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

IndyMac CEO Michael Perry has reached an agreement with the FDIC to settle the lawsuit the agency filed against him in the Central District of California in July 2011 in its capacity as receiver of the failed bank. In the settlement agreement, filed with the court on December 14, 2012,  Perry agreed to pay $1 million out of his own assets plus an additional $11 million in insurance funds. However, the insurers are not parties to the agreement; rather, the FDIC has accepted Perry’s assignment of his rights under the insurance policies, which the FDIC apparently will now seek to assert against the insurers. The parties’ stipulation of dismissal, to which their settlement agreement is attached, can be found here.

Perry’s settlement comes just a week after a jury entered a $168.8 million verdict in the separate case the FDIC filed against three other IndyMac officers. The agency filed the two lawsuits separately as part of an apparent strategy in the separate case against the three officers to recover under a second $80 million tower of D&O insurance. As noted here, in July 2012, Judge Gary Klausner held in a related insurance coverage action that all of the various IndyMac lawsuits relate back to the first lawsuit to be filed, and therefore only trigger a single tower of insurance. Klausner’s ruling is on appeal.

Just as the FDIC’s separate lawsuit against the three officers appears to be a part of an insurance-oriented strategy, the FDIC’s settlement with Perry also appears in large measure to be about the D&O insurance. (To be sure, Perry will also be paying $1 million out of his own pocket, but the remainder of the agreement pertains to the insurance issues.)

The settlement agreement specifies that the Insurers shall pay the $11 million insurance portion of the settlement within 30 days. However, the insurers are not parties to the agreement, and the agreement appears to fully anticipate that the insurers will not in fact fund the $11 million insurance portion. The settlement agreement includes detailed provisions for the assignment of Perry’s rights against the insurers, including his rights for alleged “breach of the covenant of good faith and fair dealing.” (Perry expressly reserves his rights to try to recover from the insurers his past and future attorneys’ fees.) The agreement specifies that Perry is not personally liable of the $11 million insurance portion of the settlement.

The settlement agreement recites that on July 20, 2012, certain of IndyMac’s D&O insurers (that is, insurers in the so-called first tower of insurance) filed an interpleader action in the Central District of California. As I previously noted on this blog in connection with the insurance issues in this case, IndyMac’s collapse has led to multiple lawsuits involving multiple parties, creating competition among the various claimants for the dwindling amounts of insurance available as accumulating defense expenses erode the available limits. Brian Zabcik’s December 14, 2012 Am Law Litigation Daily article about Perry’s settlement with the FDIC  (here) quotes Perry’s counsel as saying that “Perry decided to settle the FDIC’s lawsuit in large part because the insurance funds available to fund his defense had been exhausted by all the various lawsuits brought against former IndyMac officers and directors,"

Perry’s settlement agreement with the FDIC specifies that the FDIC “agrees that, in its capacity as Mr. Perry’s assignee, it shall take no position in the Interpleader Action inconsistent with Mr. Perry’s position that the Insurers are obligated to fund other settlements to which Mr. Perry is a party.” (Among the other settlements identified in Perry’s settlement agreement with the FDIC is the $5.5 million settlement in IndyMac securities class action lawsuit known as the Tripp litigation, about which refer here.)

In other words, it appears that the $11 million insurance portion of Perry’s settlement with the FDIC basically represents a claim check for the agency to try to redeem in the interpleader action. Because there are numerous other claimants each attempting to assert their own claims to the insurance proceeds, it will remain to be seen how much of the $11 million insurance portion of its settlement with Perry the FDIC will ultimately collect.

As discussed here, the FDIC filed its lawsuit against Perry, in its capacity as receiver for Indy Mac bank, in July 2011. The FDIC’s complaint against Perry alleged that he caused over $600 million in losses by having the bank purchase mortgage loans in 2007, just as the mortgage marketplace was destabilizing. The complaint alleges that Perry acted negligently when he allowed IndyMac to generate and purchase $10 billion in loans when the secondary mortgage market was becoming illiquid. When IndyMac was later unable to sell the loans, the bank transferred them to its own investment portfolio, which then caused over $600 million in losses.

Interestingly, in its settlement stipulation with Perry, the FDIC expressly acknowledges that the FDIC’s complaint “does not allege that Mr. Perry caused the Bank to fail or that he caused a loss to the FDIC insurance fund.” Nevertheless, on December 14, 2012, the FDIC entered – apparently with Perry’s consent – an Order of Prohibition from Further Participation (here) reciting that Perry “engaged or participated in unsafe or unsound banking practices” at IndyMac; that these practices "demonstrate [his] unfitness" to serve as a director or officer at any FDIC-insured institution; and prohibiting him from involvement in any financial institution. The Am Law Litigation Daily article quotes Perry’s counsel as saying with respect to this order, to which Perry consented, that “the FDIC extracted this condition at the eleventh hour because they could,” and that “the FDIC knew Perry was out of insurance funds, and they took advantage of the situation."

Yet Another FDIC Lawsuit Involving a Failed Georgia Bank: For whatever reason, the FDIC’s lawsuits against former directors and officers of failed banks have been disproportionately concentrated in Georgia. On December 13, 2012, the FDIC filed yet another failed lawsuit in connection with a failed Georgia bank. A copy of the FDIC’s complaint, filed in the Northern District of Georgia against three former officers and four former directors of the failed RockBridge Commercial Bank of Sandy Spring, Georgia, can be found here.

RockBridge was closed by regulators on December 18, 2009. The complaint asserts claims against the seven individual defendants for negligence, gross negligence, and breach of fiduciary duty. In connection with the defendants alleged “numerous, repeated and obvious breaches and violations of the Bank’s Loan Policy and procedures, underwriting requirements, banking regulations, and prudent and sound banking practices,” as “exemplified” by 16 loans made between February 14, 2007 and November 12, 2008, which allegedly caused the bank losses of in excess of $27 million.

