On June 27, 2012, when Barclays Bank PLC made international headlines for its $453 million settlement with the U.S. and UK authorities for its role in manipulating the London Interbank Offered Rate (LIBOR), the international ubiquitous benchmark interest rate became the forefront of the global economy. The settlement came amid continued calls for governments to crack down on the alleged misconduct that contributed to the 2008 financial crisis. And while the Barclays settlement may have appeared to some to be the end of the story, it was only the beginning. On December 19, 2012, UBS AG agreed to pay $1.5 billion in fines to authorities in the U.S., UK, and Switzerland for its involvement in the LIBOR case; and on February 6, 2013, Royal Bank of Scotland (“RBS”) agreed to pay $612 million in fines to authorities in the U.S. and UK. While only these three settlements have been publicly announced to date, authorities in many countries suggest that more enforcement actions are to follow.
Since the Barclays LIBOR settlement became public, numerous antitrust authorities across the world have opened investigations into certain financial institutions’ involvement in the manipulation of LIBOR. Civil class action lawsuits against some of the world’s largest financial institutions have ensued, with bid-rigging allegations and the potential for trebled damages in the U.S. To date, government investigators and private litigants have accused at least 12 international financial institutions, including, Citigroup, JP Morgan & Chase, Bank of America, HSBC, and Royal Bank of Scotland, of colluding to manipulate LIBOR. In addition, new plans to correct perceived problems with LIBOR have been discussed, proposed, and negotiated by the financial industry, antitrust authorities, and financial regulators.
Having already resulted in substantial fines against two large, international banks, the LIBOR scandal is far from over and may amount to one of the largest and most unique antitrust investigations in history. As stated in a recent New York Times article, “[m]anipulating Libor is like poisoning the water supply for the world’s financial system.”1 But because the dynamics of LIBOR — an interest rate that is an average of self-policed rates based on individual banks’ judgments — determining who was injured, who benefited, and what effects, if any, the poisoning of LIBOR had, is another story and may be a difficult one for government investigators and plaintiffs.
This article reviews the background of LIBOR and then discusses the pending antitrust investigations and litigations surrounding the financial industry. It analyzes the hurdles for investigators and plaintiffs before suggesting that the uniqueness of the LIBOR scandal could have far-reaching antitrust implications and may resound in our economy for years to come. It also identifies a few practical lessons that all companies may take-away from the scandal.
BACKGROUND OF LIBOR, ITS INHERENT FLAWS, AND INCENTIVES FOR MANIPULATION
While it is impossible to assess, the Commodity Futures Trading Commission estimates that LIBOR is used for over $800 trillion of financial instruments and derivatives.
LIBOR is one of several worldwide benchmarks that banking institutions use to set the interest rates for commercial agreements, financial instruments (bonds, stocks, swaps, credit default swaps, commercial paper, etc.), and lending on financial transactions. LIBOR is set and managed by the British Bankers’ Association (“BBA”). Every weekday after 11:00 am GMT, leading banks around the world submit a figure to the BBA based on the rate at which they estimate they could borrow funds from other banks. It is worth noting that because the actual rate at which banks will lend to others continues to vary throughout the day, the rates provided by each contributing bank are not based on a tradable rate, but rather is a benchmark — a subjective estimate — based on individual banks’ assessments of likely rates. Each submitting bank is supposedly blind to the submissions of other banks.
Once each bank has provided its estimated rates, BBA drops the four highest and four lowest submissions and averages the remaining submissions into one rate - this is LIBOR. LIBOR is calculated for 10 different currencies and 15 borrowing periods (maturity dates). After LIBOR is calculated, it is published on a daily basis by Thomson Reuters. Generally speaking, when LIBOR is set low, that means that the banks and financial institutions feel confident in each other; when LIBOR is set high, that generally means that there is instability.
While LIBOR is the most frequently utilized benchmark for interest rates globally, as explained in the Wheatley Review of LIBOR, there are fundamental flaws in the LIBOR system that erode its credibility as a benchmark. For instance, because of the inability for the system to manage conflicts of interest, LIBOR submissions have become increasingly reliant on judgment rather than on transaction data due to the stressed unsecured inter-bank term borrowing market and decreased volume of inter-bank borrowing. Too many people involved had a vested interest in gaming the system. It has been alleged, for example, there was a web of traders at different banks that attempted to work together to manipulate LIBOR to benefit one another.
In addition to the inability to manage internal conflicts of interest, the Wheatley Review identifies a lack of oversight as a flaw that allowed member banks to allegedly exploit the system by making no effort to aid credible submissions, and in fact, incentivized the banks during the financial crisis to manipulate LIBOR submissions in order to bolster perceptions of their credit worthiness. Even more, the lack of accountability to ensure that the incentives of those involved in the process were aligned with the wider interests of market participants, benchmark users, and the public has resulted in a self-policing mechanism that opened the door to the wrong incentives.
