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

As noted in a prior post (here), trial in the Vivendi securities class action lawsuit began last week in the Southern District of New York. Thanks to the AmLaw Litigation Daily (here), the transcript of the opening arguments in the case are available here. The opening statements make for some interesting reading in and of themselves, and there are already a number of critical observations that may be made about this case.

Background

This case involves the financial impact on the company from the $46 billion December 2000 merger between Vivendi, Seagram’s entertainment businesses, and Canal Plus. The plaintiffs contend that as a result of this and other debt-financed transactions, Vivendi experienced growing liquidity problems throughout 2001 that culminated in a liquidity crisis in mid-2002, as a result of which, the plaintiffs contend, Vivendi’s CEO Jean-Marie Messier and CFO Guillaume Hannezo were sacked.

The defendants in the case include the company, Messier and Hannezo. The plaintiffs contend that the between October 2000 and July 2002, the individual defendants misled investors by causing the company to issue a series of public statements "falsely stating that Vivendi did not face an immediate and severe cash shortage that threatened the Company's viability going forward absent an asset fire sale. It was only after Vivendi's Board dislodged Mr. Messier that the Company's new management disclosed the severity of the crisis and that the Company would have to secure immediately both bridge and long-term financing or default on its largest credit obligations."

Additional background regarding the case and the plaintiffs’ allegations can be found here.

A prior SEC enforcement proceeding against the company and the two former officers resulted, according to the SEC’s December 23, 2002 press release (here), in "Vivendi's consent to pay a $50 million civil money penalty. The settlements also include Messier's agreement to relinquish his claims to a €21 million severance package that he negotiated just before he resigned his positions at Vivendi, and payment of disgorgement and civil penalties by Messier and Hannezo that total over $1 million."

The Opening Statements

The lawyers making the opening statements on October 6, 2009 were: for the plaintiff class, Arthur Abbey of the Abbey, Spanier Rodd & Abrams firm; for Vivendi, Paul Saunders of Cravath, Swaine & Moore; for Messier, Micheal Malone of King & Spaulding; and for Hannezo, Martin Perschetz of Schulte, Roth & Zabel. The available transcript covers only the statements on the first day of trial, and does not include Perschutz’s opening argument, which took place the morning of the trial’s second day, so I have not discussed his opening argument below.

In his opening statement, Abbey tried to reduce the case to three points:

Number one, we are going to show you that Vivendi had growing problems during 2001 and the first half of 2002...and the problems that they had were with a thing called liquidity. Number two, they didn't tell the truth about those problems....And the third thing that we will prove is that in the middle of 2002, the truth about Vivendi's liquidity condition finally came out, and when that happened, unfortunately for my clients, the stock price fell and the investors that we represent suffered great losses. In a nutshell, that is why we are here today--a growing problem, failing to tell the truth, and then, like every lie, it finally comes out.

The overall theme of the plaintiffs’ case is that the defendants portrayed the company one way publicly, but another way internally:

Publicly, and I can’t stress this enough, defendants portrayed Vivendi as strong, healthy, and growing. They continuously downplayed the risks, the warnings, and they told the investing public how successful Vivendi was and would be in the future. But inside the company, behind the closed doors at Vivendi, the defendants were acknowledging a far different truth.

Among other things, Abbey referred to a "book of warnings" Hannezo supposedly compiled for the new CEO after Messier’s departure from Vivendi, which Abbey characterized as a collection of documents showing various forewarnings and admonitions Hannezo had send Messier and others about the company’s growing liquidity risks. Abbey read to the jury one note that Hannezo wrote to Messier at the end of 2001 following a meeting Hannezo had had with the rating agencies, in which Hannezo said "he felt like he was sitting in the death seat of a car that was accelerating in a sharp turn, and he didn't want it to all end in shame." Abbey emphasized that while Hannezo had been communicating these warnings internally, they were not communicated to investors.

