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

As the most dramatic evens from the financial crisis recede into the past, there is an urge to consign the downturn to the pages of history, But the banking crisis in Cyprus earlier this week, along with persistent unemployment in this country and elsewhere, show that, as much as we would all like to turn the page, the credit crisis still is not yet in the past. And just like the economic effects, the litigation that accumulated as a result of the crisis continues to grind through the courts as well.

The most recent example of the continuation of the credit crisis litigation involves a case pending in the Southern District of New York against Deutsche Bank and four of its directors and officers. The case was filed on behalf of investors who purchased Deutsche Bank common stock between January 3, 2007 and January 16, 2009. (Based on Morrison, the district court dismissed from the case any shareholders who purchased their shares outside the United States.) 

In a March 27, 2013 order (here), Southern District of New York Judge Katherine Forrest largely denied the defendants’ motions to dismiss the plaintiffs’ complaint. There are a number of interesting things about Judge Forrest’s ruling, in particular the significance she attached to the massive (and profitable) short bet a Deutsche Bank trader made against residential mortgage backed securities (RMBS) and collateralized debt obligations (CDOs) at the same time Deutsche Bank was profiting from packaging and selling these very kinds of securities to outside investors.

Background

As discussed here, the plaintiffs first filed their lawsuit in 2011, seeking damages under the federal securities laws based both on an alleged scheme to defraud and on alleged misrepresentations or omissions. The plaintiffs alleged that the bank had structured and sold RMBS that it knew to be poor quality; misrepresented its risk management practices; failed to write down impaired securities; and disregarded findings that the residential mortgage loans did not comply with underwriting standards.

The defendants moved to dismiss, arguing that the “scheme” theory was after the fact construct rather than a before the fact plan; that the alleged misstatements were merely subjective opinions that are not actionable and that in any event were not made with scienter, and that the specific defendants were not the makers of actionable misstatements.

In drafting their complaint, the plaintiffs were able to draw extensively on the April 2011 report about the financial crisis of the U.S. Senate Subcommittee on Investigations as well as complaints that the U.S. Department of Justice and the Federal Housing Finance Agency filed against Deutsche Bank. Among other things to which plaintiffs were able to cite and to which Judge Forrest referred in her opinion were internal emails referring to the RMBS that the bank was marketing as “crap” and referring to the CDOs that the bank was structuring as a “balance sheet dump” (As is now all too familiar with allegations of damaging internal emails, there are many similar statements in this same vein.)

In her opinion, Judge Forrest also cites at length allegations based on internal communications relating to a massive bet a Deutsche Bank trader, Greg Lippmann, had made against the very kind of RMBS that the bank was packaging and selling. His short position ultimately grew to be as large as $4 to $5 billion. The position was so large that it drew the attention of the top company management, who reviewed his position and allowed him to continue to pursue his strategy. Judge Forrest’s opinion quotes numerous internal emails in which Lippmann disparaged Deutsche Bank’s own RMBS deals. Lippmann’s short bet ultimately returned profits of $1.5 billion, allegedly “the largest profit Deutsche Bank ever obtained from a single short position.”

In denying Deutsche Bank’s motion to dismiss, Judge Forrest found the “defendants had specific knowledge of the poor quality of the mortgages” and that the defendants “demonstrated this knowledge by authorizing Lippmann to take and expand a multi-billion dollar short position. Despite their awareness of these problems, the defendants “nonetheless repeatedly assured investors that their credit and lending practices were conservative and being adhered to.”

Judge Forrest specifically rejected the defendants’ argument that the alleged misrepresentations and omissions on which the plaintiffs sought to rely were mere non-actionable statements of opinion. She noted that the plaintiffs allege that “at the very time the market was beginning to experience the early effects of the sub-prime implosion, Deutsche Bank made statements that it had acted conservatively with respect to risk and had adhered to conservative lending standards.” Noting that the plaintiffs also alleged that at the same time defendants made these statements, “the same individuals who had made the statements had been provided information indicating the opposite,” allegations that present facts “supportive of both objective and subjective falsity.”

In concluding that the scienter allegations were sufficient as to three of the four individuals defendants (the fourth was dismissed for lack of any allegations tying the individual to any specific statements), Judge Forrest noted that the defendants had made statements about the mortgage-backed securities operations “while at the same time knowing that these assets were far riskier than an investor might reasonably suppose.” She specifically reference allegations that Lippmann had made presentations to the Executive Committee, of which the three defendants were members, supporting his view that a multi-billion dollar bet against RMBSs and CDOs was appropriate. These allegations, she found, “support a strong inference of scienter.”

Discussion

A few days ago, when it was announced that Citigroup had settled the subprime-related bondholders’ action for $730 million, there was a sense that the subprime litigation stage might finally be winding up, with only a little bit of moping up left to go. At almost the same time, however, the U.S. Supreme Court denied a writ of certiorari in the Goldman Sachs bondholders’ action, ensuring that the Goldman case would go forward with a broad class definition as a result of the Second Circuit’s opinion in that case (about which refer here, fourth item).

And now Judge Forrest has denied the motion to dismiss in this case involving Deutsche Bank. The ongoing cases against Goldman Sachs and now this one against Deutsche Bank are reminders that the subprime-related litigation wave may still have a lot further to run yet.

The significance that Judge Forrest attached to Deutsche Bank’s internal emails is nothing new. By now we have now grown accustomed to the damaging use that can be made of incautions or ill-advised internal emails. What is perhaps more interesting is the significance that she attached to Lippmann’s short position and his internal communications about it (that is, his defense to company management of his investment position). It is true that Lippmann’s short position ultimately grew to several billion dollars. At the same time, though, Deutsche Bank’s mortgage group held a $102 long position, and another affiliate held a separate long position of almost $9 billion.

The defendants had tried to argue that the much larger long position showed the company’s true beliefs about the market for mortgage-backed securities. Judge Forrest said about the divergent bets that “it simply means that they are gamblers unwilling to place their entire bet on red, versus black.” The plaintiffs’ complaint, she found, “plausibly suggests that they assured investors that their bets were in one direction – and omitted that they had taken bets in both directions.” That is, everything they said was consistent with and supported their long position, without divulging the (admittedly much smaller) short position.  The key seems to be that the plaintiffs alleged both that the defendants were aware of Lippmann’s short position and his reasons for taking it; they were not only aware of the concerns on which the short bet was based but they allowed him to expose billions of dollars on the bet, while providing reassuring words to investors.

Seventh Circuit Affirms Boeing Securities Suit Dismissal: The outcome of the dismissal motions in the Deutsche Bank case shows how advantageous it can be for plaintiffs lawyers when they have extensive public resources (like a 646-page Senate report) on which to rely in crafting their allegations. The Seventh Circuit’s March 26, 2013 affirmance of the district court’s dismissal of the securities suit that had been filed against Boeing and based on production delays involving its Dreamliner aircraft shows the challenges plaintiffs’ lawyers can face when they don’t have those kinds of resources to rely upon. The Seventh Circuit’s opinion can be found here.

As detailed in the appellate court’s opinion, written by Judge Richard Posner for a three-judge panel, the plaintiffs alleged that the defendants had misled investors by failing to disclose that the company would not make its target date for the “First Flight” of the airliner, despite knowing of production issues that would require the flight to be delayed. The plaintiffs’ initial complaint was dismissed because it lacked sufficient allegations to support the allegation that the defendants knew that the production issues would require the first flight to be delayed.

In order to try to address these problems in their amended complaint, the plaintiffs sought to rely on a single confidential witness, an engineer later identified as Bishunjee Singh. The complaint relied on Singh’s statements to support amended allegations that company management knew that the airliner had failed certain tests and that the failure might result in a delay of the first flight.

There was only one problem – “No one had bothered to show the complaint to Singh” and “investigations by Boeing soon revealed that the complaint’s allegations concerning him could not be substantiated.” In his deposition, Singh “denied virtually everything that the investigator had reported.” The appellate court noted that the district court thought that the plaintiffs’ lawyers “failure to attempt to verify their allegations in the investigator’s notes amounted to a fraud on the court.”

The appellate court not only affirmed the dismissal of the plaintiffs’ complaint but remanded the case to the district court for further proceedings with respect to question of sanctions. As if that were not bad enough, the appellate court made a point of noting that the same plaintiffs’ firm had been criticized for making misleading allegations concerning confidential sources in order to stave off dismissal in other cases. The appellate court noted that “recidivism is relevant in assessing sanctions.’

Alison Frankel has a particularly interesting commentary on the Seventh Circuit’s opinion in the Boeing case in a March 26, 2013 post on her On the Case blog (here).

Readers will be interested to note that the lead plaintiffs’ firm in both the Deutsche Bank case discussed above and in the Boeing case is the same firm. Any number of conclusions might be drawn from the outcomes in the two cases, starting with the fact that one case was dismissed and may result in the award of sanctions, whereas the other case is going forward. Among the many differences between the cases, however, is that in the one case, the plaintiffs were able to rely on a detailed report for a U.S. Senate Committee in drafting their complaint. In the other case, well, the sources were not so good.

Readers mulling this over and reaching conclusions about ultimate considerations of justice may want to pause a moment and consider, from the perspective of Boeing investors, the ultimate history of the Dreamliner aircraft. As detailed in an article entitled “Requiem for a Dreamliner?” in the February 4, 2013 issue of the New Yorker (here), the latest problems with the Dreamliner’s batteries, which have grounded the entire fleet of Dreamliners, “is just the latest in a long series of Dreamliner problems, which delayed the plane’s debut for more than three years and cost Boeing billions of dollars in cost overruns. The Dreamliner was supposed to become famous for its revolutionary design. Instead, it’s become an object lesson in how not to build an aircraft.”

Given the airliner’s checkered development history, the plaintiffs’ lawyers may feel that the problem was not that they didn’t have a valid claim, but that they just couldn’t come up with the right sources. And if you were of a certain frame of mind and only focused on the portion of the Seventh Circuit’s opinion about the sanctions issue (which has certainly drawn all of the media attention), you might (or might not) take the plaintiffs’ point.

However, Judge Posner also had some very interesting things to say about scienter, that might suggest how difficult it would be for plaintiffs’ to state a securities claims based on developmental stage production delays. Judge Posner’s comments about scienter go on for several pages and are worth reading in full; it would be hard to do them full justice here. Among other things, Judge Posner noted how implausible it is that the company had any motivation to mislead either investors or prospective customers by postponing for a few days (until after the Paris Air Show) the announcement that the first flight would be delayed. Posner noted that:

A more plausible inference than that of fraud is that the defendants, unsure whether they could fix the problem by the end of June, were reluctant to tell the world “we have a problem and maybe it will cause us to delay the First Flight and maybe not, but we’re working on the problems and we hope we can fix it in time to prevent significant delay, but we can’t be sure, so stay tuned.”

Citing Kant on the difference between “a duty of truthfulness and a duty of candor,” Posner added that “there is no duty of total corporate transparency – no rule that every hitch or glitch, every pratfall, in a company’s operations must be disclosed in “real time,” forming a running commentary, a baring of corporate innards, day and night.” (Call it a hunch, but I suspect that Posner’s words are in for a long run in future dismissal motions).

At this point, the Dreamliner has accumulated a lifetime supply of hitches, glitches and pratfalls. However, Posner is saying that without more, even a snootful of glitches doesn’t amount to securities fraud. As for what might constitute “more,” well, it seems like the factual details from a voluminous report of a Senate subcommittee appears to be enough. An unreliable witness definitely is not enough -- except perhaps for sanctions

Special thanks to a loyal reader for supplying me with a copy of the Boeing decision.

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By now you will have heard that the U.S. Department of Justice has filed a securities class action lawsuit against S&P and its corporate parent, McGraw-Hill, about the rating agency’s  ratings of collateralized debt obligations as the subprime meltdown unfolded. A copy of the DoJ’s complaint, filed on February 4, 2013 in the Central District of California, can be found here.

The complaint has attracted widespread media attention, as well it should, since it represents that government’s first action against a rating agency in connection with the subprime meltdown and the credit crisis But there are a number of interesting features to this action, beyond just the fact that the DoJ has filed a lawsuit against a rating agency.

First, there’s the fact that the lawsuit was filed in the Central District of California, rather than in New York, where S&P is located. To the extent that the complaint supplies an answer for the choice of venue question, it appears that the DoJ chose the C.D. Cal. because that is where the failed Western Federal Corporate Credit Union was located. As is alleged in the complaint, the failed credit union was apparently an investor in a number of the specific CDOs mentioned in the complaint. Many of these investments resulted in a total loss to the credit union. More broadly, the DoJ alleges that the S&P engaged in a scheme to “defraud investors.” The specific investors mentioned by name in the complaint area all federally insured depositary institutions.

The second interesting thing about the complaint is that thought it was filed by the Department of Justice, it has been filed as a civil action, presumably because the DoJ feels stands a better chance of success with the lower standard of proof applicable in a civil case. But though the case was filed as a civil action, the claims asserted are a little unexpected (at least to me). The DoJ asserts substantive claims for wire fraud, mail fraud, and two counts of financial institution fraud under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”).

In its February 4, 2013 press release about the then-anticipated law suit, S&P characterizes  the DoJ’s use of FIRREA as a “questionable legal strategy” intended as an attempt to “end run” the “well-established legal precedent “ on which the defendants hope to rely. Presumably, the reference to the established precedent refers to case law finding that that rating agency’s opinions represent opinion protected under the first amendment.

I suspect a different explanation for the DoJ’s reliance on FIRREA. The fact is, many of the events described in the complaint took place many years ago, in some instances six years ago or more. The DoJ is rightly worried about possible statute of limitations concerns. That’s where FIRREA comes in. FIRREA has a ten-year statute of limitations for a violation of, or a conspiracy to violate, the mail or wire fraud statutes, if the offense affects a financial institution (about which refer here). The defendants undoubtedly will try to raise a host of defenses, but the DoJ doesn’t want statute of limitations issues to cut the action short.

Third, the complaint names as defendants only S&P and its corporate parent. None of the other rating agencies are named – a point that gripes S&P. In its February 5, 2013 press release, issued after the complaint was filed, S&P notes that “every CDO cited by the DoJ also independently received the same rating from another rating agency.” It may simply be that S&P is up first and the other rating agencies’ turn is coming. However, another possibility may be that the DoJ had more to work with against S&P, particularly from the apparent treasure trove of emails that are liberally quoted in the complaint.

The complaint paints a very detailed picture of the dynamic inside S&P as it became increasingly apparent in early 2007 that residential mortgages originated in 2006 were failing quickly, particularly with respect to subprime and Alt-A mortgages. It is clear that S&P felt under a great deal of pressure not to move any more quickly than its competitors for fear of losing business. The warning signs appeared to accumulate as 2007 unfolded while at the same time the issuers who sought out S&P’s ratings were scrambling to complete offering s, to get mortgage backed securities out of their warehouse. The emails and other internal communications (at least as portrayed in DoJ’s complaint) seem to show a sequence of events where alarm bells were sounding louder yet deals continued to get pushed through.

As things deteriorated, a gallows humor seems to have set in, provoking a number of emails in which S&P staffers apparently acknowledged the growing problems. As quoted in detail in this February 5, 2013 Business Insider column (here), the emails show an apparent perception on the part of at least some S&P staff that the firm was compromising its rating standards under pressure from issuers. The emails include the now-infamous email in which one staffer quipped that a transaction could be “structure by cows” and the firm would still rate it. Another email exchange between an analyst and an investment banker outside the firm about how the MBS world is “crashing” and the firm is running around to “save face.”

Another analyst sent an email with a spoof version of Talking Heads’ classic hit, “Burning Down the House,” including lyrics that “huge delinquencies” in the 2006 vintage were “bringing down the house.” The complaint alleges that shortly after this first email, the same analyst sent an email with a video of the analyst singing the first verse of the spoof for an audience of laughing S&P staffers. (More about the surprise appearance from the Talking Heads in the DoJ’s complaint here.)

Whatever may be the reasons why the DoJ decided to proceed under FIRREA and to sue only S&P, the agency will still have to contend with the argument that the rating agency’s ratings are inactionable opinion or are protected by the First Amendment – arguments that the Sixth Circuit appeared to validate in its December 2012 opinion dismissing actions that the Ohio Attorney General filed against the rating agencies on behalf of Ohio state employee pension funds.

Time will tell how the DoJ attempts to address these arguments, but it appears from the agency’s complaint that the agency will be attempting to argue that S&P is not entitled to rely on these defenses because the ratings did not represent the rating agency’s opinions. The complaint alleges that the rating agency “falsely represented” that the ratings “reflected S&P’s true opinion” regarding the credit risks the complex securities represented to investors.  The DoJ may be poised to argue that the alleged misrepresentations on which its claims are based are not the opinions themselves but rather the rating firm’s statements about its process and the integrity of its process.

One final question is why is the government acting now, years after the crash and years after the events described in the complaint? Several media reports suggested that the DoJ acted only after attempts to work out a negotiated settlement failed. One of the S&P’s lawyers tried to suggest on CNBC that the government investigation intensified after the rating firm downgraded the U.S.’s debt. What ever the reason that the complaint is only being filed now, if nothing else the complaint does show that we are continuing to live with the fallout from the credit crisis and the issues from the crisis are going to be litigated for some time to come.

Alison Frankel has a good summary of the complaint and its allegations in her February 5, 2013 post on her On the Case blog (here).

Special thanks to the several readers who sent me a copy of the DoJ’s complaint.

And Finally: With a hat tip to the Business Insider article linked above, here is the original video version of “Burning Down the House”

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Though many include the rating agencies among the list of culprits that contributed to the global financial crisis, the rating agencies have up until now largely dodged attempts to hold them liable. While there have been a small number of cases (refer for example here) where courts have denied the motions of rating agencies to dismiss claims that had been filed against them, those few cases have not (or least not yet) resulted in the imposition of liability against the rating agencies.

However, in a gargantuan September 5, 2012 opinion that appears to represent the first imposition of liability on a rating agency in a case arising out of the financial crisis,, an Australian Judge that ruled that S&P’s AAA rating of a complex financial instruments was “misleading and deceptive” and “involved negligent misrepresentations” and therefore that S&P was liable to twelve local Australian governments that purchased the investments. The 1,459 page ruling by Federal Court Justice Jayne Jagot can be found here. A November 5, 2012 Bloomberg news article describing the ruling can be found here.

The financial instruments in question were structured financial product known as a constant proportion debt obligation (CPDO), which one witness in the case described as “grotesquely complicated” (a description that Judge Jagot affirmed to be  “accurate”). The CPDO structure involved a special purpose vehicle that issued notes allowing investors to invest in the CPDO’s performance. The CPDO was a complex and highly leveraged vehicle that would make or lose money through notional credit default swap (CDS) contracts referencing two CDS indices. (Got that? Good.)

The CPDO was created in April 2006 by ABN AMRO, which had determined that in order to obtain a AAA rating, the rating model needed to show a very low likelihood of default (less that 0.728%). ABN AMRO determined what model inputs were needed in order to produce a determination that the instrument’s likelihood of default was within the desired range. According to Judge Jagot’s opinion, ABM AMRO convinced S&P to use the these desired inputs, even though ABN AMRO had reason to know that at least some of the inputs did not correspond to known marketplace conditions. Judge Jagot found that S&P used these inputs even though it could have determined on its own that at least some of the inputs did not correspond to marketplace conditions.

Thereafter, ABN AMRO created and sold additional versions of the CDO, including the Rembrandt 2006-2 CPDO and Rembrandt 2006-3 CPDO. S&P gave these later financial instruments the same AAA rating using the same methodology. Judge Jagot found that S&P gave these later offerings the same AAA rating and using the same methodology even though during the period between these two subsequent offerings a number of questions had been asked internally within S&P about the methodology (Internal S&P emails from this time period and cited by Judge Jagot in her opinion contain statements asking whether there was “a crisis in CPDO land” and asking whether the rating agency had been “bulldozed” by ABN AMRO.)

In late 2006 and early 2007, the Local Government Financial Services Pty (PGFS), an authorized deposit-taking institution organized by and actin g on behalf of Australian local governments (“councils”), purchased a total of A$40 milli0on of Rembrandt 2006-3 CPDO. Between November 2006 and June 2007, a number of councils in New South Wales purchased a total of A$16 million of these CPDO notes from LGFS, which kept the remainder of notes it had purchased on its own balance sheet.

As 2007 progressed, the global financial crisis began to unfold, which, among many other things, caused spreads to widen between the instruments credit default swaps and the referenced CDS indices. As the spreads widened, S&P downgraded the notes and the value of the notes declined substantially. LGFS sold the notes it continued to hold for a principal loss of $16 million. The various local councils cashed out in October 2008, receiving back less than 10% of the capital they had invested.

Judge Jagot found that S&P’s AAA rating of the Rembrandt notes was “misleading and deceptive and involved the publication of information or statements false in material particulars and otherwise involved negligent misrepresentations to the class of potential investors in Australia, which included LGFS and the councils.” She also found that ABN AMRO “engaged in conduct that was misleading and deceptive and published information or statements false in material particulars and otherwise involved negligent misrepresentations to LGFS specifically and to the class of potential investors with which ABN AMRO knew LGFS intended to deal.” Judge Jagot also concluded that LGFS has also engaged in “misleading and deceptive conduct.”

Judge Jagot concluded that ABN AMRO and S&P were equally liable to LGFS for the entity’s losses, although a part of LGFS’s claimed losses were reduced by LGFS’s own conduct. She also concluded that S&P, ABN AMRO and LGFA were each proportionately liable for one third of the councils’ losses. S&P has said publicly that it intends to appeal the ruling.

As a decision of an Australian court, the ruling will have no direct legal bearing on the outcome of any of the many cases pending against the rating agencies in the United States. Moreover, Judge Jagot’s ruling is very fact intensive and involves a host of specific factors that uniquely related to the circumstances at issue.

Nevertheless, the opinion (though dauntingly long and complicated) is very interesting and it offers a fascinating glimpse of the processes involved in rating at least one of the very complicated financial instruments that caused so many problems during the financial crisis. Judge Jagot’s opinion provides a look behind the scenes that can only be described as disturbing. Of course, S&P disputes her conclusions and intends to appeal her rulings. But Judge Jagot’s painstaking analysis suggests that, here at least, the rating agency was, as one email Judge Jagot  put it, “bulldozed” by the financial firm that created the instrument the rating agency was rating, and did not independently verify the validity of the inputs employed in the rating model it used.  

These conclusions are consistent with the allegations that have been raised in the many claims against the rating agencies here in the U.S.  -- that the rating agencies were insufficiently independent and used inadequate ratings methodologies in providing the highest investment rating to complex financial instruments in the run up to the financial crisis. The fact that a court expressly found that a rating agency misled investors as a result of which the rating agency must be held liable to the investors has no precedential effect in these other cases. But it could have an effect on the context within which these other courts consider the allegations against the rating agencies. At a minimum, Judge Jagot’s ruling could hearten the claimants in those other cases.

Without having read the entirety of Judge Jagot’s nearly 1,500 page opinion, I can’t say for sure whether or not she considered the issue that has proven so critical in so many of the cases here in the U.S. – that is, that the rating agency’s ratings are mere opinions for which the rating agency’s cannot be held liable unless the claimant can show that the rating agency did not in fact actually hold the stated opinions. The absence of this consideration could perhaps explain the difference in outcome between the Australian case and so man of the cases here in the U.S. Many of the cases in the U.S. have ben dismissed on this basis. The Australian case does show what kinds of things might come to light if the cases against the rating agencies are allowed to foreword.

ABN AMRO was of course acquired in October 2007 by a consortium of investors led by the Royal Bank of Scotland and that included Fortis, in a transaction that contributed substantially to the near collapse of both RBS and Fortis, both of which subsequently required massive government bailouts. There is a lot of competition among the deals completed in the run up to the financial crisis for the title of worst deal of all time (think, for example of BofA’s acquisition of Countrywide). But there is a good case to be made that the ABN AMRO deal takes the cake. Anybody trying to understand how it all went wrong might want to start by taking a look at the Judge Jagot’s opinion in this case. 

Felix Salmon has an absolutely terrific November 5, 2012 article on Reuters about Judge Jagot's opinion, here. Salmon is lavish in his praise for Jagot and her understanding of the complex financial instrument involved in the case.

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In what is by far the largest settlement of a credit crisis-related securities class action lawsuit, Bank of America has agreed to pay $2.43 billion to settle the suit filed against the company and certain of its directors and officers in connection with the bank’s financial crisis-driven acquisition of Merrill Lynch. The settlement is subject to court approval. Bank of America’s September 28, 2012 press release announcing the settlement can be found here.

The settlement is not only the eighth largest securities class action lawsuit settlement ever (refer here for the Stanford Law School Class Action Clearinghouse’s list of the top ten largest securities suit settlements), but according a September 28, 2012 press release from the Ohio Attorney General (whose office represented several Ohio pension funds that were among the lead plaintiffs in the case) it is the fourth largest settlement funded by a single defendant for violations of the federal securities laws, and it is largest securities class settlement ever resolving a Section 14(a) case (alleging misrepresentations in connection with the a proxy solicitation). According to the Ohio AG, the settlement is also the largest securities class action settlement where there were no criminal charges against company executives.

The three largest single-defendant securities class action settlements are Tyco’s $2.975 billion settlement in 2007; Cendant’s 1998 settlement ($2.83 billion); and Citigroup’s $2.65 billion contribution to the WorldCom case settlement. The total amount paid in settlement in each of these cases was larger than these amounts due to the contribution s of other defendants.

As discussed here, the BofA Merrill Lynch merger case had survived two rounds of dismissal motions, and according to press reports was scheduled to go to trial on October 22, 2012. In her On the Case blog (here), Alison Frankel has an interesting account of how the settlement came about and the various factors (including the looming trail date) that “forced” BofA to settle the case. Susan Beck has an interesting September 28, 20912 article on the Am Law Litigation Daily(here) in which she questions BofA’s decision to rely on the Wachtel Lipton firm (which had advised the bank in connection with the Merrill Lynch acquisition) for its defense in the securities suit. 

The case arises out of BofA’s agreement, reached in mid-September 2008, at the height of the global financial crisis, to acquire Merrill Lynch. In October and November 2008, while shareholder approval of the transaction was pending, Merrill suffered losses of over $15 billion and also took a $2 billion goodwill impairment charge. The Complaint alleges that BofA’s senior officials were aware of these losses as they occurred. The Complaint alleges that the losses were so significant that BofA management discussed terminating the transaction, prior to the December 5, 2008 shareholder vote on the merger, in which BofA shareholders approved the merger.

On December 17, 2008, BofA Chairman and CEO Kenneth Lewis called Treasury Secretary Henry Paulson to advise him that BofA was "strongly considering" invoking the “material adverse change” clause in the merger agreement, in order to terminate the deal prior to its scheduled January 1, 2009 close date.  At Paulson’s invitation, Lewis flew to Washington for a face-to-face meeting, at which Paulson and Federal Reserve Board Chair Ben Bernanke urged Lewis not to invoke the MAC clause.

In subsequent conversations, Lewis again advised the government officials that BofA intended to invoke the MAC clause. According to the plaintiffs’ allegations, BofA’s board voted on December 21, 2008 to invoke the MAC clause, but on the following day, the Board voted to approve the merger, apparently in part based on Lewis’s statement that he had received verbal assurances from Paulson that BofA would received a capital infusion and a guarantee against losses from risky assets if the merger concluded.

On January 16, 2010, BofA disclosed the fourth quarter losses of both BofA and Merrill and also revealed the federal funding package, which included $20 billion in capital and protection against further losses on $118 billion in assets. In following days, news reports revealed that in the days prior to the deal’s close, Merrill employees had been paid massive bonuses. 

In the two trading days following the January 16 disclosure, BofA’s market capitalization dropped over $20 billion, and shareholder litigation ensued. The plaintiffs alleged that the defendants misstated and concealed matters related to the Merrill bonuses, the losses that accrued in the Fourth Quarter of 2008 after the merger was announced, and the pressure to consummate the deal from government officials. After the securities and derivative lawsuits were consolidated, the defendants moved to dismiss.

In a lengthy August 27, 2010 opinion (about which refer here), Southern District of New York  Judge Kevin Castel denied in part and granted in part the defendants’ motions to dismiss. First, he denied the defendants’ dismissal motions with regard to the plaintiffs’ allegations concerning the disclosures of the Merrill bonuses. Next, he concluded that while the plaintiffs had also alleged that there were materially misleading misrepresentations or omissions about Merrill Lynch’s deteriorating 4Q08 financial condition and about the promised government financial inducements, the plaintiffs had not adequately alleged scienter as to these topics, and so he denied the defendants’ motion to dismiss as to these allegations.

Thereafter, the plaintiffs filed an amended complaint.The defendants renewed their motions to dismiss. . 

In a July 29, 2011ruling (about which refer here), Judge Castel denied the defendant’s  renewed dismissal motion as to the allegations surrounding Merrill’s declining 4Q08 financial condition, but granted the dismissal motion as to the allegations about the government bailout. He held that the plaintiffs’ amended complaint adequately alleged scienter as to the Merrill’s financial condition in the fourth quarter of 2008, but did not adequately allege a duty to update prior disclosures as to the financial support the government officials offered in order to facilitate the deal.

According to BofA’s September 28 press release about the settlement, the settlement is to be funded “by a combination of Bank of America’s existing litigation funding reserves and incremental litigation expense to be recorded in the third quarter of 2012.” The company estimates that its total third quarter litigation expense (including the incremental cost of the settlement) will be $1.6 billion. The company’s press release does not indicate that any portion of the settlement will be funded by insurance.

The settlement resolves not only the claims against the company but also those against the individual defendants as well. The individuals apparently will be making no personal contribution toward the settlement. According to Alison Frankel’s blog post, the plaintiffs attorneys intend to seek attorneys’ fees of $150 million

In addition to the monetary amount, BofA also agreed as part of the settlement to certain corporate governance reforms. Among other things, the bank agreed to institute or to continue certain corporate governance enhancements through January 1, 2015, “including those relating to majority voting in director elections, annual disclosure of noncompliance with stock ownership guidelines, policies for a board committee regarding future acquisitions, the independence of the board’s compensation committee and its compensation consultants, and conducting an annual ‘say-on-pay’ vote by shareholders.”

