Starr Int'l Co. v. Fed. Reserve Bank of N.Y.

• Decision Date: 16 November 2012
• Docket Number: No. 11 Civ. 8422 (PAE).,11 Civ. 8422 (PAE).
• Citation: 906 F.Supp.2d 202
• Parties: STARR INTERNATIONAL CO., individually and derivatively on behalf of American International Group, Inc., Plaintiff, v. FEDERAL RESERVE BANK OF NEW YORK, Defendant, American International Group, Inc., Nominal defendant.
• Court: U.S. District Court — Southern District of New York

906 F.Supp.2d 202

STARR INTERNATIONAL CO., individually and derivatively on behalf of American International Group, Inc., Plaintiff,

v.FEDERAL RESERVE BANK OF NEW YORK, Defendant,American International Group, Inc., Nominal defendant.

No. 11 Civ. 8422 (PAE).

United States District Court,

S.D. New York.

Nov. 16, 2012.

Duane Louis Loft, Nicholas A. Gravante, Jr., Robert Jeffrey Dwyer, Boies, Schiller & Flexner, LLP, John L. Gardiner, Skadden, Arps, Slate, Meagher & Flom, L.L.P., David Boies, II, Julia Carolyn Hamilton, Armonk, NY, for Plaintiff.

Gary W. Kubek, John S. Kiernan, Maeve L. O'Connor, Debevoise & Plimpton, LLP, Shari Debra Leventhal, Federal Reserve Bank of New York, New York, NY, for Defendant.

Joseph S. Allerhand, Stephen Alan Radin, Weil, Gotshal & Manges LLP, New York, NY, for Nominal defendant.

OPINION & ORDER

PAUL A. ENGELMAYER, District Judge.

This case arises out of the unprecedented financial crisis that unfolded during fall 2008, and, in particular, out of the federal government's rescue of American International Group, Inc. (“AIG”). Plaintiff Starr International Co. (“Starr”), a major stockholder in AIG, challenges, directly and derivatively on AIG's behalf, various actions taken by the Federal Reserve Bank of New York (“FRBNY”) in connection with that rescue. Starr alleges that, by virtue of its actions during the rescue, FRBNY assumed a fiduciary role at AIG, but then breached its fiduciary duties to AIG's shareholders. Most significantly, Starr alleges that FRBNY exploited its control over AIG to force AIG (1) to unwind credit default swap (CDS) contracts with its counterparties on terms needlessly detrimental to AIG, in an effort by FRBNY to fortify the counterparties' balance sheets; and (2) to cede to FRBNY an outsized portion of any residual profits received from AIG's CDS contracts. On those bases and others, Starr argues that FRBNY is liable for breach of fiduciary duty under Delaware law.

FRBNY has moved to dismiss Starr's Amended Complaint, on various grounds. For the reasons that follow, FRBNY's motion to dismiss is granted in full.

I. Background and Underlying Facts¹

The circumstances underlying AIG's fall and its rescue by the government have been well chronicled in the media ² and academic literature.³ The facts relevant here, as extracted from the presentation in Starr's Complaint, are these:

A. AIG's Business Before September 2008

AIG was founded in 1967, went public in 1969, and thereafter grew into the world's largest family of insurance and financial services companies. Am. Compl. ¶ 21. In the 1980s, AIG began a line of business in which it entered into derivative contracts. In those contracts, third parties (“counterparties”) paid AIG a fee—essentially an insurance premium—to take on the risk of business transactions. Id. ¶ 22. This business was run by an arm of AIG known as AIG Financial Products (“AIGFP”). Id. In 1998, AIGFP expanded this business and began writing insurance policies on structured debt offerings. Id. ¶ 23. Under these contracts, known as credit-default swaps, AIGFP agreed to make the counterparty whole if a credit-linked note, such as a mortgage-backed security, failed to perform because, for example, the underlying debt was not paid. Id. ¶¶ 23–24. Between 1998 and March 2005, AIGFP entered into approximately 200 CDS contracts. AIGFP thereby insured debt securities with a notional amount of nearly $200 billion. Id. ¶ 25. ⁴

After March 2005, AIGFP's business of writing CDS contracts accelerated sharply. Between then and December 2005, AIGFP entered into another approximately 220 CDS contracts. These CDS contracts mostly insured debt securities linked to subprime mortgages. Id. ¶¶ 27–28.

Many securities which AIGFP agreed to insure consisted of, or included, collateralized debt obligations, or CDOs. Id. ¶ 29. A CDO is a complex investment product: It is a security backed by a pool of bonds, loans, or other assets. In the mid–2000s, these assets often included mortgage-backed securities. Id. ¶ 30. Investors may purchase different securities corresponding to different “tranches” of the CDO, which in turn correspond to distinct assets held within the CDO. Because the tranches are comprised of distinct assets, each tranche has its own risk profile and credit rating, and each pays a different interest rate, keyed to the level of risk that the investor will be taking on. Id. ¶ 29. A CDO is a derivative, because its value is derived from events relating to a set of reference securities that may or may not be owned by the parties involved.⁵

In late 2005, however, AIGFP's senior executives concluded that writing CDSs—insurance—on CDOs was unacceptably risky. They decided to stop writing new CDSs backed by subprime mortgage debt. Id. ¶ 32. However, the CDS contracts that AIGFP had already signed remained on its books. Id.

