Collateralized Debt Obligations

Citigroup Must Contend With $1B New York CDO Lawsuit, Says Appeals Court

Published on: May 9, 2014 | by Shepherd Smith Edwards & Kantas, LLP

A New York appeals court says that Citigroup (C) must face a collateralized debt obligation lawsuit accusing the firm of lying about the risks involved in nearly $1 billion of securities. The plaintiff is Loreley Financing, a group of investment companies in the Channel Islands that was set up to invest in CDOs. It has made similar allegations in separate CDO fraud cases against other banks.

In 2012, Loreley sued Citigroup Global Markets Inc. in New York State Supreme Court in Manhattan. The plaintiff alleged that the bank secretly selected the most high-risk mortgages for sale in CDOs while purchasing credit default swaps in order to bet against them. The investment group says that Citigroup employed a similar strategy to help clients get rid of mortgage-backed securities that were toxic.

According to Loreley, it purchased $965 million of notes through Citigroup, which then made money by charging fees and getting rid of loans that were likely to sustain losses. The investment group wants the purchases rescinded and its money returned.

Goldman Sachs Must Contend with Proposed Class-Action CDO Lawsuit

Published on: January 22, 2014 | by Shepherd Smith Edwards & Kantas, LLP

U.S. District Judge Victor Marrero says that Goldman Sachs Group Inc. (GS) must face a proposed class action securities case accusing it of defrauding customers that purchased specific collateralized debt obligations at the beginning of the financial crisis. The lead plaintiff, Dodona I LLC, contends that the firm created two Hudson CDOs that were backed by residential mortgage backed-securities even though Goldman knew that subprime mortgages were doing badly.

The hedge fund claims that Goldman tried to offset its prime risk, even betting that subprime mortgages and the securities constructed around them would lose value—essentially making the CDOs to lower its own subprime exposure and simultaneously shorting them at cost to investors. Dodona purchased $4 million of Hudson CDOs.

Meantime, Goldman said that the proposed class action case should be dropped and that instead, Hudson CDO claims should be made independently. The bank said that the current case has too many conflicts and differences. Judge Marrero, however, disagreed with the bank.

Merrill Lynch Settles with SEC Over CDO Disclosures for Almost $132M

Published on: December 16, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The Securities and Exchange Commission says that Merrill Lynch Pierce Fenner & Smith Inc. (MER) will pay $131.8M to settle charges involving allegedly faulty derivatives disclosures. The regulator claims that the firm, which is the largest broker-dealer by client assets, misled investors about certain structured debt products before the economic crisis. By settling, Merrill is not denying or agreeing to the allegations. Also, the brokerage firm was quick to note that the matter for dispute occurred before Bank of America (BAC) acquired it.

According to the Commission, in 2006 and 2007 Merrill Lynch did not tell investors that Magnetar Capital impacted the choice of collateral that was behind specific debt products. The hedge fund purportedly hedged stock positions by shorting against Norma CDO I Ltd. and Octans I CDO Ltd., which are two collateral debt obligations that the firm was selling to customers.

The SEC contends that Merrill used misleading collateral to market these CDO investments. According to Division of Enforcement co-director George Canellos, the materials depicted an independent process for choosing collateral that benefited long-term debt investors and customers did not know about the role Magnetar Capital was playing to choose the underlying portfolios.

Both Sides Rest in Ex-Goldman Sachs Bond Trader Fabrice Tourre’s Trial For Alleged Mortgage-Backed Securities Fraud

Published on: July 29, 2013 | by Shepherd Smith Edwards & Kantas, LLP

In federal court, both the Securities and Exchange Commission and former Goldman Sachs Group (GS) vice president Fabrice Tourre have both rested their case in the civil trial against the bond trader. Tourre is accused of MBS fraud for his alleged involvement in a failed $1 billion investment connected to the collapse of the housing market. After the SEC finished presenting its evidence, U.S. District Judge Katherine Forrest turned down Tourre’s bid to have the securities case against him thrown out. He denies wrongdoing and says that his career is in now in shambles.

According to the regulator, Tourre purposely misled participants in the Abacus 2007-AC about the involvement of John Paulson’s hedge fund Paulson and Co. The Commission contends that Tourre concealed that Paulson helped select the portfolio of the subprime MBS underlying Abacus—a $2 billion offering linked to synthetic collateralized debt obligations. The latter then shorted the deal by betting it would fail.

