The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

At what point can we declare that the subprime securities lawsuits are not doing particularly well in the courts? It may not yet be time, but there unquestionably are growing numbers of subprime lawsuits that have failed to survive motions to dismiss, at least as a preliminary matter.

The latest evidence of this phenomenon involves the securities lawsuit filed against Fremont General and certain of its directors and officers. As detailed here, Fremont plaintiffs first initiated the securities suit in June 2007. The 175-page Amended Consolidated Complaint in the case can be found here.

The plaintiffs allege that Fremont, a subprime mortgage lender, misrepresented the "quality of Fremont’s underwriting, loan quality and loan performance," and also that misrepresentations in Fremont’s financial statements "resulted in a material deception of the investing public." It was, the plaintiffs alleged, "only a matter of time before the Company’s extremely loose lending practices – driven by aggressive volume targets and financial incentives – would result in substantially increased mortgage delinquencies and material losses for Fremont investors."

Fremont filed for bankruptcy on July 9, 2008. The securities lawsuit was stayed as to the company but proceeded against the individual defendants. The defendants moved to dismiss the plaintiffs’ complaint.

In an October 28, 2008 order (here), Central District of California Judge Florence-Marie Cooper granted the defendants’ motion to dismiss, but allowed the plaintiffs 45 days in which to file a further amended complaint.

In their motions, the defendants had contended that the plaintiffs had failed to allege sufficient facts to satisfy the material misrepresentation and scienter pleading requirements for a 10b-5 claim.

Judge Cooper began her analysis of the motions with a commentary on the "disjointed nature of the allegations" in the Amended Complaint, noting that "nearly 100 pages" of the pleading "are dedicated to recounting of the history of the company, allegations of flaws in the company’s underwriting practices, and allegations of misstatements in various financial statements." She noted that she had "scoured" the Amended complaint "in an effort to link Lead Plaintiff’s allegations of specific statements with the alleged reason(s) those statements are misleading." She observed that "the internal cross references…fail to substantiate Lead Plaintiffs’ conclusory allegations that the statements were false and, in nearly all cases, they fail to illuminate why or how the falsity was material."

The Court also noted that while the complaint has "numerous references to representations by or knowledge of ‘Defendants’" these references "collectively do not facilitate a reasoned assessment of the statements and knowledge attributable to the Individual Defendants."

Finally, Judge Cooper also noted that "more often than not, the cross-referenced allegations intended to evidence the falsity of the alleged misrepresentations fail to adequately plead scienter in connection with those statements."

Because she concluded that the plaintiffs’ allegations "do not clearly articulate the basis of Lead Plaintiff’s Section 10-b and Rule 10b-5 claims against the Individual Defendants," Judge Cooper granted the motion to dismiss, with leave to amend.

It of course remains to be seen whether the plaintiffs will be able to address the court’s concerns in their amended complaint; to the extent they can, their case may go forward. But though Judge Cooper’s dismissal ruling is merely provisional, it is the latest in a series of similar rulings where courts have proven unreceptive to similar allegations raised against companies caught up in the subprime meltdown.

As I noted in prior posts concerning dismissals in the IMPAC Mortgage case (refer here), NovaStar Financial case (here), the Standard Pacific case (here) and First Florida Home Builders of Florida case (here), courts have proven demanding in their expectations regarding the specificity of the allegations required in the claims against these participants in the subprime marketplace. The courts clearly want to see more than that the companies engaged in aggressive business practices before their residential lending portfolio collapsed.

To be sure, there have been cases in which the plaintiffs’ allegations have proven sufficient to survive a motion to dismiss, as for example in the Toll Brothers case (refer here). But several courts now have made it clear they expect to see more than the existence of a mess left from the subprime meltdown. Generalized allegations that the lending institutions were aggressive or even that they failed to follow their own loan underwriting guidelines apparently may not be enough.

The subprime litigation wave is still in its earliest stages, and for that reason it may be premature to start making any generalizations. Nevertheless, it is at least interesting to note that a growing (and arguably significant) number of the earliest filed subprime securities cases are finding it difficult to survive the preliminary motions. Some of the cases may yet go forward following the amended pleading stage. But at least based on the most recent preliminary rulings, the question does arise whether the general economic turmoil has made courts skeptical of generalized allegations of fraud.

There will of course be further developments in the weeks and months to come. I will be tracking the results on my table of subprime and credit crisis-related case dispositions, which can be accessed here.

Namesake: Fremont General’s name doubtlessly derives from that of John C. Frémont, the 19^th century American explorer, military commander and politician. Frèmont is known as "The Great Pathfinder" for his surveys of the Oregon Trail, the Oregon Territory, the Great Basin, and the Sierra Mountains in California.

Frèmont was one of the two first Senators from California in 1850. Frèmont was also the Republican party’s first candidate for President in 1856 and he was the first major party Presidential candidate to run in opposition to slavery. He had the dubious distinction of losing to James Buchanan. He did at least draw more votes than Millard Fillmore.

Frèmont’s name lives on as the moniker for numerous counties, cities and civic buildings, in California and elsewhere. And, until it went bankrupt earlier this year, there was also a subprime mortgage lender named after him as well.

Observations on the Blogosphere: Congratulations to the Drug & Device Law Blog (here), which is celebrating the second anniversary of its blogging existence. In a post today, the blog’s authors pose this question, with following commentary:

We have a question for someone with access to the data: What percentage of legal bloggers stop publishing within 12 months of launching a new blog?

We don't know the answer to that, but we bet it's like small businesses -- most fail within a year.

Why?

First, as we’ve said before, blogging is hard, hard work. It's not easy to maintain an active legal practice by day and find time at night for massive "recreational" writing. Try writing five or six shorts articles a week (which is what we've averaged) for just one week. Think about what that would feel like for three months. And now imagine what we're celebrating today -- two years cranking out posts at that pace.

The authors are absolutely correct about how difficult it is for a fully occupied professional to maintain a blog over time. The authors supply their own reasons why they continue to blog despite the enormous burdens and effort required. I concur with their views, particularly as respects interaction with the audience and the ability to influence the dialog.

Andrew Sullivan, the author of The Daily Dish blog (here) has a more detailed answer in a November 2008 Atlantic Monthly article entitled "Why I Blog" (here). Sullivan eloquently captures what makes blogging so exhilarating -- and excruciating. He notes that "for bloggers, the deadline is always now. Blogging is therefore to writing what extreme sports are to athletics: more free-form, more accident prone, less formal, more alive. It is, in many ways, writing out loud."

One particularly distinctive aspect of the blogging experience is the immediacy of the connection between author and reader. Readers can (and do) easily post comments or send emails with corrections and criticisms. As a result, Sullivan notes, "the blogger can get away less and afford fewer pretensions of authority." Some of those who send comments, Sullivan adds,

unsurprisingly, know more about a subject than the blogger does. They will send links, stories, and facts, challenging the blogger’s view of the world, sometimes outright refuting it, but more frequently adding context and nuance and complexity to an idea. The role of a blogger is not to defend against this but to embrace it. He is similar in this way to the host of a dinner party. He can provoke discussion or take a position, even passionately, but he also must create an atmosphere in which others want to participate.

As Sullivan notes, this interaction is "an integral part of the blog itself." He is absolutely correct when he observes that "you’d be surprised by what comes unsolicited into the inbox, and how helpful it often is."

But while I agree with Sullivan’s essay on many points, I also think his concept of the blogosphere is peculiarly narrow and as a result his analysis is impoverished. Sullivan apparently presumes that all blogs and blogging lives resemble his own. However, Sullivan inhabits a rarified and privileged corner of the blogosphere, one that only an infinitesimally small number of bloggers enjoy. He is, for example, able to blog full–time. In addition, he has "an assistant and interns to scour the Web for links to stories and photographs." These are assets and advantages about which most bloggers can only fantasize.

Because he is blind to the varieties of blogging experience, Sullivan overlooks the diversity of blogging philosophy and goals that coexist with his own. To use but one very concrete example, his essay completely fails to take account of the numerous excellent law blogs in the blawging community (of which the Drug and Device Law blog is a superb example.)

Were Sullivan to encompass these kinds of blogs in his descriptions, he could not assert that "the blog has remained a superficial medium" or that blog readers are unwilling to read more detailed essays. His blog may be superficial, and his readers may have short little spans of attention, but those characteristics are not universal, either as to blogs or as to blog readers.

Sullivan also seemingly overlooks the challenge and pain (duly noted on the Drug and Device Law blog) that many bloggers experience trying to juggle our blogging addiction with the demands of our day jobs. Though Sullivan’s essay nowhere recognizes these challenges, I am confident that for many working bloggers these elements define the essence of their blogging experience. Bloggers with the luxury of blogging fulltime are spared these challenges.

Some day I will unburden myself of the longer essay on blogging that burns within me. Whenever that day comes, I will attempt to fill some of the critical voids in Sullivan’s essay. The most important point is the role that that blogs can play in a specific professional community -- for the exchange of ideas, for the development of connections, and for the passing events to be noted. Over time, a blog can also become a reference source for an entire industry (a point that the authors of the Drug and Device Law blog also note in their second anniversary post).

Until the day comes when I finally write my own essay on blogging, I will have to let it suffice to quote with approval one remark in Sullivan’s essay, in which he says "there are times, in fact, when a blogger feels less like a writer than an online disk jockey, mixing samples of tunes and generating new melodies through mashups, while making his own music."

Ultimately, as Sullivan writes in explanation of how he got hooked on blogging, "the simple experience of being able to directly broadcast my own words to readers was an exhilarating literary liberation."

Hat tip to the FCPA Blog (here) for the link to Sullivan’s essay.

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The credit crisis recently entered a dark new phase, and this new darker phase has also already produced its own distinctive round of lawsuits. Like the ominous economic circumstances, the new litigation phase also seems darker and more threatening.

In the latest issue of InSights (here) -- entitled "Has the Credit Crisis Litigation Wave Reached an Inflection Point?" – I briefly review the subprime litigation wave as it developed over the past two years and then examine the dramatic events that occurred in the financial marketplace beginning in September 2008. The article then examines the recent wave of litigation surrounding these events and concludes with an assessment of what these developments may signify going forward.

No Avalanche After All?: Following the U.S. Supreme Court’s February 2008 decision in the LaRue case (about which I wrote here), in which the court recognized an individual’s right to pursue a breach of fiduciary duty claims for mismanagement of their 401(k) plan, there was significant speculation that the decision could unleash an avalanche of lawsuits. The avalanche may yet materialize. But in the meantime it is worth noting that despite his victory in the Supreme Court, LaRue himself has voluntarily dismissed his case in the district court, where the case was on remand after the Supreme Court’s decision.

As reflected in the October 21, 2008 Consent Order of Dismissal in the case (here),LaRue withdrew his complaint after he "decided that it is not financially feasible to continue to pursue his claim."

As Professor Paul Secunda noted on the Workplace Law Prof Blog (here), LaRue’s withdrawal of his case shows that "these types of claims are still extremely difficult for plaintiffs to prevail upon" and "all the doomsday prognostications to the contrary seem just a tad off."

Just In Case Those Bank Lawsuits Do Materialize: In a recent post (here), I speculated that we may be entering a new phase of litigation involving failed banks. Apparently I am not the only one who anticipates that we may be seeing more failed bank litigation. In an October 23, 2008 memorandum entitled "Failed Financial Institution Litigation: Remember When" (here), the Willkie Farr & Gallagher law firm observes that the recent dramatic financial institution failures "are likely to fan the flames for myriad government agencies to pursue litigation against all parties associated with the financial institutions."

The Willkie Farr memorandum takes a comprehensive look at the potential failed financial institution litigation that may emerge, referring to the litigation that unfolded during the S&L crisis as a guide. The memo examines likely litigants, including in particular the probable defendants. The memo also reviews the factual and legal issues that are likely to arise, including some issues that may be different in the current era than previously– for example, with respect to circumstances involving credit default swaps.

The memorandum also briefly reviews the D&O insurance issues that are likely to arise in connection with claims against the directors and officers of the failed financial institutions. Among other issues, the memorandum review issues in connection with the regulatory exclusion (about which I previously wrote here), and in connection with the insured vs. insured exclusion (which I wrote about here).

The Willkie Farr memorandum is thorough and comprehensive, and is a good resource to keep at hand in the event the "dead bank" litigation does in fact materialize.

An Insurance Professional Takes A Look Back: It may surprise those outside the industry, but the insurance business really is full of a wide assortment of interesting, amusing and entertaining people. Many of their stories are humorously retold by industry veteran Larry Goanos in his new book Claims Made and Reported: A Journey Through D&O, E&O and Other Lines of Insurance (here). Larry’s book examines the careers of some of the luminaries of professional lines insurance industry and provides valuable insights for business success.

