This digest collects and summarizes recent media reports regarding potential liability, government initiatives, litigation and regulatory actions arising from the subprime mortgage crisis and credit crunch, as well as a number of reported cases of financial fraud.
This issue focuses on concerns arising out of the Libor scandal; the status of lawsuits arising out of IndyMac Bankcorp’s failure, including a settlement by its former CEO; a class certification decision in the Credit Suisse MBS case; BNY Mellon’s settlement of the Sigma Finance case; a large settlement by an alleged Madoff feeder fund; Peter Madoff’s guilty plea; scrutiny of the National Association of Insurance Commissioners; and the status of the Dodd-Frank Act reforms.
Litigation and Regulatory Investigations
Ponzi Schemes & Fraud Actions
Government & Regulatory Intervention
Government & Regulatory Intervention
Many Issues Potentially on the Horizon in Libor Scandal
Following Barclays’ $453 million settlement with U.S. and U.K. regulators arising out of its actions in manipulating the London interbank offered rate, or Libor, several issues remain for Barclays, as well as other big banks, including the possibility of additional regulatory actions and civil lawsuits as well as criminal charges. In particular, a flood of civil lawsuits are anticipated as a result of the trillions of dollars of financial products and vehicles that may have been improperly priced between 2005 and 2009 because of Libor manipulation. Other issues include additional regulatory probes of senior bank executives based on the findings in the Barclays’ investigation, which indicated that Barclays traders had discussions regarding Libor settings with employees at 16 competing banks. It is possible that other banks will follow the lead of Barclays and seek to settle early in the investigations. Additionally, regulators are seeking ways to improve rules governing the Libor setting process. Moreover, regulators themselves may face scrutiny as a result of the scandal for failing to address Libor issues when early warning signs first surfaced back in 2008. (“What's Next to Watch in Libor Drama,” Wall Street Journal, July 9, 2012).
For additional background on the Barclays settlement and ongoing Libor manipulation investigations, see Sedgwick’s Insurance News Flash of July 5, 2012 by clicking here.
Former IndyMac CEO Settles Subprime Securities Lawsuit
Michael Perry, the former CEO of failed IndyMac Bank, has reached a settlement to resolve a subprime related securities lawsuit filed against him for $5.5 million. The March 2007 lawsuit alleged that the defendants’ public statements about the company failed to fully disclose issues with its internal lending controls and underwriting practices, as well as its insufficient loan loss contingencies. The settlement will be funded entirely by directors and officers insurance. It remains subject to court approval and possibly the approval of the bankruptcy court overseeing the IndyMac bankruptcy. If the courts do not allow for insurance proceed to be used to pay the settlement, it will be rendered null and void.
The lawsuit was initially filed against IndyMac Bancorp and its directors and officers, but went through several amended complaints and rounds of dismissal motions, following the closure of IndyMac Bank in March 2008 and the bankruptcy filing of IndyMac Bancorp in August 2008. At the time of the stipulated settlement, Perry was the sole remaining defendant.
Separate FDIC lawsuits against the former directors and officers of IndyMac Bank, including two lawsuits against Perry, remain pending. In addition, another subprime-related securities lawsuit arising out of IndyMac Bancorp’s misrepresentations surrounding Option ARM mortgages remains pending against former executives. (“IndyMac CEO Settles Long-Running Subprime-Related Securities Suit,” The D&O Diary, June 28, 2012).
BNY Mellon Settles Sigma Case for $280 Million
BNY Mellon has reportedly agreed to settle a lawsuit related to Sigma Finance, a “structured investment vehicle” fund, or “SIV,” that collapsed during the financial crisis in October 2008. The $280 million settlement resolves claims that the bank imprudently invested and ultimately lost customer money in Sigma Finance. The plaintiffs alleged that BNY Mellon’s investments of cash collateral in the bank’s securities lending program into medium-term debt issued by Sigma Finance was not done “conservatively and prudently.” SIVs such as Sigma Finance suffered heavily during the financial crisis as a result of their investments in high-yield repackaged debt. Sigma Finance was reportedly one of the last of such SIVs created prior to the financial crisis in 2008. JPMorgan Chase agreed to resolve a similar lawsuit for $150 million earlier this year. (“BNY Mellon pays to end $280m Sigma case,” Financial Times, July 6, 2012).
Plaintiffs Obtain Class Certification in MBS case against Credit Suisse
On June 29, 2012, the U.S. District Court in the Southern District of New York granted class certification in a lawsuit against Credit Suisse Securities (USA) LLC arising out statements the bank made regarding the quality of loans comprising a 2006 offering of $642 million in mortgaged-backed securities. The lawsuit alleges that Credit Suisse failed to advise investors that loans issued by IndyMac Bank forming the core of the securities were issued without proper underwriting controls, including verification of borrowers’ income, assets and job status.
The District Court held that class treatment was appropriate because of the high number of claimants, and because each individual investor’s claim was similar. The District Court rejected the defendants’ argument that more sophisticated investors were aware of IndyMac’s “deviation from its underwriting guidelines.” IndyMac and two ratings agencies that reviewed the deal were previously dismissed from the case in 2010. (“Credit Suisse To Face $642M MBS Suit As Class Action,” Law360.com, July 2, 2012).