As I noted at the outset, this settlement eclipses by far any other settlement of a subprime meltdown or credit crisis-related securities class action lawsuit, far exceeding what had until now had been the largest of the financial crisis lawsuits, the $627 Wells Fargo/Wachoia Bondholders securities suit settlement (about which refer here).

Indeed, the $2.43 billion BofA settlement amounts to nearly half of the aggregate amount of all of the other credit crisis securities suit settlements. The 54 prior credit crisis related settlements together totaled about $5.5 billion. With the addition of the latest settlement, the total of all of the credit crisis securities suit settlements is now about $7.93 billion.

It is striking what a significant portion of the $7.93 billion total that BofA has had to fund due to its credit crisis era acquisitions of Merrill Lynch and Countrywide. As noted on the top ten list below, there have been a number of credit crisis securities class action lawsuit settlements involving these two companies. The total amount that BofA has had to pay in settling these cases (including the latest settlement) is just under $4 billion, representing slightly over half of all amounts that have been paid in settlement of credit crisis cases.

The ten largest credit crisis securities suits settlements are as follows:

Though the BofA/Merrill Lynch merger securities suit was one of the highest  profile of the securities lawsuits from the financial crisis, there are other high profile cases yet to be resolved, including the one involving AIG and the Citigroup bondholders suit. The resolution of the cases filed as part of the credit crisis-related litigation wave still has much further to go.

I have updated my running tally of the subprime and credit crisis case resolutions to reflect this latest settlement. The tally can be accessed here.

Two Subprime-Related Securities Suits Dismissed: In addition to the BofA settlement, there were other developments last week in connection with high profile subprime and credit crisis-related securities suits. In separate decisions, the subprime related securities suits involving Freddie Mac and UBS were dismissed.

First, on September 24, 2012, Southern District of New York Judge John F. Keenan dismissed with prejudice the subprime-related securities class action lawsuit that had been filed against the Federal Home Loan Mortgage Corporation (Freddie Mac) and certain of its directors and officers. A copy of Judge Keenan’s order can be found here. As discussed here, Judge Keenan had previously granted the defendants’ motion to dismiss the case, but without prejudice. The plaintiffs filed an amended complaint and the defendants renewed their dismissal motions.

In a sharply worded opinion, Judge Keenan granted the defendants’ renewed motion to dismiss, saying, among other things, that “the bevy of truthful disclosures that Freddie Mac made throughout the Class Period, covering everything from detailed credit characteristics to extensive risk management also negates the inference of scienter. It defies logic to conclude that executives who are seeking to perpetrate fraudulent information upon the market would make such fulsome disclosure.” A September 27, 2012 Bloomberg article about the Freddie Mac dismissal can be found here.

Second, in a September 28, 2012 order (here), Southern District of New York Judge Richard Sullivan granted the defendants’ motion to dismiss in the subprime-related securities suit that had been filed against UBS and certain of its directors and officers. Among other things, Judge Sullivan said that “Although UBS made a series of bad bets with disastrous consequences for the company and its shareholders, those consequences alone are insufficient to establish scienter and support a claim for securities fraud.”

In granting the motion as to the individual defendants, Judge Sullivan concluded that the plaintiffs had failed to allege sufficiently specific misrepresentations as to each individual defendant, saying (in reliance on the Supreme Court’s opinion in the Janus Capital Group case) “"While it is true that Janus might not alter the well-established rule that a corporation can act only through its employees and agents, it is nonetheless also true that a theory of liability premised on treating corporate insiders as a group cannot survive a plain reading of the Janus decision.”

I have added these two dismissals to my running tally of subprime and credit crisis-related securities suits dismissal motion rulings, which can be accessed here.

Say-on-Pay Lawsuit Dismissed on the Merits: Though in many instances litigation has followed in the wake of a negative say-on-pay vote, the say-on-pay lawsuits generally have not fared particularly well, as I noted in a recent post (here). In general, however, these cases have generally faltered due to procedural shortcomings, such as a failure to make a pre-suit demand on the board of directors, rather than on the actual merits of the case. However a recent decision in a say on pay lawsuit out of Eastern District of North Carolina granted the defendants motion dismiss based on the merits.

On May 3, 2011, fifty two percent of Dex One shareholders rejected the company’s executive compensation plan. Afterwards, the board investigated shareholder concerns and ultimately decided not to amend its 2010 executive compensation plan. In September 2011, a Dex One shareholder initiated a derivative suit against Dex One, as nominal defendant, and against certain directors and executive officers of Dex One. The plaintiff alleged, among other things, that the defendants had misled the company’s shareholders about the executive compensation plan in the 2011 proxy statements and had breached their fiduciary duties in failing to amend or alter the 2010 executive compensation plan. The defendants moved to dismiss.

In a September 26, 2012 order (here), Eastern District of North Carolina Judge James C. Dever III granted the defendants’ motion to dismiss, concluding among other things that the 2011 proxy statement “did not contain false or misleading information.” Judge Dever also rejected the plaintiff’s claim that the defendants had breached their fiduciary duties by failing to alter or amend the executive compensation plan.

Judge Dever’s ruling in the Dex One case is very fact specific, and so it may be of limited applicability in other say-on-pay cases. It is, however, consistent with the outcome of many other say-on-pay cases, most of which have resulted in dismissals. But though the plaintiffs have fared poorly in these cases, that does not necessarily mean that they will stop being filed. In pursuing these cases, the plaintiffs are not motivated so much by a desire to try to secure any type of monetary recovery so much as they are trying to use the litigation as another means to try to pressure the board on executive compensation issues. Given the near certainty that disputes regarding executive compensation will continue to arise, it seems likely that we will continue to see these kinds of say-on-pay lawsuits, even though plaintiffs generally have not been very successful in these cases.

Special thanks to Alan Parry of the Smith Anderson law firm for sending me a copy of Judge Dever’s Order. The Smith Anderson represented the defendants in the Dex One say-on-pay lawsuit.

The Week Ahead: During the upcoming week, The D&O Diary will be traveling overseas on business so there may be some disruption in the publication schedule for the next few days. The publication schedule will return to "normal" after October 8.

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At the PLUS D&O Symposium in New York this past March, I participated on a panel entitled, “Financial Institutions Underwriting: Is it Safe to Come Out Yet?” The implication of the panel topic was that perhaps with the passage of the credit crisis, financial institutions might not be as big of a D&O underwriting risk as they had been perceived to be during the crisis. At the same time, the presentation of the title in the form of a question suggested that perhaps there might still be further risks ahead.

Subsequent events have proven that it was right to continue to ask the question. As I wrote in a post earlier this week, the LIBOR scandal, among other things, shows that the financial institutions arena remains a risky neighborhood. In the earlier post, I questioned whether the follow-on civil litigation arising in the wake of the LIBOR scandal would include securities class action litigation. We now know the answer to that question as well.

On July 10, 2012, a Barclays shareholder filed a securities class action lawsuit in the Southern District of New York, against Barclays PLC and two related Barclays entities, as well as the company’s former CEO, Robert Diamond; and its former Chairman Marcus Agius. The complaint, which can be found here, is filed on behalf of class of persons who purchased Barclays ADRs between July 10, 2007 and June 27, 2012.

According to the plaintiffs’ lawyers’ press release, the complaint alleges that the defendants participating in an illegal scheme to manipulate the LIBOR rates, and that the defendants “made material misstatements to the Company's shareholders about the Company's purported compliance with their principles and operational risk management processes and repeatedly told shareholders that Barclays was a model corporate citizen even though at all relevant times it was flouting the law..” Alison Frankel has a detailed July 12, 2012 post on the On the Case blog (here) detailing this new securities class action lawsuit.

Although (as discussed here) there has already been extensive antitrust litigation filed in connection with the LIBOR scandal, this latest securities suit against Barclays is the first securities class action lawsuit filed in the scandal’s wake. Obviously, Barclays is the only financial institution that has reached a settlement with the regulatory authorities. At the same time, however, Barclays wasn’t the only participant in the scheme. Many other companies have been implicated in the scandal. As the regulatory process unfolds and as other financial institutions reach regulatory settlements, it seems very likely that there will be further securities class action lawsuits to come.

While early litigation developments in this latest financial sector scandal are only beginning to unfold, the litigation fallout from earlier scandals is slowly playing itself out. There were key developments in two significant cases filed in connection with prior scandals in the financial arena.

First, in July 11, 2012 order (here), Southern District of New York William H. Pauley III denied in part the defendants’ motion to dismiss the securities class action lawsuit that had been filed against the Bank of American, certain of its directors and officers, its offering underwriters and its auditors, in a case filed in the wake of the mortgage foreclosure processing scandal.

As detailed here, the plaintiffs alleged that the bank had misrepresented its reliance (and the reliance of Countrywide Mortgage, a company Bank of American purchased at the outset of the financial crisis) on the Mortgage Electronic Registration System (MERS), a computerized system for tracking mortgages that tried to eliminate the need for mortgage originators to physically record mortgages. As the mortgage meltdown unfolded it became clear that it would be difficult if not impossible for the bank to foreclose on mortgages in MERS.

The plaintiffs also alleged because of the bank’s reliance on MERS, the bank had breached the warranties it had given in connection with mortgage securitizations that it had good title to the mortgages, and also had breached its mortgage underwriting standards, as a result of which, the plaintiffs allege, the bank is liable for repurchase claims by mortgage securitizers for billions of dollars worth of mortgages. The plaintiffs also allege that in connection with a December 2009 securities offering, the defendants misrepresented the problems associated with the bank’s reliance on MERS as well as the bank’s vulnerability to repurchase claims.

Judge Pauley granted the defendants’ motions to dismiss the plaintiffs’ Section 11 claims relating to the December 2009 offering, on statute of limitations grounds. Judge Pauley also granted the motions of the individual director and officer defendants, as well as of BofA’s offering underwriters and auditors, as to all of the remaining allegations. However, the dismissal of the claims (other than the Section 11 claims relating to the December 2009 offering) against the individual defendants was without prejudice. And most importantly from the plaintiffs’ perspective, Judge Pauley denied the motion to dismiss of the bank itself other than with respect to the Section 11 claim.

I have added this ruling to my running tally of subprime and credit crisis-related dismissal motions rulings, which can be accessed here. Jan Wolfe’s July 11, 2012 Am Law Litigation Daily article discussing Judge Pauley’s ruling can be found here.

Second, in an earlier case arising from the subprime meltdown and credit crisis, on July 9, 2012, the parties to the subprime mortgage securities suit involving BancorpSouth filed a stipulation of settlement indicating that they had agreed to settle the case for $29.25 million. The settlement is subject to court approval. According to the parties’ stipulation (a copy of which can be found here), the settlement is to be entirely funded by D&O insurance; the stipulation provides that as part of the settlement, the defendants will “cause their directors’ and officers’ insurers” to pay the $29.25 million into escrow.

As detailed here, the plaintiffs had first filed their suit against BancorpSouth and certain of its directors and offices in the Middle District of Tennessee in May 2010.  The plaintiffs alleged that as the credit crisis had unfolded, the bank had been slow to recognize losses in its lending portfolio, instead claiming that it its portfolio was of a higher quality than those of other lending institutions. Ultimately the bank was forced to recognize extensive losses. The plaintiffs alleged that the bank had failed to properly account for its construction and commercial real estate loans, failing to reflect impairment in the loans and had not adequately reserved for loan losses  On January 24, 2012, the court entered an order accepting the magistrate’s recommendation that the defendants’ motions to dismiss should be denied.

I have added the BancorpSouth settlement to my list of subprime case resolutions, which can be accessed here.

Dodd-Frank Whistleblower Developments: We are still awaiting the payment of the first whistleblower bound under the Dodd-Frank Act’s whistleblower provisions. But that is not to say that there have not been any developments. To the contrary there have been several recent rulings in various legal proceedings involving the Dodd-Frank Act whistleblower provisions.

As Jan Wolfe notes in a July 10, 2012 article in the Am Law Litigation Daily (here), several courts have recently shed significant light on the Dodd Frank whistleblower provisions. Among other things, one court has ruled that the provisions give retroactive protection to the whistleblowers at subsidiaries of public companies, not just to whistleblowers at the  publicly traded parent company. However, an earlier court ruled that, because the Dodd-Frank Act is silent about the extraterritoriality of the whistleblower provisions, the provisions do not apply extraterritorially.

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In a harsh June 21, 2012 opinion (here), Southern District of New York Judge Paul A. Crotty rejected the motion to dismiss of Goldman Sachs and three individual defendants in the securities class action lawsuit pertaining to the infamous “built to fail” Abacus CDO transaction and other ill-fated deals. Judge Crotty did, however, grant the defendants’ motion to dismiss with regard to the plaintiffs’ claims based on the company’s failure to disclose its receipt of a Wells Notice.

What makes the decision interesting, besides the sharpness of the Judge’s tone, is that in order to establish that Goldman’s alleged misstatements and omissions about its business ethics and conflicts of interest practices and policies are actionable, the plaintiffs relied on Goldman’s misstatements and alleged fraudulent conduct in connection with the Abacus transaction and three other CDO deals. Judge Crotty found that Goldman’s alleged conduct and statements in connection with the CDO deals made the statements to Goldman’s shareholders about its business practices and ethics materially misleading.

The order is also interesting because of the weight Judge Crotty gives to admissions Goldman made in the Consent it entered in its July 2010 agreement to settle the enforcement action the SEC had filed against Goldman about the Abacus transaction. As described here, in the Consent, in which Goldman neither admitted nor denied liability, the company “acknowledges” that the Abacus marketing materials “contained incomplete information” and that it was a “mistake” for the materials to state that the Abacus CDO reference portfolio was selected by ACA Management without disclosing the role of short-interest investor Paulson & Co. or that Paulson’s interests were adverse to those of the Abacus CDO investors.

These concessions fell short of an admission of fraud, but as Jan Wolfe notes in a June 22, 2012 Am Law Litigation Daily article about Judge Crotty’s decision (here), “if Goldman and its lawyers thought that this linguistic compromise would help it avoid trouble in shareholder suits, it turns out they were wrong.”

In addition to the Abacus transaction, the plaintiffs’ conflict of interest allegations also are based on three other CDO transactions – Hudson, Anderson and Timberwolf. With respect to the Hudson transaction, the plaintiffs allege that Goldman had said its interests were aligned with those of CDO investors based on a $6 million equity investment, while omitting that it also had a 100% short position at the time, representing a $2 billion interest.

With respect to the Anderson CDO transaction, Goldman stated that it would hold up to 50% of the equity tranche, worth $21 million, but omitted its $135 million short position. And with respect to the Timberwolf transaction, Goldman stated that it was purchasing 50% of the equity tranche, but failed to disclose that it was the largest source of assets in the structure and held a 36% short position in the CDO.

The plaintiffs claim that Goldman’s conduct, discloses and omissions with respect to these CDO transactions made a number of the company’s disclosures  to shareholders about its conflicts of interest policies and procedures and its commitment to legal compliance and ethics (including its commitment to “integrity” and “honesty”) materially misleading.

The defendants argued that these statements are non-actionable statements of opinion, puffery or merely corporate mismanagement. Judge Crotty called these arguments “Orwellian,” adding that:

Words such as “honesty”, “integrity”, and “fair-dealing” so not mean what they say; they do not set standards; they are mere shibboleths. If Goldman’s claim that “honesty” and “integrity” are mere puffery, the world of finance may be in more trouble than we recognize.

Judge Crotty concluded that Goldman’s conduct and disclosures in connection with the four CDO transactions “made its disclosures to its own shareholders, concerning its business practices, materially misleading,” adding that given “Goldman’s fraudulent acts, it could not have genuinely believed its statements” about its business practices and ethics. Goldman should not be able to “pass off” its “repeated assertions” as “mere puffery.” Moreover, Goldman’s “allegedly manipulative, deceitful and fraudulent conduct” in hiding its conflicts of interests in the four CDO transactions “takes the Plaintiffs’ claim beyond mere mismanagement.”

On the issue of scienter, Judge Crotty specifically relied on Goldman’s concessions in the SEC settlement, among other things, including internal emails. He noted that Goldman clearly played an active role in the Abacus asset selection process: “How else could Goldman admit that it was a ‘mistake’ not to have disclosed such information.” Crotty found that “given Goldman’s practice of making material misrepresentations to third-party investors, Goldman knew or should have known” that its statements about its conflicts of interest practices and business ethics “were inaccurate and incomplete.”

Judge Crotty also concluded that scienter allegations as to each of the individual defendants were sufficient, as each of them “actively monitored” Goldman subprime deals and assets and each knew that Goldman was “trying to purge those assets from its books and stay on the short side.”

Judge Crotty did, however, dismiss plaintiffs’ claims that Goldman had misled its shareholders by failing to disclose its receipt of a Wells Notice, noting that because a Wells Notice “indicates not litigation but only the desire of the Enforcement staff to move forward,” and therefore is a “contingency” that need “not be disclosed.” He also found that the plaintiffs’ had not shown that the company’s nondisclosure of the Wells Notice made the company’s prior disclosures about “ongoing governmental investigations” materially misleading.

Discussion

Judge Crotty’s opinion clearly quells any suggestion that Goldman’s SEC settlement – in which it made a number of admissions – offers an alternative to the “neither admit nor deny” SEC settlement approach which has proven so controversial. A frequent justification for the “neither admit nor deny” approach is that defendants can’t admit liability in an SEC settlement for fear the admissions will be used against them in related shareholder litigation. Some (including even Judge Jed Rakoff, who has been so critical of the neither admit nor deny settlements) had suggested that the Goldman settlement -- in which the company admitted no fraud but only mistakes – offered a middle ground.

However Judge Crotty found that Goldman’s attempts to argue in support of its motion to dismiss the share holder suit that it had neither admitted nor denied liability in the SEC settlement were “eviscerated” by the company’s concession that it had made a “mistake” in not disclosing Paulson’s role in the Abacus transaction. The fact that the plaintiffs were able to rely on the company’s SEC settlement concessions, and that the concessions also entered directly into Judge Crotty’s analysis of both misrepresentation and scienter issues, eliminates the Goldman settlement approach as an enforcement action settlement alternative that other defendants might be able to accept.

It is interesting that so many of the misstatements or omissions on which the shareholder plaintiffs rely were not made directly to shareholders themselves, but rather were made to CDO investors. The misleading omission in statements to the CDO investors were relied upon to show that statements that were made to Goldman shareholders about the company’s business practices and ethics were misleading.

There is a particularly harsh aspect to Judge Crotty’s decision, in that the statements to shareholders to  which he referred in denying defendants’ motion to dismiss were the company’s statements about it business ethics and integrity. What makes this particularly troubling is that his assessment that these statements were misleading was not based – as would usually be the case at this stage of the proceedings – on plaintiffs’ mere unproven allegations. Judge Crotty’s conclusions were based, at least in part, on the company’s own admissions.

Goldman likely recognized long ago that this case might well survive a motion to dismiss. (The company wouldn’t have agreed to pay over half a billion dollars to settle the SEC enforcement action if it didn’t recognize that there were serious problems with the Abacus transaction, and in addition the separate state court fraud action brought by the bond insurer on the Abacus transaction had previously survived a dismissal motion.) Nevertheless, Judge Crotty’s opinion, and in particular the harshness of its tone, has to represent an unwelcome and troubling development.

One final note has to do with Judge Crotty’s ruling with regard to the Wells Notice nondisclosure allegations. The question of whether the receipt of a Wells Notice must be disclosed is frequently debated, and many companies, out of an abundance of caution, will disclose it. Judge Crotty’s conclusion that a Wells Notice represents a “contingency” that need not be disclosed will clearly be relevant for companies considering whether nor not they must disclose receipt of a Wells Notice, and may lead more companies to withhold disclosure of receipt of a Wells Notice.

I have in any event added the Goldman decision to my running tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

Professor Peter Henning has an interesting post about the Goldman decision on the Dealbook blog (here).

Is the Business Judgment Rule Available as a Defense for Corporate Officers: One of the questions that is receiving close scrutiny in the litigation the FDIC has filed against former directors ad officers of failed banks as part of the current wave of bank failures is whether or not corporate officers – as opposed to corporate directors – can rely on the business judgment rule as a defense to claims of ordinary negligence. As discussed here, at least one court has held under Georgia law that officers can rely on the business judgment rule to preclude claims for ordinary negligence.

However, as California attorney Jon Joseph wrote in his April 11, 2012 guest post on this blog (here), courts applying California law on the issue and considering whether corporate officers as well as directors can rely on the business judgment rule have split on the issue. The ruling in the FDIC lawsuit against former IndyMac CEO that Perry could not rely on the business judgment rule is on interlocutory appeal to the Ninth Circuit.

Because of this mixed case law, the June 7, 2012 ruling in the FDIC’s lawsuit against certain former officers of County Bank of Merced, California is of interest. In the decisions, which can be found here, Eastern District of California Judge Lawrence O’Neill held that the defendant officers cannot rely on the statutorily codified business judgment rule under California Corporations Code Section 309, because the statute by its terms refers only to officers not directors.

However, with respect to the defendant officers’ efforts to rely on the common law business judgment rule, Judge O’Neill also denied the defendants’ motion to dismiss -- but not on the basis that they could not rely on the business judgment rule; rather, he said only that “the business judgment rule is an affirmative defense which involves factual issues to preclude its application to dismiss the complaint’s claims.”

While Judge O’Neill did find that the defendants’ entitlement to rely on the common law business judgment rule is a factual issue, what he did not say is that the defendants were not entitled to rely on it as a matter of law. Which can be interpreted to suggest at least by negative inference that there is a common law business judgment rule separate and apart from the statutory provision, and defendants can rely on the common law rule, if they can establish as a factual matter that the qualify for the rule’s protection.

Hat tip to Alan Makins, who had a post about the ruling in the County Bank case in his California Corporate & Securities Law Blog, here.

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The March 2008 collapse of Bear Stearns was, in the words of Southern District of New York Judge Robert Sweet, “an early and major event in the turmoil that has affected the financial markets and the national and world economies.” The securities class action litigation that followed the company’s collapse was among the highest profile of the cases that arose in the wake of the subprime meltdown and credit crisis.

The parties to the Bear Stearns securities litigation have now agreed to settle the case for $275 million, subject to court approval. The parties’ June 6, 2012 settlement stipulation, attached to the affidavit of plaintiffs’ counsel, can be found here. The parties’ motion for preliminary approval of the settlement can be found here.

As detailed here, the plaintiffs first sued Bear Stearns and certain of its directors and officers shortly after its March 2008 collapse and the company’s eleventh hour acquisition  by J.P. Morgan Chase.

In their massive consolidated amended complaint (here) , the securities class action plaintiffs allege that in a series of statements during the class period, the defendants made material misrepresentations or omissions with regard to the company’s exposure to subprime mortgages; with respect to the performance of and valuations in connection with one of its hedge funds; with respect to the company’s liquidity; with respect to the company’s risk management and valuation practices. The company is alleged to have inflated its reported financial results and financial condition, among other things due to use of inappropriate models to value the company’s subprime-mortgage related assets. Deloitte & Touche, LLP, the company’s outside auditor, is alleged to have knowingly and recklessly offered materially misleading opinions about the company’s accuracy.

As detailed in greater length here, on January 19, 2011, in a gigantic 398-page opinion, Judge Sweet denied the defendants’ motion to dismiss the securities class action lawsuit. He did however grant defendants’ motions to dismiss the related shareholders’ derivative lawsuit and ERISA class action lawsuits.

On June 6, 2012, the parties to the Bear Stearns securities litigation filed their settlement papers with the court, in which they advised the court that they had agreed to settle the case for $275 million, following mediation. The parties to the settlement include Bear Stearns and seven former Bear Stearns directors and officers (including the former Bear Stearns CEO, Jimmy Cayne). However, the list of defendants to be released by the settlement does not include Deloitte & Touche LLP.

The Settlement Stipulation provides that Bear Stearns “shall pay, or cause to be paid” the $275 million settlement amount into escrow within a specified time of preliminary settlement approval. The settlement papers do not disclose whether any portion of the settlement amount is to be paid by insurance. However, the released parties include, among others, the defendants’ “insurers.”

There may well have been an insurance component of or contribution to this settlement, but unlike the $90 million settlement of the Lehman Brothers D&O lawsuit (about which refer here), the settlement was not dependent exclusively on dwindling D&O insurance proceeds. Bear Stearns may have collapsed, but it was acquired by J.P. Morgan Chase, so there was a solvent entity to contribute to the settlement. It is entirely possible that JP Morgan anticipated the possibility of this development at the time it acquired Bear Stearns; according to press reports at the time, in connection with the acquisition, JP Morgan set aside $6 billion to cover anticipated litigation costs (among other things). 

There is nothing in the settlement papers to suggest that any of the individual defendants is being called upon to contribute in any way toward the settlement. The settlement stipulation provides only that the $275 million settlement proceeds will be paid by or on behalf of Bear Stearns.

The Bear Stearns settlement is one of the largest securities lawsuit settlements as part of the subprime and credit crisis-related litigation wave. It is by far the largest of the settlements so far in 2012, and overall, is exceeded only by the Wachovia Preferred Securities Settlement ($627 million, about which refer here); the Countrywide Settlement ($624 million, refer here); the Lehman Brothers Offering Underwriters’ settlement ($417 million, refer here); the Merrill Lynch Securities Settlement ($425 million, refer here); and the Merrill Lynch Mortgage Backed Securities Settlement ($315 million, refer here).

In any event, I have added the Bear Stearns settlement to my list of subprime and credit crisis-related case lawsuit resolutions, which can be accessed here.

SEC Awash in Whistleblower Reports: Since the enactment of the Dodd-Frank Act, which provided for rich whistleblower bounties under certain circumstances, there has been a great deal of anticipation that the provisions would lead to a flood of whistleblower reports. Indeed, the SEC’s early reports were that there had been a significant influx of whistleblower reports.

According to recent reports, the SEC is now awash in whistleblower reports. According to a June 5, 2012 Law 360 article entitled “SEC Enforcement Division Buries in Whistleblower Tips” (here, subscription required), the SEC is receiving an average of seven reports per day and the agency is “struggling to keep up.”

Even though only “two to three tips submitted per day are worth investigating,” according to an SEC source quoted in the article, the SEC may not have sufficient staff to investigate all of the reports. According to the article, “the SEC is trying to triage the tips it gets as best it can, making sure the best leads get sent to the enforcement division for investigation.”

Ironically, this surge of reports has developed even though the SEC is yet to make its first award under the Dodd-Frank whistleblower bounty provisions. According to one commentator quoted in the article, “This is going to explode once the first award comes down. The program is only going to get bigger and bigger.”

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In an interesting twist on a long –running credit-crisis related securities suit, Wells Fargo has agreed to pay $75 million to settle the Wachovia equity investor securities class action lawsuit, even though their suit had been dismissed at the district court level and was on appeal at the time of the settlement. The parties’ November 21, 2011 notification of the settlement to Southern District of New York Judge Richard Sullivan can be found here. Victor Li’s December 3, 2011 Am Law Litigation Daily article about the settlement can be found here.

The settlement relates to litigation brought by former equity shareholders and bondholders of Wachovia Corporation.  The equity securities holders’ and bondholders’ actions arise from  financial disintegration Wachovia experienced between its 2006 purchase of Golden West Financial Corporation and its 2008 merger with Wells Fargo & Company. The allegations are based on the difficulties Wachovia experienced as a result of the Golden West “Pick-A-Pay” mortgage portfolio. Further background regarding the equity securities litigation can be found here and background regarding the bondholders’ litigation can be found here.

As discussed here, on March 31, 2011, Southern District of New York Judge Richard Sullivan granted the defendants’ motions to dismiss the equity securities litigation, but he denied the motion to dismiss the bondholders’ action, other than with respect to certain bond offerings in which the plaintiffs had not actually purchased any securities. A copy of Judge Sullivan’s opinion can be found (here),

Judge Sullivan granted the defendants’ motions to dismiss the equity securities plaintiffs’ ’34 Act claims, finding that the plaintiffs had not sufficiently alleged scienter. Judge Sullivan concluded that the “more compelling inference” is that “Defendants simply did not anticipate the full extent of the mortgage crisis and the resulting implications for the Pick-A-Pay loan portfolio. Although a colossal blunder with grave consequences for many, such a failure is simply not enough to support a claim for securities fraud.” He added that “bad judgment and poor management are not fraud, even when they lead to the demise of a once venerable financial institution.”

Judge Sullivan also granted the defendants’ motion to dismiss the equity securities plaintiffs’ ’33 Act claims, finding that their “scattershot pleadings” failed to “afford proper notice, much less provide facially plausible factual allegations.” He added that he could not conclude “that the relevant offering documents contained material omissions in violation of affirmative disclosure obligations.”

Thereafter, the bondholders, whose case survived Judge Sullivan’s dismissal motion rulings, went on to settle their lawsuit for a total of $627 million, which, as discussed here, is the largest settlement to date as part of the subprime and credit crisis-related litigation wave. The settlement amount of $627 million represented two different settlement funds: $590 million on behalf of the Wachovia defendants, including 25 former directors and officers of Wachovia, as well as 72 different financial firms that underwrote bond offerings for Wachovia between 2006 and 2008; and $37 million on behalf of Wachovia’s auditor, KPMG.

Meanwhile, the Wachovia equity investors, whose action Judge Sullivan had dismissed, had appealed the dismissal to the Second Circuit. In an apparent move to avoid having the case revived on appeal, Wells Fargo has now agreed to pay $75 million to settle the equity investors’ suit. The case must be remanded from the Second Circuit in order for the settlement to be presented to the district court for approval.

As I noted at the time of the $627 million settlement with the Wachovia bondholders, Wachovia’s purchase of Golden West has to be one of the leading candidates for the title of worst deal leading into or as part of the credit crisis-related financial transactions. There is a lot of competition in the worst transaction category, including Bank of America’s purchase of Countrywide. But there is no doubt that the Golden West deal is one of the real stinkers.

