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Striking decision for investment banks in Milan: just the beginning?

Striking decision for investment banks in Milan: just the beginning?

On 19 December 2012 the Court of Milan (Fourth Criminal Division, Judge Mr. Oscar Magi) rendered a landmark decision, whose rationale is not yet known inasmuch as the grounds have not been filed yet.

The ruling, however, clearly augurs a massive defeat for UBS, JP Morgan, Deutsche Bank and Depfa Bank since they have been found guilty of fraud against theMunicipality ofMilan and therefore are sentenced to a fine of 1 million euro and a total seizure of 87 million euro.

Together with these banks, nine of their managers have been convicted for fraud with sentences ranging between six to eight months, whilst the then General Director and the Head of Financial Department of theMunicipalityofMilanhave been acquitted.

The trial focused upon the derivative contracts executed by the Municipality of Milan since 2005, which were concluded in order to restructure a debt of 1,682 million of euro made up of several loans, most of which granted by the Deposits and Loans Fund (Cassa depositi e prestiti, a state institution).

In June 2005, the Municipality converted the loans into a thirty year bullet bond (bond maturing on a given date, which the issuer cannot terminate and which cannot be prepaid  prior to such date) with the money loaned by the above mentioned four banks.

In essence, the Municipality received the money from the banks pledging to pay in one lump, with interest, in 2035.

In addition to the loan agreement a swap contract on the interest rate was executed, i.e. a transformation of the interest rate from fixed to variable, a sort of bet on the trend of the rate (the Municipality pays a variable rate to the banks, the banks a fixed rate to the Municipality).

The judgment seems to have encountered the thesis of the Public Prosecutor and its consultants, who during the trial had challenged the choices of the Municipality for two reasons: the Municipality should have retained an external consultant while, on the contrary, it trusted entirely on the banks with whom it had executed the contracts .

The transformation of the rate from fixed to variable, was made in a point in time in which the forecasts of the leading economists stated that the rates could do nothing but go up since they were at an historic low.

In regards to the fraud by the managers of the banks the Court stated that there existed an economic advantage to the Municipality in the issuance of a bond for the restructuring of the debt of the Municipality instead of the renegotiation of previously executed loans, and that due to the execution of the contract under the governing laws of England, the Municipality of Milan was willfully deprived of the protection (provided for by the Italian law, N.o.T.) owed to it under the classification of “intermediate customer”, thus violating, inter alia, the duties of the managers required by the laws as to the protections guaranteed to the customers so classified.

As to the banks, the same have been sentenced pursuant to Legislative Decree no. 231 of 2001, for “not having adopted and effectively implemented a model of management suitable to prevent crimes committed by their employees, acting on behalf and in the interest of  the banks, which in turn made a considerable profit“.

The court result was a huge setback for the banks, especially considering that in the prior months they had reached a settlement agreement with the Municipality of Milan.

Such “prototype judgement” can certainly generate trepidation in the banking community since derivative contracts in the total value of 9.5 billions of euro concerning seven Regions, two Provinces and thirty-eight Municipalities are currently under investigation.

Guido Camera
Luca Ferrari

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