It is now over two and a half years since the first subprime-related securities class action lawsuit was filed in February 2007, yet many of the cases filed as part of the ensuing litigation wave are still only in their earliest stages. But there have been some important developments recently – for example, the Eighth Circuit’s recent decision affirming the dismissal of the NovaStar Financial subprime lawsuit – suggesting that the evolving litigation wave may have reached a passed a significant milestone. With that possibility in mind, it seems appropriate to check in for a status report on the subprime and credit crisis-related litigation wave.


Filing levels

There have now been a total of 199 subprime and credit crisis-related securities class action lawsuits, of which 57 have been filed so far in 2007. A compete list of the lawsuits can be accessed here. While the subprime and credit crisis securities suits continue to be filed, in recent months the pace has definitely slowed. Of the 2009 filings, the bulk of them were filed in the first quarter, and there have only been a handful since April. Of course, the pace of filling activity could return at any time, but at least at this point there seems to be some possibility that the subprime and credit crisis litigation wave may have already crested.


Another circumstance suggesting that the litigation wave may be ebbing is changing mix of companies that are the targets of the latest securities class action lawsuits. In the first half of the year, approximately two thirds of the new securities lawsuits involved companies in the financial sector. But of the 37 new securities lawsuits filed in July and August 2009, only 13, or slightly more than a third, involved companies in the financial sector. In other words, the proportion of lawsuits against financial companies versus nonfinancial companies seems to have completely reversed.


Of course, another possibility to explain the recent filing patterns is that the litigation has changed as the nature of the financial circumstances changed. What started several years ago with the subprime meltdown has evolved into a global financial crisis, affecting all companies across the entire economy. As a result of these developments, it has become increasingly difficult to define precisely what constitutes a subprime and credit crisis-related lawsuit.


A good illustration of this definitional challenge is the case recently filed against MGM Mirage as a result of construction delays and financing issues relating to the company’s CityCenter project in Las Vegas. Whether this case should be grouped with earlier subprime and credit crisis-related cases depends on whether or not the company’s difficulties relate to a categorically separate set of issues or are simply a reflection of the overall economic turndown. In other words, it may not be so much that the subprime and credit crisis litigation wave has crested as it is that the wave has merged into a larger tidal movement and is no longer its own separately identifiable phenomenon.


Dismissal Motion Rulings

Even after two and a half years, there have still only been a handful of dismissal motion rulings in the subprime and credit crisis related lawsuits. For that reason, and because among the few rulings so far there are some that have gone one way and some that have gone the other way, it is difficult to generalize. Just the same, there have been some recent rulings suggesting that, even though there are still dismissal motion rulings going in the plaintiffs’ favor, on balance the rulings seem to be favoring the defendants, and recent rulings could be particularly useful for defendants going forward. (A complete list of the subprime and credit crisis-related lawsuit dismissal motion rulings can be accessed here.)


The most prominent among these recent developments is the Eighth Circuit’s September 1, 2009 decision in the NovaStar Financial case affirming the district court’s dismissal of the plaintiffs’ complaint, about which refer here.


There have also been a series of recent rulings in which the courts have granted motions to dismiss in recognition that the defendant company’s difficulties were the result of economic downturn, not fraud. Thus for example, in both the lawsuit that Luminent Mortgage Corporation filed against Merrill Lynch (refer here) and in the First Marblehead subprime-related securities class action lawsuit (refer here), the courts quoted with approval language from a prior RICO case in which the Second Circuit said "when the plaintiff’s loss coincides with a marketwide phenomenon causing comparable losses to other investors, the prospect that plaintiffs’ loss was caused by fraud decreases."


This latter argument – that is, if the plaintiffs were harmed, it was due to the global financial downturn, not to defendants’ supposed misconduct – could prove useful to defendants in a wide variety of subprime related cases. Given the magnitude of the economic downturn, which was nearly universally unanticipated, this argument could well be extended to many if not most of the subprime and credit crisis-related lawsuits. The extent to which the defendants are able to exploit this argument in other cases remains to be seen, but for now defendants seem to have established a significant formula for dismissal motion success in these cases.


Another development that suggests the balance may be shifting in defendants’ favor is the number of recent cases were district courts granted renewed motions to dismiss after plaintiffs had filed amended complaints seeking to cure pleading defects noting in the initial dismissal rulings. Renewed dismissal motions were recently granted in both the Downey Financial and Centerline cases (about which dismissals refer here, scroll down)– although, to be sure, the renewed dismissal motion was denied in the BankAtlantic case, where the plaintiffs’ amended complaint survived the renewed motion to dismiss, as discussed here.


