As distressed oil-and-gas-related loans continue to mount, the markets’ attention is turning to loan commitments that banks have not yet funded.  According to a recent Wall Street Journal article, ten large U.S. banks have disclosed $147 billion in unfunded loan commitments that oil and gas companies can draw upon, though the banks are expected to reduce energy credit lines secured by proven reserves by more than 30% this spring.  Smaller and international banks hold more of these unfunded commitments worth billions of dollars.  Market observers note that energy companies may be tempted to draw on these lines as they grow increasingly distressed.  According to the WSJ article, “a handful of energy borrowers announced more than $3 billion of drawdowns against these types of loans” in the first quarter of this year.  Although banks historically have not disclosed these commitments, they have begun doing so recently, with oil and gas prices in a sustained decline.

The decline in energy prices has led to a steady stream of news reports about the deteriorating quality of energy-related loans and the increase in potential losses that banks face from their exposure to the energy sector.  For instance, recent reports have revealed that some large banks, including Wells Fargo and Comerica, are likely to find more than 50% of their energy-related loans in danger of default this year.  Numerous banks have reported increases in reserves set aside for energy loan losses.  In addition, a recent Fed survey of banks revealed negative spillover effects in business and household loans – including commercial real estate, automobiles, and credit cards – made in regions dependent on the energy sector.

Although oil prices have been in a slump for well over a year, the number of energy (and related) loans entering the distressed category appears to be picking up rapidly in 2016.  Just last week, JP Morgan announced that the value of “criticized” loans to the energy sector had more than doubled – from $4.5 billion to $9.7 billion – in the first quarter.  We will continue to monitor and post on new developments as they occur.

On April 14, the Department of Justice charged the supervisor of Ramapo, New York (the city’s top elected official), and the former executive director of the Ramapo Local Development Corp. with criminal securities fraud for allegedly defrauding thousands of municipal bond investors.  The charges relate to alleged misstatements and omissions made about Ramapo’s financial condition in connection with $150 million worth of municipal bonds.  Both men were also named in a parallel civil suit by the U.S. Securities and Exchange Commission (“SEC”), along with the town of Ramapo, the Ramapo Local Development Corp., the town attorney, and the deputy finance director.

While these arrests are the first of their kind, this is just the beginning of a strategic shift in the government’s crackdown on fraud in the $3.7 trillion municipal bond market.  Over the past few years, the SEC has focused on bringing enforcement actions against municipal underwriters, issuers, and officials, although the SEC settled some of the early cases without demanding fines.  The SEC has recently started extracting significant penalties from alleged fraudsters.  To date, the SEC has resolved cases against a diverse group of defendants, including some of the largest investment banks.  On June 18, 2015, Goldman Sachs, Morgan Stanley, RBC Capital Markets, Merrill Lynch, J.P. Morgan, and Citigroup Global Markets Inc., among others, each agreed to pay $500,000 to resolve public administrative and cease-and-desist proceedings initiated by the SEC for alleged violations of an antifraud provision of the federal securities laws, in connection with their role in underwriting certain municipal securities offerings.

Now, with the real possibility of criminal charges being brought against the officials who manipulate the books, there can be no doubt that the municipal bond market is on notice.  At a press conference on April 14, U.S. Attorney for the Southern District of New York Preet Bharara warned that his office will be “looking at these things more” than in the past, making it likely that we will see more indictments.

On April 19, Lehman Brothers Special Financing (“LBSF”), a subsidiary of Lehman Brothers Holdings Inc. (“LBHI”), filed its opposition to a motion to dismiss its breach-of-contract claims related to the Pyxis transaction, one of many credit-default swap (“CDS”) transactions that were terminated as a result of LBHI’s bankruptcy. LBSF argued that the cancellation of its priority payment status under the swap agreements was a breach of contract and violated bankruptcy law.

After LBHI initiated a Chapter 11 bankruptcy proceeding in September 2008, dozens of banks and noteholders terminated a massive series of CDS transactions and enforced contractual “flip clauses,” which allowed investors to move ahead of LBSF to secure assets backing a structured-debt deal in a derivatives contract. LBSF filed suit, seeking more than $3 billion, including $1.3 billion stemming from the Pyxis transaction. In its fourth amended complaint filed in October 2015, LBSF argued that the flip clauses “wiped out [its] substantial ‘in-the-money’ position under the Swap Agreements, resulting in an enormous (and unjustifiable) windfall to the Noteholders at [its] expense.” LBSF reiterated this argument in the opposition, stating that the “reversal of priorities because of LBHI’s bankruptcy resulted from [an] application of impermissible ipso facto provisions.”

LBSF is expected to prevail on its argument that the flip clauses are unenforceable in light of the 2010 decision by U.S. Bankruptcy Judge James Peck, who oversaw Lehman’s Chapter 11 case, that such flip clauses violated U.S. bankruptcy law.

