THE SCANDAL—WHAT IT MEANS FOR THE LEGAL COMMUNITY, INVESTORS, TRADERS AND NSTITUTE

I BORROWERS

Prepared in connection with a Continuing Legal Education course presented at New York County Lawyers’ Association, 14 Vesey Street, New York, NY scheduled for December 6, 2012

Program Sponsor: NYCLA's Futures and Derivatives Committee

CLE Program Co-sponsor: NYCLA's Securities and Exchanges Committee

Program Chairs: Stuart Shroff, Esq. and Blair H. Wallace, Och-Ziff Capital Management Group

FACULTY:

Jonathan Ching, Jones Day Gordon Eng, SKY Harbor Capital Management LLC Susan E. Foster, Perkins Coie

NYCLA

This course has been approved in accordance with the requirements of the New York State Continuing Legal Education Board for a maximum of 2.5 Transitional and Non-Transitional credit hours; 1.5 Professional Practice; 1 Ethics. This program has been approved by the Board of Continuing Legal education of the Supreme Court of New Jersey for 2.5 hours of total CLE credits. Of these, 1 qualify as hours of credit for ethics/professionalism, and 0 qualify as hours of credit toward certification in civil trial law, criminal law, workers compensation law and/or matrimonial law. ACCREDITED PROVIDER STATUS: NYCLA’s CLE Institute is currently certified as an Accredited Provider of continuing legal education in the States of New York and New Jersey.

Information Regarding CLE Credits and Certification The LIBOR Scandal December 6, 2012 6:00 PM to 8:05PM

The New York State CLE Board Regulations require all accredited CLE providers to provide documentation that CLE course attendees are, in fact, present during the course. Please review the following NYCLA rules for MCLE credit allocation and certificate distribution.

i. You must sign-in and note the time of arrival to receive your course materials and receive MCLE credit. The time will be verified by the Program Assistant.

ii. You will receive your MCLE certificate as you exit the room at the end of the course. The certificates will bear your name and will be arranged in alphabetical order on the tables directly outside the auditorium.

iii. If you arrive after the course has begun, you must sign-in and note the time of your arrival. The time will be verified by the Program Assistant. If it has been determined that you will still receive educational value by attending a portion of the program, you will receive a pro-rated CLE certificate.

iv. Please note: We can only certify MCLE credit for the actual time you are in attendance. If you leave before the end of the course, you must sign-out and enter the time you are leaving. The time will be verified by the Program Assistant. Again, if it has been determined that you received educational value from attending a portion of the program, your CLE credits will be pro-rated and the certificate will be mailed to you within one week.

v. If you leave early and do not sign out, we will assume that you left at the midpoint of the course. If it has been determined that you received educational value from the portion of the program you attended, we will pro-rate the credits accordingly, unless you can provide verification of course completion. Your certificate will be mailed to you within one week.

Thank you for choosing NYCLA as your CLE provider!

New York County Lawyers’ Association

Continuing Legal Education Institute 14 Vesey Street, New York, N.Y. 10007 • (212) 267-6646

The LIBOR Scandal -- What It Means for the Legal Community, Investors, Traders and Borrowers December 6, 2012 6:00 PM - 8:05PM

Program Sponsor: NYCLA's Futures and Derivatives Committee

Program Co-sponsor: NYCLA's Securities and Exchanges Committee

Program Chairs: Stuart Shroff, Esq. and Blair H. Wallace, Och-Ziff Capital Management Group

AGENDA

5:30 PM – 6:00 PM Registration

6:00 PM – 6:05 PM Introductions and Announcements

6:05 PM – 6:35 PM Liabilities and Potential Recoveries Susan E. Foster, Perkins Coie

6:35 PM – 7:05 PM Ethical Considerations Gordon Eng, SKY Harbor Capital Management LLC

7:05 PM – 7:35 PM Future Reform of the Rates Underlying Futures, Derivatives and Loans Jonathan Ching, Jones Day

7:35 PM – 8:05 PM Questions and Answers Panel

New York County Lawyers’ Association

Continuing Legal Educatio n Institute 14 Vesey Street, New York, N.Y. 10007 • (212) 267-6646

The LIBOR Scandal -- What It Means for the Legal Community, Investors, Traders and Borrowers December 6, 2012 6:00 PM - 8:05PM

Program Sponsor: NYCLA's Futures and Derivatives Committee

Program Co-sponsor: NYCLA's Securities and Exchanges Committee

Program Chairs: Stuart Shroff, Esq. and Blair H. Wallace, Och-Ziff Capital Management Group

Table of Contents

Barclays Non-Prosecution Agreement

Barclays Statement of Facts

Complaint: City Council of

The Wheatley Review of LIBOR

Ethics Hypothetical

Applicable Rules of Professional Conduct

Applicable CFR Sections

Public Statement by SEC Official: Letter Regarding Washington State Bar Association's Proposed Opinion on the Effect of the SEC's Attorney Conduct Rules

Applicable SEC CFR Sections

Applicable Securities and Exchange Act of 1934 Sections

ABA Letter Re Preserving the Attorney-Client Privilege and the Lawyer’s Existing Duty to Maintain Client Confidentiality in the Commission’s Proposed Rules for Implementing the Provisions of Section 21F of the Securities Exchange Act of 1934; File No. S7-33-10; Release No. 34-63237

Statement by SEC Commissioner: Adoption of Rules for Implementing the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934

Applicable Statutes Title 18

The LIBOR Scandal – What it Means for the Legal Community, Investors, Traders and Borrowers, by Jonathan Ching, Jones Day

Faculty Biographies

federal antitrust law against the Defendants identified below (collectively, “Defendants”) arising from their manipulation of the London InterBank Offered Rate (“LIBOR”) from on or before

August 9, 2007 through at least February 2009 (the “Class Period”).

2. The Baltimore Plaintiffs’ claims are made on information and belief (except as to allegations specifically pertaining to the Baltimore Plaintiffs and their counsel, which are made on personal knowledge) based on the investigation conducted by and under the supervision of the Baltimore Plaintiffs’ counsel. That investigation included reviewing and analyzing information concerning Defendants and LIBOR that the Baltimore Plaintiffs (through their counsel) obtained from, among other sources: (i) analyses by consulting experts engaged by plaintiffs in these coordinated proceedings; (ii) publicly available press releases, news articles, and other media reports (whether disseminated in print or by electronic media); (iii) filings

Defendants made with the United States Securities and Exchange Commission (“SEC”); (iv)

court documents submitted in LIBOR-related proceedings in Canada, Singapore, and Japan; and

(v) scholarly literature concerning the potential manipulation of LIBOR during the Class Period.

Additionally, pursuant to the Antitrust Criminal Penalty Enhancement and Reform Act (Pub. L.

No. 108-237, tit. II, 118 Stat. 661, 665, extended by Pub. L. No. 111-190, 124 Stat. 1275), the

conditional leniency applicant to the United States Department of Justice has commenced

providing cooperation to the Baltimore Plaintiffs and is expected to continue doing so. Those

sources collectively support the Baltimore Plaintiffs’ allegations that Defendants collusively and

systematically suppressed LIBOR during the Class Period so that the interest rates on LIBOR-

based instruments that the Baltimore Plaintiffs purchased during that time were lower than they

otherwise would have been absent Defendants’ misconduct.

3. Except as alleged in this Complaint, neither the Baltimore Plaintiffs nor other

973672.6 -2- members of the public have access to the underlying facts relating to Defendants’ improper activities. Rather, that information lies exclusively within the possession and control of

Defendants and other insiders, which prevents the Baltimore Plaintiffs from further detailing

Defendants’ misconduct. Moreover, numerous pending government investigations—both domestically and abroad, including by the United States Department of Justice (“DOJ”), the

Commodity Futures Trading Commission (“CFTC”), and the SEC—concerning potential LIBOR manipulation could yield information from Defendants’ internal records or personnel that bears significantly on the Baltimore Plaintiffs’ claims. Indeed, as one news report observed in detailing U.S. regulators’ ongoing investigation, “[i]nternal bank emails may prove to be key evidence . . . because of the difficulty in proving that banks reported borrowing costs for LIBOR at one rate and obtained funding at another.”1 The Baltimore Plaintiffs thus believe further

evidentiary support for their allegations will come to light after a reasonable opportunity for

discovery.

NATURE OF THE ACTION

4. This case arises from a global conspiracy to manipulate LIBOR—the reference

point for determining interest rates for trillions of dollars in financial instruments worldwide—by

a cadre of prominent financial institutions.

5. Defendants, the banks that comprised the U.S. dollar LIBOR panel during the

Class Period (as defined below), were motivated to suppress LIBOR for two primary reasons.

First, well aware that the a bank pays (or expects to pay) on its debt is widely, if not

universally, viewed as embodying the market’s assessment of the risk associated with that bank,

Defendants understated their borrowing costs (thereby suppressing LIBOR) to portray

1 , Carrick Mollenkamp & Jean Eaglesham, “U.S. Libor Probe Includes BofA, Citi, UBS,” MarketWatch, March 17, 2011.

973672.6 -3- themselves as economically healthier than they actually were. Second, artificially suppressing

LIBOR allowed Defendants to pay lower interest rates on LIBOR-based financial instruments

that Defendants sold to investors, including the Baltimore Plaintiffs, during the Class Period.

6. Throughout the Class Period, Defendants conspired to, and did, manipulate

LIBOR by misreporting the actual interest rates at which they expected they could borrow funds—i.e., their true costs of borrowing—on a daily basis. By acting together and in concert to knowingly understate their true borrowing costs, Defendants caused LIBOR to be calculated or suppressed artificially low, reaping hundreds of millions, if not billions, of dollars in ill-gotten gains.

7. Investigations regarding LIBOR are ongoing in the United States, Switzerland,

Japan, , Canada, the European Union, and Singapore by ten different governmental agencies, including the DOJ, the SEC, and the CFTC. Additionally, numerous

employees, including supervisors, traders, and brokers, from various financial institutions have been accused of improper conduct related to LIBOR.

8. Defendants’ manipulation of LIBOR allowed them to pay unduly low interest rates to investors, including Baltimore Plaintiffs, on LIBOR-based financial instruments during the Class Period. Accordingly, the Baltimore Plaintiffs seek relief for the damages they have suffered as a result of Defendants’ violations of federal law. Baltimore Plaintiffs assert claims

under the Sherman Act, 15 U.S.C. §§ 1, et seq. and the Clayton Act, 15 U.S.C. §§ 12, et seq.

JURISDICTION AND VENUE

9. This action arises under Section 1 of the Sherman Act, 15 U.S.C., § 1, and

Sections 4 and 16 of the Clayton Act, 15 U.S.C. §§ 15 and 26.

10. This Court has jurisdiction under 28 U.S.C. §§ 1331 and 1337 and Sections 4

and 16 of the Clayton Act, 15 U.S.C. §§ 15 and 26.

973672.6 -4- 11. Venue is proper in this District pursuant to Sections 4, 12 and 16 of the Clayton

Act, 15 U.S.C. §§ 15, 22 and 26 and 28 U.S.C. § 1391(b), (c) and (d). One or more of the

Defendants resided, transacted business, were found, or had agents in the District, a substantial part of the events giving rise to Plaintiff’s claims arose in the District, and a substantial portion of the affected interstate trade and commerce described herein has been carried out in this

District.

THE PARTIES

Plaintiffs

12. Plaintiff Mayor and City Council of Baltimore (“Baltimore”) is an independent

city in the State of Maryland. During the Class Period, Baltimore purchased hundreds of millions

of dollars in interest rate swaps directly from at least one Defendant in which the rate of return

was tied to LIBOR and was injured as a result of Defendants’ anticompetitive conduct.

13. Plaintiff City of New Britain Firefighters' and Police Benefit Fund (“New

Britain”) is a pension fund located in Connecticut with the mission of providing retirement

benefits to the city’s employees and their spouses. During the Class Period, New Britain

purchased tens of millions of dollars in interest rate swaps directly from at least one Defendant in

which the rate of return was tied to LIBOR and was injured as a result of Defendants’

anticompetitive conduct.

Defendants

14. Defendant Corporation is a Delaware corporation headquartered

in Charlotte, North Carolina. Defendant Bank of America, N.A.—a federally-chartered national

banking association headquartered in Charlotte, North Carolina—is an indirect, wholly-owned

subsidiary of Defendant Bank of America Corporation. Defendants Bank of America

Corporation and Bank of America, N.A. are referenced collectively in this Complaint as “Bank

973672.6 -5- of America.”

15. Defendant Bank of Tokyo-Mitsubishi UFJ Ltd. (“BTMU”) is a Japanese company headquartered in Tokyo, Japan.

16. Defendant Barclays Bank plc (“Barclays”) is a British public limited company

headquartered in London, England.

17. Defendant , Inc. is a Delaware corporation headquartered in New York,

New York. Defendant , N.A.—a federally-chartered national banking association

headquartered in New York, New York—is a wholly-owned subsidiary of Defendant Citigroup,

Inc. Defendants Citigroup, Inc. and Citibank, N.A. are referenced collectively in this Complaint as “Citibank.”

18. Defendant Coöperatieve Centrale Raiffeisen-Boerenleenbank B.A. (“”)

is a provider headquartered in Utrecht, the Netherlands.

19. Defendant Credit Suisse Group AG (“Credit Suisse”) is a Swiss company

headquartered in Zurich, Switzerland.

20. Defendant AG (“Deutsche Bank”) is a German financial services

company headquartered in Frankfurt, Germany.

21. Defendant HSBC Holdings plc is a United Kingdom public limited company

headquartered in London, England. Defendant HSBC Bank plc—a United Kingdom public

limited company headquartered in London, England—is a wholly-owned subsidiary of

Defendant HSBC Holdings plc. Defendants HSBC Holdings plc and HSBC Bank plc are

referenced collectively in this Complaint as “HSBC.”

22. Defendant JPMorgan Chase & Co. is a Delaware corporation headquartered in

New York, New York. Defendant JPMorgan Chase Bank, National Association—a federally-

973672.6 -6- chartered national banking association headquartered in New York, New York—is a wholly- owned subsidiary of Defendant JPMorgan Chase & Co. Defendants JPMorgan Chase & Co. and

JPMorgan Chase Bank, National Association are referenced together in this Complaint as

“JPMorgan Chase.”

23. Defendant Lloyds Banking Group plc (“Lloyds”) is a United Kingdom public limited company headquartered in London, England. Defendant Lloyds was formed in 2009 through the acquisition of Defendant HBOS plc (“HBOS”)—a United Kingdom banking and insurance company headquartered in Edinburgh, Scotland—by Lloyds TSB Bank plc.

24. Defendant Royal Bank of Canada (“RBC”) is a Canada company headquartered in Toronto, Canada.

25. Defendant The Norinchukin Bank (“Norinchukin”) is a Japanese cooperative

bank headquartered in Tokyo, Japan.

26. Defendant The Group plc (“RBS”) is a United Kingdom

public limited company headquartered in Edinburgh, Scotland.

27. Defendant UBS AG (“UBS”) is a Swiss company based in Basel and Zurich,

Switzerland.

28. Defendant WestLB AG is a German joint stock company headquartered in

Dusseldorf, Germany. Defendant Westdeutsche ImmobilienBank AG—a German company

headquartered in Mainz, Germany—is a wholly-owned subsidiary of WestLB AG. Defendants

WestLB AG and Westdeutsche ImmobilienBank AG are referenced together in this Complaint as

“WestLB.”

29. Defendants Bank of America, BTMU, Barclays, Citibank, Rabobank, Credit

Suisse, Deutsche Bank, HSBC, JPMorgan Chase, Lloyds, HBOS, RBC, Norinchukin, RBS,

973672.6 -7- UBS, and WestLB (collectively, “Defendants”) were members of the BBA’s USD-LIBOR panel during the Class Period.

UNNAMED CO-CONSPIRATORS

30. Various other entities and individuals not named as Defendants in this Complaint

participated as co-conspirators in the acts complained of and performed acts and made

statements that aided and abetted and furthered the unlawful conduct alleged herein.

DEFINITIONS

31. LIBOR-Based Instruments are Instruments and Non-Derivative

Instruments. LIBOR-Based Instruments may be indexed to one or more LIBOR currencies (i.e.,

USD-LIBOR, Yen-LIBOR, and Euro-LIBOR). Only LIBOR-Based Instruments that were sold in over-the-counter transactions are at issue in the Baltimore Plaintiffs’ Complaint.

32. Derivative Instruments include but are not limited to asset swaps, collateralized debt obligations, credit default swaps, forward rate agreements, inflation swaps, interest rate swaps, total return swaps, and options.

(a) Asset Swaps are a type of over-the-counter derivative in which one

investor exchanges the cash flows of an asset or pool of assets for a different cash flow. This is

done without affecting the underlying investment position. For instance, if a Defendant wanted

to own a particular Euro-denominated fixed rate issue, but preferred to receive a floating rate US

dollar cash flow, the Defendant could purchase the Euro-denominated and then enter into

asset swap with another bank or investor to receive US Dollar LIBOR payments (+/- spread) in

return for paying a fixed rate coupon in Euros to the bank or investor. Asset Swaps can be

indexed to LIBOR.

(b) Collateralized Debt Obligations (“CDOs”) are a type of structured asset

973672.6 -8- backed security (“ABS”). ABSs are derivatives and are sold in over-the-counter transactions.

CDOs have multiple tranches, or levels of risk, and are issued by “special purpose entities.” They are collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments (and interest rates) or lower prices to compensate for additional default risk; in general, "senior" tranches are considered the safest securities. In some cases, investors utilize leverage and hope to profit from the excess of the spread offered by the senior tranche and their cost of borrowing. This is because senior tranches pay a spread above LIBOR despite their AAA-ratings. CDOs can be indexed to

LIBOR.

(c) Credit Default Swaps (“CDSs”) are a type of over-the-counter, credit- based derivative whereby the seller of the CDSs compensates the buyer of the CDS only if the underlying loan goes into default or has another “credit event.” The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults. In the event of default, the buyer of the CDS receives compensation (usually the face value of the loan), and the seller of the CDS takes possession of the defaulted loan.

However, anyone can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in the loan (these are called "naked" CDSs).

(d) Forward Rate Agreements (“FRAs”) are a type of over-the-counter derivative based on a “forward contract.” The contract sets the rate of interest or the currency exchange rate to paid or received on an obligation beginning at a future start date. The contract will determine the rates to be used along with the termination date and notional value. On this type of agreement, it is only the differential that is paid on the notional amount of the contract. It

973672.6 -9- is paid on the effective date. The reference rate is fixed one or two days before the effective date, dependent on the market convention for the particular currency. An FRA differs from a swap in that a payment is only made once at maturity. FRAs can be indexed to LIBOR.

(e) Inflation Swaps are a type of over-the-counter derivative used to transfer inflation risk from one party to another through an exchange of cash flows. In an inflation swap, one party pays a fixed rate on a notional principal amount, while the other party pays a floating rate linked to an inflation index. The party paying the floating rate pays the inflation adjusted rate multiplied by the notional principal amount. Inflation Swaps can be indexed to LIBOR.

(f) Interest Rate Swaps are a type of over-the-counter derivative in which two parties agree to exchange interest rate cash flows, based on a specified notional amount from a fixed rate to a floating rate (or vice-versa) or from one floating rate to another. These are highly liquid financial derivatives. Interest rate swaps are commonly used for both hedging and speculating. In an , each party agrees to pay either a fixed or floating rate denominated in a particular currency to the other party. The fixed or floating rate is multiplied by a notional principal amount. This notional amount is typically not exchanged between counterparties, but is used only for calculating the size of cash flows to be exchanged. Interest

Rate Swaps can be indexed to LIBOR.

(g) Total Return Swaps are a type of over-the-counter derivative based on financial contracts that transfer both the credit and market risk of an underlying asset. These derivatives allow one contracting party to derive the economic benefit of owning an asset without putting that asset on its balance sheet; the other contracting party, which retains the underlying asset on its balance sheet, is, in effect, buying protection against loss on that asset’s value. Total Return Swaps can be indexed to LIBOR.

973672.6 -10- (h) Options are a type of over-the-counter derivative based on a contract between two parties for a future transaction on an asset. The other Derivative Instruments,

defined above, can serve as the asset for an Option; an Option on a swap is commonly referred to

as a “swaption”. The buyer of an option gains the right, but not the obligation, to engage in that

future transaction (buy or sell) while the seller of the option is obligated to fulfill the future

transaction. In general, the option’s price is the difference between the asset’s reference price

and the value of the underlying asset (i.e., a stock, bond, currency contract, or futures contract)

plus a spread. Thus, where the underlying asset is indexed to LIBOR, the Option’s price is

impacted by LIBOR.

33. Non-derivative instruments include but are not limited to floating rate notes.

Floating rate notes evidence an amount of money owed to the buyer from the seller. The interest rate on floating rate notes is adjusted at contractually-set intervals and is based on a variable rate index, such as LIBOR. Thus, floating rate notes can be indexed to LIBOR.

CLASS ACTION ALLEGATIONS

34. The Baltimore Plaintiffs bring this action as a under Rules 23(a) and

23(b)(3) of the Federal Rules of Civil Procedure, on behalf of itself and all others similarly situated. The “Class” is defined as:

All persons or entities (other than Defendants and their employees, affiliates, parents, and subsidiaries) that purchased in the United States, directly from a Defendant, a financial instrument that paid interest indexed to LIBOR (“LIBOR-Based Instrument”) any time during the period August 2007 through May 2010 (the “Class Period”).

35. The Class is so numerous that joinder of all members is impracticable. While the exact number of Class members is unknown at this time, the Baltimore Plaintiffs are informed

and believe that at least thousands of geographically dispersed Class members purchased

973672.6 -11- LIBOR-Based Derivatives directly from Defendants during the Class Period.

36. The Baltimore Plaintiffs’ claims are typical of the claims of the other members of the Class. The Baltimore Plaintiffs and the members of the Class sustained damages arising out of Defendants’ common course of conduct in violation of law as complained herein. The injuries and damages of each member of the Class were directly caused by Defendants’ wrongful conduct in violation of the antitrust laws as alleged herein.

37. The Baltimore Plaintiffs will fairly and adequately protect the interests of the members of the Class and has retained counsel competent and experienced in class action litigation, including antitrust class action litigation.

38. Common questions of law and fact exist as to all members of the Class which predominate over any questions affecting solely individual members of the Class. Among the questions of law and fact common to the Class are:

(a) Whether Defendants conspired with others to artificially suppress LIBOR

in violation of the Sherman Act;

(b) Whether Defendants’ conduct had an anticompetitive and manipulative

effect on LIBOR during the Class Period;

(c) Whether Defendants’ conduct negatively affected the rates of return of

LIBOR-Based Instruments purchased directly from the Defendants during the Class Period; an

(d) The appropriate measure of damages for the injury sustained by the

Baltimore Plaintiffs and other members of the Class as a result of Defendants’ unlawful

activities.

39. A class action is superior to other available methods for the fair and efficient

adjudication of this controversy because joinder of all Class members is impracticable. The

973672.6 -12- prosecution of separate actions by individual members of the Class would impose heavy burdens upon the courts and Defendants, and would create a risk of inconsistent or varying adjudications of the questions of law and fact common to the Class. A class action, on the other hand, would achieve substantial economies of time, effort and expense, and would assure uniformity of decision as to persons similarly situated without sacrificing procedural fairness or bringing about other undesirable results.

40. The interest of members of the Class in individually controlling the prosecution of separate actions is theoretical rather than practical. The Class has a high degree of cohesion, and prosecution of the action through representatives would be unobjectionable. The amounts at stake for Class members, while substantial in the aggregate, are not great enough individually to enable them to maintain separate suits against Defendants. The Baltimore Plaintiffs do not anticipate any difficulty in the management of this action as a class action.

FACTUAL ALLEGATIONS

41. As discussed in more detail below, the British Bankers’ Association (“BBA”)

rate-setting , described below, provides the means through which Defendants could manipulate LIBOR; banks were motivated to manipulate LIBOR to hide their precarious financial conditions and to financially benefit from a manipulated LIBOR; there is economic

evidence that LIBOR was manipulated and could not have been so manipulated in the absence of

a conspiracy; there are governmental investigations worldwide regarding LIBOR manipulation;

there are news reports that LIBOR was manipulated; and there are admissions of manipulation

with respect to yen LIBOR. The foregoing factors evidence a worldwide conspiracy regarding

LIBOR manipulation.

A. LIBOR Is Administered By The BBA Rate-Setting Cartel

42. The BBA describes itself on its website as “the leading trade association for the

973672.6 -13- U.K. banking and financial services sector. We speak for over 200 member banks from 60 countries on the full range of U.K. and international banking issues.”2 The Defendants are among the member banks of the BBA. As the BBA itself concedes, it is not a regulatory body and has no regulatory function.3 Its activities are not overseen by any U.K. or foreign regulatory

agency. It is governed by a board of member banks that meets four times each year. The board is

composed of senior executives from twelve banks, including Barclays Bank plc, Citibank NA,

Credit Suisse, Deutsche Bank AG, HSBC Bank plc, J.P. Morgan Europe Ltd., and the Royal

Bank of Scotland plc.4 “This is a quaint, insider club which is clearly not fit for the 21st century,” said Richard Werner, a finance professor at the University of Southampton, England.5

43. Commencing in January of 1986, the BBA began disseminating LIBOR, initially

in three currencies: U.S. dollars, , and pound sterling; LIBOR is now disseminated

for ten currencies: the foregoing three, the Australian dollar, the Canadian dollar, the New

Zealand dollar, the Danish krone, the Euro, the , and the Swedish krone.

44. LIBOR is a daily benchmark interest rate at which designated contributor panel

banks predict they can borrow unsecured funds from other banks in the London wholesale

money market for fifteen different maturities ranging from overnight to one year. As “the

primary benchmark for short term interest rates globally,”6 LIBOR has occupied (and continues

to occupy) a crucial role in the operation of financial markets. For example, market participants

2 http://www.bba.org.uk/about-us, last accessed on April 30, 2012. 3 http://www.bba.org.uk/blog/article/bba-repeats-commitment-to-bba-libor, last accessed on April 30, 2012 4 http://www.bba.org.uk/about-us, last accessed on April 30, 2012. 5 http://www.bloomberg.com/news/2012-02-21/ubs-turning-whistleblower-in-libor-probe- pressures-rivals.html, last accessed on April 30, 2012. 6 http://www.bbalibor.com/bbalibor-explained/the-basics, last accessed on April 19, 2012.

973672.6 -14- commonly set the interest rate on floating-rate notes as a spread against LIBOR (e.g., “LIBOR +

[X] bps”)7 and use LIBOR as a basis to determine the correct rate of return on short-term fixed-

rate notes (by comparing the offered rate to LIBOR).

45. LIBOR thus affects the pricing of trillions of dollars’ worth of financial

transactions. In a May 21, 2009 press release, the BBA called LIBOR “the world’s most

important number.”8 Accordingly, it is well-established among market participants that

confidence in LIBOR “matters, because the rate system plays a vital role in the economy.”9

Moreover, given the vast universe of financial instruments LIBOR impacts, “even a small manipulation” of the rate “could potentially distort capital allocations all over the world.”10

46. LIBOR is set by the BBA and its member banks. Each of the ten aforementioned

currencies is overseen by a separate LIBOR panel created by the BBA. During the Class Period,

designated contributing panels ranged in size from eight banks for Australian dollar, Swedish

krona, Danish krone, and New Zealand dollar panels to sixteen banks for U.S. dollar, pound

sterling, Euro, and Japanese yen panels. There is substantial overlap in membership among the

panels. For example, during the Class Period, nine of the sixteen banks that served on the U.S.

dollar also served on the Japanese yen, Swiss franc and Euro LIBOR panels.11 Similarly,

7 The term “bps” stands for basis points. 100 basis points equal 1%. 8 http://www.bbalibor.com/news-releases/bba-libor-the-worlds-most-important-number-now- tweets-daily. 9 Carrik Mollenkamp and Mark Whitehouse, “Study Casts Doubt on Key Rate --- WSJ Analysis Suggests Banks May Have Reported Flawed Interest Data for Libor,” , May 29, 2008. 10 Rosa M. Abrantes-Metz and Albert D. Metz, “How Far Can Screens Go in Distinguishing Explicit from Tacit ? New Evidence from the Libor Setting,” CPI Antitrust Chronicle, March 2012. 11 Those banks are Bank of Tokyo, Barclays, Citibank, Deutsche Bank, HSBC, JP Morgan Chase, Lloyds, Rabobank, RBS, and UBS

973672.6 -15- thirteen banks participated on both the dollar and yen LIBOR panels12 and eleven banks

participated on both the U.S. dollar and Swiss franc LIBOR panels.13 It is a requirement of

membership of a LIBOR contributor panel that the bank is regulated and authorized to trade on

the London money market. As the BBA recently told Bloomberg: “As all contributor banks are

regulated, they are responsible to their regulators, rather than us.”14

47. According to the BBA’s “LIBOR Governance and Scrutiny” report issued in

2008,15 “[t]he BBA employs a full time manager to supervise on a day-to-day basis all aspects of

LIBOR calculation and dissemination to the marketplace. The LIBOR manager works with a

team of professionals both in-house and externally to ensure all processes operate to the highest

standards.” As the report goes on to explain, “Thomson ...act as the ‘designated

distributor’ of BBA LIBOR rates. All contributions to the LIBOR rate-setting process are

collected by Thomson Reuters, who currently perform checking procedures, supervised by the

LIBOR manager, on all the submissions before running the calculation and distributing the

fixes.”

48. During the Class Period, the BBA established LIBOR based on the rates that

designated banks for each currency would have to pay for an unsecured loan for each designated

12 Those banks are Bank of America, Bank of Tokyo, Barclays, Citibank, Deutsche Bank, HSBC, JP Morgan Chase, Lloyds, Rabobank, RBS, Société Générale (beginning in 2009), UBS, and West LB. 13 Those banks are Bank of Tokyo, Barclays, Citibank, Credit Suisse, Deutsche Bank, HSBC, JP Morgan Chase, Lloyds, Rabobank, RBS, and UBS. 14 http://www.bba.org.uk/blog/article/bba-repeats-commitment-to-bba-libor, last accessed on April 30, 2012. 15 http://www.bbalibor.com/news-releases/libor-gets-enhanced-governance-and-scrutiny- procedures, last accessed on April 30, 2012.

973672.6 -16- maturity period.16 Every day, the banks responded to the BBA’s question: “At what rate could

you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a

reasonable market size just prior to 11 am?” On its website, the BBA explains “a bank will

know what its credit and liquidity risk profile is from rates at which it has dealt and can construct

a curve to predict accurately the correct rate for currencies or maturities in which it has not been

active.” The banks informed the BBA of their costs of borrowing funds at different maturity

dates (e.g., one month, three months, six months). Contributed rates are ranked in descending

order and the arithmetic mean of only the middle two quartiles is used to formulate the resulting

BBA LIBOR calculation for that particular currency and maturity.17 Thomson Reuters then

publishes LIBOR, also reporting the quotes on which the BBA based its LIBOR calculation.

“Libor has always been a lie, because it represents what banks would pay for funds rather than

what they are actually paying,” said Peter Hahn, a finance professor at London’s Cass Business

School and a former managing director at Citigroup. “People who have an incentive to make

money from mispriced markets are able to misprice those markets, and that is a serious control

problem.”18

49. No regulatory agency oversees the setting of LIBOR by the BBA and its

members. The resultant rates are not filed with, or subject to the approval of, any regulatory

agency. The BBA has been quoted as saying it “calculates and produces BBA Libor at the

request of our members for the good of the market.”19

16 http://www.bbalibor.com/bbalibor-explained/the-basics, last accessed on April 30, 2012. 17 http://www.bbalibor.com/technical-aspects/setting-bbalibor, last accessed March 30, 2012. 18 http://www.bloomberg.com/news/2012-02-21/ubs-turning-whistleblower-in-libor-probe- pressures-rivals.html, last accessed on April 30, 2012. 19 http://www.businessweek.com/news/2012-03-06/libor-links-deleted-as-bank-group-backs- away-from-tarnished-rate, last accessed on April 30, 2012.

973672.6 -17- 50. The BBA’s activities in setting LIBOR for various currencies reflect a global rate-

setting cartel. As one commentator has noted, “LIBOR is not a real market rate of interest and is

instead set by a cartel of mostly foreign banks operating in London with little or no oversight and

no transparency. . . . The Wall Street Journal reported that the BBA is hesitant to change how

LIBOR is calculated because it is worried about legal liability which is not a surprise. If the BBA

admits that LIBOR isn’t a market rate but a cartel rate that was established through ,

it will be subject to global lawsuits resulting from fraudulent behavior and misrepresentations.

The likelihood of the BBA reforming itself, providing transparency and giving up its cartel

monopoly is very low given the astronomical liability that will result.”20 Indeed, the BBA directly profits from the usage of LIBOR. Since 2009, it has operated BBA LIBOR, Ltd., which earns revenue from licensing the rate.

51. Throughout the Class Period, Defendants conspired to suppress LIBOR below the

levels at which it would have been set had Defendants accurately reported their borrowing costs

to the BBA. The Baltimore Plaintiffs’ allegations that Defendants suppressed LIBOR are

supported by: (i) Defendants’ powerful incentives to mask their true borrowing costs and to reap

unjustified revenues by setting artificially low interest rates on LIBOR-based financial instruments the Baltimore Plaintiffs and other investors purchased; (ii) an independent analysis by the Baltimore Plaintiffs’ consulting experts, comparing LIBOR panel banks’ daily individual quotes with the banks’ probability of default, as measured by Kamakura Risk Information

Services, as well as LIBOR-related analyses by consulting experts in these coordinated proceedings have engaged; (iii) publicly available economic analyses, by prominent academics and other commentators, of LIBOR’s behavior during the Class Period compared with other

20 http://www.thesunshinereport.net/marksunshine/?p=36, lat accessed April 30, 2012.

973672.6 -18- well-accepted, contemporaneous measures of Defendants’ borrowing costs, as well as the notable tendency of Defendants’ daily submitted LIBOR quotes to “bunch” near the bottom quartile of the collection of reported rates used to determine LIBOR; and (iv) revelations in connection with the numerous domestic and foreign governmental investigations into potential manipulation of USD-LIBOR and LIBOR for other currencies, most prominently Yen-LIBOR.

B. Defendants Possess Financial Incentives to Suppress LIBOR.

52. Defendants each had substantial financial incentives to manipulate LIBOR. First,

Defendants were motivated, particularly given investors’ serious concerns over the stability of

the market in the wake of the that emerged in 2007, to understate their borrowing

costs—and thus the level of risk associated with the banks. Moreover, because no one bank

would want to stand out as bearing a higher degree of risk than its fellow banks, each Defendant

shared a powerful incentive to collude with its co-Defendants to ensure it was not the “odd man

out.” Indeed, analysts at Citigroup Global Markets—a subsidiary of Defendant Citigroup—

acknowledged in an April 10, 2008 report:

[T]he most obvious explanation for LIBOR being set so low is the prevailing fear of being perceived as a weak hand in this fragile market environment. If a bank is not held to transact at its posted LIBOR level, there is little incentive for it to post a rate that is more reflective of real lending levels, let alone one higher than its competitors. Because all LIBOR postings are publicly disclosed, any bank posting a high LIBOR level runs the risk of being perceived as needing funding. With markets in such a fragile state, this kind of perception could have dangerous consequences.21

Strategists at entities affiliated with other Defendants likewise confirmed that banks suppressed

LIBOR. Echoing Peng’s sentiment, William Porter, credit strategist at Credit Suisse, said in

April 2008 that he believed the three-month USD-LIBOR was 0.4 percentage points below

21 Scott Peng, Chintan (Monty) Gandhi, & Alexander Tyo, “Special Topic: Is LIBOR Broken?,” April 10, 2008.

973672.6 -19- where it should be.22 And the next month, Tim Bond, head of asset-allocation research of

Barclays Capital—a subsidiary of Defendant Barclays—observed that banks routinely misstated

borrowing costs to the BBA to avoid the perception that they faced difficulty raising funds as

credit markets seized up.23

53. Second, by artificially suppressing LIBOR, Defendants paid lower interest rates

on LIBOR-based financial instruments they sold to investors, including the Baltimore Plaintiffs,

during the Class Period. Illustrating Defendants’ motive to artificially suppress LIBOR, in 2009

Citibank reported it would make $936 million in net interest revenue if rates would fall by 25 bps

per quarter over the next year and $1.935 billion if they fell 1% instantaneously. JPMorgan

Chase likewise reported significant exposure to interest rates in 2009: The bank stated that if

interest rates increased by 1%, it would lose over $500 million. HSBC and Lloyds also

estimated they would earn hundreds of millions of additional dollars in 2008-2009 in response to

lower interest rates and would lose comparable amounts in response to higher rates. These banks

collectively earned billions in net interest revenues during the Class Period.

54. Defendants thus possessed reputational and financial incentives to manipulate

LIBOR—which, as detailed below, they did.

C. Independent Analyses By The Plaintiffs’ Consulting Experts Strongly Indicate Defendants Artificially Suppressed LIBOR During The Class Period.

55. The consulting experts in these coordinated proceedings have measured LIBOR

against other recognized benchmarks for determining banks’ borrowing costs. Employing well-

22 Carrick Mollenkamp, “Libor Surges After Scrutiny Does, Too,” The Wall Street Journal, April 18, 2008. 23 Gavin Finch and Elliott Gotkine, “Libor Banks Misstated Rates, Bond at Barclays Says,” Bloomberg, May 29, 2008.

973672.6 -20- reasoned methodologies, these experts have demonstrated that Defendants artificially suppressed

LIBOR during the Class Period. Despite any minor discrepancies in the analyses, the experts’ common conclusion is clear: During the Class Period, LIBOR did not appropriately correspond with other measures of Defendants’ borrowing costs, as indicated by: (i) the difference between

Defendants’ respective LIBOR quotes and their probabilities of default, and (ii) the spread between LIBOR and Eurodollar Deposit rates.

56. Additional independent expert analysis performed in connection with these proceedings indicates Libor suppression. At one date during the Class Period, when the BBA announced it would investigate the reporting of LIBOR, members of the LIBOR panel increased their rates in unison despite the lack of any market reason. Logically, the Defendants collectively feared that their LIBOR suppression would be uncovered. Bolstering this point is that since October 2011, when the raided most or all of Defendants in connection with the LIBOR probe, reported LIBOR has returned to its historic norm compared with the overall Eurodollar deposit market."

1. An Independent Analysis By Consulting Experts—Showing The Discrepancy Between Defendants’ LIBOR Quotes And Their Respective Probabilities Of Default—Provides Strong Evidence of LIBOR Suppression During The Class Period.

57. Assessing the likelihood that LIBOR was suppressed during the Class Period, the

Plaintiffs’ expert consultants compared USD-LIBOR panel members’ quotes from 2007 through

2008 to the daily default probability estimates for each of those banks—as determined, and updated daily for each maturity (term), by Kamakura Risk Information Services (“KRIS”).24

The study focused on identifying any periods of severe discrepancy between each bank’s

24 KRIS did not have PDs for Defendants WestLB, Rabobank, or Norinchukin, because those companies were not publicly traded. This PD analysis therefore does not include those banks.

973672.6 -21- probabilities of default (“PDs”) and the LIBOR quotes the bank submitted to the BBA.

58. The KRIS reduced-form model estimates each bank’s default risk on a daily basis by analyzing each bank’s equity and bond prices, accounting information, and general economic conditions, such as the level of interest rates, unemployment rates, inflation rates, etc. On its website, KRIS states it “provides a full term structure of default for both corporate and sovereign credit names based upon a multiple models approach” and its default probabilities “are updated daily and cover more than 29,000 companies in 36 countries.”25

59. PD provides a measure of a bank’s credit (default) risk exposure, essentially the

likelihood that the bank will default within a specified time period. PD can be estimated using

statistical models, whereas LIBOR is a rate of return required by investors lending short-term

funds to the bank. A finding of a statistically significant negative correlation coefficient between

daily LIBOR quotes and PDs for a given bank over a given term period violates the fundamental

relationship between risk and return that is the cornerstone of finance. That is, investors require

a higher required rate of return as a premium for taking on additional risk exposure. This results

in a positive relationship (correlation) between risk and return. An increase in the bank’s PD

indicates that the risk of default has increased, thereby causing investors to require a higher rate

of return for loans to the bank—which should correspond with a higher LIBOR quote.

60. Accordingly, a finding of a statistically significant negative coefficient (of any

size) between a bank’s daily LIBOR quotes and its PDs shows that increases in PDs correspond

with decreases in LIBOR quotes—which violates fundamental finance theory. This would

indicate that banks are suppressing their LIBOR quotes to avoid revealing the higher rates that

reflect their true (higher) probabilities of default. In other words, any finding of negative,

25 See http://www.kris-online.com/, last accessed on April 23, 2012.

973672.6 -22- statistically significant correlation coefficients between a bank’s PDs and its LIBOR quotes suggests LIBOR suppression by the bank over the analysis period.

61. The magnitude of the correlation coefficient is impacted by the volatility of both

PD and LIBOR for each bank during the time period. Thus, for example, if a bank has high volatility in its PDs, the absolute value of the correlation coefficient will tend to be lower (i.e., less negative) as compared to an identical bank with low PD volatility. However, both may be equally engaged in LIBOR suppression if their correlation coefficients are statistically significant and negative.

62. The Plaintiffs’ consulting experts used the KRIS database to test whether, for the period under study, each bank’s daily sealed LIBOR quote correlates with the bank’s estimated

PD that day for the same maturity term (provided by KRIS). For example, the consultants examined the correlation between Bank of America’s sealed quote for three-month LIBOR on each date with the three-month PD for Bank of America, as provided by the KRIS database on that same day. As explained above, standard finance theory implies that a positive correlation between a bank’s PD and its LIBOR quote should exist—i.e., as the bank’s default risk (PD) increases, its borrowing rate (LIBOR quote) should increase, and vice versa. That is, using the above example, standard finance theory predicts a positive correlation between Bank of

America’s three-month PD and its three-month LIBOR quote. A finding of either a zero or negative correlation between a bank’s PD and its LIBOR quote indicates the latter does not reflect the bank’s default-risk probability, which evidences LIBOR suppression. A negative correlation means the two values have an inverse relationship; as one goes up, the other tends to go down. A statistically significant negative correlation between a bank’s LIBOR quote and its

PD is consistent with the bank’s reducing its LIBOR quote in order to mask its higher risk

973672.6 -23- exposure during a period of financial crisis, such as during the 2007-2008 period. By submitting an artificially low LIBOR quote, the bank sends a false signal that it is less risky than it truly is.

63. The Plaintiffs’ consulting experts found suppression over the 2007-2008 period for one-month, three-month, six-month, and 12-month LIBOR.

64. The LIBOR quotes for all the reporting banks (except HSBC) during 2007 were negatively correlated with their daily updated PDs (for the same maturity term) to a statistically significant degree. For example, the correlation between Bank of America’s daily LIBOR quotes and its daily PDs, for example, was negative and statistically significant at a very high level for the one-month, three-month, six-month and 12-month terms, i.e., between -0.5857 and -

0.6093.26 In other words, the data indicate that, contrary to fundamental finance theory, the

higher a panel bank’s PD was, the lower its LIBOR quote was.

65. Performing the same analysis with respect to the LIBOR panel banks’ daily

LIBOR quotes and PDs during 2008, the Plaintiffs’ expert consultants found that for all of the

banks, the submitted LIBOR quotes were negatively correlated with their PDs at the one-month

and three-month maturities. Indeed, all of the banks were submitting unduly low LIBOR quotes

at all maturities from August 9, 2007 until September 12, 2008, with only one exception: from

September 15 through December 31, 2008, the period following the Lehman bankruptcy.

66. The following graphs illustrate the findings of this expert analysis—which

demonstrates a striking negative correlation between USD-LIBOR panel banks’ LIBOR quotes

and PDs during 2007 and 2008, indicating they severely depressed LIBOR during that time.

26 Correlation coefficients range from a value of -1 to 1. A correlation coefficient of -0.50, for example, would imply that a 1% increase in PD would result in a 50-basis point decline in the bank’s LIBOR quote.

973672.6 -24- Graph 1: Correlation Coefficients Between Each Bank’s Daily LIBOR Bid and Probability of Default (PD), One-Month Term

0.8000

0.6000

0.4000 2007 2008

0.2000

0.0000

-0.2000

-0.4000

-0.6000

-0.8000

-1.0000 (Note: PDs are estimated daily using the reduced form model of Kamakura Risk Information Services.)

Graph 2: Correlation Coefficients Between Each Bank’s Daily LIBOR Bid and Probability of Default (PD), Three-Month Term

0.8000

0.6000

0.4000

2007 2008

0.2000

0.0000

-0.2000

-0.4000

-0.6000

-0.8000

-1.0000 (Note: PDs are estimated daily using the reduced form model of Kamakura Risk Information Services.)

973672.6 -25- Graph 3: Correlation Coefficients Between Each Bank’s Daily LIBOR Bid and Probability of Default (PD), Six-Month Term

0.6000

0.4000

2007

2008 0.2000

0.0000

-0.2000

-0.4000

-0.6000

-0.8000

-1.0000 (Note: PDs are estimated daily using the reduced form model of Kamakura Risk Information Services.)

Graph 4: Correlation Coefficients Between Each Bank’s Daily LIBOR Bid and Probability of Default (PD), Twelve-Month Term

0.4000

2007 2008

0.2000

0.0000

-0.2000

-0.4000

-0.6000

-0.8000

-1.0000 (Note: PDs are estimated daily using the reduced form model of Kamakura Risk Information Services.)

973672.6 -26- Graph 5: Correlation Coefficients Between Each Bank’s Daily LIBOR Bid and Probability of Default (PD), 9 August 2007 – 12 September 2008 Period

0.0000

-0.1000

-0.2000

-0.3000

-0.4000

-0.5000

-0.6000

-0.7000

-0.8000 1 month 3 months 6 months -0.9000 12 months

-1.0000 (Note: PDs are estimated daily using the reduced form model of Kamakura Risk Information Services.)

Graph 6: Correlation Coefficients Between Each Bank’s Daily LIBOR Bid and Probability of Default (PD), 15 September 2008 – 31 December 2008 Period

0.8000

1 month 0.6000 3 months 6 months 12 months 0.4000

0.2000

0.0000

-0.2000

-0.4000

-0.6000

-0.8000

-1.0000 (Note: PDs are estimated daily using the reduced form model of Kamakura Risk Information Services.)

973672.6 -27-

2. The Discrepancy Between Libor And The Eurodollar Deposit Rate During The Class Period Suggests Defendants Collusively Suppressed Libor

67. As demonstrated by the work of an independent consulting expert retained by counsel in these actions, analysis of the Eurodollar market strongly supports that Defendants suppressed their LIBOR quotes and colluded to suppress reported LIBOR. Moreover, this analysis further supports that Defendants colluded to control the amount of suppression over the

Class Period.

68. The U.S. Federal Reserve prepares and publishes Eurodollar deposit rates for

banks (the “Federal Reserve Eurodollar Deposit Rate”). These Eurodollar deposit rates are

analogous to LIBOR in that they reflect the rates at which banks in the London Eurodollar

money market lend U.S. dollars to one another, just as LIBOR is intended to reflect rates at

which panel banks in the London interbank market lend U.S. dollars to one another. The Federal

Reserve obtains its data from Bloomberg and the ICAP brokerage company.27 Bloomberg

Eurodollar deposit rate is similar to BBA’s LIBOR except that the sampling is not limited to the

16 banks chosen by BBA. ICAP is a large broker-dealer in London in Eurodollar deposits.28

ICAP surveys its client banks and updates its Eurodollar deposit rates about 9:30 each morning.

69. While Defendants could have access to the ICAP Eurodollar deposit rates prior to

27 See http://federalreserve.gov/releases/h15/data.htm, footnote 8, last accessed on April 23, 2012.

28 “ICAP is the world’s premier voice and electronic interdealer broker and the source of global market information and commentary for professionals in the international financial markets. The Group is active in the wholesale markets in interest rates, credit, energy, foreign exchange and equity derivatives. ICAP has an average daily transaction volume in excess of $1.5 trillion, more than 60% of which is electronic. ICAP plc was added to the FTSE 100 Index on 30 June 2006. For more information go to www.icap.com." See http://www.icapenergy.com/company/ (last accessed April 30, 2012)

973672.6 -28- submitting their individual LIBOR quotes at 11:00 each day, they would not — absent collusion

— have access to other bank LIBOR quotes, which are confidential until submitted. Thus, even within the context of a suppressed LIBOR, absent collusion, individual panel banks would not know what quote other panel banks intended to submit relative to the Federal Reserve Eurodollar

Deposit Rate.

70. The consulting expert determined that because of the nature of the relationship between the Federal Reserve Eurodollar Deposit Rate and LIBOR (detailed below), it would be unusual even for one bank to submit a LIBOR bid below the Federal Reserve’s Eurodollar

Deposit Rate. For all Defendants to submit bids below the Federal Reserve Eurodollar Deposit

Rate would be extremely unusual, and is strong evidence of collusion among the banks.

71. Economic and statistical analysis strongly supports the use of the Federal Reserve

Eurodollar Deposit rate as a benchmark for measuring the validity of LIBOR as reported by the panel banks. To measure how well the Federal Reserve Eurodollar Deposit Rate and LIBOR move together, for the purposes of this analysis, the difference between the two rates, the

“Spread,” is calculated as follows: Spread = BBA LIBOR – Federal Reserve Eurodollar Deposit

Rate.

72. Since both LIBOR and the Federal Reserve Eurodollar Deposit Rate measure the lending cost to banks of Eurodollar deposits, important market and financial fundamentals, such as day-to-day changes in monetary policy, market risk and interest rates, as well as risk factors facing the banks generally (collectively “Market Fundamentals”), should be reflected similarly on both variables, and therefore should not affect the Spread. The BBA’s LIBOR panel is intended to reflect the Eurodollar deposit market in London. By focusing on the Spread, the model therefore should be able to factor out normal and expected co-movements in banks’

973672.6 -29- LIBOR quotes that arise from changes in Market Fundamentals.

73. To analyze how well the Federal Reserve Eurodollar Deposit Rate captures changes in Market Fundamentals and absorbs variations in LIBOR that are driven by such fundamentals, consulting experts used regression analysis to measure the day-to-day changes in the Spread against changes in the T-Bill rate and the commercial paper rate. The evidence from these regressions strongly supports that day-to-day changes in the Federal Reserve Eurodollar

Deposit Rate effectively capture day-to-day movements in LIBOR caused by Market

Fundamentals. Thus, once the Federal Reserve Eurodollar Deposit Rate is subtracted to arrive at the Spread, remaining movements in LIBOR reflected in the Spread would be unrelated to movements in Market Fundamentals.

74. Because Market Fundamentals are fully captured by the Spread, absent manipulation, the Spread should always be zero or close to zero. Thus, as more fully discussed below, negative Spreads provide a strong basis to conclude that Defendants suppressed and colluded to artificially suppress LIBOR.29

75. Figures 1 and 2 show the relationship between LIBOR, the Federal Reserve

Eurodollar Deposit Rate, and the Spread beginning in 2000 and ending in mid 2012. As can be

seen, between January 5, 2000 and around August 7, 2007, Federal Reserve’s Eurodollar Deposit

Rate tracked LIBOR very closely and the Spread remained positive and very close to zero. This

finding indicates that the Spread effectively captures shared risks of the banks sampled by BBA

and by Bloomberg and ICAP. The validity of this finding is bolstered by the fact that the Spread

29 It is important to note that to the extent panel banks submitting LIBOR quotes submit suppressed rates to the BBA, and these suppressed rates are also considered by Bloomberg or ICAP, then the resultant Federal Reserve Eurodollar Deposit rate would also be understated by the same suppression. Consequently, the Spread computed above could even understate the true magnitude of the suppression.

973672.6 -30- remained very close to zero in the face of multiple major financial dislocations, including the bursting of the dot-com bubble in 2000, the terrorist attacks of September 2001, and the 2001

U.S. economic recession. Likewise, the unusual downward movements in the Spread starting in

August 2007 strongly evidences that LIBOR was being manipulated and suppressed during this period.30

30 The Spread only became consistently positive around the end of October 2011, just after the European Commission raided banks in connection with LIBOR.

973672.6 -31-

973672.6 -32-

76. Figure 3 shows the Spread between 3-month maturity BBA LIBOR and the

Federal Reserve Eurodollar Deposit rate (3-month maturity BBA LIBOR – Federal Reserve

Eurodollar Deposit rate), from January 2006 through early April 2012.

77. The shorter period between January 3, 2006 and August 7, 2007 demonstrated

above contains 393 trading days. In this sub-period, there were only 3 days when the Spread was

negative. Furthermore, the magnitude of these negative Spreads were also very small: -0.9 basis point on June 14, 2006, -0.5 basis point on July 27, 2006 and -0.2 basis point on November 2,

2006.31 This finding again strongly supports that the Federal Reserve Eurodollar Deposit Rate

serves as a good benchmark to control for Market Fundamentals that determine LIBOR. The

average magnitude of the Spread during this period equaled less than one basis point. This

finding also strongly supports that the risks of the banks sampled by BBA and Bloomberg and

31 One basis point is one-hundredth of a percentage point.

973672.6 -33- ICAP were similar.

78. By August 2007, however, the Spread began to move into negative territory.

During the early part of August 2007, the Federal Reserve Eurodollar Deposit Rate stayed around 5.36%. On August 8, the Federal Reserve Eurodollar Deposit Rate increased by 5 basis points to 5.41%, while BBA LIBOR did not keep pace. The Spread turned negative 3 basis points on August 8, 2007. The Spread remained mostly negative after August 7 so that by

August 15, 2007, the trailing 10-day moving-average of the Spread also turned negative. By

August 31, 2007, the Federal Reserve Eurodollar Deposit rate kept increasing to 5.78%, while

LIBOR was lagging. The negative Spread on August 31 grew to -16 basis points.

79. The Spread remained negative over the next year. Between August 31, 2007 and

September 15, 2008, the Spread remained negative on 234 of the 255 days, or 91.7% of the days.

The magnitude of the negative Spread averaged about -12 basis points. During this approximately one year period, the negative Spread exceeded -25 basis points on 18 days.

80. A big shock to LIBOR (and the Spread) came just after filed for bankruptcy on September 15, 2008, leading to significantly increased concerns about the health of all banks. The increased concerns about the health of the banks were reflected in substantial increases in the Federal Reserve Eurodollar Deposit Rate. On September 15, 2008, the Federal

Reserve Eurodollar Deposit Rate equaled 3.0%, increasing to 3.2%, 3.75%, and 5% on

September 16, 17 and 18, respectively. By September 30, the Federal Reserve Eurodollar

Deposit Rate doubled to 6%.

81. In spite of increased risks and worries about the banks after the Lehman bankruptcy filing, LIBOR did not keep pace with the Federal Reserve Eurodollar Deposit Rate during this period of heightened concerns, causing the Spread to become more negative. On

973672.6 -34- September 16, 2008, the negative Spread nearly doubled to -32 basis points. The next day, on

September 17, the negative Spread doubled again reaching -69 basis points. On September 18, the negative Spread more than doubled once again reaching -180 basis points. Finally, on

September 30, 2008, the negative Spread reached -195 basis points.

82. Thus, between September 15, 2008 and September 30, 2008, the Federal Reserve

Eurodollar Deposit Rate increased by 300 basis points to reflect increasing concerns about the banks, while LIBOR increased by less than one-half, or by 123 basis points during the same period. This diversion in the behavior of the two rates strongly supports the finding that

Defendants intensified their collusive suppression of the LIBOR, and did so to understate their borrowing costs in the face of increasing concerns about the health of the banks.

83. The Spread remained negative for more than one and a half years following the

Lehman filing, until May 17, 2010. As concerns about banks’ financial health eased, so did the magnitude of the suppression of LIBOR. As stated earlier, Federal Reserve’s Eurodollar Deposit

Rate reached 6% on September 30, 2008. With the easing of the financial crisis, Federal

Reserve’s Eurodollar Deposit Rate fell to 0.45% on May 17, 2010. The average suppression of

LIBOR between October 1, 2008 and May 17, 2010 equaled negative 38 basis points. The

Spread finally turned positive for the first time during the post-Lehman period on May 17, 2010.

Following this date, the Spread again became negative, with the magnitude of the Spread averaging around -10 basis points. The dramatic period of negative Spread during the Class

Period, following years of uniform behavior between each individual Defendant Bank’s LIBOR quote and the Federal Reserve Eurodollar Deposit Rate, is also graphically demonstrated by

Figures 4 to 19 below on a bank by bank basis. Every Spread during the period August 8, 2007 to May 17, 2010 is statistically significant at the extremely high 99% confidence level.