The SEC’s complaint points to Tourre as primarily responsible for the CDO, which it says says he devised and prepped marketing collateral for and was in direct contact with investors. The regulator believes that by failing to disclose Paulson’s role, Tourre broke the law. They also contend that instead the bond trader instead told customers that as an Abacus investor, Paulson’s hedge fund expected the securities to go up.

Cayman Islands LLC Must Replead CLO Securities Case Against Deutsche Bank

Published on: June 24, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The U.S. District Court for the Southern District of New York says that Arco Capital Corp. a Cayman Islands LLC, has 20 days to replead its $37M collateralized loan obligation against Deutsche Bank AG (DB) that accuses the latter of alleged misconduct related to a 2006 CLO. According to Judge Robert Sweet, even though Arco Capital did an adequate job of alleging a domestic transaction within the Supreme Court’s decision in Morrison v. National Australia Bank, its claims are time-barred, per the two-year post-discovery deadline and five-year statute of repose.

Deutsche Bank had offered investors the chance to obtain debt securities linked to portfolio of merging markets investments and derivative transactions it originated. CRAFT EM CLO, which is a Cayman Islands company created by the bank, effected the transaction and gained synthetic exposure via credit default transactions. For interest payment on the notes, investors consented to risk the principal due on them according to the reference portfolio. However, if a reference obligation, which had to satisfy certain eligibly requirements, defaulted in a way that the CDS agreements government, Deutsche Bank would receive payment that would directly lower the principal due on the notes when maturity was reached.

Arco maintains that the assets that experienced credit events did not meet the criteria. It noted that Deutsche Bank wasn’t supposed to use the transaction as a repository for lending assets that were distressed, toxic, or “poorly underwritten.”

Synthetic CDOs Once Are Once Again In Demand Among Investors

Published on: June 4, 2013 | by Shepherd Smith Edwards & Kantas, LLP

Despite the damage attributed to them during the 2008 credit market crisis, synthetic collateralized debt obligations are once again in high demand among investors. The popularity of these risky investments, with their high returns and rock-bottom interest rates, are so high that even after being denounced by investors and a lot of lawmakers back in the day, now Morgan Stanley (MS) and JPMorgan Chase (JPM ) in London are among those seeking to package these instruments.

CDOs allow investors to bet on a basket of companies’ credit worthiness. While the basic version of these instruments pool bonds and give investors an opportunity to put their money in a portion of that pool, synthetic CDOs pool the insurance-like derivatives contracts on the bonds. These latest synthetic CDOs, like their counterparts that existed during the crisis, are cut up into varying levels of returns and risks, with investors wanting the highest returns likely buying portion with the greatest risk.

Granted, synthetic CDOs do somewhat spread the risk. Yet, also can increase the financial harm significantly if companies don’t make their debt payments.

Standard & Poor’s Seeks Dismissal of DOJ Securities Fraud Lawsuit Over RMBS and CDO Ratings Issued During the Financial Crisis

Published on: May 9, 2013 | by Shepherd Smith Edwards & Kantas, LLP

In the U.S. District Court for the Central District of California, Standard & Poor’s Financial Services LLC is asking for the dismissal of a US Department of Justice securities fraud lawsuit accusing the ratings firm of knowing that it was issuing faulty ratings to collateralized debt obligations and residential mortgage-backed securities during the financial crisis. S & P is contending that the claims are against judicial precedent and don’t establish wrongdoing.

The government sued the credit rating giant and its parent company McGraw-Hill Companies Inc. (MHP) earlier this year. It claims that S & P took part in a scheme to bilk investors by wrongly representing that its ratings for collateralized debt obligations and residential mortgage backed securities were independent and objective, purposely giving artificially high ratings to specific securities, and ignoring the risks involved. Submitted under the 1989 Financial Institutions Reform, Recovery, and Enforcement Act, this is the first federal legal action filed against a rating agency related to the economic crisis.

Now, however, S & P is arguing that the DOJ’s RMBS lawsuit does not succeed in alleging fraud. The credit rater says that it shouldn’t be blamed for not having been able to foresee the financial crisis of 2008.

