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Legal News Report 6-12-15
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Mayor de Blasio Tells New Jersey to Reject Deal With Exxon
Jun 8, 2015 | New York Times
By Benjamin Weiser
New Jersey’s proposed $225 million pollution settlement with Exxon Mobil Corporation has a prominent and new opponent: the administration of Mayor Bill de Blasio of New York, which has asked that the deal be rejected, saying it “appears wholly inadequate.” -
Another Assault On Treasury's Infamous Third Amendment: The Struggle Over The GSEs Is Not Over
Jun 8, 2015 | Forbes
By Richard Epstein
Late this past May, Thomas and Ida Saxton brought suit against the Federal Housing Finance Agency (FHFA) in the Northern District of Iowa, and thus opened up a new front in the long-running litigation over the federal takeover of Fannie Mae and Freddie Mac, two Government Sponsored Enterprises. -
Oil Firms Agree to Pay Millions in Compensation for Quebec Train Blast
Jun 10, 2015 | Wall Street Journal
By RUSSELL GOLD and DAVID GEORGE-COSH
Oil companies have quietly agreed to pay tens of millions of dollars into a compensation fund for deaths and damage caused by a 2013 oil-train explosion in Quebec, though the energy industry has maintained it wasn’t responsible for the disaster. -
Wells Fargo Increases Estimated Potential Loss to Litigation in Excess of Legal Reserves
Jun 6, 2015 | Wall Street Journal
By EMILY GLAZER And PETER RUDEGEAIR
Wells Fargo & Co. increased its estimate of the amount it may lose related to litigation in excess of legal reserves to as much as $1.2 billion as of March 31 from $1.1 billion three months earlier, according to a regulatory filing released by the bank on Wednesday. -
Litigation Bets Burn Hedge Funds
Jun 11, 2015 | Wall Street Journal
By MATT JARZEMSKY
A legal victory for J.P. Morgan Chase & Co. stung Appaloosa Management LP and other hedge-fund firms last week, the latest in a streak of soured Wall Street bets on litigation outcomes.
Legal News Report
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Mayor de Blasio Tells New Jersey to Reject Deal With Exxon
Jun 8, 2015 | New York Times
By Benjamin Weiser
New Jersey’s proposed $225 million pollution settlement with Exxon Mobil Corporation has a prominent and new opponent: the administration of Mayor Bill de Blasio of New York, which has asked that the deal be rejected, saying it “appears wholly inadequate.”
The agreement, reached by Gov. Chris Christie’s administration earlier this year, seeks to end a decade of litigation in which New Jersey demanded $8.9 billion in compensation for natural resource damage to more than 1,500 acres of wetlands and marshes at refinery sites once owned by Exxon in Bayonne and Linden.
The de Blasio administration, in a letter to the New Jersey Department of Environmental Protection, argued that the $225 million amount is just 3 percent of the damages that the state documented at a trial last year, and that the deal “inexplicably” includes hundreds of other Exxon sites and gas stations that could have contaminated groundwater and were not part of the original litigation.
“The city believes that the proposed settlement, as drafted, does not adequately compensate for the extensive and well-documented natural resource damage caused by the Exxon facilities and does not ensure that those damages will be addressed,” the office of Zachary W. Carter, the New York City corporation counsel, wrote in a letter on Friday.
The letter was filed on the last day of a two-month public-comment period before the deal is to be submitted to a judge for approval. A spokesman for the Department of Environmental Protection said on Friday that as of the middle of last week, the agency had received about 8,800 comments on the proposed deal.
In its submission, Mr. Carter’s office also argued that provisions of the deal make it unlikely “that Exxon will ever be required to pay” for separate claims concerning damage to tributaries and waterways of the New York-New Jersey Harbor estuary, which border New York City as well as New Jersey.
“It is well documented,” Mr. Carter’s office wrote, “that these waterways, including Newark Bay, Arthur Kill, Kill Van Kull and Upper New York Bay, continue to be exposed to contamination from the Exxon facilities.”
The settlement calls for the dismissal of the surface water claims and says they may be brought again only if New Jersey files a multidefendant lawsuit that names Exxon along with “other responsible parties.”
Mr. Carter’s office said this means New Jersey “must dedicate time and resources to identifying other potentially responsible parties,” even though Exxon “has seemingly already been identified as the primary source of contamination and damage.”
