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

The headlines on the business pages have been dominated in recent days by the news of the blockbuster Citigroup and UBS auction rate securities settlements (about which refer here). But as noted in an August 8, 2008 CFO.com article (here), at the same time, a number of other leading banks have been hit with regulatory subpoenas as problems surrounding auction rate securities become “the crisis of the day for the large global financial services companies.”

In addition, investor litigation against the banks related to auction rate securities continues to accumulate. For example, on August 6, 2008, STMicroelectronics sued Credit Suisse Group in the Eastern District of New York, alleging that Credit Suisse placed $450 million of the chipmaker’s securities in unauthorized auction rate securities. A copy of the complaint can be found here. An August 7, 2008 Bloomberg article describing the lawsuit can be found here.

The complaint’s tone is blistering. The complaint alleges that in August 2007, when the company sought to liquidate what it thought was a portfolio of “liquid, safe and authorized student loan securities,” it discovered that Credit Suisse had actually invested in “illiquid, risky and unsustainable auction rate securities consisting of collateralized debt obligations and credit linked notes, some of which are backed by subprime real estate loans.”

Not stopping there, the complaint further alleges that “at least a dozen other multinational corporations are victims of the same scheme,” allegedly carried out by the same Credit Suisse brokers. The complaint alleges that this supposed scheme “involves more than $2 billion of these clients’ money.” The complaint further alleges that Credit Suisse “furthered the fraud by keeping it hidden from victims, governmental authorities and the investing public” and by “refusing to follow instructions to liquidate the assets.”

The complaint also alleges that Credit Suisse had an “intentional strategy” reducing its own exposure to auction rate securities and that it accomplished that goal by “dumping into the accounts of unsuspecting clients some of the worst ARS on the market.”

According to the complaint, ST has separately filed a FINRA arbitration against Credit Suisse Securities (USA), but because Credit Suisse Group itself is not a member of FINRA, it is not subject to its arbitration requirements, and therefore is not a party to the FINRA action, which remains pending. As a result, the newly filed civil lawsuit presents the spectacle of one Swiss domiciled company suing another Swiss domiciled company in U.S. federal court.

With relation to the matters alleged in the ST complaint, it is interesting to note that on July 9, 2008, the Wall Street Journal reported (here) that federal prosecutors in the Eastern District of New York are “investigating whether two former Credit Suisse Group brokers lied to investors about how they placed their money into short-term securities.” Prosecutors are investigating whether investors were “misled about the nature of the auction rate securities they bought.”

The July 9 article quotes a statement from Credit Suisse as saying that the two employees, who resigned in September 2007, had “violated their obligations to Credit Suisse and to our clients.” The Credit Suisse statement added that “we promptly notified regulators when this matter arose last year and we have continued to work closely with them”

In addition, the Wall Street Journal reported in a front page article on July 31, 2008 (here) that one of the two brokers under investigation, a 35-year old broker named Julian Tzolov, “has left the U.S. and could have fled to his native Bulgaria.” The July 31 article also lists ten overseas companies (including ST Microelectronics) that have initiated arbitration proceedings against Credit Suisse affiliate companies based on auction rate securities companies.

On U.S. Market Competitiveness: Consider Departing Foreign Companies: Would-be reformers cite concerns that U.S financial markets are losing out to other countries’ markets due to concerns about U.S regulatory burdens and litigiousness (about which refer here). But if these concerns were as significant as the reformers suggest, you would expect that foreign companies cross-listed on U.S. exchanges would see a positive boost in their share price when they eliminate their U.S. listing. Recent academic suggest the opposite may be true.

In an August 2008 paper entitled “Why do Foreign Firms Leave U.S. Equity Markets”  (here), Andrew Korolyi and Rene Stulz of Ohio State and Craig Doidge of the University of Toronto took at look at the 59 foreign companies that chose to deregister their U.S. listings after the SEC enacted Rule 12h-6 in March 2007, making it easier for such companies to do so.

