Shuttered FrontPoint hedge funds sue Libor banks for $250 mln fraud

May 21, 2013

Last month, right after U.S. District Judge Naomi Reice Buchwald of Manhattan dismissed class action antitrust and racketeering claims against the global banks that supposedly colluded to manipulate the benchmark London Interbank Offered Rate (Libor), Daniel Brockett of Quinn Emanuel Urquhart & Sullivan politely said, “I told you so.” Brockett had been pushing an alternate theory of liability against the Libor banks, focused on securities and common-law fraud, not on antitrust violations. And even in the Libor litigation wreckage that resulted from Buchwald’s ruling, he said, fraud claims like those filed in March by Freddie Mac’s conservator against a dozen Libor banks were still viable. The only catch was that plaintiffs would have to be able to show that they relied on misrepresentations by panel banks, so cases would probably have to be brought by individual investors with big enough losses in Libor-pegged financial instruments to justify the cost of solo litigation. Nevertheless, Brockett told me he believed those investors were out there.

On Tuesday, one of them surfaced. Brockett filed a 106-page complaint in New York State Supreme Court for Salix Capital, which owns claims belonging to several shuttered hedge funds that once operated under the FrontPoint umbrella. Salix alleges that in 2007 and 2008, the FrontPoint funds engaged in Libor-pegged interest rate swaps with Libor panel banks as part of complex, multi-security deals known as corporate bond basis packages. The swaps were supposed to be a hedge against a global banking crisis, since Libor should have increased as it became more expensive for banks to borrow from one another. Instead, the complaint alleges, the panel banks artificially suppressed Libor, undermining the trading strategy of the FrontPoint funds.

The funds “relied on the integrity of how Libor was set and the truthfulness of defendants’ representations about how Libor was set in entering into these transactions,” the complaint said. “By suppressing Libor, defendants artificially lowered the amount they were contractually obligated to pay to the funds under the interest rate swaps, while still demanding that the funds make the contracted-for (comparatively high) fixed-rate payments. In marketing the basis packages, defendants misrepresented Libor and omitted to disclose their manipulation of Libor.”

The suit blames Libor manipulation for the FrontPoint funds’ big losses in 2008 and eventual demise in 2009, after an avalanche of redemption requests that the complaint attributes to Libor-related losses. (Others havelinked the redemption demands to insider trading by FrontPoint principal Chip Skowron.) The funds are asserting common-law fraud and breach of contract against the Libor banks, claiming $250 million in damages from inflated payments to the defendants, reduced payments from the banks and losses that the funds experienced in a liquidation process that they claim was triggered by the banks’ bad-faith collateral demands. That seems to be a more focused theory of liability than what we saw in the first Libor securities fraud suit to be filed after the Buchwald antitrust ruling: Charles Schwab’s suit in San Francisco Superior Court, claiming unspecified damages for losses on Libor-pegged instruments.

“These are tight, targeted fraud claims,” Brockett told me in an interview Tuesday. Because the FrontPoint funds dealt directly with Libor panel banks, he said, Salix (as the owner of their claims) can show a relationship of privity with the defendants. The complaint also takes care to offer evidence establishing New York state jurisdiction over the claims, which gives Salix the benefit of New York’s six-year statute of limitations for fraud and breach of contract.

Brockett wouldn’t tell me if Salix was already a client back in March, when Buchwald dismissed Libor antitrust claims, nor would he say whether Quinn Emanuel has other clients poised to file similar Libor suits. He certainly hasn’t stopped fishing for would-be plaintiffs. “There are lots and lots of investors who dealt directly with the panel banks. These are the people we always said have claims,” Brockett told me. “This is where the future of Libor litigation exists, if it exists.”

(Reporting by Alison Frankel. Additional reporting by Karen Freifeld.)

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