The End of LIBOR: Hotel California Edition [Part II]

To be addressed in subsequent series are (1) expected financial benefits/costs of benchmarks in financial instruments, (2) general lack of economic equivalence requirement during the LIBOR transition (except in the UK Courts), and (3) those jurisdictions with worldwide benchmarks not based upon LIBOR and alternative benchmarks not based upon risk-free rates.

To be explored in this Part are recent significant developments relating to the LIBOR transition including:

• Termination of “Zombie” LIBOR.
• Replacement of Alternative Reference Rates Committee (ARRC).
• Case status of some of the long-running LIBOR cases.

Among other topics covered in Part I of this Hotel California Series was the interchangeable use of the term Secured Overnight Financing Rate (SOFR) to mean “Term SOFR” and “Daily Simple SOFR” though each are distinct benchmarks.

Formation of New Benchmark Rate Committee

The Federal Reserve Bank of New York announced, on September 26, 2024, the formation of the Reference Rate Use Committee (RRUC) to support the integrity, efficiency, and resiliency in the use of reference rates across financial markets including, but not limited to, those produced and administered by the New York Fed. It is contemplated that RRUC will build upon the work of the ARRC, which facilitated the transition from USD LIBOR, commencing in 2014.[1]

Recent Status of LIBOR Traders’ Convictions

Scandal Background

In June 2012, the LIBOR manipulation scandal exploded publicly when initial settlements were announced by US and UK regulators, ultimately involving numerous financial institutions in billions of dollars (and pounds) of settlements. As a result, the responsibility for calculating LIBOR was moved from the British Bankers’ Association (BBA), a banking and other financial institution trade association, to a new administrator, while the UK regulator previously responsible for overseeing LIBOR was disbanded and replaced with a new UK regulator – the UK FCA.

In June 2023, USD LIBOR finally ceased to be published though, as mentioned above, “Zombie” LIBOR continued to be published until last year.

Recent United States Proceedings

Subject Cases

In 2015, Tom Hayes, former UK trader at two international financial institutions, was the first trader to be convicted of conspiracy to defraud for manipulating LIBOR rates and was sentenced to 14 years in prison (later reduced to 11 years). The UK Serious Fraud Office (SFO) alleged that Hayes was a ringleader in a global conspiracy to manipulate LIBOR rates as Hayes admitted to his participation in the dishonest scheme to rig LIBOR. Hayes was the first trader convicted in the LIBOR manipulation scandal.

In 2019, Carlo Palombo, a former trader in EURIBOR, was convicted in a separate proceeding of conspiracy to manipulate EURIBOR rates and was sentenced to four years in prison. Hayes and Palombo were amongst a score of traders who were prosecuted and convicted in the UK and US for manipulating LIBOR and EURIBOR rate benchmarks. Both traders were released from prison in 2021.

In January 2022, the US Court of Appeals for the Second Circuit reversed the conviction of two other traders convicted of LIBOR manipulation fraud (as discussed immediately below) and dismissed charges against Hayes later in October. In 2023, both Hayes and Palombo appealed to the UK Court of Appeal to overturn their convictions based upon the reasoning in the US Court of Appeals dismissal.

Related Court of Appeals Dismissal

After a multi-year US Department of Justice (DOJ) investigation, two former traders at another international bank, Matthew Connolly and Gavin Black, were charged with inducing LIBOR panel submitters to make false statements to the BBA in their LIBOR submissions so as to increase profits, or decrease losses, on existing derivatives contracts. LIBOR submitters testified that they sometimes received requests from these traders to make submissions that would be beneficial to the traders’ trading positions making them “trader-influenced” LIBOR submissions. The US government alleged Connolly directed colleagues to arrange false submissions consistent with his traders’ interests and Black encouraged false submissions to benefit his own derivative trading. The traders were ultimately convicted in the Southern District of New York (SDNY) of wire fraud and conspiracy to induce false statements in October 2018.

Even though the court determined that BBA’s LIBOR instructions explicitly barred collaboration between panel banks in determining their respective LIBOR rate submissions, only in 2013 (subsequent to the initial announcements about the scandal) did BBA adopt a LIBOR Code of Conduct limiting the permissible exchange of LIBOR-relevant information between LIBOR submitters and traders. The traders’ actions in this case preceded the adoption of the LIBOR Code of Conduct. BBA was disbanded in 2017.