From the perspective of Wells Fargo, the litigation consequences for the bank from the mortgage meltdown are becoming rather impressive. When you consider this $75 million settlement and he Wachovia defendants’ $590 contribution to the bondholders’ settlement, which came on the heels of the $125 million Wells Fargo mortgage backed securities settlement (about which refer here), it looks like the financial crisis litigation consequences for Wells Fargo have been massive . The bank’s current aggregate settlement costs of $790 million may provide some explanation why it preferred to settle this case than to run the risk that the securityholders might succeed in having the dismissal of their case overturned on appeal.

The $75 million Wachovia equity investors’ settlement comes on the heels of the public disclosure of the $315 million Merrill Lynch mortgage-backed securities settlement, which Alison Frankel first reported in a November 18, 2011 article on Thomson Reuters News & Insight (here). Though the fact and amount of the settlement have been public for a couple of weeks, the parties have only just now filed their actual stipulation of settlement, dated December 5, 2011 (here). The $315 Merrill settlement dwarfs Wells Fargo’s earlier $125 million MBS settlement, which has stood as the largest MBS-related settlement so far.

In the Merrill Lynch MBS lawsuit, the plaintiffs alleged that the defendants (Merrill Lynch and related Merrill entities; certain other underwriter defendants and certain Merrill officers) had mislead investors who purchased the MBS securities, through statements in the securities’ offering documents that misrepresented the quality of the loans and the adequacy of the collateral within the loan pools.

Like Wells Fargo, Merrill and its acquirer Bank of America have also now paid out or at least agreed to pay out an impressive aggregate amount in subprime and credit crisis-related securities lawsuit settlements. As discussed here, Merrill had previously settled the subprime-related securities lawsuit brought by its shareholders for $475 mm, and had also settled the related ERISA lawsuit for $75 million.   Merrill separately settled the subprime-related lawsuit brought by its bondholders for $150 million (refer here). With the addition of the recent $315 MBS settlement, Merrill’s aggregate settlements are now up to $1.015 bb.

And to line up everything in its proper category, the $624 million Countrywide settlement, in addition to the $1.015 bb of Merrill settlements, all arguably belong on BofA’s ledger. The Merrill and Countrywide settlements altogether total about $1.639 billion, or fully 40 percent of all of the subprime and credit crisis related lawsuit settlement amounts so far (which total about $3.913 billion). These Merrill and Countrywide settlements plus the Wells Fargo settlements total $2.48 billion, which reresents almost 64% of the aggregate amount of the subprime and credit crisis related lawsuits settlements to date

What the Merrill, Countrywide and Wachovia/Wells Fargo settlements have in common, in addition to representing the largest of the subprime and credit crisis related lawsuit settlements, is that in each case the corporate defendant is now part of a financially strong successor in interest. This circumstance contrasts significantly with other subprime and credit crisis cases – like those involving Lehman Brothers and Washington Mutual, for instance – where the corporate defendants are defunct and there is no solvent successor in interest. Securities suits involving these defunct companies have settled for much smaller amounts that those involving solvent companies.

I have in any event added the Wachovia equity investors’ settlement and the Merrill MBS settlement to my running tally of subprime and credit crisis-related securities class action lawsuit case resolutions, which can be accessed here.

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In a development that undoubtedly will attract comment and controversy, fourteen former Lehman Brothers executives – including former Lehman Chairman and CEO Dick Fuld (pictured) --have reached an agreement to settle the consolidated securities class action litigation that has been filed against them for $90 million. In a separate development, seventeen former Lehman executives have agreed to settle the separate lawsuit brought against them by the New Jersey Treasury Department Investment Division for $8.25 million.

The entire amount of both settlements is to be funded by D&O insurance. The settlements are subject to the consent of the bankruptcy court to lift the stay in bankruptcy to allow the D&O insurers to fund the settlement, as well as to the approval of the respective courts in which the respective settled actions are pending. The executives’ motion for relief from the bankruptcy stay in connection with the equity and debtholders’ action can be found here. The executives’ motion for relief from the bankruptcy stay in connection with the New Jersey action can be found here.

Peter Lattman’s August 25, 2011 article on August 25, 2011 article on The New York Times Dealbook blog  describing the motions and the settlements can be found here. Nate Raymond’s August 25, 2011 article on The Am Law Litigation Daily about the settlements can be found here.

Securities lawsuits had been filed against Lehman and certain of its directors and officers both before and after its dramatic collapse in September 2008. The cases ultimately were consolidated. On July 27, 2011, Judge Lewis Kaplan largely denied the motions to dismiss in the consolidated securities class action lawsuit, as discussed here.

At the time the first of these actions was filed against Lehman in early 2008, Lehman carried an aggregate of $250 million in D&O insurance, consisting of a $20 million primary policy and sixteen layers of excess insurance. A copy of the Lehman primary policy, which is included in the bankruptcy pleadings, can be found here. Further discussion of the details of the Lehman D&O insurance program can be found here.

Following Lehman’s bankruptcy filing, and  as the securities cases and other litigated matters went forward, from time to time the parties would appear in bankruptcy court to seek relief from the stay to allow the D&O insurers to fund ongoing defense expenses. As I noted in a prior post (here) anallyzing one of the prior requests from the relief from the stay, the defense costs have been accumulating extraordinarily rapidly.

The executives’ motions for relief from the bankruptcy stay for purposes of these settlements show just how rapidly the defense expenses and other items have been eroding the limits. In their motion with respect the $90 million securities class action settlement, the executives explain that they are seeking relief from the stay with respect to the sixth through twelfth level excess insurers in Lehman’s insurance program.

Footnote 4 of the motion identifies the excess insurers involved (their policies are also attached to the motion) and also explains that the sixth level excess insurer provide coverage of $25 million in excess of $85 million, and the twelfth level excess insurer provides coverage of $20 million in excess of $180 million. (The equivalent motion with respect to the New Jersey action seeks relief with respect to the sixth and if necessary the seventh level excess insurers, so the $8.25 million New Jersey settlement is assumed to have already eroded the limit for purposes of calculating the limits available for the consolidated securities lawsuit settlement).

Taking all of this information into account, and assuming the various stays and approvals are granted, the settlements, together with prior defense expenses and other payments, will erode up to $200 million of the $250 million tower. The two settlements together total $98.25 million.

There is nothing in any of the settlement papers to suggest that the individual defendants will contribute to either of these settlements out of their own assets. The settlements do not include the other defendants in the cases; in the securities class action lawsuit, the remaining defendants include Lehman’s offering underwriters, as well as its auditor, E&Y.

Discussion

Not only was the Lehman bankruptcy the largest in U.S. history, but the company’s collapse very nearly triggered a global economic catastrophe. The circumstances of its collapse have been the subject of extensive investigation and commentary. The company’s accounting prior to its collapse has also been the subject of intense scrutiny, most notably in the report of the bankruptcy examiner, who, among other things, he called the company’s quarter-end Repo 105 transactions “balance sheet manipulations,” about which refer here. Dick Fuld has become something of a poster child (or at least one of the poster children) for problems on Wall Street that contributed to the economic crisis.

Given that context, the fact that the individual defendants apparently are not going to contribute to this settlement is likely to be controversial. Many commentators have already bewailed the fact that cases of this type are settled exclusively with D&O insurance, and without any personal contribution by the alleged wrongdoers. These kinds of concerns will be even more exacerbated here, given the high profile nature of this case and the vilification that has heaped on Fuld and other Lehman executives. 

I have no insight into why the settlements were structured the way they were. But I can speculate at least that a major factor driving the timing, size and structure of these settlements was the alarming erosion of the policy limits as defense expense reduced the amount of insurance available with which to try to settle these cases.

The problem the plaintiffs’ lawyers faced, which is the one that claimants always face in the insolvency context, is that the plaintiffs can always hang tough and hold out for the optimal settlement, but in the meantime the policy proceeds out of which any settlement would have to be funded are rapidly disappearing. These concerns were particularly abrupt here because of the astonishing speed at which the policy limits were disappearing. An added concern for the plaintiffs here is that if they held out too long, they ran the risk that the SEC might suddenly file an enforcement complaint against one or more Lehman executive, or the DoJ might file a criminal action. If either of those things were to have happened, the rapid depletion of policy limits would have leapt into hyperspeed.

So to those who say that the plaintiffs’ lawyer here should have demanded a settlement in which the individuals contributed out of their own assets, I say that while that type of settlement might theoretically have been more satisfying at some level, it might not have produced a better result for the class members and other aggrieved parties. Indeed, if the settlement talks had dragged on too much longer, there might soon have been no insurance left at all out of which to settle the case.

I am realistic enough to know that not everyone will find this appeal to practicality to be satisfying. There is a lot of emotion associated with the Lehman collapse, and there undoubtedly will be those who will be outraged that Fuld and others are “getting off” here without having to contribute out of their own assets. This notion precedes from a basic sentiment that these executives should be punished. From my perspective, it is the job of the SEC and the DoJ to determine who needs to be punished. If the SEC and the DoJ believe these individuals should be punished in some way, they will pursue the appropriate sort of action. The types of private civil actions that are under discussion here are meant to provide a way to compensate aggrieved parties. That is the purpose of these settlements. Whether or not they are the optimal settlements, they may have been the most economically beneficial and viable settlements available given the rapid depletion of the policy limits.

I have in any event added these settlements to my running tally of credit crisis related case resolutions, which can be accessed here.

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In a detailed 106-page opinion dated July 27, 2011 (here), Southern District of New York Judge Lewis Kaplan granted in part and denied in part the defendants’ motions to dismiss in the consolidated Lehman Brothers Securities Litigation. Though Judge Kaplan knocked out certain of the plaintiffs’ allegations, what Judge Kaplan called the “core” of plaintiffs’ allegations remain, particularly with respect the company’s quarter-end Repo 105 transactions.

As detailed here, the plaintiffs allege that the defendants made false and misleading statements about Lehman Brothers prior to the company’s September 2008 collapse. The defendants include certain former officers and directors of the company; the company’s auditor; and the company’s offering underwriter. The plaintiffs amended their consolidated complaint following the March 2010 release of the report of the Lehman Brothers bankruptcy examiner (about which refer here), which, described the company’s alleged “balance sheet manipulation,” among other things by using a quarter end accounting device know as “Repo 105.” The defendants moved to dismiss.

In his July 27 opinion, Judge Kaplan granted the defendants motion to dismiss s to certain of the plaintiffs’ allegations, finding that the plaintiffs had not adequately alleged misleading falsity, for example, with respect to statements about the company’s use of risk mitigants and with respect to certain aspects of the company’s liquidity.

However, Judge Kaplan found that the allegations were sufficient with respect to a number of the plaintiffs’ other allegations, particularly with respect to the company’s use of the Repo 105 transactions; its statements about its net leverage; its statements about its use of stress testing; its statements about risk management; its statements about value at risk; and its statements about concentrations of credit risk.

With respect to the Repo 105 transactions, Judge Kaplan said that “repetitive, temporary, and undisclosed reduction of net leverage at the end of each quarter is sufficient to make out a claim.”

With respect to the statements that the plaintiffs had sufficiently alleged to be false and misleading, Judge Kaplan found that the plaintiffs had also sufficiently alleged scienter. In finding that the plaintiffs had adequately alleged scienter against the officer defendants in connection with the statements concerning the Repo 105 transactions, Judge Kaplan said:

The suggestions that defendants believed that the Repo 105 transactions were permissible in and of themselves and that the financial reporting for them, in and of itself, complied with GAAP does not address the core of plaintiffs’ claims  – that they were used to reduce temporarily and artificially Lehman’s net leverage and paint a misleading picture of the company’s financial position at the end of each quarter. The allegations of that these transactions were used at the end of each reporting period, in amounts that increased as the economic crisis intensified, to affect a financial metric that allegedly was material to investors, credit rating agencies, and analysts supports a strong inference that the Insider Defendants knew or were reckless in not knowing that use of the Repo 105 transactions and the manner in which they were accounted for painted a misleading picture of the company’s finances.

Although Judge Kaplan also knocked out many of the allegations against E&Y, the company auditor, Judge Kaplan also found that the amended complaint “adequately alleges that D&Y misrepresented in the 2Q08 that it was ‘not aware of any material modification that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.’”

Judge Kaplan’s conclusions as to the sufficiency of the Exchange Act allegations against the individual defendants also extended to the sufficiency of the Securities Act allegations against the Underwriter Defendant.

As a result of Judge Kaplan’s rulings, one of the highest profile securities suits filed in the wake of the credit crisis will now go forward. Unsurprisingly, the allegations concerning the Repo 105 transaction had a significant impact on Judge Kaplan’s consideration of the plaintiffs’ claims. While any resolution of this case would be challenging, the difficulty for all concerned is that due to the multiplicity and complexity of the various legal matters arising out of the company’s collapse, the amount of D&O insurance remaining is rapidly declining. Even if the defendants feel strongly that they are wrongly accused, they will have to think hard about whether it is better to try to work a deal while insurance funds remain, or to fight on in the hope of ultimate vindication – preferably before the insurance funds are gone.

Nate Raymond’s July 27, 2011 Am Law Litigation Daily article discussing the decision can be found here.

I have in any event added the Lehman brothers ruling to my running tally of the subprime meltdown and credit crisis related dismissal motion rulings, which can be accessed here.

Special thanks to a loyal reader for providing me with a copy of Judge Kaplan’s ruling.

Second Circuit Affirms Dismissal in CBRE Realty Subprime-Related Securities Suit: In another ruling in a subprime-related securities class action lawsuit, on July 26, 2011, the Second Circuit affirmed the district court’s dismissal of the subprime-related securities suit that had been filed against CBRE Realty Finance. The Second Circuit’s opinion can be found here.

As discussed here, the plaintiffs had alleged that in connection with company’s September 2006 IPO, the company’s offering documents had not adequately disclosed the risk of default in connection with two Maryland condominium conversion projects known as Triton. In July 2009, the District of Connecticut dismissed the plaintiffs’ claims because the loans were fully collateralized at the time of the IPO. The plaintiffs appealed.

In its July 26 opinion, a three-judge panel of the Second Circuit affirmed the district court, but on different grounds. The Second Circuit held that “the alleged misstatements were not material because the value of the transactions composed an immaterial portion of the issuer’s total assets.”

I have also added the Second Circuit’s opinion in the CBRE case to my table of credit crisis lawsuit dismissal motion rulings.

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As the worst days of the financial crisis (if not their ill effects) receded into the past, the accompanying credit crisis-related litigation wave appeared to lose its momentum. By late 2010, new credit crisis-related lawsuit filings seemingly had dwindled away. But now at the midpoint of 2011, two new credit crisis related lawsuit have arisen. These new lawsuits raise a number of interesting issues, as discussed below.

The Latest Filings

Deutsche Bank: According to their June 21, 2011 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Deutsche Bank and four of its directors and officers. The complaint, which can be found here, purports to be filed on behalf Deutsche Bank common shareholders who purchased their shares between January 3, 2007 and January 16, 2009.

The complaint, which alleges that the defendants “concealed the Company’s failure to write down impaired securities containing mortgage-related debt,” asserts that the defendants concealed that:

(a) defendants failed to record adequate provisions for losses on the deterioration in mortgage assets and collateralized debt obligations on Deutsche Bank’s books caused by the high amount of non-collectible mortgages included in the Company’s portfolio; (b) Deutsche Bank’s MortgageIT subsidiary was issuing and had issued billions of dollars of mortgage loans which did not comply with stated lending practices, leading to thousands of defaults; (c) Deutsche Bank’s internal controls were inadequate to ensure that losses on residential mortgage-related assets were accounted for properly; and (d) Deutsche Bank had transferred billions of dollars in defaulting, or soon-to-default, mortgages to unwitting investors and government programs due to its disregard of adverse findings by outside consultants.

Carlyle Capital Corp.: On June 21, 2011, a plaintiff filed a securities class action complaint in the U.S. District for the District of Columbia against certain individual officers and directors of the now defunct Carlyle Capital Corp. (CCC), its investment manager and related entities. The complaint, which can be found here, purports to be filed on behalf of all those who purchased CCC shares between June 19, 2007 and through March 17, 2008.

The complaint alleges that CCC was organized under the laws of Guernsey to profit from the spread between the its portfolio of residential mortgage-backed securities (RMBS)and the cost of financing those assets through short term repurchase agreements and other forms of financing. Its principal place of business was in Washington, D.C. The complaint alleges that the entity was a “house of cards” because it was committed to acquiring “volatile, risk-securities that could only be purchased using massive borrowing with the securities purchased serving as collateral.” The company’s RMBS portfolio deteriorated during 2007, even prior to the company’s July 2007 IPO on Euronext. The complaint alleges that the deterioration and the liquidly issues associated with the companies repo agreement financing were not disclosed to investors.

The complaint alleges that following the offering, the defendants continued to misrepresent the company’s financial condition, particularly with respect to its RMBS portfolio. Despite the deteriorating market for RMBS, CCG continued to acquire additional RMBS. The complaint alleges that as the marketplace nearly reached a “meltdown” in August 2007, the company did not recognize its portfolio losses. In early 2008, a cascade of margin calls forced the company’s managers to put the company into liquidation under the authority of the Royal Court of Guernsey.

Discussion

These two cases have more in common than just the fact that they both related (each in their own way) to the global financial crisis. First, they both involve entities organized under the laws of non-U.S. jurisdictions. Second, the complaints were first filed well after the end of the purported class period. In each of these two cases, these case attributes may present some interesting challenges for the plaintiffs.

Deutsche Bank is of course a domiciled in Germany. However, the company’s Global Registered Shares are listed on the NYSE. Its shares also trade on the Frankfurt Stock Exchange. The complaint purports to represent all investors that purchased the company’s common shares during the class period. The complaint does not explicitly restrict its class to those investors that purchased their shares on the NYSE, but the question undoubtedly will arise under Morrison v. National Australia Bank whether the relief available under the U.S. securities laws will extend to those who purchased their shares outside the U.S.

Though CCC had its principle place of business in Washington, D.C., CCC was organized under laws of Guernsey and its shared traded on the Euronext Exchange. Euronext is based in Amsterdam and has affiliates in Belgium, France, Netherlands, Portugal and the U.K. The defendants undoubtedly will seek to argue, in reliance on Morrison v. National Australia Bank, that because the transactions in which the purported class of investors purchased their shares took place outside the U.S., their alleged injuries are not cognizable under the U.S. securities laws.

The plaintiff in the CCC case, no doubt anticipating this argument, alleges in his complaint that since April 2007 Euronext has been owned by the NYSE; that most of the alleged misconduct too place in the U.S.; that a substantial majority of the CCC shares were owned by U.S. residents, and that U.S. investors “with typical brokerage accounts” access Euronext shares the same as they would NYSE or NASDAQ shares. These considerations notwithstanding, the question under Morrison is where the “transaction “ took place, and in light of the post-Morrison case law, the CCC plaintiff may face significant challenges overcoming the defendants’ Morrison-based motion to dismiss. The defendants undoubtedly will argue that Morrison expressly rejected the very kind of “conduct and effects” arguments on which the plaintiff apparently intends to rely.

The belated nature of both of these cases also presents some rather interesting issues. The Deutsche Bank case was filed about two and a half years after then end of the purported class period. The CCC complaint is even more belated, having first been filed more than three years after the class period cut off.

The timing of the Deutsche Bank complaint may have to do with the timing of the U.S. Department of Justice’s recently announced suit against the bank related to the its  alleged misrepresentations about its mortgage loans. The recently filed class action complaint, specifically references the DOJ action and the May 4, 2011 Wall Street Journal article about the DOJ complaint. The securities class action complaint appears to have followed in the wake of and in reaction to the filing of the DOJ complaint. But while the timing of the filing of the class action complaint may be understood as related to the timing of the DOJ complaint, the plaintiffs should anticipate that the defendants’ dismissal motion will include a motion to dismiss the case on statute of limitations grounds.

The CCC plaintiff’s complaint expressly anticipates the likelihood of a statute of limitations dismissal motion. The complaint contains numerous paragraphs raising the delays that the Liquidation authority faced in trying to investigate the causes of CCC’s collapse. The complaint alleges that the defendants and other related Carlyle parties “undertook deliberate and affirmative steps to conceal… facts sufficient to apprise Plaintiff and the Class of the existence of potential claims against the Defendants.” The complaint cites purported statements of the Liquidator that the defendants “repeatedly obstructed their efforts” to obtain CCG’s books and records.

On July 7, 2010 the Liquidators commenced a civil action against the defendants in multiple jurisdictions, asserting that the defendants breached their fiduciary duties to CCC. The plaintiff alleges that the defendants’ “fraud was effectively and indefinitely concealed from the public at least until July 7, 2010.”

It remains to be seen whether the CCC plaintiff’s fraudulent concealment argument will prove sufficient to overcome statute of limitations concerns. But the belated nature of these cases and the presence of the statute of limitations concerns underscore why the credit crisis-related litigation wave has largely petered out, and why we are unlikely to see very many more credit crisis-related lawsuits. Even if these cases manage to overcome the statute of limitations hurdle, any other potential case that has not yet been filed will facing even more daunting timeliness problems.

It is interesting to note how both of these cases embody filing trends that seemed to have completely played out some time ago, or at least to have dwindled out. As I noted at the outset, both of these cases are credit crisis-related, a litigation trend that seemed to have mostly played out a year ago. But these cases are “flashes from the past” in other ways as well. They are both “belated” cases, in that they were filed more than a year after their purported class period cutoff. There were a host of “belated” cases in late 2009 and early 2010 (about which refer here), but the belated cases flings seemed to have gone away some time ago.

And both cases involved companies organized under the laws of non-U.S. jurisdictions, and whose shares trade in whole or in part on exchanges located outside the U.S. In the wake of the U.S. Supreme Court’s June 2010 Morrison v. National Australia Bank case, there was widespread speculation that filing of securities class action lawsuits in the U.S. against non-U.S. companies would become a thing of the past. Of course, lawsuits against foreign companies whose shares trade on the U.S. exchanges have continued, and that may explain the Deutsche Bank suit. The CCC case seems to be another matter.

It really is interesting that, notwithstanding Morrison, how many of the 2011 securities class action lawsuit filings involve non-U.S. companies. About 33 of the approximately 109 (roughly 30%) securities class action lawsuits filed so far during 2011 involve non-U.S. companies, compared to 15.9 percent during all of 2010. To be sure, a large part of the 2011 filings involve U.S.-listed Chinese companies. But regardless of the reason, the fact is that contrary to expectations, one year after the Morrison decision, the securities class action lawsuit filings against non-U.S. companies as a percentage of all filings has actually increased.

In any event because of the issues that these two recent cases present, they will interesting to follow. It will also be interesting to see if there are any more credit crisis related lawsuit filings ahead. I have in any event added these two cases to my running list of credit crisis-related lawsuit filings, which can be accessed here.

Final Notes:  Although the credit crisis related litigation wave largely played out early in 2010, a trickle of credit crisis-related cases has continued to come in. In fact the two cases above actually bring the number of credit crisis-related cases so far in 2011 to at least four (categorization issues of course always come into these kinds of analyses, but by my categorization there have been at least four, others may categorize and therefore count differently). The prior two 2011 credit crisis-related cases are the Bank of America foreclosure documentation case (refer here) and the United Western Bancorp case (refer here).

And finally, these two cases are not the only “belated” cases filed so far in 2011. By my count, there have been at least five “belated” cases far this year, counting these two. The other three belated cases are Frontpoint Partners (here), Oilsands Quest (here) and Elan Corp. (here)

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Over the last few days, there have been a series of rulings in high-profile lawsuits arising out of the subprime meltdown and credit crisis. As discussed below, just in the past week there were dismissal motion rulings in cases involving Freddie Mac, Wachovia/Wells Fargo, and AIG. Though some or all of the claims in these cases were dismissed in whole or in part, the plaintiffs have managed to live at least for another day (if only just barely in the Freddie Mac case). At the same time,  in the AIG ERISA case, the case largely survived the dismissal motion.

Freddie Mac: On March 30, 2011, Southern District of New York Judge John Keenan granted without prejudice the defendants’ motion to dismiss in the Federal Home Loan Mortgage Corp. (Freddie Mac) subprime-related securities class action lawsuit. A copy of the March 30 order can be found here.

Freddie Mac is of course one of the government sponsored entities that was at the center of the residential mortgage crisis in 2008. On September 7, 2008, it was placed in the hands of a conservator. In August 2008, shortly before the company entered conservatorship, the company’s public shareholders filed a securities class action lawsuit against the company and certain of its directors and officers, as discussed in greater detail here.

The plaintiffs alleged that in various public statements the defendants had made three types of misrepresentations or omissions: (1) about the company’s exposure to “non-prime mortgage loans”; (2) about its capital adequacy; and (3) about the strength of its due diligence and quality control mechanisms. The defendants moved to dismiss.

In finding that the alleged misrepresentations about the company’s exposure to subprime mortgages were insufficient, Judge Keenan found that “the Amended Complaint does not explain why Freddie Mac’s disclosures in its November 2007 Financial Reports … were insufficient to convey the truth that Freddie Mac was dealing in non-conforming mortgages to the public.” He added that “Plaintiffs present no theory at all about why Freddie Mac’s disclosures would not be understood by the reasonable investor and thus part of the ‘total mix’ of information that determined its share price.”  

Judge Keenan also found that the alleged misrepresentations regarding the company’s capital adequacy were also insufficient. He observed that “in a volatile economic, political and regulatory environment like the one that existed in the summer and early fall of 2008, with even Freddie Mac’s primary regulator being replaced, Plaintiffs must show more to plausibly claim that Freddie Mac’s statements were made without any basis in fact. “ However, he concluded that “Plaintiff has not adequately pleaded sufficient facts giving rise to a strong inference that Freddie Mac’s statements about its capital adequacy or its hope that it would continue to function were made with intent to defraud or without factual basis.”

With respect to the alleged misrepresentations regarding the company’s internal controls and processes, Judge Keenan found that “there are simply no facts in the Amended Complaint from which one could reasonably infer a causal link between Freddie Mac’s statements about its underwriting standards and internal controls and any loss suffered by purchasers of its equity securities during the Class Period.” He added that “considering that the price of Freddie Mac’s stock was clearly linked to the ‘marketwide phenomenon’ of the housing price collapse, there is decreased probability that Plaintiffs’ losses were caused by fraud.”

Judge Keenan granted the motions to dismiss without prejudice and allowed the plaintiffs’ 60 days in which to file a Second Amended Complaint.

An April 1, 2011 Bloomberg article about Judge Keenan’s decision in the Freddie Mac case can be found here.

Wachovia/Wells Fargo: On March 31, 2011, Southern District of New York Judge Richard Sullivan issued his rulings on the motions to dismiss in the consolidated securities litigation that had been filed on behalf former equity shareholders and bondholders of Wachovia Corporation. In a lengthy and detailed opinion (here), Judge Sullivan granted the defendants’ motions to dismiss the equity securities litigation, but he denied the motion to dismiss the bondholders’ action, other than with respect to certain bond offerings in which the plaintiffs had not actually purchased any securities.

As Judge Sullivan wrote in summarizing the various plaintiffs’ allegations, “all claims arise from the financial disintegration Wachovia experienced between its 2006 purchase of Golden West Financial Corporation and its 2008 merger with Wells Fargo & Company.” In essence, the complaint is based on the difficulties Wachovia experienced as a result of the Golden West “Pick-A-Pay” mortgage portfolio. Further background regarding the equity securities litigation can be found here and background regarding the bondholders’ litigation can be found here.

Judge Sullivan granted the defendants’ motions to dismiss the equity securities plaintiffs’ ’34 Act claims, finding that the plaintiffs had not sufficiently alleged scienter. Judge Sullivan concluded that the “more compelling inference” is that “Defendants simply did not anticipate the full extent of the mortgage crisis and the resulting implications for the Pick-A-Pay loan portfolio. Although a colossal blunder with grave consequences for many, such a failure is simply not enough to support a claim for securities fraud.” He added that “bad judgment and poor management are not fraud, even when they lead to the demise of a once venerable financial institution.”

Judge Sullivan also granted the defendants’ motion to dismiss the equity securities plaintiffs’ ’33 Act claims, finding that their “scattershot pleadings” failed to “afford proper notice, much less provide facially plausible factual allegations.” He added that he could not conclude “that the relevant offering documents contained material omissions in violation of affirmative disclosure obligations.”

However, Judge Sullivan denied the defendants’ motions to dismiss the bondholders’ ’33 Act claims (other than with respect to the offerings in which the plaintiffs had not purchased shares, with respect to which the motion was granted). In concluding that the bondholders’ allegations were sufficient when the equity securities plaintiffs’ allegations were not, Judge Sullivan found that the bondholder plaintiffs had adequately alleged misrepresentation in the relevant offering documents with respect to loan to value rations maintained in the mortgage portfolio and with respect to the alleged manipulation of the appraisal process to produce inflated appraisal values.

On the strength of these alleged misrepresentations in the offering documents, Judge Sullivan also denied defendant KPMG’s motion to dismiss the bondholders’ 33 Act claims.

Susan Beck’s April 1, 2011 Am Law Litigation Daily detailed article about Judge Sullivan’s ruling can be found here.

AIG ERISA Action: In a March 31, 2011 order (here) in the AIG subprime-related ERISA action, Southern District of New York Judge Laura Taylor Swain, denied the defendants’ motion to dismiss, other than with respect to plan organized on behalf of Puerto Rico employees with respect to which the motion was granted on the ground that because none of the name plaintiffs participated in that plan, they lacked standing to pursue those claims.

The plaintiffs are participants or beneficiaries in I two AIG plans, the AIG Incentive Savings Plan and the American General Agents’ & Managers’ Thrift Plan between June 15, 2007 and the present. Each plan offered participants a menu of investment options, one of which was the AIG Stock Fund, which invested in AIG stock.

The plaintiffs alleged that the defendant plan fiduciaries breached the duty of prudence by continuing to offer the AIG Stock Fund as an investment option, even when they knew or should have known that AIG stock was no longer a suitable and appropriate investment. The plaintiffs further alleged that the defendants failed to disclose to fellow fiduciaries nonpublic information that was need to protect the interests of the Plans. The plaintiffs also alleged that the defendant fiduciaries failed to monitor the investments and failed to provide complete and accurate information regarding AIG’s mismanagement and improper business practices.