That “is an extremely resource intensive and burdensome process that could derail any future litigation on the part of New Jersey,” Mr. Carter’s office added.
A Christie administration official said on Monday that the “preservation of those claims is an important part of the settlement, notwithstanding their criticism of it.”
“New Jersey also has a history of pursuing that type of litigation,” the official added. (He declined to be identified by name, saying the Christie administration’s general policy is not to address the public comments filed on the settlement.)
Exxon declined to comment on Monday.
In the long-running case, Exxon’s liability was already established when the state went to trial last year to prove its damages. The deal reached by the Christie administration came just before the judge was expected to rule on that issue.
Since the settlement was revealed in an article in The New York Times in February, it has been attacked by environmental groups and other critics, while being defended by Mr. Christie, a Republican, and other New Jersey officials. (The state released the full agreement in April.)
“We have vigorously litigated this case for the good of the environment and for the people of New Jersey,” Bob Martin, the environmental commissioner, has said.
Among the comments submitted on the settlement was a 25-page statement by the Natural Resources Defense Council and Columbia Environmental Law Clinic, filed last week for about a half-dozen groups. It argued that the state had not tried to explain, “and it is inconceivable, why it would be in the public’s interest to grant Exxon such a sweeping release of its environmental liabilities in New Jersey.”
Mr. de Blasio, a Democrat, first questioned the Exxon deal in March, when he was asked about it at a news conference. “I’m absolutely concerned,” he said.
“There’s supposed to be a rigorous process for ensuring that the environment is restored,” he added. “I don’t know the details of this settlement, but if the dollar figure is so low that work can’t be done, I’m very uncomfortable with what that means for the people of New York.”
The city’s letter, which is signed by Haley Stein, a senior environmental lawyer in Mr. Carter’s office, said the city was “in the midst of an unprecedented period of investment to improve water quality in New York Harbor; more than $6 billion of projects have been completed since 2002 or are currently underway.”
“These projects, which have been almost entirely funded by New York City residents, have been extremely successful in improving the water quality of New York Harbor,” the city said.
“The proposed settlement,” the letter added, “offers a rare opportunity to further improve the health of the harbor and its waterways and to hold Exxon accountable for extensive natural resource damages caused by its facilities.”
But the additional requirements imposed on New Jersey to refile the surface water claims, the letter said, “virtually guarantee that Exxon will never be required to pay for natural resource damages from the Exxon facilities to the Arthur Kill, Newark Bay, Kill Van Kull and Rahway River, and substantially diminishes the likelihood that those damages will be addressed.”
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Another Assault On Treasury's Infamous Third Amendment: The Struggle Over The GSEs Is Not Over
Jun 8, 2015 | Forbes
By Richard Epstein
Late this past May, Thomas and Ida Saxton brought suit against the Federal Housing Finance Agency (FHFA) in the Northern District of Iowa, and thus opened up a new front in the long-running litigation over the federal takeover of Fannie Mae and Freddie Mac, two Government Sponsored Enterprises, orGSEs, that had hybrid private and public status.Saxton v. FHFA marks perhaps the most noteworthy development since District Court judge, Royce Lamberth, granted the United States an unexpected and undeserved victory, on summary judgment no less, in Perry Capital LLC v. Lew, decided on September 30, 2014. In my capacity as an advisor to a number of institutional investors, I have discussed at length the many weaknesses of that opinion in earlier Forbes posts here , here, here, and here. In this article I will not restate the many defects of economics, statutory construction and constitutional law that pervade that opinion.
It is helpful to explain how the Saxton complaint artfully weaves together the various legal, legislative and economic strands of the case to mount a full-scale and well-considered attack on FHFA and Treasury for systematically exceeding the limited authority conferred on them by the Housing and Economic Recovery Act (HERA). The Saxton complaint consciously avoids any constitutional challenges to the government’s action, but does state forceful claims that both FHFA (and Ed DeMarco in his official capacity its then Director of FHFA) and Treasury acted beyond the scope of their statutory authority, that these actions were arbitrary and capricious when tested against the normal standards of administrative law, and, finally that their actions were in breach of their contractual and good faith obligations to the private shareholders of both Fannie and Freddie.
