Jefferies sues Nasdaq over alleged losses on swaps

By Jonathan Stempel and Jonathan Spicer

NEW YORK (Reuters) - Jefferies Group Inc <JEF.N> sued Nasdaq OMX Group Inc <NDAQ.O> to recover tens of millions of dollars of alleged losses from being fraudulently induced to enter interest rate swap futures contracts.

In its unusual complaint, Jefferies said Nasdaq's majority-owned International Derivatives Clearing Group (IDCG) clearinghouse unit repeatedly misrepresented that the contracts were "economically equivalent" to similar transactions handled in the private over-the-counter (OTC) market.

Instead, Jefferies said the transactions were not similar, and that IDCG let an unnamed counterparty take advantage by setting market prices at levels that were not economically equivalent to the OTC swaps.

The swaps contracts at issue were valued at $150 million, and the counterparty is DRW Trading Group, a Chicago-based trading firm, a person familiar with the matter said.

Jefferies is seeking compensatory and punitive damages for Nasdaq's alleged aiding and abetting of fraud, breach of contract and other wrongdoing, according to its complaint filed Friday with the New York State Supreme Court in Manhattan.

Nasdaq said it will fight the lawsuit, which highlights what for years has been the quiet plumbing of the marketplace where trades are cleared.

Clearinghouses such as IDCG, which stand between parties to trades and guarantee their obligations, have taken on new prominence as lawmakers worldwide force OTC contracts through them to help stave off another financial crisis.

IDCG started clearing U.S. dollar-denominated interest rate swaps futures contracts in December 2008, shortly after the crisis hammered markets. It also clears OTC positions.

But according to Jefferies, a New York-based investment bank and broker-dealer, the defendants "did nothing and stood by" as their actions caused it to suffer "tens of millions of dollars in losses."

"I've never heard of a case where the clearinghouse has been sued for misrepresentation of what it does," said Donald Horwitz, former general counsel at the Options Clearing Corporation and at Merrill Lynch Futures. "Clearinghouses were basically quiet, in the background. But this is new."

Horwitz is now managing director of Chicago-based Donald Horwitz Consulting LLC.


Nasdaq spokesman Frank DeMaria said the company followed its rules and its contractual obligations to Jefferies, and that the Commodity Futures Trading Commission has told Jefferies as much. "Therefore, the suit is without merit, and we will vigorously defend against it," he said.

Jefferies declined to comment beyond the complaint itself. DRW Chief Executive Donald Wilson did not immediately return a call seeking comment.

The lawsuit claims that the counterparty, DRW, took the other side of trades that Jefferies was "induced" to enter and, weeks later, "began a market debate" that the trades were significantly different from similar OTC trades.

Jefferies said this created confusion and steered other market participants away, leaving the clearinghouse as a "dead exchange."

DRW is a prominent backer of Eris Exchange, which competes with IDCG.

Two DRW employees and a Columbia University professor in March co-wrote a paper that said IDCG's valuation method for swap futures causes "substantial deviations in valuation with respect to a non-cleared interest rate swap," according to an online abstract.

Nasdaq, a U.S. and European exchange operator, took a controlling stake in IDCG in 2008.

Larger clearinghouses run by London's LCH.Clearnet and Chicago's CME Group Inc <CME.O> are also battling for a piece of the estimated $350 trillion interest-rate swaps market.

Jefferies is expected on Tuesday to announce results for its fiscal third quarter ended August 31.

Nasdaq shares closed down 48 cents, or 1.9 percent, at $24.79. Jefferies shares fell 67 cents, or 4.5 percent, to $14.12.

The case is Jefferies & Co v. Nasdaq OMX Group Inc, New York State Supreme Court, New York County, No. 652560/2011.

(Reporting by Jonathan Stempel and Jonathan Spicer in New York; Editing by Gerald E. McCormick and Richard Chang)