Interestingly, one of the defendants, Arnold Tillman, who has filed for Chapter 7 bankruptcy, was sued with leave of the bankruptcy court and “nominally to the extent of insurance coverage only.” (The FDIC proceeded in the same fashion against several individual defendants in the lawsuit it filed in November 2012 in its capacity as receiver of the failed Community Bank of West Georgia, of Villa Rica, Georgia, as I discussed in a prior post, here – second item in the blog post.)

The FDIC’s assertion of claims for ordinary negligence against the former directors and officers of RockBridge is interesting in light of the now several district court decisions holding that under Georgia law officers cannot be held liable for claims of ordinary negligence, as was discussed in a recent guest blog post on this site (This issue is now on an interlocutory appeal to the 11^th Circuit in the Integrity Bank case.) The FDIC anticipated this argument, and specifically alleges in paragraph 58 of the complaint that the defendants are not entitled to rely on the business judgment rule and therefore liable for ordinary negligence.

The FDIC’s complaint against the former Rockbridge directors and officers is the 14^th that the agency has filed in connection with a failed Georgia bank and the 42^nd that the agency had filed overall, meaning that the FDIC’s D&O lawsuits involving failed Georgia banks represent one-third of all of the D&O lawsuits the agency has filed. The FDIC’s lawsuits against the failed Georgia banks represents a disproportionately high percentage of D&O suits; even though Georgia has had more bank failures than any other state, closed bank in Georgia still represent only about 18% of all bank failures. For whatever reason, the FDIC seems to be concentrating its litigation activity in Georgia. Indeed, the last four suits the agency has filed have involved failed Georgia banks.

Readers that follow the failed bank litigation closely will be interested to note that on December 11, 2012, the FDIC updated the page on its website that reports statistics and information on the agency’s failed bank litigation. In the latest update, the agency reports that it has authorized suits in connection with 89 failed institutions against 742 individuals for D&O liability. This includes 42 filed D&O lawsuits involving 41 institutions and naming 331 former directors and officers, inclusive of the latest suit against the former RockBridge directors and officers. The agency clearly will be filing many more lawsuits in the weeks and months ahead.

Special thanks to a loyal reader for providing a copy of the RockBridge complaint. Scott Trubey’s December 14, 2012 Atlanta Journal Constitution article about the FDIC’s latest lawsuit can be found here.

More About Securities Class Action Opt-Outs: In a recent post, I noted that the incidence of securities class action opt-outs seemed to be on the increase. In the prior post, I referred specifically to the high profile institutional investors that had chosen to opt out of the Pfizer securities litigation. Now it appears that there have been significant opt outs from the Citigroup subprime-related securities class action lawsuit settlement, as well.

As discussed here, in late August 2012, the parties to the high-profile Citigroup subprime-related securities class action lawsuit agreed to settle the case for $590 million, subject to court approval. However, as discussed in Nate Raymond’s December 13, 2012 On the Case blog post (here), several significant institutional investors have elected to opt out of the more than half a billion dollar settlement and are pursuing their own separate actions. The article, which notes that “opt-outs have become a regular feature fixture in any big securities class action,” reports that a total of 134 investors have chosen to opt out of the Citigroup settlement, including some institutional investors that had filed separate individual actions as long as two years ago.

The article notes that institutional investors choose to opt out where they think they can improve their recoveries by proceeding separately from the class. The article notes that this approach is “not without its risks,” including the exposure of the opting-out party to full discovery, depositions and document discovery.” Given these concerns, the allure for institutional investors in opting out will only be there, according to one commentator quoted in the article, if “the losses are substantial enough to grab the defendants’ attention.” The rise in class action opt-outs carries risks for defendants as well, as they are unable to ensure “global peace” through the class settlement, and even run the risk of the opt-outs triggering the “blow up” provision in the class settlement agreement.

As I noted in my recent post about opt-outs, class action lawsuits have for many years been a favored whipping boy for conservative commentators. But for all of the ills that the class action process can sometimes involve, the prospect of a litigation process in which mass group claims are fragmented and can only be resolved in a piecemeal fashion is no improvement. Given the apparently increasing institutional investor interest in pursuing claims separate from the larger investor class, we could very quickly be getting to the point where resolution of class litigation is only one part of a multistep process, at least in the class action lawsuits where larger losses are at issue.

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On December 7, 2012, in a comprehensive victory for the FDIC in its capacity as receiver of the failed IndyMac bank, a jury in the Central District of California entered a verdict of $168.8 million in the FDIC’s lawsuit against three former officers of the bank. As reflected in the verdict form (a copy of which can be found here), the jury found that the defendants had been negligent and had breached their fiduciary duties with respect to each of the 23 loans at issue in this phase of the FDIC’s case against the three individuals

At the time its July 11, 2008 closure, IndyMac had assets of about $32 billion, making its failure the fifth largest bank failure in U.S. history. But though there have been a few larger bank failures, none have been costlier to the FDIC’s deposit fund. IndyMac’s collapse has cost the fund nearly $13 billion.

In June 2010, the FDIC filed against a lawsuit several former officers of the bank’s homebuilder division, in what was the first D&O lawsuit the agency filed during the current bank failure wave, as discussed here. The FDIC’s lawsuit sought to recover damages from the individual defendants for “negligence and breach of fiduciary duties” and alleged “significant departures from safe and sound banking practices.” As discussed here, in July 2011, the FDIC filed a separate lawsuit against IndyMac’s former CEO, Michael Perry.

As discussed here, trial in the FDIC’s case against the former homebuilder division officers began on November 6, 2012. The three individual defendants in the case that went to trial are: Scott Van Dellen, the former President and CEO of IndyMac’s Homebuilders Division (HBD), who was alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who was alleged to have approved a number of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is also alleged to have approved many of the loans. (The FDIC’s original complaint had named a fourth individual, William Rothman, as a defendant as well. According to pleadings filed in the case, Rothman settled with the FDIC in exchange for Rothman’s assignment to the FDIC of Rothman’s rights against IndyMac’s D&O insurers.)