The historical narrative unfolds in three separate parts. It begins with the events leading up to the initial Senior Preferred Shareholder Purchase Agreement (SPSPA) of September 6, 2008, adopted at the height of the financial crises. It then follows the narrative through the adoption of the Third Amendment of the SPSPA of August 12, 2012. It then carries the narrative forward to the present day. There is a morality play at stake in this history. HERA is a well-drafted statute whose essential solution was gutted by unprincipled administrative action by FHFA and Treasury, by the extravagant positions that the government took in litigation, and by Judge Lamberth’s weak opinion in Perry Capital. The case thus shows how the potent combination of aggressive administrative action and misguided judicial interpretation can convert a sensible statute into some unrecognizable caricature of itself. I have prepared a chapter and verse analysis of all that went wrong in the NYU Journal of Law and Business.
The complaint in Saxton brings all these issues back to the surface through its careful narrative of the case. In the summer of 2008, Congress passed HERA in order to provide some federal oversight to the increasingly unstable financial housing market. The object of that legislation was, as then Secretary of Treasury Henry M. Paulson, assured Congress a “short-term” solution to expire by the end of 2009. It was never meant to be the first step toward the nationalization of both firms.
One challenge that Congress faced in 2008 is endemic to all bailouts: how to save the critical firm, without allowing a raid on the federal treasury. Given the risk of bankruptcy runs, the government often functions as the supplier of capital of last resort. Its mission is to stabilize and quiet the overall market, which often requires that some benefit be given to firms that might otherwise fail in the absence financial support. The bailout was driven by the fear that the dominant role that Fannie and Freddie played in the residential mortgage market meant that their failure could also bring down other public entities, private banks and related financial businesses.
There was, and is, an extensive dispute over whether Fannie and Freddie were insolvent in September 2008. To be sure, its mortgage portfolio had taken a beating, but that portfolio consisted of mortgages that were highly liquid, whose value could rebound if the two GSEs could weather the short-term storm. In September 2008, I do not think there was any principled argument to the effect that the federal government was obligated to bail out Fannie and Freddie, but bail them out it did when it threw both companies into a conservatorship, with an eye to fixing their short term difficulties and then returning them to the marketplace in their original form. But under HERA, FHFA could have thrown the two companies into receivership with an eye to liquidation—but only subject this caveat. Their orderly liquidation could not allow FHFA, and hence Treasury, to grab unilaterally all the assets of these two GSEs. The shareholders of these two companies had property interests in the underlying assets, so they would be entitled to a judicial evaluation to determine whether or not the liquidated value of the assets exceeded the outstanding claims against the two companies. If so, then by ordinary mortgage and bankruptcy principles the residual equity would belong to the private preferred and common shareholders in that order. It is inconceivable that the government take over any company it wanted, throw it into receivership and keep all its assets, without any judicial oversight.
When FHFA chose the conservatorship route it avoided any immediate shareholder challenges that its actions confiscated the private wealth of the shareholders. The two companies were still alive, so that nothing the government did at that juncture triggered an obligation to provide just compensation to the GSE shareholders. Precisely because FHFA served the trustee of these assets, it had a fiduciary duty under HERA to maximize their value for the shareholders.
The tricky issue was to figure out the precise terms of the bailout. Under HERA that task was left to negotiations between, it was tacitly assumed, the private and independent directors of Fannie and Freddie and the United States Treasury. HERA made it clear that the Treasury Department when it negotiated the bailout provisions could not turn the entire exercise into a massive giveaway of public funds. It therefore had explicit duties to protect “taxpayers.”In its original incarnation, HERA made perfectly good sense. The independent Board of Directors of Fannie and Freddie would negotiate at arm’s length with Treasury for a deal that would be mutually beneficial. In this instance, the deal was, as Saxtonaccurately retells it, that the United States would receive a senior preferred stock carrying 10 percent dividend if paid currently, where Fannie and Freddie had under the SPSPA the unfettered option to defer dividend payments by having an “in kind” obligation to add these to principal in exchange for increasing the dividend rate to 12 percent rate—a standard feature for all deferred obligations. The government also took warrants at a nominal price for just under 80 percent of the common stock.
The difficulty with this original transaction did not lie chiefly in its terms, but in a maneuver that Treasury executed before the September 6 bailout was completed. More specifically, it forced out the independent directors of the two GSEs and installed the then director of FHFA, James Lockhart, as their sole head, with enormous statutory powers to run the two companies. The heavy-handed maneuvers that led to this outcome are well documented in the complaint that Washington Federal filed against the United States in June 2013.
