Wednesday, October 19, 2016

Rare Win in Court for Wall Street Bank

$1bn Lawsuit Tests the Limits of Suitability

Author: David Schwartz J.D. CPA

On October 14, 2016, London’s High Court of Justice handed down a ruling in favor of the UK subsidiary of Goldman Sachs, ending a three-year challenge by the US$60 billion Libyan Investment Authority (LIA).  The decision comes after a judge rejected claims by the sovereign wealth fund that the bank's nine synthetic derivatives, crafted in 2007 and 2008, were intended to be so complex as to exploit its staff's limited financial know-how. The bank's willingness to defend itself not only reverses a long string of out-of-court settlements by Wall Street banks, but may also stiffen the resolve of other banks' legal staffs. LIA's claims rest upon a theory of suitability that will no doubt be tested further in the post-reform litigation era. 


Among the allegations made by LIA were that the bank’s efforts to secure and maintain business with LIA blurred the lines between professional and personal relationships, creating a “protected relationship of trust and confidence,” between the bank and LIA. The court rejected the assertion that the bank’s extensive marketing efforts had transformed the bank into a trusted advisor or “man of affairs” for the LIA, stating that “the relationship did not go beyond the normal cordial and mutually beneficial relationship that grows up between a bank and a client.”  


Throughout the litigation, the bank denied any undue influence and claimed the LIA was suffering from a classic case of “buyer’s remorse.” The bank argued that the synthetic derivative trades were entered into by LIA with their eyes open and for their own reasons, not the least of which was pressure to invest money quickly and to generate the kinds of returns that could not be achieved via more conservative investments in shares. Indeed, the bank argued that these synthetic derivative trades were entirely suitable for a sovereign wealth fund like LIA seeking to achieve the levels of return LIA desired. The judge in the case agreed, stating in her 120-page opinion that, “there were other reasons why the LIA wanted to enter into them and, if they were unsuitable, they were no different from many other investments that the LIA made over the period in that regard". . . "This explains why they were prepared to enter into the speculative Disputed trades even though this might appear to conflict with the long term growth objectives of the LIA as a SWF." 


The judge further chided LIA for trying to downplay the sophistication of its employees and managers, and for asserting that that alleged naiveté was exploited by the international banking firm to manipulate LIA into complex and risky trades.  Ultimately, the judge found that, based on the extensive record of negotiation and contact with the bank, the relevent personnel at the sovereign wealth fund fully grasped the nature, terms, and risks of the trades they were entering into.


Notably, the court also ruled that the price LIA paid to enter into the trades disputed in this case and the profits realized by the bank on the trades were not excessive “given the nature of the trades and the work that had gone into winning them.”


The judgment in this case astutely examines a number of aspects of the way that banks and clients conduct their relationships and structure their deals. The court's analysis provides valuable instruction on the limits and contours of banks’ fiduciary duties to their clients; investors’ responsibilities to do sufficient due diligence before entering into complex investments; and how suitability must be interpreted in the context of the stated goals, strategies, and expectations of institutional investors.  


The full text of the judgment is available via: