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

As the subprime litigation wave has churned on, many of the more recently filed lawsuits have been similar to previously filed suits. But amidst the repetition, there has also been some innovation, or at least variation, as a result of which the subprime litigation wave has continued to evolve. Two recently filed subprime and credit crisis- related lawsuits demonstrate both of these elements.

 

Fannie Mae Secondary Offering Litigation: First, on August 7, 2008, plaintiffs filed a purported securities class action under Section 12(a)(2) of the ’33 Act, in the New York (New York County) Supreme Court, in connection with the May 9, 2008 secondary offering of Federal National Mortgage Association (Fannie Mae) A copy of the complaint can be found here.

 

The complaint purports to be filed on behalf of all purchasers who bought Fannie Mae shares in the May 9 offering, in which the company sold approximately 94 million shares at $27.50 a share. (The shares closed today at $7.69.) Interestingly, Fannie Mae itself is not named as a defendant. The plaintiffs have named defendants only the offering underwriters, Lehman Brothers, J.P. Morgan and Citigroup.

 

The complaint alleges that the offering documents failed to disclose a pending change to FAS 140, which change if adopted, the complaint alleges, "could require the Company to raise as much as $46 billion of capital in order to remain in compliance" with its regulatory capital requirements. The complaint alleges that FAS 140 had previously allowed Fannie Mae to account for its liabilities for mortgage-backed securities issued by the company as if the company had sold the securities, even though the company was still obligated to guarantee the securities against defaults in the underlying assets. The supposed pending changes would require Fannie Mae to account on its balance sheet for these now off-balance sheet liabilities.

 

The complaint alleges that the offering documents had stated that upon the successful completion of the offering, the company’s capital requirements would be reduced. The complaint alleges that in July 2008, well after the offering’s completion, an analyst for Lehman Brothers (which was also one of the offering underwriters) issued a report disclosing the pending changes and the supposed impact on the company’s need for as much as $46 billion additional capital. The complaint alleges that in the week following the report, Fannie Mae’s share price dropped from $18.76 per share to $7.07 a share.

 

There are a number of curious things about this complaint. The first is that the complaint names only the offering underwriters as defendants; it does not name Fannie Mae itself. I expect this is because in connection with this firm commitment offering, the offering underwriters were the actual "sellers." (The complaint alleges that the underwriters, who directly bought the shares from the company, were "directly responsible for the offering and sale" of the shares to the market.) This would perhaps explain why the plaintiffs sought to pursue their Section 12 claim only against the underwriters, but it does not clarify why the plaintiffs did not also include in their complaint a Section 11 claim against Fannie Mae or other defendants.

 

UPDATE: Please note the reader comment below explaining that the May offering was an unregistered equity offering, and as such there was no registration statement -- hence no Section 11 claim. As an aside, I note that I am always grateful when a reader provides this kind of clarifying information. I hope that all readers will lelt me know when statements on this blog are in need of clarification or correction.  

The other interesting thing is that plaintiffs have chosen to proceed in state court rather than federal court. I have previously noted (here) the apparent interest of some plaintiffs’ lawyers as part of the current litigation wave to pursue ’33 Act claims in state court, and I have also noted that plaintiffs have had some success in having these cases remanded back to state court in opposition to defendants’ efforts to remove them to federal court. Even though this most recent lawsuit asserts claims only under Section 12, it apparently continues the developing trend of plaintiffs pursuing ’33 Act actions (primarily Section 11 actions) in state court.

 

Jurisdiction for ’33 Act actions is concurrent, meaning that plaintiffs have a choice and they are consciously choosing to proceed in state court. I have previously speculated (here) that the decision to proceed in state court represents some form of forum shopping, or perhaps a bid to avoid the requirements of the PSLRA. Whatever the reason, the court selection appears calculated and tactical, much like the decision in this case to assert claims only against the offering underwriters and only under Section 12.

 

Special thanks to Adam Savett of the Securities Litigation Watch for the complaint in this Fannie Mae Secondary Offering lawsuit.

 

Stifel Financial Auction Rate Securities Litigation: The second of these two recent lawsuits is a purported securities class action lawsuit filed in the Eastern District of Missouri on behalf of all persons who purchased auction rate securities from Stifel Financial (or its affiliate, Stifel Nicolaus & Company) between June 11, 2003 and February 13, 2008. A copy of the complaint can be found here.

 

As I have noted (here), there have been many of these auction rate securities class action lawsuits filed. By my count, about which refer below, Stifel and its affiliate are the eighteenth different set of defendants to be separately named in an auction rate securities class action lawsuits.

 

What makes this complaint noteworthy is not its allegations, which are virtually identical to those raised in the earlier auction rate securities lawsuits. Rather, what makes this complaint noteworthy is its timing. There were a flood of these auction rate securities lawsuits filed in March and April 2008, but the filings tapered off after that. The most recent of these auction rate securities class action lawsuits, as near as I can determine, was filed in May 2008.

 

The other interesting element of the lawsuit’s timing is that it comes now, shortly after the largest financial institutions have entered settlements in which the big banks have agreed to massive buy backs of these securities from retail investors (refer here). As I noted in a recent post (here), even though these settlements might have seemed to suggest that the auction rate securities mess was winding wrapping up, the lawsuits relating to the securities continue to accumulate. Notwithstanding the settlements involving the largest banks, problems with these securities continue, and the related lawsuits continue to be filed.

 

A copy of an August 13, 2008 St. Louis Business Journal article relating to the new Stifel Financial lawsuit can be found here.

 

 Run the Numbers: In any event, I have added these two new lawsuits to my running tally of the subprime and credit crisis-related securities lawsuits, which can be accessed here.

 

With the addition of these two new lawsuits, the current tally of the subprime and credit crisis-related securities lawsuits now stands at 105, of which 65 were filed in 2008. As noted above, there have been 18 separate sets of defendants sued in auction rate securities class action lawsuits.

 

Subprime Coverage: Accompanying this litigation wave is the related question of insurance coverage for these lawsuits. Matthew Jacobs, Lorelie Masters and David Weiner of Jenner & Block have written an article in the July/August 2008 issue of Coverage entitled "Insurance Coverage and the Subprime Crisis: A Broad Overview" (here), which provides a comprehensive overview of the subprime litigation and the related insurance issues, from a policyholder perspective. The article is comprehensive and well-written, and raises a number of useful and interesting observations about the subprime-related coverage issues.

