United States General Accountixig Office Washington, D.C. 20548 General Government Division B;278814 December 19, 1997 - < : The Honorable Thomas J. Bliley C-an, Committee on Commerce House of -Representatives-. - Subject: OTC Derivatives: Lawsuits Involving Sales Practice Concerns -‘Dear Mr. Chairman: This letter responds to a request made by your office during an October 16, 1997, briefjng on our report OTC Derivatives: Additional Oversight Could k (GAO/GGD-98-5, Oct. 2, 1997). This report addressed sales practices related to over-the-counter (OTC) derivatives, mortgage-backed securities (MBS), and structured notes. It included a discussion of lawsuits involving sales practices concerns, and your office asked us to provide a list of these lawsuits that describes the allegations made and the case outcomes. We produced the enclosed list from a database.of 360 losses involving OTC derivatives, MBS, and structured notes which we had compiled while working on our report1 To address your office’s request, we identified 13 OTC derivatives losses from this database that involved lawsuits in which the end- users had raised sales practice concerns. To determine the status of cases that were unresolved when we issued our report, we contacted SW from the relevant dealers and obtained information from public sources, including court ‘Our database of end-user losses was compiled from publicly available ‘information and regulatory data, including information taken from periodical and industry publications, special studies, litigation reporting services, and regulatory ease data The list was limited to end-user losses directly involving the products included in our report: OTC derivatives (forwards, options, and swaps), MBS, or structured notes. It excluded losses that dealers incurred or losses incurred by foreign end-users transacting with foreign dealers. The number and total dollar amount of losses in this list may be overstated as a result of including unrealized losses or losses . partially att&utable to products other than those addressed in the report. *I” These losses may also be understated to the extent that all losses were not :. publicly reported. w i” r’- 8, i _.- GAO/GGD-98-43Rz OTCDerivativesLawsuit B-278814 - documents, j&rnal articles, and/or press reports. We did not seek agency comments on this letter because we had already received extensive comments from all interested parties as part of preparing our report The enclosure to this letter presents additional information on the 13 lawsuits involving OTC derivatives sales practices. Of the 13 lawsuits, 6 involved Bankers Trust and the remainder involved several U.S. securities firms. The claims made in the lawsuits generally included statebased claims of fraud, breach.of fiduciary duty, and misrepresentation, but seven cases also involved claims under federal laws, including . fraud and other claims under the Commodity Exchange Act (CEA) or the Securities Exchange Act of 1934 (Exchange Act). In addition, the end-users in four of the cases claimed that their personnel had not been authorized to enter into the transactions. Three of the 11 cases are ongoing. ,. It is our understanding, based on conversations with your office; that our recently issued sales practice report, our briefing to your office, and this letter respond to the questions raised in your November 14, 1995, request regarding OTC derivatives sales practices. We plan to distribute copies of this letter to the Ranking Minority Member of your Committee and the Chairman and Ranking Minority Member of the Subcommittee on Finance and Hazardous Materials. In addition, we will provide copies to the Commodity Futures Trading Commission, the Federal Reserve, and the Securities and Exchange Commission, as well as others on request. Major contributors to this letter were Cecile 0. Trap; Assistant Director; Cody J. Goebel, Senior Evaluator; and Melvin Thomas, Senior Evaluator. Please contact me at (202) 512- 8678 or Cecile Trop at (312) 220-7705,if you or your staff have any questions. 1 Sincerely, Thomas McCool Director, Financial Institutions - and Markets Issues Enclosure 2 hAO/GGD-9%43R OTC Derivatives Lawsuits .c ‘_ :Enclosure Enclosure OTC Derivatives LossesInvolvina SalesPractice-Relatedlawsuits L Entity or Loss Specific type individual amount of derivative Relevant lawsult claims, Jo. reporting losses (millions)” product defenses, or counterclaitis Dealer , Outcome. of lawsuit I RCS Editori $371 Interest rate and Fraud, breach of fiduciary duty, Bankers Trust The parties settled for an undisclosed amount. (Italy) currency swaps and fraud under Italian securities law ! Henryk de $300 Currency Breach of fiduciary duty; : Bear Stearns Ongolng. In a ruling on the defendant’s motion to Kwiatowski forwards and negligence; fraud; negligent dismiss, the U.S. District Court for the Southern options :., misrepresentation; breach of District of New York allowed to stand the plaintiff’s 1 contract; and various violations claims related to breach of fiduciary duty, of the CEA, including fraud in negligence, and the count relating to fraud by a connection with the sale of commodities trading advisor (section 40). The commodities for future delivery court’s ruling dismissed the claims of fraud, (section 4b), fraud by a negligent misrepresentation, breach of contract, ant * commodities trading advisor the other CEA-related claims of fraud under section * (section 40) and dealing in 4b and illegal futures dealing. illegal off-exchange futures 3 State of West $280 Treasury Fraud Greenwich ’ The other dealers settled with the state for a total a Virginia options Capital 528 