Monday, September 7, 2015

Digging and Drilling in the Commodities Markets

Last week we updated you on the FX investigations.  This week, we learned just a little more about the supervisory interest in keeping tabs on the potential for commodities misconduct.

Early in 2014, German regulator BaFin expressed its concern that precious metals manipulation (like currency manipulation) may be worse than the LIBOR-rigging scandal.

The LIBOR rigging is essentially centered in the window around 2007 to 2009/2010 and the FX and commodities misconduct may both have lasted longer.  From a benchmark rigging angle, the regulators have generally focused on 2009 - 2012, but the class actions are much broader, now often going all the way back to 2004.  Insofar as the guilty pleas are concerned, much of that is for misconduct after 2009/2010.

On Friday, the WSJ ran a very interesting story covering the FCA's (UK regulator) concerns about the monitoring of abuse in the commodities markets.  The WSJ article points out that the FCA's review "comes after recent changes in the market, in which a number of large banks, such as Barclays PLC and Credit Suisse Group AG, left commodity markets."

The FCA was really looking into internal surveillance procedures, but it did find certain lapses in (1) firms' monitoring of internal communications and (2) in their limited interest in submitting Suspicious Transaction Reports (or STRs) when noticing suspicious movements. This extract from the FCA's report captures some of their concern.
Firms that did not fully recognise the risks of market abuse were more likely to employ inappropriate surveillance, in terms of the choice of automated or manual systems, calibration of systems and frequency of monitoring. Overall, there was little order level monitoring, making it difficult for firms to demonstrate effective monitoring for market manipulation, and we often found surveillance being done on an inadequate or poorly targeted sample basis.  
Most firms’ communications surveillance captured Instant Messenger and recorded lines, but did not monitor these on a systematic basis. We observed more effective monitoring at firms where sampling was targeted at higher risk periods (such as at contract expiry or around important announcements) and at higher risk individuals 
Many firms had inadequate STR procedures, with typically no written procedures and a lack of clarity on what constitutes an STR. The number of STR submissions within the commodities sector is low in comparison to other asset classes, which may indicate that potential suspicious transactions are not being appropriately reported. 
It will be interesting to see whether the FCA will succeed in getting the banks to self-police in the commodities space, especially given so many of the large banks are so heavily short, notably betting against silver and gold.  Courtesy of Ed Steer, here's a graphical depiction of the bank's overriding short interest in silver (via CFTC's data on futures contracts).

As you'll see, the banks really started to get short (particularly the US banks) in mid 2008, and have been heavily net short ever since. The dynamic is still true of non-US banks, but is far less pronounced.

Wednesday, September 2, 2015

Currency Probe Updates

There's been quite a bit of action on the FX side since we last updated you in June.

First up, we've had a few more settlements (mostly undisclosed, but BNP Paribas reportedly settled for $115 mm) in the investor class action, taking that total to over $1.7 billion.

Next, we've seen an interest among some of the side action litigants in combining their over-the-counter (OTC) and exchange-based claims with the existing behemoth case, In re Foreign Exchange Benchmark Rates Antitrust Litigation Case No. 1:13-cv-07789-LGS (S.D.N.Y.). (see examples here and here).

Third, we've seen reports that suggest that US law firms are setting themselves up to bring these currency cases in Europe.

Last, on the regulatory side, there have been reports that regulatory bodies are broadening the scope of their prior investigations to include other currency pairs and that German supervisory authority BaFin is (perhaps newly) concerned about the sheer scale of ForEx manipulation.  BaFin expects to conclude its investigation next year but was on record in early 2014, reportedly saying that currency rigging (and metals rigging) was worse than that of LIBOR.

Thursday, August 27, 2015

Shaambles at AAMC

We have from time to time covered the mortgage servicing industry, paying particular attention to Ocwen (ticker: OCN) and its affiliates.[1]  While the past 20 months have been rocky for shareholders of Ocwen and its affiliates, for Altisource Asset Management Corporation (ticker: AAMC) it has been catastrophic.[2]

What is going on at AAMC?