Their study produced two essential findings. First, they found that the 59 companies as a group “experienced significantly lower growth and lower stock returns than other U.S-exchange listed foreign firms in the years preceding the decision.” Second, they found that there is only “weak evidence that firms experience negative stock returns when they announce deregistration and stronger evidence that the stock price return is worse for firms with higher growth.”

The authors said their finding “support the hypothesis that foreign firms list shares at the lowest cost to finance growth opportunities and that, when those opportunities disappear, a listing become less valuable to corporate insiders so that firms are more likely to deregister and go home.”

As discussed here, the authors’ prior research substantiates that overseas firms benefit, through lower cost of capital, when they choose to list their shares on U.S. exchanges, and their shares trade for higher prices than do those of similar companies that do not choose to list here. One theory for this “listing premium” is the “bonding hypothesis,” which speculates that investors put more confidence in companies complying with American disclosure requirements and accounting standards. The authors’ more recent research suggest that the only companies punished for delisting from the U.S. exchanges are those that continued to have growth opportunities and a need to attract American capital. Other companies, who lack those opportunities, delist with impunity.

Perhaps ironically, current efforts to make the U.S. markets more competitive arguably may be undercutting the “listing premium,” which might be the U.S. markets’ greatest competitive advantage. As discussed in Floyd Norris’s August 8, 2008 New York Times article entitled “Reasons Some Firms Left the U.S.” (here):

By letting companies walk away easily, the advantage of an American registration is reduced, Mr. Stulz has argued. The S.E.C. is moving to allow foreign companies to use international accounting rules, so any advantage from confidence in U.S. accounting rules will vanish. And the commission is making it much easier for brokers to sell unregistered foreign shares to Americans.

“I think there is a grave risk that the advantage may be lost because of the continued chipping away at the rock,” Mr. Karolyi said. “It just doesn’t seem like the right time or the right place to be engaged in a serious deregulation of financial markets.”

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Regular readers know that I have been tracking subprime-related class-action lawsuits (here). In a recent post, I noted my interest in trying to develop a similar list of subprime-related derivative lawsuits. In response to my request, a number of readers supplied helpful information, and as a result I have been able to develop a list of subprime-related derivative lawsuits, which can be accessed here.

The list is accurate but it may not be complete. Readers aware of any other subprime-related derivative lawsuits are encouraged to let me know, so that I can address any omissions. I will update the list as new lawsuits come in or as new information becomes available.

The table of cases I have compiled lists the companies that have been named as nominal defendants in shareholders’ derivative lawsuits. Some of the companies listed actually have been sued in multiple derivative suits, and some companies have been sued in multiple jurisdictions. However, where the allegations relate to substantially similar allegations, each company has only been listed once, regardless of the number of actual derivative lawsuits pending. Where I have been able to supply relevant links (in most cases to the actual complaint), the link pertains to the first filed suit.

As the list reflects, a total of 20 companies have been sued as nominal defendants in subprime-related derivative lawsuits. The derivative suits against seven of these companies were first filed in 2008, the rest in 2007. Most (but not all) of the companies named in the derivative suits have also been named in subprime-related securities class action lawsuits. Most of the companies sued in the derivative lawsuits are in the lending and banking industries, but the list also includes insurance companies, home builders, and REITs, among other.

Special thanks to Adam Savett of the Securities Litigation Watch (here) for providing information and links to several of the lawsuits, and thanks to all readers who provided information and suggestions in response to my inquiry.

Another Auction Rate Securities Lawsuit: On April 8. 2008, plaintiffs’ lawyers filed another purported securities class action lawsuit on behalf of auction rate securities investors against the companies that allegedly sold them the securities, in this case Raymond James Financial. A copy of the plaintiffs’ lawyers’ April 8 press release can be found here, and a copy of the complaint can be found here.

