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Procter & Gamble Sues Bankers Trust Over Derivatives

October 28, 1994 GMT

NEW YORK (AP) _ Bankers Trust New York Corp.’s derivatives problems worsened when Procter & Gamble Co. filed a $130 million lawsuit against the bank over its investments in the exotic securities.

The suit Thursday by the leading maker of disposable diapers and laundry soap alleged that Bankers Trust misled Procter & Gamble on the terms and risks of a derivative contract whose value was tied to interest rates.

P&G lost $102 million on two such contracts it bought from Bankers Trust, and decided to sue over one because it believes the bank lied about a built-in ″safety valve″ in the contract intended to protect P&G from losses if interest rates changed.

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″The safety-valve was an illusion,″ Edwin L. Artzt, P&G chairman and chief executive, said in a statement. ″The issue here is Bankers Trust’s selling practices.″

P&G wants the bank to cancel the contract and pay $130 million compensatory damages and unspecified punitive damages.

Bankers Trust denied the charges, saying the risks were fully disclosed to P&G and the company understood fully and approved the transaction.

P&G is the second company to sue the New York bank, a big derivatives dealer, over the contracts. Gibson Greetings Inc. filed a $73 million lawsuit last month, also alleging the bank did not adequately disclose risks of derivatives it bought.

P&G’s suit is more damaging to Bankers Trust’s reputation, banking analysts said, because P&G is viewed as highly sophisticated in financial matters.

When the company first threatened a suit in April, many analysts privately voiced doubts that such a savvy firm could not have understood the risks involved in derivatives.

P&G said a thorough internal review of the transaction led the company to believe it had been misled. Some analysts were troubled that P&G decided to go ahead with the lawsuit.

″It damages their reputation, because their business depends on trust,″ said Stephen Berman, an analyst at County Natwest Securities. ″You don’t go out and do a high-profile thing like this unless you think you have grounds.″

Some analysts speculated that P&G tried to negotiate a settlement with Bankers Trust and filed suit because it was unsuccessful. A P&G spokesman would not confirm or deny that the company had tried to settle out of court.

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Bankers Trust said in a statement that it offered to ″tear up″ the transaction - for a price - but P&G declined.

P&G took pains to say in its complaint it has conservative policies for managing its financial matters and that it would not make highly speculative bets with derivatives. Lawyers said this is important because firms that speculate in derivatives are vulnerable to shareholder litigation and regulatory censure if losses occur.

Nonetheless, P&G is being sued by a shareholder over the losses and is under a Securities and Exchange Commission investigation.

P&G said it bought a customized derivative from Bankers Trust to minimize its exposure to changes in interest rates.

Derivatives are complex securities involving payments that are linked to or derived from some underlying financial asset or index, such as interest rates, stocks or bonds.

When a company enters into a derivatives contract, it is making a bet on whether interest rates or stock prices will go up or down.

In a typical interest rate swap, one party agrees to pay a fixed interest rate on a certain amount of money in exchange for receiving a floating rate from another party.

If the company bets correctly on whether rates will go up or down, it can protect itself from higher borrowing costs. P&G apparently bet wrong, and when rates began to rise in February, it started to lose money.

P&G claims Bankers Trust said the contract contained a safety valve that would have limited the company’s risk to higher rates. It said Bankers trust used a secret computer model that locked P&G into a no-win situation.

″It now appears that the Bankers Trust formula would penalize P&G . . . regardless of stable rates, rising rates or even modestly declining rates,″ said the company.

P&G said it would have made at the most $1.5 million a year for five years if the contract had gone its way and was never told of the magnitude of the potential losses if the contract soured.

Bankers Trust, on the other hand, set aside $3 billion to cover itself for potential losses, meaning that it knew all along how damaging the contract could be, P&G said in its complaint.

″Nowhere was this true risk disclosed to P&G,″ the company said in a statement.

P&G said it is still considering whether to sue the bank over a second contract.