LIBOR Litigation. Spotlight on Insurance Coverage. November 15, Charles Proctor Partner Edwards Wildman UK London

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1 LIBOR Litigation Spotlight on Insurance Coverage November 15, 2012 John D. Hughes Partner Edwards Wildman Boston Mary-Pat Cormier Partner Edwards Wildman Boston Charles Proctor Partner Edwards Wildman UK London 2012 Edwards Wildman Palmer LLP & Edwards Wildman Palmer UK LLP

2 Introduction It s hard to imagine a bigger case than LIBOR. ~anonymous government official quoted in The New York Times (July 14, 2012) 2

3 LIBOR How Did We Get Here Growth of syndicated loan markets in the 1980s. Need to ascertain uniform interest applicable to a diverse range of lenders. Agent contacting selected reference banks ( ad hoc panels) to obtain an average rate. Time consuming/ inconvenient. BBA LIBOR with pre-selected panels (January 1986). Growth of swap market/ other instruments using LIBOR.

4 LIBOR The Problems Recent problems have highlighted flaws in the construction, application and governance of LIBOR. LIBOR assumes existence of an unsecured cash market among banks. Markets thin since Result is that quotations more speculative and easier to manipulate. Governance issues LIBOR established by BBA whose main subscribers are the major banks. Conflict of interest. Litigation Guardian Care Homes v Barclays

5 LIBOR Panel for USD Transactions 1. Bank of America 2. Bank of Tokyo Mitsubishi UFJ 3. Barclays Bank 4. BNP Paribas 5. Citibank NA 6. Credit Agricole CIB 7. Deutsche Bank AG 8. HSBC 9. JP Morgan Chase 10. Lloyds Banking Group 11. Rabobank 12. Royal Bank of Canada 13. Société Générale 14. The Norinchukin Bank 15. The Royal Bank of Scotland Group 16. UBS AG 17. Credit Suisse 18. Sumitomo Mitsui Banking Corp. 5

6 How is the LIBOR Used? loans and derivatives Loans The LIBOR is the primary benchmark for global short term interest rates. Lenders use the LIBOR rate as a base and add basis points depending on the borrower s credit-worthiness. Derivatives The price of many financial instruments is pegged to the LIBOR, including swaps and futures contracts. The notional amount outstanding of OTC interest rate derivatives contracts linked to the LIBOR in the first half of 2011 = $554 trillion. Source: Financial Services Authority The current value of all LIBOR-pegged financial instruments may be as high as $800 trillion. 6

7 The LIBOR Scandal what happened? Historically, the LIBOR and the costs of credit default swap obligations were correlated. In certain periods, however, the cost of CDS obligations rose substantially more than their US LIBOR quotes would suggest. -Source: WSJ, 5/29/2008 7

8 The LIBOR Scandal what happened? Some banks are far slower to change their submissions than others. Some banks Libor submissions track the market view of their credit risk, as measured by their CDS swaps, far more closely than others. -Source: WSJ, 9/28/12 8

9 The LIBOR Scandal broadening scope Since July 2012, criminal and civil investigations have been opened against several banks. Regulators in multiple countries are now investigating LIBOR rate-rigging. Barclays is not alone news reports indicate that other financial institutions may have participated in LIBOR rate manipulation. 9

10 The LIBOR Scandal broadening scope RBS: Revealed it has fired several employees for misconduct related to LIBOR rigging, and admitted being investigated by the DOJ, CFTC, and the FSA, among others. Bank of America: Acknowledged receiving subpoenas from the DOJ, CFTC, and FSA. JPMorgan: Disclosed investigations by the DOJ, SEC, and CFTC in the US, and the European Commission, Canada s Competition Bureau, and the Swiss Competition Commission overseas, among others. Citigroup, UBS, HSBC and Deutsche Bank are also in discussions with the DOJ, SEC, and CFTC, as well as foreign authorities. 10

