February 2013: Libor Litigation Update
UBS and Barclays Acknowledge Making False Libor Submissions. Investigations into misconduct at UBS and Barclays have revealed pervasive corruption of the London Interbank Offered Rate (“Libor”), which provides a benchmark for more than $350 trillion in financial instruments. The British Bankers’ Association (“BBA”) calculates Libor in several currencies and maturities based on banks’ reported borrowing costs in the London interbank lending market. This reliance on self-reporting makes Libor vulnerable to manipulation if banks misreport their true cost of borrowing. With numerous government probes ongoing, regulators are expected to ensnare more global banks and uncover new evidence of Libor manipulation that will influence already-filed and potential litigation.
UBS became the second bank to admit to Libor-related wrongdoing late last year, when it agreed to pay $1.5 billion to resolve investigations by U.S., British, and Swiss authorities. The UBS settlement—following the $453 million fine imposed on Barclays in June—includes a rare admission of criminal wrongdoing by UBS’s Japanese subsidiary. The Justice Department is also pursuing wire fraud charges and antitrust violations against two Tokyo-based UBS traders accused of conspiring to manipulate Yen Libor.
Regulators have identified three main categories of Libor-related wrongdoing at UBS and Barclays.
First, both banks systematically suppressed their Libor submissions in an effort to protect their reputations during the global financial crisis. Managers at UBS and Barclays directed their respective submissions desks to adjust their USD Libor and other submissions downward to avoid being perceived as a high outlier relative to other panel banks.
Second, traders manipulated their own banks’ rate submissions in order to benefit their trading positions. In Barclays’ case, traders in New York, London, and Europe sought to influence the bank’s USD Libor and Euro Interbank Offered Rate (“Euribor”) submissions. The allegations against UBS focus on traders in Tokyo, London, and Zurich, and relate primarily to the bank’s Yen Libor, Sterling Libor, and Swiss Franc Libor submissions.
Third, some of this trader-driven misconduct involved coordination with other banks. The most damaging revelations concern UBS’s Japanese subsidiary, where traders colluded with interdealer brokers and other panel banks to manipulate Yen Libor. This scheme reportedly involved traders at Citigroup, Deutsche Bank, HSBC, JPMorgan, and other institutions. The Barclays probe also found that traders colluded with peers at other banks to manipulate USD Libor and Euribor submissions.
More revelations are certainly forthcoming. Royal Bank of Scotland (“RBS”) is widely expected to be the next panel bank to reach a settlement with authorities, who have reportedly unearthed evidence of improper USD and Yen Libor submissions. Many other banks are under investigation or are facing litigation, including JPMorgan, Bank of America, and Citibank. These probes will likely lead to further acknowledgements of misconduct.
Quantifying Crisis-Era Libor Suppression. UBS and Barclays have both admitted to systematically understating their Libor submissions beginning in 2007, and it is now clear that Libor was abnormally low during the same period. By late 2007, emerging discrepancies between Libor and comparable interest rates attracted the attention of officials at the Federal Reserve Bank of New York. Concerns about the reliability of Libor spilled into public view in April 2008, when the Wall Street Journal published articles questioning whether banks’ submissions accurately reflected their borrowing costs. A Citigroup analyst estimated at the time that Libor “may understate actual interbank lending costs by 20-30 bps.” In addition, submissions by Citigroup, Bank of America, and JPMorgan Chase often clustered, suspiciously, around the lowest rate that could be submitted without being discarded as an outlier.
A growing body of statistical research has attempted to quantify the degree of Libor distortion during the crisis period. According to one study comparing Libor submissions with comparable funding transactions, Libor understated banks’ borrowing costs by 10 basis points between August 2007 and March 2008, and by up to 30 basis points for the remainder of the year. The Federal Housing Finance Agency and other investors have estimated much larger spreads, finding that Libor diverged from comparable Federal Reserve Eurodollar Deposit rates by as much as 300 basis points at the peak of the financial crisis. This misreporting could have damaged large investors by substantially reducing the interest paid on Libor-indexed financial products.
The Existing Litigation Does Not Cover Potential Investments and Causes of Action. Investors have filed numerous actions based on rate-setting misconduct at panel banks, including an individual investor claim by Charles Schwab and a number of class actions. All of the current Libor cases are part of the multi-district litigation before Judge Naomi Buchwald in the Southern District of New York: In re: Libor-Based Financial Instruments Antitrust Litigation, No. 1:11-md-02262-NRB. The class cases have been consolidated into two main actions, the “direct purchaser” case and the “over-the-counter” action. Judge Buchwald recently imposed a stay on any action that is not the subject of pending motions to dismiss filed in June 2012.
The current class complaints assert antitrust violations, unjust enrichment claims, and violations of the Commodity Exchange Act on behalf of investors who purchased or held Libor-linked assets. Members of these classes may receive the benefit of American Pipe tolling, but the existing actions only cover a small subset of potential investments and causes of action. For example, the main class actions do not assert securities fraud, RICO, or common-law fraud claims, which may prove to be the most viable causes of action. The statutes of limitations on these claims are generally not tolled by the class actions and they continue to run. For claims brought under the Securities Exchange Act of 1934, which are governed by a five-year statute of repose, this means that claims relating to investments made in late 2007 are already barred, with more claims being barred daily.
The primary hurdle facing antitrust claims is pleading an agreement among the panel banks. Government investigations have unearthed evidence of collusion among individual traders seeking favorable rate submissions, and the consistency of the banks’ Libor submissions (especially their departure from historical norms) suggests that the banks may have been acting in concert. But neither the Barclays nor the UBS settlement has produced any direct evidence of a high-level agreement between the banks systematically to suppress Libor. Thus, while the current facts may be sufficient to overcome a motion to dismiss under the Twombly plausibility standard, the antitrust claims may face tougher scrutiny at the summary judgment stage.
For this reason and others, investors considering opt-out suits should not limit themselves to antitrust claims, but rather should consider claims that do not require proof of collusion among the panel banks. For example, RICO claims do not require an industry-wide conspiracy, and carry potential treble damages. Claims brought under the 1934 Act likewise do not require a conspiracy, although such claims are only available for investors who purchased Libor-linked “securities” (not loans, swaps, or other non-security instruments).
Notably, RICO and 1934 Act claims are likely mutually exclusive because securities fraud cannot be a predicate act for a federal RICO claim. Whether to allege securities fraud or RICO will depend largely on the makeup of the particular investor’s portfolio. Investors asserting fraud-based claims will have strong arguments that the Libor panel banks committed fraud when they offered instruments whose returns were benchmarked to Libor, without disclosing that Libor was being manipulated.
Common-law fraud claims have a number of advantages that will make them particularly attractive to opt-out claimants. For instance, common-law fraud: (1) does not require a conspiracy among the panel banks; (2) can be brought with respect to all types of Libor-based financial instruments; (3) should not be subject to the heightened standards of the PSLRA; and (4) depending on the jurisdiction, may have longer statute of limitations than other claims.
The Libor scandal is almost certain to grow. Due to the potential size of the banks’ fraud, and the fast-approaching expiration of the statute of limitations for certain causes of action not included as part of the class actions, investors should perform a detailed analysis of their portfolios as soon as possible. Only those investors who have analyzed their portfolios in advance will be well positioned to respond to any changes in this fast-unfolding scandal.