Judge Swain rejected all of the grounds on which the defendants’ sought to dismiss the allegations asserted on behalf of participants and beneficiaries of the AIG Incentive Saving Plan and the American Genera Agents’ and Managers’ Thrift Plan. Judge Swain held that Plaintiffs had sufficiently alleged that had there been an investigation triggered by  the “warning signs” regarding problems in AIG’s Financial Products Unit, “it would have demonstrated that AIG stock had become an imprudent investment.”

Judge Swain also found that the Plaintiffs “have adequately alleged that Defendants failed to disclose the true extent of the risk facing AIG as a result of its financial decisions and the decline of the residential housing market, and that Defendants affirmatively misrepresented the strength and extent of the processes AIG had in place to mitigate this risk.”

Finally, she found that the plaintiffs “have sufficiently alleged that AIG and the director defendants were aware of the increasingly risky financial position maintained by AIG, material weaknesses in AIG’s financial health and the potential impending erosion of the value of AIG’s stock.”

An April 1, 2011 Bloomberg article about Judge Swain’s rulings can be found here.

I have in any event added these  rulings to my running tally of subprime-related lawsuit dismissal motion rulings, which can be found here.

Discussion

It has been quite a while since the subprime and credit crisis litigation wave first started in early 2007. Yet many of the cases are still working their way through the system. The cases discussed above involve some of the highest profile participants in many of the events surrounding the credit crisis. One thing that is striking, at least about the Freddie Mac and the Wachovia cases, is the extent to which the courts seemed influenced by the comprehensiveness of the credit crisis. It seems that in the context of a global economic crisis – particularly one that caught so many by surprise – the courts continue to be skeptical of fraud claims, absent concrete support for the allegations.

These rulings suggest that the barrier to overcome the initial judicial skepticism may be substantial. Indeed, the plaintiffs in the Wachovia case failed to overcome the court’s concerns despite having assembled 50 confidential witnesses, and despite the fact that the aggregate market cap drop on which the equity shareholders was approximately $109 billion.

On the other hand, the hurdle the plaintiffs must overcome is not insurmountable. The Wachovia bondholders’ Section 11 claims are going  forward. And even the plaintiffs in the Freddie Mac case will have at least another chance to replead to try to overcome the initial pleading hurdles.

Judge Swain’s ruling in the AIG ERISA case seemed more receptive. But it is worth keeping in mind that ERISA plaintiffs do not face the same heightened pleading standards that securities lawsuit plaintiffs face under the PSLRA. Perhaps even more significantly, the ERISA plaintiffs do not have to plead scienter.

In any event, all three of these cases will be worth watching as they continue to work their way through the system.

Special thanks to the loyal readers who provided me with copies of these rulings.

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Many observers have been waiting to see whether and to what extent the FDIC will pursue claims against former directors and officers of banks that have failed during the current bank failure wave. So far, the FDIC has filed just a single suit, against former officers of a subsidiary of IndyMac.

However, on August 31, 2010, federal regulators filed a complaint in the Central District of California against 16 officer and directors of a failed financial institution – but the agency filing the lawsuit was not the FDIC and the failed institution was not a bank. Rather, the agency filing suit was the National Credit Union Administration, and the failed institution was a credit union, Western Corporate Federal Credit Union (or WesCorp) of San Dimas, California.

A copy of the NCUA’s complaint can be found here. A copy of the NCUA’s August 31, 2010 press release can be found here.

Prior to its closure, WesCorp had operated as a wholesale or corporate credit union, providing back office services to other credit unions. As reflected in the agency’s press release at the time, on March 20, 2009, the NCUA placed WesCorp in conservatorship. At the time, WesCorp had $23 billion in assets and 1,100 retail credit union members.

As reported in the Agency’s August 31 press release, the former directors and officers were originally sued in November 2009 in Los Angeles County Superior Court in action brought by seven WesCorp member credit unions. The NCUA intervened in that suit and sought leave to substitute the NCUA as the proper party plaintiff. The court granted the NCUA’s motion and to file an amended complaint by August 31. The NCUA’s complaint supersedes the initial complaint filed by the member credit unions.

The NCUA’s complaint alleges beginning in 2002, after Robert Siravo became the institution’s CEO, WesCorp embarked "an aggressive campaign" to grow, which was successful due to the institution’s reliance on borrowed funds to make investments in mortgage backed securities. While WesCorp grew, so did its borrowings, which eventually equaled over 30% of the institution’s assets. As the firm grew, so too did its exposure to exotic mortgage backed assets, particularly securities backed by Option ARM mortgages.

In 2009, WesCorp was forced to record $6.9 billion in losses, rendering the institution insolvent. About two-thirds of the losses were from Option ARM securities WesCorp purchased in 2006 and 2007.

In addition to allegations against all defendants alleging negligence and breach of fiduciary duty, the NCUA complaint also allege that Siravo and the former head of Human Resources manipulated their retirement accounts to make them more lucrative, resulting in over $4.4 million in overpayments, including an extra $2.3 million to Siravo.

One of the defendants in the case is William Cheney, who was a member of WesCorp’s board from May 2002 to February 2006. Cheney is currently the President of the National Credit Union Association, which is the credit union industry’s national trade association.

At the time that the NCUA took control of WesCorp, the institution was the largest of the corporate credit union. The credit union industry, along with the rest of the financial sector, had been suffering some turbulence over the last several years. The NCUA has closed 14 retail credit unions in 2010, and closed 12 retail credit unions in 2009. There were 7,554 federally insured credit unions as of December 31, 2009.

The Wall Street Journal’s September 2, 2010 article about the NCUA’s lawsuit can be found here.

Be Excellent to Each Other: San Dimas is not only the pre-conservatorship home of WesCorp. It is also the home of San Dimas High School, which is of course where Bill and Ted went to school in the most excellent 1989 movie, Bill and Ted’s Excellent Adventure. (I wonder if Bill and Ted went on to work at WesCorp after their high school graduation. Perhaps in the investment division.) I am sure that when Bill and Ted learned that WesCorp had been put into conservatorship, they said something like "Bogus. Heinous. Most non-triumphant."

In honor of San Dimas High School and the school’s two most famous alums, here’s a video tribute to Bill and Ted, showing their history report at a San Dimas high school assembly:　

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Though we are in the midst of the dog days of summer (at least in the northern hemisphere), the federal courts, at least, have been busy. In the last several days alone, several courts have issued dismissal motion rulings in lawsuits arising out of the subprime meltdown and the credit crisis.

As noted below, several of these decisions involve failed or troubled banks, and therefore may be of particular interest in relation to the many banks have failed in recent months or that are continuing to struggle now. Though investor plaintiffs in other cases involving failed or troubled banks have sometimes struggled to survive the initial pleading stages, in the cases discussed below, the plaintiffs managed to survive the dismissal motions, at least in part.

PFF Bancorp: In an August 9, 2010 opinion (here), Central District of California Judge Andrew Guilford denied the defendants’ motions to dismiss in the securities class action lawsuit against two former directors and officers of PFF Bancorp, the corporate parent for PFF Bank & Trust, which failed on November 21, 2008.

As reflected here, in January 2009, shareholders of the holding company filed a securities lawsuit alleging that the company’s President and CEO and its CFO contending that they concealed the Bank’s unsafe lending practices and made misleading statements about the bank’s loan loss reserves and capital levels.

In his August 9 order, Judge Guilford found that while the plaintiffs’ allegations that defendants made misleading statements about the banks’ "cautious" and "conservative" lending practices were insufficient to state a claim, the plaintiffs’ allegations that defendants had falsely characterized the bank’s loan loss reserves as "adequate" were sufficient to state a claim.

Judge Guilford also found that plaintiffs had adequately alleged scienter, finding that plaintiffs’ allegations "permit the inference that Defendants knew PFF’s loan practices were risky and that PFF had inadequate loan loss reserves, yet told investors that the loan loss reserves were adequate."

Interestingly, Judge Guilford found plaintiffs’ scienter allegations to be adequate despite the defendants’ contention that they had actually purchased PFF shares at the supposedly inflated prices. Judge Guilford declined, at the motion to dismiss state, to take judicial notice of the SEC forms on which defendants sought to rely in order to establish their share purchases.

Popular, Inc. (Securities Claim): In an August 2, 2010 order (here), District of Puerto Rico Judge Gustavo Gelpí granted in part and denied in part the defendants motion to dismiss the securities class action lawsuit that had been filed against Popular, Inc., certain of its directors and officers, its auditor and its offering underwriters.

The plaintiffs’ complaint focused on the company’s accounting for a deferred tax asset. In the three years preceding the beginning of the class period (which went from January 24, 2009 to February 2009), the company had recorded tax loss carry forwards that totaled over $1 billion, largely as a result of the company’s U.S. subprime and other lending operations. The benefit of these deferred tax assets could only be realized if the company experienced sufficient U.S.-based gains within 20 years.

To offset the possibility the company might not fully realize the value of the deferred tax assets, accounting rules required reporting companies to take a valuation allowance, but the company recorded no material valuation allowance of this asset until late 2008. The company ultimately recorded an allowance for the full value of the asset. Following the announcement of this action, the company’s share price fell substantially.

The plaintiffs allege that the increasing, multiyear U.S.-based operating losses prevented it from anticipating sufficient taxable income to realize the full value of the deferred tax asset prior to the expiration of the 20-year period, yet failed to take a valuation reserve because doing so would have lowered the bank’s risk-based capital ratio below regulatory requirements. The financial picture the company’s treatment of the asset portrayed allowed the company to raise over $300 million in a May 2008 offering.

The Court found that the plaintiffs allegations adequately alleged material misrepresentations, given that "Popular’s three-year cumulative loss position, combined with the Company’s significant downsizing of its U.S. mainland operations and the worsening market conditions, constituted strong evidence that at the beginning of the class period it was more likely than not that the Company would not be able to realize the benefit of its [deferred tax asset] in full."

The Court also concluded that the complaint adequately alleged scienter, concluding that the defendants’ decision "not to take an earlier valuation allowance was ‘highly unreasonable’ and an ‘extreme departure from the standards of ordinary care’ to the extend that the danger was either know to the defendants or so obvious that they must have been aware of it."

The Court also concluded that the ’33 Act allegations against the officer defendants were also sufficient. However, because the Court found that the amended complaint in which the plaintiffs added as defendants the outside directors, the company’s auditor and its offering underwriters had been filed more than a year after there were sufficient "storm warnings" to put the plaintiffs on inquiry notice, the ’33 Act claims against those defendants were untimely and were therefore dismissed.

Popular, Inc. (Derivative Suit): In an August 11, 2010 opinion (here), applying Puerto Rico law, in the shareholders’ derivative lawsuit filed against Popular, Inc, as nominal defendant, certain of its directors and officers, and its outside auditor, Judge Jay Garcia-Gregory denied in part and granted in part the defendants’ motions to dismiss. The allegations in the derivative suit largely mirror those alleged in the securities class action lawsuit.

The officer and director defendants had moved to dismiss on the ground that the plaintiff had not presented a demand to the company’s board to pursue the lawsuit. The plaintiff argued that demand was futile, and the Court agreed. The Court found that the plaintiffs’ allegations and of the requirements of SFAS 109 "provide ‘reason to doubt’ the legality of declining to record a valuation allowance until 2009" and therefore "demand is excused" because the presumption that the board took a valid business judgment had been rebutted by the alleged lack of "legal fidelity."

The Court did, however, dismiss the plaintiff’s gross mismanagement claim as duplicative of the breach of fiduciary duty claim. The Court also found that the plaintiff had not adequately alleged corporate waste. Finally, the Court found that the plaintiff’s claim against the company’s auditor should also be dismissed, on the grounds that the plaintiff had not made a demand on the company’s board to pursue the claim and had not established demand futility.

Discussion

Plaintiffs have had some difficult surviving initial dismissal motions in many of the securities class action lawsuits that have been filed against the directors and officers of banks that have failed during the current failed bank wave. For example, the securities class action lawsuit arising out the failure of Downey Financial Corp. (whose operating bank failed the same day as PFF Bank & Trust) was dismissed with prejudice.

Similarly, the motion to dismiss in the Fremont General case was also ultimately dismissed with prejudice. Similarly, the motion to dismiss was granted in the BankUnited securities case, albeit without prejudice.

More recently, however, the motion to dismiss was denied in the securities class action lawsuit arising out of the failure of Corus Bankshares. With the above decisions, it seems as if the plaintiffs in these cases have managed to overcome the initial pleading hurdle at least in several cases now.

To be sure, the reasoning the Popular case is based on circumstances that may be unique to that case. The allegations in the PFF Bancorp case, however, arguably are more typical. But while the PFF Bancorp case survived the dismissal motions, it remains to be seen whether the case will survive additional proceedings in the case, if defendants are able to establish that the purchased company shares at the allegedly inflated prices.

Ultimately, the fundamental question about the failed banks is whether the FDIC will lower the litigation boom on directors and officers of the failed banks. So far, the FDIC’s litigation activity has been limited to a single lawsuit it filed against officers of a subsidiary of IndyMac (about which refer here). Whether and to what extent the FDIC will pursue other claims will be revealed in the weeks and months ahead.

In any event, I have added these decisions to my running tally of subprime and credit crisis-related dismissal motion rulings, which can be accessed here.

Very special thanks to the loyal readers who provided me with copies of these decisions.

Another Banking Institution Dismissal Motion Ruling: Though the financial institution involved has neither failed nor is seriously troubled, it should be noted here at least briefly that in an August 10, 2010 order (here), Southern District of Ohio Judge Sandra Beckwith denied in part and granted in part the defendants’ motion to dismiss in the securities class action lawsuit that had been filed against Fifth Third Bancorp and certain of its directors by former shareholders of First Charter, which Fifth Third acquired in a deal announced in August 2007.

As discussed here, the former First Charter shareholders alleged that in connection with the merger, Fifth Third and certain of its directors and officers had materially misrepresented Fifth Third’s exposure to poorly performing residential real estate markets, and had not fully represented how seriously its mortgage portfolio was deteriorating.

Judge Beckwith’s detailed and painstaking August 10 opinion denied the motion to dismiss as to the claims of certain classes of First Charter shareholders, but granted the motion to dismiss as to all other claims and claimants.

Another Credit-Crisis Related Securities Suit Dismissal Motion Ruling: In an August 13, 2010 order (here), District of Maryland Judge Catherine Blake denied in part and granted in part defendants’ motions to dismiss the securities class action lawsuit that had been filed against Constellation Energy.

As discussed here, Constellation Energy was one of the many nonfinancial companies that suffered credit crisis related financial reverses in late 2008 and early 2009 and attracted securities litigation arising out the companies’ financial woes.

In September 2008, Constellation shareholders and subordinated debenture holders filed a securities class action lawsuit against the company, certain of its directors and officers and offering underwriters. Their complaint asserts claims under Section 11, 12(a)(2) and 15 of the ’33 Act and under Section 10(b) of the ’34 Act.

Essentially, the plaintiffs alleged that the defendants had misrepresented the additional collateral the company would have to post in connection with its merchant energy business in the event of a company credit downgrade. (As the company itself later disclosed, the collateral requirements for a one-notch credit downgrade were less than had been disclosed; the collateral requirements for a two or three notch downgrade were significantly greater than disclosed.)

The plaintiffs also alleged that the defendants had not sufficiently disclosed the company’s exposure to Lehman Brothers. The plaintiffs also alleged that the defendants’ misrepresented the company’s future earnings, business outlook, risk management and internal controls.

In fall 2008, after the company suffered a several notch ratings downgrade and after Lehman collapsed, the company’s share price fell and investors’ sued. The company ultimately sold a substantial portion of its assets.

In her August 13 order, Judge Blake found that the plaintiffs’ ’33 Act allegations regarding the company’s downgrade collateral obligations were sufficient to state a claim. Interestingly, Judge Blake reached her conclusion even though the company’s debenture prices dropped only slightly immediately after the disclosure of the company’s revised collateral obligation and in fact rose thereafter for several weeks. These facts "ultimately may counsel against materiality" but are "not dispositive at this stage of the litigation.

Judge Blake found that the plaintiffs’ remaining ’33 Act allegations were insufficient to state a claim.

As for plaintiffs ’34 Act allegations, Judge Blake found that the plaintiffs had not adequately alleged scienter in connection with the downgrade collateral obligations. She noted that "without additional factual allegations that the defendants were somehow aware that the downgrade collateral requirements were miscalculated …neither Constellation nor its officers can be presumed to have known of a faulty computer calculation."

Judge Blake also found that the plaintiffs’ remaining ’34 Act allegations were inadequate.

I have also added the Fifth Third and Constellation Energy rulings to my running tally of credit crisis lawsuit dismissal motion rulings, which again can be accessed here.

Special thanks to a loyal reader for providing a copy of the Constellation Energy decision.

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As the dramatic events in the financial marketplace during fall 2008 recede further into the past, the wave of related litigation activity has also clearly started to slow. But a newly filed lawsuit arising directly from the financial crisis suggests that there may still be further credit crisis cases yet to come, particularly as plaintiffs’ lawyers continue to initiate class action litigation with proposed class period cut-off dates well in the past.

As reflected in their November 10, 2009 press release (here), plaintiffs’ lawyers have launched a securities class action lawsuit in the Southern District of New York against certain former officers VeraSun Energy Corp., a of South Dakota-based ethanol producer that filed for bankruptcy on October 31, 2008.

According to the press release, the complaint (a copy of which can be found here) alleges that the defendants failed to disclose that:

(i) VeraSun was, in part, a speculative commodities trader in addition to an ethanol producer; (ii) VeraSun engaged in speculative and risky derivate transactions that exposed the Company to substantial financial and liquidity risk; (iii) VeraSun experienced substantial loses on speculative derivative transactions causing margin pressures on the Company; (iv) as a result of margin pressures from bad speculative derivative transactions, the Company sold out of a large short position in corn and incurred substantial losses; (v) the Company entered into highly risky "accumulator" contracts that obligated VeraSun to purchase increasing amounts of corn after the price of corn fell in price per bushel; and (vi) VeraSun’s financial condition and especially its liquidity were negatively impacted as a result of speculative commodity transactions, ultimately causing the Company to file for bankruptcy.

The complaint further alleges  that:

On September 16, 2008, VeraSun announced that it commenced a public offering of 20 million shares of its common stock to raise money for "general corporate purposes." The true purpose of this public offering was to raise capital in an effort to prevent a disastrous impact from the huge losses experienced by the Company as a result of its speculative trading and risky bets on the price of corn.

Not only are these events all well over one year ago, but the proposed class period also covers a segment of time that is also well past -- the complaint purports to be filed on behalf of a class of persons who purchased VeraSun shares between March 12, 2008 and September 16, 2008.

The complaint’s allegations resemble the facts and circumstances alleged in a number of credit crisis-related cases that were filed last fall, where (as described here) the defendant companies were alleged to have suffered significant financial reverses due to wrong way bets on commodities or currencies, often (as was the case with VeraSun) in connection with hedging transactions. In each case, the sudden and dramatic events in the financial markets during September and October 2008 produced a magnified impact on financial condition of these companies.

The prior lawsuits generally were filed closer in time to the events involved, while the VeraSun case has only just been filed. The lapse in time between the events alleged and the VeraSun lawsuit filing is, however, consistent with the filing pattern that has emerged during 2009, where (as noted here) numerous newly filed complaints have proposed class period cutoff dates that fall well before the filing date.

I have previously speculated that these seemingly belated filings may perhaps reflect a filing backlog that developed as plaintiffs’ lawyers were caught up in the rush of credit crisis related lawsuits and Madoff related litigation. The VeraSun case filing suggests that this apparent backlog may even include yet to be filed credit crisis-related lawsuits, which in turn suggests that there there may be more credit crisis suits yet to come.

The VeraSun case is also the latest example of a securities class action lawsuit arising in the wake of a corporate bankruptcy. The surging numbers of business-related bankruptcies may further contribute to the further instigation of securities class action litigation. The possibility of these kinds of cases arising, like the VeraSun case, well after the bankruptcy date suggests these cases could continue to arrive for some time to come.

All of which suggests to me that, even of the pace of new credit crisis-related securities lawsuit filings have declined, the litigation fallout from the global financial crisis is likely to continue to accumulate in the months ahead.

I have in any event added the VeraSun case to my list of credit crisis related cases, which can be accessed here.

Another Options Backdating-Related Securities Suit Settlement: Another one of the remaining options backdating-related securities lawsuits has settled. As reflected in their October 15, 2009 stipulation of settlement (here), the parties to the Sonic Solutions options backdating-related securities suit have agreed to settle the case for $5 million.

A complete list of the options backdating-related lawsuit resolutions can be accessed here.

Adam Savett of the Securities Litigation Watch blog has been tracking (here) the options backdating related settlements.Adjusting his data to take account of the Sonic settlement would mean that 30 of the 39 options backdating-related securities class action lawsuits have now been resolved, with nine of these cases having been dismissed and twenty-one of them having been settled. Prior to the Sonic settlement, the average settlement amount was $77.8 million – or $33.23 million if the outsized UnitedHealth settlement is disregarded.

UPDATE: The Securities Litigation Watch has updated its options backdating settlement tally and analysis to reflect the Sonic settlement, here.

My Dinner with Bill: I am in Chicago this week at the PLUS International Conference, where the keynote speaker was none other than Bill Clinton. Let me just say that he though he is now "only" a former President, he retains all of his rhetorical powers. His speech was entertaining, thought-provoking, funny and serious, and impressive.

During the Q&A, one of the questions he was asked is a rather conventional parlor game question: if you could have dinner with any historical figure, who would you choose and why? Perhaps because it was a conventional question, he gave a rather conventional, almost undergraduate-approval-seeking type answer. And being a politician, he couldn’t name just one person – he named three: Socrates, Jesus, and Genghis Kahn. Clinton had his reason for each of the three.

I will grant you that Genghis Kahn is an interesting answer, but the other two are safe, predictable and, well, kind of boring. I will stipulate that everyone if they had a chance would want to meet Jesus. Socrates is pretty much in the same category. (Same with Gandhi and Winston Churchill) So if we all agree that Jesus and Socrates (and Gandhi and Churchill) are not available, which historical figure would you want to have dinner with?

Because Clinton gave himself three choices, I am going to give myself three as well.

First, I would choose Charles Maurice de Talleyrand-Perigord, also known as the Bishop of Autun. Talleyrand lived through some of the most interesting events in all of human history and somehow not only managed to be involved in them all, but what is perhaps a more impressive feat, to have survived them all. He was involved in the French revolution from the start and even acted as foreign minister to the revolutionary government. He later managed to become a key advisor to Napoleon, until they fell out over policy. Ultimately, he became one of the key players in the Bourbon restoration. Though often reviled as unprincipled and cynical, I believe he may have been one of the most interesting people in the grand march of history, and he certainly led one of the most interesting lives.

Second, I would choose Moshe ben Maimon, now known as Maimonides, the Jewish theologian, physician and philosopher. He also lived at an incredibly interesting time, having been born in Islamic Spain in the twelfth century and then fled persecution through Northern Africa. His wisdom, scholarship and knowledge of languages have shaped European thought up until this very day. He was among the first Europeans both to appreciate and advocate Aristotle. His rationalist philosophy would still appeal to most moderns, which to me is a reflection of what an original and powerful thinker he was.

Having chosen two historical figures, I feel I should be a little bolder and unconventional with my last choice. So my third selection is John Lennon. He was a radical advocate for peace whose art and originality touched the lives of millions.

A dinner with all three of these persons simultaneously would be chaos. But a dinner with any one of them (language and cultural issues aside) would be fascinating.

So, now you have Bill Clinton’s choices and my choices. Who would you choose? And why? If you are attending the conference and you have views on this question, I hope you will stop me and let me know your thoughts. And if you are not at the conference, I hope you will use the comment function on this blog to let me and other readers know what you think.

The one final thought I have to add is that , after having heard Bill Clinton speak today, honestly, I think a dinner with him would be pretty damn interesting, too.  I suspect we could talk about Talleyrand and Maimonides and even John Lennon or Genghis Kahn and it would be memorable and entertaining.

UPDATE: My friend and former colleague Marty Hacala provided the following e-mail answer to my dinner guest question: 

I agree that Clinton's answer was boring and conventional. We are after all talking about a dinner party and not a lecture. Who wants to listen to a failed carpenter and a suicidal Greek talk about the hereafter while picking at their food? Genghis Khan is an interesting choice if only because he might tire of the conversation and dispatch the first two before dinner has even begun.

My invitations would go to Oscar Wilde, Abraham Lincoln and Groucho Marx. (I could substitute Churchill for Lincoln, but I fear the alcohol wouldn't last and so the meal would end on an unhappy note.) Just imagine the stories they would tell? I see myself sitting there mesmerized listening to Wilde and Marx trade high and low-brow barbs, while Lincoln tells long stories of how they remind him of mostly made up characters from his youth. It would be an evening to remember. 　

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It is always useful to look at aggregate securities lawsuit filing data to try to determine what trends and themes can be discerned, but occasionally it is also useful to look at a single new filing whether it might suggest anything. To choose one example, a closer look at a new securities class action lawsuit filed on October 14, 2009 in the Eastern District of Pennsylvania against Advanta Corporation and certain of its directors and officers seems to reflect a variety of different securities litigation tendencies and motifs.

Advanta at one time was the country’s largest issuer of Visa and MasterCard credit cards, through its subsidiary, Advanta Bank Corp. As reflected in the plaintiffs’ lawyers’ October 14, 2009 press release (here), the lawsuit alleges that the defendants failed "to disclose the impact of the economic environment and the deteriorating credit trends on its business and that the Company failed to adequately and timely record losses for its impaired loans and customer delinquencies, causing its financial results to be materially false."

Specifially, the complaint (which can be found here) alleges that:

(a) Advanta’s assets contained tens of millions of dollars worth of impaired credit card receivables for which the Company had not accrued losses; (b) prior to and during the Class Period, Advanta had been extremely aggressive in granting credit to customers without verifying the customers’ ability to pay, to such a degree that by the summer of 2009, Advanta customers’ default rate would be almost six times worse than industry average; (c) Advanta’s manipulation of its cash rewards program angered customers and caused the Company to lose good, creditworthy customers; (d) Advanta’s credit receivables were unduly risky due to the Company’s practice of issuing credit cards to small business owners without, in many instances, verifying income; (e) defendants failed to properly account for Advanta’s continuing delinquent customers and the credit trends in the Company’s portfolio, resulting ultimately in large charges to reflect impairments; and (f) the Company was not on track to be profitable in 2008.

The complaint alleges that the company’s share price plunged after its October 2007 disclosure that it was experiencing a higher rate of delinquencies. The complaint alleges that thereafter the news only got worse, and in May 2009 the company announced in May 2009 the cancellation of "millions of cards held by small businesses." On June 30, 2009, the FDIC entered a cease and desist order (here) against Advanta Bank following allegations of unsafe and unsound banking practices.

Though the complaint references these more recent events, the putative class period proposed in the complaint runs from October 31, 2006 through November 27, 2007.

This complaint is of course a reflection of the specific circumstance alleged with respect to this one company and its banking subsidiary. Nevertheless, the complaint also reflects a number of different securities litigation themes and trends, some of which are well-established and some of which may only just be emerging.

First, this case is yet another example of the kinds of litigation that may emerge in connection with the growing numbers of troubled banks. As I have noted in numerous posts (most recently here), though the level of litigation involving failed and troubled banks is still well below what might be expected given the number of distressed institutions, a number of lawsuits have begun to emerge and there may yet be more in the future.

Second, while I have noted elsewhere that as 2009 has progressed the wave of subprime and credit crisis related litigation definitely seems to have slowed (or even just merged into larger litigation developments to the point that it may no longer be its own separately identifiable category of litigation), this case suggests that it is far too early to declare that the litigation wave has ended. Obviously, there may yet be other cases that raise similar credit related lawsuits in the months ahead.

This case also demonstrates with respect to the subprime and credit crisis-related litigation wave that the lawsuits encompass a wide variety of kinds and categories of credit, including, as shown here, credit card debt. As noted here with respect to the litigation involving American Express, there have been prior credit crisis securities lawsuits filed with respect to issues concerning credit card debt.

Third, the 23-month gap between the end of the proposed class period and the filing of this lawsuit is yet another example of the significant number of filings in the second and third quarter of 2009 that involve class period cutoff dates in the distant past. As noted in prior posts (most recently here), this phenomenon might suggest that while the plaintiffs’ lawyer were previously preoccupied filing numerous credit crisis and Madoff related lawsuits, they developed a backlog of cases that they have now started to work off.

Indeed, just in the past several days there have been several other cases with long past class period cutoff dates, including the lawsuit recent filed involving RHI Entertainment (filed on October 8, 2009, class period cutoff of June 19, 2008); Men’s Wearhouse (filed on October 8. 2009, class period cutoff date of January 9, 2008); and EnergySolutions (filed October 9, 2009, class period cutoff date of October 14, 2008).

Apparently, as the Advanta case suggests, the backlog may even include other credit crisis cases, which is yet another reason that, as noted above, there may be still other credit crisis cases yet to come.

In any event, I have added this case to my list of subprime and credit crisis-related securities lawsuits, which can be found here. If this case is any indication, there could be others credit crisis securities cases yet to come.

Courtroom Drama: While we all remain interested in the developments in the ongoing trial in the Vivendi securities class action lawsuit, there is certainly nothing new about courtroom drama, and some of the most compelling courtroom tales have an ancient and venerable pedigree.

A particularly engaging tale of courtroom drama is told in The Life and Times of Constantine the Great, a biography of the Roman emperor by D.G. Kousoulas. During Constantine’s reign, Athanasius, the bishop of Alexandria and one of the protagonists in the long-running Arian controversy, was accused by his foes of murder. An inquest of bishops and imperial officials was convened.

At the inquest, the accusers presented their case against Athanasius, and even produced a blackened hand, allegedly that of the victim, Arsenius. Kousoulas describes the scene:

After the accusers had enjoyed a moment of triumph as they passed the blackened hand around, Athanasius asked in a quiet voice if any of those present knew Arsenius personally. A number of bishops claimed to have known the murdered bishop well. Would they recognize him if they saw him, Athanasius asked. Certainly, they replied, "if he were alive." At that point Athanasius signaled to a man who was standing near the doorway, his face covered with his cloak. The man, his face still covered, moved to the front. "Lift your cloak," Athanasius said. The man removed the cloak and [as a contemporary account noted] "lo and behold it was Arsenius himself." Athanasius moved closer and drew first one and then the other sleeve. Aresenius had both of his hands. "Has God given a man more than two hands?" Athanasius asked with a sarcastic smile.