According to news reports, the jury reached its verdict after 16 days of trial. During the trial, the defendants attempted to argue that they and the bank were victims of an unanticipated downturn in the housing market. The FDIC in turn argued that the bank officials disregarded danger signals about the housing market and continued to approve loans in order to meet production goals and obtain bonus compensation.

The jury verdict form reflects separate verdicts as to each of the 23 loans that were at issue in this phase of the trial of the case. With respect to each of the loans, the jury separately found that the specific defendants who were named as to each of the loans had been negligent and had breached their fiduciary duties. The jury assigned separate damages as to each of the loans as well. The separate damage awards total $168.8 million. However, each of the three defendants was held liable for differing amounts. All three of the defendants were named only with respect to 14 of the 23 loans. With respect to five of the 23 loans, only Van Dellen and Shellem were named, and as to four of the loans, Van Dellen alone was named. Thus the jury found Van Dellen liable as to all 23 of the loans, but found Shellem liable only as to 18 of the loams and found Koon liable only as to 14 of the loans.

The just completed trial apparently represents only the first trial phase of this matter. There apparently will be a separate trial phase that will address the FDIC’s allegations as to scores of other loans as well as allegations with respect to the bank’s loan portfolio as a whole. The FDIC apparently is seeking total damages of more than $350 million. In addition, the FDIC’s separate case against Perry, the bank’s former CEO, will continue to go forward as well.

Given the magnitude of the jury’s verdict, there undoubtedly will be post-trial motions and, after the conclusion of all remaining trial phases, appeals as well. One issue that likely will be subject of an appeal will be Central District of California Judge Dale Fischer’s October 2012 determination under California law that the three defendants, as former officers (but not former directors), could not rely on the business judgment rule and therefore could be held liable for mere negligence. (The potential appeal value of this issue for the defendants may be diminished somewhat due to the fact that the jury specifically found that the defendants had not only been negligent, but had also violated their fiduciary duty, suggesting that the defendants would still have been found liable even if they couldn’t be held liable for negligence).

While the jury verdict unquestionably represents a victory for the FDIC, the FDIC may face considerable challenges attempting to collect on the verdict. There may be little or no remaining D&O insurance out of which the FDIC might try to recover. As discussed at length here, in July 2012, Central District of California Judge Gary Klausner held in a related D&O insurance coverage case that all of the various lawsuits related to Indy Mac’s collapse (including the case that in which the jury verdict was just entered) were interrelated to the first-filed lawsuit, and thus triggered only the D&O insurance that was in force when the first suit was filed. Because all of the later-filed lawsuits related back to the first lawsuit, the later lawsuits – including the lawsuit in which the jury verdict was entered -- did not trigger a second $80 million insurance program that was in force when the later suits were filed. (The FDIC has filed an appeal of Judge Klausner’s ruling.)

In other words, unless Judge Klausner’s insurance coverage ruling is reversed on appeal, the only insurance available out of which the FDIC might be able to try to realize the amount of the jury verdict is whatever is left under the first tower of insurance. However, as I noted in a prior post, in pleadings that they filed in July 2012, the defendants represented to the court that defense fees incurred in all of the various IndyMac-related lawsuits, as well as settlements that had been reached in some of the suits, had exhausted or would soon exhaust the first tower of insurance.

Pleadings that the three individuals filed in the case state that “the FDIC specifically structured this lawsuit in order to reach the Tower 2 Policy.” Judge Klausner’s ruling in the insurance coverage case obviously upset the FDIC’s strategy in this case. The outcome of the appeal in the insurance coverage case may well determine whether or not the massive verdict the FDIC just won results in any significant monetary benefits for the agency.

This case was not only the first case the FDIC filed against the former directors and officers of a failed bank as part of the current bank failure wave, but it is also the first case to go to trial. Since the FDIC filed this suit back in July 2010, the agency has filed forty more cases against the directors and officers of failed banks. There undoubtedly will be more lawsuits yet to come. Many of the individual defendants named in these cases vigorously dispute the FDIC’s allegations. However, the jury verdict in the IndyMac case may communicate a sobering message about what it might mean to force a case all the way to trial. Given this verdict, it may now be even more unlikely that one of these cases would go to trial.

Scott Recard’s December 8, 2012 Los Angeles Times article about the jury verdict can be found here.

Special thanks to Thomas Long of the Nossaman law firm for sending me the jury verdict form. The Nossaman firm represented the FDIC at the IndyMac trial.

D&O Insurer, FDIC Settle Claims Against Former BankUnited Officials: The FDIC’s efforts to try to recover under failed banks’ D&O insurance do not always involve a lawsuit. Sometimes the FDIC asserts its claims in a demand letter that it presents to the former directors and officers of a failed bank, with a copy of the letter also send to the failed bank’s D&O insurers. Sometimes these kinds of letter demands result in a settlement without a lawsuit ever being filed. That apparently is what has happened in connection with the FDIC’s claims against former directors and officers of BankUnited, a Coral Gables, Florida bank that failed in May 2009, at least according to a December 6, 2012 article in the South Florida Business Journal.

As reflected here, on November 5, 2009, the FDIC, in its capacity as BankUnited’s receiver, sent a letter to fifteen former directors and officers of the bank, in which the FDIC presented its "demand for civil damages arising out of losses suffered as a result of wrongful acts and omissions committed by the named Directors and Officers." The letter, a copy of which can be found here, explains that the demand for civil damages is "based on the breach of duty, failure to supervise, negligence, and/or gross negligence of the named Directors and Officers." Though the letter is nominally addressed to the fifteen individuals, copies of the letters also were sent directly to the bank’s primary and first level excess D&O insurers.

In addition to the FDIC’s claims against former directors and officers of the failed bank, shareholders of the failed bank’s holding company (which is now bankrupt) filed a lawsuit against certain former bank directors and officers. The bankruptcy trustee asserted claims against the individuals as well.

