As the number of failed and troubled banks has surged, one recurring question has been whether the banks woes would lead to a new round of banking-related litigation. While a few lawsuits had emerged in connection with earlier bank failures (refer here), there really has been nowhere near the number of suits as might be expected from the number of trouble banks – until now, perhaps. The arrival of a couple of bank loan loss reserve lawsuits this past week, as well as other banking-related developments, raises the question whether the conjectured round of bank related lawsuits may now have begun.


First, on September 8, 2009, plaintiffs filed a securities class action lawsuit in the Central District of California against Pacific Capital Bancorp and certain of its directors and officers, as well as a stock analyst that follows the bank’s stock. According to the plaintiff’s counsel’s September 8, 2009 press release (here), the complaint alleges that the defendants misled investors by representing that:


that the Company was maintaining a strong allowance for loan losses which would enable it to absorb losses in its portfolio. As alleged in the complaint, defendants’ misstatements and omissions relating to Pacific Capital’s loan loss provision caused the Company’s common stock to trade at artificially inflated levels between April 30, 2009, when the Company reported that it maintained its loan loss provision at a very high level, through July 30, 2009, when the Company admitted that it had not adequately reserved for loan losses, had not applied a conservative reserve methodology, and needed to record an additional loan loss provision of $117 million. The "buy" rating issued by the analyst defendants on the Company’s common stock also contributed, as alleged, at certain times during the Class Period to the artificial inflation in the price of Pacific Capital stock.


Second, on September 11, 2009, plaintiffs filed a securities class action lawsuit in the Northern District of California against UCBH Holding and certain of its directors and officers. (UCBH Holding is a bank holding company for United Commercial Bank, a California-state chartered bank with its headquarters in San Francisco, refer here.) According to the plaintiffs’ lawyers’ September 11, 2009 press release (here), the complaint alleges:


UCBH knowingly falsified its financial statements by concealing the rising level of loan losses and non-performing loans through a series of improper accounting tricks and outright deception of regulators and auditors. On September 8, 2009, UCBH announced that its Chairman and CEO, Thomas Wu, and its Chief Credit Officer, Ebrahim Shabudin, were resigning following the results of an investigation of the improper loan accounting. As a result of the accounting improprieties, UCBH must restate its financial statements for each quarter and the full fiscal year of 2008. News of the accounting fraud and the pending restatement caused UCBH’s stock price to fall significantly, damaging investors.


The complaint can be found here.


The final related development this past week took place on Friday night after the close of business, when the FDIC closed Corus Bank, N.A. about which refer here. (The FDIC actually closed three banks on Friday, refer here, bringing the 2009 year to date total number of bank failures to 92.) Though Corus only just now failed, the bank’s holding company and certain of its directors and officers had already been sued earlier this year (refer here) in a securities class action lawsuits in the Northern District of Illinois alleging that:


(i) that Corus was failing to recognize losses on its condominium loans in accordance with generally accepted accounting principles ("GAAP"); (ii) that Corus and/or its affiliates was purchasing condominiums in developments Corus had financed in an attempt to: (a) inflate the appraised values of condominiums to delay having to recognize losses on financing for such condominiums; (b) inflate developers’ sales figures to increase the likelihood of successful future sales; and (c) create the illusion of successful sales histories in order to inflate appraisal values for the condominiums to ensure inflated future prices for the condominiums; and (iii) that Corus was involved in detailed and in-depth negotiations with the Federal Reserve Bank of Chicago and the Office of the Comptroller of Currency regarding its deteriorating pool of condominium loans.


The arrival of the new lawsuits and the development involving Corus all in this past week may well have been coincidental. It remains to be seen whether there will in fact be a significant number of additional lawsuits involving failed or troubled banks.


That said, there is definitely a familiar tone to these recent cases. The allegations regarding the various banks’ alleged loan loss reserve deficiencies and alleged failure to recognize failing loans will be quite familiar to anyone who was involving in any way in the wave of failed bank litigation that accompanied the last round of failed banks during the S&L crisis. Though the future is uncertain, it is difficult no to speculate that we will see many more of these kinds of loan loss reserve inadequacy cases in the months ahead.


