Jefferies v Nasdaq Complaint

8/14/2019 Jefferies v Nasdaq Complaint

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ILED: NEW YORK COUNTY CLERK 09/16/2011 INDEX NO. 652560/

YSCEF DOC. NO. 1 RECEIVED NYSCEF: 09/16/


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SUPREME COURT OF THE STATE OF NEW YORKCOUNTY OF NEW YORK

JEFFERIES & COMPANY, INC.,

Plaintiff,

v.

THE NASDAQ OMX GROUP, INC.,INTERNATIONAL DERIVATIVES CLEARINGGROUP, LLC, and INTERNATIONALDERIVATIVES CLEARINGHOUSE, LLC,

Defendants.

Index No. _________________

Jury Trial Demanded

COMPLAINT

September 16, 2011

BOIES, SCHILLER & FLEXNER LLP575 Lexington AvenueNew York , New York 10022Telephone: (212) 446-2300

Attorneys for Plaintiff Jefferies & Company,

Inc.


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Table of Contents

Summary of the Action ...................................................................................................................1

TheParties .......................................................................................................................................7

Jurisdiction and Venue ....................................................................................................................8

Factual Allegations..........................................................................................................................8

I. Plain-Vanilla OTC Interest Rate Swaps........................................................................8

II. Role of Clearinghouses................................................................................................11

III. Defendant Clearinghouses Mechanisms for ClearingPlain-Vanilla IR Swaps ...............................................................................................13

IV. Clearinghouses Repeated and Unequivocal Representationsof Economic Equivalence............................................................................................14

V. Clearinghouse Solicits Jefferies with Unequivocal Promiseof Economic Equivalence, and Jefferies Tests ClearinghousesPromise ........................................................................................................................17

VI. NASDAQ Solicits Jefferies to Kick-Start and Bolster ItsClearinghouse Business...............................................................................................20

VII. Jefferies Engages in Transactions through Defendant

Clearinghouse ..............................................................................................................22

VIII. Clearinghouses Failure to Provide Economic EquivalenceCaused Jefferies to Suffer Tens of Millions of Dollars ofLosses, and Clearinghouse Refused to Rectify the Situation......................................25

A. The Fixed Rate Counterparty Was the Sole Fixed RatePayer of the IDCG Swap Futures Contracts Market .............................................25

B. The Fixed Rate Counterparty Created Confusion in theIDCG Swap Futures Contracts Market, and ClearinghouseInitially Agreed to Clarify such Confusion, but Subsequently

Refused to Do So...................................................................................................25

C. Clearinghouse Permitted the Fixed Rate Counterparty toSet Prices Favorable to Itself in the IDCG Swap FuturesContracts at Jefferies Expense .............................................................................30

D. Jefferies Resolved Its Dispute with the Fixed RateCounterparty..........................................................................................................33


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FIRST CAUSE OF ACTIONFraudulent Inducement(Against IDCG and IDCH)............................................................................................................33

SECOND CAUSE OF ACTIONAiding and Abetting Fraud(Against NASDAQ) ......................................................................................................................36

THIRD CAUSE OF ACTIONNegligent Misrepresentation(Against IDCG and IDCH)............................................................................................................38

FOURTH CAUSE OF ACTIONBreach of Contract(Against IDCG and IDCH)............................................................................................................41

FIFTH CAUSE OF ACTIONPromissory Estoppel(Against IDCG and IDCH)............................................................................................................42

Prayer for Relief ............................................................................................................................44

Jury Demand..................................................................................................................................44


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Plaintiff Jefferies & Company, Inc. (Jefferies), through its undersigned attorneys,

brings this civil action against Defendants and alleges for its complaint, with knowledge as to its

own actions and events occurring in its presence, and upon information and belief as to all other

matters, as follows:

Summary of the Action

1. This is an action to recover damages suffered by Jefferies because of Defendants

fraudulent inducement, breach of contract, and other misconduct. Specifically, Defendants

International Derivatives Clearing Group, LLC (IDCG) and its subsidiary International

Derivatives Clearinghouse, LLC (IDCH and, together with IDCG, Clearinghouse)

fraudulently induced Jefferies to enter into transactions in interest rate swap futures contracts

through Clearinghouse by repeatedly misrepresenting that these transactions would be

economically equivalent to engaging in transactions in like instruments in the over the counter

(OTC) market. Indeed, Clearinghouses own rules require that it provide transactions that are

equivalent to transactions engaged in on the OTC market. Yet the transactions that

Clearinghouse induced Jefferies to enter on Clearinghouses new exchange were not

economically equivalent to OTC transactions as Clearinghouse had represented and as its own

rules required. Clearinghouses own rules constituted a binding contract between Clearinghouse

and Jefferies, and Clearinghouses failure to enforce these rules breached the contract.

Furthermore, Clearinghouses false representations constituted fraudulent inducement.

2. In addition to its fraudulent inducement, Clearinghouse also permitted another

Clearinghouse trading counterparty (the Fixed Rate Counterparty) to take advantage of

Clearinghouses failure to provide economic equivalence, causing Jefferies to suffer losses. The

Fixed Rate Counterparty became the fixed rate payer of all transactions traded through


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to Jefferies that the pricing methods being tested by shadow pricing and in the small test trade

were the same as those that would be applied throughout the life of any swap transactions

entered into through Clearinghouse. Such a representation was fundamental to Jefferies

decision to enter into trades through Clearinghouse.

9. Throughout this examination period, Clearinghouse published pricing data

generated by its proprietary interest rate curve (referred to as the IDEX Curve). The IDEX

Curve had pricing data consistent with the data observed in the OTC market. Satisfied with the

results of Clearinghouses shadow clearing data and its own small test trade, Jefferies in

September 2010 entered into additional transactions involving over $175 million in notional

exposure through Clearinghouse in lieu of entering into OTC IR Swaps. These additional

transactions are referred to as the Listed Futures Contracts.

10. The Fixed Rate Counterparty was the counterparty on the Listed Futures

Contracts, and was on the same economic side (it was the fixed rate payer) on all of the Listed

Futures Contracts. Indeed, upon information and belief, the Fixed Rate Counterparty

participated in Clearinghouse trades only as the fixed rate payer, and is the fixed rate payer on

almost all trades cleared through Clearinghouse. Prior to Jefferies having entered into the Listed

Futures Contracts, the Fixed Rate Counterparty had been trying to become the fixed rate payer

on all trades cleared through Clearinghouse.

11. In October 2010, the Fixed Rate Counterparty began a debate in the market

concerning the treatment of interest earned on the collateral posted by a party to the

Clearinghouse futures contracts. In the OTC market, such collateral belongs to the posting party,

who is entitled to the interest earned thereon. However, the Fixed Rate Counterpartywhich

weeks earlier had entered into the Listed Futures Contracts knowing that Clearinghouse was


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promising that these contracts would be economically equivalent to OTC swapsnow began

promoting the idea that the futures contracts cleared through Clearinghouse treated the collateral

inconsistently with the OTC market, contrary to Clearinghouses numerous and repeated

representations of economic equivalence. The Fixed Rate Counterparty even published a white

paper arguing that the transactions cleared through Clearinghouse were not economically

equivalent to those entered into on the OTC market, and that a contractual modification would be

required to bring them into economic equivalence.

