FILED: NEW YORK COUNTY CLERK 09/16/2011

NYSCEF DOC. NO. 1

INDEX NO. 652560/2011 RECEIVED NYSCEF: 09/16/2011

SUPREME COURT OF THE STATE OF NEW YORK COUNTY OF NEW YORK JEFFERIES & COMPANY, INC., Plaintiff, v. THE NASDAQ OMX GROUP, INC., INTERNATIONAL DERIVATIVES CLEARING GROUP, LLC, and INTERNATIONAL DERIVATIVES CLEARINGHOUSE, LLC, Defendants. Jury Trial Demanded Index No. _________________

COMPLAINT

BOIES, SCHILLER & FLEXNER LLP 575 Lexington Avenue New York , New York 10022 Telephone: (212) 446-2300 September 16, 2011 Attorneys for Plaintiff Jefferies & Company, Inc.

Table of Contents Summary of the Action ...................................................................................................................1 The Parties .......................................................................................................................................7 Jurisdiction and Venue ....................................................................................................................8 Factual Allegations ..........................................................................................................................8 I. II. III. IV. V. Plain-Vanilla OTC Interest Rate Swaps ........................................................................8 Role of Clearinghouses................................................................................................11 Defendant Clearinghouses Mechanisms for Clearing Plain-Vanilla IR Swaps ...............................................................................................13 Clearinghouses Repeated and Unequivocal Representations of Economic Equivalence............................................................................................14 Clearinghouse Solicits Jefferies with Unequivocal Promise of Economic Equivalence, and Jefferies Tests Clearinghouses Promise ........................................................................................................................17 NASDAQ Solicits Jefferies to Kick-Start and Bolster Its Clearinghouse Business...............................................................................................20 Jefferies Engages in Transactions through Defendant Clearinghouse ..............................................................................................................22 Clearinghouses Failure to Provide Economic Equivalence Caused Jefferies to Suffer Tens of Millions of Dollars of Losses, and Clearinghouse Refused to Rectify the Situation ......................................25 A. The Fixed Rate Counterparty Was the Sole Fixed Rate Payer of the IDCG Swap Futures Contracts Market .............................................25 B. The Fixed Rate Counterparty Created Confusion in the IDCG Swap Futures Contracts Market, and Clearinghouse Initially Agreed to Clarify such Confusion, but Subsequently Refused to Do So...................................................................................................25 C. Clearinghouse Permitted the Fixed Rate Counterparty to Set Prices Favorable to Itself in the IDCG Swap Futures Contracts at Jefferies Expense .............................................................................30 D. Jefferies Resolved Its Dispute with the Fixed Rate Counterparty ..........................................................................................................33

VI. VII. VIII.

FIRST CAUSE OF ACTION Fraudulent Inducement (Against IDCG and IDCH)............................................................................................................33 SECOND CAUSE OF ACTION Aiding and Abetting Fraud (Against NASDAQ) ......................................................................................................................36 THIRD CAUSE OF ACTION Negligent Misrepresentation (Against IDCG and IDCH)............................................................................................................38 FOURTH CAUSE OF ACTION Breach of Contract (Against IDCG and IDCH)............................................................................................................41 FIFTH CAUSE OF ACTION Promissory 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

Clearinghouse. Then, in or about October 2010within weeks of entering into the other side of the transactions that Clearinghouse induced Jefferies to enter into as economically equivalent to OTC swapsthe Fixed Rate Counterparty began a market debate that the transactions it entered into through Clearinghouse were significantly different from transactions of the similar nature on the OTC market. This debate created substantial confusion and steered bona fide participants away from the Clearinghouse futures contracts market. Accordingly, Clearinghouse became effectively a dead exchange. Then, Clearinghouse permitted the Fixed Rate Counterparty to place purportedly executable bids into the market in January 2011 to set the market price at levels that were notand that Clearinghouse knew not to beeconomically equivalent to the OTC swaps. 3. Instead of preventing or rectifying that situation and fulfilling its promise to

deliver a cleared swap futures contract that was economically equivalent to OTC swaps, Clearinghouse did nothing and stood by while it caused Jefferies to suffer tens of millions of dollars in losses. 4. This story began in December 2008, when Clearinghouse launched its clearing

business for the clearing and trading of interest rate swap futures contracts. Clearinghouses business struggled from the very beginning because many, if not most, swap dealers preferred not to clear their interest rate swaps (IR Swaps) through an open clearinghousedoing so would jeopardize their lucrative OTC trading business. 5. To help-kick start this new business line, NASDAQ OMX Group, Inc.

(NASDAQ)the parent company of Clearinghouseand Clearinghouse set their sights on Jefferies. Jefferies at the time was a logical target for Clearinghouse because Jefferies had no substantial existing OTC business that would be threatened by Clearinghouses operations.