973672.6 -35- 973672.6 -36- 973672.6 -37- 973672.6 -38- 973672.6 -39- 973672.6 -40-

973672.6 -41- 973672.6 -42-

84. As the following chart demonstrates, the average Spread for each of the individual

Defendants was uniformly negative throughout the entire Class Period, strongly supporting that each of these banks was suppressing its LIBOR quotes, and colluding to suppress reported

LIBOR.

Average Spread between August BANK NAME 8, 2007 through May 17, 2010 1. Bank of Tokyo-Mitsb. -25 basis points 2. Bank of America -30 basis points 3. Barclays -25 basis points 4. Citi -32 basis points 5. CSFB -27 basis points 6. Deutsche Bank -31 basis points 7. HBOS -29 basis points 8. HSBC -32 basis points 9. JP Morgan Chase -35 basis points 10. Lloyds -30 basis points

973672.6 -43- 11. Norin Bank -25 basis points 12. Rabo Bank -32 basis points 13. Royal Bank of Canada -28 basis points 14. Royal Bank of Scotland -26 basis points 15. UBS -29 basis points 16. West -35 basis points

85. Moreover, as set forth in the following chart, during the critical two week period following the bankruptcy of Lehman Brothers, each of Defendants dramatically increased its collusive suppression of LIBOR.

Average Spread between BANK NAME September 16, 2008 and September 30, 2008 1. Bank of Tokyo-Mitsb. -120 basis points 2. Bank of America -144 basis points 3. Barclays -87 basis points 4. Citi -142 basis points 5. CS -122 basis points 6. Deutsche Bank -129 basis points 7. HBOS -110 basis points 8. HSBC -141 basis points 9. JP Morgan Chase -153 basis points 10. Lloyds -146 basis points 11. Norin Bank -126 basis points 12. Rabo Bank -143 basis points 13. Royal Bank of Canada -140 basis points 14. Royal Bank of Scotland -140 basis points 15. UBS -141 basis points 16. West -138 basis points

86. Every Spread during the period from September 16, 2008 to September 30, 2008 is statistically significant at the extremely high 99% confidence level.

87. Plaintiffs’ consulting expert finds the results reflected in these two tables to be powerful and statistically significant evidence of Defendants’ collusive suppression of LIBOR during the Class Period.

973672.6 -44- 88. As detailed above, analysis based on well accepted statistical methodologies strongly supports that suppression of LIBOR occurred during the Class Period, accomplished through the collusive conduct of Defendants. The sustained period during which the Federal

Reserve Eurodollar Deposit – LIBOR Spread fell and remained starkly negative, as seen in

Figure 2 above, accounting as it does for Market Fundamentals, is not plausibly achievable absent collusion among Defendants. The intensified suppression from September 16, 2008 to

September 30, 2008 (following the Lehman bankruptcy), in defiance of economic expectations, provides further powerful support for the suppression of LIBOR achieved through collusion by

Defendants. Because no Defendant Bank – absent collusive conduct – could know what LIBOR quote another panel bank actually intended to submit prior to those numbers being made public after 11:00 each morning, the fact that all Defendants submitted LIBOR quotes below the

Federal Reserve Eurodollar Deposit Rate over the Class Period further strongly supports the participation of each Defendant Bank in the suppressive and collusive scheme.

D. Empirical Analyses By Academics And Other Commentators Further Indicate LIBOR Suppression Occurred.

89. In addition to the independent expert work detailed above, publicly available analyses by academics and other commentators likewise support the Baltimore Plaintiffs’ allegations. While those studies used various comparative benchmarks and did not employ uniform methodologies, they collectively indicate LIBOR was artificially suppressed during the

Class Period.

1. The discrepancy between Defendants’ reported LIBOR quotes and their CDS spreads indicates the banks misrepresented their borrowing costs to the BBA.

90. One economic indicator that Defendants suppressed USD-LIBOR during the

Class Period is the variance between their LIBOR quotes and their contemporaneous cost of

973672.6 -45- buying default insurance—i.e., a credit-default swap (“CDS”)—on debt they issued during that period.

91. The spread serves as a measure of the perceived risk of default by the entity issuing the underlying bond or receiving the loan—the greater the risk of default the underlying bond or loan bears, the greater the CDS spread. In the case of a CDS for which the underlying instrument consists of an interbank loan where a USD-LIBOR panel bank is the borrower, the greater the perceived risk the panel bank will default on the loan, the higher the applicable CDS spread, as this higher spread represents the cost of insuring against the increased risk of a default on the underlying loan.

92. As one commentator has observed, “The cost of bank default insurance has generally been positively correlated with LIBOR. That is, in times when banks were thought to be healthy, both the cost of bank insurance and LIBOR decreased or remained low, but when banks were thought to be in poor condition, both increased.”32 During the Class Period,

however, those historically-correlated indicia of banks’ borrowing costs diverged significantly.

93. That discrepancy was detailed in a May 29, 2008 Wall Street Journal article

reporting the results of a study it had commissioned. The Journal’s analysis indicated numerous

banks caused LIBOR, “which is supposed to reflect the average rate at which banks lend to each

other,” to “act as if the banking system was doing better than it was at critical junctures in the

financial crisis.”33 The Journal found that beginning in January 2008, “the two measures began

to diverge, with reported LIBOR rates failing to reflect rising default-insurance costs.”

94. The Journal observed that the widest gaps existed with respect to the LIBOR

32 Justin Wong, “LIBOR Left in Limbo; A Call for More Reform,” 13 North Carolina Banking Institute 365, 371 (2009) (footnotes omitted). 33 See Carrick Mollenkamp and Mark Whitehouse, “Study Casts Doubt on Key Rate --- WSJ Analysis Suggests Banks May Have Reported Flawed Interest Data for Libor.”

973672.6 -46- quotes of Defendants Citibank, WestLB, HBOS, JPMorgan Chase, and UBS. According to the

Journal’s analysis, Citibank’s LIBOR quotes differed the most from what the CDS market suggested the bank’s borrowing cost was. On average, the rates at which Citibank reported it could borrow dollars for three months (i.e., its three-month LIBOR quote) were about 87 basis points lower than the rates calculated using CDS data. WestLB, HBOS, JPMorgan Chase, and

UBS likewise exhibited significant LIBOR-CDS discrepancies—of 70, 57, 43, and 42 basis points, respectively—while Defendants Credit Suisse, Deutsche Bank, Barclays, HSBC, Lloyds, and RBS each exhibited discrepancies of about 30 basis points. The study’s authors concluded

“one possible explanation for this gap is that banks understated their borrowing rates.”

95. Citing another example of suspicious conduct, the Journal observed that on the afternoon of March 10, 2008, investors in the CDS market were betting that WestLB—hit especially hard by the credit crisis—was nearly twice as likely to renege on its debts as Credit

Suisse, which was perceived to be in better shape, yet the next morning the two banks submitted identical LIBOR quotes.

96. Additionally, having compared the banks’ LIBOR quotes to their actual costs of borrowing in the commercial-paper market, the Journal reported, for example, that in mid-April

2008, UBS paid 2.85% to borrow dollars for three months, but on April 16, 2008, the bank quoted a borrowing cost of 2.73% to the BBA.

97. The Journal further noted an uncanny equivalence between the LIBOR panel banks’ quotes: the three-month borrowing rates the banks reported remained within a range of only 0.06 of a percentage point, even though at the time their CDS insurance costs (premiums) varied far more widely, reflecting the market’s differing views as to the banks’ creditworthiness.

According to Stanford University professor Darrell Duffie, with whom the authors of the Journal

973672.6 -47- article consulted, the unity of the banks’ LIBOR quotes was “far too similar to be believed.”

98. David Juran, a statistics professor at Columbia University who reviewed the

Journal’s methodology, similarly concluded that the Journal’s calculations demonstrate “very convincingly” that reported LIBOR is lower, to a statistically significant degree, than what the market thinks it should be.

99. Calculating an alternate borrowing rate incorporating CDS spreads, the Journal estimated that misreporting of LIBOR had a $45 billion effect on the market, representing the amount borrowers (the banks) did not pay to lenders (investors in debt instruments issued by the banks) that they would otherwise have had to pay.

100. According to the Journal, three independent academics, including Professor

Duffie, reviewed its methodology and findings, at the paper’s request. All three deemed the

Journal’s approach “reasonable.”

101. Further economic analysis supports the correlation seen in the Journal’s report.

A study by Connan Snider and Thomas Youle—of the economics departments at UCLA and the

University of Minnesota, respectively—released in April 2010 concluded LIBOR did not accurately reflect average bank borrowing costs, its “ostensible target.”34 Noting that “[i]n a

competitive interbank lending market, banks’ borrowing costs should be significantly related to

their perceived credit risk,” Snider and Youle posited that if LIBOR quotes “express true,

competitively determined borrowing costs,” they should “be related to measures of credit risks,

such as the cost of default insurance.” According to Snider and Youle’s analysis, however,

quotes provided by USD-LIBOR panel banks in fact deviated from their costs of borrowing as

reflected in CDS spreads.

34 Connan Snider and Thomas Youle, “Does the LIBOR reflect banks’ borrowing costs?”, April 2, 2010.

973672.6 -48- 102. Comparing, for example, the 12-month USD-LIBOR quotes from Citigroup and

Bank of Tokyo together with each banks’ corresponding one-year senior CDS spreads, Snider and Youle observed (as illustrated in the graph below) “that while Citigroup has a substantially higher CDS spread than [Bank of Tokyo], it submits a slightly lower Libor quote.” Accordingly, the authors explain, while the CDS spreads “suggest that the market perceives Citigroup as riskier than [Bank of Tokyo], as it is more expensive to insure against the event of Citigroup’s default,” the banks’ LIBOR quotes “tell the opposite story.”

103. Snider and Youle further noted the level of Citigroup’s CDS spreads relative to its

Snider and Youle further noted the level of Citigroup’s CDS spreads relative to its LIBOR

quotes was “puzzling.” The authors explained, “Given that purchasing credit protection for a

loan makes the loan risk free, one would expect [the] difference between the loan rate and the

CDS spread to roughly equal the risk free rate. This corresponds to the idea that a loan’s interest

rate contains a credit premium, here measured by the CDS spread.” But the authors observed

973672.6 -49- that Citigroup’s quote was often “significantly below its CDS spread,” implying “there were interbank lenders willing to lend to Citigroup at rates which, after purchasing credit protection, would earn them a guaranteed 5 percent loss.” (Emphasis added). That discrepancy contravenes basic rules of economics and finance, thus indicating Citibank misreports its borrowing costs to the BBA.

2. Cross-currency discrepancies in Defendants’ LIBOR quotes indicate they suppressed USD-LIBOR.

104. Defendants’ LIBOR quotes also displayed inexplicable “cross-currency rank reversals.” That is, as detailed in Snider and Youle’s paper referenced above, at least some

Defendants reported lower rates on USD-LIBOR than did other panel members but, for other currencies, provided higher rates than did those same fellow banks. Both BAC and BTMU, for instance, quoted rates for USD-LIBOR and Yen-LIBOR during the period under study, yet BAC quoted a lower rate than BTMU for USD-LIBOR and a higher rate than BTMU for Yen-LIBOR.

Other Defendants included in Snider and Youle’s analysis—Barclays, Citigroup, and JPMorgan

Chase—displayed similar anomalies across currencies, as the graphs below illustrate. Citigroup, for example, often reported rates at the top of the Yen-LIBOR scale while simultaneously quoting rates at the bottom of the USD-LIBOR scale. Because, Snider and Youle explain, “the same bank is participating in each currency,” the credit risk “is the same for loans in either currency”; thus these “rank reversals” demonstrate that differences in the banks’ LIBOR quotes

“are not primarily due to differences in credit risk, something we would expect of their true borrowing costs.”

973672.6 -50-

973672.6 -51-

973672.6 -52- 3. The frequency with which at least certain Defendants’ LIBOR quotes “bunched” around the fourth-lowest quote of the day suggests manipulation.

105. During the Class Period, the rates reported by certain Defendants—in particular,

Citibank, BAC, and JPMorgan Chase—also demonstrated suspicious “bunching” around the fourth lowest quote submitted by the 16 banks to the BBA. Indeed, Citibank’s and BAC’s quotes often tended to be identical to the fourth-lowest quote for the day. Because the LIBOR calculation involved excluding the lowest (and highest) four reported rates every day, bunching around the fourth-lowest rate suggests Defendants collectively depressed LIBOR by reporting the lowest possible rates that would not be excluded from the calculation of LIBOR on a given day.

106. Bunching among Defendants’ respective LIBOR quotes indicates the banks intended to report the same or similar rates, notwithstanding the banks’ differing financial conditions, which, as detailed above, reasonably should have resulted in differing LIBOR quotes.

Those discrepancies suggest Defendants colluded to suppress LIBOR.

107. The following charts show the frequency with which the USD-LIBOR quotes submitted by Defendants Citigroup, BAC, and JPMorgan Chase fell within a given percentage rate from the fourth-lowest quote. A negative difference means the reporting bank was below the fourth-lowest quote, and therefore its rate was not included in the daily LIBOR calculation, while zero difference means that the bank reported the fourth-lowest quote on a given day (either by itself or tied with other reporting banks).35

35 In the event of a tie between two or more banks, one of the banks’ quotes, selected at random, was discarded.

973672.6 -53-

973672.6 -54-

108. According to Snider and Youle, the fact that observed bunching occurred around the pivotal fourth-lowest reported rate reflected the reporting banks’ intention to ensure the lowest borrowing rates were included in the calculation of USD-LIBOR (which includes only the fifth-lowest through the twelfth-lowest quotes).

109. In other words, banks that bunched their quotes around the fourth-lowest submission helped ensure the maximum downward manipulation of the resulting rate.

Furthermore, that a panel bank reported one of the four lowest quotes (i.e., quotes excluded from the ultimate LIBOR calculation) does not mean the bank did not also participate in the collusion.

110. Further demonstrating the aberrant nature of the observed bunching around the fourth-lowest quote, Snider and Youle noted “the intraday distribution of other measures of bank borrowing costs do not exhibit this bunching pattern.” (Emphasis added).

111. Additionally, Snider and Youle detailed a discrepancy between USD-LIBOR panel banks’ LIBOR quotes and their CDS spreads. The authors found that “with the intra-day variation of both Libor quotes and CDS spreads increasing from their historical levels,” the CDS

973672.6 -55- spreads’ intra-day variation “grew considerably larger than that of Libor quotes.”36

112. Snider and Youle further observed that—as the graphs below, embodying a

composite of all the banks, illustrate—during the Class Period Defendants’ quotes tended to

“bunch” around the fourth-lowest quote much more commonly than those banks’ CDS spreads

“bunched” around the fourth-lowest spread. The authors concluded, “If banks were truthfully

quoting their costs, . . . we would expect these distributions to be similar.”

113. Given the method by which the BBA calculates LIBOR—discarding the highest

and lowest reported rates and averaging the remainder—that strong concentration around the

fourth-lowest rate is exactly what would occur if a number of banks sought in concert to depress

LIBOR.

36 Snider and Youle, “Does the LIBOR reflect banks’ borrowing costs?”

973672.6 -56- 4. That LIBOR diverged from its historical relationship with the Federal Reserve auction rate indicates suppression occurred.

114. A comparison between LIBOR and the Federal Reserve auction rate further

suggests Defendants artificially suppressed LIBOR during the Class Period. An April 16, 2008

Wall Street Journal article, for example, noted the Federal Reserve had recently auctioned off

$50 billion in one-month loans to banks for an average annualized interest rate of 2.82%—10

basis points higher than the comparable USD-LIBOR. That differential would make no

economic sense if the reported LIBOR was accurate, the Journal observed: “Because banks put

up securities as collateral for the Fed loans, they should get them for a lower rate than Libor,

which is riskier because it involves no collateral.”

115. A subsequent Journal article raised further concerns about LIBOR’s accuracy

based on the comparison of one-month LIBOR with the rate for the 28-day Federal Reserve

auction.37 According to the Journal, because the Federal Reserve requires collateral:

[B]anks should be able to pay a lower interest rate [to the Fed] than they do when they borrow from each other [e.g., as ostensibly measured by LIBOR] because those loans are unsecured. It is the same reason why rates for a mortgage, which is secured by a house, are lower than those for credit cards, where the borrower doesn’t put up any collateral. In other words, the rate for the Fed auction should be lower than Libor.

To the contrary, though, two days before the Journal article (September 22, 2008), the

rate for the 28-day Fed facility was 3.75%—much higher than one-month USD-LIBOR, which was 3.18% that day38 and 3.21% the next day.

37 Carrick Mollenkamp, “Libor’s Accuracy Becomes Issue Again,” The Wall Street Journal, September 24, 2008. 38 The Journal initially reported the one-month USD-LIBOR rate for that day as 3.19% but later noted the correct figure.

973672.6 -57- 5. LIBOR’s divergence from its historical correlation to overnight index swaps also suggests it was artificially suppressed during the Class Period.

116. Yet another measure of LIBOR’s aberrant behavior with respect to other measures of banks’ borrowing costs during the Class Period is its observed deviation from the overnight-index swap (“OIS”) rate. In his academic article analyzing LIBOR data for the period

of the second half of 2007 and 2008, Justin Wong observed that between 2001 and July 2007,

when the global credit crisis began, the spread between LIBOR and the OIS rate “averaged

eleven basis points.”39 By July 2008, on the other hand, that gap approached 100 basis points, a figure significantly higher than the spread from a year prior, and by October 2008, “it peaked at

366 basis points.” While the spread “receded somewhat in November 2008 to 209 basis points,” that was still “far above the pre-crisis level.” Wong’s analysis provides further support for

Plaintiffs’ allegations that Defendants suppressed LIBOR.

6. Additional data suggest LIBOR may have been manipulated as early as August 2006.

117. As the empirical evidence in support of LIBOR manipulation continues to develop, at least some of the data point to possible manipulation as early as August 2006. In a recent paper, Rosa Abrantes-Metz (of NYU Stern School of Business’s Global Economics

Group) and Albert Metz (of Moody’s Investors Service) compared one-month LIBOR against the Fed Funds effective rate and the one-month Treasury Bill (“T-Bill”) rate.40 Studying the

period of early August 2006 through early August 2007, the authors observed the level of one-

month LIBOR was “virtually constant,” while the Fed Funds effective rate and the one-month T-

39 Justin T. Wong, “LIBOR Left in Limbo; A Call for More Reform,” North Carolina Banking Institute, Vol. 13 p. 365-84 (Feb. 22, 2009). 40 Rosa M. Abrantes-Metz and Albert D. Metz, “How Far Can Screens Go in Distinguishing Explicit from Tacit Collusion? New Evidence from the Libor Setting.”

973672.6 -58- Bill rate did “not present such striking stability.” Spurred by that “highly anomalous” discrepancy, Abrantes-Metz and Metz examined the LIBOR panel members’ individual quotes, which showed that during the studied period, the middle eight quotes used to set LIBOR each day were “essentially identical day in and day out”—another “highly anomalous” finding.

118. The authors concluded that “explicit collusion” presented “the most likely explanation” for this anomalous behavior. They explained that because LIBOR quotes are submitted sealed, “the likelihood of banks moving simultaneously to the same value from one day to the next without explicit coordination is extremely low, particularly given that their idiosyncrasies would not imply completely identical quotes under a non-cooperative outcome.”

They further opined “it is difficult to attribute it to tacit collusion or strategic learning, since the change is abrupt, the quotes are submitted sealed, and the quotes themselves sometimes change from one day to the next in an identical fashion.”

119. Abrantes-Metz and Sofia B. Villas-Boas (of UC-Berkeley’s Department of

Agricultural & Resource Economics) used another methodology—Benford second-digit reference distribution—to track the daily, one-month LIBOR over the period 2005-2008.41

Based on this analysis, the authors found that for sustained periods in 2006 and 2007, the

empirical standard-deviation distribution differed significantly from the Benford reference

distribution for nearly all banks submitting quotes. The authors also observed large deviations

from Benford for a sustained period in 2008.

120. Those studies indicate at least a possibility that Defendants’ suppression of

LIBOR goes back even further than August 2007.

41 Rosa M. Abrantes-Metz and Sofia B. Villas-Boas, “Tracking the Libor Rate,” July 2010.

973672.6 -59- 7. Expert Analysis Performed In Connection With These Proceedings Indicates LIBOR’s Increase Following Expressions of Concern Over LIBOR’s Viability Resulted from Defendants’ Reaction to Events Unrelated to Market Factors.

121. On April 17, 2008, the day after The Wall Street Journal initially reported on

LIBOR’s anomalous behavior and the BBA stated it would conduct an inquiry concerning

LIBOR, there was a sudden jump in USD-LIBOR—the three-month borrowing rate hit 2.8175% that day, about eight basis points more than the previous day’s rate of 2.735%.

122. Suspiciously, reported LIBOR for other currencies fell or remained relatively flat

at the time USD-LIBOR rose, a sign that the latter was susceptible to manipulation.

123. A consulting expert engaged by the Plaintiffs in these coordinated proceedings

conducted an analysis of the change in LIBOR on the single date of April 17, 2008. The analysis

tested the hypothesis that if banks did not manipulate LIBOR, there would be no systematic

changes in LIBOR expected on April 17, 2008 relative to typical changes on other days between

January 5, 2000 to May 13, 2011, whereas if banks did manipulate LIBOR—and were responding to The Wall Street Journal article and BBA announcement—the reporting banks

would be likely to reduce or abandon the manipulation immediately in response to these events.

An immediate reduction in LIBOR manipulation would result in an increase in LIBOR quotes by

the member banks on April 17, 2008.

124. To conduct the analysis, the consulting expert ran a regression using the daily

changes in LIBOR. Table 1 below shows the studies’ results. As discussed above, LIBOR

increased on April 17, 2008 at a statistically significant level. Moreover, the increase in

composite LIBOR as well as of 11 of the 16 bank quotes were statistically significant. These

findings were consistent with the hypothesis that the banks manipulated and suppressed LIBOR.

973672.6 -60- Table 1 Changes in LIBOR on April 17, 2008 in Percentage Points*

Change in the dependent Average variable on Statistical change April 17, Significance at Dependent variable during non- 2008 the 1-5% level

suppression relative to of the April days non- 17, 2008 move suppression days' average

1 BBA LIBOR -0.000371 0.0909* 5%

2 HSBC LIBOR 0.000154 0.1273** 1%

3 JPMC LIBOR -0.000333 0.0872* 5%

4 BARCLAYS LIBOR -0.000333 0.1072* 5%

5 WEST LB LIBOR -0.000314 0.0971* 5%

6 RBS LIBOR -0.000352 0.0921* 5%

7 RABOBANK LIBOR -0.000364 0.0872* 5%

8 CITI LIBOR -0.000344 0.1022* 5%

9 RBC LIBOR 0.002067 0.1021* 5%

10 UBS LIBOR -0.000777 0.1021* 5%

11 NORIN LIBOR -0.00038 0.0971* 5%

12 HBOS LIBOR 0.002467 0.1111* 5%

Statistical significance is assessed using a AR(3) model for the residuals * While not shown here, an additional dummy variable is used to control for changes during the Relevent Period of August 8, 2007 to May 17, 2010.

973672.6 -61-

125. An alternative hypothesis is that, in addition to reacting to the Journal, other confounding effects that are related to the risk of the banking sector or overall Market

Fundamentals could have emerged on April 16, 2008 and April 17, 2008. This alternative hypothesis also predicts an increase in LIBOR. To test this alternative hypothesis, instead of looking at daily changes in LIBOR quotes, it is possible to examine daily changes in the difference between banks’ LIBOR quotes and the Federal Reserve Eurodollar Deposit Rate (the

“Spread”). If risk-related factors or Market Fundamentals played a role, they would affect both the banks’ LIBOR quotes as well as the Federal Reserve’s Eurodollar Deposit Rate. Thus, if this hypothesis is correct, one should not see any changes to the Spread on April 17, 2008, since these two effects should cancel out. However, if there were no risk-related news and only a reaction to The Wall Street Journal article and the BBA announcement played a major role, then only LIBOR would be affected, leaving Federal Reserve’s Eurodollar Deposit Rate mostly unaffected. In this case, the Spread would again be expected to increase.

126. The test of this alternative hypothesis showed that the Spreads of all 16 panel banks increased on April 17, 2008, and, as shown in Table 2 below, 11 of the 16 changes were statistically significant at levels ranging from 1% to 5%. Once again, these finding were consistent with the manipulation hypothesis and inconsistent with the hypothesis that other risk factors explained the April 17, 2008 shock to LIBOR.

Table 2

Changes in Spread (BBA LIBOR – Federal Reserve’s Eurodollar Deposit Rate) on April 17, 2008 in Percentage Points*

973672.6 -62- Change in the dependent Average Statistical variable on change in Significance April 17, Spread at the 1-5% Dependent variable 2008 during non- level of the relative to suppression April 17, 2008 non- days move suppression days' average

1 BBA LIBOR Spread -0.000078 0.0838 5%

2 HSBC LIBOR Spread 0.000508 0.1205 1%

3 JPMC LIBOR Spread -0.000103 0.0803* 5%

4 BARCLAYS LIBOR Spread -0.000067 0.1002** 1%

5 RBS LIBOR Spread -0.0001 0.0851* 5%

6 TOKYO LIBOR Spread -0.000092 0.0797* 5%

7 CITI LIBOR Spread -0.00012 0.0953* 5%

8 CS LIBOR Spread -0.000224 0.07* 5%

9 RBC LIBOR Spread -0.000135 0.0951* 5%

10 UBS LIBOR Spread -0.000172 0.095* 5%

11 NORIN LIBOR Spread -0.000179 0.0903** 1%

12 HBOS LIBOR Spread 0 0.1007* 5%

Statistical significance is assessed using a AR(3) model for the residuals * While not shown here, an additional dummy variable is used to control for changes during the Relevent Period of August 8, 2007 to May 17, 2010.

127. The conclusions of this study are consistent with the contemporaneous views

973672.6 -63- expressed by high-level employees of various Defendant panel banks recounted above.

E. That At Least Some Defendants Faced Dire Financial Circumstances During the Class Period Further Renders Their Unduly Low LIBOR Quotes Striking.

128. The independent economic analyses performed in connection with these proceedings, whose findings are corroborated by the publicly available scholarly work detailed above, strongly indicate Defendants’ LIBOR quotes during the Class Period did not appropriately reflect those banks’ actual borrowing costs at that time—and, indeed, that

Defendants collectively suppressed LIBOR. Further illustrating the striking discrepancy between

Defendants’ submissions to the BBA and their actual borrowing costs, during 2008 and 2009 at least some of those banks’ LIBOR quotes were too low in light of the dire financial circumstances the banks faced, as described in numerous news articles from the Class Period.

1. Citigroup

129. On November 21, 2008, The Wall Street Journal reported that Citigroup

executives “began weighing the possibility of auctioning off pieces of the financial giant or even

selling the company outright” after the company faced a plunging stock price. The article noted

Citigroup executives and directors “rushing to bolster the confidence of investors, clients and

employees” in response to uncertainty about Citigroup’s exposure to risk concerning mortgage-

related holdings.42 Similarly, On November 24, 2008, CNNMoney observed:

If you combine opaque structured-finance products with current fair-value accounting rules, almost none of the big banks are solvent because that system equates solvency with asset liquidity. So at this moment Citi isn’t solvent. Some argue that liquidity, not solvency, is the problem. But in the end it doesn’t matter. Fear will drive illiquidity to such a point that Citi could be rendered

42 See http://online.wsj.com/article/SB122722907151946371.html?mod=testMod

973672.6 -64- insolvent under the current fair-value accounting system.43

130. On January 20, 2009, Bloomberg reported that Citigroup “posted an $8.29 billion fourth-quarter loss, completing its worst year, and plans to split in two under Chief Executive

Officer Vikram Pandit’s plan to rebuild a capital base eroded by the credit crisis. The article further stated, “The problems of Citi, Bank of America and others suggest the system is bankrupt.” (Emphasis added).44

2. RBS, Lloyds, and HBOS

131. An April 23, 2008 analyst report from Société Générale concluded, with respect to RBS’s financial condition in the midst of its attempt to raise capital:

Given the magnitude and change in direction in a mere eight weeks, we believe that management credibility has been tarnished. We also remain unconvinced that the capital being raised is in support of growth rather than merely to rebase and recapitalise a bank that overstretched itself at the wrong point in the cycle in its pursuit of an overpriced asset.

* * *

[I]n our eyes, RBS has not presented a rock solid business case that warrants investor support and the bank has left itself almost no capital headroom to support further material deterioration in either its assets or its major operating environments. We believe £16bn (7% core tier I ratio) would have provided a solid capital buffer.

The analysts also opined, “[W]e are not of the belief that all of RBS’ problems are convincingly behind it.” They further explained, “When faced with the facts and the events leading up to yesterday’s request for a £12bn capital injection, we believe shareholders are being asked to invest further in order to address an expensive mishap in H2 07 rather than capitalise on growth opportunities.”

43 See http://money.cnn.com/2008/11/21/news/companies/benner_citi.fortune/ 44 See http://www.bloomberg.com/apps/news?pid=21070001&sid=aS0yBnMR3USk

973672.6 -65- 132. On October 14, 2008, The Herald Scotland reported a £37 billion injection of state capital into three leading banks, including RBS and HBOS. The article observed, “Without such near-nationalisations, . . . Royal Bank of Scotland and HBOS, would almost certainly have suffered a run on their remaining reserves and been plunged into insolvency. Their share prices could scarcely have taken much more of their recent hammering.”45

133. On December 12, 2008, Bloomberg reported that shareholders approved HBOS’s

takeover by Lloyds TSB Group plc following bad-loan charges in 2008 rising to £5 billion and

an increase in corporate delinquencies. The article also quoted analysts characterizing HBOS’s

loan portfolio as “‘generally of a lower quality than its peers.’” Bloomberg further observed that

HBOS suffered substantial losses on its bond investments, which totaled £2.2 billion, and losses

on investments increased from £100 million to £800 million for the year.46

134. A January 20, 2009, analyst report from Société Générale stated: “We would note

that given the 67% drop in the share price following [RBS]’s announcements yesterday [relating

to capital restructuring due to greater-than-expected credit-market related write downs and bad

debt impairments in Q4], the loss of confidence in the bank’s ability to continue to operate as a

private sector player and concern over the potential ineffectiveness of the Asset Protection

Scheme may prompt the U.K. government to fully nationalise the bank. In this instance, the

shares could have very limited value, if at all.”47

135. On March 7, 2009, Bloomberg reported that Lloyds “will cede control to [the

45 See http://www.heraldscotland.com/reckless-banks-brought-this-financial-firestorm-down- upon-their-own-heads-1.891981. 46 See http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a4BTqdgwhPTc&refer=uk. 47 See January 20, 2009 Société Générale analyst report on Royal Bank of Scotland titled “Little value left for shareholders.”

973672.6 -66- British Government] in return for state guarantees covering 260 billion pounds ($367 billion) of risky assets.” The article further observed that in September 2008, Lloyds agreed to buy HBOS for roughly £7.7 billion as the British Government sought to prevent HBOS from collapsing after credit markets froze. The HBOS loan book was described as “more toxic than anyone ever dreamed.”48

136. On November 24, 2009, Bloomberg reported the provided £62 billion ($102 billion) of “taxpayer-backed emergency financing” to RBS and HBOS at the height of the financial crisis in October 2008 and that “[t]he [financing] operations were kept secret until now to prevent unnerving markets.” The Bank’s Deputy Governor was quoted as stating in evidence to the Treasury Committee in London that “‘[h]ad we not done it, the cycle would have been a lot worse…[and that] [t]his was tough stuff, a classic lender of last resort operation.’”49

3. WestLB

137. A September 9, 2008 article in Spiegel Online reported WestLB was “heavily

hit as a result of the US sub-prime crisis and the resulting . Ill-advised speculation

resulted in a 2007 loss of €1.6 billion -- leading the bank to the very brink of insolvency.” The

article reported that in early 2008, a special investment vehicle was set by WestLB’s primary shareholders to “guarantee €5 billion worth of risky investments.” The European Commissioner approved the public guarantee but demanded that the bank be “completely restructured to avoid falling afoul of competition regulations.” The European Commissioner for Competition later warned that if WestLB did not significantly improve its restructuring package, Brussels would

48 See http://www.businessday.com.au/business/lloyds-the-latest-uk-bank-to-be-rescued- 20090308-8sfd.html. 49 See http://www.bloomberg.com/apps/news?pid=21070001&sid=a9MjQj6MNTeA

973672.6 -67- not approve the public assistance that European Union had already provided to the bank.

Further, if that occurred, WestLB would have to pay back €12 billion to the EU.50

138. On November 24, 2009, Bloomberg reported that BNP Paribas SA said

“[i]nvestors should buy the euro [ ] on speculation that capital will need to be repatriated to support German bank WestLB AG.” Furthermore, two German regional savings bank groups that hold a majority stake in WestLB were “prepared to let the Dusseldorf-based lender become

insolvent” and that “the prospect of insolvency may force state-owned banks and savings banks

outside North Rhine-Westphalia, WestLB’s home state, to contribute to capital injections.”

Moreover, WestLB needed “as much as 5 billion euros ($7.5 billion) in capital and may be shut

by Nov. 30 unless a solution for its capital needs can be found.”51

F. Defendants’ Improper Activities Have Incited Governmental Investigations Legal Proceedings and Disciplinary Action Worldwide.

139. As described in more detail below, investigations regarding LIBOR are ongoing

in the United States, Switzerland, Japan, United Kingdom, Canada, the European Union, and

Singapore by nine different governmental agencies, including the DOJ, the SEC, and the CFTC.

Indeed, on February 27, 2012, the DOJ represented to the Court overseeing these multidistrict

proceedings that the Justice Department “is conducting a criminal investigation into alleged

manipulation of certain benchmark interest rates, including of several currencies.” The

investigation represents an unprecedented joint investigation by both the criminal and antitrust

divisions of the DOJ.

50 See Anne Seith, Germany’s WestLB under Attack from Brussels, SPIEGEL ONLINE, Sept. 9, 2008, http://www.spiegel.de/international/business/0,1518,druck-577142,00.html. 51 See Matthew Brown, BNP Says Buy Euro on Speculation WestLB to Be Rescued (Update 1), BLOOMBERG, Nov. 24, 2009, http://www.bloomberg.com/apps/news?pid=21070001&sid=aI9ZPZShrjWI.

973672.6 -68- 140. Authorities are attempting to determine, among other things, “whether banks whose funding costs were rising as the financial crisis intensified tried to mask that trend by submitting artificially low readings of their daily borrowing costs.”52 Though the proceedings

are ongoing, several Defendants have admitted that regulators—including the DOJ, SEC, and

CFTC—have targeted them in seeking information about potential misconduct.

141. Moreover, documents submitted in connection with legal proceedings in Canada

and Singapore reveal that at least certain Defendants misreported their borrowing costs to

artificially suppress Yen-LIBOR.

1. News reports and Defendants’ regulatory filings indicate U.S. government and foreign regulatory bodies are engaged in expansive investigations of possible LIBOR manipulation.

142. The first public revelation regarding government investigations into possible

LIBOR manipulation occurred on March 15, 2011, when UBS disclosed in a Form 20-F (annual

report) filed with the SEC that the bank had “received subpoenas” from the SEC, the CFTC, and

the DOJ “in connection with investigations regarding submissions to the [BBA].” UBS stated it

understood “that the investigations focus on whether there were improper attempts by UBS,

either acting on its own or together with others, to manipulate LIBOR rates at certain times.”

The bank further disclosed that it had “received an order to provide information to the Japan

Financial Supervisory Agency concerning similar matters.” UBS stated it was “conducting an

internal review” and was “cooperating with the investigations.”

143. On March 16, 2011, the reported that UBS, BAC, Citigroup, and

Barclays received subpoenas from U.S. regulators “probing the setting of” USD-LIBOR

“between 2006 and 2008.” The Times further noted investigators had “demanded information

52 David Enrich, Carrick Mollenkamp, & Jean Eaglesham, “U.S. Libor Probe Includes BofA, Citi, UBS.” The Wall Street Journal, March 18, 2011

973672.6 -69- from” WestLB, and that the previous fall, “all 16 members of the committee that helped the

[BBA] set the dollar Libor rate during 2006-08 received informal requests for information.”53

144. The same day, MarketWatch similarly reported “[m]ultiple U.S. and European

banks, which provide borrowing costs to calculate Libor every day, have been contacted by

investigators,” including the DOJ, the SEC, and the CFTC.54

145. The next day, Bloomberg reported that Barclays and Citigroup had received subpoenas from U.S. regulators and that Defendants WestLB, Lloyds, and BAC had been contacted by regulators. The article specified BAC had received subpoenas from the SEC and the DOJ.55

146. On March 23, 2011, Bloomberg revealed that Citigroup Inc., Deutsche Bank,

BAC, and JPMorgan Chase were asked by U.S. regulators “to make employees available to

testify as witnesses” in connection with the regulators’ ongoing investigation.56

147. The next day, the Financial Times reported that Defendant Barclays was

“emerging as a key focus of the US and U.K. regulatory probe into alleged rigging of [LIBOR].”

According to the Times, investigators were “probing whether communications between the

bank’s traders and its treasury arm,” which helps set LIBOR, “violated ‘Chinese wall’ rules that

prevent information-sharing between different parts of the bank.” The Times further stated

53 Brooke Masters, Patrick Jenkins & Justin Baer, “Banks served subpoenas in Libor case,” FT.com, available at http://www.ft.com/cms/s/0/52958d66-501f-11e0-9ad1- 00144feab49a.html#axzz1sJNEDIiI, last accessed on April 17, 2012. 54 Carrick Mollenkamp and David Enrich, “Banks Probed in Libor Manipulation Case,” MarketWatch, March 16, 2011. 55 Gavin Finch and Jon Menon, “Barclays, Citigroup Said to Be Subpoenaed in Libor Probe,” Bloomberg, March 17, 2011. 56 Joshua Gallu and Donal Griffin, “Libor Probe Spurs Witness Call-up at Citigroup, Deutsche Bank,” Bloomberg, March 23, 2011.

973672.6 -70- investigators were “said to be looking at whether there was any improper influence on Barclays’ submissions” during 2006-2008 for the BBA’s daily survey used to set LIBOR.57

148. Additional information regarding the regulatory probes emerged during the next

few months, including revelations about other banks’ possible—or actual—misconduct.

149. In an “Interim Management Statement” filed on April 27, 2011, for example,

Barclays stated it was “cooperating with” the investigations by the U.K. Financial Services

Authority, the CFTC, the SEC, and the DOJ “relating to certain past submissions made by

Barclays to the [BBA], which sets LIBOR rates.”

150. RBS similarly disclosed, in a Form 6-K filed with the SEC on May 6, 2011, the

bank was “co-operating with” the investigations being conducted by the CFTC, the SEC, and the

European Commission “into the submission of various LIBOR rates by relevant panel banks.”

151. Soon after, on May 16, 2011, Lloyds disclosed that it too “had received requests

for information as part of the Libor investigation and that it was co-operating with regulators,

including the [CFTC] and the European Commission.”58 Britain’s Daily Telegraph further

reported that Defendant HBOS, which merged with Lloyds TSB in January 2009 to form Lloyds

Banking Group, “was the main target given its near collapse in late 2008 as it lost access to

wholesale funding markets.”

152. On May 23, 2011, the Telegraph reported that the Federal Bureau of Investigation

(“FBI”) was working with regulators in connection with the LIBOR investigations, and the FBI’s

British counterpart, the Serious Office, “revealed it is also taking an active interest.”

57 Brooke Masters and Megan Murphy, “Barclays at centre of Libor inquiry,” FT.com, March 24, 2011, available at http://www.ft.com/intl/cms/s/0/1c3228f6-5646-11e0-82aa- 00144feab49a.html#axzz1sJNEDIiI, last accessed on April 17, 2012. 58 Harry Wilson, “Lloyds Banking Group in Libor investigation,” The Daily Telegraph, May 17, 2011.

973672.6 -71- 153. In a Form 6-K filed with the SEC on July 26, 2011, UBS disclosed that it had

“been granted conditional leniency or conditional immunity from authorities in certain jurisdictions, including the Antitrust Division of the DOJ, in connection with potential antitrust or competition law violations related to submissions for Yen LIBOR and Euroyen TIBOR

(Tokyo Interbank Offered Rate).” Accordingly, the company continued, it would “not be subject to prosecutions, fines or other sanctions for antitrust or competition law violations in connection with the matters [UBS] reported to those authorities, subject to [UBS’s] continuing cooperation.”

The conditional leniency UBS received derives from the Antitrust Criminal Penalties

Enhancement and Reform Act and the DOJ’s Corporate Leniency Policy, under which the DOJ only grants leniency to corporations reporting actual illegal activity. UBS later disclosed (on

February 7, 2012) that the Swiss Competition Commission had granted the bank conditional

immunity regarding submissions for Yen LIBOR, TIBOR, and Swiss franc LIBOR.

154. Similar to the other Defendants discussed above, HSBC, in an interim report filed

on August 1, 2011, disclosed that it and/or its subsidiaries had “received requests” from various

regulators to provide information and were “cooperating with their enquiries.”

155. On or about the same day, Barclays—which several months earlier had referenced

its “cooperation” with governmental entities investigating potential misconduct relating to

LIBOR—specified the investigations involved “submissions made by Barclays” and other

LIBOR panel members. Barclays further stated it was engaged in discussions with those

authorities about potential resolution of these matters before proceedings are brought against the

bank.

156. On September 7, 2011, the Financial Times reported that as part of their LIBOR

investigation, the DOJ and the CFTC—in assessing whether banks violated the Commodity

973672.6 -72- Exchange Act, which can result in criminal liability—were examining “whether traders placed

bets on future yen and dollar rates and colluded with bank treasury departments, who help set the

Libor index, to move the rates in their direction,” as well as “whether some banks lowballed their

Libor submissions to make themselves appear stronger.”59

157. On October 19, 2011, The Wall Street Journal reported that the European

Commission “seized documents from several major banks” the previous day, “marking the

escalation of a worldwide law-enforcement probe” regarding the Euro Interbank Offered Rate, or

Euribor—a benchmark, set by more than 40 banks, used to determine interest rates on trillions of

euros’ worth of euro-denominated loans and debt instruments. The inquiry, the Journal

explained, constitutes “an offshoot” of the broader LIBOR investigation that had been ongoing

for more than a year. According to the Journal, while the list of financial firms raided by the

European Commission was not available, people familiar with the situation had counted “a large

French bank and a large German bank” among the targets, and the coordinated raids “occurred in

London and other European cities.”

158. On October 31, 2011, the Financial News observed that “[a]n investigation into

price fixing, first ordered by the [SEC] in 2008, focused on whether banks, including UBS,

Citigroup, and Bank of America, had been quoting deliberately low rates.”60

159. On December 9, 2011, Law360 reported that the Japanese Securities and

Exchange Surveillance Commission (“SESC”) alleged that Citigroup Global Markets Japan Inc.

and UBS Securities Japan Ltd. “employed staffers who attempted to influence” TIBOR “to gain

59 Brooke Masters and Kara Scannell, “Libor inquiry looks at criminal angle,” FT.com, September 7, 2011, available at http://www.ft.com/cms/s/0/c8ed4248-d962-11e0-b52f- 00144feabdc0.html#axzz1sRxAdyPS, last accessed on April 18, 2012. 60 Tom Osborn, “Is Libor in its death throes?” Financial News, October 31, 2011.

973672.6 -73- advantage on derivative trades.” The SESC recommended that the Japanese prime minister and the head of Japan’s Financial Services Agency (“JFSA”) take action against the companies. The

Commission specified that Citigroup’s head of G-10 rates and a Citigroup trader, as well as a

UBS trader, were involved in the misconduct, further stating, “[t]he actions of Director A and

Trader B are acknowledged to be seriously unjust and malicious, and could undermine the fairness of the markets.” Moreover, the Commission added, “[i]n spite of recognizing these actions, the president and CEO . . . who was also responsible for the G-10 rates, overlooked these actions and the company did not take appropriate measures, therefore, the company’s internal control system is acknowledged to have a serious problem.”61 Law360 reported that the SESC

released “a similar statement” about UBS’s alleged conduct.

160. Citigroup and UBS did not deny the SESC’s findings. A Citigroup spokesperson

stated, “Citigroup Global Markets Japan takes the matter very seriously and sincerely apologizes

to clients and all parties concerned for the issues that led to the recommendation. The company

has started working diligently to address the issues raised.” A UBS spokesperson similarly

stated the bank was taking the findings “very seriously” and had been “working closely with” the

SESC and the JFSA “to ensure all issues are fully addressed and resolved.” She added, “We

have taken appropriate personnel action against the employee involved in the conduct at issue.”

161. Citigroup later disclosed that on December 16, 2011, the JFSA took

administrative action against Citigroup Global Markets Japan, Inc. (“CGMJ”) for, among other

things, certain communications made by two CGMJ traders about the Euroyen Tokyo InterBank

Offered Rate (“TIBOR”). The JFSA issued a business improvement order and suspended

CGMJ’s trading in derivatives related to Yen-LIBOR, as well as Euroyen and Yen-TIBOR from

61 Juan Carlos Rodriguez, “Japan Accuses Citi, UBS Of Market Trickery,” Law360, December 9, 2011.

973672.6 -74- January 10 to January 23, 2012. On the same day, the JFSA also took administrative action against Citibank Japan Ltd. for conduct arising out of Citibank Japan’s retail business and also noted that the communications made by the CGMJ traders to employees of Citibank Japan about

Euroyen TIBOR had not been properly reported to Citibank Japan’s management team.

162. UBS likewise recently revealed further details regarding the Japanese regulators’ findings and the resulting disciplinary action. Specifically, the bank announced that on

December 16, 2011, the JFSA commenced an administrative action against UBS Securities Japan

Ltd. (“UBS Securities Japan”) based on findings by the SESC that:

(i) a trader of UBS Securities Japan engaged in inappropriate conduct relating to Euroyen TIBOR and Yen LIBOR, including approaching UBS AG, Tokyo Branch, and other banks to ask them to submit TIBOR rates taking into account requests from the trader for the purpose of benefiting trading positions; and (ii) serious problems in the internal controls of UBS Securities Japan resulted in its failure to detect this conduct.

Based on those findings, the JFSA “issued a Business Suspension Order requiring UBS

Securities Japan to suspend trading in derivatives transactions related to Yen LIBOR and

Euroyen TIBOR” from January 10 to January 16, 2012 (excluding transactions required to perform existing contracts). The JFSA also issued a “Business Improvement Order” requiring

UBS Securities Japan to enhance “compliance with its legal and regulatory obligations” and to establish a “control framework” designed to prevent similar improper conduct.

163. The Wall Street Journal has since cited people familiar with the UBS matter as identifying the trader as Thomas Hayes, who joined UBS Securities Japan in 2006 “and traded products linked to the pricing of short-term yen-denominated borrowings”; he worked at UBS for about three years.62

62 Jean Eaglesham, Atsuko Fukase, & Sam Holmes, “Rate Probe Keys On Traders: Investigators Footnote continued on next page

973672.6 -75- 164. In the same article, the Journal more broadly reported that investigators in the

U.S. and foreign LIBOR probes “are focusing on a small number of traders suspected of trying to influence other bank employees to manipulate the rates.”

165. Other news accounts in recent months have confirmed—based at least in part on information from people familiar with the ongoing investigations—that investigators are examining potential improper collusion by traders and bankers to manipulate LIBOR or other rates. On February 3, 2012, for instance, Credit Suisse disclosed that the Swiss Competition

Commission commenced an investigation involving twelve banks and certain other financial intermediaries, including Credit Suisse, concerning alleged collusive behavior among traders to affect the bid ask spread for derivatives tied to the LIBOR and TIBOR reference rates fixed with respect to certain currencies, and collusive agreements to influence these rates.

166. Additionally, on February 14, 2012, Bloomberg reported that two people with knowledge of the ongoing LIBOR probe said global regulators “have exposed flaws in banks’ internal controls that may have allowed traders to manipulate interest rates around the world.”

The same people, who were not identified by name (as they were not authorized to speak publicly about those matters), stated investigators also had “received e-mail evidence of potential collusion” between firms setting LIBOR. Those sources further noted Britain’s Financial

Services Authority was “probing whether banks’ proprietary-trading desks exploited information they had about the direction of Libor to trade interest-rate derivatives, potentially defrauding their firms’ counterparties.”63

Footnote continued from previous page Suspect Employees at Some Banks Tried to Manipulate Rates,” The Wall Street Journal, February 7, 2012. 63 Lindsay Fortado and Joshua Gallu, “Libor Probe Said to Expose Collusion, Lack of Internal Controls,” Bloomberg, February 14, 2012.

973672.6 -76- 167. Bloomberg further reported that RBS had “dismissed at least four employees in connection with the probes,” and Citigroup and Deutsche Bank “also have dismissed, put on leave or suspended traders as part of the investigations.”

168. Bloomberg also reported that European Union antitrust regulators are also investigating whether banks effectively formed a global cartel and coordinated how to report borrowing costs between 2006 and 2008.

169. In March 2012, the Monetary Authority of Singapore disclosed that it has been approached by regulators in other countries to help in investigations over the possible manipulation of interbank interest rates.64

170. Bloomberg interviewed money-market traders in March 2012, who said that staff

responsible for panel banks’ LIBOR submissions “regularly discussed where to set the measure

with traders sitting near them, interdealer brokers, and counterparts at rival banks.”65 “The talks

became common practice after money markets froze in 2007. . . . Traders interviewed said there

were no rules stopping talks between employees, or guidelines on how the rate should be set.”

The “BBA says only a bank’s Treasurer or other nominated individual can make a submission,

but a trader at one firm [told Bloomberg] that a large number of employees had access to the

software used to make the bank’s submissions and could overwrite other’s figures.” The

Telegraph reported that “senior bankers privately admit it is easy for banks to fix Libor at rates

that are favorable to their own interests, as the task of setting the rate is often undertaken by

relatively junior employees.”66

64 Business Times, March 9, 2012. 65 Liam Vaughan, Gavin Finch and Jesse Westbrook, “Life as Libor Traders Knew It Seen as Abusive,” Bloomberg, March 2, 2012. 66 Jamie Dunkley and Harry Wilson, “UBS accused of manipulating Libor,” The Telegraph, March 15, 2011.

973672.6 -77-

171. According to the Daily Mail, investigations by the SEC, Britain’s Financial

Services Authority, the Swiss Competition Commission, and regulators in Japan focus on three

concerns: First, whether banks artificially suppressed LIBOR during the financial crisis, making banks appear more secure than they actually were; second, whether bankers setting LIBOR

leaked their data to traders before officially submitting the banks’ LIBOR quotes to the BBA;

third, whether traders at the banks, and at other organizations (such as funds), may have

tried to influence LIBOR by making suggestions or demands on the bankers providing LIBOR

quotes.

2. Evidence disclosed to date in the Canadian and Singapore proceedings confirms that certain Defendants conspired to manipulate Yen-LIBOR as part of the global conspiracy.

Canadian Action

172. In the Canadian action, Brian Elliott, a Competition Law Officer in the Criminal

Matters Branch of the Competition Bureau, submitted an affidavit in May 2011 (the “May 2011

Elliott Affidavit”) in support of “an Ex Parte Application for Orders to Produce Records

Pursuant to Section 11 of the Competition Act and for Sealing Orders” in the Court of Ontario,

Superior Court of Justice, East Region. Specifically, the May 2011 Elliott Affidavit sought

orders requiring HSBC Bank Canada, Royal Bank of Scotland N.V., Canada Branch, Deutsche

Bank, J.P. Morgan Bank Canada, and Citibank Canada (referenced collectively in the Affidavit

as the “Participant Banks”) to produce documents in connection with an inquiry concerning

whether those banks conspired to “enhance unreasonably the price of interest rate derivatives

from 2007 to March 11, 2010; to prevent or lessen, unduly, competition in the purchase, sale or

supply of interest derivatives from 2007 to March 11, 2010; to restrain or injure competition

unduly from 2007 to March 11, 2010; and to fix, maintain, increase or control the price for the

973672.6 -78- supply of interest rate derivatives from March 12, 2010 to June 25, 2010.”

173. The May 2011 Elliott Affidavit further states the Competition Bureau “became aware of this matter” after one of the banks (referenced in the affidavit as the “Cooperating

Party”) “approached the Bureau pursuant to the Immunity Program” and, in connection with that bank’s application for immunity, its counsel “orally proffered information on the Alleged

Offences” to officers of the Competition Bureau on numerous occasions in April and May 2011.

Furthermore, according to the Affidavit, counsel for the Cooperating Party “stated that they have conducted an internal investigation of the Cooperating Party that included interviews of employees of the Cooperating Party who had knowledge of or participated in the conduct in question, as well as a review of relevant internal documents.” The Affidavit also notes that on

May 17, 2011, counsel for the Cooperating Party provided the Competition Bureau with

“electronic records,” which Elliot “believe[s] to be records of some of the communications involving the Cooperating Party that were read out as part of the orally proffered information by counsel for the Cooperating Party.” The press has reported that UBS was the “Cooperating

Party” referred to in the Elliott Affidavits.

174. The Affidavit recounted that, the Cooperating Party’s counsel, during the Class

Period the Participant Banks—at times “facilitated” by “Cash Brokers”—“entered into agreements to submit artificially high or artificially low London Inter-Bank Offered Rate

(‘LIBOR’) submissions in order to impact the Yen LIBOR interest rates published by the

[BBA].” Those entities engaged in that misconduct to “adjust[] the prices of financial

instruments that use Yen LIBOR rates as a basis.” The Affidavit further states the Cooperating

Party’s counsel “indicated the Participant Banks submitted rates consistent with the agreements

and were able to move Yen LIBOR rates to the overall net benefit of the Participants.”

973672.6 -79- 175. More specifically, counsel proffered that, during the Class Period, the Participant

Banks “communicated with each other and through the Cash Brokers to form agreements to fix the setting of Yen LIBOR,” which “was done for the purpose of benefiting trading positions, held by the Participant Banks, on IRDs [interest rate derivatives].” By manipulating Yen

LIBOR, the Affidavit continues, “the Participant Banks affected all IRDs that use Yen LIBOR as a basis for their price.” The misconduct was carried out “through e-mails and Bloomberg instant

messages between IRD traders at the Participant Banks and employees of Cash Brokers (who

had influence in the setting of Yen LIBOR rates).” The Affidavit details:

IRD traders at the Participant Banks communicated with each other their desire to see a higher or lower Yen LIBOR to aid their trading position(s). These requests for changes in Yen LIBOR were often initiated by one trader and subsequently acknowledged by the trader to whom the communication was sent. The information provided by counsel for the Cooperating Party showed that the traders at Participant Banks would indicate their intention to, or that they had already done so, communicate internally to their colleagues who were involved in submitting rates for Yen LIBOR. The traders would then communicate to each other confirming that the agreed up rates were submitted. However, not all attempts to affect LIBOR submissions were successful.

The Cash Brokers were asked by IRD traders at the Participant Banks to use their influence with Yen LIBOR submitters to affect what rates were submitted by other Yen LIBOR panel banks, including the Participant Banks.

176. The Affidavit indicates the Cooperating Party’s counsel further proffered that at

least one of the Cooperating Party’s IRD traders (“Trader A” or “Trader B”) communicated with

an IRD trader at HSBC, Deutsche Bank, RBS, JPMorgan (two traders), and Citibank. In that

regard, the Affidavit specifies:

Trader A communicated his trading positions, his desire for a certain movement in Yen LIBOR and instructions for the HSBC trader to get HSBC to make Yen LIBOR submissions consistent with his wishes. Attempts through the HSBC trader to influence Yen LIBOR were not always successful. Trader A also

973672.6 -80- communicated his desire for a certain movement in the Yen LIBOR rate with the Cash Brokers. He instructed them to influence the Yen LIBOR submitters of HSBC. The Cash Brokers acknowledged making these attempts.

Trader A communicated his trading positions, his desire for certain movement in Yen LIBOR and asked for the Deutsche IRD trader’s assistance to get Deutsche to make Yen LIBOR submissions consistent with his wishes. The Deutsche IRD trader also shared his trading positions with Trader A. The Deutsche IRD trader acknowledged these requests. Trader A also aligned his trading positions with the Deutsche IRD trader to align their interests in respect of Yen LIBOR. The Deutsche IRD trader communicated with Trader A considerably during the period of time, mentioned previously, when Trader A told a Cash Broker of a plan involving the Cooperating Party, HSBC and Deutsche to change Yen LIBOR in a staggered and coordinated fashion by the Cooperating Party, HSBC and Deutsche. Not all attempts to change the LIBOR rate were successful.

Trader A explained to RBS IRD trader who his collusive contacts were and how he had and was going to manipulate Yen LIBOR. Trader A also communicated his trading positions, his desire for certain movement in Yen LIBOR and gave instructions for the RBS IRD trader to get RBS to make Yen LIBOR submissions consistent with Trader A’s wishes. The RBS IRD trader acknowledged these communications and confirmed that he would follow through. Trader A and the RBS IRD trader also entered into transactions that aligned their trading interest in regards to Yen LIBOR. Trader A also communicated to another RBS IRD trader his trading positions, his desire for a certain movement in Yen LIBOR and instructions to get RBS to make Yen LIBOR submissions consistent with his wishes. The second RBS IRD trader agreed to do this.