According to the newspaper article, these various parties have reached a settlement agreement, subject to bankruptcy court approval, to divide the bank’s $10 million primary D&O insurance policy four ways: $3.5 million to the class action plaintiff; $2.5 million to the FDIC; $1.65 to the bankruptcy trustee; and the balance going to pay legal defense fees and other costs. The settlement agreement also allows the FDIC to attempt to pursue a recovery from the carrier that issued the bank’s $10 million first level excess D&O insurance carrier, which has refused to pay under its policy.

This settlement is interesting because it reflects the tensions that can arise when multiple claims have been asserted against the former directors and officers of a failed bank. When there are multiple claims and only limited insurance, the various claimants are put in competition with each other, as they each race to try to capture as much of the insurance as they can while at the same time accumulating defense fees erodes what little insurance there may be. The division here of the $10 million primary D&O policy reflects an effort between and among the various claimants to try to work out a split of the insurance  so that each of the various sets of claimants at least gets a part of the policy proceeds. The challenge for other claimants trying to work out similar deals in other cases is to try and get a deal done before defense fees exhaust the insurance fund.

Special thanks to a loyal reader for sending me a link to the article about the BankUnited settlement.

Civic Duty: I will be on jury duty this week. We'll see if anybody has the guts to allow me to remain in the jury box. If I am called, it may be a few days before I am able to resume normal blogging activities.  

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Trial in the FDIC’s failed bank lawsuit against three former officers of IndyBank commenced on November 6, 2012 in the federal court in Los Angeles. According Scott Reckard’s November 9, 2012 Los Angeles Times article (here), the parties’ counsel have delivered their opening statements. The case, which was the first failed bank lawsuit the FDIC filed as part of the current bank failure wave, is also the first to go to trial.

As detailed here, the FDIC first filed the lawsuit against the former IndyMac officers in June 2010. The FDIC’s lawsuit seeks to recover damages from the individual defendants for "negligence and breach of fiduciary duties." The lawsuit alleges "significant departures from safe and sound banking practices."  As discussed here, in July 2011, the FDIC filed a separate lawsuit against IndyMac’s former CEO, Michael Perry.

There are three individual defendants in the case that is now in trial:  Scott Van Dellen, the former President and CEO of IndyMac’s Homebuilders Division (HBD), who is alleged to have approved all of the loans that are the subject of the FDIC’s suit; Richard Koon, who was HBD’s Chief Lending Officer until mid-2006 and who is alleged to have approved a number of the loans at issue; Kenneth Shellem, who served as HBD’s Chief Compliance Officer until late 2006, and who is alleged to have approved many of the loans at issue.

The case against the three former IndyMac officers has been very vigorously litigated; I detailed the particularly memorable hearing regarding one discovery dispute that arose in the case here. (While writing this article, I reread the article about the discovery dispute; Central District of California Judge Dale Fischer’s comments during the hearing make for very interesting reading, and I commend the article to readers looking for a little diversion.) Among other significant pretrial rulings, in October 2012, Judge Fischer also held that under California law the individuals were not entitled to rely on the business judgment rule, as discussed here.

And in June 2012, as discussed here, in a significant ruling in a related D&O insurance coverage case, Central District of California Judge Gary Klausner held that all of the various IndyMac lawsuits (including the one the FDIC filed against the three former IndyMac officers) were interrelated to the first filed lawsuit, and thus triggered only a single tower of D&O insurance. This holding was of particular significance both to the former IndyMac officers and to the FDIC, as the FDIC’s lawsuit was filed during the policy period of the second insurance tower. The ruling that the subsequent lawsuit are all interrelated to the first filed lawsuit means that the only insurance available for the individuals (and out of which the FDIC might recover from the insurers) is whatever is left under the first tower of insurance.

According to their July 2012 motion to stay the FDIC’s lawsuit against them, the three defendants represented to the court that defense fees in various IndyMac-related lawsuits as well as the costs associated with settlements that had been reached in several of the cases will deplete or threaten to deplete all of the remaining proceeds under the first tower of insurance.  (The motion asserts that defense fees in excess of $50 million and settlements totaling $29 million would deplete the $80 million insurance tower.) The defendants sought to stay the FDIC’s lawsuit against them so that they could pursue their appeal of Judge Klausner’s insurance coverage ruling. The defendants’ motion can be found here. Judge Fischer denied the defendants’ motion to stay the proceedings.

The upshot of the unavailability of the second tower of insurance and the apparent exhaustion of the first tower is that the three individual defendants face the prospect of that there might not be any insurance available to protect them in the event that the trial results in an award of damages against them (subject of course to the outcome of the pending appeals of Judge Klausner’s insurance coverage ruling).

The FDIC’s original complaint had named a fourth individual, William Rothman, as a defendant as well. According to a footnote in the motion to stay referenced above, Rothman had settled with the FDIC in exchange for Rothman’s assignment to the FDIC of Rothman’s rights under the second tower of insurance.  The separate suit against IndyMac’s former CEO, Michael Perry, remains pending.

In any event, it will be very interesting to see how this case proceeds. It is highly unusual for a case like this to proceed to trial, particularly where there may be limited or even no insurance out of which the FDIC may be able to recover any judgment. (Interestingly, in the defendants’ motion to stay referenced above, counsel for the defendants asserts that “the FDIC specifically structured this lawsuit in order to reach the Tower 2 Policy,” in which case Judge Klausner’s insurance coverage ruling upset a part of the FDIC’s strategy in their case against the three individual defendants.) Obviously, the outcome of the appeal in the insurance coverage case is of keen interest to the FDIC as well as to the individual defendants.

I am sure that there are many readers who will be following this trial closely and who may be able to monitor the case more closely than I can. I would be grateful if readers would be willing to keep me informed about the case.

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When plaintiffs first filed their securities class action lawsuit against IndyMac Bancorp back in March 2007, the suit was one of the first of what later became a wave of subprime and credit crisis-related securities class action lawsuits. The suit itself, which has come to be known as the Tripp litigation, initially was dismissed and ultimately went through multiple rounds of dismissal motions. In March 2008, during the round of preliminary motions, and in what is the fifth largest bank failure in U.S. history, regulators closed IndyMac Bank. In August 2008, IndyMac Bancorp itself filed for bankruptcy. By the time all of these events had completely unfolded, including in particular the many rounds of dismissal motion rulings, the sole remaining defendant in the Tripp litigation was the company’s former CEO, Michael Perry.

