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‘How not to conduct investment banking’: Addleshaws defeats Mayer Brown in UBS Commercial Court derivatives battle

Banking giant UBS has been defeated in the Commercial Court today (4 November) over a $340m dispute it mounted against German water utility company Kommunale Wasserwerke Leipzig (KWL) relating to the sale of complex derivatives products by the bank, after a five-year long battle that saw Addleshaw Goddard and German firm Noerr defeat Mayer Brown.

KWL, the municipal water company for the City of Leipzig, entered into four single tranche collateral debt obligations (STCDOs) between 2006 and 2007 either directly with UBS or indirectly through two other intermediary banks, Depfa Bank and Landesbank Baden-Württemberg (LBBW). The STCDOs, which each consisted of a synthetic portfolio of credit default swaps on which KWL ‘sold’ credit protection to UBS in exchange for payment of a ‘premium’, had a notional value of over $400m.

After the STCDOs sustained major losses in the wake of the financial crisis, it emerged that the sale had been procured by substantial bribes paid by KWL’s financial advisers to its then managing director. Consequently, UBS sought to enforce each of the STCDOs against KWL and the intermediary banks.

Following a 14 week trial, Justice Males described the case as ‘a case study in how not to conduct investment banking in an honest and fair way’ and made findings of serious misconduct by UBS personnel and other parties involved, including bribery and dishonest behaviour which led to KWL investing in the complex products.

Notably, the court said it seemed surprising that a municipal water company should engage in the speculative business of selling credit protection which, if things went wrong, would expose it to liabilities on such a scale.

This was expressed in an internal email sent by Dublin bank Depfa, a third party to the proceedings, in November 2008: ‘You have to wonder what in the name of God a utility company were doing selling protection on this portfolio!! They must have been persuasive UBS salesmen!!!’

The judgment further criticised UBS Global Asset Management (UBS GAM) and held that it failed to properly monitor its concentrated bet on high risk financial entities. Males further found that the losses that KWL sustained under the STCDOs were caused by UBS GAM’s negligent portfolio management and KWL would therefore have been entitled to recover these losses as damages from UBS GAM if the STCDOs had not been rescinded.

Brick Court Chambers quartet Tim Lord QC, Simon Salzedo QC, Stephen Midwinter and Craig Morrison were all instructed for KWL by Addleshaw Goddard, which included a team led by partner Michael Barnett. Instructed by Mayer Brown for the UBS parties was Lord Falconer, and Brick Court Chambers trio Richard Slade QC, Jonathan Dawid and Edward Harrison.

Fountain Court Chambers’ trio David Railton QC, Richard Power and Edward Levey were instructed by Dentons for Depfa, while Maitland Chambers’ Nicholas Peacock QC, Catherine Addy, and Fiona Dewar were instructed by Baker & McKenzie for LBBW. Bakers’ financial disputes partner, Arun Srivastava, said: ‘We are pleased to have secured a positive outcome for our client LBBW. The Court accepted LBBW’s case on construction that the swap with UBS was not enforceable.’

On the decision, Addleshaws partner Barnett said: ‘While the judge expressed the hope that the bank’s conduct in this case “belonged to a bygone era”, the outcome highlights the importance for banks of maintaining rigorous, effective and independent control functions.’