Abbey also argued in his opening that the company was under pressure to meet EBIDTA goals, and he further argued that the company was only able to report that it had met these goals by using, accounting adjustments (Abbey cited internal Vivendi documents referring to "accounting magic"), particularly "purchase accounting." Abbey told the jury that Vivendi never told investors the significant impact purchase accounting had on Vivendi’s reported results. He argued further that while use of accounting adjustments allowed the company to continue to report that it had met EBIDTA goals, the noncash adjustments did not help the company with its liquidity problems.

In support of the plaintiffs’ contentions, Abbey also referred to documents the company had filed in its severance dispute with Messier, in which the company supposedly said that Messier had driven the company "to the brink" yet had failed to disclose the problems to the company’s board.

Saunders, on behalf of Vivendi, argued that, contrary to the plaintiffs’ allegations about the company’s supposed liquidity problems, the company always had enough cash and credit to pay its bills, and in fact did pay all of its bills. He also argued that, contrary to the plaintiffs’ arguments that the defendants had misled investors, the company never had to restate its financials, even after new management came in. Saunders also emphasized that within days of his arrival, the new CEO completed a financing of over $1 billion, which, Saunders argued, demonstrated that even at the peak of the supposed crisis the company had sufficient resources (including credit) to pay its bills.

Saunders also argued that far from representing anything sinister, the company’s use of "purchase accounting" was only entirely appropriate, it was in fact required as a result of the three-way merger.

Saunders conceded that the company did have difficulties during the class period, but largely as a result of the September 11 tragedy and the following decline in economic activity (particularly at the company’s theme park properties). In that regard, he compared Vivendi’s stock price decline to the stock graphs of companies that the plaintiffs’ own expert had said were comparable, and that the stock graphs were virtually indistinguishable.

Finally, Saunders explained the two individuals’ departures from the company as a result of disagreements over the strategic steps the company should take in response to the business challenges it was facing, including a dispute between the board and Messier over whether Vivendi should sell its heirloom French water utility business.

Malone, arguing on behalf of Messier, contended that the plaintiffs’ case depended entirely on discrete "snippets" take out of context from a wide variety of documents, but that when the statements were put back in context, they show only the ordinary activities of business people struggling to deal with day to day business challenges. Malone emphasized the case is not about whether or not the company had problems or even about whether or not there were errors of judgment, but only about whether or not there had been an intentional effort to mislead investors.

Malone also emphasized that when Messier exercised stock options at the end of 2001, he invested all of the proceeds in Vivendi shares, and even took out a bank loan to buy additional shares. Messier also invested his entire April 2002 bonus in Vivendi shares, and indeed, within days of leaving Vivendi, Messier invested even more in Vivendi shares. Malone argued that Messier never sold a share, and that when Vivendi’s share price collapsed, no individual lost more than Messier.

Observations

Though the transcript only represents the arguments of counsel and not the actual presentation of evidence, a number of themes clearly emerge.

First, this case will be complex and will require the jury to grapple with a host of daunting technical terms and concepts. Just in his opening, Abbey referred to EBIDTA; purchase accounting; debt service; noncash earnings; nonoperational accounting entries; free cash flow; liquidity; and dividends. Saunders referred to negative cash flow; generally accepted accounting principles; and market capitalization. Malone referred to options exercises; hedging and hedging transactions; and tax advantages.

It is not that juries are incapable of figuring out these kinds of things. The problem is that these kinds of things put an enormous burden on the lawyers, the witnesses and the court to keep things clear; to avoid letting the trial get bogged down in technical minutiae; and making sure the jury it neither confused nor bored to death.

Second, much has been made (for example, here) of the fact that this Vivendi case is so unusual because it is the first "f-cubed" case to go to trial – that is, it involves claims against a foreign-domiciled company by foreign claimants who bought their shares on foreign exchanges. Whatever else might be said about whether or not f-cubed cases ought to be heard in U.S courts, it is clear just from the attorneys’ opening statements that there are serious challenges involved in attempting to put on one of these cases in a U.S. court. All of the lawyers wrestled with problems, for example, involving currency conversions and language translations. Abbey in particular seemed to experience embarrassment and discomfort using French names and phrases. The lawyers also warned that much of the testimony and many of the documents are in French for which the jury would be given English translations.

In addition, the opening statements also showed the complications that will arise from differing accounting systems, different account practices and standards, and different accounting conventions.