In summary, from the start, the LIBOR system, based on market transactions, not real transactions, had built-in incentives for abuse without any oversight or scrutiny. Banks could submit what they wanted and organizations and individuals were left unchecked. In a feeble economy, such a relaxed process created opportunities for cheating and manipulation. However, the cheating and manipulation of LIBOR cannot be done effectively alone. A single institution could not affect the rate by simply reporting an artificially high or low rate relative to the other reporting institutions. If one did, it would run the risk of being one of the outlier rates that were ultimately dropped from the LIBOR calculation. In fact, even several institutions acting together by reporting a batch of rates that were intended to influence the average would not be able to impact the final rate with certainty. So while it is virtually impossible to determine how many financial institutions would need to have colluded to successfully manipulate LIBOR, it is clear that at least a large portion of the institutions involved in setting the rate, if not all of them, would need to participate in any collusion in order to have a guaranteed predictable impact. Therefore, revelations of new settlements between regulators and institutions, new arrests of bank employees, and civil litigations may continue until most of the institutions involved in setting the LIBOR have been involved.
THE POTENTIAL ANTIRUST IMPLICATIONS IN THE LIBOR SCANDAL
The LIBOR scandal dates back as far as the initial financial crisis in 2008. In fact, as far back as 2007, U.S. regulators, including the Federal Reserve Bank of New York, realized that the LIBOR-setting process was flawed and vulnerable to misrepresentation, and began discussions with UK regulators about reforms. However, the knowledge of any potentially criminal manipulation of rates was not publicized until the June 2012 announcement of the Barclays settlement for $453 million. Barclays admitted to submitting false information at the behest of its traders to benefit pricing for derivatives, and later providing incorrect interest rates to counter media speculation about the bank’s stability. However, Barclay’s settlement with the Justice Department’s Fraud Section, and not the Antitrust Division, did not include guilty pleas. However, it was only a matter of time before the U.S. Department of Justice’s Antitrust Division became more active in the investigation. Six months later, UBS AG reached a settlement with the U.S. and UK authorities for $1.5 billion, while its Japanese subsidiary plead guilty to a U.S. criminal count of fraud related to manipulation of benchmark rates and two former senior UBS traders were charged with colluding to manipulate Yen LIBOR interest rates for the purpose of improving trading positions held by UBS. More recently, RBS reached a settlement with the U.S. and UK authorities for $612 million for participation in a price-fixing conspiracy in violation of the Sherman Act, and its Japanese subsidiary plead guilty to a separate count of criminal wire fraud.
The U.S. Department of Justice, along with a number of other regulators worldwide, continue to actively work together during this ongoing investigation into manipulating LIBOR. The allegations of the ongoing criminal investigation by the U.S. Department of Justice’s Criminal and Antitrust Divisions center on the process of submitting rates to the BBA. Specifically, the BBA member institutions and their employees are being accused of having colluded to submit rates that were artificially high or low between 2005 and 2010, and intended either to: (i) avoid a bank being perceived as having a low credit rating during the feeble financial period; or (ii) benefit the trading positions of individual traders by reducing pay-outs to institution investors. These attempted manipulation claims stem from the reams of emails from Barclay’s files that showed how the bank sought to move LIBOR rates to profit on trades and to hide its high borrowing costs during the financial crisis.
Antitrust civil litigation has also commenced in the U.S. and more recently in the UK with respect to both over-the-counter products and exchange traded products affected by LIBOR. The claims in the U.S. are centered on Sherman Act anti-competitive cartel and bid-rigging allegations, but also include allegations of breach of contract. However, the information underpinning the antitrust claims relies in large part on media reports with attempts being made to secure disclosure from other BBA member banks. Most of the LIBOR related cases in the U.S. have been consolidated in the U.S. District Court for the Southern District of New York, in a case styled In Re: Libor Based Financial Instruments Antitrust Litigation, No. 11-md-2262. The consolidated amended complaint alleges that the member banks conspired to cap their borrowing costs by reporting artificially low interbank interest rates used to formulate LIBOR. Specifically, the plaintiffs allege the member banks agreed to fix the returns investors received on financial instruments based on LIBOR, which directly determined the returns on plaintiffs’ financial instruments, and that such activity constitutes a price fixing agreement among direct competitors and is thus per se illegal under Section 1 of the Sherman Act. The case is currently awaiting a decision on the defendant banks’ motion to dismiss, filed in June, which argues that the investors failed to adequately plead a conspiracy, restraint of trade, or the antitrust injury required to establish standing for a private antitrust claim under the Sherman Act.
THE LIKELY FUTURE OF THE LIBOR SCANDAL
As the LIBOR scandal grows, lawsuits are mounting against the world’s largest financial institutions, and the further anticipated regulatory and criminal settlements of other BBA member banks likely will provide important evidence for both the criminal and civil antitrust matters. As discussed above, because of the difficulty to manipulate the LIBOR rate with the participation of only a few member banks, any allegation that the financial institutions colluded to rig the benchmark rate would only come to fruition after most, if not all, member banks were brought into the fold. Even more, given that LIBOR is a benchmark, to show any actual effect that a manipulated LIBOR had on financial instruments and interest rates used for financial transactions may be impossible under the current antitrust laws. No known case has been based on the manipulation of an index that lies outside the marketplace and that is not attached to an underlying commodity. As such, and as further analyzed below, proving a violation under the Sherman Act may not be so simple when dealing with LIBOR.