According to papers filed in the Central District of California this week, Perry has now reached a settlement of the securities suit against him. As reflected in the parties’ June 26, 2012 stipulation (here), the parties have agreed to settle the case for a payment of $5.5 million. According to the stipulation, the settlement amount will be entirely funded from “insurance policies providing coverage to former officers and directors of IndyMac for the period March 1, 2007 through March 1, 2008.” The settlement is subject to court approval.

The litigation involving IndyMac’s former directors and officers includes not only this securities suit, but also a separate securities suit relating to IndyMac’s alleged misrepresentations regarding its exposure to Option ARM mortgages. In addition, there are two different FDIC lawsuits against former IndyMac executives. Indeed, the FDIC’s first lawsuit against former directors and officers of failed banks filed during the current wave of bank failures was filed against two former IndyMac executives (about which refer here). The FDIC also filed a separate lawsuit against Perry. The FDIC’s suit against Perry has been watched closesly as a result of the ruling in the case that Perry, as a former officer, is not entitled to rely on the business judgment rule under California law (the business judgment rule being construed by the district court as protective of directors only, not officers).

As noted in an accompanying post, as a result of a June 27, 2012 determination in the IndyMac insurance coverage litigation, there is insurance coverage if at all for these various lawsuits under the 2007-2008 insurance program, meaning that the various claimants in the various cases are in competition with each other for the proceeds of the 2007-2008 insurance program.  It is probably fortunate for the claimants in the Tripp litigation that the parties in the Tripp litigation were able to reach a settlement before the June 27 ruling in the insurance coverage litigation, as the competition for insurance under the 2007-2008 program could have even further complication the settlement of the Tripp litigation.

The stipulation provides that insurers from the 2007-2008 insurance program that will be funding this settlement may be required to seek the approval of the bankruptcy court in the IndyMac Bancorp bankruptcy proceedings in order to obtain the bankruptcy court’s approval to use the proceeds for the settlement. The stipulation adds that the parties to the settlement “expressly acknowledge and agree that all obligation of the Defendant with respect to the Settlement Amount are subject to the funding of such Settlement Amount by the Insurers,” adding that the Defendant “shall under no circumstances have an obligation to fund such amount from personnel assets.” The stipulation does provide that if the settlement amount is not paid according to the terms of the stipulation, the settlement is null and void.

I have in any event added the Perry settlement to my running tally of subprime and credit crisis-related case resolutions, which can be accessed here.

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One of the perennial D&O insurance coverage questions is whether or not subsequent claims are “interrelated” with a prior claim and therefore deemed first made at the time of the prior claim. This question can be particularly critical when the subsequent claims arose during a successor policy period; the answer to the “interrelatedness” question can determine whether the claims trigger one or two insurance programs.

In the wave of litigation that arose in connection with the subprime meltdown and the credit crisis, many of the organizations involved were hit with multiple lawsuits filed over period of time, and thus often presenting, in connection with the determination of the availability of D&O insurance coverage, the interrelatedness question.

A June 27, 2012 opinion in the D&O insurance coverage litigation arising out the collapse of IndyMac bank takes a close look at these issues. A copy of the opinion can be found here. In his opinion, Central District of California Judge R. Gary Klausner concluded, based on the relevant interrelatedness language, that a variety of lawsuits that first arose during the bank’s 2008-2009 policy period were deemed first made during the policy period of the bank’s prior insurance program, and by operation of two other policy provisions were excluded from coverage under the 2008-2009 program. Because of high profile of the IndyMac case and the sweeping reach of Judge Klausner’s opinion, his ruling could prove influential in the many of the other subprime and credit crisis cases presenting interrelatedness issues.

Background

IndyMac failed on July 11, 2008. The bank’s closure represented the second largest bank failure during the current banking crisis, behind only the massive WaMu failure. (IndyMac has assets of about $32 billion at the time of its closure).

As I detailed in a prior post (here), the bank’s collapse triggered a wave of litigation. The lawsuits include a securities class action lawsuit against certain former directors and officers of the bank; lawsuits brought by the FDIC and by the SEC against the bank’s former President; and a separate FDIC lawsuit against four former officers of Indy Mac’s homebuilders division. There are a total of eleven separate lawsuits and claims pending. The first of these lawsuits was a consolidate securities class action lawsuit initiated in March 2007, which Judge Klausner refers to in his June 27 opinion as the Tripp litigation. (As noted in an accompanying post, the Tripp litigation has recently and separately settled.)

Prior to its collapse, IndyMac carried D&O insurance representing a total of $160 million of insurance coverage spread across two policy years, the first applying to the 2007-2008 period and the second applying to the 2008-2009 period. The insurance program in place for each of the two policy years consists of eight layers of insurance. Each layer has a $10 million limit of liability. The eight layers consist of a primary policy providing traditional ABC coverage, with three layers of excess insurance providing follow form ABC coverage, followed by four layers of Excess Side A insurance. The lineup of insurer involved changed slightly in second year.

In the insurance coverage litigation, the carriers in the 2008-2009 raised essentially three arguments: first, that the lawsuits and claims that arose during the 2008-2009 policy period were interrelated with the Tripp lawsuit, and therefore are deemed first made during the 2007-2008 policy period; that because the subsequent claims and lawsuits are interrelated with the Tripp lawsuit, which was noticed as a claim during the prior period, the subsequent claims and lawsuits are excluded from coverage under the 2008-2009 program under the applicable “prior notice” provision; and all of the subsequent claims are excluded from coverage under a specific exclusion endorsed onto the policies in the 2008-2009 program precluding coverage for claims related to the Tripp litigation. The former IndyMac officers and directors filed counterclaims contending that they were entitled to coverage under the 2008-2009 program. The various parties filed cross-motions for summary judgment.