6.

Clearinghouse, along with NASDAQ, aggressively sought Jefferies business. In

June 2010, a senior NASDAQ executive personally called and wrote to a senior Jefferies executive to solicit this business on behalf of Clearinghouse. Throughout this aggressive courtship, one central promise was repeatedly made by Clearinghouse to Jefferies: transactions through Clearinghouse would be economically equivalent to similar transactions entered on the OTC market; that is, Clearinghouses yield curve (a curve of interest rates used to calculate an instruments net present value) would be substantially the same as the yield curve in the OTC market. 7. Jefferies engaged in extensive due diligence to test Clearinghouses assurances of

economic equivalence. In a process called shadow clearing, participants engaged in simulated trading and clearing of trillions of dollars worth of notional value in swaps. Clearinghouse then published daily yield curves from which the price for these instruments was derived. This shadow clearing was used by market participants to verify Clearinghouses clearing process and pricing accuracy and consistency. At all times, the shadow clearing closing prices were economically equivalent to the closing OTC swap curve. Before it began trading with Clearinghouse, Jefferies carefully followed and studied the pricing of various instruments, including to ensure the economic equivalence of entering into such transactions through Clearinghouse versus in the OTC market. Jefferies even entered into a small trade ($6 million in notional value) through Clearinghouse so that it could further verify that the instruments cleared by Clearinghouse were economically equivalent to instruments traded on the OTC market. 8. Jefferies purpose in engaging in the shadow clearing and the small test trade was

to verify Clearinghouses pricing accuracy and consistency. Through the manner in which Clearinghouse engaged in these studies with Jefferies, Clearinghouse represented and promised

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

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

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 fide market 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,

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.

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. 25. This Court has jurisdiction over Defendants pursuant to C.P.L.R. 301 and 302. 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. 8

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 payer1 in 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

Conversely, the floating rate payer is also the fixed rate receiver and the fixed rate payer is also the floating rate receiver. 9

rate payer equal to the agreed upon floating interest ratetypically a rate at, or calculated using, LIBOR2 on 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.

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 London wholesale money market or interbank lending market. 10

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.

Another 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 from the borrowers perspective because the borrower (i.e., the fixed rate payer) would continue to pay the fixed rate, which is now at a lower level relative to the market. 11

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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44.

Clearinghouse well understood this need. Indeed, it claimed in a presentation to

Jefferies titled Clearinghouse Presentation that it would provide futures products that are economically equivalent to what exists today in the OTC market that do not require participants to change their market risk management behavior. (Emphasis added.) A copy of the presentation is attached hereto as Exhibit 1. 45. Under Clearinghouses system, counterparties would first execute a bilateral OTC

IR Swap with each other that sets out the economic terms of the transaction. This bilateral OTC IR Swap would then be presented to Clearinghouse for entry as an exchange-traded swap (i.e., for clearing). Upon approving the swap, Clearinghouse would sell a pair of mirrored, but separate, futures contracts to the parties. After entering into such a transaction through Clearinghouse, the original OTC IR Swap would be canceled as the pair of futures contracts purchased from Clearinghouse replaced it. 46. To conduct transactions through Clearinghouse, an entity could either become a

Clearing Member of Clearinghouse to transact business directly or transact through a Clearing Member. Clearing Members are required to deposit a certain amount of capital with Clearinghouse and to obtain performance bonds. The capital and performance bonds are to indemnify Clearinghouse in case a Clearing Member breaches its obligations under any futures contracts. IV. Clearinghouses Repeated and Unequivocal Representations of Economic Equivalence 47. In or about August 2008, Clearinghouse submitted its application to the United

States Commodity Futures Trading Commission (the CFTC) for registration as a Derivatives Clearing Organization (DCO).

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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 practices but 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 Minor variations existed most likely due to the timing of data collected for curve construction. 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). 17
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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

20

exchange similar to a futures contract. However, Clearinghouse had not to that point attracted any significant amount of trading from market participants. 71. One of the reasons for Clearinghouses initial failure was that existing dealers

were not inclined to support such an exchange as it could cannibalize the dealers existing OTC bilateral businesses; since market participants may opt to transact through Clearinghouse instead of engaging in bilateral OTC swaps, Clearinghouse competes with the dealers exiting bilateral OTC business. These bilateral businesses were very significant to the dealers, and an exchange would reduce the need for bilateral deals. 72. At the time, Jefferies was one of the few logical targets for Clearinghouse because

Jefferies did not have a large existing bilateral OTC business requiring protection. 73. In order to foster the business of its majority owned and controlled subsidiaries

