Information reload

The history of economic downturn is marked by an upsurge in litigation. The present credit crisis – prompted by the collapse of the US subprime mortgage market – is proving no exception.

Indeed, the general consensus that much of the crisis is owed, in the large part, to avoidable misjudgement, miscalculation and weak oversight – on the part of multiple, variously entwined parties – will ensure that litigation is a prominent feature of this particular episode. Littered as it already is with mass repossessions, liquidations, major write-downs, the demise of several major hedge funds, and the near collapse of US investment bank Bear Stearns and UK mortgage lender Northern Rock, it could hardly be ­otherwise.

Many law firms and legal publications already report an upsurge in litigious activity, both in the US – where cases are already in their advanced stages – and in the UK, where suits are now being filed. Sally Butt, a partner at international law firm Addleshaw Goddard, and a specialist in asset finance-related recovery and dispute, told The Banker that the firm has experienced an appreciable increase in litigious activity during the past two to four months – most noticeably in the field of professional negligence.

“Financial services institutions are ­pursuing professionals that have valued properties and assets, or parties from whom they have solicited advice on ­transactions,” says Ms Butt. Even auditors, she adds, are finding themselves under increasing legal scrutiny. Mean­while, ­specialist publication Legal Week reports that bank-on-bank litigation – a notoriously tricky area of financial services litigation – is on the rise. In late December 2007, for example, a top-tier global investment bank filed a claim against Bear Stearns in relation to two of its collapsed hedge funds. The suit is only one of several filed against the investment bank that was subsequently acquired by JPMorgan Chase in April 2008.

In another high-profile case, San Francisco-based real estate fund Luminent Mortgage Capital is suing a top-tier global bank. The former accuses the bank of improperly valuing nine subprime mortgage bonds. Elsewhere, class action suits filed by investors against ­subprime mortgage lenders; firms that underwrote ­mortgage-backed securities and collateralised debt obligations; and investors in hedge funds and other ­investment vehicles containing subprime mortgage exposure, are growing rapidly. By April 2, 2008, risk management specialists RiskMetrics reported more than 67 subprime-related securities class actions filed by investors.

Furthermore, this kind of activity has historically proved to be self-feeding. The insurance and securities industries provides many examples of this being the case: in the wake of Hurricane Katrina – which overwhelmed the US city of New Orleans in August 2005 – many insurance firms were hit by an upsurge of litigation suits filed by failed claimants. Success in several instances further perpetuated the trend, stimulating further claimants to pursue failed claims that might otherwise have gone undisputed. Likewise, success in the above cases will likely prompt a flurry of future suits.

Litigation threat

To a large extent, however, these examples merely represent the short-term threat of litigation. In its recent report on business liability conducted in conjunction with the Economist Intelligence Unit, Lloyds of London found that the credit crunch will likely increase the long-term causes of litigation among financial services firms, with 45% of firms anticipating a highly adverse impact on share price; 45% anticipating a highly adverse impact on the cost of borrowing; and 34% anticipating a highly adverse impact on the ability to execute strategy. In their ability to inhibit growth, such factors will likely lead to further disputes, with 61% of firms anticipating future shareholder ­tension: in other words, the worst is yet to come.

But while preceding instances of crisis-induced litigation might offer many lessons for busy legal departments across the industry, the present crisis remains distinguished by a feature previously unseen: a colossal information management challenge, in which millions of pieces of data, information and documents pertaining to a suit must be discovered and disclosed during legal proceedings.

Securitisation saga

To some extent, the problem has been brought about by the complexity of the transactions that have characterised the securitisation of subprime mortgage debt. Andrew Matuszeski, business development consultant for the worldwide ­financial services industry at Hewlett Packard, explains: “It is important to remember that securitisation usually involved the bundling and trading of pools of contracts. These underlying ­contracts are usually paper contracts. Securitisation therefore allows a level of abstraction to occur between those paper contracts and the actual trading instruments that were going back and forth between institutions.”

In this phenomenon, loans have often been sold on between six or eight times before finally finding their way into a security. Every instance in which the loan is sold on requires the seller to sign over the mortgage notes to the buyer. But during the US mortgage boom – in which loans were effectively mass produced and sold on at high speed – the assignment of ownership has often been inadequately completed, mis-assigned, or vital documents have simply been misplaced.