This brings the total number of auction rate securities lawsuits to eleven. My prior post discussing the auction rate securities lawsuits can be found here. I have been tracking the auction rate securities lawsuits as part of my running tally of subprime-related class action lawsuits, about which more below.

Adjusting the Subprime-Related Class Action Litigation Tally: Also as a result of my efforts to build the list of subprime-related derivative lawsuits, I received additional information regarding three previously filed securities class action lawsuits. In the past, I had determined that these three lawsuits were not appropriately categorized as subprime-related. However, upon further inquiry and based on conversations with some readers, I have now added these three additional lawsuits to my running tally of subprime-related securities class action lawsuits. The three added lawsuits related to Municipal Mortgage & Equity (about which refer here), WSB Financial Corp. (refer here), and CBRE Realty Finance (refer here).

With the addition of these three lawsuits, and with the addition of the Raymond James auction rate securities lawsuit referenced above, my running tally of subprime-related lawsuits now stands at 68. One unfortunate consequence of my decision to add these three cases is that now my running tally may no longer agree with others’ tallies, such as the Stanford Law School Securities Class Action website (here). There is an inherent categorization problem in trying to track the subprime lawsuits. Reasonable minds will disagree about whether a case is or is not appropriately categorized as subprime related. There are almost always going to be some disagreements at the margins.

Many thanks to the readers who supplied the information and commentary about the three class action lawsuits.

Subprime ERISA Lawsuit Update: As most readers know, I have also been tracking subprime-related ERISA lawsuits (here). As a result of my research and inquiries regarding subprime derivative lawsuits, I identified three additional subprime-related ERISA lawsuits of which I previously had been unaware. These three additional ERISA lawsuits pertain to Huntington Bankshares (refer here), National City Corp. (refer here), and Impac Mortgage (refer here).

With the addition of these three suits to my list, the number of subprime-related ERISA lawsuits now stands at 14, five of which have been filed in 2008, and the remainder of which were filed in 2007.

Two Options Backdating Case Developments: Two courts recently issued rulings on motions to dismiss in options backdating-related lawsuits.

First, on March 31, 2008, in the Juniper Networks option backdating-related securities litigation (about which refer here), Judge James Ware of the United States District Court for the Northern District of California largely denied the defendants’ motion to dismiss, except that he granted the motion (with leave to amend) as to one individual defendants, and he granted the motion to dismiss all alleged misrepresentations that took place prior to July 14, 2001, as time barrred. A copy of the March 31 order in the Juniper Networks case can be found here.

Second, and also on March 31, 2008, in the Microtune options-backdating related derivative litigation, Judge Richard Schiff of the United States District Court for the Eastern District of Texas granted the defendants’ motion to dismiss, albeit with leave to amend as to certain individuals on certain claims. A copy of the Microtune opinion can be found here. Judge Schell first concluded the Congress had not created a private right of action under Section 304 of the Sarbanes-Oxley Act, and dismissed that claim. Judge Schell also granted the dismissal with prejudice of claims of allegedly misleading proxy statements as to the individual defendants who were not on the board at the time of the proxy. The proxy allegations were dismissed without prejudice as to the remaining individual defendants. Similarly, the plaintiffs’ claims based on Section 10(b) were also all dismissed, but with prejudice as to some defendants and without prejudice as to others. The court declined to exercise jurisdiction over the plaintiffs’ state law claims.

I have added these two decisions to my table of options backdating related case dispositions, which can be accessed here. Readers are encouraged to let me know about case dispositions of which they become aware so that I can add them to the list.

Special thanks to Nick Even of the Haynes and Boone firm for the link to the Microtune decision.

New Century Updated: In an earlier post (here), I noted that the court had granted (with leave to amend) the defendants’ motion to dismiss in the first-filed subprime related securities class action lawsuit, involving New Century Financial Corporation. On March 24, 2008, the plaintiffs filed their amended complaint (here), which names as defendants not only certain former directors and officers of the company, but also the company’s former auditor, KPMG, and the company’s offering underwriters.