The difficulty with the original SPSPA was twofold. The fact that Lockhart negotiated with Treasury meant that the United States was in effect negotiating with itself. The normal presumption in favor of the fairness of any deal that is negotiated between sophisticated parties at arm’s length no longer applies, because the United States is now on both sides of the transaction. The normal good faith business judgment rule should therefore be displaced by a stricter “fair value” rule that would have allowed the original preferred or common shareholders of Fannie and Freddie to challenge that deal.
Most of the lawsuits on this matter have declined to follow Washington Federal in attacking the 2008 transaction, given the difficulties on valuation during the tumultuous events of September 2008. In any event, as Saxtonrelates, the 2008 transaction turned out to have major benefits for the private shareholders. The market turned upward, so that even though Treasury eventually forced Fannie and Freddie to borrow about $187 billion, much of which they did not need, the two GSEs became sufficiently strong that they were poised to conservatorship as fully capitalized businesses with their own boards, just as matters stood before September of 2008.
That, however, never came to pass. As the Saxtonnarrative explains, the people at Treasury and FHFA well knew of the financial situation in the market. Indeed the Fannie Mae Second Quarter Report of August 8, 2012 noted “significant improvement in our financial results for the second quarter and first half of 2012 compared with the second quarter and first half of 2011.” Against that backdrop, the other shoe dropped on August 17, 2012, when FHFA and Treasury announced their Third Amendment, signed only by Edward DeMarco, then the director of FHFA and Timothy Geithner, then Secretary of Treasury, to the SPSPA that did away with the carefully calibrated 2008. Going forward FHFA and Treasury agreed that all the net income that accrued to Fannie and Freddie would be paid out so that neither GSE could ever pay down a dime of their principal indebtedness. In all but name, the government had nationalized the two companies in a collusive transaction with itself. No one gave any explanation as to why the wipeout of the potential equity of the two firms was consistent with the obligations that the FHFA as a conservator had to its private shareholders. As the Saxton complaint states with commendable clarity, the entire transaction made a mockery of the fiduciary element implicit in any and all conservatorship arrangements. If any private company had entered into that kind of transaction with its own senior preferred shareholders, the deal would be set aside and the SEC would have immediately begun civil and criminal proceedings against the parties.
The question then arises as to why matters are different when the government pulls this type of giant heist. In this regard, there is an instructive difference between the private and public settings, but it cuts against, not for, the government position. In dealing with some of the analytical difficulties under the takings clause—“nor shall private property be taken for public use, without just compensation”—the late Professor Joseph Sax in his 1964 article “Takings and the Police Power” made the simple distinction between the government when it acts in its arbitral capacity and when it acts in its entrepreneurial capacity. It takes the arbitral role for example when it adjudicates claims between private parties, and the system would come to a halt if every decision would expose government officials to takings liability to the losing party. The right way to look at the system is from the ex ante perspective where everyone, whether a future winner or loser, benefits from having a fair and impartial system of justice to handle their claims. Lawsuits by losers would inundate the court system and leave all players worse off than before.
The world, however takes a different coloration when the government takes the role of a market participant, seeking to advance its own interest. Now the conflict of interest issues are greater, so that the presumption of validity no longer applies, and higher levels of scrutiny should be needed. This analysis applies to the statutory claims in Saxton just as it applies to any claims under the takings clause, none of which were brought here.
The difference between the two cases lies not so much in the analysis of government misbehavior but in the choice of remes that can be sought against the government. In a takings case, the matter is closed once the Third Amendment is adopted, and the proper measure of relief is the decline in the market value of the securities attributable to the government decision to strip away, without return consideration, the assets of the company. To that claim, statutory interest must be added.
The breach of fiduciary duty claims under HERA point in a different direction. All the money, above and beyond, the dividends paid pursuant to the 2008 SPSPA, should be credited to the repayment of the $187 billion that the government lent to Fannie and Freddie. At this point, the Saxton complaint notes that nearly $170 billion in net income has passed to the government from the fourth quarter of 2012 (when the sweep was clearly in effect) to the end of the first quarter of 2015. By this account senior preferred has been virtually all redeemed, so that the 10 percent dividend rate applies only to approximately $30 billion left unpaid. The correct procedure is to call for an end of the conservatorship given that HERA only requires that the conservatorship remain until the enterprises are solvent, thus ending the conservatorship will allow Fannie and Freddie to resume their ordinary operations. Under the current set-up that will never happen, which means that unless the transaction is somehow set aside the government will succeed in turning Fannie and Freddie into its own cash cow.