 

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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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After New York Attorney General Andrew Cuomo announced (here) earlier today that Citigroup had agreed to a blockbuster settlement regarding auction rate securities, it certainly seemed like the deal would put pressure on other investment banks to adopt similar measures. So perhaps it was not unexpected later in the day that Merrill Lynch announced (here) that it too would "buy back at par auction rate securities sold by it to its retail clients."

 

If Merrill Lynch’s response is any indication, other banks and broker-dealers may also now find themselves pressured to buy back auction rate securities from their retail clients at par. UPDATE: It appears that UBS got the memo, too; the August 8, 2008 headlines include reports that UBS will be entering its own deal today with state and federal regulators (refer here). There were quite a number of other features to Citigroup’s settlement beyond the retail investor buy back. In addition, Citigroup not only settled with the NY AG, but also preliminarily settled with the SEC as well, as discussed in the SEC’s August 7, 2008 press release (here).

 

 

Other companies that want the same degree of resolution as Citigroup may have to swallow many if not all of the terms to which Citigroup agreed, so the entire package is worth a closer look.

 

Without access to all of the settlement documents, it is not possible to obtain a complete understand of everything to which Citigroup agreed. But there is a great deal of information in NYAG’s and SEC press releases linked above, as well as Citigroup’s own press release about the settlement (here).

 

The major components of the deal are that Citigroup will buy back at par $7.5 billion in auction rate securities that it sold to individual investors, small business and charities. In addition, Citigroup agreed to use its "best efforts" to liquidate another $12 billion in auction rate securities sold to retirement plans and institutional investors by the end of 2009.

 

Citigroup also agreed to pay the state of New York a civil penalty of $50 million, and to pay a separate civil penalty of $50 million to the North American Securities Administrators, which, according to the NYAG’s press release, has had a task force conducting investigations into the marketing and sale of auction rate securities.

 

Beyond these basic outlines, there are a number of other terms designed to make investors whole.

 

First, Citigroup will, according to the NYAG, "fully reimburse all retail investors who sold their auction rate securities at a discount after the market failed."

 

Second, as described in the SEC press release, "until Citi actually provides for the liquidation of the securities…Citi will provide no-cost loans to customers that will remain outstanding until all the ARS are repurchased, and will reimburse customers for any interest costs incurred under any prior loan program."

 

Third, according to the SEC, "Citi will not liquidate its own inventory of a particular ARS before it liquidates its own customers’ holding in that security."

 

Fourth, in one of the deal’s more interesting components, Citigroup agreed that (according to the SEC press release, which has the best description of this component) with respect to any customer who contends that he or she has "incurred consequential damages beyond the loss of liquidity," that it will participate in a "special arbitration process that the customer may elect and that will be overseen by FINRA." In these proceedings, Citigroup "will not contest liability for its misrepresentations and omissions…but may challenge the existence or amount of any consequential damages." Customers who elect not to participate in these special procedures "may pursue all other arbitration or legal of equitable remedies available through any other administrative or judicial process."

 

Fifth, with respect to its investment bank clients, according to Citigroup’s press release, "Citi will refund refinancing fees to municipal ARS issuers that issued ARS in the primary market between August 1, 2007 and February 11, 2008, and refinanced those securities after February 11, 2008."

 

The SEC’s press release emphasizes that Citigroup’s settlement with the SEC is "preliminary" and that the company "faces the prospect of a financial penalty to the SEC after it has completed its obligations under the settlement agreement." The amount of the penalty if any will be based on an assessment "whether Citi has satisfactorily completed its obligations under the settlement," as well as the costs Citi incurred in meeting those obligations.

 

With respect to the issue of costs to Citigroup, the company itself noted that the financial impact it would sustain as a result of acquiring the $7.3 billion of its retail investors’ auction rate securities "is expected to be de minimus." The company estimates that the difference between the purchase price and the market price is ‘in the range of $500 million on a pretax basis," although the actual pre-tax loss will depend on market values at the time of purchase.

 

Citigroup did not attempt to estimate the costs to the company of its commitment to use its "best efforts" to liquidate its institutional investors $12 billion in auction rate securities. Nor does its press release reflect an estimate of the costs to the company of the various provisions designed to make its retail and investment bank customers whole. The "consequential damages" arbitrations could be particularly interesting in the respect, and I am guessing these proceedings will also involve some pretty elaborate allegations. Given the marketplace's reaction to the settlement announcement -- Citigroup's stock closed down 6.24% today -- the perception seems to be that the overall costs will something more than "de minimum."

 

It is worth noting that the $12 billion retail investor buy back that Merrill Lynch announced today, while clearly designed to try to ingratiate the company to regulators and to try to buy the company some room to maneuver, acknowledged only one part of the Citigroup’s multi-component settlement. Merrill’s initiative lacked any provision for liquidation of institutional investors’ holdings, and it similarly lacked any of the "make whole" components of the Citigroup settlement. Regulators will undoubtedly press Merrill for similar concessions.

 

Whatever the aggregate costs to Citigroup of the settlement announced today will ultimately be depends to an enormous extent on whether this settlement, and the others that undoubtedly will be reached in the coming days and weeks, are collectively enough to melt the frozen auction rate securities market. At this point, nobody is buying the securities because they don’t want to get stuck with an asset they can’t turn around and sell if they have to. But if confidence does return, the banks and other companies will be able either to hold these newly acquired assets on their balance sheets at par, rather than at a discount, or to sell the assets in an orderly marketplace at reasonable marketplace prices.

 

On the other hand, it is possible that all that is happening is that the problems are being shifted around. The banks will have to be taking on to their balance sheets a huge quantity of illiquid assets at a time when their balance sheets are already under pressure. All of them will face the same desire, and perhaps need, to sell these assets, at the same time that they will also be under pressure to use their "best efforts" to help their institutional investor clients unload their holdings. These arrangements address the retail investors problems (which is fair, appropriate and necessary, from both a practical and prudential standpoint), but the other problems are not yet solved, and they will not be finally solved until there are as many interested buyers as they are eager would-be sellers. And these arrangements certainly bake in a host of holders who will want to be sellers.

 

The key component of the settlement may be the "best efforts" provision pertaining to institutional investors, which Citigroup described in its press release as follows:

Citi will work with issuers and other interested parties to provide liquidity solutions for Citi institutional investor clients. In doing so, Citi will use its best efforts to facilitate issuer redemptions and/or to resolve its institutional investor clients' liquidity concerns through resecuritizations and other means. The New York Attorney General will monitor Citi's progress and, beginning on November 4, 2008, retains the right to take legal action against Citi with respect to its institutional investor clients. The other regulators have entered into a similar arrangement but with a December 31, 2009 date.