While writing the book, Larry apparently interviewed over 400 people, some of whom started in the industry back in the 1940s and 1950s. Many of the stories Larry recounts have become legendary in the industry, such as the tale of the broker whose suit was seemingly in flames during a meeting while he continued to talk or the mid-level executive who bought a Rolls Royce as his company car --on his lunch hour. The book is written with in the same spirit of friendship and good humor that characterizes the best side of our industry, and will be enjoyable for anyone who is a part of or is interested in the industry.

Congrats to Larry on his book. He obviously had a lot of fun writing it, and a lot of people are going to have fun reading it. It is worth noting that Larry intends to split the proceeds from the book’s sales among four charities, including the PLUS Foundation and Grateful Nation Montana.

What the Hell is the Point of 36 Watches -- Or, For That Matter, Three Mirrored Disco Balls?: In an October 29, 2008 Wall Street Journal article (here) describing unexpected challenges facing lenders that foreclosed on properties, the article details issues arising in connection with Indianapolis developer Christopher T. White and his business, Premier Properties USA:

Indianapolis prosecutors charged Mr. White in June with theft and fraud for writing a $500,000 check to Premier for payroll purposes on a nearly empty account. Mr. White's defense attorney counters that the developer believed money was arriving to cover the check. A lender seized Mr. White's personal property and in August auctioned items including five Vespa scooters, 15 flat-panel televisions, 36 watches and three mirrored disco balls.

"Where the Hell is Matt?": If you have not yet seen this latest viral Internet video, you have to take four minutes and watch it right now. Absolutely guaranteed to make you smile. Matt really does seem to have visited (and danced in) all the places depicted, which kind of makes you wonder how long it took to make this video. While he was dancing, the rest of us were sitting at our desks doing much more productive things...

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Do private securities lawsuits play an important role in deterring fraud and compensating defrauded investors, or are they simply wasteful and ineffective? These were the questions that on October 23, 2008 Stanford Law School Professor Joseph Grundfest and Duke Law School Professor James Cox debated in New York at the Forum for Institutional Investors sponsored by the Bernstein Litowitz Berger & Grossman law firm.

The professors' discussion, moderated by Bernstein Litowitz partner Sean Coffey, addressed some of the perennial questions concerning private securities litigation. I have summarized the professors’ comments below, followed by my own observations.

The Professors’ Debate

Professor Grundfest: Professor Grundfest addressed the issues first. He characterized private securities litigation as a process "for moving money around for the benefit of the people moving the money around." Professor Grundfest was particularly emphatic in arguing that private securities litigation is a poor deterrent of misconduct. He pointed to the many allegations of wrongdoing that have accompanied the current financial crisis as evidence that private securities litigation is not a deterrent to misconduct.

Professor Grundfest argued that because the vast preponderance of private securities litigation is settled with insurance proceeds or company money, there is no "individual responsibility," because the "wrongdoers" are not "hit in the pocketbook."

In order for the system to provide deterrence, Professor Grundfest suggested, the process should be changed so that rather than having as its objective simply to be to produce "the largest pot of money" from whatever source derived, the objective should be geared toward settlements funded directly out of individuals’ pockets, even if it results in a much smaller settlement.

Professor Grundfest described the current system as a "drug induced fantasy," as it essentially involves institutional lead plaintiffs suing companies in which institutional investors are the primary shareholders. Professor Grundfest asserted that this system produced nothing more than a very elaborate and costly pocket shifting, as a result of which it is mathematically impossible for a fully diversified investor to come out ahead. The only effective deterrent, Professor Grundfest argued, would be to require individual settlement contributions as a regular part of private securities litigation settlements.

Professor Cox: Professor Cox challenged the assertion that private securities litigation provides no deterrence, stating that it is not enough to look at litigation defendants alone to determine whether securities litigation has a deterrent effect. Rather, Professor Cox argued, the question is whether the threat of litigation raises the standard of conduct across the marketplace, among all companies. Professor Cox said that it is difficult to measure the benefit to the entire marketplace of increased disclosures and other conduct calculated to avoid litigation.

Professor Cox specifically observed that the performance of the U.S. markets in the current financial crisis demonstrates that these safeguards do work. He noted that while the markets around the world are all down, the U.S. markets are down less than other markets because the U.S. markets generally are viewed as more transparent and more trustworthy.

Professor Cox also noted that as it has evolved, our system of securities enforcement has come to require a public/private partnership. He cited research that looked at circumstances where both public enforcement and private litigation were involved, as well as circumstances where only one or the other initiative was involved. He said this research shows that the SEC has tended to pursue enforcement cases against securities violations involving smaller companies where fewer dollars are involved, while the private securities litigation bar has concentrated on the larger companies where more is at stake, where both the costs and the incentives for private action are greater. Professor Cox argued that this private/public partnership has contributed to a more comprehensive enforcement of the securities laws.

Professor Cox was dismissive of the portfolio theory against the effectiveness of private securities litigation. He noted first that Chamber of Commerce research had shown that the analysis that diversified institutional investors could not come out ahead, at a minimum, does not apply in the IPO and M&A context. He also pointed out that this portfolio theory is not raised as an objection to other types of commercial litigation, where one company sues another to recover damages. The same pocket shifting argument could be applied to all commercial litigation, but no one is suggesting that all commercial litigation be eliminated as unjustified under portfolio theory.

In the end, however, Professor Cox is not opposed to the idea of having individuals contribute toward class settlements, and he even suggested that the judiciary should have their consciousness raised about asking what the individual defendants have contributed towards settlement.

Sean Coffey: The panel moderator, Sean Coffey, commented that he believed that in order for private securities litigation to be most effective, individuals need to feel that they are "at risk." Coffey commented that he believed that the spectacle of the individuals being required to contribute to the WorldCom settlement did produce the kind of heightened awareness that could deter improper behavior.

But at the same time, Coffey noted, "because you don’t want to deter people from serving" on boards, the instances when individuals should be required to contribute should be "rare."

Professor Grundfest closed by commenting that individual responsibility is "the message that needs to go out" and he asked rhetorically, "why is it so rare?" He also asked "isn’t it was really works?" -- adding that motivating behavior is a more important goal than moving money around.

Discussion

Anyone who has had a close look at the securities litigation process can only be appalled at the wasteful expense, most of which has little to do with the merits or anything else important that is at stake, but has more to do with the enrichment of the process participants. But as profligate as the process inefficiency is, this costliness is not unique to securities litigation. Our system of litigation may not have been designed to enrich the lawyers, but that certainly is one of its most apparent effects.

But while there undoubtedly are ways our securities litigation system could be improved, that does not mean that the system overall fails to achieve its intended goals. In particular, I believe that private securities litigation does have a deterrent effect.

My perception is that most corporate officials have a strong desire to avoid accusations of fraud, even if the accusation were to come only in the form of a private securities lawsuit. For most corporate officials, the idea of their name and picture appearing in the local newspaper accompanied by the word "fraud" is their worst nightmare. Most corporate officials work hard to prevent this from happening. Of course there are those individuals whose greed overcomes their fear, and about this group I have further comments below.

As for whether the system compensates investors or simply moves money around, all I can say is that there are a large number of sophisticated, well-informed and profit motivated institutional investors that continue to actively participate in securities litigation, some serving frequently as lead plaintiffs. These institutional investors believe that the litigation is in their financial interest, notwithstanding what modern portfolio theory might purport to suggest. In addition, many of these investor plaintiffs are often interested in using litigation to achieve governance changes or other nonmonetary objectives. They clearly believe that private securities litigation helps them to achieve those goals.

And as for the idea that individuals should be forced to contribute routinely out of their own assets towards civil litigation settlements, I think we need to take a giant step back and look at what we are talking about. Most securities cases settle in their early stages, often even before motions for summary judgment have been determined. Rarely at the time of settlement have there been any factual determinations of any kind, much less any findings of culpability.

Most securities lawsuits settle because of the costs and burdens of litigation and because of the catastrophic loss potential involved if the case were to go forward through trial. Given these virtually universal settlement dynamics, it would, in my view, be a miscarriage of justice if individuals were to be required routinely to contribute out of their own funds toward settlement. Indeed, in the absence of culpability findings, any mandate requiring individual contribution arguably would be confiscatory and could violate due process, at least when there otherwise would be indemnity and insurance available.

We do not bar defendants in other contexts from availing themselves of liability insurance. We do not bar, say, defendants in auto accident cases from availing themselves of auto liability insurance, though one might hypothesize that drivers would be more careful if liability insurance were unavailable. Similarly, doctors are permitted to insure against allegations of malpractice, though mandated uninsured liability might motivate greater caution (or, more probably, result in fewer doctors). Why should defendants in securities lawsuits be any less able to benefit from contractual indemnity or liability insurance provisions?

There are of course those individuals whose greed outweighs their fear, and for whom the threat of litigation is no deterrent. These kinds of people undeniably are out there, but these people are not going to be forestalled by any deterrence mechanisms, even the threat of direct personal liability. The most effective approach to these kinds of bad actors is prevention, not deterrence. Meaningful transparency requirements and effective systems of internal controls monitored by independent watchdogs– that is how to fight bad actors’ misconduct.

Finally, even if there are occasional circumstances where individuals’ behavior theoretically might dictate their individual contribution toward private securities litigation settlements, these occasions should be rare. In that respect, I agree with the Sean Coffey’s comments that if these kinds of impositions were to become routine, talented individuals correctly might conclude that it is not in their personal financial interest to serve on a corporate board.

Looking Ahead

Regardless who wins the upcoming Presidential election, that there will be significant postelection efforts to strengthen regulatory mechanisms to try to prevent future financial marketplace crises and misconduct. There is some danger in this environment, where scape-goating is in high gear, that the idea of mandating the imposition of financial burdens directly onto individual directors and officers might gain some traction. Indeed, the Wall Street Journal op-ed column discussed below underscores that risk.

If this initiative were premised on the idea of requiring individual contributions toward settlement even in the absence of findings of culpability, any initiatives along these lines would inappropriately and unfairly shift costs to individuals. Attention more appropriately should be focused on mechanisms designed to improve monitoring, oversight and disclosure, so that greater transparency will allow the marketplace to do more to police behavior and prevent misconduct.

It will in any event be interesting to watch what unfolds after the election. There is little doubt that there will be an enormous effort to overhaul the financial markets’ regulatory structure. The outcome of these efforts will substantially affect markets and market participants, and could even affect the liability exposures of corporate officers and directors.

Where Were the Directors?: If early indications are any gauge, the idea that board members should be held individually accountable is likely to be a featured part of the regulatory reform discussions that undoubtedly lie ahead. By way of illustration, in an October 25, 2008 Wall Street Journal op-ed column entitled "Where Were the Boards?" (here), Papa John’s founder and Chairman John Schnatter asked, with respect to the current financial crisis "Where were the boards of directors of the companies that helped create this mess?"

Schnatter noted that boards "have a clear-cut fiduciary responsibility to provide oversight," as a result of which he observed that "we should not ignore their roles in contributing to this financial meltdown."

Schnatter conludes that "politicians in Washington would be wise" to "adjust their focus upward" (where, as Schatter noted "true power lies") and "set greater accountability for boards, requiring stringent oversight by those who are empowered to set the ground rules for American companies." He does, however, allow that penalties should not be so "harsh" that "no sensible business person would become a director."

Regardless of the level of authority with which Schnatter may speak, the concept of "greater accountability" at the director level undoubtedly will be part of the regulatory reform dialog that will follow the upcoming election. The practical usefulness of any conversation along these lines will depend critically on the extent to which the concern about the willingness of sensible business people to serve as directors is appropriately respected.

To Encourage the Others: The very idea that a few individual directors should be punished periodically as deterrent against the misbehavior of all others reminds me of the unfortunate British admiral, John Byng, who was court-martialed and shot to death for "failing to do his utmost" during the Battle of Minorca at the outset of the Seven Years’ War.

Voltaire included this incident in his novel, Candide, in which the main character, Candide himself, witnesses Admiral Byng’s execution in Portsmouth. Candide is told "Dans ce pays-ci, il est bon de tuer de temps en temps un amiral pour encourager les autres." (In this country, it is wise to kill an admiral from time to time to encourage the others.)

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On October 23, 2008, in a much-anticipated decision addressing what it called "the vexing question of the extraterritorial application of the securities laws," the Second Circuit in the National Australia Bank (NAB) case ruled (here) that U.S. courts lack subject matter jurisdiction over the claims of foreign claimants in that case who bought their NAB shares on a foreign exchange. Although the Second Circuit did not, as friends-of-the-court had urged, pronounce a bright line rule against jurisdiction in such "f-cubed" claims, it nevertheless provided guidelines that will be relevant to similar cases going forward.