Trader A communicated his trading positions, his desire for a certain movement in Yen LIBOR and gave instructions for them [two JPM IRD traders] to get JPMorgan to make Yen LIBOR submissions consistent with his wishes. Trader A also asked if the IRD traders at JPMorgan required certain Yen LIBOR submissions to aid their trading positions. The JPMorgan IRD traders acknowledged these requests and said that they would act on them. On another occasion, one of the JPMorgan IRD traders asked Trader A for a certain Yen LIBOR submission, which Trader A agreed to help with. Trader A admitted to an IRD trader at RBS that he colluded with IRD traders at JPMorgan.

973672.6 -81- Trader B of the Cooperating Party communicated with an IRD trader at Citi. They discussed their trading positions, advanced knowledge of Yen LIBOR submissions by their banks and others, and aligned their trading positions. They also acknowledged efforts to get their banks to submit the rates they wanted.

177. On May 18, 2011, the Ontario Superior Court signed the orders directing the

production of the records sought by the May 2011 Elliott Affidavit. But, to the Baltimore

Plaintiffs’ knowledge, the Affidavit was not publicly available until February 2012.

178. Elliott submitted another affidavit in June 2011 (the “June 2011 Elliott

Affidavit”), which sought an order requiring ICAP Capital Markets (Canada) Inc., believed to be one of the “Cash Brokers” referenced in the May 2011 Elliott Affidavit, to “produce records in the possession of its affiliates, ICAP PLC and ICAP New Zealand Ltd.” The June 2011 Elliott

Affidavit primarily detailed communications between “Trader A” (an IRD trader) of the previously-referenced “Cooperating Party” and an ICAP broker (referenced in the June 2011

Elliott Affidavit as “Broker X”) during the Class Period.

179. The Affidavit specifies that Trader A “discussed his current trading positions with

Broker X and where he would like to see various maturities of Yen LIBOR move.” Trader A

“asked Broker X for Yen LIBOR submissions that were advantageous to Trader A’s trading

positions,” and Broker X, in turn, “acknowledged these requests and advised Trader A about his

efforts to make them happen.” The Affidavit further states:

Counsel for the Cooperating Party has proffered that the expectation was for Broker X, directly or through other brokers at ICAP, to influence the Yen LIBOR submissions of Panel Banks. Broker X communicated to Trader A his efforts to get brokers at ICAP in London to influence Yen LIBOR Panel Banks in line with Trader A’s requests. The efforts of Broker X included contacting a broker at ICAP in London who issued daily LIBOR expectations to the market. Trader A also communicated to Broker X his dealings with traders at other Participant Banks and a broker at another Cash Broker. Not all efforts to influence Yen LIBOR panel banks were successful. Broker X had additional discussions around the

973672.6 -82- setting of Yen LIBOR with another trader of the Cooperating Party (“Trader B”).

180. On June 14, 2011, the Ontario Superior Court issued an order allowing the document requests concerning ICAP.

Singapore Proceedings

181. More information about the collusive behavior of Yen LIBOR panel banks was

revealed in a Singapore wrongful termination lawsuit. In a pending legal action in Singapore’s

High Court, Tan Chi Min, former head of delta trading for RBS’s global banking and markets

division in Singapore (who worked for RBS from August 12, 2006 to November 9, 2011),

alleges in his Writ of Summons and Statement of Claim that the bank condoned collusion

between its traders and LIBOR rate-setters to set LIBOR at levels to maximize profits. In the

same filing, Tan stated RBS commenced an internal probe following inquiries by European and

U.S. authorities about potential LIBOR manipulation.

182. Tan—whom RBS terminated, asserting he engaged in “gross misconduct”—

alleges that RBS’s internal investigations “were intended to create the impression that such

conduct was the conduct not of the defendant itself but the conduct of specific employees who

the defendant has sought to make scapegoats through summary dismissals.” Tan asserted RBS’s rate setters took “into account the views of various employees before submitting a rate to the appropriate rate setting body.” Tan further alleges that it was “part of his responsibilities to

provide input and submit requests to the rate setter and there is no regulation, policy, guideline or

law that he has infringed in doing this,” and that “it was common practice among [RBS]’s senior

employees to make requests to [RBS]’s rate setters as to the appropriate LIBOR rate.” Those

requests, Tan specified, “were made by, among others, Neil Danziger, Jezri Mohideen (a senior

manager), Robert Brennan (a senior manager), Kevin Liddy (a senior manager) and Jeremy

973672.6 -83- Martin,” and the practice “was known to other members of [RBS]’s senior management including Scott Nygaard, Todd Morakis and Lee Knight.” Tan added that RBS employees “also took requests from clients (such as Brevan Howard) in relation to the fixing of LIBOR.”

183. In his complaint, however, Tan alleged that he could not have influenced the rate on his own. He also stated it was “common practice” among RBS’s senior employees to make requests as to the appropriate LIBOR quote.

184. Indeed, in responding to Tan’s allegations, RBS admitted he had tried to

improperly influence RBS rate-setters from 2007 to 2011 to submit LIBOR quotes at levels that would benefit him.

185. In subsequent filings with the Singapore High Court, Tan claims that RBS

“interest-rate traders were seated with one of the main rate setters in its London office to share information, and discussed rates on conference calls,” according to Businessweek.67 Tan also

claims that RBS’s head of compliance sent an email to Tan’s manager indicating that it was

acceptable for a trader to request specific swap-offer rates from rate setters. According to

Businessweek, Tan also asserts in his filing that he was told by his manager that “the practice of requesting to change the rate Libor is common in every rate setting environment in the banking industry.”

3. Numerous employees from various financial institutions, including employees of Defendants and their affiliates, have been accused of improper conduct related to LIBOR.

186. Other individuals employed by the Defendants and their affiliates who have engaged in the illegal communications and conduct among Defendants to report artificially low

LIBOR quotes include, but are not limited to, the following. These individuals were not

67 Andrea Tan, “RBS rate Traders Sat With Libor Setter, Fired Banker Says,” Businessweek, March 27, 2012.

973672.6 -84- randomly selected from Defendants but are people who have been identified by the press or government agencies as the targets of the world-wide government investigations.

(a) Yvan Ducrot was the Co-head of UBS’s rates business. According to an

article in Citywire, he was suspended by UBS in connection with international probes.68

(b) Holger Seger was the global head of short-term interest rates trading at

UBS. According to an article in Citywire, Mr. Seger was suspended by UBS in connection with international probes and left his position at UBS in April 2012.69

(c) Paul White was the principal rate-setter for Yen-LIBOR for RBS.

According to an article in Businessweek, Mr. White was fired by UBS in November 2011 in

connection with the circumstances brought to light by the Singapore lawsuit.70

(d) Tan Chi Min was the head of short-term interest rate trading for Yen and

the head of Delta One trading at RBS. In his Singapore lawsuit, Mr. Tan alleges that RBS fired

him “ because he tried to improperly influence the bank’s rate setters from 2007 to 2011 to

persuade them to offer Libor submissions that would benefit his trading positions.”71

(e) Sim Suh Ting was the executive director and head of regulatory risk &

compliance for South East Asia. According to the Singapore lawsuit, Mr. Ting “[S]ent an

internal e-mail to Robert Brennan and Todd Morakis 'to the effect that it was acceptable for a

trader to request the SOR rate setters that the SOR be set at a specific level.”’72

(f) Todd Morakis was the managing director at RBS. According to the

68 http://citywire.co.uk/new-model-adviser/ubs-suspends-traders-amid-libor-probe/a567164 69 Id. 70 http://www.businessweek.com/news/2012-03-27/rbs-rate-traders-sat-with-libor-setter-fired- employee-tan-says. 71 Id. 72 Id.

973672.6 -85- Singapore lawsuit, Mr. Morakis “orally confirmed to [Tan] round October [2011] that ‘the practice of requesting to change the rate Libor is common in every rate setting environment in the banking industry.’” 73

(g) Thomas Hayes was a derivatives trader for Citibank. According to an

article in the Financial Times, Mr. Hayes “attempted to pressure colleagues and employees at

other banks involved in the rate-setting process for the Tokyo Interbank Offered Rate, or

Tibor.”’74

(h) Christopher Cecere was the head of G10 trading and sales for Asia at

Citibank. The Japanese FSA found that Mr. Cecere “and another Citigroup trader engaged in

‘seriously unjust and malicious’ conduct by asking bankers to alter data they submitted while

setting a benchmark Japanese lending rate.”75

(i) Brent Davies was a sterling trader at RBS in London. According to an

article in Businessweek, Mr. Davies was named in Canadian Competition Law Officer Brian

Elliott’s May 18, 2011 affidavit as one of the traders believed to be involved in the manipulation

of Yen LIBOR. According to the affidavit, Trader A explained to Mr. Davies who his collusive

contacts were and how he had and was going to manipulate Yen LIBOR. Trader A also

communicated his trading positions, his desire for certain movement in Yen LIBOR and gave

instructions for Mr. Davies trader to get RBS to make Yen LIBOR submissions consistent with

Trader A’s wishes. Mr. Davies trader acknowledged these communications and confirmed that

he would follow through. Trader A and Mr. Davies also entered into transactions that aligned

73 Id. 74 http://www.ft.com/intl/cms/s/0/7089ffda-534a-11e1-aafd- 00144feabdc0.html#axzz1qWqNwPlz 75 http://www.businessweek.com/news/2012-02-16/ex-citigroup-trader-denies-wrongdoing-in- tibor-probe.html

973672.6 -86- their trading interest in regards to Yen LIBOR.76

(j) Will Hall was a derivatives trader at RBS in London. He was named in

Canadian Competition Law Officer Brian Elliott’s May 18, 2011 affidavit as one of the traders

believed to be involved in the manipulation of Yen LIBOR. According to the affidavit, Trader A

communicated to Mr. Hall his trading positions, his desire for a certain movement in Yen

LIBOR and instructions to get RBS to make Yen LIBOR submissions consistent with his wishes,

and Mr. Hall agreed to do this.77

(k) Paul Glands was a derivatives trader with JP Morgan. He was named in

Canadian Competition Law Officer Brian Elliott’s May 18, 2011 affidavit as one of the traders believed to be involved in the manipulation of Yen LIBOR. According to the affidavit, Trader A communicated to Mr. Glands his trading positions, his desire for a certain movement in Yen

LIBOR and instructions to get JP Morgan to make Yen LIBOR submissions consistent with his wishes, and Mr. Glands agreed to do so.78

(l) Stewart Wiley was a derivatives trader with JP Morgan. He was named in

Canadian Competition Law Officer Brian Elliott’s May 18, 2011 affidavit as one of the traders

believed to be involved in the manipulation of Yen LIBOR. According to the affidavit, Trader A

communicated to Mr. Wiley his trading positions, his desire for a certain movement in Yen

LIBOR and instructions to get JP Morgan to make Yen LIBOR submissions consistent with his

wishes, and Mr. Wiley agreed to do so.79

(m) Guillaume Adolph was a derivatives trader at Deutsche Bank. He was

76 Brian Elliott’s May 18, 2011 Affidavit, Ontario Superior Court. 77 Id. 78 Id. 79 Id.

973672.6 -87- named in Canadian Competition Law Officer Brian Elliott’s May 18, 2011 affidavit as one of the traders believed to be involved in the manipulation of Yen LIBOR. According to the affidavit,

Trader A communicated to Mr. Adolph his trading positions, his desire for a certain movement in Yen LIBOR and instructions to get JP Morgan to make Yen LIBOR submissions consistent with his wishes, and Mr. Adolph agreed to do so.80

(n) Peter O’Leary was a derivatives trader at HSBC. He was named in

Canadian Competition Law Officer Brian Elliott’s May 18, 2011 affidavit as one of the traders

believed to be involved in the manipulation of Yen LIBOR. According to the affidavit, Mr.

O’Leary was instructed by Trader A at UBS "to get HSBC to make Yen LIBOR submissions

consistent with his wishes.” 81

(o) Andrew Hamilton is a former investment advisor at RBS in London.

According to an article in Bloomberg, Mr. Hamilton was dismissed by RBS on October 21, 2011

and now is listed as inactive on the U.K. Financial Services Authority’s register of people

approved to work in the industry. 82

(p) Neil Danzinger is a former trader at RBS in London. According to an

article in Bloomberg, Mr. Danzinger was dismissed by RBS on October 21, 2011 and now is listed as inactive on the U.K. Financial Services Authority’s register of people approved to work in the industry. 83

80 Id. 81 Id. 82 http://www.bloomberg.com/news/2012-02-09/rbs-said-to-dismiss-4-bankers-as-libor-probe- widens-to-brokers.html 83 Id.

973672.6 -88- (q) Brian McAppin was Citigroup’s brokerage head in Japan. According to an article in the Wall Street Journal, the Japanese investigation found that he "overlooked" alleged attempts by the two traders to influence interest rates despite "recognizing these actions."84

THE DISCOVERY RULE, FRAUDULENT CONCEALMENT, AND TOLLING OF THE STATUTE OF LIMITATIONS.

187. The Baltimore Plaintiffs did not discover and could not have discovered through the exercise of reasonable diligence that they were injured by any LIBOR manipulation, much

less who caused that injury until, at the very earliest, March 15, 2011, when the government

investigations into the Defendants were revealed to the public for the first time.

188. Before the government investigations into the Defendants’ alleged misconduct

was revealed for the first time on May 15, 2011, Baltimore Plaintiffs could not have stated facts

plausibly suggesting a concerted and conspiratorial effort to under-report LIBOR.

A. The Unlawful Activity Was Inherently Self-Concealing.

189. The Defendants conspired to share their interest rate information and falsely

report interest rate information to the BBA and Reuters. Their purpose was to depress USD-

LIBOR to artificially low levels and thereby manipulate the price for Eurodollar futures and

other exchange-based contracts.

190. By its very nature, the Defendants’ alleged misconduct was self-concealing. First,

the Defendants’ actual or realistic interest rates were not public information, making any

comparison to the rates they published to the BBA, and in turn Reuters, and any discernment of

discrepancies an impossibility. Second, the Defendants’ internal communications and

communications among each other were not public information, rendering impossible any

84 http://online.wsj.com/article/SB10001424052970203315804577207212704268678.html.

973672.6 -89- ascertainment of the specific misconduct of individual Defendants’ or the conspiracy. Third, the

Defendants’ trades on the exchanges or in the markets for LIBOR products were not public

information, making it impossible to discern that they were using their false LIBOR reports to

cause artificial prices and engage in manipulative trading.

191. As a result of the self-concealing nature of the Defendants’ collusive scheme, no

person of ordinary intelligence would previously have discovered their conspiracy to manipulate

LIBOR or the manipulative trades to the detriment of Baltimore Plaintiffs and the Class.

B. In Addition To Engaging In Inherently Self-Concealing Misconduct, The Defendants Engaged In A Concerted Media Strategy Of Affirmatively Providing Plausible (But False) Alternative Explanations For The (In Actuality) Manipulated LIBOR.

192. In late Spring 2008, the media began to engage in speculation that the LIBOR

banks were under-reporting their LIBOR quotes.

193. In any event, the Defendants engaged in a media strategy that had the effect of

diffusing speculation and further concealing their conduct. In particular, the Defendants provided

affirmative, public assurances that there were innocent, plausible explanations for the divergence

in LIBOR quotes that were the subject of media speculation. Because of Defendants’ affirmative

statements plaintiff's continuing ignorance as to their claims was not a result of a lack of due

diligence.

194. On April 21, 2008, Dominic Konstam of Credit Suisse affirmatively stated that

the low LIBOR quotes were attributable to the fact that U.S. banks, such as Citibank and JP

Morgan, had access to large customer deposits and borrowing from the Federal Reserve and did not need more expensive loans from other banks. “Banks are hoarding cash because funding

from the asset-backed commercial paper market has fallen sharply while money market funds are

973672.6 -90- lending on a short term basis and are restricting their supply.”85 This alternative explanation had the effect of diffusing any speculation that the Defendants were engaged in a manipulation of

LIBOR.

195. On April 21, 2008, Jeffrey Rosenberg, head of credit strategy at Bank of America

Securities, echoed Mr. Konstam’s misrepresentation. Mr. Rosenberg affirmatively

misrepresented that LIBOR’s divergence was the result of systemic conditions rather than active manipulation, explaining that the BBA approach “works when both overall bank risk is low and the dispersion of risks across banks is small … [however, that] is clearly not the case currently.”86

196. In an April 28, 2008 interview with The Financial Times Credit Suisse’s Dominic

Konstam continued to reinforce LIBOR’s reliability. “Libor has been a barometer of the need

for banks to raise capital. The main problem with LIBOR is the capital strains facing banks …

Initially there was some confusion that LIBOR itself was the problem, with talk of the rate being

manipulated and not representative of the true cost of borrowing.”87

197. On May 16, 2008, in response to a media inquiry, JP Morgan affirmatively

misrepresented that “[t]he Libor interbank rate-setting process is not broken, and recent rate

volatility can be blamed largely on reluctance among banks to lend to each other amid the

current credit crunch.”88 “Everyone is funding at a similar level,” said Terry Belton of JP

85 Gillian Tett & Michael Mackenzie, “Doubts Over Libor Widen,” FT.com, available at http://www.ft.com/cms/s/0/d1d9a792-0fbd-11dd-8871-0000779fd2ac.html#axzz1szdS58jE, last accessed on April 24, 2012. 86 Id. 87 Michael Mackenzie, “Talk of quick fix recedes as Libor gap fails to close,” FT.com, available at http://www.ft.com/intl/cms/s/0/3da27a46-5d05-11dd-8d38-000077b07658.html#axzz1szdS58jE, last accessed on April 24, 2012. 88 Kirsten Donovan, Jamie McGeever, Jennifer Ablan, Richard Leong & John Parry, “European, U.S. Footnote continued on next page

973672.6 -91- Morgan, “but when credit conditions worsen and we have periods like this of unprecedented turmoil, the reality is there is not a single borrowing rate.” This alternative explanation had the effect of diffusing any speculation that the Defendants were engaged in a manipulation of

LIBOR.

198. That very same day, Colin Withers of Citigroup assured the public that LIBOR remained reliable. “We need to let the dust settle, markets stabilize and then have a review. But the measures we are using are historic -- up to 30 to 40 years old.”89

199. In May 2008, The Wall Street Journal asked various Defendants to comment on

the media speculation concerning divergence in LIBOR quotes. Rather than declining or refusing

to comment, the Defendants made affirmative representations designed to further conceal their

wrongdoing. On May 29, 2008, Citibank affirmatively claimed innocence and stated that it

continued to “submit [its] Libor rates at levels that accurately reflect our perception of the

market." HBOS similarly denied the Journal’s allegations, asserting that its rate quotes were a

"genuine and realistic" indication of its borrowing costs.90

C. The BBA’s Public Statements Also Had The Effect Of Concealing The Defendants’ Misconduct.

200. In addition, throughout 2008, the BBA engaged in affirmative acts that deffused

any speculation that LIBOR had been or was being manipulated. Although the BBA announced

on April 17, 2008 that it would push forward its annual review of the LIBOR rate-setting

Footnote continued from previous page bankers work on Libor problems,” reuters.com, available at http://in.reuters.com/article/2008/05/16/markets-rates-bba-idINL162110020080516, last accessed on April 24, 2012. 89 Id. 90 Carrick Mollencamp & Mark Whitehouse, “Study Casts Doubt on Key Rate,” The Wall Street Journal, May 29, 2008.

973672.6 -92- process, seemingly in response to media speculation concerning rate manipulation, a BBA spokesman affirmatively stated that the review was a “relatively simple auditing process to check that the figures are consistent.”91 Indeed, the same BBA spokesman assured the public that the

BBA did not believe “the data we collect is anything other than accurate.”92

201. LIBOR increased exponentially in the days following the BBA’s announcement.

The BBA admitted that banks “were likely to have reconsidered the information they supplied

for use in setting Libor.” However, on April 18, 2008, the BBA continued to affirmatively

assert that rate quotes submitted prior to the BBA’s announcement were more the result of

“concerns about difficult market place conditions than questions about credibility.”93

202. Much like the Defendants, the BBA also made affirmative, public assurances that

there were innocent, plausible explanations for the divergence in LIBOR quotes that were the

subject of media speculation. By way of example:

(a) On May 13, 2008, Angela Knight, CEO of the BBA, explained to

bloomberg.com that the BBA audit was needed to determine if the divergence was the result of

“difficult markets'' or was “giving the right answer, just one that people don't want to hear.” Ms.

Knight stressed that rate swings were “hardly surprising'' given credit markets.94

91 Allistair Barr, “BBA to start Libor review earlier as rate spikes,” MarketWatch.com, available at http://articles.marketwatch.com/2008-04-17/news/30791717_1_lending-rates-interest-rates-libor, last accessed on April 25, 2012. 92 Jessica Mortimer, “U.K.'s BBA confirms bringing forward Libor review but denies issues of credibility,” lse.co.uk, available at http://www.lse.co.uk/FinanceNews.asp?ArticleCode=0ojr2utyp0yw3y2&ArticleHeadline=U.K.s_BBA_c onfirms_bringing_forward_Libor_review_but_denies_issues_of_credibility, last accessed on April 25, 2012. 93 Peter Taylor, “Dollar Libor soars as banks rethink their borrowing rates,” The Daily Telegraph, April 18, 2008. 94Ben Livesey & Gavin Finch, “Libor Set for Overhaul as Credibility Is Doubted (Update1),” bloomberg.com, available at http://www.bloomberg.com/apps/news?pid=newsarchive&sid=az3eSerjPuDA&refer=home, last accessed Footnote continued on next page

973672.6 -93- (b) On September 16, 2008, the BBA explained that the “Libor overnight rate recognizes that, in the current uncertain market, banks are looking to their own liquidity as the priority … This is particularly reflected in the US Dollar because of the well-known world wide shortage of this currency.”95

203. The BBA also attempted to defuse speculation premised on LIBOR’s divergence

from the default insurance market. The BBA stated that LIBOR was reliable, and that the

financial crisis had caused many indicators to act in unusual ways. On May 29, 2008, a

spokesman for the BBA stated that there was “no indication” that the default insurance market

provided a picture of banks’ borrowing costs more accurate than that provided by LIBOR.96

204. In sum, the BBA’s alternative explanations, in conjunction with the Defendants’

affirmative representations and the inherently self-concealing nature of the conduct at issue,

made it impossible for Baltimore Plaintiffs to state facts setting forth a plausible manipulation

claim before the public announcement of government investigations.

E. The Truth Was Not Revealed For The First Time Until March 15, 2011

205. The truth was not revealed until March 15, 2011, when UBS released its annual

report 20-F stating that it had received subpoenas from the Department of Justice, the SEC, the

Footnote continued from previous page on April 25, 2012.

95Michael Mackenzie & David Oakley, “Banks make their own liquidity a priority,” FT.com, available at http://www.ft.com/cms/s/0/20d62052-8424-11dd-bf00-000077b07658.html#axzz1t4N9ezuQ, last accessed on April 25, 2012. 96Michael Mackenzie, “Talk of quick fix recedes as Libor gap fails to close,” FT.com, available at http://www.ft.com/intl/cms/s/0/3da27a46-5d05-11dd-8d38-000077b07658.html#axzz1szdS58jE, last accessed on April 24, 2012.

973672.6 -94- CFTC, as well as an information request from the Japanese Financial Supervisory Agency, all relating to its interest rate submissions to the BBA. UBS described the focus of the investigation as “whether there were improper attempts by UBS, either acting on its own or together with others, to manipulate LIBOR at certain times.”

206. In addition, on March 16, 2011, the Financial Times reported that “[a]ll the panel members are believed to have received at least an informal request for information—an earlier stage in an investigation process before a subpoena.”97

207. In the weeks and months that followed, the extent of the Defendants’ collusive

scheme to manipulate the value of USD-LIBOR was publicly revealed for the first time. A

steady stream of media reports revealed that a number of domestic and foreign regulatory and

enforcement agencies had begun to investigate the Defendants, finally indicating to the public

that the Defendants had indeed conspired to manipulate USD-LIBOR. By way of example:

(a) On March 23, 2011, Bloomberg revealed that Citigroup Inc., Deutsche

Bank, BAC, and JPMorgan Chase were asked by U.S. regulators “to make employees available

to testify as witnesses” in connection with the regulators’ ongoing investigation.98

(b) The next day, the Financial Times reported that Defendant Barclays

was “emerging as a key focus of the US and U.K. regulatory probe into alleged rigging of

[LIBOR].” According to the Times, investigators were “probing whether communications

between the bank’s traders and its treasury arm,” which helps set LIBOR, “violated ‘Chinese

wall’ rules that prevent information-sharing between different parts of the bank.” The Times

97 Brooke Masters, Patrick Jenkins & Justin Baer, “Big banks investigated over Libor,” FT.com, available at http://www.ft.com/intl/cms/s/0/ab563882-4f08-11e0-9c25-00144feab49a.html#axzz1szdS58jE, last accessed on April 24, 2012. 98 Joshua Gallu and Donal Griffin, “Libor Probe Spurs Witness Call-up at Citigroup, Deutsche Bank,” Bloomberg, March 23, 2011.

973672.6 -95- further stated investigators were “said to be looking at whether there was any improper influence on Barclays’ submissions” during 2006-2008 for the BBA’s daily survey used to set LIBOR.99

(c) On May 23, 2011, the Telegraph reported that the Federal Bureau of

Investigation (“FBI”) was working with regulators in connection with the LIBOR investigations,

and the FBI’s British counterpart, the Serious Fraud Office, “revealed it is also taking an active

interest.”

(d) On October 19, 2011, The Wall Street Journal reported that the European

Commission “seized documents from several major banks” the previous day, “marking the escalation of a worldwide law-enforcement probe” regarding the Euro Interbank Offered Rate, or

Euribor—a benchmark, set by more than 40 banks, used to determine interest rates on trillions of euros’ worth of euro-denominated loans and debt instruments. The Euribor inquiry, The Wall

Street Journal explained, constitutes “an offshoot” of the broader LIBOR investigation that had been ongoing for more than a year.

208. Moreover, while the governments’ investigations became public information in

March 2011, the facts necessary to plausibly state claims for conspiracy and manipulation have become available as the Defendants’ improper motive finally became apparent. For example, as discussed above, affidavits filed in a Canadian regulatory proceeding investigating Yen-LIBOR

revealed that traders with the Canadian subsidiaries and/or affiliates of Defendants routinely

discussed trading strategies, expected LIBOR quotes, and other confidential business information

in an attempt to manipulate the value of Yen-LIBOR and commodities whose value is based directly on that measure.

99 Brooke Masters and Megan Murphy, “Barclays at centre of Libor inquiry,” FT.com, March 24, 2011, available at http://www.ft.com/intl/cms/s/0/1c3228f6-5646-11e0-82aa- 00144feab49a.html#axzz1sJNEDIiI, last accessed on April 17, 2012.

973672.6 -96- 209. It is noteworthy that, in stark contrast to their earlier media campaign of offering innocent (but false) explanations for their LIBOR quotes, the Defendants began simply declining to comment to the media. For example, after March 15, 2011, representatives of Deutsche Bank,

Bank of America, Citigroup, Credit Suisse, JP Morgan, Barclays and Lloyds have specifically declined to comment in response to inquiries concerning whether the Defendants colluded to artificially reduce LIBOR.

210. Likewise, in stark contrast to its 2008 conclusions that LIBOR was reliable, in

February 2011 the BBA expanded the Panel of banks that contribute to U.S. dollar LIBOR from sixteen to twenty members.

211. The Baltimore Plaintiffs and members of the Class had no knowledge of the unlawful conduct alleged in this Complaint, or of any facts that could or would have led to the discovery thereof, until the government investigations became public on March 15, 2011.

212. Because the Defendants employed acts and techniques that were calculated to wrongfully conceal the existence of such illegal conduct, the Baltimore Plaintiffs and the Class

could not have discovered the existence of this unlawful conduct any earlier than its public

disclosure on March 15, 2011.

213. Because of the Defendants’ fraudulent concealment, any applicable statute of

limitations affecting or limiting the rights of action by the Baltimore Plaintiffs or members of the

Class has been tolled during the period of such fraudulent concealment.

E. Other Tolling Principles.

214. In addition, any applicable statute of limitations affecting or limiting the rights of

action by the Baltimore Plaintiffs or members of the Class has been tolled by the filing of other

class actions against the Defendants, commencing in April 2011.

973672.6 -97- 215. The Defendants are equitably estopped to assert that any otherwise applicable period of limitations has run.

216. The Defendants’ conduct as alleged herein constitutes a continuing violation of law. The Baltimore Plaintiffs and members of the Class bring this action within two years of the end of such continuing violation.

DEFENDANTS’ ANTITRUST VIOLATIONS

217. During the Class Period, as explained above, Defendants and their co-conspirators

engaged in a continuing agreement, understanding, or conspiracy in restraint of trade to

artificially fix, maintain, suppress and stabilize LIBOR and thus the prices and rates of return on

LIBOR-Based Derivatives sold by them.

218. In formulating and effectuating the contract, combination, or conspiracy,

Defendants and their co-conspirators engaged in anticompetitive activities, the purpose and

effect of which were to fix, maintain, suppress and otherwise make artificial the price of LIBOR-

Based Derivatives. These activities included the following:

(a) Defendants participated in meetings and/or conversations to unlawfully discuss their reporting of their borrowing rates to Thomson Reuters for calculation of the daily

LIBOR;

(b) Defendants agreed during those meetings and conversations to unlawfully report their borrowing rates to Reuters for calculation of LIBOR in order to drive down LIBOR and otherwise to depress or make artificial LIBOR;

(c) Defendants signaled to one another their intention to depress or otherwise

make artificial LIBOR and colluded with one another in achieving this unlawful and

anticompetitive purpose; and

973672.6 -98- (d) Pursuant to such an unlawful conspiracy in restraint of trade, Defendants knowingly and collusively traded in order to depress or otherwise make artificial the price of

LIBOR-Based Instruments.

ALLEGATIONS OF ANTITRUST INJURY TO THE BALTIMORE PLAINTIFFS AND THE CLASS

219. Defendants’ anticompetitive conduct had severe adverse consequences on

competition in that The Baltimore Plaintiffs and other members of the Class who traded in

LIBOR-Based Derivatives during the Class Period were trading at artificially determined prices

that were made artificial as a result of Defendants’ unlawful conduct. As a consequence thereof,

The Baltimore Plaintiffs and the Class suffered financial losses and were, therefore, injured in

their business or property.

FIRST CLAIM FOR RELIEF VIOLATION OF SECTION 1 OF THE SHERMAN ACT

220. The Baltimore Plaintiffs incorporate by reference the preceding allegations.

221. Defendants and their unnamed co-conspirators entered into and engaged in a conspiracy in unreasonable restraint of trade in violation of Section 1 of the Sherman Act and

Section 4 of the Clayton Act.

222. During the Class Period, Defendants controlled what LIBOR quote would be

reported and therefore controlled the rates of return on LIBOR-Based Derivatives sold by them.

223. The conspiracy consisted of a continuing agreement, understanding or concerted

action between and among Defendants and their co-conspirators in furtherance of which

Defendants fixed, maintained, suppressed and stabilized LIBOR and thus the prices and rates of

return on LIBOR-Based Derivatives sold by them. Defendants’ conspiracy is a per se violation

of the federal antitrust laws and is, in any event, an unreasonable and unlawful restraint of trade

973672.6 -99- and commerce.

224. Defendants’ conspiracy, and resulting impact on the market for LIBOR-Based

Derivatives, occurred in or affected interstate and foreign commerce.

225. As a proximate result of Defendants’ unlawful conduct, the Baltimore Plaintiffs and members of the Class have suffered injury to their business or property.

226. The Baltimore Plaintiffs and members of the Class are each entitled to treble damages for the violations of the Sherman Act alleged herein.

SECOND CLAIM FOR RELIEF UNJUST ENRICHMENT AND RESTITUTION

227. The Baltimore Plaintiffs incorporate by reference the preceding allegations.

228. It would be inequitable for Defendants to be permitted to retain the benefit which

Defendants obtained from their manipulative acts and at the expense of the Baltimore Plaintiffs

and members of the Class.

229. The Baltimore Plaintiffs and members of the Class are entitled to the

establishment of a constructive trust impressed on the benefits to Defendants from their unjust

enrichment and inequitable conduct.

230. Alternatively or additionally each Defendant should pay restitution or its own

unjust enrichment to the Baltimore Plaintiffs and members of the Class.

RELIEF SOUGHT

Accordingly, the Baltimore Plaintiffs demands relief as follows: A. That the Court determine that this action may be maintained as a class action

under Rule 23(b)(3) of the Federal Rules of Civil Procedure, that the Baltimore Plaintiffs be

973672.6 -100- appointed as class representative, and that the Baltimore Plaintiffs’ counsel be appointed as counsel for the Class;

B. That the unlawful conduct alleged herein be adjudged and decreed to be an unlawful restraint of trade in violation of Section 1 of the Sherman Act and Section 4 of the

Clayton Act;

C. That Defendants, their subsidiaries, affiliates, successors, transferees, assignees and the respective officers, directors, partners, agents, and employees and all other persons acting or claiming to act on their behalf, be permanently enjoined and restrained from continuing and maintaining the conspiracy alleged in the Complaint;

D. That the Baltimore Plaintiffs and the Class recover damages, as provided under federal antitrust laws, and that a joint and several judgment in favor of the Baltimore Plaintiffs

and the Class be entered against Defendants in an amount to be trebled in accordance with such

laws;

E. That the Baltimore Plaintiffs and the Class recover their costs of the suit,

including attorneys’ fees, as provided by law; and

F. That the Court direct such further relief it may deem just and proper.

DEMAND FOR JURY TRIAL

Pursuant to Rule 38(a) of the Federal Rules of Civil Procedure, the Baltimore Plaintiffs

demand a jury trial as to all issues triable by a jury.

973672.6 -101- Dated: April 30, 2012 Respectfully submitted,

/s/ Arun Subramanian______Arun Subramanian William Christopher Carmody Suyash Agrawal SUSMAN GODFREY L.L.P. 560 Lexington Avenue, 15th Floor New York, New York 10022 Telephone: (212) 336-8330 Facsimile: (212) 336-8340 Email: [email protected] Email: [email protected]

Marc M. Seltzer SUSMAN GODFREY L.L.P. 1901 Avenue of the Stars, Suite 950 Los Angeles, CA 90067 Telephone: (310) 789-3100 Facsimile: (310) 789-3150 Email: [email protected]

Michael D. Hausfeld William P. Butterfield Hilary K. Scherrer Nathaniel C. Giddings HAUSFELD LLP 1700 K St. NW, Suite 650 Washington, D.C. 20006 Telephone: (202) 540-7200 Facsimile: (202) 540-7201 Email: [email protected] Email: [email protected] Email: [email protected] Email: [email protected]

Interim Lead Counsel for the Baltimore Plaintiffs and the Proposed Class

Max R. Schwartz (MS2517) Donald A. Broggi SCOTT+SCOTT LLP 500 Fifth Avenue, 40th Floor New York, NY 10110 Telephone: (212) 223-6444

973672.6 -102- Facsimile: (212) 223-6334 Email: [email protected] Email: [email protected]

Christopher M. Burke SCOTT+SCOTT LLP 707 Broadway, Suite 1000 San Diego, CA 92101 Telephone: (619) 233-4565 Facsimile: (619) 233-0508 Email: [email protected]

Additional Counsel for Plaintiffs

973672.6 -103- The Wheatley Review of LIBOR: final report

September 2012

The Wheatley Review of LIBOR: final report

September 2012 © Crown copyright 2012 You may re-use this information (not including logos) free of charge in any format or medium, under the terms of the Open Government Licence. To view this licence, visit http://www.nationalarchives.gov.uk/doc/open- government-licence/ or write to the Information Policy Team, The National Archives, Kew, London TW9 4DU, or e-mail: [email protected]. Any queries regarding this publication should be sent to us at: [email protected]. ISBN 978-1-909096-01-1 PU1361

Contents

Page Foreword 3

Chapter 1 The blueprint for LIBOR reform 5

Chapter 2 Regulation and sanctions 11

Chapter 3 Strengthening institutions and governance 21

Chapter 4 Rules and guidance for LIBOR 27

Chapter 5 Reforms to the LIBOR mechanism 35

Chapter 6 Alternatives to LIBOR for the longer term 43

Chapter 7 Implications for other benchmarks 53

Annex A Analysis of other reform options 61

Annex B Summary of consultation responses 67

Annex C The case for reform of LIBOR 75

1

Foreword

In a few months’ time, subject to completion of the remaining Parliamentary stages of the Financial Services Bill, the new Financial Conduct Authority will come into being. This body – of which I will be the first Chief Executive – will have a sharp focus on making sure that financial services and markets function well, by promoting market integrity, consumer protection and effective competition.

This, alongside the creation of dedicated new prudential and macro-prudential regulatory authorities, will represent a significant milestone in strengthening financial regulation in the UK. I am very much looking forward to leading the FCA as it takes over the work of ensuring that UK financial services conducts its business in line with the highest standards of integrity.

Important as these institutional changes will be, it is clearly absolutely crucial that the regulatory authorities remain entirely focused on the continuing business of supervision and oversight during the transition. Consumers and market participants must be sure that the regulators stand ready to deal quickly and effectively with issues as they arise. This has been particularly true of the conduct business unit at the Financial Services Authority over the last two years, and nowhere has it been more apparent than in the work that we have undertaken – in partnership with our counterparts in the US, Japan, Switzerland, the EU and elsewhere – to tackle the attempted manipulation of LIBOR.

So I was very pleased when the Chancellor of the Exchequer asked me to consider – independently of my responsibilities for investigating and tackling potential LIBOR manipulation – whether the revelations surrounding LIBOR (and, indeed, other financial benchmarks) require a wider policy response. I regard this as an issue with far-reaching implications for international financial markets, not least because of the risk to London’s status as a leading global financial centre. As one of those responsible for upholding the standards that underpin London’s pre- eminence, I recognise how important it is that swift and decisive action is taken to restore confidence in LIBOR – a benchmark referenced by contracts worth well in excess of $300 trillion.

My work in reviewing LIBOR has therefore, of necessity, proceeded quickly. I have been enormously helped in this by the prompt and constructive engagement my Review has received from stakeholders who are involved with or use LIBOR. And I am confident that the substantial package of reforms that I recommend in this final report provides a credible blueprint for the restoration of trust in LIBOR.

It now falls to the Government, the British Bankers’ Association, the banks and other market participants, and the international regulatory community, to consider these recommendations and take them forward, in many cases working closely with the FSA and (in due course) the FCA. So while this is the Wheatley Review’s final report, I am well aware that it is far from the last word on the subject. However – speaking as the person ultimately responsible for conduct regulation in the UK – I am determined that the FSA and FCA will do whatever is needed to restore the faith of financial markets in LIBOR. I expect those with a direct interest in LIBOR – particularly those in the markets who contribute to or use the benchmark – to show the same degree of commitment to getting this right.

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The blueprint for LIBOR 1 reform

The Wheatley Review of LIBOR

1.1 The London Inter-Bank Offered Rate (hereafter referred to as LIBOR) refers to a series of daily interest rate benchmarks administered by the British Bankers’ Association (BBA). These rates are currently calculated across ten currencies and fifteen tenors (i.e. borrowing periods) ranging from overnight to one year. They serve as a series of interest rate benchmarks of the average cost to banks of unsecured borrowing for a given currency and time period.

1.2 Since 2009, the Financial Services Authority (FSA), together with regulators and public authorities in a number of different jurisdictions – including the United States, Canada, Japan, Switzerland and the European Union – has been investigating a number of institutions for alleged misconduct relating to LIBOR and other benchmarks, including EURIBOR (the Euro Inter- Bank Offered Rate) and TIBOR (the Tokyo Inter-Bank Offered Rate).

1.3 Following the announcement of findings against Barclays in late June 2012, the Government asked Martin Wheatley, managing director of the FSA and CEO-designate of the new Financial Conduct Authority (FCA),1 to establish an independent review into a number of aspects of the setting and usage of LIBOR.

1.4 Box 1.A sets out the Review’s terms of reference. The Review has not considered any specific allegations against particular financial institutions or individuals regarding attempts to manipulate LIBOR or other benchmarks. These allegations will continue to be investigated by the FSA and other regulators around the world.

1.5 This report sets out the final recommendations of the Wheatley Review to the Government, the BBA, banks and the regulatory authorities. The report is organised as follows:

 Chapter 2 makes the case for regulation of activities related to LIBOR, and strengthening the sanctions regime;

 Chapter 3 establishes the need for a new set of institutions to administer and oversee LIBOR;

 Chapter 4 describes how these two new elements of the framework – statutory regulation and strengthened institutional governance – should operate together to establish new rules governing LIBOR submissions;

 Chapter 5 recommends a number of immediate reforms that should be adopted by those currently involved in the setting of LIBOR;

 Chapter 6 discusses potential alternatives to LIBOR; and

 Chapter 7 explores the implications of the Wheatley Review for other global benchmarks.

1 All references to the FSA within the Wheatley Review final report should be understood also to apply to the FCA once the latter organisation is established.

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Box 1.A: Terms of reference of the Wheatley Review

The Wheatley Review will formulate policy recommendations with a view to:

1 Reforming the current framework for setting and governing LIBOR. This work should, inter alia, consider:

 whether participation in the setting of LIBOR should be brought into the regulatory perimeter under the Financial Services and Markets Act 2000 as a regulated activity;

 how LIBOR is constructed, including the feasibility of using of actual trade data to set the benchmark;

 the appropriate governance structure for LIBOR;

 the potential for alternative rate-setting processes; and

 the financial stability consequences of a move to a new regime and how a transition could be appropriately managed.

2 Determining the adequacy and scope of sanctions to appropriately tackle LIBOR abuse. This work should consider:

 the scope of the UK authorities’ civil and criminal sanctioning powers with respect to financial misconduct, particularly market abuse and abuse relating to the setting of LIBOR and equivalent rate-setting processes; and

 the FSA’s Approved Persons regime and investigations into market misconduct.

3 Whether similar considerations apply with respect to other price-setting mechanisms in financial markets, and provide provisional policy recommendations in this area.

Discussion paper and consultation

1.6 On 10 August, the Wheatley Review published a discussion paper, which can be found on the Wheatley Review webpage.2 That paper set out the case for reform of LIBOR (which is summarised in Annex C) and proposed a range of options for reform of the benchmark. In addition, the paper considered potential alternatives to LIBOR and examined the implications of the Review’s thinking on other global benchmarks.

1.7 The discussion paper marked the beginning of the consultation phase of the Wheatley Review, which ran until 7 September. During this period, interested parties were encouraged to submit responses to the discussion paper, while the Review team held a large number of meetings with key stakeholders.

1.8 Despite the necessarily brief consultation period, the Wheatley Review received over 60 written responses from stakeholders and met with over 60 individuals and organisations. The Review team is extremely grateful to those who participated in the consultation process. Annex B contains an overview of the responses received during the consultation process.

1.9 The Review’s analysis and findings of the failings in the LIBOR process were largely accepted by those who engaged in the consultation process. The Review has therefore proceeded to draw

2 http://www.hm-treasury.gov.uk/wheatley_review.htm

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up its final recommendations and conclusions on the basis of the diagnosis published in the discussion paper. Key conclusions and recommendations

1.10 Through the process of analysis and consultation, the Wheatley Review has reached three fundamental conclusions that underpin its recommendations.

1.11 First, the Review has concluded that there is a clear case in favour of comprehensively reforming LIBOR, rather than replacing the benchmark. LIBOR is used in a vast number of financial transactions; it is estimated that contracts with an outstanding value of at least $300 trillion reference the benchmark. A move to replace LIBOR could only be justified by clear evidence that the benchmark is severely damaged, and that a transition to a new, suitable benchmark or benchmarks could be quickly managed to ensure limited disruption to financial markets.

1.12 The Wheatley Review has concluded that the issues identified with LIBOR, while serious, can be rectified through a comprehensive and far-reaching programme of reform; and that a transition to a new benchmark or benchmarks would pose an unacceptably high risk of significant financial instability, and risk large-scale litigation between parties holding contracts that reference LIBOR.

1.13 Furthermore, through the course of the consultation, it has become clear that, despite the loss of credibility that LIBOR has suffered recently, there has been no noticeable decline in the use of LIBOR by market participants. Indeed, a clear majority market participants responding to the Review’s consultation argued for the continuation of a form of LIBOR, rather than its wholesale replacement. While there are other benchmarks that are used in some cases as substitutes for LIBOR, there is clearly a large role that LIBOR plays in financial markets for which there is no immediately obvious alternative.

1.14 It should however be noted that, given the immediate focus of the Review and the difficulties identified with attempting to replace LIBOR quickly, this Review has not attempted to conduct a detailed evaluation of alternatives that might, over time, come to be used by market participants. That work should proceed, as described in Chapter 6, through internationally coordinated action.

1.15 Second, the Review has concluded that transaction data should be explicitly used to support LIBOR submissions. A number of the Review’s recommendations are intended to establish strict and detailed processes for verifying submissions against transaction data and limiting the publication of LIBOR to those currencies and tenors that are supported by sufficient transaction data.

1.16 Third, the Review has concluded that market participants should continue to play a significant role in the production and oversight of LIBOR. While LIBOR needs to be reformed to address the weaknesses that have been identified, it would not be appropriate for the authorities to completely take over the process of producing a benchmark which exists primarily for the benefit of market participants.

1.17 Many alternative benchmarks do already exist and are in use in a number of markets, although none with such widespread usage as LIBOR. Market participants can, and do, adopt the benchmark that is most appropriate for each type of contract. The role of the authorities is primarily to ensure the integrity of the process by which benchmarks are determined rather than to direct users to adopt a particular benchmark This said, the market is likely to coalesce around the most reliable and verifiable benchmark for any given transaction; the reforms recommended by the Wheatley Review to strengthen LIBOR should inform the work being done by the IOSCO Board Level Task Force (see Chapter 7).

1.18 Drawing on these three fundamental conclusions, this report presents the Wheatley Review’s ten-point plan for the comprehensive reform of LIBOR, summarised in Box 1.B below.

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Box 1.B: A ten-point plan for comprehensive reform of LIBOR

Regulation of LIBOR

1 The authorities should introduce statutory regulation of administration of, and submission to, LIBOR, including an Approved Persons regime, to provide the assurance of credible independent supervision, oversight and enforcement, both civil and criminal (see Chapter 2). Institutional reform

2 The BBA should transfer responsibility for LIBOR to a new administrator, who will be responsible for compiling and distributing the rate, as well as providing credible internal governance and oversight. This should be achieved through a tender process to be run by an independent committee convened by the regulatory authorities (see Chapter 3, paragraphs (3.5 to 3.16). 3 The new administrator should fulfil specific obligations as part of its governance and oversight of the rate, having due regard to transparency and fair and non- discriminatory access to the benchmark. These obligations will include surveillance and scrutiny of submissions, publication of a statistical digest of rate submissions, and periodic reviews addressing the issue of whether LIBOR continues to meet market needs effectively and credibly (see paragraphs 3.17 to 3.38). The rules governing LIBOR

4 Submitting banks should immediately look to comply with the submission guidelines presented in this report, making explicit and clear use of transaction data to corroborate their submissions (see paragraphs 4.5 to 4.13). 5 The new administrator should, as a priority, introduce a code of conduct for submitters that should clearly define:

 guidelines for the explicit use of transaction data to determine submissions;

 systems and controls for submitting firms;

 transaction record keeping responsibilities for submitting banks; and

 a requirement for regular external audit of submitting firms.

(see Chapter 4, paragraphs 4.14 to 4.31)

Immediate improvements to LIBOR

6 The BBA and should cease the compilation and publication of LIBOR for those currencies and tenors for which there is insufficient trade data to corroborate submissions, immediately engaging in consultation with users and submitters to plan and implement a phased removal of these rates (see Chapter 5, paragraphs 5.3 to 5.13). 7 The BBA should publish individual LIBOR submissions after 3 months to reduce the potential for submitters to attempt manipulation, and to reduce any potential interpretation of submissions as a signal of creditworthiness (see paragraphs 5.14 to 5.18). 8 Banks, including those not currently submitting to LIBOR, should be encouraged to participate as widely as possible in the LIBOR compilation process, including, if necessary, through new powers of regulatory compulsion (see paragraphs 5.19 to 5.28).

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9 Market participants using LIBOR should be encouraged to consider and evaluate their use of LIBOR, including the a consideration of whether LIBOR is the most appropriate benchmark for the transactions that they undertake, and whether standard contracts contain adequate contingency provisions covering the event of LIBOR not being produced (see paragraphs 5.29 to 5.39). International co-ordination

10 The UK authorities should work closely with the European and international community and contribute fully to the debate on the long-term future of LIBOR and other global benchmarks, establishing and promoting clear principles for effective global benchmarks (see Chapters 6 and 7).

Next steps

1.19 This report contains a number of recommendations for the Government, the BBA and the banks, and the regulatory authorities both in the UK and internationally.

1.20 The Government has already indicated that the Financial Services Bill will be the legislative vehicle for taking forward those recommendations which are accepted. The Bill is currently being considered by the House of Lords.

1.21 Under the leadership of Martin Wheatley, the conduct business unit of the FSA, and in particular the markets division, will work closely with the BBA and the banks to ensure that the recommendations addressed to market participants are implemented. Martin Wheatley and the FSA will also continue to engage proactively with international partners in relation to the global debate on benchmarks, working closely with the Treasury and the Bank of England.

1.22 In addition, the Wheatley Review hopes to inform other work being done by international organisations to strengthen globally significant benchmarks. In particular, the Review recognises the work being done by the IOSCO Board Level Task Force, the European Commission and the to improve benchmarks on an international basis and hopes that the Review is taken as a significant step towards their respective goals.

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2 Regulation and sanctions

Box 2.A: Key reforms and specific recommendations

The authorities should introduce statutory regulation of administration of, and submission to, LIBOR, including an Approved Persons regime, to provide the assurance of credible independent supervision, oversight and enforcement, both civil and criminal.

To implement this key reform, the Wheatley Review specifically recommends that:

 administering LIBOR and submitting to LIBOR become regulated activities under the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001;

 controlled functions are created in connection with both of these activities;

 the UK supports efforts in the EU to proceed swiftly with developing and implementing a new civil market abuse regime and open and transparent access to benchmarks; and

 Section 397 of the Financial Services and Markets Act 2000 is amended to enable the FSA to prosecute manipulation or attempted manipulation of LIBOR.

2.1 A clear finding of the Review is that the systems, controls and governance arrangements covering the processes of submitting to and administering LIBOR have proven inadequate especially given the pressures on LIBOR created by market developments in recent years. Given the importance of the benchmark to the stable and efficient operation of a wide range of financial markets, there is a strong case for bringing these activities clearly and explicitly within the regulatory perimeter.

2.2 The FSA and other international regulators have taken action in respect of attempted manipulation of LIBOR. However, the Review is of the view that a purpose built regime, including an Approved Persons regime allowing the regulator to exercise control and oversight over individuals as well as firms, will significantly increase the ability of the new Financial Conduct Authority to oversee LIBOR effectively.

2.3 This chapter makes recommendations to the Government and the regulatory authorities to propose amendments to the Financial Services and Markets Act 2000 (FSMA), and associated secondary legislation and rules, to enable these changes in regulation and enforcement to be implemented. Regulation Making submitting to and administering LIBOR regulated activities

2.4 At present neither submitting to LIBOR, nor administering LIBOR, is a regulated activity under FSMA. As a result, while the FSA is currently taking regulatory action in relation to attempted manipulation of LIBOR by firms, this action is proceeding on the basis of the connection between LIBOR submitting and other regulated activities, and there is no directly applicable specific regulatory regime covering these activities. This affects the FSA’s ability to supervise and take enforcement action in relation to these activities, even when carried out by a

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firm that is regulated in respect of its general business activities. The discussion paper therefore raised the option of specifying either or both of these activities as regulated under the FSMA 2000 (Regulated Activities) Order 2001 (RAO).

2.5 On the basis of analysis and consultation responses, the Review has concluded that, as the highest risk of misconduct occurs in the contribution of submissions to LIBOR, there is a strong case to support making submitting to LIBOR a regulated activity.

2.6 However, the administrator also has an integral role in the production of LIBOR. In particular, the administrator is likely to be best placed to identify any potential manipulation, carry out preliminary enquiries into this and advise the regulator of the concerns. Failure to regulate the administration of LIBOR could therefore create a potentially significant gap in the regulatory regime. Regulation of the administrator would allow the regulator to ensure that the administrator maintains proper systems and controls for identifying and investigating suspicious submissions, and reports these to the FSA. The Wheatley Review has therefore concluded that LIBOR administration should also be a regulated activity.

2.7 Making the acts of submitting to and administering LIBOR regulated activities will significantly enhance the FSA’s ability to oversee these processes and take action in relation to any misconduct. In particular, it will enhance the ability of the FSA to take the following steps:

 write and implement rules in relation to the LIBOR process, which will – among other things – set out the systems and controls that a firm must have in place for the production of LIBOR;

 supervise the conduct of the firms and individuals involved in the process, with this supervision including regular reviews of relevant systems and controls in place, as well as the performance of the activities; and

 take regulatory action for misconduct. If a firm does not conduct itself in accordance with either the FSA’s Principles for Businesses or any other regulatory requirements in its LIBOR activities, the FSA will be able to impose a public censure or financial penalty, and will in addition be able to impose regulatory requirements on a firm, for example by varying the firm’s permission.

2.8 This will result in a clear, robust regulatory regime that firms will be required to abide by, while the existence of sanctions will provide a powerful incentive on firms to ensure they act properly and in compliance with the relevant regulatory requirements. It will also enable the FSA to create controlled functions in relation to these activities, as discussed below.

2.9 The majority of responses to the discussion paper have been in favour of making both of these activities regulated activities. In particular, there was broad consensus that making LIBOR submissions should be a regulated activity under FSMA, with some respondents commenting that this regulation should have the scope to cover benchmarks more broadly.

2.10 Where there was opposition to such regulation, it came from responses advocating that judgement be removed from submitting banks, with submissions instead relying entirely on transaction data or committed quotes. In relation to the question of whether administering LIBOR should become a regulated activity, most of the responses addressing this issue were in favour of regulation.

2.11 While there are some disadvantages to making these activities regulated activities, including, in particular, increased compliance costs for firms and an increased supervisory burden on the regulator, the Review considers that these burdens are outweighed by the benefits of regulating these activities.

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2.12 The Wheatley Review therefore recommends that submitting to LIBOR, and the administration of LIBOR, become regulated activities. While the Government will need to consider the specific legislative changes needed to implement this recommendation, should it choose to proceed, initial analysis by the Review indicates that these changes can be implemented by:

 amending Section 22 of FSMA, which currently sets out the nature of the activity which can be regulated in a way that does not cover LIBOR related activities;

 amending Schedule 2 to FSMA, which sets out the indicative list of the activities which may be brought within the scope of FSMA regulation, to include contributing to, and administering a benchmark; and

 amending the Regulated Activities Order to include, as regulated activities, contributing to and administering a benchmark, with LIBOR specified as a relevant benchmark. The scope of the regulated activities

2.13 The new regulated activities should be defined in such a way as to cover the production of the submissions, the calculation of the benchmark and its publication. Regulation of these activities should also cover the systems and controls regarding these functions, including, in particular, the processes for identifying and querying suspicious submissions and advising the FSA of any such conduct.

2.14 The Wheatley Review does not recommend that regulation should seek to prescribe the exact elements of the money markets that LIBOR is intended to measure – in other words, the precise question that submitters are requested to answer. Instead, this should continue to be market led, thereby being able to respond to the needs and requirements of the market as these evolve.

2.15 This Review has been narrowly focused on LIBOR, and the recommendations are therefore only made in respect of LIBOR. However, the Review is aware of other work underway in relation to benchmarks generally, including the EU Commission’s consultation on benchmarks and the Board Level Task Force set up by the International Organisation of Security Commissions (IOSCO). In light of this wider work, it is suggested that legislation should ensure that the regulatory regime can be extended to other benchmarks in the future, if appropriate. Controlled functions

2.16 Assuming that LIBOR activities will be regulated, the question arises as to how the Approved Persons regime under FSMA should be applied to these activities.

2.17 Under the Approved Persons regime, certain activities can be designated as controlled functions by the FSA. The holder of a controlled function must be approved by the FSA in order to perform that function, and must also comply, in the performance of that function, with the FSA’s Principles for Approved Persons.

2.18 Creating controlled functions in relation to both submitting and administering will therefore allow the FSA to:

 ensure that only individuals who can satisfy the FSA that they are “fit and proper” to perform the role are allowed to hold these controlled functions; and

 ensure the accountability of key individuals – if they do not comply with the relevant regulatory requirements, the FSA will have the power to impose a public censure or financial penalty on the individual, in addition to being able to prohibit them from being involved in any regulated activity.