If these efforts prosper, they may go a long way toward restoring an efficient marketplace for these securities. The problem is that, without a funtioning marketplace, it is not immediately apparent (at least from this brief description), how institutional investors' "liquidity concerns" will be resolved, short of Citigroup itself buying out the institutional investors too --although to my eyes at least this "best efforts" stops short of a firm buyout commitment.

 

It may be that a Citigroup buyout of institutional investors is implied in this "best efforts" provision, especially given the looming threat of further state regulatory action, amoint to an implicit buyout commitment. To the extent other banks provide similar commitments, it might well be enough to unfreeze the marketplace for these securities. Which unquestionably would be a good thing for all concerned. The risk of course is that the banks could wind up holding a pile of assets nobody else wants.

 

There are many unanswered questions. One of the more practical questions is what the Citigroup settlement announced today will do for the private auction rate securities litigation pending against the company (about which refer here). The settlement clearly seems calculated to try to make at least the retail investors whole, and at least for those retail investors who are comfortable with the special "consequential damages" procedure, there would seem to be no point for continuing the class action (although I would be interested to know if readers have a different perspective). Institutional investors may well have another view, particularly until it is known whether Citigroup’s "best efforts" to liquidate the investors’ auction rate securities holding are successful.

 

The Citigroup settlement was discussed in a number of news articles today, including articles appearing on CFO.com (here) and Bloomberg (here).

 

Or is the Worst Yet to Come?: Coincidentally, my friends Kimberly Melvin and Cara Tseng Duffield of the Wiley Rein law firm published a memorandum today whose title seems even more provocative in light of today’s development. Their memo, entitled "Auction Rate Securities: Is the Worst Yet to Come?" (here), has a detailed overview of the outstanding claims involving auction rate securities that is informative and useful.

 

The memo was written prior to and therefore without awareness of the Citigroup settlement, The memo still makes for interesting reading. Among other things, the memo contains a number of interesting observations concerning the insurance implications of the ARS claims. The authors note that because many of the ARS claims arise out of the defendant companies’ investment sales activities, the claims likely do not represent D&O insurance losses; rather the claims "appear to represent primarily E&O exposures."

 

Finally, and pertinent to the Citigroup settlement, the authors note that "to the extent that the investment banks buy back or rescind their customers’ ARS, thereby receiving the securities in return for par value, issues exist regarding whether the banks have suffered a covered loss."

 

I Never Really Wanted to Sell CDOs, I Wanted to be a Lumberjack: And now, for something completely different, I recommend Mark Gilbert’s August 7, 2008 Bloomberg column entitled "CDO Market is Dead, Not Just Pining for Fjords" (here).

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Next up as targets in the ever-growing wave of subprime-related class action lawsuits are closed-end funds that issued auction preferred securities. The auction marketplace for these securities, like the market for auction rate municipal bonds, has broken down, and investors who bought the securities are now suing the closed end funds that issued the instruments.

First, some background. According to the Investment Company Institute’s web page describing and explaining closed end funds (here), closed end funds are managed investment companies that issue a fixed number of shares. The shares trade on the open market. In addition to these common shares, many closed end funds also issue preferred shares. The owners of the preferred shares are paid dividends, but they do not participate in the fund’s gains and losses. The sale of preferred shares gives the fund leverage, by permitting the fund to make additional investments, hoping to improve the common shareholders’ returns. For auction rate preferreds, the dividend rate is set through periodic auctions, typically held every seven or 28 days.

According to a March 9, 2008 New York Times article entitled “As Good as Cash, Until It’s Not” (here), the marketplace for municipalities’ auction rate notes is $330 billion, and the market for closed end fund auction rate preferred securities is $65 billion. But more to the point, investors in auction rate preferred securities, like investors in municipalities’ auction rate notes, have discovered that due to the February 2008 breakdown of the auction rate marketplace, investors find they are “stuck” with their investments and unable to sell them through the auction market.

But auction rate preferred investors are, according to the Times article, faring “far worse than investors stuck with municipal issues,” because many municipal note investors are receiving a penalty rate of up to 12 percent or more, a rate that is “much higher than the caps on closed-end notes, which are currently around 3.25 percent.” The closed end issuers “have no incentive to redeem their notes since the interest rate resulting from the failed auction is so low.”

A March 30, 2008 New York Times article entitled “If You Can’t Sell, Good Luck” (here) explains that auction rate preferred investors’ difficulties put the closed-end fund issuers “in something of a conflicted position,” because the common shareholders’ returns are enhanced by the leverage from the preferred securities investment. While the preferred holders would like their shares to be redeemed, the “common shareholders would lose out on extra income generated by the preferred share structure.”

Under these circumstances, it is hardly surprising that the class action securities attorneys have now gotten involved. According to their press release (here), on April 21, 2008, the plaintiffs’ attorneys’ filed a purported securities class action lawsuits in the United States District Court for the Southern District of New York against the Calamos Global Dynamic Income Fund, on behalf of investors who acquired “Auction Rate Cumulative Preferred Shares” (ARPS) in the fund’s September 17, 2007 offering of $350 million of the securities. The complaint, which can be found here, also names as defendants the two investment banks that led the offering.

According to the press release, the complaint alleges that the offering documents omitted that:

(i) the purported “auctions” used by Calamos Fund to get the dividend rates were not bona fide auctions at all, but rather a mechanism to maintain the illusion of an efficient and liquid market for the ARPS so that the Calamos Fund could continue to earn fees from the so-called auctions and from the ongoing stabilizing of the market because of the lack of buyer demand; (ii) the default interest rate set as a consequence of a failed auction is less than the interest rate paid when auctions of certain competing municipal auction rate securities (“MARS”) offered directly by municipal issuers fail; (iii) the ARPS suffer from an additional disadvantage compared to MARS because the ARPS are securities which exist in perpetuity until such time as the Fund calls them due while MARS have a set due date; and (iv) the default interest rate as set would cause the ARPS to trade at a discount to their par value if, and when, the auctions began to fail.

The complaint further alleges that as a result of the auction rate marketplace failure “auction rate securities that were once offered as ‘cash equivalents’ are now illiquid, resulting in economic losses and severe hardships for investors.”

