Credit Crunch Digest -- November 2013

This issue of the Credit Crunch Digest focuses on new Libor cases filed against major banks and an update regarding two U.K. Libor cases; a jury verdict against Bank of America in connection with conduct by Countrywide; additional mortgage-backed securities litigation; and potential changes to the Dodd-Frank financial reforms.

Libor Scandal

Litigation and Regulatory Investigations

Government and Regulatory Intervention

Libor Scandal

U.K. Judge Allows Libor Manipulation Allegations in Two Test Cases

The Court of Appeal in London recently heard two cases alleging the manipulation of Libor in lawsuits brought by Unitech Ltd. and Guardian Care Homes, clients of Barclays and Deutsche Bank.  The plaintiffs claim they were missold swap contracts by the banks and are attempting to rescind the unsuccessful products due to their connection with Libor.  The appellate ruling, issued on November 8, 2013, allowed plaintiffs to keep Libor-related allegations in their complaints.

In the ruling, Judge Andrew Longmore stated “[t]he banks did propose the use of Libor and it must be arguable that, at the very least, they were representing that their own participation in the setting of the rate was an honest one.”  Judge Longmore noted that if borrowers became aware of Libor rigging, they would have a reasonable expectation of rescinding any deals made with the banks.  Analysts opine that this ruling will allow more bank clients to sue for money-losing contracts by citing Libor rigging.  (“Bank Ruling Could Spur More Libor-Linked Mis-Selling Cases,” Reuters, November 8, 2013)

Fannie Mae Files Libor Suit Against Major Banks

On October 31, 2013, Fannie Mae filed suit against nine global banks for Libor manipulation due to the rate’s ties to the setting of interest rates on credit cards, student loans and mortgages.  Fannie Mae is seeking more than $800 million in damages from Barclays, Rabobank, Royal Bank of Scotland, UBS, Bank of America, Citigroup, Credit Suisse, Deutsche Bank and JPMorgan Chase.  The complaint also names the British Bankers’ Association as a defendant.  The suit alleges that the Libor manipulation caused Fannie Mae to lose profits from mortgages and interest-rate swaps it made with the named defendants.

Four of the defendant banks, including Barclays, Rabobank, Royal Bank of Scotland, and UBS, have already settled Libor suits with federal regulators, paying collectively more than $3.6 billion in fines.  Fannie Mae has noted those settlements in its complaint to support the allegations made therein.  Before the current lawsuit, JPMorgan Chase announced a $4 billion settlement with Fannie Mae and Freddie Mac for misrepresentations in mortgage securities sold to the companies.  (“Fannie Mae sues Wall St Banks Over Libor,” CNN Money, October 31, 2013)

Litigation and Regulatory Investigations

JPMorgan Settles With the Justice Department for $13 Billion

On November 19, 2013, JPMorgan and the Justice Department announced a $13 billion settlement in connection with various state and federal investigations regarding the bank’s sale of mortgage-backed securities from 2005 to 2008.  The settlement represents the largest amount paid by a company to the government, and comes after months of high-level negotiations, including direct negotiations between Attorney General Eric Holder and JPMorgan CEO Jamie Dimon.  The government alleged that the bank did not fully disclose the risks associated with the mortgage-backed securities sold to investors.  According to reports, the $13 billion payment will likely erase half of the bank’s annual profit.

The $13 billion settlement requires JPMorgan to pay fines to prosecutors, compensate harmed investors and provide relief to struggling homeowners.  Of the $7 billion earmarked for investors, the largest recipient of such funds will be the Federal Housing Finance Agency (FHFA).  FHFA oversees Fannie Mae and Freddie Mac, both of which purchased billions in dollars of mortgage-backed securities.  (“In Extracting Deal from JPMorgan, U.S. Aimed for Bottom Line,” New York Times Dealbook, November 19, 2013).

Government Seeks Maximum Penalty Against Bank of America

Following a jury’s finding that Bank of America (BofA) was liable for its sale of flawed loans to U.S. backed entities, including Fannie Mae and Freddie Mac, the Department of Justice is seeking the maximum penalty of $863 million. In one of the first cases by U.S. prosecutors, the government obtained a jury verdict against BofA arising out of its actions in connection with its Countrywide unit. In seeking the penalty, prosecutors described BofA’s actions as “simple but brazen” and alleged  that the bank knowingly sold the deficient loans to Fannie Mae and Freddie Mac.