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2.19 This will help to ensure that these individuals are fully aware of their responsibilities in the performance of their duties, and will thereby assist in supervising and influencing the behaviours of others involved in the processes.

2.20 Creating controlled functions for these activities may introduce a modest burden on the individuals involved, and will also involve some additional cost for the firms, as a result of the necessity for the relevant individuals to be approved. Nonetheless, in light of the importance of LIBOR, it is considered that it is appropriate and proportionate for these controlled functions to be created. In introducing this (or indeed any other) element of a new regulatory regime, the FSA would, of course, be under a duty to have regard to the statutory principle of proportionality – the burden imposed by any action it takes must be proportionate to the benefit that will be realised.

2.21 Accordingly, the Review recommends that controlled functions are created in relation to both submitting to and administering LIBOR. The next section considers the practicalities of implementing this recommendation. Location of the new controlled function

2.22 In relation to submitting, the discussion paper identified three possible options for the creation of the controlled function. These are:

 senior management;

 the manager responsible for the submission process; or

 the individual submitters.

2.23 The Review considers that the manager of the LIBOR submitting process would be the most suitable role for locating the controlled function. The individual holding this position will be closely involved in the submission process, and will therefore be able to exercise close control over the process by checking and confirming the LIBOR submissions, and by directly supervising the conduct of other employees involved in the process. The manager will also have more oversight of the process than the individual submitters.

2.24 A number of submitters to LIBOR are currently located outside the UK. Assuming a controlled function is created, the requirement for a relevant individual to be approved, and the obligations on the individual, including their liability for a regulatory sanction in the event of misconduct, would still apply if the individual were located outside the UK (save that in the case of a European Economic Area (EEA) firm the FSA may not make a function into a controlled function if the role of assessing the fitness and propriety of the person performing it is reserved to the domestic regulator).

2.25 In relation to administration, the role of the manager of the administration process should become a controlled function. Again, this role is closely involved in the relevant process, and the relevant individual will be able to monitor and supervise the process, as well as the conduct of any other employees involved in it.

2.26 As the Approved Persons regime currently applies to those who have significant influence over the conduct of a firm’s affairs in relation to a regulated activity, the amendments to FSMA and secondary legislation recommended above will be sufficient to enable these new controlled functions to be created. Transition to the new regulatory regime

2.27 If the Government accept these recommendations, it is anticipated that the necessary amendments to primary legislation could come into force in 2013, when the regulatory regime provided for in the Financial Services Bill comes into force. The precise timing of the introduction of the new regulatory regime will depend on the practicalities involved in the making of

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amendments to the Regulated Activities Order and the FSA developing, including consulting upon, the rulebook covering the new regulated activities.

2.28 Consideration will also need to be given as to how relevant firms are authorised. In particular, it is possible that a future benchmark administrator (see the next chapter for detailed discussion of new institutional arrangements) may not currently be an authorised person. A possible approach to the transition would be for firms who are already performing these activities to be deemed to be authorised, pending application within a limited specified time. This would enable the new regime to apply with minimal disruption. Enforcement and other sanctions for misconduct

2.29 As set out above, regulation will enhance the FSA’s ability to take enforcement action against the firms and Approved Persons involved in the process, including by imposing financial penalties on the firms and individuals for breach of the relevant regulatory requirements. There are also alternative options for enabling enforcement action to be taken, including under the civil market abuse regime, the proposed European regime for criminal market abuse sanctions and the wider criminal regime. This report considers these below. Market abuse

2.30 As set out in the discussion paper, there is already a well-developed civil market abuse regime in the UK, which stems largely from the EU Market Abuse Directive 2003. However, the EU and UK market abuse regimes were designed to capture market abuse in relation to financial instruments, and were not constructed with activities such as benchmark manipulation in mind. As a result, and for the reasons set out in Annex B of the discussion paper, the regime is unlikely to capture LIBOR misconduct directly, and even where it might capture such conduct indirectly, it places a high burden of proof on the competent authority to show the effect, or likely effect, on one or more financial instruments of any manipulation of submissions.

2.31 The Review has concluded that submission of false or misleading information in connection with a benchmark such as LIBOR is a form of wider market manipulation and should therefore be brought within the scope of market abuse. Benchmarks should be brought within scope in their own right, due to their importance to market functioning, rather than requiring competent authorities to establish a consequent effect on a particular financial instrument.

2.32 New EU legislation is currently being developed in this area, as follows:

 a new Market Abuse Regulation (MAR) is currently being developed, harmonising EU law on market abuse. MAR will apply to all EU countries, and is likely to come into force two years after it is adopted, replacing the existing Market Abuse Directive 2003;

 a new Market in Financial Instruments Regulation (MIFIR), which for the first time brings benchmarks into the scope of regulation and ensure fair and non- discriminatory access to them and, in so doing, provides an essential underpinning to the market abuse regime; and

 a Directive requiring the establishment of criminal offences for the most serious cases of market abuse (CS-MAD), to which a Justice and Home Affairs “opt-in” applies for the UK and Ireland. The UK may decide to adopt this Directive by opting in to it in due course, provided the standards are sufficiently robust and do not entail a reduction in protections against market abuse. The Government has indicated that it will consider its position once negotiations on MAR and the proposed revised Markets in Financial Instruments Directive (MIFID), on which CS- MAD depends, have concluded.

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Market Abuse Regulation

2.33 EU proposals to begin to extend the regulatory perimeter and principles of fair access and transparency to benchmarks in MIFIR and amendments to extend the proposed market abuse regime under MAR to cover attempts to manipulate benchmarks have now been put forward by the Commission, as set out in Box 2.B below. The Commission has also made a proposal for corresponding changes to the draft CS-MAD.

Box 2.B: EU amendments to MAR and MIFIR

The amendments are detailed in the Amended Proposal for a Regulation of the European Parliament and of the Council on Insider Dealing and Market Manipulation (2011/0295).

The Amended Proposal extends the definition of market abuse to include transmitting false or misleading information, providing false or misleading inputs, or any action which manipulates the calculation of a benchmark.

This provision applies to transactions, orders to trade or other behaviour relating to benchmarks, where any transmission of information, input, calculation or behaviour is used to affect, affects or is likely to affect the calculation of the benchmark. A benchmark is defined for these purposes as being any commercial index or published figure calculated by the application of a formula to the value of one or more underlying assets or prices, including estimated prices, interest rates or other values, or surveys by reference to which the amount payable under a financial instrument is determined.

2.34 These amendments are helpful, positive steps forward, which start to address the concerns raised in relation to the manipulation of, or attempts to manipulate, LIBOR. The UK should welcome these proposals from the Commission, while working with its EU partners to secure the amendments to the proposal which are necessary to ensure that MAR covers the full range of false submissions in respect of such benchmarks.

2.35 As MAR will apply to all EU countries and is likely to come into force in the near future (subject to the Regulation being adopted), and as prompt action is being taken to extend MAR to cover the attempted manipulation of benchmarks, it is recommended that the UK should not make unilateral changes to its civil market abuse regime prior to MAR being agreed, but should instead continue to assist in the finalisation of MAR.

2.36 It is, nevertheless, important that MAR is sufficiently wide to cover the possible manipulation of relevant benchmarks. While work to date has gone a long way towards formulating the relevant provisions, careful consideration still needs to be given as to the precise formulation of MAR, including:

 whether the proposed definition of benchmarks is sufficient to cover all benchmarks, including, in particular, any benchmarks which may not be based on the value of underlying assets or prices, or which may not use a formula to calculate the level of the benchmark; and

 whether it should be a necessary element of market abuse that the calculation of the benchmark was in fact affected, or whether making a false or misleading submission is sufficient, even if the calculation of the benchmark was not affected. Thought should be given as to whether a requirement to consider the effect on the benchmark will push some scenarios, where false submissions are made, out of scope.

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2.37 In relation to this second consideration, determining the impact on the benchmark, or likely impact, may introduce new difficulties regarding evidential burden for the relevant Competent Authorities which require careful consideration.

2.38 Furthermore, there is a potential risk that a requirement that the calculation of the benchmark was affected will inadvertently exclude certain scenarios from the regime. For example, if a false LIBOR submission were made for purposes other than to affect the benchmark or relevant financial instruments, and did not in fact affect the calculation of LIBOR as it fell at the top or bottom of the range of submissions and was therefore discarded from the calculation of the rate.

2.39 It is also important that the sanctions available under MAR for market abuse by firms and individuals are sufficiently serious to deter this behaviour. The financial penalty of £85 million imposed on Barclays (reduced to £59.5 million for agreeing to settle at an early stage) for its failings in respect of its submissions to LIBOR and EURIBOR represents a serious disincentive in relation to this type of behaviour, and it is suggested that similar penalties should be available under MAR. Indeed, the LIBOR and EURIBOR investigations underline the importance of many objectives underpinning impending EU legislation. The need for a strong sanctioning regime in the proposed Market Abuse Regulation is clear: it sends a powerful message of deterrence across the EU that market abuse will not be tolerated.

2.40 The UK should, therefore, continue to oppose any attempts to weaken the sanctioning regime proposed by the European Commission. In particular, a lowering of the indicative maximum fines provided for in the Market Abuse Regulation would be hard to justify. Having indicative penalties of this sort provided for in unilateral EU legislation is highly valuable: it sends a strong public message that the EU takes market abuse, including the manipulation of benchmarks, very seriously. New EU-harmonised criminal offences for market abuse

2.41 Important progress has also been made by the EU in the development of CS-MAD. This includes an amended Commission proposal which provides that criminal conduct shall include intentionally transmitting false or misleading information, providing false or misleading inputs, or any other equivalent activity which intentionally manipulates the calculation of a benchmark.1

2.42 As with MAR, the Review has concluded that the amended Commission proposal is a helpful response by the EU to address the concerns that have arisen in relation to attempts to manipulate benchmarks. The same considerations should be given to the scope of the offence of market manipulation and the definition of a benchmark.

2.43 As detailed above, and in contrast to MAR, CS-MAD will not automatically apply in the UK – the UK has not at present opted in to CS-MAD, which is necessary for the new Directive to apply in the UK. Furthermore, if the UK does decide to opt in, it would be able to extend or strengthen specific provisions (as long as this is consistent with the Directive).

2.44 In light of the greater flexibility available to the UK in this area, the Review therefore considers it sensible to evaluate the question of whether new criminal sanctions in UK law are required for LIBOR manipulation without reference to the current CS-MAD proposals. The next section of the report therefore considers this issue on a standalone basis. However, it should be noted that the recommendations set out below do not seek to prejudice the ongoing development CS-MAD or preclude the UK from being able to opt in.

1 The Amended Proposal for a Directive of the European Parliament and of the Council on criminal sanctions for insider dealing and market manipulation (2011/0297 (COD))

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New offences under FSMA

2.45 The FSA currently only has statutory powers of investigation with respect to various offences under FSMA and insider dealing under the Criminal Justice Act 1993. While attempts to manipulate LIBOR could potentially constitute a criminal offence under legislation other than FSMA, the FSA is currently not in a position to investigate and prosecute such conduct.

2.46 As set out in the discussion paper, a possible approach is therefore to amend FSMA to include, as an offence, the making of a false or misleading statement in order to manipulate LIBOR, potentially by making changes to Section 397 of FSMA.

2.47 While this approach drew some support from certain quarters, many respondents were cautious about introducing criminal sanctions for LIBOR submissions. Some concerns were raised about combining criminal sanctions with the continued application of judgement by banks. There were also concerns expressed that amending Section 397 could unintentionally criminalise some unrelated activities, create overlap with existing fraud offences and create legal uncertainty. At least one respondent argued that if criminal prosecution proved difficult to pursue in many cases, the existence of specific criminal sanctions could prove counter-productive as authorities could be criticised for not using available powers.

2.48 The Review is mindful of these comments, and of the Government’s wider policy that there should not be a proliferation of unnecessary criminal offences.

2.49 However, the Review is also aware that, in light of the high value of the contracts that reference LIBOR, and the financial benefits that might possibly be obtained from manipulating LIBOR, some individuals may nonetheless be motivated to deliberately and dishonestly attempt to manipulate LIBOR, either directly or through collusion with others. Such behaviour would normally be for direct or indirect advantage – for example, by benefiting trading positions. The perpetrators of such behaviour are likely to be conscious of the dishonesty of their conduct, and civil sanctions under either the regulatory code of conduct or the civil market abuse regime may not therefore be sufficient to prevent such behaviour in all cases.

2.50 Further, while this conduct may fall within the scope of other criminal offences, it is important that the FSA, as the body responsible for the supervision of the financial services sector, is able to conduct effective criminal investigations and prosecutions in this area. The FSA is responsible for monitoring and investigating behaviour in the financial markets in relation to the regulatory and market abuse regimes. The Review considers that it is sensible that the FSA is also able to use its statutory powers of investigation and bring prosecutions in relation to such conduct where appropriate.

2.51 The Wheatley Review has concluded that this can best be achieved by amending Section 397, rather than empowering the FSA to investigate and prosecute fraud offences more generally. This will ensure that the FSA’s ability to investigate and prosecute offences is clearly limited to offences connected with the financial markets, and will avoid an uncertain and potentially wide ranging extension of the FSA’s criminal investigation powers.

2.52 The Review also considers that any attempts to manipulate LIBOR constitute sufficiently serious conduct to merit this being a criminal offence. As set out above, this conduct is likely to occur in full awareness of the potentially serious and wide ranging impact that manipulation of LIBOR may have in light of its global use. For these reasons, it is considered that there are strong public interest grounds for ensuring that this conduct can be prosecuted.

2.53 Accordingly, while it is recognised that there are arguments both for and against amending the current criminal regime, the Review recommends that Section 397 of FSMA is amended to cover manipulation of LIBOR, so that the FSA is able to investigate and prosecute such conduct.

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2.54 It is envisaged that this could be achieved by amending Section 397 so that it applies to individuals who intentionally or recklessly make a false or misleading statement in relation to the setting of a benchmark. The scope of the offence could be limited to false or misleading statements in relation to the setting of a specified benchmark, or relevant financial instruments or relevant agreements as currently defined in FSMA. This would retain the necessary connection to the financial markets. Consideration should be given as to whether it should be necessary to show that the person acted in order to obtain a profit or benefit, or avoid a loss, and to whether the offence should also cover undertaking an equivalent course of action (for example, undertaking transactions at an artificial level in order to manipulate a submission based on these transactions).

2.55 It would also be appropriate at this time to review the workability of Section 397 as a whole, so that the scope of the market manipulation provision for benchmarks is consistent with the scope of market manipulation of financial instruments.

2.56 By creating this offence, the actions of others who attempt to persuade submitters to submit false figures, or who attempt to manipulate benchmarks through collusion, should be caught as encouraging or assisting others to commit this offence, or conspiring with others to commit the offence.

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Strengthening institutions 3 and governance

Box 3.A: Key reforms and specific recommendations

The BBA should transfer responsibility for LIBOR to a new administrator, who will be responsible for compiling and distributing the rate, as well as providing credible internal governance and oversight. This should be achieved through a tender process to be run by an independent committee convened by the regulatory authorities.

The new administrator should fulfil specific obligations as part of its governance and oversight of the rate, having due regard to transparency and fair and non-discriminatory access to the benchmark. These obligations will include surveillance and scrutiny of submissions, publication of a statistical digest of rate submissions, and periodic reviews addressing the issue of whether LIBOR continues to meet market needs effectively and credibly.

3.1 In its discussion paper, the Wheatley Review identified a number of failings with the current administration of LIBOR, focusing on three key areas of weakness:

 insufficient independence of the governance structures, which relied too heavily on the participating banks and their own industry organisation;

 inadequate oversight structures, such as the lack of systematic oversight of systems and controls within contributing banks; and

 limited transparency and accountability of the governance structures.

3.2 Further analysis of the issues and failings with the administration and governance of LIBOR can be found in Annex C. During the consultation process, the vast majority of respondents agreed with this analysis. In particular, many noted that that the BBA acts as the lobby organisation for the same submitting banks that they nominally oversee, creating a that precludes strong and credible governance. Many questioned whether the BBA could remain involved in the governance and administration of LIBOR.

3.3 Respondents also raised concerns that the institutions of LIBOR are not empowered to effectively administer and govern the benchmark. The failure of these institutions to identify, investigate and sanction participants for alleged misconduct was seen as evidence of this failing.

3.4 As set out in the previous chapter, the Wheatley Review recommends that submission to, and administration of, LIBOR are regulated by the FSA. However, it is clear that, on its own, regulation is not a sufficient solution to all of the problems identified with LIBOR. LIBOR must also, in the first instance, be administered in a robust fashion, with regulation acting as a back- stop, providing statutory powers for intervention and enforcement. A new set of institutions for LIBOR

3.5 Informed by the considerations immediately above, the Review has concluded that weak institutions helped to create the opportunity for misconduct, which in turn discredited LIBOR. A new set of institutions would have the capacity to administer and govern LIBOR in such a

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manner that credibility could be restored in the benchmark. Therefore the Review recommends that the BBA passes on the role of future administration and governance of LIBOR, subject to the identification of a new institution (or institutions) to take on these roles.

3.6 The Wheatley Review has concluded that LIBOR should be a market-led benchmark, administered by a private organisation rather than by a public body. The functioning of LIBOR affects a much wider group of actors than those involved directly in the production of the benchmark. However, while there is significant justification for regulation and reform of the benchmark, it is not clear that there is sufficient justification for a public authority to administer the benchmark.

3.7 As an important market benchmark, it is appropriate that LIBOR can evolve to meet the needs of users. A private organisation is likely to have a greater incentive to ensure that the benchmark is fit for purpose and evolves to meet the changing needs and nature of the market. In contrast, public ownership would: change the relationship between the market that created and developed LIBOR, and the future evolution of the benchmark; reduce the incentive and ability for LIBOR to adapt to the needs of market participants; and potentially affect the choice of benchmarks by these participants.

3.8 Further, the Wheatley Review has concluded that LIBOR can and should be successfully administered by private organisations, within rules and guidance set by the authorities. The package of recommendations put forward by the Review is a proportionate response to the issues and failings identified, and should be sufficient to deliver a benchmark that is robust and accountable, without moving the ownership of LIBOR to a public authority.

3.9 Introducing a public body to administer LIBOR could also set a precedent for other globally significant benchmarks. LIBOR is one of many important benchmarks that are used across financial, commodity and other markets. A policy of transferring such benchmarks to public bodies, rather than guiding reform through oversight and regulation, could set a precedent that would need to be applied to many of these other benchmarks.

3.10 The process to identify other candidates to take on these functions should be as streamlined as possible to ensure that there is limited disruption arising from the transition between administrators.

3.11 Therefore, the Wheatley Review recommends that the BBA should, under guidance from the authorities, immediately commence a process for tendering out the role of LIBOR administration and governance to an independent party. This should take account of the failings with the existing model and propose a reformed mode of administration and governance.

3.12 Specifically, new institutions should demonstrate:

 greater independence, with a clear distinction between the interests of institutions and submitting banks;

 specific oversight processes to be set up at administration, governance and bank levels;

 transparent systems, processes and structures, with clear accountabilities at every level; and

 a firm commitment to providing access to the benchmark on fair and non- discriminatory terms.

These expectations of a new institutional model are expanded upon below.

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Process for tendering LIBOR institutions

3.13 In order to ensure that an open and transparent process is followed, and that the recommendations of this Review are implemented in such a way that credibility is fully restored to LIBOR, the Review recommends that the BBA delegates the tendering process to an independent committee, convened by the Government and the FSA. The membership of the committee should be appointed by the authorities, and include an independent chairperson and representatives from the authorities, the BBA and a variety of other market participants.

3.14 Once established, this committee will conduct a tendering process, based on a set of explicit criteria. These criteria will be designed to ensure that the new rate administrator puts in place a reformed governance structure that is sufficiently strong and credible (as discussed in more detail below). Further, it will take into account other factors such as legal and intellectual property considerations. The committee will then make a recommendation to the BBA as to the preferred candidate to take ownership of LIBOR. The BBA will be expected to transfer ownership and responsibility to the preferred candidate. If LIBOR administration becomes a regulated activity, the successful candidate will also need to apply for a permission to carry out this activity, in due course.

3.15 The Review understands that the balance of incentives may not be sufficient to encourage a new administrator to take ownership of the benchmark in absence of a financial incentive. As a result, the new administrator should be permitted to explore the commercial viability of LIBOR, and this will be reflected in the design of the tender process. However, the clear priority in conducting the tender process will be to find a new administrator to provide a robust operational and oversight framework for LIBOR.

3.16 Details of the selection committee and criteria will be provided on the Wheatley Review webpage as soon as possible. Proposals for a reformed governance framework

3.17 The Review presented recommendations for the regulatory oversight of LIBOR in the preceding chapter. As such, the FSA will provide a strong degree of external governance to the entire framework, through supervision and oversight of contributing firms and the benchmark administrator.

3.18 Given that the Review has recommended that the BBA entrust the role of LIBOR administrator and sponsor to a new administrator, the Review considers that the detailed design of the overall internal governance framework should be established by the new rate administrator. Organisations interested in taking on this role will likely have differing views on the most effective and robust organisational frameworks, and the tender process will allow these to be evaluated carefully.

3.19 The Review is open to some aspects of benchmark administration being undertaken by different bodies, provided this is operationally effective. For example, the separation from administration of the activities of LIBOR distribution or calculation to another body through a process of delegation. However, the benchmark administrator should retain overall responsibility for all these activities.

3.20 While the new benchmark administrator would have the flexibility to design and manage the organisational and commercial aspects of the framework, there are a number of high-level elements that the Review would expect to see reflected in the future governance structure. Indeed, the Review expects that these aspects should take prominence in the tender process for a new benchmark administrator.

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3.21 In particular the Review expects the governance framework should have certain structures and features. First, the benchmark administrator should be under a requirement to analyse and scrutinise submissions from contributing banks. Second, the framework should include a prominent decision-making and oversight role conducted by an independent and powerful committee with the ability to operate autonomously.

3.22 Finally, the benchmark administrator and oversight committee should take responsibility for developing and implementing an industry-led code of conduct outlining the detailed policies and procedures that contributing firms and the LIBOR administrator would be expected to follow (as detailed below). Structures for a reformed governance framework Role of an administrator/distributor

3.23 The benchmark administrator will be ultimately responsible for the effective oversight and operation of all aspects of LIBOR. There is a specific set of requirements that the Review believes the administrator should meet in order to ensure that confidence in the integrity of LIBOR as a benchmark is widely restored.

3.24 The benchmark administrator should have responsibility for many of the operational aspects of LIBOR, which include the day-to-day management and administration, as well as public relations.

3.25 The Commission’s proposals in Article 30 of the Markets In Financial Instruments Regulation (MIFIR) require benchmark providers to provide fair, reasonable, and non- discriminatory licenses to trading venues and central clearing counterparties to trade and clear products related to their benchmarks. The administrator and distributor, whether a single body or not, would need to ensure that access to LIBOR is not reserved for certain market participants.

3.26 Scrutiny of submissions is also a crucial aspect of the benchmark administrator function to ensure the integrity and credibility of the benchmark. Therefore, as part of the wider benchmark compilation responsibilities, the administrator should have in place rigorous and effective systems and procedures for such scrutiny. This should include both pre-publication verification checks, to avoid manifest errors in submissions, as well as post-publication scrutiny against a set of verifiable statistics, encompassing inter-bank and other unsecured deposit transactions, as well as other relevant financial data.

3.27 In addition, there are a number of operational issues that a rate administrator would need to consider, including:

 defining procedures and criteria for banks to become members of LIBOR panels and setting out the responsibilities of notice period for banks considering leaving the LIBOR panels; and

 technical and operational procedures for submitting rates to LIBOR; e.g. to whom submissions should be made, submission time window, and other operational issues.

3.28 When administering the benchmark, there are a number of issues that may be best achieved through multilateral agreement. For example, there are decisions relating to the definition and calculation of the benchmark, which should be achieved through in-depth consultation with market participants. In order to achieve all of these objectives, the administrator should convene an oversight committee.

3.29 The administrator should refer any anomalous submissions to the oversight committee as part of a process of discussion and triage ahead of any referral to the FSA.

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Role of an oversight committee

3.30 While, as the regulated entity, the benchmark administrator will have ultimate responsibility for all aspects of governance, many of the decision-making and technical discussions should be devolved to an independent and separate external oversight committee.

3.31 The oversight committee should take responsibility for those aspects of LIBOR internal governance which require the input from a wider pool of stakeholders. The role of an oversight committee establishes a level of independence and collective decision-making which in turn should improve the credibility and transparency of the governance process.

3.32 Importantly, the definition, scope and context of LIBOR as a benchmark should remain the discretion of the oversight committee as this aspect should be informed by market participants. This would allow participants to ensure that the definition of LIBOR evolves in line with changes in the structure and operation of financial markets.

3.33 Other responsibilities of the oversight committee should include collective scrutiny of individual submissions by contributors. As discussed, the rate administrator will have responsibility for identifying and analysing the submissions against a set of parameters. Those parameters may need to be defined by the oversight committee, using their expertise and understanding of the inter-bank funding market.

3.34 The oversight committee should have responsibility for the key instrument of the governance framework, a code of conduct. The code of conduct should outline the responsibilities of the relevant institutions of governance, including contributing banks, the oversight committee and the benchmark administrator (see Chapter 4 for a detailed discussion).

3.35 The oversight committee should be able to enforce low-level sanctions with respect to participating banks, for example as a result of recurring operational problems. All other breaches should be referred to the FSA for supervisory review.

3.36 In order to improve representation and independence, the oversight committee should include members from beyond the ranks of the contributing panel banks, particularly from the wider cross-section of participants that use LIBOR, or industry bodies who represent those users. All members should have equal standing on this committee.

3.37 The discussion paper outlined a number of actions that could be taken to improve the transparency of such an oversight committee, and these should be implemented:

 the terms of reference of the committee should be made available to the public;

 the details of the membership of the committees should be published, along with any declarations of conflicts of interest and processes for election or nomination of members of the committee; and

 minutes of meetings should also be published, with a delay where necessary.

3.38 One proposal raised by consultation respondents was that the regulatory authorities should join the oversight committee. However, the Review has concluded that if, in line with its recommendations, rate administration and submission are regulated, it would be inappropriate for the regulator to sit on such an oversight committee, as there would need to be a clear distinction between external regulatory oversight and internal governance. For this reason, the Review does not recommend the participation of the regulators.

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Rules and guidance for 4 LIBOR

Box 4.A: Key reforms and specific recommendations

Submitting banks should immediately look to comply with the submission guidelines presented in this report, making explicit and clear use of transaction data to corroborate their submissions.

The new administrator should, as a priority, introduce a code of conduct for submitters that should clearly define:

 guidelines for the explicit use of transaction data to determine submissions;

 systems and controls for submitting firms;

 transaction record keeping responsibilities for submitting banks; and

 a requirement for regular external audit of submitting firms.

4.1 In prior chapters, the Wheatley Review has concluded that LIBOR, as an industry-defined benchmark, should continue to be administered by a private organisation rather than a public authority. Furthermore, the Review has recommended the introduction of regulatory oversight of the submission and administration of LIBOR, which would allow the FSA to apply its Principles for Businesses to LIBOR administration and to write rules specifically relating to LIBOR submission and administration.

4.2 However, in addition to these rules, the Wheatley Review will also recommend in this chapter that the LIBOR administrator and oversight committee (discussed in the preceding chapter) should develop and implement an industry-led code of conduct to provide detailed guidance on operational and procedural issues of submitting to LIBOR. In due course, the FSA should consider endorsing this code as industry guidance, providing contributors with clear guidance on how to act in accordance with applicable FSA rules on the new regulated activity.

4.3 Recognising the transition times required for introducing this new regime, the Review therefore recommends that, in advance of the code of conduct being agreed, contributors should be guided by submission guidelines that set out a detailed and accountable process for the determination of submissions.

4.4 This chapter sets out the key elements that the Review expects to be included in a code of conduct and defines the submission guidelines that contributors should begin to implement immediately. LIBOR submission guidelines

4.5 One of the key findings of the Wheatley Review is that LIBOR submissions should be explicitly and transparently supported by transaction data. While the Review supports retaining the existing definition of LIBOR based on unsecured inter-bank lending, there are other relevant transactions that can be used to support contributors’ assessment of the market for inter-bank funding, especially during periods of limited activity.

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4.6 A detailed, industry-led code of conduct drawn up by the rate administrator and oversight committee, as discussed below, would serve to ensure that best practice is applied to operational aspects of LIBOR submissions, in a manner consistent with FSA rules.

4.7 However, it will be some time before the new rule-book and a fully-developed code of conduct are in place. Given that there is a need to introduce immediate reform to the process of LIBOR submission, the Wheatley Review recommends that, in advance of the agreement of a more detailed code of conduct, LIBOR submitters should refer to the suggested submission guidelines set out in Box 4.B in the determination of their LIBOR submissions.

4.8 These submission guidelines set out the specific transactions that contributing firms should use to determine their assessment of the inter-bank funding market and the hierarchy of these transactions.

Box 4.B: LIBOR submission guidelines

LIBOR submissions should be determined based upon the following hierarchy of transaction types. Submitters should use their experience of the inter-bank deposit market and its relationships with other markets to develop their LIBOR submission. Greatest emphasis should be placed on transactions undertaken by the contributing bank.

1 Contributing banks’ transactions in:

 the unsecured inter-bank deposit market;

 other unsecured deposit markets, including but not limited to, certificates of deposit and commercial paper; and

 other related markets, including but not limited to, overnight index swaps, repurchase agreements, foreign exchange forwards, interest rate futures and options and central bank operations.

2 Contributing banks’ observations of third party transactions in the same markets.

3 Quotes by third parties offered to contributing banks in the same markets.

4 In the absence of transaction data relating to a specific LIBOR benchmark, expert judgement should be used to determine a submission.

Submissions may also include adjustments in consideration of other variables, to ensure the submission is representative of and consistent with the market for inter-bank deposits. In particular, the information obtained above may be adjusted by application of the following considerations:

 Proximity of transactions to time of submission and the impact of market events between transactions and submission time;

 Techniques for interpolation or extrapolation from available data;

 Changes relative credit standing of the contributor banks and other market participants; and

 Non-representative transactions.

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4.9 These submission guidelines are closely modelled on the undertakings proposed by the Commodity Futures Trading Commission (CFTC) in their settlement with Barclays Bank Plc.1 It is the view of the Wheatley Review that banks should begin to create their LIBOR submissions by taking account of these guidelines immediately.

4.10 The proposed submission guidelines place greatest weight on the inter-bank deposit transactions of contributing banks, in accordance with the current definition of LIBOR. For some currencies and maturities there are sufficient underlying transactions with which to determine submissions; in this case the weighted average rate of those transactions should be used.

4.11 However, where a contributor bank has few transactions in inter-bank deposits, or those transactions are not representative of the inter-bank market, then an assessment of the inter- bank funding market should be based on transactions or observations of other sources of unsecured deposits and other relevant financial instruments, as set out in the guidelines.

4.12 Chart 4.A demonstrates that, for a reasonable number of currencies and maturities, there may be sufficient transactions in the inter-bank and other wholesale deposit markets to be explicitly used when determining submissions to LIBOR.

1 http://www.cftc.gov/ucm/groups/public/@lrenforcementactions/documents/legalpleading/enfbarclaysorder062712.pdf

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Chart 4.A: Unsecured deposit transactions by LIBOR contributing banks, per bank in 2011 Inter-bank deposit transactions No. of O/N 1w 2w 1m 2m 3m 4m 5m 6m 7m 8m 9m 10m 11m 12m banks USD 12 GBP 9 EUR 10 JPY 10 CHF 8 CAD <7 AUD <7 NZD <7 SEK <7 DKK <7

Wholesale deposit transactions No. of O/N 1w 2w 1m 2m 3m 4m 5m 6m 7m 8m 9m 10m 11m 12m banks USD 12 GBP 9 EUR 10 JPY 10 CHF 8 CAD <7 AUD <7 NZD <7 SEK <7 DKK <7

low activity medium-low activity medium activity high activity

Note: This is based on data from a subset of contributing banks, may not be include all relevant transactions or be entirely representative for all currencies.

Source: Oliver Wyman, Bank of England and Wheatley Review calculations

4.13 The Review recognises that there are limited transactions on which to base LIBOR submissions for some currencies and maturities. In Chapter 5 the Review recommends that the number of currencies and maturities for which LIBOR is published be reduced, with those currencies and maturities that are thinly traded and used to be phased out over a 12-month transition period. Code of conduct for contributing banks

4.14 The Wheatley Review recommends that FSA Principles and rules should provide the high- level basis for the regulation of contributing banks and the administrator. It may be necessary for the FSA to draft specific rules relating to these regulated activities. However, the Review believes that once a new rate administrator is in place, more detailed guidance relating to submissions to LIBOR should be developed and implemented.

4.15 Therefore the Review recommends that the LIBOR administrator, through the oversight committee, should draft a code of conduct, in collaboration with contributors and market participants, which should serve as a manual for the internal governance and organisation of LIBOR submission, detailing the specific requirements for firm behaviour and procedures.

4.16 To the extent that these details are not covered by FSA rules, the code of conduct will serve as guidance on the FSA Principles and rules in relation to the regulated activity of LIBOR

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submission. Since the code will be drafted by industry participants, it will constitute industry guidance, rather than FSA guidance, on those Principles and rules.

4.17 The FSA rules are principle-based and outcome-focused; therefore, the details for submission guidance should remain with the institutions of LIBOR, which will remain responsible for the definition of the benchmark. The benefit of industry guidance is that the rate administrator can develop the code of conduct over time; as both LIBOR and the market that it is intended to assess evolve, the requirements of its users will also change.

4.18 The FSA has a detailed policy for endorsing industry-led guidance, known as ‘FSA confirmation’, which clarifies and standardises the role of industry guidance and its stature within the regulatory framework.2 This process should be applied to the code, subject to the FSA being satisfied that it is fit for purpose. Once the detailed code of conduct has been confirmed by the FSA, the code should serve to ensure that best practice is applied to LIBOR submissions and all operational aspects of LIBOR, in a manner consistent with FSA rules. Coverage of the code of conduct

4.19 The Wheatley Review recommends that the code of conduct should cover the areas discussed below. The code of conduct should also be published to ensure transparency around the industry guidance for LIBOR submission. Submission procedures

4.20 The code should specify, in detail, the process by which submission are made, including:

 specific and detailed LIBOR submission guidelines; for example, the role and explicit use of inter-bank deposit transactions and other transaction data, other relevant and related markets which can be used to develop a precise assessment of the inter-bank funding market. Should also include specific aspects that should not be taken into account when determining submissions;

 a requirement to keep accurate and accessible internal records of all transactions in the inter-bank deposit market and other relevant markets, alongside a requirement to provide these records to the rate administrator and oversight committee on a regular basis and on request. (Submitting banks should begin implementing this immediately, as discussed below.);

 detailed procedures for validation of submissions prior to publication and corroboration of submissions after publication. Validation and corroboration should be compared with relevant financial data and parameters should be agreed in advance. Procedures to include contact between the calculation agent and the submitters, with appropriate managerial oversight;

 policies for training of the LIBOR submitter, including what inputs to take into account when determining submissions and how to use expert judgement, within the framework of submission guidelines. Also, should include knowledge of regulatory responsibilities and the code of conduct as outlined. Similarly, training for derivatives traders detailing their potential role in the rate determination, but also outlining types of unacceptable contact with LIBOR submitters; and

 a requirement for all institutions to have in place suspicious submission reporting procedures to the rate administrator and oversight committee for review. Any unaccountable and anomalous submissions should be escalated to the FSA.

2 For details on this process, see Policy Statement 07/16, available at: http://www.fsa.gov.uk/pubs/policy/ps07_16.pdf

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Internal systems and control policies

4.21 The code should also cover, in detail, the requirements and expectations for systems and controls related to the submission process, including:

 an outline of personal responsibilities within each firm, including internal reporting lines and accountability. Specifically, location of LIBOR submitters and associated managers to be within the function responsible for the contributors’ liquidity and liability management. Names of relevant individuals should be recorded, alongside alternates. To reiterate the requirement that certain individuals within the firms are Approved Persons;

 internal procedures for sign-off of rate submissions as well as exception reporting and provision of management intelligence;

 implementing disciplinary and/or whistle-blower procedures for attempts to manipulate or failing to report attempted manipulation by parties external to the LIBOR submission process. Subsequent reporting of misconduct and disciplinary proceedings to the FSA;

 installation of effective conflicts of interest management procedures and communication controls, both within banks and between banks and other third parties to avoid any inappropriate external influence over those responsible for submitting rates. Specifically, LIBOR submitters should be physically separated from interest rate derivatives traders;

 a requirement that all relevant records relating to the submission process (over and above transaction-related records) should be kept. Of particular focus should be:

 the process surrounding rate determination and subsequent sign-off;

 the names of individuals and their responsibilities;

 any communications between the submitting parties and others in determining submissions, such as internal and external traders and brokers;

 any interaction with the rate administrator or calculation agent;

 any submission queries and their respective outcomes;

 sensitivity reports to LIBOR fixing rates for interest rate swap trading books and any other derivative trading book with a significant exposure to LIBOR fixings; and

 the findings of any internal and external audits.

 requirements for annual internal audit and regular compliance reviews; and

 requirements for external audit, to be first implemented 6 months after introduction of the code, and subsequently every 2-3 years (outlined in more detail below). The oversight committee can require an external audit of contributing firms if dissatisfied with aspects of their conduct. (See below for the Review’s recommendations regarding external audit of submissions and governance). The requirement for submitting banks to record relevant transactions

4.22 As discussed above, expert judgement will be supported by transactions in inter-bank deposits and other relevant instruments. This facilitates the corroboration of submissions, both internally within the submitting firm, as well as externally by the new administrator of LIBOR and the oversight committee. During the course of supervision of panel banks, the FSA may also request to see these records, when reviewing firms’ systems and controls for submissions.

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4.23 In the longer-term, a code of conduct will specify how submitting banks should make use of trade data in their LIBOR submissions, while, in the short term, the submission guidelines above will advise banks on how best to use trade data in advance of the introduction of the code.

4.24 At present, submitting banks do not have to record the trade data used to support their LIBOR submissions. This means that it is difficult for the administrator and the regulator to compare the expert judgement of a submitting bank against trades that have been undertaken by the submitting bank.

4.25 Therefore, the Wheatley Review recommends that contributing banks keep accurate and accessible records of transactions in inter-bank deposits and other relevant financial instruments (including information on currency, maturity, price and counterparty-type).

4.26 Moreover, these records should be made available to the new rate administrator and any relevant governance committees on a regular basis. The administrator of LIBOR will make use of this information to monitor submissions, comparing transaction information against submissions and referring any anomalies to the regulatory authorities.

4.27 These transaction records should also be made available to the FSA for the purpose of supervising contributing firms’ submission as well as firms’ system and control procedures. Industry guidelines for assurance and audit

4.28 Contributing banks and the rate administrator will together establish a code of conduct outlining requirements and responsibilities of individual firms. The Review’s broad recommendations for the contents of the code were outlined above. A key component of the code is that institutions will be required to obtain regular external assurance to confirm their adherence to the code.

4.29 Assurance from external auditors can play a major role in instilling public confidence and establishing credibility to LIBOR. External assurance provides an independent review that published benchmarks are fairly presented as well as firm systems and internal controls used to support LIBOR submissions and internal governance arrangements.

4.30 Such external assurance should be provided on a consistent basis and based upon a robust framework. The Review welcomes the project announced by the Institute of Chartered Accountants of England and Wales (ICAEW) to develop guidance for providing external assurance on interest rate benchmark submissions, including LIBOR, based upon standards set out by the International Auditing and Assurance Standards Board. The Review recommends that the ICAEW work with the new LIBOR administrator to ensure that their guidance informs and is consistent with the code of conduct.

4.31 Development of this guidance will ensure standardisation of assurance and audit across all participants, which will benefit contributing banks, the rate administrator and the regulatory authorities. However, the Review recognises that the systems and controls of banks are likely to be dynamic while a code of conduct is developed and implemented, but stresses the creation of this guidance should be in place when banks are required to obtain external assurance.

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Reforms to the LIBOR 5 mechanism

Box 5.A: Key reforms and specific recommendations

The BBA and, in due course, the new administrator, should cease the compilation and publication of LIBOR for those currencies and tenors for which there is insufficient trade data to corroborate submissions, immediately engaging in consultation with users and submitters to plan and implement a phased removal of these rates.

The BBA should publish individual LIBOR submissions after 3 months to reduce the potential for submitters to attempt manipulation, and to reduce any potential interpretation of submissions as a signal of creditworthiness.

Banks, including those not currently submitting to LIBOR, should be encouraged to participate as widely as possible in the LIBOR compilation process, including, if necessary, through new powers of regulatory compulsion.

Market participants using LIBOR should be encouraged to consider and evaluate their use of LIBOR, including whether standard contracts contain adequate contingency provisions covering the event of LIBOR not being produced.

5.1 The preceding chapters of this report have set out a blueprint for reform of the regulation of LIBOR and the institutions that will administer the rate in a more robust and transparent fashion. There are also a number of other reforms that could serve to strengthen the credibility of LIBOR in the immediate term. These include:

 reducing the number of currencies and maturities for which LIBOR is published;

 delaying the publication of individual submissions; and

 ensuring sufficiently large panel sizes for LIBOR.

5.2 In addition, there are also reforms that could improve the understanding of LIBOR among market participants and potentially increase the resilience of the markets that reference LIBOR. In particular:

 developing robust contingencies for the unavailability of LIBOR within contracts; and

 regular publication of statistical bulletins on the transactions that LIBOR submissions are intended to reflect. Improving the LIBOR mechanism Reducing the number of currencies and maturities for which LIBOR is published

5.3 LIBOR is currently published for ten currencies and fifteen maturities. The discussion paper, and subsequent responses, demonstrated that:

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 the volume of transactions underpinning each LIBOR benchmark published vary considerably, with very few underlying trades in some currencies and maturities; and

 some LIBOR benchmarks are not used as a reference for many transactions. They tend to correspond to smaller markets, or where domestic alternatives are preferred.

5.4 The Wheatley Review has recommended that LIBOR submissions should be explicitly and transparently supported by transaction data (see Chapter 4). However, there is a lack of regular transactions for many of the currencies and tenors for which LIBOR is calculated; Chart 4.A shows the volume of inter-bank deposit transactions for each currency and maturity over 2011. While this data shows significant numbers of transactions in core currencies and tenors, trading volumes are thin for many others. LIBOR submissions for these currencies and maturities would be more difficult to support using transaction data.

5.5 The prevalence of the use of different currencies and maturities in interest rate swaps and floating rate notes referencing LIBOR is illustrated by Table 5.A. While based on incomplete data – no comparable data could be found for syndicated loan transactions, mortgages and other markets – the Table clearly shows that usage of LIBOR is concentrated in a few core currencies and maturities was supported anecdotally by respondents throughout the Review process, who also noted the use of overnight and 9 month maturities. This analysis makes it clear that the use of LIBOR, at least in these applications, is concentrated:

 for currencies, in US Dollar, Pound Sterling, Swiss Franc, Japanese Yen and, to a lesser extent, the Euro; and

 for maturities, in overnight, 1 month, 3 months, 6 months and to a lesser extent 9 and 12 months.

Table 5.A: The use of LIBOR as a reference rate Interest rate swaps and floating rate notes

1m 3m 6m 12m Total USD 5.6% 52.8% 0.3% 0.1% 59% EUR - - 0.1% - 0% GBP 0.4% 2.9% 8.9% - 12% JPY 0.1% 3.6% 23.5% - 27% CHF 0.1% 0.4% 1.6% - 2% AUD - - - - 0% CAD - - - - 0% NZD - - - - 0% SEK - - - - 0% DKK - - - - 0% Total 6% 60% 34% 0% 100%

Source: Dealogic, Depositary Trust and Clearing Corporation

5.6 For some of the less-used currencies, benchmarks calculated in domestic jurisdictions tend to be preferred to LIBOR, due to the greater liquidity of transactions in the domestic markets. For example, the Stockholm Inter-bank Offered Rate (STIBOR) is used more frequently than the corresponding Swedish Krona LIBOR benchmark.

5.7 Thus, the Wheatley Review has concluded that there are a number of published LIBOR benchmarks that are both difficult to support using trade data, and are not heavily used by market participants. Furthermore, given the low usage of many of the currencies and tenors for

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which LIBOR is published, the Wheatley Review has concluded that a carefully managed and phased reduction in the number of LIBOR benchmarks published could occur without significant market disruption.

5.8 During the Wheatley Review consultation process, market participants made it clear that, in the absence of certain tenors, interpolation or extrapolation techniques could be used to create intermediate maturities between existing data points.

5.9 Therefore, the Review recommends that the number of currencies and tenors for which LIBOR is published be reduced. Specifically:

 publication of all LIBORs for Australian Dollars, Canadian Dollars, Danish Kroner, New Zealand Dollars and Swedish Kronor should be discontinued;

 for remaining currencies, publication of LIBOR for 4 months, 5 months, 7 months, 8 months, 10 months and 11 months tenors should be discontinued;

 continued publication of overnight, 1 week, 2 weeks, 2 months and 9 months should also be re-considered.

5.10 Should this recommendation be implemented in full, the number of LIBOR benchmarks published daily could be reduced from 150 to 20. These remaining rates could more easily be supported by trade data, and moreover, are heavily used by market participants.

5.11 Despite the infrequent use of LIBOR in some currencies and maturities, there are likely to be at least some outstanding contracts referencing every LIBOR rate. As a result, immediate cessation of those rates could have potentially disruptive implications for financial markets. Any reduction in the availability of particular LIBOR rates should therefore be preceded by a significant and public notice period to facilitate an orderly transition to alternative rates and arrangements.

5.12 The Review recommends a 12-month transition period for the full implementation of these changes. However, some LIBORs may be able to be reduced in a shorter time period, perhaps within six months. This timeframe would give market participants time to adapt to alternative benchmarks. It would also give market participants the time to establish market-wide solutions, where appropriate. In addition, bond issuers would have the opportunity to reflect the changes to LIBOR in annual updates to their issuance programmes.

5.13 Work towards implementing this recommendation should be taken forward by the BBA and, in due course, the new LIBOR administrator, through an open process of consultation with LIBOR users and submitting banks. Delaying publication of individual submissions

5.14 Up until now, the LIBOR submissions of individual contributors have been published daily, alongside the final LIBOR rate. This publication was originally intended as a mechanism to promote transparency and public accountability for the accuracy of submissions.

5.15 However the discussion paper highlighted a concern that the publication of individual submissions could facilitate the manipulation of the rate and create incentives for contributors to submit inappropriate rates. In particular:

 the submissions provide information to contributors that may facilitate manipulation since contributors can, assuming that other contributions do not change significantly from day-to-day, estimate the likely impact of their submission on the overall rate; and

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 while individual submissions reflect elements other than solely idiosyncratic counterparty credit risk, changes in a particular bank’s submission may be interpreted by some observers as an implicit signal as to the creditworthiness of that contributor. Real-time publication of submissions can create incentives to submit a lower rate than would otherwise have been submitted.

5.16 The Review considers that these considerations outweigh the merits of making this information public in real-time. Therefore, the Review recommends that the publication of individual submissions be delayed by a period of at least 3 months.

5.17 Individual submissions will remain available to the rate administrator and if necessary any relevant oversight committees in real-time, for the purpose of calculating the rate and facilitating corroboration and monitoring techniques. The information will also remain available to the FSA for the purpose of supervision and market monitoring.

5.18 The Review believes there is relatively low level of transition risk to the implementation of this recommendation and therefore, recommends that the BBA and Thomson Reuters introduce this change immediately. Ensuring sufficiently large panel sizes for LIBOR

5.19 It is important that banks continue to take an active role in the process of submitting to LIBOR. The benchmark is compiled from banks’ submissions; thus, in the absence of participating banks, LIBOR would lack sufficient submissions to be an accurate reflection of bank borrowing costs and would eventually fail, leading to major implications for banks, institutions and financial markets.

5.20 At present, 23 banks are members of LIBOR panels and the panels vary in size between 6 and 18 banks. Participation is voluntary, and eligible banks nominate themselves for selection to become a member of each LIBOR currency panel, and are subsequently selected and approved by the Foreign Exchange and Money Markets (FX&MM) Committee, based on criteria such as market activity, expertise and reputation.

5.21 The existence of LIBOR provides significant benefits to a wide variety of market participants, such as commercial banks, investment banks, borrowers and investors around the world. The many benefits of a single benchmark for inter-bank interest rates have been discussed at length in the discussion paper.

5.22 While the benefits of LIBOR are enjoyed by all banks (and a large number of other market participants), only a small group of banks contribute to the benchmark, and there are some notable large banks that do not participate in the LIBOR panels.

5.23 In the discussion paper, the Wheatley Review noted that large panel sizes would benefit the accuracy and credibility of the benchmark. This was reflected in the consultation process, where many respondents supported large panels of submitting banks. There were two main reasons cited for ensuring large panel sizes.

 large panels ensure that individual submissions have a limited impact on the published benchmark. Thus wider panels discourage attempts to manipulate LIBOR; and

 an increase in the number of contributors could increase the overall representativeness of the LIBOR benchmark.

5.24 Given the global importance of LIBOR, the Wheatley Review also believes that the international community stands to gain from the continuing participation of major banks in the LIBOR panels. Therefore, the Wheatley Review asks that international authorities engage with relevant institutions to encourage continuing participation in the LIBOR panels.

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5.25 A reduction in the number of currencies for which LIBOR is published will lead to the existence of fewer panels. The remaining panels will require the submission of rates that are based on heavily-traded transactions, thus limiting the potential risks associated with use of expert judgement in the absence of trade data. This will make it easier for banks to make submissions to LIBOR.

5.26 The introduction of regulation and more robust governance of LIBOR will also benefit participating banks. While these reforms may impose some moderate costs on submitting banks, they will deliver a series of benchmarks that are more accurately compiled. This will, in turn, re- establish credibility in LIBOR, restoring the prestige of being a member of a submitting panel.

5.27 At this stage, the Wheatley Review does not consider it necessary to recommend that the FSA compel particular banks to be members of LIBOR panels. However, the Wheatley Review recognises that, if submitting banks were to explore leaving the LIBOR panels, or if panel sizes did not increase, this might be necessary. For example, there could be a state of affairs whereby banks that have expertise in certain inter-bank markets, including those not currently involved in LIBOR, might be required to participate in LIBOR panels as a condition of their activity in those markets. This could possibly be achieved by making rules requiring such firms to contribute, on a continuing basis, to LIBOR.

5.28 While the FSA’s current powers would allow it to impose such an obligation on a temporary basis, for example to avoid the threat of financial stability or a loss of market integrity, they would not allow the imposition of a long term continuing obligation on banks to submit to LIBOR. This suggests there is a potential gap in the regulatory toolkit. The Wheatley Review therefore recommends that the Government legislate to provide the FSA with an express “reserve” power to compel LIBOR submissions, to be used only if the FSA should consider it to be necessary in the future. Improving understanding and resilience Develop robust contingencies for the failure of LIBOR within contracts

5.29 Many of the contracts that reference LIBOR use definitions and terms and conditions that are standardised across the industry and which are published by trade organisations. For example, the vast majority of interest rate swap contracts use International Swaps and Derivatives Association (ISDA) documentation. Similarly, although less homogenous, syndicated loan agreements generally use the Loan Markets Association (LMA) Agreement. There is also a wide variety of other, less standardised forms of documentation for contracts that reference LIBOR.

5.30 Most types of documentation contain contingency provisions in the event that LIBOR is unavailable. These provisions are intended to be used in the event of occasional operational problems, or other market disruptive events, which lead to LIBOR not being published in the usual manner.

5.31 In most cases, the contractual provision in the case of LIBOR being unavailable is to trigger an alternative rate calculation process. This process generally requires contacting a set of reference banks, each of whom would be asked to provide indicative quotes for deposit rates in the required currency and maturity. The mean of these quotes would then be used to make payments due, in place of LIBOR.

5.32 There are number of problems with this approach:

 first, given the huge volume of contracts that reference LIBOR, it is likely that, in the event that LIBOR was unavailable, the sheer volume of existing contracts would make this approach unworkable;

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 second, given that the reference banks are in many cases the same as the LIBOR submitting banks, there is a risk that these banks may not be prepared to provide quotes in a circumstance where LIBOR has failed; and

 third, widespread use of these contingencies would mean that different contract provisions may lead to different interest rates payable in place of LIBOR between counterparties.

5.33 Fundamentally, the established contingency plan for the failure of LIBOR relies on the same inputs that one could expect to be unavailable in the instance of LIBOR being unavailable, albeit without the benefit of the inputs and outputs being standardised through a single institution.

5.34 Therefore, the Wheatley Review recommends that industry bodies that publish standardised legal documentation in relation to contracts referencing LIBOR, as well as LIBOR users, should develop robust contingency procedures to take effect in the event of longer-term disruption to the publication of LIBOR. Specifically, new contingency provisions should be designed to function without reliance on submissions from LIBOR panel banks. Chapter 6 explores alternative benchmark rates that could be used in such a contingency. Regular publication of statistical bulletins on underlying trades

5.35 Currently, the market for inter-bank deposits is not transparent; LIBOR users are not necessarily aware of the volumes of the inter-bank transactions that underpin the benchmark. Better record-keeping by banks in relation to inter-bank and other transactions would allow more detailed aggregate statistics to be compiled.

5.36 These bulletins could be used to improve transparency in these markets, as well as to develop user understanding and education, which could facilitate selection of rate usage. This would help users understand the extent to which expert judgement was used for a given LIBOR benchmark.

5.37 Therefore, the Wheatley Review recommends that the new LIBOR administrator should publish a regular statistical bulletin detailing the condition of the underlying market. This publication should use the data collected from contributing banks of relevant transactions. In particular, the statistical bulletin should include the volume and value of relevant inter-bank funding transactions and other related financial instruments.

5.38 As an example, Chart 5.A below shows the evolution of unsecured cash lending and borrowing in the Euro money markets, by maturity. Analogous detailed data does not exist for other currency markets. A similar statistical bulletin detailing the volumes of transactions that support LIBOR would be a primary instrument of user education.

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Chart 5.A: Average daily turnover in unsecured Euro lending and borrowing, 2011 Index: daily turnover in 2002 = 100

180

160

140

120

100

80

60

40 Total Cash borrowing 2002 = 100 = 2002 borrowing Cash Total

20

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Overnight T/N to 1m 1m to 3m 3m to 1y Over 1y

Source: European Central Bank, Euro Money Market Survey 2011

5.39 The Wheatley Review expects that submitting banks and the new LIBOR administrator will need to develop new operational systems to collect, store and analyse the relevant information and that the process of upgrading the necessary systems should begin immediately.

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Alternatives to LIBOR for 6 the longer term

Box 6.A: Key reforms and specific recommendations

The UK authorities should work closely with the European and international community and contribute fully to the debate on the long-term future of LIBOR and other global benchmarks, establishing and promoting clear principles for effective global benchmarks.

As part of this process:

 International authorities should take forward a discussion of existing applications of inter-bank rates such as LIBOR, the merits of alternative reference rates for certain applications, and the role – if any – that the authorities should play in facilitating or encouraging transition to these reference rates. In the first instance this should be the Financial Stability Board (FSB), working in conjunction with IOSCO, the European and other interested regional and domestic authorities; and

 users of LIBOR should ensure that they are using the most appropriate reference rate for their purpose. Where this is not LIBOR, they should look to transition to a new reference rate where feasible.

6.1 This chapter will explore the following:

 the extent to which there is a case for a scenario in which a variety of viable alternatives to LIBOR exist, with different interest rate benchmarks used for different applications;

 the role of authorities in promoting or mandating the use of alternative benchmarks to LIBOR; and

 the most plausible candidate alternative benchmarks that were presented in the discussion paper, and examines each of these in more detail.

6.2 Conclusions and recommendations on these issues are beyond the scope of this Review. However, it is intended that the issues raised by the Review can serve as a starting point for further discussion by both market participants and the authorities. The case for an alternative to LIBOR

6.3 The recommendations for reform of the existing LIBOR model set out in the preceding chapters are intended to restore the credibility of LIBOR.

6.4 As stated above, the Wheatley Review has found that LIBOR should be reformed, rather than replaced, in the immediate term. This view was strongly supported by responses to the discussion paper.

6.5 Further, one of the conclusions of the Review is that there is a package of feasible reforms to the current LIBOR system that could serve to (a) strengthen LIBOR sufficiently that credibility, integrity and confidence in it are restored, and (b) without putting at risk the substantial stock of outstanding contracts that reference LIBOR.