The June 27 Opinion

In his June 27 opinion, Judge Klausner, applying California law, granted the insurers’ motions for summary judgment and denied the former IndyMac directors and officers cross-motions. Although his opinion is detailed, it boils down to his conclusions that each of the three sets of policy provisions at issue are unambiguous; that under each of the three sets of policy provisions, the subsequent claims are interrelated with the Tripp litigation; and by operation of the prior notice and Tripp litigation exclusions, all of the subsequent litigation is precluded from coverage under the 2008-2009 insurance program.

In concluding that the subsequent claims were interrelated with the Tripp litigation within meaning of the relevant language in the various policies, he noted that the policies’ definition of “interrelated wrongful act” is unambiguous and “describes a broad range of relationships between the original claim and other lawsuits that will be deemed as part of that same claim and made at the time of the first claim.”

The prior notice exclusion in the various policies, Judge Klausner noted, “describes a broad relationship between subsequent claims and claims that were made during prior policies such that these subsequent claims will be excluded from coverage.”

The Tripp litigation exclusion, Judge Klausner noted, is unambiguous and “excludes from coverage cases that have a broad range of relationships to the facts in the Tripp Litigation.”

Judge Klausner found that all of the subsequent claims and lawsuits “are sufficiently related to the Tripp litigation to be excluded under at least one clause of the [2008-2009] policies.”  The set of allegations that Judge Klausner found to be common among the various claims and lawsuits was the assertion that IndyMac failed to follow its underwriting standards and the resulting alleged issuance of high risk mortgages. Judge Klausner found that this commonality extended among the various suits and claims even if the specific allegations in a particular claim or suit “may fall outside the temporal scope of the Tripp litigation.”

Discussion

Judge Klausner’s opinion in this case is potentially significant, and not just because it means that the insurance under IndyMac’s 2008-2009 insurance program will not be available for the defense and settlement of the various subsequent claims. As I noted at the outset, many of the claims, lawsuits and disputes that have arisen in the wake of the subprime meltdown and the credit crisis present this same interrelatedness issue. Judge Klausner’s broad reading of the interrelatedness provisions, and in particular his willingness to interpret the policy provisions as not limited temporally but instead as having a broad meaning and reach, could prove influential.

It is important to note as an aside that Judge Klausner did not consider wording differences between the interrelatedness provisions in the “traditional” A/B/C policies and in the Side A policies in the 2008-2009 to be particularly significant (although, to be sure, he did note the differences). From an outcome determinative standpoint, the broad scope Judge Klausner gave to the interrelatedness provision could be the most significant feature. Because the interrelatedness language at issue, or substantially similar language, is found in most current D&O insurance policies, Judge Klausner’s analysis and the broad scope he gave to the policy language, could prove significant in a broad variety of other cases.

There is one aspect of Judge Klausner’s analysis that may limit its applicability to other disputes. That is that his ultimate conclusion that the various subsequent claims and lawsuits are precluded from coverage depended on the operation of all three of the policy provisions on which the insurers’ relied. It may be argues that it not enough for Judge Klausner to reach his conclusion that there is no coverage under the second tower that the subsequent claims were interrelated with the Tripp litigation; his conclusion that the subsequent claims were precluded from coverage also depended on the operation of the prior notice exclusion and the Tripp litigation exclusion arguably may distinguish this case from other interrelatedness disputes that may arise.

The practical effect of Judge Klausner’s decision is that there is insurance coverage, if at all, for the various subsequent claims under the 2007-2008 program. Although the 2007-2008 program represents a total of $80 million in insurance, the program has been eroded by over five years of attorneys’ fees in the Tripp litigation, as well as by the settlement of the Tripp litigation. The claimants in the various subsequent claims will now be in competition with each other for the remaining proceeds, while at the same time any amounts remaining will be further eroded by additional attorneys’ fees. The finite and dwindling amount of insurance and the sheer number of claims and claimants could make it challenging to resolve the claims and suits, at least to the extent insurance funds are to be involved. This observation is relevant to all claimants but it is probably worth noting that it is also applicable to the FDIC in connection with the two lawsuits the agency has filed in its role as IndyMac’s receiver against former officers of the bank.

A June 27, 2012 memo from the Wiley Rein law firm discussing Judge Klausner’s opinion can be found here.

I would like to thank the several loyal readers who sent me copies of this opinion. I appreciate everyone’s willingness to make sure that I am aware of significant developments so that I can pass them along to my readers.

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Recent sharply-worded accusations that the FDIC had failed to preserve documents attracted quite a bit of media attention. For example, a January 27, 2012 Wall Street Journal article reported the charges of counsel for two former IndyMac bank executives, repeating counsel’s remarks accusing the agency of a “stunning display of incompetence” for failing to preserve documents. Counsel made these statements in a filing in an action the FDIC had filed against fhe individuals in its capacity as receiver for the failed bank.

The Journal article also quoted the individual defendants’ counsel’s statement that “the breadth and depth of the government’s document-retention failures are staggering, and violations of this magnitude rarely occur,” and that “it is a stunning display of incompetence from an agency that is supposed to be an expert at seizing and managing banks.”

Based on these accusations, two of the inidividual defendants  sought sanctions against the government for willful spoliation of evidence, dismissal of the relevant counts of the lawsuit and an adverse instruction to the jury based on the government’s failure to preserve evidence.

The defense counsel’s provocative language may have succeeded in getting his accusations published in the Wall Street Journal. However, the language proved less successful when the matter came before Central District of California Judge Dale Fischer in a hearing on January 30, 2012. As reflected in a transcript of the hearing, Judge Fischer had quite a lot to say about counsel’s approach, including in particular, counsel’s use of language.

Judge Fischer started her remarks with a comment about counsel’s pleading tactics and then went on from there:

THE COURT: Now, there were a number of declarations attached to the reply that apparently were not filed immediately after they were signed. Why was that?

