This issue of the Credit Crunch Digest focuses on new proposed Libor guidelines; a CFTC lawsuit against U.S. Bank stemming from Peregrine Financial’s fraud and collapse; a settlement between Citigroup and a large coalition of institutional investors; a dropped action by MBIA investors; the FDIC finalizing its initial list of systemically important nonbank financial institutions; Bloomberg LP’s lawsuit against the CFTC; and the banking industry’s record-setting first-quarter profit.
Litigation and Regulatory Investigations
Fraud and Ponzi Schemes
Government and Regulatory Intervention
Interim EU Guidelines to Prevent Libor-Rigging Published
Interim guidelines developed with the purpose of stopping banks from rigging Libor and other market benchmarks were published on June 6, 2013. Among the changes included in the draft law, which is to be published in the coming weeks, is a proposal shifting the supervision of Libor from London to Paris.
The principles were drawn up with the European Banking Authority and include a framework for the administrating, calculating, publishing and submitting of quotes for compiling all benchmarks. The guidelines will require benchmark providers to have contingency plans if data for compiling the index dries up. Additionally, the data used to compile a given benchmark will represent the underlying asset, such as a commodity or interest rate, and will be based on “observable transactions entered into at arm’s length.”
The new benchmarks are aimed at satisfying regulators such as Gary Gensler, head of the U.S. Commodity Futures Trading Commission. Gensler has advocated for eliminating Libor and replacing it with a benchmark based on actual market transactions. However, other regulators argue that such a benchmark is not feasible in the short term.
Steven Maijoor, chair of the Paris-based pan-European watchdog group European Securities and Markets Authority (ESMA), said the immediate adoption of the principles will not only help restore confidence in financial benchmarks, but will also set the table for future legislation. Until earlier this year, Libor was unregulated. However, the ESMA principles do not address the issue of whether banks should be compelled to contribute to interest rate benchmarks to ensure there are enough quotes to make them representative. This has become more of an issue since the Libor scandal, as many banks have left panels that compile Libor. (“Libor Scandal: EU publishes guidelines to prevent banks rigging benchmarks,” The Guardian, June 6, 2013)
Litigation and Regulatory Investigations
Institutional Investor Coalition Plaintiffs Reach Settlement in Citigroup Securities Case
After reaching a settlement with Citigroup, on May 31, 2013, a coalition of about 20 institutional investors (mostly European pension funds) filed a stipulation in federal court in the Southern District of New York agreeing to drop claims that Citigroup Inc. misrepresented its exposure to a large amount of subprime investments. The settlement amount was not disclosed.
The coalition was made up of plaintiffs that chose not to join a pair of class actions that raised essentially identical claims. Those two litigations, In re Citigroup Bond Litigation and In re Citigroup Securities Litigation, have resulted in settlements in the amounts of $730 million and $590 million, respectively, in the last year. However, both settlements await court approval.
Citi announced in November 2007 that it would write down between $8 billion and $11 billion over its exposure to subprime mortgage-backed securities. Securities fraud class actions followed immediately after. (“Opt-Out Plaintiffs Clinch Deal in Citigroup Securities Case,” The AmLaw Litigation Daily, June 3, 2013)
MBIA Investors Voluntarily Discontinue Fraud and Breach of Contract Suit
A group of MBIA investors filed a joint motion of dismissal in New York state court on June 7, 2013, in its suit against MBIA Inc. That lawsuit, which was filed against MBIA and two of its subsidiaries, alleged claims for breach of contract, unjust enrichment, breach of the covenant of good faith and fair dealing, fraud, and interference with contract, among other claims. The suit was originally filed in November 2012, and alleged that MBIA devised a complex scheme to defraud MBIA Insurance’s investors and creditors in the wake of the financial crisis. Specifically, the plaintiffs alleged that in 2008, MBIA Insurance was facing a number of issues, including defaulting on various contracts, being entangled in litigation, and was facing huge liabilities that threatened its existence and ability to pay dividends.
The suit was dismissed without prejudice and MBIA counsel confirmed that the plaintiffs dismissed the claim without payment. (“MBIA Investors Drop Fraud Suit Over Gutted Insurance Unit,” Law360.com, June 10, 2013)
Fraud and Ponzi Schemes
U.S. Bank Sued by Federal Regulators Over Peregrine Financial Fraud and Collapse
The U.S. Commodity Futures Trading Commission (CFTC) has filed a civil suit against U.S. Bank for mishandling customer funds from the collapsed brokerage firm, Peregrine Financial. Peregrine’s founder and CEO, Russell Wasendorf Sr., was sentenced earlier this year to 50 years in prison for stealing $215 million in customer funds following his botched suicide attempt and admission of his fraud in an accompanying suicide note. The CFTC lawsuit alleges that between 2008 and July 2012, U.S. Bank improperly and illegally accepted Peregrine customer funds as loan collateral for loans to Wasendorf, his wife and related companies. The CFTC also asserts that U.S. Bank held Peregrine customer funds in an account that was used as Peregrine’s commercial checking account. U.S. Bank is alleged to have knowingly allowed Wasendorf’s transfers of millions in Peregrine customer funds to be used for his lavish personal expenses.