IDCG and IDCH (i.e., Clearinghouse), NASDAQ lobbied Jefferies to do business with Clearinghouse. On June 3, 2010, a senior executive sent an email from his NASDAQ email addressed to a senior Jefferies executive with the subject Jeffries, IDCG. The email identified certain Jefferies employees that Garry OConnors team has been working with. 74. In a June 4, 2010 email, the senior Jefferies executive told the two Jefferies

employees identified by the senior NASDAQ executives email that a senior NASDAQ executive called me to tell me you guys are working with his guys on an IR Swaps business, and that the senior NASDAQ executive made it sound like we were working as partners, but it was evident that the senior NASDAQ executive want[ed] our flow and they own the biz. 75. In response, a Jefferies employee stated that the senior NASDAQ executive

essentially wants our flow to make his clearinghouse a success.

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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; 22

iii.

On or about September 20, 2010, Jefferies entered into an IDCG Swap Futures Contract as a floating rate payer on $50 million notional value with a thirty-year term; and

iv.

On or about September 21, 2010, Jefferies entered into an IDCG Swap Futures Contract as a floating rate payer on $50 million notional value with a thirty-year term.

79.

The Fixed Rate Counterparty was the fixed rate payer on each of the Listed

Futures Contracts. 80. Upon information and belief, the Fixed Rate Counterparty is the fixed rate payer

on all, or nearly all, IDCG Swap Futures Contracts transacted through Clearinghouse. 81. Jefferies offset the risk of the Listed Futures Contracts by entering into

corresponding swaps in the OTC market on which it was the fixed rate payer to other counterparties. Because the Listed Futures Contracts had been promised to be economically equivalent to the OTC market and because the shadow clearing and test trade appeared to substantiate that promise by Clearinghouse, these offsetting positions should have resulted in no economic risk to Jefferies. Instead, because Clearinghouses representations and promises of economic equivalence proved to be false, Jefferies lost tens of millions of dollars. 82. To arrange the Listed Futures Contracts at Clearinghouse, Jefferies and the Fixed

Rate Counterparty first entered into OTC IR Swaps. Jefferies and the Fixed Rate Counterparty exchanged confirmations in which both agreed to the terms and conditions of the OTC swap confirmed in this confirmation (the Transaction). As confirmed in the confirmations, the OTC swaps were then to be submitted by a broker to Clearinghouse for clearing and settlement through replacement of the Transaction as a cleared futures contract through an exchange of

23

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 day by 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 upon the IDEX Curve that corresponds to the fixed rate portion of the swap. A net present value of the position will be determined and set as the Daily Settlement Price. Notwithstanding the preceding sentence, the Clearinghouse may, in its sole discretion, establish a Daily Settlement Price that is a fair and appropriate reflection of the market. The Final Settlement Price shall be the Daily Settlement Price 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 to protect the respective interests of the Clearinghouse and Clearing Members, the Clearinghouse may establish the Settlement Price for any Contract at a price deemed appropriate by the Clearinghouse under the circumstances. When the Clearinghouse determines that circumstances necessitate the application of this paragraph, the reasons for that determination and the basis for the establishment of the Settlement Price in such circumstances shall be published in a Notice to Members. 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 Rectify the Situation A. 89. The Fixed Rate Counterparty Was the Sole Fixed Rate Payer of the IDCG Swap Futures Contracts Market 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 Futures Contracts Market, and Clearinghouse Initially Agreed to Clarify such Confusion, but Subsequently Refused to Do So The economics and pricing by Clearinghouse of the Listed Futures Contracts

91.

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 25

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 view paying interest

26

on excess reserves is fundamental [to] the fungibility of the IDCG vs 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-thecounter 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

28

making the IDCG Swap Futures Contracts not economically 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 rate swap 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 a cleared instrument and an identical uncleared one. [Clearinghouse] also offers a clearing facility for (regular) interest rate swaps, which deploys a PAI adjustment that is not used with the [Futures Contract]. This paper focuses solely on the [Futures Contract], where there is no adjustment for convexity and NPV effects. We will see, however, that the design of the [Futures Contract] does not address the convexity effect nor the NPV effect; as a result, it leads to substantial differences in valuation compared to an uncleared swap. Since January 2011, the IDCG settlement curve has started to deviate from the LIBOR swap curve as the market place came to a better understanding of the nature of the IDCG futures contract. With the same model parameters as of February 9, 2011, we compute the 10-year swap rate 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-year swap.