12. Contrary to the assertion contained in the Fixed Rate Counterpartys white paper,

however, it is not necessary to change the terms of any existing contracts to properly account for

the interest earned on variation margin. Changing the contract specifications is not necessary

because Clearinghouse only needs to adjust its margin methodology properly to bring the

existing contracts into economic equivalence with entering into like transactions on the OTC

market. Clearinghouse was aware of the Fixed Rate Counterpartys efforts and its assertion

concerning whether a change in contracts was necessary to achieve economic equivalence, but

stood by and did nothing to rectify the situation.

13. Clearinghouses failure to rectify the situation generated substantial confusion

with respect to Clearinghouses interest rate swap futures clearing market, and this confusion

deterred others participants from this market. In fact, Clearinghouse has not cleared any new

trades since October 2010, other than the treatments necessary for Jefferies and the Fixed Rate

Counterparty to unwind their respective positions in the Listed Future Contracts as part of a

settlement between Jefferies and the Fixed Rate Counterparty.

14. In January 2011, the Fixed Rate Counterparty began to enter purported bids into

the Clearinghouse market. Despite the fact that Clearinghouse was fully aware that such bids


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destroyed the economic equivalence that had theretofore existed between the IDEX Curve and

the OTC market curve, Clearinghouse permitted the use of such bids to generate the IDEX Curve.

The Fixed Rate Counterpartys prices disfavored Jefferies, which had to post substantially more

collateral.

15. Indeed, the effects of the Fixed Rate Counterpartys bids on the Clearinghouse

market are self-evident and known to Clearinghouse. Were the Fixed Rate Counterparty not to

enter these bids into the Clearinghouse market each day, the lack of bids on the Clearinghouse

market would cause the IDEX Curve, from which the prices of instruments cleared through

Clearinghouse are calculated, to converge immediately with the OTC market curve, thereby

reverting the yield curve of the Listed Futures Contracts back into economic equivalence with

the OTC market. In that case, much of the millions of dollars in collateral that Jefferies posted

would have been returned to Jefferies.

16. Jefferies repeatedly engaged in discussions with Clearinghouse and brought this

situation to Clearinghouses attention. Jefferies demanded that Clearinghouse clarify to the

market that the treatment of interest earned on collateral for transactions it cleared is identical

and thus economically equivalent to similar OTC transactions, as had been repeatedly promised

and represented by Clearinghouse. Such a clarification would also rectify the artificial pricing

level by, inter alia, encouraging other bona fidemarket participants to enter the Clearinghouse

market.

17. Clearinghouse initially agreed with Jefferies entirely. Indeed, it promised

Jefferies in or about October and November 2010 that such clarification and necessary

adjustments to bring the Listed Futures Contracts back into economic equivalence with the OTC

market was a done deal and will with certainty happen. In fact, according to Clearinghouse,


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such adjustments were so fundamental [to] the fungibility of Clearinghouses service that,

without it, Clearinghouse will no longer be a relevant product in the space.

18. Despite such promises, Clearinghouse suddenly reversed its position and refused

to take any action whatsoever. This sudden reversal of its position, which violates its own rules,

was motivated solely by Clearinghouses self-interest and other ulterior motives.

19. The Listed Futures Contracts exist for long periods of time. As a result of the

improper pricing and treatment of these instruments, Jefferies has suffered tens of millions of

dollars in economic damages. This action seeks to recover losses caused by Defendants

fraudulent inducement and other misconduct.

The Parties

20. Plaintiff Jefferies & Company, Inc. (Jefferies) is a broker dealer registered with

the Securities and Exchange Commission (SEC) and a Delaware corporation with its

headquarters in New York, New York. Jefferies is a full-service securities and investment

banking firm that engages in, among other activities, the sales and trading of a panoply of equity

and fixed income securities and derivatives thereon.

21. Defendant NASDAQ OMX Group, Inc. (NASDAQ) is a Delaware corporation

with its headquarters in New York, New York. NASDAQ is a leading global exchange group

that delivers trading, exchange technology, securities listing, and public company services across

six continents. NASDAQs businesses include trading across multiple asset classes, market data

products, financial indexes, capital formation solutions, financial services, and market

technology products and services. Its technology powers markets across the globe, supporting

cash equity trading, derivatives trading, clearing and settlement, and many other functions.


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22. Defendant International Derivatives Clearing Group, LLC (IDCG) is a

Delaware limited liability company with its headquarters in New York, New York inside

NASDAQs headquarters. Through its subsidiary International Derivatives Clearinghouse, LLC

(IDCH, and together with IDCG, Clearinghouse), IDCG is a central clearinghouse that

provides a forum in which to clear and settle interest rate swap contracts and other fixed income

derivatives contracts. IDCG is a majority-owned subsidiary of NASDAQ.

23. Defendant International Derivatives Clearinghouse, LLC (IDCH) is a Delaware

limited liability company with its headquarters in New York, New York. IDCH is a central

clearinghouse that was intended to provide an exchange to clear and settle interest rate swaps and

interest rate swap futures. IDCH is a wholly owned subsidiary of IDCG.

Jurisdiction and Venue

24. This Court has jurisdiction over Defendants pursuant to C.P.L.R. 301 and 302.

25. Venue is proper in this Court under C.P.L.R. 503 because the principal places of

business of Jefferies, NASDAQ, and Clearinghouse are located in New York, New York.

Factual Allegations

I. Plain-Vanilla OTC Interest Rate Swaps

26. IR Swaps are derivative contracts in which each counterparty agrees to pay to the

other counterparty either a fixed or a floating interest rate denominated in a specific currency.

The fixed or floating interest rate in such a transaction is multiplied by a notional amount. This

notional amount is generally not exchanged between counterparties, but is used only as the basis

for calculating the size of interest payments to be exchanged or netted in the IR Swap.

27. IR Swaps can be used to hedge against interest rate movements. They can also be

used to expose a party to interest rate movements for potential profit. IR Swaps are highly liquid

instruments.


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28. IR Swaps can be, and are, traded in the OTC market. In the OTC market,

counterparties find each other in the marketplace or are brought together by brokers and

negotiate and enter into contracts bilaterally. Thus, each party is also exposed to the risk that its

counterparty will not meet its obligations (default or credit risk).

29. OTC IR Swaps come in myriad forms and can be structured to meet the specific

needs of the counterparties. Unlike more complex financial derivative instruments that exist in

the market, plain-vanilla OTC IR Swaps are among the most common and simple forms of

derivative instruments. The operation of plain-vanilla OTC IR Swaps and how they are valued

are universally understood by market participants. Indeed, the value of, and calculation of

payments owing under, a plain-vanilla OTC IR Swap is affected by only a single factorthe

movement of interest ratesand not by any other unknown or unquantifiable risk that plagues

more complex and risky financial derivatives.

30. In a plain-vanilla OTC IR Swap, two parties enter into a bilateral agreement in

which one party acts as the floating rate payer and the other party acts as the fixed rate

payer1in respect of an agreed upon specific notional amount (which, though notional, is the

amount that is used as the principal for purposes of the interest calculations under the swap)

for an agreed upon time period. During the life of the swap, the fixed rate payer agrees to make

periodic payments to the floating rate payer equal to the agreed upon fixed interest rate on the

notional amount. The floating rate payer in turn agrees to make periodic payments to the fixed

1 Conversely, the floating rate payer is also the fixed rate receiver and the fixed rate

payer is also the floating rate receiver.


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rate payer equal to the agreed upon floating interest ratetypically a rate at, or calculated using,

LIBOR2on the notional amount.

