Diplomats in robes

New York federal courts have rattled nerves around the globe with recent decisions that impact far beyond US borders. Last month, an Eastern District jury verdict found a Jordanian bank responsible for terrorist financing. Meanwhile, over in the Southern District, Judge Griesa is working to force Argentina into a settlement with so-called “vulture funds” that have rejected that country’s debt restructuring offers. These laws have never been successfully adjudicated before, but the judges in each case dismissed arguments of the Obama administration that caution should prevail. In particular, the administration claimed that the way the judges interpreted the law risked damaging US foreign policy interests and economic stability. Both cases raise questions about how the judges catapulted themselves into these diplomatic roles and if there is any way to contain them.

This is the beginning of a post of mine on Huffington Post. For the rest, go to the link.

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Bailout blunders

The AIG lawsuit by Maurice Greenberg attracts some scathing attention from Andrew Ross Sorkin in today’s Times. He’s right on the politics, but is he right on the law?

Sorkin has little sympathy for Greenberg, who is suing the government over its handling of the AIG takeover, writing that the insurance giant “stupidly insured big banks on large swaths of bad mortgage deals via credit-default swaps.”

As Sorkin recounts,

Mr. Greenberg, who sued on behalf of fellow shareholders and seeks more than $40 billion from the government, does not dispute that A.I.G. needed $192 billion to survive the financial crisis. It instead challenges the onerous nature of the rescue.

On Monday, his lawyer, David Boies, hammered Henry M. Paulson Jr., the former Treasury secretary, about why A.I.G.’s shareholders were nearly wiped out when the government took what eventually became a 92 percent stake in the firm and put the interest rate on the loans at a high 14 percent. The onerous terms were unlike the deals made for so many other institutions receiving bailouts in 2008, including Morgan Stanley, Citigroup and Bank of America.

In his complaint, Mr. Greenberg asserts that the terms amounted to a violation of the Fifth Amendment. “This is the only time in history when the government has taken without just compensation and/or illegally exacted the assets and equity of a company and its shareholders in connection with a loan, let alone a fully secured loan bearing an extortionate interest rate,” the suit says.

To Sorkin, this is a ridiculous argument. The AIG takeover was “punitive” and “confiscatory”, and “it was supposed to be”. Or, as Sorkin quotes,

On questioning, Mr. Paulson didn’t beat around the bush. ““It was important that the terms be harsh because I take moral hazard seriously,” he said, confirming that the deal was structured so as to be punitive to A.I.G. shareholders. “When companies fail, shareholders bear the losses,” he said, “It’s just the way our system is supposed to work.”…

So why was the government so tough on A.I.G. and so easy on the banks that bought the soured mortgage bundles in the first place?

In truth, because the government thought that such a deal wouldn’t destabilize A.I.G. — and a tougher deal for banks might undermine confidence in the financial system in the markets.

That’s the same reason the government didn’t push harder for A.I.G.’s counterparties — i.e. the banks — to take “haircuts,” or less than the money they were owed on the insured payouts. The government worried it would only make people more nervous about the strength of the banking system, undermining the confidence it was trying to sow.

Sorkin is right on the political optics of the case. If the Court of Federal Claims were to award any money to shareholders, it would be politically toxic for the legal system and at least two administrations.

But, as his reporting reveals, the government actually did seek to confiscate and use its force with AIG, and made it bear a burden not imposed on other financial players. This starts to sound like a regulatory taking, even if it were a politically justified one.

Now, even though this is a colorable taking case, I would be surprised if US courts sided with Greenberg. But this is because of the politics, not the law.

Indeed, as I wrote earlier in Greenberg’s lawsuit, he may have a better chance bringing his claim under the US’ investment treaty with Panama – which is where Greenberg’s holding company is domiciled.

I can see at least four reasons why a treaty based claim could yield more fruit than a domestic case.

My colleague Matt Porterfield has compared the domestic regulatory takings doctrine to the analogous international indirect expropriation doctrine. While the former is relatively pro-government, the latter is more deferential to investors. And in this case, the principals are on the record as saying they intended to punish and take shareholders’ property.

Second, if a US court failed to side with Greenberg despite the legal merits, he could claim additionally that the US judiciary contributed to the taking or to denial of justice.

Third, to my knowledge of the case law, Paulson’s moral hazard defense would not carry water – investment tribunals have been loath to give much weight to economics-rooted defenses. The government’s speculations that banks would be more able to bear the brunt of the burden would be just that. Greenberg could bring in many experts that will just say that the banks could have / should have failed. In treaty cases, experts tend to cancel each other out.

Finally, international arbitral tribunals do not face the same type of political pressures as US courts to side with the US government on a case that is “too big to lose”.

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Hamas’ Bank: Meet US trial lawyers

Could a jury decision on terror financing trigger #WTO liability for the US?

