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

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.

• Email This
• Print
• Comments
• Trackbacks

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.

• Email This
• Print
• Comments
• Trackbacks

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.

• Email This
• Print
• Comments
• Trackbacks

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.

• Email This
• Print
• Comments
• Trackbacks (1)

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.

• Email This
• Print
• Comments (1)
• Trackbacks

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.

• Email This
• Print
• Comments
• Trackbacks (1)

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.

• Email This
• Print
• Comments
• Trackbacks

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.

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.

• Email This
• Print
• Comments
• Trackbacks

 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).

• Email This
• Print
• Comments (2)
• Trackbacks

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.

• Email This
• Print
• Comments
• Trackbacks

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.

• Email This
• Print
• Comments
• Trackbacks