***

For a moment there was stunned silence. Then one of the accusers declared loudly that all this was sorcery and devil’s work. The man was not Arsenius although he had his face, he was not even human but an illusion produced by Athanasius with his knowledge of black magic. Athanasius asked the bishops to come and touch the man he was accused of having murdered. The meeting turned into a brawl, and Dionysius, the imperial officer attending the meeting on orders from Constantine, had to hurry Athanasius out to save his life.

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By now it is not news that the current credit crisis and related litigation wave have both spread far beyond the residential real estate sector in which they both first began. But the details surrounding the extension remain interesting and may even contain hints about what may lie ahead, as suggested by a recent lawsuit.

As reflected in their February 20, 2009 press release (here), plaintiffs’ attorneys have filed a securities class action lawsuit in the Southern District of New York against American Express and its CEO and CFO. The complaint (which can be found here) is filed on behalf of those persons who purchased the company’s securities between March 1, 2007 and November 12, 2008.

According to the complaint, American Express is the world’s largest issuer of charge cards. The complaint alleges that during the class period, the company "deviated from its historical strategy" of targeting the "premium market sector" and instead "engaged in riskier lending," while it "reassured investors and analysts that it did not engage in such riskier transactions."

The complaint alleges that the defendants "mislead investors by falsely representing American Express’s exposure to the riskiest credit card holders." The complaint alleges that the defendants repeated these reassurances to "artificially support" the company’s share price "as the building credit crisis in the market punished most companies that dealt with risky customers."

The complaint further alleges that as a result of the company’s "shift to risky card business," its brand has been "cheapened" and its stock has dropped over 65%. The complaint also alleges that the company won approval to convert to a bank holding company in order to qualify for TARP money – "a capital infusion required to save the Company from its risky endeavors."

On the one hand, it is hardly surprising in this environment that any credit lending facility should be experiencing difficulties or that those difficulties might result in litigation. But on the other hand, this new lawsuit does demonstrate both how far afield from the original subprime-related problems that triggered the current crisis, and how diverse the credit problems are that are now driving the related credit crisis litigation wave.

For some time now, the spreading subprime and credit crisis-related litigation wave has spread to encompass sectors of the credit marketplace beyond just subprime lending. Some time ago, for example, student lenders were drawn in (refer here), as were commercial construction companies (refer here). The involvement of a credit card company represents just another category of the credit marketplace to be drawn into the litigation wave.

But even though this new lawsuit may be just an extension of previously existing trends, it still has some ominous overtones. For one thing, American Express may be one of the largest providers of consumer credit, but it is far from the only one. Many businesses, other than just credit card companies, depend at some level upon the extension of consumer credit as part of their business model. The financial troubles these companies are now facing could also mean vulnerability to possible future litigation.

Another troubling note suggested by American Express’s woes is that a great deal of consumer debt, like the residential real estate debt, was packed into securities backed by the debt. The challenges facing the mortgage-backed securities market are at this point well known. Deteriorating conditions in the consumer credit arena could have significant implications for securities backed by the consumer debt.

In the meantime, American Express seems to be taking matters into its own hands to try to avoid further defaults as the recession deepens. According to February 23, 2008 news reports (here), American Express has offered to pay some cardholders $300 to pay off their outstanding balances and close their accounts by April 30, 2009. According to the news reports, analysts are concerned that credit card defaults could reach 11 percent by year end. One commentator is quoted as saying that what the company is trying to do is to "move to the front of the line in terms of getting paid back."

In any event, I have added the American Express complaint to my running tally of the subprime and credit crisis related securities litigation, which can be accessed here. With the addition of the American Express complaint, the current litigation tally now stands at 162, of which 19 have been filed so far in 2009. A spreadsheet reflecting the 2009 cases can be found here.

Special thanks to Adam Savett at the Securities Litigation Watch for the link to the American Express Complaint.

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I have previously tried to anticipate the future direction of the credit crisis litigation wave (refer, for example, here), but what I failed to foresee is that as the credit crisis itself has entered the remedial phase – or what we all hope turns out to be the remedial phase – there also would be litigation arising from the administration of the remedies. A recent securities lawsuit demonstrates how circumstances surrounding the government’s bailout efforts can lead to litigation.

As reflected in their February 9, 2009 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Middle District of Alabama against Colonial BancGroup and certain of its officers. Colonial is a bank holding company that operates Colonial Bank, N.A., which has 347 bank branches in Florida, Alabama, Georgia, Nevada and Texas, and over $26 billion in assets.

The lawsuit relates to Colonial’s efforts to obtain TARP money, and in particular to the company’s December 2, 2008 and January 27, 2009 press releases discussing the company’s TARP-related efforts. A copy of the complaint can be found here. Special thanks to Courthouse News Service for the complaint.

In its December 2, 2008 press release entitled "Colonial BancGroup Received Preliminary Approval from the U.S. Treasury for $550 Million in Capital" (here), Colonial announced that it had "received preliminary approval" to participate in the Treasury Department’s capital purchase program, pursuant to which Colonial "will receive $550 million from the Emergency Economic Stabilization Act of 2008."

In the December 2 press release, Colonial also stated that in exchange for its investment, the Treasury was to receive preferred shares paying a 5% dividend for the first five years. If the preferred shares are not redeemed within five years, the dividend rate increases to 9%. The press release also stated that the Treasury will also receive warrants to purchase shares of Colonial.

According to the plaintiffs’ lawyers’ February 9 press release, in response to Colonial’s December 2 announcement, Colonial’s share price "surged over 50 percent from its $2 per share close on December 1, 2008 to close at $3.08 per share on December 2, 2008."

However, the complaint alleges that the defendants failed to disclose that "Colonial would be required to raise additional outside capital of $300 million before it could receive the $550 million in TARP funding." The complaint further alleges that Colonial "belatedly disclosed" this requirement after the markets closed on January 27, 2009. The complaint alleges that in response to the company’s January 27 announcement, Colonial’s share price declined 45%, from $1.58 per share to $0.85 per share.

Colonial’s January 27, 2009 press release, which can be found here, stated that Colonial’s participation in TARP is "subject to Colonial’s increasing equity by $300 million." The January 27 press release also states that Colonial is "actively pursuing a variety of capital raising alternatives to increase equity by $300 million, which should satisfy this condition of the TARP preliminary approval."

As discussed in a February 6, 2009 Birmingham Business Journal article (here), Colonial’s announcement that it must raise $300 million of additional funds to qualify for TARP "is raising eyebrows among some banking analysts and banking experts." The article quotes one commentator as saying that this item represents "a pretty significant omission" on Colonial’s part in its announcement of the TARP funding. The article also quotes an analyst as saying she felt "deceived" by the bank because it "withheld important information."

The Colonial lawsuit is far from the first credit crisis-related securities lawsuit in which governmental intervention of one sort or another is involved. For example, the government’s role in brokering Bank of America’s acquisition of Merrill Lynch features prominently in the securities lawsuit recently filed against BofA (about which refer here). The need for governmental rescues has also featured in a number of other credit crisis-related securities lawsuits, including for example, the lawsuits filed against Fortis (refer here), ING (refer here), and the Royal Bank of Scotland (refer here). But so far as I know, the Colonial case is the first securities lawsuit where the allegations are tied directly to the TARP funding program.

I supposed that after more than two years of credit crisis litigation, as well as massive governmental involvement in the financial markets, it should come as little surprise that we have reached the point where lawsuits relating to the bailout efforts themselves are starting to arise. I suppose we should start getting ready now for the inevitable stimulus-related lawsuits which undoubtedly will follow not long after Congress finishes its current efforts.

The Colonial lawsuit does raise an interesting categorization issue, which is whether the case properly should be counted as credit crisis-related and grouped with the previously filed credit crisis-related securities lawsuits. After reviewing Colonial’s press releases and considering the reasons why the company needed TARP money in the first place, I have concluded that the lawsuit is related to the ongoing credit crisis and therefore it belongs in my running tally of credit crisis related securities lawsuits.

My running tally of the subprime and credit crisis-related securities lawsuits can be accessed here. With the addition of the Colonial lawsuit, the tally of subprime and credit crisis-related securities lawsuits that have been filed during the period 2007 through 2009 now stands at 156, of which 15 have been filed in 2009. A spreadsheet showing the 2009 credit crisis related securities lawsuits can be accessed here.

One final note about TARP -- the Bank Lawyer's Blog reports (here) that some banks in the Dallas area are advertising the fact that they haven't taken TARP money because they don't need to. That line of analysis could get awfully murky under the Treasury department's proposed updated bailout approach, under which banks will be "stress tested" and only the likeliest to survive will receive aid.

Madoff Update: Regular readers know that in addition to my running tally of the subprime and credit crisis-related securities lawsuits, I have also been maintaining a separate tally of Madoff-related litigation. The Madoff-related litigation register, which can be accessed here, is subdivided into multiple tables, reflecting the various types of litigation that has arisen out of the Madoff scandal.

I recently updated the Madoff lawsuit register by adding a number of new Madoff lawsuits, based on excellent information, materials and links provided by several readers, including in particular Jon Jacobson of the Greenberg Traurig law firm. My special thanks to all for the contributions.

And Finally: Describing it as "the beginning of a long process," the SEC Actions blog has a post (here) discussing the partial settlement that Bernard Madoff has reached with the SEC. The WSJ.com Law Blog also has a post here describing the partial settlement. A link to the SEC’s litigation release regarding the partial settlement can be found here.

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The credit-crisis securities litigation wave, which began with the filing of the first subprime mortgage-related lawsuits in early February 2007, is about to enter its third year. Though the wave has evolved during the intervening period, it shows no sign of slowing down. The more interesting question going forward will be whether the litigation, which up until now has largely been concentrated in the financial sector, will spread to encompass companies in the wider economy.

The Wave’s History – So Far

The current subprime and credit crisis-related securities litigation wave began on February 8, 2007, with the filing of a securities lawsuit against New Century Financial Corporation and certain of its directors and officers. (Refer here for my most recent post on the New Century case.) Two years later, there have been 152 separate subprime or credit crisis-related lawsuits filed against companies and other entities, as reflected in my running tally of the suit, which can be accessed here.

The initial cases during 2007 were largely filed against subprime loan originators, banks, mortgages companies, home builders and residential real estate investment trusts. However, by year end 2007, a number of lawsuits had also been filed against investment banks, investment advisors, and rating agencies.

During 2007, there were a total of 40 subprime-related securities lawsuits filed.

In 2008, the lawsuits against banks and other mortgage originators continued to mount, but the litigation activity spread beyond just residential mortgage and real estate issues. The litigation also involved student lenders, commercial construction companies, commercial real estate investment trusts, bond insurers, and mortgage guaranty insurers. As I noted at the time (refer here), by early 2008, the litigation activity was no longer just about the subprime meltdown but had by that time become a credit crisis litigation wave.

The litigation wave also picked up considerable momentum during 2008, driven in part by the onslaught of cases involving auction rate securities. A total of 21 separate auction rate securities lawsuits were filed in 2008, against broker dealers, security issuers and mutual funds, among others. There were also a significant number of separate securities lawsuits filed on behalf of preferred shareholders and subordinated debtholders, which represents a relatively unusual securities litigation development, as discussed here.

The crisis in the global financial markets during fall 2008 also significantly affected the litigation wave. As I noted here, as a result of the financial market turmoil, the litigation wave reached an "inflection point" during the third quarter of 2008, where companies began to find themselves exposed to litigation not because of their own direct vulnerability to the credit crisis, but because of the companies’ exposure to other companies that were experiencing credit crisis-related issues.

During 2008, a total of 101 subprime and credit crisis-related securities lawsuits were filed.

As 2009 has begun, the litigation wave has shown no sign of slowing down. Indeed, during January 2009 alone, there were eleven new credit crisis-related securities lawsuits. A spreadsheet of the 2009 cases can be found here.

One important consequence of the litigation wave’s evolution over time is that it has become increasingly difficult to maintain absolute definitional clarity about what should be included in the category. This challenge has become even more difficult now that the financial crisis basically encompasses the entire global economy. It has become progressively tricky to determine whether or not newly filed lawsuits logically ought to be group together with the earlier suits, or whether they represent something entirely different. This categorization challenge has made simply "counting" the subprime and credit crisis-related lawsuits increasingly more difficult over time.

Financial Sector Concentration

Though the litigation has evolved and become more diverse, the litigation activity has largely been concentrated in the financial sector. Of the 152 subprime and credit crisis-related securities lawsuits that have been filed as of February 4, 2009 and that involved companies or other entities that have assigned standard industrial classification codes (SIC Codes), fully 117 of them have involved companies or other entities with SIC Codes in the 6000 series (Finance, Insurance and Real Estate).

Moreover, the 18 entities that have been sued but that have no SIC Code designated are also almost exclusive concentrated in the financial sector. These entities include mutual funds, private equity firms, hedge funds, and foreign firms whose shares do not trade on U.S. exchanges (e.g., Fortis and Société Générale).

Of the financial companies, the SIC Code categories with the largest number of lawsuits were SIC Code 6021 (National Commercial Banks) and SIC Code 6798 (Real Estate Investment Trusts), both of which had 16 lawsuits. Other categories with a significant number of securities lawsuits include SIC Code 6211 (Security Broker Dealers), which had 13 lawsuits; SIC Code 6189 (Asset Backed Securities), which had 12 lawsuits; and SIC Code 6035 (Savings Institutions, Federally Chartered), which had 11 lawsuits.

Has the Wave Entered a New Phase?

But while the litigation activity has largely been concentrated in the financial sector, there has more recently been a "new wave" of credit crisis lawsuits, as discussed at greater length here. These new wave lawsuits involved companies exposed to some of the credit crisis casualties (Lehman Brothers, Fannie Mae, Freddie Mac, Washington Mutual, American International Group, etc); that made wrong-way bets on commodities or currencies; and companies outside the financial sector whose balance sheets are laden with auction rate securities or other troubled assets.

The interesting question these new wave cases present is how far outside the financial sector these kinds of cases will spread as we go forward.

How are the Cases Faring?

Even though the subprime and credit crisis-securities litigation wave is about to enter its third year, most of the cases are still only in their earliest stages. There has really been only one significant settlement, the recent massive $550 million settlement involving Merrill Lynch (about which refer here). The few other settlements have been considerably more modest (refer here).

Only a handful of these cases have even reached the motion to dismiss stage. Among the cases where dismissal motions actually have been addressed, there have been several notable cases in which the dismissal motions were denied – for example, the New Century case (refer here) and the Countrywide case (refer here).

On the other hand, there have also been a handful of cases in which the motions to dismiss have been granted, and at least some courts have seemed skeptical that the target companies financial woes were the result of fraud (about which refer here).

My complete list of subprime and credit crisis-related securities lawsuit settlements, dismissals and dismissal denials can be found here.

Looking Ahead

Even though the litigation wave is about to enter its third year, it is clear that we have still only just begun. With the cases already filed only in their earliest stages and with new lawsuits continuing to pour in, the subprime and credit crisis-related litigation wave is likely to continue to remain an important feature of the litigation landscape for years and years to come.

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The growing problems surrounding option adjustable-rate mortgages (Option ARMs) are a concern I have previously noted (here). But it now appears that the problems may be far worse even than previously feared. These problems not only represent a growing threat to borrowers and lenders alike, but the also present the increasing likelihood for further shareholder litigation.

According to a January 30, 2009 Wall Street Journal article entitled “Option ARMs See Rising Defaults” (here), nearly $750 billion in Option ARMs were issued from 2004 to 2007. Unfortunately, as of December 2008, 28% of Option ARMs were in default or foreclosure, and an additional 7% involved properties that have already been take back by lenders. A chart accompanying the Journal article shows that the Option ARM default rate is already far greater now than was the subprime default rate at the beginning of 2008.

Borrowers holding Option ARM mortgages now find themselves having to play a particularly unattractive hand. In particular, as a result of the way these loans are structured, borrowers that have been paying only the minimum have likely seen their principal amount due increase as a result of so-called “negative amortization.”

At the same time, housing values around the country have declined. The Journal article reports that more than 55% of borrowers with Option ARMs owe more than the current value of their homes.

Think that sounds bad? Things are about to get worse. A lot worse.

As detailed in a lengthy January 4, 2009 post on the Seeking Alpha blog (here), the interest rates on billions of dollars are due to reset in 2009 and 2010. The problems that likely will ensue “are expected to be more pronounced than the subprime crisis since the economy is already nearing its trough, the consumer confidence has slumped to an all time recent history low and financial markets are in a gridlock.”

In explaining why the problems associated with the Option ARM resets could be so bad, the Seeking Alpha blog post goes through a detailed analysis of the timing and likely magnitude of the resets. In explaining the problems that could follow, the author notes:

The potential average payment increase on the loans recast is 63%, representing an additional $1,053 due each month on top of the current average payment of $1,672. These large payment increases could cause delinquencies to increase, and increase dramatically, after the recast. The fact that only 65% of borrowers have elected (or are able) to make only minimum payments underscores the magnitude of the potential problem. The potential payment shock combined with the continuous deteriorating outlook for home prices and lack of refinancing opportunities could be a negative cause of concern for investors in Option ARM securities. Even more ominous, is pall cast upon the banks that hold these assets and are additionally exposed to other forms of consumer credit, ie. HELOCs, credit card debt and other unsecured loans.

As a result of these problems and possibilities, sources quoted in the Journal article estimate that more than half of all option ARMs outstanding will default, and that nearly 61% of options ARMs originated in 2007 will eventually default.

These looming problems not only represent a threat to borrowers, investors and lenders, but they also present the possibility for even further litigation.

Problems arising from Option ARM mortgages have already been the source of considerable securities litigation. The most recent lawsuit involves Triad Guaranty, which provides private mortgage insurance products to residential mortgage lenders and investors in the United States.

As reflected in their January 29, 2009 press release (here), plaintiffs’ attorneys have filed a securities class action lawsuit in the Middle District of North Carolina against Triad and certain of its directors and officers. According to the press release, the complaint (which can be found here), alleges that

beginning in late August 2007 and continuing throughout 2008, Triad began to acknowledge serious issues surrounding its exposure to anticipated losses and defaults related to its book of business for its Alt-A and pay-option adjustable rate mortgage (“ARM”) products written in 2006 and 2007 due to a failure to engage in proper underwriting practices, resulting in a decline in Triad’s stock price. Then, on November 10, 2008, Triad issued its financial results for the third quarter of 2008, reporting a net loss for the quarter ended September 30, 2008 of $160.1 million. On this news, Triad’s stock price dropped $0.11 per share to close at $0.70 per share on November 11, 2008.

The complaint further alleges that the defendants concealed from the investing public that:

(a) the Company was not adequately accounting for its loss reserves in violation of Generally Accepted Accounting Principles, causing its financial results to be materially misstated; (b) the Company failed to engage in proper underwriting practices for its book of business related to insurance written in 2006 and 2007, including the insurance related to its Alt-A and pay-option ARM products; (c) the Company had far greater exposure to anticipated losses and defaults related to its book of business related to insurance written in 2006 and 2007, including its Alt-A and pay-option ARM portfolios, than it had previously disclosed; (d) the Company lacked effective internal controls to detect fraud and misrepresentations in the underwriting process; and (e) the Company failed to disclose the true risks associated with its ability to continue to write new business and, given rating downgrades and capital limitations, the Company would be forced to liquidate its Canadian subsidiary and stop writing new insurance policies and transition the business to run-off.

Even before this recent lawsuit was filed against Triad, there had already been a number of securities lawsuits raising allegations concerning Option ARMs, including for example cases filed against Wachovia (refer here), Washington Mutual (refer here) and Downey Financial (refer here).

All of those prior lawsuits involved either companies that issued the Option ARMs or the issuers’ successors in interest. Triad, by contrast, is not an issuer but rather is a mortgage insurer. Triad’s involvement in a securities lawsuit raising Option ARM-related allegations highlights the potential for extensive further litigation, involving not just the issuers themselves but other types of companies as well.

I have in any event added Triad to my running tally of subprime and credit crisis-related securities litigation, which can be accessed here. With the addition of the Triad lawsuit, the current tally of subprime and credit crisis related securities litigation filed during the period 2007 through 2009 now stands at 150, of which eight have been filed in 2009. A spreadsheet reflecting the 2009 lawsuits can be found here.

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As has been well-publicized, within a matter of weeks of closing its acquisition of Merrill Lynch, Bank of America announced previously undisclosed 4Q08 operating losses at Merrill of $21.5 billion that required BofA to obtain an emergency $20 billion cash injection from the U.S. Treasury, as well as an additional $118 billion asset backstop. BofA’s stock market valuation has dropped more $100 billion since the day before the merger was announced through the company’s January 16 earnings release.

As the Wall Street Journal reported (here), questions immediately arose following BofA’s announcement of the Merrill losses, such as why BofA’s CEO Kenneth Lewis "didn’t discover the problems prior to the Sept. 15 deal announcement" and "why he didn’t disclose the losses prior to the vote on the Merrill deal on Dec. 5 or before closing the deal on Jan. 1."

With these kinds of questions circulating, it comes as no surprise that plaintiffs’ attorneys have initiated litigation. There were actually two different lawsuits announced on January 21, 2009 relating to these circumstances. Both of the lawsuits purport to be filed on behalf of persons who held BofA securities on October 10, 2008, the record date for the December 5, 2008 special meeting of shareholders to approve the merger.

The first of these two lawsuits was filed in the Southern District of New York, as described in the plaintiffs’ lawyers’ January 21 press release (here). The second was filed in the Northern District of Georgia, as described a separate January 21 press release (here). The complaint in the N.D.Ga. action can be found here.

Both complaints name as defendants Bank of America and certain of its directors and officers. The S.D.N.Y. action also names Merrill’s CEO John Thain as a defendant as well. Both lawsuits allege that the defendants made materially false and misleading statements in the proxy materials in order to secure sufficient proxies to approve the merger. The defendants are alleged to have known that excessive losses at Merrill should have been disclosed to allow shareholders a well-informed vote on the merger.

Of all the interesting issues surrounding these circumstances, the most significant is the question of when BofA became aware of the magnitude of Merrill’s losses. (A related question is when Merrill became aware of the losses, but don’t expect any Merrill shareholders to raise the concern, as the completion of the merger was clearly in their best interest.)

The Journal article linked above reports that BofA now asserts that it learned of the magnitude of Merrill’s losses after the Dec. 5 shareholder vote, and that by Dec. 17, Lewis was so alarmed by the losses, which he reportedly characterized as "monstrous," that he traveled to Washington for an emergency meeting with Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson.

What happened at this Dec. 17 meeting presents its own interesting set of issues. Paulson and Bernanke apparently told Lewis that, according to the Journal, "failing to complete the Merrill acquisition would be disastrous" and would "further destabilize markets" and "hurt the bank" and potentially set off a "ripple effect that would exacerbate a fragile situation." The government officials also promised Lewis the backstop protection if the losses proved to be as significant as Lewis feared.

The meeting raises a host of questions, as discussed in the January 20, 2009 Wall Street Journal article entitled "BofA’s Merrill Deal Exposes Myth of Transparency" (here). The article suggests that "by most any reasonable measure, if the Merrill losses were concrete enough to seek a government lifeline, they were concrete enough to report to the company’s shareholders." The question is whether Lewis kept mum about the losses and the promised lifeline at Bernanke and Paulson’s request; the article asks whether perhaps the government was "complicit in nondisclosure."

While there may have been a marketplace interest in keeping the deal on track, there is no existing law that would relieve the company of its disclosure duties for the benefit of larger marketplace interests. The January 20 Journal article raises the question whether "a new legal standard could eventually emerge, sort of a ‘national interest’ doctrine absolving companies of governance actions that may be potentially harmful, but are important to an economic or defense emergency."

These are interesting questions. However, it should be noted that they arguably are irrelevant to the recently filed lawsuits, as the December 17 meeting took place well after the December 5 shareholder vote. There is of course always the possibility of a separate lawsuit on behalf of persons who acquired BofA shares, for example, between the December 17 meeting and before the company’s recent announcement of the Merrill-related losses. UPDATE: In the day immediately after I added this post, additional lawsuits came flooding in, including at least one (here) that is filed against, among others, a subclass of claimants who purchased Bank of America securities between January 2, 2009 and January 16, 2009.

Regardless whether or not other lawsuits in fact emerge, two questions will be paramount: when did the magnitude of the Merrill losses become apparent, and when did BofA have a duty to disclose this information to its shareholders?

Whatever else might be said about these circumstances, the certainly do underscore the magnitude of the problems confronting the economic and banking systems, as well as the challenges facing the incoming administration as it struggles to address these problems while taking up the reins of government.

These circumstances also raise serious questions about whether or not there are or should be exceptions to the transparency principles on which our entire system of securities and market regulation is based. It doesn’t require much imagination to picture the bedlam that could have ensued if the Merrill deal had fallen apart just before Christmas. The system can ill afford any more of the kind of chaos that enveloped the markets in September and October last year.

On the other hand, BofA’s shareholders might well feel that any analysis concluding that information was properly withheld from them for the sake of the overall market improperly negates their rights and expectations as shareholders.

It may or may not get addressed in a court in connection with the litigation involving the Merrill deal, but the question whether or not there is "national interest" exception to the standard disclosure principles is surely a very interesting question.

Professor Larry Ribstein discusses the question whether there is a national interest exception to the securities laws in his Ideoblog, here.

I have in any event added the Bank of America/Merrill Lynch litigation to my running tally of the subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of this new litigation, the current tally of these cases now stands at 146, of which five have been filed in 2009.

More Madoff Litigation: The Madoff-related litigation wave has also continued to roll on. For example, on January 21, 2009, plaintiffs’ lawyers announced (here) that they had initiated a class action lawsuit in the Southern District of New York on behalf of persons who purchased between 2003 and the present variable universal life insurance issued by Tremont International Insurance Limited or Argus International Bermuda Limited.

The complaint (which can be found here) alleges that the insurer, an entity owned by Tremont Capital Management had breached its duties by offering Tremont-related funds as investment options for the variable investment account component of the policies. The complaint further alleges that the Tremont-related funds were heavily invested in Madoff funds.

The complaint alleges that the defendants violated a number of legal duties. The complaint does not, however, assert a violation of the federal securities laws. As a result I have included in the list of "other" litigation in my table of the Madoff-related litigation, which can be accessed here.

This latest lawsuit not only demonstrates that the Madoff litigation continues to roll in. It also shows what an incredible diversity of individuals and investors were harmed by losses from Madoff’s fraudulent scheme. It also shows how incredibly complicated it all is going to be to unwind this whole mess.

And Finally: Readers who registered the question posed on my preceding blog post whether President Obama had completed the oath of office as required by the Constitution will be relieved to know that the issue has been resolved.

On the apparent theory that there is nothing in the Constitution against do overs, Obama and Chief Justice reprised their roles in another rendition of the oath of office in a considerably less formal ceremony at the White House on the evening of January 21, 2009, as reported here.

That certainly is a load off my mind.

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We are barely into the New Year, but all signs are that two of the critical securities litigation trends of 2008 – the subprime/credit crisis related litigation wave and the Madoff-related litigation wave – remain significant factors and apparently will continue to drive new lawsuit filings as we head into 2009, as the recent lawsuit filings discussed below suggest.

The New RBS Lawsuit

First, with respect to the credit crisis litigation, on January 12, 2009, plaintiffs’ lawyers issued a press release (here) stating that they had initiated a securities class action lawsuit in the Southern District of New York on behalf of purchasers of Series S American Depositary Shares (ADSs) of the Royal Bank of Scotland Group and related entities and certain directors and officers. The complaint also names as defendants the offering underwriters that conducted the June 2007 offering of the shares.

The Complaint (which can be found here) alleges misrepresentations and omissions in the offering documents, which incorporated the Company’s 2004, 2005 and 2006 financial statements. The Complaint alleges that the company "ultimately announced huge multi-billion pound impairment charges associated with its exposure to debt securities, including mortgage-related securities tied to the U.S. real estate markets, causing the price of RBS’s Series S ADSs issued in the Offering to decline." The ADSs, which were originally offered at $25/share, now trade around $10/share.

According to the Complaint, the offering documents omitted that:

(a) defendants’ portfolio of debt securities was impaired to a much larger extent than the Company had disclosed; (b) defendants failed to properly record losses for impaired assets; (c) the Company’s internal controls were inadequate to prevent the Company from improperly reporting its debt securities; (d) the Company’s participation in the consortium which acquired ABN AMRO would have disastrous results on the Company’s capital position and overall operations; and (e) the Company’s capital base was not adequate enough to withstand the significant deterioration in the subprime market and, as a result, RBS would be forced to raise significant amounts of additional capital.

RBS is actually the second company from the ill-fated consortium that was the "successful" bidder in the ABN AMRO buyout to get dragged into U.S. securities litigation.

As I noted here, another consortium member, Fortis, was also hit with a securities class action lawsuit in October 2008. As I noted in that prior post, "it is one more of those amazing things about the current circumstances that, despite the size of the ABN AMRO calamity, it is effectively just background noise in the larger cataclysm." (An abridge version of the ABN AMRO debacle can be found here.) Both RBS and Fortis have also been the recipients of massive bailout efforts from their respective governments.

The ABN AMRO losses to RBS continue to amount. For example, on January 12, 2009, Bloomberg reported (here) that, as a result of loans RBS acquired as part of the ABN AMRO deal, RBS is the biggest lender to bankrupt U.S. chemical maker Lyondell Chemical Co., and may face losses on its $3.47 billion of loans. The loans were part of the $20.5 billion raised to finance Bassell AF’s 2007 leveraged buyout of Lyondell.

More Madoff Litigation

According to their release (here), on January 12, 2009, plaintiff’s counsel initiated another Madoff-related securities class action lawsuit in the Southern District of New York on behalf of investors in the Herald USA Fund, Herald Luxemburg Fund, Primeo Select Funds, and Thema International Funds, against the Funds, Medici Bank, Bank Austria Creditianstait, Unicredit S.A., Pioneer Alternative Investments, HSBC Holdings plc and Ernst & Young LLP, as well as Medici Bank’s founder Sonja Kohn and its former CEO Peter Scheithauer. A copy of the complaint in the case can be found here.

