Wall Street Bank Investors in Dark on Libor Liability
Barclays Plc (BARC) investors, blindsided by the bank’s $451.4 million regulatory fine for trying to rig benchmark rates, saw the stock drop 16 percent a day later. Other bank shareholders may be just as surprised.
Barclays, like other lenders that help set key rates for $360 trillion in securities, has given investors scant guidance on the liability they face for alleged market manipulation. More than a dozen banks are being probed by U.S., Asian and European regulators for collusion in setting interbank lending rates. The others have mirrored Barclays on minimal disclosure.
“The automatic reaction from investors is: ‘Who’s next?’” said Todd Hagerman, a New York-based analyst at Sterne Agee & Leach Inc. who recommends investors remain “cautious” on the biggest U.S. banks. “It’s fair to assume that legal and related professional fees and associated reserves are going to continue to remain elevated, if not increase.”
Bank of America Corp., Citigroup Inc. (C), Royal Bank of Scotland Group Plc and UBS AG (UBSN) are among the lenders whose participation in setting the London and Europe interbank offered rates, known as Libor and Euribor, are under investigation. None of the banks would say if they set aside reserves to cope with potential liabilities and, if so, how much.
“I believe that Barclays had previously reserved for only about one-third of their ultimate liability” in regulatory fines, Charles Peabody, a banking analyst at New York-based Portales Partners LLC, said in an e-mail. Other banks’ reserves “will probably prove inadequate.”
Barclays’s fines were the first in a two-year, inter- continental investigation into manipulation of Libor and Euribor, benchmarks used globally for setting borrowing rates. Among the 18 lenders on the U.S. dollar panel are the three biggest American banks, JPMorgan Chase & Co. (JPM), Bank of America and Citigroup, as well as Barclays and Zurich-based UBS. The 16- member British pound panel includes Barclays, UBS, JPMorgan and Frankfurt-based Deutsche Bank AG. (DBK)
“The two-year investigation into banks rigging Libor, which has taken a toll on Barclays, has the potential to hurt Citigroup, JPMorgan and Bank of America,” Mike Mayo, an analyst at CLSA Ltd. in New York, wrote in a July 2 research note. The banks face risks of fines, lawsuits, negative news and new regulations, according to Mayo.
“While there is no evidence that the three U.S. money- center banks did anything wrong, there is a heightened possibility of scrutiny after recent events at Barclays,” Mayo said.
Barclays shareholders were notified of the Libor probe, while getting little information on how much money was set aside for potential fines and legal costs. First-quarter operating expenses for the firm’s investment bank rose 4 percent to 2.14 billion pounds ($3.3 billion), reflecting a 115 million-pound increase in provisions for legal and regulatory costs, partly offset by non-performance cost savings, the bank said in an April regulatory filing. The company didn’t specify whether any of the increase was due to Libor-related provisions.
The regulatory fine is just the beginning for London-based Barclays, which is a defendant in some of the 24 interrelated Libor lawsuits that have been aggregated before U.S. District Judge Naomi Reice Buchwald in Manhattan federal court.
“The global quantity of claims against Barclays as a result of it having manipulated Libor, it could stretch from the hundreds of millions into the billions,” said Robert Hickmott, an attorney with Los Angeles-based Quinn Emanuel Urquhart & Sullivan LLP. He said litigation in London may follow soon.
U.S. liabilities may be higher because American plaintiffs are allowed to ask for punitive damages for bad conduct, while the British are limited to compensatory awards, Hickmott said.
Criminal liability could be added to those regulatory fines and civil lawsuits. The U.K. Serious Fraud Office said July 2 that it would decide within a month whether to open a criminal investigation into Libor-fixing. The U.S. Justice Department already is conducting a criminal probe into the attempted manipulation of interbank-offered rates.
Barclays, in its accord with U.S. authorities, agreed to cooperate with the joint British-American investigation in exchange for a two-year non-prosecution agreement.
“Barclays’s cooperation has been extensive, in terms of the quality and type of information and assistance provided, and has been of substantial value in furthering the department’s ongoing criminal investigation,” the Justice Department said in a statement last week.
“Specific disclosure on litigation reserves for any Libor suit settlements is completely lacking in any regulatory filings,” Portales’s Peabody said, referring to all banks. “My guess is that litigation reserves for civil suits from municipalities, class action suits, etc. are non-existent.”
Lawsuits could be filed “by anyone stuck on the wrong side of these transactions,” said Anthony Maton, an attorney at Washington-based Hausfeld LLP, which is representing claimants in the New York litigation and working on a British case to be filed later this year. “Large corporate local authorities, other banks and financial institutions on the wrong side of the trades, pension funds, a very large variety of people that have been affected by this.”