31. These plain-vanilla OTC IR Swaps are almost universally governed by

International Swaps and Derivatives Association (ISDA) documentation, including ISDAs

collateral mechanisms. ISDAs collateral mechanisms require parties to post collateral from

time to time depending on the mark-to-market value of the swap. These collateral mechanisms

serve to mitigate the exposure of one party to the credit risk of its counterparty in the OTC

market. Under ISDA documentation, such posted collateral is generally called the delivery

amount or the return amount. For cleared swaps or swap futures, such posted collateral is

called variation margin, and that term will be used herein.

32. The mark-to-market value of IR Swaps is typically determined by calculating the

net present value of the expected stream of fixed payments against the net present value of the

expected stream of floating payments. The stream of expected floating rate payments is

calculated based on a yield curve, often the LIBOR yield curve as it is observed on the OTC

market (the OTC Curve). Typically, IR Swaps are entered into at the par swap rate,

meaning that the net present value of the fixed payments equals the net present value of the

floating payments. Accordingly, at the time of entry into such swaps, the difference between the

net present value of the fixed payments and the floating payments is zero, and thus the value to

each counterparty in the transaction is the same, and no variation margin is required from either

party.

2 LIBOR means the London Interbank Offered Rate. It is a daily reference rate based

on the interest rates at which banks borrow unsecured funds from other banks in the Londonwholesale money market or interbank lending market.


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33. Over time, as the interest rate yield curve changes, the value of a plain-vanilla

OTC IR Swap relative to each counterparty also changes. Such changes result in one party being

in the money and the other party being out of the money. This is because the net present

value of the stream of payments one party expects to receive no longer equals the net present

value payable by such party (and receivable by the other party). For example, if LIBOR

increases relative to the agreed fixed interest rate in the swap, the fixed rate payer will be in the

money, i.e., the net present value of the stream of floating payments that party is entitled to

receive is greater than the net present value of the stream of fixed rate payments the party is

required to pay to its counterparty.

3

34. Under the standard ISDA collateral documentation, and thus in nearly all OTC

transactions, the out of the money party is required to post variation margin for the benefit of

the other counterparty. For a plain-vanilla OTC IR Swap using the ISDA collateral

documentation, variation margin remains the property of the posting party and, accordingly, the

posting party retains all rights to any interest accrued on such posted amounts.

35. Because a plain-vanilla OTC IR Swap could be entered into for very long terms

(e.g., 10, 20, or 30 years), the interest accrued on the variation margin, which is retained by the

posting party, can be substantial.

II. Role of Clearinghouses

36. A clearinghouse is a financial institution that provides clearing and settlement

services for financial and commodities derivatives and securities transactions.

3Another way to conceptualize this is by analogizing it to a fixed-rate loan. If the

interest rates increase after a fixed-rate loan was made, the loans economic value increases fromthe borrowers perspective because the borrower (i.e.,the fixed rate payer) would continue topay the fixed rate, which is now at a lower level relative to the market.


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37. Specific to IR Swaps, a clearinghouse sells a financial product (such as a futures

contract) to the two contracting parties to an IR Swap by creating a transaction in which it stands

between the two parties and separately contracting with each of the counterparties. Subsequently,

the counterparties are in privity not with one another, but with the clearinghouse, and each

counterparty may look only to the clearinghouse for performance. This financial product has

value to the contracting parties because the clearinghouse is capitalized to a certain

predetermined level, and thus is intended to mitigate or eliminate the risk that a counterparty

would default on its obligations under the IR Swap. In an IR Swap entered into through a

clearinghouse, fixed and floating payments, as well as variation margin, are settled between each

party and the clearinghouse, instead of directly between the counterparties.

38. Variation margin in the plain-vanilla OTC IR Swap is treated as the property of

the posting party, to whom any interest earned on such posted amounts accrues. In the cleared

case, however, variation margin is the property of the receiving party (not the posting party),

who would then have a right to withdraw those funds from the clearinghouse and earn interest on

that collateral in the absence of the clearinghouse paying interest directly. Accordingly, the

posting party would lose the benefit of any interest that would have otherwise accrued on its

posted margin. As noted above, the treatment of this interest earned on the variation margin is

one aspect that determines whether a transaction done through Clearinghouse is economically

equivalent to a similar one engaged on the OTC market.

39. Because of this potential discrepancy in the treatment of interest earned on the

variation margin between IR Swaps transactions cleared through a clearinghouse (the Cleared

IR Swaps) and those transactions entered into on the OTC market, clearinghouses must account

for this discrepancy to ensure that the Cleared IR Swaps traded as futures contracts are


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economically equivalent to those traditionally traded in the OTC market as agreements between

two counterparties.

40. One way for clearinghouses to account for this potential discrepancy is to include

a Price Alignment Interest (PAI) adjustment to the margin required on the Cleared IR Swaps.

A PAI adjustment accounts for the interest earned on the variation margin when pricing the

swaps and is thus one mechanism to achieve economic equivalence between the Cleared IR

Swaps and OTC IR Swaps. PAI adjustments (or other similar adjustments to deal with this

discrepancy) are used by clearinghouses other than Defendant Clearinghouse to account for

differences in variation margin treatment.

III. Defendant Clearinghouses Mechanisms for Clearing Plain-Vanilla IR Swaps

41. Clearinghouse launched its clearing business in December 2008 to provide an

alternative IR Swaps clearing and trading system to the market. At the time, Clearinghouses

business stood apart from other options in that these other clearing services limited participation

to a group of the largest dealers in the IR Swap market.

42. Clearinghouse understood and conveyed that it would not be able to attract market

participants unless it created transactions that were economically equivalent to those transactions

available on the OTC market. Clearinghouse thus solicited business, including from Jefferies, by

promising to provide transactions economically equivalent to those in the OTC market.

43. Economic equivalence is important to potential market participants because,

among other reasons, those participants have well-established risk management systems from

their trading experience in the OTC market. Without economic equivalence, these market

participants would be forced to change these well-developed risk management systems and

thereby be deterred from switching to trade through Clearinghouse.


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48. In describing the Instruments Accepted for Clearing, the application stated:

The Clearinghouse intends to accept for clearing futures contracts that are (a) economically

equivalent to plain vanilla fixed versus floating interest rate swaps . . . . (Emphasis added.)

Based at least in part on these representations, the CFTC approved and certified Clearinghouse

as a DCO in December 2008. A copy of the application is attached hereto as Exhibit 2.

49. On or about June 9, 2009, Christopher Edmonds, then CEO of Clearinghouse,

testified before the congressional subcommittee on Capital Markets, Insurance, and Government

Sponsored Entities. Edmonds testified that Clearinghouse offers a product that is the economic

equivalent to the interest rate swap (IRS) product that trades in the OTC market and that the

Clearinghouse solution employs a set of exchange traded futures contracts rich enough to

replicate existing OTC market practicesbut without introducing additional complexities to the

way the product behaves or is priced. (Emphasis added.) A copy of the congressional

testimony is attached hereto as Exhibit 3.

50. In a press release issued on March 31, 2010, Clearinghouse claimed that it had

cleared in excess of $3 trillion in notional value in its Shadow Clearing environment; a process

to prepare market participants for central clearing of derivatives. Shadow clearing was a means

by which Clearinghouse tested its clearing services without actual clearing. It allowed market

participants to value actual or hypothetical IR Swap portfolios based on information provided by

Clearinghouse for settlement and margining. Market participants could review the information

or reports furnished by Clearinghouse as if Clearinghouse had actually cleared the shadow

portfolio.

