[authors: Jennifer Broda, Matthew Ferguson, Jennifer Hamilton, Thomas Orofino, and Eric Scheiner]
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, including cases of financial fraud.
This issue focuses on the competing customer and creditor claims following the collapse of MF Global; JPMorgan’s efforts to improve board oversight following its recent $2 billion trading loss; the settlement of the Bear Stearns subprime related securities lawsuit for $275 million; Madoff Trustee Irving Picard’s recent filing of lawsuits targeted at European banks; Picard’s attempt to throw out California lawsuits against the Chais estate; whistleblower payouts under the Dodd-Frank reforms; and proposed capital reserve requirements on U.S. banks.
Litigation and Regulatory Investigations
Fraud and Ponzi Schemes
Government and Regulatory Intervention
Litigation and Regulatory Investigations
Trustee: MF Global Creditor Claims Could Top $3 Billion
Louis J. Freeh, a former FBI director and the court-appointed creditor trustee in the MF Global bankruptcy, estimates that creditors’ claims could be in excess of $3 billion. In his recent report to the bankruptcy court, Freeh estimates creditors likely include major banks, investors and service providers, potentially leading to 112 claims against MF Global, which collapsed in October 2011.
The Freeh report followed another trustee’s report issued by James W. Giddens, the trustee in charge of returning customer account money. The 275-page report authored by Giddens states that he is considering claims against MF Global’s senior executives, including Jon S. Corzine, the company’s former CEO, to recover more than $1 billion in customer funds, which still remain missing.
The creditor trustee and the customer trustee are reportedly battling over the limited funds available to MF Global. Freeh contends that the creditor claims may take precedence over MF Global’s customers. Giddens appears to disagree, as his report states that the creditors’ claims would not “appear to have a priority over customer claims.” (“MF Global Trustee Says Claims May Exceed $3 Billion,” New York Times Deal Book, June 5, 2012).
JPMorgan Ignored Investor Warnings About Risk Controls Prior to Trading Loss
According to reports, JPMorgan reportedly failed to heed an investor advocate group’s warnings more than a year ago that the bank should improve its risk controls. In particular, JPMorgan allegedly dismissed investor warnings that it was not keeping up with other major banks’ actions, which increased board oversight of investment risks. Following a $2 billion trading loss in May, JPMorgan is now poised to enhance the level of expertise of the individuals serving on the investment risk oversight board.
Critics contend that the bank still has oversight weaknesses, namely, the relative power of the bank’s chief risk officer. Former JPMorgan traders have stated that the company’s chief risk officer was not focused on the losing bets the chief investment officer made in the credit markets. JPMorgan disputes these contentions stating that there is no lack of authority in the chief risk officer’s office. Critics assert that after weathering the credit crisis, JPMorgan became complacent and loss ground in their risk management operations. For support, critics point to the fact that other peer banks’ chief risk officers earned substantially more in compensation than the chief risk officer at JPMorgan.
JPMorgan is still expected to report substantial profits for the second quarter of 2012, but the recent losses may bolster regulators’ attempts to re-write banking industry rules. (“JP Morgan Was Warned About Lax Risk Controls,” New York Times, June 3, 2012).
Bear Stearns, Plaintiffs Agree to $275 Million Settlement of Credit Suit
According to a June 6, 2012 stipulation filed by plaintiffs, the parties to the Bear Stearns securities litigation have agreed to settle the matter for $275 million. The settlement remains subject to approval by the U.S. District Court in New York City.
The plaintiffs’ 2008 lawsuit alleged that the defendants made material misrepresentations or omissions with regard to the Bear Stearns’ exposure to subprime mortgages. The defendants’ efforts to dismiss the securities lawsuit was denied in January 2011, but the defendants were able to obtain dismissal of the related shareholders’ derivative and ERISA class actions.
The settlement includes Bear Stearns and seven of its former directors and officers, including its former CEO, Jimmy Cayne. The proposed settlement does not include the company’s outside auditor, Deloitte & Touche LLP. Thus far, the settlement is the largest credit crisis related settlement in 2012. Only a handful of settlements arising out of subprime-related lawsuits have been larger, including the Wachovia Preferred Securities settlement, the Countrywide settlement, the Lehman Brothers Offering Underwriters’ settlement, and the Merrill Lynch Mortgage Backed Securities Settlement. (“Bear Stearns Settles Credit Crisis Securities Suit for $275 Million,” D&O Diary, June 8, 2012).
