Financial Cannibalism: Money Managers Turn on Banks in Post-Libor Tussle for Earnings

The Law of the Jungle is that only the strong survive.

It's business corollary may be that when profits are limited, everyone is a potential meal.

The banks and investment managers have worked hand-in-hand to create tremendous wealth and power for themselves, some of which has trickled down to their clients. But as the world continues to tighten regulations in the wake of the financial crisis, investors remain wary of markets they sense are rigged to others' advantage and business growth is stymied by the fallout from the inefficient distribution of market returns, the excess profits that fueled financial services growth are diminishing. That, in itself, has led to layoffs and consolidations.

But as the details of the Libor-fixing scandal become better understood, the largest institutional investors are beginning to analyze to what degree their own returns - and those of their clients - may have suffered as a result. And they are not contemplating turning the other cheek.

Cutting to the chase, legal action will probably produce either a settlement or a trial which is likely to result in some sort of partial victory for both sides. The issues are simply on their face but whether that can be turned into a victory in court is less certain. The upshot may well be that bank capital is further depleted, in some cases causing violations of the Basel III accords which mandated specific levels. Ultimately, this will create a further squeeze on the financial institutions.

Governments and legislatures may not have had the guts to take firm action on their own, but the markets themselves are not going to leave cash on the proverbial table. JL

Christoper Condon and Alexis Leonidis report in Bloomberg:

BlackRock Inc. (BLK), Fidelity Investments and Vanguard Group Inc., firms that collectively manage more than $7 trillion, are gauging how their clients have been hurt by Libor manipulation and whether to take legal action as at least a dozen banks are being investigated for rate-rigging.

The money managers can take cues from Charles Schwab Corp. (SCHW) and the city of Baltimore, which in lawsuits predating the record fine levied on London-based Barclays Plc (BARC) last month, sued lenders for artificially suppressing, Libor, or the London interbank offered rate.
Schwab alleged last year that returns on money funds and short-term debt strategies were depressed by the banks’ actions, while Baltimore’s lawsuit against Barclays and other banks stems from lower returns on interest-rate swaps.
Libor-related litigation “has the potential to be the biggest single set of cases coming out of the financial crisis because Libor is built into so many transactions and Libor is so central to so many contracts,” said John Coates, a professor of law and economics at Harvard Law School in Cambridge, Massachusetts. “It’s like saying reports about the inflation rate were wrong.”

Global regulators are reviewing the rate-setting mechanism and contemplating criminal charges against bank traders who manipulated Libor, a benchmark interest rate for about $500 trillion in financial products. While Libor affects a broad range of investments from money funds to leveraged buyout financing, firms seeking to sue may struggle to quantify losses and pinpoint which banks are responsible for them, according to interviews with more than half-a-dozen industry executives, lawyers and former regulators.

Barclays Fine
Barclays was fined 290 million pounds ($449 million) by U.S. and U.K. regulators on June 27 after admitting it submitted false rates. The scandal led to the resignation of Robert Diamond as the bank’s chief executive officer.

Barclays, like other lenders that help set Libor rates, could potentially face lawsuits from any investor that was on the wrong side of the transactions, who could claim that they were kept in the dark about a key benchmark. Barclays is a defendant in at least 24 interrelated lawsuits that have been aggregated in Manhattan federal court.

Libor is determined by a daily poll carried out on behalf of the British Bankers’ Association that asks banks to estimate how much it would cost to borrow from each other for different periods and in different currencies. Quotes in the top and bottom quartile are excluded and an average of the remaining entries is calculated.

‘Important’ Number
Libor is used as the basis for pricing securities including the rate of return on short-term variable and fixed-rate bonds as well as for the pricing and settlement of Eurodollar futures and options. The British Bankers’ Association has called it “the world’s most important number” on its website.

For investment firms, money-market funds would probably be most affected by Libor-rigging, said Robert Pozen, a senior lecturer at Harvard Business School. Returns earned by investors in money funds, which hold only short-term debt, would decline if Libor were kept lower, he said.

BlackRock, which oversees $3.56 trillion; Fidelity, which manages $1.6 trillion; and Vanguard, with $2.1 trillion, said they’re examining the impact on clients.

Evaluating Actions
“On behalf of our clients and shareholders, we have been following developments in the Libor market and the related litigation activity for some time,” Vincent Loporchio, a spokesman for Boston-based Fidelity, said in an e-mailed statement. “We have noted recent news with interest and continue to evaluate our options.”

BlackRock, the world’s largest asset manager, said litigation surrounding Libor is complex and that “it will be some time before greater clarity emerges,” according to Bobbie Collins, a spokeswoman for the New York-based company.

Laurence D. Fink, chief executive officer of BlackRock, said in a July 3 interview on Bloomberg Television’s “Market Makers” that Diamond “led with a lot of emotion which obviously” angered regulators and others in the U.K. “For me, it’s sad. I know Bob very well,” Fink said.

Barclays owned a 19.6 percent stake in BlackRock until May, when the bank sold the holding and Diamond stepped down from the money manager’s board. Barclays took the stake in December 2009, when it sold its investment unit to BlackRock.

Vanguard, the world’s largest mutual-fund company, “will take some time to determine the impact and conduct a cost- benefit analysis before pursuing other actions on behalf of the funds,” John Woerth, spokesman for the Valley Forge, Pennsylvania-based firm, said in an e-mail.