AIGFP's positions relating to CDOs carried two types of risk—credit risk and collateral risk. Id. AIGFP's credit risk was a function of the assets underlying the CDOs and mortgage-backed securities it had insured: If the homeowners who took out the underlying mortgages defaulted, the securities linked to those mortgages would be impaired, and AIGFP would be called upon to make up the difference. In a worst-case scenario, this could require AIGFP to purchase the CDO at full value. Id. ¶ 33. AIGFP's collateral risk arose from the CDS contracts themselves: Many contained a provision requiring AIGFP to post cash collateral if AIGFP's credit rating fell, or if the valuation of the underlying CDOs or mortgage-backed securities that it had insured declined. Id. ¶ 34. These collateral requirements had the potential to tie up AIGFP's available cash in the event of a market downturn.

In 2007, such a downturn began. The housing market declined, and the value of homes began to fall. Id. ¶ 35. As mortgage default rates soared, mortgage-backed securities became impaired. The securities linked to those mortgage-backed securities—CDOs, synthetic CDOs, and the CDSs insuring them—lost value as well. Id. ¶ 35. AIGFP's CDS counterparties thereupon asserted that the value of the assets AIGFP had insured was falling precipitously. These counterparties made increasingly large collateral calls on AIGFP. This, in turn, forced AIGFP to post collateral, as required by the CDS contracts. Id. ¶ 36.

By summer 2008, AIG had posted nearly $15 billion of cash collateral to its CDS counterparties. Id. ¶ 39. However, as economic conditions continued to deteriorate, AIG faced the prospect of receiving a collateral call that it lacked the liquid assets to meet. Id. ¶ 39. In or about July 2008, AIG's CEO expressed concern to the company's Board of Directors that the company faced a possible liquidity crisis; in such a situation, given the size of AIG's exposure, the only possible source of the necessary liquidity would be the government. Id. ¶ 40. In July 2008, AIG requested access to the Federal Reserve's “discount window” for liquidity assistance. FRBNY denied AIG such access. Id. ¶¶ 41–43.

B. September 2008

On September 12, 2008, Standard & Poor's (“S & P”) placed AIG on a negative credit watch. Id. ¶ 44. This signaled a potential upcoming downgrade of the company's credit rating. Id. ¶ 44. Over the weekend of September 13–14, 2008, AIG's management made renewed attempts to access the Federal Reserve's discount window for liquidity assistance. AIG began to consider the consequences of filing for protection under the Bankruptcy Code. Id. ¶¶ 45–46.

On Monday, September 15, 2008, Lehman Brothers filed for bankruptcy protection. This significantly worsened the global financial crisis. Id. ¶ 47. That same day, Moody's, S & P, and Fitch all downgraded AIG's long-term credit rating; AIG's stock price dropped sharply. Id. ¶ 48. As a result of these events, AIG was effectively unable to access the short-term lending markets. Id.

On the morning of September 16, 2008, AIG's CEO alerted the government, including FRBNY, that, as a result of its inability to obtain access to liquidity, including via the Federal Reserve's discount window, AIG was seriously considering bankruptcy as an option. Id. ¶ 51.

C. The $85 Billion Credit Facility and October 2008

In response to AIG's September 16, 2008 appeal for access to liquidity, FRBNY took action. FRBNY offered AIG a proposal including a revolving credit facility of $85 billion, fully secured by AIG's assets, and bearing an initial annual interest rate of 14.5%; under the proposal, the government was also to receive AIG common stock carrying approximately 80% voting rights. Id. ¶ 51(a). On the afternoon of September 16, 2008, FRBNY sent AIG a 3–page term sheet describing the proposed transaction. Id. ¶ 52. Starr alleges: “AIG's Board of Directors was left with no choice.” Id. Mindful of the company's dire position, the risk that AIG would otherwise be blamed for “a historic global collapse,” and FRBNY's admonition that “this was ‘the only proposal you're going to get,’ ” AIG's Board accepted the term sheet, even while regarding FRBNY's “demandfor 80% of the company as outrageous.” Id. Starr alleges: “The members of the Board knew that if they refused FRBNY's demands, the blame for a historic global collapse, and the attendant public opprobrium and risk of legal liability, likely would fall on their own shoulders.” Id.

On September 17, 2008, before the start of the trading day, AIG's acceptance of the $85 billion credit facility was announced. Id. ¶ 53. On September 18, 2008, AIG's CEO was removed and replaced with Edward Liddy. Liddy, Starr alleges, “would be under the control of FRBNY.” Id. ¶ 54.

On September 22, 2008, AIG and FRBNY formally executed the agreement (“the Credit Agreement”) memorializing the $85 billion credit facility. Id. ¶ 55. Consistent with the parties' September 17 agreement, the Credit Agreement provided that FRBNY's loan to AIG was secured by substantially all of AIG's assets; FRBNY's loan was payable by AIG...