On appeal, Connolly and Black argued that DOJ failed to prove that their requests for LIBOR rate submissions were false, fraudulent, or misleading. In response, the US government argued that the evidence to support defendants’ convictions of wire fraud, and of conspiracy to commit wire fraud, was sufficient because the LIBOR submissions were either false statements or fraudulent omissions because they did not reveal that they had been influenced by trader requests, or misleading half-truths because they impliedly certified that there had in fact been no trader influence.

The Second Circuit agreed with the defendants and determined that there was insufficient evidence of fraud. The Second Circuit stated that even though the traders’ actions “may have violated any reasonable notion of fairness,” the US government failed to produce evidence that any of the bank’s LIBOR submissions that were influenced by the traders were not rates at which the bank could actually request, receive offers, or accept loans based upon LIBOR.

The Second Circuit also rejected the government’s theory of falsity. The court stated that there were two principal respects in which the trial evidence, viewed as a whole, failed to support the foundations of DOJ’s theory that there was one true interest rate, automatically generated by the bank’s LIBOR pricer model, which was the bank’s LIBOR submission as generated except when there was a request from a trader. The court noted that first, witness testimony revealed that there were many factors other than the data automatically received by the pricer that informed the bank’s final LIBOR submission and, second, there were many loans available to the bank, with varying interest rates and, as the bank could agree to such rates, there was no one true rate that it was required to submit. As a result, the court reversed the traders’ convictions in United States v. Connolly, No. 19-3945 (2d Cir. 2022).

Recent United Kingdom Proceedings

Subject Case Determinations (UK Court of Appeal)

In July and October 2023, respectively, the Court of Appeal by the Criminal Cases Review Commission of the UK (CCRC) referred Hayes’ and Palombo’s cases to the UK Court of Appeal on the basis that there was a possibility that the UK Court would find helpful as guidance the recent Second Circuit’s findings in Connolly. The CCRC only refers cases when all other appeal options have been exhausted and when new evidence is presented. On March 27, 2024, the UK Court of Appeal dismissed the appeals of Hayes and Palombo.

The UK Court of Appeal also rejected the submissions in the Connolly decision with respect to Second Circuit guidance stating that the Connolly decision had nothing to do with any conclusion of law but, rather, addressed only the question of the sufficiency of evidence from a factual standpoint. The UK Court of Appeal decision is a stark contrast to the US Second Circuit decision, which established Hayes’ and Palombo’s innocence for the same alleged offense. In addition, the UK Court of Appeal refused its permission for Hayes and Palombo to appeal to the UK Supreme Court but left it to the UK Supreme Court to consider their cases because there remained “a point of law of general public importance,” which provides grounds for an appeal to the UK Supreme Court subject to the Court’s discretion to take the cases.

General Public Importance Certification (UK Court of Appeal)

Notwithstanding the court’s refusal to permit Hayes’ and Palombo’s appeal, the UK Court of Appeal certified that the following points of law were of general public importance in connection with the proper construction of the definitions of “LIBOR” and “EURIBOR”:

• [i]f a LIBOR or a EURIBOR submission is influenced by trading advantage, it is for that reason not a genuine or honest answer to the question posed by the definitions;
• the submission must be an assessment of the single cheapest rate at which the panel bank, or a prime bank, respectively, could borrow at the time of submission, rather than a selection from within a range of borrowing rates.[2]

Grant of Appeal (UK Supreme Court)

On July 22, 2024, the UK Supreme Court granted its approval to hear the appeals of Hayes and Palombo, where it may consider, or separately address, the legal issues of general public importance identified above by the UK Court of Appeal. A hearing before the UK Supreme Court is scheduled for March 25 and is expected to last three days.[3]

To summarize concerns outlined in this edition and to be outlined in future editions of this series:

And still those voices are calling from far away,

Wake you up in the middle of the night

Just to hear them say…

Welcome to the Hotel California

Such a lovely place (such a lovely face)

They livin’ it up at the Hotel California

What a nice surprise, bring your alibis