Third, all of the lawyers’ opening statements underscore the problems any plaintiff would face when large unrelated but material events – such as the 9/11 tragedy and the dot-com crash – happened at the same time as the supposed events of which the plaintiffs were complaining. Abbey tried to anticipate these issues and explain the plaintiffs’ theory of how these events should be understood in the context of the plaintiffs’ case. The defense counsel, for their part, showed that the defendants will argue that the challenges the company faced can only be understood within the context of these external events, which are, the defense counsel contend, among the root causes of the company problems involved in the case.

The parallel to the challenges facing the plaintiffs in the current round of subprime and credit crisis-related cases is unmistakable. The plaintiffs in these more recent cases will face the same challenge of attempting to explain how company-specific rather than marketplace-wide developments led to the defendant companies’ problems.

The final observation from a reading of the transcript is that the trial of a complex matter like a class action securities case is an elaborate, time-consuming, pain-staking exercise that could quickly become mind-numbingly tedious. Just judging from the opening statements, the jury could be in for a very long slog. One can only imagine how the jurors’ hearts sank when they heard Messier’s counsel tell them in his opening statement that "this trial will go on for months."

Nor will the verdict of this jury bring an end to this matter. Not only will there likely be further proceedings in this case, but as a result of the court’s class certification ruling in this case excluding Austrian and German investors from the plaintiff class, this case may only be the first of the trials in this matter. As reported in an October 7, 2009 article in the Telegraph (here), the defendants could face a "second trial" brought on behalf of European investors excluded from the plaintiff class in the Southern District of New York. (Hat tip to the 10b-5 Daily, here, for the Telegraph article link).

In my earlier post about the Vivendi trial, I noted how rare trials are in securities class action lawsuits. In an October 8, 2009 post (here) on his Enforcement Action blog, Bruce Carton (also the author of the Securities Docket blog), interviewed Adam Savett of the Securities Litigation Watch blog. In the brief interview, hosted on the Enforcement Docket site, Savett reviews statistical data regarding the prior securities cases that have gone to trial, and discusses why trials in these cases are so rare. He also discusses the significance of the presence of the f-cubed claimants.

They’re a Page Right Out of Hist-oh-Ree: Even allowing for the fact that The Flintstones show was set in the Stone Age, the program advertisement linked below still seems deeply primitive. Clearly, prehistoric peoples had a longer attention span, as the commercial seems almost movie-length compared to its more modern counterparts.

And even allowing for the time lapse since those long ago days, the advertisement’s politically incorrect premise and tobacco-related message seem vestiges of a culture completely unrelated to our own.

Finally, the way that Fred and Barney are sneaking around together and hiding from their wives, you do start to wonder whether the final line in the show’s theme song lyrics implied more than might originally have been suggested.

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When the various broker dealers and investment banks recently announced their agreements with government regulators to buy back auction rate securities, the announcements raised questions about the continuing need for the pending auction rate securities litigation. But, at least based on a recently filed lawsuit, it now appears that the settlements may have opened the door for a whole new round of securities litigation related to the settlements themselves.

On October 3, 2008, plaintiffs’ lawyers initiated a securities class action lawsuit in New York (New York County) Supreme Court on behalf of investors who purchased bonds and preferred securities in various offerings conducted pursuant to Merrill Lynch’s March 31, 2006 shelf registration. A copy of the complaint can be found here. The complaint, which asserts claims under Sections 11, 12 and 15 of the ’33 Act, names as defendants Merrill Lynch and related entities; certain current and former Merrill Lynch directors and officers; the underwriters that conducted the various offerings; and Merrill Lynch’s auditor.

The complaint alleges that the offering documents "misstated Merrill’s financial condition and failed to disclose that the Company bore massive exposure to losses from investments tied to subprime and other mortgages, and was responsible for significant liability arising from its participation in the market for auction rate securities (ARS). Further Merrill improperly valued mortgage-backed assets on its books, and failed to account for its contingent obligations in the ARS market."