Since reporting 2Q15 earnings before the open on August 10th, shares of AAMC have plunged 75%!  By comparison, the Russell 2000 has fallen 6% over the same timeframe.  So … what is going on with AAMC that has investors panicked?    

AAMC is “an asset management company that provides portfolio management and corporate governance services to investment vehicles that own real estate related assets.”[3]  By our reading, AAMC’s only significant client is another Ocwen affiliate, Altisource Residential Corporation (ticker: RESI).  RESI and AAMC are, uh, closely affiliated – they have the same management team (CEO; CFO; CAO; GC). 

Essentially all of AAMC’s revenue is dependent on the asset management fees it collects from RESI.  Those fees are determined by an Asset Management Agreement, which until recently, had been quite favorable to AAMC – at the expense of RESI shareholders.  (It probably won’t surprise you to learn that back in the day former Ocwen, RESI, and AAMC chairman William Erbey had a much larger dollar stake in AAMC than RESI.) 

But in February, RESI shareholder Capstone Equities complained about the one-sidedness of the arrangement, and demanded that the RESI board “terminate the Asset Management Agreement, dated as of December 21, 2012, (the “AMA”), for cause without paying a termination fee….” (emphasis in original) [4]

On March 31, 2015, RESI and AAMC revised their agreement[5], apparently (and oddly) to the relief of AAMC investors, who drove shares of AAMC up 40% over the following week.  Perhaps they were relieved that AAMC was able to retain its sole client.  But the new agreement apportions more of the pie to RESI and is much less favorable to AAMC. 

But the full extent of the damage to AAMC earnings may not have been readily apparent to shareholders until they were able to digest a quarter’s worth of post-agreement earnings, which they got August 10.  See table below for daily price action, which shows the slide beginning on the 10th of August.  

[1] You may recall that Ocwen has garnered the attention of regulators such as the CFPB, New York Department of Financial Services, and the California Department of Business Oversight, as well as investors such as BlueMountain Capital.
[2] AAMC is one of four companies to have spun off from Ocwen (technically AAMC spun off from ASPS, which itself spun off from Ocwen).

Wednesday, July 22, 2015

Should Puerto Rico Bondholders Get a Taxpayer Bailout?

Critics of extending Chapter 9 to Puerto Rico argue that the policy would allow the Commonwealth to wiggle out of its commitments. If Puerto Rico’s cities and public corporations can file bankruptcy petitions, they will be handed an option to avoid making debt service payments on time and in full.

Public sector entities don’t need municipal bankruptcy laws to default: thousands defaulted before Chapter 9 was first added to the bankruptcy code in 1934.  More recently, Harrisburg defaulted on multiple obligations despite the fact that Pennsylvania does not permit Chapter 9.

That said, opposition to Puerto Rico municipal bankruptcy is rooted in an important moral sense: when we make commitments, we should keep them. Performing on a bond indenture is just another form of keeping one’s word. If this moral underpinning of our debt markets were to seriously erode, borrowers would face much higher interest rates or even complete lack of access to funds.

But is this consideration an absolute or should it be balanced against other concerns? In the case of Puerto Rico, many public sector entities are no longer able to meet the expectations of all their stakeholders: which include public employees, service recipients and taxpayers in addition to bondholders.

Because bondholders have a written agreement that clearly outlines their claims, they warrant special consideration. That said, we need to recognize that bond commitments are often fulfilled by taking money from taxpayers - who may not have approved of the bonds in the first place.

In recent decades, conservatives have been very critical of taxation in all its forms. This stance is partially inspired by the libertarian view that “taxation is theft”. If we take this idea to its logical extreme, we conclude that the government has no right to service bonds with tax money – implying that all general obligation debt should be repudiated.

Since most of us have exposure, directly or indirectly, to tax supported debt, such a widespread repudiation would wreck considerable havoc. But, while we may shy away from the logical extreme, the taxpayer perspective deserves consideration. The bondholder’s right to repayment must be balanced against the taxpayer’s right to keep at least some of her income and wealth.

