NY Appeals Court Dismisses Fraud Suit Brought by Investors Says Investors can take care of themselves.

The investor in a synthetic CDO who claimed that fraud on the part of Swiss banking giant, UBS, is what led to its incurring losses of over $500 million, has found a wholly unsympathetic ear in the appellate division of the New York State Supreme Court, who dismissed the suit on March 27, 2012, saying that investors are capable of protecting themselves.

# # # 


In a judgment handed down by the appellate division of the New York State Supreme Court on March 27, justices said German bank, HSH Nordbank could not characterize itself as a simple commercial bank that did not understand the product.


HSH Nordbank is a commercial bank headquartered in Hamburg, Germany.  Its core business, historically, included ship financing, private banking and corporate clients, and its operations spanned the globe including operations in Luxembourg, New York, London and Singapore.


By 2009, after losing close to 2.8 billion euros in 2008, HSH was in trouble.  With no one willing to partner with, much less acquire the bank, the government bailout of 13 billion euros, came with the understanding that more could be required.


It’s the classic tale of a bank gone bad.  How do these things happen?  You raise them… teach them right from wrong… and then one day they come home wearing a navy pinned-stripe suit and wingtips, talking about net present values and obsessing over ROI.


Usually, when a bank like this one goes bad, there were warning signs.  First, it’s hidden fees on checking accounts, then a 29 percent bump on credit card interest, and before you know it, that nice, clean cut bank you once knew is hip deep in a mortgage-backed security, shooting credit default swaps, and talking up a synthetic CDO-squared like housing prices will never go down.


As is often the case, it could be that HSH started going downhill after it started hanging out with a certain unsavory element… bankers from the short side of the trade… or in other words, when Goldman Sachs alum, J.C. Flowers, bought a 24 percent stake in HSH… followed by UBS arriving on the scene hawking its wares.


Next thing anyone knew, HSH was agreeing to act as the “protection seller for the trade,” and “assume exposure to the first $500 million of losses on a $3 billion portfolio of US real-estate-linked securities,” in return for premiums paid by UBS… who was actively managing the underlying pool of assets.


And baby, that’s a long way from financing a ship or helping rich people with their banking needs.  (It reminds me of Warren Buffett talking about how he never invests in companies whose products he doesn’t understand, and why it’s probably a good rule of thumb.)


Referred to as the “North Street” transaction, for the first six years no credit events occurred in the reference pool, and HSH collected the full interest due on its notes.  But in 2008… as stated in the German bank’s complaint… as the financial crisis intensified, credit events spiked to the extent that HSH lost almost all of its $500 million investment.


Ouch.  That’s gotta’ sting.


All it took was a drop of 19 percent in the value of the underlying portfolio to wipe out the investment HSH Nordbank’s made in the North Street notes… but the HSH lawsuit alleged that while it was busy losing everything, UBS came out smelling like J.C. Flowers used to when he was still at Goldman Sachs… with a gain of over $275 million.


Like most of the CDO-related lawsuits, HSH’s claim was that the portfolio was managed in such a way that the risks to the protection seller increased significantly.  HSH accused UBS of substituting riskier assets into the deal when no one was looking, and selecting assets with spreads to wide for their respective credit ratings.


In dismissing the suit, the court didn’t so much weigh in on UBS’ behavior, but rather made its view clear that HSH was quite capable of taking care of its own interests.  From the court’s decision…


“At bottom, HSH is complaining that UBS – which HSH agreed was not acting as its adviser or fiduciary in this matter – induced it to enter into a deal that would enable UBS to exploit, at HSH’s expense, a feature of the relevant securities market that was common knowledge among participants in that market. This does not constitute a legally sufficient cause of action for fraud, certainly not when pleaded by a sophisticated business entity that disclaimed reliance on the party it now accuses of fraud.”


Oooh, snap!


HSH-Nordbank tried to make the case that it was just a simple commercial bank hardly capable of understanding the big-city-type investment product UBS was offering… which must have been hysterical to watch especially with Goldmanite and zillionaire, Flowers on everyone’s mind at least once or twice during the case.


Again, from the courts decision…


“HSH – a sophisticated commercial entity – cannot satisfy the element of justifiable reliance, inasmuch as the undisputed documentary evidence establishes that HSH agreed it was not relying on any advice from UBS; assented to the inherent conflicts of interest that would result from UBS’s multiple roles with regard to the reference pool; and was explicitly warned of the risks it was undertaking in this highly leveraged and complex transaction.”


Some are saying the case may set a precedent for the packagers of CDOs, making their only responsibility to disclose risks and conflicts of interest involved.  A lawyer said to be “deeply involved” in the case, was quoted as saying…


“This is one of the most, if not the most, comprehensive decisions the appellate division in New York has ever issued in a case involving sophisticated parties to a structured credit transaction.”


“The court unanimously held that a sophisticated commercial bank cannot justifiably rely on alleged misstatements or omissions regarding an investment when it had the means to uncover the alleged fraud through the exercise of reasonable diligence. The decision could have far-reaching implications for other cases involving sophisticated plaintiffs claiming they were fraudulently induced to enter into complex financial transactions.”