The complaint alleges that as a result of later disclosures about the company’s "true financial condition," the value of the securities sold in the referenced offerings declined materially. The complaint specifically refers to, regarding the company’s true financial condition, Merrill Lynch’s August 7, 2008 announcement (here) that "it would repurchase $12 billion in ARS from investors due to the failure of the ARS market."

Merrill Lynch previously was the target of what I will call a "conventional" auction rate securities lawsuit. Background regarding this prior lawsuit can be found here and regarding the prior auction rate securities lawsuits generally can be found here.

This new Merrill Lynch lawsuit complaint differs from the prior conventional auction rate securities lawsuit in a variety of ways. The most important distinction is who is represented in the plaintiff class. The prior auction rate securities lawsuits were brought on behalf of auction rate securities investors – that is, the people who bought the actual auction rate securities. The plaintiffs in the Merrill Lynch lawsuit are not persons who bought auction rate securities, but who bought Merrill Lynch’s own securities in the referenced offerings.

The misrepresentations alleged are different as well. In the conventional auction rate securities lawsuits, the allegation is that the risks of the auction rate securities were insufficiently disclosed. In this new lawsuit, the allegation is not about the risks of auction rate securities themselves, but rather that Merrill Lynch did not disclose its own susceptibility to contingent liability in connection with its issuance or sale of the auction rate securities.

One other peculiarity of the prior auction rate securities lawsuits is that those suits generally did not name any individual defendants. The new Merrill Lynch complaint names a couple of dozen individual defendants, as well as several dozen offering underwriters.

Given the number and identities of the various defendants, this lawsuit will keep a lot of lawyers employed for a long time. Among the preliminary issues on which the lawyers will be engaged is the court’s subject matter jurisdiction. The plaintiffs elected to file their lawsuit in state court pursuant to the concurrent jurisdiction provisions in Section 22 of the ’33 Act. The defendants undoubtedly will seek to remove the lawsuit to federal court, and the plaintiffs in turn will seek to have the case remanded to state court.

As I noted in a prior post (here), the Ninth Circuit recently upheld the decision of the district court in the Luther v. Countrywide case to remand a ’33 Act case back to state court, where it originally had been filed before being removed to federal court. However, as the 10b-5 Daily blog recently noted (here), a judge in the Southern District of New York refused to remand New Jersey Carpenters Vacation Fund v. Harborview Mortgage Loan Trust, which had been removed to federal court. Among other things the court in the Harborview case held that the provisions of the Class Action Fairness Act trumped the jurisdictional provisions of the ’33 Act.

In view of the fact that the new Merrill Lynch case likely will be remanded to the Southern District of New York (the same court in which the Harborview case is pending), it will be interesting to see whether the plaintiffs are able to have the case remanded back to the New York state court where they initially filed the new Merrill Lynch complaint.

As I have previously noted, along with the question whether or not a ’33 Act case properly can be removed to federal court is the more practical question of why the plaintiffs want to proceed in state court in the first place. Some day someone will explain to me why the plaintiffs’ bar suddenly has developed this fascination with pursuing ’33 Act claims in state court. Is it, as I have supposed, an effort to circumvent the procedural requirements of the PSLRA?

In any event, I have added the new Merrill Lynch complaint to my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here. With the addition of the new lawsuit, the current tally now stands at 125, of which 85 have been filed in 2008. Of these, 21, including the new Merrill Lynch lawsuit, are auction rate securities lawsuits.

Motion to Dismiss Granted in Subprime Securities Lawsuit: On September 29, 2008, Judge John Steele of the Middle District of Florida granted the defendants’ motion to dismiss, without prejudice, in one of the more unusual subprime related securities lawsuits. A copy of the opinion can be found here.

As detailed here, the plaintiffs allege that the defendants (First Home Builders of Florida and two residential real estate brokerage firms, as well as successor entities), in violation of the federal securities laws, had fraudulently induced plaintiffs to purchase real estate investment properties by promising that defendants would procure lease-to-own tenants for the investors’ properties; that the tenants rental payments would cover all of the investors’ out-of-pocket costs; and that investors would receive a guaranteed 14% return on the investment in the first year.

