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Postcard from London

An Age of Litigation –the Credit Crisis

28 February 2008

Jonathan Kelly

Head of Financial Markets Litigation

2© Simmons & Simmons 2008

Overview

What is the Credit Crisis and where did it come from

Who has lost what – financials and people

Structure of the market - Key flashpoints

What litigation claims have been or will be brought

Defences and practical considerations

Discussion


What is the Credit Crisis and where did it come from? (1)

Confluence of factors– low interest rates– economic prosperity – low inflation– rising real estate values– exponential growth in use of securitisation techniques– ease of transfer of risk across the capital markets– shift from traditional lending model (“Originate-and-hold”) to de-coupled

process (“underwrite/distribute/invest”)– the search for yield by investment managers, pension funds, investors



These factors– increased the appetite/need for higher returns for investors– triggered enormous advances in financial engineering and reallocation of

risk processes– helped to diffuse risk across different markets– resulted in some loss of transparency – reduced the markets’ ability to identify sources and concentration of risk– witnessed the issue of $500 billion of CDOs in 2006, and $485 billion in

2007



What happened?– worst US housing slump in 25 years– foreclosures, bankruptcies, further house price falls– knock-on effects ripple through the mortgage system into the wider

financial markets– providers of financial services/products and investors suffer severe

losses– credit is curtailed and withdrawn altogether, leading to credit and liquidity

issues– institutions and investors forced to write down vast amounts


Who has lost what - financialsMain Sub-Prime losses/write-downs so far*

$1.1bnWachovia$3.4bnHSBC$13.5bnUBS$2bnFreddie Mac$2.6bnRoyal Bank of Scotland$3.2bnDeutsche Bank$197mParibas$1bnCredit Suisse$9.4bnMorgan Stanley$18bnCitigroup$14.1bnMerrill Lynch$3.2bnBear Stearns$3.2bnJP Morgan Chase$2.6bnBarclays$2.6bnIKB$3bnBank of America

Current losses: $140 - $150 billionExpected global bank losses range from $265 billion+ to $400 billion

* Source: BBC Company Reports

+ Source: Standard & Poors estimate


Who has lost what - people

Barclays Capital– Aug 2007 - Head of Collaterised Debt - Edward Cahill resigns

Bear Stearns– 5 Aug 2007 – Co-President and Co-Chief Operating Officer – Warren

Spector resigns– 7 Jan 2008 – Chief Executive – James Cayne resigns

Citigroup– 5 Nov 2007 – Chairman and Chief Executive – Charles Prince resigns

Merrill Lynch– 30 October 2007 – Chairman and Chief Executive – Stan O’Neal resigns

Structure of the Market –key flashpoints

German Landesbanks(HSH Nordbank)

Italian Banks (BancoPopolare)

Australian Investors (Lehman Brothers)

Greek Pension Funds (JP Morgan)

Retail Structured Product Investors (Private banks, retail banks, broker dealers).

Other classes of borrower

Lending Banks

Sub-prime borrowers: e.g. NINJA(No Income, No Job, No Assets)

Mortgage Brokers

Special Purpose Vehicles

Specialist Bond Insurers ACA, Ambac, MBIA

Rating Agencies

Structuring Investment Bank

Structured Products CDOs, CLOs etc

Investors: risk versus return


What litigation claims have been or will be brought?Stage One

278 federal cases filed in the US in 2007

181 cases filed in H2/2007, compared with 97 in H1

48% were borrower class actions: seeking to force re-purchase of loans

Other categories included Securities Class Actions, shareholder derivative claims and employment related

Largely focussed on (i) domestic and (ii) principal participants in residential mortgage securitisation

Some discernible trends suggest a widening of the net


What litigation claims have been or will be brought?Stage Two

Claims against the structuring banks are emerging

Range of cases on swap definitions, valuation and liquidation ofCDOs and other securities and portfolio management.