Fraud and Ponzi Schemes
Madoff Trustee Targets European Private Banks With New Lawsuits
On June 6, 2012, the trustee liquidating Bernard L. Madoff Investment Securities Inc., Irving Picard, filed new lawsuits in the U.S. Bankruptcy Court in Manhattan against several European private banks. Included in the many new lawsuits he has filed are a complaint seeking $122.2 million against ABN Amro Fund Services Nominees Ltd.; a complaint seeking $108.1 million against Belgian private lender Banque Degroof SA; and two complaints filed against Swiss private banks EFG Bank SA and Lombard Odier Darier Hentsch & Cie, respectively seeking amounts of $354.9 million and $179.4 million. Picard seeks to recover money transferred to third-party feeder funds, including Fairfield Greenwich Group’s Fairfield Sentry Ltd., Fairfield Sigma Ltd., Kingate Management Ltd.’s Kingate Global Fund Ltd. and Kingate Euro Fund Ltd. Picard alleges that the funds funneled much of their customers’ money to Bernard L. Madoff Investment Securities LLC. The lawsuits were filed one day short of the expiration of the statute of limitations for Picard to file subsequent “transfer cases” based on the terms of a settlement between the trustee and Fairfield Sentry liquidators. (“Madoff trustee files many new lawsuits,” Reuters, June 7, 2012).
Swiss Banks Challenge Picard’s Claims
Lombard Odier and Banque Cantonale Vaudoise (BCV), two Swiss banks targeted in Irving Picard’s recent lawsuits filed on June 6, 2012, are contesting Picard’s legal claims. Both BCV and Lombard Odier acknowledge that they indeed held Madoff-linked funds. However, they contend they did not benefit financially from any transactions related to those funds. Specifically, Lombard Odier asserts that it “did not recommend any of the funds managed by Mr. Madoff’s company, nor the feeder funds, as part of its investment policy” and that “[i]nvestments in funds exposed to Madoff were made by individual clients or third-party managers” thereby limiting Lombard Odier’s role as a “depository bank, holding deposits on behalf of its clients.” Both banks plan to fight Picard’s lawsuits against them. (“Swiss banks to contest Madoff legal claims,” Financial Times, June 7, 2012).
Picard Contends California Lawsuit Violates Federal Bankruptcy Law
Irving Picard is seeking to block a $270 million state enforcement action brought by California Attorney General Kamala Harris against investment adviser Stanley Chais’ estate. Picard argues that pursuant to federal bankruptcy laws, only the trustee can recoup funds on behalf of Madoff’s former customers. Harris, in turn, contends that her lawsuit is an exception to the federal bankruptcy laws because she is exercising her police powers under state law. Picard has rebutted this argument, alleging that because Harris is suing for money, rather than to preserve public safety or welfare, her lawsuit remains subject to federal bankruptcy rules. According to Picard, “[w]hen the focus of the third party action is not to prevent acts that threaten public safety and welfare but instead to obtain pecuniary benefit for a private party, the automatic stay applies.” Harris brought her lawsuit against Chais’ estate in 2009 in California state court. Picard, in turn, brought his suit against Harris on January 4, 2012, in the U.S. Bankruptcy Court in the Southern District of New York. Picard’s suit alleges that Harris’ lawsuit interferes with the collection of assets needed to help compensate Madoff victims. (“California Madoff Investor Suit is Illegal, Picard Says,” Bloomberg Businessweek, June 7, 2012).
Government and Regulatory Intervention
SEC Readies First Payouts Under Dodd-Frank Whistleblower Program
Under the Dodd-Frank financial reforms, a new process was put in place that allows whistleblowers who report corporate wrongdoing to receive anywhere from 10 percent to 30 percent of any fine levied against the corporation. While the SEC has always had a process for whistleblowers to report securities fraud, the new reforms allow sizable payouts for successful tips. In addition, the reforms give protection to any employee against retribution by their employer. In the first seven weeks of the program, the SEC reportedly received 334 whistleblower calls pertaining to alleged securities fraud in 37 states, as well as internationally.
Because of the length of the investigative process following a whistleblower’s tip and the subsequent appeal process, there have not been any payouts to date by the SEC under the new program. That, however, is about to change. According to reports, complainant’s lawyers are expecting the first payouts to be made in the near future from the half-billion dollars allocated to fund the program. In response, the SEC is reportedly bracing for an increase in whistleblower tips as the public sees the sizable payouts under the program. (“Whistleblowers Set To Receive First SEC Payouts,” SFGate, June 13, 2012).
FDIC Board Joins Federal Reserve to Advance Strict Bank Capital Requirements
On June 12, 2012, the FDIC board voted 5-0 in favor of joining the Federal Reserve in advancing proposals designed to prevent another financial crisis by requiring all U.S. banks to hold capital worth at least 7 percent of their assets. Currently, the minimum bank capital requirements are 2 percent. The stricter capital cushion would bring the U.S. in line with international standards. However, two of the FDIC directors worry that the new requirements are not stringent enough.
According to reports, nearly all U.S. banks already meet the increased capital requirements. However, the banking lobby has argued against the proposals, saying that the large capital reserves could limit their lending capacity. The proposed capital requirement rules are in an open comment period until September and will then move toward final implementation. (“FDIC Joins Fed In Proposing Stricter Capital Rules,” Bloomberg Businessweek, June 12, 2012).