Earlier this week, a New York jury found a Jordanian bank liable for damages under the 1990 US Anti-Terrorism Act (ATA). According to the Times, it was “the first time a bank has ever been held liable in a civil suit under a broad antiterrorism statute.” The Bank plans to appeal the case, which could produce a damage award in the billions of dollars.

Allegedly, the Arab Bank (Jordan’s largest bank and a major conduit of US and Israeli foreign aid money) ran a life insurance program for suicide bombers. US victims of suicide bombing attacks in Israel invoked the ATA to claim civil damages. According to Fortune, the US courts have jurisdiction over the case because some of the transfers were conducted through Arab Bank’s New York affiliate – although the New York link is pretty tenuous from the available records.

The Arab Bank claims innocence, but has also refused to hand over documents proving this – saying it would violate financial secrecy laws of several countries where it conducts business. Here is Fortune again:

The Arab Bank’s prospects of successfully defending itself have been hobbled, if not foreclosed, by U.S. District Judge Nina Gershon’s July 2010 order imposing stiff sanctions on the bank for its failure to turn over records, an act that would have—according to both the bank and the Kingdom of Jordan, which filed papers on the bank’s behalf—violated the country’s bank secrecy laws…

Judge Gershon’s controversial sanctions order relates to document requests the plaintiff made in 2005, seeking bank records of certain named individuals and organizations. Most of the records were located in Jordan, Lebanon, or Palestinian territories, where they were protected by bank secrecy laws, meaning that the bank would have risked criminal prosecution in those countries for complying with Judge Gershon’s order.

The general U.S. rule is that, even under such circumstances, U.S. judges do have the power to order records to be turned over, but they must first perform a balancing test, examining all the equities of the situation and taking into account considerations of international “comity”—i.e., respect for foreign countries’ laws. Given the interests that both the U.S. and Jordan had expressed in fighting terrorism, Judge Gershon ordered the records turned over and, when they weren’t, imposed a crushing and, potentially, case-dispositive sanction order.

Under that order the jury would be instructed that it may (though it need not) infer solely from the bank’s failure to turn over those records that the bank did, indeed, “knowingly and purposefully” aid the financing of terrorists. Equally devastating, the order forbids the bank from introducing any evidence of its allegedly innocent state of mind if that evidence might have been contradicted by the records that were never turned over.

In other words, the judge made a decision that US interests trump foreign laws and that a jury was to be instructed to disregard much of Arab Bank’s argument. This does not put the Arab Bank in a strong position.

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Ejusdem regs

Canada and the EU’s draft trade agreement was recently leaked, and it appears to give more space to nations to regulate the financial services sector than past trade deals. (h/t @snlester) But CETA may actually introduce new problems for financial regulators.

A quick refresher: the Uruguay Round of trade talks produced the world’s first major “trade” deal that also included rules restricting what types of financial regulations countries could apply on their home turf. This obviously concerned financial regulators, who were worried that WTO adjudicators would give more weight to “trade” concerns than regulatory ones. The compromise was a “prudential measures defense” or “prudential carve-out” that a country could invoke in WTO proceedings if its financial regulations were ever challenged. The problem is that the defense is not clearly written, and may cause more problems than it solves, as I have written here and here.

The CETA drafters appear to be sensitive to this criticism, and have a lot more language emphasizing the importance of regulation. (I’ve posted the full thing below). But even the permissive language (e.g. “Each Party may determine its own appropriate level of prudential regulation”) does not mean that investors or states could not challenge that regulation once the state established it.

A few quick points.

First, the CETA text puts states back in the drivers’ seat. Other trade agreements outsource power to international courts and adjudicators, who are seen as trustees and independent interpreters of a system of rules that hold states to account. Some scholars have questioned the wisdom of this. As Eric Posner and John Yoo write,

Tribunals are likely to be ineffective when they neglect the interests of state parties and, instead, make decisions based on moral ideals, the interests of groups or individuals within a state, or the interests of states that are not parties to the dispute. The difference between our view and the conventional wisdom centers on the role of tribunal independence. A tribunal is independent when its members are institutionally separated from the state parties-when they have fixed terms and salary protection, and the tribunal itself has, by agreement, compulsory rather than consensual jurisdiction. Conventional wisdom holds that independence at the international level, like independence at the domestic level, is the key to the rule of law as well as the success of formalized international dispute resolution. We argue, by contrast, that independent tribunals pose a danger to international cooperation because they can render decisions that conflict with the interests of state parties. Indeed, states will be reluctant to use international tribunals unless they have control over the judges. On our view, independence prevents international tribunals from being effective.

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What is at Fault in #GrieFault?

Simon Lester asks what part of Judge Griesa’s anti-Argentina injunctions would be actionable under WTO rules. This was a possibility I raised here. On Twitter, he asks “have other courts interpreted similar clauses differently than Griesa did?” and “Isn’t this US court enforcing a private contract, rather than interpreting statute/regulation?”