Austrian regulators took control of Bank Medici after the bank revealed that it had invested as much as $3.2 billion in funds managed by Bernard Madoff and his firm. Bank of Medici is 25% owned by Unicredit. As reported here, one of the Bank’s largest customers was Unicredit’s Pioneer Investments, which invested as much as €805 with the Funds. Further background can be found here.

According to the press release, the Complaint alleges defendants caused the Funds "to concentrate almost 100% of their investment capital with entities that participated in the massive, fraudulent scheme perpetrated" by Madoff and his firm.

Run the Numbers: With the addition of the RBS case, the total number of subprime and credit crisis-related securities lawsuits going back to 2007 now stands at 143, of which two have been filed already in 2009. My updated tally of the subprime and credit crisis-related cases can be accessed here.

The new lawsuit on behalf of the Bank Medici Funds investors brings the total of Madoff-related securities class action lawsuits to eight, as reflected on my running tally of the cases, which can be accessed here.

Keeping Count: In my analysis (here) of the recently released Cornerstone/Stanford Clearinghouse report regarding the 2008 securities litigation, I noted that the report’s count of new 210 securities lawsuit filings through December 15, 2008 contrasted with my own count of 224 securities lawsuits through December 31, 2008. As I noted in my analysis, the additional lawsuits filed between December 15 and December 31 were critically important in understanding fully 2008 filing trends, as they significantly affect relative and absolute filing numbers during the year.

The Stanford Law School Securities Class Action Clearinghouse website has now updated its count through year’s end, bringing their 2008 tally to 226. The Stanford website can be accessed here.

On further review of their figures, my account appropriately should be adjusted from 224 to 226.

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In the latest ruling on a motion to dismiss in a subprime-related securities lawsuit, on December 22, 2008, Judge Legrome Davis of the Eastern District of Pennsylvania granted in part and denied in part defendants’ motion to dismiss the suit that plaintiffs’ filed in August 2007 against RAIT Financial Trust and certain of its officers and trustees. The opinion can be found here.

Judge Davis’s ruling largely denied defendants’ motions, other than with respect to the plaintiffs’ ’33 Act claims concerning the company’s July 2007 secondary offering, which were dismissed due to the plaintiffs’ lack of standing. Otherwise, Judge Davis ruled in plaintiffs favor. The plaintiffs’ remaining ’33 Act claims and all of the plaintiffs’ ’34 Act claims will now go forward.

Background

RAIT is a real estate investment trust providing debt financing to home builders, mortgage lenders and other real estate companies. As more fully set forth here, plaintiffs’ complaint relates to the July 30, 2007 failure of American Home Mortgage to make a payment due under certain trust preferred securities, resulting in a net equity exposure to RAIT of at least $95 million. Shortly thereafter, the company disclosed that it had $373 million of similar exposures. The plaintiffs allege that the defendants failed to disclose its exposure to these types of investments and failed to reserve adequately for the risk of nonpayment or default.

The plaintiffs’ complaint asserts claims under both the ’33 Act and the ’34 Act. The defendants in the ’33 Act claims include the offering underwriters that facilitated RAIT’s January 2007 common stock offering and July 2007 preferred stock offering, as well as the company’s auditor, Grant Thornton. The defendants’ moved to dismiss.

The December 22 Opinion

First, the court dismissed the ’33 Act claims relating to the July 2007 preferred stock offering due to lack of standing, because none of the named plaintiffs purchased securities traceable to the offering.

However, the court denied the defendants’ motion to dismiss the ’33 Act claims raised in connection with the January 2007 offering. Judge Davis found that the plaintiffs had adequately alleged falsity and materiality, and rejected defendants’ contentions that the plaintiffs’ arguments represented nothing more than "fraud by hindsight." Judge Davis also rejected the defendants’ contentions that the alleged misrepresentations "bespoke caution" or were "mere puffery."

Judge Davis also found that his rulings that the plaintiffs had adequately pled falsity and materiality applied to the plaintiffs’ ’34 Act claims as well.The defendants nevertheless sought to have the ’34 Act claims dismissed, arguing that the plaintiffs had not adequately pled scienter.

Judge Davis found that "despite the demanding standard of recklessness imposed in pleading a strong inference of scienter," the plaintiffs nevertheless had adequately pled scienter. His ruling depended on the "core business operations" theory, with respect to which he stated:

Because the alleged misstatements involved RAIT’s core business operations and because the Officer Defendants had ample reason to know of the falsity of the statements, there is a strong inference of scienter in this case.

Judge Davis also found that though the core business operations allegations alone were sufficient, other allegations also supported the inference of scienter, including "the sheer size of the impairment eventually taken by RAIT," which he found adds to "the imputation" that defendants "must have had some awareness that problems were brewing." Judge Davis also found that "familial and business relationships involved" in a RAIT acquisition were "relevant in our consideration of scienter."

Discussion

Other than the ’33 Act claims relating to the July 2007 offering (which was dismissed for lack of standing), the plaintiffs largely prevailed on the dismissal motions. Judge Davis’s ruling is significant not only because it seems to run counter to the early trend other courts arguably have established (albeit with some notable exceptions) of general skepticism toward subprime-related allegations. Judge Davis’s ruling is noteworthy in that regard for its rejection of the defendants’ "fraud by hindsight" arguments.

Judge Davis’s opinion is perhaps most noteworthy in its acceptance of the "core business operations" theory in concluding that the plaintiffs had adequately pled scienter. Though earlier courts had rejected this theory as inconsistent with the PSLRA’s pleading requirements, more recently courts, for example, in the Ninth Circuit (refer here) and the Seventh Circuit (refer here), have taken it up. As noted in a recent commentary by the Katten Muchin law firm entitled "Reform Act Under Attack?" (here), the core operations theory "has made a comeback in 2008," which the authors contend is inconsistent with the PSLRA’s meaning and intent.

Were other courts similarly willing to take up the core operations doctrine, it could substantially impact the many pending dismissal motions in various subprime-related securities lawsuits.

In any event, I have added the RAIT opinion to my table of subprime and credit crisis-related securities lawsuit settlements, dismissals, and dismissal denials, which can be accessed here.

Special thanks to a loyal reader for alerting me to the RAIT opinion.

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Securities lawsuit filings reached a six-year high in 2008, according to a year-end report released today by NERA Economic Consulting. The report, entitled "2008 Trends in Securities Class Actions" (here), was written by NERA economists Stephanie Plancich and Svetlana Starykh, and reports that through December 14, 2008, there were 255 securities class action filings, up from only 131 filings in 2006 and 195 filings in 2007. NERA's December 18, 2008 press release regarding the report can be found here.

If the "atypical" cases (e.g., IPO laddering) are excluded from the comparison, the 2008 filings are "on pace to reach a 10-year high." The filings are also on pace for a 37% increase over 2007 and the highest annual increase since 2002 (the year of the corporate scandals).

The report attributes the "surge" in filings to the credit crisis. Of the 255 YTD filings, 110 were credit crisis related, and almost 50% of cases involved defendants in the financial sector, as compared to only 16% of cases in the 2005-06 period. (My table of the credit crisis-related securities lawsuit filings can be accessed  here.)

But while the financial sector saw increased litigation activity, "other sectors also saw continued filing activity." For example, though lawsuits against companies in the health technology sector declined as a percentage of all filings, the absolute number of filings against companies in the health technology sector increased, as there were 29 filings against health technology companies in 2008, compared to only 19 in 2006.

The 2008 filings have been concentrated in the second and ninth circuits. The second circuit filings were increased by the large number of filings in the Southern District of New York, particularly financial companies domiciled there.

Though the pattern of increased filing activity in 2008 is clear, "there have been no clear increasing or decreasing trends in the patter of resolutions." The report notes that median settlements have "remained relatively stable." The 2008 median settlement of $7.5 million is slightly below the 2007 median of $9.4 million, but above the 2006 median of $7.0 milllion.

Average settlements, which can be substantially affected by large settlements, were up in 2008 relative to 2007. The average settlement in 2008 was $38 million, up from $31 million in 2007, but well below the post-Sarbanes Oxley average from 2003 to 2008 of $45 million. (The annual average settlement has ranged from $21 million to $82 million during this six-year period.)

The report does observe that over time there has been an increase in the dollar value of claimed investor losses, from about $120 million ten years ago, to around $340 million during 2008. However, the ratio of median settlement to median investor losses has "stayed relatively steady in the 2-3% range over the past few years."

Looking forward, the report notes that there could be "two opposing factors" that could determine whether or not average or median settlements will increase in the future. On the one hand, investor losses associated with the credit crisis lawsuits in 2008 are very large, which could be "an indicator of big settlements to come." On the other hand, the credit crisis has "dramatically shrunk the size of many defendants’ pockets." Lower financial wherewithal might operate as a downward force on settlement values.

The report concludes that "only time will tell if the huge investor losses for credit crisis filings may put upward press on median settlements in the future, or if the financial distress faced by defendant companies may pull median settlement values down."

My own observations on the 2008 securities litigation activity will be detailed in my year-end analysis, which will be forthcoming after the first of the new year. UPDATE: My year end analysis can be found here. For now, I note a few things.

First, this has been an extraordinarily difficult year in which to just try and count the cases. For example, many litigation targets have been sued multiple times by different claimants, whether they are shareholders who acquired their shares over different time periods, or they are security holders with different classes of equity interests. Whether a new filing should or should not be "counted" has been difficult. Further complicating this has been the large number of state court filings, which are difficult just to find. I emphasize this point simply because there is going to be a significant variation in the various commentators’ year-end reports about how many filings there were this year. My own count is lower than NERA’s.

Second, while the 2008 filings were significantly increased by filings against companies in the financial sector, as the year has progressed and the impact of the credit crisis has become more widespread, the credit crisis-related filings have spread outside the financial sector (refer for example here).

Third, you may see comments elsewhere that the 2008 filings were inflated by one-time sector events, like the auction rate securities lawsuits. While this is true, the recent surge of litigation activity involving the Madoff victims demonstrates that in many ways the pace of securities litigation activity is simply a reflection of a series of supposed one-time events. The mere fact that there is an identifiable event arguably may be irrelevant to analyses of current or future filing trends.

Fourth, the NERA report makes no projections about what is likely to happen to the pace of filing activity in 2009. My own view is that the current active filing pace is likely to continue well into 2009 and perhaps beyond. Among other things, filing activity has been elevated over the last several weeks, which is unusual for December, historically a slow month. The continued spread of credit crisis filings outside the financial sector is likely to continue in 2009. Moreover, the impacts of the financial downturn will begin to emerge as company’s report their 2008 results and as the year progresses, which could contribute to litigation activity.

As I said, my own report will be forthcoming. I am very interested in hearing readers’ thoughts and reactions in the interim.

Special thanks to Ben Seggerson of NERA for providing me with a copy of the NERA report.

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If today’s filings are any indication, a huge wave of Madoff victim lawsuits could be coming. Madoff investors were quick to sue Madoff and his firm, with the first complaint filed last Friday (as noted here). But with Madoff’s firm in liquidation and the money likely long gone, investors who lost money as a result of Madoff’s scheme are casting around for other targets from whom to try to recover their losses. Early returns suggest that investment firms and Madoff "feeder funds" could find themselves facing substantial Madoff victim litigation.

UPDATE: Please note that a regularly updated table of Madoff investor litigation, including "feeder fund" litigation can be accessed  here.

First, as reflected in their December 16, 2008 press release (here), plaintiffs’ lawyers have filed a securities lawsuit in the Southern District of New York against investment partnership Ascot Partners L.P., its founder and general partner (Merkin), and its auditor, BDO Seidman. The class members are persons who purchased limited partnership interests in Ascot.

According to the press release, the complaint alleges that Ascot and Merkin

caused and permitted $1.8 billion -- virtually the entire investment capital of Ascot -- to be handed over to Madoff to be "invested" for the benefit of plaintiff and the other limited partners of Ascot. Plaintiff's investment in Ascot has been wiped out, as a direct result of: (a) defendant Merkin's abdication of his responsibilities and duties as General Partner and Manager of Ascot and its investment funds and; (b) the failure of Ascot's auditor Seidman, in light of "red flags" indicating a high risk to Ascot from concentrating its investment exposure in Madoff as sole third-party investment manager for all of the Partnership's assets, to perform its audits and provide its annual audit reports in conformance with generally accepted auditing standards.

The press release states that the complaint alleges ’34 Act violations as well as related statutory and common law breaches. A copy of the complaint can be found here.

UPDATE: On December 16, 2008, investors also filed a separate lawsuit against a different fund affiliated with Merkin, Gabriel Partners. A copy of the December 17, 2008 press release can be found here.  A copy of the complaint can be found here.  A WSJ.com Law Blog post about the Ascot and Gabriel lawsuits can be found here.

Second, and also on December 16, another plaintiffs’ firm initiated a separate securities lawsuit in the Central District of California. The lawsuit is filed against Madoff and his firm, but also names as defendants Brighton Company, a California limited partnership and a so-called "feeder fund," and its principal ( Stanley Chais). The firm’s press release (here) states that Brighton was "one of the many feeder funds that directed investor capital" to Madoff and his firm. The press release says that Chais "managed several investment groups [including Brighton], the monies for which were given to Madoff" and his firm.

The complaint (here) alleges that the plaintiff invested money through CMG Ltd., a California limited partnership. The complaint alleges that CMG provided all of its investment capital to Chais as general partner for Brighton, which in turn invested all of CMG’s money with Madoff. The complaint alleges that "all defendants contributed to the false, misleading, unlawful, unfair and fraudulent acts and practices associated with the Ponzi scheme."

The purported class consists of two groups; all persons who invested capital with Chais and Brighton, and all persons who invested with Madoff and his firm. The complaint alleges violations of the ’34 Act.

The press release also states that "the firm is investigating the actions of other feeder firms on behalf of investors." The December 17, 2008 Wall Street Journal has an article (here) discussing Stanley Chais and his investment funds'  (and charitable organizations') relation to Madoff
 

Given the magnitude and widespread dispersion of the Madoff losses, and given the fact that there appears to be little money left with Madoff and his fund, it seems highly likely that there will be other (perhaps many other) investment funds, "feeder funds," hedge funds, funds of funds, and other entitles, targeted by Madoff victims. The attention in the press (for example, here) to alleged failures of investment firms to catch supposed red flags or to conduct due diligence will only increase the likelihood of this kind of litigation. The inclusion of the auditor in the Ascot lawsuit suggests that some of these claims could range pretty far afield.

A December 16, 2008 Business Week article discussing the likelihood of Madoff investor claims against hedge funds and others, also discussing the Ascot lawsuit, can be found here.

The Wall Street Journal is helpfully collecting a list of Madoff’s victims here. It is a long list but it is also clearly incomplete; for example, Fairfield Greenwich Advisors may have been hit with $7.5 billion in losses, but those amounts in reality represent the losses of Fairfield’s own investors. The list would be substantially longer if all of these and other fund investors and customers were listed individually. The fund investors are the ones, like the plaintiffs in the cases described above, that will likely target the investment funds.A December 17, 2008 Wall Street Journal article entitled "Fairfiled Group Forced to Confront its Madoff Ties" (here) conveys some pretty strong suggestions along those lines.

In any event, going forward, the number one question D&O insurance underwriters will be asking financial institution applicants will be whether the applicant invested funds with Madoff.

Meanwhile, the Credit Crisis Litigation Wave Churns On: It seems as if the plaintiffs’ lawyers have kicked it into high gear as the year end approaches. There has been a flood of new securities lawsuit filings so far in December. By my informal count, there have already been at least 20 new securities lawsuit filings so far this month (if you count the two cases described above), an unusually high number for December, which historically is a quiet month for securities filings.

And though the filings have included a diversity of cases (as I discussed here), the filings have also included a number of new subprime and credit crisis related lawsuits, including at least four new cases that have been filed or become public this week.

For example, as reflected in their press release (here) on December 16, 2008, plaintiffs’ lawyers initiated a securities class action lawsuit in the Southern District of New York against investors in the C-Bass Trust Certificates backed by residential mortgage loans and issued by Credit-Based Asset Servicing and Securitization LLC. The defendants include C-Bass, the issuing trusts, and the offering underwriters. The complaint, which can be found here, asserts claims under the ’33 Act.

In addition, on December 4, 2008, plaintiffs’ initiated a securities class action on behalf of investors who purchased AIG shares in shelf offerings conducted during the period 2003 to 2007. The complaint (here) asserts claims against AIG, certain of its directors and officers, and its offering underwriters under the ’33 Act.

And on December 8, 2008, defendants removed to federal court a lawsuit that previously had been filed in New York County (New York) Supreme Court against Residential Asset Securitization Trust (which issued certain residential mortgage pass-through certificate), its offering underwriter, and two rating agencies. A copy of the removal petition, to which the original complaint is attached, can be found here.

Finally, plaintiff shareholders have initiated a securities class action lawsuit (here) against private equity firm American Capital Ltd. in the District Court of Maryland, alleging among other things that the firm failed to disclose its exposure to disruptions in the credit market.

I have added these new lawsuits to my running tally of subprime and credit-crisis related litigation, which can be accessed here. With the addition of these new lawsuits, the running tally of subprime and credit-crisis securities lawsuits now stands at 138, of which 98 have been filed during 2008.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing information and links about these new lawsuits.

And Finally: Before writing this post, I had no prior acquaintance with the phrases "Madoff victims" and "feeder funds." I guess I better get used to them.

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In the latest preliminary ruling in a subprime or credit crisis-related securities lawsuit, Southern District of Florida Judge Ursula Ungaro in a December 11, 2008 opinion (here) granted the defendants’ motion to dismiss the plaintiffs’ complaint, with leave to amend.

Background

BankAtlantic Bancorp is a bank holding company that offers consumer and banking lending services, through its wholly-owned subsidiary. The plaintiffs complaint alleged securities law violations against the holding company and five present and former directors and officers of the holding company or of the subsidiary. The plaintiff purports to represent persons who purchased the holding company’s stock during the period November 9, 2005 though October 25, 2007. Background regarding the case can be found here.

As summarized in the December 11 opinion, the complaint alleges that the company "sought to capitalize on the Florida real estate boom through expansion of its commercial real estate loan portfolio." To fuel the growth, the company "cut corners" including "ignoring the Company’s internal lending guidelines." The company also allegedly "failed to adequately reserve for loan losses" in its commercial real estate loan portfolio, "resulting in material misstatements in the Company’s financials." After the Florida real estate market "entered a free fall in 2007," borrowers "began defaulting" and the company was "forced to reveal the true extent of the Company’s exposure in its real estate portfolio."

The Opinion

In her December 11 opinion, Judge Ungaro held that the complaint "adequately alleges misrepresentations and omissions in a manner sufficient to withstand a motion to dismiss," and that the complaint "is legally sufficient in so far as it pleads loss causation." However, she found that the complaint did not adequately allege scienter.

As a preliminary matter, Judge Ungaro addressed the complaint’s reliance on confidential witness statements. She found that "there is no specific information as to the confidential witnesses’ positions in the Company, their employment duties, the foundation or basis for their knowledge, or whether they were even employed with the company during the relevant time period." Accordingly, she concluded that she is "unable to give any significant weight to the allegations made by those confidential witnesses.

She then considered the scienter allegations against the individual defendants. With respect to the allegations against the Vice Chairman, the current CEO and the Chairman, she found that the "factual allegations do not give rise to a strong inference of scienter." She said that even assuming the confidential witness statements could be given weight, the allegations are insufficient; "the confidential witness’s vague and conclusory assertion that it was ‘common knowledge’ that the Company had risky loans on its books is not the type of particularized allegations required under the PSLRA."

She also noted that the defendants’ "knowledge of the company’s lending or accounting practice by virtue of their high-level positions…does not create a strong inference of scienter." She also found that the fact that these individuals received "Exception Reports" establishes "nothing about what these Defendants knew or should have known about the Company’s lending practices."

Judge Ungaro also rejected the contention that the defendants’ $7.8 million in insider stock sales established scienter, because the complaint "does not allege that the amount or percentage of shares sold …were unusual," nor does the complaint alleged "that the sales were inconsistent with their prior trading history."

With respect to the scienter allegations against the company’s former and its current CFO, Judge Ungaro concluded that the complaint "does not contain factual allegations that would support a finding that [the defendants’] statements were made with scienter." The complaint "lacks particularized allegations" that these two officials "played a role in approving loans or in setting loan loss reserves," and the complaint does not allege that they were "presented with information that would have shown the falsity of the Company’s financial statements or that they were confronted with concerns regarding the Company’s lending practices or loan loss reserves."

Finally, with respect to the company (but without reference to more generalized theories regarding "collective scienter"), Judge Ungaro held that the plaintiff "has not adequately pled scienter as to any of the Individual Defendants; therefore, Plaintiff has failed to adequately pled [sic] scienter as to BankAtlantic."

The court’s grant of the defendants’ dismissal motion is without prejudice and the plaintiffs have 20 days in which to file an amended complaint.

Discussion

The BankAtlantic case joins a growing list of subprime and credit crisis related securities cases that failed to survive preliminary motions. To be sure, the dismissal motions in the Countrywide subprime securities case (refer here) and the New Century Bankcorp subprime securities case (refer here) were both recently denied in strongly worded opinions. But as reflected in my running tally of subprime and credit crisis-related securities lawsuit settlements, dismissal and motion denials (which can be accessed here), a greater number of dismissal motions have been granted than denied.

It should be noted that at this point only a handful of dismissal motions have been resolved one way or the other. And many of the dismissals that have granted have been without prejudice. The plaintiffs in these cases may yet successfully amend their complaints and survive a subsequent motion to dismiss. Nevertheless, the early returns seem to suggest that many of these cases are facing judicial resistance.

On a related note, I have observed elsewhere (refer here) that the growing wave of bank failures could lead to an increased number a new wave of "dead bank" litigation. To the extent these cases do emerge, the Bank Atlantic opinion may suggest that the cases could face significant pleading hurdles.

In any event, I have added the BankAtlantic opinion to my running tally of subprime and credit crisis-related lawsuit settlements, dismissals and dismissal denials, which can be accessed here.

Court Rejects KLA-Tencor’s Special Litigation Committee’s Motion to Dismiss Backdating Case: In a December 11, 2008 opinion (here) that is extensively redacted due to its reliance on evidence submitted under seal, Judge James Ware of the Northern District of California denied the motion of KLA-Tencor’s Special Litigation Committee (SLC) to dismiss the options backdating derivative lawsuit pending against the company, as nominal defendant, and certain of its directors and officers.

The plaintiffs had filed a complaint alleging that the defendants "permitted senior KLA insiders to unlawfully manipulate the grant dates associated with KLA stock options, resulting in hundreds of millions of dollars of losses to KLA." (Background regarding the options backdating allegations at KLA-Tencor can be found here.) In response to the filing of the complaint, the company’s board formed the SLC and appointed two directors to serve as its members. The SLC prepared a report and filed a motion to dismiss the derivative action, concluding that the derivative action "is no longer in the interests of KLA or its shareholders."

Judge Ware considered the motion under Delaware law. Because of the redactions in his opinion, his reasoning is not always entirely evident. Basically, he was concerned that one of the SLC members "was on the Board and on the Audit Committee at a time when continued backdating may have been occurring at KLA." This raises the "possibility" that the one SLC member was "tasked with investigation corporate malfeasance that he had previously, if unintentionally, approved," which in turn raised questions about his independence.

Because of the independence concerns, the Court was also "concerned by the overall size of the SLC, as it consisted of only two members." On these grounds, the court found that the SLC had not carried its burden, noting that

Although no single factor is dispositive in the Court’s determination, evaluation of the totality of the circumstances, including the size of the SLC, questions surrounding its independence, and the depth and focus of its inquiry leads to this conclusion.

Accordingly, the court denied the SLC’s dismissal motion, denied certain individual defendants’ proposed (unspecified) settlements, and scheduled the case to go forward.

Without having statistical evidence to support the observation, I note that it is relatively unusual for a court to reject an SLC’s recommendation to drop a derivative case. On the other hand it is also unusual for an SLC to have only two members, and these two unusual features wound up being related. A December 17, 2008 Law.com article discussing these aspects of Judge Ware's opinion can be found here.

In any event, I have added the KLA-Tencor decision to my table of options backdating related lawsuit settlements, dismissal and dismissal denial, which can be accessed here. KLA-Tencor’s $65 million settlement of the options backdating securities class action lawsuit that had been filed against the company is discussed here.

Are European Investor Groups Turning to U.S. Court for Subprime Claims?: A December 16, 2008 post (here) on PomTalk, the blog of the securities plaintiffs’ firm Pomerantz Haudek Block Grossman & Gross, noting that "pension funds around the globe have lost hundreds of billions of dollars" in the credit crisis, as a result of which "increasingly, they are turning to U.S. courts to seek recovery of losses."

The article notes that "in recent years, European funds have begun to play a more prominent role" in U.S. class actions, and that according to a U.K. pension fund group, "23% of British pension funds have now actively participated in a U.S. securities class action."

The article suggests that European funds "will be particularly affected by three categories of suits": suits against financial services companies; suits involving structured financial instruments; and suits involving agency obligations and preferreds (this latter category is a reference to the securities of government sponsored entities). The article concludes by noting that "European funds are certain to remain a fixture in U.S. securities class action."

Readers of this blog may be interested to read the article’s observations in connection with litigation against financial services companies:

A major question in suits against banks is whether they have the ability to satisfy a large judgment or enter into a reasonable settlement. Many banks have already gone under or are hanging by a thread. But even failed banks generally have D&O insurance, and there may be other viable defendants like underwriters.

Ah, yes. Round up the usual suspects. Be sure to frisk them for insurance, as well as the presence of any professional advisors.

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As the year end approaches, various commentators will be issuing their retrospectives on the year’s securities litigation activity. The lead story undoubtedly will be that the wave of subprime and credit crisis-related lawsuits continued to flood in during the year. With some 94 new subprime and credit crisis related securities lawsuits so far in 2008 (by my count, which can be accessed here), the litigation wave undoubtedly is an important part of the story. But it is not the whole story. The danger is that the wave of credit crisis-related litigation has become so predominant that other important developments may be overlooked.

This past week illustrates my point. There were seven new securities class action lawsuits filed during the week of December 8, which is noteworthy in and of itself, as December historically is a slow month for securities class action lawsuit filings.

Among this past week’s seven new securities lawsuits was one new credit-crisis related filing. On December 11, 2008, plaintiffs’ lawyers filed a class action lawsuit against GS Mortgage and certain of its directors and officers, on behalf of purchasers of mortgage pass-through certificates and asset-backed securities the company issued. (GS Mortgage is an affiliate of Goldman Sachs, which is also named as a defendant.)

According to the plaintiffs’ press release (here), the GS Mortgage complaint alleges a variety of misrepresentations in the instruments’ offering documents, including with respect to the underwriting standards and appraisals used in the origination of the underlying mortgages.

But while the seven lawsuits filed last week did include this one subprime-related lawsuit, the other six lawsuits appear completely unrelated to the subprime or credit crisis-related events.

The remaining six companies named include a Canadian mining company, Crystallex International, allegedly facing regulatory issues in Venezuela (about which refer here); two medical device companies, Medtronix and Atricure (refer here and here); a media conglomerate, CBS Corporation, that announced non-cash impairment charges to intangible assets and goodwill (refer here); a laser and technology manufacturer, GSI Corp., that restated its financials due to revenue recognition issues (refer here), and a Chinese agricultural company, China Organic Agriculture, facing allegations regarding its development of organic products (refer here).

These six lawsuits represent a diverse mix of companies and allegations. The point here is that none of these six lawsuits is related to the subprime meltdown or credit crisis. Similarly, during the past year, while there have been a host of credit crisis-related lawsuits filed, there have also been many other lawsuits that are totally unrelated to the credit crisis.

Given the nature and magnitude of the financial developments this year, it is hardly surprising that there has been significant litigation activity involving the financial sector. What may be even more noteworthy is that notwithstanding the predominance of the financial events, there have been a significant number of lawsuits having nothing to do with the credit crisis or the financial sector.

I will detail these observations in my own forthcoming year-end analysis of securities litigation activity. In the interim, particularly as the various year-end reports emerge, it is important to keep in mind that 2008 securities litigation activity was not just about the credit crisis alone, nor was it confined just to the financial sector.

Does This Sounds Familiar?: Our age is not the first to have to contend with the consequences from cultural excess fueled by speculation, debt and deficit spending enabled by “financial wizardry.” A similar pattern also appeared in the events leading up to the French Revolution. In his book, Revolutionary France, 1770-1880 (here), historian François Furet details the country’s astonishing accumulation of indebtedness, and the consequences that followed.

In particular, Furet explores the way the French monarchy, led by Finance Minister Jacques Necker, financed its participation in the American war of independence by increasing state-guaranteed life annuities, fueling a speculative bubble and enabling borrowing backed by inflated values. Furet writes:

In total, between 1776 and 1781, 530 million in loans of all kinds fed the Treasury and financed a war that was all the more popular because it was painless. Money continued to flow in, and the resale of annuities enriched Parisian speculation. Even if the state was seriously compromising its future, Necker retained his popularity. In 1781, to counter-attack court intrigues … he published the Compte rendu, a statement of accounts which concealed the expenditure of the extraordinary budget and revealed an apparent surplus revenue of ten million livres.

As Furet observed, “after three years of war and no new taxes, that was truly  financial wizardry!” The problem is that, contrary to Necker’s assurances, “the real deficit lay in the region of eighty million.”

Similar deficit financing by Necker’s successors furthered the French government’s financial challenges. A successor minister, Charles Alexandre de Calonne, “found, out of 600 million livres in annual revenue, 176 million committed in advance, 250 million absorbed by debt service, and 390 million in accounts in arrears to be settled.” What was Calonne’s response? “He borrowed money on all sides, even more and at a higher rate than his predecessors.”

Among other things, this massive indebtedness enabled the illusion of prosperity; “one would need to reconstruct the entire circuit of money borrowed by Calonne to understand how these years were without doubt the most dazzling in court civilization.” But, as Furst notes, “sinking borrowed money into the parasitic round of court life proved eventually to be the downfall of this aristocratic sleight of hand.” This “artifice” unleashed “one of the most gigantic crashes in history.”

