Agricultural Bank of China Agrees to $215 Million Penalty in Anti-Money Laundering Investigation

On November 4, the New York State Department of Financial Services (“DFS”) and the Agricultural Bank of China agreed to a Consent Order requiring the bank to pay a $215 million penalty and to install an independent monitor to review the bank’s program for compliance with anti-money laundering laws (“AML”), including the Bank Secrecy Act (“BSA”).

The Agricultural Bank of China’s New York Branch (the “Branch”) conducts U.S. dollar clearing in large volumes through foreign correspondent accounts.  Since U.S. dollar clearing – a process by which U.S. dollar-denominated transactions are settled between counterparties through a U.S. bank – is a high-risk business line that creates an opportunity for bad actors to launder money or facilitate terrorist transactions, transaction monitoring systems are particularly important for entities that engage in this type of activity.

According to the Consent Order, despite warnings by DFS in 2014 that the Branch’s transaction monitoring systems were inadequate for a greater volume of clearing activity, the Branch substantially increased its clearing activity without implementing stronger monitoring systems.  Furthermore, when the Chief Compliance Officer (“CCO”) raised concerns in 2014 about potentially suspicious activity, Branch management failed to properly address these concerns and curtailed the CCO’s independence and ability to carry out vital compliance responsibilities.

The Consent Order states that during its 2015 investigation, DFS discovered an “‘unmanageable’ backlog of nearly 700 alerts of potential suspicious transactions” at the Branch that had not yet been investigated.  Additionally, DFS uncovered several alarming transaction patterns, including unusually large round-dollar transfers between Chinese and Russian companies and potentially suspicious dollar-denominated payments from trading companies located in the Middle East.

In a press release accompanying the Consent Order, New York Superintendent of Financial Services Maria T. Vullo stated that “[t]he failure of a strong compliance program at the New York Branch of the Agricultural Bank of China created a substantial risk that terrorist groups, parties from sanctioned nations, and other criminals could have used the Bank to support their illicit activities.”  Therefore, according to Superintendent Vullo, “serious sanctions and remedial action” were implemented.  The press release further noted that the settlement was the first between DFS and a Chinese bank, and “highlights the importance of DFS’s new risk-based anti-terrorism and anti-money laundering regulation that requires regulated institutions to maintain programs to monitor and filter transactions for potential BSA/AML violations and prevent transactions with sanctioned entities.”

Insurance Coverage for SEC Investigations: Lynn Tilton’s Patriarch Partners Sue for Coverage and Highlight Traps to Avoid

With all the news surrounding the SEC’s headline-grabbing prosecution of Lynn Tilton and her firm, Patriarch Partners LLC, it is easy to miss the insurance coverage element of the case.  It is no secret that in recent years, and particularly following the enactment of the Dodd-Frank Act in 2010, the SEC has dedicated more resources to investigating and targeting, among others, private equity firms, hedge funds, and mutual funds.  Responding to an SEC subpoena or investigation can be extremely expensive and disruptive.  Importantly, in some instances, these costs may be covered by a company’s liability insurance policies.

Patriarch Partners is seeking coverage from AXIS Insurance (“AXIS”) for an SEC subpoena and subsequent enforcement action. Patriarch Partners LLC v. AXIS Insurance Company, No. 1:16-cv-02277-VEC (S.D.N.Y. filed March 29, 2016).  AXIS has denied coverage and is seeking a court ruling that there is no coverage because (1) Patriarch allegedly did not disclose in a warranty for the AXIS policy that it had received an informal request for documents from the SEC; (2) the claim was barred by a prior acts exclusion; and (3) the SEC claims at issue constituted a “claim” made prior to the policy period.

In short, AXIS is arguing that, because the SEC allegedly requested certain documents from Patriarch and started an inquiry prior to the policy period, no coverage is available for the SEC’s subsequent claims.  Notably, although AXIS is contesting its coverage obligation, the primary insurer and the lower-layer excess carriers agreed to fund Patriarch’s defense and already have exhausted their limits.

