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

On August 23, 2011, a three-judge panel of the Second Circuit in an opinion by Judge Barrington D. Parker affirmed the dismissal of the subprime-related securities lawsuit that had been brought against Regional Financial Corporation and certain of its directors and officers. A copy of the Second Circuit’s opinion can be found here.

Background

As reflected in greater detail here, the plaintiffs first filed a securities class action lawsuit in the Southern District of New York against Regions on April 1, 2009. The plaintiffs represented investors that had purchased securities in the company’s $345 million April 2008 trust preferred securities offering. The defendants included the company, certain of its directors and officers, its offering underwriters, and its auditor.

The plaintiffs alleged that the April 2008 offering documents were false and misleading because they incorporated by reference financial statements that overstated goodwill associated with Regions Financial’s 2006 acquisition of AmSouth and underestimated loan loss reserves associated with the AmSouth’s declining mortgage lending porfolio. Among the financial statements incorporated into the offering documents was the company’s 2007 Form 10-K.

The complaint alleged that the company "did not write down any of the massive goodwill" it recorded in its 2007 10-K "despite growing evidence indicating that serious problems existed at the time of the acquisition." The complaint also alleges that Regions "only marginally increased its loan loss reserves" despite "the high risk of loss inherent in its mortgage loan portfolio." The defendants moved to dismiss on the grounds that the plaintiffs had failed to allege any actionable misstatements or omissions.

As discussed here, in a May 10, 2010 opinion, Southern District of New York Judge Lewis Kaplan granted the defendants’ motions to dismiss, holding that the statement about goodwill and the loan loss reserves represented opinions that were not actionable because the complaint failed to allege that defendants did not honestly hold those opinions at the time they were expressed. The plaintiffs appealed.

The Second Circuit’s Opinion

The Second Circuit affirmed Judge Kaplan’s dismissal of the trust preferred securities investors’ securities lawsuit. With respect to the allegations regarding the statement concerning goodwill, the Second Circuit observed that “as Judge Kaplan correctly recognized, plaintiffs’ allegations regarding goodwill do not involve misstatements or omissions of material fact, but rather a misstatement regarding Regions’ opinions.”

In concluding that the plaintiffs had not adequately alleged actionable misstatements regarding misstatements or omissions regarding goodwill, the court said that

Plaintiff relies mainly on allegations about adverse market conditions to support the contention that defendants should have reached different conclusions about the amount of and the need to test for goodwill. The complaint does not, however, plausibly allege that defendants did not believe that statements regarding goodwill at the time they made them.

The Second Circuit went on to conclude that the plaintiffs’ allegations regarding loan loss reserves “suffer from the same deficiencies as those regarding goodwill.” The court approvingly cited Judge Kaplan’s statement that “determining the adequacy of loan loss reserves is not a matter of objective fact”; rather, loan loss reserves “reflect management’s opinion or judgment about what, if any, portion of amounts due on the loans ultimately might not be collectible.” Because the plaintiff failed to allege that the defendants’ opinions were “both false and not honestly believed when they were made,” the loan loss reserve allegations also fail to state a claim.

Discussion

The Second Circuit’s opinion in the Regions case is the latest in a series of decisions in which the appellate courts have affirmed the district court’s dismissals of subprime or credit crisis-related securities class action lawsuits. Earlier example include the NovaStar Financial case (about which refer here), the Centerline Holdings case (refer here),  the Impac Mortgage Holdings case (refer here) and the HomeBanc case (refer here).  At this point, it seems clear the appellate courts are reluctant to setting aside the dismissal motion rulings of the district courts in these cases.

What makes the Regions Financial trust preferred securities case noteworthy and even interesting is that the case was dismissed, and the dismissal was affirmed, while related complaints involving many of the same facts have actually survived dismissal motions. In particular and as noted here, in June 2011, Northern District of Alabama Judge Inge Prytz Johnson denied the motions to dismiss in the securities class action lawsuit filed on behalf of Regions Financial’s shareholders.

The Northern District of Alabama lawsuit also alleges that the company had failed to recognize the impairment of the goodwill associated with the AmSouth merger. As I discussed in my prior post about Judge Johnson’s ruling, she expressly recognized that Judge Kaplan had previously dismissed the Southern District of New York lawsuit filed on behalf of the trust preferred securities investors. However, she differentiated the allegations in the case in her court based on the plaintiffs’ allegations made based on the statements of confidential witnesses.