Judge Steele granted the defendants’ motion to dismiss, ruling that as a result of the plaintiffs’ failure "to allege who made what misrepresentations," the plaintiffs’ fraud allegations failed to meet the pleading requirements of Rule 9(b). Judge Steele declined to rule on the plaintiffs’ group pleading theory. He allowed plaintiffs 30 days to file an amended complaint.

I have added the First Home Builders of Florida dismissal to my table of subprime and credit crisis-related lawsuit case dispositions, which can be accessed here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) both for the Merrill Lynch complaint and for the opinion in the First Home Builders of Florida case.

Note from Ohio: I want to know how the Saturday Night Live scriptwriters managed to get the whole  "Joe the Plumber" schtick inserted into tonight's actual Presidential debate. But the one thing I do know is that after tonight's debate, my fellow Ohioan, Joe the Plumber, is moving to Canada, where he will be left in peace because their national election is already finished.

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

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

According to the press release, the complaint alleges that

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

The complaint specifically alleges that: 

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

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

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

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

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

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

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

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

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

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Earlier this week when I posted my list of subprime lawsuits dismissal motion grants and denials (here), I was hoping the publication would encourage readers to let me know about case dispositions of which I was previously unaware. My strategy worked, because a loyal reader who prefers anonymity responded to my post by alerting me to the May 19, 2008 opinion (here) in the subprime-related securities class action lawsuit involving Standard Pacific. Because the court’s opinion is particularly thorough, it merits a detailed review.

Standard Pacific is a California-based residential construction company that concentrated in recent years on the formerly go-go growth areas of California, Florida, Texas and Nevada. As s result of the residential real estate slump, the company’s sales activity declined in 2006 and 2007. Plaintiff shareholders initiated a securities class action lawsuit against two Standard Pacific executives in August 2007.

The plaintiffs alleged that the defendants misrepresented Standard Pacific’s ability to open new, successful communities; misled the public about the demand for Standard Pacific homes; and lied about the company’s ability to continue its historically strong earning growth. Further background regarding the lawsuit can be found here.

In a May 19, 2008 opinion, Judge Margaret M. Morrow of the United States District Court for the Central District of California granted the defendants’ motion to dismiss, but allowed the plaintiffs’ 45 days’ leave to amend.

The defendants first argued that the plaintiffs’ complaint failed to satisfy the PSLRA’s pleading requirements because it is a “classic example of prohibited puzzle-pleading,” in that it contains extensive block quotations from the company’s class period statements “without specifying the particular statements that are false and misleading.”

The plaintiffs sought to address this issue in their reply papers, but the court found that “the organization the plaintiffs offer in their opposition brief does not cure the deficiencies in the complaint. To the contrary, it highlights plaintiffs’ failures to plead defendants’ purportedly false and misleading statements with specificity as required by the PSLRA,” and accordingly the court granted the motion to dismiss, with leave to amend.

The defendants also moved to dismiss on the grounds that the plaintiffs had not adequately pled scienter. The plaintiffs alleged, based on the confidential witness information, that defendants misled investors because they continued to cite sales information in reliance on internal reports they supposedly knew to be inaccurate. Defendants contended that, to the contrary, they informed investors that the company was experiencing sales declines, and that “the crux of plaintiffs’ fraud claim is not that the defendants flatly misrepresented the company’s performance but that they were deliberately reckless because the failed to lower their projections enough.”

The court found that

the fact that defendants reduced earnings and home delivery guidance cuts against plaintiffs’ claim that defendants acted with fraudulent intent. As no facts are pled supporting an inference that defendants selected the level of reductions they announced fraudulently or with deliberate recklessness, the complaint suggests a plausible nonculpable explanation for defendants’ conduct…. Taken as a whole…plaintiffs’ allegations do not give rise to a “strong inference” that at the time they made the statements, defendants knew or should have known that the state of affairs was much worse than they had acknowledged publicly….In effect, by arguing that defendants’ predictions and forecasts were not low enough, plaintiffs improperly attempt to allege “fraud by hindsight.”

The court similarly rejected the plaintiffs’ attempt to rely on the defendants’ certifications of the company’s SEC filings.