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6.6 However, there is a case for exploring alternative benchmarks that could be used in certain applications. A number of responses to the discussion paper addressed the issues, exploring two questions in particular:

1 LIBOR may no longer serve its original intended purpose: representing the average marginal funding cost across a range of leading banks

First, the shortening in the maturity of unsecured inter-bank lending markets, along with the increasing extent to which banks’ borrowing is overnight and collateralised, may mean that the assumption of a permanent and deep inter-bank market for term, as originally envisaged by the LIBOR user, is no longer correct.

Second, a single benchmark representing the average credit and liquidity risk of an increasingly diverse set of banks may no longer relate to a given institution’s own borrowing costs. Originally, the credit risk of a panel of leading banks was assumed to be low and relatively homogenous. Where institutions used LIBOR, it was with the understanding that variations in funding costs had a relationship to LIBOR. Now, LIBOR rates have a much more complex credit and liquidity risk elements.

2 Alternative reference rates may be more suitable in some of the current applications of LIBOR

For example, many users of derivative contracts that reference LIBOR may be using them to manage exposure to interest rate changes, and therefore do not need an inter-bank credit and liquidity risk aspect in the contract. In this case it could be argued that referencing a benchmark that more purely relates to short-term interest rate risk (such as Overnight Index Swaps) might be more suitable. When the inter- bank credit and liquidity risk elements of LIBOR were small, the difference did not matter much in practice; however now that these elements are large and volatile, the issue may be of greater significance.

6.7 The following section of the chapter explores some of the many and varied applications of LIBOR, and to what extent these arguments apply. Examples of applications of LIBOR Lending and borrowing

6.8 LIBOR is used to determine variable interest rates in some syndicated loans, floating rate notes (including asset-backed securities and corporate bonds), and variable rate mortgages (although this last usage is relatively rare in the UK).1 The use of a benchmark such as LIBOR allows lenders to use it as a barometer of the inter-bank funding market to base the margin to be applied to its customers.

6.9 The use of a benchmark that reflects the average cost of funds for a panel of leading banks to price loans and other floating rate notes would appear to be justified. However, there is a question as to whether LIBOR is the most suitable floating rate for referencing some of these assets and liabilities when the underlying market has dramatically changed. There is a question as to whether the cost of a variable rate mortgage should reflect the cost to access liquidity in local currency for a particular set of international banks.

1 There will also be an indirect link to the price of fixed rate mortgages since these tend to be driven by the price of interest rate swaps, which in turn will depend on a reference rate for pricing and determining cash flows.

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Interest Rate Derivatives

6.10 Interest rate derivatives are financial products that allow the managing of and speculation on interest rate risk. They can be used by market participants to manage their balance sheets. For example they can be used to match maturity structure and the balance between floating and fixed interest rates across assets and liabilities. Furthermore, they can be used to take a position on future developments in financial markets: for example, changes in interest rates or credit spreads. Interest rate derivatives can also be used as a price reference curve for loans or bonds.

6.11 LIBOR, or alternative interest rate benchmarks, can be used in two main ways in relation to interest rate derivatives:

 as a reference rate – the interest rate on which payment amounts are based. For example, a fixed-floating interest rate swap may involve the exchange of a fixed rate of interest of say 1 per cent for interest calculated from 3-month LIBOR. In this case 3-month LIBOR is the floating reference rate that determines the payment amount; or

 as a discount rate – the discount rate is used to calculate the present value of an interest rate swap. It does not determine the nominal cash flow that passes between counterparties to a swap. Instead it is the interest rate used to calculate the present value of that cash flow and is used to determine the value of the cash flows involved in the swap. LIBOR as a reference rate

6.12 LIBOR may not always be the most suitable interest rate benchmark for all financial products, as this will depend on what the product is used for. For example, LIBOR may not be the most suitable reference rate for some swaps used to hedge exposure to funding costs, as it does not reflect all elements of bank funding sources.

6.13 Several responses to the discussion paper argued that, for at least some of the uses of interest rate derivatives, a rate containing a purer measure of interest expectations may be more suitable than a benchmark including bank credit risk such as LIBOR.

6.14 One specific example given in a response to the discussion paper was that, for pension funds and insurance companies, both substantial users of long-dated interest rate swaps, the credit risk element of LIBOR may be unnecessary. However, due to the lack of liquidity in long-dated swaps referencing viable alternatives (such as SONIA and EONIA) switching is difficult at present. LIBOR as a discount rate

6.15 Since interest rate derivatives involve the exchange of future cash-flows, valuing these instruments requires first calculating the present value of these future cash-flows. This is done by discounting these flows using an interest rate called the ‘discount rate’. Discounting cash flows can be done for a variety of purposes for example swap pricing, accounting, calculating counterparty risk or determine collateral amounts. Market participants should choose the best benchmark curve to determine those present values and be aware that LIBOR discounting might not necessarily be always the best option.

6.16 The Wheatley Review recommends that users of LIBOR should ensure that they are using the most appropriate reference rate for their purpose. Where this is not LIBOR, they should look to transition to a new reference rate where feasible. The role of the authorities and market in transition to an alternative

6.17 If there were a desire to move to using alternative interest rate benchmarks for at least some of the current uses of LIBOR, there could be a question about what role, if any, the

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authorities should play in facilitating and encouraging any transition. The potential rationale for authority intervention would rest on two sources of inertia:

 first, inter-dependency between past exposures and future contracts – to the extent that financial instruments are used to hedge against existing exposures and movements in LIBOR, a switch to an alternative rate may be difficult. Thus, there will be a desire to ensure that future contracts use the same reference rate so that basis risk – the exposure to movements in LIBOR – can be managed; and

 second, network effects – there are significant benefits from common reference rates – the more they are used, the market for products linked to these rates is substantially more liquid and the easier it is to hedge past exposures. This results in inertia, which can lead to the locking-in of particular benchmarks; because of the strong liquidity effects, reference rates may be used even where they are not necessarily the most ideal reference rate in order to take advantage of liquidity.

6.18 A further potential justification for active intervention by government or the regulatory authorities lies in the fact that, in some cases, reference rates are of systemic importance to financial markets. For example, the choice of benchmark may have implications for the monetary policy transmission mechanism, financial stability objectives or both.

6.19 Therefore, if moves to alternative reference rates were desirable for at least some of the uses to which LIBOR is currently put, then there could be justification for the involvement of public authorities to assist the transition, whether to specific alternative rates, or a plurality. However, there is, as yet, no consensus on the role for authorities in facilitating or encouraging transition to such alternative benchmarks. There may be merit in the international community taking forward this debate.

6.20 While several responses to the discussion paper were in favour of exploring whether alternatives could be used in the future for certain existing applications of LIBOR, most suggested that the choice of alternatives should be market-led. A handful of responses to the Review recognised a need for authorities to facilitate transition to other benchmarks, given that such a migration would inevitably involve investor protection and market integrity issues.

6.21 The Review recommends that, at an international level, authorities should take forward a discussion of existing applications of inter-bank rates such as LIBOR, the merits of alternative reference rates for certain applications, and the role, if any, that the authorities should play in facilitating or encouraging transition to these reference rates. In the first instance this should be the Financial Stability Board (FSB), working in conjunction with IOSCO, the European and other interested regional and domestic authorities. Consideration of alternative benchmarks

6.22 As set out in the discussion paper, there are a number of criteria that can be used to determine the suitability of a particular interest rate as a direct alternative to LIBOR:

 the benchmark should have a maturity curve for the full spectrum of maturities;

 the underlying market should be resilient, as far as possible, through periods of stress and illiquidity;

 a liquid underlying market with transaction volumes would help corroborate the rate;

 an interest rate benchmark should be transparent, simple and standardised with respect to the instruments and transactions that are used to determine the rate. In particular, across multiple currencies. This can facilitate a deeper and more liquid market from which the rate can be derived; and

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 ideally a historical time series would be available for alternative benchmarks, allowing past behaviour to be used in pricing and risk models.

6.23 Responses to the discussion paper were generally sceptical that immediate alternatives to LIBOR exist, particularly if interpreted as direct replacements, exhibiting same elements of interest rate expectations, term premia and credit risk. However, several respondents were in favour of exploring whether alternatives could be used in the future for certain existing applications of LIBOR, although most suggested that the choice of alternatives should be market-led.

6.24 Although there may be few, if any, candidates for direct substitutes for LIBOR, there may be certain benchmarks that can be used for certain applications. Further, it is worth noting that some of the instruments described below could be considered as part of a framework to determine appropriate LIBOR submissions (see Chapter 4).

6.25 With regards to alternatives to LIBOR for certain applications specifically mentioned by responses to the Review, overnight index rates (SONIA, EONIA, Federal Funds Effective Rate), and the swaps based upon them (for example, OIS), received the most support.

6.26 However, respondents pointed out that alternative benchmarks have limitations. For example, OIS benchmarks are a snapshot of a largely bespoke transaction market, and thus subject to many of the same issues as LIBOR. To address this, some of these responses recommended the creation of formal OIS fixes where they do not already exist. There was some, albeit relatively limited, support for a ‘synthetic’ rate consisting of OIS plus a credit spread.

6.27 It is important to note that a detailed analysis of these rates is beyond the scope of this Review. While the candidate alternative rates that were presented in the discussion paper are examined in turn in more detail below, along with the relevant points drawn from the responses to the Review, no detailed analysis is offered as to whether these rates are more robust or credible than LIBOR; they may exhibit similar, or indeed a different, weaknesses and conflicts to LIBOR. Central Bank Policy Rate

6.28 Central bank policy rates are the target rates for the central bank and, in the UK, the rate which certain deposits (e.g. currently all central bank reserves, although within the currently- suspended Sterling Market Framework, the reserves averaging target) are remunerated. Because it is not a rate at which transactions are undertaken, other than those with the central bank that are largely short maturity, such a rate does not include a measure of market expectations of future changes in interest rates. Few, if any, jurisdictions have developed derivative markets that reference the central bank policy rate (rather than the equivalent market overnight rate such as SONIA, EONIA or Fed Funds). Overnight Index Rates (OIR) and Overnight Index Swaps (OIS)

6.29 The markets for overnight unsecured lending are fairly developed and liquid. In the UK the main benchmarks for overnight interest rates – Overnight Index Rates (OIR) – are SONIA and EURONIA, which are based on overnight unsecured money market transactions brokered in London and denominated in Sterling and Euros respectively. Volume-weighted average prices are collected by a selection of brokers and submitted to the Wholesale Market Brokers’ Association (WMBA). The main US and European OIRs are the Federal Funds Effective Rate and EONIA respectively, although it should be noted that these are defined differently.

6.30 While OIRs do not, by definition, have a maturity curve, broadly comparable rates for longer maturities can be derived from related markets such as the Overnight Index Swap (OIS) market. OISs are essentially a swap between a floating rate based on the OIR and a fixed interest rate, where the start and end dates can be customised, often to fit around central bank decision dates.

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6.31 In theory there are two sources of credit risk in an OIS:

 credit risk in underlying market for overnight unsecured borrowing (e.g. SONIA, EONIA or Fed Funds will include a small premium for credit risk); and

 credit risk arising from the possibility of default of one of the swap counterparties, which will be very small if collateralised.

However both should be relatively small – because the underlying instrument is an interest rate swap, at the repayment date the parties exchange the difference between the fixed and floating rates multiplied by an agreed notional amount; this notional amount (“principal”) does not change hands.

6.32 As OIR and OIS do not contain much credit risk, they are not a direct substitute for LIBOR. However it may still be attractive for certain uses. The fixed interest rate that market participants are willing to exchange for a floating overnight rate gives an indication of how the market expects these overnight rates, which are primarily determined by monetary policy, are going to evolve. Therefore it can serve as a proxy for the ‘credit risk’-free interest rate, incorporating a measure of market expectations of the future path of monetary policy rates. However, caution needs to be taken when interpreting these curves and a good analysis of the multiple factors influencing OIR and OIS is recommended.

6.33 One disadvantage of OIS is that there is a lack of liquidity, particularly in longer tenors. Another barrier to adoption of OIS as a reference rate is that a standard, widely accepted OIS ‘fix’ may not exist. Currently cash brokers provide indicative OIS curves as a reference, however in general the brokers are not committed to trade at these quotes. Short-term government debt

6.34 Another alternative would be to use the yield of high-quality, short-term debt securities, such as short-term government debt. Short-term government debt is defined as having a duration of less than a year.

6.35 In some cases, an established and liquid market for short-term government debt already exists and it is relatively straightforward to create a yield curve from transactions in these currencies. However, this often requires complex interpolation between moving maturity reference points, and these reference points can be influenced by certain idiosyncratic factors.

6.36 In theory short-term government debt is not risk-free. However, in practice, these issuers are seen as being more creditworthy than other issuers. Thus, demand, and therefore yields, can be affected by risk aversion, collateral shortage and flights to quality. In many cases this will be significantly different from, and either negatively correlated, or uncorrelated, with, the credit risk and funding costs of financial institutions. Short-term government debt yields may be negative and it remains unclear whether some markets (such as floating rate notes) are prepared for negative coupons.

6.37 If the rate used does not need to reflect the credit risk of banks then, arguably, OIS rates could be used. The spread between OIS and short-term government debt is largely driven by the relative balance between supply and demand across the two markets. In times of stress, yields on short-term government debt can be driven down by a flight to quality and safe haven flows, or up by concerns about sovereign creditworthiness. Chart 6.A illustrates how OIS rates and short-term government debt yields have moved relative to LIBOR and each other since 2007.

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Chart 6.A: Spreads between 3-month LIBOR, OIS and government debt yields (monthly 2007-2012) US Dollar Sterling

% 4 % 4

3 3

2 2

1 1

0 0

-1 -1 LIBOR-OIS LIBOR-T-BILL T-BILL-OIS LIBOR - OIS LIBOR - T-Bill T-Bill - OIS -2 -2 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012

Source: Federal Reserve Economic Database (FRED), Bank of England and Bloomberg

Certificates of Deposit and Commercial Paper

6.38 Certificates of Deposit (CDs) and Commercial Paper (CPs) are another way in which institutions can raise short-term unsecured funding. CDs are typically unsecured promissory notes issued by banks to investors in return for depositing funds with the bank for a specified length of time. They may pay fixed or floating rates of interest. As with inter-bank deposits, once the money has been deposited for a period of time, the depositor cannot withdraw the funds without incurring a penalty. However, a key difference between CDs and inter-bank deposits is that they can be negotiable, which means that they can be sold on in the secondary market before the term of the loan is up.

6.39 CPs are similar, with the main difference that they are debt certificates issued as proof of purchase of the issuer’s debt, and typically have a duration of up to 270 days (9 months), while CDs are usually for a longer term (usually up to five years, but can in principle be for longer maturities). However, in practice CDs and CPs are most liquid in short tenors up to 3 months.

6.40 In principle, interest rates paid on CDs and CPs issued in the primary market and traded in the secondary market could be used to construct a benchmark. However, they suffer from similar issues to unsecured inter-bank lending, in that:

 the market has come under severe stress in the aftermath of the financial crisis, being adversely affected by heightened perceptions of counterparty credit risk; and

 liquidity beyond short-term is low in both the primary and secondary markets, which may make them less reflective of underlying conditions and potentially vulnerable to manipulation if used as a benchmark.2 Secured Lending (Repo Rates)

6.41 Secured lending rates are another alternative based on lending that is collateralised through repurchase agreements (or “repos”). The WMBA publishes a rate for overnight gilt repurchase agreements called the Repurchase Overnight Index Average (RONIA). For longer maturities, the BBA publishes a repo index that is compiled in a similar manner to the LIBOR rates for unsecured inter-bank lending. A transactions-based index, the DTCC General Collateral

2 For example, in its response to the Review, the International Capital Markets Association (ICMA) noted that “activity in this market segment is concentrated in much the same say as actual market transactions underlying LIBOR.”

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Finance (GCF) Repo Index, exists in the US, and has to some extent been seen as an alternative to the Federal Funds rate as a reference rate, although not as yet as an alternative to LIBOR.

6.42 Only a few responses to the discussion paper saw repo rates as a direct substitute for LIBOR, since they do not fully reflect bank credit risk. Some issues were also highlighted: for example, it was noted that term repo rates are particularly sensitive to credit and liquidity risks of the underlying collateral, so they could be influenced by factors such as collateral supply and liquidity and the yields of the underlying assets. One solution to this would be to use narrowly defined general collateral (GC) repos. However, GC repo indices have yet to gain wide acceptance from the market. They are concentrated in shorter tenors and are subject to collateral fragmentation. Synthetic Rate

6.43 For uses in applications that more closely reflect individual banks’ cost of funding, it may be that one possible alternative rate is a synthetic rate that combines a risk-free rate (for example OIS) and a bank specific measure of credit risk (perhaps based on bond yields, CDS premia, fixed premia or similar).

6.44 There are a number of advantages and disadvantages of such a model. The advantages include the fact that such rates can be designed to reflect the components desired in the benchmark – for example, risk free rates such as OIS can be combined with benchmarks that may represent credit risk (such as bond yields or CDS prices).

6.45 The disadvantages include the fact that any synthetic rate is only as strong as the components that constitute it. Further, some components may incorporate unrelated elements as well as those that are desirable. Therefore it would be necessary to ensure that all of the respective components are representative and robust – in particular, that the markets underlying them are not illiquid, subject to attempted manipulation and that benchmarks from these markets are fit for purpose. Summary of alternative benchmarks

6.46 Table 6.A summarises the features of the main alternatives to LIBOR outlined in this chapter and in the discussion paper. Since responses to the Review were consistent with the analysis presented in the discussion paper, this analysis is unchanged from that paper. A synthetic rate is not included in the table because its features would depend on which instruments were used in its design.

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Table 6.A: Comparison of alternative interest rate benchmarks

6.47 Responses to the Review and the analysis above illustrates that each potential interest rate benchmark has advantages and disadvantages, and no one rate is likely to be able to serve as a single benchmark rate for all the current uses of LIBOR. Further, while several responses to the discussion paper were in favour of exploring whether alternatives could be used in the future for certain existing applications of LIBOR, most suggested that the choice of alternatives should be market-led.

6.48 While conclusions and recommendations on these issues are beyond the scope of this Review, it is intended that the issues raised by the Review can serve as a starting point for further discussion by both market participants and international authorities as to the future usage of interest rate benchmarks.

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Implications for other 7 benchmarks

Box 7.A: Key reforms and specific recommendations

The UK authorities should work closely with the European and international community and contribute fully to the debate on the long-term future of LIBOR and other global benchmarks, establishing and promoting clear principles for effective global benchmarks.

On an international basis, the Wheatley Review welcomes ongoing work by the IOSCO Board Level Task Force and the European Commission on other important benchmarks. The Review recommends that an international organisation should act as a co-ordinator and information-sharing platform for work undertaken globally in relation to benchmarks. The Financial Stability Board (FSB) is well-placed to deliver this.

At a domestic level, the Review recommends that the FSA should review important benchmarks, and apply the recommendations of this Review, including assessing the perimeter of regulation, where appropriate. In doing this, the FSA should act in accordance with internationally agreed principles for regulatory authorities.

Furthermore, the FSA should ensure that sponsors of benchmarks, and other relevant participants, apply the general guidelines developed by international bodies.

7.1 LIBOR is only one of a large number of important benchmarks that are used in contracts around the world. While the nature of these benchmarks may be different to LIBOR, there may be some lessons for these benchmarks from this Review. More generally, it may be possible to develop a set of overarching principles that can be applied to benchmarks more broadly, which could ensure that they are robust and credible.

7.2 Further, many important benchmarks are global in nature, both in that they originate in, and are used across, many different jurisdictions. As a consequence there is likely to be a role for international coordination of work in relation to these benchmarks.

7.3 It is not within the scope or remit of this Review to identify particular benchmarks that should be improved, or recommend particular principles or elements of best practice that seek to ensure benchmarks are robust and credible. Instead, the purpose of this Chapter is to:

 set out some initial thinking on features of credible benchmarks, and recommend further work in this area;

 recommend that, given the global nature of many important benchmarks, further work be undertaken by international organisations, benchmark sponsors,1 regulators and other relevant participants to ensure that other important benchmarks are appropriately robust and credible; and

1 The term ‘benchmark sponsor’ is used here to refer to the organisations that own and administer important benchmarks. In the case of LIBOR, this was the British Bankers’ Association.

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 recommend further work be taken forward by the UK authorities with respect to benchmarks that are compiled in the UK or otherwise relate specifically to the UK. Definition of a benchmark

7.4 The term ‘benchmark’ relates to a standardised reference price, index or rate that can be used to:

 determine financial flows arising from contractual agreements;

 price or value financial products; and

 assess the performance of assets and portfolios.

7.5 There are a wide variety of benchmarks, used across many asset classes and financial markets, which vary in scope and nature. In addition to LIBOR, there are a number of other inter-bank benchmarks, such as EURIBOR and TIBOR. Like LIBOR, these benchmarks are used as a reference rate in international financial markets, including in loans, bonds, derivatives contracts and as benchmark reference rates used in their respective currencies. These inter-bank rates exhibit similar characteristics to LIBOR such as:

 being based on judgement-led surveys, requiring contributing banks to rely on inference and judgement rather than reporting actual borrowing rates; and

 having similar governance structures to that of LIBOR, with relatively low levels of scrutiny of the rate.

7.6 Some of these other benchmarks may be vulnerable to similar conflicts of interest and weak governance issues that have been identified with LIBOR. In the wake of the alleged attempted manipulation of LIBOR, many benchmarks have come under increased scrutiny and investigations into the attempted manipulation of some of these benchmarks are ongoing.

7.7 Further, there are many other benchmarks for other markets and asset classes, including, but not limited to:

 money markets – these are benchmarks that are related to the cost of lending and borrowing in the wholesale money markets. In the UK, the most prominent money market benchmarks are the overnight lending rates (SONIA, EURONIA and RONIA), swap rates (OIS) and inter-bank term borrowing rates (LIBOR);

 equity markets – these are benchmarks that typically reflect the value of baskets of equities. The most widely used London-based equity indices are the FTSE series of UK indices (including, although by no means limited to, FTSE100, FTSE250 and the FTSE All-Share);

 credit markets – credit market benchmarks, whether cash or synthetic, take a variety of different forms, varying from indices that track the price of single names, to those that relate to more complex indices; and

 commodity markets – these can be indices that track, or are based on, the prices of single commodities or baskets.

7.8 In most cases, the purpose of a benchmark is to represent an underlying market. It is important to note that there is no single correct process for determining a benchmark. No benchmark is likely to be a perfect representation of the underlying market; in many cases a number of different processes could deliver a recognised benchmark for a particular market and, in some markets, competing benchmarks already exist.

7.9 Reflecting this, the design of benchmarks varies markedly. Some are based largely on data from actual transactions, while others rely heavily on surveys of market participants. Almost all

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benchmarks involve an element of judgement, although the degree of judgement varies between benchmarks. Some benchmarks rely on a more formulaic methodology, while others involve a greater degree of discretion and judgement.

7.10 The way in which benchmarks are used also varies: in some markets, the use of benchmarks is fairly standardised (by, for example, ISDA definitions for swaps and OTC derivatives), while others are determined on an ad hoc basis by the counterparties to a specific transaction.

7.11 Given the extensive use of benchmarks in both institutional and retail contracts, it is vital that consumers and markets are confident that these benchmarks are credible, trustworthy and accurate. Widely used benchmarks should also be available to market participants on fair and non-discriminatory commercial terms.

7.12 The credibility of a benchmark can be undermined if the benchmark can be distorted, either by accidental errors in its compilation or calculation, or through the exposure of participants to conflicts of interest or incentives to manipulate the benchmark, or through abuse of a dominant competitive position in the compilation of a benchmark. Different methodologies or types of benchmark are subject to different vulnerabilities, for example:

 where benchmarks are based on transaction data it may be possible to use transactions in the underlying market to manipulate the benchmark; thus, the benchmark may be vulnerable to gaming;

 where benchmarks are based on survey responses or submissions in a market, there may be an incentive for market participants to present inaccurate submissions. Where no commitment to trade is associated with the submission, there is a reduced incentive to provide accurate submissions;

 where benchmarks are subject to intellectual property provisions, there may be an incentive to prevent fair and non-discriminatory access to those benchmarks through licensing agreements. Fair access is particularly important for systemically relevant benchmarks; and

 it is also possible that conflicts of interests may exist at the level of the owner of the benchmark. For example, in some cases the owners or overseers of benchmarks are, or may be influenced by, participants in markets in which those benchmarks are used. This may lead to incentives to compile or rebalance the benchmark in certain ways that may not be the most appropriate, or lead to insufficient incentives to ensure that benchmarks are properly governed. Features of a credible benchmark

7.13 A set of general principles could be developed to enhance the integrity and credibility of benchmarks. Drawing on the findings of this Review and preliminary work by IOSCO in relation to oil price reporting agencies, these principles could cover aspects of the rate methodology, governance and regulation, with the objective that benchmarks should be:

 representative – the inputs to the benchmark should be a fair reflection of the market that underlies it;

 transparent – the methodology used to turn the inputs into a benchmark should be transparent and consistent, as this will aid the detection of inaccuracies or attempted manipulation. There may be cases where transparency needs to be balanced against other concerns, such as intellectual property, confidentiality or the potential facilitation of manipulation. Benchmarks should have clear rules that are publicly available and which govern administration;

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 fair and non-discriminatory access: benchmarks which are systemically relevant should be available to all market participants on a fair and non-discriminatory basis with reasonable commercial terms; and

 subject to credible oversight – the degree of, and balance between, governance and oversight and formal regulation will depend on the type of benchmark and how it is derived. For example, the process surrounding a benchmark that is based primarily on data from transactions in the underlying market could look very different to one that is based on a survey of market participants. However, notwithstanding the precise design of a benchmark, a credible governance and regulation structure should have sufficient independence and powers to ensure that attempted manipulation of the benchmark does not occur.

7.14 Many key benchmarks are international in nature, therefore there is merit in further work at an international level to develop principles for benchmarks, and how these could be taken forward by international organisations, benchmark sponsors, domestic authorities and other relevant participants.

7.15 This work could consider the definition of systemic importance in the context of benchmarks, including the threshold beyond which benchmarks are viewed as such. This could include their impact on financial stability, public policy objectives, wholesale conduct or conduct in relation to retail clients. Existing and future work to reform benchmarks

7.16 The Wheatley Review recognises the work that is being undertaken by international organisations to review the workings of a number of key systemic benchmarks. In particular, the Review notes the creation of the IOSCO Board Level Task Force, with its goal to review benchmarks and develop principles for them.

7.17 The Review recommends that this work be supported by international authorities and the sponsors of benchmarks. To this end, the Wheatley Review recommends that an international body, such as the Financial Stability Board, takes responsibility for acting as a co-ordinator and information-sharing platform for work undertaken globally in relation to benchmarks. International work to reform benchmarks

7.18 The discussion paper asked whether there should be an overarching framework for key international benchmarks. There was broad agreement from respondents that such a framework should be developed at an international level, and that organisations such as the Financial Stability Board (FSB) and IOSCO would be well placed to take this forward, drawing on existing work by IOSCO, European authorities and the Global Financial Markets Association (GFMA)2. That said, many respondents pointed out that designing such a framework may be challenging, and that there are many fundamental differences between LIBOR and some other benchmarks, and that this would need to be considered in developing such a framework.

7.19 At present there are a number of areas of ongoing work on benchmarks at an international level, some of which are outlined here.

7.20 IOSCO has set up a Board-Level Task Force on Benchmarks to look at other benchmarks.3 It will be chaired by Martin Wheatley, the Managing Director of the FSA and Gary

2 GFMA is an international trade association consisting of three regional trade associations. 3 Press release available at: http://www.iosco.org/news/pdf/IOSCONEWS250.pdf

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Gensler, the Chairman of the US Commodity Futures Trading Commission (CFTC), and will draw on the significant expertise within IOSCO members. The Task Force has a mandate to:

 identify benchmark-related issues across securities and derivatives and other financial sectors;

 define the types of benchmarks that are relevant to financial markets;

 propose how benchmarks should be scrutinised and overseen; and

 develop global policy guidance and principles, including those related to effective self-regulation.

7.21 The IOSCO Task Force will take into account other relevant initiatives and consider issues related to necessary enforcement powers, information sharing and sanctions regimes. The aim is to produce a consultation report by early in 2013.

7.22 The European Commission has made amendments to the proposals for a Regulation4 and Directive5 on insider dealing and market manipulation, including criminal sanctions, initially published on 20 October 2011. These amendments aim to prohibit the manipulation of benchmarks and make attempts at such manipulation a criminal offence. In addition, proposals for a Regulation on Markets in Financial Instruments (MiFIR) include a definition of benchmarks and ensure that licensing arrangements controlling the use of benchmarks are not allowed to frustrate fair and transparent use of benchmarks.

7.23 The European Commission is also conducting a review of other benchmarks. It published a discussion paper on 5 September 2012 that covers many of the same issues as the Wheatley Review; although with a wider remit of indices and benchmarks (see Box 7.B)6. The intention is to consult until 15 November 2012.

7.24 The BIS Governors have also agreed to set up a group of senior officials to take forward examination of issues relating to LIBOR and other important financial benchmarks, and to consult with the market in order to provide input into the wider official debate coordinated by the FSB.7

4 Amended proposal for a Regulation on insider dealing and market manipulation, COM(2012) 2011/0295 (COD). Available at http://ec.europa.eu/internal_market/securities/docs/abuse/20120725_regulation_proposal_en.pdf 5 Amended proposal for a Directive on criminal sanctions for insider dealing and market manipulation, COM(2012) 2011/0297 (COD). Available at http://ec.europa.eu/internal_market/securities/docs/abuse/20120725_directive_proposal_en.pdf 6 Available at http://ec.europa.eu/internal_market/consultations/docs/2012/benchmarks/consultation-document_en.pdf 7 Press release available at: www.bis.org/press/p120910.htm

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Box 7.B: EU Consultation on Benchmarks in Financial and other Contracts

On 5 September 2012, the European Commission published a consultation on benchmarks in financial and other contracts. That consultation covers many of the same issues as the Wheatley Review, although the scope is significantly broader than LIBOR. Specifically, the consultation covers the use of all benchmarks in contracts, where benchmarks are defined as statistical measures, typically of prices and quantities, calculated from a representative set of underlying data, and which are used in contracts. It raises questions in the following areas:

 governance and transparency – the consultation raises a number of important questions with respect to the governance and transparency of benchmarks. For example, the specific transparency and governance arrangements necessary to ensure the integrity of benchmarks;

 purpose and uses of benchmarks –the consultation discusses the various uses of benchmarks, and considers whether the use of benchmarks for particular purposes should be controlled;

 organisations that produce benchmarks – the consultation raises the question as to whether certain important indices and benchmarks should be provided by public bodies, and the extent to which their calculation, provision and governance should be supervised by public bodies; and

 transition, continuity and international issues relating to benchmarks –the issue of changing existing benchmarks is discussed, which raises the challenges of transition when benchmarks are referred to in legal contracts. The international dimension of many benchmarks is also considered. The consultation is set to run until 15 November 2012.

7.25 As set out in the Wheatley Review Discussion paper and mentioned above, IOSCO has been asked by the G20 to produce recommendations on improving the functioning and oversight of Price Reporting Agencies (PRAs) by November (see Box 7.C). This work will look at the oil markets in detail, and produce a set of principles for PRAs.

7.26 Further, PRAs have agreed an industry code for Independent Price Reporting Organisations (IPROs)8, which covers best practice with respect to governance, conflicts of interest and transparency. These responses may be sufficient to ensure credibility in the oil markets, but lessons from this review should be applied to wider benchmarks where appropriate, and any other work on benchmarks that is relevant to oil PRAs should feed back to best practice in this area.

8 Available at: http://platts.com/IM.Platts.Content/aboutplatts/mediacenter/mediakits/draftiprcode30apr12.pdf

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Box 7.C: IOSCO work on Oil Price Reporting Agencies One area where significant work has already been done is in the oil market. Oil is not an exchange-traded product or a regulated market, and benchmark prices in this market tend to be compiled by third-party Price Reporting Agencies (PRAs). Work in this area is being conducted by IOSCO at the request of the G20. An interim report was published in June, which highlighted a number of areas of potential concern. In particular:

 methodology – the data from which prices are derived should not be susceptible to manipulation or otherwise artificially influenced or distorted;

 judgement – use of judgement will be necessary in some cases, but contributes to the potential for manipulation or gaming. Safeguards might include; having an objective and transparent set of criteria against which judgement is exercised and how the exercise of judgement should be recorded and retained for an appropriate amount of time;

 reporting of submissions - where based on voluntary submissions of trades or quotes, those submitting can chose to represent a partial picture. Potential safeguards may include a process of internal and external controls that validate the veracity of information considered;

 independence and avoidance of conflicts of interest – the need for recommendations that focus on ensuring that the assessment process is made by independent analysts and not tainted by conflicts of interest. Such concerns are typically addressed through written policies setting out requirements for communication barriers (“firewalls”), an internal supervisory process and staff disclosures;

 complaints – the need for a transparent complaint resolution process that recognises the need in some circumstances for price sensitive decisions to be resolved in real-time and that an independent dispute resolution process is available;

 audit trails – to support potential concerns in other areas, one potential safeguard might be to require document retention and disclosure; and

 external accountability – with respect to oil price reporting agencies, there is neither statutory regulation or an external accountability mechanism or entity. Potential solutions include an independent review committee with an oversight function. Although there will be some differences in particular cases, many of the same issues will be relevant to benchmarks in general, therefore the IOSCO work, together with the Wheatley Review of LIBOR, should serve as a starting point for further work on other benchmarks.

7.27 In addition to this work by international authorities, there are some examples of initiatives by private organisations. For example the GFMA has published a set of principles for financial benchmarks9, which it offers to draw attention to the need for international standards in relation to financial benchmarks, and as a basis for crafting such standards. The GFMA proposes a definition of the benchmarks that it believes should be within the scope of such principles – based on use in financial contracts, importance in financial markets and whether the indices are produced by public or private entities – and sets out principles under the headings of governance, methodology and quality and controls.

9 Available at http://www.gfma.org/Initiatives/Market-Practices/GFMA-Provides-its-Principles-for-Financial-Benchmarks-to-the-Global-Regulatory- Community/

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7.28 To ensure that there is consistency between the various ongoing initiatives, and given its international nature, there is merit in international organisations continuing to take forward work on benchmarks, coordinate the work of authorities across a large number of jurisdictions and potentially achieve official endorsement of a set of principles that draws on the work of both public and private organisations.

7.29 Therefore, the Wheatley Review recommends that further work is undertaken on other important benchmarks at an international level. In particular, work should be undertaken to develop and agree an overarching international framework that could be used as a guide for sponsors of benchmarks, regulatory authorities and other relevant participants.

7.30 This work should be taken forward by IOSCO, through the Board Level Task Force, and the European Commission, coordinated by the Financial Stability Board (FSB).

7.31 Further, there would be merit to an international organisation acting as a co-ordinator and information-sharing platform for global work undertaken in relation to benchmarks. The FSB is well positioned to take on this role, given its global reach and capabilities. Domestic work to reform benchmarks

7.32 As noted earlier in this chapter, it is the view of this review that it is the responsibility of the sponsors of benchmarks, in concert with regulatory authorities, to ensure that their benchmarks are robust and credible and do not raise either financial stability or conduct concerns.

7.33 Some of the governance and regulatory changes appropriate for strengthening LIBOR may also be relevant to other benchmarks. In some cases the proposals in the preceding chapters can be implemented such that they cover other benchmarks as well as LIBOR. For example, the recommendation to make contribution to, and administration of, benchmarks a regulated activity could be done such that primary legislation enables specific benchmarks to be defined either in secondary legislation or within FSA rules. UK authorities should also consider the recommendations arising from other international work.

7.34 Therefore the Review recommends that the FSA review important benchmarks, and apply the recommendations of this Review, including assessing the perimeter of regulation, where appropriate. In doing this, the FSA should act in accordance with internationally agreed principles for regulatory authorities.

7.35 Furthermore, the FSA should ensure that sponsors of benchmarks, and other relevant participants, apply the general principles developed by international bodies.

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Analysis of other reform A options

A.1 The initial discussion paper set out a number of options that could be considered as part of a package of reforms to the LIBOR process. Some of these options and other ideas were represented by respondents to the Review, either through written responses or in the course of bilateral discussions.

A.2 The Review has decided not to take forward some of these options. This Annex outlines an assessment of these potential options and presents the reasons for not making these specific recommendations. “Prime bank” definition of LIBOR

A.3 LIBOR is a benchmark intended to be a contributor banks’ assessment of the market for inter-bank deposits. As such, contributors are required to provide a submission based on that particular banks’ cost of borrowing unsecured cash for specific currencies and maturities, by answering the question below. “At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11am?”

A.4 Chapter 3 of the discussion paper proposed amending the definition of LIBOR away from the current definition above, back to definition used for LIBOR prior to 1998, which was an assessment of the cost of borrowing between two hypothetical “prime” banks, as defined by answering the separate question below:

“At what rate do you think inter-bank term deposits will be offered by one prime bank to another prime bank for a reasonable market size today at 11am?”

A.5 A significant number of respondents were in favour of this approach, noting that a similar definition applies for EURIBOR. A key motive for most respondents was to expand the set of contributors to LIBOR, as under a “prime bank” definition the set of eligible contributors to LIBOR can be expanded beyond banks.

A.6 However, a key conclusion of this Review is that submissions should be based on expert judgement, supported by underlying transactions in the inter-bank deposit and other relevant markets. This in turn allows the corroboration of LIBOR submissions, which should ensure the integrity of submissions and establish a link to realised transactions.

A.7 By definition, assessment of deposit rates at a “prime bank” does not facilitate this approach for two reasons: Firstly, there would likely be uncertainty in precisely defining the nature of a “prime bank”, without leading to confusions with interpretation or implicitly referring to existing banks. Secondly, due to the hypothetical nature of the assessment, there is an increased reliance on inference and subjectivity when determining submissions, reducing the ability to effectively corroborate or base submissions where possible on transactions.

A.8 As a result, the Review has concluded that while a “prime bank” definition of LIBOR could be used to increase the number and type of contributors to LIBOR, there would be a significant reduction in the ability to corroborate and support submissions to LIBOR with relevant transaction data.

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Broadening the scope of the definition of LIBOR

A.9 A key issue identified by the initial discussion paper was the low transaction volume in the inter-bank deposit market, particularly for longer maturities and less-used currencies. In order to expand the set of transactions relevant to the construction of LIBOR, one option set out in the discussion paper was to widen the definition of LIBOR beyond inter-bank deposits, to include deposits from other wholesale and international sources.

A.10 For example, it has been proposed that the definition of LIBOR could be expanded to include funding from sources such as corporate and local authority deposits, money market funds and so on. The justification of such an approach was to expand the set of relevant and observed transactions to assist with the determination of appropriate LIBOR submissions, as well as to improve the independent corroboration of those submissions.

A.11 However, in the final analysis, the Review has concluded that the potential risks to the legal validity of some contracts that reference LIBOR are too great to make this an appropriate recommendation. Respondents to the Review were largely of the view that preserving the essence of LIBOR was important to ensure legal continuity and the status of the large stock of existing contracts.

A.12 Given that the definition of LIBOR has been understood by market participants to mean the “London Inter-bank Offered Rate” for a considerable number of years, any change to the definition of the rate to a broader wholesale concept may not be within the bounds of this definition, leading to a risk of contractual dispute.

A.13 The Review believes that, while LIBOR should remain representative of inter-bank funding, there are other relevant transactions that can be used to support contributors’ assessment of the inter-bank deposit market. As set out in Chapter 4, the Wheatley Review recommends that the rules of LIBOR allow for the use of these other relevant transactions to inform LIBOR submissions.

A.14 The Review has recommended that the role of transaction data within rate determination processes should be outlined precisely within a full code of conduct, subsequently confirmed by the FSA. The Review has also set out submission guidelines, which, without a change in definition, allow for the use of a broader range of transactions to determine submissions, which should be implemented in advance of the code of conduct. Other calculation formulas

A.15 LIBOR is currently calculated by using a ‘trimmed mean’ approach. This means that the individual submissions are ranked in numerical order and the highest and lowest submissions are discarded. A mean is then calculated using the remaining submissions to compile LIBOR.

A.16 The discussion paper raised the possibility of amending the calculation formula, by moving away from the current approach towards a median or random selection of submissions from the centre of the distribution. Use of a median to calculate LIBOR

A.17 A number of responses to the Review voiced support for the use of a median, citing a key advantage that it is less susceptible to influence from outliers. Moreover, as demonstrated by Chart 3.B in the discussion paper, the use of a median could make identification of potentially manipulative submissions easier. Further, moving to a median from the current approach would have a minimal effect on the value of the resulting LIBOR fix and its volatility, as demonstrated in Chart A.1.

A.18 However, there are a number of disadvantages to amending LIBOR to be calculated using a median. The improvement in the identification of suspicious submissions is a corollary of the fact

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that individual submissions are more able to move the final LIBOR. Importantly, as the smoothing created by the use of a mean is lost, attempts to manipulate the rate will likely have a greater affect on LIBOR. In turn, the returns from attempting to manipulate by a single institution are higher, which further incentivises those attempts. Use of a random submission to calculate LIBOR

A.19 In the discussion paper, the review proposed the use of a random submission method to calculate LIBOR. The random submission is selected after discarding the top and bottom quartiles of the submissions. A key benefit of compiling LIBOR using a random submission is that any individual contributor would never be sure that their submission will be used to compile the final rate. This in turn means that any attempt to manipulate LIBOR would be unlikely to succeed.

A.20 A number of respondents shared the view that using a random submission would reduce the ability to manipulate the rate. However, given the small number of contributors to LIBOR, and the relative dispersion of submissions arising from heterogeneity of credit risk within the contributor panels, using a random submission could lead to increased volatility of the final benchmark. This increased volatility is illustrated in Chart A.1.

Chart A.1: US Dollar 3-month LIBOR, simulated median and random submission

% 0.60

0.58 Trimmed random selection LIBOR (trimmed mean) Median 0.56

0.54

0.52

0.50

0.48

0.46

0.44

0.42

0.40 Jan 2012 Mar 2012 May 2012 Jul 2012

Source: Bloomberg and Review calculations

Transaction-based rate

A.21 LIBOR is currently compiled from a daily survey of participating banks, asking for their assessment of the market for inter-bank deposits. The discussion paper also presented a discussion on whether the benchmark could be created mechanically using deposit transaction data.

A.22 Many responses to the discussion paper noted that in an ideal scenario, that the use of transaction data would be the best solution to reforming LIBOR. However, most respondents also recognised that there would be many problems with such an approach, agreeing with our initial analysis.

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A.23 In particular, the issues associated with changing the LIBOR mechanism to a rate based on transaction-prices include:

 The number of transactions under the current LIBOR definition of inter-bank lending is particularly thin for certain maturities and currencies.

 Transaction rates may reflect other elements than pure inter-bank borrowing. They may be “bids”, or rates that reflect other specific circumstances between the borrower and the lender.

 Difficulties with compiling a benchmark in the absence of sufficient relevant transactions. One solution could be to use the previous day’s rate. However, in periods of sustained illiquidity, the benchmark would effectively become fixed, and unreflective of the true state of wider market conditions (not just wholesale funding), which could cause market disruption.

 A transaction data approach is not immune to manipulation. Particularly in a low volume environment, only a small number of transactions at off-market rates would be sufficient to move the final rate fixing. Manipulation of this type may be harder to monitor as it could be attempted by both internal and external parties.

 There may also be operational issues arising from the timing of a fix based on trading data. Overnight cash deposit rates, such as SONIA use data collected throughout the trading day and fixed at the close of the market (approximately 5pm). By contrast, LIBOR fixes at 11am for all currencies and this timing is embedded into most contracts. Use of transaction data means that either:

 the timing of the fix would have to change;

 a partial days’ transaction data must be used; or

 or data from two calendar days must be used (24 hour period before 11am).

 Establishing a trade repository would be potentially complex and costly.

A.24 A small number of responses to the Review favoured the removal of judgement entirely from the LIBOR process, advocating a move to a purely transaction-based model. It was noted that in order for this mechanical approach to be successful, the inter-bank deposit market would need to be reinvigorated, potentially through amendments to prudential regulatory requirements.

A.25 The Review has concluded that moving to a transaction-based model is not a viable option in the short-term. However, in the event that the unsecured inter-bank lending market does revive, either due to cyclical influences or due to the economics of unsecured inter-bank lending improving, a transaction-based benchmark could be re-considered. Committed quote platform

A.26 A further option, noted briefly in the discussion paper, would be to compile LIBOR from a trading platform mechanism, based on tradable quotes by participants, rather than traded prices.

A.27 The platform would be used to transact a nominal, but sizeable, sum between the participants on a daily basis. In essence, participating firms would be required to provide executable bid and offer quotes for that cash sum, plus an interest rate, to the platform. Should those quotes cross then a transaction between the relevant counterparties would occur. LIBOR would then be compiled from the executed price of the transaction, or, in the absence of transactions, the mid-price of the provided quotes.

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A.28 This mechanism could provide a robust and transparent market for unsecured deposits, as all quotes and transactions would be visible, but anonymous. A key advantage of a mechanism for compiling LIBOR based on executable quotes is that specific transactions are not necessarily required for all currencies and maturities, provided that executable bids and offers are provided to the platform. A second advantage that would arise, as contributors would bear an economic cost to providing inaccurate quotes (should those quotes be executed). Thirdly, once a platform had been established, other sources of liquidity could be introduced.

A.29 Despite these advantages, there remain a number of shortcomings to using this approach. In particular, contributing banks are potentially able to increase the size of their balance sheet by creating assets and liabilities on a daily basis, as their quotes are executed. Assuming that the nominal size of cash transactions on the platform is $10 million and sixteen banks participate in the platform, a single bank could create up to $150 million in exposures on a daily basis for each individual LIBOR currency and maturity.

A.30 By contrast, participating banks may want to avoid taking on these exposures and subsequently widen their bid and offer quotes to such an extent that their contribution to the platform becomes worthless. To avoid this, the platform may require minimum bid and offer spreads. As a result of the above concerns, it may be very difficult to ensure continued participation by banks. Strong economic incentives may be required to encourage participation in this process, as bank balance sheets may be forced to expand.

A.31 As with a transaction-based model, the Wheatley Review has concluded that moving to a committed quote-based model is not a viable option in the short-term. However in the longer- term, if the economics of unsecured inter-bank lending for banks can be made attractive enough then a committed-quote based system could be re-considered. Changing the timing or creating a second publication time

A.32 LIBOR is currently published between 11:30am and 12:00pm every London business day. Contributors are asked to provide an assessment of their cost of funding “just prior to 11:00am”, as up to one hour is required for verification and calculation procedures. One option that was not raised in the discussion paper was the potential to amend the timing of the publication to later in the day.

A.33 11:00am was chosen historically to maximise the exposure of the benchmark to market conditions in different time-zones. Some respondents suggested that one way to either increase the volume of relevant transactions would be to increase the exposure to the US market by moving the timing of the submission and publication of LIBOR from 11:00am to 2:00pm. Additionally, as this time would be more closely aligned with the opening of the US market, it could allow more US banks to join the LIBOR panels.

A.34 Existing financial contracts that refer to LIBOR do not reference the benchmark in a standardised way. Typically though, a significant number of those contracts refer to LIBOR and the particular time of publication; for example, the rate which appears on the relevant screen (e.g.”LIBOR01”) at 11:00am, London time.

A.35 Furthermore, London’s geographical position means that a benchmark set at 11:00am London time is accessible within working hours in many other locations; moving the LIBOR process to later in the trading day would reduce the ability of Asian markets to make use of the benchmark.

A.36 The Review has therefore chosen not to pursue the option of delaying the publication of LIBOR because of the potential legal difficulties arising from that amendment and in order to preserve the stock of existing contracts.

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A.37 One possible alternative would be to create a second LIBOR fixing, which is published later in the day, in addition to the 11:00am publication. However, having separate publication times could potentially cause problems with cross-currency swaps, since these instruments need a benchmark reference which is settled at a single time to avoid undue basis risk. Furthermore, the existence of two fixes could lead to uncertainty, and to the extent that it would be possible to use either LIBOR in different financial instruments, it could potentially fragment the market and lead to lower liquidity.

A.38 One case study of this approach is the New York Funding Rate (NYFR) benchmark, sponsored by ICAP ltd, which was discontinued in August 2012. This benchmark was intended to function as a competitor to LIBOR, compiled by banks based in the USA, publishing a benchmark just after 10:00am EST (equivalent to 3:00pm GMT). NYFR did not gain sufficient market share and liquidity relative to LIBOR, reinforcing the argument that London’s geographical location supports LIBOR’s global significance.

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Summary of consultation B responses

B.1 This annex summarises the main themes that have emerged from responses to the discussion paper. These responses have, in turn, informed the analysis, conclusions and recommendations of the Review. Chapter 2: Issues and failings with LIBOR Do you agree with our analysis of the issues and failings of LIBOR?

B.2 Almost all the responses to the Review were in agreement with the analysis of the issues and failings of the current LIBOR framework set out in the discussion paper. A few responses suggested that certain aspects should have been given more or less weight, but none of these respondents contended the issues raised by the discussion paper. Chapter 3: Strengthening LIBOR Can LIBOR be strengthened in such a way that it can remain a credible benchmark?

B.3 Responses to the Review were unanimous in the view that there is an immediate requirement to strengthen LIBOR such that it exists as a credible benchmark in order to ensure continuity of existing contracts. Alongside this, almost all responses recognised the difficulties that the large stock of legacy contracts poses, and therefore there was consensus that reforming LIBOR in a way that ensures legal certainty is essential and the immediate priority.

B.4 With regard to the nature of the necessary reform, there was a consensus that repairing LIBOR means that it needs to (a) represent a ‘market’ interest rate, reflective of the underlying market, and (b) have widespread acceptance and recognition. While there were a variety of views about how to achieve these two objectives, there was a broad consensus that strengthening existing governance and introducing official regulation of some sort would be required as self-regulation of LIBOR has become unviable.

B.5 The appetite for significant changes to the mechanism underlying LIBOR among respondents was limited. This was largely due to a concern about jeopardising existing contracts. There were mixed views on whether LIBOR could remain a benchmark involving judgement in the longer- term. Several submissions advocated a model based on either (a) transaction data, or (b) a committed-quote model.

B.6 Responses in relation to specific options to change the LIBOR mechanism are summarised below. Corroboration

B.7 There was support for greater collection of data in relation to relevant transactions, and a view that this should be used to corroborate LIBOR submissions, likely with a small time lag. The knowledge that submissions would be subject to scrutiny would incentivise justifiable submissions and detailed record keeping on behalf of the banks. Responses were in favour of a clear and standardised determination process for LIBOR submissions, with some respondents explicitly pointing to the relevant sections of the Commodity Futures Trading Commission (CFTC) undertakings to Barclays. There was more support for decentralised data collection by banks that

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could be then subject to scrutiny by a regulator or independent corroborator rather than a central trade repository due to concerns about the propriety nature of the data. The scope of relevant transactions

B.8 There was broad support among respondents for broadening the scope of relevant transactions beyond inter-bank lending to other unsecured wholesale funding. While some suggested that this be done explicitly by changing the question, there was more support for achieving the same result by making clear the range of transactions that should be used to inform submissions, in accordance with the CFTC undertakings, since this would pose less of a threat to existing contracts. Changing the Panel Size

B.9 The balance was largely in favour of increasing panel sizes, with the caveat that consideration should be given to the fact that increasing the panel does not simply increase the average credit risk or add contributors with limited activity in the relevant markets.

B.10 There were some notable dissenters to this view that argued that quality was as important as quantity: panels may actually be too large given that they already represent such a wide- range of credit risk and that users generally want an index based on banks with similar creditworthiness. Further, many responses recognised that increasing panel sizes might be difficult unless participation were to be mandated based on reasonable criteria, though some suggested changing the timing of the fix may help. Publication of individual submissions

B.11 Responses were broadly in favour of ceasing or delaying publication of individual submissions, noting that this would reduce the existing conflicts of interest. There were no strong preferences for one over the other. Some respondents did raise a concern that this would be seen as a reduction in transparency, which could have an impact on the credibility of LIBOR. It was pointed out that merely delaying submissions for a period would not necessarily remove the credit-signalling incentive, unless it was sufficiently long. Some responses thought that this reduction in transparency could be offset by producing a regular statistical bulletin on the underlying market, including aggregate transaction volumes by currency and maturity. Reduction in currencies and maturities

B.12 Due to the limited volume of unsecured term inter-bank transactions, and therefore the difficultly of determining and corroborating accurate LIBOR submissions, most respondents believed that a reduction of LIBOR currencies and maturities, where they can be replaced by local alternatives, would be a positive development. However, some raised concerns about the impact on those contracts that reference these rates and the associated market disruption, suggesting a cautious approach in this respect and that, in each case, an appropriate consultation with the relevant domestic authorities should be undertaken to ensure minimal disruption.

B.13 One submission raised the point that this risks losing a potential corroboration technique since submissions across currencies should be internally consistent, although given that the rates that would be dropped would be those with minimal underlying transactions, it is not clear how useful they would be a corroboration mechanism.

B.14 With regard to currencies, responses mentioned that the ISDA definitions for interest rate swaps do not currently define the Danish Krone (DKK), the Swedish Krona (SKK) and the New Zealand Dollar (NZD), and that there were probably only a relatively small number of contracts referencing Australian Dollar (AUD) and Canadian Dollar (CAD) rates. With regard to maturities, responses generally viewed the 4, 5 and 7-11 month tenors as candidates to be phased out. Tenors of overnight up to 3 months and the 6 month tenor were seen to be important from the

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perspective of the cash and money markets, and the 3 and 6 month tenors are important for lending, floating rate notes and swaps, with some use of the 12 month rate as well. Calculation formula

B.15 Of the few responses that mentioned it, the change from the current ‘trimmed mean’ approach to a median received some support, as it was suggested it would make the LIBOR rate less sensitive to outliers. There were also some suggestions to weight submissions by some relevant criteria, for example, by bank size, and use different techniques to ‘clean’ the submissions before fixing. Prime bank question

B.16 Views on returning to the ‘prime bank’ question were mixed. Some were in favour, arguing that it removed the credit-signalling incentive. It was also noted that a prime bank definition of LIBOR could allow the panels to be enlarged. Others were against, arguing it would increase subjectivity, particularly at a time when the credit risk of banks is heightened. Regardless of whether in favour or against, responses discussing this issue recognised that defining ‘prime bank’ would be difficult and would have to be done very carefully. Code of conduct, including standardised & clear submission framework

B.17 Of those that mentioned it, there was almost unanimous support for a code of conduct and a clear framework for rate determination along the lines of the CFTC undertakings, although there was less agreement on the question of who should own the code of conduct; some felt this should be the regulator, while others were in favour of it being industry-led. Could a hybrid methodology for calculating LIBOR work effectively?

B.18 The meaning of the term ‘hybrid methodology’ was left ambiguous by the discussion paper and, as a consequence, responses interpreted this question in different ways. In general, ‘hybrid’ was interpreted as meaning a process that combined judgement with transaction data where it is available and relevant.

B.19 Many responses noted that the ideal model would be based on transaction data; however most of these also recognised that there are problems with such an approach. The balance of responses was in favour of a model where transaction data is used, where possible, augmented by judgement, either at the level of the contributing bank, or a central body.

B.20 A small number were in favour of removing judgement entirely and moving to a pure transaction-based or committed-quote model. This approach was usually combined with suggestions on how to revive the inter-bank lending market, for example, by creating special considerations for the inter-bank market, similar to market-maker exemptions (e.g. capital relief, more relaxed liquidity rules, etc.). Is an alternative governance body for LIBOR required in the short-term?

B.21 There were mixed views on the future role of the BBA. Many respondents thought that the current position of the BBA is untenable due to its loss of credibility from past involvement in LIBOR and its vested interest in defending the banks. For those respondents that were in favour of, or indifferent to, a continued role for the BBA, significant reform of the existing governance and oversight framework was almost always considered a pre-requisite. This usually included widening participation on the FX&MM committee beyond contributing banks to other parties with an interest in LIBOR, such as significant users and trading venues.

B.22 There were few, if any, concerns about extending the membership of the oversight function beyond banks to other interested parties and increasing transparency of the membership of the oversight committee and the minutes of meetings. Views about

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representation of the authorities on such a committee were mixed: some were in favour due to the credibility it would bestow, while others thought it would confuse the role of the regulator with the rate owner or provider. Should the setting of and/or the submission to LIBOR be regulated activities?