Background

NAB is Australia’s largest bank. Its shares trade on securities exchanges in Australia, London, Tokyo and New Zealand. Its American Depositary Receipts trade on the New York Stock Exchange. NAB has a mortgage servicing subsidiary, HomeSide, based in Florida. In 2001, NAB disclosed that it was taking a significant write-down due to a recalculation of the amortized valuating of HomeSide’s mortgage servicing rights. Following this announcement, the price of NAB’s shares and ADRs declined, and investors filed a securities class action lawsuit in the Southern District of New York.

The claim was initially brought by four plaintiffs. One of the four purported to represent domestic purchasers of NAB’s securities. The three other plaintiffs bought their shares abroad and sought to represent a class of non-U.S. purchasers. Background regarding the case can be found here.

On October 25, 2006, the District Court granted defendants’ motion to dismiss the complaint. The District Court held that it lacked subject matter jurisdiction over the foreign claimants claim. The court dismissed the domestic plaintiff’s action for failure to state a claim because the domestic plaintiff failed to allege that he suffered damages. The three foreign plaintiffs appealed. The domestic plaintiff’s claim was not before the Second Circuit, and so the appellate court was exclusively concerned with the jurisdictional issue.

The Second Circuit’s Opinion

In its October 23 opinion, written by Judge Barrington Parker, the Second Circuit noted that the "difficulty of the case was heightened by its novelty" – that is, the involvement of so-called "foreign-cubed" claimants. The appellees and several amici had urged the Second Circuit to adopt a "bright-line rule" by holding that in "foreign-cubed" securities litigation that mere domestic conduct should not be enough for a U.S. court to exercise subject matter jurisdiction where the conduct had no effect in the U.S. Links to the briefs for the parties and the amici can be found here. My prior post detailing the issues surrounding "f-cubed claims" generally can be found here.

The Second Circuit duly acknowledged what it characterized as the "parade of horribles" the friends-of-the-court invoked in favor of a bright line test, including the possibility that exercising jurisdiction in those cases could bring U.S. securities laws in conflict with those of other jurisdictions.

However, the Second Circuit observed that declining jurisdiction over all "foreign cubed" cases "would conflict with the goal of preventing the export of fraud from America." In particular, the Court was concerned that the U.S. should not be seen as a "safe haven for cheaters." The court said that "we are leery of a rigid bright line rule because we cannot anticipate all the circumstances in which the ingenuity of those inclined to violate the securities laws should result on their being subject to American jurisdiction."

Having rejected the bright line test, the Court went on to observe that "we are an American court, not the world’s court, and we cannot and should not expend our resources resolving cases that do not affect Americans or involve fraud emanating from America." The Second Circuit said that "in our view the ‘conduct text’ balances those competing concerns." Under the conduct test, subject matter jurisdiction exists "if activities in this country were more than merely preparatory to a fraud and culpable acts or omissions occurring here directly caused the losses abroad."

The Court then turned to applying the conduct test to the NAB case. The claimants urged that because miscalculation of HomeSide’s mortgage servicing rights had taken place in this country, U.S. courts could exercise jurisdiction. The Second Circuit nevertheless determined that U.S. courts lack jurisdiction, citing three factors: "the fraudulent statements at issue emanated from NAB’s headquarters in Australia; the complete lack of any effect on America or Americans; and the lengthy chain of causation between HomeSide’s actions and the statements that reached investors."

Discussion

Though the defendants in the NAB case prevailed, the case hardly means the end of f-cubed litigation. Arguably, in light of the Second Circuit’s refusal to adopt a bright line test, the jurisdictional standards remain largely unchanged, and litigants will continue to argue whether there is sufficient U.S. based conduct and U.S based effects to support the U.S. court’s exercise of jurisdiction.

Moreover, the Second Circuit made it clear that there will be circumstances in which it will be entirely appropriate for U.S. courts to exercise jurisdiction over the f-cubed claims. For that reason, and even though the Second Circuit held that the U.S. courts lacked jurisdiction of over the NAB case itself, foreign claimants likely will continue to try to assert claims against foreign-domiciled companies in U.S. courts.

That said, the claimants case against NAB did get tossed. The Second Circuit did caution against U.S. courts presuming to act as "the world’s court" and also cautioned against the exercise of jurisdiction over claims that do not affect Americans or involve fraud emanating from America. In other words, not all foreign claimants’ claims against foreign domiciled companies will go forward in U.S. courts.

Moreover, these issues are relevant not only at the motion to dismiss stage but also at the other procedural stages, including the lead plaintiff stage (refer here). As Adam Savett noted on the Securities Litigation Watch blog (here), courts have been increasingly willing to craft class certification to exclude foreign domiciled claimants at least in certain circumstances.

All of that said, the NAB decision will be grist for the mill in the onslaught of litigation involving foreign domiciled companies sued in connection with the current subprime and credit crisis litigation wave. The NAB decision necessarily implies a case-by-case determination and so litigants will continue to wrestle to determine whether these cases will go forward in U.S. courts. In the meantime, the cases will continue to be filed.

An October 23, 2008 Bloomberg article discussing the case can be found here.

Special thanks to George T. Conway, III of the Wachtell, Lipton law firm, who successfully represented NAB in the Second Circuit, for providing me with a copy of the opinion.

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As I noted in a prior post (here), NERA Economic Consulting, in a May 15, 2008 paper (here), had asked the question whether options backdating-related securities class action lawsuits were settling for less than data from prior class action settlements would predict. In the May 15 paper, looking at the settlements to date, NERA found that the options backdating-related securities lawsuit settlements were well below predicted amounts.

NERA has now published an October 22, 2008 paper (here) that revisits its earlier analysis in light of intervening options backdating-related securities settlements.

With respect to the previously observed expectations gap, NERA had hypothesized in its earlier paper that either suits alleging backdating are generally viewed as weaker or the weakest cases had simply settled most quickly.

In its most recent paper, NERA revisits these hypotheses in light of three recent settlements – Brocade Communications, UnitedHealth Group and Monster Worldwide – finding that there may be support for the conclusion that the initial settlements may have been low because the weakest cases settled first. In these three more recent dispositions, the settlements were either at or well above predicted ranges. Indeed, NERA found that the UnitedHealth Group case was as much as five times greater than the predicted amount.

At the same time, NERA noted that four of the more recent settlements were more consistent with prior observations, in that the settlements were below predicted ranges.

In its earlier report, NERA had concluded that on average the options backdating cases were settling for about 38% of the predicted amount. With the addition of the intervening settlements the average settlement is up to about 74% of predicted amounts. However, this increase is largely driven by the inclusion of the UnitedHealth Group settlement. Without the UnitedHealth Group settlement, the average of the options backdating settlements drops to 43% of the predicted amounts.

Nevertheless, based on its analysis (and I am simplifying here), NERA still cannot reject the hypothesis that options backdating-related securities settlements are on average no different than settlements in non-backdating cases with similar level of investor losses and other similar traits.

NERA notes that of the overall options backdating-related securities lawsuits, 17 remain to be settled, which represents a larger group of cases than the 15 cases that have settled to date. It remains to be seen whether or not these remaining cases will or will not settle within expected ranges.

My table showing all options backdating related case dispositions, including settlements and dismissals both for all options backdating-related securities lawsuits and options backdating related derivative lawsuits, can be found here.

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The calamity that began as a U.S.-based subprime mortgage meltdown has now grown into a global financial crisis that has resulted in bankruptcies and bailouts involving some of the world’s largest financial institutions. Along the way, these financial institutions’ investors have seen their investment interests damaged or destroyed, leaving many angry and aggrieved. If a new lawsuit is any indication, investors aggrieved by their lost investments in global financial institutions may be turning to the U.S. courts for redress.

As reflected in their press release (here), on October 22, 2008, plaintiffs’ attorneys filed a purported securities class action in the Southern District of New York on behalf of investors who purchased securities of the recently nationalized Belgium-based financial services company, Fortis N.V. , related entities, and certain of its directors and officers.

According to the press release, though the company portrayed itself as stable and largely immune to the turmoil that was sweeping financial markets, "the Company was practically insolvent at all relevant times and needed to sell assets at fire-sale prices and raise capital at extraordinarily high rates to remain viable."

The press release states that the company’s balance sheet was impaired by assets acquired in connection with the company’s October 2007 acquisition of ABN AMRO.

On September 29, 2008, the governments of Netherlands, Belgium and Luxembourg agreed to bailout the company, but only if it were to sell its troubled stake in ABN AMRO. A September 30, 2008 Wall Street Journal article about the action of the three governments, and the role of the ABN AMRO transaction, can be found here. Even though the deal was in the form of an emergency infusion of 11.2 billion Euros ($16.9 billion), it was "not enough to stem Fortis’ continued decline."

On October 4, 2008, the Dutch government took over the company’s operations for 16.8 billion Euros ($23 billion). As the plaintiffs’ lawyers’ press release puts it, "news that the famed financial giant was in ruins and required nationalization further punished Fortis’ already bruised stakeholders." An October 6, 2008 Wall Street Journal article describing the government takeover, including the sale of Fortis banking and insurance assets to BNP Paribas, can be found here.

The plainitffs' lawyers' press release adds:

On October 14, 2008, Fortis traded on the Brussels exchange at the lowest levels that it had ever seen since it was formed 18 years ago, after selling most of its operations to three governments and BNP Paribas SA. Fortis, which resumed trading after a six-day suspension, declined 78 percent to 1.22 euro, valuing the Company at 2.86 billion euros ($3.91 billion).

The complaint in this case, which can be found here, apparently purports to be filed on behalf of  ALL investors who bought Fortis shares between January 28, 2008 and October 6, 2008, and not just U.S. domiciled investors or those who bought their shares on exchanges in the U.S. (where Fortis shares trade over the counter). The complaint specifically alleges that Fortis shares trade on the Brussels, Euronext and Luxembourg stock exchanges, as well as in the U.S.

To the extent the class action purports to be filed on behalf of foreign-domiciled investors who bought their shares in Belgium-domiciled Fortis on foreign exchanges, the case appears to present a classic instance of the so-called "f-cubed" problem (the reference is to the three foreign connections – foreign corporate domicile, foreign investor domicile, and foreign exchange location).

This case does not present the extreme situation represented in the lawsuit filed against EADS (and about which I wrote here) in which the foreign company's shares did not trade in the U.S. at all, but it nevertheless does present all the jurisdictional problems associated with subjecting foreign domiciled companies to potential liability under U.S. securities laws. As I noted here in connection with the recent ruling in the AstraZeneca case, courts increasingly are showing reluctance to project U.S securities liability in connection with f-cubed claims.

There is of course a well-established pattern of foreign domiciled companies becoming involved in U.S. securities litigation. Indeed, just in connection with the current subprime and credit crisis-related litigation wave, there have been U.S. securities lawsuits that have been filed against, Société Générale, Swiss Re, Deutsche Bank, and UBS, among many others.

What sets this most recent lawsuit against Fortis apart from these prior cases, at least in my mind, is that it relates so directly to the dramatic actions of foreign governments to try to salvage the company. These circumstances involve a magnitude, a depth of clearly foreign involvement and interests, and a combination of purely global financial circumstances that could be far beyond the purview of a U.S based court. To be sure, there may well have been misrepresentations made in connection with these events (the complaint certainly makes numerous allegations to that effect), and there may well of course have been misrepresentations of a kind for which the U.S. laws are designed to provide provide relief, which of course will have to be determined at a later date.

The case also involves such a vivid example of the momentous events that have moved across the global financial stage in recent weeks. The litigants will of course present their arguments about whether and to what extent a U.S. court is the appropriate forum here. Those of us not directly involved in the case may ask whether U.S. courts appropriately should perform roving inquests on the bailouts and bankruptcies that emerge around the globe as a result of the current financial crisis.

In any event, the Fortis lawsuit may represent another example of the new wave of credit crisis-related litigation, where the connection to the subprime meltdown is indirect, and the events that triggered the lawsuit are related to the catastrophic events in the financial market place that began to unfold in September 2008. My most recent prior post on this new litigation wave can be found here. On the other hand, it may also be argued that the problems Fortis faced are simply the result of the subprime mortgage exposure and subprime-related investments of the company it acquired, much the same as, for example, Wachovia was exposed to the subprime-related problems from Golden West, which Wachovia acquired.

Here Be Dragons: The ill-fated ABN AMRO transaction is a veritable treasure trove of excesses, extremes and subsequent moral lessons. Undoubtedly a book will be written some day about how the investor consortium led by Royal Bank of Scotland, and including Fortis, outbid (to the consortium’s eternal regret) the prior ABN AMRO bid of Barclays. Until the book comes out, readers may want to refer to the highly abridged version of events on Wikipedia, here.

