Deutsche Bank must compensate a small-business customer for losses incurred as a result of an interest-rate swap, Germany's highest appeals court ruled today.  The decision could raise the liability of German banks for the complicated financial products they sell and affect other banks doing business in the country. 

e.g. - Germany's southern city of Pforzheim, which is suing JPMorgan Chase in a Frankfurt court for the equivalent of $71 million in losses from a swap transaction.  Its general counsel said, "It certainly sets a precedent."

While the direct legal ramifications are limited to Germany, the Deutsche Bank case focuses attention on exotic financial products that banks sold to customers in many countries, including the United States, who later experienced severe losses.

Swaps were often marketed as ways for businesses or communities to minimize interest payments, but the bank customers either underestimated or were not fully informed about the huge sums they could lose if financial markets went in the wrong direction.

    Court Ruling:  Where Deutsche Bank Went Wrong.   the Federal Court of Justice.   Germany's Federal Court of Justice concluded that Deutsche Bk had failed to adequately warn its customer, a supplier of paper products, about the risks of the transaction, known as a CMS Spread Ladder Swap. In addition, the swap was rigged against the customer so that Deutsche Bank would be able to resell its side of the transaction to another investor, the court said.

The bank “deliberately designed the risk structure of the transaction to the disadvantage of the client, in order to immediately resell the risk at a profit.”  -- Court Summary of Decision.

The decision against Deutsche Bank, which found that the bank had a “grave conflict of interest,” was reminiscent of accusations last year that Goldman Sachs fraudulently sold a mortgage security to customers just as cracks appeared in the housing market.  That security, called Abacus 2007-AC1, allowed a prominent hedge fund manager, John A. Paulson, to place a bet against mortgage bonds.

A Deutsche Bank spokesperson said the bank will carefully review the decision, but does not plan to appeal in this case. 

For the complete story, go to:   [NYT Dealbook, 3/22, "German Court Rules.."]