Of course, even if the cases do arrive in significant numbers, that does not necessarily mean that they will succeed. Some cases previously filed in connection with banks that failed in 2008 have already been dismissed. For example, the Fremont General lawsuit (refer here) and the Downey Financial lawsuit (refer here) have both been dismissed, and in Downey Financial’s case, the dismissal is with prejudice.


Nevertheless, the most recent filings seem to suggest that plaintiffs’ lawyers are not deterred by the prior dismissals. Given the depth of the current difficulties in the banking sector (about which refer here), there may yet be more, perhaps much more, banking-related litigation to come.


Citigroup Auction Rate Securities Lawsuit Dismissed: On September 11, 2009, Southern District of New York Judge Laura Taylor Swain dismissed the auction rate securities lawsuit that had been filed Citigroup. A copy of the September 11 opinion can be found here.


This action follows the earlier dismissals of the auction rate securities lawsuits that had been filed against UBS (refer here) and Northern Trust (refer here). However, this dismissal represents its own separate development, because unlike many of the other auction rate securities lawsuits, which were based on alleged misrepresentations in connection with the sale of the securities, the Citigroup auction rate securities lawsuit was based on a market manipulation theory.


As reflected in greater detail here, the plaintiff in the Citigroup auction rate securities lawsuit had alleged "defendants manipulated the market for Citigroup ARS by fostering the illusion that a valid market existed where buyers and sellers came together, with supply and demand in balance, allowing for the successful completion of auctions of Citigroup ARS. In fact, no such balance existed." The defendants moved to dismiss.


In her September 11 order granting the defendants’ motion to dismiss, Judge Swain held with respect to the plaintiff’s market manipulation claim under Section 10(b) of the ’34 Act that the plaintiffs had insufficiently alleged fraud; scienter; reliance; and loss causation. She also dismissed the plaintiffs’ claims under the Investment Advisers Act for lack of subject matter jurisdiction and the plaintiffs’ state law claims because they were preempted by SLUSA.


With respect to the plaintiffs’ market manipulation claim, she found the plaintiff’s fraud allegations insufficient because the complaint "does not include specific allegations as to which Defendants performed what manipulative acts at what times and with what effect" but instead that the complaint "relies on general and conclusory allegations regarding Defendants’ practices" regarding the ARS auctions. She concluded that "absent particularized allegations regarding Defendants’ alleged manipulative conduct, Plaintiff cannot state a claim for market manipulation."


With regard the plaintiff’s scienter allegations, Judge Swain found that the plaintiff has not sufficiently alleged motive and opportunity, holding that "Plaintiff’s conclusory allegations regarding Defendants’ motive for the alleged manipulation focus principally on Defendants’ desire to sell Citigroup ARS to offset subprime losses and to obtain fees for services in connection with the auctions." She found these allegations "too generalized to meet the scienter pleading requirement."


She also found that plaintiff had failed to allege particularize facts giving rise to a strong inference of scienter based on circumstantial evidence of conscious misbehavior or recklessness. She found that "the very market conditions – specifically the ‘subprime crisis’ – that Plaintiffs cites in his Complaint…give rise to an opposing and compelling inference that Defendants engaged only in bad (in hindsight) business judgments in connection with the ARS, and did not engage in the alleged conduct with an intent to deceive."


Judge Swain found further that the plaintiff had not adequately alleged reliance. In reaching this conclusion, Judge Swain specifically reference an SEC report that preceded the class period in which many of the practices of which the plaintiff complains regarding the ARS market auction process. These materials "disclosed that the ARS market was not necessarily set by the ‘natural interplay of supply and demand’" and therefore Plaintiff has not identified any basis on which the class reasonably could have relied on "the market ‘integrity’ assumption."


Finally, Judge Swain found that the market manipulation claim also fails because the plaintiff’s loss causation allegations are insufficient. In reaching this conclusion, she observed that "Plaintiff does not specifically allege that he tried to sell his ARS, nor does he allege that the interest rates set through Defendants’ manipulative conduct were lower than they would have been absent such conduct."


The dismissal granted in Judge Swain’s September 11 ruling is without prejudice; the plaintiff has until October 1, 2009 to file an amended complaint.


I have in any event added the Citigroup auction rate securities dismissal to my table of subprime and credit crisis-related lawsuit dismissal motion ruling, which can be accessed here.


Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing me with a copy of Judge Swain’s ruling.