As I have previously noted (most recently here and here), there already is a growing wave of auction rate securities class action lawsuits. However, this most recent lawsuit differs from the prior actions, and not merely because it involves closed end fund auction rate preferred securities rather auction rate notes issued by municipalities. The new lawsuit is also different because it targets the issuer; in the prior auction rate lawsuits, the plaintiffs targeted the broker dealers that sold the securities, not the municipalities that issued the securities.

One thought I had while reviewing the Calamos complaint is that many of these auction rate lawsuits may present some interesting issues related to damages. In most instances, the instruments are continuing to pay interest according to their terms. With respect to the closed end fund notes, the securities are backed by real assets held in the funds, which would seem to suggest that the instruments retain substantial economic value. Even if the auction rate market itself proves to be permanently broken, it would seem that there should be strong economic incentives all the way around for a secondary market for these shares to develop. Of course, whether a fully functional secondary market emerges, and whether the marketplace requires a significant discount for these shares to trade, remains to be seen. But right now, calculating the alleged damages does seem to pose some challenging issues, particularly some mechanism to trade the shares develops while these cases are pending.  

Subprime Litigation Wave Hits Credit Suisse: On April 21, 2008, plaintiffs’ counsel also initiated a securities class action lawsuit in the United States District Court for the Southern District of New York against Credit Suisse Group and certain of its directors and officers. According to the plaintiffs’ attorneys’ press release (here), the complaint alleges that the “defendants failed to write down known impaired securities containing mortgage-related debt.” Specifically, the complaint alleges that

(a) that defendants failed to record losses on the deterioration in mortgage assets and collateralized debt obligations (“CDOs”) on Credit Suisse’s books caused by the high amount of non-collectible mortgages included in the portfolio; (b) that Credit Suisse’s internal controls were inadequate to ensure that losses on residential mortgage-related assets were accounted for properly; and (c) that Credit Suisse’s traders had put incorrect values on CDOs and other debt securities, concealing the exposure the Company had to losses.

The complaint (which can be found here), also alleges that on February 19, 2008, the company announced (here) fair value reductions of $2.25 billion following its repricing of its asset-backed positions, triggering a sharp decline in the company’s share price.

The plaintiffs’ lawyers have engineered the purported class on whose behalf the action is brought, in a clear attempt to avoid jurisdictional challenges and other concerns. The purported class includes all shareholders who purchased Credit Suisse ADRs on the NYSE, and all U.S. residents or citizens who purchased Credit Suisse stock elsewhere. This purported class excludes non-U.S. investors who purchased their securities outside of the United States.

This class composition seems tailored to match the composition of the class recently certified in the Converium securities lawsuit (as discussed in greater detail on the Securities Litigation Watch blog, here). This class composition also avoids many of the so-called “f-cubed” litigant problems (involving foreign domiciled shareholders who bought their shares in a foreign company on a foreign exchange). Avoiding this issue could eliminate friction at the lead plaintiff, motion to dismiss, and class certification stages. It does raise questions about the foreign litigants and their apparent inability to seek class remedies of the type that other securityholders in the same company are able to pursue in the U.S. Whether that triggers these securityholders to file a bunch of individual actions, as happened after the foreign litigants were excluded from the Vivendi lawsuit (as also discussed on the Securities Litigation Watch blog, here), remains to be seen.

For further background about the “f-cubed” issue, refer to my prior posts, here and here.

Run the Numbers: With the addition of these two new lawsuits, the current tally of subprime and other credit crisis related lawsuits, which can be accessed here, now stands at 76, 36 of which have been filed in 2008. Of the 38 so far in 2008, 15 (including the Calamos lawsuit described above) are auction rate securities lawsuits.

Excess D&O Insurance Coverage Issues: In several posts (most recently here), I have examined the increasingly important emergence of coverage disputes involving excess D&O insurance. In the latest issue of InSights, entitled “Excess Liability Insurance: Coverage Disputes and Possible Solutions” (here), I take a more comprehensive look at the coverage issues involving excess D&O insurance.

Speaker’s Corner: On April 22, 2008 at 1:00 P.M. EDT, I will be participating in a one-hour webinar sponsored by Merrill Corporation entitled “The Subprime Ripple Effect: Preparing for the Wave of Litigation.” The other participants include Thomas Reilly, the former Massachusetts Attorney General and a shareholder in the Greenburg Traurig law firm, and Mark Kindy, EVP of Strategy and Operations for Merrill Corp. Registration (which is free) can be accessed here.

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Add corporate debt to the type of lending caught up in the current credit crisis, and add both commercial real estate financing companies and private equity firms (or at least one that recently completed a high profile public offering) to the kinds of companies now ensnared in the current wave of lawsuits. The latest round of lawsuits suggests just how far afield these cases may spread before all is said and done.  

The iStar Lawsuit: The lawsuit filed on April 14, 2008 in the United States District Court for the Southern District of New York against iStar Financial and certain of its directors and officers represents these latest variants in the evolving course credit crisis litigation wave. A copy of the plaintiffs’ lawyers’ press release about the iStar lawsuit can be found here, and the complaint can be found here.

The iStar lawsuit is brought on behalf of shareholders of the company who bought their shares in the company’s December 13, 2007 secondary offering, in which the company raised more that $227 million. According to the complaint, the offering documents failed to disclose that the company was at the time of the offering experiencing negative effects from the credit market turmoil and failed to recognize more that $200 million of losses on its “corporate loan and debt portfolio.”

On February 28, 2008, the company reported (here) a fourth quarter 2007 loss of 478.7 million, due in part to $134.9 million in charges associated with the “the impairment of two credits that are accounted for as held-to-maturity debt securities in its Corporate Loan and Debt portfolio.” and due to the fact that the company had increased its loan loss provisions by $113 million.

The Blackstone Lawsuit: In another example of the far flung effects from the current market turmoil, investors who bought shares of The Blackstone Group, L.P in the firm’s June 25, 2007 IPO have filed a lawsuit in the United States District Court for the Southern District of New York against the company and certain of its directors and officers.

According to the plaintiffs’ lawyers’ April 15, 2007 press release (here), the complaint alleges that the offering documents failed to disclose that Blackstone’s “portfolio companies were not performing well and were of declining value and, as a result, Blackstone’s equity investment was impaired and the Company would not generate anticipated performance fees on those investments or would have fees ‘clawed-back’ by limited partners in its funds.”

