A group of institutional investors recently filed a class action complaint against some of the world’s largest banks alleging a conspiracy fix prices and monopolize the market for Credit Default Swaps (“CDS”) in violation of the Sherman Act § 1.  Defendants include Bank of America, Barclays, Citibank, and Goldman Sachs.   The complaint also names the International Swaps and Derivatives Association (“ISDA”), a financial trade association, which the complaint alleges is controlled by the defendant banks.  The plaintiffs are claiming potentially billions of dollars in damages.

A credit default swap is a method of transferring the risk of default for a financial instrument.  The purchaser pays a fixed payment to the seller in exchange for the promise to pay off the underlying debt in the event of a default.  The complaint alleges that because of the CDS market structure is unregulated and over the counter, every transaction must be with one of the defendant banks.

The complaint characterizes the CDS market as “starkly divided” between the defendant banks “who control and distort the market” and the plaintiffs “who, in order to participate in the market, must abide their distortions.”  The complaint alleges that this is the result of an opaque trading environment in which the defendant banks manipulate the bid-ask spreads through their negotiations with individual traders.  These manipulations cost the plaintiffs billions of dollars, says the complaint.  Plaintiffs allege that several of their attempts to create and regulated exchange were rebuffed by defendants.

Both the DOJ and the European Commission have been conducting their own investigations into these activities.  In March, the EU indicated that “ISDA may have been involved in a coordinated effort of investment banks to delay or prevent exchanges from entering the credit derivatives business.”

In Levitt v. J.P. Morgan Sec., Inc., 10-4596-CV, 2013 WL 1007678 (2d Cir. Mar. 15, 2013), the Second Circuit reversed a district court’s grant of class certification to a group of plaintiffs who alleged that Bear Sterns (subsequently bought by J.P. Morgan) had violated its duty to disclose when it did not notify investors of a fraudulent scheme by Sterling Foster, a now-defunct brokerage firm.

The case concerned allegations of fraud arising from a September 1996 IPO of ML Direct, a television marketing firm.  Sterling Foster orchestrated the IPO as the introducing broker, with Bear Sterns (subsequently acquired by J.P. Morgan) acting as the clearing broker.  In general, the clearing broker in a transaction owes no duty of disclosure to the customers of the introducing broker.  However, the plaintiffs sought to overcome this hurdle by establishing that Bear Sterns actively participated in the fraudulent scheme.

The district court agreed with the plaintiffs that Bear Sterns’s participation was extensive enough to trigger a duty to disclose.  However, the Second Circuit held that the plaintiffs had failed to allege “sufficiently direct involvement” by Bear Sterns.

The Second Circuit noted that providing “normal clearing services” do not give rise to a duty to disclose, even when the broker providing those services is aware of the introducing broker’s fraudulent intentions.  Rather, to trigger a disclosure duty, the clearing broker would have to actively depart from its normal passive clearing functions and affirmatively exert “direct control” over the introducing broker and the fraudulent trades.  The court found that Bear Sterns, by merely “allowing” such trades to proceed, had not assumed such a level of control.

The plaintiffs’ counsel characterized the ruling as “a sad day for investor protection,” stating that the court had “has for the first time held that a clearing firm has no duty to disclose that it is knowingly participating in market manipulation by its introducing broker.”

The court, however, carefully declined to address the legal implications of “market manipulation itself” on the duty to disclose, confining itself to its factual conclusion that Bear Sterns did not directly engage in such manipulation.  Underscoring the narrowness of the Second Circuit’s ruling, the New York district court refused to apply Levitt to a case where a defendant had made misleading statements, holding that the making of misleading statements constituted direct involvement.  The same district court has also recently observed that the question of market manipulation remains open.

The Obama Administration has continued its aggressive prosecution of suspect players in the financial meltdown that shaped most of the President’s first term.

Four mortgage insurers, including an AIG subsidiary, have agreed to a $15 million settlement over allegations of improper ‘kickbacks’ paid to lenders for more than a decade.  The Consumer Financial Protection Bureau made the announcement today.  Its director, Richard Cordray, charged, “We believe these mortgage insurance companies funneled millions of dollars to mortgage lenders for well over a decade.”  For more, see the NYTimesand WSJ.

Also today, the U.S. Department of Justice filed a fraud suit against Golden First Mortgage Corp, alleging the company and its CEO “repeatedly lied” to the government.  The complaint claims that Golden First rushed paperwork through internally, although the company certified (to HUD and the FHA) that proper due diligence had been conducted.  According to the government, Golden First used three employees to process 100-200 loans per month—predictably leading to “extraordinarily high” default rates as high as 60% in 2007.  For more, see Thomson Reuters.

