Could Libor bankrupt the banks?

9 min read

Just when you thought the most turbulent and dangerous part of the Libor manipulation hurricane had blown itself out, back it comes with a vengeance - not just to darken the doors of the 16 dollar Libor panel bank defendants (including 10 G-SIBs) but to potentially blow those doors off their hinges.

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The US appeals court’s May 23 ruling is, in my view, wonky. Overturning the district court’s previous decision and dictating that plaintiffs don’t have to prove antitrust injury vis-a-vis Libor manipulation – and separately remanding for further proceedings the issue of whether appellants are efficient enforcers of antitrust laws – could end up being the straw that broke the camel’s back.

The US$9bn of fines to-date levied on the banks for Libor rigging will pale into insignificance if the civil case brought by multiple plaintiffs succeeds and the banks end up on the hook for massive damages that could be levied to pay out every plaintiff and Libor counterparty. Some observers say successful pursuit of the case could even bankrupt some of the defendants.

Bank of America Merrill Lynch, Bank of Tokyo Mitsubishi, Barclays, Citigroup, Credit Suisse, Deutsche Bank, HSBC, JP Morgan, Lloyds Banking Group, Norinchukin Bank, Rabobank, Royal Bank of Canada, RBS, Societe Generale, UBS and WestLB/Portigon are all named. My sense is it’s unlikely the banks will be pushed to the wall but the latest turn will doubtless have struck dread into their souls. Litigation reserves will need to shoot up, even if the banks come out fighting.

I contacted all of the banks after the appeals court ruling. Of the15 banks that responded, most declined comment. RBC had this to say: “The Second Circuit decision does not indicate any findings of fact against RBC, and we will be vigorously defending against the civil action”. Portigon’s comment was similar: “Portigon AG remains convinced … that neither it nor its employees can be accused of illegally manipulating the interest-rate quote”.

Legacy

Beyond the fact that the appellants in this case have a green light to go after the defendants, the US appeals court decision could unleash a wave of copycat suits from entities claiming injury from rate and other benchmark manipulation.

The Libor manipulation saga has already left in its wake a legacy of grave reputational damage for the banking industry; that lengthy (and in my view questionable) UK prison sentence for Tom Hayes; US prison time (much shorter) for former Rabobank traders Anthony Allen and Anthony Conti; another group of ex-Rabobank traders as well as Barclays’ Peter Johnson pleading guilty to the charges against them; a string of past, current and future trials that will stretch for years; the firing of Bob Diamond and the dismissal of a raft of executives and employees.

Libor has been among the most painful episodes of a whole series of calamities that have upturned the banking sector’s standing since the global financial crisis. It has also been a major catalyst behind a significant shake-up of banks’ internal governance processes and procedures.

Coming out of it we’ve had the Financial Stability Board publish reforms; IOSCO issue principles; the European Parliament pass on April 28 the EU regulation on indices used as benchmarks in financial instruments and financial contracts; submissions from banks in the UK governed by the approved persons and senior managers’ regimes and manipulating Libor being designated a criminal offence; new Libor setter ICE come out with a roadmap including shifting to a trade data download model; and the UK’s brand new FICC Market Standards Board working on a set of standards for the trading of benchmarks.

180 degree turn

The original lawsuit alleged that the banks colluded to depress Libor by violating rate‐setting rules, decreasing financial returns in violation of Section One of the antitrust Sherman Act. The various suits against the banks had been consolidated into what the appeals court referred to as “sprawling” multi‐district litigation involving “a host of parties, claims, and theories of liability”.

An earlier district court ruling dismissed the complaint in its entirety on the grounds that none of the appellants “plausibly alleged that they suffered antitrust injury”.

Circuit judge Dennis Jacobs turned that on its head. “The district court reasoned that the Libor‐setting process was collaborative rather than competitive, that any manipulation to depress Libor therefore did not cause appellants to suffer anti-competitive harm, and that they have at most a fraud claim based on misrepresentation. The complaints were thus dismissed on the ground that they failed to allege harm to competition.

“We vacate the judgment on the ground that: (1) horizontal price‐fixing constitutes a per se antitrust violation; (2) a plaintiff alleging a per se antitrust violation need not separately plead harm to competition; and (3) a consumer who pays a higher price on account of horizontal price‐fixing suffers antitrust injury.

“Since the district court did not reach the second component of antitrust standing – a finding that appellants are efficient enforcers of the antitrust laws – we remand for further proceedings on the question of antitrust standing. The banks urge affirmance on the alternative ground that no conspiracy has been adequately alleged; we reject this alternative,” Judge Jacobs said in his decision.

Four groups of plaintiffs had filed complaints that became subject to the banks’ motions to dismiss, three of which are class actions. The first group, the OTC plaintiffs, purchased hundreds of millions of dollars of interest-rate swaps directly from at least one defendant in which the rate of return was tied to Libor. This group is led by the Mayor and City Council of Baltimore, and the City of New Britain Firefighters and Police Benefit Fund.

The second group, the bondholder plaintiffs, say the alleged conspiracy reduced the returns on debt securities in which they held an interest. The lead plaintiffs are Ellen Gelboim, the sole beneficiary of an IRA that owned a Libor‐based debt security issued by GECC; and Linda Zacher, a beneficiary with similar rights to a security issued by Israel. The third group are Charles Schwab subsidiaries and bond and money-market funds that say they suffered similar harm to the first two classes.

The fourth group, the exchange‐based plaintiffs – Metzler Investment (a unit of Germany’s Metzler Bank), certain futures funds of FTC Capital, Atlantic Trading USA, 303030 Trading, and Illinois residents Gary Francis and Nathanial Haynes – claimed injury from the purchase and trading of contracts based on Eurodollar futures. They alleged that the banks’ suppression of Libor caused Eurodollar contracts to trade and settle at artificially high prices reducing gains made in trades.

The latest US appeals court ruling is certainly more consistent with the approach taken by the UK courts in supporting the notion of conspiracy charges as opposed to having to prove actual fraud, given the lack of any burden on plaintiffs to claim injury or for the prosecution to have to prove that Libor was even rigged as a result of any supposedly manipulative attempts.

Case update

Beyond the institutional fines meted out, the US courts have to-date successfully prosecuted Libor cases against a group of ex-Rabobank employees, two of whom (Allen and Conti) were handed short prison sentences; others are awaiting sentence. Two former Deutsche Bank employees have been indicted, while one, Gavin Campbell Black, has pleaded guilty to a single count of conspiracy to commit wire fraud.

The UK has so far only secured one conviction – that of Tom Hayes – on conspiracy charges. Six inter-dealer brokers who were his supposed co-conspirators, were acquitted earlier this year. A group of former Barclays employees is currently on trial in London. Former Barclays employee Peter Johnson had already pleaded guilty to one count of conspiracy prior to the commencement of the trials. A further 11 individuals from Barclays, Deutsche Bank and SocGen have been charged by the UK’s Serious Fraud Office with conspiracy to defraud in cases related to Euribor. Trials for some of those are set to commence in 2017.

Libor trials

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Libor trials