In a landmark ruling, Deutsche Bank lost a case over interest-rate swaps in Germany’s highest court, Bloomberg reports.
The case is reminiscent of the one Goldman Sachs faced over the Abacus deal, in so far as one of the main elements of the trial was a focus on conflict-of-interest.
The lender has been ordered to pay Ille Papier Service close to $770,000 plus interest over the swap purchase because the court found that Deutsche didn’t “adequately disclose the risks of the product,” the WSJ reports.
Sales of derivatives have prompted similar lawsuits against banks in France, England and Italy, and there are at least 20 more like it pending in Germany.
The judge said that not only was there a “gross conflict of interest” in acting as an adviser and selling its CMS Spread Ladder Swap to Ille Papier, the bank also failed to explain properly the risk of buying the swap, to its client, which was, the paper company could “‘theoretically’ face unlimited losses.”
The judge said, via Bloomberg:
As an adviser to its customer, the bank must guard the customers’ interest alone. But as a seller of the swap, a loss to the customer works to the banks’ advantage.
The bank consciously structured the risk to its own advantage and at the expense of its client to be able to sell that risk to the market. The negative market value, consciously structured by the bank, was a manifestation of a grave conflict of interest.
Deutsche had argued that its client was sophisticated and knew what it was doing when it decided to by the swap in 2005 “based on its expectation the spread would widen and the customer would make money.” (Meanwhile, Deutsche was hedging its own risk through options). But then the spread narrowed, and Ille Papier lost a ton of cash — about $769,000.
The bank’s lawyers said “every high school graduate could calculate the formula the swap was structured on,” according to Bloomberg.
The judge disagree. He responded:
Let me put it this way: If you are able to read the words of a poem, you haven’t necessarily also understood its meaning. That also applies to this swap’s formula.
This case now sets a precedent for all the other claims that have been filed against Deutsche by other small companies, local governments and community-owned service providers. A lawyer told Bloomberg: “The judges took a very strict line with this ruling. They clearly said that as a bank you may not confuse your roles as an adviser to your customer and as a seller of products.”