11 The LIBOR Litigation How will these claims fare? What are the coverage issues? Four Key Categories: Customer Class Actions Securities Class Actions Shareholder Derivative Suits Regulatory and Criminal Investigations 11

12 The LIBOR Litigation what have been and may be the claims? Sherman Act Antitrust State Antitrust Commodity Exchange Act Securities Law RICO ERISA Common Law Exchange Act of 1934 Shareholder Derivative Breach of Fiduciary Duty against Ds & Os Disgorgement Restitution Unjust Enrichment Fraud 12

13 Customer Class Actions In re Libor-Based Financial Instruments Antitrust Litigation Multi-District Litigation in S.D.N.Y. (Dkt. 11-MD-2262), with four plaintiff groups currently active: 1. Over-the-Counter led by plaintiff City of Baltimore. Principal claims are under the Sherman Act. Plaintiffs purchased hundreds of millions of dollars in interest rate swaps. Complaint also encompasses asset swaps, CDOs, credit default swaps, forward rate agreements, inflation swaps, interest rate swaps, total return swaps, and options. 2. Exchange Based led by plaintiff FTC Futures Fund. Principal claims are under the Commodity Exchange Act. Plaintiffs traded on exchange-based products such as Eurodollar futures. 13

14 Customer Class Actions In re Libor-Based Financial Instruments Antitrust Litigation 3. Corporate Bondholders led by plaintiffs Ellen Gelboim and Linda Zacher. Seeks relief under the Sherman Act. Plaintiffs are holders of LIBOR-based debt securities not issued by any defendant. The class period is August 2007 through May Bond Funds led by plaintiff Charles Schwab Bond Market Fund. Principal claims are under the Sherman Act and RICO. The Schwab Fund acquired billions of dollars worth of LIBORbased financial instruments which paid artificially low returns to the Funds due to Defendants suppression of LIBOR. 14

15 Customer Class Actions In re Libor-Based Financial Instruments Antitrust Litigation On August 8, District Judge Naomi Rice Buchwald stayed any actions not currently subject to motions to dismiss. This includes the Community Bank, Berkshire Bank, Green Pond and Lieberman, Adams and Courtyard at Amwell actions. Judge Buchwald encouraged the prompt filing of new complaints in order to better evaluate future procedural structure of the cases. Replies filed on September 27, 2012; awaiting ruling. 15

16 Customer Class Actions Laydon v. Mizuho Bank, et al (12-cv-3419, S.D.N.Y.) Class Action alleging manipulation of Euroyen TIBOR (Tokyo Interbank Offered Rate) and Yen LIBOR rates. Brings claims under the CEA, Sherman Act, Illinois consumer Fraud Act, NY Business Law, and common law. First Amended Complaint due to be filed on 11/30/12. Seeks to represent all who bought or sold exchange-traded Euroyen futures and options contracts from 6/1/06 to 9/10. Damages: The class transacted in Euroyenbased derivatives at artificial prices. 16

17 Customer Class Actions Adams v. Bank of America, et al. (12-cv-07461, S.D.N.Y.) Class Action alleging manipulation of LIBOR to get higher yields on mortgage-backed securities. Alleges a manipulated increase on the 1st day of each month when ARM rates were set. Plaintiffs are homeowners who held subprime mortgages tied to LIBOR, and allegedly paid higher rates. Brings claims under the Sherman Act, RICO, New York state antitrust law, and common law claims including unjust enrichment, restitution and breach of contract. Seeks to represent over 10,000 borrowers with ARMS tied to LIBOR between January 2000 and February Damages: Overpayments of interest and loss of equity in homes. 17

18 Customer Class Actions potential defenses Sherman Act RICO Common Law Parallel Conduct versus Agreement to Conspire. Bell Atlantic Corp. v. Twombly, 127 S. Ct (2007) What would have been the correct USD LIBOR? Direct Purchaser Rule. Illinois Brick Co. v. Illinois, 431 U.S. 720 (1977). Standing only established through purchase from conspirator. Of note: This is not true of all state antitrust laws. Barred by PSLRA RICO Amendment. U.S. laws are not generally extraterritorial. Morrison v. Nat l. Australia Bank, 130 S.Ct (2010). Statute of Limitations. WSJ articles first appeared in April