B.23 The discussion paper set out the possibility of different roles in the LIBOR process being made regulated activities, thus giving the relevant regulator clearer powers of investigation and sanction in relation to LIBOR setting. The discussion paper suggested that either contributing to LIBOR or administrating LIBOR could be made regulated activities. Submissions as a regulated activity:

B.24 There was broad consensus that LIBOR submissions – and some argued that the relevant legislation and rules should have the scope and flexibility to cover benchmarks more broadly – should be a regulated activity under FSMA. Where there was opposition to such regulation, it came from responses advocating that judgement be removed from submitting banks. In this case they argued that as LIBOR would involve less judgement, there would be less of a case for making it a regulated activity. Administration and oversight as a regulated activity

B.25 Most of the responses that addressed this issue were in favour, or at least not against, regulation of the administration and oversight functions. It was suggested that this would ensure that the regulator would be able to make rules requiring organisations that administer benchmarks to have suitable governance and oversight frameworks, as well as transparent and effective benchmark design. One suggestion was that this could potentially be done via the FSA’s Service Company Regime. Market Abuse

B.26 There was consensus that the UK regulatory framework should be consistent with European legislation, including on market abuse (Market Abuse Regulation) and Criminal Sanctions Market Abuse Directive for insider dealing and market manipulation (CS-MAD). Responses noted that it is important to strike the right balance between a clear definition of the sanctions regime and ensuring that the regime is fit for purpose to deal with future market abuse.

B.27 Reponses noted that if the UK opts out of CS-MAD, there may be inconsistencies between the UK and EU criminal regimes and civil market abuse regimes across jurisdictions. Should the regulator be provided with specific powers of criminal investigation and prosecution in relation to attempted manipulation of LIBOR?

B.28 While it drew some support from certain quarters, many respondents were cautious about criminal sanctions for LIBOR submissions. In particular, concerns were raised about combining criminal sanctions and continued application of judgement by banks. Together, they may act as a significant deterrent to participating in LIBOR panels due to the risk of prosecution.

B.29 There was also concern that amending s.397 of FSMA could unintentionally criminalise a large number of unrelated activities, create overlap with existing fraud offences and legal uncertainty. At least one respondent argued that if criminal prosecution proved difficult to pursue in many cases, the existence of specific criminal sanctions could prove counter-productive as authorities could be criticised for not using available powers. Several responses highlighted the need for further assessment, consultation and careful consideration before introducing or amending legislation relating to criminal sanctions.

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B.30 The most common alternative argument was that a combination of (a) appropriately amended civil market abuse legislation (consistent with proposed MAR and CSMAD); (b) bringing LIBOR activities under FSMA as regulated activities, and (c) existing fraud legislation would be sufficient to provide the necessary powers and greater clarity than making LIBOR- related offences criminal, and would therefore not have such deleterious effects on incentives to participate in the LIBOR process. What role should authorities play in reforming the mechanism and governance of LIBOR?

B.31 There were mixed views on the role of the regulator. Some responses suggest that the authorities should take ownership of the rate, including rate-setting, while others did not believe that this was where the regulator could add value.

B.32 There was some support for compulsory submissions, although few responses were explicit about how this could be done. One suggestion, mentioned by a handful of responses, was to make it a condition of holding a banking license or being an authorised credit institution that, should a bank fulfil certain criteria set out by the authorities, they would be required to participate.

B.33 Where responses were against compulsory participation, it was usually on the grounds that imposing onerous and costly obligations on participants was seen as undesirable. What degree of change to LIBOR can be accommodated before the existing volume of transactions referencing LIBOR is put at risk?

B.34 Most responses recommended caution with regards to making significant changes to LIBOR, in case it puts existing transactions at risk. There was a general view that the key consideration was preserving the essence of LIBOR. To most respondents, this meant retaining the current definition of an unsecured ‘inter-bank offered rate’. There was also a concern that step changes in the rate as a consequence of changes to LIBOR may pose legal difficulties. Which types of financial contract, if any, would be particularly affected by the risks of a transition from LIBOR?

B.35 Responses to the Review reiterated that LIBOR is used extensively across a number of financial markets, including, but not limited to: interest rate swaps, commercial loans, mortgages, student loans, floating rate notes (including corporate bonds and syndicated loans). There did not seem to be a concern that particular types of financial contracts would be more affected than others from changes to LIBOR. Chapter 4: Alternatives to LIBOR Are there credible alternative benchmarks that could replace LIBOR’s role in the financial markets?

B.36 There was a consensus that in the short-term there are no obvious candidates to replace LIBOR. Several responses agreed with the sentiment, noting that the weaknesses of LIBOR have been widely discussed for some time, but LIBOR-based swaps have remained the market standard and LIBOR continues to be used as the main reference rate for a wide variety of transactions.

B.37 In terms of specific alternatives, overnight rates (SONIA, EONIA, fed funds effective) and OIS1 seemed to receive the most support from those that suggested alternatives, although many pointed out this was not without problems – it is similarly a ‘snapshot’ of a largely OTC2 market, and thus subject to many of the same issues as LIBOR; some of these responses recommended

1 Overnight Index Swaps 2 Over-the-counter

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the creation of formal OIS fixes where they do not already exist. There was some, albeit relatively limited, support for a ‘synthetic’ rate consisting of OIS plus a credit spread. Should an alternative benchmark fully replace LIBOR, or should it substitute for LIBOR in particular circumstances?

B.38 Several respondents raised questions about the use of LIBOR, either questioning whether a rate based on a small inter-bank market was the appropriate benchmark for a much larger volume of financial contracts or whether a plurality of rates might be appropriate to satisfy the existing range of users. A few responses argued that for at least some floating rate loans and some of the uses of interest rate derivatives, a rate containing a purer measure of interest rate expectations would be more appropriate than a rate including bank credit risk such as LIBOR. One specific example was that for pension funds and insurance companies, which are substantial users of long-dated interest rate swaps, the credit risk element of LIBOR is unnecessary. However, the lack of liquidity in long-dated swaps referencing viable alternatives (e.g. SONIA3 and EONIA4) means switching is difficult at present.

B.39 There was some support for considering the appropriateness of use of LIBOR in products for certain types of investors and customers; for example, whether LIBOR should be excluded from being used in retail products. Should particular benchmarks be mandated for specific activities?

B.40 A mandatory transition to a new rate, either as a wholesale replacement for LIBOR or in particular applications, was viewed particularly negatively by the majority of respondents. It was seen as the role of the market, rather than that of the authorities, to choose which benchmarks best suit their purposes.

B.41 Some respondents thought that there was a role for the authorities to facilitate transition to other rates and there was some opposition to authorities encouraging and promoting transition. One response suggested that an ISDA protocol for voluntary switching of existing contracts might be helpful. Over what time period could an alternative to LIBOR be introduced?

B.42 In general, responses to the Review were not of the view that alternatives to LIBOR exist. There was a view that the market should determine the move to any alternative rates. As for the time horizon over which this could take place, the balance of view of those that addressed the issue was that any transition would have to be lengthy, particularly for applications in long- dated swaps (for example, those used by pension funds and insurance companies to manage their long-dated liabilities), and carefully managed. What role should authorities play in developing and promoting alternatives to LIBOR?

B.43 There was some support for authorities and industry to ensure that there is clarity around the rates are that are referenced in contracts, what contingencies are in place should those rates become unavailable and that the risks around both are well understood by users.

B.44 One suggestion to improve resilience of contracts to attempted manipulation or other disruption was that authorities and organisations such as ISDA5 and the LMA6 could work with users to explore whether certain contracts could reference an average of a number of days of LIBOR fixings rather than one day’s fixing.

3 Sterling Overnight Index Average 4 Euro Overnight Index Average 5 International Securities and Derivatives Association 6 Loan Market Association

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Chapter 5: Potential implications on other benchmarks Are there other important markets or benchmarks that could face similar issues to those identified relating to LIBOR?

B.45 Where responses to the Review raised areas of particular potential concern, the most common references were to EURIBOR, ISDAFix and benchmarks deriving from the commodity and energy markets. More generally, some responses pointed out that characteristics of other reference rates may make them particularly vulnerable to similar issues as LIBOR: for example, other ‘polled’ rates or those relying on subjective judgement. Should there be an overarching framework for key international reference rates?

B.46 Of those that addressed the issue, there was broad agreement – though there were one or two notable dissenting views – that an overarching framework for benchmarks should be developed at an international level, and that an organisation such as the Financial Stability Board, drawing on existing work by IOSCO, European authorities and the Global Financial Markets Association, would be well-placed to take this forward. That said, many responses pointed out that designing such a framework may be challenging, and those involved in other markets were keen to point out the many and varied differences between LIBOR and their industries, and therefore that this would need to be considered in developing such a framework; a “one-size-fits-all” approach is to be avoided.

B.47 There was a consensus that co-ordination of the various initiatives on these issues by an international organisation would be valuable.

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The case for reform of C LIBOR

C.1 LIBOR is the most frequently utilised benchmark for interest rates globally, referenced in transactions with a notional outstanding value of at least $300 trillion.

C.2 However, LIBOR has a number of significant weaknesses that have eroded its credibility as a benchmark:

 LIBOR is intended to be a representation of unsecured inter-bank term borrowing costs; as this segment of the market has significantly declined, submissions to LIBOR have become increasingly reliant on expert judgement rather than transaction data.

 Banks and individuals working for banks have an incentive to attempt to manipulate the submissions that compile the rate, either to signal their perceived institutional creditworthiness or to support trading positions.

 The mechanism by which LIBOR is administered leaves opportunity for contributors to attempt to manipulate submissions in line with these incentives; submissions are not always based on transactions and the process is self-policing.

 There are weaknesses in governance arrangements for the compilation process, and within contributing banks themselves. Stronger oversight, with greater independence and transparency is needed.

C.3 There are ongoing investigations by a number of global financial regulators and public authorities into alleged attempted manipulation of LIBOR. It is already clear that at least some serious misconduct has taken place relating to LIBOR submissions in recent years.

C.4 Retaining LIBOR unchanged in its current state is not a viable option, given the scale of identified weaknesses and the loss of credibility that it has suffered. Therefore, LIBOR has to be significantly strengthened to take account of these weaknesses, while, in parallel, alternative benchmarks that can take on some or all of the roles that LIBOR currently performs in the market should be identified and evaluated. The development and use of LIBOR

C.5 LIBOR is an indication of the costs of unsecured borrowing in the London inter-bank markets. In essence it is a benchmark that gauges the interest rate, credit premium and liquidity premium that a leading bank would expect to be offered by another similar institution.

C.6 It was established in the 1980s in order to provide a fair and standardised interest rate benchmark for loans, thereby facilitating the growth of the syndicated loans market. Standardised inter-bank rates were attractive as a benchmark for investors and borrowers as they allowed the lending banks to pass on changes in the funding costs of an average bank over the course of the duration of the loan. The development of LIBOR was also driven, from an early stage, by the growth in new financial instruments such as forward rate agreements, which also required a standardised interest rate benchmark.

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Box C.1: Definition of LIBOR

LIBOR is calculated by Thomson Reuters on behalf of the BBA. Contributing banks submit a response to the following question for each currency and tenor:

“At what rate could you borrow funds, were you to do so by asking for and then accepting inter-bank offers in a reasonable market size just prior to 11 am?”

The highest and lowest submissions are discarded, with the remaining submissions averaged to create LIBOR for the given day. For some currencies, more outliers are discarded as there are a higher number of contributing banks.

C.7 Today, inter-bank benchmarks such as LIBOR and EURIBOR are used across the world for a range of financial products by a wide variety of financial market participants, for both hedging and speculative purposes. Table C.1 sets out some of the more common uses for LIBOR, along with an estimate of the notional value of financial products using LIBOR, which is estimated to be at least $300 trillion. No comprehensive source of data on the use of LIBOR exists so this data is drawn from a number of different published sources and relies on a number of assumptions, none of which will be complete or exact. Table C.1 should therefore be treated as indicative rather than comprehensive. A number of other estimates of the value of contracts linked to LIBOR exist in the public domain, ranging from $300 trillion up to $800 trillion.

Table C.1: Use of LIBOR in Financial Contracts Instrument/Application Estimated value of contracts with LIBOR as benchmark Syndicated Loans ~$10 trillion(a) Floating Rate Notes ~$3 trillion(b) Interest Rate Swaps $165(c) – $230 trillion(d) Exchange-traded Interest Rate Futures and $30 trillion(d) Options

Forward Rate Agreements $25(d) – $30 trillion(e) Total ~$300 trillion

Note: Assumption that 50 per cent of contracts reference LIBOR; this list is not exhaustive.

Sources: (a) Oliver Wyman; (b) Dealogic; (c) DTCC; (d) Bank for International Settlements; (e) Trioptima

C.8 Although LIBOR is currently published for ten currencies and fifteen maturities, this was not always the case. LIBOR was originally published for just three currencies – Sterling, US Dollar and Japanese Yen – before growing to cover a total of 16 currencies prior to the introduction of the euro in 2000. Similarly, the number of maturities has increased over time from 12 to 15 – in 1998 the 1-week rate was added, and in 2001 the overnight and 2-week rates were added.

C.9 Although LIBOR is calculated in London, it is based on daily submissions from a number of international banks and is used as a benchmark globally. The increasing global integration of financial markets has meant that contracts have converged to a single internationally recognised benchmark, and LIBOR in particular has benefited from a combination of the rise of the euro markets and the convenient time-zone in which London sits. Additionally, as the prevalence of LIBOR-linked contracts increased, there were network effects that made it more attractive for other products to link to LIBOR: for example, adjustable rate mortgages in local markets moved from being linked to niche measures of cost of funds to the more widely recognised and more easily hedged LIBOR.

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Developments in the inter-bank borrowing market

C.10 Inter-bank benchmarks, such as LIBOR and EURIBOR, are an indication derived from information and activity in the market for inter-bank borrowing costs. Therefore the functioning of these underlying markets will have a direct impact on the benchmarks, and consequently on all contracts referenced to them. Unsecured inter-bank markets for term borrowing have come under severe stress and banks have been relying on other sources of funding for a greater proportion of their funds, including secured borrowing, retail deposits and liquidity provided by central banks.

C.11 This has been driven by several factors:

 There has been a significant increase in perceived risk of counterparty default (i.e. credit risk), particularly in the aftermath of the collapse of Lehman Brothers. The spread between inter-bank term interest rates and projected overnight cash rates (derived from OIS) increased sharply around this time, although has since fallen (Chart C.1). Further, regulatory capital charges arising from this increase in counterparty risk have reduced the demand for unsecured funding.

 The introduction of liquidity coverage ratios – in the UK and in Basel III – have modified the demand and supply of inter-bank funding, as banks transition to more longer maturity funding and more secured funding sources.

 There was, and continues to be, a significant increase in liquidity available to banks as a consequence of the exceptional measures taken by major central banks during and after the crisis.

Chart C.1: 3-month LIBOR-OIS Spread

4.0

GBP USD 3.5

3.0

2.5

2.0

1.5

1.0

0.5

0.0 2007 2008 2009 2010 2011 2012

Source: Bloomberg

C.12 The long-term impact of these factors will vary. The increase in perceived counterparty credit risk may be cyclical, although its effect on the inter-bank market may last for longer. The effect of central bank operations has reduced the reliance of banks on private credit facilities.

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However, the changing regulatory requirements concerning capital and liquidity – both in the UK, and anticipated at an international level – reflect a permanent structural change, and so might have a permanent effect on the volume of lending in the inter-bank market, and particularly on inter-bank unsecured lending at longer maturities.

C.13 Under the current definition of LIBOR a lower volume of trades is not necessarily a problem since there is no mechanical link from transactions to the LIBOR calculation. However it might make the expert judgement required to determine the appropriate rate submission more difficult. The problem of limited transactions is not uniform. While there is still some inter-bank lending, for many currencies and maturities trading remains very thin (see Chart C.2).

Chart C.2: Unsecured deposit transactions by LIBOR contributing banks, per bank in 2011 Inter-bank deposit transactions No. of O/N 1w 2w 1m 2m 3m 4m 5m 6m 7m 8m 9m 10m 11m 12m banks USD 12 GBP 9 EUR 10 JPY 10 CHF 8 CAD <7 AUD <7 NZD <7 SEK <7 DKK <7

low activity medium-low activity medium activity high activity

Note: This is based on data from a subset of contributing banks, may not be include all relevant transactions or be entirely representative for all currencies.

Source: Oliver Wyman, Bank of England and Wheatley Review calculations

C.14 Overall, the limited number of transactions means that there are some problems inherent in a widely used benchmark that is nominally derived from unsecured inter-bank term lending. First, determining an appropriate rate for all required points is difficult. Second, a relatively small and illiquid market is used as the basis for determining rates in global loan and derivative contracts that have a nominal outstanding value that is several multiples of the value of the underlying inter-bank transactions.

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Table C.2: The use of LIBOR as a reference rate Interest rate swaps and floating rate notes

1m 3m 6m 12m Total USD 5.6% 52.8% 0.3% 0.1% 59% EUR - - 0.1% - 0% GBP 0.4% 2.9% 8.9% - 12% JPY 0.1% 3.6% 23.5% - 27% CHF 0.1% 0.4% 1.6%1 - 2% AUD - - - - 0% CAD - - - - 0% NZD - - - - 0% SEK - - - - 0% DKK - - - - 0% Total 6% 60% 34% 0% 100%

1Swiss National Bank monetary policy target rate.

Source: Dealogic; Depository Trust and Clearing Corporation

C.15 However the large majority of financial contracts use only a small sub-set of these maturities. In particular, three and six months are used most often, while use of the other tenors in contracts is very limited. And dollar, yen and sterling rates continue to be by far the most widely used, as Table C.2 illustrates this in the case of interest rate swaps and floating rate notes.

C.16 Furthermore, it could be argued that, in the current environment inter-bank lending rates are dominated by credit risk and there is a large dispersion in the perceived creditworthiness of banks. This, together with the low volume of inter-bank unsecured lending transactions, arguably means that the concept of an average inter-bank rate derived from a panel of diverse banks has less meaning as a measure of bank funding costs. Failures of the current LIBOR regime

C.17 As discussed, LIBOR and similar benchmarks have in recent years come under increasing scrutiny from regulators around the world. In the UK, the issue achieved widespread public awareness with the publication of the FSA’s findings against Barclays (see Box C.2). This is only the first of a number of investigations the FSA is carrying out into contributing banks.

C.18 LIBOR is a representation of unsecured inter-bank borrowing costs, and given not all contributing banks need to borrow at all maturities and in all currencies every day, it involves an element of judgement and inference on the part of the contributor.

C.19 The need for judgement on the part of a contributor involves a discretion which can be misused. Some contributing banks have sought to exploit the conflicts of interest that arose from their respective roles as contributor to the rate, user of the rate, and wider participant in the market. There is a risk that submissions may have reflected inappropriate factors, such as the bank’s trading position, or concerns as to adverse media comment, as illustrated above.

C.20 There are two types of problem that might arise from these conflicts of interest:

 First, the credit-signalling (or stigma) effect: although a bank’s daily LIBOR submission does not necessarily reflect increased counterparty risk, it may be interpreted by external observers as an indication of the creditworthiness of that particular bank. During periods of market stress there is therefore an incentive to

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lower submissions in order that perception of that bank’s relative creditworthiness is not negatively affected.

 Second, there are private economic incentives: contributing banks are both users of and contributors to LIBOR and will therefore have assets and liabilities with substantial sensitivities to changes in LIBOR. This then gives traders within banks a clear incentive to seek to affect the overall LIBOR rate for the benefit of a particular trading exposure. Further, the possibility of collusion between contributing banks exists.

C.21 Whatever the ultimate outcome of the ongoing investigations into alleged attempted manipulation of LIBOR by a number of global banks, it has become increasingly clear that there are a number of potential failings that need to be considered in detail:

 weaknesses in the LIBOR mechanism;

 limitations in the existing governance and regulation framework; and

 whether existing regulatory powers and sanctions are appropriate.

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Box C.2: The FSA’s Final Notice to Barclays1

On 27 June 2012, the FSA fined Barclays Bank plc £59.5 million for significant failings relating to LIBOR and EURIBOR. Barclays’ breaches occurred over a number of years. Barclays were found to have breached several of the FSA’s Principles for Businesses in relation to its submissions to the LIBOR and EURIBOR setting process. It breached the following Principles:

A firm must observe proper standards of market conduct (Principle 5)

Barclays acted inappropriately and breached Principle 5 on numerous occasions by making LIBOR and EURIBOR submissions which took into account requests made by its interest rate derivative traders. These traders were motivated by profit and sought to benefit Barclay’s trading positions.

Further, on numerous occasions Barclays sought to influence the EURIBOR submissions of other banks.

Barclays acted inappropriately and breached Principle 5 on numerous occasions by making LIBOR submissions that took into account concerns over the negative media perception of Barclays’ LIBOR submissions, which were seen by some commentators as a measure of their inability to raise funds. Senior management’s concerns resulted in instructions being given by less senior managers to reduce LIBOR submissions to avoid negative media comment.

A firm must take reasonable care to organise and control its affairs responsibly and effectively, with adequate risk management systems (Principle 3)

Barclays breached Principle 3 by failing to have adequate risk management systems or effective controls in place relating to its LIBOR and EURIBOR submissions processes. There were no specific systems and controls in place until December 2009. The extent of Barclays’ misconduct was exacerbated by these inadequate systems and controls.

A firm must conduct its business with due skill, care and diligence (Principle 2)

Compliance failures meant that inappropriate submissions and inadequate controls persisted. Barclays failed to conduct its business with due skill, care and diligence when considering issues raised internally in relation to its LIBOR submissions, thereby breaching Principle 2. LIBOR issues were escalated to its internal Compliance function on three occasions, and in each case Compliance failed to assess and address them effectively.

As a consequence of these breaches, the FSA fined Barclays £59.5 million, which included a 30 per cent discount under the FSA’s executive settlement procedures for agreeing to settle at an early stage. Were it not for this discount, Barclays would have been fined £85 million. Barclays was separately fined $360 million by the US authorities for attempted manipulation of and false reporting concerning LIBOR and EURIBOR benchmark interest rates over a four year period commencing as early as 2005.

There are a series of ongoing investigations by regulatory authorities concerning conduct with respect to LIBOR, and the Barclays settlement is merely the first to conclude.

1 This box is a summary of the Final Notice issued in respect to the Barclays case. The document is available in full at http://www.fsa.gov.uk/static/pubs/final/barclays-jun12.pdf

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Weaknesses in the LIBOR mechanism

C.22 The detailed procedures by which LIBOR is calculated are described in Annex A. In summary terms, contributing banks for each currency submit interest rates for a range of maturities, responding to a hypothetical question. From these submissions, an average is calculated once data points at the top and bottom of the range have been excluded.

C.23 While this seems a relatively straightforward mechanism, specific problems include the following factors:

 The rates that banks submit require expert judgement and inference on the part of the contributor. This allows flexibility when determining rates but can give rise to a risk of manipulation due to conflicts of interest.

 There is currently no standard, regularly employed, procedure to corroborate individual submissions, which can allow contributors to act on the conflicts of interest set out above.

 It is difficult to corroborate individual submissions as the market that LIBOR is intended to provide an assessment of is illiquid and the types of transactions are becoming increasingly less relevant for bank funding. This is particularly the case for less well-used currencies and maturities.

 Knowledge of intended or recent submissions from individual banks can facilitate manipulation and individual submissions to LIBOR are made public on a daily basis.

 The rate definition is for a cost of funds for the contributors own bank. Although it provides transparency and accountability, such information is market sensitive as it can be interpreted as an indicator of a particular bank‘s creditworthiness.

 The existing LIBOR panels are relatively small. Although they vary in size, even the largest panels have only 18 banks at most. Furthermore, participation is voluntary, so a large group of users benefit from the contribution of a small group of banks. Limitations of the current governance framework

C.24 The day-to-day running of LIBOR is the responsibility of BBA LIBOR Ltd, a subsidiary of the BBA and run by the LIBOR Manager. A separate company, Thomson Reuters, is responsible for collecting the submissions from contributing banks and submitting them to checks and verification, before publishing the final calculation to the market.

C.25 Clearly, contributing banks should themselves be primarily responsible for the quality of the submissions they make to the LIBOR process. In order to fulfil this responsibility, the management of these banks should ensure that they have robust processes in place, with appropriate systems and controls in place to ensure high quality of submissions. Furthermore, responsibility should be subject to the internal governance provided by the boards of these banks.

C.26 There is also a need for a degree of centralised oversight to ensure the integrity of the benchmark. Oversight of LIBOR is currently the responsibility of the Foreign Exchange and Money Markets Committee (FX&MM). Its remit includes the design of the benchmark and the governance and scrutiny of all data and panel bank contributions. One of the important functions played by FX&MM is to set, and periodically review, the parameters against which submissions are verified by Thomson Reuters. The Fixings and Oversight subcommittees of FX&MM are respectively responsible for investigating issues with submissions, and taking necessary action against contributors.

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C.27 These arrangements have a number of potentially significant limitations. First, there appears to be insufficient independence built into these governance structures. There is currently a substantial overlap between the roles of contributing banks in providing the inputs that are used to compile LIBOR, and in overseeing the LIBOR setting process (including technical and procedural standards). Combined with the fact that contributing banks are also users of the benchmark, this overlap suggests that there might be insufficient incentive for those responsible for enforcing standards to do so with complete objectivity and independence. At the very least, the lack of independence does little to enhance the credibility of the governance framework.

C.28 Second, oversight is insufficiently robust – specifically:

 internal compliance and systems and controls within contributing banks, or within BBA LIBOR Ltd, are not systematically overseen in order to provide assurance before any potential misconduct arises; and

 it is not clear that the oversight function carried out by the Oversight subcommittee has either the capacity – in terms of resource and expertise – or the appropriate sanctions to detect, investigate and enforce against misconduct effectively.

C.29 Third, there is an apparent lack of transparency – the oversight and scrutiny provided by FX&MM and its two subcommittees does not appear to be sufficiently open and transparent to provide the necessary degree of accountability to firms and markets with a direct interest in being assured of the integrity of LIBOR. For example:

 the membership of FX&MM and its subcommittees is not publicly known; and

 information regarding referrals of potentially problematic submissions to the LIBOR manager or the Fixings Subcommittee, or relating to any enforcement action taken by the Oversight Committee, is not published. Regulation of LIBOR-related activities

C.30 The current regulatory and legal framework is not designed to allow the FSA to regulate activities related to LIBOR. First, and most fundamentally, the activities of contributing to or administering LIBOR (or any similar benchmark) are not currently “regulated activities” as defined under the Financial Services and Markets Act 2000 (FSMA).

C.31 While the FSA is currently taking regulatory action in relation to attempted manipulation of LIBOR by firms, this has been on the basis of the connection between LIBOR submitting and other regulated activities, and there is no directly applicable specific regulatory regime covering LIBOR-related activities. Further, as LIBOR setting is not a regulated activity, individual employees of banks involved in the process do not have to be “Approved Persons” under FSMA, restricting the FSA’s ability to take disciplinary action against individuals.

C.32 As noted above, a related issue is that participation on a LIBOR panel is currently voluntary. LIBOR provides a significant benefit to a wide variety of market participants including banks, investment banks, credit card and loan providers and investors. However, only small subset of users, made up entirely of major banks, contribute to the setting of LIBOR, while the remainder of users are able to benefit from its availability to the wider market. It could be argued that one of the gaps in the current regulatory regime is the lack of a lever to compel participation in LIBOR panels, given the risks that participants face and the relatively limited rewards. Sanctions – the market abuse regime

C.33 The civil market abuse regime in the UK is governed by Section 118 of FSMA and provides the FSA with the ability to take civil action against market participants for activities such as market manipulation. Section 118 of FSMA, which implements the EU Market Abuse Directive

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2003. However, for a number of reasons, much manipulation and attempted manipulation of LIBOR or other benchmarks is unlikely to be covered by the market abuse regime:

 Inter-bank lending and over-the-counter (OTC) interest rate swaps do not take place on a prescribed market;

 Trading exchange-traded interest rate derivatives are potentially covered, but there might be difficulties showing in particular cases that benchmark manipulation had the requisite effect on a qualifying investment trading on a prescribed market;

 Of the likely motivations for manipulation and attempted manipulation of LIBOR – the desire to avoid negative media coverage of a bank’s financial soundness, improving returns in OTC interest rate swaps and improving returns in exchange traded interest rate derivatives, only the last and possibly the first will fall within the scope of the market abuse regime;

 Even in the case of trading in exchange-traded interest rate futures, the s. 118 regime can be used only if one of the subsections applies. Subsection (8) is perhaps the most likely to be apt as it potentially applies if (a) a LIBOR submission is likely to give a regular user of the market a false or misleading impression as to the price or value of qualifying investments, or (b) a LIBOR submission would be, or would be likely to be, regarded by a regular user of the market as behaviour that would distort, or would be likely to distort, the market in such an investment. However, subsection (8) will cease to have effect from 31 December 2014.2 Sanctions – criminal offences

C.34 A further issue – as set out in the Review’s terms of reference – is whether the criminal sanctions in respect of potential LIBOR manipulation and attempted manipulation are sufficient to provide effective enforcement and deterrence.

C.35 In summary, LIBOR manipulation and attempted manipulation is unlikely to constitute a criminal offence which falls under the prosecutorial responsibility of the FSA. Even the most likely offence in FSMA, concerning misleading statements and practices established by Section 397 of FSMA, is unlikely to apply.

C.36 However, LIBOR manipulation and attempted manipulation may well constitute a criminal offence under the law relating to fraud – for example, fraud by false representation under Section 2 of the Fraud Act 2006 – but this regime is not enforced and prosecuted by the FSA. The Serious Fraud Office (SFO) has announced that it intends to proceed with investigations into LIBOR, but the application of law relating to possible LIBOR-related offences is, for now, untested.

2 See section 118(9). Subsection 118(8) will cease to have effect from 31 December 2014, as this is a super-equivalent provision in the UK’s market abuse regime and is subject to a sunset clause. As the Market Abuse Directive 2003 is being replaced with a directly-applicable Regulation, this provision will not exist under the future MAR.

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The Wheatley Review contacts This document can be found in full on our website: http://www.hm-treasury.gov.uk If you require this information in another language, format or have general enquiries about The Wheatley Review and its work, contact: The Wheatley Review HM Treasury 1 Horse Guards Road London SW1A 2HQ Tel: 020 7270 5000 E-mail: [email protected] NEW YORK COUNTY LAWYERS’ ASSOCIATION The LIBOR Scandal – What it Means for The Legal Community, Investors, Traders and Borrowers Thursday, December 6, 2012, 6:00 PM – 8:05 PM

Ethics Faculty: Gordon Eng General Counsel & Chief Compliance Officer SKY Harbor Capital Management, LLC

Ethics Hypothetical

Global Bank & Trust Co. (“GBTCo”), a subsidiary of a U.S. registered public bank holding company is a nationally chartered bank headquartered in Manhattan. GBTCo has a significant presence in a number of countries including a large branch in the City of London, where as a participating member of the British Bankers’ Association (“BBA”), GBTCo is one of the eighteen Reference Banks that provide daily US dollar interbank offered rate indicative quotes to the BBA for the calculation of LIBOR, an interest rate benchmark referred to in countless documents, transactions, and financial products throughout the world. GBTCo is also a global player in creating, distributing and managing a large portfolio of derivative instruments for its proprietary book and its clients worldwide.

Media sources have recently reported that IBA International Bank (“I-Bank”) another Reference Bank, which is also a participant in the daily LIBOR fixings has become the target of an investigation by the Financial Services Authority (“FSA”), the British financial regulator, concerning allegations of having systematically manipulated LIBOR between 2005 and 2009. The news articles suggested that the motivation for the rate manipulation was for certain derivatives traders to make profits on derivatives pegged to LIBOR. Swaps and other derivatives traders allegedly asked I-Bank employees who submitted the rates to provide rates that would benefit the traders instead of submitting the rates that accurately reflected I-Bank’s actual borrowing and lending rates in the interbank market. Notably, the news reports also disclosed evidence that these rate manipulations were coordinated with other Reference Banks to alter rates as well. Moreover the media reported that the investigation also involved allegations that I- Bank manipulated the LIBOR downward during the onset of the financial crisis by submitting artificially low rates to the BBA to make the bank appear that it was able to borrow money at low rates and thus implying it was not paying undue credit risk premiums. The object of the conduct allegedly was to provide the bank with a degree of stability during a period of chaotic market conditions. Some reports have indicated that the LIBOR manipulation could implicate trillions of dollars of financial instruments that were priced at the wrong rates.

1 1949 New York County Lawyers’ Association December 6, 2012 Ethics Hypothetical for The LIBOR Scandal CLE Program

A. Shortly after the news broke, Leigh Cali, the GBTCo’s Chief Legal Officer, received an anonymous written letter purportedly from an employee of the bank claiming knowledge of at least one incident involving certain as yet unnamed derivatives traders based in the U.S. and in London secretly conspiring with the bank’s Global Treasury Department to manipulate the LIBOR rate in a like manner as recently reported in the news.

a. Your firm is a major provider of legal services to the GBTCo particularly the corporate department, which handles the bank’s more complex derivatives transactions. You receive an urgent email from Leigh describing the anonymous letter and ending with an urgent request to “Please Advise.” Apart from legal liability issues, what are the ethical considerations that you and your client need to weigh?

b. Should you advise Leigh to initiate an internal investigation and if so, who should perform it, the bank or outside counsel?

c. Regardless of who is chosen, if GBTCo decides to proceed with an internal investigation what if any ethical obligations are owed to GBTCo’s employees?

d. What steps, if any, will you need to consider concerning protecting client-attorney privilege and obtaining confidential information in a cross border context?

e. What will you advise concerning Leigh’s legal and ethical obligation to report this anonymous letter up the ladder to the GBTCo’s CEO or the Board of Directors, or the Audit Committee?

B. A few weeks after reports of the I-Bank investigation, the SEC telephoned Leigh as a professional courtesy to advise that the Commission is opening an industry-wide investigation into possible violations of the federal securities laws concerning what was quickly being dubbed “the LIBOR Scandal.” Accordingly, GBTCo will soon be receiving a written notice from the Commission initiating the investigation.

a. The Notice arrives in the form of a letter requesting a voluntary submission of an initial list of documents. Should you voluntarily comply or wait until the SEC issues a Subpoena?

b. The SEC also has an interest in meeting with employees and has requested GBTCo’s cooperation in identifying key employees to be “interviewed” by the Commission. The Commission wants to interview anyone who may have relevant factual knowledge of the subject of the investigation. What are the ethical considerations that will inform your response to this request?

2 1949 New York County Lawyers’ Association December 6, 2012 Ethics Hypothetical for The LIBOR Scandal CLE Program

c. What are your ethical obligations in preparing GBTCo’s employees for the SEC interviews? Should the employees be advised that they have the right to their own counsel and if so, who will pay for it?

C. Several months into the matter, Guy Hu Betts, a US employee in the one of the bank’s departments that was subject to the document retention and litigation hold arising from the SEC investigation contacts the SEC claiming to have original information concerning GBTCo’s culpability in the LIBOR Scandal that he believes will lead to a successful enforcement action by the SEC under the recently-enacted Dodd Frank Act. Guy’s job involves primarily ministerial details in connection with documenting the more complex derivatives transactions. His duties have involved such tasks as providing counterparties with authorized signatories, certificates of incumbency and like administrative matters. Guy was not on the list of key employees to be interviewed by the SEC. The CLO has asked you to learn as much as possible about Guy Hu Betts’ whistleblowing and specifically if you believe Guy satisfies the SEC’s criteria as a legitimate whistleblower eligible for an award.

a. What criteria must Guy Hu Betts meet to be eligible for an award?

b. Does the fact that Guy is an employee of the GBTCo at a time the bank is under an investigation disqualify him as a whistleblower eligible for an award?

c. It turns out that Guy Hu Betts is a relatively new hire at GBTCo. He only joined the GBTCo a year ago, and before that he was an employee of I-Bank, where he was interviewed by the FSA in connection with I-Bank’s alleged misconduct. Part or all of his original information may have been previously reported to the FSA. Leigh Cali has asked you to opine whether that fact would per se disqualify him as a whistleblower eligible for an award? Leigh also wants to know what if any discipline the bank may impose on Guy Hu Betts for contacting the SEC without first going through the bank’s compliance or legal departments, a violation of the bank’s employee policies and procedures.

d. It turns out Guy Hu Betts is also admitted to the New York Bar. Is Guy ethically permitted to receive a monetary award for whistleblowing under New York’s Rules of Professional Conduct?

e. Celia Anne Charybdis is one of the SEC case officers assigned to this investigation. Ms. Charybdis is also a member of the New York Bar. While Guy continues to be an employee of the bank, is Ms. Charybdis permitted by New York Rules of Professional Conduct to contact Guy directly in connection with his whistleblower testimony?

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(iv) give written notice to the parties and any lating to the representation to persons outside the appropriate tribunal to enable it to ascer- organization. Such measures may include, among tain compliance with the provisions of this others: Rule; and (1) asking reconsideration of the matter; (2) there are no other circumstances in the partic- (2) advising that a separate legal opinion on the ular representation that create an appearance of matter be sought for presentation to an appro- impropriety. priate authority in the organization; and (e) An arbitrator selected as a partisan of a party in a (3) referring the matter to higher authority in the multimember arbitration panel is not prohibited organization, including, if warranted by the se- from subsequently representing that party. riousness of the matter, referral to the highest authority that can act in behalf of the organi- RULE 1.13: zation as determined by applicable law. Organization As Client (c) If, despite the lawyer’s efforts in accordance with paragraph (b), the highest authority that can act on (a) When a lawyer employed or retained by an organ- behalf of the organization insists upon action, or a ization is dealing with the organization’s directors, refusal to act, that is clearly in violation of law and officers, employees, members, shareholders or other is likely to result in a substantial injury to the or- constituents, and it appears that the organization’s ganization, the lawyer may reveal confidential in- interests may differ from those of the constituents formation only if permitted by Rule 1.6, and may with whom the lawyer is dealing, the lawyer shall resign in accordance with Rule 1.16. explain that the lawyer is the lawyer for the organ- ization and not for any of the constituents. (d) A lawyer representing an organization may also rep- resent any of its directors, officers, employees, (b) If a lawyer for an organization knows that an offi- members, shareholders or other constituents, sub- cer, employee or other person associated with the ject to the provisions of Rule 1.7. If the organiza- organization is engaged in action or intends to act tion’s consent to the concurrent representation is or refuses to act in a matter related to the represen- required by Rule 1.7, the consent shall be given by tation that (i) is a violation of a legal obligation to an appropriate official of the organization other the organization or a violation of law that reason- than the individual who is to be represented, or by ably might be imputed to the organization, and (ii) the shareholders. is likely to result in substantial injury to the organ- ization, then the lawyer shall proceed as is reason- ably necessary in the best interest of the RULE 1.14: organization. In determining how to proceed, the Client With Diminished Capacity lawyer shall give due consideration to the serious- (a) When a client’s capacity to make adequately con- ness of the violation and its consequences, the scope sidered decisions in connection with a representa- and nature of the lawyer’s representation, the re- tion is diminished, whether because of minority, sponsibility in the organization and the apparent mental impairment or for some other reason, the motivation of the person involved, the policies of lawyer shall, as far as reasonably possible, maintain the organization concerning such matters and any a conventional relationship with the client. other relevant considerations. Any measures taken shall be designed to minimize disruption of the or- (b) When the lawyer reasonably believes that the client ganization and the risk of revealing information re- has diminished capacity, is at risk of substantial

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the amount of maintenance, support, eq- (3) the total fee is not excessive. uitable distribution, or property settle- (h) Rule 1.5(g) does not prohibit payment to a lawyer ment; formerly associated in a law firm pursuant to a sep- (ii) a written retainer agreement has not been aration or retirement agreement. signed by the lawyer and client setting forth in plain language the nature of the RULE 1.6: relationship and the details of the fee arrangement; or Confidentiality of Information (iii) the written retainer agreement includes a (a) A lawyer shall not knowingly reveal confidential in- security interest, confession of judgment formation, as defined in this Rule, or use such in- or other lien without prior notice being formation to the disadvantage of a client or for the provided to the client in a signed retainer advantage of the lawyer or a third person, unless: agreement and approval from a tribunal (1) the client gives informed consent, as defined in after notice to the adversary. A lawyer shall Rule 1.0(j); not foreclose on a mortgage placed on the (2) the disclosure is impliedly authorized to ad- marital residence while the spouse who vance the best interests of the client and is ei- consents to the mortgage remains the ti- ther reasonable under the circumstances or tleholder and the residence remains the customary in the professional community; or spouse’s primary residence. (3) the disclosure is permitted by paragraph (b). (e) In domestic relations matters, a lawyer shall provide “Confidential information” consists of information a prospective client with a statement of client’s gained during or relating to the representation of a rights and responsibilities at the initial conference client, whatever its source, that is (a) protected by and prior to the signing of a written retainer agree- the attorney-client privilege, (b) likely to be embar- ment. rassing or detrimental to the client if disclosed, or (f) Where applicable, a lawyer shall resolve fee disputes (c) information that the client has requested be by arbitration at the election of the client pursuant kept confidential. “Confidential information” does to a fee arbitration program established by the not ordinarily include (i) a lawyer’s legal knowledge Chief Administrator of the Courts and approved or legal research or (ii) information that is generally by the Administrative Board of the Courts. known in the local community or in the trade, field (g) A lawyer shall not divide a fee for legal services with or profession to which the information relates. another lawyer who is not associated in the same (b) A lawyer may reveal or use confidential information law firm unless: to the extent that the lawyer reasonably believes (1) the division is in proportion to the services per- necessary: formed by each lawyer or, by a writing given to (1) to prevent reasonably certain death or substan- the client, each lawyer assumes joint responsi- tial bodily harm; bility for the representation; (2) to prevent the client from committing a crime; (2) the client agrees to employment of the other (3) to withdraw a written or oral opinion or repre- lawyer after a full disclosure that a division of sentation previously given by the lawyer and fees will be made, including the share each reasonably believed by the lawyer still to be re- lawyer will receive, and the client’s agreement lied upon by a third person, where the lawyer is confirmed in writing; and has discovered that the opinion or representa-

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tion was based on materially inaccurate infor- (3) the representation does not involve the asser- mation or is being used to further a crime or tion of a claim by one client against another fraud; client represented by the lawyer in the same lit- (4) to secure legal advice about compliance with igation or other proceeding before a tribunal; these Rules or other law by the lawyer, another and lawyer associated with the lawyer’s firm or the (4) each affected client gives informed consent, law firm; confirmed in writing. (5) (i) to defend the lawyer or the lawyer’s em- ployees and associates against an accusa- RULE 1.8: tion of wrongful conduct; or Current Clients: Specific Conflict of (ii) to establish or collect a fee; or Interest Rules (6) when permitted or required under these Rules (a) A lawyer shall not enter into a business transaction or to comply with other law or court order. with a client if they have differing interests therein (c) A lawyer shall exercise reasonable care to prevent and if the client expects the lawyer to exercise pro- the lawyer’s employees, associates, and others fessional judgment therein for the protection of the whose services are utilized by the lawyer from dis- client, unless: closing or using confidential information of a (1) the transaction is fair and reasonable to the client, except that a lawyer may reveal the informa- client and the terms of the transaction are fully tion permitted to be disclosed by paragraph (b) disclosed and transmitted in writing in a man- through an employee. ner that can be reasonably understood by the client; RULE 1.7: (2) the client is advised in writing of the desirability Conflict of Interest: Current Clients of seeking, and is given a reasonable opportu- nity to seek, the advice of independent legal (a) Except as provided in paragraph (b), a lawyer shall counsel on the transaction; and not represent a client if a reasonable lawyer would conclude that either: (3) the client gives informed consent, in a writing signed by the client, to the essential terms of (1) the representation will involve the lawyer in the transaction and the lawyer’s role in the representing differing interests; or transaction, including whether the lawyer is (2) there is a significant risk that the lawyer’s pro- representing the client in the transaction. fessional judgment on behalf of a client will be (b) A lawyer shall not use information relating to rep- adversely affected by the lawyer’s own financial, resentation of a client to the disadvantage of the business, property or other personal interests. client unless the client gives informed consent, ex- (b) Notwithstanding the existence of a concurrent con- cept as permitted or required by these Rules. flict of interest under paragraph (a), a lawyer may (c) A lawyer shall not: represent a client if: (1) solicit any gift from a client, including a testa- (1) the lawyer reasonably believes that the lawyer mentary gift, for the benefit of the lawyer or a will be able to provide competent and diligent person related to the lawyer; or representation to each affected client; (2) prepare on behalf of a client an instrument giv- (2) the representation is not prohibited by law; ing the lawyer or a person related to the lawyer

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any gift, unless the lawyer or other recipient of senting a client, or anything of value related to the the gift is related to the client and a reasonable lawyer’s representation of the client, from one other lawyer would conclude that the transaction is than the client unless: fair and reasonable. (1) the client gives informed consent; For purposes of this paragraph, related persons in- (2) there is no interference with the lawyer’s inde- clude a spouse, child, grandchild, parent, grandpar- pendent professional judgment or with the ent or other relative or individual with whom the client-lawyer relationship; and lawyer or the client maintains a close, familial rela- (3) the client’s confidential information is protected tionship. as required by Rule 1.6. (d) Prior to conclusion of all aspects of the matter giv- (g) A lawyer who represents two or more clients shall ing rise to the representation or proposed represen- not participate in making an aggregate settlement tation of the client or prospective client, a lawyer of the claims of or against the clients, absent court shall not negotiate or enter into any arrangement approval, unless each client gives informed consent or understanding with: in a writing signed by the client. The lawyer’s dis- (1) a client or a prospective client by which the closure shall include the existence and nature of all lawyer acquires an interest in literary or media the claims involved and of the participation of each rights with respect to the subject matter of the person in the settlement. representation or proposed representation; or (h) A lawyer shall not: (2) any person by which the lawyer transfers or as- (1) make an agreement prospectively limiting the signs any interest in literary or media rights with lawyer’s liability to a client for malpractice; or respect to the subject matter of the representa- tion of a client or prospective client. (2) settle a claim or potential claim for such liability with an unrepresented client or former client (e) While representing a client in connection with con- unless that person is advised in writing of the templated or pending litigation, a lawyer shall not desirability of seeking, and is given a reasonable advance or guarantee financial assistance to the opportunity to seek, the advice of independent client, except that: legal counsel in connection therewith. (1) a lawyer may advance court costs and expenses (i) A lawyer shall not acquire a proprietary in- of litigation, the repayment of which may be terest in the cause of action or subject mat- contingent on the outcome of the matter; ter of litigation the lawyer is conducting (2) a lawyer representing an indigent or pro bono for a client, except that the lawyer may: client may pay court costs and expenses of liti- (1) acquire a lien authorized by law to secure the gation on behalf of the client; and lawyer’s fee or expenses; and (3) a lawyer, in an action in which an attorney’s fee (2) contract with a client for a reasonable contin- is payable in whole or in part as a percentage of gent fee in a civil matter subject to Rule 1.5(d) the recovery in the action, may pay on the or other law or court rule. lawyer’s own account court costs and expenses of litigation. In such case, the fee paid to the (j) (1) A lawyer shall not: lawyer from the proceeds of the action may in- (i) as a condition of entering into or continu- clude an amount equal to such costs and ex- ing any professional representation by the penses incurred. lawyer or the lawyer’s firm, require or de- (f) A lawyer shall not accept compensation for repre- mand sexual relations with any person;

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(ii) employ coercion, intimidation or undue merly represented a client in a matter shall not influence in entering into sexual relations thereafter: incident to any professional representation (1) use confidential information of the former by the lawyer or the lawyer’s firm; or client protected by Rule 1.6 to the disadvantage (iii) in domestic relations matters, enter into of the former client, except as these Rules sexual relations with a client during the would permit or require with respect to a cur- course of the lawyer’s representation of the rent client or when the information has become client. generally known; or (2) Rule 1.8(j)(1) shall not apply to sexual relations (2) reveal confidential information of the former between lawyers and their spouses or to ongo- client protected by Rule 1.6 except as these ing consensual sexual relationships that predate Rules would permit or require with respect to the initiation of the client-lawyer relationship. a current client. (k) Where a lawyer in a firm has sexual relations with a client but does not participate in the representa- RULE 1.10: tion of that client, the lawyers in the firm shall not Imputation of Conflicts of Interest be subject to discipline under this Rule solely be- cause of the occurrence of such sexual relations. (a) While lawyers are associated in a firm, none of them shall knowingly represent a client when any one of them practicing alone would be prohibited RULE 1.9: from doing so by Rule 1.7, 1.8 or 1.9, except as Duties to Former Clients otherwise provided therein. (a) A lawyer who has formerly represented a client in (b) When a lawyer has terminated an association with a matter shall not thereafter represent another per- a firm, the firm is prohibited from thereafter rep- son in the same or a substantially related matter in resenting a person with interests that the firm which that person’s interests are materially adverse knows or reasonably should know are materially to the interests of the former client unless the for- adverse to those of a client represented by the for- mer client gives informed consent, confirmed in merly associated lawyer and not currently repre- writing. sented by the firm if the firm or any lawyer (b) Unless the former client gives informed consent, remaining in the firm has information protected by confirmed in writing, a lawyer shall not knowingly Rule 1.6 or Rule 1.9(c) that is material to the mat- represent a person in the same or a substantially re- ter. lated matter in which a firm with which the lawyer (c) When a lawyer becomes associated with a firm, the formerly was associated had previously represented firm may not knowingly represent a client in a mat- a client: ter that is the same as or substantially related to a (1) whose interests are materially adverse to that matter in which the newly associated lawyer, or a person; and firm with which that lawyer was associated, for- merly represented a client whose interests are ma- (2) about whom the lawyer had acquired informa- terially adverse to the prospective or current client tion protected by Rules 1.6 or paragraph (c) of unless the newly associated lawyer did not acquire this Rule that is material to the matter. any information protected by Rule 1.6 or Rule (c) A lawyer who has formerly represented a client in 1.9(c) that is material to the current matter. a matter or whose present or former firm has for- (d) A disqualification prescribed by this Rule may be

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waived by the affected client or former client under (1) shall comply with Rule 1.9(c); and the conditions stated in Rule 1.7. (2) shall not represent a client in connection with a (e) A law firm shall make a written record of its en- matter in which the lawyer participated person- gagements, at or near the time of each new engage- ally and substantially as a public officer or em- ment, and shall implement and maintain a system ployee, unless the appropriate government agency by which proposed engagements are checked gives its informed consent, confirmed in writing, against current and previous engagements when: to the representation. This provision shall not (1) the firm agrees to represent a new client; apply to matters governed by Rule 1.12(a). (2) the firm agrees to represent an existing client in (b) When a lawyer is disqualified from representation a new matter; under paragraph (a), no lawyer in a firm with which that lawyer is associated may knowingly un- (3) the firm hires or associates with another lawyer; dertake or continue representation in such a matter or unless: (4) an additional party is named or appears in a (1) the firm acts promptly and reasonably to: pending matter. (i) notify, as appropriate, lawyers and non- (f) Substantial failure to keep records or to implement lawyer personnel within the firm that the or maintain a conflict-checking system that com- personally disqualified lawyer is prohibited plies with paragraph (e) shall be a violation thereof from participating in the representation of regardless of whether there is another violation of the current client; these Rules. (ii) implement effective screening procedures (g) Where a violation of paragraph (e) by a law firm is to prevent the flow of information about a substantial factor in causing a violation of para- the matter between the personally disqual- graph (a) by a lawyer, the law firm, as well as the ified lawyer and the others in the firm; individual lawyer, shall be responsible for the vio- lation of paragraph (a). (iii) ensure that the disqualified lawyer is ap- portioned no part of the fee therefrom; (h) A lawyer related to another lawyer as parent, child, and sibling or spouse shall not represent in any matter a client whose interests differ from those of another (iv) give written notice to the appropriate gov- party to the matter who the lawyer knows is repre- ernment agency to enable it to ascertain sented by the other lawyer unless the client con- compliance with the provisions of this sents to the representation after full disclosure and Rule; and the lawyer concludes that the lawyer can adequately (2) there are no other circumstances in the partic- represent the interests of the client. ular representation that create an appearance of impropriety.