It’s a good question. My take is that the measures at issue would not be the underlying contractual term, but Griesa’s interpretation of it plus any judicial or executive branch efforts to enforce the holding.

First, on the question of the weight of precedent. There has not been much interpretation by courts of the so-called pari passu clauses which are at issue here. As SCOTUS Blog notes

One promise [by Argentina] was that any dispute would have to be settled under New York law.  And another was a so-called “equal treatment” guarantee.  That second promise goes by a Latin phrase, pari passu.  Loosely translated, it means that everybody gets treated the same when it comes to investors’ rights.  It is a standard part of almost all international borrowings by governments. …

Ultimately, a federal judge in New York City, Thomas P. Griesa (in time, fully supported by a higher court, the U.S. Court of Appeals for the Second Circuit), ruled that if Argentina made any more payments to the swap participants, it had to pay what it owed to the holdouts — that is $1.33 billion.  That, Judge Griesa said, is what pari passu means.

Argentina thinks pari passu means something else: only that it would treat the investors in a single borrowing the same, not that it would treat everyone in the world to whom it owed money the same.  The holdouts had a chance to make a swap, and they chose not to. 

The rival interpretations could be recast as to whether pari passu clauses guarantee equality of outcome (payment) or equality of opportunity (everyone given same procedural rights to make a deal).

The US argued for the latter interpretation in its amicus brief. The Obama administration lawyers said that the correct legal result (as a matter of New York contract law) is that which is consistent with settled expectations of the meaning of contractual terms at the time of original contract. Citing a long string of academic and historical publications, the US argued that the settled understanding was limited to procedural equality.

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GrieFault Backfire?

Could the US face WTO sanctions for the recent Argentina bonds debacle?

A quick recap of where we are. US Judge Griesa recently ruled that Argentina cannot pay off its restructured bondholders without first paying a group of “vulture fund” holdouts. Those restructured bondholders were due their payments last night, but US banks were enjoined from making the payments on Argentina’s behalf (despite having Argentina’s money to do so). This prompted Standard & Poors to declare Argentina in technical default. Financial reporter Felix Salmon is referring to the mess using the hashtag #GrieFault on Twitter, distinguishing a judicially determined default from one where a government doesn’t have the economic resources to meet its payment obligations.

Argentina prefers a different nomenclature, noting that the US is “internationally responsible” for its judiciary, which it accuses of “transfer restrictions“.

In the world of international law, thems are fighting words. Back in 2011, the WTO ruled that the US court rulings are “a priori capable of constituting a measure attributable to the United States, which may be challenged in dispute settlement proceedings under” the WTO. And a decade earlier, a WTO panel noted that – if US prosecutors or courts moved to block payments and transfers to offshore gambling sites – it risked violating its WTO obligations.(Indeed, Argentina just announced that it might pursue action at the International Court of Justice, although it is not clear on what basis.)

It would be ironic if the Obama administration, which supported Argentina’s positions in US court filings, now finds itself on the hook for judicial actions it disagrees with. But them’s the rubs when it comes to international law (as I write in this piece for UNCTAD).

Here’s a bit more detail on how I see such a claim playing out:

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Court ok’s Argentine fishing expedition

This is not the latest Malbec-themed eco-lodge in Mendoza. The Supreme Court, led by Justice Scalia, determined in a 7-1 decision that Argentina’s hold-out creditors can use US courts to obtain information about the government’s assets all around the world. The case is called Republic of Argentina v. NML Capital (“NML”). NML was requesting information on the global transactions made for Argentina by Bank of America and Banco de la Nacion, including with individuals, defense ministries, subfederal governments, and more.

This information would be used to eventually attempt to ask courts (in the US and elsewhere) to attach Argentina’s assets to make up for what the creditors feel they are owed. In short, the Supreme Court’s authorized a global fishing expedition to find Argentine assets. This is an interesting contrast with the sharp limitations put on tax authorities using similar techniques to find laundered and tax-evaded income (see page 52 of this report, for instance).

NML is the latest in a long saga of investor and bondholder complaints related to steps that Argentina took following its 2001-02 financial crisis.

The case shows how US courts are becoming increasingly embroiled in sensitive foreign affairs issues. It comes on the heels of a March Supreme Court decision (BG Group PLC v. Republic of Argentina) that found that US courts will defer to investment arbitrators’ awards against sovereign states, even when (as Argentina and the Obama administration suggested in their losing argument) that the investor complainant hadn’t complied with the terms of the underlying investment treaty. Chief Justice Roberts, in a dissent, wrote that the majority “trivializes the significance to a sovereign nation of subjecting itself to arbitration anywhere in the world, solely at the option of private parties…”

The present case is a bit different.

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