This moral balance can shift when the creditor is wealthy and at least some of the taxpayers aren’t. This is what united left and right in criticizing the 2008 bailout of AIG. It is important to remember that the largest beneficiaries of the AIG bailout were its creditors, many of whom were wealthy financial industry players like Goldman Sachs. The bailout of AIG thus constituted a wealth transfer from middle income taxpayers to the financial elite.

That could happen once again in the case of Puerto Rico. Much of the Commonwealth’s debt has been snappedup by hedge funds at steep discounts. If the funds can compel Puerto Rico public sector entities to service their bonds on time and in full, they will make substantial profits. One out of every five dollars of this profit will go to hedge fund managers, who will be taxed at lower capital gains rates.

For those reading this blog on the US mainland, the fact that taxpayer money might be unjustly diverted to hedge funds may not seem like a salient concern. But, it is, because a considerable share of Puerto Rico government revenue comes from taxpayers in the fifty states.

Public sector entities in Puerto Rico receive over $7.2 billion in federal grants annually. This amount represents over 10% of the Commonwealth’s GNP and 22% of total government spending. I have uploaded a list of recipient entities and amounts for FY 2013 here.

Further, according to, the US federal government spent a total of $21.3 billion in Puerto Rico in fiscal year 2014, while the IRS reports that Commonwealth residents and corporations contributed just $3.6 billion in federal tax revenue during the same year. The difference between these two figures – net transfers from taxpayers in the fifty states - represents about a quarter of Puerto Rico’s GNP.

Thus, Puerto Rico and its governments derive much of their revenue from US taxpayers. Although federal grants are always made for a specific purpose, government revenues and expenditures are fungible. Governments receiving federal support can shift their own-source revenue away from federally subsidized priorities and towards other purposes – such as enriching hedge fund managers.

Consequently, the debate over debt relief for Puerto Rico cannot be properly addressed by platitudes about fiscal responsibility and the need to live up to one’s commitments. By denying the Chapter 9 option to Puerto Rico municipalities and public corporations, Congressional Republicans might well be doing a disservice to the middle class taxpayers they claim to represent.

Monday, July 13, 2015

The Specious Case against Extending Chapter 9 to Puerto Rico

Last week, Congressional Republicans blocked legislation that would have allowed Puerto Rico public sector entities to file municipal bankruptcy petitions. Among their arguments against extending Chapter 9 to the Commonwealth are that bond investors – who purchased Puerto Rico obligations with the knowledge that issuers could not file bankruptcy – would be unfairly punished and that the island’s government has not implemented sufficient austerity measures.

While buyers of Puerto Rico bonds may have known that issuers did not have access to Chapter 9, they were aware that default was a distinct possibility – and that is all that really counts. We can confirm that investors knew of the existence of default risk by comparing Puerto Rico bond yields to risk free interest rates.

In November 2009, Puerto issued 30-year bonds at a yield of 6%. At the time, 30-year US Treasury bonds were yielding under 4.5%. While differences in liquidity might explain some difference in yields – this effect cannot possibly account for a 150bp gap. Further, interest on Puerto Rico bonds is exempt from federal income tax whereas Treasury bond interest is not (interest on both types of bonds is exempt from state and local income taxes. This tax effect should easily overwhelm any liquidity effect.

I use a 2009 example to show that investors have been pricing Puerto Rico default risk for a long time. Those who bought Puerto Rico bonds more recently demanded and received much higher default risk premia. The Commonwealth’s 2014 issue yielded 500 basis points above 30-year Treasuries and the gap has widened further in secondary trading.

Thus anyone who purchased Puerto Rico bonds over the last several years was compensated for default risk. Indeed, depending upon the type of restructuring Puerto Rico implements, many secondary market investors could still see positive returns.

During the Depression era, sub-sovereigns in the US, Canada and Australia (operating under similar legal systems) extended maturities and/or unilaterally reduced coupon rates. In all these cases (Arkansas, South Carolina, Alberta, Australia and New Zealand), investors eventually received their full principal. These older cases may be more relevant to Puerto Rico than the oft-cited cases of Detroit, Stockton and Greece in which investors suffered significant principal losses. Puerto Rico is more analogous to a US state than either Stockton or Detroit, and it is not a serial defaulter operating outside Anglo-Saxon law like Greece. In her recent government-commissioned report, former IMF Managing Director Ann Krueger argues that the Commonwealth can obtain debt relief “through a voluntary exchange of old bonds for new ones with a later/lower debt service profile.”