The case raises a number of issues that all sophisticated buyers of insurance need to anticipate to increase the likelihood that coverage will be available for SEC claims:

  1. Be careful in completing applications and executing warranties. In purchasing insurance, policyholders are often required to complete applications or execute warranties.  Insureds, of course, must be honest in these applications and warranties because, as the Patriarch case demonstrates, insurance companies may attempt to avoid their coverage obligation based on purported misrepresentations.  But, as the Patriarch case also shows, responding to insurance applications is often easier said than done.  For example, to challenge coverage, AXIS is relying on a warranty by Patriarch stating that it was not “aware of any facts or circumstances that would reasonably be expected to result in a Claim” covered by the AXIS policy.  At the time Patriarch executed its warranty, however, its representation likely was accurate:  it likely did not know that a limited investigation by the SEC would result in a claim leading to more than $20 million in fees.  Nevertheless, Patriarch now faces an obstacle to coverage that could have been avoided.
  1. How the term “Claim” is defined. Most management liability insurance policies are written on a claims-made basis, which means that they are triggered by claims made during the policy term.  The definition of “Claim,” however, varies significantly from policy form to policy form.  In virtually all policies, the definition of “Claim” will include civil lawsuits, but, as reflected in the Patriarch case, it may also include a subpoena, an order of investigation, or an SEC Form 1662.  Policies also generally tie the definition of “Claim” to instances where there are allegations of “wrongful acts.”  The definition of “Claim” can have broad consequences for coverage and will affect the policyholder’s notice obligations, which policy period(s) is triggered, and how exclusions are applied.
  1. Understand the ramifications of prior acts and prior litigation exclusions. The vast majority of D&O policies contain prior acts or prior litigation exclusions that bar coverage for claims arising out of acts, or “related” lawsuits, that took place prior to the policy period.  The language of these exclusions again differs from policy to policy.  Where possible, seek a narrower and clearer exclusion, so that there is little doubt regarding what is excluded.  For example, in the Patriarch case, the policy contains a somewhat expansive exclusion barring coverage for claims “based upon, arising out of or attributable to any demand, suit or other proceeding pending” against Patriarch on or prior to July 31, 2011, “or any fact, circumstance or situation underlying or alleged therein.”  AXIS still will be required to show that this exclusion clearly and unambiguously bars coverage for the claim at issue, but this type of language gives insurers too much room to try to contest coverage.

There is no way to guarantee that all SEC claims will be covered, but by being proactive and anticipating key issues, you will put your firm in the best possible position to obtain coverage and manage this critical risk.  We will be monitoring the Patriarch case as it develops.


* Joseph Saka is a member of Lowenstein Sandler’s Insurance Recovery Group.  Zachary Rosenbaum, Chair of the Capital Markets Litigation Group, contributed to this post.

IPO Fraud Investigation Marks Historic Turn for Chinese Regulatory Enforcement

On October 21, the China Securities Regulatory Commission (“CSRC”) opened an investigation into six Chinese companies for alleged fraud relating to initial public offerings (“IPOs”).  The six companies under investigation are (1) Longbao Ginseng & Antler Co. (“Longbao”), a biotechnology and pharmaceutical company; (2) Guangdong Guangzhou Daily Media Co., an advertising firm; (3) Ingenious Ene-Carbon New Materials Co., a graphite supplier; (4) Infotomic Co., a property developer; (5) P2P Financial Information Service Co., a real estate developer; and (6) Shenzhen Ecobeauty Co., a natural gas equipment manufacturer.  One of the six companies, Longbao, is currently preparing an IPO, while the remaining five have already gone public.

These six cases mark the start of a relatively new campaign by the CSRC intended to detect and punish IPO fraud.  The commission announced that it will be investigating all parties involved in the IPOs, including the lawyers, underwriters, and auditors.  It also announced that penalties could include delisting the companies’ stocks, issuing financial penalties, and even imposing criminal charges and fines.

The alleged fraudulent acts for the six companies under investigation include false representations made in IPO prospectuses and inflation of company revenue and net income, designed to induce market speculation and artificially boost company stock prices following an IPO.  While foreign investors are barred from being shareholders in domestic Chinese companies, IPO fraud is an enormous area of concern affecting Chinese investors, who stand to lose millions, with China only recently starting to seriously crack down on this type of market fraud.

This past June, China for the first time expelled a company for committing IPO fraud from one of its several stock markets, the Shenzhen Stock exchange, after an investigation revealed that Dandong Xintai Electric fabricated financial data in its IPO application.  The underwriter of the IPO was also ordered to pay 550 million yuan ($82.2 million) to compensate investors and an additional penalty of 57.3 million yuan ($8.5 million).

The deputy chairman of the CSRC, Jiang Yang, noted back in June that the CSRC would strictly enforce its delisting procedures on companies that fail to meet the highest corporate disclosure standards.  Yang noted that “what we should focus on at present is a solid capital market foundation composed of listed companies … the market shouldn’t allow sensational hype”; and the “bottom line [is] in preventing systematic risks.”