The dismissal, even though it is without prejudice, is still significant. First, the opinion is very detailed and thorough, which could carry some weight in other subprime securities cases, particularly the numerous other cases pending in the Central District of California.

Second, many of the other subprime complaints arguable share the “puzzle pleading” defect of the complaint in this case – all too often, the complaints in these subprime cases consist of block quotations from the defendants company’s disclosure documents, without direct connections specifying what about the disclosure the plaintiffs allege is false and misleading, and in what way the statements are false and misleading.

Third, many of the companies named in subprime securities lawsuits, like Standard Pacific, are accused not of failing to acknowledge problems but of failing to recognize the problems enough. To the extent other courts view these pleadings with the same level of skepticism as Judge Morrow, the complaints could face some formidable challenges at the motion to dismiss stage.

In any event, I have added the Standard Pacific opinion to the list of subprime lawsuit dismissal motion grants and denials. I hope other readers will let me know of any other subprime lawsuit dismissal motion rulings of which they are aware, so that the list can be as complete as possible.

Special thanks to the anonymous loyal reader for alerting me to the Standard Pacific opinion.

Another Option ARM Lawsuit: In a different post earlier this week (here), I noted the lawsuits that had been filed up to that point relating to Option ARM mortgages, and I suggested the likelihood that there would be further lawsuits relating to Option ARMs. In a quick confirmation of my prediction, on June 11, 2008, plaintiffs’ counsel initiated a securities class action lawsuit in the Central District of California against IndyMac Bancorp and certain of its directors and officers. A copy of the plaintiffs’ lawyers’ June 11 press release can be found here. A copy of the complaint can be found here.

According to the press release, the complaint alleges that

defendants issued materially false and misleading statements regarding the Company’s business and financial results. Specifically, defendants downplayed and concealed IndyMac’s growing exposure to non-performing assets, particularly loans in its pay-option adjustable-rate mortgage (“Option ARM”) and homebuilder construction portfolios, and made numerous positive representations regarding the Company’s capital position to alleviate investors’ fears concerning the Company’s capital erosion. As a result of defendants’ false statements, IndyMac stock traded at artificially inflated prices during the Class Period.

It is important to note that IndyMac had previously been sued in a subprime-related securities class action lawsuit, the background regarding which can be found here. In concluding that this latest lawsuit is sufficiently distinct from this prior lawsuit to represent a new lawsuit, I note the following: first, the class period of the prior lawsuit was May 4, 2006 to March 1, 2007, whereas the purported class period for the new lawsuit is from August 16, 2007 to May 12, 2008. In addition, the substantive allegations in the two lawsuits relate to different alleged misrepresentations. In particular, the prior lawsuit does not appear to relate to the companies representations regarding Options ARM mortgages or the company’s capital position.

Accordingly, I am recognizing this latest complaint as a new and separate filing. However, I encourage readers who may disagree to let me know of any circumstances that might militate in favor of a different conclusion.

I have added the new IndyMac lawsuit to my running tally of subprime and credit-crisis related securities lawsuits, which can be found here. With the addition of the new IndyMac lawsuit, the tally of subprime and credit crisis-related lawsuits now stands at 90, of which 50 have been filed in 2008.

Finally, it is worth noting that, as reflected in my list of subprime dismissal motions grants and denials referenced above that motion to dismiss have twice been granted with leave to amend in the prior IndyMac lawsuit.

More Subprime ERISA Lawsuits:  I have also added two subprime-related ERISA lawsuits to my running tally of subprime-related lawsuits.

First, in a June 11, 2008 press release (here), plaintiffs’ lawyers announced that they had initiated a lawsuit in the Southern District of New York under ERISA against Wachovia Corporation and various of its officers and administrators. According to the press release, the defendants allegedly violated their duties to participants in the Wachovia Savings Plan by “continuing to invest in and hold Wachovia stock despite the fact that they knew or should have known that Wachovia was not properly reporting its financial condition and was not disclosing significant problems which had the effect of inflating the value of Company stock.”