As we face the consequence of the collapse of our own era of debt-fueled prosperity, with its accompanying speculation, asset-valuation bubbles and financial wizardry, there is something sobering in realizing that once again the response consists of “borrowing money on all sides.” The ever-cumulating deficits have reached the point where figures of billions and trillions have lost all meaning. I am sure I am not the only one with the uneasy  feeling that we may be sinking borrowed money into parasitic hands and that we could be “seriously compromising our future.”

PLUS D&O Symposium: The Professional Liability Underwriting Society (PLUS) will be holding its annual D&O Symposium on February 25 and 26, 2009, at the Marriott Marquis in New York City. I will be co-Chairing the event again this year, along with my good friends, Tony Galban of Chubb and Chris Duca of Navigators Pro. There will be a terrific line up of speakers, including the keynote speakers Madeline Albright and New York Insurance Commissioner Eric Dinallo .

The panels will include all of the familiar favorites, such as the securities litigation update panel, to be chaired again by Boris Feldman of the Wilson Sonsini firm, and View from the Top panel, featuring the heads of the leading D&O underwriting facilities. Other panels will also address issues surrounding the governmental bailouts and increased business failures. An added bonus is that the fascinating video The Rise and Fall of Bill Lerach will be shown during the conference. (View a trailer of the video here).

Further information about the 2009 PLUS D&O Symposium, including registration information, can be found here. This event sells out every year, so early registration is advised.

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All litigants face the challenge of managing lawsuit expenses and exposures. The Reserve Primary Fund investor litigation defendants have crafted a novel approach to addressing these challenges – they apparently intend to finance their defense as well as any indemnity out of funds due to investors -- that is, the funds of the very people on whose behalf the claims are being asserted.

Background

In September, the Reserve Primary Fund ("the fund") gained notoriety when the money market fund "broke the buck," as massive redemptions and the fund’s exposure to Lehman Brothers’ securities drove the fund’s per share net asset value below one dollar. Due to the magnitude of the redemption requests, the fund’s trustees voted to liquidate the fund and distribute the assets to investors.On December 8, 2008, the Wall Street Journal ran a front page article (here) detailing the events behind the fund's woes.

Meanwhile, investors initiated a number of securities lawsuits against the fund, its directors and officers, its investment advisor and related parties. (Refer here for background regarding the lawsuits.) The lawsuits allege, among other things, that the defendants’ selective or inaccurate disclosure regarding the fund’s troubled assets enabled certain institutional investors to avoid losses to the detriment of other investors. The lawsuits also alleged that the fund failed to disclose its vulnerability due to its alleged overexposure to Lehman. The lawsuits also allege that the Lehman Brothers investments were inappropriate for a money market fund, and that the fund deviated from its stated investment approach.

The Liquidation Plan

On December 3, 2008, the fund’s trustees issued a "Plan of Liquidation and Distribution of Assets" (here). Among other things, the Liquidation Plan provides a plan for distribution of fund assets through "interim payments." The interim payments are to include distribution amounts "up to the amount of a special reserve, which would include amounts that would be required to satisfy disputed claims."

As the Liquidation Plan explains, this special reserve will be used to finance "costs and expenses of the Fund, its officers and Trustees"; "pending and threatened claims against the Fund"; and claims, "including but not limited to claims of indemnification that could be made against plan assets." Were the fund to distribute its assets without the special reserve, investors could expect about 98.5 cents per share. However, the special reserve, the amount of which has yet to be determined, will reduce this per share distribution.

As a December 5, 2008 New York Times article entitled "Embattled, Fund Shifts Costs to Investors" (here), put it, investors might hope to get 98.5 cents on the dollar, but "if they continue to wage legal battles against the fund managers, the company will use investors’ own money to defend itself against allegations or mismanagement and deception." Moreover, the Liquidation Plan makes it clear that the special reserve is not just for litigation expense, but also to "satisfy disputed claims." The December 8 Journal article cited above states that the fund has told investors "the fund will use some if its assets to fight suits investors have filed, which could reduce the money available to return to them."

Insurance and Indemnification

Readers who like me wonder whether there isn’t D&O liability insurance available to pay these amounts will be interested to learn that there is insurance, just not very much. According to the Liquidation Plan, the fund has a directors’ and officers’ liability insurance policy with a $10 million aggregate limit of liability.

Not only does the fund only have a $10 million D&O policy, but it is a "joint" policy, insuring not just the fund and its directors, officers and trustees, but also its investment advisor, its corporate parent, and other affiliated parties and person, many of whom are co-defendants with the fund and its directors and officers in the mass of investor lawsuits that have been filed.

In other words, though the fund has D&O insurance, its limits are, well, limited, and are also subject to erosion or depletion due to competing interests of multiple parties in the policy proceeds. It should be emphasized that under most D&O policies, defense expense reduces the amount of insurance remaining under the policy, meaning that there could be little or no insurance available to satisfy investors’ claims if the various cases are actively litigated.

The rights of the fund’s individual officers, directors and trustees to indemnification are not eliminated merely because of the allegations raised in the lawsuits (indeed, the outbreak of litigation is precisely the circumstances that trigger the operation of indemnification rights). Angered investors who may want to contend that the individual’s supposed misconduct should forfeit their rights to indemnification can try to argue based on Section 17(h) of the Investment Company Act that the fund cannot indemnify the individuals for "willful malfeasance, bad faith, gross negligence, or reckless disregard."

The problem for any investor inclined to make that argument is that the only way to establish that the statutory indemnification prohibitions have been triggered is to litigate the issue – which, as the Times article notes, is "the very act that could reduce the return to investors." In order to establish that the disqualifying conduct occurred, investors would have to pursue their case all the way to verdict, and arguably through appeal as well, a process that would be as uncertain as it would be costly and protracted.

Discussion

So basically the message seems to be, you want to litigate, investors? Fine, knock yourselves out. It’s your money. As the Times article puts it, the choice offered investors under the Liquidation Plan "struck some legal experts as brazen."

The fund’s insurance limits are also worthy of comment. The fund had assets of approximately $64 billion. In that light, some may find the fund’s $10 million D&O insurance limits, well, surprising, particularly given that the limits insure not just the fund and its directors, officers and trustees, but also the fund’s investment advisor and other affiliated parties and person. Reasonable minds might well question the fund’s limits selection.

These circumstances also highlight the risks associated with widely shared limits. The number and diversity of entities and person who will be depending on the limits, along with the apparent seriousness and extent of the litigation involved, raises the probability that the litigation expense will quickly erode if not altogether deplete the available limits. The risk of limits erosion associated with these kinds of shared limits further underscores the fact that reasonable minds might well question the fund’s insurance limits selection.

In any event, the circumstances, particularly the Liquidation Plan, present investors with some difficult decisions. It will be interesting to see their next move, and whether they try to challenge the Liquidation Plan.

Special thanks to Kelly Rehyer for the link to the Times article.

And Speaking of Threats to Litigating Investors: As I noted in a prior post (here), investors have sued the Bank of America, challenging the loan modifications to which the bank agreed in connection with mortgages issued by Countrywide. The litigation has apparently caught the attention of FDIC chairman Sheila Bair.

As reported in a December 4, 2008 Los Angeles Times article (here), Bair told a consumer group gathering that "there is an obligation to modify mortgages," and that "investors should take a hard look at what they are advocating." She also said that "the harder investors push, the more there’s going to be a backlash here." She suggested that Congress may step in and change the legal obligations of mortgage services toward investors.

Interestingly, Bair did not state that the investors’ opposition to the mortgage makeovers is illegitimate or unmeritorious, only that their assertion of their interests represents an obstruction to policy goals she advocates. It certainly can be inconvenient when concerned parties insist on asserting their rights, but the threat of a Congressional backlash could strike some as heavy-handed.

Call it a hunch, but Bair’s remarks seem likelier to embolden rather than to discourage investors, as her remarks suggest that she recognizes the potential significance of their claims. In any event, whether or not Congress has the power or political will to set aside the agreements on which the investors are relying, if Congress were to take such a step it would do little to restore investor confidence in mortgage marketplace mechanisms, which would seem to be an indispensible part to restoring stability to the mortgage lending industry.

And Speaking of the FDIC: In yet another Friday-night special, on December 5, 2008, First Georgia Community Bank of Jackson, Georgia became the twenty third U.S. bank failure this year, after state regulators closed the bank and the FDIC was named receiver. The closure is Georgia’s fourth bank failure this year.

The FDIC’s December 5, 2008 press release can be found here. The FDIC’s updated list of bank failures can be found here. My prior post about the significance of the accumulating bank failures can be found here, and my prior post about the prospects for a new wave of "dead bank" litigation can be found here.

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In a recent post (here), I described the "new wave" of credit crisis lawsuits, in which the companies involved were damaged by their exposures to other companies experiencing credit crisis losses. The latest of these new wave lawsuits to be filed involves the Federal Agricultural Mortgage Corporation, or "Farmer Mac" as it is more familiarly known.

Freddie Mac is a government sponsored entity that was established to support a secondary market for agricultural real estate and rural housing mortgage loans. According to their December 5, 2008 press release (here), plaintiffs’ lawyers have initiated a securities lawsuit against Farmer Mac and certain of its directors and officers in federal court in the District of Columbia. According to the press release,

a) defendants were inflating Farmer Mac's results through manipulations relating to the characterization of impairment costs and/or depreciation expenses which inflated the Company's reported cash flows, gross margins and Core and GAAP-earnings; (b) the Company's financial results were inflated by defendants' use of overly optimistic assumptions of asset valuations and investments, which were also reflected in defendants' misuse of mark-to-market accounting; (c) the Company's exposure to investment losses and credit problems of trading partners such as Lehman Bros. and Fannie Mae was much greater than represented; and (d) the Company was not on track to meet or exceed guidance sponsored or endorsed by defendants.

Investors only first learned the truth about Farmer Mac on September 12, 2008, when its shares closed at $16.56, from an open of $23.78, losing over 30% of their value in one day after the Company filed documents with the SEC saying it would incur significant charges due to its exposure to Fannie Mae securities. Further, shares of the Company continued to trade down thereafter to close to $2.00 per share following announcements concerning the resignation of its Chairman of the Board and losses related to debt issued by Lehman Brothers.

The involvement of the allegations relating to the company’s Fannie Mae and Lehman Brothers investments is the reason I have characterized this case as a new wave credit crisis lawsuit. That is, it was its exposure to these other companies that caused Farmer Mac’s problems, at least in part.

However, because of the allegations relating to Farmer Mac’s own asset valuations, including its alleged misuse of mark-to-market accounting, the lawsuit also has characteristics of the more conventional subprime and credit-crisis related type of litigation that has accumulated over the last two years.

In any event, I have added the Farmer Mac lawsuit to my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of the Farmer Mac lawsuit, the current tally of subprime and credit crisis-related securities lawsuits now stands at 132, of which 92 have been filed in 2008.

And Speaking of Credit Crisis Litigation: One of the more noteworthy events during the current credit crisis was the collapse of Bear Stearns in March 2008 (which already seems like a long time ago, doesn't it?) and its acquisition by JP Morgan Chase.

Following JP Morgan’s March 16, 2008 agreement to acquire Bear Stearns, shareholders of Bear Stearns filed a New York (New York County) Supreme Court lawsuit against both Bear Stearns and JP Morgan, alleging that the $10 per share consideration JP Morgan paid for Bear Stearns was inadequate. The plaintiffs sought damages from Bear Stearns’ directors for claimed violations of their fiduciary duties and from JP Morgan for its allegedly tortious conduct in effecting the merger.

In a December 4, 2008 opinion (here), Judge Herman Cahn granted the defendants’ motion for summary judgment. The court rejected the plaintiffs’ challenges to the deal, holding that the business judgment rule applied, and that under the rule, the court could not second guess the board:

In response to a sudden and rapidly-escalating liquidity crisis, Bear Stearns’ directors acted expeditiously to consider the company’s limited options. They attempted to salvage some $1.5 billion in shareholder value and averted a bankruptcy that may have returned nothing to the Bear Stearns’ shareholders, while wreaking havoc on the financial markets. The Court should not, and will not, second guess their decision.

In a December 5, 2008 post on the Harvard Law School Corporate Governance Blog (here), the attorneys that represented JP Morgan in the Bear Stearns case discuss the decision in greater detail, noting that "as the credit crisis continues and evolves, boards will continue to face serious challenges. The Bear Stearns opinion confirms, however, that the directors that act diligently and in good faith should not have exposure for their actions."

The suggestion that the Bear Stearns opinion represents a precedent in support of the protection of directors arguably has already been borne out in a North Carolina court.. As Francis Pileggi discusses on his Delaware Corporate and Commercial Litigation Blog (here), the North Carolina court considering shareholders’ challenges to the merger of Wachovia and Wells Fargo has dismissed the action, with reference to  the New York court’s decision in the Bear Stearns case. The Wachovia and Wells Fargo merger was arranged in similarly unusual circumstances in light of the economic turmoil that in very short order saw some of the countries largest financial institutions "go under" or need "bailouts."

A December 6, 2008 Charlotte Observer article describing the ruling in the Wachovia case can be found here.

Fake ID: In a recent post (here), I analyzed the problems associated with credential inflation and reviewed famous examples of identity misrepresentation. However, a recent episode involving prominent attorney Marc S. Dreier, the name partner of Drier LLP, may represent a whole new level of identity misrepresentation.

As reported on December 5, 2008 on the City Room blog (here), earlier last week Toronto police arrested Drier for "fraudulent impersonation." A December 8. 2008 Law.com article (here) reports that at a meeting in the offices of the Ontario Teachers’ Pension Plan with representatives of Fortress Investment Group and involving a multimillion dollar deal between the two organizations, Drier "pretended to be Michael Padfield, senior legal counsel for investments at Ontario Teachers." The Wall Street Journal reports (here) that Dreier passed out Padfield's business card and signed documents as Padfield. When Padfield himself arrived at the meeting, police were called.

As if that were not enough, three attorneys from the Wilson Sonsini firm have been retained "to examine firm operations and finances, including escrow accounts." Whether or not these concerns are related to Drier’s arrest is not specified. However, the Above the Law blog reports here that as much as $38 million is missing from the Dreier firm’s client escrow account.

The Journal also reports that federal prosecutors are looking into concerns raised by Solow Realty, a former client of the firm, "that Mr. Dreier allegedly was selling to hedge funds fraudulent documents falsely purporting to be debt instruments of Solow without Solow's authority."

The firm’s holiday party, planned to take place last Thursday night at the Waldorf Astoria, was cancelled. I guess it is hard to party when your name partner is (or was) in jail and your client escrow account is missing tens of millions of dollars.

I doubt even John Grisham could have made this one up.

UPDATE: The Marc Dreier story just keeps getting weirder and weirder. In a totaly bizarre development, on December 8, 2008, the SEC filed a complaint against Dreier in which it accused him of "fraud in connection with an elaborate scheme that raised at least $113 million from the sale of bogus promissory notes." Read the SEC's press release here. The press release that Dreier has already admitted his involvement with the phony note sale. The WSJ.com Law Blog reports (here), that the DoJ has also filed a criminal complaint against Dreier and that he was arrested upon his return to the U.S. on Sunday. The firm's lender has also sued the law firm because the firm is in default on its line of credit.

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In an earlier post (here), I suggested that the credit crisis litigation wave had reached an inflection point, and in subsequent posts, I identified additional "new wave" credit crisis lawsuits.

The exact contours of this "new wave" is admittedly amorphous, but the basic concept is that it involves, first, companies that were not themselves undermined by the credit crunch but rather as result of their exposure to companies that were. The most prominent examples are companies that suffered losses due to their exposure to Lehman Brothers. One specific example is Constellation Energy, which, as noted here, is the target of a securities lawsuit alleging among other things that the company insufficiently disclosed its exposure to Lehman Brothers securities.

That there will be other lawsuits in the "exposed to others’ misfortunes" category is demonstrated by the lawsuit initiated on December 3, 2008 in the Southern District of New York against Chinese solar cell manufacturer JA Solar Holdings and certain of its directors and officers. According to the plaintiffs’ counsel’s December 3 press release (here), the Complaint alleges that the defendants failed to disclose that:

JA Solar purchased from a subsidiary of Lehman Brothers Inc. ("Lehman Brothers") a three month, $100 million note (the "Lehman note") on or about July 9, 2008. At the time of this purchase, Lehman Brothers, which guaranteed the Lehman note, was under severe financial distress. According to the complaint, defendants failed to disclose: (i) that JA Solar had made a material, highly speculative investment in a subsidiary of Lehman Brothers, an entity that was then undergoing a credit crisis and under significant financial distress; (ii) that the value of JA Solar’s investment in the Lehman note had diminished considerably; and (iii) that, as a result of the foregoing, defendants’ positive statements concerning JA Solar’s financial performance, outlook and earnings guidance were materially false and misleading and without reasonable basis.

Ultimately, at the end of the Class Period, JA Solar wrote off its $100 million investment in the Lehman note. After JA Solar fully disclosed and recorded an impairment in the value of its investment in the Lehman note, on November 12, 2008, JA Solar’s stock closed at $2.38 per share, a price that represented a decline of more than 87% from the high during the three month Class Period.

A copy of the JA Solar complaint can be found here.

Constellation Energy and JA Solar are far from the only companies experiencing losses as a result of the onslaught of bankruptcies and bailouts. Many companies have experienced huge losses as a result of the collapse of Lehman Brothers, Fannie Mae and Freddie Mac, AIG, Washington Mutual, and the other recent massive failures. There undoubtedly will be further lawsuits like the ones filed Constellation Energy and JA Solar.

Another category of "new wave" credit crisis litigation relates to companies that made wrong way bets on commodities and currencies, as I noted in a prior post (here). These companies have experienced significant losses as commodities prices and currency exchange rates suddenly and unexpectedly reversed direction this fall. Some of these companies have also been hit with securities lawsuits, as I noted in my prior post, and as also illustrated in the lawsuit recently filed against Aracruz Cellulose (about which refer here).

As discussed in a December 3, 2008 Wall Street Journal article entitled "Rapid Price Decline in Commodities Turns Some Offsets into Big Losses" (here), a number of companies "have taken hedging-related losses in the third quarter as a result of the rapid decline in commodities costs." But, the article emphasizes, "it isn’t over, either." Companies hedge their costs a few quarters in advance, so hedges taken more recently "are going to hurt profits for many in the fourth quarter and beyond." The article specifically mentions Campbell Soup, Kraft Foods, Pilgrim’s Pride, and Southwest Airlines.

The reference to Pilgrim’s Pride is particularly noteworthy as part of this discussion, because as I previously noted (here), the company has already been hit with a securities lawsuit based among other things on the company’s wrong way bet on corn prices. As the Journal notes, there will be other companies reporting losses after the end of the fourth quarter and even beyond on wrong way commodities and currency bets. Some of these companies likely will also face securities lawsuits.

The final category (or at least final until a new category emerges) involves auction rate securities. I refer here not to the mass of litigation filed earlier this year by auction rate investors against the broker-dealers that sold them the auction rate securities. Rather, I am referring to the cases where investors have sued companies because of losses the companies suffered as a result of the companies’ investment in auction rate securities.

An example of this auction rate case is the one involving NextWave Wireless (about which refer here) in which it is alleged, among other things, that the company "failed to timely disclose that it had invested all of its marketable securities in extremely illiquid auction rate securities."

There are a host of other companies facing distress due to their exposure to illiquid auction rate securities. For example, a December 3, 2008 Wall Street Journal article entitled "LandAmerica’s Collapse Leaves Investors Looking for Cash" (here) describes the failure of title insurance company LandAmerica Financial Group, which came about because one of the company’s subsidiaries had put funds held for real-estate investors in auction rate securities. Land America filed for bankruptcy last week.

There undoubtedly will be other companies facing liquidity crises as a result of their exposure to auction rate securities, and some of these companies, like NextWave Wireless, will face securities litigation as a result.

One final point about the evolution of the credit crisis litigation wave is that many of the companies involved in these various "new wave" categories identified above are outside the financial services sector. To the extent these new wave lawsuits continue to accumulate, this evolutionary process could be the means by which the credit crisis litigation wave spreads outside the financial sector to the larger economy.

Premonition of War Foretold: As we wonder how we got into the mess, one of the things that is becoming obvious is that the sober voices were silenced and mocked, and the dialog was dominated by the voices of those who had spent far too much time at the punch bowl.

The following video compiles of series of clips from the period 2006 through 2007, showing both how many foolish things were said, and also showing the prescience of Peter Schiff of Euro Pacific Capital. I don't know what is more amazing about this video, that Schiff's predictions were so uncanny or that the others, who mocked and even laughed at him, so badly misperceived what was happening, especially with respect to housing prices. I guarantee you will shake your head in disbelief at some of the things that are said in this video. Schiff in the meantime sounds like a man who had access to a crystal ball.

Hat tip to Joe Nocera of the New York Times in his Executive Suite blog (here) for the link to the video.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The plainitffs' lawyers' press release adds:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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Allegations that the defendant companies and their senior managers failed to disclose the hazards associated with the company’s risky investments. Allegations that management failed to account for losses on high risk investments in a timely or complete manner. Allegations that company management minimized the deteriorating values of high risk investments in piecemeal damage control statements to the marketplace.

Sound familiar?

You may be surprised to learn that these allegations do not come from a lawsuit filed as part of the recent wave of subprime and credit crisis litigation. Instead these allegations appear in a case filed against American Express and certain of its directors and offices in July 2002. Background regarding the case can be found here.

On September 26, 2008, Judge William H. Pauley of the Southern District of New York, considering the case on remand from the Second Circuit, granted the defendants’ motion to dismiss in an opinion (here) that may have considerable significance for the more recently filed subprime and credit crisis securities lawsuits.

The plaintiffs had alleged that in the late 90s, the company began investing in "high-risk, high yield debt securities such as below-investment grade bonds and collateralized debt obligations." The complaint alleges that in early 2001, the company recognized $123 million in losses during the preceding fiscal year in losses on the High Yield Debt Portfolio, and that during the first calendar quarter of 2001, the defendants became aware that the portfolio was "deteriorating rapidly." In April 2001, the company announced an additional $185 million in portfolio losses.

During the second calendar quarter of 2001, the second amended complaint alleges, the defendants became aware that "even the investment grade CDOs" were "damaged due to defaults in the underlying bonds." In July 2001, the company announced a $826 million pre-tax charge to recognize additional write-downs to the High Yield Debt Portfolio.

The plaintiffs sought to pursue claims on behalf of persons who had purchased the company’s shares between July 18, 1999 and July 17, 2001. Their second amended complaint alleged three categories of fraud: (1) false and misleading statements that the company had adopted risk management policies; (2) failure to properly account for investment losses; and (3) mischaracterizations of developments relating to the High Yield Portfolio.

Judge Pauley granted the defendants’ motion to dismiss the second amended complain on the grounds that the plaintiffs had failed to establish a strong inference that the defendants had acted with scienter.

Judge Pauley found that the allegations that the defendants were motivated to commit fraud by the senior managers’ aggressive income targets and incentive compensation "were not entitled to any weight."

Judge Pauley also rejected plaintiffs’ contention that defendants were "reckless" in not knowing the risks of the high yield investments and that the public disclosures of the company about those investments misrepresented that risk. Those allegations, the court concluded, "do no more than state in conclusory fashion what Defendants should have known, they are not entitled to any weight."

The court also rejected the plaintiffs’ allegations based on confidential sources, holding that:

None of the confidential sources specifically states that any Individual Defendants had information or access to information indicating that Amex was not properly valuing the High Yield Debt, that is risk control policies were inadequate, that Amex was violating GAAP, or that contradicted the Company’s statements in 2001.

With respect to plaintiffs’ allegations that the defendants minimized the deteriorating asset valuations through piecemeal disclosures, Judge Pauley focused on the internal efforts the Company was making to evaluate its deteriorating assets and found that "the more compelling inference is that Defendants were not acting with intent to deceive, but rather attempting to quantify the extent of the problem before disclosing it to the market."

Judge Pauley also found that the allegations about defendants’ examination of the High Yield Debt Portfolio "suggest that the Defendants upheld their duty to monitor," which "precludes any inference of recklessness."

The SEC Actions blog has a detailed analysis of the opinion, here.

The allegations in the American Express case contain many parallels with many of the lawsuits in the current litigation wave. Indeed the nature of the investment assets involved, including in particularly the investment grade CDOs, and the causes of the valuation declines (including the deteriorating of the bonds underlying the CDOs) bear an uncanny resemblance to many of the allegations in the more recent subprime and credit crisis related litigation.

With the insertion of the words "subprime mortgages," the case arguably would be indistinguishable from many of the more recent cases. Many of the more recent cases allege, like the American Express lawsuit, that the defendant companies lacked internal controls, failed to account for declining investment valuations, and soft-pedaled the seriousness of the valuation declines through piecemeal write-downs.

Because of these similarities, the failure of the American Express lawsuit to survive a motion to dismiss is potentially significant with respect to the more recent lawsuits. Of course, every lawsuit has its own distinct allegations, and the differences in any given case could well be sufficient to produce a different outcome.

Nevertheless, Judge Pauley’s scienter analysis may be particularly important to many of the subprime and credit crisis-related securities lawsuits, in view of the fact that a very large percentage of the recent cases have been filed in the Southern District of New York, where the American Express case was also pending.

Special thanks to Neil McCarthy of LawyerLinks (here) for providing a copy of the American Express opinion.

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In my preceding post, I wrote about a possible new wave of credit crisis lawsuits, where the defendant companies are not themselves directly affected by credit crisis fallout, but instead suffer from exposure to other companies that have been directly affected. In a litigation example of these circumstances at work, plaintiffs’ lawyers today initiated another securities class action against a company suffering the effects of Lehman Brothers’ collapse.

In a September 22, 2008 press release (here), plaintiffs’ lawyers announced their filing in the Southern District of New York of a securities class action lawsuit against Constellation Energy Group and certain of its directors and officers. A copy of the complaint can be found here.

According to the press release, the complaint alleges that

In July 2008, the Company reported favorable financial results and reaffirmed EPS guidance of 5.75 per share for 2008. In August 2008, analysts questioned Constellation’s accounting and the implications of a credit downgrade. Then, on September 15, 2008, investors and the market became aware of Constellation’s exposure to Lehman Brothers Holdings Inc.’s (“Lehman”) bankruptcy, which affected the Company’s ability to engage in energy-related trades. With this news, Constellation’s shares plunged to $47.99, a 50% drop from the Company’s Class Period high of $97.34 per share.

The complaint specifically alleges that: 

(a) defendants were inflating Constellation’s results through manipulations relating to the characterization of depreciation expense which inflated the Company’s reported cash flows; (b) the Company’s financial results were inflated by overly optimistic assumptions which were reflected in mark-to-market accounting; (c) the Company’s exposure to credit problems of trading partners was much greater than represented – in fact, one of Constellation’s key trading partners, Lehman, was having severe financial problems; and (d) the Company was not on track to report 2008 EPS of $5.25+ per share.

This lawsuit raises a number of different allegations against the defendants, and the allegations relating to Lehman’s collapse are only part of this lawsuit. Nevertheless, this lawsuit demonstrates that the reverberations from the most recent phase of the credit crisis are spreading far beyond the high profile financial services companies whose names have dominated recent headlines. As Constellation’s circumstances show, the financial companies’ turmoil has also affected their “trading partners,” adding to their partners’ difficulties, and, at least in the case of Constellation, leading to litigation.

One of the questions I have long been asking about the subprime and credit crisis litigation wave is whether it will eventually spread beyond the financial sector. There may not yet be quite enough evidence to declare that the wave has done so. But the allegations against Constellation, and the fact that a company like Constellation has been sued, does suggest the way the litigation wave could well spread outside the financial sector, if it eventually does in any numerically significant way.

In my previous post, I described this potential new class of credit crisis litigation as representing the “second derivative” of the credit crisis litigation wave – that is, the companies targeted may not themselves have been directly affected by the credit crisis, but other companies to which they are exposed have been directly affected, as a result of which even the company seemingly remote from the direct credit crisis turbulence winds up experiencing and suffering from its effects.

It remains to be seen whether this new wave of credit crisis litigation becomes widespread. The one thing I know for sure is that the consequences from last week’s event are enormous and are continuing to ripple through the financial markets and the entire economy. Many companies are likely to be affected and some will be sued.

Some readers may recall that Constellation was also in the news last week in connection with the announcement that Constellation is to be acquired by Berkshire Hathaway affiliate company MidAmerican Energy. Indeed, MidAmerican has agreed to buy Constellation in a transaction valued at about $4.7 billion (refer here). Investors’ reaction to this transaction may be assessed from the per share acquisition price of $26.50, which is less than half the company’s market value just a week previously. At latest word (refer here), a competing bidder is weighing an alternative bid despite the fact that Buffett’s company has already injected $1 billion in cash into Constellation.

Ripple in Still Waters: In another illustration of the wide dispersion of the economic consequences from the large financial institutions’ failures, the September 23, 2008 Wall Street Journal reports in an article entitled “Fannie Mae, Freddie Mac Takeovers Cost U.S. Banks Billions” (here), that about a quarter of the nation’s banks lost a combined $10 to $15 billion due to the mortgage giants’ government takeover.

According to the Journal, the American Bankers Association reports that approximately 2300 banks hold Fannie and Freddie preferred shares, which are likely worthless. 85% of the affected institutions are community banks with assets less than $1 billion. The irony is that many of these banks themselves steered clear of subprime lending excesses, and at the same time considered Fannie and Freddie, as the Journal states, “rock solid investments.”

For most of the affected banks, the losses will be small and manageable. Nevertheless, the dispersion of the losses shows how widespread are the effects from recent events. The impact on companies that were not themselves directly involved in subprime lending illustrates the way these consequence are spreading the effects of the credit crisis to the larger economy.

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Since the earliest days of the subprime litigation wave, one of the recurring questions has been whether the wave would spread beyond the financial sector. The question remains, but allegations in a new securities lawsuit suggest that circumstances arising from the subprime crisis are affecting a diverse variety of companies, and by extension the claims asserted against them.