National Credit Union Administration Settles RMBS Claims Against RBS for $1.1 Billion

The National Credit Union Administration (NCUA) and the Royal Bank of Scotland (RBS) have reached a $1.1 billion agreement to settle two separate federal cases that arose out of RBS’s sale of residential mortgage-backed securities (RMBS) to two corporate credit unions that later failed and were placed into NCUA conservatorship.  The two complaints, pending in the District of Kansas and the Central District of California, alleged that RBS misrepresented the risks of RMBS investments, particularly the likelihood that borrowers would default on the mortgage loans underlying the transactions.

The Kansas suit revolves around RMBS that U.S. Central Federal Credit Union purchased in 2006 and 2007, which resulted in approximately $800 million in losses.  The California suit concerns RMBS purchases by the now-defunct Western Corporate Federal Credit Union.  Both suits survived RBS motions to dismiss last year.

The NCUA has settled numerous other RMBS claims against banks, including a $491 million settlement with Goldman Sachs in June, a $69 million settlement with UBS in June, and a $29 million settlement with Credit Suisse in March.  Last year, the NCUA reached a $225 million settlement with Morgan Stanley in December, inked a $378 million settlement with Barclays and Wachovia in October, and accepted a $129.6 million offer of judgment from RBS Securities in September concerning other failed credit unions.  The NCUA’s recoveries in RMBS matters now exceed $4.3 billion.

While the NCUA continues to pursue other RMBS claims against Credit Suisse and UBS Securities, more and more RMBS claims, like those of the U.S. Central Federal Credit Union and Western Corporate Federal Credit Union, will continue to arise.

No Bankruptcy Automatic Stay for Banks in $7.7B NovaStar MBS Fraud Action

U.S. Southern District Judge Deborah A. Batts shut down underwriter defendants’ attempt to avoid proceeding with discovery in a $7.7 billion mortgage-backed securities fraud action, by arguing that an automatic bankruptcy stay applied to the underwriter defendants in addition to the debtor defendants.

The current discovery dispute arises from a proposed class action lawsuit against the now bankrupt NovaStar Mortgage Inc. (“NMI”) and NovaStar Mortgage Funding Corporation (“NMFC”) and the investment banks that underwrote $7.7 billion of NovaStar mortgage-backed securities issued in 2006.  The underwriter defendants include RBS Securities Inc., Deutsche Bank Securities Inc., and Wells Fargo Securities LLC.  The class action alleges that the offering documents failed to disclose that NovaStar had abandoned its underwriting standards in the wake of the 2009 housing crisis, which caused significant losses for investors.

NovaStar initiated voluntary bankruptcy proceedings on July 20 in the U.S. Bankruptcy Court for the District of Maryland.  The underwriter defendants then argued that the automatic bankruptcy stay bars them from continuing with discovery in the class action.  They reasoned that the automatic stay applied because (1) continuation of the action would have an “immediate adverse economic consequence” for the debtor defendants’ reorganization and (2) the underwriter and debtor defendants are “inextricably woven” such that a finding of liability would necessarily implicate the debtor defendants.

Judge Batts rejected the underwriter defendants’ arguments, concluding that “the automatic stay provision of the bankruptcy code does not operate to stay this action except as to the Debtor Defendants [NovaStar].” The Court rejected the “immediate adverse economic consequence” argument, finding that “the mere possibility of a future indemnification claim [against debtor defendants] will not support application of the automatic stay” and neither will concerns about the creation of adverse precedent or collateral estoppel, given that the bankruptcy operates to deprive the debtor defendants of a full and fair opportunity to litigate the claims.  Finally, Judge Batts rejected the “inextricably woven” rationale because the underwriter defendants and the debtor defendants, NMI and NMFC, are separate entities and the claims against them are legally distinct; therefore, “the concern that Debtor Defendants are the ‘real party defendant’ is not present in this Action.”

The case is captioned New Jersey Carpenters Health Fund v. Royal Bank of Scotland Group, PLC, et al., case number 1:08-cv-05310, in the U.S. District Court for the Southern District of New York.

National Credit Union Administration Succeeds in RMBS Appeal to Ninth Circuit

The U.S. Court of Appeals for the Ninth Circuit recently reversed a trial court’s dismissal of the National Credit Union Administration’s (NCUA’s) residential mortgage-backed securities (RMBS) fraud claims against Nomura Home Equity Loan Inc.  The appellate court held that the Financial Institutions Reform Recovery and Enforcement Act of 1989 (FIRREA) extended all applicable deadlines for the NCUA to file any suit in its capacity as conservator or liquidating agent for a troubled credit union.  Among many other reforms, FIRREA included an “extender” provision that allows the NCUA to bring claims that would otherwise be barred by applicable statutes of limitation and statutes of repose.  Similar statutes govern claims brought by the Federal Deposit Insurance Corporation (FDIC) as conservator or receiver for a failed bank, as well as claims brought by the Federal Housing Finance Agency (FHFA) as conservator or receiver for government-sponsored entities such as Fannie Mae and Freddie Mac.