Why Chapter 9 Is Needed

Puerto Rico’s headline debt number - $72 billion of par representing a 104% debt/GNP ratio – includes a lot of moving parts. Some of this complexity is captured by the Commonwealth’s debt statement shown below. 

The statement shows numerous classes of debt – with varying coverage pledges – owed by different types of obligors. But it hides an even greater level of detail: the Commonwealth’s $4 billion in municipal debt is owed by 78 separate municipos – county-like entities – on the island. The $30 billion of public corporation debt was incurred by six different entities.

These obligors have widely varying levels of credit quality. As I reported in the Bond Buyer earlier this year, the Commonwealth’s third largest city, Carolina, was running a balanced budget and reported significant reserves in its 2013 financial statement. By contrast, the small municipio of Maunabo, was flat broke – with a large negative general fund balance, bank overdrafts and defaulting on a US Department of Agriculture loan. The Chapter 9 process would provide an essentially bankrupt community like Maunabo with the ability to reorganize its finances in a more sustainable manner. Fiscally healthy communities like Carolina can signal their strength to investors by avoiding Chapter 9 and continuing to perform on their obligations.

Inconvenient Truths about the Austerity Argument

Almost half of Puerto Rico’s debt was issued by entities other than the Commonwealth government. The Commonwealth’s $38 billion of debt represents just under 70% of Gross National Product. If we use Puerto Rico’s less widely reported (bur more internationally comparable) Gross Domestic Product as the denominator, the ratio falls to around 37%. All this compares favorably to the US federal government’s debt-to-GDP ratio of 74%.

The accompanying chart and this Google sheet show the evolution of Puerto Rico’s debt ratios over the last 40 years. The main takeaways are that the Commonwealth has had a heavy public sector debt burden for a long time, but it rose steadily 2000 to 2014. 

Puerto Rico had a Republican Governor for a significant part of this period: Luis Fortuño. Not only was he a Republican, but he was a darling of the Party establishment: invited to address the 2012 Republican Presidential convention and receiving consideration as a Vice-Presidential nominee. During Fortuño’s last full fiscal year, 2011-2012, total governmental revenues were $15.8 billion and total expenditures were $21.0 billion. The $5.2 billion deficit was the worst in ten years. Since the Democratically-aligned Alejandro Padilla administration took control, deficits have fallen. According to the most recent Commonwealth financial report, the general fund deficit fell from $2.4 billion in fiscal 2012 to $1.3 billion in fiscal 2013 and $0.9 billion in fiscal 2014.

This progression toward budgetary balance and the Commonwealth’s loss of market access have produced a flattening of Puerto Rico’s debt ratios. In the nine months ended March 2015, total public sector debt actually declined slightly in nominal terms.

Puerto Rico’s fiscal policy has thus been more austere under the current left-of-center government than under the prior Republican administration. Moreover, the Puerto Rican government is accumulating debt at a slower rate than the US federal government – which is now mostly under Republican control.

Thus, Congressional Republicans seem poorly positioned to lecture Puerto Rico about fiscal responsibility. A better alternative would be to approve Chapter 9 legislation, so that Commonwealth entities can get on with the process of restructuring their diverse debt burdens.

Tuesday, July 7, 2015

Disclosure, or What You Will

Seven years after the demise of Lehman Brothers, lawsuits on related financial products are heating up, with a number of RMBS and CDO cases seeing reversals of fortune. 

But first, some background. 

This may seem odd – but so far most of the arguments have had little to do with whether the defendants did anything wrong.[1]  

Rather, the focus has been on peripheral issues, like: (1) jurisdiction; (2) whether the plaintiffs had standing to sue; (3) whether the plaintiffs sued within the permissible time frame; (4) whether the defendants were indeed obligated to fulfill any of the duties they are accused of violating; and (5) whether the investment risks were appropriately disclosed. 

