Credit Crunch Digest -- September 2013

This issue of the Credit Crunch Digest focuses on JPMorgan’s $920 million “London Whale” settlement; interdealer broker fines for Libor manipulation; the European Union’s proposed regulations for Libor oversight; cost estimates related to the credit crisis for the largest banks; Countrywide-related litigation; a bankruptcy court ruling that the Madoff trust may not dispense “time-based” damages; and new proposed regulations for Dodd-Frank mortgage rules.

London Whale Trading Loss Settlement

Libor Scandal

Litigation and Regulatory Investigations

Fraud and Ponzi Schemes

Government and Regulatory Intervention

  London Whale Trading Loss Settlement

JPMorgan Pays $920 million to U.S. and U.K. Regulators

JPMorgan, the largest bank in the United States, has agreed to pay $920 million in fines to U.S. and U.K. regulators in connection with charges that the bank failed to properly oversee its trading operations and engaged in unsafe and unsound practices.  The charges stem from last year’s “London Whale” trading loss, in which a London-based JPMorgan trading team participated in complex derivatives bets that ultimately left the bank with approximately $6 billion in losses.  The bank has admitted violating securities laws in 2012, at which time senior executives failed to advise the board that traders in the chief investment office in London were concealing losses to a derivatives portfolio through irregular pricing.

The massive fine will be distributed amongst several regulators.  Specifically, $200 million will be distributed to the Securities and Exchange Commission, $300 million to the Office of the Comptroller of the Currency, $200 million to the Federal Reserve and $220 to the U.K. Financial Conduct Authority. (JPMorgan Fined $920 Million in ‘London Whale’ Trading Loss, CNNMoney, September 19, 2013).

JPMorgan Admits Wrongdoing in “London Whale” Trading Loss Settlement

JPMorgan’s admission of wrongdoing in connection with the $920 million “London Whale” trading loss settlement represents a break in the Securities and Exchange Commission’s previous practice of allowing settlements without any admission of liability.  The SEC recently vowed to push for admissions of wrongdoing from financial institutions as pressure mounted from federal judges and the public criticizing large settlements without any admission of liability on the part of defendants.

Many defendants in the SEC’s crosshairs may balk at JPMorgan’s admission of wrongdoing; however, securities laws experts say the settlement does not give plaintiffs in related private lawsuits much of an advantage.  While JPMorgan did admit to inadequate internal controls and the failure to ensure accuracy of its public disclosures, all admissions were made in connection with a regulatory provision that only the government can enforce.  According to Adam C. Pritchard, a professor at the University of Michigan Law School, “[i]t’s an admission that they were careless and should have done a better job with their internal controls . . . [b]ut it doesn’t have serious implications for the private lawsuits they are facing. It’s just an admission of negligence.”  According to Pritchard, private plaintiffs need to prove fraud, and JPMorgan’s settlement does not rise to an admission of fraud.  (“JPMorgan’s Admission: A symbolic victory for the SEC, of limited use in private lawsuits, The Washington Post, September 19, 2013).

Libor Scandal

ICAP Agrees to Settle Regulatory Investigations for Libor Manipulation

ICAP, one of the leading interdealer brokers, entered into settlements with the U.S. Commodity Futures Trading Commission (“CFTC”) and the U.K. Financial Conduct Authority (“FCA”) to settle allegations that it engaged in manipulation of Japanese Yen LIBOR.  As part of the settlement, ICAP will pay penalties totaling $87 million, consisting of a $65 million penalty to the CFTC and a £14 million ($22 million) fine to the FCA.  In addition, the U.S. Department of Justice (“DOJ”) has charged three ICAP brokers with fraud.  The settlement makes ICAP the fourth financial firm, and first interdealer broker, to settle with regulators over allegations of Libor manipulation.  (“ICAP Fined $87 million over, three former staff charged,” Reuters, September 25, 2013)

Libor Regulation Stays in London

The European Commission recently considered changing the oversight committee for Libor from London’s treasury regulators to the European Securities and Markets Authority (“ESMA”) located in Paris, France.  However, a revised version of this proposal keeps London as the primary supervisor for Libor.  This is viewed as a substantial victory for the U.K. Treasury, which lobbied hard to kill the original supervision plan.