Were there not so many other current events, the financial pages undoubtedly would be full of what-went-wrong retrospectives on the ABN AMRO deal. It is one more of those amazing things about the current circumstances that, despite the size of the ABN AMRO calamity, it is effectively just background noise in the larger cataclysm.

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In the latest of the decisions in which subprime and credit crisis-related securities lawsuits have failed to withstand preliminary judicial scrutiny, on October 6, 2008, Central District of California Judge Andrew Guilford granted (here) defendants’ motion to dismiss the plaintiffs’ second amended complaint in the IMPAC Mortgage Holdings case, with leave to amend.

As reflected here, the plaintiffs initially filed their purported class action complaint on August 17, 2007. The initial complaint was subsequently amended twice, and the October 6, 2008 ruling related to the plaintiffs’ second amended complaint. The second amended complaint essentially alleged that contrary to the company’s public statements, the company’s Alt-A loans were actually being sold to less creditworthy borrowers, so that the Alt-A loan portfolio was as risky as a portfolio of subprime mortgages. The plaintiffs further alleged that at the same time, the company misrepresented its true financial condition by its failure to write down the value of its loan portfolio.

In his October 6 opinion, Judge Guilford states that "plaintiff packs the Complaint with 30 pages of supposed misstatements or culpable acts, but none of them shows fraudulent intent or deliberate or conscious recklessness." The statements of the former employees on whom the plaintiffs sought to rely are, Judge Guilford found, "completely benign," or "so vague as to be meaningless."

Judge Guilford concluded that the plaintiffs’ allegations "do not provide any specifics, and they do not show fraudulent intent or conscious recklessness." The PLSRA, the court noted, "was intended to guard against exactly these sorts of vague, conclusory allegations." Judge Guilford therefore granted the defendants’ motion to dismiss, allowing the plaintiffs’ 21 days to file an amended complaint.

The plaintiffs in the IMPAC Mortgage case not only face a tight timeframe but also face an uphill battle to satisfy the shortcomings Judge Guilford identified. The complaint Judge Guilford rejected had already been amended twice, so it unlikely the plaintiffs held anything back or have a reservoir or additional powerful allegations to draw upon. The short work Judge Guildford made of their multifarious allegations could hardly be encouraging. In addition, Judge Guilford did not even reach the issues of whether the complaint adequately pled misrepresentation or appropriately relied on the group pleading doctrine, holding that his ruling on the scienter issue relieved him of the necessity to reach those other issues.

Judge Guilford’s approach in the IMPAC Mortgage case has appeared in a number of the preliminary rulings in the current wave of subprime and credit crisis-related cases. Even though we are still only in the very earliest stages of most of these cases, there have already been a number of cases where courts have been similarly skeptical of plaintiffs’ allegations. Some recent examples include the First Home Builders of Florida ruling (discussed here) or the NovaStar Financial ruling (here).

While there have of course been decisions going the other way, these skeptical courts have made it clear that they expect to see more than mere allegations that a mortgage loan portfolio underperformed prior expectations or that the lender’s financial condition has deteriorated. If the early returns are any indication, plaintiffs in many of the subprime and credit crisis-related cases may face similar skepticism in order on their preliminary motions.

In any event, I have added the IMPAC Mortgage decision to my table of subprime and credit crisis case dispositions, which can be accessed here.

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One feature of the current financial turmoil is that the government has taken or will take control of or ownership positions in a number of business organizations. The phenomenon of government ownership of a private enterprise potentially could present any number of conflicts and challenges. Among other problems that may arise is the question of exactly what the government’s role should be with respect to ongoing or future litigation.

This particular litigation dilemma is explored in an October 18, 2008 Wall Street Journal article entitled "Fannie Suit Vexes Regulator, May Pay Shareholders" (here). The article states that the securities lawsuit filed in connection with Fannie Mae’s September 2008 collapse puts the government regulatory agency now acting as Fannie Mae’s conservator "in an awkward position." Background regarding the lawsuit, filed on September 8, 2008, can be found here. My prior post about the lawsuit can be found here.

The Journal article notes that Freddie Mac settled a prior securities lawsuit for $410 million (about which refer here). Implicitly using the amount of this prior settlement as a point of reference for the possible magnitude of any future settlements of the Fannie Mae lawsuit, the Journal article observes that the "government’s control of Fannie puts taxpayers potentially on the hook for hundreds of millions of dollars of damages stemming from the lawsuit."

The Journal article also notes that one of the key elements of the new case will be the government regulator’s 340-page May 2006 report that was highly critical of Fannie Mae. The article notes that "a vigorous defense on Fannie’s part would require rebutting the agency’s own report. An acknowledgement of the report’s veracity could mean admitting wrongdoing and an even bigger payout."

The Journal article may well be correct that the government regulator’s role as Fannie Mae’s conservator potentially puts the regulator in an awkward litigation position. But in making this point, the article overlooks a number of important considerations about the lawsuit.

First and foremost, the recent lawsuit, unlike the prior Fannie Mae lawsuit, does not in fact name Fannie Mae itself as a defendant. The only defendants named are several present or former directors or officers of the company. Because the company itself is not a defendant, it will find it less awkward to stand by its report than the Journal article suggests.

Second, while the May 2006 report may be relevant, it is unlikely to be the centerpiece of the plaintiffs’ case, simply because the report was published nearly a year and a half before the start of the class period alleged in the plaintiffs’ complaint. The complaint purports to assert claims on behalf of persons who bought Fannie Mae shares between November 16, 2007 and September 5, 2008, and the alleged misrepresentations and omissions on which the complaint is based allegedly occurred during that period. The prior report is unlikely to play a role anywhere near as crucial as the Journal article suggests.

UPDATE: An observant reader has pointed out the possibiltiy that the Journal article is not referring to the newly filed Fannie Mae lawsuit, but rather is referring to a 2004 lawsuit involving Fannie Mae, in which Fannie Mae is in fact a defendant. Background regarding this prior lawsuit can be found here. On close reading, it appears possible that the Journal article was referring to this earlier lawsuit. To the extent the article was referring to the 2004 lawsuit not the most recenlty filed one, my two prior comments may be inapplicable. However, the following comment remains valid, regardless of which lawsuit the article was referring to. As an aside --  with a publication like the Journal, we really shouldn't have to wonder  which lawsuit an article is referring to.

Third, it remains to be seen what role if any the company or its governmental conservator will play in any eventual settlement. Fannie Mae likely has tens, if not hundreds, of millions of dollars of D&O insurance that at least potentially could respond to this lawsuit. (In making these observations, I emphasize that I have no firsthand knowledge of Fannie’s D&O insurance program.) To the extent the insurance does respond to this claim and to the extent that policy terms and conditions do not otherwise bar coverage, the insurance program, rather than the government itself, would likely fund potential settlements. The Journal article fails to address or even acknowledge this possibility, which potentially could be a critical settlement factor.

Notwithstanding these observations, there are legitimate concerns about the possible role of the government regulator in the pending litigation. The essential point of the Journal article – that the government has its own interests– is unquestionable true. Moreover, this concern about diverging governmental interests is true not only with respect to the conduct of litigation alone, but applies broadly to the general conduct of business in the various enterprises in which the government has taken a controlling or an ownership interest.

Government Ownership in Private Enterprise: In connection with the various entities and organizations that the government has nationalized in whole or in part in recent weeks, Treasury Secretary Henry Paulson has stated that the government’s role will be passive and apolitical. But, as James Grant, the author of Grant’s Interest Rate Observer, noted in an October 18, 2008 Wall Street Journal essay (here), "the record of the Depression-era Reconstruction Finance Corp. suggests that the government is a shareholder that can throw its weight around. Besides, would Mr. Paulson’s apolitical intentions bind his successor?"

Anyone doubting the complicating nature of the government as an owner in private enterprise should consider what has occurred at AIG since the government’s bailout and 79.9% ownership stake was first announced. The incredible scrutiny that AIG has faced regarding severance compensation and marketing expenses clearly demonstrates that the arrival of government control is by no means a friendly embrace.

Moreover, AIG’s recent agreement with New York AG Andrew Cuomo, as a result of which, among other things, AIG has "canceled 160 conferences and events" underscores the austere, constrained existence AIG must now sustain under the supervision of its government appointed caretaker/liquidator.

I am not defending AIG’s severance compensation payments. However, the problem with the more generalized austerity requirements is that they may be contrary to taxpayers’ larger interests. AIG’s ability to service its interest obligations (which now reportedly amount to $1 billion per month), sell off business units in an orderly way, and repay its debt obligation to the U.S. government is unlikely to be advanced by the prohibition on conferences and events. Politicians’ insistence that the company forbear from ordinary marketing activities will impede the company’s ability to conduct business and potentially could hinder the company’s ability to fulfill its bailout obligation. Unfortunately, grandstanding politicians appear to be a compulsory accessory of governmental ownership.

Other companies faced with the prospect of government ownership in exchange for a government bailout might consider the offer at least a mixed blessing, if not an actual poisoned chalice.

D&O Insurance: There Will Be Blood: Though the Journal article discussed above may have overlooked the significant potential litigation role of directors’ and officers’ liability insurance, others have not been so remiss. For example, the October 18, 2008 New York Times article entitled "Financial Crisis Provides Fertile Ground for Boom in Lawsuits" (here), expressly cites the availability of insurance as one reason why plaintiffs' lawyers may be interested in pursuing litigation related to the current credit crisis.

The article states that "even companies that have suffered huge losses may still be worth pursuing because of their liability insurance." The article also quotes Stanford Law Professor Joseph Grundfest as saying that "You can’t get blood from a stone. But you sure can get money from the insurance company that covered the stone."

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Most of the focus on Rule 10b5-1 plans lately has been on possible abuses (refer, for example here). Indeed, one of the reasons the court cited in the dismissal motion denial in the Countrywide derivative lawsuit pending in California was concern about Angelo Mozillo’s possible manipulation of his 10b5-1 plan (refer here). 

However, an October 16, 2008 Eighth Circuit opinion in Elam v. Neidorff (here) confirms that corporate officials’ proper use of Rule 10b5-1 plans can still afford a substantial securities lawsuit defense.

As discussed more fully here, on July 28, 2006, plaintiffs had initiated a securities class action lawsuit against Centene Corporation and certain of its directors and officers. On June 29, 2007, Judge Catherine D. Perry of the Eastern District of Missouri granted the defendants’ motion to dismiss, on the grounds that "plaintiffs have not met the heavy pleading standard required" by the PSLRA. Judge Perry’s opinion can be found here. The plaintiffs appealed.

The Eighth Circuit, in an opinion written by Judge Bobby E. Shepherd, affirmed the district court’s ruling on two grounds. First, the Court held that "the district court properly found that plaintiffs have not adequately pled that defendants’ … statements were false when made." Second, the Eight Circuit held that "the district court properly found that plaintiffs have not met the PSLRA’s standard for pleading scienter."

In ruling that the plaintiffs had not adequately pled scienter, the Eighth Circuit considered among other things, the fact that the individual defendants’ stock sales on which the plaintiffs sought to rely had been made pursuant to a Rule 10b5-1 trading plan.

The Court’s opinion stated (citations and internal quotations omitted):

Neidorff and Witty each sold a portion of their personal holdings of Centene stock in April 2006 pursuant to Rule 10b5-1 trading plans, in place since December 2005. The sales constituted 5.3 percent of Neidorff’s unrestricted holdings and 2.4 percent of Witty’s unrestricted holdings. Stock sales pursuant to Rule 10b5-1 trading plans can raise an inference that the sales were prescheduled and not suspicious. This is particularly true where, as here, the stock sales at issue represent only a small portion of each seller’s overall holdings. Accordingly, no inference of scienter arises from Neidorff’s and Witty’s April 2006 stock sales.

The Eighth Circuit’s opinion is a reminder that, notwithstanding the concerns that recently have been raised about possible Rule 10b5-1 plan abuses, proper trading plans can afford substantial protection and can permit company officials to trade in their shares in company stock without fear that the trades might later serve as the basis of liability under the federal securities laws.

As examples of trading plans that successfully averted any scienter inference, the Centene officials’ plans merit a closer look.

The Eighth Circuit stated that the individual defendants’ trading plans "lay out in advance the dates at which the trade will be made in advance and give control of the trades to a broker." The District Court’s dismissal opinion stated further that the plaints "provided for automatic sales on certain dates if the stock price was above $25." The only sales made under the plans, which were instituted in December 2005, were two in February and April 2006. "There were no later sales, not because defendants halted the program, but because the stock price never reached the $25 mark."

The critical aspects of the plan appear to have been, first, that the officials entered the plan in advance; second, that the plan specified the trading dates, but subject further to a specified trading price: three, that the trading on those dates, if the price criterion was met, was automatic; and fourth, that a broker controlled the trades. It does not seem to have mattered that the officials did not trade regularly under their plans, because of the minimum share price requirement.