Judge Johnson concluded that the plaintiffs in the case before her have “pled many facts showing that the defendants had information that did not support defendants’ opinions.” Among other things, she cited the statements of the confidential witnesses “showing how defendants improperly handled and classified loans, defendants were aware of the collapsing commercial real estate in Florida yet continued to push for more growth there, and continued to ignore [internal] reports signaling a negative risk-adjusted bottom line.

Judge Johnson concluded that the plaintiffs has sufficiently alleged that the company’s loan loss reserves were false and misleading, citing the testimony of several confidential witnesses that “defendants mishandled loans in order to manipulate their financial reporting numbers.” Because the loan loss reserves impacted the company’s reported income (which was the measure by which the company tested its goodwill), Judge Johnson concluded that the plaintiffs had adequately alleged that the company’s goodwill was “overstated, false and misleading.”

On August 23, 2011, Judge Johnson denied the defendants' motion for reconsideration, rejecting the defendants' argument that the Supreme Court's recent decision in the Janus Capital case required a different result. Judge Johnson's August 23 order can be found here.

In addition, and as noted here, the plaintiffs in the separate shareholders’ derivative lawsuit filed in Alabama Circuit Court against Regions Financial, as nominal defendant, and certain of its directors and officers, also survived a motion to dismiss. However, it should be noted that the Alabama court was determining only whether or not the requirement for pre-suit demand was excused based on the circumstances alleged.

Finally, and just to complete the picture, in March 2010, the motions to dismiss was also denied in the Regions Financial ERISA action, about which refer here.

While the differences in the outcome between the New York lawsuit and the other lawsuits can be accounted for based on differences in the claims asserted and the specific matters alleged, there is also a sense in reading through all of these opinions that the outcomes may also be understood based on the respective court’s starting points. As I noted in my prior posts discussing the prior dismissal motions denials, for the other judges, the context matters, but for Judge Kaplan (and now for the Second Circuit) the context is irrelevant. There is also a sense that the more geographically proximate the decisions maker to the locus of the corporate defendant and its woes, the less sympathetic the courts are to the defendants’ position.

In any event, I have adjusted my tally of the dismissal motion rulings in subprime-related securities suits to reflect the Second Circuit’s opinion. The tally can be accessed here.

Special thanks to Douglas Henkin of the Milbank law firm for providing me with a copy of the Second Circuit’s opinion. Milbank represented the Underwriter defendants before the Second Circuit.

Deutsche Bank Subprime-Related Securities Suit Survives Dismissal Motion Ruling: In an August 19, 2011 opinion, here, Southern District of New York Judge Deborah Batts largely denied the motion to dismiss in the subprime-related securities suit filed against Deutsche Bank and certain of its directors and officers.

As discussed here, several groups of investors, who had purchased Deutsche shares in a series of offerings during the period 2005 to 2007, filed lawsuits asserting claims that the offering materials contained material misrepresentations and omissions in the associated offering documents. The plaintiffs basically alleged that the bank had misrepresented its exposure to residential mortgage backed securities and collateralized debt obligations. The various cases were later consolidated before Judge Batts and the defendants moved to dismiss.

In her August 19 order, Judge Batts granted the motion to dismiss as to stock offering from October 2006. However, Batts left intact claims relating to five other offerings, or gave the plaintiffs a chance to replead their allegations.

I have also added the Deutsche Bank decision to my tally of subprime related dismissal motion rulings.

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In a decision that largely turned on detailed confidential witness statements, on June 7, 2011, Northern District of Alabama Judge Inge Prytz Johnson denied the motions to dismiss in the Regions Financial Corporation subprime-related securities lawsuit. This ruling is the latest of a series of decisions involving the company. The June7 ruling can be found here.

Background

As detailed here, this case arose following the company’s January 20, 2009 announcement that it was taking a goodwill impairment of nearly $6 billion related to the company’s November 2006 purchase of AmSouth Bancorporation. As the plaintiffs later alleged, even though Regions acquired AmSouth, with a year former AmSouth executives were running the combined company. The AmSouth loan portfolio was heavily weighted toward Florida real estate.