Recent rulings have focused on this final element, and have been rendered in a way largely favorable to the plaintiffs. This is the focal point of today’s post. 

Disclosures and Disclosures – Five Shades of Grey 

Disclosures are subjective issues; they are forms of art. And, most importantly, they are not Boolean – they are not simply present or absent. 

There are various shades of grey. Consider for example the following possible disclosures regarding a bridge: 
  1. Cross bridge at your own risk 
  2. We have performed one or more tests and happen to believe that this bridge is particularly risky, or more risky than other bridges 
  3. This bridge fails to satisfy the criteria set for bridges by the relevant architectural/building standards and safety boards 
  4. We built this bridge and know that it suffers from certain structural flaws 
  5. This may look like a bridge, but it is made of straw and has simply been dressed up to look like a bridge. Do not cross! 

These disclosures differ greatly, and one cannot reasonably argue that all provide the same informational content. 

Of course, it may be okay to sell a distressed asset or a structurally flawed house, as long as its known shortcomings are appropriately disclosed; but when a particular risk is known to one party (often the seller) we argue that the material information needs to be properly disclosed. 

For our purposes, it may be helpful to break disclosures down into three broad categories: 
  1. Those that are general (non-specific) and describe overall risk
  2. Those that describe particular risk(s)
  3. Those that describe the advanced knowledge that one party to an agreement has (over the other) pertaining to particular risk(s) 

Reliance – A Practitioner’s Perspective[2] 

The recent rulings, which we’ll get to in a moment, give us some confidence that the legal system is supporting the essence of what investing in the US financial markets is all about. 

The defenses that “it was disclosed that the investment contained risk” or that “we warned the investor to perform his own due diligence” seem to us to be off-point and insufficient. 

From a practitioner’s perspective, it should be noted that investors are just about always warned that investments contain risks. Of course they do – there’s seldom a reason to invest without the expectation of a positive return[3], and risk and return go hand in hand. And due diligence can often be impractical or prohibitively expensive, and even if it can be performed it may not uncover the true nature of hidden risks, especially if they are known only to certain insiders. 

But in this “trust -but-verify” bargain, is the “trust” element still there? 

Let’s suppose that due diligence could be performed. Should investors have to check everything – every piece of data represented to them to be true and accurate, every potential conflict disclosed or undisclosed, every legal opinion upon which the transaction’s solidity is based, and every accounting record? What is the purpose of a representation or warranty, if the onus remains on the person accepting the representation or warranty? 

In short, shouldn’t investors be allowed to rely on some things? 

Buying a new car encourages some level of diligence too – one may want to take it for a test-drive. But is it healthy to expect or require each car buyer to have advanced engineering or mechanical skills and to test each part for herself? 

We argue it isn’t: such due diligence, while commendable, defeats the purpose. When buying a new car, a purchaser ought to be able to rest easy, relying on her property rights and on the manufacturer’s name and representations, and fairly assume that the parts used are new, in working order, and are expected (certainly by the manufacturer) to last. 

Similarly, when buying a financial product that has been structured by a bank, it would promote market efficiency and be most expedient if investors were able to freely rely on representations and warranties made to them by the banks about the collateral supporting the product. And when a representation turns out to have been faulty, investors could then expect to have recourse through the court system – one of the very reasons overseas investors invest in US-based financial products! 

Decisions, Decisions… 

On the RMBS/CDO side, a recent lower court ruling and a slew of higher court rulings have ended favorably for plaintiffs, finding that the disclosures and disclaimers[4]  provided were not specific enough – reversing decisions made by lower courts that those disclosures had been sufficiently specific. 

Various groups of defendants, in different litigation matters, had regularly made the argument that they had disclosed that some of the thousands of loans that made their way into the mortgage pool may fail to comply with the representations and warranties made of them. Well that’s fair enough – there may have been a data error here or there that is yet to be discovered. 