The complaint (which can be found here) alleges that in the company’s March 10, 2008 announcement (here)of fourth quarter and year end financial results, the company announced “announced that it was writing down its investment in Financial Guaranty Insurance Company by $122 million.”

Financial Guaranty Insurance Company is a bond insurer that has been struggling due to downgrades of its own credit rating. FGIC’s travails have already resulted in a prior securities class action lawsuit against the company’s other significant investor, The PMI Group. My prior discussion of The PMI Group securities litigation can be found here.

These events and ensuing lawsuits represent the latest extension of the circumstances that originated with the subprime lending meltdown but now are increasingly widespread. I recently highlighted (here) the turmoil (and ensuing litigation) that had affected the student lending sector. The extension of the effects and of the litigation, first to the commercial lending sector and to a commercial real estate financing company, and next to a private equity firm that went public only a short while ago amidst great hoopla and now has been sued for it, are merely the latest developments in what clearly promises to be an increasingly encompassing phenomenon.

As I have noted before, observers who persist in viewing the credit crisis and ensuing litigation as an exclusively “subprime”-related problem will not only fail to comprehend what has already occurred, but will likely underestimate what may lie ahead.

Another Auction Rate Securities Lawsuit: Another related recent development in this area is the lawsuit filed on April 14, 2008 on behalf of auction rate securities investors against Wells Fargo & Co. The plaintiffs’ attorneys’ press release can be found here and a copy of the complaint can be found here.

With the addition of the iStar, Blackstone and Wells Fargo lawsuits, my current tally of credit crisis-related securities lawsuits, which can be accessed here, now stands at 73, 33 of which have been filed in 2008. Thirteen of 73 lawsuits are brought on behalf of auction rate securities investors.

More Suits Against Securitzers: In earlier posts (here and here), I noted the emergence of securities class action lawsuits brought on behalf of investors against the investment banks and related entities that securitized mortgages and other types of debt into financial instruments in which the investors invested and in which they lost money.

The latest of these lawsuits was brought on March 19, 2008 in New York Supreme Court by the City of Ann Arbor Employees’ Retirement System on behalf of investors who purchased Mortgage Pass-Through Certificates as part of a December 12, 2006 offering of the instruments. Named as defendants are Citigroup Mortgage Loan Trust, which organized the offering of certificates backed by pools of mortgages, and 18 mortgage loan trusts, in which the mortgages were held. The defendants have removed the lawsuit to the United States District Court for the Eastern District of New York. Background regarding the lawsuit can be found here. A copy of the removal petition, to which the complaint is attached, can be found here.

The complaint alleges that the offering documents misrepresented the underwriting standards used in connection with the mortgage origination, and also misrepresented the various criteria used to qualify loans and properties. As a result, the complaint alleges, the offering documents misrepresented the risk profile of both the secured assets and the certificates.

The Citigroup lawsuit is substantially similar to the lawsuits previously brought against affiliates of Nomura (about which refer here), Countrywide (refer here) and Wachovia (refer here). This latest complaint is also similar to those prior complaints in that the plaintiffs (who in each case are represented by the Coughlin Stoia firm) sought to initiate each lawsuit in state court. My detailed analysis of the jurisdictional issues involved can be found in the post linked above regarding the Nomura lawsuit.  

Though the defendants have uniformly sought to remove these cases to federal court, in the Countrywide case, the earliest of these cases to be filed, the federal court granted the plaintiffs’ motion to remand the cases to state court. As noted in my discussion of the Countywide remand decision here, the federal court’s remand of the case to state court was based on the grant of concurrent jurisdiction to state courts for ’33 Act liability cases, a jurisdictional grant the federal court found has not been eliminated by subsequent legislation.

I have previously speculated that the plaintiffs’ strategy for pursuing these cases in state court is to avoid the requirements of the PSLRA, an impression that is reinforced by the fact that the plaintiffs’ lawyers did not issue a press release at the time they filed these state court complaints. Whether other defendants’ attempts to remove these lawsuits to federal court will ultimately prove to be successful remains to be seen, but the prospect of significant nationwide securities litigation going forward in state court seems fraught with the potential for uncertainty, opacity and complexity.

You’re Such a Lovely Audience, We’d Like to Take You Home With Us: As your reward for reading this far, I am going to share a wonderful little secret with you. Stanford Law School, which has long maintained its excellent Securities Class Action Clearinghouse (here) has now started the Stanford Global Class Action Clearinghouse (here). The new site is devoted to tracking the development of class action litigation throughout the world. While the site is new and is only just getting started, it already has very interesting materials and shows great promise. We can only hope its sponsors and guardians develop and maintain this new site as well as the predecessor.

Hat Tip to my good friends at the Drug and Device Law Blog (here) for the link to the new site.

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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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Add E*Trade and SunTrust Bank to the growing list of companies that have been sued in purported class action lawsuits on behalf of auction rate securities investors against companies that sold them the instruments. The plaintiffs’ attorney’s April 2, 2008 press release regarding the E*Trade auction rate securities lawsuit can be found here, and the complaint can be found here. The plaintiffs’ attorneys’ April 2, 2008 press release regarding the SunTrust lawsuit can be found here and the SunTrust complaint can be found here. With the addition of these two new suits, there have now been a total of ten companies sued in these auction rate securities class action lawsuits.

The auction rate lawsuits are interesting. Clearly the plaintiffs’ lawyers think they are worth pursing. And if the intensity of the auction rate securities investors’ anger is an accurate gauge, then the plaintiffs’ lawyers filing of these lawsuits ultimately could be justified. As a result of prior posts on this blog (here and here) about auction rate securities, I have received numerous emails and inquiries from upset auction rate securities investors. Notwithstanding the investor anger, it is probably worth noting that so far as I can tell the leading plaintiffs’ securities firms are not (at least not yet) active in this space. Most of the auction rate securities class action lawsuits thus far have been filed by two plaintiffs’ firms (refer here and here).

The allegations in these auction rate securities class action lawsuits are largely identical. Essentially the plaintiffs contend that the defendants failed to disclose material facts about the instruments. In particular, the defendants are alleged to have failed to disclose that the auction rate securities were not cash alternatives, but rather that there were only liquid at the time of auction. More to the point, the complaints allege that the defendants failed to disclose that the auction rate securities would become illiquid as soon as the broker-dealers stopped maintaining the auction market.

In each of these class action lawsuits, the complaint names as defendants a specific financial institution and its broker-dealer affiliate. No individual defendants are named. While each complaint contains substantially identical generalized allegations of misrepresentations or omissions, the complaints contain virtually no allegations about specific statements the particular defendants companies are alleged to have made.