Multinational companies face difficult interactions with the US Court system – and vice versa.  Professor Verity Winship has a piece at CLS BlueSky Blog covering this issue, including the application of personal jurisdiction to multinationals in light of Daimler v. Bauman.   Amiad Kushner and Richard Bodnar previously covered Daimler and some progeny in the Westlaw Journal.

Does a lawsuit brought in New York based on advice regarding investment agreements signed in Hong Kong for a Chinese company belong in a Hong Kong court? UBS AG (“UBS”) thinks so, and moved to dismiss a lawsuit brought in New York Supreme Court by Ace Decade Holdings Limited (“Ace”). Among other claims, Ace alleged fraud, breach of fiduciary duty, and negligent misrepresentation against UBS for advising Ace to invest $500 million in shares of a Chinese company through an intermediary, Haixia Huifu Asset Investment and Fund Management Co., Ltd. (“Haixia-Huifu”), which ultimately resulted in a loss of Ace’s entire investment. Ace claimed UBS concealed that Haixia-Huifu was actually controlled by UBS’s joint venture partner and was therefore not acting independently.

In arguing that the lawsuit should be venued in Hong Kong rather than in New York, UBS moved to dismiss on jurisdictional and forum non conveniens grounds. UBS claimed that, as a Swiss bank, it is not subject to personal jurisdiction in New York because the transactions occurred entirely in Hong Kong and that New York is an inconvenient forum, considering that all relevant people and documents are in China or Hong Kong. As such, litigation in New York would be a burden on the court and the parties.

In opposing UBS’s motion to dismiss, Ace argued that, although the investment agreements were signed in December, the money was not transferred until May, well after UBS’s agent handling the transaction had moved to New York. During oral argument, Judge Eileen Bransten of the Commercial Division in New York Supreme Court ordered the parties to produce copies of the actual investment agreements before she would rule on the motion. It remains to be seen whether the case will continue in New York, but Judge Bransten is interested in the exact wording of the governing contracts, specifically to the extent to which they specify where a dispute should be brought.

The case is Ace Decade Holdings Ltd. v. UBS AG, case number 653316/2015, in New York State Supreme Court.

Earlier this month, California Attorney General Kamala Harris filed suit against Morgan Stanley in San Francisco Superior Court, alleging violations of the California False Claims Act and other state laws.  Brought on behalf of the California Public Employees Retirement System—the nation’s largest pension fund—and the California State Teachers Retirement System, the suit alleges that Morgan Stanley failed to disclose that the loans underlying many of the residential mortgage-backed securities (“RMBS”) it sold to the pension funds were delinquent.

From 2004 to 2007, Morgan Stanley packaged the RMBS it sold to investors with loans it purchased from subprime mortgage originators including its subsidiary, Saxon, and California-based New Century.  As the subprime mortgage market soared, those and other originators pressured Morgan Stanley to purchase as many loans as possible, pushing the bank to loosen restrictions on purchasing high-risk mortgages.  The complaint alleges that Morgan Stanley’s RMBS offering materials failed to disclose the true risk of the loans underlying the RMBS.  Morgan Stanley knowingly purchased loans made by borrowers with poor credit, and loans for which the accompanying appraisal was purposefully inflated to allow the borrower to obtain as large a loan as possible.

The California pension funds ultimately lost hundreds of millions of dollars on their RMBS investments, including investments in structured investment vehicles (“SIVs”) backed by RMBS and other assets that were created by Cheyne Capital Management, together with Morgan Stanley.  The complaint alleges that Morgan Stanley failed to disclose concerns about the risks of the Cheyne SIVs, and even pressured rating agencies to give them unmerited high ratings.

The suit seeks treble damages and civil penalties under the California False Claims Act, the Corporate Securities Law, the Unfair Competition Law, and the False Advertising Law.  The case is People of the State of California v. Morgan Stanley, No. 16-551238 in the Superior Court of California, County of San Francisco.

The Department of Justice (“DOJ”) recently announced that it has narrowed its scope of investigation into numerous financial institutions’ involvement in manipulating the US Treasury market.  The Fraud Division of the DOJ initiated the investigation in June 2015 when it requested documents from banks that are “primary dealers” of US Treasury bonds.

A primary dealer is permitted to purchase US Treasuries directly from the Federal Reserve when an auction of treasuries is announced.  There are 22 primary dealers of U.S. government debt.  The market for US Treasuries functions in three stages.

  • First, the Treasury Department announces that an auction of Treasuries will take place, which creates the when-issued market. In this market, the primary dealers solicit potential investors to place orders for when-issued securities.
  • Next, the dealer and investor agree on a price on a conditional basis and the deal is finalized when the Treasuries are actually issued.
  • The primary dealers then submit bids for securities to cover the amount of when-issued sales made. The difference between the price paid by the dealers at auction and the price agreed to by the investors in the when-issued market is the dealers’ profit.