(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. 106. Clearinghouse Permitted the Fixed Rate Counterparty to Set Prices Favorable to Itself in the IDCG Swap Futures Contracts at Jefferies Expense 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

30

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. 108. Clearinghouse knew such bids would be ignored by other market participants. 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 uncleared swap 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. 118. Jefferies Resolved Its Dispute with the Fixed Rate Counterparty 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 abovedescribed 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. 33

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 equivalent to 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

34

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. 124. Indeed, there has been a complete lack of any trading through Clearinghouse ever

since the Fixed Rate Counterparty began to generate a debate about the economic equivalence of the instruments traded through Clearinghouse. This fact further shows the reality that market participants rely heavily on the assurances of economic equivalence for this market. 125. Jefferies was aware of Clearinghouses representations that are described in this

complaint before it entered into the Listed Futures Contracts from Clearinghouse and believed them at the time to be accurate. Jefferies reasonably believed that these statements were true because, among other indicia, such statements were made to the CFTC and to Congress. In addition, Clearinghouse further represented that transactions it cleared would be economically equivalent to OTC transactions and confirmed and restated its representations through its shadow clearing process as well as through months of actual pricing of real trades. When Jefferies committed real capital by engaging in the First Swap, Clearinghouses results again 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. 126. Jefferies reasonably relied upon Clearinghouses misrepresentations when it chose

to engage in the Listed Futures Contracts. 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 any transactions through Clearinghouse.

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

through 130 as though fully set forth herein. 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.

37

THIRD CAUSE OF ACTION Negligent Misrepresentation (Against IDCG and IDCH) 138. Jefferies incorporates by reference the allegations set forth in paragraphs 1

through 137 as though fully set forth herein. 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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142.

Indeed, there has been a complete lack of any trading through Clearinghouse ever

since the Fixed Rate Counterparty began to generate a debate about the economic equivalence of the instruments traded through Clearinghouse. These facts further show the reality that market participants rely heavily on the assurances of economic equivalence. 143. Jefferies was aware of Clearinghouses representations that are described in this

complaint before it entered into the Listed Futures Contracts from Clearinghouse and believed them at the time to be accurate. Jefferies reasonably believed that these statements were true because, among other indicia, such statements were made to the CFTC and to Congress. In addition, Clearinghouse further represented that transactions it cleared would be economically equivalent to OTC transactions and confirmed and restated its 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 again 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. 144. Jefferies reasonably relied upon Clearinghouses misrepresentations when it chose

to engage in the Listed Futures Contracts. 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 any transactions through Clearinghouse. 145. Clearinghouse had specialized or unique experience and knowledge in areas such

as the structures of its clearing business. It also knew that Jefferies relied on its specialized or unique experience and knowledge in deciding to clear trades through Clearinghouse. As a facilitator of otherwise bilateral transactions, Clearinghouse is uniquely situated because it is

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trading on both sides of a transaction. Such a unique position also provided it with specialized knowledge of details of a trade from all perspectives. By contrast, a market participant, like Jefferies, is only privy to one side of the transaction and was refused access by Clearinghouse to Clearinghouses proprietary pricing model. Clearinghouse knew that market participants like Jefferies generally rely, and that Jefferies in particular relied, on Clearinghouses unique or specialized experience and knowledge to evaluate that plain-vanilla OTC IR Swaps were economically equivalent to the IDCG Swap Futures Contracts cleared through Clearinghouse. And Jefferies in fact relied on Clearinghouses unique or specialized experience and knowledge in deciding to enter into transactions, i.e., the Listed Futures Contracts, through Clearinghouse. Such knowledge gives rise to a duty for Clearinghouse to provide accurate and complete information to Jefferies. 146. Clearinghouses representations of economic equivalence were false, and

Clearinghouse was negligent and reckless in making these representations to Jefferies. The interest earned on variation margin is an important and highly relevant issue to market participants when considering the economic value of an IR Swap. Clearinghouse, in designing the IDCG Swap Futures Contracts, must have considered the treatment of interest earned on variation margin because of the importance of this issue and thus was aware of the falsity of its representations. Clearinghouse knew or should have known that different treatments of the interest earned on variation margin would destroy economic equivalence, and it was reckless and negligent in representing to Jefferies that it provided an economically equivalent product. 147. Relying on Clearinghouses material misrepresentations, Jefferies entered into the

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

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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 (Against IDCG and IDCH) 149. Jefferies incorporates by reference the allegations set forth in paragraphs 1

through 148 as though fully set forth herein. 150. 151. Clearinghouses Rules constitute a contract between Jefferies and Clearinghouse. 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 contract that 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 day by 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 upon the IDEX Curve that corresponds to the fixed rate portion of the swap. A net present value of the position will be determined and set as the Daily Settlement Price. Notwithstanding the preceding sentence, the Clearinghouse may, in its sole discretion, establish a Daily Settlement Price that is a fair and appropriate reflection of the market. The Final Settlement Price shall be the Daily Settlement Price 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 (Against IDCG and IDCH) 157. Jefferies incorporates by reference the allegations set forth in paragraphs 1

through 156 as though fully set forth herein. 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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