51. During this shadow clearing testing process, Clearinghouse made available to the

public its proprietary IDEX Curve. Using the IDEX Curve, market participants were able to


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calculate the net present value of their various IR Swap positions, and thus were able to price

such swaps. Other than saying that they are observed OTC rates, the precise data source used to

generate the IDEX Curve (i.e.,how the IDEX Curve was marked) was proprietary and never

disclosed.

52. Before engaging in the Listed Futures Contracts, Jefferies specifically asked

Clearinghouse How are you marking your IDEX Curve? What time do you snap it? What

are the sources of the curve? Matt Guadagno, Clearinghouses Director of Sales and Marketing,

responded via Bloomberg message that The sources are various market data sources we pull in

from. We mark it at 11am and 3pm NY time and run an average process for 15 minutes before

those times to determine the marks.

53. Mr. Guadagnos response, in particular that The sources are various market data

sources we pull in from, suggested, and Jefferies reasonably understood it to mean, that

Clearinghouse used OTC market data to generate the IDEX Curve. In addition, various market

data sources specifically suggested that these data sources were from the OTC market because

this was and remains the only market for IR Swaps that could provide multiple data sources.

54. Clearinghouse publishes the IDEX Curve on both public and private portions of

its website. To access the private portion, a participant must register with Clearinghouses

website and use a username/password combination. The IDEX Curve is updated twice a day in

the public portion, which is available to all for free, and is updated more frequently in the private

portion. Jefferies had access to and monitored the private portion of Clearinghouses website

during the shadow clearing testing.


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55. During the shadow clearing, the IDEX Curve matched the OTC Curve nearly

identically.4 Because the curves were used to calculate the prices of swaps, the prices calculated

using the IDEX Curve during this time consistently and precisely matched the prices calculated

using the OTC Curve. This became another means by which Clearinghouse proclaimed to the

market that its swap futures contracts (hereinafter IDCG Swap Futures Contracts) would be

economically equivalent to OTC IR Swaps.

56. Clearinghouses own Rule 418 states, and has so stated in substantially similar

language from the outset, Swap agreements that are traded on a bilateral basis and submitted

through the trade registration system of a Participating Trading Facility for clearing by the

Clearinghouse will be cleared as futures contracts through a replacement process whereby the

original over-the-counter swap agreement is replaced by an economically equivalent futures

contract that complies with the Exchange Contract terms specified by the Participating Trading

Facility or the Clearinghouse. (Emphasis added.) An excerpt of Clearinghouses Rules is

attached hereto as Exhibit 4.

57. To this day, Clearinghouse continues to represent, inaccurately, on its website that

it offers market participants the ability to replace their existing portfolio of bilateral interest

rate swap contracts with economically equivalent listed [IDCG] Swap Future contracts.5

(Emphasis added.) A printout of the relevant web page is attached hereto as Exhibit 5.

V. Clearinghouse Solicits Jefferies with Unequivocal Promise of Economic Equivalence,

and Jefferies Tests Clearinghouses Promise

58. Clearinghouse first approached Jefferies in or about February 2009 to solicit

interest in its clearing services and its IDCG Swap Futures Contracts. Clearinghouse represented

4 Minor variations existed most likely due to the timing of data collected for curveconstruction. These variations, however, were within acceptably narrow margin.

5 See http://www.idcg.com/idcg/press/11.14.08.html(last visited September 14, 2011).


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to Jefferies that engaging in IDCG Swap Futures Contracts through Clearinghouse would be

economically equivalent to entering into OTC IR Swaps and thus would allow Jefferies to

transact in IR Swaps in the same way that it has done in the past while gaining the benefits of a

centrally cleared product.

59. On or about February 13, 2009, Clearinghouses CEO, Garry OConnor, made

initial contact with Jefferies by reaching out to Chris Bury, Jefferies Co-Head for Rates Trading

and Sales. Mr. OConnor forwarded a presentation that highlighted the economic equivalence

between entering into IDCG Swap Futures Contracts and plain-vanilla OTC IR Swaps. This

initial presentation (attached as Exhibit 6) represented to Jefferies that not only would the IDEX

Curve calculations and methodology be shared with all participants, but there would be No

curve negotiation, meaning that Clearinghouse would have its own methodology to construct

the IDEX Curve so as to produce a transparent pricing system.

60. On or about March 10, 2009, Jefferies signed a participation agreement, which

acknowledged its initial interest in the clearing services sold by Clearinghouse and allowed

Clearinghouse to promote to potential clearing firms that Clearinghouse was building interest in

its services.

61. On or about May 14, 2009, Jefferies received an email from Mr. Guadagno stating,

While the transition from the OTC market to a centrally cleared market may seem troublesome,

the current product offering from IDCG eases this evolution. IDCG Clearing Members and their

customers have the ability to hedge interest rate risk in the same manner as they have done in the

past. By introducing a standardized CFTC approved contract spec for interest rate swap futures

that are the economic equivalent of an OTC interest rate swap, IDCG does not force market


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participants to comply with limited products that dont accurately fit market demand.

(Emphasis added.)

62. On or about June 9, 2009, Mr. OConnor encouraged Jefferies to talk to Chris

Concannon of Virtu Financial LLC, a backer of Clearinghouse, in order to discuss how

algorithmic trading strategies would help push the Clearinghouse market and business forward.

63. On or about June 30, 2009, Mr. OConnor sent Mr. Bury a press release about

another investors investment in Clearinghouse. The email stated that we are in the game and

pushing hard.

64. On or about August 12, 2009, Mr. OConnor emailed Mr. Bury regarding

regulatory reform. Mr. OConnor wrote, We are developing a product which is cleared only

with a valuation based on our exchange [eligible] contracts that you have already seen. The

eligible contracts that you have already seen stated that the futures contracts would be marked

to the IDEX Curve, and thus these futures contracts would be equivalent from an economic

valuation standpoint to OTC IR Swaps.

65. On or about October 14, 2009, Dave Reed, Clearinghouses Managing Director

for Business Development, emailed a non-disclosure agreement and Excel file for Jefferies

execution so that Jefferies could submit actual instead of shadow trades.

66. On or about March 17, 2010, Mr. Reed sent an email to Jefferies attaching

Clearinghouses Term of Use and encouraged Jefferies to submit its portfolio for shadow

clearing.

67. On or about March 31, 2010, Mr. OConnor emailed Jefferies a joint press release

by Clearinghouse and Markit.com Financial Information Services highlighting new capability for


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market participants to submit their derivative trades to Clearinghouse via MarkitSERV, a widely

used platform for trade submission in the OTC market.

68. On or about April 5, 2010, Mr. Reed sent an email to Jefferies transmitting

Clearinghouses most recent presentation, in which Clearinghouse represented that in addition

to the migration of counterparty credit risk, Clearinghouse provides all market participants

with: . . .Products which are economically equivalent to what exists today in the OTC market

that do no require participants to change their market risk management behavior. (Emphasis

added.) That presentation further represented that Clearinghouse offers central clearing of OTC

Interest Rate Derivatives through a tried and tested futures solution. [IDCG] Swap Futures are

economically equivalent to an OTC Interest Rate Swap . . . .

69. Starting in or about May 2010, Jefferies began to test the clearing services offered

by Clearinghouse by engaging in shadow clearing of IR Swap positions. Jefferies mimicked

the transactions entered through Clearinghouse of IDCG Swap Futures Contracts with the same

terms as some of its own OTC IR Swaps. During this testing phase, Jefferies received

information on the IDEX Curve from Clearinghouse as well as the corresponding settlement

price for the shadow cleared IR Swap positions calculated from the IDEX Curve. The results of

the shadow clearing of IDCG Swap Futures Contracts consistently showed that engaging in such

futures contracts through Clearinghouse would be economically equivalent to engaging in OTC

IR Swaps.

