Secret Weapon

On May 6, inside a sprawling court building in central Milan, a dozen attorneys and a scrum of reporters crammed into a courtroom for the opening day of a high-profile financial trial. As the lawyers took their seats on a few rows of wooden benches, they had to edge around two iron cages intended for criminal defendants. The cages, typically used for non–white collar defendants, were empty. But the setting was a bracing reminder to the defendants in this trial–JPMorgan Chase & Co., UBS AG, Deutsche Bank AG, Depfa Bank plc, and 11 executives from the banks–that the case against them is criminal.

The banks and the individuals face the same charge: aggravated fraud. The charges stem from a complex derivative transaction the banks arranged for the city of Milan in 2005: a floating-interest-rate swap on a 30-year, $2.3 billion public bond. JPMorgan Chase, UBS, Deutsche Bank, and Depfa (now a unit of Hypo Real Estate Holding AG) had pitched the swap as a way for the city to reduce debt costs, but Milan now faces higher debt payments than before and current mark-to-market losses on the swap that it estimates at $285 million. The prosecutor charges that the banks also reaped $125 million in undisclosed profits from the deal. The banks respond that no laws were broken, and that Milan was hardly the market neophyte it claims to be.