Expert Witness Advice on How to Demonstrate and Prove Economic Damages in LIBOR Manipulation Lawsuits
Renowned nationwide banking and economic damages expert witness for plaintiffs and defendants in over 500 cases, former high-level banking executive, high-level banking regulator, and banking consultant to over 80 banks and numerous municipalities and other governmental entities, Don Coker, explains some of the important nuances of establishing and quantifying economic damages in Libor manipulation litigation.
LIBOR – the London Interbank Offered Rate - is established daily based upon input provided by a selected group of banks.
The US Dollar LIBOR rate is the average interbank interest rate at which banks that are active in the London money market – essentially all of the big banks - will lend each another unsecured funds denominated in US Dollars.
LIBOR Rate Basics
People are sometimes surprised to learn that there are actually 150 different LIBOR rates published every day since rates are cited for 15 different maturities (1 day, 1 week, 2 weeks, 1 month, 2 months, 3 months, 4 months, 5 months, 6 months, 7 months, 8 months, 9 months, 10 months, 11 months, and 12 months); and the rates for those 15 different maturities each are quoted in 10 different currencies (Australian dollar - AUD, Canadian dollar - CAD, Swiss franc – CHF, Danish krone – DKK, Euro – EUR, British pound sterling – GBP, Japanese yen – JPY, New Zealand dollar - NZD, Swedish krona – SEK, and the US dollar - USD).
Until very recently, the management of the quoting of the various LIBOR rates was carried out by the British Bankers Association. However, since the recent rate manipulation controversy erupted, the BBA has turned over the actual calculation of the LIBOR rates to financial publishing powerhouse Thomson Reuters. (Disclaimer: Thomson Reuters sometimes refers business to me, for which I am thankful.) Thomson Reuters publishes the various LIBOR rates each business day around 11:00 a.m. London time.
LIBOR in Mortgage Securities
In the United States, adjustable rate mortgage loans often are LIBOR-indexed. Typically, an adjustable-rate mortgage indexed to LIBOR would reflect an interest rate 2 to 3 percent over the six-month LIBOR rate.
Investors in mortgage securities who receive smaller interest payments due to an artificial lowering of LIBOR received less income than they would otherwise. The investors’ economic loss is the difference between the interest they actually received and the interest that they would have received had the LIBOR rate not been manipulated lower.
LIBOR in Corporate Securities
Corporations that borrow based upon LIBOR indexed debt normally pay around 1% over the LIBOR rate.
Many writers of derivatives use LIBOR in establishing their pricing for hedging instruments tied to oil, other commodities, various interest rates, various currencies and other assets.
LIBOR in Municipal and Government Finance and Interest Rate Swaps
States and municipalities in the United States immediately realized that they may have sustained economic losses through their common use of interest rate swaps wherein the state or city borrows funds in the bond market, agreeing to pay bondholders a floating interest rate but have to pay their bankers a fixed rate through the swap arrangement. Clearly, if Libor is artificially manipulated to a lower rate, then the borrowing governmental entity is obligated to pay out the same fixed rate, but receives an artificially smaller variable payment from its bank due to the downward manipulation of LIBOR. This artificially smaller payment that results from LIBOR rate manipulation effectively produces an economic loss for the governmental entity that it would not have sustained but for the LIBOR rate manipulation.
Some governmental finance officials have estimated economic losses for their particular governmental unit in the millions to the tens of millions of dollars.
Challenges in LIBOR Lawsuits
Some securities lawyers state that to win a LIBOR manipulation lawsuit, the plaintiff will have to prove that LIBOR was artificially manipulated down for an extended period of time; but this does not seem to me to be a challenge considering the testimony that keeps popping up, even in the media; and we are not even in the litigation stage yet.
Likewise, some securities lawyers state that it is important to demonstrate that LIBOR was artificially manipulated downward on the particular day when certain payments were calculated. Again, this does not seem to me to be a great challenge since the pattern and practice of artificial LIBOR rate manipulation is what this controversy is all about. Read the newspapers.
Overview of the Methodology and Process for Establishing Economic Damages
Nationwide industry standard policies, practices, principles and procedures in litigation involving economic damages includes several steps.
Recognizing, establishing and effectively demonstrating Economic Damages in litigation requires a holistic comparative view of the damaged entity’s situation prior to and after the proximate causal event, a realistic and reasonable multi-year projection of how the damages will affect the damaged entity in the future, and a net present-value calculation to provide a current damages estimate that will also incorporate future damages.
Let’s break this down into its comprehensible components:
Step 1. Establishing the Economic Situation Before the Proximate Causal Event.
Step 2. Demonstrating the Most Likely Future Economic Situation Without the Proximate Causal Event.