And even though the complaints purport to allege breaches of Section 10(b) of the ’34 Act, the complaints’ only basis for alleging scienter are generalized allegations of knowing falsity; there are no allegations of insider trading, and no particularized factual allegations supporting the general allegations of knowing falsity. The complaints similarly depend on the failure of the auction rate market itself as satisfying the loss causation requirement, rather than referring to any alleged curative disclosures or anything else in particular about the specific securities in which the class members invested.

The defendants undoubtedly will argue that these generalized allegations are insufficient to meet the threshold pleading requirements, in reliance in particular on Tellabs and Dura Pharmaceuticals. But while the defendants may seek to have the actions dismissed, the plaintiffs’ lawyers clearly intend to keep filing these actions.

The lawsuits potentially may also raise some interesting D & O liability insurance coverage issues. Because the complaints do not name any individuals as defendants, the sole potential coverage under the typical D & O policy that these claims might trigger is the so-called “entity coverage” found in most policies. In most public company D & O policies, the entity coverage is strictly limited to “securities claims.” While the auction rate securities lawsuits purport to raise claims under the securities laws, these allegations may or may not trigger the potentially applicable entity coverage, depending on how the term “securities claim” is defined in the applicable policy.

There are two general variants of the “securities claim” definition. One variant defines the term “securities claim” by reference to the securities laws themselves, including within the definition claims that assert breaches of federal or state securities laws or their equivalent. The other definitional variation defines “securities claim” by reference to the claimants and securities allegation with respect to which would be recognized as a securities claim. For example, this latter category might limit a “securities claim” to claims brought by holders of the company’s securities, or alternatively, might limit a securities claim to alleged breaches in connection with trading of the company’s own securities.

Clearly this definitional distinction could make a difference in connection with these recently filed auction rate securities lawsuits, as these claims might assert a “securities claim” and trigger the entity coverage in policies that use the former variants, but may or may not trigger the entity coverage in the policies that have the latter variant.

It is probably also worth noting that a number of the companies (for example, E*Trade) that have been sued in these auction rate securities class actions have also separately been sued in securities class action lawsuits by the companies’ own shareholders. These companies’ available insurance coverage may be under significant pressure already.

With the accumulation of these lawsuits, whose numbers are likely to continue to grow, it may well be time for these lawsuits to be broken out into their own separate statistical category, much as the IPO laddering cases were when the were filed in 2001. The auction rate securities lawsuits clearly represent a litigation category distinct from the more typical securities class action brought by public company shareholders.

But with the addition of the two latest lawsuits, the total number of subprime related lawsuits, as reflected on my running subprime lawsuit tally (which may be accessed here), now stands at 64, of which 26 have been filed in 2008. As noted above ten of these 64 lawsuits represent lawsuits brought by auction rate securities investors. Two of the 64 were brought by asset-backed securities investors against the investment banks who created the instruments. Two of the 64 were brought by mutual fund investors against the fund companies and fund managers. The remaining lawsuits were brought by public company shareholders.

Subprime Derivative Lawsuits: In addition to securities lawsuits, some shareholders have also filed subprime-related shareholders’ derivative lawsuits against company management alleging breach of fiduciary duty and other legal breaches. The latest of these subprime-related derivative lawsuits was filed on April 1, 2008 in the United States District Court for the District of Maryland against Municipal Mortgage & Equity (“Muni Mae”) , as nominal defendant, and certain of its directors and officers (complaint here). Muni Mae has previously been sued in a subprime-related securities lawsuit (refer here).

The derivative suit against Muni Mae joins other subprime-related derivative lawsuits that previously have been filed against, among others, Countrywide, American International Group, Regions Financial, and Bear Stearns. I have not been separately tracking the subprime-related derivative lawsuits, basically because I failed to anticipate that shareholders would file as many subprime-related derivative actions as they have. In response to readers’ inquiries, I will now endeavor to track the subprime-related derivative suits.

Unfortunately, because I am coming at this task belatedly, I may fail to account for derivative lawsuits that were filed previously and of which I am unaware. I would be grateful if readers would let me know of any pending subprime-related derivative lawsuits of which they are aware, so that I can add them to my tally and the list will be as complete as possible.

Subprime Litigation Overview: The field of subprime-related litigation has continued to grow and expand, to the point where it is difficult to get an organized sense of the range of issues and litigants involved. An April 1, 2008 memorandum from the Gibson Dunn law firm entitled “Subprime-Related Securities Litigation: Where Do We Go From Here?” (here) provides a top-level overview of current exposures facing companies involved in subprime-related businesses. The paper identifies early trends and key defenses, takes a brief look at likely D & O insurance issues, and describes the factors that are likely to affect the likely future direction of this litigation.

A Canadian Backdating Lawsuit: Though the backdating scandal now seems like ancient history, it seems that the lawsuits are still continuing to come in, although the most recent instance involves a Canadian company sued in a Canadian court.

According to news reports (here), a shareholder of Savanna Energy Services Corp. has filed an action in Alberta’s Court of Queen’s Bench against eleven current or former directors and officers of the company, alleging that the defendants manipulated the company’s stock options in order to profit personally. The lawsuit seeks damages equal to the defendants’ ill-gotten gains and a ban on issuing options to the company’s executives. The plaintiffs’ complaint relies on an affidavit from Eric Lie, the University of Iowa professor whose research initially triggered the options backdating scandal. Lie’s affidavit reports “a high statistical probability” that individuals at Savanna backdated options between 2004 and 2007.

Because Savanna is a Canadian company whose shares trade only on the Toronto Stock Exchange and because it has been sued in Canadian court under Canadian law, I have not tried to shoehorn the case into my running tally of options backdating lawsuits (which may be accessed here). The Savanna lawsuit may represent its own unique category of one.

Delaware Corporate Law Update: Francis Pileggi has posted on his Delaware Corporate and Commerical Litigation Blog (here) an interesting series of posts (here, here and here) reporting on the proceedings at Tulane University's Corporate Law Institute, which took place this past week. The posts include a number of interesting commentaries from members of the Delaware judiciary. Francis's post (here) about Delaware law regarding the sale of companies is particularly noteworthy and interesting, particularly Vice Chancellor Strine's remarks about the duties of boards of companies in the process of the sale of a company.

