edwards wildman john hughes libor litigation: spotlight on insurance coverage

© 2013 Edwards Wildman Palmer LLP & Edwards Wildman Palmer UK LLP

LIBOR LitigationSpotlight on Insurance Coverage

Presented by:

John D. Hughes

Jacquelyn Burke

Gregory D. Pendleton

http://www.edwardswildman.com/jhughes/

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“It’s hard to imagine a bigger

case than LIBOR.”

~anonymous government official quoted in The New York Times (July 14, 2012)

Introduction

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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.

LIBOR panel for USD transactions

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♦ 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.

♦ 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.

how is the LIBOR used?loans and derivatives

Loans

Derivatives

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the LIBOR scandalwhat 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

the LIBOR scandalwhat happened?

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♦ 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

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the LIBOR scandalbroadening 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.

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the LIBOR scandalbroadening scope

♦ Barclays: Settled with CFTC, DOJ and FSA for $450 million in June 2012.

♦ 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: Settled with CFTC, DOJ, and FSA for $612 million on February 6, 2013.

♦ Japanese subsidiary pled guilty to one count of wire fraud.

♦ 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, HSBC and Deutsche Bank are also in discussions with the DOJ, SEC,

and CFTC, as well as foreign authorities.

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the LIBOR scandalregulatory 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

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the LIBOR scandalregulatory 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

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the LIBOR litigationHow 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

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♦ Sherman Act Antitrust

♦ State Antitrust

♦ Commodity Exchange Act

♦ Securities Law

♦ Exchange Act of 1934

♦ Shareholder Derivative

♦ Breach of Fiduciary Duty

against Ds & Os

♦ RICO

♦ ERISA

♦ Common Law

♦ Disgorgement

♦ Restitution

♦ Unjust Enrichment

♦ Fraud

the LIBOR litigationwhat have been and may be the claims?

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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.

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Customer Class ActionsIn 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 LIBOR-

based financial instruments…which paid artificially low returns to the

Funds due to Defendants’ suppression of LIBOR.‖

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Customer Class Actionsdefenses

♦ 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.

♦ Barred by PSLRA ―RICO Amendment.‖

♦ U.S. laws are not generally extraterritorial.

♦ Morrison v. Nat’l. Australia Bank, 130 S.Ct. 2869

(2010).

♦ Statute of Limitations.

♦ WSJ articles first appeared in April 2008.

Sherman Act

RICO

Common Law

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Customer Class Actionsdefenses (continued)

♦ 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.

Commodities Exchange Act (“CEA”)

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♦ On March 29, 2013, Judge Naomi Reice Buchwald dismissed the majority

of the plaintiffs’ claims, including:

♦ 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.

♦ She allowed one type of claim to proceed:

♦ 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.

♦ 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.

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♦ 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.

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♦ 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.

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Customer Class ActionsLaydon 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 exchange-

traded Euroyen futures and options contracts from

6/1/06 to 9/10.

♦ Damages: The class transacted in Euroyen-based

derivatives at artificial prices.

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.

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♦ 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

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Customer Class ActionsFederal Home Loan Corp. v. Bank of America (13-cv-342, E. D. Va.)

♦ 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.

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Customer Class ActionsSalix Capital v. Banc of America (New York Supreme)

Customer Class ActionsRegents 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

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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

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Customer Class Actionscoverage 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.

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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%.

Securities Class Actions Gusinsky v. Barclays (12-cv-5329, S.D.N.Y.)

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Securities Class ActionsGusinsky 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.

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Securities Class Actionscoverage 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.

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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

Shareholder Derivative Litigation Zucker v. Rubin (Sup. Ct. N.Y.)

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Shareholder Derivative Litigationpotential 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).

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Shareholder Derivative Litigationcoverage 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).

♦ 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.

♦ 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.

♦ 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.

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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.

Regulatory and Criminal Investigations

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).

UBS has paid:



♦ $260 million to the FSA (UK).

♦ $65 million to FINMA (Switzerland).

RBS has paid:



♦ $137 million to the FSA (UK).

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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.

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Regulatory and Criminal Investigationscoverage 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.

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QUESTIONS?

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Contact Us

John D. Hughes

Partner

Edwards Wildman Palmer LLP

Boston, MA

617.951.3373

[email protected]

Jacquelyn Burke

Associate


Boston, MA

617.239.0540

[email protected]

Gregory D. Pendleton

Associate


Boston, MA

617.239.0764

[email protected]

mailto:[email protected]