RULE 1.11: (c) Except as law may otherwise expressly provide, a Special Conflicts of Interest for Former lawyer having information that the lawyer knows and Current Government Officers and is confidential government information about a Employees person, acquired when the lawyer was a public of- ficer or employee, may not represent a private client (a) Except as law may otherwise expressly provide, a whose interests are adverse to that person in a mat- lawyer who has formerly served as a public officer ter in which the information could be used to the or employee of the government: material disadvantage of that person. As used in

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this Rule, the term “confidential government in- RULE 1.12: formation” means information that has been ob- Specific Conflicts of Interest for Former tained under governmental authority and that, at Judges, Arbitrators, Mediators or Other the time this Rule is applied, the government is Third-Party Neutrals prohibited by law from disclosing to the public or has a legal privilege not to disclose, and that is not (a) A lawyer shall not accept private employment in a otherwise available to the public. A firm with matter upon the merits of which the lawyer has which that lawyer is associated may undertake or acted in a judicial capacity. continue representation in the matter only if the (b) Except as stated in paragraph (e), and unless all par- disqualified lawyer is timely and effectively screened ties to the proceeding give informed consent, con- from any participation in the matter in accordance firmed in writing, a lawyer shall not represent with the provisions of paragraph (b). anyone in connection with a matter in which the (d) Except as law may otherwise expressly provide, a lawyer participated personally and substantially as: lawyer currently serving as a public officer or em- (1) an arbitrator, mediator or other third-party ployee shall not: neutral; or (1) participate in a matter in which the lawyer par- (2) a law clerk to a judge or other adjudicative of- ticipated personally and substantially while in ficer or an arbitrator, mediator or other third- private practice or nongovernmental employ- party neutral. ment, unless under applicable law no one is, or (c) A lawyer shall not negotiate for employment with by lawful delegation may be, authorized to act any person who is involved as a party or as lawyer in the lawyer’s stead in the matter; or for a party in a matter in which the lawyer is par- (2) negotiate for private employment with any per- ticipating personally and substantially as a judge or son who is involved as a party or as lawyer for other adjudicative officer or as an arbitrator, medi- a party in a matter in which the lawyer is par- ator or other third-party neutral. ticipating personally and substantially. (d) When a lawyer is disqualified from representation (e) As used in this Rule, the term “matter” as defined under this Rule, no lawyer in a firm with which in Rule 1.0(l) does not include or apply to agency that lawyer is associated may knowingly undertake rulemaking functions. or continue representation in such a matter unless: (f) A lawyer who holds public office shall not: (1) the firm acts promptly and reasonably to: (1) use the public position to obtain, or attempt to (i) notify, as appropriate, lawyers and non- obtain, a special advantage in legislative matters lawyer personnel within the firm that the for the lawyer or for a client under circum- personally disqualified lawyer is prohibited stances where the lawyer knows or it is obvious from participating in the representation of that such action is not in the public interest; the current client; (2) use the public position to influence, or attempt (ii) implement effective screening procedures to influence, a tribunal to act in favor of the to prevent the flow of information about lawyer or of a client; or the matter between the personally disqual- (3) accept anything of value from any person when ified lawyer and the others in the firm; the lawyer knows or it is obvious that the offer (iii) ensure that the disqualified lawyer is ap- is for the purpose of influencing the lawyer’s ac- portioned no part of the fee therefrom; tion as a public official. and

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(iv) give written notice to the parties and any lating to the representation to persons outside the appropriate tribunal to enable it to ascer- organization. Such measures may include, among tain compliance with the provisions of this others: Rule; and (1) asking reconsideration of the matter; (2) there are no other circumstances in the partic- (2) advising that a separate legal opinion on the ular representation that create an appearance of matter be sought for presentation to an appro- impropriety. priate authority in the organization; and (e) An arbitrator selected as a partisan of a party in a (3) referring the matter to higher authority in the multimember arbitration panel is not prohibited organization, including, if warranted by the se- from subsequently representing that party. riousness of the matter, referral to the highest authority that can act in behalf of the organi- RULE 1.13: zation as determined by applicable law. Organization As Client (c) If, despite the lawyer’s efforts in accordance with paragraph (b), the highest authority that can act on (a) When a lawyer employed or retained by an organ- behalf of the organization insists upon action, or a ization is dealing with the organization’s directors, refusal to act, that is clearly in violation of law and officers, employees, members, shareholders or other is likely to result in a substantial injury to the or- constituents, and it appears that the organization’s ganization, the lawyer may reveal confidential in- interests may differ from those of the constituents formation only if permitted by Rule 1.6, and may with whom the lawyer is dealing, the lawyer shall resign in accordance with Rule 1.16. explain that the lawyer is the lawyer for the organ- ization and not for any of the constituents. (d) A lawyer representing an organization may also rep- resent any of its directors, officers, employees, (b) If a lawyer for an organization knows that an offi- members, shareholders or other constituents, sub- cer, employee or other person associated with the ject to the provisions of Rule 1.7. If the organiza- organization is engaged in action or intends to act tion’s consent to the concurrent representation is or refuses to act in a matter related to the represen- required by Rule 1.7, the consent shall be given by tation that (i) is a violation of a legal obligation to an appropriate official of the organization other the organization or a violation of law that reason- than the individual who is to be represented, or by ably might be imputed to the organization, and (ii) the shareholders. is likely to result in substantial injury to the organ- ization, then the lawyer shall proceed as is reason- ably necessary in the best interest of the RULE 1.14: organization. In determining how to proceed, the Client With Diminished Capacity lawyer shall give due consideration to the serious- (a) When a client’s capacity to make adequately con- ness of the violation and its consequences, the scope sidered decisions in connection with a representa- and nature of the lawyer’s representation, the re- tion is diminished, whether because of minority, sponsibility in the organization and the apparent mental impairment or for some other reason, the motivation of the person involved, the policies of lawyer shall, as far as reasonably possible, maintain the organization concerning such matters and any a conventional relationship with the client. other relevant considerations. Any measures taken shall be designed to minimize disruption of the or- (b) When the lawyer reasonably believes that the client ganization and the risk of revealing information re- has diminished capacity, is at risk of substantial

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to harass or maliciously injure another; or formation otherwise protected by Rule 1.6. (3) the lawyer knowingly asserts material factual (d) In an ex parte proceeding, a lawyer shall inform the statements that are false. tribunal of all material facts known to the lawyer that will enable the tribunal to make an informed decision, whether or not the facts are adverse. RULE 3.2: Delay of Litigation (e) In presenting a matter to a tribunal, a lawyer shall disclose, unless privileged or irrelevant, the identi- In representing a client, a lawyer shall not use means ties of the clients the lawyer represents and of the that have no substantial purpose other than to delay or persons who employed the lawyer. prolong the proceeding or to cause needless expense. (f) In appearing as a lawyer before a tribunal, a lawyer shall not: RULE 3.3: (1) fail to comply with known local customs of Conduct Before a Tribunal courtesy or practice of the bar or a particular (a) A lawyer shall not knowingly: tribunal without giving to opposing counsel timely notice of the intent not to comply; (1) make a false statement of fact or law to a tribu- nal or fail to correct a false statement of material (2) engage in undignified or discourteous conduct; fact or law previously made to the tribunal by (3) intentionally or habitually violate any estab- the lawyer; lished rule of procedure or of evidence; or (2) fail to disclose to the tribunal controlling legal (4) engage in conduct intended to disrupt the tri- authority known to the lawyer to be directly ad- bunal. verse to the position of the client and not dis- closed by opposing counsel; or RULE 3.4: (3) offer or use evidence that the lawyer knows to Fairness to Opposing Party and Counsel be false. If a lawyer, the lawyer’s client, or a wit- ness called by the lawyer has offered material A lawyer shall not: evidence and the lawyer comes to know of its (a) (1) suppress any evidence that the lawyer or the falsity, the lawyer shall take reasonable remedial client has a legal obligation to reveal or pro measures, including, if necessary, disclosure to duce; the tribunal. A lawyer may refuse to offer evi- (2) advise or cause a person to hide or leave the ju- dence, other than the testimony of a defendant risdiction of a tribunal for the purpose of mak- in a criminal matter, that the lawyer reasonably ing the person unavailable as a witness therein; believes is false. (3) conceal or knowingly fail to disclose that which (b) A lawyer who represents a client before a tribunal the lawyer is required by law to reveal; and who knows that a person intends to engage, is (4) knowingly use perjured testimony or false evi- engaging or has engaged in criminal or fraudulent dence; conduct related to the proceeding shall take reason- able remedial measures, including, if necessary, dis- (5) participate in the creation or preservation of ev- closure to the tribunal. idence when the lawyer knows or it is obvious that the evidence is false; or (c) The duties stated in paragraphs (a) and (b) apply even if compliance requires disclosure of in- (6) knowingly engage in other illegal conduct or

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RULE 3.9: state or imply that the lawyer is disinterested. When the Advocate In Non-Adjudicative Matters lawyer knows or reasonably should know that the un- represented person misunderstands the lawyer’s role in A lawyer communicating in a representative capacity the matter, the lawyer shall make reasonable efforts to with a legislative body or administrative agency in con- correct the misunderstanding. The lawyer shall not give nection with a pending non-adjudicative matter or pro- legal advice to an unrepresented person other than the ceeding shall disclose that the appearance is in a advice to secure counsel if the lawyer knows or reason- representative capacity, except when the lawyer seeks in- ably should know that the interests of such person are formation from an agency that is available to the public. or have a reasonable possibility of being in conflict with the interests of the client. RULE 4.1: Truthfulness In Statements To Others RULE 4.4: In the course of representing a client, a lawyer shall not Respect for Rights of Third Persons knowingly make a false statement of fact or law to a (a) In representing a client, a lawyer shall not use third person. means that have no substantial purpose other than to embarrass or harm a third person or use methods RULE 4.2: of obtaining evidence that violate the legal rights of such a person. Communication With Person Represented By Counsel (b) A lawyer who receives a document relating to the representation of the lawyer’s client and knows or (a) In representing a client, a lawyer shall not commu- reasonably should know that the document was in- nicate or cause another to communicate about the advertently sent shall promptly notify the sender. subject of the representation with a party the lawyer knows to be represented by another lawyer in the matter, unless the lawyer has the prior consent of RULE 4.5: the other lawyer or is authorized to do so by law. Communication After Incidents (b) Notwithstanding the prohibitions of paragraph (a), Involving Personal Injury or Wrongful and unless otherwise prohibited by law, a lawyer Death may cause a client to communicate with a repre- (a) In the event of a specific incident involving poten- sented person unless the represented person is not tial claims for personal injury or wrongful death, legally competent, and may counsel the client with no unsolicited communication shall be made to an respect to those communications, provided the individual injured in the incident or to a family lawyer gives reasonable advance notice to the rep- member or legal representative of such an individ- resented person’s counsel that such communica- ual, by a lawyer or law firm, or by any associate, tions will be taking place. agent, employee or other representative of a lawyer or law firm representing actual or potential defen- RULE 4.3: dants or entities that may defend and/or indemnify said defendants, before the 30th day after the date Communicating With Unrepresented of the incident, unless a filing must be made within Persons 30 days of the incident as a legal prerequisite to the In communicating on behalf of a client with a person particular claim, in which case no unsolicited com- who is not represented by counsel, a lawyer shall not munication shall be made before the 15th day after

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(2) Counsel means any attorney rep- mination by the Public Company Ac- resenting a party or any other person counting Oversight Board; or representing a party pursuant to (vi) By the filing, pursuant to § 242.601 § 201.102(b); of this chapter, of an application for re- (3) Disciplinary proceeding means an view of an action or failure to act in action pursuant to § 201.102(e); connection with the implementation or (4) Enforcement proceeding means an operation of any effective transaction action, initiated by an order insti- reporting plan; or tuting proceedings, held for the pur- (vii) By the filing, pursuant to pose of determining whether or not a § 242.608 of this chapter, of an applica- person is about to violate, has violated, tion for review of an action taken or has caused a violation of, or has aided failure to act in connection with the or abetted a violation of any statute or implementation or operation of any ef- rule administered by the Commission, fective national market system plan; or whether to impose a sanction as de- or fined in Section 551(10) of the Adminis- (viii) By the filing, pursuant to Sec- trative Procedure Act, 5 U.S.C. 551(10); tion 11A(b)(5) of the Securities Ex- (5) Hearing officer means an adminis- change Act of 1934, of an application trative law judge, a panel of Commis- for review of a determination of a reg- sioners constituting less than a istered securities information proc- quorum of the Commission, an indi- essor; vidual Commissioner, or any other per- (10) Secretary means the Secretary of son duly authorized to preside at a the Commission; hearing; (11) Temporary sanction means a tem- (6) Interested division means a division porary cease-and-desist order or a tem- or an office assigned primary responsi- porary suspension of the registration of bility by the Commission to partici- a broker, dealer, municipal securities pate in a particular proceeding; dealer, government securities broker, (7) Order instituting proceedings means government securities dealer, or trans- an order issued by the Commission fer agent pending final determination commencing a proceeding or an order whether the registration shall be re- issued by the Commission to hold a voked; and hearing; (12) Board means the Public Company (8) Party means the interested divi- Accounting Oversight Board. sion, any person named as a respondent (b) [Reserved] in an order instituting proceedings, [60 FR 32796, June 23, 1995, as amended at 69 any applicant named in the caption of FR 13175, Mar. 19, 2004; 70 FR 37617, June 29, any order, persons entitled to notice in 2005] a stop order proceeding as set forth in § 201.200(a)(2) or any person seeking § 201.102 Appearance and practice be- Commission review of a decision; fore the Commission. (9) Proceeding means any agency A person shall not be represented be- process initiated: fore the Commission or a hearing offi- (i) By an order instituting pro- cer except as stated in paragraphs (a) ceedings; or and (b) of this section or as otherwise (ii) By the filing, pursuant to permitted by the Commission or a § 201.410, of a petition for review of an hearing officer. initial decision by a hearing officer; or (a) Representing oneself. In any pro- (iii) By the filing, pursuant to ceeding, an individual may appear on § 201.420, of an application for review of his or her own behalf. a self-regulatory organization deter- (b) Representing others. In any pro- mination; or ceeding, a person may be represented (iv) By the filing, pursuant to by an attorney at law admitted to § 201.430, of a notice of intention to file practice before the Supreme Court of a petition for review of a determina- the United States or the highest court tion made pursuant to delegated au- of any State (as defined in Section thority; or 3(a)(16) of the Exchange Act, 15 U.S.C. (v) By the filing, pursuant to § 201.440, 78c(a)(16)); a member of a partnership of an application for review of a deter- may represent the partnership; a bona

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fide officer of a corporation, trust or the effective date of the withdrawal. If association may represent the corpora- the person seeking to withdraw knows tion, trust or association; and an offi- the name, address, and telephone num- cer or employee of a state commission ber of the new representative, or knows or of a department or political subdivi- that the person for whom the appear- sion of a state may represent the state ance was made intends to represent commission or the department or polit- him- or herself, that information shall ical subdivision of the state. be included in the notice. The notice (c) Former Commission employees. must be served on the parties in ac- Former employees of the Commission cordance with § 201.150. The notice shall must comply with the restrictions on be filed at least five days before the practice contained in the Commission’s proposed effective date of the with- Conduct Regulation, Subpart M, 17 drawal. CFR 200.735. (e) Suspension and disbarment—(1) (d) Designation of address for service; Generally. The Commission may cen- notice of appearance; power of attorney; sure a person or deny, temporarily or withdrawal—(1) Representing oneself. permanently, the privilege of appear- When an individual first makes any fil- ing or practicing before it in any way ing or otherwise appears on his or her to any person who is found by the Com- own behalf before the Commission or a mission after notice and opportunity hearing officer in a proceeding as de- for hearing in the matter: fined in § 201.101(a), he or she shall file (i) Not to possess the requisite quali- with the Commission, or otherwise fications to represent others; or state on the record, and keep current, (ii) To be lacking in character or in- an address at which any notice or other tegrity or to have engaged in unethical written communication required to be or improper professional conduct; or served upon him or her or furnished to (iii) To have willfully violated, or him or her may be sent and a telephone willfully aided and abetted the viola- number where he or she may be tion of any provision of the Federal se- reached during business hours. curities laws or the rules and regula- (2) Representing others. When a person tions thereunder. first makes any filing or otherwise ap- (iv) With respect to persons licensed pears in a representative capacity be- to practice as accountants, ‘‘improper fore the Commission or a hearing offi- professional conduct’’ under cer in a proceeding as defined in § 201.102(e)(1)(ii) means: § 201.101(a), that person shall file with the Commission, and keep current, a (A) Intentional or knowing conduct, written notice stating the name of the including reckless conduct, that re- proceeding; the representative’s name, sults in a violation of applicable pro- business address and telephone num- fessional standards; or ber; and the name and address of the (B) Either of the following two types person or persons represented. of negligent conduct: (3) Power of attorney. Any individual (1) A single instance of highly unrea- appearing or practicing before the sonable conduct that results in a viola- Commission in a representative capac- tion of applicable professional stand- ity may be required to file a power of ards in circumstances in which an ac- attorney with the Commission showing countant knows, or should know, that his or her authority to act in such ca- heightened scrutiny is warranted. pacity. (2) Repeated instances of unreason- (4) Withdrawal. Any person seeking to able conduct, each resulting in a viola- withdraw his or her appearance in a tion of applicable professional stand- representative capacity shall file a no- ards, that indicate a lack of com- tice of withdrawal with the Commis- petence to practice before the Commis- sion or the hearing officer. The notice sion. shall state the name, address, and tele- (2) Certain professionals and convicted phone number of the withdrawing rep- persons. Any attorney who has been resentative; the name, address, and suspended or disbarred by a court of telephone number of the person for the United States or of any State; or whom the appearance was made; and any person whose license to practice as

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an accountant, engineer, or other pro- of the Federal securities laws or of the fessional or expert has been revoked or rules and regulations thereunder. suspended in any State; or any person (ii) Any person temporarily sus- who has been convicted of a felony or a pended from appearing and practicing misdemeanor involving moral turpi- before the Commission in accordance tude shall be forthwith suspended from with paragraph (e)(3)(i) of this section appearing or practicing before the may, within 30 days after service upon Commission. A disbarment, suspension, him or her of the order of temporary revocation or conviction within the suspension, petition the Commission to meaning of this section shall be lift the temporary suspension. If no pe- deemed to have occurred when the dis- tition has been received by the Com- barring, suspending, revoking or con- mission within 30 days after service of victing agency or tribunal enters its the order, the suspension shall become judgment or order, including a judg- permanent. ment or order on a plea of nolo (iii) Within 30 days after the filing of contendere, regardless of whether an a petition in accordance with para- appeal of such judgment or order is graph (e)(3)(ii) of this section, the Com- pending or could be taken. mission shall either lift the temporary (3) Temporary suspensions. An order of suspension, or set the matter down for temporary suspension shall become ef- hearing at a time and place designated fective upon service on the respondent. by the Commission, or both, and, after No order of temporary suspension shall opportunity for hearing, may censure be entered by the Commission pursuant the petitioner or disqualify the peti- to paragraph (e)(3)(i) of this section tioner from appearing or practicing be- more than 90 days after the date on fore the Commission for a period of which the final judgment or order en- time or permanently. In every case in tered in a judicial or administrative which the temporary suspension has proceeding described in paragraph not been lifted, every hearing held and (e)(3)(i)(A) or (e)(3)(i)(B) of this section other action taken pursuant to this has become effective, whether upon paragraph (e)(3) shall be expedited in completion of review or appeal proce- accordance with § 201.500. If the hearing dures or because further review or ap- is held before a hearing officer, the peal procedures are no longer avail- time limits set forth in § 201.540 will able. govern review of the hearing officer’s (i) The Commission, with due regard initial decision. to the public interest and without pre- (iv) In any hearing held on a petition liminary hearing, may, by order, tem- filed in accordance with paragraph porarily suspend from appearing or (e)(3)(ii) of this section, the staff of the practicing before it any attorney, ac- Commission shall show either that the countant, engineer, or other profes- petitioner has been enjoined as de- sional or expert who has been by name: scribed in paragraph (e)(3)(i)(A) of this (A) Permanently enjoined by any section or that the petitioner has been court of competent jurisdiction, by rea- found to have committed or aided and son of his or her misconduct in an ac- abetted violations as described in para- tion brought by the Commission, from graph (e)(3)(i)(B) of this section and violating or aiding and abetting the that showing, without more, may be violation of any provision of the Fed- the basis for censure or disqualifica- eral securities laws or of the rules and tion. Once that showing has been made, regulations thereunder; or the burden shall be upon the petitioner (B) Found by any court of competent to show cause why he or she should not jurisdiction in an action brought by be censured or temporarily or perma- the Commission to which he or she is a nently disqualified from appearing and party or found by the Commission in practicing before the Commission. In any administrative proceeding to any such hearing, the petitioner may which he or she is a party to have vio- not contest any finding made against lated (unless the violation was found him or her or fact admitted by him or not to have been willful) or aided and her in the judicial or administrative abetted the violation of any provision proceeding upon which the proceeding

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under this paragraph (e)(3) is predi- unless otherwise ordered by the Com- cated. A person who has consented to mission on its own motion or after con- the entry of a permanent injunction as sidering the motion of a party. described in paragraph (e)(3)(i)(A) of (f) Practice defined. For the purposes this section without admitting the of these Rules of Practice, practicing facts set forth in the complaint shall before the Commission shall include, be presumed for all purposes under this but shall not be limited to: paragraph (e)(3) to have been enjoined (1) Transacting any business with the by reason of the misconduct alleged in Commission; and the complaint. (2) The preparation of any statement, (4) Filing of prior orders. Any person opinion or other paper by any attor- appearing or practicing before the ney, accountant, engineer or other pro- Commission who has been the subject fessional or expert, filed with the Com- of an order, judgment, decree, or find- mission in any registration statement, ing as set forth in paragraph (e)(3) of notification, application, report or this section shall promptly file with other document with the consent of the Secretary a copy thereof (together such attorney, accountant, engineer or with any related opinion or statement other professional or expert. of the agency or tribunal involved). [60 FR 32796, June 23, 1995, as amended at 63 Failure to file any such paper, order, FR 57122, Oct. 26, 1998; 69 FR 13176, Mar. 19, judgment, decree or finding shall not 2004; 70 FR 72569, Dec. 5, 2005] impair the operation of any other pro- vision of this section. § 201.103 Construction of rules. (5) Reinstatement. (i) An application (a) The Rules of Practice shall be for reinstatement of a person perma- construed and administered to secure nently suspended or disqualified under the just, speedy, and inexpensive deter- paragraph (e)(1) or (e)(3) of this section mination of every proceeding. may be made at any time, and the ap- (b) In any particular proceeding, to plicant may, in the Commission’s dis- the extent that there is a conflict be- cretion, be afforded a hearing; however, tween these rules and a procedural re- the suspension or disqualification shall quirement contained in any statute, or continue unless and until the applicant any rule or form adopted thereunder, has been reinstated by the Commission the latter shall control. for good cause shown. (c) For purposes of these rules: (ii) Any person suspended under para- (1) Any term in the singular includes graph (e)(2) of this section shall be re- the plural, and any term in the plural instated by the Commission, upon ap- includes the singular, if such use would propriate application, if all the grounds be appropriate; for application of the provisions of that (2) Any use of a masculine, feminine, paragraph are subsequently removed or neuter gender encompasses such by a reversal of the conviction or ter- other genders as would be appropriate; mination of the suspension, disbar- and ment, or revocation. An application for (3) Unless the context requires other- reinstatement on any other grounds by wise, counsel for a party may take any any person suspended under paragraph action required or permitted to be (e)(2) of this section may be filed at taken by such party. any time and the applicant shall be ac- corded an opportunity for a hearing in § 201.104 Business hours. the matter; however, such suspension The Headquarters office of the Com- shall continue unless and until the ap- mission, at 100 F Street, NE., Wash- plicant has been reinstated by order of ington, DC 20549, is open each day, ex- the Commission for good cause shown. cept Saturdays, Sundays, and Federal (6) Other proceedings not precluded. A legal holidays, from 9 a.m. to 5:30 p.m., proceeding brought under paragraph Eastern Standard Time or Eastern (e)(1), (e)(2) or (e)(3) of this section Daylight Saving Time, whichever is shall not preclude another proceeding currently in effect in Washington, D.C. brought under these same paragraphs. Federal legal holidays consist of New (7) Public hearings. All hearings held Year’s Day; Birthday of Martin Luther under this paragraph (e) shall be public King, Jr.; Presidents Day; Memorial

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SEC Public Statement: Washington State Bar Association's Proposed Statement on the Ef... Page 1 of 3

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Public Statement by SEC Official: Letter Regarding Washington State Bar Association's Proposed Opinion on the Effect of the SEC's Attorney Conduct Rules

by

Giovanni P. Prezioso

General Counsel, U.S. Securities and Exchange Commission

July 23, 2003

J. Richard Manning President, Washington State Bar Association 925 Logan Building 500 Union Street Seattle, WA 98101-4073

David W. Savage President-Elect, Washington State Bar Association 1230 SE Bishop Boulevard Pullman, WA 99163-0604

Re: Washington State Bar Association's Proposed Interim Formal Opinion Regarding the Effect of the SEC's Sarbanes-Oxley Regulations on Washington Attorneys' Obligations Under the Rules of Professional Conduct.

Dear President Manning and President-Elect Savage:

The Securities and Exchange Commission ("Commission") has authorized me to submit, on its behalf, these comments on the above-referenced Proposed Interim Formal Opinion, which I understand the Board of Governors will shortly take up at its annual meeting. As you know, earlier this year the Commission issued final rules governing the conduct of attorneys appearing and practicing before it. The Commission is particularly interested in the Proposed Interim Formal Opinion because it interprets the Washington Rules of Professional Conduct in a manner that affects the intended operation of the Commission's rules. As the Board of Governors considers the Proposed Interim Formal Opinion, and as the WSBA RPC Committee contemplates revisions to Washington RPC 1.6, perhaps these comments will aid your deliberations by providing the Commission's perspective on the relevant sections of its new attorney-conduct rules.

Let me note at the outset that actual conflicts between the Washington Rules of Professional Conduct and the Commission's new attorney-conduct

http://www.sec.gov/news/speech/spch072303gpp.htm 5/16/2012 SEC Public Statement: Washington State Bar Association's Proposed Statement on the Ef... Page 2 of 3

rules are likely to be rare, as the Commission's rules do not address the overwhelming majority of attorney conduct, which remains fully covered by applicable state bar rules. Instead, the Commission's rules apply to attorneys only in the limited scope of their "appearing and practicing" before the Commission. See 17 CFR 205.2(a) (defining "appearing and practicing before the Commission").

Despite the narrow scope of the Commission's rules, the Proposed Interim Formal Opinion does identify potential areas of conflict. First, the Proposed Interim Formal Opinion opines that WSBA members appearing and practicing before the Commission are prohibited - under threat of liability and bar disciplinary action - from disclosing to the Commission certain information that the Commission's rules permit them to disclose. Second, the Proposed Interim Formal Opinion opines that a Washington attorney cannot claim to be complying in "good faith" with the Commission's rules under Section 205.6(c) of the rules, if the attorney acts contrary to the Formal Opinion.

In opining that the Washington RPC 1.6 bars attorney disclosures permitted by Section 205.3(d)(2) of the Commission's rules, however, the Proposed Interim Formal Opinion is inconsistent with prevailing Supreme Court precedent. The Court has consistently upheld the authority of federal agencies to implement rules of conduct that diverge from and supersede state laws that address the same conduct. See, e.g., Sperry v. State of Florida, 373 U.S. 379 (1963) (Florida could not enjoin non-lawyer registered to practice before the Patent and Trademark Office from prosecuting patent applications in Florida, even though non-lawyer's actions constituted unauthorized practice of law under Florida bar rules). In particular, where, as here, a conflict arises because a state rule prohibits an attorney from exercising the discretion provided by a federal regulation, the federal regulation will take priority. See Fidelity Fed Sav. & Loan Ass'n v. de la Cuesta, 458 U.S. 141, 155 (1982) (holding that a conflict between an agency's regulations and state law "does not evaporate because the [agency's] regulation simply permits, but does not compel," what state law prohibits; state law is preempted because its prohibition removes the "flexibility" provided by the agency's regulation). Thus, Section 205.3(d)(2) of the Commission's rules will take precedence over any conflicting provision of RPC 1.6.

Federal law will also determine whether, under Section 205.6(c) of the Commission's rules, an attorney has complied in "good faith" with the Commission's rules. Section 205.6(c) shields an attorney from discipline and liability under inconsistent state-law conduct rules if the attorney complies in "good faith" with the Commission's conduct rules. Because the issue whether an attorney has acted in "good faith" under Section 205.6(c) requires an interpretation of a Commission rule, states must defer to the Commission's construction. See Barnard v. Walton, 535 U.S. 212, 122 S. Ct. 1265, 1269 (2002) (agency's interpretation of regulation must be sustained if based on a permissible construction). The purposes of the Commission's "good faith" provision would be frustrated by a state-based definition of "good faith" that is inconsistent with the Commission's interpretation. Thus, a conflicting state definition of "good faith" would be preempted. See United States v. Locke, 529 U.S. 108, 110 (2000) ("a federal agency acting within the scope of its delegated authority may pre- empt state regulation"); City of New York v. FCC, 486 U.S. 57, 64 (1989) (federal agency regulations preempt any state law that frustrates the

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purposes of those regulations).

The Commission's rules would also be frustrated if, as contemplated by the Proposed Interim Formal Opinion, the WSBA were to initiate a disciplinary proceeding against an attorney who, in complying in "good faith" with the Commission's rules, did not comply with a conflicting RPC. Even if the WSBA proceeding exonerated the attorney, the proceeding itself would thwart the purposes of the Commission's rules by subjecting attorneys to disciplinary proceedings for attempting in good faith to comply with a Commission rule that conflicts with an RPC.

Please do not hesitate to contact me, or Richard Humes or Tom Karr of our office, if you should have any questions regarding this letter.

Sincerely yours,

Giovanni P. Prezioso General Counsel

http://www.sec.gov/news/speech/spch072303gpp.htm

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http://www.sec.gov/news/speech/spch072303gpp.htm 5/16/2012 Securities and Exchange Commission § 240.21F–3

applicant (such as the proposed em- § 240.21F–2 Whistleblower status and ployer) on behalf of such person, with- retaliation protection. out oral hearing. Any request for oral (a) Definition of a whistleblower. (1) hearing or argument should be sub- You are a whistleblower if, alone or mitted with the notice or application. jointly with others, you provide the (h) The Rules of Practice (17 CFR Commission with information pursuant part 201) shall apply to proceedings to the procedures set forth in § 240.21F– under this rule to the extent that they 9(a) of this chapter, and the informa- are not inconsistent with this rule. tion relates to a possible violation of (15 U.S.C. 78a et seq., as amended by Pub. L. the Federal securities laws (including 94–29 (June 4, 1975) and by Pub. L. 98–38 (June any rules or regulations thereunder) 6, 1983), particularly secs. 11A, 15, 19 and 23 that has occurred, is ongoing, or is thereof (15 U.S.C. 78k–1, 78o, 78s and 78w)) about to occur. A whistleblower must [46 FR 58661, Dec. 3, 1981, as amended at 48 be an individual. A company or another FR 53691, Nov. 29, 1983] entity is not eligible to be a whistle- blower. SECURITIES WHISTLEBLOWER INCENTIVES (2) To be eligible for an award, you AND PROTECTIONS must submit original information to the Commission in accordance with the SOURCE: Sections 240.21F–1 through procedures and conditions described in 240.21F–17 appear at 76 FR 34363, June 13, §§ 240.21F–4, 240.21F–8, and 240.21F–9 of 2011. this chapter. (b) Prohibition against retaliation.(1) § 240.21F–1 General. For purposes of the anti-retaliation Section 21F of the Securities Ex- protections afforded by Section change Act of 1934 (‘‘Exchange Act’’) 21F(h)(1) of the Exchange Act (15 U.S.C. (15 U.S.C. 78u-6), entitled ‘‘Securities 78u-6(h)(1)), you are a whistleblower if: Whistleblower Incentives and Protec- (i) You possess a reasonable belief tion,’’ requires the Securities and Ex- that the information you are providing change Commission (‘‘Commission’’) to relates to a possible securities law vio- pay awards, subject to certain limita- lation (or, where applicable, to a pos- tions and conditions, to sible violation of the provisions set who provide the Commission with forth in 18 U.S.C. 1514A(a)) that has oc- original information about violations curred, is ongoing, or is about to occur, of the Federal securities laws. These and; rules describe the whistleblower pro- (ii) You provide that information in a gram that the Commission has estab- manner described in Section lished to implement the provisions of 21F(h)(1)(A) of the Exchange Act (15 Section 21F, and explain the procedures U.S.C. 78u-6(h)(1)(A)). you will need to follow in order to be (iii) The anti-retaliation protections eligible for an award. You should read apply whether or not you satisfy the these procedures carefully because the requirements, procedures and condi- failure to take certain required steps tions to qualify for an award. within the time frames described in (2) Section 21F(h)(1) of the Exchange these rules may disqualify you from re- Act (15 U.S.C. 78u-6(h)(1)), including ceiving an award for which you other- any rules promulgated thereunder, wise may be eligible. Unless expressly shall be enforceable in an action or provided for in these rules, no person is proceeding brought by the Commission. authorized to make any offer or prom- ise, or otherwise to bind the Commis- § 240.21F–3 Payment of awards. sion with respect to the payment of (a) Commission actions: Subject to the any award or the amount thereof. The eligibility requirements described in Securities and Exchange Commission’s §§ 240.21F–2, 240.21F–8, and 240.21F–16 of Office of the Whistleblower administers this chapter, the Commission will pay our whistleblower program. Questions an award or awards to one or more about the program or these rules whistleblowers who: should be directed to the SEC Office of (1) Voluntarily provide the Commis- the Whistleblower, 100 F Street, NE., sion Washington, DC 20549–5631. (2) With original information

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(3) That leads to the successful en- § 240.21F–12(a) of this chapter. Addi- forcement by the Commission of a Fed- tional procedures apply to the payment eral court or administrative action of awards in related actions. These pro- (4) In which the Commission obtains cedures are described in §§ 240.21F–11 monetary sanctions totaling more than and 240.21F–14 of this chapter. $1,000,000. (3) The Commission will not make an award to you for a related action if you NOTE TO PARAGRAPH (a): The terms volun- tarily, original information, leads to successful have already been granted an award by enforcement, action, and monetary sanctions the Commodity Futures Trading Com- are defined in § 240.21F–4 of this chapter. mission (‘‘CFTC’’) for that same action pursuant to its whistleblower award (b) Related actions: The Commission program under Section 23 of the Com- will also pay an award based on modity Exchange Act (7 U.S.C. 26). amounts collected in certain related Similarly, if the CFTC has previously actions. denied an award to you in a related ac- (1) A related action is a judicial or ad- tion, you will be precluded from reliti- ministrative action that is brought by: gating any issues before the Commis- (i) The Attorney General of the sion that the CFTC resolved against United States; you as part of the award denial. (ii) An appropriate regulatory au- thority; § 240.21F–4 Other definitions. (iii) A self-regulatory organization; or (a) Voluntary submission of informa- (iv) A state attorney general in a tion. (1) Your submission of informa- criminal case, and is based on the same tion is made voluntarily within the original information that the whistle- meaning of §§ 240.21F–1 through 240.21F– blower voluntarily provided to the 17 of this chapter if you provide your Commission, and that led the Commis- submission before a request, inquiry, or sion to obtain monetary sanctions to- demand that relates to the subject taling more than $1,000,000. matter of your submission is directed to you or anyone representing you NOTE TO PARAGRAPH (b)(1): The terms ap- (such as an attorney): propriate regulatory authority and self-regu- (i) By the Commission; latory organization are defined in § 240.21F–4 of (ii) In connection with an investiga- this chapter. tion, inspection, or examination by the (2) In order for the Commission to Public Company Accounting Oversight make an award in connection with a Board, or any self-regulatory organiza- related action, the Commission must tion; or determine that the same original infor- (iii) In connection with an investiga- mation that the whistleblower gave to tion by Congress, any other authority the Commission also led to the success- of the Federal government, or a state ful enforcement of the related action Attorney General or securities regu- under the same criteria described in latory authority. these rules for awards made in connec- (2) If the Commission or any of these tion with Commission actions. The other authorities direct a request, in- Commission may seek assistance and quiry, or demand as described in para- confirmation from the authority bring- graph (a)(1) of this section to you or ing the related action in making this your representative first, your submis- determination. The Commission will sion will not be considered voluntary, deny an award in connection with the and you will not be eligible for an related action if: award, even if your response is not (i) The Commission determines that compelled by subpoena or other appli- the criteria for an award are not satis- cable law. However, your submission of fied; or information to the Commission will be (ii) The Commission is unable to considered voluntary if you voluntarily make a determination because the Of- provided the same information to one fice of the Whistleblower could not ob- of the other authorities identified tain sufficient and reliable information above prior to receiving a request, in- that could be used as the basis for an quiry, or demand from the Commis- award determination pursuant to sion.

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(3) In addition, your submission will this chapter, the applicable state attor- not be considered voluntary if you are ney conduct rules, or otherwise; required to report your original infor- (ii) If you obtained the information mation to the Commission as a result in connection with the legal represen- of a pre-existing legal duty, a contrac- tation of a client on whose behalf you tual duty that is owed to the Commis- or your employer or firm are providing sion or to one of the other authorities services, and you seek to use the infor- set forth in paragraph (a)(1) of this sec- mation to make a whistleblower sub- tion, or a duty that arises out of a judi- mission for your own benefit, unless cial or administrative order. disclosure would otherwise be per- (b) Original information. (1) In order mitted by an attorney pursuant to for your whistleblower submission to § 205.3(d)(2) of this chapter, the applica- be considered original information, it ble state attorney conduct rules, or must be: otherwise; or (i) Derived from your independent (iii) In circumstances not covered by knowledge or independent analysis; paragraphs (b)(4)(i) or (b)(4)(ii) of this (ii) Not already known to the Com- section, if you obtained the informa- mission from any other source, unless tion because you were: you are the original source of the infor- (A) An officer, director, trustee, or partner of an entity and another per- mation; son informed you of allegations of mis- (iii) Not exclusively derived from an conduct, or you learned the informa- allegation made in a judicial or admin- tion in connection with the entity’s istrative hearing, in a governmental processes for identifying, reporting, report, hearing, audit, or investigation, and addressing possible violations of or from the news media, unless you are law; a source of the information; and (B) An employee whose principal du- (iv) Provided to the Commission for ties involve compliance or internal the first time after July 21, 2010 (the audit responsibilities, or you were em- date of enactment of the Dodd-Frank ployed by or otherwise associated with Wall Street Reform and Consumer Protec- a firm retained to perform compliance tion Act). or internal audit functions for an enti- (2) Independent knowledge means fac- ty; tual information in your possession (C) Employed by or otherwise associ- that is not derived from publicly avail- ated with a firm retained to conduct an able sources. You may gain inde- inquiry or investigation into possible pendent knowledge from your experi- violations of law; or ences, communications and observa- (D) An employee of, or other person tions in your business or social inter- associated with, a public accounting actions. firm, if you obtained the information (3) Independent analysis means your through the performance of an engage- own analysis, whether done alone or in ment required of an independent public combination with others. Analysis accountant under the Federal securi- means your examination and evalua- ties laws (other than an audit subject tion of information that may be pub- to § 240.21F–8(c)(4) of this chapter), and licly available, but which reveals infor- that information related to a violation mation that is not generally known or by the engagement client or the cli- available to the public. ent’s directors, officers or other em- (4) The Commission will not consider ployees. information to be derived from your (iv) If you obtained the information independent knowledge or independent by a means or in a manner that is de- analysis in any of the following cir- termined by a United States court to cumstances: violate applicable Federal or state (i) If you obtained the information criminal law; or through a communication that was (v) Exceptions. Paragraph (b)(4)(iii) of subject to the attorney-client privi- this section shall not apply if: lege, unless disclosure of that informa- (A) You have a reasonable basis to tion would otherwise be permitted by believe that disclosure of the informa- an attorney pursuant to § 205.3(d)(2) of tion to the Commission is necessary to

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prevent the relevant entity from en- other entity provided to the Commis- gaging in conduct that is likely to sion. cause substantial injury to the finan- (6) If the Commission already knows cial interest or property of the entity some information about a matter from or investors; other sources at the time you make (B) You have a reasonable basis to your submission, and you are not an believe that the relevant entity is en- original source of that information gaging in conduct that will impede an under paragraph (b)(5) of this section, investigation of the misconduct; or the Commission will consider you an (C) At least 120 days have elapsed original source of any information you since you provided the information to provide that is derived from your inde- the relevant entity’s audit committee, pendent knowledge or analysis and chief legal officer, chief compliance of- that materially adds to the informa- ficer (or their equivalents), or your su- tion that the Commission already pos- pervisor, or since you received the in- sesses. formation, if you received it under cir- (7) If you provide information to the cumstances indicating that the enti- Congress, any other authority of the ty’s audit committee, chief legal offi- Federal government, a state Attorney cer, chief compliance officer (or their General or securities regulatory au- equivalents), or your supervisor was al- thority, any self-regulatory organiza- ready aware of the information. tion, or the Public Company Account- (vi) If you obtained the information ing Oversight Board, or to an entity’s from a person who is subject to this internal whistleblower, legal, or com- section, unless the information is not pliance procedures for reporting allega- excluded from that person’s use pursu- tions of possible violations of law, and ant to this section, or you are pro- you, within 120 days, submit the same viding the Commission with informa- information to the Commission pursu- tion about possible violations involv- ant to § 240.21F–9 of this chapter, as you ing that person. must do in order for you to be eligible (5) The Commission will consider you to be considered for an award, then, for to be an original source of the same in- purposes of evaluating your claim to formation that we obtain from another an award under §§ 240.21F–10 and source if the information satisfies the 240.21F–11 of this chapter, the Commis- definition of original information and sion will consider that you provided in- the other source obtained the informa- formation as of the date of your origi- tion from you or your representative. nal disclosure, report or submission to In order to be considered an original one of these other authorities or per- source of information that the Com- mission receives from Congress, any sons. You must establish the effective other authority of the Federal govern- date of any prior disclosure, report, or ment, a state Attorney General or se- submission, to the Commission’s satis- curities regulatory authority, any self- faction. The Commission may seek as- regulatory organization, or the Public sistance and confirmation from the Company Accounting Oversight Board, other authority or person in making you must have voluntarily given such this determination. authorities the information within the (c) Information that leads to successful meaning of these rules. You must es- enforcement. The Commission will con- tablish your status as the original sider that you provided original infor- source of information to the Commis- mation that led to the successful en- sion’s satisfaction. In determining forcement of a judicial or administra- whether you are the original source of tive action in any of the following cir- information, the Commission may seek cumstances: assistance and confirmation from one (1) You gave the Commission original of the other authorities described information that was sufficiently spe- above, or from another entity (includ- cific, credible, and timely to cause the ing your employer), in the event that staff to commence an examination, you claim to be the original source of open an investigation, reopen an inves- information that an authority or an- tigation that the Commission had

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closed, or to inquire concerning dif- upon which the award was based any ferent conduct as part of a current ex- subsequent Commission proceeding amination or investigation, and the that, individually, results in a mone- Commission brought a successful judi- tary sanction of $1,000,000 or less, and cial or administrative action based in that arises out of the same nucleus of whole or in part on conduct that was operative facts. the subject of your original informa- (e) Monetary sanctions means any tion; or money, including penalties, (2) You gave the Commission original disgorgement, and interest, ordered to information about conduct that was al- be paid and any money deposited into a ready under examination or investiga- disgorgement fund or other fund pursu- tion by the Commission, the Congress, ant to Section 308(b) of the Sarbanes- any other authority of the Federal gov- Oxley Act of 2002 (15 U.S.C. 7246(b)) as a ernment, a state Attorney General or result of a Commission action or a re- securities regulatory authority, any lated action. self-regulatory organization, or the (f) Appropriate regulatory agency PCAOB (except in cases where you means the Commission, the Comp- were an original source of this informa- troller of the Currency, the Board of tion as defined in paragraph (b)(4) of Governors of the Federal Reserve Sys- this section), and your submission sig- tem, the Federal Deposit Insurance nificantly contributed to the success of Corporation, the Office of Thrift Super- the action. vision, and any other agencies that (3) You reported original information may be defined as appropriate regu- through an entity’s internal whistle- latory agencies under Section 3(a)(34) blower, legal, or compliance procedures of the Exchange Act (15 U.S.C. for reporting allegations of possible 78c(a)(34)). violations of law before or at the same (g) Appropriate regulatory authority time you reported them to the Com- means an appropriate regulatory agen- mission; the entity later provided your cy other than the Commission. information to the Commission, or pro- vided results of an audit or investiga- (h) Self-regulatory organization means tion initiated in whole or in part in re- any national securities exchange, reg- sponse to information you reported to istered securities association, reg- the entity; and the information the en- istered clearing agency, the Municipal tity provided to the Commission satis- Securities Rulemaking Board, and any fies either paragraph (c)(1) or (c)(2) of other organizations that may be de- this section. Under this paragraph fined as self-regulatory organizations (c)(3), you must also submit the same under Section 3(a)(26) of the Exchange information to the Commission in ac- Act (15 U.S.C. 78c(a)(26)). cordance with the procedures set forth § 240.21F–5 Amount of award. in § 240.21F–9 within 120 days of pro- viding it to the entity. (a) The determination of the amount (d) An action generally means a sin- of an award is in the discretion of the gle captioned judicial or administra- Commission. tive proceeding brought by the Com- (b) If all of the conditions are met for mission. Notwithstanding the fore- a whistleblower award in connection going: with a Commission action or a related (1) For purposes of making an award action, the Commission will then de- under § 240.21F–10 of this chapter, the cide the percentage amount of the Commission will treat as a Commission award applying the criteria set forth in action two or more administrative or § 240.21F–6 of this chapter and pursuant judicial proceedings brought by the to the procedures set forth in Commission if these proceedings arise §§ 240.21F–10 and 240.21F–11 of this chap- out of the same nucleus of operative ter. The amount will be at least 10 per- facts; or cent and no more than 30 percent of the (2) For purposes of determining the monetary sanctions that the Commis- payment on an award under § 240.21F–14 sion and the other authorities are able of this chapter, the Commission will to collect. The percentage awarded in deem as part of the Commission action connection with a Commission action

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may differ from the percentage award- degree of assistance provided by the ed in connection with a related action. whistleblower and any legal represent- (c) If the Commission makes awards ative of the whistleblower in the Com- to more than one whistleblower in con- mission action or related action. In nection with the same action or related considering this factor, the Commis- action, the Commission will determine sion may take into account, among an individual percentage award for other things: each whistleblower, but in no event (i) Whether the whistleblower pro- will the total amount awarded to all vided ongoing, extensive, and timely whistleblowers in the aggregate be less cooperation and assistance by, for ex- than 10 percent or greater than 30 per- ample, helping to explain complex cent of the amount the Commission or transactions, interpreting key evi- the other authorities collect. dence, or identifying new and produc- tive lines of inquiry; § 240.21F–6 Criteria for determining amount of award. (ii) The timeliness of the whistle- blower’s initial report to the Commis- In exercising its discretion to deter- sion or to an internal compliance or re- mine the appropriate award percent- porting system of business organiza- age, the Commission may consider the tions committing, or impacted by, the following factors in relation to the securities violations, where appro- unique facts and circumstances of each priate; case, and may increase or decrease the (iii) The resources conserved as a re- award percentage based on its analysis sult of the whistleblower’s assistance; of these factors. In the event that (iv) Whether the whistleblower ap- awards are determined for multiple propriately encouraged or authorized whistleblowers in connection an ac- others to assist the staff of the Com- tion, these factors will be used to de- mission who might otherwise not have termine the relative allocation of participated in the investigation or re- awards among the whistleblowers. lated action; (a) Factors that may increase the amount of a whistleblower’s award. In de- (v) The efforts undertaken by the termining whether to increase the whistleblower to remediate the harm amount of an award, the Commission caused by the violations, including as- will consider the following factors, sisting the authorities in the recovery which are not listed in order of impor- of the fruits and instrumentalities of tance. the violations; and (1) Significance of the information pro- (vi) Any unique hardships experi- vided by the whistleblower. The Commis- enced by the whistleblower as a result sion will assess the significance of the of his or her reporting and assisting in information provided by a whistle- the enforcement action. blower to the success of the Commis- (3) Law enforcement interest. The Com- sion action or related action. In consid- mission will assess its programmatic ering this factor, the Commission may interest in deterring violations of the take into account, among other things: securities laws by making awards to (i) The nature of the information pro- whistleblowers who provide informa- vided by the whistleblower and how it tion that leads to the successful en- related to the successful enforcement forcement of such laws. In considering action, including whether the reli- this factor, the Commission may take ability and completeness of the infor- into account, among other things: mation provided to the Commission by (i) The degree to which an award en- the whistleblower resulted in the con- hances the Commission’s ability to en- servation of Commission resources; force the Federal securities laws and (ii) The degree to which the informa- protect investors; and tion provided by the whistleblower sup- (ii) The degree to which an award en- ported one or more successful claims courages the submission of high qual- brought in the Commission or related ity information from whistleblowers by action. appropriately rewarding whistle- (2) Assistance provided by the whistle- blowers’ submission of significant in- blower. The Commission will assess the formation and assistance, even in cases

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where the monetary sanctions avail- tor, the Commission may take into ac- able for collection are limited or poten- count, among other things: tial monetary sanctions were reduced (i) The whistleblower’s role in the se- or eliminated by the Commission be- curities violations; cause an entity self-reported a securi- (ii) The whistleblower’s education, ties violation following the whistle- training, experience, and position of re- blower’s related internal disclosure, re- sponsibility at the time the violations port, or submission. occurred; (iii) Whether the subject matter of (iii) Whether the whistleblower acted the action is a Commission priority, with scienter, both generally and in re- whether the reported misconduct in- lation to others who participated in volves regulated entities or fiduciaries, the violations; whether the whistleblower exposed an (iv) Whether the whistleblower finan- industry-wide practice, the type and cially benefitted from the violations; severity of the securities violations, (v) Whether the whistleblower is a re- the age and duration of misconduct, cidivist; the number of violations, and the iso- (vi) The egregiousness of the under- lated, repetitive, or ongoing nature of lying fraud committed by the whistle- the violations; and blower; and (iv) The dangers to investors or oth- (vii) Whether the whistleblower ers presented by the underlying viola- knowingly interfered with the Commis- tions involved in the enforcement ac- sion’s investigation of the violations or tion, including the amount of harm or related enforcement actions. potential harm caused by the under- (2) Unreasonable reporting delay. The lying violations, the type of harm re- Commission will assess whether the sulting from or threatened by the un- whistleblower unreasonably delayed re- derlying violations, and the number of porting the securities violations. In individuals or entities harmed. considering this factor, the Commis- (4) Participation in internal compliance sion may take into account, among systems. The Commission will assess other things: whether, and the extent to which, the (i) Whether the whistleblower was whistleblower and any legal represent- aware of the relevant facts but failed ative of the whistleblower participated to take reasonable steps to report or in internal compliance systems. In con- prevent the violations from occurring sidering this factor, the Commission or continuing; may take into account, among other (ii) Whether the whistleblower was things: aware of the relevant facts but only re- (i) Whether, and the extent to which, ported them after learning about a re- a whistleblower reported the possible lated inquiry, investigation, or enforce- securities violations through internal ment action; and whistleblower, legal or compliance pro- (iii) Whether there was a legitimate cedures before, or at the same time as, reason for the whistleblower to delay reporting them to the Commission; and reporting the violations. (ii) Whether, and the extent to which, (3) Interference with internal compli- a whistleblower assisted any internal ance and reporting systems. The Com- investigation or inquiry concerning the mission will assess, in cases where the reported securities violations. whistleblower interacted with his or (b) Factors that may decrease the her entity’s internal compliance or re- amount of a whistleblower’s award. In de- porting system, whether the whistle- termining whether to decrease the blower undermined the integrity of amount of an award, the Commission such system. In considering this factor, will consider the following factors, the Commission will take into account which are not listed in order of impor- whether there is evidence provided to tance. the Commission that the whistleblower (1) Culpability. The Commission will knowingly: assess the culpability or involvement (i) Interfered with an entity’s estab- of the whistleblower in matters associ- lished legal, compliance, or audit pro- ated with the Commission’s action or cedures to prevent or delay detection related actions. In considering this fac- of the reported securities violation;

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(ii) Made any material false, ficti- (b) You may submit information to tious, or fraudulent statements or rep- the Commission anonymously. If you resentations that hindered an entity’s do so, however, you must also do the efforts to detect, investigate, or reme- following: diate the reported securities viola- (1) You must have an attorney rep- tions; and resent you in connection with both (iii) Provided any false writing or your submission of information and document knowing the writing or docu- your claim for an award, and your at- ment contained any false, fictitious or torney’s name and contact information fraudulent statements or entries that must be provided to the Commission at hindered an entity’s efforts to detect, the time you submit your information; investigate, or remediate the reported (2) You and your attorney must fol- securities violations. low the procedures set forth in § 240.21F–9 of this chapter for submit- § 240.21F–7 Confidentiality of submis- ting original information anony- sions. mously; and (a) Section 21F(h)(2) of the Exchange (3) Before the Commission will pay Act (15 U.S.C. 78u–6(h)(2)) requires that any award to you, you must disclose the Commission not disclose informa- your identity to the Commission and tion that could reasonably be expected your identity must be verified by the to reveal the identity of a whistle- Commission as set forth in § 240.21F–10 blower, except that the Commission of this chapter. may disclose such information in the following circumstances: § 240.21F–8 Eligibility. (1) When disclosure is required to a (a) To be eligible for a whistleblower defendant or respondent in connection award, you must give the Commission with a Federal court or administrative information in the form and manner action that the Commission files or in that the Commission requires. The pro- another public action or proceeding cedures for submitting information and that is filed by an authority to which making a claim for an award are de- we provide the information, as de- scribed in § 240.21F–9 through § 240.21F– scribed below; 11 of this chapter. You should read (2) When the Commission determines these procedures carefully because you that it is necessary to accomplish the need to follow them in order to be eli- purposes of the Exchange Act (15 U.S.C. gible for an award, except that the 78a) and to protect investors, it may Commission may, in its sole discretion, provide your information to the De- waive any of these procedures based partment of Justice, an appropriate upon a showing of extraordinary cir- regulatory authority, a self regulatory cumstances. organization, a state attorney general (b) In addition to any forms required in connection with a criminal inves- by these rules, the Commission may tigation, any appropriate state regu- also require that you provide certain latory authority, the Public Company additional information. You may be re- Accounting Oversight Board, or foreign quired to: securities and law enforcement au- (1) Provide explanations and other thorities. Each of these entities other assistance in order that the staff may than foreign securities and law enforce- evaluate and use the information that ment authorities is subject to the con- you submitted; fidentiality requirements set forth in (2) Provide all additional information Section 21F(h) of the Exchange Act (15 in your possession that is related to U.S.C. 78u–6(h)). The Commission will the subject matter of your submission determine what assurances of confiden- in a complete and truthful manner, tiality it deems appropriate in pro- through follow-up meetings, or in other viding such information to foreign se- forms that our staff may agree to; curities and law enforcement authori- (3) Provide testimony or other evi- ties. dence acceptable to the staff relating (3) The Commission may make dis- to whether you are eligible, or other- closures in accordance with the Pri- wise satisfy any of the conditions, for vacy Act of 1974 (5 U.S.C. 552a). an award; and

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(4) Enter into a confidentiality agree- with information about possible viola- ment in a form acceptable to the Office tions involving that person; or of the Whistleblower, covering any (ii) With the intent to evade any pro- non-public information that the Com- vision of these rules; or mission provides to you, and including (7) In your whistleblower submission, a provision that a violation of the your other dealings with the Commis- agreement may lead to your ineligi- sion, or your dealings with another au- bility to receive an award. thority in connection with a related (c) You are not eligible to be consid- action, you knowingly and willfully ered for an award if you do not satisfy make any false, fictitious, or fraudu- the requirements of paragraphs (a) and lent statement or representation, or (b) of this section. In addition, you are use any false writing or document not eligible if: knowing that it contains any false, fic- (1) You are, or were at the time you titious, or fraudulent statement or acquired the original information pro- entry with intent to mislead or other- vided to the Commission, a member, wise hinder the Commission or another officer, or employee of the Commis- authority. sion, the Department of Justice, an ap- § 240.21F–9 Procedures for submitting propriate regulatory agency, a self-reg- original information. ulatory organization, the Public Com- pany Accounting Oversight Board, or (a) To be considered a whistleblower any law enforcement organization; under Section 21F of the Exchange Act (15 U.S.C. 78u–6(h)), you must submit (2) You are, or were at the time you your information about a possible secu- acquired the original information pro- rities law violation by either of these vided to the Commission, a member, methods: officer, or employee of a foreign gov- (1) Online, through the Commission’s ernment, any political subdivision, de- Web site located at http://www.sec.gov; partment, agency, or instrumentality or of a foreign government, or any other (2) By mailing or faxing a Form TCR foreign financial regulatory authority (Tip, Complaint or Referral) (ref- as that term is defined in Section erenced in § 249.1800 of this chapter) to 3(a)(52) of the Exchange Act (15 U.S.C. the SEC Office of the Whistleblower, 78c(a)(52)); 100 F Street NE., Washington, DC (3) You are convicted of a criminal 20549–5631, Fax (703) 813–9322. violation that is related to the Com- (b) Further, to be eligible for an mission action or to a related action award, you must declare under penalty (as defined in § 240.21F–4 of this chap- of perjury at the time you submit your ter) for which you otherwise could re- information pursuant to paragraph ceive an award; (a)(1) or (2) of this section that your in- (4) You obtained the original infor- formation is true and correct to the mation that you gave the Commission best of your knowledge and belief. through an audit of a company’s finan- (c) Notwithstanding paragraphs (a) cial statements, and making a whistle- and (b) of this section, if you are pro- blower submission would be contrary viding your original information to the to requirements of Section 10A of the Commission anonymously, then your Exchange Act (15 U.S.C. 78j-a). attorney must submit your informa- (5) You are the spouse, parent, child, tion on your behalf pursuant to the or sibling of a member or employee of procedures specified in paragraph (a) of the Commission, or you reside in the this section. Prior to your attorney’s same household as a member or em- submission, you must provide your at- ployee of the Commission; torney with a completed Form TCR (6) You acquired the original infor- (referenced in § 249.1800 of this chapter) mation you gave the Commission from that you have signed under penalty of a person: perjury. When your attorney makes (i) Who is subject to paragraph (c)(4) her submission on your behalf, your at- of this section, unless the information torney will be required to certify that is not excluded from that person’s use, he or she: or you are providing the Commission (1) Has verified your identity;

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(2) Has reviewed your completed and § 240.21F–10 Procedures for making a signed Form TCR (referenced in claim for a whistleblower award in § 249.1800 of this chapter) for complete- SEC actions that result in monetary ness and accuracy and that the infor- sanctions in excess of $1,000,000. mation contained therein is true, cor- (a) Whenever a Commission action rect and complete to the best of the at- results in monetary sanctions totaling torney’s knowledge, information and more than $1,000,000, the Office of the belief; Whistleblower will cause to be pub- (3) Has obtained your non-waivable lished on the Commission’s Web site a consent to provide the Commission ‘‘Notice of Covered Action.’’ Such No- with your original completed and tice will be published subsequent to the entry of a final judgment or order that signed Form TCR (referenced in alone, or collectively with other judg- § 249.1800 of this chapter) in the event ments or orders previously entered in that the Commission requests it due to the Commission action, exceeds concerns that you may have knowingly $1,000,000; or, in the absence of such and willfully made false, fictitious, or judgment or order subsequent to the fraudulent statements or representa- deposit of monetary sanctions exceed- tions, or used any false writing or doc- ing $1,000,000 into a disgorgement or ument knowing that the writing or other fund pursuant to Section 308(b) of document contains any false fictitious the Sarbanes-Oxley Act of 2002. A or fraudulent statement or entry; and claimant will have ninety (90) days (4) Consents to be legally obligated to from the date of the Notice of Covered provide the signed Form TCR (ref- Action to file a claim for an award erenced in § 249.1800 of this chapter) based on that action, or the claim will within seven (7) calendar days of re- be barred. ceiving such request from the Commis- (b) To file a claim for a whistleblower sion. award, you must file Form WB–APP, (d) If you submitted original infor- Application for Award for Original Infor- mation in writing to the Commission mation Provided Pursuant to Section 21F after July 21, 2010 (the date of enact- of the Securities Exchange Act of 1934 ment of the Dodd-Frank Wall Street (referenced in § 249.1801 of this chapter). You must sign this form as the claim- Reform and Consumer Protection Act) ant and submit it to the Office of the but before the effective date of these Whistleblower by mail or fax. All claim rules, your submission will be deemed forms, including any attachments, to satisfy the requirements set forth in must be received by the Office of the paragraphs (a) and (b) of this section. If Whistleblower within ninety (90) cal- you were an anonymous whistleblower, endar days of the date of the Notice of however, you must provide your attor- Covered Action in order to be consid- ney with a completed and signed copy ered for an award. of Form TCR (referenced in § 249.1800 of (c) If you provided your original in- this chapter) within 60 days of the ef- formation to the Commission anony- fective date of these rules, your attor- mously, you must disclose your iden- ney must retain the signed form in his tity on the Form WB–APP (referenced or her records, and you must provide of in § 249.1801 of this chapter), and your copy of the signed form to the Commis- identity must be verified in a form and sion staff upon request by Commission manner that is acceptable to the Office staff prior to any payment of an award of the Whistleblower prior to the pay- to you in connection with your submis- ment of any award. sion. Notwithstanding the foregoing, (d) Once the time for filing any ap- you must follow the procedures and peals of the Commission’s judicial or conditions for making a claim for a administrative action has expired, or whistleblower award described in where an appeal has been filed, after all appeals in the action have been con- §§ 240.21F–10 and 240.21F–11 of this chap- cluded, the staff designated by the Di- ter. rector of the Division of Enforcement (‘‘Claims Review Staff’’) will evaluate all timely whistleblower award claims