Death by Blogging?: Readers who may not appreciate how stressful it can be to maintain a blog may want to review the April 6, 2008 New York Times article entitled “In Web World of 24/7 Stress, Writers Blog Till They Drop” (here), which surveys the toll that blogging is taking on some authors.

While no one here at The D & O Diary seems to be in any immediate danger, maintaining the blog is unquestionably stressful. The authors described in the Times article are (or rather, were) at least getting paid for their troubles, whereas The D & O Diary lacks even that consolation. Our blogging efforts defy Samuel Johnson’s sage words that “No man but a blockhead ever wrote except for money” -- words that we frequently contemplate to our distress. Yet on we blog, as if by compulsion. A blog is indeed a harsh mistress.

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Driven by the growing wave of subprime-related litigation (particularly a spate of auction rate securities lawsuits), the number of new securities class action lawsuit filings surged in March 2008. The total number of new securities class action lawsuit filings -- 25 – matches the number of new filings in November 2007, which in turn represented the highest monthly total of new filings since January 2005.

The 25 new securities lawsuits in March included 14 new subprime-related suits, taking account the new auction rate securities filed against J.P. Morgan Chase on March 31, 2008 (about which refer here). Of the 14 subprime-related suits, eight (including the new J.P. Morgan Chase lawsuit) were brought on behalf of auction rate securities investors against the companies that sold them the instruments. The remaining lawsuits (both those that are subprime-related and those that are not) were brought on behalf of public company shareholders against the companies and their directors and officers, other than one lawsuit brought on behalf of mutual fund investors.  

Largely because of the subprime-related litigation, many of the March lawsuits were filed in the United States District Court for the Southern District of New York – a total of 11 of March’s 25 new securities lawsuits were filed in the S.D.N.Y. Six of the new securities lawsuits filed in March involved companies domiciled overseas.

With the addition of the 25 new lawsuits in March, the total number of new securities lawsuits filed in the first quarter of 2008 totaled 52, of which 24 are subprime-related. All of the auction rate securities lawsuits were filed in March. (A complete list of the subprime-related lawsuits can be found on my running tally of subprime lawsuits, which may be accessed here.)

The 52 new securities class action filings in the first quarter of 2008, if extrapolated across four quarters, imply an annual filing rate of 208 new securities class action lawsuits, which is consistent with historical norms. (According to Cornerstone’s year-end 2007 securities analysis, here, the average number of securities class action filings during the period 1997 to 2006 is 1994). However, while this filing rate is consistent with historical levels, it is well above the annual levels seen in the most recent years, particularly 2006 (116) and 2007 (166).

Again, largely due to the number of subprime-related filings, the S.D.N.Y had the largest number of first quarter filings, with 21. The federal district with the next highest numbers of filings, D.Mass., had only five.

The companies sued in new securities lawsuits in the first quarter represented 31 different Standard Industrial Classification (SIC) Code categories, which might suggest that a broad diversity of companies were sued, but in most of those 31 categories only a single company was sued. The SIC Code categories with the largest numbers of companies sued were SIC Code category 6211 (Security Brokers and Dealers), with 7 companies sued, and 6021 (National Commercial Banks), with 6 companies sued. In all 29 companies in the 6000 SIC Code series (Finance, Insurance and Real Estate) were sued in the first quarter.

Nine of the companies sued for the first time in the first quarter of 2008 were domiciled overseas, representing eight different countries (including Switzerland, in which two of the companies are domiciled; the other seven countries had only one each.)

Six on the companies sued for the first time in the first quarter of 2008 had completed an initial public offering less than 12 months before the date of the first-filed lawsuit.

A final word about my lawsuit count: I am largely dependent on publicly available sources for my information about securities class action filings, although I have been able to supplement my information with data and links supplied by readers. (I am always grateful when readers bring information to my attention). I have compared my count to the information available on the Stanford Law School Securities Class Action Clearinghouse website (here) and have elected to omit certain cases that the Stanford site has included, largely because at least three of the cases listed on the Stanford site do not involved publicly traded companies. I will say that the diversity and variation of cases that have arisen in the last few months have created some very difficult categorization issues, and reasonable minds clearly could differ as to whether any particular case should or should not be “counted.”

While the securities class action lawsuit filing rate has fluctuated since mid-2007, the evidence remains consistent that the "lull" in filings that occured between mid-2005 and mid-2007 is over. It does remain to be seen if the filings will continue at their current rate, especially whethter factors such as the auction rate securities crisis will continue to drive litigation. On the other hand, the litigation activity is being driven by so many different aspects of the current crisis, it seems probable that subprime and other credit-related litigation will continue to accumulate. The more interesting question may be the extent to whcih the credit crisis litigation will spread beyond the financial sector.

A Further Thought about Securities Class Action Settlements: Earlier today I posted about the new Cornerstone report on 2007 class action settlements. The report is interesting and includes useful analysis and information. But upon reflection, it occurred to me that it is increasingly the case that class action settlement data alone may not provide all of the information necessary to understand the costs involved in resolving securities lawsuits. As I have noted in numerous prior posts (refer here), class opt outs are an increasingly important part of securities lawsuit resolution, a development that gained considerable momentum during 2007. Indeed, as I note here, the aggregate amount required to settle the Qwest opt-out actions actually exceeded the amount of the class settlement, and the amount paid in settlement of other opt actions is also very substantial.

For that reason, any assessment of the total costs involved in securities case resolution cannot be limited to class action settlements alone. The costs involved with separate opt-out actions must also be considered.

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As the markets for various types of subprime-related assets have seized up, many companies find themselves faced with complicated issues concerning asset valuation and disclosure. These issues have in turn both subjected companies to the possibility of litigation and encouraged investors to target the entities and institutions that sold them the assets in the first place. The extent of the asset valuation and disclosure issues suggests that the turmoil, and the ensuing litigation, will continue to spread.

One example where the valuation and disclosure issues have already led to litigation involves the securities class action lawsuit filed in the United States District Court for the District of Minnesota on March 28, 2008 against MoneyGram International and certain of its directors and officers. A copy of the plaintiffs’ attorneys’ press release can be found here and a copy of the complaint can be found here.

The complaint against Moneygram relates to the company’s January 14, 2008 press release (here) in which the company stated that it had completed its valuation of its investment portfolio as of November 30, 2007, as a result of which the company said that it had “experienced net unrealized losses of $571 million from September 30, 2007, bringing cumulative net unrealized losses to $860 million.” The company also announced that it has commenced a process to “realign is portfolio away from asset-backed securities,” as a result of which it had realized in January a loss of $200 million on asset sales of $1.3 billion.