VI. NASDAQ Solicits Jefferies to Kick-Start and Bolster Its Clearinghouse Business

70. In or about early June 2010, a senior executive of NASDAQ called a senior

Jefferies executive to solicit Jefferies to do business with Clearinghouse. At the time,

Clearinghouse was one of the first entities to offer an IR Swap product that traded on an


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76. The solicitation from the NASDAQ executive helped to persuade Jefferies to

engage in transactions through Clearinghouse.

77. On or about July 16, 2010, shortly after the solicitations from NASDAQ to

engage in clearing transactions with Clearinghouse, Jefferies entered into a live transaction of

$6 million in notional amount as a test of transacting trades through Clearinghouse (the First

Swap). Jefferies was the fixed rate receiver on the First Swap. As it had during the shadow

clearing process engaged in by Jefferies through September 2010, Clearinghouse reported, and

Jefferies observed, Settlement Prices on the First Swap that matched comparable OTC IR Swap

pricesfurther bolstering Clearinghouses prior promises and representations that its product

was economically equivalent to plain-vanilla OTC IR Swaps and that its pricing methodology

appropriately accounted for any difference in treatment of margin or other factors impacting the

economics of the transaction as between a Cleared IR Swap and an OTC IR Swap.

VII. Jefferies Engages in Transactions through Defendant Clearinghouse

78. In reliance on Clearinghouses representations that its IDCG Swap Futures

Contracts would be economically equivalent to transactions on the OTC market, in September

2010, Jefferies entered into four separate IDCG Swap Futures Contracts with an aggregate

notional value of $175 million through Clearinghouse (together, the Listed Futures Contracts).

Jefferies was the floating rate payer under each of these futures contracts:

i. On or about September 13, 2010, Jefferies entered into an IDCG Swap

Futures Contract as a floating rate payer on $50 million notional value with a

ten-year term;

ii. On or about September 14, 2010, Jefferies entered into an IDCG Swap

Futures Contract as a floating rate payer on $25 million notional value with a

thirty-year term;


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futures for swap (EFS) mechanism. The Transaction shall be . . . automatically terminated

upon acceptance of the EFS futures contract for clearing by Clearinghouse (and no termination

or other payment shall be due from either party to the other in connection with the terminated

Transaction).

83. Clearinghouse subsequently accepted the OTC swaps and sold futures contracts to

Jefferies and the Fixed Rate Counterparty (the futures contracts sold to Jefferies are in the form

of the Listed Futures Contracts).

84. The terms and conditions of the Listed Futures Contracts are set forth in

Clearinghouses Rules.

85. Clearinghouses Rule 602(a) provides that the Settlement Price (which is used

to calculate the value of the Listed Futures Contracts and thus the necessary variation margin)

shall be determined in accordance with the terms of the contract specifications set forth in

Chapter 10.

86. Chapter 10 of Clearinghouses Rules provides that the Daily Settlement Price is

set by Clearinghouse as follows:

Each open position is valued by the Clearinghouse at the end of each trading dayby valuing each leg of the cash flows of the contract (fixed and floating)according to discount factors generated by the IDEX Curve. Each Trading Day,the Daily Settlement Price shall be established by the Clearinghouse based uponthe IDEX Curve that corresponds to the fixed rate portion of the swap. A netpresent value of the position will be determined and set as the Daily SettlementPrice. Notwithstanding the preceding sentence, the Clearinghouse may, in its solediscretion, establish a Daily Settlement Price that is a fair and appropriatereflection of the market. The Final Settlement Price shall be the Daily SettlementPrice on the Last Trading Day.

87. Clearinghouse Rule 602(c) provides Clearinghouse with flexibility to deviate

from the terms set forth in Chapter 10 of the Rules by stating:


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Notwithstanding the foregoing, when deemed necessary by the Clearinghouse toprotect the respective interests of the Clearinghouse and Clearing Members, theClearinghouse may establish the Settlement Price for any Contract at a pricedeemed appropriate by the Clearinghouse under the circumstances. When theClearinghouse determines that circumstances necessitate the application of this

paragraph, the reasons for that determination and the basis for the establishmentof the Settlement Price in such circumstances shall be published in a Notice toMembers.

88. At no time did Clearinghouse ever publish a Notice to Members indicating that

it was necessary for Clearinghouse to change the method that established the settlement price for

its contracts.

VIII. Clearinghouses Failure to Provide Economic Equivalence Caused Jefferies to

Suffer Tens of Millions of Dollars of Losses, and Clearinghouse Refused to Rectifythe Situation

A. The Fixed Rate Counterparty Was the Sole Fixed Rate Payer of the IDCG SwapFutures Contracts Market

89. Upon information and belief, the Fixed Rate Counterparty also solicited the fixed

rate paying side of transactions from participants other than Jefferies in the IDCG Swap Futures

Contracts market.

90. Those efforts were highly successful in helping the Fixed Rate Counterparty to

become the fixed rate payer on all or nearly all transactions cleared through Clearinghouse.

B. The Fixed Rate Counterparty Created Confusion in the IDCG Swap FuturesContracts Market, and Clearinghouse Initially Agreed to Clarify such Confusion,but Subsequently Refused to Do So

91. The economics and pricing by Clearinghouse of the Listed Futures Contracts

initially matched those traded on the OTC market during Jefferies shadow clearing test period,

as well as on the First Swap. But in October 2010, within just a few weeks of entering into the

Listed Futures Contracts, two clearing members of Clearinghouse informed Jefferies that a payer

of fixed interest under one or more IDCG Swap Futures Contracts (presumably the Fixed Rate

Counterparty) was advocating that Clearinghouse was not properly pricing these IDCG Swap


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Futures Contracts because, in essence, Clearinghouse has improperly structured the margin such

that the fixed payer is an unequal beneficiary of interest earned on variation margin posted by its

counterparty at Clearinghouse.

92. Such comments created uncertainty in the IDCG Swap Futures Contracts market.

To clarify that the Listed Futures Contracts were economically equivalent to the OTC swaps, as

had been promised by Clearinghouse, Jefferies asked Clearinghouse to confirm that, just as in the

OTC market, IDCG Swap Futures Contracts either properly accounted for the interest accrued on

the variation margin or accounted for any discrepancies in the yield curve.

93. Through numerous conversations between Jefferies and Clearinghouse in or about

October and November 2010, including in conversations with Mr. OConnor and Mr. Guadagno,

Jefferies was assured by Clearinghouse that an adjustment, most likely in the form of a PAI

adjustment, would be applied to the Listed Futures Contracts to make such transactions

economically equivalent to OTC IR Swaps. Indeed, Mr. Guadagno represented to Jefferies that

including a PAI adjustment in the IDCG Swap Futures Contracts was a done deal because

without such an adjustment, nobody would engage in trading of IDCG Swap Futures Contracts.

Mr. OConnor also told Jefferies that he had received the blessing of the CFTC to make such

changes.

