In early December we became aware of a potential lawsuit led by Squire Patton Boggs lawyers (SPB) against Fitch Ratings agency. We met with SPB before Christmas to better understand the details and nuances of the case they are proposing and their objectives. The background to these new potential claims against Fitch is the previously successful claim SPB made against S&P. A potential alternate proposal to the SPB one is currently being developed by a competing law firm. It is likely both cases will involve investors who formerly held the Kakadu, Henley Jnr, and Esperance CDO’s and potentially any other Fitch rated CDO’s that suffered losses.
Many investors believe they have already recovered all or nearly all their monies lost on the CDO products from claims against Lehman Brothers Australia, the major banks and other distributors; however we have found this is a common misconception. Typically, investors have recovered sums close to the total of their lost principal, but this does not take into account lost interest. In a legal claim the interest “lost” is often calculated as the cash rate plus 4% (court pre-judgement interest rate) which compounded over a large number of years adds significantly to a claim, especially since some claims relate back to the time before the cash rate was reduced to its current 1.5%. As a simple example, using broadly representative numbers, if an investor lost $10 of principal on a CDO, with interest their claim against LBA may increase to $15 (using the CRP calculation of interest at BBSW + 0.45%) and they will likely have made a partial recovery of $9 (around 60% of their claim). As a result, the claimant may believe they have only made a $1 loss ($10 – $9), looking solely at their principal position. In reality, they are still out of pocket by $6 and interest on these monies at the court rates inflates a potential claim to $10. It is unlikely investors will recover this full amount after funding costs, but clearly any result that would return them around half or more of these monies is a good result and will likely make them whole for any principal or “actual interest” lost (calculating interest at a rate close to what they would have received had they invested in bank FRN’s or term deposits as an alternative).
Our recommendation is for investors to wait and see how things develop and not sign up to the SPB case at present. The reason for not recommend joining the SPB group now is the potential viability of the second proposal and its ability to cause SPB to improve its current offer. This will be dependent on how many investors have already signed up to the SPB group and what support the second proposal can garner. Our initial feeling is that given the success of the previous lawsuits and the low risk (virtually no risk) assumed by investors in a funded action, that former holders would likely be better off signing up to one of the potential law suits. The positive of a funding agreement is there is virtually no downside risk for any potential claimants as the funder absorbs all the costs if the lawsuit is unsuccessful.
However, the negative of a funding agreement is investors pay away a considerable amount of any settlement sum to a funder. In theory the terms of the funding agreement should reflect the risks involved for the funder resulting in a larger share for the funder if the case is likely to be difficult, expensive, drawn-out over a number of years and with great uncertainty as to the outcome. A case that is likely to be low risk, quick, cheap and easy should be reflected in a low funding fee. This theory breaks down when there is no competitive tension in the market between funders which is why we welcome a potential alternative lawsuit to the one run by SPB as it may avoid a situation of a funder charging an egregious sum for a simple case and investors having no alternative but to sign up or miss out. Amicus does not consider it worth going back to SPB at this stage in the absence of a firm alternative proposal and asking SPB to improve their funding terms as there is no incentive for them to do so without an alternative being available to their investors.
An additional level of complexity also arises because in some cases such as claims made by investors against Lehman Brothers Australia, those who did not sign up to the initial funder lawsuit were essentially free riders and received full payment without any fees to funders, but in others such as the recent case against S&P investors received a broadly similar “net” result between the SPB and JWS competing cases with S&P settling the SPB case for roughly twice the sum of the JWS case. We reviewed this recent case in an article we published in November and which can be viewed via the following link: http://www.amicusadvisory.com.au/comparison-of-results-of-lawsuits-against-sp/ Hence, it may not be a case of simply going with the group that has the lowest funding fee and other factors need to be considered as well.
Our recommendation is that holders of Kakadu, Henley Jnr, Esperance or any other Fitch rated CDO’s register their interest with Amicus and we can keep them abreast of developments and the options open to them as the cases develop. This is offered as a free service to all investors with no future obligations to Amicus. We do this because in the past we have gained work from investors who have decided to go forward as part of the claims preparation process. We also provide an independent view for investors because clearly the lawyers have a conflict of interest in wanting investors to sign up for their particular case.