Readers will recall that in connection with the New Century bankruptcy proceeding, the bankruptcy examiner recently released a detailed report (about which refer here) in which, among other things, the examiner reviewed the question of the auditors’ and the company's directors and officers' potential responsibility for certain accounting practices and statements at the company. In light of the bank examiner’s report, the plaintiffs sought (and the defendants’ agreed not to oppose) leave to file a second amended complaint, which the court granted. The plaintiffs’ must file their second amended complaint by April 30, 2008. The court also set a briefing schedule for the anticipated motion to dismiss, to be argued September 8, 2008. A copy of the court’s order granting leave and setting the scheduling can be found here.

A German Securities Trial?: The Securities Litigation Watch has an interesting post (here) about the apparent mass securities lawsuits trial that has commenced in Germany involving Deutsche Telecom. An April 7, 2008 Business Week article discussing the trial can be found here.

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The subprime litigation wave is growing in amplitude and volume, as four companies have found themselves the targets of a total of five new subprime-related securities class action lawsuits, joining the now quite lengthy list of companies that have been swept up in the wave. With the addition of these five new securities lawsuits, as well as the numeous other suits filed in just the last few days, it appears that the subprime litigation wave is building dangerous momentum

Wachovia:  The first of these new lawsuits was actually filed back on January 31, 2008, against Wachovia Corporation , certain of its officers and directors, a related Wachovia unit that issued certain securities involved in the lawsuit, and the offering underwriters that underwrote Wachovia’s May 2007 preferred securities offering. (As noted further below, Wachovia was also named in a separate securities lawsuit relating to auction rate securities).

The Wachovia lawsuit flew under the radar screen at the time that it was filed because the plaintiffs’ lawyers chose to file the lawsuit in New York Supreme Court (Nassau County), though the defendants have removed the action under the Securities Litigation Uniform Standards Act (SLUSA) and the Class Action Fairness Act (CAFA). A copy of the removal petition, to which the initial complaint is attached, can be found here.

The complaint assert claims based on allegedly false and misleading statements in the registration and prospectus issued in connection with Wachovia’s $750 million May 2007 offering of preferred securities. The complaint alleges that the registration statement failed to disclose that Wachovia’s "portfolio of collateralized debt obligations ("CDOs") contained billions of dollars worth of impaired and risky securities, many of which were backed by subprime mortgage loans." The complaint also alleges that the defendants failed to "properly account for highly leveraged loans such as mortgage securities." Finally, the complaint alleges that the complaint failed to disclose that Wachovia was "heavily involved in option adjustable rate mortgages (ARMs)…that would become toxic (for both Wachovia and the borrowers) once house prices stopped increasing at a rapid rate."

The complaint alleges claims only under the ’33 Act, and expressly asserts that the state court has concurrent jurisdiction under Section 22 of the ’33 Act in connection with plaintiff’s claims. The plaintiff in the Wachovia law suit seems to be pursuing the same state court strategy that I discussed at length in my prior post (here) analyzing the class action securities lawsuits that investors have filed against the securitizers who created mortgage backed assets. Significantly, the Coughlin Stoia firm is involved in both those cases and the Wachovia case. Given the sophistication of the firm involved, one must assume that these state court filings are part of a conscious strategy on the firm’s part.

Though defendants have removed the Wachovia case to the United States District Court for the Eastern District of New York, it remains to be seen whether or not the plaintiffs will be able to have the case remanded to state court. As I noted here, the plaintiffs in the Luther v. Countrywide case, a ’33 Act class action lawsuit filed against mortgage backed asset securitizers, succeeded in having their case remanded back to state court. The court in Luther case concluded that concurrent jurisdiction provisions in the ’33 Act prohibit the state court’s case’s removal to federal court.

