Edwards Wildman John Hughes LIBOR Litigation: Spotlight on Insurance Coverage


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In this presentation, John Hughes, a partner in Edwards Wildman's Insurance and Reinsurance Department, analyzes LIBOR litigation and its effects on insurance coverage.

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Edwards Wildman John Hughes LIBOR Litigation: Spotlight on Insurance Coverage

  1. 1. LIBOR Litigation Spotlight on Insurance Coverage Presented by: John D. Hughes Jacquelyn Burke Gregory D. Pendleton © 2013 Edwards Wildman Palmer LLP & Edwards Wildman Palmer UK LLP
  2. 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. 3. LIBOR panel for USD transactions 1. Bank of America 10. Lloyds Banking Group 2. Bank of Tokyo – Mitsubishi UFJ 11. Rabobank 3. Barclays Bank 12. Royal Bank of Canada 4. BNP Paribas 13. Société Générale 5. Citibank NA 14. The Norinchukin Bank 6. Credit Agricole CIB 15. The Royal Bank of Scotland Group 7. Deutsche Bank AG 16. UBS AG 8. HSBC 17. Credit Suisse 9. JP Morgan Chase 18. Sumitomo Mitsui Banking Corp. 3
  4. 4. 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. 4
  5. 5. 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 5
  6. 6. 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 6
  7. 7. 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, UBS and RBS have settled, but they are not alone – news reports indicate that 40-50 other financial institutions may have participated in LIBOR rate manipulation, including interbank brokers. 7
  8. 8. the LIBOR scandal broadening scope ♦ Barclays: ♦ UBS: Settled with CFTC, DOJ, FSA and FINMA for $1.5 billion in December 2012. ♦ Japanese subsidiary pled guilty to one count of wire fraud. ♦ RBS: ♦ ♦ Bank Settled with CFTC, DOJ and FSA for $450 million in June 2012. Settled with CFTC, DOJ, and FSA for $612 million on February 6, 2013. Japanese subsidiary pled guilty to one count of wire fraud. 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, HSBC and Deutsche Bank are also in discussions with the DOJ, SEC, and CFTC, as well as foreign authorities. 8
  9. 9. the LIBOR scandal regulatory reactions ♦ As part of the fallout from the LIBOR scandal, UK regulators announced on July 9, 2013, that a unit of NYSE Euronext – the parent company of the New York Stock Exchange – would assume responsibility for administering LIBOR from the British Bankers’ Association as of early 2014. ♦ LIBOR will keep name and remain under oversight of British regulators. ♦ New administrator from NYSE Euronext will be subject to ongoing scrutiny by U.K. Financial Conduct Authority (―FCA‖). ♦ Activities of submitting and administering LIBOR are now regulated activities. ♦ Banks required to have submission methodology. Submitting banks systems will be monitored and then comprehensively reviewed in late 2013. ♦ LIBOR administrator obliged to monitor and survey submissions in order to identify potential manipulation. ♦ U.K. Financial Services Act makes it a criminal offense to knowingly or deliberately make false statements relating to benchmark setting. * Sources: Financial Stability Board; GOV.UK 9
  10. 10. the LIBOR scandal regulatory reactions ♦ Movement toward benchmark derived from actual short term loans as opposed to estimate of what interest rate would be if banks did lend each other money? ♦ Financial Stability Board, regulating arm of the Group of 20 leading economies, scheduled to issue report in June 2014 on how a reformed LIBOR could be based on actual transactions.* ♦ FSB report will also discuss how to implement new LIBOR scheme without major market disruption. ♦ Transition to new LIBOR regime likely to take several years. * Source: Reuters 10
  11. 11. the LIBOR litigation How are these claims faring? What are the coverage issues? Four Key Categories: ♦ ―Customer‖ Class Actions ♦ Securities Class Actions ♦ Shareholder Derivative Suits ♦ Regulatory and Criminal Investigations 11
  12. 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. 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 main plaintiff groups: 1. Over-the-Counter – led by plaintiff City of Baltimore. ♦ ♦ ♦ Principal claims were under the Sherman Act. Plaintiffs purchased ―hundreds of millions of dollars‖ in interest rate swaps. Complaint also encompassed 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 were under the Commodity Exchange Act. Plaintiffs traded on exchange-based products such as Eurodollar futures. 13
  14. 14. Customer Class Actions In re Libor-Based Financial Instruments Antitrust Litigation 3. Corporate Bondholders – led by plaintiffs Ellen Gelboim and Linda Zacher. ♦ ♦ ♦ Sought 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 2010. 4. Bond Funds – led by plaintiff Charles Schwab Bond Market Fund. ♦ ♦ Principal claims were 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. 15. Customer Class Actions defenses Sherman Act ♦ Parallel Conduct versus Agreement to Conspire. ♦ Bell Atlantic Corp. v. Twombly, 127 S. Ct. 1955 (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. RICO ♦ Barred Common Law ♦ Statute by PSLRA ―RICO Amendment.‖ ♦ U.S. laws are not generally extraterritorial. ♦ Morrison v. Nat’l. Australia Bank, 130 S.Ct. 2869 (2010). of Limitations. ♦ WSJ articles first appeared in April 2008. 15