But at the time of writing this disclosure that “some” loans “may” fail, the truth was very different. Often some loans were already failing (and known to have been failing) to meet one or more of the criteria needed to pass. Moreover, and importantly, it was even the expectation of some defendants at that time that several other loans would imminently be found to fail too. 

In other words, several defendants made the weakest possible disclosure: that something may possibly happen. Meanwhile, defendants often already knew that it was happening, and often en masse. Disclosing that a violation may occur is different from disclosing (1) that violations are known to be occurring, or (2) that the procedures employed leave ample room for the occurrence of violations (and so forthcoming violations should be expected).[5] 

As it happens, in some cases defendants had set up tests to identify noncompliance in loans sampled within the pool. When they found that a high percentage of the sampled loans failed to comply with the representations and warranties, they failed to re-examine the non-sampled loans, but waived them into the securitization trusts anyway. Thus, they knew, or should have known, that a high percentage of the non-sampled loans would fail to meet the criteria upon which they were being purchased into the trusts. In FHFA v Nomura, the court examined the true nature of the mortgage loans being waived into the trust as conforming collateral: 
"Measured conservatively, the deviations from originators’ guidelines made anywhere from 45% to 59% of the loans in each [supporting loan group] materially defective, with underwriting defects that substantially increased the credit risk of the loan."[6] 

Some Examples – Decisions Favorable to Plaintiffs 

     Basis Yield v Goldman (CDO) [7]

The First Department decided that the disclosures were “boilerplate statements” that failed to put the investors on notice of the nature of the risks inherent in the investment (as alleged by the plaintiffs) [8]. The court held that if “plaintiff's allegations are accepted as true, there is a ‘vast gap’ between the speculative picture Goldman presented to investors and the events Goldman knew had already occurred.”[9]  

     ACA v Goldman (CDO) 

In May 2015, the New York Court of Appeals – the state’s highest court – reversed an order by the Appellate Division, holding that “plaintiff here claims that defendant knew that [co-defendant] Paulson was taking a position contrary to plaintiff's interest, but withheld that information, despite plaintiff's inquiries.”[10] 

     FHFA v Nomura (RMBS) 

In this bench trial, the court honed in on the direct issue at hand, ruling in favor of the plaintiff: 
“This case is complex from almost any angle, but at its core there is a single, simple question. Did defendants accurately describe the home mortgages in the Offering Documents for the securities they sold that were backed by those mortgages?”[11] 
     Basis Yield v Morgan Stanley (CDO) 

The court leaned heavily on several prior rulings[12] of the First Department which had recently rejected most of the contentions raised by Morgan Stanley, similar to those advanced in the same court. 

In the court’s words, “The First Department held that New York law is ‘abundantly clear’ that ‘a buyer’s disclaimer of reliance cannot preclude a claim of justifiable reliance on the seller’s misrepresentations or omissions unless (1) the disclaimer is made sufficiently specific to the particular type of fact misrepresented or undisclosed; and (2) the alleged misrepresentations or omissions did not concern facts peculiarly within the seller’s knowledge.” 

In denying Morgan Stanley’s motion to dismiss, the court held that, assuming plaintiff’s allegations to be true, the disclosures “did not apprise investors that Morgan Stanley had deliberately sabotaged assets in the CDO to profit from its short positions.”[13] 

Some Examples – Decisions Favorable to Defendants 

     HSH Nordbank v UBS AG (RMBS) 

HSH Nordbank is one example of an RMBS ruling that went the way of defendants. 

The court ruled that “Here, the core subject of the complained-of representations was the reliability of the credit ratings used to define the permissible composition of the reference pool. The reliability of those ratings was the premise on which the entire deal was sold to HSH. Far from being peculiarly within UBS's knowledge, the reliability of the credit ratings could be tested against the public market's valuation of rated securities.” 

In other words, plaintiff HSH could reasonably have uncovered that the ratings were misrepresented had HSH exercised the necessary due diligence.[14] 

     Lanier v BATS (HFT) 

Lanier, a case concerning high-frequency trading (or HFT), presents a more recent set-back for plaintiffs. 