At this point, the outcome of the litigation is uncertain chiefly because the courts make exactly the wrong assumption in evaluating these transactions. All too often they assume that government officials always act in good faith, which means that courts should defer to their decisions under either the business judgment rule used in fiduciary duty cases or the low-level of “rational basis” scrutiny used in takings case. But in light of the serious conflict of interest, the basic standard should be otherwise, with the “fair value” rule for the breach of fiduciary claims and a form of intermediate or strict scrutiny on the takings claim. The outcome of all these cases will depend hugely on the initial attitudes that are brought to this behavior. My great fear is that in all the GSE cases courts will continue to adopt the see-no-evil, hear-no-evil approach that marked the Lamberth opinion in Perry Capital. Now that Saxton has been filed, there is at least another forum in which the government can be brought to account. Rest assured that there is an enormous interaction between the two cases given their common factual core. If the government loses in any of its cases, a trip to the Supreme Court is virtually assured. If the government wins in all these cases, there is a troublesome chance that the Supreme will choose not to hear the issue, notwithstanding its major implications for the soundness of the overall mortgage system. The lack of an authoritative Supreme Court decision would be a tragedy for the current shareholders. It would also be an ominous sign for the long-term stability of our entire financial system, especially now that private sector confidence in the management decisions by the U.S. government have been sapped by the Fannie and Freddie litigation.
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Oil Firms Agree to Pay Millions in Compensation for Quebec Train Blast
Jun 10, 2015 | Wall Street Journal
By RUSSELL GOLD and DAVID GEORGE-COSH
Oil companies have quietly agreed to pay tens of millions of dollars into a compensation fund for deaths and damage caused by a 2013 oil-train explosion in Quebec, though the energy industry has maintained it wasn’t responsible for the disaster.
Royal Dutch Shell PLC, Marathon Oil Corp., ConocoPhillips, Irving Oil Ltd. and others have contributed to a $345 million fund for victims of the accident in Lac-Mégantic, according to court filings and interviews.
If U.S. and Canadian courts approve the fund, the companies would be shielded from several lawsuits claiming wrongful death and negligence in connection with the tragedy.
Montreal, Maine & Atlantic Railway Ltd., the small railroad hauling the crude oil, sought bankruptcy protection soon after the accident, in which an unattended train carrying oil from North Dakota’s Bakken Shale formation derailed and erupted into flames, killing 47.
A trustee appointed by the bankruptcy court, who has approved the compensation fund, contended in court filings that oil producers were well aware the oil they were selling was dangerously volatile and failed to take action to make transporting it safer.Advertisement
Oil companies, however, have said that their responsibility ended with properly labeling the crude oil after pumping it out of the ground, which they say they did.
Bankruptcy court has become a common arena for settling complex litigation alleging negligence by multiple parties. Bankruptcy trustees, by statute, can seek a centralized settlement, including a compensation fund, to streamline the process and avoid a lengthy legal battle.
Most companies identified in court filings as participating in the proposed Lac-Mégantic settlement declined to comment. The size of their payments are generally sealed by the court, including contributions from a unit of General Electric Co. and other railcar leasing firms.
But Marathon Oil, which produced some of the crude involved in the Lac-Mégantic disaster, said its decision to pay into the fund wasn’t an acknowledgment of liability.
The Houston-based company, a big producer of oil in North Dakota, declined to disclose the sum it paid. It contributed to avoid “the time and expense associated with protracted litigation,” a spokeswoman said. She said Marathon doesn’t believe it “mislabeled, misclassified or otherwise misled others regarding the characteristics of the crude oil.”
In the almost two years since the Lac-Mégantic disaster, there have been nearly a dozen other fiery derailments involving crude oil from North Dakota, though no fatalities.
Despite a recent decline in shipments caused by lower oil prices, nearly one million barrels of crude are loaded on trains every day, according to federal statistics, up fromalmost none before 2009.