94. In an email dated October 18, 2010 from Christian Cooper, a Jefferies employee,

to Jefferies Mr. Bury, Mr. Cooper summarized an unsolicited telephone call from Mr. Guadagno

to Mr. Cooper. Mr. Coopers email stated: From Matt [Guadagno] at IDCG . . . in their mind,

the interest paid on excess reserves is a done deal and will with certainty happen. He further

went on to say we will be happy and someone else will not so obviously they are looking at the

existing book but they are willing to deal with that. He also indicated they viewpaying interest


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on excess reserves is fundamental [to] the fungibility of the IDCGvs other competing products

in the space and will be changed basically because if they [dont], IDCG will no longer be a

relevant product in the space. (Emphasis added.)

95. Clearinghouses own words and deeds also reflect that properly accounting for

interest earned on the variation margin is a requirement to achieve economic equivalence. In or

about November 2010, Clearinghouse submitted to the CFTC a self-certification for a new

product marketed by Clearinghouse called the OTC Contracts. This product is cleared through

Clearinghouse in the same manner as it clears IDCG Swap Futures Contracts, but instead of

selling mirrored swap futures contracts in the clearing process for the counterparty relationship

that would exist if the transaction were done on the OTC market, the clearing process for the

OTC Contracts would utilize mirrored swap contracts, instead of futures contracts, traded on the

OTC markets. Again economic equivalence is critical for the OTC Contracts to attract any

market participants. Thus, for the OTC Contracts, Clearinghouse incorporated a PAI adjustment

to account for the interest earned on the variation margin, further showing its knowledge and

understanding that such a PAI adjustment, or some other adjustment like it, is necessary for

cleared IR Swaps to be economically equivalent to engaging in such a transaction on the OTC

market.

96. In explaining its request to include the PAI adjustment for its OTC Contracts,

Clearinghouse stated: in order to more accurately reflect the current practice in the over-the-

counter interest rate swap market, [Clearinghouse] will apply a price alignment interest (PAI)

adjustment for OTC Contracts cleared by OTC Clearing Members. The November 10, 2010

self-certification is attached as Exhibit 7.


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97. Similarly, on or about November 15, 2010, Clearinghouse issued a Notice to

Members, stating: Please be advised that beginning today, in order to more accurately reflect

the current practice in the over-the-counter interest rate swap market, [Clearinghouse] will apply

a price alignment interest (PAI) adjustment for OTC Contracts cleared by OTC Clearing

Members. The Notice to Members is attached as Exhibit 8.

98. Despite the numerous representations and assurances previously given by

Clearinghouse to Jefferies, by December 2010, Clearinghouse had not acted to rectify the

mistreatment of interest earned on variation margin for its IDCG Swap Futures Contracts.

Accordingly, in December 2010 Jefferies requested that Clearinghouse poll all the market

participants that traded IDCG Swap Futures Contracts to determine whether a PAI adjustment in

the IDCG Swap Futures Contracts was appropriate to deal with variation margin discrepancies.

Every Clearing Member and all but one market participant (presumably the Fixed Rate

Counterparty, who is, on information and belief, the fixed rate payer on all or nearly all of the

IDCG Swap Futures Contracts) were in favor of including a PAI adjustment in the IDCG Swap

Futures Contracts.

99. Despite numerous representations to the contrary, Clearinghouse refused to

comply with Jefferies request and the request of all its Clearing Members and an overwhelming

number of market participants, to properly account for the interest accrued on the variation

margin on IDCG Swap Futures Contracts cleared through Clearinghouse.

100. Upon information and belief, as Clearinghouse permitted and as its actions and

inactions condoned, the Fixed Rate Counterparty continued to publicly insist that the in the

money party should be the beneficiary of the interest earned on variation margin posted by its

counterparty for the IDCG Swap Futures Contracts, contrary to the OTC markets practice and


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making the IDCG Swap Futures Contracts noteconomically equivalent to OTC market

transactions. Such a public statement created substantial confusion among the market

participants and deterred participation in the IDCG Swap Futures Contracts market.

Clearinghouse was aware of the Fixed Rate Counterpartys public statements but did nothing to

stop the confusion.

101. In or about March 2011, two of the Fixed Rate Counterpartys employees and a

Columbia University professor published a white paper titled Central Clearing of Interest Rate

Swaps: A Comparison of Offerings. The paper asserted, among other positions:

modifications in contract design are required in order for a centrally cleared interest rateswap to be economically equivalent to its uncleared counterpart.

Central clearing requires the daily exchange of collateral and margin payments.Ironically, this daily exchange of funds results in differences in cash flows between acleared instrument and an identical uncleared one.

[Clearinghouse] also offers a clearing facility for (regular) interest rate swaps, whichdeploys a PAI adjustment that is not used with the [Futures Contract]. This paper focusessolely on the [Futures Contract], where there is no adjustment for convexity and NPVeffects.

We will see, however, that the design of the [Futures Contract] does not address theconvexity effect nor the NPV effect; as a result, it leads to substantial differences invaluation compared to an uncleared swap.

Since January 2011, the IDCG settlement curve has started to deviate from the LIBORswap curve as the market place came to a better understanding of the nature of the IDCGfutures contract.

With the same model parameters as of February 9, 2011, we compute the 10-year swaprate from the fair settlement curve should be 30 basis points higher than the

corresponding uncleared swap rate, and around 70 basis points higher for the 30-yearswap.

(Emphasis added.)

102. Clearinghouse did nothing to respond to the white paper.


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103. The market confusion caused by Clearinghouses failure to rectify the situation

led to serious consequences for the IDCG Swap Futures Contracts market. Upon information

and belief, not a single market participant has transacted any trades in IDCG Swap Futures

Contracts since October 2010, the month when the Fixed Rate Counterparty initiated the market

debate. As of today, Clearinghouse is effectively a dead exchange because it no longer clears

any trades.

104. Contrary to the assertion contained in the Fixed Rate Counterpartys white paper,

and as known but not corrected by Clearinghouse, it is not necessary to change the terms of any

existing contracts to properly account for the interest earned on variation margin. Changing the

contract specifications is not necessary because Clearinghouse only needs to properly adjust its

margin methodology such that the existing contracts will become economically equivalent as

was represented. Indeed, Chapter 10 of Clearinghouses Rules, i.e.,its contract specifications, is

silent as to the margining process.

105. According to Clearinghouses interest rate swap contract specifications, cash

flows take place between the fixed rate payer and the floating rate payer as defined by the

specification. Jefferies takes no issue with these cash flow exchanges. Proper treatment of

interest earned on the variation margin, however, is related to the way Clearinghouse calculates

daily margin and does not contradict or require any change in the contract specifications. In fact,

margin methodology is not referenced anywhere within the contract specifications for IDCG

Swap Futures Contracts.

C. Clearinghouse Permitted the Fixed Rate Counterparty to Set Prices Favorable toItself in the IDCG Swap Futures Contracts at Jefferies Expense

106. In early January 2011, despite the fact that there had been no trading on

Clearinghouse of any IDCG Swap Futures Contracts since as early as October 2010, the Fixed


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Rate Counterparty began to submit live bids daily. These bids are purportedly executable by

other market participants. Clearinghouse permitted the Fixed Rate Counterparty to submit such

live bids.

107. Clearinghouse knew such bids would be ignored by other market participants.

108. Despite knowing that such bids differed from its internally generated proprietary

IDEX Curve and contradicted its assurance of economic equivalence to the OTC market,

Clearinghouse began to use these purported live bids to construct the IDEX Curve rather than

using the methodology IDCG used since well before March of 2010. Suddenly, without having

disclosed that such a change in the IDEX Curve methodology was a possibility, and despite

Clearinghouses express representation that there would be No curve negotiation of its

internally generated proprietary IDEX Curve, the IDEX Curve that Clearinghouse published as

the basis for setting the settlement prices of IDCG Swap Futures Contracts began to match the

purported live bids provided by the Fixed Rate Counterparty. As a consequence, the IDEX

Curve dramatically diverged from the OTC Curve, and the settlement prices as calculated using

the IDEX Curve also significantly diverged from the settlement prices as calculated using the

OTC Curve and what Jefferies would have expected from its earlier shadow clearing and its

actual trading experience from July 2010 through January 2011. As a result, the Listed Futures

Contracts were no longer economically equivalent to the transactions Jefferies would have

entered on the OTC market.