Lanier’s argument, to a degree, is this: Lanier paid for time-sensitive trading information from NASDAQ; NASDAQ has other clients who paid more, and so they got this time-sensitive information before Lanier did, rendering the information stale and inaccurate by the time it arrived at Lanier’s desk. Lanier argues that he was not appropriately informed that he was being trumped – and that the spirit of the agreement was that nobody would get information before him. 

To use the court’s words, Lanier’s argument is that “when defendants make market data available to preferred data customers more quickly than other customers, they violate Regulation NMS, which is incorporated by reference into contracts between plaintiff Lanier and defendants.” In his words, he seeks “redress for a violation of a contractual commitment prohibiting defendants from providing earlier access to market data to Preferred Data Customers” and as a result, the sale of stale data to him. 

In Lanier’s words, “The Preferred Data Customers are then able to cancel orders and execute trades before Subscribers [like Lanier] even receive the market data.” 

But the court sympathized with the provision of what seems to us to be an extraordinarily weak form of disclosure. The court viewed the following paragraph in the subscription agreement to have been, in the court’s words, “pertinent.” 
“Neither NYSE, any Authorizing SRO nor the Processor (the “disseminating parties”) guarantees the timeliness, sequence, accuracy, or completeness of Market Data or other market information or messages disseminated by any disseminating party. No disseminating party shall be liable in any way to Subscriber or to any other person for (a) any inaccuracy, error or delay in, or omission of, (i) any such data, information, or message, or (ii) the transmission or delivery of any such data, information or message, or (b) any loss or damage arising from or occasioned by (i) any such inaccuracy, error, delay or omission, [or] (ii) non-performance . . . .” (emphasis added by the court) [15]
The court also took particular comfort in the provision within the Nasdaq Subscriber Agreement of a disclosure that reads “STOCK QUOTES MIGHT NOT BE CURRENT OR ACCURATE” and grants the motion to dismiss, preventing any further discovery.[16] 

 Indeed Nasdaq warranted to Lanier that it would “endeavor to offer the Information as promptly and accurately as is reasonably practicable.” If we take plaintiff’s allegations to be true, as we must at the motion to dismiss stage, then clearly NASDAQ did not provide it to Lanier as promptly as reasonably practicable, and it knew it wasn’t doing so. 

The court asserted that Lanier’s “argument misreads the Subscriber Agreements, which promise one thing: the provision of consolidated market data to Lanier and other subscribers like him. The contracts do not prohibit provision of the same data in different forms to different kinds of customers, whether in consolidated or unconsolidated form. And in general the duty of good faith and fair dealing does not provide a cause of action separate from a breach of contract claim, as “breach of that duty is merely a breach of the underlying contract.” 

Sadly, in rendering its opinion the court ignores the spirit of the agreement – the intent – and probably the content too. 


[1] For example, in a bench trial (FHFA v Nomura), the court noted that no real defense was presented as to the inappropriateness of defendants’ actions. “Today, defendants do not defend the underwriting practices of their originators. They did not seek at trial to show that the loans within the SLGs were actually underwritten in compliance with their originators’ guidelines. At summation, defense counsel essentially argued that everyone understood back in 2005 to 2007 that the loans were lousy and had not been properly underwritten.” Opinion at page 267. 

[2] Our goal here is to share a practitioner’s perspective. We do not provide advice of any kind –certainly not legal advice. 

[3] As scientists we must disclose our awareness of several situations in which investments are made without the expectation of a directly positive return, above 0%. While such examples exist, they are in the great minority of investments. For example, 5-year Swiss government bonds currently yield negative 0.539%, and there do exist rational arguments for investing in a negative yielding instrument, including for lack of available alternatives.) 

[4] Hereafter, we will use the short-hand “disclosures” to describe both disclosures and disclaimers. 

[5] An argument could be made that disclosure is faulty when it describes an occurrence as a remote possibility, when it’s known to be likely or inevitable – akin to a form of false advertising. Such disclosure disguises the true nature of the possibility. 