A spokesperson for the German bank said: “HSH Nordbank has based its lawsuit primarily on three charges: fraud, misrepresentation and breach of contract. The charges of fraud and misrepresentation have now been rejected by a New York court in an appeal hearing. The charge of breach of contract still applies. We shall carefully examine the ruling of the New York court to decide what legal consequences it will have for us.”


But the court didn’t exactly give UBS a free pass either. 


The judges told the Swiss bank that their alleged conduct “leaves much to be desired as a matter of business ethics,” and made very clear that UBS should not interpret the judgment to mean that “if UBS did in fact engage in the sharp dealing alleged by HSH, it is to be commended; such practices are indeed troubling”.


My commentary on this decision…

There are no doubt going to be those that will find this decision a blow to the “punish-Wall-Street-for-fraud” movement.  They will say that this decision inhibits the ability of investors to sue the bankers that defrauded pension plans, insurance companies and  sovereign wealth funds all over the world, leading to the global financial crisis.  “They” have been waiting with bated breath for these investor lawsuits to come and save the day, in what might be considered the modern day version of “The Clash of the Titans.” 

It’s as if to say that what consumers couldn’t accomplish, the investors will… and now, as a result of this decision… maybe they won’t after all… and the thought of the bankers getting off scott free is simply intolerable. 

I disagree.

I think this ruling shows that the justices that make up NY’s appeals court are smart.  Twenty-five percent of HSH-Nordbank is owned by J.C. Flowers, as I mentioned in the article above, do you know who and what he is?

First of all, J.C. Flowers graduated from Harvard with degree in applied mathematics, which in many ways makes him the worst kind of Wall Streeter, or at least the most dangerous.  His mathematical models tell him what to do, which is not all that different from someone who is directed by mysterious voices. 

After Harvard he worked at Goldman Sachs for 20 YEARS, becoming a partner in 1988.  Not only that, but he founded Goldman’s immensely profitable, financial institutions merger practice.  Think about that for am moment… Flowers is considered to be one of the world’s leading experts on the value of financial institutions.

After leaving Goldman in 1998, he was the main partner in a venture that acquired Long-term Credit Bank of Japan and turned it into Shinsei Bank, where Flowers is still a Director. When Shinsei went public a few years later, Flowers made about a billion.

In 2001, he started J.C. Flowers & Co., which is a private equity firm that owns large stakes in Shinsei, HSH-Nordbank, NIBC Bank, Hypo Real Estate… have you ever heard of any of those banks or whatever they are?  No one has, and you can bet that Flowers knows stuff regular folk don’t. 

During the collapse, Flowers was called upon by Bank of America to advise it on the potential acquisition of Lehman Bros. and a couple days after that he was brought in by AIG to advise it on how it might avoid falling apart at the seams.  He was one of the first to warn, then Treasury Secretary Hank Paulson, of the coming collapse of AIG and Lehman, and was depicted by the actor, Michael O’Keefe in the movie “Too Big to Fail,” on HBO.

Back in 2008, he even bought the First National Bank of Cainesville in Missouri and renamed it… “Flowers Bank.”

And he owned 24 percent of HSH-Nordbank.

And he was unhappy, I suppose, because UBS pulled a Goldman on one if his banks, who came into court acting as if they were the savings and loan from “It’s a Wonderful Life.”  And the court didn’t buy it for a second… so, good for them.  Bravo!  What’s good for the goose is good for the gander, as my mother used to like to say.

Not every mortgage-backed security deal ever done was a fraud.  There were certainly some that were, and Goldman Sachs did more than their share, I’m sure.  In fact, a good part of Wall Street’s culture is based on being able to find, “dumber money.”  So, if you get involved in a deal so complicated that you get the short end of the stick, you don’t get to cry foul and use the courts system to go after one of your peers for doing what you wish you would have done.

Sorry, Mr. Flowers… this time you didn’t come out smelling like a rose.  But, don’t worry too much… I’m sure you’ll get to stick it to someone else in similar fashion soon enough.

If a pension plan comes to court and can establish that “reps and warranties” were actually “lies and more lies,” then I’m sure the courts will respond appropriately.  But everyone lost during this last raping of the planet… EVERYONE… except maybe a few dozen guys now in the Hamptons watching their statute of limitations clocks and  hoping the U.S. Attorney’s office doesn’t show up at their door before their time runs out.

So, just because you lost, doesn’t mean you get to cry fraud.  Let’s get the bad guys, no question.  But let’s be smart about it… because that’s what will act as a deterrent for future fraudsters.  No one is afraid of being caught by the dumb and dumber. 

I’m just saying…

Mandelman out.


The case related to a 2002 synthetic CDO transaction that HSH Nordbank entered into with UBS termed ‘North Street Reference Linked Notes 2002–04’.


A link to the complete story can be found at RISK.net.

Page Rank