109. Had the Fixed Rate Counterparty not submitted its live bids daily, or had

Clearinghouse not permitted the Fixed Rate Counterpartys market practice through such

conduct, the IDEX Curve would revert back to the OTC Curve, which would have resulted in

millions of dollars in collateral being returned to Jefferies.


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110. In a letter from the Fixed Rate Counterparty to the CFTC dated April 7, 2011, the

Fixed Rate Counterparty notes that, prior to January 2011, Clearinghouse looked at prices in

other markets to establish a Daily Settlement Price. Specifically, Clearinghouse used publicly

available prices from the unclearedswap market [i.e., the OTC market] to establish a Daily

Settlement Price. (Emphasis added.) This methodology is consistent with a method that was

designed to achieve, and during the shadow clearing process did achieve, economic equivalence

between IDCG Swap Futures Contracts and corresponding transactions on the OTC market.

111. Beginning in January 2011, the Fixed Rate Counterparty began entering bids

directly into the IDEX electronic system. According to the Fixed Rate Counterpartys letter,

with these bidsand no other bids were mentionedClearinghouse started to determine the

settlement prices for its swap futures contracts.

112. In a similar letter from IDCG to the CFTC dated April 12, 2010, IDCG confirmed

that In January 2011, bids for certain maturities of IDCHs swap futures contracts began to be

posted on the IDEX electronic trading platform. These bids necessarily influenced the IDEX

Curve, and therefore the settlement prices for IDCHs swap futures contracts, as would any

posted bids or offers.

113. Clearinghouses change in the pricing practice destroyed economic equivalence

between the Listed Futures Contracts and similar transactions entered into on the OTC market.

114. Jefferies repeatedly brought the situation to Clearinghouses attention and

demanded that Clearinghouse fulfill its promise of economic equivalence. Clearinghouse never

rectified the situation.

115. Clearinghouse is and was well aware of the pricing discrepancy between its

internally generated proprietary IDEX Curve and the Fixed Rate Counterpartys live bids. For


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example, on May 23, 2011, Clearinghouse did not timely publish its daily curve at 3 pm. As a

result, Michael Miller, a Clearinghouse employee, sent the IDEX Curve for May 23, 2011 to

Jefferies via email with attachment file entitled IDCG_USD_CURVE_3M

FUT_OFFICIAL_20110523 (the May 23 Email).

116. The IDEX Curve sent via email did not reflect a curve generated using the Fixed

Rate Counterpartys bids. Instead, it essentially matched the OTC curve for May 23, 2011that

is, it was economically equivalent to the OTC marketand was claimed to be the official IDEX

Curve. Later, when it discovered that it had sent that data as its official IDEX Curve for May 23,

2011, Clearinghouse speciously attempted to explain the transmission of the economically

equivalent IDEX Curve.

117. Clearinghouses May 23, 2011 transmission showed that it has maintained and

continues to maintain two sets of curves: the OTC-equivalent IDEX curve and the IDEX Curve

generated using the Fixed Rate Counterpartys bids. It is thus evident that Clearinghouse is

aware of the discrepancy between these curves.

D. Jefferies Resolved Its Dispute with the Fixed Rate Counterparty

118. Jefferies approached Defendants and the Fixed Rate Counterparty to make plain

that it planned to seek legal recourse to recover the losses it had incurred because of the above-

described fraud and market practices.

119. Subsequent to the discussions, the Fixed Rate Counterparty and Jefferies entered

into a Mutual Release Agreement, whereby they resolved their disputes.

FIRST CAUSE OF ACTION

Fraudulent Inducement

(Against IDCG and IDCH)

120. Jefferies incorporates by reference the allegations set forth in paragraphs 1

through 119 as though fully set forth herein.


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121. Clearinghouse (IDCG and IDCH) misrepresented that engaging in IDCG Swap

Futures Contracts cleared through Clearinghouse would be economically equivalent to engaging

in plain-vanilla OTC IR Swaps engaged in on the OTC market. Such misrepresentations were

communicated to Jefferies, as well as other market participants, through various means,

including, among others, (1) its CFTC application; (2) its CEOs testimony before Congress;

(3) presentations specifically made to Jefferies; (4) its own Rules; (5) the shadow clearing

testing process as well as the First Swap; and (6) its own website. These misrepresentations

were extensively quoted above in Sections IV and V.

122. Clearinghouses misrepresentations were material because, among other reasons,

they were made to the CFTC and to Congress. In addition, these misrepresentations go to the

heart of risk managementa fundamental pillar of any financial institutions core business. For

example, Clearinghouses April 5, 2010 presentation to Jefferies specifically emphasized not

only the economic equivalence of the transactions, but also the reason why such economic

equivalence was absolutely critical to market participants. In Clearinghouses own words, it

offered Products which are economically equivalentto what exists today in the OTC market that

do no require participants to change their market risk management behavior. (Emphasis

added.) Jefferies and most other market participants would not have been willing to change their

market risk management so that they could engage in transactions through Clearinghouse. The

fact that Clearinghouses presentation specifically referenced this issue indicates that

Clearinghouse was well aware of this sentiment, and its ability to attract new business depended

on this representation.

123. Further, Jefferies participated in the OTC IR Swaps market where it had

accumulated significant experience in the OTC market and built reliable models to analyze the


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127. When Clearinghouse misrepresented the economically equivalent nature of its

IDCG Swap Futures Contracts to plain-vanilla OTC IR Swaps, it did so knowingly.

128. As outlined above, Clearinghouses own words and deeds in connection with its

OTC Contracts clearing arrangement also reflect its knowledge of the falsity of its

misrepresentations.

129. Indeed, with respect to the OTC Contracts, Clearinghouses specifically stated to

the federal regulators and its Clearing Members: in order to more accurately reflect the current

practice in the over-the-counter interest rate swap market, [Clearinghouse] will apply a price

alignment interest (PAI) adjustment for OTC Contracts cleared by OTC Clearing Members.

130. Relying on Clearinghouses material misrepresentations, Jefferies entered into

transactions, i.e., the Listed Futures Contracts, through Clearinghouse. Further relying on the

promise of economic equivalence, Jefferies entered into OTC swap transactions to offset the risk

of the Listed Futures Contracts. As a result, Jefferies has suffered tens of millions of dollars of

damages when Clearinghouse failed to provide economic equivalence for the Listed Futures

Contracts and then refused rectify the situation.

SECOND CAUSE OF ACTION

Aiding and Abetting Fraud

(Against NASDAQ)



132. As set forth in more detail above in paragraphs 120 through 130, Clearinghouse

fraudulently misrepresented to Jefferies the economic equivalence of the transactions entered

into through Clearinghouse and as result induced Jefferies to enter into the relevant transactions,

i.e., the Listed Futures Contracts, through Clearinghouse.