It is probably important to note that the plan lacked many of the attributes that recently have drawn negative attention to these kinds of plans. That is, the Centene officials’ plans were not changed, nor were the plans stopped and started; and the individuals were not running multiple plans.

Amidst the negative publicity that recently has surrounded Rule 10b5-1 plans, the Eighth Circuit’s opinion is a useful reminder that Rule 10b5-1 plans can and should be a part of a coordinated securities litigation loss prevention program. A comprehensive (although now slightly dated)overview of securities litigation loss prevention in general can be found here.

The 10b-5 Daily blog has a post relating to the Eighth Circuit’s opinion here, as does the Securities Docket, here.

Not Exactly Lou Gehrig’s Farewell Speech, But Still Entertaining: If you have not yet seen the October 17, 2008 farewell letter from Andrew Lahde of Lahde Capital Management, you will want to refer here. Lahde, one of whose funds returned 870 percent last year by betting against subprime mortgages, decided to close down his funds and return money to investors after concluding that the danger of losing money from a bank collapse was too high.

Lahde claims that he wrote his farewell letter "not to gloat" -- but darned if his letter nevertheless doesn’t sound an awful lot like gloating (except for the part where he is advocating the legalization of marijuana). The letter is worth reading in full for its entertainment value, but among the highlights is the following single-finger salute to his now-former competitors and counterparties:

The low hanging fruit, i.e., idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.

Lahde also suggests the institution of a forum (perhaps to be funded by George Soros) to "create a new system of government that truly represents the common man’s interest, while at the same time creating rewards great enough to attract the best and the brightest minds to serve in government roles without having to rely on corruption to further their interests or lifestyles. The forum could be similar to the one used to create the operating system, Linux."

Wikigovernment. Cool.

Special thanks to Peter Schwartz of the Wired Mosaic blog (here) for bringing Lahde’s letter to my attention.

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When the various broker dealers and investment banks recently announced their agreements with government regulators to buy back auction rate securities, the announcements raised questions about the continuing need for the pending auction rate securities litigation. But, at least based on a recently filed lawsuit, it now appears that the settlements may have opened the door for a whole new round of securities litigation related to the settlements themselves.

On October 3, 2008, plaintiffs’ lawyers initiated a securities class action lawsuit in New York (New York County) Supreme Court on behalf of investors who purchased bonds and preferred securities in various offerings conducted pursuant to Merrill Lynch’s March 31, 2006 shelf registration. A copy of the complaint can be found here. The complaint, which asserts claims under Sections 11, 12 and 15 of the ’33 Act, names as defendants Merrill Lynch and related entities; certain current and former Merrill Lynch directors and officers; the underwriters that conducted the various offerings; and Merrill Lynch’s auditor.

The complaint alleges that the offering documents "misstated Merrill’s financial condition and failed to disclose that the Company bore massive exposure to losses from investments tied to subprime and other mortgages, and was responsible for significant liability arising from its participation in the market for auction rate securities (ARS). Further Merrill improperly valued mortgage-backed assets on its books, and failed to account for its contingent obligations in the ARS market."

The complaint alleges that as a result of later disclosures about the company’s "true financial condition," the value of the securities sold in the referenced offerings declined materially. The complaint specifically refers to, regarding the company’s true financial condition, Merrill Lynch’s August 7, 2008 announcement (here) that "it would repurchase $12 billion in ARS from investors due to the failure of the ARS market."

Merrill Lynch previously was the target of what I will call a "conventional" auction rate securities lawsuit. Background regarding this prior lawsuit can be found here and regarding the prior auction rate securities lawsuits generally can be found here.

This new Merrill Lynch lawsuit complaint differs from the prior conventional auction rate securities lawsuit in a variety of ways. The most important distinction is who is represented in the plaintiff class. The prior auction rate securities lawsuits were brought on behalf of auction rate securities investors – that is, the people who bought the actual auction rate securities. The plaintiffs in the Merrill Lynch lawsuit are not persons who bought auction rate securities, but who bought Merrill Lynch’s own securities in the referenced offerings.

The misrepresentations alleged are different as well. In the conventional auction rate securities lawsuits, the allegation is that the risks of the auction rate securities were insufficiently disclosed. In this new lawsuit, the allegation is not about the risks of auction rate securities themselves, but rather that Merrill Lynch did not disclose its own susceptibility to contingent liability in connection with its issuance or sale of the auction rate securities.

One other peculiarity of the prior auction rate securities lawsuits is that those suits generally did not name any individual defendants. The new Merrill Lynch complaint names a couple of dozen individual defendants, as well as several dozen offering underwriters.

Given the number and identities of the various defendants, this lawsuit will keep a lot of lawyers employed for a long time. Among the preliminary issues on which the lawyers will be engaged is the court’s subject matter jurisdiction. The plaintiffs elected to file their lawsuit in state court pursuant to the concurrent jurisdiction provisions in Section 22 of the ’33 Act. The defendants undoubtedly will seek to remove the lawsuit to federal court, and the plaintiffs in turn will seek to have the case remanded to state court.

As I noted in a prior post (here), the Ninth Circuit recently upheld the decision of the district court in the Luther v. Countrywide case to remand a ’33 Act case back to state court, where it originally had been filed before being removed to federal court. However, as the 10b-5 Daily blog recently noted (here), a judge in the Southern District of New York refused to remand New Jersey Carpenters Vacation Fund v. Harborview Mortgage Loan Trust, which had been removed to federal court. Among other things the court in the Harborview case held that the provisions of the Class Action Fairness Act trumped the jurisdictional provisions of the ’33 Act.

In view of the fact that the new Merrill Lynch case likely will be remanded to the Southern District of New York (the same court in which the Harborview case is pending), it will be interesting to see whether the plaintiffs are able to have the case remanded back to the New York state court where they initially filed the new Merrill Lynch complaint.

As I have previously noted, along with the question whether or not a ’33 Act case properly can be removed to federal court is the more practical question of why the plaintiffs want to proceed in state court in the first place. Some day someone will explain to me why the plaintiffs’ bar suddenly has developed this fascination with pursuing ’33 Act claims in state court. Is it, as I have supposed, an effort to circumvent the procedural requirements of the PSLRA?

In any event, I have added the new Merrill Lynch complaint to my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of the new lawsuit, the current tally now stands at 125, of which 85 have been filed in 2008. Of these, 21, including the new Merrill Lynch lawsuit, are auction rate securities lawsuits.

Motion to Dismiss Granted in Subprime Securities Lawsuit: On September 29, 2008, Judge John Steele of the Middle District of Florida granted the defendants’ motion to dismiss, without prejudice, in one of the more unusual subprime related securities lawsuits. A copy of the opinion can be found here.

As detailed here, the plaintiffs allege that the defendants (First Home Builders of Florida and two residential real estate brokerage firms, as well as successor entities), in violation of the federal securities laws, had fraudulently induced plaintiffs to purchase real estate investment properties by promising that defendants would procure lease-to-own tenants for the investors’ properties; that the tenants rental payments would cover all of the investors’ out-of-pocket costs; and that investors would receive a guaranteed 14% return on the investment in the first year.

Judge Steele granted the defendants’ motion to dismiss, ruling that as a result of the plaintiffs’ failure "to allege who made what misrepresentations," the plaintiffs’ fraud allegations failed to meet the pleading requirements of Rule 9(b). Judge Steele declined to rule on the plaintiffs’ group pleading theory. He allowed plaintiffs 30 days to file an amended complaint.

I have added the First Home Builders of Florida dismissal to my table of subprime and credit crisis-related lawsuit case dispositions, which can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) both for the Merrill Lynch complaint and for the opinion in the First Home Builders of Florida case.

Note from Ohio: I want to know how the Saturday Night Live scriptwriters managed to get the whole  "Joe the Plumber" schtick inserted into tonight's actual Presidential debate. But the one thing I do know is that after tonight's debate, my fellow Ohioan, Joe the Plumber, is moving to Canada, where he will be left in peace because their national election is already finished.

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In what is as far as I am aware the first class action settlement in the current wave of subprime-related securities lawsuits, on October 14, 2008, WSB Financial Group announced (here) that it had entered into a settlement agreement of the class action lawsuit pending against the company and certain of its directors and officers.

As detailed in greater length here, on October 30, 2007, plaintiffs’ lawyers’ had initiated a securities class action lawsuit in the Western District of Washington. A copy of the plaintiffs’ consolidated complaint can be found here.

WSB Financial Group is the parent company of Westsound Bank. The lawsuit alleged that the offering documents associated with the company’s December 21, 2006 IPO contained material misrepresentations or omissions. Among other things, the complaint alleges that the offering documents stated that the company “focused on originating and maintaining a high-quality loan portfolio and had rigid underwriting policiesdesigned to ensure the credit quality of the Company's portfolio. In reality, however, WSB Financial originated hundreds of high-risk loans in violation of the Company's stated policies for a total amount of at least $90 million.”

In its October 14 press release, the company stated that the parties had agreed to a settlement of $4.85 million. The press release also states that the company’s D&O insurance policy would contribute $4.45 million toward the settlement and had previously contributed approximately $350,000 toward the cost of the settlement. The proposed settlement is subject to court approval.

As a relatively small settlement of one of the smaller, lower profile cases in the current litigation wave, this settlement is likely to have relatively little direct influence on other pending cases. The significance of this settlement may simply be that it has happened at all. With so many of the subprime and credit crisis-related cases only in their earliest stages, the likelihood of settlements emerging seemed like a distant prospect. It may yet be a considerable time before the higher profile cases move toward the settlement stage, even assuming they survive preliminary motions. This settlement suggests that at least some cases will move more quickly toward resolution.

Nevertheless, anyone who thinks that the current litigation morass might quickly be cleaned up may need to curb their enthusiasm. An October 13, 2008 Law.com article entitled “New Wave of Class Actions Filed in Wake of Subprime Collapse” (here) quotes a plaintiffs’ securities class action attorney as saying that he anticipates that subprime litigation “will keep us busy for seven or eight years.”

In any event, I have added the WSB settlement to my table of subprime and credit-crisis related case dispositions, which can be accessed here.

A Different Approach: In our country, the most important issue in any crisis is figuring out who to blame. Refined distinctions are not a necessary part of this blame assignment process, and blame can be assigned indiscriminately. (If you doubt this assertion, please refer to the public statements of any U.S. politician during the current financial turmoil.) Our transatlantic cousins apparently take a different approach, which I must say has much to recommend it.

According to an October 14, 2008 Law.com article (here), the nationalized British lender Northern Rock has announced that it will not bring legal action against its former directors and officers, after having concluded that "there are insufficient grounds to proceed with a negligence action against the ex-directors." The article also reports that "the bank's auditors are off the hook."

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When, as has been the case recently, there is a single predominant story, there also is a danger that other important developments may be overlooked. The subprime and credit crisis meltdown and related litigation has been so preoccupying that almost nothing else has broken through the noise.

However, a recent casual observation made me go back and take a closer look at latest securities class action lawsuit filings. I was surprised to observe that, at least by one measure, a majority of recent filings are unrelated to the credit crisis.

What initially caught my eye was the recent flurry of litigation filing activity involving life sciences companies. Just since September 23, 2008, four life sciences companies have been sued in securities class action lawsuits:

1. Spectranetics: On September 23, 2008, plaintiffs’ lawyers initiated a securities class action lawsuit in the District of Colorado against Spectranetics, a medical device manufacturer, and certain of its directors and officers. As reflected more fully here, shareholders filed the suit after the company’s stock price declined following publicity relating to the company’s alleged involvement in customs’ law violations.

2. Medicis Pharmaceuticals: On October 3, 2008, plaintiffs’ lawyers filed a securities class action lawsuit in the District of Arizona against Medicis Pharmaceuticals, a specialty pharmaceutical company, and certain of its directors and officers. As described here, the lawsuit followed the company’s announcement that it would be restating its annual and quarterly financial statements for the period 2003 through 2007, due to the company’s sales return reserve calculation.

3. Biovail: On October 8, 2008, plaintiffs’ lawyers announced that they had filed a securities class action lawsuit against Biovail, a specialty pharmaceutical company, and certain of its directors and officers, following disclosures of issues involving one of the company’s developmental stage drugs. The plaintiffs’ lawyers’ October 8 press release can be found here.

4. Elan Corp.:  On October 14, 2008, plaintiffs' lawyers initiated a securities class action lawsuit in the Southern District of New York against Irish biopharmaceutical company Elan Corp. and certain of its directors and officers alleging that the company failed to disclose unfavorable results in Phase II clinical trials of a compount the company is developing to be used to treat patients suffering from Alzheimer's disease. A copy of the plaintiffs' lawyers' October 14 press release can be found here.