DEFENSE COUNSEL: Your Honor, we waited to file them with our reply.

THE COURT: And you seriously thought that was the appropriate approach?

DEFENSE COUNSEL: Yes, I did, your honor.

THE COURT: Well, for future reference, it wasn’t. Don’t hold back evidence that relates to your motion until after the opposing party files its opposition and then just stick it to them at the end. So I’m not sure why you thought that was appropriate, but now you know.

Along those lines: I also want to tell you, I don’t know why lawyers do this, and there’s a lot of them in the room so take heed, all of you, language like failures are staggering, violations of this magnitude rarely occur, stunning display of incompetence, bitter irony, breathtaking dereliction of duty are not only unpersuasive, they’re somewhat annoying. I don’t have time for rhetoric. I’m really, really busy. Why anyone would want this job, I don’t know…

But in any event, it’s just – I don’t know whether you stay up nights trying to think of clever phrases, but trust me, no judge that I’ve ever spoken to has ever said, Boy, can that guy turn a phrase. They only say, Boy, why didn’t he get to the point. So, please, in future pleadings, remember that.

DEFENSE COUNSEL: Yes, your Honor.

THE COURT: In addition to that, I’ve been around awhile both in practice and on the bench, so I suspect I’ve seen a few more cases than you, and really, it’s not all that staggering and it’s not all that great a magnitude, so when your experience and mine differ, it just takes all of the punch out of those comments.

To make matters even worse, Counsel, your statement that the government failed to make any effort to preserve the documents is simply false. And your statements in your papers so often go beyond the bounds of zealous advocacy that I have to say your papers had very little persuasive value. In fact, as I was trying to check some of the references you made to deposition testimony, I looked at it three or four times because I thought I must be searching for the wrong page because the pages you were citing to had oftentimes no relationship to the proposition you were citing them for. You started off extremely poorly as I started reading the papers, and I had little confidence in anything you had to say as I went through them.

Judge Fischer denied the defendants’ motion.

Readers of this blog may also be interested to read the discussion in the hearing transcript, beginning at page 27, about the role that the D&O insurance program in the ongoing case. From reading the transcript, it appears that the individual defendants contend that there a second $80 million insurance tower is relevant to this claim, although defense costs are being funded out of a first $80 million tower. The lawyers present at the hearing disagreed about the exact amount, but it appears that defense expenses to date in all of the various IndyMac-related lawsuits have totaled $35 million or $45 million. There were various references in the transcript to the lack of responses from the carrier. (The make-up of the two insurance towers and a prior coverage dispute involving IndyMac’s D&O insurance are discussed here.)

Also, and though it is difficult to discern from the bare face of the transcript, it appears that the reason that the FDIC wants to take this case to trial is to substantiate damages in excess of the applicable policy limits, in an apparent attempt to impose a judgment in excess of the limits on the D&O insurer(s).

As Judge Fischer commented at the outset of the discussion about the D&O Insurance, the case “seems to be insurance-company driven.” Which corroborates a point I have made before on this blog, that the D&O insurance may be the real battleground in the FDIC’s failed bank litigation.

This case, which was filed in July 2010, was the first that the FDIC filed against former officers of a failed bank as part of the current bank failure wave, as discussed at greater length here. It is also one of two FDIC actions against former IndyMac officials. The agency separately filed an action against the failed bank’s former CEO, as discussed here.

Judge Fischer’s aside that she doesn’t know why anyone would want to be a federal judge, triggered as it was by her frustration with the  matter before her, was remarkably like my own reaction as I read through the transcript. As I read along, my own decision years ago to walk away from the active practice of law seemed more and more like a really smart move.

Reading about the tone and temper of the parties’ pleadings in this case reminded me of the lyrics from the Crosby, Stills & Nash song “You Don’t Have to Cry,” which I often sing to myself when I hear about litigators bashing each other: “You are living a reality I left years ago, it quite nearly killed me/In the long run, it will make you cry, make you crazy and old before your time.”

What Do You Make, He Asked?: If you have not seen this video about teachers, drop everything and watch it right now. Thank you.

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A federal court has denied the motion of former IndyMac CEO Matthew Perry to dismiss the action that the FDIC, as the failed bank’s receiver, had filed against him. In a December 13, 2011 order (here), Central District of California Judge Otis D. Wright II held that under California law the business judgment rule does not protect officers’ corporate decisions and accordingly he rejected Perry’s argument that the FDIC’s complaint must be dismissed for failure to plead around the business judgment rule.

As discussed here, in July 2011, the FDIC as receiver for the failed IndyMac bank sued Perry alleging that as the bank’s CEO he had breached his duties to IndyMac and acted negligently in allowing IndyMac to continue to generate and acquire more than $10 billion in risky residential loans for sale into the secondary market. As the secondary market became unstable, the bank was forced to take the loans into its own investment portfolio, where the generated substantial losses, allegedly in excess of $600 million. IndyMac failed on July 11, 2008 and the FDIC was appointed as the bank’s receiver.

Perry moved to dismiss the FDIC’s complaint, arguing that the FDIC failed to allege facts sufficient to overcome the business judgment rule. Perry argued that the business judgment rule applies and insulates him from personal liability for his actions prior to IndyMac’s demise.

In opposing Perry’s motion, the FDIC argued that under California law the business judgment rule does not apply to officers. Judge Wright agreed. He concluded that the relevant legal authority does not support a conclusion that common law business judgment rule encompassing the general judicial policy of deference to business decisions should apply to officers. He also found that California’s statutory business judgment rule does not extend its protection to corporate officers. After reviewing the statute, applicable legislative history and relevant case law, he concluded that when the California legislature codified the business judgment rule, “it purposely excluded its application to corporate officers.” Because the FDIC’s allegations against Perry in his capacity as an office, Judge Wright denied his motion to dismiss.