On a related note, district court Judge Victor Marrero (S.D.N.Y.) indicated that he may not accept a “neither admit nor deny” provision in SAC Capital Advisor’s insider trading settlement.  At a hearing last week, he made a point unlikely to encounter much resistance:  “There is something counterintuitive and incongruous in a party agreeing to settle a case for $600 million that might cost $1 million to defend and litigate if it truly did nothing wrong.”  Judge Marrero is not the first to question these clauses – commonly demanded by corporate litigants – but his remarks demonstrate a growing judicial skepticism with the practice.  For more, see Businessweek, Reuters, and The New Yorker.

Wells Fargo’s bid to block the government’s most recent charges against it stemming from the mortgage crisis—primarily alleged violations of the False Claims Act and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (“FIRREA”)—took a blow earlier this month when a court ruled that its $5 billion contribution to the multi-bank, $25 billion settlement in April over foreclosure practices did not preclude the new charges.  Previous coverage of Wells Fargo’s attempt to preclude the litigation is here.  U.S. District Judge Rosemary Collyer ruled that the settlement did not bar all civil or administrative claims against Wells Fargo, including those under the False Claims Act, paving the way for prosecutors in the United States Attorney’s Office for the Southern District of New York to move forward with the suit.

Collyer’s decision left the bank’s lawyers, led by teams from Fried Frank and K&L Gates, vehemently protesting the court’s interpretation of contested language in the settlement.  According to Collyer, that language indicated the government retained the right to sue Wells Fargo for material violations of Housing and Urban Development/ Fair Housing Administration (“HUD-FHA”) requirements, only barring claims based on false annual certifications regarding the bank’s compliance with those requirements.  Collyer stated that the current charges do not fall under the precluded claims, finding Wells Fargo ignored the plain language of the settlement in coming to a mistaken interpretation.   As a result, the government can bring allegations under the False Claims Act in the current suit.

Collyer, however, did not address the pending case directly.  The court for the Southern District of New York will still have to make a final determination as to whether the prosecution has pled barred claims as the case moves forward.

The defense team has strongly attacked the government’s charges in its court filings, framing the current charges as part of a broader effort to avoid honoring FHA and HUD commitments to insure thousands of defaulting mortgages as it attempts to wrongly implicate the financial industry for the defaults.

The prosecution has not yet filed its response to Wells Fargo’s motion to dismiss the current suit.

The Ninth Circuit recently affirmed a judgment – from the Central District of California – that the victims of Bernard Madoff’s Ponzi scheme lack subject matter jurisdiction to sue the Securities and Exchange Commission as an agency of the United States under the Federal Tort Claims Act.

The SEC compiled a 450-page public report highlighting its failure to uncover Madoff’s problematic investment activities.  The allegations posed by the victim plaintiffs centered on decisions made by the SEC which the district court acknowledged “should have and could have been made differently” and “reveal[ed] the SEC’s sheer incompetence.”  Nevertheless, the court held that the United States was protected from suit because the Securities and Exchange Commission was engaged in a discretionary function.  An exception is set aside in the Federal Tort Claims Act (“FTCA”) whereby employees of the Government cannot be held liable for failures relating to purely “discretionary” functions of that employee.

The district court, considering the legislative history of the FTCA, noted that Congress “repeatedly and explicitly suggested” that the SEC should be shielded by the discretionary function exception.  The FTCA only allows a claim where statutory language mandates a particular course of action.  By contrast, the duties and functions of the SEC allow it discretion in choosing who to investigate and when to bring enforcement proceedings.  Because the plaintiffs could not demonstrate that the SEC violated a specific and mandatory policy directive that related to the investigation, the court held they failed to overcome an FTCA claim’s threshold requirement.

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The director of the U.S. Consumer Financial Protection Bureau may be facing a challenge the constitutionality of his “recess appointment,” following a January 25 ruling by the D.C. Circuit Court of Appeals.  In that case, the court held three of President Obama’s appointments to the NLRB were unconstitutional.  The party challenging director Richard Cordray’s status would likely argue that the opinion applies to him as well, as he was appointed via the same process.  For more, see Bloomberg.

The Justice Department has sued Anheuser-Busch InBev in Washington D.C. district court, attempting to block the company’s proposed $20.1 billion merger with Modelo.  The head of the DOJ’s antitrust division, William J. Baer, said the deal would reduce competition in the American beer industry, as InBev would control 46 percent of the country’s annual sales.  “Even small price increases could lead to significant harm,” Baer said.  For more, see the NYTimes.