My theory on these state court lawsuits has been that the plaintiffs intend to argue that the provisions of the PSLRA to not apply to their state court ’33 Act lawsuits. The fact that the plaintiffs’ lawyers issued no press release at the time they filed the complaint tends to reinforce this impression. But regardless of their theory they seem to be making a comprehensive effort to bring these cases in state court. The involvement of state courts in these lawsuits will be very interesting to watch.

Lehman Brothers: On February 22, 2008, a Lehman Brothers shareholder filed a purported securities class action lawsuit in the United States District Court for the Northern District of Illinois, alleging that Lehman Brothers made certain misrepresentations or omissions about its exposure to subprime mortgages during the class period from September 13, 2006 through July 30, 2007. A copy of the complaint can be found here.

There are a variety of very odd things about this lawsuit, and almost all of these odd features repeat the same odd attributes of the subprime-related securities class action lawsuit was previously filed against Morgan Stanley, as I discussed in my prior post here.

The first odd feature about this lawsuit is that it does not name the company, its directors or its senior managers as defendants in the lawsuit. The sole named defendant is the company’s Chief Financial Officer, yet no misrepresentations or omissions are attributed directly to him. The allegations against the CFO are attributed solely to his position within the company. There are no allegations that the CFO sold shares of stock. It is not particularly clear why the CFO should be named as defendant while other officials are not.

The allegations regarding the alleged misrepresentations are sparse, and are essentially limited to a few occasions when the company supposedly downplayed its exposure to subprime mortgages. The class period ends at an odd time, too; the class period end is not in January 2008, when the company said that it has lost $5.9 billion on its mortgage related positions, but on July 30, 2007, when an equity analyst downgraded the company.

The named plaintiff is also an odd representative for the purported class. Though the class period purports to run from September 13, 2006 to July 30, 2007, the named plaintiff did not even buy his shares until July 15, 2007, making him an unlikely representative for a class of that duration. Moreover, the complaint itself refers to events and statements at or about the same time that the plaintiff bought his stock which surely raised questions about subprime-related exposures in general and subprime exposures at Lehman brothers in particular.

The plaintiff also chose to file his complaint in the Northern District of Illinois, though Lehman’s headquarters are in Manhattan.

But regardless of the complaint’s numerous anomalies, the complaint does represent a subprime-related securities class action lawsuit, and so, as noted further below, I have added it to my running tally of subprime-related securities lawsuits.

Schwab: On March 18, 2008, plaintiffs filed a securities class action lawsuit in the United States District Court for the Northern District of California against the Schwab Corporation, certain of its directors and officers, and as well as the underwriter and investement adviser associated with two Schwab YieldPlus Funds. The lawsuit is filed on behalf of investors who purchased Schwab YieldPlus Investor Funds Investor Shares and Schwab YieldPlus Funds Select Shares during the period March 17, 2005 through March 18, 2008. A copy of the plaintiffs’ counsel’s press release can be found here.

The complaint alleges that the defendants issued untrue statements regarding the lack of diversification of the funds and the extent of the funds’ exposure to subprime-backed securities. The complaint alleges that while the funds advertised themselves as a safe alternative to money market funds, they were in fact critically exposed because more than 50 percent of the funds assets were invested in the mortgage industry. The plaintiffs allege that the funds have lost over 18 percent of their value since mid-2007 and 11 percent since January 2, 2008. The plaintiffs allege that the defendants violated Section 11 of the ’33 Act based in misrepresentations in the funds’ offering documents.

The Schwab funds are actually the second mutual funds to be sued in connection with the subprime crisis; as discussed here, the earlier lawsuit involved Morgan Keegan.

Special thanks to a loyal reader for copies of the Wachovia and Lehman Brothers complaints.

More Auction Rate Securities Litigation: As readers may recall, in an earlier post (here), I speculated that lawsuits related to  auction rate securities may represent the next wave in subprime securities litigation. Last week, I noted (here) the securities class action lawsuit that had been brought against Deutsche Bank on behalf of auction rate securities investors. Auction rate securities investors have now filed two additional securities class action lawsuits, one involving Wachovia, and the other involving TD Ameritrade.