The plaintiffs allege that the company and its senior officials were well aware of the deteriorating conditions in the Florida real estate market, but they failed to recognize the non-performing loans in the company’s portfolio. As a result, the defendants “repeatedly, yet falsely, claimed that the $6 billion in goodwill associated with the AmSouth acquisition was unimpaired. “

But by January 2009, “the collapsing real estate market proved more devastating than even defendants’ fraud could conceal,” and on January 20, 2009, “defendants were forced to finally announce a huge increase in loan loss reserves , and a colossal $6 billion writedown of goodwill.” The company’s share price declined and litigation ensured. The defendants moved to dismiss.

The June 7 Opinion

Judge Johnson’s June 7 Opinion denying the defendants’ motions to dismiss relied heavily on the statements of confidential witnesses cited in the amended complaint. Her opinion recites this testimony at length. Among other things, one confidential witness reports that senor bank officials changed the status of nonaccrual loans at month or quarter end, but that following the month or quarter end, the numbers would be switched back, the delay done with the purpose of “making the numbers.” Another confidential witness stated  that the company did not properly classify nonperforming loans as nonaccruing assets in a timely manner.

The plaintiffs also relied on confidential witness statements to establish that “defendants were kept aware of this process through both the reporting structure and periodic reports.” The confidential witness cited specific detailed reports senior managers were regularly given.

Another confidential witness statedthat the Federal Reserve has opened an investigation into the company’s classification of loans as “non-accrual,” and that the Company’s Audit Committee is now in the process of conducting its own investigation, and has hired an outside law firm to investigate.

In denying the denying the defendants’ motions to dismiss, Judge Johnson differentiated the plaintiffs’ allegations from those involved in a separate case relating to Regions’ alleged delay in recognizing the impairment of the AmSouth transaction goodwill, in which Southern District of New York Judge Lewis Kaplan had granted the motion of the defendants in that case to dismiss the complaint.

By contrast to the allegations in that case, Judge Johnson said, the plaintiffs in this case have “pled many facts showing that the defendants had information that did not support defendants’ opinions.” Among other things, she cited the statements of the confidential witnesses “showing how defendants improperly handled and classified loans, defendants were aware of the collapsing commercial real estate in Florida yet continued to push for more growth there, and continued to ignore [internal] reports signaling a negative risk-adjusted bottom line.

Judge Johnson concluded that the plaintiffs has sufficiently alleged that the company’s loan loss reserves were false and misleading, citing the testimony of several confidential witnesses that “defendants mishandled loans in order to manipulate their financial reporting numbers.” Because the loan loss reserves impacted the company’s reported income (which was the measure by which the company tested its goodwill), Judge Johnson concluded that the plaintiffs had adequately alleged that the company’s goodwill was “overstate, false and misleading.”

Judge Johnson also relied on the confidential witnesses’ statements in concluding that the plaintiffs had adequately alleged scienter. Taking the fact that the defendants had compensation tied to company performance as one possible motive to be considered, Judge Johnson also noted that the defendants “had access to reports showing the true state of affairs regarding Regions’ loans and the deteriorating markets, particularly in Florida.”

Judge Johnson also found that the defendants’ “significant and sudden increase in loan loss reserves along with its $6 million goodwill write-down, considered collectively with all allegations, supports a strong inference of scienter.”  Judge Johnson added that “coupled with allegations of defendants’ knowledge of the scheme to manipulate classifications of loans, it was apparent to defendants that the financials were inaccurate long before their adjustment in January 2009.”

Discussion

Securities plaintiffs have been uniformly successful in attempting to rely on confidential witness statements  in order to try to meet the PSLRA’s pleading requirements This case is a notable example where use of confidential witness statements was successful. The success depended on a number of factors. The witnesses’ statements was detailed and specific. More importantly, Judge Johnson found that the witnesses’ statements  showed that the defendants were aware of the information about which the witnesses testified, in particular about alleged differences between the information cited by the witnesses and what the company was saying publicly.

At the same time it seems that the witnesses’ statements  reinforced Judge Johnsons’ predispositions. She clearly found the magnitude of the $6 billion write-down and the January 2009 increase in loan loss reserves to be disturbing, and even suspicious. These factors came together to support her conclusions.