U.S. Bank has stated that the lawsuit, pending in the U.S. District Court for the Northern District of Iowa, is without merit and is “an inappropriate attempt to reassign blame to U.S. Bank” for the unfortunate losses at Peregrine. U.S. Bank further emphasized that it did not have any knowledge of the fraudulent scheme at any time. (“Govt. Sues US Bank Over Peregrine Financial Fraud,” Associated Press, June 5, 2013)
Government and Regulatory Intervention
FDIC Determines Which Nonbank Financial Institutions Will Receive Heightened Oversight
On June 4, 2013, the Federal Deposit Insurance Corp. (FDIC) finalized the Dodd-Frank rule that defines which key insurers and nonbank financial companies will receive heightened regulatory oversight due to their systemic importance to financial markets. Although the full list is not yet available publicly, some companies have already confirmed that they have been notified that they have been selected, including American International Group Inc., Prudential Financial Inc., and General Electric Capital Corp.
Companies on this list will receive additional regulatory scrutiny because the FDIC will be responsible for liquidating these businesses if they fail, pursuant to Title II of the Dodd-Frank Act. Title II grants the FDIC the authority to act as receiver in the bankruptcy process. The finalized rule allows for any company that generated 85 percent or more of its total consolidated revenue from financial activities in the past two years to be considered a “financial company” that is systemically important and subject to the heightened regulations. The agency broadly defines financial activities to include various services such as money lending, insurance activities, financial consulting, acting as a principal during investment transactions, processing financial data, and providing real estate services.
Heightened oversight includes participating in “stress tests” and providing proposed strategies on how to liquidate the company if it fails. Once an insurer or nonbank financial institution is added to the list of systemically important companies affecting the financial market, they will have 30 days to request an appeal hearing. (“FDIC Finalizes Dodd-Frank Nonbank Liquidation Rule,” Law360.com, June 5, 2013)
D.C. District Court Judge Dismisses Bloomberg’s Challenge to Swap Trade Regulations
U.S. District Court Judge Beryl Howell dismissed Bloomberg LP’s lawsuit against the CFTC, which challenged its new regulations on derivatives trades. Bloomberg’s services include helping financial firms trade swaps. Bloomberg alleged that the CFTC failed to perform a cost-benefit analysis before executing swaps trading regulations, and that the new rules would require the company to post higher collateral on such trades, which would cause customers to pursue alternative and cheaper ways to trade.
The decision dismissing the lawsuit noted that Bloomberg failed to demonstrate that it would suffer an immediate and lasting harm from the new swaps trading rules pursuant to the Dodd-Frank Act. Judge Howell found that Bloomberg’s argument failed because its claim was “based entirely on a series of worst-case scenario assumptions that are anything but certain.” Bloomberg has already stated that it plans to challenge the decision. (“Federal Judge Dismisses Bloomberg’s Challenge To New Federal Regulations on Swaps Trading,” The Washington Post, June 8, 2013)
Banks Set First-Quarter Profit Record With $40.3 Billion
U.S. banks have set a new record of $40.3 billion in first-quarter profits this year. These profits correlate with a decline in loan losses to $16 billion, the lowest amount since 2007, which means it is not necessary for banks to set aside more money to cover defaulted loans. Additionally, only four of the approximately 7,000 FDIC-insured banks in this country failed in the first three months of the year, which is the lowest quarterly amount since 2008. The number of banks at risk of failure also declined for the eighth straight quarter to 612 financial institutions.
These numbers make FDIC Chair Martin Gruenberg cautiously optimistic that the banking industry continues to show consistent signs of recovery from the 2008 financial crisis. Although the report demonstrates progress, he also notes that the industry has 20 percent more assets than six years ago, which held the previous record for first-quarter profits. Moreover, he warns that record low interest rates, which have decreased by $2.4 billion since the first quarter of last year, poses an obstacle for future earnings. Analysts speculate that the current financial situation will attempt to make higher-yielding investments, while regulators will continue to use Dodd-Frank in an attempt to limit the amount of excessive risk taken going forward. (“Banks Post Record $40.3-Billion Profit In First Quarter, FDIC Says,” Los Angeles Times, May 29, 2013)