Discussion

Historically, courts in applying the business judgment rule have not always carefully examined whether or not the rule’s protection should apply to officers as well as to directors. Over time, some have argued rather vigorously that the rule should not apply to officers. Others have argued that officers should be entitled to rely on the business judgment rule. Certainly it would seem that in those jurisdictions where officers and directors are held to have the same duties then they should be entitled to the same protections.

In any event, the question of whether or not an officer is entitled to the same protection under the business judgment rule as a director is a question of state law on which state law will control. Judge Wright’s decision is clearly reflection of his analysis under California state law. But though it is limited on that basis, his conclusion nevertheless highlights the interesting question whether as a matter of public policy the decisions and actions of corporate officers should enjoy the same protection under the business judgment rule as directors.

Setting aside the question of whether or not officers are entitled to the protection of the business judgment rule is the question of whether or not questions involving the applicability of the protections should be addressed at the motion to dismiss stage. There is the further procedural question of whether the plaintiffs must be expected to plead around the defense in order for their case to go forward, or whether the protections are in their nature more in the form of an affirmative defense to be invoked and substantiated by the defendant as the case goes forward. Judge Wright’s analysis does not examine these issues in detail but they present and added level of inquiry beyond the issues Judge Wright does address.

In any event, special thanks to a loyal reader for providing me with a copy of Judge Wright’s decision.

More About the FDIC’s Settlement with WaMu Executives: As was widely reported yesterday, the FDIC has settled the action it brought as receiver for the failed Washington Mutual bank against three former WaMu executives and their wives.  The early reports did not specify the amount of the settlement, but a December 14, 2011 Wall Street Journal article (here) fills in some of the missing details.

The total amount of the settlement is $64 million, consisting of about $400,000 from the settling parties themselves, and the balance of the cash amount to be paid by insurance. The executives are also to forego a total of $24 million in retirement benefits and bonus claims.

The Journal article also makes a tantalizingly brief mention of a prior $125 million settlement that the FDIC previously reached “to release claims against other former outside directors and officers.” As I noted here, there had been some suggestion in the press when the FDIC first filed its action against the three executives that the agency had separately settled or reached an agreement with the failed bank’s outside directors, but the brief mention in the Journal article is the first affirmative substantiation I have seen since that time referencing this separate settlement. Any readers that can shed light on this separate settlement are encouraged to pass along whatever information they can.

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In the eighth lawsuit that the FDIC has filed so far as part of the current round of bank failures, on July 6, 2011, the FDIC filed suit in the Central District of California against former IndyMac CEO, Michael Perry. The FDIC’s complaint can be found here.  

IndyMac failed nearly three years ago, on July 11, 2008, as discussed here. The FDIC’s complaint against Perry alleges that he caused over $600 million in losses by causing the bank to purchase mortgage loans in 2007, just as the mortgage marketplace was destabilizing. The complaint alleges that Perry acted negligently when he allowed IndyMac to generate and purchase $10 billion in loans when the secondary mortgage market was becoming illiquid. When IndyMac was later unable to sell the loans, the bank transferred them to its own investment portfolio, which then caused over $600 million in losses.

The news articles report that the Complaint alleges the “instead of enforcing credit standards, Perry chose to roll the dice in an aggressive gamble to increase market share while sacrificing credit standards.”

Even though its complaint against Perry is only the eighth so far during the current banking crisis, the lawsuit is the second that the FDIC has filed against former IndyMac executives. As discussed at length here, the first lawsuit the FDIC filed during the current round was filed in July 2010 against four former officers of IndyMac’s Homebuilder Division.

The FDIC’s concentration on IndyMac likely has something to do with the fact that the bank’s closure represented the second largest bank failure as part of the current banking crisis, following only the massive WaMu failure. (IndyMac has assets of about $32 billion at the time of its closure). IndyMac was also one of the earliest banks to fail – it was just the fifth bank to fail during 2008, while there have been well over 300 bank failures since then. So the FDIC’s post-mortem processes may be further along on IndyMac than with respect to the many other bank failures that have followed.

The FDIC’s lawsuit is far from the first legal imbroglio in which Perry has become involved. As discussed here, on February 11, 2011, the SEC filed a lawsuit against Perry and two other former IndyMac officers, accusing them of “misleading investors about the mortgage lender’s deteriorating financial condition.”

Perry is also one of the defendants named in the consolidated securities class action lawsuit first brought in the Central District of California in 2007 by IndyMac shareholders. The shareholder suit has a long and involved history, as discussed here. On March 29, 2010, Central District of California Judge George Wu denied the defendants’ motion to dismiss the plaintiffs’ sixth amended complaint, while at the same time certifying the case for interlocutory appeal to the Ninth Circuit. Judge Wu’s order can be found here.

In any event, a list of the eight lawsuits that the FDIC has filed can be found on the FDIC’s website, here. As noted on the same page, as of July 7, 2011, the FDIC “has authorized suits in connection with 28 failed institutions against 248 individuals for D&O liability with damage claims of at least $6.8 billion.” Since the eight lawsuits filed so far involve only seven institutions and only 53 former directors and officers, there clearly are many more lawsuits (perhaps as many as 21 or more) the FDIC is preparing to file. In all likelihood, even further lawsuits will be approved in the future as well. All of which means that we could be heading into a period of very significant failed bank litigation.

Readers who scan the FDIC’s website closely will undoubtedly notice that one of the eight lawsuits has already settled. The settled case  is the lawsuit the agency filed in March 2011 in connection with Corn Belt Bank and Trust Company (about which here). As reflected in the FDIC’s May 10, 2011 motion (here), the parties settled the case. However, the court records do not reveal any of the details of the settlement.

The Name Game:  As far as I am aware, Michael Perry, the former Indy Mac CEO, is not related to Michael Dean Perry, who played football in the NFL, for the Cleveland Browns among others, during the 80s and 90s. According to Wikipedia (here), Michael Dean Perry had a McDonald’s hamburger sandwich named after him – the “MDP,” which was only served in Cleveland-area McDonald’s while Perry played for the Browns. As far as I am aware, the former IndyMac CEO did not have a sandwich named after him.

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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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