation’s biggest credit firm issued unduly optimistic reviews of a number of financial instruments from 2004 to 2007, which helped lead to the credit crisis and housing crash. The lawsuit represents the first government enforcement action against a major ratings firm following the crisis. S&P has denied any culpability. Also named is S&P’s parent company, McGraw-Hill.
The DOJ alleges that the ratings firm misled investors by touting its objective methodologies and representing to the public that it was "uninfluenced by any conflicts of interest." The action details S&P’s ratings of mortgage-backed bonds before the financial meltdown, alleging that the firm ignored the risks associated with those products to “favor” large banks and to increase its share of the ratings market.
The case is pending in the U.S. District Court for the Central District of California. Other state officials are expected to join the action. “Feds file suit over S&P mortgage bond ratings,” USA Today, February 5, 2013.
Second Circuit Hears Dispute on Judge Rakoff’s Rejection of SEC-Citigroup Proposed Settlement
On February 8, 2013, the Second Circuit Court of Appeals heard arguments from the Securities and Exchange Commission (SEC), Citigroup, and a court-appointed lawyer for federal district Judge Jed S. Rakoff, in order to determine whether Judge Rakoff exceeded his authority in rejecting a proposed settlement between Citigroup and the SEC in a lawsuit arising from the financial crisis. The SEC originally sued Citigroup in a civil fraud action arising out of the sale of approximately $1 billion in mortgage bonds. According to the SEC, Citigroup deceived its customers by selling them pools of risky mortgages that the bank knew would decline in value. In total, Citigroup customers suffered approximately $600 million in losses. Citigroup and the SEC eventually reached an agreement to settle the case, with Citigroup paying $285 million and avoiding any admission of wrongdoing. However, Judge Rakoff refused to approve the agreement and criticized the SEC practice of agreeing to settle without requiring the defendant to admit to any wrongdoing.
According to the court-appointed lawyer for Judge Rakoff, a judge does not “automatically approve whatever consent decree the SEC brings him and assume that it is in the public’s interest.” In opposition, the SEC argued that Judge Rakoff’s refusal to approve the settlement conflicted with a century of judicial practice and would only serve to overburden federal agencies by requiring regulators to get an admission of wrongdoing from corporate defendants, which would likely lead to costly trials and fewer settlements. Lawyers for Citigroup highlighted this concern: “Many corporations will decide to not settle matters if a requirement is to admit liability. The federal regulatory enforcement regime would screech to a grinding halt.” “Court Hears Arguments on Judge’s Rejection of S.E.C.-Citigroup Deal,” The New York Times, February 8, 2013.
Fraud and Ponzi Schemes
Antigua and Barbuda Implicated in Allen Stanford’s $7 Billion Ponzi Scheme
Allen Stanford’s investor committee and bankruptcy receiver, Ralph Janvey, filed suit in a Dallas, Texas federal court against Antigua and Barbuda. The lawsuit charges that the Eastern Caribbean dual-island nation was given more than $230 million in loans by the Stanford International Bank, whose terms were not enforced, in exchange for helping to cover up Stanford’s $7 billion Ponzi scheme. The lawsuit seeks the return of more than $90 million in loan proceeds, plus punitive damages.
In March 2012, Stanford was convicted and sentenced to 110 years in federal prison for using his Antigua-based bank as a means to defraud investors into purchasing bogus certificates of deposit. Stanford then allegedly stole the customer funds, all while Antigua and Barbuda benefited from the scheme, offsetting the losses from its struggling economy. Stanford, who is serving his sentence in Florida, is appealing his conviction.
Additionally, the investor committee filed a separate lawsuit against the Eastern Caribbean Central Bank for its role in nationalizing Stanford’s other financial institution, the Bank of Antigua, and ceding shares of the bank to the government of Antigua and other Caribbean banks. This lawsuit alleges that the Bank of Antigua, which is potentially worth “hundreds of millions of dollars,” should be distributed to Stanford’s defrauded investors.
Janvey has also filed suit against 23 former executives of the Stanford International Bank for their roles in concealing the scheme to defraud investors. In that suit, Janvey seeks the return of all compensation paid to the directors and officers for their involvement. “Stanford Investors Sue Antigua, Caribbean Central Bank,” Bloomberg, February 18, 2013.
Picard to Seek Additional $505 Million Payout to Madoff Investors
Irving Picard, trustee for the liquidation of Bernard Madoff’s investment firm, recently indicated that he intends to seek permission from the U.S. Bankruptcy Court to disburse an additional $505 million to Madoff investors. Should the court grant Picard’s request, the total payout to defrauded investors will rise above $5 billion, an amount far less than the estimated $17.3 billion that was lost by investors as a result of Madoff’s Ponzi scheme.
Approximately 2,500 claims have been allowed by Picard, which total in excess of $11 billion. After payment of the proposed $505 million, Picard will have indemnified investors for roughly half of the claims submitted and approved. The hearing date for Picard’s motion is set for March 13, 2013 in the U.S. Bankruptcy Court for the Southern District of New York. “Madoff trustee seeks to boost payout to over $5 billion,” Yahoo! Finance, February 13, 2013.
Government and Regulatory Intervention
Eight States File Joint Lawsuit Challenging Dodd-Frank
Several states, including Alabama, Georgia, Kansas, Montana, Nebraska, Ohio, Texas and West Virginia, have joined a lawsuit filed in federal court in June 2012, alleging that certain regulations promulgated in the Dodd-Frank Act are unconstitutional. Specifically, the states’ respective Attorneys General, along with the State National Bank of Big Spring, Texas, and two conservative political action groups, are challenging legislation that allows for taxpayer money to pay creditors of failing banks in order to avoid another financial collapse similar to the consequences of Lehman Brothers filing for bankruptcy in 2008.
The lawsuit, brought by the states as creditors of many large financial companies impacted by the law, alleges that this “orderly liquidation authority” provision is unconstitutional for three main reasons. First, it infringes upon the creditors’ rights during liquidation. Second, it does not provide for meaningful judicial review when dismantling a bank, and third, the legislation would unilaterally pick preferred creditors among similarly situated ones. While taxes would pay off creditors initially, regulators would recoup costs by imposing fees on large banks. “Eight States Join Lawsuit Challenging Dodd-Frank,” MarketWatch.com, February 13, 2013.