  16. 16. Customer Class Actions 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. 16
  17. 17. Customer Class Actions In re Libor-Based Financial Instruments Antitrust Litigation ♦ On March 29, 2013, Judge Naomi Reice Buchwald dismissed the majority of the plaintiffs’ claims, including: ♦ ♦ ♦ ♦ ♦ She allowed one type of claim to proceed: ♦ ♦ Antitrust claims: No standing because LIBOR-setting is not a competitive process. RICO claim: Barred by PSLRA, and extraterritorial. Restitution: No direct relationship between plaintiffs and defendants, which is required for a quasi-contract claim. State law claims: Declined to exercise supplemental jurisdiction in favor of judicial economy. Commodity Exchange Act claims: Properly pled, except for any claims that rely on contracts purchased from 8/07 -5/08, as those were time-barred. Judge Buchwald pointed out that the ―broad public interests‖ in punishing the wrongdoing here was met by the regulatory settlements. 17
  18. 18. Customer Class Actions In re Libor-Based Financial Instruments Antitrust Litigation ♦ On 8/23/13, Judge Buchwald issued lengthy opinion denying various motions for reconsideration of her 3/29/13 ruling. She did, however: ♦ ♦ ♦ (i) invite additional motion for reconsideration briefing as to adequacy of scienter allegations vis-à-vis the exchange-based plaintiffs’ commodity manipulation claims; and (ii) allow OTC plaintiffs to file an second amended complaint to plead state law claims for unjust enrichment and breach of implied duty of good faith and fair dealing. Bondholder plaintiffs have appealed dismissal of their antitrust claims. OTC plaintiffs have also asked Judge Buchwald to enter final judgment as to their antitrust claims so they can appeal alongside bondholders. 18
  19. 19. Customer Class Actions In re Libor-Based Financial Instruments Antitrust Litigation ♦ On April 29, 2013, the Schwab Plaintiffs filed suit in California Superior Court. ♦ Complaint asserts state law claims for fraud, unfair business practices, interference with prospective economic advantage, bad faith, rescission of contract, and unjust enrichment. ♦ Schwab also asserts claims for violations of Sections 11, 12(a)(2) and 15 of the ’33 Act. ♦ Much of the complaint is devoted to demonstrating why the statute of limitations has not run. 19
  20. 20. Customer Class Actions In re Libor-Based Financial Instruments Antitrust Litigation ♦ On September 23, 2013, the National Credit Union Administration (―NCUA‖) filed suit in federal district court in Kansas. NCUA brought suit as liquidator for five failed credit unions. Alleges that the credit unions received less interest income than they were entitled to by virtue of traders at LIBOR banks artificially depressing rate reports. ♦ Case likely to be consolidated in the LIBOR MDL and transferred to Judge Buchwald for pre-trial rulings. ♦ Complaint asserts claims for federal antitrust violations under the Sherman Act and state antitrust, unfair competition, and restraint of trade violations. No allegation of securities fraud. ♦ Interesting pleading decision since Judge Buchwald previously dismissed the antitrust claims in the consolidated action. NCUA appears to be banking on the Second Circuit reinstating antitrust claims. 20
  21. 21. 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. ♦ Second Amended Complaint filed on 4/15/13. ♦ Motion to dismiss briefing scheduled to be completed by 9/27/13. Oral argument set for 11/12/13. ♦ Seeks to represent all who bought or sold exchangetraded Euroyen futures and options contracts from 6/1/06 to 9/10. ♦ Damages: The class transacted in Euroyen-based derivatives at artificial prices. 21
  22. 22. Customer Class Actions ♦ Several new cases including allegations taken from UBS settlements filed in December 2012 and January 2013—see, e.g.: ♦ LACERA v. Bank of America et al., C.D.Ca. 12-10903 ♦ CA antitrust, RICO, interference with economic advantage claims. ♦ Class is all California persons or entities that held any financial instrument tied to LIBOR from 1/1/05 to 12/31/10. County of San Diego v. Bank of America et al., S.D.Ca., 13-00048 ♦ CA and federal antitrust, common law fraud, negligent misrepresentation, interference with economic advantage, bad faith and unjust enrichment claims. ♦ Plaintiff purchased LIBOR-based instruments that paid unduly low interest rates, including interest rate swaps directly with at least one defendant. Both cases are now part of the MDL in the S.D.N.Y. ♦ ♦ 22
  23. 23. Customer Class Actions Federal Home Loan Corp. v. Bank of America (13-cv-342, E. D. Va.) ♦ Freddie Mac filed suit on the ―rocket docket‖ in Virginia. ♦ Defendants are LIBOR panel banks and the British Bankers’ Association. ♦ Freddie Mac asserts Sherman Act claims as well as claims for fraud, tortious interference and breach of contract. ♦ Freddie Mac was part of the City of Baltimore class in the MDL, but believes its claims are distinct because it entered into contracts directly with the defendant banks. ♦ Case has now been consolidated into the MDL in the SDNY 23