The Commodity Futures Trading Commission is drafting rules for “swaps,” under the directive of the Dodd-Frank financial markets overhaul.  The stakes are high, as the complex instruments account for eight-ninths of the derivatives market—and Wall Street banks have been jockeying to frame the proposals as too burdensome for their respective industries.  For more, see Reuters.

Capitol Hill may again take up a system of voluntary cybersecurity standards.  According to a new Senate Commerce Committee report, there is strong support among Fortune 500 companies.  U.S. Senator Jay Rockefeller (D., W.Va.) has spearheaded the effort, and his data suggests differing perspectives from industry leaders and the U.S. Chamber of Commerce.  Sen. Rockefeller hopes to pass a bill this year.  For more, see the Wall Street Journal.

In August 2012, six federal financial regulatory agencies issued a proposed rule to implement Section 1471 of the Dodd-Frank Act which sets forth appraisal requirements for “higher-risk” mortgage loans.

The intended purpose of the proposed rule is to tighten valuation standards for homes in order to reduce the risk of appraisal fraud, a move meant to reassure creditors, borrowers, and investors alike. Section 1471 was created as part of Congress’ intention to prevent the use of false or inflated appraisals in obtaining mortgages. If the proposed rule is finalized without amendment, lenders seeking to issue high-risk mortgage loans will be “unable to value properties on the basis of broker-price opinions, automated valuations, or drive-by appraisals”. The proposed rule would affect mortgages with annual percentage rates (APRs) at designated levels above the Average Prime Offering Rate (APOR). First-lien loans (such as standard mortgages) with an APR 1.5 percentage points above the APOR would be classified as a higher risk mortgage under the proposed rule, while first-lien jumbo loans with APRs 2.5 percentage points above, and subordinate-lien loans with an APR 3.5 percentage points above the APOR would similarly be considered higher-risk.

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As the debate over how to reform the housing finance market takes a back seat to the 2012 General Election, Dodd-Frank’s statutory changes to mortgage servicing will see no delay in its implementation.  On April 10, 2012, the Consumer Financial Protection Bureau released its first set of proposed mortgage servicing rules:

“The proposed rules currently under consideration aim to protect consumers from surprises by directing servicers to provide:

• Clear monthly mortgage statements that explicitly breakdown principal, interest, fees, escrow, and due dates
• Warnings before adjusting interest rates on certain adjustable rate mortgages (ARMs) that explain how the new rate was determined, when it will take effect, dates of future adjustments, and a list of alternatives for consumers to consider
• Options for avoiding expensive “forced-placed” insurance, which is insurance charged to borrowers by servicers when their existing insurance appears to have lapsed
• Early outreach to struggling borrowers that informs them of potential options to avoid foreclosure

We also want to address the issue of consumers getting the “run-around” when dealing with servicers.  To accomplish this, the Bureau is considering proposals that would require:

• Payments to be credited to consumer accounts the day payment is received
• Implementing new policies and procedures so that records are kept up-to-date and accessible
• Quickly addressing and correcting errors
• Giving homeowners direct and ongoing access to servicer staff members who have access to the homeowners’ records and can actually help address their issue(s)”

The rules are scheduled to become effective in early 2013 unless the Bureau issues finals rules first.  An outline of the proposals under consideration was also posted on the Bureau’s website.

To learn more about these proposed changes to mortgage servicing as well as other housing reforms arising out of the financial crisis, please register for “The Foreclosure Crisis: Challenges and Solutions to the Mortgage Meltdown,” Friday, April 13, 2012 at the International House on the U.C. Berkeley Campus, and stay tuned as we live-blog the event throughout the day.

On April 5, 2012, U.S. District Court Judge Rosemary Collyer approved the $25 billion settlement negotiated on February 9, 2012, between 49 states and the federal government and five banks – Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, and Ally Financial.  The deal, the largest multistate settlement since the Tobacco Settlement in 1998, settles federal and state claims against five of the largest banks in the United States for what has become known as “robo-signing”: signing foreclosure related documents outside of the presence of a notary public and without ensuring the documents were correct.

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Updating a prior post on the impact of the Concepcion decision, two recent lower court cases have demonstrated the limits of Concepcion’s reach and identify at least two particular claims that could render class-action waivers unenforceable: unconscionability and Magnuson-Moss Act claims.

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