As financial institutions continue to seek closure on their exposures arising out of a variety of practices engaged in around the turn of the Millennium, the insurance and reinsurance markets feel the consequences.
With the lawsuit brought by Enron’s shareholders due to begin in October this year, and amid the high profile extradition of the NatWest three (accused of defrauding NatWest through a series of transactions with Enron), the Royal Bank of Scotland (of which NatWest is a subsidiary) is reportedly close to joining the growing number of banks which have entered settlements with the Enron shareholders. Some of those settlements have run into hundreds of millions of pounds, and the banks are seeking recovery from their financial institutions’ insurers.
Of course, it is not just the Enron settlements which have been coming home to roost. Financial institutions also have alleged exposures arising out of the collapse of WorldCom, and the practices of "laddering" and trading in mutual funds.
Insurers have faced an avalanche of financial institutions claims and will need to take care when settling them in order to be sure that they will be able to recover from their reinsurers. Much will depend on the wordings of the relevant reinsurance contracts. If these do not contain "follow the settlements" clauses, the reinsured will have to be able to demonstrate on the balance of probabilities that it had a liability under the original policy, and that it has a valid claim under the reinsurance. Whether losses can be aggregated or presented as a number of losses will depend on the particular terms of the treaties involved with the consequence that financial institutions’ insurers on the same risks may have different outcomes from their reinsurance presentations.
So, what briefly are the underlying claims? The lawsuits brought by Enron’s shareholders in the US (after Enron filed for bankruptcy in December 2001) involved claims that a number of banks, over a period from October 1998 to November 2001, knowingly financed a number of special purpose vehicles which allowed Enron fraudulently to remove debt from its financial statements.
The lawsuits brought in the US (after WorldCom filed for bankruptcy in July 2002) by investors in, and creditors of, WorldCom involved alleged breaches of US securities legislation against a syndicate of banks which (in contrast with the Enron scenario) participated in only one bond issue (for $12bn) for WorldCom in May 2001.
The laddering claims arose from a variety of alleged types of misconduct by investment banks during the period 1998 to 2000 in connection with the underwriting of numerous initial public offerings and issuing of research analysis. In addition to lawsuits filed by investors, penalties have been imposed on the banks by the regulatory authorities and substantial costs incurred by the banks.
The claims involving mutual fund managers arise from the cost of dealing with numerous US regulatory investigations and liabilities arising out of civil law suits brought in the US alleging that favoured investors were allowed to trade in the mutual funds in ways which enabled those investors to exploit the peculiarities of the way mutual fund shares are priced.
An instinctive reaction on initially learning of the alleged practices is to question whether, if true, financial institutions’ policies would cover such conduct. Also, with some of the conduct spanning significant periods, inevitably questions arise as to how many losses are involved and which policy years are affected. Again, much depends on the wording of the original policies which, of course, may vary from one financial institution to another. The cover can be very broad in nature and, although the conduct alleged may have been unsavoury, there is nothing in English law (many of the policies however, are subject to US law) to prevent an insured from protecting itself from the misconduct of its employees. Many of the original policies will also have included provisions allowing for losses arising out of inter-related wrongful acts to be treated as one loss.
It can add to the already complex task of dealing with the underlying losses when deals are done which blur how liability under the original policies arose. Insurers need to tread carefully and keep firmly in mind the provisions of their outwards treaties.
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