U.S. and Canadian rail regulators have ordered railroads carrying crude oil from the Bakken Shale to take precautions includingslowing down oil trains, and are also requiring shippers to phase instronger tanker cars that can withstand accidents without rupturing.
Some U.S. officials, however, have complained that oil companies haven’t agreed to make their crude oil safer to transport by stripping out volatile gases before putting it aboard trains. North Dakota imposes some limits on such gases.
Legal experts say North Dakota oil producers should expect to face more legal risk in the wake of the Lac-Mégantic settlement. “In the past, railroads have been the only target in derailment cases,” said David Potter, a partner with Oppenheimer Wolff & Donnelly LLP in Minneapolis who has defended railroads in such cases. “Now you have an additional target.”
Until earlier this year, it wasn’t unusual for oil producers to provide train operators with generic—and often outdated—information about the physical characteristics of crude-oil cargoes. New federal rules and North Dakota law now require additional crude testing.
Matt Gatewood, a partner at Sutherland Asbill & Brennan LP who has defended energy companies in complex safety litigation, said companies involved in shipping crude oil need to be careful about testing it.
“They have to be fully aware of what it is they are selling and give an accurate representation of it to the company they are selling it to,” he said.
Earlier this week, World Fuel Services Corp. said it agreed to pay $110 million into the Lac-Mégantic fund.
The Miami-based company bought oil in North Dakota and contracted to have it hauled by rail to a refinery in New Brunswick. In a statement, World Fuel’s chief executive said that participating in the settlement was “in the best interests of our shareholders.”
The oil was hauled first by Canadian Pacific Railway Ltd., and then by Montreal, Maine & Atlantic Railway.
Canadian investigators and Montreal, Maine & Atlantic’s bankruptcy trustee contend the crude oil was more volatile than its label indicated.
World Fuel didn’t return calls seeking comment.
The crude was to be delivered to New Brunswick refiner Irving Oil, which has agreed to pay $60 million into the compensation fund.
“Everyone involved in transport of crude oil is responsible for safety,” said Robert J. Keach, the bankruptcy-court trustee.
A trustee’s role is to recover as many assets as possible to pay creditors of the company whose bankruptcy case he oversees, often by bringing claims against other companies.
Canadian Pacific hasn’t agreed to pay into the fund. A Canadian Pacific spokesman said compensation should be from companies “responsible for the derailment,” and not from companies that want to be shielded from future lawsuits.
A spokeswoman for Lac-Mégantic’s local government said she hoped the settlement will let the town’s 6,000 residents “turn the page” on the accident.
Corrections & Amplifications:
Marathon Oil Corp. produced some of the crude involved in the Lac-Mégantic disaster; World Fuel Services Corp. agreed to pay $110 million into the Lac-Mégantic fund. An earlier version of this article stated incorrectly that Marathon owned the oil and misidentified the other company as World Fuels Services. (June 10, 2015) -
Wells Fargo Increases Estimated Potential Loss to Litigation in Excess of Legal Reserves
Jun 6, 2015 | Wall Street Journal
By EMILY GLAZER And PETER RUDEGEAIR
Wells Fargo & Co. increased its estimate of the amount it may lose related to litigation in excess of legal reserves to as much as $1.2 billion as of March 31 from $1.1 billion three months earlier, according to a regulatory filing released by the bank on Wednesday.
The estimate is closely watched by investors to gauge whether legal costs are rising or falling versus a bank’s previous expectations. Wells Fargo and other banks generally don’t disclose their reserves.
The filing by the San Francisco-based lender also said more Wells Fargo borrowers in the energy industry fell behind on loan payments in the first three months of 2015.
Loans outstanding to oil and gas companies that the bank has classified as “non-accrual,” meaning there is uncertainty about whether they will be paid back on time, increased 26% from the previous quarter to $96 million.
The overall size of Wells Fargo’s energy portfolio increased slightly to $18.48 billion, or around 2% of its total loan portfolio. Nevertheless, energy loans comprised 14% of all of Wells Fargo’s commercial and industrial loans classified as non-accrual.Advertisement
Given the decline in oil prices since mid-2014, some deterioration in loan performance was expected. Last month, Chief Financial OfficerJohn Shrewsberry said the bank “realized minimal credit losses” on energy loans in the first quarter.