The confidential witness statements were  clearly important and  help explain the difference in outcome between her ruling and that of Judge Kaplan in the separate ’33 Act claim that had been brought on behalf of class of investors who had purchased Regions trust preferred securities in a separate securities offering. As noted above, in that case, Judge Kaplan had granted the motion to dismiss. The difference seems to be the allegations based on the statements  of the confidential witnesses.

There have been a number of other credit crisis-related lawsuits in which the presence of statements from confidential witnesses seemed to have made a difference in enabling plaintiffs’ claims to survive the initial pleading hurdles. Among these cases are: the Sallie Mae case (refer here); and  the Wells Fargo Mortgage-Backed Securities case (refer here). Indeed, in the Credit Suisse case, which later settled for $70 million dollars, the court found that the information in confidential witness statements cited in the amended complaint was sufficient to permit the plaintiffs’ amended complaint to survive the renewed dismissal motions, after the motion to dismiss the initial complaint had been granted, as discussed here.

As I noted in a prior post, here, here have been a number of cases filed against this company in the wake of the AmSouth merger and in light of the problems Regions encountered during the financial crisis. A number of these cases are proceeding, including, as discussed in a prior post, the state court derivative complaint.

These cases are part of the huge number of cases that continue to work their way through the system following the financial crisis. I have in any event added the June 7 ruling to my running tally of credit crisis-related dismissal motion rulings, which can be accessed here.

Special thanks to a loyal reader for sending along a copy of the June 7 order.

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As the various subprime-related securities lawsuits have reached the motion to dismiss stage, some of the rulings have gone for the defendants and other have gone for plaintiff. Regions Financial Corporation experienced one of each kind of ruling in two separate cases involving allegations about the goodwill the company carried on its balance sheet as a result of its November 2006 acquisition of AmSouth.

As discussed below, the motion to dismiss was denied in the Alabama state court derivative suit, but the motion to dismiss was granted in the securities class action lawsuit pending in the Southern District of New York.

Regions Shareholders’ Derivative Lawsuit (Alabama)

Background

Plaintiffs filed their shareholders’ derivative complaint in May 2009 in Alabama (Jefferson County) Circuit Court against Regions, as nominal defendant, and certain current and former members of Regions’ board of directors. The complaint asserts claims against the company defendants for breach of fiduciary duty, corporate waste, and abuse of control. (The complaint asserts separate claims against the company’s offering underwriters and auditing firm for aiding and abetting and breach of professional duties).

The complaint’s allegations pertain to the company’s November 2006 $10 billion purchase of AmSouth and the alleged falsification of the company’s public statements and disclosure documents both during and following the transaction. The complaint principally focuses on the company’s disclosures between the time of the merger and the company’s January 2009 write down of over $6 billion of goodwill. Throughout that period, and despite the deteriorating real estate market, the merger allegedly was touted as a success, notwithstanding Regions’ acquisition of AmSouth’s exposure to the Florida real estate market.

According to the complaint in June 2008 the SEC questioned the company’s determination in its 2007 10-K that its goodwill balance was not impaired. Analysts also began to question this issue as well, but it was not until January 2009 that the company, as the Alabama court later put it "wrote down its goodwill and admitted that the value of its loan portfolio was billions less that [sic] what had been reported." The plaintiff alleges that the defendants knew of the true financial situation and misrepresented or concealed those facts.

The company defendants moved to dismiss on the grounds that the plaintiff had failed to make a pre-suit demand that the company itself bring the claims. The plaintiff countered that demand was excused.

The May 6 Ruling

In a May 6, 2010 order (here), Circuit Court Judge Robert S. Vance, Jr., applying Delaware substantive law and Alabama procedural requirements largely denied the defendants’ motions to dismiss, finding that the plaintiffs "have met their burden, at least at to the extent needed to establish demand futility at this point."

Judge Vance noted the widespread deterioration of the Florida real estate market, and also reviewed the duties of the board, particularly its audit committee, to consider critical financial issues such as goodwill impairment. Judge Vance noted that:

Given these duties along with the well-known and heavily publicized deterioration of the real estate market (especially in Florida) and the corresponding collapse in the credit market, and the letter received from the S.E.C. in June 2008, the members of the audit committee can fairly be said to confront a substantial likelihood of liability as a result of Regions’ failure to advise its shareholders prior to January 2009 that its financial situation was threatened.