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133. NASDAQ had knowledge of this fraudulent scheme through its senior executive

who solicited Jefferies business on behalf of Clearinghouse. This senior NASDAQ executive

was a member of IDCGs board of directors and had close contact with Mr. OConnor, the CEO

of IDCG. Upon information and belief, this senior NASDAQ executive also discussed,

evaluated, and decided, at the highest management level at Clearinghouse, various aspects of

pricing model and contract specification, including treatment of margin and interest earned on

variation margin.

134. At the time, Clearinghouse and its majority owner NASDAQ were eager to land

Jefferies as a client to kick-start and bolster its clearinghouse business. To achieve this, and with

knowledge of Clearinghouses fraud, NASDAQ substantially assisted Clearinghouse to achieve

the intended fraudulent goal by using its market influence to solicit Jefferies business. The

senior executive of NASDAQ personally reached out and contacted a senior executive of

Jefferies to advance the deal, and such personal communications at the senior executive level

substantially assisted the fraudulent scheme and achieved its desired endto induce Jefferies to

commit to transactions with over $180 million in notional on Clearinghouse and kick-started and

bolstered the exchange business before it had any substantial transactions.

135. Induced by the fraudulent scheme, Jefferies entered into transactions through

Clearinghouse, i.e., the Listed Futures Contracts.

136. With knowledge of Clearinghouses fraudulent scheme, NASDAQs conduct in

soliciting Jefferies substantially assisted Clearinghouse to defraud Jefferies.

137. As a result, Jefferies has suffered tens of millions of dollars of damages when

Clearinghouse failed to provide economic equivalence for the Listed Futures Contracts and then

refused rectify the situation.


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THIRD CAUSE OF ACTION

Negligent Misrepresentation




139. Clearinghouse (IDCG and IDCH) misrepresented that engaging in IDCG Swap

Futures Contracts cleared through Clearinghouse would be economically equivalent to engaging

in plain-vanilla OTC IR Swaps on the OTC market. This misrepresentation was communicated

to Jefferies, as well as to other market participants, through various means, including, among

others, (1) its CFTC application; (2) its CEOs testimony before Congress; (3) presentations

specifically made to Jefferies; (4) its own Rules; (5) the shadow clearing testing process as

well as the First Swap; and (6) its own website. These misrepresentations were extensively

quoted above in Sections IV and V.

140. Clearinghouses misrepresentations were material because, among other reasons,

they were made to the CFTC and to Congress. In addition, these misrepresentations go to the

heart of risk managementa fundamental pillar of any financial institutions core business. As

stated above, Clearinghouse represented in a presentation dated April 5, 2010 that there would be

no change to a participants risk management system.

141. Further, Jefferies participated in the OTC IR Swaps market and had accumulated

significant experience in the OTC market and built reliable models to analyze the OTC market.

Assurance of economic equivalence was critical for Jefferies to engage in any transactions

through Clearinghouse in lieu of trading on the OTC market, including because only with such

economic equivalence could Jefferies accurately understand, evaluate, and manage its market

risk, which it was well versed in doing from its experience in OTC transactions.


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on the promise of economic equivalence, Jefferies entered into OTC swap transactions to offset

the risk of the Listed Futures Contracts.

148. Thus, Clearinghouse negligently or intentionally made material

misrepresentations (and omitted facts which in the context of the statements it made rendered

those statements false) to Jefferies to induce Jefferies to enter into transactions through

Clearinghouse, when Clearinghouse had a duty to disclose the truth because of its special

knowledge. As a result of reasonably relying on such misrepresentations, Jefferies has suffered

tens of millions of dollars of damages when Clearinghouse failed to provide economic

equivalence for the Listed Futures Contracts and then refused rectify the situation.

FOURTH CAUSE OF ACTION

Breach of Contract




150. Clearinghouses Rules constitute a contract between Jefferies and Clearinghouse.

151. Clearinghouses Rule 418 states, Swap agreements that are traded on a bilateral

basis and submitted through the trade registration system of a Participating Trading Facility for

clearing by the Clearinghouse will be cleared as futures contracts through a replacement process

whereby the original over-the-counter swap agreement is replaced by an economically equivalent

futures contractthat complies with the Exchange Contract terms specified by the Participating

Trading Facility or the Clearinghouse. (Emphasis added.)

152. Clearinghouse did not follow its Rule 418 because it failed to provide economic

equivalence for the Listed Futures Contracts. The Listed Futures Contracts are not economically


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equivalent because (1) they fail to credit to the post party the interest accrued on variation margin;

and (2) they follow the IDEX Curve, which is substantially different from the OTC Curve.

153. Chapter 10 of Clearinghouses Rules provides that the Daily Settlement Price is

set by Clearinghouse as follows:

Each open position is valued by the Clearinghouse at the end of each trading dayby valuing each leg of the cash flows of the contract (fixed and floating)according to discount factors generated by the IDEX Curve. Each Trading Day,the Daily Settlement Price shall be established by the Clearinghouse based uponthe IDEX Curve that corresponds to the fixed rate portion of the swap. A netpresent value of the position will be determined and set as the Daily SettlementPrice. Notwithstanding the preceding sentence, the Clearinghouse may, in its solediscretion, establish a Daily Settlement Price that is afair and appropriate

reflection of the market. The Final Settlement Price shall be the Daily SettlementPrice on the Last Trading Day. (Emphasis added.)

154. Because of Clearinghouses repeated representation that engaging in IDCG Swap

Futures Contracts would be economically equivalent to engaging in OTC IR Swaps, the

market referenced in Chapter 10 was the OTC market.

155. Clearinghouse had failed to provide economic equivalence for the Listed Futures

Contracts, in violation of its Rules under Chapter 10.

156. As a result of Clearinghouses breach of these contractual terms, Jefferies has

suffered tens of millions of dollars of damages.

FIFTH CAUSE OF ACTION

Promissory Estoppel




158. Clearinghouse promised and represented, in clear and unambiguous terms, that

IDCG Swap Futures Contracts cleared through Clearinghouse would be economically equivalent

to plain-vanilla OTC IR Swaps. Such promises and representations were communicated to


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Jefferies through various means, including, among others, (1) its CFTC application; (2) its

CEOs testimony before Congress; (3) presentations specifically made to Jefferies; (4) its own

Rules; (5) the shadow clearing testing process as well as the First Swap; and (6) its own

website. These misrepresentations were extensively quoted above, in Sections IV and V.

159. Jefferies reasonably relied upon these statements because Clearinghouse

represented that transactions it cleared would be economically equivalent and supported its other

representations through its shadow clearing process as well as through months of actual pricing

of real trades. Further, when Jefferies committed real capital by engaging in the First Swap,

Clearinghouses results appeared to verify the promise of economic equivalence. Finally,

Jefferies further reasonably believed the truthfulness of Clearinghouses misrepresentations

because they were embedded within Clearinghouses own Rules.

160. Jefferies reasonably relied upon Clearinghouses promises when it decided to

enter into transactions, i.e.,the Listed futures Contracts, through Clearinghouse. Without the

assurances provided by Clearinghouse that the transactions Jefferies was entering into would be

economically equivalent to OTC transactions, Jefferies would not have engaged in transactions

through Clearinghouse. Further relying on the promise of economic equivalence, Jefferies

entered into OTC swap transactions to offset the risk of the Listed Futures Contracts.

161. Jefferies reasonable reliance on Clearinghouses promises was to its own

detriment because it has suffered tens of millions of dollars of damages when Clearinghouse

failed to provide economic equivalence for the Listed Futures Contracts and then refused rectify

the situation.


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Documents

Jefferies v Nasdaq Complaint