LEGAL
When Paul McCartney sat at the piano of a Scottish farmhouse to pen the words to The Beatles' last number one single, "The Long and Winding Road," he was describing the twilight of the iconic group, which would soon part ways. When the song was released in June 1970, the London Inter-Bank Offered Rate, or Libor, was a mere twinkle in the eye of hopeful City bankers. But today, Sir Paul's song could well describe the beleaguered state of the once heralded financial metric, which now faces an uncertain future.
In June, British banking giant Barclays PLC announced a blockbuster £290 million ($460 million) settlement with U.S. and U.K. 1. While the settlement value grabbed attention at the time, the manipulation of the Libor, resting at the heart of the matter, proved far more consequential. But as the Beatles continue to dominate iTunes 40 years later, Libor is a story that is likely to be with us for several years.
Libor is a set of 150 blended rates, quoted daily, based upon a hypothetical interest rate banks would charge one another to borrow funds on a given day, in a specific currency, for a fixed period of time.2 Libor serves as a "benchmark" or "reference" rate for tens of thousands of financial contracts including home loans, student debt, mortgages and municipal debt. On the derivatives market, counterparties to a contract use Libor to fix payment terms and to establish market values for trillions of dollars of complex derivative instruments.
The British Bankers Association (BBA), a financial industry trade group comprised of member banks, created and administers Libor.3 The BBA is a consortium of U.K. banks and not a government institution. It is independent of the Bank of England (BOE), Britain's central bank responsible for setting the nation's monetary policy. Libor is set in a mechanical fashion as described below:
One peculiar feature of Libor is that it is an "estimated" lending rate, not a real interest rate charged to another bank. The theoretical quality of Libor concerned critics, who claim this feature meant Libor was at best an educated guess and at worst pure speculation, especially for longer maturities.5 In fact, a recent study questioned whether banks even bothered to adjust the rate at all to reflect market conditions during normal times.6
Two other concerns have risen to the forefront in light of recent investigations.
During the crisis, several rates, including the overnight or spot rate, were impossible to calculate accurately because there was no credible overnight lending, an unprecedented event at the time. Each institution feared that others might collapse under the weight of undisclosed derivative liabilities. Banks across the world scrambled to assure the public, counterparties and bond markets that they were financially sound. Part of this process apparently involved some banks submitting "reassuringly low" Libor rates.
The Libor scandal has set in motion vast and complicated legal claims, given the centrality of the rate to global finance. Estimates of minimum damage run in the billions of dollars.7 Investigations are proceeding on several tracks.
Civil and criminal regulatory investigations by prosecutors and/or market regulators in various countries as well as individual U.S. states continue today. The investigations became public over the summer.8 Recent reports indicate that additional subpoenas have been issued to a wider circle of banks from a joint probe by the New York and Connecticut attorneys-general.9 Yet, both U.S. and U.K. regulators are again pushing for another wave of settlements over the next 12 months after cooperation slowed this past summer.10
More troubling for the financial industry are the signs of impending criminal proceedings against specific individuals based on probes launched over the summer. Recently, prosecutors at the U.K.'s Serious Fraud Office (SFO) have indicated they may act against ex-traders at UBS, RBS and Barclays.11 This could threaten banks with potential enterprise liability if the claims reach high enough. The jockeying among regulators to bring charges before their foreign counterparts, and therefore hold sway over the direction of a prosecution provides an interesting twist to events as well.12
To add to the circus, even the regulators are being investigated. In October, media outlets reported that U.S. congressional staff began examining documents obtained from the Federal Reserve Bank of New York with respect to its monitoring of banks and key interest rates. A spokesman for the House Financial Services Committee confirmed the report: "These documents include internal New York Fed communications, communications between the New York Fed and U.S. regulatory agencies, and communications between the New York Fed and foreign government agencies in the United Kingdom."13 This is in addition to the parliamentary inquiries in the U.K. which have been going on for several months.
Litigation against banks is proceeding on several fronts and involves a stream of dozens of cases filed from 2011 until present.14 The cases, filed by a diverse group of plaintiffs including municipalities, brokerages, individuals, pension funds, and enterprises, include allegations of:
Triple damages could ratchet up liability. The criminal nature of the potential penalties means these claims could cripple senior bank management and ruin individual careers.
The legal problems facing banks promise to be enormous and long-lasting. Lawsuits could feasibly originate from almost every corner of the financial system given both the widespread use of Libor to set payment terms for commercial contracts and the use of Libor-based derivatives contracts by thousands of counterparties. Legal experts have referred to the Libor scandal as the financial industry's "tobacco" or "asbestos" litigation, recalling products liability cases which have involved decades of litigation, tens of thousands of lawsuits, and complicated claims processing and administration, spawning entire legal sub-specialties that persist today.
Rajat Soni, Assistant Vice President, Litigation Solutions is a senior U.S. litigator who manages all aspects of document review intake, operation, and delivery, especially on complex document reviews. Reggie joined Pangea3 in 2010 after litigating at Davis Polk & Wardwell and at Fulbright & Jaworski. During his tenure at those firms, Reggie specialized in litigations involving antitrust, securities, market regulation, internal investigation and Foreign Corrupt Practices Act examinations. Reggie holds a J.D. from Northwestern University and a B.A. from Dartmouth College.
Kulbir Kaur, Director, Litigation Solutions supervises large teams of lawyers working on complex Pangea3 document review projects and frequently communicates with international clients on project-related matters. She has managed document reviews for litigation related to products liability, financial companies' due diligence, and patent infringement cases. Kulbir received an LL.B. and a B.M.S. (Finance) from the University of Mumbai, a Diploma in Intellectual Property Law from K.C. Law College in Mumbai, and a Diploma in Business Administration from ICFAI University.
-->