Judge Vance also denied (in reliance on the Citigroup derivative lawsuit case) defendants’ motions to dismiss the plaintiffs claims for waste "to the extent that corporate waste allegations pertain to compensation issues specifically authorized by the directors."

However, Judge Vance found that the plaintiffs had failed to show enough to maintain claims based on an alleged failure to oversee Regions’ subsidiary, Morgan Keegan, holding that the plaintiffs "fail to show in what particular ways the Regions’ board has consciously failed to oversee the operations of its subsidiary."

Southern District of New York Securities Class Action Lawsuit

Background

As reflected in greater detail here, the plaintiffs first filed a securities class action lawsuit in the Southern District of New York against Regions on April 1, 2009. The plaintiffs represented investors that had purchased securities in the company’s $345 million April 2008 trust preferred securities offering. The defendants included the company, certain of its directors and officers, its offering underwriters, and its auditor.

The plaintiffs alleged that the April 2008 offering documents were false and misleading because they incorporated by reference financial statements that overstated goodwill and underestimated loan loss reserves. Among the financial statements incorporated into the offering documents was the company’s 2007 Form 10-K.

The complaint alleged that the company "did not write down any of the massive goodwill" it recorded in its 2007 10-K "despite growing evidence indicating that serious problems existed at the time of the acquisition." The complaint also alleges that Regions "only marginally increased its loan loss reserves" despite "the high risk of loss inherent in its mortgage loan portfolio."

The defendants moved to dismiss on the grounds that the plaintiffs had failed to allege any actionable misstatements or omissions.

The May 10 Ruling.

In his May 10, 2010 opinion (here), Southern District of New York Judge Lewis Kaplan granted the defendants’ motions to dismiss.

With respect to the plaintiff’s allegations regarding goodwill, Judge Kaplan concluded that "in the absence of particularized allegations that management believed that the goodwill figure was materially overstated, the amended complaint is insufficient as a matter of law."

In reaching this conclusion, Judge Kaplan noted that the goodwill was intended to reflect the excess of the acquisition price over the fair value of AmSouth’s assets at the time of the acquisition. He noted that the value of AmSouth’s loan portfolio "was not a matter of objective fact," as its loan assets were not traded on an efficient market, adding "nor has plaintiff pointed to any other objective standard of value." Given the lack of "any objective or readily determinable value," the question of the falsity of the goodwill presented in the offering documents is not a question of whether or not the value was wrong in some empirical sense, but whether or not the offering documents actually reflected management’s "honest opinion." Because the complaint did not allege that the goodwill did not reflect management’s opinion, the complaint’s allegations regarding goodwill were insufficient as a matter of law.

Even though the SEC’s June 2008 inquiry letter came two months after the April 2008 securities offering, Judge Kaplan expressly addressed the letter’ implications He noted that the SEC did not question the validity of Regions’ goodwill balance, but rather asked only for Regions to disclose how it determined that the goodwill balance was not impaired. Regions had responded that the goodwill reflected the fact that a potential buyer would offer a control premium for the business franchise. The SEC had replied that it had no further comments. Judge Kaplan concluded that the exchange with the SEC did not support an inference that Regions was aware that its goodwill was impaired at the time its alleged misstatements.

Judge Kaplan reached a similar conclusion with respect to the alleged insufficiency of Regions’ loan loss reserves, noting that the loan loss reserves are not a matter of objective fact, but rather were statements of opinion. He noted that the complaint is "devoid of any allegation that the defendants did not truly hold those opinions at the time they were made public."

Discussion

The difference in outcome of these two dismissal motion rulings is largely a reflection of the fact that the two courts were engaged in significantly different exercises. The Alabama court was determining only whether or not the requirement for pre-suit demand was excused based on the circumstances alleged.

Judge Kaplan was not only examining the legal sufficiency of the allegations, but he was also considering whether or not the complaint met the specific legal requirements for the specific claims alleged.

But the difference between these two opinions reflects more than the difference in the precise questions before the respective courts.