Ponzi Schemes & Fraud Actions
Hedge Fund Manager Settles Madoff Claims With New York Attorney General
On June 22, 2012, a New York judge approved a settlement between Wall Street hedge fund manager J. Ezra Merkin and the New York Attorney General’s office, putting an end to the civil fraud case filed back in April 2009. The New York Attorney General’s office alleged that Merkin deceived his clients by collecting hundreds of millions of dollars in management fees, when in fact he was giving the money to Bernard Madoff to invest in Madoff’s Ponzi scheme, rather than manage the investments himself. Based on the terms of the settlement, Merkin has agreed to pay $405 million over three years to investors who lost money in connection with the Ponzi scheme, and has agreed to pay an additional $5 million to the New York Attorney General’s office to cover fees and costs.
At the collapse of Madoff’s fraud in 2008, Merkin’s losses were estimated at $1.2 billion. It is reported that the $405 million payment will benefit investors in the following four private funds: Ariel Fund Ltd.; Gabriel Capital L.P.; Ascot Fund Ltd.; and Ascot Partners. According to the attorney general, more than 10 percent of the money invested in these four funds represents money invested by several charities and nonprofit organizations, including, but not limited to: Bard College; New York Law School; the Harlem Children’s Zone; and the Metropolitan Council on Jewish Poverty in New York.
The $405 million settlement is expected to face legal challenges from Madoff Trustee, Irving Picard, whom currently has a lawsuit pending against Merkin in the U.S. Bankruptcy Court for the Southern District of Manhattan seeking to recover $500 million. A spokesperson for Picard stated that “[t]o the extent any third-party settlement seeks to divert funds [sought by the trustee], we will have to consider taking appropriate steps.” Picard considers the fees paid to Merkin to come from the pool of money that Madoff stole from other people, and accordingly, Picard believes that any settlement with Merkin should benefit all eligible Madoff victims rather than just clients of Merkin. As the settlement stands now, the funds will be distributed by the receivers overseeing the liquidation of the Merkin funds with final oversight being provided by the New York judge that approved the settlement, Richard B. Lowe III. (“Hedge Fund Manager to Pay $405 Million in Madoff Settlement,” The New York Times, June 24, 2012).
Madoff’s Younger Brother Pleads Guilty
Bernard Madoff’s younger brother, Peter Madoff, pleaded guilty on June 30, 2012 to criminal charges of conspiracy and falsifying records. As a result, Peter Madoff has agreed to serve 10 years in prison and to surrender all assets. While prosecutors presented Peter Madoff as being criminally incompetent and alleged that he falsified several compliance reports to the Securities and Exchange Commission, Peter Madoff portrayed himself as ignorant to the mammoth Ponzi scheme until his older sibling disclosed the truth to him in December 2008. “I was in total shock,” Peter Madoff stated, “[m]y world was destroyed. I lost everything I worked for.” Peter Madoff maintained that he was so confident of his elder brother’s skills that he persuaded his wife, daughter, granddaughter and sister to invest millions in the Ponzi scheme, which they eventually lost. Although Peter Madoff maintained his ignorance of the fraudulent acts of his elder brother, he admitted to engaging in tax fraud and attempting to hide millions of dollars from the IRS. Peter Madoff is free on $5 million bail until his October 4, 2012 sentencing. (“Peter Madoff pleads guilty in NYC, blames brother,” The CBS Money Watch, June 30, 2012).
Government & Regulatory Intervention
Regulators Release Portions of Big Banks’ Living Wills
As part of the Dodd-Frank Act financial reforms, large financial institutions were required to submit to U.S. regulators so called “living wills,” outlining the ways in which each large financial institution would wind down its operations should it find itself in catastrophic financial distress. Under the Dodd-Frank Act, should regulators find a bank’s submitted plan not credible, they could force the financial institution to restructure its operations, or even sell off certain business lines. According to experts, it is doubtful that regulators will use the plans to force major structural changes. Regulators have only released small summary memorandums of each “living will” as the banks submitted their detailed plans to regulators confidentially. According to reports, nine of the largest global banks released plans saying that they could be salvaged or dismantled without taxpayer bailouts should they become insolvent. Regulators plan to respond to the proposed “living wills” by September of this year. (“Top banks say they are not too big to fail,” Reuters, July 3, 2012).
Congressman Scrutinizes National Association of Insurance Commissioners
U.S. Rep. Ed Royce, a California Republican, is asking the Federal Insurance Office (FIO) to examine the “nature and scope” of the National Association of Insurance Commissioners’ (NAIC) operations. As part of the Dodd-Frank Act financial reforms, the FIO was set up within the U.S. Treasury and tasked with, among other duties, suggesting how to modernize current insurance regulation. According to a letter sent by Congressman Royce to FIO, the NAIC (a group of state insurance commissioners) “appears to be engaging in regulatory activity.” Royce believes there may be evidence that the NAIC is overstepping its authority. Royce cited as examples certain NAIC services, including a rate filing system and an office that assesses the credit quality of investments. Congressman Royce sits on the House Financial Services Committee and supported the creation of the FIO. In response to Royce’s charges, NAIC President and Florida Insurance Commissioner Kevin McCarty stated, “NAIC as a nonprofit corporation does not have regulatory authority, and I am not aware that it has ever presented itself as having such authority.” (“Congressman Seeks Treasury Exam of State Insurance Group,” Bloomberg, July 12, 2012).