The U.S. Commodity Futures Trading Commission, one of the agencies investigating the Libor manipulation, said last week that Barclays employees tried to manipulate Libor and Euribor by making false interest-rate reports to increase derivatives- trading profits and to decrease losses from 2005 to 2009.
Proving actual damages may be difficult for investors, said Brad Hintz, a Sanford C. Bernstein & Co. analyst.
“The large fine is for attempting to move the market, not for moving the market,” Hintz said. “The civil guys are going to have to prove that the market was moved here.”
The extent of lenders’ liability may be difficult to determine, Hintz said. Banks may argue that any derivatives trading losses must be determined on a net basis, because such trades typically are hedged.
Sterne Agee’s Hagerman said he didn’t think any of the big U.S. banks had set aside reserves for Libor-related costs.
For bank stock investors “it hasn’t been top-of-mind,” he said. “I’ve only received a couple phone calls about it and the reaction has been surprise.”
David Kovel, an attorney who represents euro futures traders in the New York federal court litigation, proposes to represent a class including anyone involved in such trading between August 2007 and May 2010, a number of traders he said could be in the thousands. He declined to estimate the value of the alleged damages.
“Even a 2- to 3-basis-point manipulation would have a large impact on the product and the investors in that product,” he said. A basis point is 0.01 of a percentage point.
Two days after the Barclays fine was announced, banks being sued in New York filed motions asking Buchwald to dismiss allegations against them. Exchange-based plaintiffs’ claims are barred by lapse of time and extra-territoriality, lawyers for lenders including Bank of America and Citigroup argued in one filing.
“It is of course a mathematical truism that the published index would have been different if higher or lower rates had been reported by a sufficient number of banks,” lawyers for those same lenders said in arguing against antitrust claims in a different filing. “That might impact financial results to those who chose to incorporate the index in their transactions, but that is not a restraint of trade,” they wrote.
Barclays, in its own brief, joined the other bank defendants in asking Buchwald to throw out allegations against it, excepting those contending the exchange-based plaintiffs had made a case for market manipulation.
Jeffrey Shinder, an antitrust attorney with New York-based Constantine Cannon LLP who has been following that Libor litigation, said potential bank liabilities could be “massive.”
“This is potentially the mother lode in terms of potential damages,” he said.
While it’s not possible to predict a specific loss amount, damages could be in the tens or hundreds of billions of dollars if the lenders are found liable, Shinder said.
“Everyone in the industry knows if you knock down a few basis points here and there billions of dollars shift between counterparties,” Shinder said. Adjusting Libor up or down affects the interest rates on scores of financial instruments. “This is price-fixing,” he said.
Bank of America has said that as of March 31, costs from litigation and regulatory matters could be as much as $4.2 billion beyond its accrued liability. The firm said that it sets aside liabilities when losses are “both probable and estimable.” The bank hasn’t said whether Libor liability fell into that category. Bill Halldin, a spokesman for the Charlotte, North Carolina-based bank, declined to say whether it had.
U.S. laws generally require companies that issue securities to disclose information that people reasonably would need to make investment decisions. Regulators typically provide guidance on their expectations without setting specific criteria on what should be disclosed.
Authorities including the Securities and Exchange Commission and the Financial Accounting Standards Board have taken steps in the past two years to pressure banks to disclose more information about potential costs from litigation as claims mounted in the wake of the subprime-mortgage crisis. FASB, based in Norwalk, Connecticut, sets accounting rules for public companies under authority delegated by the SEC.
Royal Bank of Scotland, which is majority owned by the U.K. government, acknowledged the ongoing international probe in a February report and said it’s cooperating with authorities including the CFTC and Justice Department, the Financial Services Authority and Japanese regulators.
“It is not possible to estimate with any certainty what effect these investigations and any related developments may have on the group,” Edinburgh-based Royal Bank of Scotland said in a statement at the time.
UBS and Credit Suisse Group AG, Switzerland’s biggest banks, declined to say what, if any, reserves they had set aside for possible Libor-related liabilities. Deutsche Bank, Germany’s biggest lender, also declined to comment on whether it has set aside reserves.
Plaintiffs seeking to prove their cases against the banks may be aided by studies whose “results imply that the Barclays manipulation was probably successful and further imply that more than just one bank was involved in the scheme,” Bernstein analysts led by Hintz said in a June 29 report. Barclays and regulators haven’t said the attempted manipulation succeeded.
“This is a major regulatory issue for the Libor banks that will likely generate significant civil claims over the next four to five years,” the analysts wrote. “Investors should not minimize the importance of this matter.”
Barclays rose 1.3 percent to 168.20 pence in London trading.
The multidistrict case is In Re Libor-based Financial Instruments Antitrust Litigation, 11md2262, U.S. District Court for the Southern District of New York (Manhattan).