The two opinions also reflect strongly different starting points. Judge Vance in the Alabama case took it as a given that the residential real estate marketplace was rapidly deteriorating during the relevant time period, and that the deterioration was a relevant consideration. Judge Vance also considered the SEC’s letter relevant to whether or not the company’s financial statements were misleading due to the company’s delay in recognizing the impairment of the goodwill.

Judge Kaplan’s analysis seems to suggest that that these external considerations were irrelevant, and the only consideration was whether or not the offering documents accurately reflected management’s opinion about goodwill.

Judge Vance was, of course, concerned with a broader period of time and a broader range of communications than was Judge Kaplan. And unlike the plaintiffs in the securities fraud lawsuit before Judge Kaplan, the plaintiffs in the derivative lawsuit had expressly alleged knowing or reckless misrepresentation. Because the claims before Judge Kaplan were asserted under the ’33 Act, the plaintiffs in that case had not alleged knowing or reckless misrepresentation.

Accordingly, it might be asserted that the differences between the two opinions are simply a reflection of the differences in the facts alleged and the substantive difference in the claims asserted. That assertion might even be true. However, I find it very hard in reading these two opinions not to conclude that these opinions are best explained by the differences in the two Judge’s starting points. For Judge Vance, it was all about the external context. For Judge Kaplan, the context is irrelevant.

Just to round out the picture here, it is worth noting that in a March 9, 2010 order (here), Western District of Tennessee Judge Samuel H. Mays, Jr. denied the motion to dismiss in the Regions Financial subprime-related ERISA class action lawsuit. On the one hand you might say that this is yet another decision relating to the same set of circumstances, but it could also be argued that the ERISA plaintiffs have alleged a substantially broader array of misrepresentations. At a minimum, you can say that the dismissal motion rulings in the subprime-related cases involving Regions Financial Corp. are basically all over the map.

Once final note is that Judge Vance’s ruling may be significant due to the fact that it is a higher-profile subprime related derivative suit in which the complaint survived the initial motions to dismiss. This outcome stands in contrast to prior rulings in subprime-related derivative suits – for example, in the Citigroup derivative lawsuit (about which refer here) and AIG derivative lawsuit (refer here). Based on these rulings, a perception has been growing the plaintiffs are struggling in these cases.

Judge Vance’s holding that demand in this case is excused is a potentially significant holding, although its impact is likely to be limited both due to the somewhat case specific facts (including in particular the SEC’s June 2008 letter inquiry), and due to the fact that the ruling is the product of an Alabama state court applying Delaware law. These factors may restrict the impact of the case.

Nevertheless the May 6 order does represent an example where plaintiffs were able to overcome the challenging initial hurdles involved in shareholders’ derivative litigation.

I have in any event added the two Regions-related rulings to my running tally of subprime-related dismissal motions rulings, which can be accessed here.

Special thanks to several loyal readers for providing me with copies of the various Regions Financial rulings. .

E*Trade Subprime Securities Suit Dismissal Motion Ruling Denied: And speaking of subprime-related securities lawsuits in which the dismissal motions were denied, in another order dated May 10, 2010 (here), Southern District of New York Judge Robert Sweet denied the defendants' motion to dismiss in the subprime related securities suit pending against E*Trade and certain of its directors and officers.

As reflected in greater detail here, the plaintiffs had first filed their securities actions against E*Trade in October 2007, alleging that the company had failed to disclose deterioration in its mortgage and home equity loan portfolio. The defendants moved to dismiss, arguing among other things that the company's losses were the result of a "worldwide economic catastrophe" and the plaintiffs' claims were nothing more than "fraud by hindsight."

In denying the defendants' arguments, Judge Sweet rejected this "global meltdown" arguments saying that "because the issue in this action is what the Defendants knew and when they knew it, a securities violation has been adequately alleged." 

Andrew Longstreth's May 12, 2010 Am Law Litigation Daily article about the dismisal motion ruling in the E*Trade case can be found here. I have also added the E*Trade ruling to my running tally of subprime lawsuit dismissal motion rulings.

Reflection: Judge Vance is the eldest son of Robert Smith Vance, who served as a United States District Circuit Judge, first in the Fifth Circuit and later in the Eleventh Circuit. The elder Judge Vance is one of the few federal judges to be assassinated as a result of his judicial service. Judge Vance was killed by a mail bomb in 1989. Prosecutors later concluded that the bomb had been sent by a convicted criminal upset because the Eleventh Circuit had refused to expunge the conviction.