Specifically, the Ninth Circuit held that the extender provision of FIRREA applies to both statutes of limitation, which set forth deadlines by which plaintiffs must file suit, and related statutes of repose, which set absolute deadlines after which defendants may not be sued.  Thus, the NCUA’s claims, although filed in 2011, more than three years after the subject RMBS were purchased in 2006 and 2007, were still timely.

The NCUA brought the underlying suit on behalf of Western Corporate Credit Union (WesCorp), which originally purchased the securities at issue.  The complaint alleges that Nomura and other defendants falsely represented to WesCorp that these RMBS were low risk, while knowing and failing to disclose that the mortgage loans underlying the RMBS failed to meet applicable underwriting standards, in violation of Section 13 of the Securities Act of 1933.  Because WesCorp was placed into NCUA conservatorship following its failure in 2009, the appellate court concluded that NCUA’s 2011 suit was well within the three-year statute of limitations.  The Ninth Circuit’s holding follows similar rulings interpreting extender statutes by its sister courts, the Second Circuit, Fifth Circuit, and Tenth Circuit.

MassMutual Agrees to Settle $235 Million RMBS Suit Against RBS

Massachusetts Mutual Life Insurance Company (MassMutual) and RBS Securities Inc. (RBS) have reached a confidential agreement to settle MassMutual’s claims that RBS misrepresented the quality of $235 million in residential mortgage-backed securities (RMBS) sold to MassMutual between 2005 and 2007. MassMutual’s complaint alleges that RBS Financial Products Inc. (then operating as Greenwich Capital Financial Products Inc.) made knowingly false representations as to the quality of the loans serving as collateral for the 10 securities RBS sold to MassMutual.

Because MassMutual had no access to the loan-level data underlying the deals, it relied on RBS’s allegedly false representations that the loans were underwritten in accordance with market standards.  MassMutual claims that RBS knew that the loans were issued based on overstated income, false verification of employment, and inflated appraisals, among other defects.  Additionally, the insurer claims that RBS routinely allowed exceptions to underwriting guidelines to approve loans for no reason other than its bottom line.

The parties filed a joint request to dismiss the case with prejudice, noting that they had reached a confidential settlement that would resolve all of MassMutual’s claims against RBS and related entities. The case was filed in U.S. District Court for the District of Massachusetts.

MassMutual has recently settled numerous other RMBS suits against big banks.  In March, it reached a settlement with Barclays Capital Inc. concerning the purchase of $175 million of RMBS.  And in October 2015, MassMutual settled with JPMorgan Chase & Co. regarding more than $2.3 billion worth of RMBS.  Additionally, the insurer has settled claims against HSBC Bank PLC, Bank of America Corp., UBS, and Deutsche Bank AG.  However, its claims against Credit Suisse Group Inc. and Goldman Sachs Group Inc. are still active.

Morgan Stanley Cannot Avoid Litigating Its Alleged RMBS Misconduct

Morgan Stanley continues to face the legal consequences of its actions leading up to and during the financial crisis. On August 11, the First Department of the Appellate Division in New York issued two decisions against the bank, both holding that claims against Morgan Stanley for its alleged misconduct involving residential mortgage backed securities (“RMBS”) should proceed.

In a case brought by trustee US Bank National Association (“US Bank”), the Appellate Division revived breach of contract and gross negligence claims against Morgan Stanley that had been dismissed by the New York Supreme Court in 2014. US Bank alleged that Morgan Stanley breached its contractual duty to notify the trustee of defects in the loans underlying the trust. On behalf of the trust, US Bank also claimed that Morgan Stanley failed to repurchase the loans after being made aware of numerous breaches of its own representations and warranties regarding the quality of the loans in the trust.

In another case brought by IKB International SA (“IKB”), a Luxembourg subsidiary of German lender and bank IKB Deutsche International AG, the First Department upheld the lower court’s 2014 denial of Morgan Stanley’s motion to dismiss IKB’s fraud claims. The court found that IKB had plausibly stated facts sufficient to show that Morgan Stanley, as underwriter of the RMBS whose name appeared on the offering documents, not only knew about the poor quality of the loans but also actively participated in the securitization process.

Morgan Stanley faces hundreds of millions of dollars in damages in both cases: the trust in the US Bank contract case suffered $111 million in losses and IKB alleges losses over $147 million in its fraud case.