Obviously, none of these lawsuits has anything directly to do with the turmoil in the financial markets that has been dominating the headlines. Nor are these cases the only securities lawsuits filed in recent weeks that are unrelated to the financial meltdown.

A review of the securities lawsuit filings during September 2008 reveals that a majority – 14 out of 24 – of the September filings were not directly related to the credit crisis. Moreover, the case filings spread across a wide variety of kinds of companies, including children’s apparel (Carter’s, about which refer here), gas exploration and development companies (Quest, refer here) and computer graphics, (NVDIA, refer here).

There was a flurry of activity in September involving companies in the wireless industry. The September filings included lawsuits against wireless broadband companies NextWave Wireless (refer here) and Novatel Wireless (refer here), and a wireless network management software company, Harris Stratex (refer here).

But whether or not there is any significance to this flurry of lawsuits involving companies in the wireless industry, or to the flurry of lawsuits noted above involving life sciences companies, the most noteworthy point is that these lawsuits are not related to the credit crisis, and that many of the other recent filings similarly are unrelated to the credit crisis.

There is no doubt that the most significant factor in the overall increase in securities litigation activity in recent months has been the subprime and credit crisis related litigation. But merely because this litigation has been the most important factor does not mean that it is the only factor. There has been a significant amount of securities litigation activity unrelated to the subprime meltdown and the credit crisis. Focusing exclusively on the credit crisis-related litigation could result in overlooking the other important securities lawsuit filing developments.

Although the plaintiffs’ lawyers have been quick to pursue claims from the credit crisis, they have not done so to the exclusion of all other activities. Indeed, the plaintiffs’ bar continues to pursue other kinds of claims, and so merely because a company has not been directly affected by the credit crisis does not by itself mean that the company is free from securities litigation exposure in the current environment.

A Note About Lawsuit Counts: There are two cases that complicate how the September 2008 filings are categorized. As I have previously noted (here and here), the lawsuit filings involving The Reserve Group and Constellation Energy do not directly arise out of the subprime meltdown or credit crisis. However, as explained more fully in my prior posts, these cases arguably represent a "second derivative" of the credit crisis.

At the same time, it should be noted that the Stanford Law School Securities Class Action Clearinghouse, employing a strict definition, did not categorize these two cases as subprime related. I have noted on this blog in the past the difficulties involved with "counting" these lawsuits as the subprime litigation wave has evolved. But, in any event, the statement above that the majority of September securities lawsuit filings were not related to the credit crisis, uses the Stanford website’s categorization, which I suspect also reflects a more common understanding.

A Final Note: The essential thrust of this blog post depends on the assumption that the distinction between cases that are and are not credit crisis-related is readily apparent. However, as the credit crisis becomes more generalized and if there is a significant downturn in the larger economy, there may be an eventual convergence of the two categories, as all companies become subject to the general downturn.

If the entire economy is suffering the effects of the unavailability of credit, the litigation that follows may no longer be susceptible to the categorization I have been trying to maintain. The possibility of this development is one more reason to maintain a broader perspective across all of the ongoing litigation activity.

Déjà vu All Over Again: Biovail, a Canadian corporation, is no stranger to U.S.-style securities class action litigation. As reflected here, the company was the target of a 2003 securities class action lawsuit that ultimately settled for $138 million. The settlement was just finalized on August 8, 2008, exactly three months before the filing of the most recent securities lawsuit against the company. (UPDATE: As a result of the reader comment, I relaize the prior sentence should say that the new lawsuit was exactly TWO months to the day from the finalization of the prior dismissal. I stand corrected!)

Similarly, Elan, a company domiciled in Ireland, has been the target of two previous securities class action lawsuits, refer here and here.

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After the close of business on Friday, October 10, 2008, the FDIC announced (here and here) that state regulators had closed two banks, Meridian Bank of Eldred, Illinois, and Main Street Bank of Northville, Michigan. The closure of these two banks brings the 2008 total number of bank closures to 15.

By way of comparison, there were only three bank closured during all of 2007. Indeed, there were none at all between June 25, 2004 and February 2, 2007. (An FDIC table showing all bank closures since 2000 can be found here.) According to an October 11, 2008 Bloomberg article (here), the 15 bank closures during 2008 already represents the highest annual total since 1993, which of course was the tail end of the last era of failed banks.

Nor is this current wave of bank failures over. Conditions in the housing market continue to deteriorate, and job losses associated with the anticipated recession could only accelerate this process. A slumping economy will challenge borrowers across all lines of credit. This June 30, 2008 FDIC chart (here) graphically illustrates the dramatic growth in troubled loans over recent periods, and both trendlines and headlines suggest that this will only continue.

Moreover, the balance sheets of many banks are already under pressure because of the banks’ extensive holdings in securities of Fannie Mae and Freddie Mac, and, to a lesser extent, Washington Mutual, AIG, and Lehman Brothers. Banks dependent on short term interbank loans may also be experiencing liquidity issues as a result of the current disruption in the credit markets.

As of the end of the second quarter 2008, the FDIC listed (refer here) 117 banks on its "Problem List," which represents a 30 percent jump since the end of the first quarter. The "Problem List" numbers through the end of the third quarter are not yet available, but significant further deterioration seem probable given third quarter events, and developments already in the first two weeks of the fourth quarter certainly have not helped.

UPDATE: Consistent the hyperspeed circumstances that have come to characterize recent events, the announcement this evening after the close of the market that the U.S. will buy stakes in the Nation's largest banks (refer to WSJ article here), along with related disclosures, potentially impacts the foregoing analysis as well as much that follows. In particular, the Journal is reporting that "one central plank of these new efforts is a plan for the Treasury to take approximately $250 billion in equity stakes in potentially thousands of banks." This obviously could impact the issue whether or not or to what extent other banks will fail. As these details are only now emerging (after I wrote this entire blog post, wouldn't you know it), and as it will take some time before the details become clear, much less that the government acts, the discussion in this post may remain relevant. How relevant remains to be seen, depending on the specifics of the government's plan and its implementation.

A significant part of the last era of failed banks was the appearance of a flotilla of lawsuits, in which investors and regulators sought to assign blame and recover losses. There already has been extensive litigation filed in connection with the two most prominent bank failures of 2008, IndyMac (refer here and here) and Washington Mutual (refer here).

The follow-on failed bank litigation has started to emerge in connection even with the lower profile failures, as illustrated by the recent lawsuit filed in connection with the failure of Integrity Bank of Alphretta, Ga.

State banking regulators closed Integrity on August 29, 2008, and the FDIC was appointed as its receiver (about which refer here). The bank’s deposit liabilities and some of its assets were sold to Regions Financial Corp. Prior to a March 2008 delisting, shares of Integrity’s holding company, Integrity Bancshares, traded on Nasdaq.

On September 12, 2008, Integrity shareholders filed a purported class action in Georgia (Fulton County) Superior Court against the holding company and four Integrity officers. On October 7, 2008, the defendants removed the case to the Northern District of Georgia. A copy of the removal petition, to which the state court complaint is attached, can be found here.

The plaintiffs’ complaint alleges that the defendants misled investors about the bank holding company’s health during 2006 and 2007, as a result of which the plaintiffs allege violation of state securities laws, common law fraud, and negligent misrepresentation. The complaint specifically alleges that the defendants understated or failed to disclose "the nature and degree of risk associated with the following conditions":

(i) a loan portfolio comprised almost entirely on real estate acquisition, development and construction, which risk was further by an unreasonable concentration of such toasts its borrower relationship (the "Related Loans"), (ii) a loan portfolio principally collateralized by real estate, (iii) operating with a Board of Directors that failed to provide adequate supervision over and direction to Bank management (iv) operating with inadequate management not sufficiently experienced in or Knowledgeable of good lending practices, (v) operating with inadequate equity capital and reserves in relation to the volume and quality of assets held by the operating with a large volume of poor quality loans, (vii) operating with inadequate allowance for loan and lease basses, (viii) operating with hazardous loan and administration practices, (ix) banking regulations concerning safe lending practices, (x) the potential for cross-defaults with respect to some or all of the Related Loans, (xi) potential difficulty in and realizing on loan collateral in market conditions, (xii) the potential and severity of losses from deteriorating market affecting borrowers, and (xiii) the adverse affect of losses from such loan defaults on the Bank’s liquidity, capital resources and operations.

The Integrity lawsuit is not the only complaint to be filed in connection with the current wave of bank failures. In addition to the Washington Mutual and IndyMac lawsuits cited above, investors also filed a securities class action lawsuit in connection with the failure of NetBank, about which refer here. The FDIC’s press release about the September 28, 2007 closure of NetBank, which coincidentally was also based in Alphretta, Georgia, can be found here.

The failure of additional banks, while not inevitable, seems more likely than not. (I doubt there are many informed observers now who would assert that there will be no further bank failures.) To the extent more banks fail, there undoubtedly will also be further related litigation. And to the extent the pace of bank closures quickens, which certainly is within the range of possibilities, there could be a surge of "dead bank" litigation comparable to the flood of lawsuits that kept so many lawyers employed during the late 80s and early 90s (including, it should be noted, your humble correspondent).

If the earlier era is any guide, the lawsuits that may arise will include not just investor lawsuits like the one involving Integrity, but also actions by regulators as well. And again, if the earlier era is any guide, the defendants will include not only the financial institutions’ directors and officers, but also the financial institutions’ outside professionals, particularly the auditors and attorneys.

During the competitive D&O insurance marketplace conditions that have prevailed in recent years, many financial institutions were able to procure D&O insurance policies without a so-called regulatory exclusion (for further background about which refer here). It may be that in light of current conditions in the banking industry, the regulatory exclusion could be poised for a comeback.

In any event, community banks and other small to medium-sized banks, which have enjoyed a competitive D&O insurance marketplace for several years may now face rapidly changing and less advantageous conditions. Certainly, the D&O insurance underwriters will undoubtedly approach these kinds of accounts with a great deal more caution than in recent years.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Integrity removal petition.

That Goes for Subordinated Investors Too:  In a prior post, here, I suggested that the dramatic failure of several prominent companies was drawing preferred shareholders into securities class action litigation. It appears that these events may be having the same effect on investors in subordinated securities as well.

According to the plaintiffs’ October 10, 2008 press release (here), a purported class action lawsuit has been filed in the Southern District of New York on behalf of person who purchased securities in the December 11, 2007 offering of 7.70% Series A5 Junior Subordinated Debentures of AIG, against certain AIG directors and officers, as well as the offering underwriters. The complaint alleges that the offering documents did not accurately represent AIG’s financial condition, and in particular misrepresented the company’s exposure to loss associated with credit default swaps.

As I noted in my earlier post, the massive investment losses associated with the collapse of these prominent financial companies is drawing many new classes of litigants who previously would not have become involved in securities litigation.

Run the Numbers: With the addition of the Integrity and the AIG subordinated debenture lawsuits, my current tally of the subprime and credit crisis-related securities lawsuits now stands at 124, of which 84 have been filed in 2008. The lawsuit tally can be accessed here.

When They Are Done in Reykjavik, Would They Be Willing to Come to Wall Street?: An October 13, 2008 Financial Times article entitled "Icelandic Women to Clean Up 'Male Mess'" (here) reports that two women, Elín Sigfúsdóttir and Birna Einarsdóttir, are set to become chief executives of two nationalized banks the Icelandic government created in the wake of the recent banking crisis. A government official quoted in the ariticle said that these appointments were "an attempt to signal a new culture within the banking system"

The article quotes a banker who blames the Icelandic banking system's collapse on "young and predominately male bankers" whose "eyes were bigger than their stomachs." A government official is quoted as saying that "now the women are taking over. It's typical, the men make the mess and the women come in to clean it up."

Meanwhile, Iceland may run out of food, or at least imported food. Bloomberg reports (here) that due to the unwillingness of banks outside the country to trade in Iceland's currency, the krona, the country's foreign trade has come to a standstill. As a result, the country's food shelves are being stripped bare, and they may not soon be replenished.

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On October 7, 2008, in a decision that could affect other litigation relation to Countrywide Financial, Judge Sue Robinson dismissed the consolidated shareholders’ derivative lawsuit pending in Delaware federal court against the company, as nominal defendants, and ten of its former directors and officers. A copy of the October 7 opinion can be found here.

The plaintiffs in the Delaware federal court derivative lawsuit had alleged that the individual defendants had violated the federal securities laws’ disclosure requirements, and also had committed state law violations of breach of contract and breach of fiduciary duty. As Judge Robinson noted in her October 7 opinion, the plaintiffs’ "most serious allegation" was that the defendants caused Countrywide to repurchase $2.37 billion worth of the company’s common stock "concomitant to the sale of $373 million worth of shares personally owned by members of the Board who were in possession of non-public, materially adverse information."