In memory of Judge Vance, the name of federal building and courthouse in Birmingham, Alabama as been changed to the Robert S. Vance Federal Building and United States Courthouse.

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

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

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

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

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

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

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

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

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

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

Second, Regions has also been hit with a lawsuit filed under ERISA on behalf of its participants in the Regions defined contribution plan. A copy of the complaint can be found here. The complaint alleges that the offered plan participants Regions stock and investment options in Regions Morgan Keegan funds “when it was imprudent to do so.” The complaint also alleges that the investment in Regions stock and the Regions Morgan Keegan funds was maintained “when it was no longer prudent to do so.”  The complaint alleges that the defendants knew or should have known that these investments were imprudent because of Regions and the funds heavy investment in or vulnerability to subprime mortgage investments, loans and securities. The complaint also alleges that the defendants failed to communicate the risks of investing in the plan and also failed to communicate conflicts of interest.

As noted on my running tally of subprime related litigation (which can be accessed here), with the addition of the Regions ERISA litigation, my running tally of subprime-related ERISA lawsuits now stands at 11.

I have not been keeping a running tally of subprime-related derivative litigation (basically because the primarily state court oriented litigation is hard to track), but there has been substantial subprime related derivative litigation, involving, among others, Bear Stearns, American International Group, and Countrywide.

Special thanks to alert reader Rob Lichenstein for the links to the two Regions lawsuits and the Birmingham News article.

About the Bear Stearns Deal: If as I do you find many of the articles discussing the updated Bear Stearns deal confusing, you will want to read a couple of interesting posts on the Conglomerate blog, that provide insight into a couple of points about the revised deal that have received significant press attention.

First, there has been a great deal of discussion in the press about the possibility that the improved buyout offer may have resulted in part from drafting errors in the initial deal documents. BYU law professor Gordon Smith deconstructs this issue in a detailed Conglomerate blog post here (here), with helpful citations and cross-references to other blogs. Smith’s analysis of the differences between the original and the revised deal documents raise some interesting questions about what J.P. Morgan seems to have sought by offering revised terms. Bottom line, in exchange for the improved merger price, J.P. Morgan has eliminated the provisions that would have kept the deal open for a full year, and also obtained a 39.5% ownership interest as a means to try to ensure that the deal is concluded.

Second, and with respect to that 39.5% ownership interest transfer, Smith has a separate post on Conglomerate (here), that explores the Delaware case law behind the 39.5% interest and the limitations on share transfers to lock in shareholder merger approvals. As Professor Smith’s post notes, there is no automatic cutoff under Delaware law whereby a company can sell up to 40% of itself without shareholder approval, and suggestions to that effect in the mainstream media are “what is known in the law biz as ‘wrong.’” Practitioners have evolved the 40% rule of thumb, but “none of this has been tested in court.”

More About the FCPA: Regular readers know that I have frequently commented (most recently here) on the growing importance of Foreign Corrupt Practices Act enforcement proceedings and follow on civil litigation. Two recent publications provide significant additional information on this topic.

First, a March 25, 2008 Law.com article entitled “Today, No Bribe is Too Small” (here), takes a look at the expanding reach of enforcement activities. As the title suggests, the article looks at some seemingly small corrupt transactions that have attracted regulatory attention. The article states that “it seems that no bribe is too small to earn the attention of the department.” The article also focuses on regulatory actions that have been taken by middlemen and third party contractors, and how those seemingly remote actors’ actions have come back to haunt the sponsoring company.

Second, in a much more detailed look at recent FCPA enforcement activity, Porter Wright attorney Tom Gorman has recently posted a running series on the issues involved in recent FCPA regulatory actions on his SEC Actions blog. The most recent post can be found here. Taken collectively, these posts present an excellent overview of the current state of FCPA regulatory actions.

Finally, readers who recall my recent post (here) about the civil litigation arising from potentially problematic activities involving Alcoa’s operations in Bahrain will be interested to note that the U.S. Department of Justice has initiated a criminal investigation of the activities, and in that connection has asked for the entry of stay in the civil proceedings,  as discussed in a March 21, 2008 Wall Street Journal article entitled “U.S. Opens Alcoa Bribery Probe” (here).

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