In addition to the jury’s verdict against the bank, former Countrywide executive Rebecca Mairone was also found liable.  Counsel for Mairone stated that she intends to appeal the verdict and oppose any penalty. Presiding U.S. District Judge Jed Rakoff indicated that he would determine the appropriate penalties at a later date. (“BofA Should Pay $863 Million in Fannie Mae Case: U.S.,” Bloomberg, November 10, 2013)

RBS and SEC Settle Mortgage-Backed Securities Case

The U.S. Securities and Exchange Commission (SEC) and the Royal Bank of Scotland (RBS) have agreed to settle claims that the bank misled purchasers of mortgage-backed securities. The SEC had alleged that an RBS subsidiary packed a $2.2 billion mortgage-backed securities offering with risky loans that were likely to default.  Under time pressure to close the deal and finalize the offering, RBS allegedly did not perform adequate due diligence on the underlying loans, which did not meet the claimed underwriting standards.  According to the SEC, RBS’ disclosures surrounding the securities were misleading, and the bank should have known that 30 percent of the loans were substandard and thus were not properly included in the offering.  The $153.7 million settlement, in which RBS did not admit or deny wrongdoing, is among several high-profile settlement reached by the SEC recently arising out of the financial crisis. (“Royal Bank of Scotland to Pay $153.7 Million to Settle Mortgage Case,” New York Times DealBook, November 7, 2013)  

Civil Suit Targets Ratings Agencies Over Bear Stearns Funds’ Collapse

Liquidators of two failed Bear Stearns hedge funds have filed a lawsuit against ratings agencies Standard & Poor’s (S&P), Fitch Ratings and Moody’s Investors Service for their alleged inflated credit ratings to mortgage bonds held by the failed funds. The lawsuit, brought on behalf of investors in the funds, is pending in New York state court, and alleges excess of $1 billion in investor losses.

Based on a number of emails that have been uncovered in other cases, the plaintiffs contend that the credit agencies were aware that the high ratings were unsupportable. Among the colorful language used in the complaint included observations by an S&P employee, which stated that “[i]t could be structured by cows and we would rate it,” and another that described the ratings by that firm as a “scam.” One of the Moody employees stated that the rating agency had “sold [its] soul to the devil for revenue.” The plaintiffs assert that the rating agencies benefited from the continued generation of rating fees at the expense of the investors in the underlying bonds.

The lawsuit, which is based on conduct that occurred in 2007, was apparently filed shortly before the six-year statute of limitations expired for fraud under New York law. The three credit agencies have uniformly alleged that the subject lawsuit, as well as similar cases brought by private parties and regulators, are meritless. ("Suit Charges 3 Credit Rating Agencies With Fraud in Bear Stearns Case" New York Times, DealBook, November 11, 2013)

Government and Regulatory Intervention

Representatives Pass Bill to Overturn Dodd-Frank Rules Regarding Swaps Trading

On October 30, 2013, the U.S. House of Representatives passed H.R. 992, a bill attempting to revise the Dodd-Frank Act.  H.R. 992 seeks to reverse the requirement that banks must detach their swaps trading and deposit-taking units.  With a vote of 292 to 122, this bill garnered bipartisan support, including 70 Democrats.  However, H.R. 992 faces an uphill battle to become law because the Senate recently failed to approve a similar bill.  Additionally, the White House has already remarked that it would veto the bill if it makes it to the president for signature, believing the law to be premature and disruptive of Dodd-Frank reform.

Ben Bernanke, chair of the Federal Reserve, previously critiqued the original rule of dividing swaps trading units.  He feared that the so-called “pushout provision” of Dodd-Frank would allow financial companies to transfer swaps trading units to related entities that do not face the stricter regulations placed on banks.  With the two-year extension to comply with the current law of moving swaps trading to affiliated companies, banks are waiting to see if H.R. 992 will overturn the Dodd-Frank pushout provision.  (“House Approves Derivatives Pushout Bill Amending Dodd-Frank,” Bloomberg, October 30, 2013)

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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