Bank of America, Citigroup, and Other Major Banks Manipulate Credit Default Swap Market, Class Action Alleges

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Bank of America, Citigroup, Deutsche Bank, and others have exploited their market power and rigged credit default swap (CDS) auctions to suit them, illegally raking in billions of dollars for more than a decade, a new class action lawsuit alleges.

The class action lawsuit was filed in New Mexico by the state’s State Investment Council (SIC), which is being represented by the New Mexico Attorney General’s Office, Law360 reported.

The SIC alleges that the banks and other leading CDS dealers have violated the Sherman Act and Commodity Exchange Act in a years-long scheme to manipulate benchmark prices used to value credit default swap contracts at settlement, pulling in billions for themselves at the expense of the CDS market.

“Because of the regulatory patchwork that governs the credit default swap market, no regulator has unearthed the defendants’ conspiracy,” the class action lawsuit states.

According to the 128-page claim, the scheme started with the 2005 CDS auction process, which settles credit default swaps. In the process, a CDS buyer can collect a payout from the CDS seller to compensate for lost value on whatever asset is underlying the CDS contract, Law360 reported.

But, the claim explains, that rather than having sellers and buyers negotiate the new price individually, the auction process results in a single, market-wide price based on submissions from dealer banks, which can be both CDS sellers and buyers.

The SIC says that the dealer banks coerced the CDS market into adopting the auction process and made themselves the “exclusive gatekeepers” of the market in a working group formed in 2008 that had no formal name and whose existence was never publicized.

According to the claim, it operated as a “front organization” for the dealer banks.

“At the dealer-only working group meetings, the dealers reached several agreements to exclude and constrain non-dealer participation in the auctions,” the claim alleges, adding the banks have profited “by sharing competitively and commercially sensitive pricing information with each other, and then coordinating their auction submissions to drive the final auction price in the direction that suits their respective CDS positions.”

Econometric analyses of publicly available CDS auction and bond pricing data shows evidence of secret coordination and information-sharing, Law360 reported, and traders at different dealer banks have had access to key pricing information at competitor banks, which is supposed to be off-limits.

With the information gathered, dealer banks — who are often net buyers of CDS protections — then lead auctions towards a “supra-competitive” final price, often on the lower end, the claim alleges.

“Even minor deviations in the final auction price cause a sea change in the amount of money that changes hand for CDS settlement purposes marketwide, netting the dealers billions of dollars in additional CDS protection payments over time,” the SIC says.

The SIC wants to represent investors who have settled a CDS contract based on the auction process. It is suing for violations of the Sherman Act and Commodity Exchange Act, and for unjust enrichment. It seeks unspecified treble damages with interest, attorney fees, and other relief.

Do you think it’s fair that banks and other CDS industry members are able to control the prices set at CDS auctions? Let us know in the comments section!

The SIC is represented by P. Cholla Khoury of the Office of the New Mexico Attorney General and by David E. Kovel and Thomas Popejoy of Kirby McInerney LLP.

The Big Banks CDS Scheme is New Mexico State Investment Council v. Bank of America Corp. et al., Case No. 1:21- cv-00606, in the U.S. District Court for the District of New Mexico.

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