With respect to TD Ameritrade, the plaintiffs filed a securities class action lawsuit in the United States District Court for the Southern District of New York on behalf of persons who purchased auction rate securities from TD Ameritrade and an affiliate between March 19 2003 and February 13, 2008 and who continued to hold the securities. A copy of the plaintiffs’ attorneys’ March 19, 2008 press release can be found here, and a copy of the complaint can be found here

The complaint alleges that the defendants failed to disclose:

(1) the auction rate securities were not cash alternatives, like money market funds, but were instead, complex, long-term financial instruments with 30 year maturity dates, or longer; (2) the auction rate securities were only liquid at the time of sale because TD Ameritrade and other broker-dealers were artificially supporting and manipulating the auction rate market to maintain the appearance of liquidity and stability; (3) TD Ameritrade and other broker-dealers routinely intervened in auctions for their own benefit, to set rates and prevent all-hold auctions and failed auctions; and (4) TD Ameritrade continued to market auction rate securities as liquid investments after it had determined that it and other broker dealers were likely to withdraw their support for the periodic auctions and that a "freeze" of the market for auction rate securities would result.

With respect to Wachovia, the plaintiffs filed a securities class action lawsuit in the United States District Court for the Southern District of New York on behalf of all investors who purchased auction rate securities from Wachovia and an affiliate between March 19, 2003 and February 13, 2008 and who continue to hold the securities. A copy of the plaintiffs’ counsel’s March 19, 2008 press release can be found here and a copy of the complaint can be found here. The allegations against Wachovia are substantially similar to the allegations against TD Ameritrade.

An additional lawsuit has been brought on behalf of an investor in auction rate securities, although in this case it is an individual action rather than a class action. On March 18, 2008, plaintiffs filed a lawsuit in the United States District Court for the Western Disrict of Texas against Wells Fargo and Wells Fargo Investments, alleging that the defendants violated the securities laws and breached their fiduciary duties in connection with the plaintiffs’ purchase of $2 million of auction rate market preferred shares. A copy of the complaint can be found here. (Hat tip to Courthouse News Service for a copy of the complaint.)

The plaintiffs contend that the Wells Fargo investment adviser referred to the securities as "bonds" that were "represented to be without risk." The plaintiffs claim that the defendants said that the securities could be redeemed on 7 days notice, but that when the plaintiffs sought to redeem the securities on March 11, 2008, they were told that no market exists for the securities. The complaint seeks recovery of $2 million plus punitive damages.

Some Observations and Tallies: Even for those that have been paying only intermittent attention, it is pretty clear that the pace of subprime-related litigation activity has picked up significantly over the last few days. Even without regard to these five new securities class action suits listed above, we had already seen a notable number of new subprime securities suits just in the last week, including for example, new lawsuits against SocGen, PMI Group, Deutsche Bank, and, most significantly, Bear Stearns. Adding these five new subprime-related securities class action lawsuits listed above to the list reinforces the impression that the litigation wave is gathering dangerous momentum, with the likelihood that even greater activity is yet to come.

With the addition of these new lawsuits to my running tally of subprime- related securities class action litigation, which can be accessed here, the current total of subprime securities lawsuits now stands at 56, of which 18 have been filed in 2008. Two of these 56 represent lawsuits by investors against mortgage backed asset securitizers, three are class action on behalf of investors in auction rate securities, and two relate to mutual funds, as noted above. The remaining 50 lawsuits were brought by shareholders of publicly traded companies.

More About Credit Default Swaps: In yet another prior post (here), I noted that problems arising from credit default swaps could be another source of litigation arising from the credit crisis. The March 20, 2008 Wall Street Journal is reporting (here) that Merrill Lynch has sued a unit of Security Capital Assurance, seeking to prevent SCA from avoiding its financial obligations to insure as much as $3.1 billion on seven credit default swaps.

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