[6] Opinion at page 171 

[7] First Department decision and opinion at page 9 (1/30/2014) 

[8] In the court’s words “These disclaimers and disclosures, in our view, fall well short of tracking the particular misrepresentations and omissions alleged by plaintiff.” 

[9] A similar finding was made by the First Department in Loreley v Citigroup

[10] ACA Financial Guaranty Corp., Appellant, v. Goldman, Sachs & Co., Respondent, Paulson & Co., Inc. et al., NY INDEX NO. 650027/2011; Court of Appeals, No. 49, at page 4 (5/7/2015). Importantly, the court notes that ACA’s case differs from a prior case, in which the plaintiffs "knew that defendants had not supplied them with the financial information to which they were entitled, triggering 'a heightened degree of diligence.'" (Pappas v Tzolis, 20 NY3d 228, 232-233 [2012], quoting Centro Empresarial Cempresa S.A. 17 NY3d at 279). 

[11] Opinion and order at page 7

[12] Specifically, Loreley v Citigroup; Loreley v Merrill Lynch; Basis Yield v Goldman; and CDIB v Morgan Stanley 

[13] For example, the court specifically notes that the disclosure that Morgan Stanley would be acting in ‘its own commercial interest’ was … insufficient to put the Fund on notice of Morgan Stanley’s intent to offload low-rated RMBS from its books.” 

[14] For what it’s worth, our opinion is that it is impractical to have to second guess every party to a transaction; and having tried to, we can argue that it is very difficult if not impossible for a non-rating agency expert (and possibly even for a ratings expert) to effectively reverse-engineer ratings agencies’ complex models – which are often black-boxes, driven by and reliant on internal assumptions that cannot be seen by the most sophisticated of users. Having said that, the court raised its concern that, according to its reading of the amended complaint, HSH may not have provided sufficient factual information to support such the allegation, in the court’s words, “that the credit rating conferred on a security by a rating agency did not necessarily correspond to the security's risk level as perceived by the market.” 

[15] Ruling at page 26

[16] Here we have the same issue: Does disclosing the potential for delays in data distribution appropriately notify the subscriber that the data provided to him was always or regularly or intentionally being delayed? Aside from the omissions complained of, this disclosure, itself seems untruthful. Is it not misleading to state that “a quote might not be current,” when knowing that it is not current? If one wanted to be honest, one would disclose: “quotes are not current – beware!” 

CASE CAPTIONS (links can be clicked to download opinions)

ACA v Goldman: ACA Financial Guaranty Corp., Appellant, v. Goldman, Sachs & Co., Respondent, Paulson & Co., Inc. et al., NY INDEX NO. 650027/2011 

Basis Yield v Goldman: Basis Yield Alpha Fund (Master) v Goldman Sachs Group, Inc., NY INDEX NO. 652996/2011; 2014 NY Slip Op 00587 

Basis Yield v Morgan Stanley: Basis Yield Alpha Fund Master v Morgan Stanley, NY INDEX NO. 652129/2012 

CDIB v Morgan Stanley: China Development Industrial Bank v Morgan Stanley & Co. Incorporated et al, NY INDEX NO. 650957/2010 

FHFA v Nomura: Federal Housing Finance Agency (“FHFA”) v Nomura Holding America, Inc., et al, 11-cv-06201-DLC 

HSH Nordbank: HSH Nordbank AG v UBS AG et al, 2012 NY Slip Op 02276 

Lanier v BATS: HAROLD R. LANIER, on behalf of himself individually and on behalf of others similarly situated v BATS Exchange, Inc. et al, 14-cv-03865-KBF 

Loreley v Citigroup: Loreley Financing (Jersey) No. 3 Ltd., et al v Citigroup Global Markets Inc., et al, NY INDEX NO. 650212/2012; 2014 N.Y. Slip Op. 03358 (N.Y. App. Div. 2014) 

Loreley v Merrill Lynch: Loreley Financing (Jersey) No. 28, Limited v Merrill Lynch, Pierce, Fenner & Smith Incorporated, et al., NY INDEX NO. 652732/2011; 2014 NY Slip Op 03326 (N.Y. App. Div. 2014) 

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