Missing notes

Now, as lenders in the US move to foreclose on thousands of mortgages, they are often unable to produce the original loan note demanded by the courts. This dislocation – between what institutions thought they were trading, and what was actually being traded – has in many cases made it difficult for the bank in question to prove that it is the holder of that note and therefore the owner of the loan. During the first wave of court activity undertaken in the US, judges in five states have suspended foreclosure proceedings for this very reason, reports Bloomberg.

Paying the price

In such cases, banking institutions are being forced to pay a steep price for what are, commonly, poor processes for handling complex, paper-based transactions and information. This problem, although highlighted by it, is not specific to the present credit crunch. Rather, the crisis has served to underline – more starkly than ever before – the banking community’s persistent struggle to fully master its paper-based processes.

This is particularly true of those processes that span the gap between the front and back offices. In one salient example The Banker has learnt of, a US bank, which remains reliant on the daily physical transportation of paperwork from its branches to back-office operations elsewhere, decided to calculate the cost of its manual, back-to-front office workaround. When calculated during a period of a year, the bank’s daily courier runs to its branches was found to equal 11 roundtrips to the Moon.

Besides the cost and inefficiency of this process – to say nothing of its adverse environmental impact – the most serious immediate issues arise, in such instances, in lost items, the manual sorting and the exception processing associated with the physical transportation of paper-based information. The reputational risk of data loss during this process, meanwhile, is not trivial – and has been amply demonstrated in numerous high-profile data loss cases during the past two years.

Historically, the overarching drive towards automation in all areas of banking has enthroned the belief that the digitisation of paper-based information and processes is the answer to all such problems. But in fact, where digitisation has prevailed, it has frequently proved otherwise, serving instead to bloat further the information load. This is due, in the large part, to the proliferation of information creation and capture points. These include Microsoft Word and Excel ­documents, e-mail, mobile devices such as Blackberries, messaging systems, as well as numerous other customer relationship management (CRM) and enterprise resource planning applications and ­databases.

In its 2007 report, The Expanding Digital Universe, research giant IDC found that the amount of business-related digital information being stored has grown at a compound annual growth rate of 60% during the past decade. For individuals involved in litigation, as partners at Addeshaw Goddard report, the information burden associated with litigation has also expanded in recent years, in line with this explosion. Furthermore, IDC predicts that more than 70% of this information is created and stored in what is called ‘unstructured’ form – making its discovery and, subsequently, its sensible disclosure, a painstaking process.

In England and Wales, this issue is especially pressing. Under these jurisdictions, litigants are required to disclose any relevant digital documents, including highly granular information such as metadata – the information relating to how a document has been created and amended (of which most users are unaware).

E-mail, in particular, is frequently a source of information overload, as swathes of deleted e-mails must often be recovered.

E-mail cost

It is not uncommon, says Craig Rattray, a partner in Addleshaw Goddard’s outsourcing practice (which has also seen a rise in cases filed by banks against its outsourced providers) to disclose six years worth of e-mails. Many organisations are not able to do this with ease. In one instance The Banker has learnt of, a North American institution which spent $6m in order to find a single e-mail that proved the organisation acted in compliance with Reg NMS.

Bytes and bits, it seems – in their ­current free-flowing state – are no more ­successfully processed, archived and rendered easily retrievable than pieces of paper. Thanks to the credit crunch (or not, depending on which side of the contract an organisation is sitting) the problem has been brought into sharp relief, says Jens Henrik Osmundsen, director of business services, EMEA, for the financial services industry at Hewlett Packard. “Now that there is extraordinary pressure on financial institutions to retrieve this information, they have realised that they don’t have the most effective system in place for managing documents.” In a bid to achieve what is termed ‘litigation preparedness’, many organisations are now rethinking their information management policies and processes.

Building a case

If the initial flurry of post-market downturn litigation has brought to light flaws in the way in which banks manage their information flows, it will not – in the vast majority of organisations unaffected by legal proceedings – cement the business case for change.

Litigation support represents a subset of broader regulatory compliance requirements, however. Here, the case can be made more convincingly. Under regulations such as the Markets in Financial Instruments Directive (MiFID), for example, brokers are already required to archive, and make easily retrievable, all correspondence between themselves and their clients. The ever-burdensome requirement to provide high levels of transparency around such transactions, coupled with the concern – which has been reinvigorated by recent events – to better manage all forms of risk, provides a compelling argument for ambitious information management improvement projects that will, in turn, lighten the load in the case of litigation proceedings.