Step 3. Defining the Proximate Causal Event and Tying it to the Damages It Caused.
Step 4. Establishing the Most Likely Future Economic Situation After the Proximate Causal Event.
Step 5. Demonstrating the Difference Between the Most Likely Future Situation Without the Proximate Causal Event and the Most Likely Future Situation After the Proximate Causal Event.
Step 6. Calculating the Net Present-Value of the Difference in the Two Projections.
Now, let’s take them one at a time:
Step 1. Establishing the Economic Situation Before the Proximate Causal Event
The best way to do this is to establish a financial “snapshot” of the entity’s financial situation for the subject transaction as it was immediately prior to the proximate causal event. This should be easy enough to accomplish by using past financial statements and tax returns.
Trends need to be established so as to reflect how the financial condition has changed year over year to arrive at the present “snapshot,” and that can be accomplished by looking at historical financial statements and tax returns for the three to five previous years before the proximate causal event.
Step 2. Demonstrating the Most Likely Future Economic Situation Without the Proximate Causal Event
Having established the past trend that brought the entity to the position that it was in immediately prior to the proximate causal event, you should then project that same trend into the future so as to establish a realistic and reliable estimate of future financial performance.
The projection should be carried out for as many years as the underlying financial transaction ran subject to the manipulated LIBOR rate. That projection may be five years, and it may be twenty-five years depending on the subject transaction.
Step 3. Defining the Proximate Causal Event and Tying it to the Damages it Caused
The proximate causal event in this case is the artificial manipulation of the LIBOR rate.
Step 4. Establishing the Most Likely Future Economic Situation After the Proximate Causal Event
This is the same process as described above in Step 2 except that it includes the negative influence of the proximate causal event. The number of years projected into the future should be the same as used in Step 2 above. In some cases, you will have financial statements that clearly reflect the impaired financial performance of the entity.
Step 5. Demonstrating the Difference Between the Most Likely Future Situation Without the Proximate Causal Event and the Most Likely Future Situation After the Proximate Causal Event
Once you have established the most likely future income projections before (Step 2) and after the proximate causal event (Step 4), the difference in these two projections is the gross amount of the loss for the projection period, not taking time into consideration. That is your base number that you carry forward into the next step.
Step 6. Calculating the Net Present-Value of the Difference in the Two Projections.
This is a mathematical exercise that involves net present-valuing the difference in the two projections (Steps 2 and 4) in order to arrive at an Economic Damages value as of the date of the proximate causal event.
Range of Values
It is acceptable to produce an Economic Damages value that is a range of values. Due to the level of judgment and speculation that is involved in estimating Economic Damages, it is sometimes best to recognize that a particular factor could just as easily be one figure as another figure. In a case like this, it is acceptable to calculate the future financial performance using both factors, and then state the Economic Damages estimate as a range.
Expert Strategy in LIBOR Manipulation Lawsuits
If you are involved in LIBOR manipulation litigation that involves Economic Damages, then hire a professional that is familiar with interest rate factors as well as Economic Damages calculation techniques, and that is highly experienced in providing supporting testimony at deposition and at trial. You can be assured that the expert will be questioned thoroughly regarding every step and factor of their methodology.
This methodology of calculating an estimation of Economic Damages is Daubert compliant since it assists the trier of fact to understand the evidence or to determine a fact in issue, is widely published and peer reviewed, is generally accepted as an accurate procedure, and is capable of being replicated by another competent professional.
It is extremely valuable for both sides to engage an Economic Damages expert since usually the Plaintiff’s expert will provide an Economic Damages opinion and the Defendant’s expert will either provide an alternate Economic Damages estimate or a critical review of the estimate provided by the Plaintiff’s expert, or both.
© 2012 by Don Coker
ABOUT THE AUTHOR: Banking and Economic Expert Witness Don Coker
Expert witness and consulting services. Over 500 cases for plaintiffs & defendants nationwide, 120 testimonies, 12 courthouse settlements, all areas of banking and finance. Listed in the databases of recommended expert witnesses of both DRI and AAJ. Clients have included numerous individuals, 80 banks, and governmental clients such as the IRS, FDIC.
Employment experience includes Citicorp, Ford Credit, and entities that are now JPMorgan Chase Bank, BofA, Regions Financial, and a two-year term as a high-level governmental banking regulator.
B.A. degree from the University of Alabama. Completed postgraduate and executive education work at Alabama, the University of Houston, SMU, Spring Hill College, and the Harvard Business School. Called on by clients in 31 countries for work involving 61 countries. Widely published, often called on by the media. Don Coker serves clients worldwide from his Atlanta metro area office.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.