The defendants had moved to dismiss the amended complaint based, among other things, on the plaintiffs’ failure to make demand on the Board prior to the filing of the lawsuit.

However, on January 11, 2008, Countrywide and Bank of America announced that Bank of America was acquiring Countrywide in a stock for stock transaction. Bank of American’s press release announcing the merger can be found here. On July 1, 2008, the merger closed and all outstanding shares of Countrywide were exchanged for Bank of America shares. Banks of America’s July 1, 2008 press release can be found here. Countrywide became a wholly owned subsidiary of Bank of America.

Defendants thereafter filed a further motion to dismiss, arguing that as a result of the merger, the plaintiffs were no longer Countrywide shareholders and therefore lacked standing to pursue the derivative lawsuit.

Judge Robinson granted the defendants’ motion, stating that "the Delaware Supreme Court has unequivocally declared that plaintiffs in derivative suits lose standing post-merger."

Notwithstanding several creative arguments plaintiffs raised trying to avert this outcome, Judge Robinson’s decision is unremarkable given Delaware law on the issue. The more interesting question is the impact Judge Robinson’s ruling may have on the other pending Countrywide litigation.

The most immediate impact may be on the Countrywide derivative lawsuit pending before Judge Mariana Pfaelzer in the Central District of California. Readers may recall that on May 14, 2008, Judge Pfaelzer issued a blistering opinion in that case largely denying the defendants’ motion to dismiss and granting plaintiffs leave to file an amended complaint regarding the few portions of the case that were dismissed. My prior post discussing Judge Pfaelzer’s opinion can be found here.

Among other thing, Judge Pfaelzer said in her May 14 opinion that plaintiffs’ allegations in that case create a "cogent and compelling inference that the individual defendants misled the public with regard to the rigor of Countrywide’s loan origination process, the quality of its loans, and the Company’s financial situation – even as they realized that Countrywide had virtually abandoned its own loan underwriting process."

The defendants in the California derivative litigation have now moved for judgment on the pleadings based on the same lack of standing argument that the defendants in the Delaware lawsuit had raised. Indeed, the parties in the California derivative litigation have already filed competing pleadings (here) with respect to the dismissal of the Delaware action. In view of the nature and tone of Judge Pfaelzer’s May 14 opinion in the case, it will be interesting to see whether she follows Judge Robinson’s ruling on post-merger lack of standing.

An even more interesting question is what effect, if any, these developments will have on the consolidated Countrywide subprime securities litigation, which is also pending before Judge Pfaelzer (and about which refer here). The Bank of America acquisition of Countrywide should have no impact on the standing of the securities class action plaintiffs. However, outcome of the dismissal motions in the California derivative litigation potentially could affect the context within which Judge Pfaelzer considers the motions to dismiss in the securities litigation, especially given the strong views Judge Pfaelzer previously expressed in her prior derivative lawsuit dismissal denial.

Oral argument on the pending securities litigation dismissal motions is upcoming.

Very special thanks to a loyal reader for providing copies of Judge Robinson’s October 7 opinion and related pleadings.

You Could Put ‘em on a List: I have added the Countrywide Delaware Derivative lawsuit dismissal to my table of subprime and credit crisis-related securities and derivative lawsuit case dispositions, which can be accessed here.

A Sign of the Times: In connection with a school assignment, my son conducted a census of Obama and McCain lawn signs in our community. He found that the sign that appeared on the highest number of front lawns said "For Sale." 

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The full consequences of the dramatic recent events in the financial markets may take years to emerge, but one direct effect has already appeared – the collapse of several large financial institutions has turned preferred shareholders into securities class action plaintiffs.

Historically, securities class action lawsuits have been pursued on behalf of common shareholders, and to a lesser extent, the holders of public debt securities. Preferred shareholders only infrequently became involved in this type of litigation, for several interrelated reasons.

In the United States, the issuance of preferred shares largely has been limited to REITs, financial institutions and utilities (as noted here). Investment in these types of securities generally is limited to institutional investors. Moreover, the offering of these kinds of securities is even further limited as a practical matter to companies regarded as likely to fulfill their preferred dividend commitments (although less financial stable companies can still attempt a preferred stock offering by including a higher dividend rate).

Companies issuing these securities, therefore, are typically financially stable companies in industries with historically lower securities class action frequency levels. Moreover, institutional investors, who typically buy preferred securities, were, at least until the last several years, less likely to become involved in this kind of litigation. (To be sure, these generalities are not invariable, and there are certainly prior examples of securities litigation involving preferred shareholders.)

The remarkable recent failure of several of the most prominent financial institutions apparently has changed all that, and within the space of a few short weeks, there has been a sudden influx of securities class action lawsuits filed on behalf of failed financial institutions’ preferred shareholders.

Here are the four specific cases to which I am referring:

1. Fannie Mae Preferred Stock, Series T: The first of these recent lawsuits was filed on September 17, 2008 in the Southern District of New York on behalf of purchasers of Federal National Mortgage Association’s ("Fannie Mae") May 13, 2008 offering of 8.25% Non-Cumulative Preferred Stock, Series T. The complaint names as defendants the five offering underwriters and four directors and officers of Fannie Mae. Background regarding this case can be found here.

2. Freddie Mac Preferred Stock, Series Z: On September 23, 2008, plaintiffs’ counsel filed a securities class action lawsuit in the Southern District of New York on behalf of purchasers of Federal Home Loan Mortgage Corporation’s ("Freddie Mac") November 29, 2007 offering of 8.375% Non-Cumulative Perpetual Preferred Stock, Series Z. The complaint names as defendants only the three offering underwriters. For background, refer here.

3. Lehman Brothers Preferred Series J Stock: On September 24, 2008, plaintiffs’ counsel initiated a securities class action lawsuit in the Southern District of New York on behalf of purchasers of Lehman Brothers’ February 5, 2008 offering of Preferred Series J Stock. The complaint names as defendants certain Lehman Brothers directors and officers and the offering underwriters. For background, refer here.

4. Fannie Mae Preferred Stock, Series S: On October 8, 2008, plaintiffs’ counsel filed a securities class action lawsuit in the Southern District of New York on behalf of investors who between December 14, 2007 and September 5, 2008 purchased Fannie Mae’s 8.25% Fixed-to-Floating Rae Non-Cumulative Preferred Stock, Series S. The complaint names as defendants several former Fannie Mae directors and officers as well as the offering underwriters. For background, refer here.

These four lawsuits have several things in common, in addition to the fact that each plaintiff represents a class of preferred shareholders. All of these lawsuits involved companies that failed shortly before the lawsuits were filed. They were all filed in the Southern District. All of the lawsuits assert claims under the ’33 Act (the fourth of the lawsuits also asserts claims under the ’34 Act).

Another common thread of these lawsuits is that they all involve companies that already had been hit with one or more securities lawsuits filed on behalf of common shareholders. The existence of a separate plaintiff class at least potentially represents an opportunity for a different plaintiffs’ firm that may be shut out of the earlier class lawsuit to participate in the litigation assault on the affiliated persons left standing following the companies’ collapse. The existence of the separate class potentially represents a bite at the apple for these plaintiffs’ firms.

In earlier posts (here and here), I suggested that the volcano of events in the financial markets that began in September 2008 potentially could represent an "inflection point" in the ongoing subprime and credit crisis-related litigation wave. I suggested that as a result of these events a new group of defendants potentially could be drawn into the litigation wave. The four cases described above further suggest that a whole new group of litigants also could become involved as plaintiffs, starting with the emergence of preferred shareholders and other investor classes as class action litigants. The sheer magnitude of the losses sweeping through the marketplace undoubtedly will draw out these new classes of claimants, as these aggrieved parties seek to shift their losses "upstream" (a process I discussed here).

In the interests of accuracy, I should acknowledge that preferred shareholders class actions are not unknown. Indeed, just a few months ago, in June 2008, investors in Fremont General Corporation’s 9% Trust Originated Preferred Securities filed a securities class action lawsuit in the Central District of California (about which refer here). One might argue that this earlier case merely represents the advance guard for the squadron of lawsuits that came later.

While there may have been prior preferred shareholder lawsuits, the filing of four preferred shareholder class actions lawsuits in quick succession as a direct result of the collapse of several larger financial institutions represents a separately identifiable and categorically distinct phenomenon. It also undeniably represents a direct consequence of the unprecedented turmoil in the financial markets that began in September 2008.

The massive investment losses triggered by these September (and following) events are distributed across a wide variety of types and classes of investors, representing individuals and institutions, as well as holders of many types of debt and equity in many different forms and classes. Some of these aggrieved persons will seek to recover their losses in court. Further company failures (a distinct possibility) will only amplify these trends. All of which reinforces the view that one of the consequences of the enormous events of the past several weeks is a litigation wave "inflection point."

Run the Numbers: With the addition of the most recently filed lawsuits, my running tally of subprime and credit-crisis related securities class action lawsuits (which can be accessed here) now stands at 122, of which 82 have been filed in 2008.

In addition, I have added to my list of subprime and credit crisis-related derivative lawsuits (which can be accessed here), the shareholders’ derivative lawsuit filed on October 7, 2008 against Perini Corp., as nominal defendant, and several of its directors and officers. A copy of the Perini derivative complaint can be found here. (Hat tip to Courthouse News for the Perini derivative complaint.) I previously wrote here about the securities class action lawsuit that was filed earlier against Perini.

With the addition of the Perini complaint, my current tally of subprime and credit crisis-related derivate lawsuits now stands at 25.

One thing that has happened as the credit crisis has grown, spread and become a more generalized financial crisis. That is, it has become increasingly more difficult to proceed with definitional certainty about exactly what I am "counting." As the economic downturn affects more and more companies in an ever broader variety of ways, and as the general conditions become increasingly remote from the subprime-related causes, the related lawsuits are becoming less and less categorically distinct. At some point, the distinctions may no longer exist, and the counting exercise will have to be redesigned or even cease all together.

Who could have anticipated where all of this would lead when the subprime litigation wave first started to emerge back in February 2007?

Are State Court ’33 Act Cases Removeable to Federal Court?: In prior posts (most recently here), I have discussed the fact that plaintiffs’ attorneys’ have been filing subprime related ’33 Act cases in state court, in reliance on the ’33 Act’s concurrent jurisdiction provisions.

Lyle Roberts notes on his 10b-5 Daily blog (here), that on September 24, 2008, the Southern District of New York refused to remand the Harborview Mortgage case (which I previously discussed here) back to state court. Roberts does note that this holding is contrary to the Ninth Circuit’s decision in Luther v Countrywide earlier this year. I discuss the Luther case here.

With this split in the decisions there is now fertile ground for further jurisdictional wrangling. Even less clear is the reason why plaintiffs are so intent on pursuing a federal securities lawsuit in state court in the first place.

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When asked at the October 7, 2008 presidential debate whom he would appoint as his Treasury Secretary, John McCain commented that "it’s going to have to be someone that inspires trust and confidence." The first specific name McCain mentioned was that of Warren Buffett, someone, as McCain noted, that has "already weighed in and helped stabilize some of the difficulties in the markets."

In some ways, it is no surprise that McCain mentioned Buffett (notwithstanding the fact that Buffett has – as McCain duly noted – publicly supported Barrack Obama), given Buffett’s prominence and reputation. And in view of Buffett’s wealth and well-known business approach, it is unsurprising that once again Buffett is in the position to offer financial aid to troubled companies.

But while Buffett’s mention as a potential Treasury Secretary in a time of turmoil might now be unsurprising, it is worth reflecting that there is nothing about the way Buffett achieved his wealth, prominence or reputation that was inevitable. The remarkable story of how Buffett achieved this level of respect while he accumulated his vast fortune is compellingly told in Alice Schroeder’s splendid new biography, The Snowball: Warren Buffett and the Business of Life.

While numerous prior authors have attempted to detail Buffett’s life, none had the benefit of direct access to Buffett himself, as well as to his blessing to contact his family and friends, as Schroeder did. In addition, because Schroeder spent five years between 2003 and 2008 gathering material and writing her book, she wound up as a percipient witness to many of the critical events of the most recent years of Buffett’s life.

What emerges is more literary than a mere business biography. Indeed, prospective readers should probably be forewarned that this book is not devoted to the minute exploration of Buffett’s investment philosophy or his approach to investment decisions. Readers particularly interested in that aspect of Buffett’s story would do better to read Roger Lowenstein’s excellent 1995 Buffet biography, entitled Buffett: The Making of an American Capitalist.

Readers who want to understand the development and character of a man who has come to embody trust and integrity at a time when those qualities are sorely lacking (particularly in the financial marketplace) will find Schroeder’s book absorbing and instructive. The power of the book is its deep appreciation of the sweep of Buffett’s life, the role of so many of the key people he befriended along the way, and its respect for the way that events and experiences shaped and changed him.