Wells Fargo has largely avoided major legal settlements that other banks have dealt with to remedy regulatory concerns in the run-up to the financial crisis. Wells Fargo remains involved in some legal proceedings but there were no major updates or large new cases reported in Wednesday’s filing with the Securities and Exchange Commission.
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Litigation Bets Burn Hedge Funds
Jun 11, 2015 | Wall Street Journal
By MATT JARZEMSKY
A legal victory for J.P. Morgan Chase & Co. stung Appaloosa Management LP and other hedge-fund firms last week, the latest in a streak of soured Wall Street bets on litigation outcomes.
Appaloosa was among holders of failed thrift Washington Mutual Inc.’s $6 billion in senior bonds, which sold off following the judge’s decision, according to people familiar with the matter. The bet was popular with hedge funds and had many other takers, some of which are being advised by investment bank Houlihan Lokey Inc. and law firm Dechert LLP, people familiar with the situation said.
It isn’t clear how much of the WaMu bonds Appaloosa held or how much it lost when the bonds fell after the ruling. The investment accounted for a relatively small piece of the hedge fund’s holdings, according to a person familiar with the matter.
The legal decision marked the latest setback for hedge funds trying to predict how a judge will rule in lawsuits stemming from corporate bankruptcies or crisis-era dealings, then buying deeply discounted securities likely to increase in value if the investors are right about the ruling. in the past year, funds have suffered similar backfires in rulings related to Nortel Networks Corp.’s bankruptcy and lawsuits against mortgage giants Fannie Mae and Freddie Mac that sent securities prices tumbling.
Distressed-debt investors have piled into litigation bets in an era of historically low interest rates, which are keeping a lid on bond returns and allowing many troubled companies to stave off bankruptcy. Adding to their allure, the performance of such investments is unrelated to that of asset classes like stocks and government debt. As pension funds and other institutional investors take a closer look at manager fees for plain-vanilla investments, these uncorrelated investments are an easy sell to fund backers, market participants say.Advertisement
Some of these bets have been successful. In November, a federal appeals court ruled Chesapeake Energy Corp. improperly redeemed $1.3 billion in debt at a favorable price, a win for hedge funds such as Aurelius Capital Management LP and River Birch Capital LLC. The decision increased the creditors’ odds of collecting on more than $400 million in disputed payments.
But a series of recent backfires have illustrated the risky nature of this tactic.
In the latest case, hedge funds had purchased WaMu’s senior bonds at deeply discounted prices, betting in part that a judge would saddle J.P. Morgan—which bought WaMu’s banking operations at the height of the financial crisis—with certain liabilities related to a Deutsche Bank National Trust Co. lawsuit over soured mortgage bonds.
Instead, U.S. District Judge Rosemary M. Collyer limited J.P. Morgan’s potential liabilities from the WaMu deal, leaving a Federal Deposit Insurance Corp.-run WaMu receivership backing the bonds potentially on the hook for the bulk of any damages that may result from the Deutsche lawsuit.
A WaMu bond that traded around 28 cents on the dollar before the decision lost about one-fifth of its value on June 3 following the ruling, according to MarketAxess.
Bonds of bankrupt telecommunications company Nortel Networks Corp. tumbled after U.S. and Canadian judges unveiled a scheme that creditors hadn’t anticipated to divide $7 billion in cash. Nortel bondholders that had bought the debt and pressed for interest payments included hedge funds Angelo, Gordon & Co. and Aurelius.
In September, preferred shares in Fannie Mae and Freddie Mac widely held by hedge funds plummeted after a U.S. District Judge threw out lawsuits challenging the government’s crisis-era dealings with the mortgage giants. Fairholme Capital Management LLC, Perry Capital LLC and Pershing Square Capital Management LP were among the investors that took big paper losses amid the selloff, The Wall Street Journal reported.
To be sure, investors on the losing side of a litigation can still make money on the bonds if they are ultimately worth more than what the holders paid or if future price swings allow them to trade out profitably. Investors often hold out for appeals that can turn their fortunes around.
Still, the recent losses are a blow to hedge funds that invest in distressed debt, which continue to face a dearth of investment opportunities as defaults remain near all-time lows.
“There’s a lot of money chasing very few ideas right now, many of which are very binary in their outcomes,” said Kevin Starke, an analyst at research firm CRT Capital Group LLC.
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