Second, on May 9. 2008, plaintiffs’’ counsel initiated a lawsuit in the Western District of Tennessee on behalf of past and present employees of First Horizon National Corporation who participated in the First Horizon Savings Plan. A copy of the complaint can be found here. The complaint alleges that the defendants breached their fiduciary duty by requiring plan participants to invest in First Horizon shares, which the plaintiffs contend was “imprudent… because First Horizon was not fairly and accurately disclosing the risks and likely consequences of a number of its banking practices such that the Plan was purchasing shares of First Horizon Stock at an inflated price.” Among the undisclosed risks alleged is the company’s exposure to subprime and Alt-A mortgages.

I have added the Wachovia and First Horizon ERISA lawsuits to my running tally of subprime-related ERISA lawsuits, which can be found here. With the addition of the new ERISA lawsuit, the tally of subprime-related ERISA lawsuits now stands at 17

Special thanks to a loyal reader for identifying the new ERISA lawsuits.

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We knew it was coming but it sure got here fast. On March 17, 2008, plaintiffs’ counsel initiated a securities class action lawsuit in the United States District Court for the Southern District of New York against Bear Stearns and certain of its directors and officers. A copy of the plaintiffs’ lawyers’ press release can be found here, and the complaint can be found here.

According to the press release, the complaint alleges that during the class period between December 14, 2006 and March 14, 2008, defendants issued false and misleading statements, as a result of which “Bear Stearns stock traded at artificially inflated prices … reaching a high of $159.36 per share in April 2007.” The press release further states that:

In late June 2007, news about Bear Stearns’ risky hedge funds began to enter the market and its stock price began to fall. On March 10, 2008, information leaked into the market about Bear Stearns’ liquidity problems, causing the stock to drop to as low as $60.26 per share before closing at $62.30 per share. On March 13, 2008, news that Bear Stearns was forced to seek emergency financing from the Federal Reserve and J.P. Morgan Chase hit the market and Bear Stearns stock fell to $30 per share. Then, on Sunday, March 16, 2008, it was announced that J.P. Morgan Chase was purchasing Bear Stearns for $2 per share. By midday on Monday, March 17, 2008, Bear Stearns stock had collapsed another 85% to $4.30 per share on volume of 75 million shares.

The press release states that the defendants’ statements during the class period “due to defendants’ failure to inform the market of the problems in the Company’s hedge funds due to the deteriorating subprime mortgage market, which would cause Bear Stearns to have to rescue the funds, cause the Company and its officers possible criminal liability and hurt the Company’s reputation.”

The principals at JP Morgan clearly anticipated this development. According to a March 17, 2008 Law.com article (here), JP Morgan is “setting aside $6 billion to cover potential litigation” as well as other transaction and severance costs arising out of JP Morgan’s acquisition of Bear Stearns JP Morgan’s own March 16 press release (here) announcing the transaction does not mention any reserve or set aside for transaction expenses, but the March 18, 2008 Wall Street Journal (here) also says that “J.P. Morgan plans to set aside about $6 billion in reserves to cover the potential exposure and other costs.”

(Perhaps it is an idle thought but one does wonder why the $6 billion was not applied directly to the acquisition price. …)

Yet another possibility that may yet arise is that individual Bear Stearns investors might choose to pursue their own litigation separately. According to the March 17, 2008 Wall Street Journal (here), there are individual investors whose losses from the Bear Stearns collapse approach $1 billion. According to the March 18, 2008 Wall Street Journal (here), “billionaire investor Joseph Lewis, one of Bear Stearns's biggest shareholders, with a 9.4% stake, rejected [J.P. Morgan’s] offer, saying it doesn't represent the true value of Bear Stearns. Mr. Lewis, though a spokesman, said the offer ‘is derisory, and I do not believe that shareholders will approve it.’” Certainly individual losses of that magnitude, if nothing else, raise the possibility of their proceeding on their own rather than as part of a larger shareholder class.

Update: According to news reports (here), an action has also been filed against Bear Stearns and its executives on behalf of Bear Stearns employees alleging that they "breached their fiduciary duties to plan participants by allowing their retirement savings to be invested in the company's stock despite knowing such an investment was imprudent."  The complaint alleges that the investment bank failed to disclose material adverse facts regarding its financial well-being, the potential consequences of its "substantial entrenchment in the subprime mortgage market," that the firm's stock price was artificially inflated and heavy investment of retirement savings in company stock would inevitably result in significant losses to the plan and its participants.