Standard Poors Wants DOJ’s Mortgage Debt Lawsuit Against It Tossed

Published on: April 24, 2013 | by Shepherd Smith Edwards & Kantas, LLP

Standard Poors is asking a judge to dismiss the US Justice Department’s securities lawsuit against it. The government claims that the largest ratings agency defrauded investors when it put out excellent ratings for some poor quality complex mortgage packages, including collateralized debt obligations, residential mortgage-backed securities, and subprime mortgage-backed securities, between 2004 and 2007. The ratings agency, however, claims that the DOJ has no case.

Per the government’s securities complaint, financial institutions lost over $5 billion on 33 CDOs because they trusted S & P’s ratings and invested in the complex debt instruments. The DOJ believes that the credit rater issued its inaccurate ratings on purpose, raising investor demand and prices until the latter crashed, triggering the global economic crisis. It argues that certain ratings were inflated based on conflicts of interest that involved making the banks that packaged the mortgage securities happy as opposed to issuing independent, objective ratings that investors could rely on.

Now, S & P is claiming that the government’s lawsuit overreaches in targeting it and fails to show that the credit rater knew what the more accurate ratings should have been, which it contends would be necessary for there to be grounds for this CDO lawsuit. In a brief submitted to the United States District Court for the Central District of California, in Los Angeles, S & P’s lawyers argue that there is no way that their client, the Treasury, the Federal Reserve, or other market participants could have predicted how severe the financial meltdown would be.

Deutsche Bank Settles Massachusetts CDO Case for $17.5 Million

Published on: April 1, 2013 | by Shepherd Smith Edwards & Kantas, LLP

Deutsche Bank Securities Inc. has consented to pay $17.5 million to the state of Massachusetts to settle allegations by that it did not disclose conflicts of interest involving collateralized debt obligation-related activities leading up to the financial crisis. Secretary of the Commonwealth William Galvin also is accusing the firm of inadequately supervising employees that knew about the conflicts but did not disclose them. DBSI, a Deutsche Bank AG (DB) subsidiary, has agreed to cease and desist from violating state securities law in the future.

In particular, the subsidiary allegedly kept secret its relationship with Magnetar Capital LLC. Galvin claims that DBSI proposed, structured, and invested in a $1.6 billion CDO with the Illinois hedge fund, which was shorting some of the securities’ assets. In total, Deutsche Bank Securities and Magnetar are said to have invested in several CDOs worth approximately $10 million combined.

The state of Massachusetts’s case focused on Carina CDO Ltd., of which Magnetar was the sponsor that invested in the security’s equity and shorted the assets that were BBB-rated. Ratings agencies would go on to downgrade the collateralized debt obligation to junk. Galvin contends that it was Deutsche Bank’s job to tell investors what Magnetar was doing rather than keeping this information secret.

US Justice Department Sues Standard and Poor’s Over Allegedly Fraudulent Ratings of Collateralized Debt Obligations

Published on: February 5, 2013 | by Shepherd Smith Edwards & Kantas, LLP

The US Department of Justice and has filed civil fraud charges against Standard & Poor’s Ratings Service, contending that credit rating agency’s fraudulent ratings of mortgage bonds played a role in causing the economic crisis. Settlement talks with Justice Department reportedly broke down after the latter indicated that it wanted at least $1 billion. S & P was hoping to pay around $100 million. Also, there was disagreement between both sides as to whether or not the credit rater could agree to settle without having to admit to any wrongdoing.

The securities case against S & P involves over 30 collateralized debt obligations, which were created in 2007 when the housing market was at its height. The government believes that between September 2004 and October 2007 the credit rater disregarded the risks that came along with the investments, giving them too high ratings in the interest of profit and gaining market share. The ratings agency allegedly wanted the large financial firms and others to select it to rate financial instruments. Meantime, S & P continued to tout its ratings as objective, misleading investors as a result. S & P would go on to make record profits, and the complex home loan bundles eventually failed.

Although there have been questions for some time now about the credit ratings agencies’ role in creating a housing bubble, this is the first securities lawsuit brought by the government against one of these firms over the financial crisis. It was in 2010 that a Senate probe revealed that from 2004 to 2007 S & P and Moody’s Investors Service (MC) both applied rating models that were inaccurate, which caused them to fail to predict exactly how well the risky mortgages would do. The lawmakers believed that the credit rating agencies let competition between each other affect how well they did their jobs.