The US Justice Department is conducting a criminal antitrust investigation into whether some investors in collateralized loan obligations colluded to bolster their positions as markets transitioned away from the scandal-plagued London interbank offer rate in early 2023, according to people familiar with the matter.
Antitrust prosecutors in New York have sent subpoenas to financial firms as they seek to determine whether investors with an equity stake in the $1.3 trillion CLO market illegally coordinated as the underlying buyout debt was repriced, said the people, who asked not to be identified discussing the confidential probe. The investigation was opened about a year-and-a-half ago, the people said.
A spokesperson for the Justice Department declined to comment.
In the last few months of 2022 and early 2023 — shortly before the final phaseout of Libor — a flurry of companies in the leveraged loan market rushed to switch the benchmarks on their debt. Often, they tried to exclude an adjustment that was meant to compensate investors for the fact that the Secured Overnight Financing Rate — the debt’s new benchmark — consistently printed below Libor.
CLO managers, who repackage leveraged loans into bonds of varying risk and size, saw how some companies were about to reap benefits during that transition if that additional spread wasn’t added, as it lowered the interest the companies paid. The most junior holders of the bonds they issued, also known as equity, stood to lose millions as they get paid last after every other investor in the bond has received their payments.
Communications between CLO equity holders near the transition deadline is part of what is being investigated by prosecutors, said the people familiar with the matter.
CLO equity investors were particularly exposed during the transition because their returns depend on the excess cash flows from underlying loans after higher-ranking CLO debt holders have been paid, and because of the significant leverage built into the structures. Smaller interest payments mean there’s less left over for them to pocket.
Antitrust law bars competitors from colluding for economic gain. Because each CLO investor is a separate entity, it could potentially be illegal for them to agree with each other on the financial terms for an investment.
In criminal collusion or price-fixing cases, prosecutors must show evidence of an agreement, but don’t need to provide proof of economic harm, potentially giving them an advantage if a case goes to trial. Still, if the government ultimately brings charges, it would need to convince a jury the actions came from collusion instead of firms reaching the same decision independently.
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