According to the plaintiffs’ lawyers’ press release, the complaint alleges that the defendants “concealed from the investing public” that:

(a) the Company lacked requisite internal controls to ensure that the reserves for the Company’s investments in asset-backed securities were adequate, and, as a result, the Company’s projections and reported results issued during the Class Period were based upon defective assumptions and/or manipulated facts; and (b) the Company concealed the extent of its potential losses arising from its exposure to asset-backed securities containing uncollectible debt.

The prospect of securities litigation arising from asset valuation and disclosure issues is a potentially very substantial problem, because so many companies are facing these same kinds of issues due to asset-backed securities in their investment portfolio. Similarly, companies holding auction rate securities are facing particularly challenging valuation and disclosure issues, and as I have previously noted (most recently here), these challenges are not limited to companies in the financial sector, but indeed are widely dispersed throughout the economy. For example, a March 28, 2008 Wall Street Journal article entitled “’Auction Rates’ Clip Tech Firms’ Profits” (here) discusses the financial impacts that a variety of technology companies are facing because of the companies’ inability to convert their auction rate securities holdings into cash.

One measure of the depth of the problems arising from the failure of the auction rate securities market is that it is not just companies whose balance sheets are under pressure. Many households and individuals are also now about to recognize their own personal balance sheet hits due to the auction rate problem. According to a March 29, 2008 Wall Street Journal article entitled “UBS Plans Auction-Rate Price Cut” (here), UBS is going to lower the values of the auction rate securities held by its customers. The reduced values, which will be based on computer models and “will range from a few percentage points to more than 20%” will be reflected on their customers’ forthcoming statements.

As I have previously noted (most recently here), investors have already filed a number of class action lawsuits against the companies that sold them auction rate securities, and on March 27, 2007, Citibank became the latest to be sued in a securities class action on behalf of investors for its sale of auction rate securities (see press release here and complaint here). The reduction of the carrying values of auction rate securities on investors’ statements will likely further bestir investors and could lead to even more litigation. But making no adjustments could create a different set of issues and lead to greater problems later.

The question of how best to reflect the valuation of assets for which there is no current market is one that potentially affect participants at all levels of the economy. And while there undoubtedly will be more lawsuits on behalf of investors against the companies that sold them the auction rate securities, a potentially greater litigation threat may arise from shareholders who may contend they were misled about a company’s balance sheet exposure to these kinds of assets. There could well be a great deal of litigation in which it is alleged, as asserted in the complaint in the MoneyGram case, that a company failed to disclose the “extent of its potential losses arising from its exposure to asset-backed securities containing uncollectible debt.”

The extent of the problem shall be revealed in the fullness of time. But meanwhile the subprime-related securities class action litigation still continues to accumulate. With the addition of the MoneyGram and Citigroup lawsuits, my running tally of subprime-related securities lawsuits (which can be accessed here) now stands at 61, 23 of which have been filed in 2008, and seven of which are filed on behalf of auction rate investors against the companies who sold them the securities.

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Add Merrill Lynch and Morgan Stanley to the growing list of companies that have been sued in securities class action lawsuits by investors for allegedly deceptive representation in connection with the sale of auction rate securities. According to the plaintiffs’ attorneys’ March 25, 2008 press release (here), the plaintiffs’ have filed a securities class action lawsuit in the United States District Court for the Southern District of New York against Merrill Lynch and its asset management company on behalf of investors who purchased auction rate securities from Merrill Lynch between March 25, 2003 and February 13, 2008.  A copy of the complaint can be found here.

According to the press release, Merrill Lynch “offered and sold auction rate securities to the public as highly liquid cash-management vehicles and as suitable alternatives to money market mutual funds.” The complaint alleges that Merrill Lynch failed to disclose that  

(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 Merrill Lynch and other broker-dealers were artificially supporting and manipulating the auction rate market to maintain the appearance of liquidity and stability; (3) Merrill Lynch 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) Merrill Lynch 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.

According to news reports (here), plaintiffs also filed a separate but substantially similar lawsuit against Morgan Stanley, raising more or less the same allegations on behalf of a class of investors who purchased auction rate securities from Morgan Stanley during the same class period as proposed in the Merrill Lynch lawsuit. I have not located the Morgan Stanley complaint itself, but will add a link when I get a copy.

UPDATE: A copy of the plaintiffs' lawyers' March 25, 2008 press release announcing the Morgan Stanley auction rate securities lawsuit can be found here and a copy of the complaint can be found here.

These two new lawsuits join a group of similar lawsuits, all filed by the same law firm on behalf of auction rate securities investors, against Deutsche Bank, Wachovia, TD Ameritrade and UBS. The law firm’s webpage describing these various lawsuits can be found here.

With the addition of these two new subprime-related securities class action lawsuits, my running tally of subprime related securities lawsuits, which can be accessed here, now stands at 59, of which 21 have been filed in 2008. Two of these 59 represent lawsuits brought on behalf of investors against mortgage-backed asset securitizers, six are class action lawsuits on behalf of auction rate securities investors, two are brought on behalf of mutual fund investors, and the remaining 49 of which are brought on behalf of public company shareholders.

Subprime Litigation Wave Hits Regions: Birmingham, Alabama-based Regions Financial Corporation has been hit with a couple of different subprime-related lawsuits as the subprime wave continues to spread beyond New York, California, and Florida, the states where the subprime litigation originally was concentrated.

First, according to a March 25, 2008 Birmingham News article (here), the Catholic Medical Mission Board, a Regions shareholder, has filed a shareholders’ derivative lawsuit against Regions, as nominal defendant, and certain Regions directors and officers, alleging that the defendants failed to disclose the extent of Regions’ lending exposure to residential homebuilders, which permitted company insiders to sell their shares in company stock at inflated prices. According to the news report, the complaint alleges that "Regions Financial's stock was artificially inflated because the defendants directed the company to hide the true extent of its subprime exposure.’

The derivative complaint (which can be found here) asserts claims for breach of fiduciary duty, waste of corporate assets, unjust enrichment, and breach of Section 10(b) of the ’34 Act.

Second, Regions has also been hit with a lawsuit filed under ERISA on behalf of its participants in the Regions defined contribution plan. A copy of the complaint can be found here. The complaint alleges that the offered plan participants Regions stock and investment options in Regions Morgan Keegan funds “when it was imprudent