Securities Suit Against Deutsche Bank for Auction Rate Securities: On March 17, 2008, a different plaintiffs’ firm launched a securities lawsuit in the United States District Court for the Southern District of New York against Deutsche Bank and its wholly owned broker–dealer subsidiary, on behalf of a class of persons who purchased auction rate securities from Deutsche Bank and the broker dealer between March 17, 2003 and February 13, 2008, inclusive (the “Class Period”), and who continued to hold such securities as of February 13, 2008. A copy of the plaintiffs’ counsels’ press release can be found here and a copy of the complaint can be found here. 

According to the press release, the plaintiffs allege that the defendants violated the securities laws “by deceiving investors about the investment characteristics of auction rate securities and the auction market in which these securities traded.” The press release states that the defendants 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 Deutsche Bank and other broker-dealers were artificially supporting and manipulating the auction rate market to maintain the appearance of liquidity and stability; (3) Deutsche Bank 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) Deutsche Bank 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.

The auction rate securities purchasers’ lawsuit against Deutsche Bank is not the usual class action securities lawsuits brought against a publicly trade company by its own shareholders. The Deutsche Bank auction rate securities lawsuit is, however, subprime-related and it is a class action that alleges violations of the federal securities laws. For those reasons, I have added it to my running tally of subprime-related securities lawsuits, which can be found here. On a going forward basis, I will try to keep the parallel tallies too, taking into account the different kinds of litigation within the larger running tally.

With the addition of the Bear Stearns and Deutsche Bank securities lawsuits, the current tally of subprime-related securities lawsuits now stands at 51, twelve of which have been filed so far in 2008. Of these 51, two are securities lawsuits filed by mortgage–backed securities investors against the asset securitizers, and one (as noted above) was filed by purchasers of auction rate securities. The remaining 48 are more traditional securities class action lawsuits by public company shareholders.

Bear Ironies and Morgan Echoes: Bear Stearns shareholders can be forgiven if they fail to appreciate it, but there is a certain irony that Bear Stearns was the bailout recipient last Friday. This weekend’s whirlwind meetings involving the Fed and the lions of Wall Street present an uncanny echo of the closed door meetings at the New York Fed on September 23 1998, when government officials and Wall Street bankers were struggling to avert the collapse of Long Term Capital Management that all feared might trigger global financial panic. As colorfully told in the prologue of Roger Lowenstein’s excellent book about LTCM, When Genius Failed (here), the government’s rescue efforts nearly aborted because one Wall Street bank refused to cooperate in the government’s rescue plan - none other than Bear Stearns, whose then CEO and current Chairman James Cayne refused to play along.

This past weekend’s events also harken back to an even earlier episode, one in which JP Morgan Chase’s founder and primary namesake played the central role. As described in Robert Bruner and Sean Carr’s readable recent book, The Panic of 1907 (here), a capital crisis that originated from a liquidity drain following the 1906 San Francisco earthquake culminated in October 1907 in runs on a series of New York banks. J.P. Morgan himself, in effect functioning as the central banker in the absence of any more formal institution, caused his firm to intervene to provide liquidity to the Trust Company of America, declaring, to his colleagues “This is the place to stop the trouble, then.”

A century later, his firm is once again playing a central role in an effort to avert a financial crisis, and while some may argue that an important difference is that in 1907 Morgan didn’t acquire any of the rescued banks, it is a fact that one of the steps Morgan took in 1907 was a U. S. Steel-led buyout of Tennessee Coal, Iron & Railroad Company, a move claimed at the time was designed to avoid a collapse that could have undermined the stock market. The TCI & R rescue efforts, for which he and his firm were later criticized and subjected to a congressional investigation, ultimately proved to be good both for the Morgan firm as well as for the financial markets.

UPDATE: CFO.com has an excellent March 18, 2008 article entitled "J.P. Morgan Returns to Its Rescue Roots" (here) going into much greater detail about J.P. Morgan's storied past.

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