19 Customer Class Actions potential defenses (continued) Commodities Exchange Act ( CEA ) Claim by primarily foreign investors who maintain that because defendants unlawfully suppressed USD LIBOR, their cost to purchase EURIBOR (Euro Interbank Offered Rate) futures, which are priced inversely to 3-month USD LIBOR, was artificially increased. CEA, like the Securities Exchange Act, requires loss causation. Dura Pharm., Inc. v. Broudo, 544 U.S. 336 (2005). The plaintiffs must thus prove that they sold their Eurodollar futures contracts at a loss after the price of Eurodollars dropped because defendants manipulation of USD LIBOR had either ceased or been revealed. 19

20 Customer Class Actions measure of damages Guardian Care Homes (UK Litigation) Nursing home provider brought $61M suit against Barclays in the UK over mis-selling two interest rate swaps in 2007 and Case set to go to trial on damages Will shed light on how possible claims against other banks involved might fare in court. 20

21 Customer Class Actions coverage and claims issues E&O Policies for Financial Institutions: Manipulation of LIBOR rates does not constitute a Professional Service plaintiffs are not customers or clients in contract privity with alleged LIBOR manipulating banks. Antitrust exclusions; misconduct exclusions. D&O Policies: Antitrust claims are not Securities Claims. If individual defendants are named, could be coverage. Antitrust exclusions; misconduct exclusions. Claims Spotlight: Defense costs defense costs for any claims that survive motions to dismiss could be extremely costly to insurers. However, large financial institutions may have big SIRs (sources indicate SIRs as high as $50 million). Indemnity remains to be seen whether covered damages in civil actions can be proven. 21

22 Securities Class Actions Gusinsky v. Barclays (12-cv-5329, S.D.N.Y.) Named defendants: Barclays; Robert Diamond (former CEO); Marcus Aguis (former Chairman) Causes of Action: 10(b) and 10(b)(5) violations under Exchange Act against all defendants. 20(a) violations against individual defendants. Class Allegations: Seeks to represent all persons who purchased Barclays sponsored American Depository Receipts between 7/10/07 and 6/27/12. St. Louis pension fund named lead plaintiff; amended complaint expected shortly. Damages: Barclays stock traded at artificially high prices, then reacted negatively with news of fines. Claims that on 6/28/12, shares dropped 12%, and on 6/29/12, shares dropped another 5%. 22

23 Securities Class Actions potential defenses Responsive pleadings and lead plaintiff motions are due this Fall. Barclays stock has bounced back and is now trading at nearly the same price as it was before the settlement was announced. Disaggregation Considering the size of the defendant institutions, the settlements being paid are not necessarily significant enough to have a material impact on their balance sheets or stock price. Forum non conveniens no evidence of NY Traders or US management involved 23

24 Securities Class Actions coverage and claims issues Securities Claims against institutions typically covered under D&O entity/side-c coverage. Securities Claims against individual Ds & Os typically covered under Side-B (insures company to extent of its obligation to indemnify Ds & Os). Side-A covers Ds & Os where the institution is not indemnifying them. Stand-alone Side-A DIC policies should drop down to fill coverage gaps in company s primary D&O policy. Large banks typically have large SIRs. This should reduce insurer exposure on defense costs and possibly indemnity. 24

25 Shareholder Derivative Litigation Zucker v. Rubin (Sup. Ct. N.Y.) Named defendants: Current and former Ds & Os of Citigroup. Causes of Action: Breaches of fiduciary duty ( loyalty, good faith, oversight, and diligence in management and administration of [Citi s] affairs ). Alleges that demand is futile and should be excused. Damages: Citigroup faces fines, penalties, investigation costs, and litigation costs as a result of alleged LIBOR manipulation. 25