  24. 24. Customer Class Actions Salix Capital v. Banc of America (New York Supreme) ♦ Now-defunct hedge funds filed suit on May 20, 2013 in New York state court. ♦ Complaint alleges fraud and breach of contract claims, as the funds entered into direct interest rate swap contracts with the panel banks pegged to LIBOR. ♦ The funds seek $250 million in damages. ♦ Removed to federal court 6/12/13; as of 9/23/13, motion to remand pending. 24
  25. 25. Customer Class Actions Regents of U. Calif. v. Bank of America, 13-cv-2921 N.D.Cal. ♦ Suit alleges violations of state and federal antitrust laws between August 2007 and March 2011 ♦ Up to $6 billion of the University system’s securities lending portfolio tied to LIBOR during that time. ♦ The Complaint includes information from charges recently filed against individual traders. ♦ Common law claims include fraud, negligent misrepresentation, interference with economic advantage, bad faith, and unjust enrichment. ♦ MDL panel transferred case to SDNY on 7/24/13 25
  26. 26. Customer Class Actions measure of damages Guardian Care Homes (UK Litigation) ♦ Nursing home provider brought suit against Barclays in the UK over ―mis-selling‖ two interest rate swaps in 2007 and 2008. ♦ Trial of case delayed until April 2014.* ♦ Will shed light on how possible claims against other banks involved might fare in court. * Source: Reuters 26
  27. 27. Customer Class Actions coverage and claims issues E&O Policies for Financial Institutions: ♦ Manipulation of LIBOR rates may not constitute a ―Professional Service‖ – are plaintiffs customers or clients in contract privity with alleged LIBOR manipulating banks? ♦ Antitrust exclusions and misconduct exclusions also may apply. D&O Policies: ♦ Antitrust claims may not be ―Securities Claims.‖ ♦ If individual defendants are named, coverage analysis could be affected. ♦ Antitrust exclusions; misconduct exclusions also may apply. 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. 27
  28. 28. 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. 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%. 28
  29. 29. Securities Class Actions Gusinsky Case Dismissed May 13, 2013 ♦ General statement about a company’s business practices are ―puffery‖; no reasonable investor would rely on them and they do not support at 10(b)(5) claim. ♦ There was no loss causation: ♦ The false submissions allegedly took place in 2009, while the corrective disclosures did not take place until 2012. ♦ Plaintiffs moved for reconsideration, asserting that they can plead materiality and loss causation. Motion denied on 6/13/13. Plaintiffs filed appeal on 7/12/13. 29
  30. 30. 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. If that is the case, it should reduce insurer exposure on defense costs and possibly indemnity. 30
  31. 31. Shareholder Derivative Litigation Zucker v. Rubin (Sup. Ct. N.Y.) Named defendants: Current and former Ds & Os of Citigroup, and Citigroup. Causes of Action: Breach of fiduciary duty Damages: Citigroup faces fines, penalties, investigation costs, and litigation costs as a result of alleged LIBOR manipulation. ♦ ♦ ♦ Amended Complaint filed 4/19/13 Alleges that demand is futile and should be excused. Motion to Dismiss filed 9/20/13 31
  32. 32. 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). 32
  33. 33. 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 JP Morgan). ♦ ♦ 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. 33
  34. 34. 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 Bank of America, JPMorgan, HSBC, Citigroup, and Deutsche Bank among others. Criminal Investigations ♦ DOJ Foreign Regulators ♦ Canadian, Swiss, and Japanese regulators have begun investigations. ♦ In addition to Barclays, UBS, and RBS, at least 15 regulatory investigations are known to be ongoing. 34
  35. 35. Regulatory and Criminal Investigations how will the investigations fare? Barclays has paid: ♦ ♦ ♦ $200 million to the CFTC. $160 million to the DOJ. $92.8 million to the FSA (UK). RBS has paid: ♦ ♦ ♦ $325 million to the CFTC. $150 million to the DOJ. $137 million to the FSA (UK). UBS has paid: ♦ ♦ ♦ ♦ $700 million to the CFTC. $500 million to the DOJ. $260 million to the FSA (UK). $65 million to FINMA (Switzerland).  More fines will almost certainly result from continuing investigations.  Deutsche Bank has acknowledged that it may face substantial fines; new Deutsche Bank documents indicating large profit from trades pegged to LIBOR in 2008 released in January 2013; has set aside significant litigation reserves. 35
  36. 36. 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. 36
  37. 37. QUESTIONS? 37
  38. 38. Contact Us John D. Hughes Partner Edwards Wildman Palmer LLP Boston, MA 617.951.3373 JHughes@edwardswildman.com Jacquelyn Burke Associate Edwards Wildman Palmer LLP Boston, MA 617.239.0540 JBurke@edwardswildman.com Gregory D. Pendleton Associate Edwards Wildman Palmer LLP Boston, MA 617.239.0764 GPendleton@edwardswildman.com 38