 

The cases are: Morgan Stanley Mtge. Loan Trust 2006-13ARX v. Morgan Stanley Mtge. Capital Holdings LLC, case number 2016 NY Slip Op 05781; and IKB International SA in Liquidation et al. v. Morgan Stanley et al., case number 653964/2012.

PwC Fails in Bid to Terminate MF Global $1B Malpractice Suit

On August 5, U.S. Southern District Judge Victor Marrero denied PricewaterhouseCoopers’ (PwC) motion for summary judgment with respect to a $1 billion professional malpractice suit filed by the plan administrator for the now-defunct MF Global Holdings Ltd. (MF Global).

The suit accuses PwC of dispensing negligent accounting advice to MF Global on how to handle European sovereign debt deals that generated short-term income but saddled it with significant future liabilities.  The malpractice cause of action is the last remaining piece of MF Global’s three-claim lawsuit filed against PwC in August 2014 following MF Global’s collapse and Chapter 11 filing in October 2011.  PwC had acted as an outside auditor and accountant for MG Global before it went bankrupt.  MF Global is seeking at least $1 billion for PwC’s “extraordinary and egregious professional malpractice and negligence,” claiming that the accounting decisions PwC approved were substantial causes of MF Global’s bankruptcy.

After unsuccessfully moving to dismiss and upon conclusion of discovery, PwC moved for summary judgment.  PwC argued that MF Global could not overcome the affirmative defense of in pari delicto, i.e., that MF Global was equally responsible for the alleged malpractice because of its decision to implement PwC’s strategies, and that it could not show that PwC’s accounting advice caused MF Global’s collapse and subsequent harm to shareholders.  Judge Marrero denied summary judgment on both the equal fault and causation grounds, finding that “PwC has not satisfied its burden of demonstrating the absence of any genuine issue of material fact.”

Under the in pari delicto doctrine, “the pleadings and undisputed facts presented in the course of litigation must establish intentional wrongdoing by the plaintiff that is the subject of the litigation,” Judge Marrero wrote.  Judge Marrero held that PwC’s “broad reading of the doctrine” was “not in line” with New York law and would “insulate an auditor from liability whenever a company pursues a failed investment strategy after receiving wrongful advice from an accountant.”  The court concluded that “the record presented by [MF Global] could support a reasonable jury finding that MF Global developed preliminary conclusions about sale accounting in good faith and consistently asked PwC to review its conclusions,” but that MF Global still must prove that it “innocently accepted PwC’s negligent advice.”  On the causation issue, Judge Marrero found that the “resulting complex factual determination as to what harm to MF Global was caused by the negligent accounting advice and what harm was caused by the [company’s European sovereign debt strategy] is one for a factfinder to resolve.”

The case is captioned MF Global Holdings Ltd. v. PricewaterhouseCoopers LLP, case number 1:14-cv-02197, in the United States District Court for the Southern District of New York.

Barclays Agrees to $100 Million Settlement in LIBOR Manipulation Investigation

On August 8, Barclays Bank PLC and Barclays Capital Inc. (collectively “Barclays”) reached a $100 million settlement to resolve a 44-state multistate investigation that exposed Barclays’ fraudulent and anticompetitive schemes to manipulate the London Interbank Offered Rate (“LIBOR”) from 2005 to 2009.  The investigation, led by Attorney General Eric T. Schneiderman of New York and Attorney General George Jepsen of Connecticut, revealed that Barclays’ managers instructed LIBOR rate submitters to artificially lower their LIBOR submissions in order to avoid the appearance that Barclays was in financial difficulty.  Also, Barclays’ traders asked LIBOR rate submitters to adjust the submissions to benefit the traders’ positions.

LIBOR is a benchmark that is designed to reflect the cost of borrowing funds in the market, and it is applied to many types of financial instruments, including futures, swaps, options, and bonds.  It is also referenced by consumer lending products such as mortgages, credit cards, and student loans.  LIBOR manipulation had a widespread impact on global markets and consumers, including government entities and not-for-profit organizations.

New Jersey Attorney General Chris Porrino highlighted the importance of this settlement: “As we all recognize, when public confidence in banks and the practice of investing erodes, the entire economy can suffer.  This is an important settlement, not only for the recovery it provides for government entities and nonprofit organizations that were harmed, but also for the message it sends — that manipulation of financial markets is not acceptable and will not be tolerated.”

While Barclays is the first big bank to reach a settlement for LIBOR manipulation, it will likely not be the last.  Connecticut Attorney General George Jepsen stated that the multistate investigation “developed significant evidence that some banks, like Barclays, that were responsible for setting LIBOR rates intentionally manipulated LIBOR in order to protect their public image and to help the business side of their operations be more profitable.”

LexBlog