The DOJ is investigating whether the dealers are improperly using and sharing the information on the demand for Treasuries received as a result of the when-issued market.

Since the initiation of the investigation in June, many institutional investors have filed lawsuits against the primary dealers, alleging that their manipulation of the auction process has been detrimental to investors.  For example, in an action filed in the United States District Court in the Southern District of New York, the plaintiffs allege that the dealers communicated confidential customer information and coordinated trading strategies in order to increase the prices paid by investors in the when-issued market.  The complaint also alleges that the dealers coordinated trading strategies in order to depress the prices paid by the dealers at auction.  The suppression of a competitive market in the auction process drives down the prices of Treasury futures and options as the prices of these instruments are tied to Treasury auction prices.

To date, 25 such lawsuits have been filed in New York, Illinois, and the U.S. Virgin Islands. In December 2015, all 25 cases were consolidated and transferred to the Southern District of New York by the U.S. Judicial Panel on Multidistrict Litigation (“MDL Panel”).  The MDL Panel reviews complex cases filed in numerous federal courts that involve common questions of fact and determines whether the consolidation of pretrial proceedings would promote the just and efficient conduct of such actions.  The cases have been assigned to Judge Paul G. Gardephe, who has previously managed other multidistrict litigations related to financial products.

On March 23, 2016, Novartis AG settled with the United States Securities and Exchange Commission (“SEC”) for $25 million, resolving allegations that Novartis subsidiaries in the People’s Republic of China violated the U.S. Foreign Corrupt Practices Act (“FCPA”) when subsidiary employees allegedly bribed Chinese doctors.  The SEC alleged that from 2009 to 2013, Novartis employees buried payments to various government officials in China as event planning and travel expenses, among other subterfuge.

This is far from the first FCPA action involving pharmaceutical companies and China.  Last month, the SEC settled with SciClone Pharmaceuticals over alleged bribery of Chinese health care professionals, with SciClone paying out approximately $13 million.  As they did with Novartis, the SEC alleged that SciClone employees were providing things like and related items to Chinese doctors.  Similarly, in October 2015, Bristol-Myers Squibb Co. settled a Department of Justice (“DOJ”) inquiry of alleged FCPA violations by providing items such as travel to doctors and other health care professionals at state-owned hospitals in China.

Pharmaceutical companies have not been the sole source of FCPA settlements with the U.S. government. Last month, software company PTC Inc. paid nearly $30 million to settle bribery allegations stemming from its Chinese subsidiary’s provision of trips to certain individuals employed by PTC customers.  In early March, Qualcomm settled like allegations for $7.5 million.

In part because of the unique nature of its economy, China is fraught with FCPA risk. Numerous major companies in China, especially hospitals, are state-owned enterprises (“SOE”).  The DoJ and the SEC have taken the position that state-owned enterprises act as instrumentalities of the Chinese government and are therefore considered foreign officials; thus employees of an SOE come within the ambit of the FCPA’s requirement that a foreign official be involved for FCPA liability to attach.  Routine actions for sales representatives in the United States may, potentially, accrue FCPA liability when executed in China precisely because of the SOE status.  Providing a business contact with tickets to sporting events, travel to conferences, meals, or the like can be a standard business practice around the globe – but, again, in China, when dealing with SOEs, FCPA liability lurks.

On March 15, Alere, yet another pharmaceutical giant, announced that it received a grand jury subpoena related to – almost without saying – FCPA compliance and sales practices in, among other places, China.  The string of FCPA settlements, and charges, is unlikely to cease.

On March 14, almost six months after Volkswagen AG (“VW”) admitted to installing software in its diesel vehicles to cheat emissions testing, VW was hit with a $3.6 billion lawsuit in Germany.  The case was filed in Braunschweig on behalf of 278 institutional investors, including investors from Australia, Austria, Canada, Denmark, France, Italy, Japan, Luxembourg, the Netherlands, Norway, Sweden, Switzerland, Taiwan, the U.K., and the U.S.  Investors claim that the German automaker took too long to disclose information about its diesel emissions scandal.

The U.S. Environmental Protection Agency (EPA) first publicly unveiled the scandal on September 18, 2015, when it issued a notice of violation of the Clean Air Act to VW.  VW reacted with an apologetic press release two days later and a formal market disclosure on September 22.  Immediately thereafter, VW’s stock price plummeted and VW became the target of regulatory investigations in multiple countries.

VW is currently facing a multitude of lawsuits around the world, including 70 cases pending in Braunschweig over losses on VW shares, seeking between 600 and 2 million euro.  While this suit is VW’s biggest legal challenge in Germany to date, it may not be the last.  Other institutional investors are reportedly in talks about bringing an additional suit.

For more information, see links below.