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submitted on Form WB–APP (ref- those materials available for your re- erenced in § 249.1801 of this chapter) in view. accordance with the criteria set forth (f) If you fail to submit a timely re- in these rules. In connection with this sponse pursuant to paragraph (e) of process, the Office of the Whistleblower this section, then the Preliminary De- may require that you provide addi- termination will become the Final tional information relating to your eli- Order of the Commission (except where gibility for an award or satisfaction of the Preliminary Determination rec- any of the conditions for an award, as ommended an award, in which case the set forth in § 240.21F–(8)(b) of this chap- Preliminary Determination will be ter. Following that evaluation, the Of- deemed a Proposed Final Determina- fice of the Whistleblower will send you tion for purposes of paragraph (h) of a Preliminary Determination setting this section). Your failure to submit a forth a preliminary assessment as to timely response contesting a Prelimi- whether the claim should be allowed or nary Determination will constitute a denied and, if allowed, setting forth the failure to exhaust administrative rem- proposed award percentage amount. edies, and you will be prohibited from (e) You may contest the Preliminary pursuing an appeal pursuant to Determination made by the Claims Re- § 240.21F–13 of this chapter. view Staff by submitting a written re- (g) If you submit a timely response sponse to the Office of the Whistle- pursuant to paragraph (e) of this sec- blower setting forth the grounds for tion, then the Claims Review Staff will your objection to either the denial of consider the issues and grounds ad- an award or the proposed amount of an vanced in your response, along with award. The response must be in the any supporting documentation you form and manner that the Office of the provided, and will make its Proposed Whistleblower shall require. You may Final Determination. also include documentation or other (h) The Office of the Whistleblower evidentiary support for the grounds ad- vanced in your response. will then notify the Commission of (1) Before determining whether to each Proposed Final Determination. contest a Preliminary Determination, Within thirty 30 days thereafter, any you may: Commissioner may request that the (i) Within thirty (30) days of the date Proposed Final Determination be re- of the Preliminary Determination, re- viewed by the Commission. If no Com- quest that the Office of the Whistle- missioner requests such a review with- blower make available for your review in the 30-day period, then the Proposed the materials from among those set Final Determination will become the forth in § 240.21F–12(a) of this chapter Final Order of the Commission. In the that formed the basis of the Claims Re- event a Commissioner requests a re- view Staff’s Preliminary Determina- view, the Commission will review the tion. record that the staff relied upon in (ii) Within thirty (30) calendar days making its determinations, including of the date of the Preliminary Deter- your previous submissions to the Office mination, request a meeting with the of the Whistleblower, and issue its Office of the Whistleblower; however, Final Order. such meetings are not required and the (i) The Office of the Whistleblower office may in its sole discretion decline will provide you with the Final Order the request. of the Commission. (2) If you decide to contest the Pre- liminary Determination, you must sub- § 240.21F–11 Procedures for deter- mit your written response and sup- mining awards based upon a re- lated action. porting materials within sixty (60) cal- endar days of the date of the Prelimi- (a) If you are eligible to receive an nary Determination, or if a request to award following a Commission action review materials is made pursuant to that results in monetary sanctions to- paragraph (e)(1) of this section, then taling more than $1,000,000, you also within sixty (60) calendar days of the may be eligible to receive an award Office of the Whistleblower making based on the monetary sanctions that

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are collected from a related action (as the Office of the Whistleblower may re- defined in § 240.21F–3 of this chapter). quire that you provide additional infor- (b) You must also use Form WB–APP mation relating to your eligibility for (referenced in § 249.1801 of this chapter) an award or satisfaction of any of the to submit a claim for an award in a re- conditions for an award, as set forth in lated action. You must sign this form § 240.21F–(8)(b) of this chapter. Fol- as the claimant and submit it to the lowing this evaluation, the Office of Office of the Whistleblower by mail or the Whistleblower will send you a Pre- fax as follows: liminary Determination setting forth a (1) If a final order imposing monetary preliminary assessment as to whether sanctions has been entered in a related the claim should be allowed or denied action at the time you submit your and, if allowed, setting forth the pro- claim for an award in connection with posed award percentage amount. a Commission action, you must submit (e) You may contest the Preliminary your claim for an award in that related Determination made by the Claims Re- action on the same Form WB–APP (ref- view Staff by submitting a written re- erenced in § 249.1801 of this chapter) sponse to the Office of the Whistle- that you use for the Commission ac- blower setting forth the grounds for tion. your objection to either the denial of (2) If a final order imposing monetary an award or the proposed amount of an sanctions in a related action has not award. The response must be in the been entered at the time you submit form and manner that the Office of the your claim for an award in connection Whistleblower shall require. You may with a Commission action, you must also include documentation or other submit your claim on Form WB–APP evidentiary support for the grounds ad- (referenced in § 249.1801 of this chapter) vanced in your response. within ninety (90) days of the issuance (1) Before determining whether to of a final order imposing sanctions in contest a Preliminary Determination, the related action. you may: (c) The Office of the Whistleblower (i) Within thirty (30) days of the date may request additional information of the Preliminary Determination, re- from you in connection with your claim for an award in a related action quest that the Office of the Whistle- to demonstrate that you directly (or blower make available for your review through the Commission) voluntarily the materials from among those set provided the governmental agency, forth in § 240.21F–12(a) of this chapter regulatory authority or self-regulatory that formed the basis of the Claims Re- organization the same original infor- view Staff’s Preliminary Determina- mation that led to the Commission’s tion. successful covered action, and that this (ii) Within thirty (30) days of the date information led to the successful en- of the Preliminary Determination, re- forcement of the related action. The quest a meeting with the Office of the Office of the Whistleblower may, in its Whistleblower; however, such meetings discretion, seek assistance and con- are not required and the office may in firmation from the other agency in its sole discretion decline the request. making this determination. (2) If you decide to contest the Pre- (d) Once the time for filing any ap- liminary Determination, you must sub- peals of the final judgment or order in mit your written response and sup- a related action has expired, or if an porting materials within sixty (60) cal- appeal has been filed, after all appeals endar days of the date of the Prelimi- in the action have been concluded, the nary Determination, or if a request to Claims Review Staff will evaluate all review materials is made pursuant to timely whistleblower award claims paragraph (e)(1)(i) of this section, then submitted on Form WB–APP (ref- within sixty (60) calendar days of the erenced in § 249.1801 of this chapter) in Office of the Whistleblower making connection with the related action. those materials available for your re- The evaluation will be undertaken pur- view. suant to the criteria set forth in these (f) If you fail to submit a timely re- rules. In connection with this process, sponse pursuant to paragraph (e) of

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this section, then the Preliminary De- (ii) The final judgment, consent termination will become the Final order, or final administrative order; Order of the Commission (except where (iii) Any transcripts of the pro- the Preliminary Determination rec- ceedings, including any exhibits; ommended an award, in which case the (iv) Any items that appear on the Preliminary Determination will be docket; and deemed a Proposed Final Determina- (v) Any appellate decisions or orders. tion for purposes of paragraph (h) of (2) The whistleblower’s Form TCR this section). Your failure to submit a (referenced in § 249.1800 of this chapter), timely response contesting a Prelimi- including attachments, and other re- nary Determination will constitute a lated materials provided by the whis- failure to exhaust administrative rem- tleblower to assist the Commission edies, and you will be prohibited from with the investigation or examination; pursuing an appeal pursuant to (3) The whistleblower’s Form WB– § 240.21F–13 of this chapter. APP (referenced in § 249.1800 of this (g) If you submit a timely response chapter), including attachments, and pursuant to paragraph (e) of this sec- any other filings or submissions from tion, then the Claims Review Staff will the whistleblower in support of the consider the issues and grounds that award application; you advanced in your response, along with any supporting documentation (4) Sworn declarations (including at- you provided, and will make its Pro- tachments) from the Commission staff posed Final Determination. regarding any matters relevant to the (h) The Office of the Whistleblower award determination; will notify the Commission of each (5) With respect to an award claim in- Proposed Final Determination. Within volving a related action, any state- thirty 30 days thereafter, any Commis- ments or other information that the sioner may request that the Proposed entity provides or identifies in connec- Final Determination be reviewed by tion with an award determination, pro- the Commission. If no Commissioner vided the entity has authorized the requests such a review within the 30- Commission to share the information day period, then the Proposed Final with the claimant. (Neither the Com- Determination will become the Final mission nor the Claims Review Staff Order of the Commission. In the event may rely upon information that the en- a Commissioner requests a review, the tity has not authorized the Commis- Commission will review the record that sion to share with the claimant); and the staff relied upon in making its de- (6) Any other documents or materials terminations, including your previous including sworn declarations from submissions to the Office of the Whis- third-parties that are received or ob- tleblower, and issue its Final Order. tained by the Office of the Whistle- (i) The Office of the Whistleblower blower to assist the Commission re- will provide you with the Final Order solve the claimant’s award application, of the Commission. including information related to the claimant’s eligibility. (Neither the § 240.21F–12 Materials that may form Commission nor the Claims Review the basis of an award determina- Staff may rely upon information that tion and that may comprise the the entity has not authorized the Com- record on appeal. mission to share with the claimant). (a) The following items constitute (b) These rules do not entitle claim- the materials that the Commission and ants to obtain from the Commission the Claims Review Staff may rely upon any materials (including any pre- to make an award determination pur- decisional or internal deliberative suant to §§ 240.21F–10 and 240.21F–11 of process materials that are prepared ex- this chapter: clusively to assist the Commission in (1) Any publicly available materials deciding the claim) other than those from the covered action or related ac- listed in paragraph (a) of this section. tion, including: Moreover, the Office of the Whistle- (i) The complaint, notice of hearing, blower may make redactions as nec- answers and any amendments thereto; essary to comply with any statutory

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restrictions, to protect the Commis- § 240.21F–14 Procedures applicable to sion’s law enforcement and regulatory the payment of awards. functions, and to comply with requests (a) Any award made pursuant to for confidential treatment from other these rules will be paid from the Secu- law enforcement and regulatory au- rities and Exchange Commission Inves- thorities. The Office of the Whistle- tor Protection Fund (the ‘‘Fund’’). blower may also require you to sign a (b) A recipient of a whistleblower confidentiality agreement, as set forth award is entitled to payment on the in § 240.21F–(8)(b)(4) of this chapter, be- award only to the extent that a mone- fore providing these materials. tary sanction is collected in the Com- mission action or in a related action § 240.21F–13 Appeals. upon which the award is based. (c) Payment of a whistleblower award (a) Section 21F of the Exchange Act for a monetary sanction collected in a (15 U.S.C. 78u–6) commits determina- Commission action or related action tions of whether, to whom, and in what shall be made following the later of: amount to make awards to the Com- (1) The date on which the monetary mission’s discretion. A determination sanction is collected; or of whether or to whom to make an (2) The completion of the appeals award may be appealed within 30 days process for all whistleblower award after the Commission issues its final claims arising from: decision to the United States Court of (i) The Notice of Covered Action, in Appeals for the District of Columbia the case of any payment of an award Circuit, or to the circuit where the ag- for a monetary sanction collected in a grieved person resides or has his prin- Commission action; or cipal place of business. Where the Com- (ii) The related action, in the case of mission makes an award based on the any payment of an award for a mone- factors set forth in § 240.21F–6 of this tary sanction collected in a related ac- chapter of not less than 10 percent and tion. not more than 30 percent of the mone- (d) If there are insufficient amounts tary sanctions collected in the Com- available in the Fund to pay the entire amount of an award payment within a mission or related action, the Commis- reasonable period of time from the sion’s determination regarding the time for payment specified by para- amount of an award (including the al- graph (c) of this section, then subject location of an award as between mul- to the following terms, the balance of tiple whistleblowers, and any factual the payment shall be paid when findings, legal conclusions, policy judg- amounts become available in the Fund, ments, or discretionary assessments in- as follows: volving the Commission’s consider- (1) Where multiple whistleblowers ation of the factors in § 240.21F–6 of this are owed payments from the Fund chapter) is not appealable. based on awards that do not arise from (b) The record on appeal shall consist the same Notice of Covered Action (or of the Preliminary Determination, the related action), priority in making Final Order of the Commission, and these payments will be determined any other items from those set forth in based upon the date that the collec- § 240.21F–12(a) of this chapter that ei- tions for which the whistleblowers are ther the claimant or the Commission owed payments occurred. If two or identifies for inclusion in the record. more of these collections occur on the The record on appeal shall not include same date, those whistleblowers owed any pre-decisional or internal delibera- payments based on these collections tive process materials that are pre- will be paid on a pro rata basis until pared exclusively to assist the Com- sufficient amounts become available in the Fund to pay their entire payments. mission in deciding the claim (includ- (2) Where multiple whistleblowers ing the staff’s Draft Final Determina- are owed payments from the Fund tion in the event that the Commis- based on awards that arise from the sioners reviewed the claim and issued same Notice of Covered Action (or re- the Final Order). lated action), they will share the same

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payment priority and will be paid on a ments dealing with information cov- pro rata basis until sufficient amounts ered by § 240.21F–4(b)(4)(i) and § 240.21F– become available in the Fund to pay 4(b)(4)(ii) of this chapter related to the their entire payments. legal representation of a client) with respect to such communications. § 240.21F–15 No amnesty. (b) If you are a director, officer, The Securities Whistleblower Incen- member, agent, or employee of an enti- tives and Protection provisions do not ty that has counsel, and you have initi- provide amnesty to individuals who ated communication with the Commis- provide information to the Commis- sion relating to a possible securities sion. The fact that you may become a law violation, the staff is authorized to whistleblower and assist in Commis- communicate directly with you regard- sion investigations and enforcement ing the possible securities law viola- actions does not preclude the Commis- tion without seeking the consent of the sion from bringing an action against entity’s counsel. you based upon your own conduct in connection with violations of the Fed- INSPECTION AND PUBLICATION OF eral securities laws. If such an action is INFORMATION FILED UNDER THE ACT determined to be appropriate, however, the Commission will take your co- § 240.24b–1 Documents to be kept pub- lic by exchanges. operation into consideration in accord- ance with its Policy Statement Con- Upon action of the Commission cerning Cooperation by Individuals in granting an exchange’s application for Investigations and Related Enforce- registration or exemption, the ex- ment Actions (17 CFR 202.12). change shall make available to public inspection at its offices during reason- § 240.21F–16 Awards to whistleblowers able office hours a copy of the state- who engage in culpable conduct. ment and exhibits filed with the Com- In determining whether the required mission (including any amendments $1,000,000 threshold has been satisfied thereto) except those portions thereof (this threshold is further explained in to the disclosure of which the exchange § 240.21F–10 of this chapter) for purposes shall have filed objection pursuant to of making any award, the Commission § 240.24b–2 which objection shall not will not take into account any mone- have been overruled by the Commission tary sanctions that the whistleblower pursuant to section 24(b) of the Act. is ordered to pay, or that are ordered (Sec. 24, 48 Stat. 901; 15 U.S.C. 78x) against any entity whose liability is based substantially on conduct that CROSS REFERENCE: For regulations relating the whistleblower directed, planned, or to registration and exemption of exchanges, see §§ 240.6a–1 to 240.6a–3. initiated. Similarly, if the Commission determines that a whistleblower is eli- [13 FR 8214, Dec. 22, 1948] gible for an award, any amounts that the whistleblower or such an entity § 240.24b–2 Nondisclosure of informa- tion filed with the Commission and pay in sanctions as a result of the ac- with any exchange. tion or related actions will not be in- cluded within the calculation of the PRELIMINARY NOTE: Confidential treatment amounts collected for purposes of mak- requests shall be submitted in paper format ing payments. only, whether or not the filer is required to submit a filing in electronic format. § 240.21F–17 Staff communications (a) Any person filing any registration with individuals reporting possible statement, report, application, state- securities law violations. ment, correspondence, notice or other (a) No person may take any action to document (herein referred to as the impede an individual from commu- material filed) pursuant to the Act nicating directly with the Commission may make written objection to the staff about a possible securities law public disclosure of any information violation, including enforcing, or contained therein in accordance with threatening to enforce, a confiden- the procedure set forth below. The pro- tiality agreement (other than agree- cedure provided in this rule shall be

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the results of operations included pursuant to the rules and regulations of the Commission; (D) any statement of the assumptions underlying or relating to any statement described in subparagraph (A), (B), or (C); (E) any report issued by an outside reviewer retained by an issuer, to the extent that the report assesses a forward- looking statement made by the issuer; or (F) a statement containing a projection or estimate of such other items as may be specified by rule or regulation of the Commission. (2) INVESTMENT COMPANY.—The term ‘‘investment com­ pany’’ has the same meaning as in section 3(a) of the Invest­ ment Company Act of 1940. (3) GOING PRIVATE TRANSACTION.—The term ‘‘going private transaction’’ has the meaning given that term under the rules or regulations of the Commission issued pursuant to section 13(e). (4) PERSON ACTING ON BEHALF OF AN ISSUER.—The term ‘‘person acting on behalf of an issuer’’ means any officer, direc­ tor, or employee of such issuer. (5) OTHER TERMS.—The terms ‘‘blank check company’’, ‘‘rollup transaction’’, ‘‘partnership’’, ‘‘limited liability company’’, ‘‘executive officer of an entity’’ and ‘‘direct participation invest­ ment program’’, have the meanings given those terms by rule or regulation of the Commission.

(June 6, 1934, ch. 404, title I, Sec. 21E, as added Pub. L. 104-67, title I, Sec. 102(b), Dec. 22, 1995, 109 Stat. 753.)

SEC. 21F. SECURITIES WHISTLEBLOWER INCENTIVES AND PROTEC­ TION. (a) DEFINITIONS.—In this section the following definitions shall apply: (1) COVERED JUDICIAL OR ADMINISTRATIVE ACTION.—The term ‘‘covered judicial or administrative action’’ means any ju­ dicial or administrative action brought by the Commission under the securities laws that results in monetary sanctions exceeding $1,000,000. (2) FUND.—The term ‘‘Fund’’ means the Securities and Ex­ change Commission Investor Protection Fund. (3) ORIGINAL INFORMATION.—The term ‘‘original informa­ tion’’ means information that— (A) is derived from the independent knowledge or analysis of a whistleblower; (B) is not known to the Commission from any other source, unless the whistleblower is the original source of the information; and (C) is not exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report, hearing, audit, or investigation, or from the news media, unless the whistleblower is a source of the informa­ tion. 327 SECURITIES EXCHANGE ACT OF 1934 Sec. 21F

(4) MONETARY SANCTIONS.—The term ‘‘monetary sanc­ tions’’, when used with respect to any judicial or administra­ tive action, means— (A) any monies, including penalties, disgorgement, and interest, ordered to be paid; and (B) any monies deposited into a disgorgement fund or other fund pursuant to section 308(b) of the Sarbanes- Oxley Act of 2002 (15 U.S.C. 7246(b)), as a result of such action or any settlement of such action. (5) RELATED ACTION.—The term ‘‘related action’’, when used with respect to any judicial or administrative action brought by the Commission under the securities laws, means any judicial or administrative action brought by an entity de­ scribed in subclauses (I) through (IV) of subsection (h)(2)(D)(i) that is based upon the original information provided by a whis­ tleblower pursuant to subsection (a) that led to the successful enforcement of the Commission action. (6) WHISTLEBLOWER.—The term ‘‘whistleblower’’ means any individual who provides, or 2 or more individuals acting jointly who provide, information relating to a violation of the securities laws to the Commission, in a manner established, by rule or regulation, by the Commission. (b) AWARDS.— (1) IN GENERAL.—In any covered judicial or administrative action, or related action, the Commission, under regulations prescribed by the Commission and subject to subsection (c), shall pay an award or awards to 1 or more whistleblowers who voluntarily provided original information to the Commission that led to the successful enforcement of the covered judicial or administrative action, or related action, in an aggregate amount equal to— (A) not less than 10 percent, in total, of what has been collected of the monetary sanctions imposed in the action or related actions; and (B) not more than 30 percent, in total, of what has been collected of the monetary sanctions imposed in the ac­ tion or related actions. (2) PAYMENT OF AWARDS.—Any amount paid under para­ graph (1) shall be paid from the Fund. (c) DETERMINATION OF AMOUNT OF AWARD; DENIAL OF AWARD.— (1) DETERMINATION OF AMOUNT OF AWARD.— (A) DISCRETION.—The determination of the amount of an award made under subsection (b) shall be in the discre­ tion of the Commission. (B) CRITERIA.—In determining the amount of an award made under subsection (b), the Commission— (i) shall take into consideration— (I) the significance of the information pro­ vided by the whistleblower to the success of the covered judicial or administrative action; (II) the degree of assistance provided by the whistleblower and any legal representative of the Sec. 21F SECURITIES EXCHANGE ACT OF 1934 328

whistleblower in a covered judicial or administra­ tive action; (III) the programmatic interest of the Com­ mission in deterring violations of the securities laws by making awards to whistleblowers who provide information that lead to the successful en­ forcement of such laws; and (IV) such additional relevant factors as the Commission may establish by rule or regulation; and (ii) shall not take into consideration the balance of the Fund. (2) DENIAL OF AWARD.—No award under subsection (b) shall be made— (A) to any whistleblower who is, or was at the time the whistleblower acquired the original information submitted to the Commission, a member, officer, or employee of— (i) an appropriate regulatory agency; (ii) the Department of Justice; (iii) a self-regulatory organization; (iv) the Public Company Accounting Oversight Board; or (v) a law enforcement organization; (B) to any whistleblower who is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower otherwise could receive an award under this section; (C) to any whistleblower who gains the information through the performance of an audit of financial state­ ments required under the securities laws and for whom such submission would be contrary to the requirements of section 10A of the Securities Exchange Act of 1934 (15 U.S.C. 78j-1); or (D) to any whistleblower who fails to submit informa­ tion to the Commission in such form as the Commission may, by rule, require. (d) REPRESENTATION.— (1) PERMITTED REPRESENTATION.—Any whistleblower who makes a claim for an award under subsection (b) may be rep­ resented by counsel. (2) REQUIRED REPRESENTATION.— (A) IN GENERAL.—Any whistleblower who anony­ mously makes a claim for an award under subsection (b) shall be represented by counsel if the whistleblower anony­ mously submits the information upon which the claim is based. (B) DISCLOSURE OF IDENTITY.—Prior to the payment of an award, a whistleblower shall disclose the identity of the whistleblower and provide such other information as the Commission may require, directly or through counsel for the whistleblower. (e) NO CONTRACT NECESSARY.—No contract with the Commis­ sion is necessary for any whistleblower to receive an award under 329 SECURITIES EXCHANGE ACT OF 1934 Sec. 21F subsection (b), unless otherwise required by the Commission by rule or regulation. (f) APPEALS.—Any determination made under this section, in­ cluding whether, to whom, or in what amount to make awards, shall be in the discretion of the Commission. Any such determina­ tion, except the determination of the amount of an award if the award was made in accordance with subsection (b), may be ap­ pealed to the appropriate court of appeals of the United States not more than 30 days after the determination is issued by the Com­ mission. The court shall review the determination made by the Commission in accordance with section 706 of title 5, United States Code. (g) INVESTOR PROTECTION FUND.— (1) FUND ESTABLISHED.—There is established in the Treas­ ury of the United States a fund to be known as the ‘‘Securities and Exchange Commission Investor Protection Fund’’. (2) USE OF FUND.—The Fund shall be available to the Commission, without further appropriation or fiscal year limi­ tation, for— (A) paying awards to whistleblowers as provided in subsection (b); and (B) funding the activities of the Inspector General of the Commission under section 4(i). (3) DEPOSITS AND CREDITS.— (A) IN GENERAL.—There shall be deposited into or credited to the Fund an amount equal to— (i) any monetary sanction collected by the Com­ mission in any judicial or administrative action brought by the Commission under the securities laws that is not added to a disgorgement fund or other fund under section 308 of the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7246) or otherwise distributed to victims of a violation of the securities laws, or the rules and reg­ ulations thereunder, underlying such action, unless the balance of the Fund at the time the monetary sanction is collected exceeds $300,000,000; (ii) any monetary sanction added to a disgorgement fund or other fund under section 308 of the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7246) that is not distributed to the victims for whom the Fund was established, unless the balance of the disgorgement fund at the time the determination is made not to distribute the monetary sanction to such victims exceeds $200,000,000; and (iii) all income from investments made under paragraph (4). (B) ADDITIONAL AMOUNTS.—If the amounts deposited into or credited to the Fund under subparagraph (A) are not sufficient to satisfy an award made under subsection (b), there shall be deposited into or credited to the Fund an amount equal to the unsatisfied portion of the award from any monetary sanction collected by the Commission Sec. 21F SECURITIES EXCHANGE ACT OF 1934 330

in the covered judicial or administrative action on which the award is based. (4) INVESTMENTS.— (A) AMOUNTS IN FUND MAY BE INVESTED.—The Com­ mission may request the Secretary of the Treasury to in­ vest the portion of the Fund that is not, in the discretion of the Commission, required to meet the current needs of the Fund. (B) ELIGIBLE INVESTMENTS.—Investments shall be made by the Secretary of the Treasury in obligations of the United States or obligations that are guaranteed as to principal and interest by the United States, with matu­ rities suitable to the needs of the Fund as determined by the Commission on the record. (C) INTEREST AND PROCEEDS CREDITED.—The interest on, and the proceeds from the sale or redemption of, any obligations held in the Fund shall be credited to the Fund. (5) REPORTS TO CONGRESS.—Not later than October 30 of each fiscal year beginning after the date of enactment of this subsection, the Commission shall submit to the Committee on Banking, Housing, and Urban Affairs of the Senate, and the Committee on Financial Services of the House of Representa­ tives a report on— (A) the whistleblower award program, established under this section, including— (i) a description of the number of awards granted; and (ii) the types of cases in which awards were grant­ ed during the preceding fiscal year; (B) the balance of the Fund at the beginning of the preceding fiscal year; (C) the amounts deposited into or credited to the Fund during the preceding fiscal year; (D) the amount of earnings on investments made under paragraph (4) during the preceding fiscal year; (E) the amount paid from the Fund during the pre­ ceding fiscal year to whistleblowers pursuant to subsection (b); (F) the balance of the Fund at the end of the preceding fiscal year; and (G) a complete set of audited financial statements, in­ cluding— (i) a balance sheet; (ii) income statement; and (iii) cash flow analysis. (h) PROTECTION OF WHISTLEBLOWERS.— (1) PROHIBITION AGAINST RETALIATION.— (A) IN GENERAL.—No employer may discharge, demote, suspend, threaten, harass, directly or indirectly, or in any other manner discriminate against, a whistleblower in the terms and conditions of employment because of any lawful act done by the whistleblower— (i) in providing information to the Commission in accordance with this section; 331 SECURITIES EXCHANGE ACT OF 1934 Sec. 21F

(ii) in initiating, testifying in, or assisting in any investigation or judicial or administrative action of the Commission based upon or related to such informa­ tion; or (iii) in making disclosures that are required or protected under the Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201 et seq.), the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.), including section 10A(m) of such Act (15 U.S.C. 78f(m) [107]), section 1513(e) of title 18, United States Code, and any other law, rule, or regulation subject to the jurisdiction of the Commis­ sion. (B) ENFORCEMENT.— (i) CAUSE OF ACTION.—An individual who alleges discharge or other discrimination in violation of sub­ paragraph (A) may bring an action under this sub­ section in the appropriate district court of the United States for the relief provided in subparagraph (C). (ii) SUBPOENAS.—A subpoena requiring the at­ tendance of a witness at a trial or hearing conducted under this section may be served at any place in the United States. (iii) STATUTE OF LIMITATIONS.— (I) IN GENERAL.—An action under this sub­ section may not be brought— (aa) more than 6 years after the date on which the violation of subparagraph (A) oc­ curred; or (bb) more than 3 years after the date when facts material to the right of action are known or reasonably should have been known by the employee alleging a violation of sub­ paragraph (A). (II) REQUIRED ACTION WITHIN 10 YEARS.— Not­ withstanding subclause (I), an action under this subsection may not in any circumstance be brought more than 10 years after the date on which the violation occurs. (C) RELIEF.—Relief for an individual prevailing in an action brought under subparagraph (B) shall include— (i) reinstatement with the same seniority status that the individual would have had, but for the dis­ crimination; (ii) 2 times the amount of back pay otherwise owed to the individual, with interest; and (iii) compensation for litigation costs, expert wit­ ness fees, and reasonable attorneys’ fees. (2) CONFIDENTIALITY.— (A) IN GENERAL.—Except as provided in subpara­ graphs (B) and (C), the Commission and any officer or em­ ployee of the Commission shall not disclose any informa­ tion, including information provided by a whistleblower to

107So in original. Probably should be ‘‘78j-1(m)’’. Sec. 21F SECURITIES EXCHANGE ACT OF 1934 332

the Commission, which could reasonably be expected to re­ veal the identity of a whistleblower, except in accordance with the provisions of section 552a of title 5, United States Code, unless and until required to be disclosed to a defend­ ant or respondent in connection with a public proceeding instituted by the Commission or any entity described in subparagraph (C). For purposes of section 552 of title 5, United States Code, this paragraph shall be considered a statute described in subsection (b)(3)(B) of such section. (B) EXEMPTED STATUTE.—For purposes of section 552 of title 5, United States Code, this paragraph shall be con­ sidered a statute described in subsection (b)(3)(B) of such section 552. (C) RULE OF CONSTRUCTION.—Nothing in this section is intended to limit, or shall be construed to limit, the abil­ ity of the Attorney General to present such evidence to a grand jury or to share such evidence with potential wit­ nesses or defendants in the course of an ongoing criminal investigation. (D) AVAILABILITY TO GOVERNMENT AGENCIES.— (i) IN GENERAL.—Without the loss of its status as confidential in the hands of the Commission, all infor­ mation referred to in subparagraph (A) may, in the discretion of the Commission, when determined by the Commission to be necessary to accomplish the pur­ poses of this Act and to protect investors, be made available to— (I) the Attorney General of the United States; (II) an appropriate regulatory authority; (III) a self-regulatory organization; (IV) a State attorney general in connection with any criminal investigation; (V) any appropriate State regulatory author­ ity; (VI) the Public Company Accounting Over­ sight Board; (VII) a foreign securities authority; and (VIII) a foreign law enforcement authority. (ii) CONFIDENTIALITY.— (I) IN GENERAL.—Each of the entities de­ scribed in subclauses (I) through (VI) of clause (i) shall maintain such information as confidential in accordance with the requirements established under subparagraph (A). (II) FOREIGN AUTHORITIES.—Each of the enti­ ties described in subclauses (VII) and (VIII) of clause (i) shall maintain such information in ac­ cordance with such assurances of confidentiality as the Commission determines appropriate. (3) RIGHTS RETAINED.—Nothing in this section shall be deemed to diminish the rights, privileges, or remedies of any whistleblower under any Federal or State law, or under any collective bargaining agreement. 333 SECURITIES EXCHANGE ACT OF 1934 Sec. 23

(i) PROVISION OF FALSE INFORMATION.—A whistleblower shall not be entitled to an award under this section if the whistle- blower— (1) knowingly and willfully makes any false, fictitious, or fraudulent statement or representation; or (2) uses any false writing or document knowing the writing or document contains any false, fictitious, or fraudulent state­ ment or entry. (j) RULEMAKING AUTHORITY.—The Commission shall have the authority to issue such rules and regulations as may be necessary or appropriate to implement the provisions of this section con­ sistent with the purposes of this section.

(June 6, 1934, ch. 404, title I, Sec. 21F, as added Pub. L. 111-203, title IX, Sec. 922(a), July 21, 2010, 124 Stat. 1841.)

HEARINGS BY COMMISSION SEC. 22. Hearings may be public and may be held before the Commission, any member or members thereof, or any officer or offi­ cers of the Commission designated by it, and appropriate records thereof shall be kept.

(June 6, 1934, ch. 404, title I, Sec. 22, 48 Stat. 901.)

RULES, REGULATIONS, AND ORDERS; ANNUAL REPORTS SEC. 23. (a)(1) The Commission, the Board of Governors of the Federal Reserve System, and the other agencies enumerated in sec­ tion 3(a)(34) of this title shall each have power to make such rules and regulations as may be necessary or appropriate to implement the provisions of this title for which they are responsible or for the execution of the functions vested in them by this title, and may for such purposes classify persons, securities, transactions, statements, applications, reports, and other matters within their respective ju­ risdictions, and prescribe greater, lesser, or different requirements for different classes thereof. No provision of this title imposing any liability shall apply to any act done or omitted in good faith in con­ formity with a rule, regulation, or order of the Commission, the Board of Governors of the Federal Reserve System, other agency enumerated in section 3(a)(34) of this title, or any self-regulatory organization, notwithstanding that such rule, regulation, or order may thereafter be amended or rescinded or determined by judicial or other authority to be invalid for any reason. (2) The Commission and the Secretary of the Treasury, in mak­ ing rules and regulations pursuant to any provisions of this title, shall consider among other matters the impact any such rule or regulation would have on competition. The Commission and the Secretary of the Treasury shall not adopt any such rule or regula­ tion which would impose a burden on competition not necessary or appropriate in furtherance of the purposes of this title. The Com­ mission and the Secretary of the Treasury shall include in the statement of basis and purpose incorporated in any rule or regula­

May 20, 2011

The Honorable Mary L. Schapiro Chairman U.S. Securities and Exchange Commission 100 F Street, N.E. Washington, DC 20549-1090

Re: Preserving the Attorney-Client Privilege and the Lawyer’s Existing Duty to Maintain Client Confidentiality in the Commission’s Proposed Rules for Implementing the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934; File No. S7-33-10; Release No. 34-63237

Dear Chairman Schapiro:

On behalf of the American Bar Association, which has nearly 400,000 members, I urge you and your fellow Commissioners to ensure that the final version of the SEC’s proposed rules for implementing the whistleblower provisions of Section 21F of the Securities Exchange Act of 1934 referenced above (the “Proposed Rules”)1 continues to adequately protect the attorney-client privilege, the confidential attorney-client relationship, and the fundamental right to effective counsel. In particular, I would like to address an important aspect of the Proposed Rules that is essential to maintaining our system of justice and of concern to all lawyers: the implications of the Proposed Rules to the lawyer’s duty to maintain and preserve client confidentiality.

The ABA appreciates that, in proposing the rules, the Commission remained sensitive to these concerns and understood that providing whistleblower awards to lawyers who disclose privileged information they have received from clients during the course of their professional engagement creates significant ethical issues and could undermine clients’ fundamental attorney-client privilege and work product protections. Unfortunately, at least one recent commenter has suggested that the Commission’s proposed exclusions of lawyers from eligibility for whistleblower awards are overly broad and that the final rules should allow lawyers to receive such awards under circumstances that we believe would violate their clear ethical duties and professional responsibilities.

1 On January 4, 2011, the ABA Business Law Section’s Federal Regulation of Securities Committee (the “Committee”) submitted a detailed comment letter to the SEC regarding the Proposed Rules, which is available at http://sec.gov/comments/s7-33-10/s73310-253.pdf. Although the Committee’s comments were not approved by the ABA House of Delegates or Board of Governors and hence represent the views of the Committee only, the ABA strongly agrees with the Committee that the Proposed Rules must not result in the violation of any existing lawyer professional obligations, including the obligation to maintain client confidences. See, e.g., the Committee’s comments at page 8.

The Honorable Mary L. Schapiro May 20, 2011 Page 2

The ABA has serious concerns regarding these suggested changes to the Proposed Rules, and we believe that the arguments underlying the suggestions are flawed in a number of respects.

First, the commenter has suggested that, rather than disqualifying a class of lawyers from award eligibility, the Commission should instead limit the exclusion to specific information that is privileged, while still allowing the lawyer providing information to receive a whistleblower award. The ABA believes that these proposals mischaracterize the scope and extent of a lawyer’s legal duty to preserve client confidences.

The confidential relationship between the client and the lawyer is sacred, and lawyers are ethically bound to maintain all confidential client information, not just that which is privileged or protected by the work product doctrine. Court rulings allowing the government to obtain and use non- privileged information from whistleblowers do so in the context of information not arising from the confidential lawyer-client relationship; the lawyer is never allowed to be the source of confidential client information, except in very narrow circumstances. Thus, our professional rules extend more broadly to any information relating to a representation. Comments [2] and [3] to Rule 1.6 of the American Bar Association’s Model Rules of Professional Conduct (the “Model Rules”), which clearly set forth the scope and extent of the lawyer’s duty to preserve client confidentiality, provide as follows:

A fundamental principle in the client-lawyer relationship is that, in the absence of the client's informed consent, the lawyer must not reveal information relating to the representation. …. This contributes to the trust that is the hallmark of the client-lawyer relationship. The client is thereby encouraged to seek legal assistance and to communicate fully and frankly with the lawyer even as to embarrassing or legally damaging subject matter. The lawyer needs this information to represent the client effectively and, if necessary, to advise the client to refrain from wrongful conduct. Almost without exception, clients come to lawyers in order to determine their rights and what is, in the complex of laws and regulations, deemed to be legal and correct. Based upon experience, lawyers know that almost all clients follow the advice given, and the law is upheld.

The principle of client-lawyer confidentiality is given effect by related bodies of law: the attorney-client privilege, the work product doctrine and the rule of confidentiality established in professional ethics. The attorney-client privilege and work-product doctrine apply in judicial and other proceedings in which a lawyer may be called as a witness or otherwise required to produce evidence concerning a client. The rule of client-lawyer confidentiality applies in situations other than those where evidence is sought from the lawyer through compulsion of law. The confidentiality rule, for example, applies not only to matters communicated in confidence by the client but also to all information relating to the representation, whatever its source. A lawyer may not disclose such information except as authorized or required by the Rules of Professional Conduct or other law.

Second, the ABA disagrees with the suggestion that excluding all lawyers in a retained law firm from eligibility for whistleblower awards—even those who may not have individual knowledge of the represented client—inappropriately limits potential sources of information. It is an established

The Honorable Mary L. Schapiro May 20, 2011 Page 3

principle of professional responsibility that when a client engages a law firm, all of the firm’s lawyers owe a range of professional duties to the client. These include, among other things, maintaining client confidences, as well as compliance with rules relating to conflicts of interest. A lawyer at a law firm, who becomes aware of confidential information regarding a firm client by reason of his or her work at the firm, is clearly not entitled to disclose that information to third parties just because the lawyer has not personally worked for that client and has no individual knowledge of the client. We are also of the view that significant issues are implicated if an attorney who independently obtains information regarding misconduct involving a firm client discloses that information as a whistleblower rather than considering his or her professional obligations to disclose such information to the client.2 The ABA believes that such a position would undermine the client’s expectations of confidentiality and professional responsibility, and could chill client communications with lawyers, harming the confidential lawyer-client relationship.

Third, the ABA opposes the suggested changes to the Proposed Rules because allowing a lawyer to receive a whistleblower award as a result of a breach of his or her duty of confidentiality to a client would create an objectionable conflict of interest. Rule 1.8 of the Model Rules provides that, subject to certain exceptions, “a lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client.” In their representation of clients, lawyers should be focused solely on providing the most competent and professionally responsible representation, not on the benefits they may obtain were they to use for personal gain the information they have been provided by their clients.

The ABA is concerned that any provisions in the final rules that would entitle whistleblowers to collect substantial awards may create a strong incentive for a lawyer to compromise his or her ethical obligations and undermine the client confidence that the U.S. Supreme Court recognized in the Upjohn case as critical to assuring the continued effectiveness of the attorney-client privilege and the work product doctrine. A client’s awareness that its attorneys may use information provided confidentially to obtain large whistleblower awards could well prevent the free flow of information necessary to the client’s right to effective counsel.

Even if this is not likely to occur on a frequent basis, publicity about lawyers who have breached their professional obligations in order to obtain whistleblower awards may cause clients to reconsider the scope of the information they are willing to disclose to counsel, to the ultimate detriment of the quality of the legal representation counsel can provide. Rather than seeking to mine the information known to lawyers as a result of their confidential client relationships, the

2 We note that such conduct would also be inconsistent with Section 205.3(b) of the Commission’ attorney conduct rules, which provides that “If an attorney, appearing and practicing before the Commission in the representation of an issuer, becomes aware of evidence of a material violation by the issuer or by any officer, director, employee, or agent of the issuer, the attorney shall report such evidence to the issuer's chief legal officer (or the equivalent thereof) or to both the issuer's chief legal officer and its chief executive officer (or the equivalents thereof) forthwith.” In addition, many law firms have internal policies, applicable to all attorneys in the firm, dealing with attorney conduct relating to firm clients. These policies have been implemented in order to permit the firms to satisfy their legal and professional obligations to their clients.

The Honorable Mary L. Schapiro May 20, 2011 Page 4

Commission, in its final rules, should seek to protect the significant policy goals that confidentiality promotes.

We greatly appreciate the concern that the Commission has shown in many of its past policies to assure protection of client confidentiality, attorney-client privilege, and work product. As the Supreme Court noted in Upjohn, an uncertain privilege is little better than no privilege at all. Suggestions that attorneys can use information gained from their client relationships for the attorneys’ own personal benefit would undermine the effectiveness of the privilege, deny the client’s right to effective counsel, and would be contrary to the clear case law prohibiting such a use of confidential client information. We therefore urge the Commission to continue to be sensitive to this potential conflict in connection with its rulemaking.

Thank you for considering the views of the American Bar Association on this subject, which is of vital importance to our system of justice. If you have any questions regarding the ABA’s concerns, please contact our Governmental Affairs Director, Thomas Susman, at (202) 662-1765, or the Chair of the ABA Business Law Section’s Federal Regulation of Securities Committee, Jeffrey Rubin, at (212) 918-8224.

Sincerely,

Stephen N. Zack cc: The Honorable Luis A. Aguilar, Commissioner The Honorable Kathleen L. Casey, Commissioner The Honorable Troy A. Paredes, Commissioner The Honorable Elisse B. Walter, Commissioner Mark Cahn, General Counsel Robert Khuzami, Director, Division of Enforcement SEC Speech: Adoption of Rules for Implementing the Whistleblower Provi... Page 1 of 4

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Statement by SEC Commissioner: Adoption of Rules for Implementing the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934

by

Commissioner Kathleen L. Casey

U.S. Securities and Exchange Commission

Open Meeting Washington, D.C. May 25, 2011

Thank you, Chairman Schapiro. I’d also like to thank the staff working on today’s rule for their efforts over the past several months. Without a doubt, crafting an effective and efficient whistleblower program of this magnitude is a significant challenge, and the staff involved with this rule have tried very hard to meet that challenge.

Notwithstanding their efforts, however, I am afraid that the program being adopted today materially suffers in key respects and makes it less likely that our whistleblower program will be successful in meeting the important goals of prevention, timely detection, and effective enforcement of securities law violations.

Most fundamentally, the rule suffers in two overarching ways:

(1) It significantly underestimates the negative impact on internal compliance programs; and

(2) It significantly overestimates our capacity to effectively triage and manage whistleblower complaints.

As I mentioned at the proposing stage, the whistleblower provisions of the Dodd-Frank statute are particularly challenging to implement because of the important and sometimes conflicting public policy interests that are at stake: in particular, between promoting robust internal compliance reporting programs and encouraging high quality tips from whistleblowers. It is a delicate balancing act. And, striking the right balance between these at times competing interests is imperative because there are trade offs that affect the overall effectiveness and efficiency of our enforcement efforts, as both play an important role in our investor protection scheme.

In our proposing release, the Commission noted the importance that the securities laws and our enforcement efforts place on robust internal http://www.sec.gov/news/speech/2011/spch052511klc-item2.htm 12/1/2012 SEC Speech: Adoption of Rules for Implementing the Whistleblower Provi... Page 2 of 4

compliance programs; it highlighted concerns that large whistleblower financial incentives might unduly undermine these useful and complementary resources and functions; and it queried how best to approach the task of balancing these interests.

While I appreciate that today’s release seeks to provide additional incentives for whistleblowers to use internal reporting channels, I remain deeply concerned that they are not sufficient to preserve the value of internal compliance programs and their contribution to our enforcement efforts.

An inherent risk of the approach adopted in the final rule, is that the monetary sums at stake will provide a significant enough incentive for whistleblowers to completely bypass internal reporting in favor of coming straight to the Commission. A fundamental failure of today’s release is that it underestimates this dynamic and the ensuing impact on internal compliance reporting mechanisms.

Corporate compliance programs depend on a robust flow of information in order to be effective. Indeed, information is the lifeblood of such programs. Diverting a large portion of that flow of information to the government will impair companies’ ability to step in and interrupt violations at an early stage. This does not benefit investors, and it is at odds with the purposes of the securities laws.

Reporting such information exclusively to our Division of Enforcement will not have the same effect as reporting such information to a company’s internal compliance program. Unlike a company engaged in the act of self- policing, the Division must observe numerous legal formalities that are required of government actors. As a consequence, the public investigative process can be substantially more ponderous and time-consuming than private investigative processes. And there is a danger in not addressing matters quickly and decisively. By diverting tips and complaints from private channels to the Commission, we may end up permitting violations to last longer and grow more serious. This cannot be the result intended by Congress in creating the Dodd-Frank whistleblower program.

Indeed, I fear the Commission has elected to implement a whistleblower program that favors a pound of cure over an ounce of prevention.

The Division of Enforcement’s task will only get harder once it starts to receive more and more whistleblower complaints. The volume of these complaints will surely grow as we begin writing some very large checks to successful whistleblowers, which has been the experience of the Justice Department in the False Claims Act area.

This leads me to a second fundamental failure of today’s release: namely, it overestimates the ability of the Division of Enforcement to triage and manage incoming tips and complaints. Any triage process like this will be challenging, and a high-volume flow of information will strain our existing triage resources. The staff has assured me that they’ll be able to handle the incoming flow of complaints, but I fear they are not being adequately circumspect.

Complex regulatory programs inevitably have unintended consequences, http://www.sec.gov/news/speech/2011/spch052511klc-item2.htm 12/1/2012 SEC Speech: Adoption of Rules for Implementing the Whistleblower Provi... Page 3 of 4

and too little has been done here to anticipate and prepare for such eventualities. A better course, in my view, would have been to adopt some form of contemporaneous reporting to both the Commission and to internal compliance programs, thereby ensuring a greater degree of confidence that potential securities law violations would be timely detected and acted upon without sacrificing the prerogative of the Commission to act as it sees fit in any given case. Indeed, such an approach would have been more incremental in nature, and it would have given the Commission an opportunity to evaluate its program in operation before taking decisions that could irreversibly damage valuable corporate compliance mechanisms.

Today’s release suffers from other notable weaknesses as well.

One such weakness relates to the treatment of information provided by attorneys in order to obtain a whistleblower award. Permitting attorneys to be freely eligible for such awards would undermine the attorney-client privilege and have far-reaching, unpredictable consequences. The release has acknowledged as much, noting the importance of protecting the attorney-client privilege. Accordingly, at least in the first instance, the rule excludes information obtained through attorney-client privileged communications from the definition of “independent knowledge” or “independent analysis.”

This would appear, at first glance, to prevent attorneys from breaching their duties of loyalty and confidence by becoming whistleblowers. However, what the rule gives with one hand, it appears to take away with the other. The above exclusion will not apply where the attorney whistleblower has a reasonable basis to believe that disclosure of the privileged information is necessary to prevent substantial injury to the financial interest or property of investors.1

This exception utterly swallows the rule. Many, if not most, potential securities law violations can be characterized as threatening substantial financial injury to investors and our natural instinct will be to interpret this provision liberally. Thus, this exception to the attorney exclusion will have the effect of allowing attorneys to breach their duties of trust and confidence to their clients, thereby undermining the very privilege that the rule purports to protect.

Finally, while there are equally difficult issues concerning other parts of the rule, I would like to focus on just one of them by revisiting an issue I’ve discussed in a variety of contexts, including last week’s proposal of rules concerning nationally recognized statistical ratings organizations. The Commission has taken the view that it is only required to analyze costs and benefits flowing from the Commission’s exercise of its discretionary authority. This approach is too narrow and improperly limits the scope and regulatory value of cost-benefit analysis. In the context of the current rule, this approach has led us to drastically underestimate the costs of the whistleblower program.

As one of many examples, consider the following: to the extent that the rule will tend to convert internal complaints into SEC investigations, the defense costs of companies will increase materially as they are forced to hire outside counsel to represent them before the Division of Enforcement. Yet today’s release makes no effort to quantify with specificity the impact of http://www.sec.gov/news/speech/2011/spch052511klc-item2.htm 12/1/2012 SEC Speech: Adoption of Rules for Implementing the Whistleblower Provi... Page 4 of 4

that likely cost increase, and this has prevented the Commission from fully considering the true impact of the rule.

Given the importance of whistleblower complaints to our enforcement efforts, we all share a common interest in establishing a strong and effective whistleblower program. Unfortunately, I don’t believe that today’s rule will achieve its intended purposes. So, for the reasons outlined, I cannot support today’s rule, but I would again like to thank the staff for their hard work at both the proposing and adopting stages of this process.

1 The rule excludes information obtained from attorney-client privileged communications, or in connection with the legal representation of a client, from the definitions of “independent knowledge” and “independent analysis” unless disclosure of such information would be permitted by, among other things, applicable state attorney conduct rules. See Rule 21F-4(b)(4)(i) and (b)(4)(ii). Under Model Rule of Professional Conduct 1.6(b), which has been adopted in some form in most states, “[a] lawyer may reveal information relating to the representation of a client to the extent the lawyer reasonably believes necessary: … to prevent, mitigate or rectify substantial injury to the financial interests or property of another that is reasonably certain to result or has resulted from the client’s commission of a crime or fraud in furtherance of which the client has used the lawyer’s services.” Model Rules of Professional Conduct R. 1.6(b)(3).

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The LIBOR Scandal – What it Means for the Legal Community, Investors, Traders and Borrowers

December 6, 2012 Quick Facts about LIBOR

• LIBOR is the most widely used global interest rate benchmark. • LIBOR is determined by the British Bankers' Association (BBA) and is published daily by Thomson Reuters, Bloomberg and other financial information service providers. • LIBOR is currently comprised of 150 different benchmarks in 10 currencies for 15 different maturities. • BBA surveys a panel of banks – for US Dollar LIBOR, the panel has 18 banks – as to the rate at which they could borrow unsecured funds in the London inter-bank market immediately prior to 11 a.m. on that day. • The four highest and four lowest submissions are excluded, and the remaining 10 submissions are then averaged to arrive at that day's rate. What is affected by LIBOR?

• Derivatives • LIBOR is often used to price financial instruments like swaps transactions and futures contracts. At least an estimated $350 trillion in derivatives and other financial products are tied to it. • Mortgages • Of the mortgages in the United States that are adjustable-rate, about 45 percent of prime mortgages and 80 percent of subprime have interest rates based on LIBOR. • Student Loans • About half of variable-rate private student loans are tied to LIBOR. How was LIBOR manipulated?

• Based on the findings from the Barclays matter, there were two broad kinds of manipulation: • In the boom market times (2005 – 2007), employees in Barclays’ trading units convinced employees responsible for submitting Libor rates to alter the bank's rates based on their derivatives trading positions to bolster their own profits. • After Lehman collapsed in 2008, Barclays submitted artificially low rates to give the impression that the bank could borrow money cheaply and was healthier than it was. The Wheatley Review

• Following the dramatic revelations of the Barclays investigation, the English government commissioned a study called “Wheatley Review” after its primary author, FSA Managing Director Martin Wheatley to explore possible changes to fix the LIBOR system. • Published on September 28, 2012, the Wheatley Review recommended that: • LIBOR should be reformed, rather than replaced. • Actual transaction data should be used to support LIBOR • Rarely used LIBOR rates should be phased out over time (number drops to 20 from 150). • BBA should transfer responsibility for overseeing LIBOR to a new administrator, which will compile and distribute the rate. • Individual LIBOR submissions should be withheld from publication for 3 months to reduce the potential for submitters to manipulate the market. “New” LIBOR

• There are several possible outcomes: • A new entity creates a smaller, more robust LIBOR which replaces the old BBA model • A new index emerges and is adopted by the market such as the one being proposed by Bloomberg (BLIBOR). • Derivative contracts could move to another reference source such as Fed Funds, OIS, or another secured funding rate. LIBOR and OTC Swaps

• Interest rate swaps were initially developed as a way for debt issuers to change the cash flows in a deal – if you had a floating rate obligation, you could swap into a fixed rate, and vice versa. • LIBOR was meant to mean the average funding cost of a typical bank. • Swaps are often collateralized, so there are two separate cash flows – one from the contract (fixed/floating) and one from the collateral that is posted. • Both of these flows refer to LIBOR. OIS has already replaced LIBOR for use in collateral calculations (called OIS discounting) What is the effect of changing LIBOR for Swap Calculations?

• In standard ISDA swap transactions there is a fallback if LIBOR is unavailable – polling of a specified number of “Reference Banks” to arrive at an agreed rate. • This mechanism could backstop adjustments to LIBOR • However, if changes affect a large portion of the market (particularly the interbank market where prices are often reached through a joint calculation agent approach) the process could involve thousands of interbank polls or large scale ISDA protocol(s) with thousands of participants. • ISDA also believes that material changes to LIBOR or a complete disengagement from the standard definition could give rise to one or both contractual parties making claims under doctrines of contractual frustration or impossibility, thereby throwing the OTC rates market into turmoil. Faculty Biographies

Jonathan Ching has significant corporate and law firm experience working with derivatives and their applications in trading and capital markets. He has handled numerous transactions involving product structuring, valuation and margin arrangements, insolvency issues, and trade unwinds. His transactional practice includes the financing of various assets through lending arrangements, repos, derivatives, and other structured solutions. Jonathan has conducted meetings with U.S., U.K., and European Union regulators in connection with regulation of OTC derivatives. He also has worked with industry groups on documentation efforts related to OTC derivatives clearing and regulations proposed in connection with the Dodd-Frank Act. Prior to joining Jones Day, Jonathan was vice president and counsel at a global investment firm where he negotiated documentation in connection with a multitude of transactions, including: a margin lockup agreement for a term convertible bond swap facility with a Japanese bank; bespoke CDS on ABS documentation with U.S. investment banks; credit derivatives documentation with the Singapore and Hong Kong offices of a global investment bank for synthetic investments in emerging market assets; and derivatives valuation and claims termination agreements in connection with the bankruptcy estate of a major U.S. investment bank. He also has structured and marketed synthetic CDOs, leveraged note products, and synthetic financing structures. He has written and spoken extensively on the OTC and on the impact of the Dodd-Frank Act on derivatives and financial products. He graduated from Fordham University (J.D. 2002; Editor, Fordham Moot Court Board; Journal of Corporate and Financial Law) and University of Southern California (B.A. with honors 1997; Dean's Scholar).

Gordon Eng is General Counsel and Chief Compliance Officer of SKY Harbor Capital Management, LLC, a registered investment adviser. He was formerly associated with the law firms of Debevoise & Plimpton LLP, and Fried Frank Harris Shriver & Jacobson LLP where his practice focused on white collar, internal investigations, and commercial litigation of complex financial instruments. Mr. Eng was admitted to the bar in New York in 2005 and is admitted to appear before the US District Courts for the SDNY and EDNY, and the 2d Cir. Court of Appeals. Mr. Eng is a member of the Board of Directors of the New York County Lawyers' Association (NYCLA), co-chair of the NYCLA Ethics Committee, and a founding member of the Advisory Board of the NYCLA Ethics Institute. He is a contributing editor to the publication New York Rules of Professional Conduct (2010), which is edited by the NYCLA Ethics Institute. Mr. Eng is a member of House of Delegates of the New York State Bar Association and the Litigation Committee of the Asian American Bar Association of New York (AABANY). Mr. Eng received his J.D., magna cum laude, from Fordham University School of Law, Order of Coif in 2005 where he was a published member of the Fordham Urban Law Journal. He received his M.B.A. from New York University, Stern School of Business with honors and his B.S. in Economics from the Wharton School of the University of Pennsylvania.

Susan Foster, a partner in Perkins Coie’s Litigation practice, focuses her practice on antitrust and trade regulation counseling and litigation as well as intellectual property, advertising and other complex business and financial litigation. In her counseling practice Susan assists clients with a full range of antitrust and marketing issues including distribution counseling, advertising and promotion issues, strategic alliances and Hart-Scott-Rodino premerger notification matters. Her clients encompass businesses from a range of high-technology and other industries, including aerospace and computer software. She graduated from University of Puget Sound School of Law, J.D., magna cum laude, 1988 Lead Articles Editor, Puget Sound Law Review, 1987 - 1988 and Pacific Lutheran University, B.A., Legal Studies, 1984.