Although the European Commission (“the Commission”) will no longer propose ESMA to fully oversee Libor, as London attempts to restore trust in this market rate, the Commission will still put forward a plan to have various supervisors from multiple countries help oversee Libor.  To support this change, the Commission argues that cross-country oversight is necessary since the market rate affects the entire European Union.  The ESMA will still have a role in this new proposal as the legal body, mediating any disputes that arise between supervisors and issuing binding orders.  All proposals are expected to be presented at a later time in the Commission’s legislative calendar.  (“Libor Control to Remain in London,” Financial Times, September 11, 2013

Litigation and Regulatory Investigations

Banks Face Massive Legal Bills Related to Financial Crisis

According to data compiled by Bloomberg, the largest six U.S. banks have incurred approximately $103 billion in legal costs since the onset of the financial crisis.  This figure includes fees paid to attorneys and costs of settlements. Approximately 40 percent of those costs have been incurred since January 2012. 

About 75% of the costs have been incurred by giants JPMorgan and Bank of America. Since the beginning of 2008, JPMorgan has spent $21.3 billion in legal fees and litigation cost. Although five years have passed since the financial collapse in 2008, banks continue to face private and governmental actions.  Last month, U.S. Attorney General Eric Holder announced that he is readying additional actions related to the financial crisis in the coming months. (“U.S. Bank Legal Bills Exceed $100 Billion,” Bloomberg, August 28, 2013)

FDIC Seeks Reconsideration of Countrywide Dismissal

Following the dismissal of the Federal Deposit Insurance Corporation’s (FDIC) fraud claims against a number of lenders in connection with the sale of $1.5 billion in mortgage-backed securities, the FDIC has filed a motion for reconsideration with the U.S. District Court in the Central District of California. The District Court dismissed the case in August.

In dismissing the case, the District Court held that the FDIC’s claims against Countrywide and several other larger banks involving misstatements about the underlying assets of the packaged securities did not fall within the applicable statute of limitations under the Securities Exchange Act, and thus were time-barred. The FDIC’s reconsideration motion asserts that the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), which contains an extender provision, overrides the statue of repose under the Securities Exchange Act relied on by the District Court.  The FDIC argued that the decision was “without the benefit of full briefing and based largely upon defendants' presentation of inapposite case law at oral argument, result[ing] in an error of law.”  

The FDIC’s complaint, filed last year, alleges that Countrywide, CWALT Inc., Bank of America Corp., Deutsche Bank Securities Inc. and Goldman Sachs & Co. misled investors about soundness of the mortgages underlying the packaged securities in violation of the Texas Securities Act and the federal Securities Exchange Act of 1933. The FDIC asked the District Court to reverse its dismissal, or alternatively to certify the case for interlocutory appeal. ("FDIC Seeks Another Shot At $1.5B Countrywide RMBS Suit,” Law360, September 11, 2013)

Fraud and Ponzi Schemes

No Interest for Madoff’s Fraud Victims

United States Bankruptcy Judge Burton Lifland decided that the approximately $1.36 billion recovered in the Madoff trust is not subject to interest or inflation adjustments, which will likely speed up the recovery time to dispense the money to fraud victims.  Although Irving Picard, Trustee for the Madoff Liquidating Trust, has already distributed approximately $5.4 billion of the $11.1 billion recovered, $1.36 billion was kept in reserve awaiting the Bankruptcy Court’s decision regarding whether long-term investors should be able to recover time-based damages under the Securities Investor Protection Act. 

Judge Lifland stated that awarding “time-based” damages would be unfair because it would favor investors who have already recovered their principal, and possibly allow traders to recover from Madoff’s estate even though they may not have been victims of the fraud.  The victims never bargained for this adjustment, and therefore, could not expect guaranteed rates of return or an inflation projection when originally investing.  (“Madoff Trustee Wins Dispute Over Fraud Victims’ Damages,” Reuters, September 10, 2013)

Government and Regulatory Intervention

Regulators Propose New Dodd-Frank Mortgage Rules

In late August, six federal agencies in charge of regulating banking and housing finance published a 499-page proposal to change the Dodd-Frank rules surrounding mortgages.  The current provision demands that banks keep a portion of the generated risk when securitizing home mortgages.  The intent behind the rule was to keep lenders’ profits tied to their loan packages to enjoin them from engaging in high-risk lending.  The original proposal also included a definition for qualified residential mortgages, which included a required 20 percent down payment for homes. However, opponents warned that this requirement would negatively impact would-be borrowers who cannot meet the financial requirements for homeownership.

The new proposal relaxes the definition for qualified residential mortgages, removing the down payment requirement.  Rather, if the proposal is accepted, the mortgages must only align with standards set by the Consumer Financial Protection Bureau, an agency established by Dodd-Frank to police predatory lending.  This regulation is now in the public comment period until October 30.  After reviewing comments, the six agencies will vote the new regulations into effect.  (“Regulators Look for Do-Over on Dodd-Frank Mortgage Regulation,” The Washington Examiner, Aug. 28, 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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