‘Considering Litigation’
“We are evaluating the facts and considering litigation,” Meghan McAndrew, a spokeswoman for Pittsburgh-based Federated Investors Inc. (FII), said in a statement. Federated manages about $364 billion and is the third-biggest provider of U.S. money- market funds behind Fidelity and JPMorgan Chase.

It wouldn’t be the first time that investment firms would be pitted against banks over losses stemming from the financial crisis. BlackRock and Pacific Investment Management Co. were part of an investor group that brought claims against Bank of America Corp. over mortgage bonds they had purchased, which last year resulted in an $8.5 billion settlement agreement. That settlement is now being challenged by other investors and state regulators.

Rival Banks
Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS) are among financial firms that may bring lawsuits against their rivals, Bradley Hintz, an analyst with Sanford C. Bernstein & Co., said last week. Even if Goldman Sachs and Morgan Stanley forgo claims on their own behalf, they oversee money-market funds that may be required to pursue restitution for injured clients, he said.

It’s not just lower rates that hurt investment firms. Libor rates that were artificially inflated could also potentially damage investors such as private-equity firms, which obtain deal financing based on the benchmark rate.

Regulators are looking at whether banks made submissions that understated funding costs during the credit crisis or if traders at the firms influenced Libor to boost profits. In addition to Barclays, UBS AG (UBSN), Citigroup Inc. (C), JPMorgan Chase & Co. (JPM) and Credit Suisse Group AG (CSGN) are among at least a dozen banks to disclose inquiries.

Attorneys general in at least five states in the U.S. are conducting investigations tied to manipulation of Libor, adding to probes by regulators including the U.S. Justice Department.

‘Complicated Case’
If the banks involved in the scandal neither admit nor deny wrongdoing to the Justice Department, it’s a much harder case for fund companies, said Harvard’s Pozen. To make a legal case, investment firms would have to show which banks’ Libor submissions were included in the daily rate, how much they affected the average and quantify how much money their funds have lost, he said.

“While you can say in general money-market funds got less than they should have, for them to win a court case, they would have to show who’s culpable for that,” Pozen said. “It’s a complicated case and in order to win, someone has to go day-by- day to show who did what and how it influenced Libor and how it influenced the fund managers’ investment decisions.”

Instead of trying to prove one or two banks influenced the rate fraudulently, plaintiffs might accuse the banks collectively of conspiring to rig the rate, Barry Barbash, head of the asset-management group at law firm Willkie Farr & Gallagher LLP, said in a telephone interview.

“Both theories are hard to show,” said Barbash, a former director of the U.S. Securities and Exchange Commission’s division of investment management.

Illinois Brick
Among existing lawsuits, the city of Baltimore may stand a better chance than Schwab of winning back investment losses linked to the Libor-rigging scandal if U.S. courts stick to a precedent set by a 1977 landmark price-fixing case.

The Supreme Court’s ruling in Illinois Brick Co. versus Illinois barred indirect purchasers from recovering federal antitrust damages, Andrew Verstein, a lecturer at Yale Law School, said in a telephone interview. Applied to the alleged manipulation of Libor, he said only investors such as Baltimore, that lost out in transactions directly with rate-rigging banks, might successfully sue.

“Different plaintiffs will fight about this precedent” depending on whether it helps or hurts their case, said Verstein, who is also executive director of the school’s Center for the Study of Corporate Law.

Baltimore Lawsuit
Baltimore’s case, filed last year, stems from its purchase of interest-rate swaps aimed at protecting the city from an increase in rates after it sold variable-rate bonds. When Libor was artificially pushed down, Baltimore’s suit alleges, the city got a lower rate of return.

“I am going to fight for this city and do what I can to protect the city taxpayers who ultimately suffered financial damage as result of Libor manipulation,” Baltimore’s Mayor Stephanie Rawlings-Blake said in an e-mailed statement.

Schwab, based in San Francisco, is attempting to recover money it said its mutual funds and other investment products lost when they bought short-term debt instruments with interest rates linked to Libor. While some of the debt Schwab funds bought was issued directly by banks accused of rigging Libor, some of it was also purchased from third parties, according to the suit. The suit names more than a dozen financial institutions as defendants, including units of Barclays, Bank of America, Citigroup, JPMorgan Chase and Credit Suisse.

Sarah Bulgatz, a spokeswoman for Schwab, said the firm doesn’t comment on pending litigation.

Credit Suisse CEO Brady Dougan said during a July 18 conference call with analysts that “we don’t believe that we have any material issues” related to Libor.

Valid Claim
Steven Vames, a spokesman in New York for Zurich-based Credit Suisse, declined to comment, as did Karina Byrne, a spokeswoman for UBS, Danielle-Romero Apsilos, a spokeswoman for Citigroup, Kerrie Cohen, a spokeswoman for Barclays, and Lawrence Grayson, a spokesman for Bank of America. Jennifer Zuccarelli, a spokeswoman for JPMorgan Chase, did not immediately return calls.

Dan Brockett, a partner in the New York office of Quinn Emanuel Urquhart & Sullivan LLP, said plaintiffs that didn’t buy securities directly from lenders who set Libor rates when the benchmark was being manipulated still have a valid claim because the banks allegedly did have a direct impact on the pricing of securities and it was foreseeable that their actions would have an impact on holdings.

“We still think there’s a respectable claim by a third party investor that didn’t buy securities directly from one of the Libor banks under federal securities law and common law fraud,” Brockett said.