Barclays shunted hundreds of millions of dollars of toxic mortgage assets into two secretive investment vehicles that it had created itself. It did this just as the collapse of two Bear Stearns hedge funds last year alerted executives to the extent of the coming troubles in the credit markets, according to a lawsuit.
Barclays must decide this week if it will try to persuade a US court to throw out the suit, which alleges that the bank defrauded investors in the two structured investment vehicles "SIV-lites". Both went bust just weeks after the transfers. The bank must file for dismissal by Friday or face a trial.
Barclays, under its president Bob Diamond, is now expanding its US investment banking operations aggressively, and the case threatens to hurt its reputation and reveal details of how it responded to the emerging crisis in the credit markets last year. The transfers of toxic mortgage derivatives into its SIV-lites occurred as another division of the bank was facing big losses on its investment in the Bear Stearns funds, which Barclays is now alleging were used by that bank as a dumping ground for toxic assets of its own.
Across the world, lawyers have begun to pick through a vast network of inter-connected investment vehicles created during the credit market boom, through which increasingly complex mortgage derivatives were spread around the financial system. Civil lawyers and criminal investigators are looking for evidence deep in the contracts that defined these vehicles and set out the relationships between the banks that created them, the hedge funds that managed them and the investors that bet on them.
In the latest case, Barclays is being sued by a French asset manager in a New York court over the collapse of two investment vehicles designed in London and managed out of the tax havens of Jersey and Guernsey.
Oddo Asset Management says it lost its $50m (around £30m) investment in two SIV-lites, Mainsail and Golden Key, because of a scheme cooked up between Barclays and its partners.
The two vehicles purchased, at face value, several hundred million dollars of mortgage derivatives that had previously been sitting on Barclays' balance sheet and threatened to cause big losses for the UK company.
SIV-lites were a risky investment vehicle that took on huge amounts of debt in order to buy a variety of complex mortgage derivatives. They exploded into view last year when they became unable to service their debts, and dozenscollapsed. Some of the banks that created them took them on to their own books; others let them fail.
Barclays offered $2.5bn in credit lines to Golden Key and Mainsail in August 2007, but this was not enough to save them. Oddo claims that although both vehicles were ostensibly managed independently – Golden Key by Avendis (now in liquidation), Mainsail by Solent Capital Partners – Barclays manipulated them to get them to buy mortgage assets from itself, at what the bank knew were inflated prices.
"Barclays created these vehicles and hired investment advisers to manage the funds who were beholden to it," said Geoffrey Jarvis, Oddo's lawyer.
In June 2007, over the objections of Oddo but with the support of other investors, Golden Key bought mortgage assets from Barclays at face value – even though there were signs that their market value was far lower. A similar transaction took place at Mainsail. Within weeks, the credit rating agency Standard & Poor's reversed its view that both SIV-lites were as safe as government bonds and downgraded the pair's debt rating to junk status. Days later, they went bust.
A Barclays spokesman refused to comment on whether it would file a motion to dismiss, but said it would defend the lawsuit vigorously.
The case has parallels with a suit launched by the UK bank against Bear Stearns last year. In that case, which is pending in New York, Barclays said Bear Stearns and two of its fund managers – Ralph Cioffi and Matt Tannin, who have since been served with criminal charges – duped it into investing in two hedge funds where Bear Stearns dumped the toxic mortgage assets it couldn't sell. Those funds were forced to resell many of those assets at depressed prices in June.