According to their press release (here), on September 16, 2008, plaintiffs’ counsel filed a securities class action lawsuit in the United States District Court for the Southern District of California against NextWave Wireless and certain of its directors and officers. NextWave is a mobile broadband and multimedia technology company that develops, produces and markets mobile multimedia and wireless broadband products. A copy of the complaint can be found here.

According to the press release, the complaint alleges that:

Defendants issued materially false and misleading statements regarding the Company’s business and financial results. As a result of defendants’ false statements, NextWave stock traded at artificially inflated prices during the Class Period, reaching as high as $10.10 per share in June 2007.

On August 7, 2008, after the market closed, Nextwave issued its second quarter 2008 financial results, announcing it only had $71.1 million in cash and similar instruments available as of June 30, 2008 and, unless it raised money, its cash would run out at the beginning of October 2008. As a result, the Company was seeking financing that would give the Company enough money to operate through June 2009. On this news, NextWave’s stock fell $1.90 per share to close at $0.95 per share, a one-day decline of 67%.

According to the complaint, the true facts, which were known by the defendants but concealed from the investing public during the Class Period, were as follows: (a) NextWave did not have adequate sources of liquidity to continue operations as it executed its growth strategy and continued making aggressive worldwide acquisitions; (b) defendants had no reasonable basis to make favorable statements that the Company’s WiMAX semiconductor products would be available for commercial sale in the first half of 2008; (c) NextWave’s growth and acquisition strategy was not financially successful and did not provide the basis for continued growth or financial success because it was straining NextWave’s fragile liquidity position and NextWave did not have the financial resources to continue to operate its world-wide operations through the end of 2008; (d) NextWave failed to timely disclose that it had invested all of its marketable securities in extremely high-risk and illiquid auction rate securities; and (e) NextWave’s ability to continue as a going concern was seriously in question by reason of the facts alleged in subparagraphs (a)-(d) above.

The most interesting part about these allegations to me is the reference to the company’s investment in auction rate securities. The complaint itself further alleges with respect to these "extremely high-risk and illiquid auction rate securities" that NextWave "had misrepresented these investments as marketable securities on its balance sheet included in its financial statements disseminated in its Form 10-K and 10-Q and press release."

There have of course been many prior lawsuits against investment banks and broker-dealers in which it is alleged that the financial institutions misrepresented the risks of auction rate securities. But this new lawsuit against NextWave represents the first instance of which I am aware in which an auction rate investor has been sued for failing to disclose its exposure to auction rate securities investments. Obviously, there are a lot of other allegations in the lawsuit, but the auction rate investments allegations are an important part of the complaint and, if nothing else, are noteworthy.

The allegations about the company’s alleged balance sheet misclassification of its auction rate investments is of particular concern. Many companies (and other entities) hold auction rate securities investments, and all of these entities have been struggling both with valuation issues and with balance sheet classification issues. These classification and disclosure issues affect not just auction rate related investments but subprime and other mortgage-backed investments as well. At least theoretically, plaintiffs’ lawyers could allege similar investment disclosure and asset classification issues in connection with these companies.

Perhaps I am getting ahead of myself, but I also wonder whether similar "failure to disclose investment exposure" allegations might be alleged against companies that will be reporting significant write-downs in their holdings of securities of, for example, Fannie Mae, Freddie Mac, Lehman Brothers, and AIG. Admittedly, this may be a far-fetched possibility at this point. But some companies’ write-downs of their investments in those assets could be material, which in turn could affect the reporting companies’ own stock market valuations. If the impact is significant, angry investors might consider their litigation alternatives.

Another Credit Crisis Lawsuit: There was also a more conventional credit crisis lawsuit filed today. According to the plaintiffs’ counsel’s September 16, 2008 press release (here), plaintiffs have filed a securities class action lawsuit against BankUnited Financial Corp. and certain of its directors and officers. A copy of the complaint can be found here.

According to the press release, the complaint alleges that

Defendants made false and misleading statements about BankUnited. Specifically, defendants misrepresented: (a) the losses the Company was likely to suffer due to BankUnited’s poor underwriting standards, which losses would occur once interest rates reset on the billions of dollars of pay-option arms (adjustable rate mortgages where borrowers had the ability to choose their payment amount during the initial period of the loan); (b) BankUnited’s sketchy appraisal process, which permitted borrowers to obtain mortgages in excess of their ability to pay and in excess of the value of the underlying property; and (c) BankUnited’s policies with regard to "piggy-back" loans, which are essentially second mortgages made at the time a home is purchased to fund a down payment.

The BankUnited lawsuit is the latest to raise allegations involving Option ARM mortgages, which I have discussed in prior posts, most recently here.

Run the Numbers: Many readers know that I have been tracking subprime and credit crisis-related securities lawsuits. My running tally can be accessed here. As time has gone by, definitional issues have become increasingly challenging. The NextWave lawsuit may present the most significant definitional challenge to date, because the auction rate investment allegations arguably are a peripheral part of the complaint.

I could go either way on this one, but after some thought, I have decided to include the NextWave lawsuit in my count, simply due to the fact that the company’s financial problems apparently were due in part to its investments in auction rate securities. Reasonable minds could differ on whether or not to include the lawsuit.

But with the addition of the NextWave and BankUnited lawsuits, the current tally of subprime and credit crisis-related lawsuits now stands at 114, of which 74 have been filed in 2008.

Dear Bob, you might not remember me, but I used to work at AIG: If you have not yet seen it, you must read the September 16, 2008 letter (here) that Maurice "Hank" Greenberg, AIG’s former Chairman and CEO and current Chairman and CEO of C.V. Starr, to now-former AIG Chairman and CEO Robert Willumstad.

I can’t imagine why Greenberg thinks Willumstad might have been concerned that Greenberg would "overshadow" him. Willumstad undoubtedly was reassured that, although Greenberg did feel compelled to note "you and the Board have presided over the virtual destruction of shareholder value built up over 35 years," it was not Greenberg’s "intention to point fingers or be critical."

Hat tip to the Wall Street Journal for the link.

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The current securities litigation wave first arose out of the collapse of the residential real estate subprime mortgage market. As I have previously noted (here), the wave long ago ceased to be just about subprime mortgages, as the litigation as expanded to encompass the fallout from a more general credit crisis. As demonstrated in a recent lawsuit, the wave now includes litigation arising from disruptions in major development construction project financing.

According to their August 20, 2008 press release (here), plaintiffs’ counsel have initiated a purported securities class action in the United States District Court for the District of Massachusetts against Perini Corp. and certain of its directors and officers. A copy of the complaint can be found here.

According to the press release, the complaint alleges that Perini, a company that offers general contracting, construction management and design-build services to private clients and public agencies worldwide, failed to disclose:

(a) that the developer of Perini’s Las Vegas, Nevada projects, including the CityCenter Project, was experiencing financial problems because it failed to secure financing for the entire project and was dependent upon raising the remainder of the financing from the expected sale of residential units. However, the proceeds from the residential unit sales were based on unrealistic and aggressive prices at a time when the condo market in Las Vegas, Nevada was extremely weak; (b) that the Company’s Las Vegas projects were being delayed, and could possibly be halted; (c) that the developer was in risk of defaulting on its construction loan; (d) that the Company’s future revenue and profit was dependent upon the Las Vegas projects since the projects consisted of approximately 20% of its backlog; and (e) as a result of the foregoing, the Company’s ability to maintain its profit margins was in serious doubt.

Then, on January 17, 2008, the Company issued a press release announcing that Deutsche Bank "delivered a notice of loan default to the developer of the Cosmopolitan Resort and Casino project under construction in Las Vegas, Nevada." In response to this announcement, shares of the Company’s common stock fell $10.05 per share, or 27%, to close at $27.65 per share, on heavy trading volume.

The general economic downturn is now affecting a broad variety of companies in diverse industries. As I have previously noted (most recently here), in all likelihood, in the weeks and months ahead, other companies will be finding that transactions entered in more clement circumstances now appear troubled. As more companies stumble on these troubled transactions, further lawsuits undoubtedly will emerge. And as is the case with the Perini lawsuit, most of these lawsuits will have little to do with subprime mortgages directly.

In any event, I have added the Perini lawsuit to my list of subprime and credit crisis-related securities class action lawsuits, which can be accessed here. With the addition of the Perini lawsuit, the current tally of subprime and credit crisis-related securities lawsuits now stands at 108, of which 68 have been filed in 2008.

For those who are curious, information about the CityCenter Las Vegas project can be found here. Background about the Cosmopolitan Resort and Casino can be found here.

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While I have been keeping track of the subprime and credit crisis-related litigation as it has accumulated (refer here), it has been some time since I have undertaken a detailed litigation overview. Fortunately, NERA Economic Consulting, in a July 3, 2008 report entitled “Subprime Securities Litigation: Key Players, Rising Stakes and Emerging Trends” (here), has taken care of it, with an excellent analysis of the subprime litigation to date.

The NERA Report, written by my friend Dr. Faten Sabry and her colleagues Anmol Sinha and Sungi Lee, observes that the growing wave of subprime lawsuits has swept up an increasingly diverse array of plaintiffs and defendants. With respect the defendants, the Report notes that:

Almost every market participant in the securitization process—which transforms illiquid assets such as mortgages, auto loans, and student loans into tradable securities—has been named as a defendant. The list of defendants includes lenders, issuers, underwriters, rating agencies, accounting firms, bond insurers, hedge funds, CDOs, and many more.

The Report also describes the way that the litigation has evolved, noting that:

The majority of the early lawsuits have been against mortgage lenders. As various other market participants reveal the extent of their losses and exposure, they too are being dragged into litigation. The plaintiffs include shareholders, investors, issuers and underwriters of securities, plan participants, and others.

The NERA Report specifically discusses the subprime-related lawsuits that have been filed against lenders, issuers, rating agencies, bond insurers and asset management companies. The Report also observes (as has been noted on this blog, here) that as the litigation has accumulated, it has spread far beyond just subprime-related issues, and has encompassed parties and circumstances “in the context of the trouble in the broader markets.”

The Report notes that as the subprime litigation has evolved, the broader “credit crunch” litigation has encompassed a wider variety of lawsuits and litigants, including lawsuits involving asset-backed commercial paper, lawsuits related to failed deals, lawsuits related to corporate debt losses, and lawsuit related to asset-backed securities.

The NERA Report was clearly intended to be descriptive and not exhaustive, so it is no criticism of the report  for me to add some additional observations. There are, in fact, a few notes I would add to the report’s overview.

In addition to the categories of litigants the NERA Report discusses, there are some additional categories I think merit attention. The first relates to hedge funds. While the NERA Report does reference hedge funds, I think the involvement of hedge funds is worth of separate comment. Hedge funds have become involved both as plaintiffs (refer here) and as defendants (refer here and here). The likelihood of additional litigation involving hedge funds seems strong.

One group not specifically mentioned in the NERA report is the mutual fund industry. By my count, there have been at least five subprime securities lawsuits against mutual funds and mutual fund families. (Refer for example here and here.) These lawsuits are brought by investors claiming that the mutual funds misrepresented the relative stability of their investment strategy and assets.

The NERA report does specifically discuss the litigation against the credit rating agencies. The only thing I would add is that the credit rating agency litigation falls into two categories. The first involves lawsuits brought by the credit rating agencies’ own shareholders, for allegedly inadequate disclosures (refer, for example, here). The second involves investor lawsuits brought against the rating agencies for the rating company’s actual rating activities (about which refer here).

Yet another industry group that has been hit with subprime lawsuits is the mortgage insurance industry, in which all of the leading participants – including MGIC (refer here), The PMI Group (refer here), and Radian (refer here) – have all been hit with securities lawsuits. Indeed, the Blackstone Group was also hit with a securities lawsuit (refer here) for alleged disclosure issues relating to its investment in mortgage insurer FGIC. As discussed in a July 11, 2008 Wall Street Journal article (here), the mortgage insurers’ woes are one of the litany of problems besetting Fannie Mae and Freddie Mac. Freddie Mac has also itself been the target of a subprime-related securities class action, as noted here.

The NERA Report specifically acknowledges the fact that the litigation wave has long since moved past subprime lending alone. For example, the NERA report specifically mentions lawsuits involving corporate debt (as I also noted, here). An important corollary of this observation is that even with respect to residential real estate lending, the litigation wave has swept far beyond subprime lending alone; for example, it has also encompassed Option ARM loans, as I discussed here. IndyMac, the lending institution whose dramatic collapse over the weekend may potentially signal a dark new inflection point in the evolving credit crisis, was focused on so-called Alt-A loans.

In addition, other kinds of debt have also been the source of credit crunch litigation. For example, in addition to corporate debt, problems arising from student loans have also been the source of litigation, as discussed here and here.

Finally, I do think it is noteworthy that at least one credit crisis lawsuit, involving MoneyGram International (refer here), relates to the company’s disclosures about its investments in subprime-related assets. Many companies, including many companies outside the financial sector, have balance sheet exposure to subprime assets, and therefore there is the potential at least for this kind of litigation to spread far beyond the financial sector. I have discussed this issue at length in prior posts (most recently here), but I recognize at this point that it remains to be seen whether or not there will be substantial credit crisis-related litigation outside the financial sector. As I recently noted in my mid-year review of securities litigation (refer here), the vast bulk of credit crisis-related litigation has been in the financial sector.

The NERA report concludes with the observation that “most of the lawsuits are still in their initial stages and it is too early to predict the outcomes,” but that “given the continuing turmoil in the financial markets, the mounting losses, and the growing list of lawsuits, this story is far from over.” I couldn’t agree more, and as the story continues to evolve, I will continue to track the lawsuits – the securities and ERISA lawsuits here, and the derivative lawsuits here. I will also continue to track subprime and credit crisis-related lawsuit case dispositions, here.

Rubble Without a "Cause"?: I was struck by the reports in the press coverage surrounding the regulatory seizure of IndyMac Bank, for example in the July 12, 2008 Wall Street Journal (here), that Office of Thrift Supervision director John Reich blamed the bank’s failure on “comments made in late June by Senator Charles Schumer, who sent a letter to the regulator raising concerns about the bank’s solvency.” Spooked depositors reportedly withdrew $1.3 billion in 11 days. The Journal reports that “Mr. Reich said Sen. Schumer gave the bank a ‘heart attack.’”  A July 14, 2008 Wall Street Journal article (here) also quotes Reich as saying that "Schumer sparked a deposit run that 'pushed IndyMac over the edge.' "

Schumer is reported to have responded that if the regulator had done its job and prevented the bank’s “poor and loose lending practices,” we “wouldn’t be where we are today.”  (This is of course the same Senator Schumer who barely a year ago urged that regulatory standards should be loosened in order for America’s financial markets to be more competitive globally.)

The sharp exchange between Reich and Schumer dramatically highlights the fundamental question of causation that surrounds so many problems arising from the entire subprime meltdown. While Senator Schumer’s letter may well have undermined IndyMac depositor confidence, it was also merely one link in a chain of events leading up to the bank’s failure. The bank’s very business model, built around so-called Alt-A loans, in which borrowers are not required to fully document income or assets, arguably could be a more fundamental cause. Or if plaintiffs’ allegations are to be believed, the bank’s failure to follow its own underwriting standards also could have led to the bank’s failure.

Indeed, it is arguably possible to take the causal chain even further back. Here, I have in mind several driving trips I made during 2005 and 2006 on the I-10 corridor between LA and Palm Springs. It seemed as if on each trip, yet another roadside hilltop even further east than the last had been scraped bare and festooned with hundreds of cookie-cutter monstrosities “attractively priced in the low 500,000s."

The continuing emergence of these self-described “lifestyle” communities depended in the end on ever-rising house prices, record low interest rates, and two dollar a gallon gas. When all of these circumstances changed, the construct collapsed. (A more technical summary of this analysis can be found in a July 14, 2008 Wall Street Journal article, here, entitled "Continuing Vicious Cycle of Pain in Housing and Finance Ensnares Market.")

The ensuing defaults may or may not have been inevitable but they surely were a latent possibility built into lending arrangements borrowers had to stretch to afford. Every participant in the process contributed and accepted some part of this risk. In other words. it could plausibly be argued that the ultimate cause of the subprime meltdown (even if not the collapse of IndyMac) was cultural, or perhaps social. Call it cultural complicity.

Theorists would contend that the cultural context was merely a causally relevant condition but not the proximate cause either of the subprime meltdown or of IndyMac’s collapse, and perhaps they would be correct. Indeed, in a society that insists on assigning legal blame, proximate causation may be the only relevant inquiry.

But on that score, it may be worth noting that Reich, the OTS official, is reported to have asked rhetorically, “Would the institution have failed without the deposit run? We’ll never know the answer to that question”

Reich’s rhetorical inquiry, technically a “counterfactual,” poses a causal inquiry based on possible consequences from alternative facts. An interesting recent discussion of counterfactuals in the securities litigation context appears in yet another recent NERA Economic Consulting paper, entitled “Shareholder Class Actions and the Counterfactual” (here). This interesting June 24. 2008 paper poses questions that may prove particularly provocative in the context of the subprime meltdown.

The courts will eventually assign blame for IndyMac’s collapse. (Somehow, I doubt the blame will ultimately be placed on Senator Schumer.) But, the legal inquiry aside, it is possible that the final answer to the question of ultimate causation may be found only at the bottom of a bottomless well.

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The subprime and credit crisis-related litigation wave has come a long way since the first of the subprime lawsuits was filed in February 2007. Now that the litigation phenomenon is now nearly a year and a half old, the rulings on the motions to dismiss are finally starting to accumulate. It appears to be time for The D&O Diary to initiate the latest in its ongoing and ever-popular series of lists, this most recently created one to track the accumulated subprime and credit-crisis related lawsuit dismissals and dismissal motion denials.

The D&O Diary’s newly created list of subprime and credit crisis-related dismissals and motion denials can be found here. PLEASE NOTE that this document also lists all settlements of subprime and credit crisis related lawsuits as well

As befits the relatively early stages of most of this litigation, the list of case dispositions is, as of the time of the list’s initial creation, pretty sparse. I will endeavor to update the list as new dismissal motion rulings emerge, and wherever possible I will provide a link to the actual ruling. As I update the list, I will indicate at the top of the list the date of the list’s most recent revision.

The more complete the list is, the more useful it will be for everyone, so all readers are strongly invited and encouraged to let me know about any subprime and credit crisis related lawsuit dismissal motion rulings that are not already on the list.

As of the date of the creation of this post, I am not aware of any subprime or credit-crisis related lawsuit settlements. The settlements will emerge sooner or later, and when the do, I will created a supplemental document tracking the settlements.

Readers who may be unaware of the other lists that I am maintaining may be interested to know about the following lists:

1. The List of Subprime and Credit Crisis-Related Securities Class Action Lawsuit Filings (which may be accessed here).
2. The List of Subprime and Credit Crisis-Related Derivative Lawsuits (here).
3. The List of Options Backdating-Related Lawsuit Filings (here)
4. The List of Options Backdating-Related Dismissals, Denials and Settlements (here).
5. The List of Securities Class Action Opt-Out Settlements (here).

I am always interested in any additional information or correcting information that is required to make these lists more accurate or complete. I am also always interested in readers’ thoughts and comments, about these lists or anything else.

Welcome Back: Serial blogger Bruce Carton is back at it again, with his new blog, Unusual Activity, which can be found here. The blog describes itself as "The Securities Litigation and Enforcement Reporter."  Many readers will recall that Bruce is the founder and long-time author of the Securities Litigation Watch blog. Bruce more recently wrote the Best in Class blog. Everyone here welcomes Bruce back to the blogging circuit, and we look forward to reading his new blog.

Speakers's Corner: On June 19 and 20, 2008, I will be co-Chairing the Mealey's Subprime Mortgage & Insurance Coverage Litigation Conference at the Ritz-Carlton in Pentagon CIty, Virginia, with my good friend, Matt Jacobs, of Jenner & Block.

The agenda (which can be found here), includes many distinguished speakers and panelists, such as Andrew Carron of NERA Economic Consulting, Adel Turki of Cornerstone Research, Robert Rothman of the Lerach Coughlin firm, Dan Bailey of Bailey & Cavalieri, John McCarrick of Edwards Angell Palmer & Dodge, David Hensler of Hogan & Hartson, and Mitchell Dolin of Covington & Burling.

Registration instructions and other intormation about the conference can be found here.

And Finally: If you have never heard of the Social Science Research Network (SSRN), then you will want to review the article yesterday's New York TImes (here) discussing the latest in academic anxieties. It used to be all publish or perish, but it is now all about the downloads and links. And you thought your job was competitive.

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 As I have previously observed, the current credit crisis is about more than subprime loans. Among the other kinds of credit are so-called Option ARMs, which frequently involve prime borrowers. These loans are adjustable rate mortgages where the borrower has the option of paying less than the full amount of interest due, with the unpaid balance added to the principle (that is, the loan can negatively amortize). My prior post describing and discussing the nature of Option ARM loans can be found here.

This negative amortization payment feature of Option ARMs only makes sense (if at all) at a time of rising home prices. At a time of declining home values, it can quickly put the borrower in a position where they owe more than the value of their home. As unattractive as this position is, it can get worse when the interest rate adjusts upwards, leaving the borrower in a position of paying even more to stay in a home that is worth less than the mortgage debt.

Unsurprisingly, borrowers are having difficulties with Option ARM loans, which in turn is leading to problems for lenders with Option ARM portfolios. These problems in turn are leading to litigation.

The latest company to be sued in a securities class action lawsuit arising out of problems with Option ARM loans is Wachovia Corporation, which was sued, together with certain of its directors and officers, on June 6, 2008 in the United States District Court for the Central District of California. The plaintiffs’ lawyers’ June 9, 2008 press release about the lawsuit can be found here. The complaint can be found here. UPDATE: As correctly noted in the reader comment, this case is actually pending in the Northern District of California, rather than the Central District as original text incorrectly stated.

According to the press release, the complaint alleges that:

Defendants misled investors by falsely representing that Wachovia had strict and selective underwriting and loan origination practices and a conservative lending approach that set it apart from other lenders. Such reassurances were repeated by defendants throughout the Class Period in order to artificially support Wachovia's stock price in the midst of a weakening mortgage market. In response to increased market concern with the mortgage lending industry, and Wachovia's option ARMs in particular, Wachovia falsely represented that its loan underwriting practices were much better than at other banks and that this would allow it to prosper while lenders with less exacting standards and procedures would fare much worse. In reality, Wachovia's actual lending practices differed materially from the description of those practices in statements made to investors. The Company's ability to weather the deterioration in the real estate and credit markets was grossly exaggerated by Defendants, at precisely the worst time, when analysts began to ask tough questions. The Company, moreover, had inadequate loan loss reserves and falsely represented that its capital position was sufficient to fund its dividend.

Shortly after last assuring the market of its liquidity, the strength of its underwriting practices, and the adequacy of its reserves, Wachovia reported a surprise quarterly loss, undertook emergency measures to increase capital, and cut its dividend. On April 14, 2008, before the open of ordinary trading, Wachovia reported a loss of $350 million, or $0.20 per share, for the first quarter of 2008. The Company attributed the results to: (1) a $2.8 billion increase credit loss reserves, including $1.1 billion specifically for ``Pick-A-Pay'' reserve build, the lending program highly touted by the Company during the Class Period. The need to increase Pick-A-Pay reserves was attributed to Wachovia's adoption of a ``refined reserve modeling'' that resulted in ``higher than expected loss factors on Pick-a-Pay''; and (2) $2 billion in mark-to-market losses for mortgage backed securities, including a ``$729 million loss on unfunded leveraged finance commitments.'' In order to shore-up its capital, Wachovia announced the following steps: (1) reduce the dividend 41% to $0.375; and (2) plan to raise capital by $7-8 billion through public offerings.

Wachovia is only the latest company to become embroiled in securities litigation arising out of Option ARM problems. Companies previously sued in securities lawsuits involving Option ARM allegations include Washington Mutual (about which refer here) and Downey Financial (refer here). It seems highly unlikely that these companies will be the only ones to become involved in lawsuits involving these concerns.

Indeed, as bad as the situation involving Options ARMs may now appear, circumstances are likely to deteriorate in the months ahead. As discussed in the June 5, 2008 Business Week article entitled “The Next Real Estate Crisis” (here), foreclosures on Options ARMs have already tripled in the last year, but could further hasten as “monthly options recasts are expected to accelerate starting in April 2009, from $5 billion to a peak of about $10 billion in January 2010.” The Option ARM loan defaults “could accelerate next year even if subprime defaults subside.”

The possibility of further Option ARM related securities litigation seems likely.

In any event, I have added the new Wachovia case to my running tally of subprime and credit-crisis related securities class action lawsuits, which can be accessed here. The current tally now stands at 89, of which 49 have been filed in 2008.

It is probably worth noting that this new case is the third in which Wachovia has become involved as part of the current credit-crisis related litigation wave. In addition to the new lawsuit, Wachovia was previously sued in an auction rate securities lawsuit (refer here), and in a Prospectus Liability case arising out of the company’s offering of certain Trust Preferred Securities (about which refer here).

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In my preceding post, I quoted recent reassuring words from Treasury Secretary Henry Paulson about the current credit crunch. Billionaires Warren Buffett and George Soros apparently have a less sanguine view, and there is in any event substantial recent evidence to support the view that, whether or not the worst is over, the effects will be felt for some time to come.

According to news reports (here), Warren Buffett told reporters in Europe yesterday that “I don’t necessarily think we’re halfway through or necessarily a quarter of the way through the effects throughout the general economy. The initial effects are felt by people who really did the silliest things, but you can have a whole bunch of domino-type effects that eventually can get to people who are doing fairly sound things.” Buffett added that “I think there will be rippling secondary, tertiary effects.”

Soros, while willing to concede (here) that the “acute phase” of the crisis may have passed, also said that “now we have to feel the effects,” which he said might “almost inevitably” include recessions in the U.S. and U.K.

An even more pessimistic voice is that of Meredith Whitney, the analyst for Oppenheimer who correctly predicted disaster for Citigroup and others last fall. She recently said (here) that "the credit crisis is far from over" and "what lies ahead will be worse that what is behind us." Dang.

There are already a wide variety of effects that are rippling through the economy and affecting a diverse array of companies, even outside the financial sector. For example, on May 19, 2008 Bloomberg reported (here) that “more than 300 companies are struggling to value auction rate bonds” that they are carrying on their balance sheets. These companies’ auction rate securities investments were valued at $98 billion as recently as January 1, 2008.

“About half” of these companies have “reported losses totaling $1.8 billion as the markets for securities, sold as higher-yielding alternatives to money markets, seized up.” Among the companies the Bloomberg article names as having taken auction-rate securities-related write-downs are UPS, Google, HCA and Teva Pharmaceuticals. But while half of the companies holding these assets may have recognized the valuations issues, the other half have not, and even the companies that have taken some recognition have the issue of whether or not they got it right.

The wide dispersion of these and other credit crunch-related exposures throughout the economy puts pressure on many companies to recognize the risk; companies that delay or avoid recognition may be laying in problems down the road. As one commentator said in another Bloomberg article (here), “the smart people are the ones who’ve identified the problems, put them out there in full transparency, and addressed them by raising more capital. There is still billions of dollars of crap out there that hasn’t worked its way through the system.”

The May 19, 2008 Bloomberg article in which this latter statement appeared is entitled “Banks Keep $35 billion Markdowns Off Income Statements” (here). The article describes multiple financial institutions that are “failing to acknowledge their in their income statements at least $35 billion of additional write-downs included in their balance sheets.” A commentator in the article notes that “keeping the markdowns off income statements just delays the realization of losses.” Indeed, the article suggests that ignored bad debt and postponing the inevitable losses is one of the reasons behind Japan’s decades long economic slump.

Behind every postponed day of reckoning is an optimistic hope that the reckoning might not just be delayed but perhaps avoided altogether. And perhaps things will come right. But the kinetic potential for the kinds of secondary and tertiary ripple effects Buffett projected inheres within every one of these postponements, laying the potential for further disruption when the day of reckoning arrives.

The consequences of these secondary and tertiary effects inevitably will include litigation, as is perhaps illustrated by the lawsuit, described in today’s Wall Street Journal (here), in which Fifth Third Bank has sued an insurer and a brokerage firm that arranged an investment for the bank in the Citigroup Falcon Strategies hedge fund. (A copy of the complaint can be found here.)

Fifth Third’s investment involved a complex life insurance investment, in which the aggregate premiums were invested in a diversity of assets. The complaint alleges that the defendants failed to monitor and manage Fifth Third’s $612 million investment, particularly when changing conditions (triggered by the credit crunch) should have triggered a reallocation of assets. This lawsuit demonstrates the range of potential litigation issues and the breadth of potential litigation targets that may become involved in future litigation. 

In a post on this blog last December (here), I discussed “the truth telling yet to come” in connection with the subprime meltdown. In many ways, the phrase is even more apt now. The dynamic possibilities of the truth telling yet to come include the litigation yet to come, as well. And as Buffett said, we are not necessarily even a quarter of the way through this yet.

A June 1, 2008 article in Corporate Counsel entitled “Wipeout!” (here) describes the credit crisis-related litigation to date and the litigation yet to come. Among other things, the article quotes one commentator as saying that “we haven’t seen most of the litigation yet.”

Top Ten Securities and Corporate Law Review Articles: The Securities Litigation Watch blog (here) has reproduced (with hyperlinks) the list of the Top Ten Corporate and Securities Law Review articles of the year. I was very pleased to see that my good friends Tom Baker and Sean Griffith's article "The Missing Monitor in Corporate Governance: The Directors' & Officers' Liabiltiy Insurer" (here) made the list. I discussed Professor Baker and Griffith's article at length in an earlier post, here.

A Big Fee Anwhere (But Especially in Tajikistan): A May 20, 2008 Financial Times article about lawyers’ fees entitled “Time to Stop the Lawyers’ Clock from Ticking” (here), noted that observers had

expressed concern about the £50m in fees that Herbert Smith, another top firm, expects to bill on behalf of Tajikistan in a dispute over alleged corruption at a state-owned aluminum smelter.

The projected costs, revealed at a High Court hearing in April, would represent 2.7 per cent of the central Asian nation’s gross domestic product, where the average monthly wage stands at a paltry $63.

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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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