For Buffett devotees such as myself (full disclosure: I own Berkshire Hathaway B shares, although not nearly as many as I wish I did), the book is full of rich anecdote and fascinating detail even with respect to events well told before. For example, the details of Buffett’s childhood have been well-chronicled, but no prior account of his life so thoroughly explores the significance of Buffett’s relationship with his parents, particularly his respect for his stock broker and congressman father and his fear of his tempestuous, unstable mother.

As a result of Schroeder’s access, her book also discloses numerous interesting details about Buffett’s early life, such as the fact that the current paragon shoplifted extensively from the Sears near his parents’ home while his father sat in Congress.

In an incident full of significance given recent events, Buffett, while a ten-year old on a visit to New York with his father, visited the offices of Goldman Sachs. Who could have foreseen the role he would come to play a half century later at a critical moment in the firm’s existence?

And the counterparty on Buffett’s first transaction while a brand new trader at Graham-Newman investment bank -- a complex arbitrage deal involving cocoa beans and cocoa bean futures -- was a shrewd investor named Jay Pritzker, whose family business, Marmon Corporation, Buffett would agree to buy in a multi-billion dollar transaction in late 2007 (refer here).

But even more significant than these details is the overarching theme that defines the book. This book is not so much about the way Buffett accumulated wealth as it is the way he accumulated friends and knowledge and insight. The friends enriched his life and contributed each in their own way to Buffett’s remarkable personal story. The roles that Ben Graham and Charlie Munger played have been noted elsewhere but the inside account of how Munger and Buffett met, became friends and began investing together is fully explored in this book. Schroeder’s access allowed her to describe how Buffett met and became friends with Bill Gates, and even more significantly the intellectual and philanthropic interests they share.

Schroeder’s emphasis on Buffett’s relationships, combined with her unfettered access and her obvious preoccupation with the topic, leads her to explore Buffett’s complex relationships with the women in his life. The book makes it clear that Buffett might well not have become who he is without the influence in his early adulthood of his late wife, Susie.

The book also explores Buffett’s relationships with other women, including his long-time friend Astrid Menks, with whom he lived for nearly 30 years while still married to Susie, and whom he married after Susie’s death; Kay Graham, the publisher of the Washington Post, with whom he had something more than a mere business partnership; and Sharon Osberg, his bridge partner and frequent companion. Undoubtedly due to her privileged status as authorized biographer, Schroeder is very elusive about the exact nature of Buffett’s relationship with these women, as well as Susie’s relationship with her long time friend and tennis coach (to whom Susie left $8 million in a secret and surprising codicil to her will).

Schroeder’s exploration of Buffett’s emotional life is perhaps at its most perceptive pitch in her analysis of the events surrounding the near collapse of Solomon Brothers in 1991. In the usual retelling of the tale, Buffett is portrayed as the gallant knight riding to the rescue, saving the company by the sheer strength of his integrity. Schroeder makes it clear that these events were for Buffett horrible and extremely challenging.

Buffett also found these events distressing, but not because he could have lost an enormous amount of money if the company failed. Rather, the events at Solomon filled him with dread and anxiety because the events could have cost him something even more precious – his reputation. In a particularly noteworthy detail about the episode, and one that says a great deal both about Buffett and about the culture of Wall Street, the book recounts that the senior managers at Solomon, whose jobs Buffett saved, sneered that "all he cares about is his reputation."

Notwithstanding her privileged access, Schroeder does not by any means avoid identifying Buffett’s shortcomings. Indeed, he comes across in many ways as a stunted person, someone whose world view is so limited that no matter how important the occasion or the requirements of decorum, he cannot bring himself to eat anything but a hamburger and French fries. His perspective is so narrow that he never noticed that the walls of the guest bedroom at Kay Graham’s house, where he stayed many times, were lined with original Picassos. He also comes off as almost childlike in his extremely squeamish inability to tolerate any discussion of someone’s medical issues or other topics he found uncomfortable.

Buffett was forced to confront many of these issues during Susie’s final illness and death. Because Schroeder was present during many of the events surrounding Susie’s death, her description of these events take on a particularly novelistic quality. Her recounting of the events is interwoven with Buffett’s own description to Schroeder of his thoughts and reactions, feelings and emotions. The depiction of Susie’s death is moving and serves as a reminder that even great wealth is no protection against the most basic of human susceptibilities. Although we are reading about these events because of who Buffett is, it is their universal character that gives the description its power and depth.

It is through the characteristics such as this that the book gains its ultimate insight, which is that Buffett was not born as "Buffett" nor did he one day simply become "Buffett." Rather, Buffett has become who he is as his life has evolved, and he has been becoming Buffett and has continued to become Buffett all along the way. Consistent with the book’s metaphorical title, Buffett has accumulated many things, not just wealth, but friends, and even wisdom and insight.

While she admittedly had a worthy subject to begin with, Schroder has managed to do something remarkable. She has managed to take the story of one man’s accrual of enormous wealth, a feat that might seem base or even vulgar, and turned it into a tale worth pondering. Schroder’s book succeeds because she understands that what makes Buffett fundamentally interesting is not the mere fact of his wealth alone, but how he conducted himself both while he became wealthy and even after (perhaps especially after) his fortune was assured.

That said, this is not a perfect book. For one thing, at 838 pages (not counting endnotes and the index), it is way too long, arguably by as much as one third. By way of illustration, someone should have stopped Schroeder from reporting that Astrid had a pedicure at Canyon Ranch while Susie was recovering from surgery. And the book would have been improved without such details as the lengthy description of Susie’s visit to Bono’s Mediterranean villa. There are many other unnecessary details of the same kind.

I also think it is a flaw, and a surprising one too, that Schroeder does not fully discuss the history of Buffett’s investment in General Reinsurance Corporation. (Full disclosure: for several years, I was employed by a Gen Re subsidiary). Give Schroeder’s background as a PaineWebber securities analyst for the insurance industry, I expected her to have much more to say about the Gen Re transaction and the way it turned out, especially in light of the fact that it was and still is Buffett’s largest acquisition ever. In the book’s "Afterword" Schroeder explains that because of certain continuing legal issues involving Berkshire, and the possibility that she might be a witness, she does not feel entirely free to comment. But while this explanation makes the paucity of discussion of Gen Re understandable, the limited treatment of the topic does diminish the book.

Notwithstanding its flaws, I still enthusiastically recommend the book. The timing of the book’s arrival, coincident with all of the astonishing recent events in the financial markets, dramatically underscores the wisdom of so many of Buffett’s recurring messages. He may or may not be the right choice to be Treasury Secretary, but if his health lasts, he undoubtedly will play a significant role in many of the events to come as the financial crisis continues to unfold.

Regardless of how events play out, Buffett’s humor, wisdom and insight will provide useful guidance for years to come, and not just for investors, but for anyone who aspires to reach a goal and to do so with their integrity intact.

A Literary Afterword: The narrative sweep of Schroeder’s book and the inclusion of so many family, friends and personal details gives the book the air of a family saga, and in many ways the book has the makings of a great novel. This characteristic of the book brought to mind another great book about the conflicts of life and business within one family, Thomas Mann’s first novel, Buddenbrooks.

Though Buddenbrooks is set in a much different time and place (19^th century Germany) and though it is much a much darker, fatalistic and negative book (its subtitle is "The Decline of a Family"), it nevertheless represents a sweeping retelling of the fortunes of one family and how business affect the lives of four generations.

Some might consider it more than a stretch to invoke Buddenbrooks in connection with Schroeder’s biography of Buffett. I certainly do not mean to suggest any comparison between Schroeder and Thomas Mann. But I do think the two books share a common goal. That is, both books aspire to draw moral lessons from the interaction of business and life within the context of a single family. The moral conclusions may differ significantly, but both books offer insight into the ways life can be lived, on the practical level where the business of life actually is conducted.

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According to news reports (here), MBIA has filed a lawsuit breach of contract lawsuit in New York state court against Countrywide Financial Corp. (now part of Bank of America) alleging that Countywide made fraudulent misrepresentations about is loan underwriting standards in connection with the securitization of over $14 billion of securities for which MBIA provided default insurance and that were backed by mortgages and home equity loans that Countrywide originated.

MBIA alleges that based on Countrywide’s representations about its mortgage lending practices and lending guidelines, MBIA provided "credit enhancements" in connection with the mortgage backed securities, in the form of billions of dollars of trust obligation guarantees.

The complaint alleges that contrary to Countrywide’s representations in connection with the transactions, during the period 2005 to 2007 Countrywide engaged in a "systemic pattern and practice of abandoning its own guidelines for loan origination" as part of the company’s attempt to expand its market share, as a result of which the risk profile of Countrywide’s mortgage portfolio "fundamentally changed." The complaint further alleges that "Countrywide deliberately abandoned its own guidelines to drive up revenues from increased origination fees, securitization fees and origination fees – no matter what the cost to borrowers, investors or guarantors like MBIA."

The complaint further alleges that MBIA has already paid out more than $459 million on it guarantees of the securitized loans and "is exposed to claims in excess of several hundred million dollars more."

The Seeking Alpha blog notes (here) that this lawsuit "may be the beginning of what may be a long battle by bond insurers MBIA and AMBAC to recover losses from those responsible, a process they refer to as remediation." Both insurers have said they expect substantial recoveries "due to misrepresentations and breaches of warranty with respect to securities that they have insured."

The Seeking Alpha blog further notes that these kinds of efforts may be a "painful and necessary" part of the process of putting responsibility where it belongs: "Every fraudulent transaction needs to be pushed back along the chain of perpetrators to its original source, if that person or entity can be located. As much as possible, those whose dishonesty caused the losses must bear them."

There have been multiple other recent attempts to by other litigants to assign blame, as part of the process that seeks to upstream losses back to their source. I discuss a couple of additional examples below.

Special thanks to a loyal reader for links concerning the MBIA lawsuit.

Wisconsin Schools Sue Over CDO Losses: On September 29, 2008, five Wisconsin school districts filed a lawsuit (here) in Wisconsin state court seeking to rescind and to recoup their losses on the $200 million the school districts invested in three synthetic CDOs. The lawsuit alleges that Stifel Nicholaus & Co. and Royal Bank of Canada and their respective related entities omitted or misrepresented the true nature of the investment and of the risks involved.

In 2006, the school districts invested largely borrowed funds into the CDOs to help pay their non-pension retiree benefits. Stifel Nicolaus & Co. and affiliated entities allegedly brokered the deal, while Royal Bank of Canada devised the instruments and determined their value.

The investments have lost approximately $150 million, or three quarters of their value. The lawsuit alleges that the investment was "complex, convoluted, and opaque, and as Stifel and RBC then well knew, beyond the investment knowledge or experience of the School Districts, their school board members, and their administrators."

The complaint also alleges that contrary to the defendants’ representations, the CDOs were collateralized by subprime mortgage loans. The CDOs also allegedly issue credit default swap protection as an additional source of income, which increased the CDOs credit default risk, which risk the lawsuit alleges was not fully disclosed.

The school districts seek rescission of the CDO transaction plus damages.

As losses accumulate, more and more aggrieved persons will join in this process of upstreaming losses back to their source. As I have noted many times, the litigation arising the subprime meltdown is likely to take years to unfold. As these cases illustrate, the litigation is also likely to involve an ever broader array of litigants, asserting an ever more diverse range of claims.

The SEC Pursues a Subprime Related Claim: Private litigants are not the only ones that will participate in this process of assigning blame. The SEC also clearly intends to get into the act, as reflected in its October 3, 2008 filing (refer here) of an enforcement action against five representatives of World Group Securities. The action alleges that the defendants fraudulently sold unsuitable securities to persons whose acquisitions were financed by mortgage refinancings.

The SEC’s complaint alleges that the defendants moved the customers, many of whom had little education and spoke little English, from fixed-rate mortgages to "subprime adjustable-rate negative amortization mortgages." The refinancing proceeds were then invested in variable universal life insurance and other unsuitable securities.

The defendants are alleged to have "misrepresented the expected returns from the securities, the liquidity of the securities, and the nature of the securities and the terms of the new mortgages while failing to disclose material facts about the products."

At one level this new SEC enforcement proceeding may seem unrepresentative of the larger subprime meltdown owing to its particular facts. The SEC action does share several common elements with the cases described above. Like the Wisconsin school suit, the SEC action contains both disclosure and suitability allegations, and like the MBIA lawsuit, the SEC action alleges misrepresentation of the true conditions.

Many of the subprime-related losses are on a much larger scale than that involved in the SEC action, but the SEC action underscores how widespread and diverse the losses are. Because of the degree of excesses involved and the overall magnitude of the losses involved, the blame assigning process yet to come will be complex and protracted. The lawsuits will continue to arise and the losses continue to emerge.

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