Most significantly, claims are being made by sophisticated banksagainst other banks:– Barclays Bank vs. Bear Stearns: 19 December 2007– HSH Nordbank vs. UBS: 25 February 2008

An overview of the claims


The mood out there

“There will be a Sub-Prime litigation tsunami : there is lots of blame to go round. Sub-Prime is the new dotcom” - US Securities Class action lawyer

“There is never only one cockroach – the investment banks and the rating agencies cannot be allowed to get away with it” – a senior Bloomberg journalist

… speaking at a Sub-Prime and Global Credit Symposium on 7 February 2008


Principles emerging from other recent attacks on financial institutions

The good news– no general duty to advise a counterparty– no English law duty of good faith or fair dealing – but beware Civil Code

and US law duties– importance of written contractual terms has been re-asserted as a

general principle– investors cannot simply circumvent a contractual intermediary– Court will not readily assume fiduciary relationship – must be clearly

established– claims in dishonesty – deceit, fraudulent breach of constructive trust,

conspiracy – very difficult to establish: burden and clarity


Principles emerging from attacks on financial institutions

The bad news– misrepresentation/mis-selling claims are likely to increase– more examples of liabilities outside contract : tortious duties are being

expanded– fact-specific and fairness/policy considerations create uncertainty– the asymmetry of information on value, pricing, modelling and fees will

be relevant considerations and will invariably count against thestructuring/managing entity

– beware of over-reliance on disclaimers


Liabilities outside contractIncreasing tort-based duties

Riyadh Bank v Ahli United Bank (UK) plc [2006] 2 All ER (Comm) 777(June 2006)

Customer/ Client

(A)

Performance of servicesunder main contract Contractual

Service Provider (B)

Delegated Service Provider(s)(C)

Duty of care in tort?Delegation of services by sub- contract(s)

Actual provision of some or all services under the main contract


The role of “name” advisors (1)

Issuer of securities

Arranger

Investor

Arranger underwrites mezzanine facility

Arranger supplies information memorandum

Investor buys Issuer’s bonds and warrants from Arranger


The role of “name” advisors (2)

IFE v Goldman Sachs [2006] EWHC 2887 (QB) (Comm)– arranger impliedly represented that it was acting in good faith and not

knowingly putting forward information likely to mislead– importance of boilerplate– Affirmed by the Court of Appeal – July 2007


Intermediated sales : related (agent) intermediary (1)

Intermediary related to product

provider

Investor

Oral pre-contractual misrepresentation

Written contract with no misrepresentation

Productprovider


Intermediated sales : related (agent) intermediary (2)

Peekay v ANZ, Court of Appeal, [2006] EWCA Civ 386 (April 2006)– structured Russian GKO-based derivative product– pre-contractual misrepresentation re nature of complex product– original judgment held that signed final terms and conditions (including

generic disclaimers) did not extinguish pre-contractual misrepresentation re nature of complex product

– Court of Appeal held that no actionable misrepresentation– beware approach of Judge at first instance– impact of marketing/sales on legal


Intermediated sales : third party intermediary (1)

Productprovider

Third party Intermediary

Investorcontract

no duty of care?

tortcontract

no contract


Intermediated sales : third party intermediary (2)

Seymour v (1) Ockwell (2) Zurich IFA, [2005] EWHC 1137 (May 2005)– direct duty of care by breached by financial adviser– no direct duty owed by Zurich to investor– Zurich responsible to financial adviser for 66% of claims (but, fact specific –

continuing representation)



Horses, gates and bolts

Caveat emptor, arms length negotiations and “heavy” transaction documents

Contractual protections:– “Big Boy” letters expressly representing non-reliance – Warranties as to capacity, sophistication and independent advice– Express and clear disclaimers and exclusions in main contracts/offering

documents– Key terms in intermediary agreements:

– principals and indemnity– obligations regarding onward sale/marketing

– Defining scope of responsibility and role



Evidence– [Enforced] mobility of personnel in the financial markets – future

cooperation and compromise agreements– important of structuring processes to protect legal professional privilege– retention of experts from a very limited pool in:

– financial modelling and valuation– market practice in different securitisation techniques

– policies on “deep store” electronic material : back-up tapes– FSA approach to telephone recordings: marginal long term historical

impact



jurisdiction, forum and governing law – first strike capability

will there be a stampede of European Securities Class Actions

trading in litigation – distressed debt, workouts, extracting value

Concluding remarks


Postcard from London

An Age of Litigation –the Credit Crisis

Jonathan Kelly

28 February 2008

jonathan kelly postcard from london an age of litigation .../media/files/articles/2008/20080228...

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