26 Shareholder Derivative Litigation potential defenses Failed to make demand on board. Breach of duty of care notoriously difficult for plaintiffs to prove. In re Caremark Intl. Inc. Derivative Litig., 698 A.2d 959, 967 (Del. Ch. 1996) (a claim for violation of duty of care is possibly the most difficult theory in corporation law upon which a plaintiff might hope to win a judgment. ); Benihana of Tokyo, Inc. v. Benihana, Inc., 891 A.2d 150, 192 (Del. Ch. 2005) (a gross negligence standard applies to claims of breach of the duty of care). Business Judgment Rule provides a shield against breach of fiduciary duty claims by creating a presumption that Ds & Os acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. In re Walt Disney Co. Derivative Litig., 907 A.2d 693, 747 (Del. Ch. 2005). 26

27 Shareholder Derivative Litigation coverage and claims issues Industry exposure probably low just three LIBOR-setting banks are domiciled in the U.S. (Citigroup, Bank of America, and JPMorgan). A-Side Coverage applies where corporation does not indemnify its Ds & Os because it is: (1) prohibited by law from doing so; (2) permitted to do so by law and company bylaws but chooses not to; or (3) financially incapable of doing so. These are the only likely defendants in derivative suits because of the internal affairs doctrine, pursuant to which courts of a corporation s home country should address issues concerning the governance of the corporation. U.S. courts are thus unlikely fora for derivative suits against foreign banks. Judgments or settlements of derivative suits not indemnifiable. See 8 Del. C. 145(b). Misconduct exclusions for breach of duty of loyalty claims (final adjudication). Fully severable knowledge of one insured not imputed to another insured. Special Litigation Committee Second Circuit has held these are covered as defense costs under certain D&O policies. See MBIA, Inc. v. Fed. Ins. Co., 652 F.3d 152 (2d Cir. 2011). Policy sub-limits for investigations of shareholder demands. 27

28 Regulatory and Criminal Investigations Domestic Regulators SEC CFTC State Attorney Generals The AGs of New York and Connecticut have already sent subpoenas to 16 banks in a joint investigation including Barclays, Bank of America, JPMorgan, HSBC, UBS, Citigroup, Deutsche Bank, and RBS among others. Criminal Investigations DOJ Foreign Regulators Canadian, Swiss, and Japanese regulators have begun investigations. In addition to Barclays, 17 regulatory investigations are known to be ongoing. 28

29 Regulatory and Criminal Investigations how will the investigations fare? Barclays has already paid: $200 million to the CFTC $160 million to the DOJ 59.5 million to the Financial Services Authority More fines will almost certainly result from continuing investigations. RBS and Deutsche Bank have acknowledged that they may face substantial fines. 29

30 Regulatory and Criminal Investigations coverage and claims issues Policy Language Definitions of Securities Claim. Do subpoenas qualify as Claims? Defense Costs Appears to be significant exposure for formal investigations by regulators. Responding to subpoenas or requests for information could be very costly. Indemnity Should be no coverage for fines, penalties, and/or disgorgement. Coverage Defenses Loss does not include restitution, fines, or penalties. 30

31 LIBOR The Reforms Recommendations of Wheatley Report. Reform LIBOR rather than replace it to avoid contractual problems. Require that actual market data be more clearly used to determine LIBOR submissions. Designate LIBOR setting as a regulated activity/ benchmark manipulation as criminal offence. Introduce code of conduct for LIBOR setters. Dispense with peripheral currencies/ maturities. Appoint independent administrators in place of BBA. Tender process underway.

32 Contact Us John D. Hughes Partner Edwards Wildman Palmer LLP Boston, MA Mary-Pat Cormier Partner Edwards Wildman Palmer LLP Boston, MA Charles Proctor Partner Edwards Wildman Palmer UK LLP London +44 (0)