Tuesday, September 4, 2012

LIBOR Banks Face a Hurricane of Litigation

A storm, or more aptly, a hurricane of litigation is on its way for the banks involved in the LIBOR rate-rigging scandal. The LIBOR banks face not just the prospect of criminal prosecution, but also exposure to law suits by thousands of market participants and others who relied upon the key interest rate in transactions and financial products.   Getting out ahead of the other banks, the UK's Barklays has been busy making deals to contain its exposure to prosecution and protect its executives.  Upon admitting its role in the scandal and implicating the other rate setting banks as well as central banks, Barclays promptly entered a civil settlement with the Commodities and Futures Trading Commission, agreeing to pay $200 million, and negotiated a deal with the UK's Financial Services Authority and the US Justice Department whereby Barclays and its executives escape prosecution. The remaining rate setting banks, however, remain under threat of prosecution for antitrust and fraud violations, potentially including prosecution under statutes created to fight organized crime. The prospect of criminal prosecution and the threat of anti-trust treble damages are only the beginning.  All of the rate setting banks, including Barclays, face the prospect of wave after wave of lawsuits from market participants affected by or reliant upon LIBOR.   These include major banks like Goldman Sachs whose interest rate swap products relied on LIBOR, as well as approximately 75% of America's major cities across the country who purchased those interest rate swaps.  In addition, large public pension funds as well hospitals, universities, and other nonprofits who held interest rate swaps or other derivatives pegged to LIBOR are considering suing the banks.

Civil Law Suits

Goldman Sachs and Morgan Stanley, both non-rate setting banks, have already made preliminary threats of litigation, though they have declined to make anything definitive yet.  Other non-LIBOR banks may yet band together in class action law suits. In fact, In May 2012, the Community Bank & Trust of Sheboygan, Wisconsin, filed a racketeering lawsuit (organized crime under the US Racketeer Influenced and Corrupt Organizations Act or RICO) naming the US rate setting banks, Bank of America, JPMorgan, Citigroup, and others. The law suit was filed as a class action to encourage other local, independent banks to join in, and in July the suit was consolidated with three other LIBOR class action anti-trust suits. Additionally, attorneys general in Massachusetts and New York have launched investigations into the extent the rate rigging may have affected interest rate swaps entered into by the states' municipalities or the states themselves.  The results of these investigations could bring prosecution by New York and Massachusetts, as well as launch thousands of civil claims by cities, towns, hospitals, universities, pension funds and others, in a potential "feeding frenzy."

Criminal Suits

On the prosecutorial level, the Justice Department has confirmed that it has an ongoing criminal investigation into the LIBOR issue, as do the FSA and Serious Fraud Office in the UK.  In the US, the banks face the prospect of prosecution for racketeering, antitrust violations, wire fraud, bid rigging and price fixing.  Proving collusion by the banks is a major factor in these cases.  Typically, collusion is difficult, though not impossible, to prove in a court of law.   A recent court victory by the Department of Justice in US v. Carollo, Goldberg and Grimm, however, shows just how such a prosecution might work.  In US v. Carollo, the DOJ proved that GE Capital employees colluded with a host of big name Wall Street banks and finance companies to rig the public bids on municipal bonds.  The DOJ was able to demonstrate definitively that this was not an instance of one bad bank, but rather that the employees at the banks were acting in concert, as a cartel, and orchestrated a massive manipulation of municipal bond rates for their own financial gain.  Similarly, if the DOJ is able to prove the collusion among the LIBOR banks, that they acted as a cartel for their own gain, such a successful prosecution could change banking as we know it.

Central Banks

In coming forward and making their deals with regulators and prosecutors, Barclays implicated the Fed and other central banks in the scandal.  It is unclear what the role of central banks in enabling the LIBOR rate-fixing will have on these criminal prosecutions.  Was fixing LIBOR illegal if it was not technically or even practically forbidden?  

What is clear is that LIBOR permeated the global financial system.  It was instrumental in prices of almost every adjustable-rate vehicle on earth, from mortgages and credit cards to interest-rate swaps and sometimes even currencies. Its manipulation by the rate setting banks may be the most far-reaching financial scandal in history.  For that reason, the rate setting banks may be in for the worst litigation storm imaginable.