million, but after a jury trial in the Circuit Court Markets, of Kanawha County, West Virginia, Morgan Stanley Goldman was ordered to pay the state $56 million. The Sachs, Morgan Supreme Court of Appeals of West Virginia Stanley, overturned the lower court’s ruling and ordered a 1 NatWest new trial. Morgan Stanley subsequently settled Government with the state for $20 million. ’ Securities, and Salomon Brothers t z 3 GAOIGGD-98-43R OTC Derivatives J.awsuits Enclosure Enclostire Entity or Loss Speclflc type individual amount of derivative Relevant lawsuit claims, Uo. reporting losses (millions) product defenses, or counterclaims Dealer Outcome of lawsuit I Procter & Gamble $157 Interest rate Fraud, breach of fiduciary duty, Bankers Trust In ruling on a motion by Bankers Trust, the U.S. swaps negligence, misrepresentation, District Court of the Southern District of Ohio fraud in connection with the dismissed or found in favor of the dealer on all sale of a security under the securities and commodities law counts and left Exchange Act, and violations of counts related to fraud and contract validity to be the CEA’s general fraud section tried. On the day the ruling was issued, the two (4b) and fraud by a parties settled, with Bankers’Trust forgtvtng about commodities trading advisor $150 million of the $200 million that it was owed by (40) Procter & Gamble. 5 PT Dharmala $64 Interest rate Misrepresentation, breach of Bankers Trust The Commercial Court of England ruled in favor of Saktl Sejahtera swaps contract, breach of duty of Bankers Trust, indicating that the dealer owed no (Indonesia) care, and transactlon duties beyond that of ensuring that the facts In any conducted with unauthorized representations were made fairly and accurately. end-user personnel The parties subsequently settled for an undisclosed amount. Fraud, breach of fiduciary duty, Lehman Ongoing. / i Minmetals $52 Currency options and transaction conducted with Brothers swaps unauthorized end-user personnel, and fraud under the Exchange Act and the CEA I UNIPEC $44 Currency swaps Fraud, breach of fiduciary duty, Lehman The parties settled for an undisclosed amount. transaction conducted with Brothers unauthorized end-user / personnel, and fraud under the Exchange Act and the CEA I Seita ~,, ,,, $30 Interest,rate and Misrepresentation, breach of Salomon ’ Ongoing. if, currency swaps fiduciary duty, negligence, and Brothers ‘i ~: breach of contract I I. 4 GAO/GGD-98-43R OTC Derivatives Lawsuiti Enclosure Enblosure Entlty or Loss Specific type individual amount of derivative Relevant lawsuit claims, So. reporting losses (mllllons)’ product defenses, or counterclaims Dealer Outcome of lawsuit ‘. I Lastlo Tauber $26 Currency Fraud, breach of fiduciary duty, Salomon In a ruling later affirmed by .the Fourth Circuit Court, swaps, violations of state bucketing Brothers the US. District Court for the Eastern District of forwards, and and gambling laws, and Virginia rejected all of Tauber’s state-based options transactions in dispute were defenses and counterclaims. In addition, the court illegal off-exchange futures and concluded that the disputed transactions were options under the CEA exempt from the CEA and thereby rejected all of the counterclaims asserting that the dealer had violated the CEA. IO Gibson Greetings, $21 Interest rate Fraudulent concealment, Bankers Trust The parties settled, with Bankers Trust forgiving Inc. swaps and breach of fiduciary duty, $14 million of the $21 million owed to it by Gibson options reckless and negligent Greetings. misrepresentation, and violations of the CEA’s general fraud section (4b) and fraud by a commodities trading advisor (40) 1 Sinochem $20 Interest rate Transaction conducted with Lehman The parties settled for an undisclosed amount. swaps unauthorized end-user Brothers personnel 2 PT Adimitra $16 Interest rate Breach of fiduciary duty, Bankers Trust The U.S. District Court for the Southern District of Rayapratama swaps professional negligence, New York dismissed the federal commodities and negligent misrepresentation, RICO claims because they were precluded by the violation of the CEA parties’contractual choice of the Iah of England. commodities trading advisor The court also dismissed the common law claims fraud section (40) that remained because the dismissal of the federal and violation of the Racketeer law claims removed its jurisdiction over those Influenced and Corrupt claims. The parties subsequently settled for an Organizations Act (RICO) undisclosed amount. GAO/GGD-9843R OTC Derivatives Lawsuits Enclosure Enclosure EntIty or Loss Specific type individual amount of derivative Relevant lawsuit claims, No. reporting losses (millions)” product defenses, or counterclaims Dealer Outcome of lawsuit 13 Equity Group $11 Interest rate Negligent misrepresentation Bankers Trust The parties settled for an undisclos’ed amount. Holdings (bond) options and breach of flduclary duty .’ ?‘he loss amounts reported may include realizedltisses, unrealizedlosses,losses arising ifi p& fro& pro&As or activities other than OTC derivatives, or the amount of the loss may be in dispute. t; Sources: Court documents,journal articles, press accounts,knd interviews with dealer officiak. (233661) 6 GAO/GGD8843R OTC Derivatives Lawsuits Ordering Information The first copy of each GAO report and testimony is free. Additional copies are $2 each. 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OTC Derivatives: Lawsuits Involving Sales Practice Concerns
Published by the Government Accountability Office on 1997-12-19.
Below is a raw (and likely hideous) rendition of the original report. (PDF)