First, most of the factual evidence available focuses on false reporting which, without more, may not constitute a violation of Section 1 of the Sherman Act. LIBOR arguably is not a “price” of anything, and is not “transaction based,” so there is no competition associated with the mere reporting of the rates of LIBOR. Even if LIBOR falls under the purview of the Sherman Act, an antitrust injury potentially would be difficult to prove, as there is no “correct” or “competitive” LIBOR.
Second, as noted in the defendants’ motion to dismiss in In Re: Libor Based Financial Instruments Antitrust Litigation, some injuries alleged are speculative and/or indirect. Given that LIBOR is not an actual price, but rather a composite index derived from the BBA’s survey of member banks, “[t]here are no buyers or sellers, no market profit, and no competition of any kind associated with the mere reporting of rates or setting of USD LIBOR.” Even if LIBOR falls under the purview of a product or service, injury would still be difficult to show as some borrowers or investors benefited from the artificially low rates. For example, a variety of mutual funds invest in securities and other financial instruments with returns tied to LIBOR. Investors could have been receiving a lower yield than they should have if banks were rigging the rate lower. On the other hand, mutual funds that invested in derivatives could have been benefited because if a fund entered into an interest-rate swap and paid a floating rate based on LIBOR, it might have paid less that it should have. Additionally, whether investors lost money on certain investments depends on whether they were on the winning or losing side of the specific transaction — most investors both paid interest and collected interest at rates determined by LIBOR. Thus, while borrowers or investors may have suffered as a result of alleged rate-rigging, some might have benefited, some might have been harmed, and others likely both had some benefits and suffered some harm. Additionally, under the Sherman Act in the U.S., any indirect injury would be bared by the Illinois Brick Doctrine, which prohibits indirect purchasers of goods or services from recovering antitrust damages from violators of the Federal antitrust laws.
Third, and perhaps more applicable to a criminal investigation, LIBOR is regulated by the UK authorities who arguably supported lower LIBOR submissions when markets were in turmoil and confidence in banks was fraying, thus implicating BBA rather than the individual banks themselves. Such evidence will become known during the banks’ internal investigation — the reports of which prosecutors rely heavily on for evidence of wrongdoing. Even more, while prosecutors tend to go after high-level executives of the organizations, the setting of the interest rates submitted for LIBOR is not something that is done at the executive level - it is a mundane exercise handled by lower-level bank employees. Given that LIBOR is not set or regulated by individual banks or bank executives, any purported liability may be difficult to establish.
CONCLUSION & SUGGESTED LESSONS LEARNED
The LIBOR scandal is unique in breadth and could affect businesses in virtually every industry both with respect to future business dealings and antitrust compliance. While the Bank of England has considered the future of LIBOR, there is no current suggestion that it will be discontinued as the global benchmark. However, the lack of faith in bank estimates and the problems caused by a lack of interbank lending has pushed the market towards LIBOR reforms, and arguably to migrate to a new standard. Because the world’s credit markets depend on LIBOR to such an enormous degree that the scandal undermines confidence in regulators, it is most likely that we will begin to see increased regulation on the U.S. financial system. Additionally, while the scandal is still panning out at both the regulatory and civil stages, it should not go unnoticed that a benchmark rate — a rate that may or may not have had any actual effect on the prices of anything — is the center of the alleged antitrust infringements. Whether basing price fixing allegations on the coordinated manipulation of this benchmark could potentially expand the application of antitrust and competition laws to conduct in other areas is yet to be determined, but a potentially broader consequence to watch.
The ultimate results of the LIBOR scandal will be played out over the months and likely years to come, as enforcers in different countries progress their investigations, and the lawsuits run their course. There is one potential lesson, however, which all companies can take now from the LIBOR scandal. That is, once again, a reminder of the importance of antitrust compliance, and specifically preventative compliance, including internal audits and robust antitrust compliance policies and training. As noted above, in many cases it has been alleged that much of the activity involved in the LIBOR scandal occurred via communications between relatively low-level day traders at different member banks, with little to no knowledge of senior corporate executives. These contacts often took the form of routine, informal communications — such as emails and even text messages — that are ubiquitous in today’s business world. It is highly likely that the individuals who wrote and sent these communications never imagined they would become “Exhibit A” in a government investigation or class action lawsuit. This should stand as another lesson for companies of the importance of having an effective antitrust compliance policy and communicating that policy to all levels of a sophisticated corporate structure. Aside from the potential legal and financial benefits arising from having an effective compliance policy in place (such as the possibility for the early detection of wrongdoing and a reduction in potential fines) corporate compliance can help employees throughout an organization to recognize potentially risky conduct (especially direct communications with competitors) before it occurs. An ounce of prevention could be worth a “pound” (or, quite literally, hundreds of millions of Pounds, Dollars, Yen, Euros, etc.) of cure.