The wave of subprime lending related lawsuits (which I am tracking here) continues to grow. On July 31, 2007, the Lerach Coughlin law firm sued beleaguered home lender American Home Mortgage Investment Corp. (press release here) in a securities class action lawsuit. The suit alleges that American Home is a REIT that engages in investment and origination of residential mortgage loans. The company (prior to its bankruptcy filing, about which refer here), originated residential home mortgages and sold mortgage loans to institutional investors. The complaint alleges that the Company failed to disclose increasing delinquency levels and difficulties in selling loans it originated, and overstated its financial results, in part by failing to write down the value of the troubled loans.
The prospective amplitude of the subprime lending litigation wave really lies in the potential for follow-on litigation, as the consequences from the subprime lending mess spread beyond mortgage lenders to other companies that did business with them. An example of the possibilities of this kind of litigation may be seen from the securities lawsuit filed on August 1, 2007 (refer here) against RAIT Financial Trust. RAIT is also a REIT that, among other things, provided debt financing options to the real estate industry. According to the plaintiffs’ lawyers’ press release, the complaint alleges that RAIT failed to disclose its “financial relationship” to American Home, a relationship that allegedly could involve a net exposure for RAIT of $95 million, an exposure for which RAIT allegedly failed to establish appropriate reserves. Upon RAIT’s July 31 announcement (here) that it did not receive its July 31 scheduled preferred securities payment from American Home, RAIT’s share price allegedly declined from approximately $16/share to approximately $10/share.
According to the running tally that I have been maintaining (here), the addition of these two new lawsuits brings the number of securities class action lawsuits against subprime lenders and related companies to six, in addition to the two securities class action lawsuits that have been brought against home builders. Although I have not been tracking the cases, there have also been a number of subprime lending related shareholder derivative lawsuits, in addition to the securities class action lawsuits; for example, on August 3, 2007, officers and directors of Countrywide Financial Corp. were sued in California state court (no link available) on grounds that the defendants breached their fiduciary duties by misleading investors about the company’s loan delinquency rate and preparedness for a downturn, while selling their personal holdings in company stock.
The suddenness of the spread of American Home’s misfortune, and the speed with which litigation followed not just against American Home itself but also against a company with which it had an investment relationship, shows the contagion potential of the subprime lending mess. Even though some savants have been proclaiming a permanent reduction in the level of securities class action lawsuits (refer here), it is the potential for exactly this kind of contagion dynamic that has led me to be skeptical that recent low securities litigation levels will prove to be permanent. I have long believed that the lower levels of securities class action activity were due in part to relatively benign economic and market conditions. Conditions have, however, changed. The strong possibility that other companies (not just subprime lenders) will suffer ill effects from the subprime mess and from restricted credit availability generally suggests that the contagion will continue spread, and as it does, other companies will find themselves the target of an increasingly broad wave of litigation activity. (An earlier post discussing the potential of the subprime lending litigation wave may be found here.)
Bull (Litigation) Market for Bear (Stearns): The potential reach of the subprime litigation wave may also be seen in the claim an individual investor filed last week against Bear Stearns Cos. and Bear Stearns Asset Management, alleging that the firms were misleading investors about their exposure to subprime mortgages. (A Washington Post article describing the claim can be found here.) The claim, which was filed with NASD (which is now part of FINRA), follows the collapse of two Bear Stearns hedge funds that invested in subprime mortgages and related instruments. The plaintiffs’ lawyer who filed the claim, Jacob Zamansky of Zamansky & Associates, is quoted as saying that he has been contacted by numerous investors and that “we expect to file claims in excess of $100 million in losses.”
According to the Courthouse News Service (here), Bear Stearns and several of its directors and officers have also been sued in a shareholders derivative suit in New York state court (link unavailable) on similar grounds.
Self-Reporting: I’m Chiquita Banana and I’ve Come to Say, One of Our Subsidiaries (Allegedly) Has Been Paying Off Terrorists in a Certain Way: In earlier posts (most recently here), I have discussed the increasing pressure on publicly traded companies to self-report regulatory violations, particularly violations involving improper foreign payments. An August 2, 2007 Wall Street Journal article (here) discusses circumstances involving Chiquita Brands International and the company’s problems following its self-reporting of payments that one of its subsidiaries allegedly made to a Columbian terrorist group.
According to the Journal, the current investigation “illustrates the recent posture taken by the U.S. authorities to prosecute aggressively even when companies turn themselves in for breaking the law.” The government’s aggressive posture may cause some companies, according to the Journal article, to think twice about self-reporting.
A very interesting commentary on the Chiquita Brands story appears on the Race to the Bottom blog (here). According to the blog’s August 6, 2007 post, Chiquita’s case is not “the usual case of a company discovering improper behavior, putting a stop to it, and self-reporting to the government.” Rather, the blog asserts, “this is a case that involves a fundamental breakdown in the system of corporate governance.” In particular, the blog notes (and details) that the existence of the payments “was apparently widely known among top management and allowed to continue.”
I should add that the Race to the Bottom blog, which is a joint effort of students and two professors from the University of Denver Law School, is an interesting and often provocative resource on corporate governance issues. I read it regularly and commend it to the attention of readers of The D & O Diary.
Speaker’s Corner: On August 13, 2007, I will be speaking at the 2007 American Bar Association Annual Meeting in San Francisco (about which refer here), at the ABA Section of Business Law session entitled “Representing the Public Company in Crisis: Current Developments in Securities Litigation and Government Investigations.” The session, which will be moderated by my friend Bill Baker of the Latham & Watkins law firm, and which will include Marc Fagel, who runs the enforcement program in the SEC’s San Francisco Office, and Barry Sabin, the Deputy Assistant Attorney General for the Criminal Division, will be held in the Fairmount Hotel Grand Ballroom from 10:30 am to 12: 30 pm. If you are planning on attending the ABA Annual Meeting, I hope you will attend our session and if you do I hope you will greet me and introduce yourself.
Bananas Have to Ripen in a Certain Way: For those readers too young to recall the iconic Chiquita Banana commercial alluded to above, here it is, for nostalgia’s (if not for art’s) sake. The commercial certainly has lots of useful banana-related advice, but it does neglect to mention the utility of avoiding making protection payments to terrorist organizations.