Frequently, however, the most compelling argument is economic: the re-­engineering of inefficient business processes can deliver huge cost savings to the business, speed up the delivery of key products and services, and improve ­customer-service. Many banks are therefore pursuing a two-pronged strategy based on the twin virtues of risk mitigation as a business necessity, and business process improvement as a means to build out superior products and services.

More broadly, IT directors and CIOs should also attempt to build such projects into the organisation’s CRM strategy, in order to achieve a highly personalised customer service. In their retail businesses, banks are looking at ways to ­capture more ­information about their customers during the transaction process. This often relates to the context in which the customer is banking – in order to identify key personal information, for example if a ­customer is married or has children. Having gained visibility on ­customers’ personal lives, banks will be better positioned to cross-sell and up-sell, and improve that much sought after ­quality – customer loyalty. But the ­information has to be captured and deployed in an ­intelligent fashion across multiple, ­integrated channels.

The new way

In order to achieve this end, many banks are now revising both their paper-based and digital information processes. Most notably, they are now moving away from a deeply ingrained belief that the world of information is bifurcated between that captured in paper form, and information held in digital form – never to be integrated within business processes. This belief has traditionally led many organisations to drive forward dematerialisation projects – that is the automation of all paper flows – in the hope that all paper can be digitised across the organisation.

Rather, banks are now trying to understand how they can develop more sophisticated processes, in which paper-based tasks and information are processed in a manner that allows their integration with digital ‘workflows’ – that is, the step-by-step method by which processes are fulfilled. In this way, information is able to flow across the all-too common divide between the digital barrier and physical paper world. In this model, paper-based processes that have existed outside ­properly auditable digital workflows – therefore allowing them to be lost or mis­placed, as experienced by some mortgage companies – can be integrated with digital processes, allowing the organisation to gain more control and visibility over its paper.

However, the points at which paper is produced, recreated and captured in ­digital form – that is the printing, faxing, ­photocopying and image-scanning desktop environment – must also be rationalised. Traditionally, this area of organisations has been an unmanaged space, creating inefficiencies, and serious waste in the form of paper and electricity. This too is a major issue when considering a bank’s carbon footprint: because the amount of energy required to create a piece of paper is 10 times that used to print it, it is not enough that banks have recycling facilities in place to accommodate unmanaged printing and photocopying flows. Banks must restrict their use altogether.

Streamlined systems

Through the rationalisation and centralisation of equipment and device usage, and the deployment of multi-function devices offering printing, copying and scanning capabilities, banks can help to reduce consumption and streamline the several junctures at which digital and paper information meet. “If you put the right imaging and printing infrastructure in place, you can not only achieve significant rationalisation, you can actually take that to the next step, and utilise that as strategic aid to the business,” says Mr Osmundsen. In the case of one European bank that The Banker has learnt of, a single floor of IT workers were operating no fewer than 200 printers: this has subsequently been whittled down to 12.

Strategic gains

In such examples, the rationalisation of complex and inefficient paper-based and digital workflows can bring economic gains through cost-reduction, increased productivity and reduced risk. But there are also further gains to be made. For the most ambitious banks hoping to address their digital information challenge, new – often dramatic – strategies are emerging. Many are searching for a universal model when approaching enterprise-wide information management – that is, pursuing information lifecycle management projects and enterprise data management initiatives in a unified way, across the ­organisation.

This means having a unified records management with multiple content types, powerpoints, e-mail, CRM applications and so on, all under one centralised record authority. This model allows standardisation across records capture, retention setting, discovery and retrieval. “Search and retrieval capability for information and documents – across all businesses and all geographies – is close to happening. I haven’t seen anyone get there yet, but this motion is afoot,” say Mr Wagle.

In this model, large global organisations will be able to retrieve information in one business unit, and strategically apply it to processes, product development and services, operated by another area of the business. In addition, ­organisations will be better able to ­optimise the value of their data and infor­mation, and build an operating model that is able to more efficiently drive long-term growth.

This vision – in which all information is instantly accessible and easily reconstituted for new purposes – has traditionally been regarded as something of a nirvana. But the burden of regulatory compliance, combined with the immediate need for litigation preparedness, and the requirement to seek out new models for growth in an economically inhospitable environment, offers no small incentive to pursue this ideal. Those in a position to respond quickly to the unforeseen challenges created by the ongoing fall out of the subprime blow-out will be best placed to protect their business now, and to ensure its growth in years to come.