Another significant recent development suggesting that defendants may have developed an advantage at the dismissal stage is the dismissal granted in the CBRE Realty case. As discussed at greater length here, the district court granted the dismissal motion even though the plaintiff asserted only claims under the ’33 Act, and therefore did not have to satisfy the more rigorous initial pleading requirements that apply to ’34 Act claims (as for example the need to plead scienter). This development may be particularly significant because many of the subprime and credit crisis-related lawsuits, particularly many of those filed in 2009, assert only claims under the ’33 Act. Of course, it remains to be seen whether or not the complaints in these other cases will be found to be similarly deficient as the one in the CBRE Realty case, but for now (based on admittedly few data points) the balance seems to be in the defendants’ favor on these cases.


One final note is that the apparent pendulum swing in defendants’ favor at the motion to dismiss stage is that it is not limited just to the subprime and credit crisis-related securities cases. As shown by the recent dismissals in the Citigroup subprime related derivative lawsuit (refer here, scroll down) and in the Citigroup subprime related ERISA lawsuit (refer here, scroll down), the recent development suggest that defendants may be faring well at the dismissal motions stage in these other kinds of cases as well.


To be sure, there are also cases in which the motions to dismiss recently have been denied, as for example in the Levitt Corp. subprime related securities lawsuit (about which refer here, scroll down). The dismissal motion rulings are by no means all going in defendants’ favor and the outcome of the dismissal motions in any particular case is by no means predetermined. There are many more dismissal motions yet to be heard.



If there are only a few dismissal motion rulings in these cases so far, there are even fewer settlements, and it is even more difficult to generalize.


By far the most attention-grabbing feature of the settlements so far is the series of eye-popping settlements in subprime lawsuits involving Merrill Lynch. The three Merrill Lynch settlements so far are the three largest subprime-related lawsuit settlements. The $475 million securities lawsuit settlement (refer here), the $150 million bond action settlement (refer here) and the $75 million ERISA action settlement (refer here) stand out among the few other, more modest settlements.


It is not just their size that may set these Merrill Lynch settlements apart. The fact that these enormous settlements were entered before the motions to dismiss were heard in each of these cases and also shortly after Bank of America acquired Merrill Lynch suggests that following its acquisition of Merrill, Bank of America moved quickly to clear the decks of Merrill litigation that predated the merger, even if substantial sums proved to be required to accomplish that goal. Because of the possibility that these settlements may represent the outcome of their own unique settlement dynamic, they may be of little guidance with regard to possible settlement ranges of other cases.


There have been other significant settlements in other cases, from which some generalizations may or not be able to be drawn. Thus, for example, the RAIT Financial subprime-relates securities lawsuit recently settled for $32 million (refer here) and the Accredited Home Lenders case recently settled for $22 million (refer here). Both of these cases had survived the defendants’ motions to dismiss, which suggests that while it may difficult for these cases to survive dismissal motions, when the cases do survive they can be quite costly to resolve.


Two other noteworthy recent settlements include the $37.25 million settlement in the American Home subprime-related lawsuit (refer here) and the $30.5 million settlement in the Beazer Homes subprime related lawsuit (refer here). These settlements are notable because in both instances the cases settled before the motions to dismiss had been ruled upon. While each of these cases had their own particular features and each was resolved for reasons particular to each case, they do suggest that resolving more serious cases can be prove costly to settle. These cases also suggest that when the claims are sufficiently serious the plaintiffs may be able to avoid the initial pleading hurdle altogether.


So while the defendants may have won some important recent victories in the courtroom at the motion to dismiss stage, the overall costs of defending and settling these cases taken in the aggregate nevertheless continues to look as if it will be enormous. By any measure, the subprime and credit crisis-related litigation wave continues to represent a tremendous loss exposure for D&O insurers.


In any event, a complete list of settlements in the subprime and credit crisis-related lawsuits can be accessed here.


Gatekeeper Liability

One of the characteristics of many of these subprime and credit crisis related lawsuits is the extent to which the plaintiffs are seeking to impose liability on the gatekeepers of the target companies. The gatekeepers named as defendants include not only the directors and officers of the target companies, but also the companies’ auditors and offering underwriters, as well as the rating agencies that provided rating on the companies’ securities offerings.


The plaintiffs have shown particular willingness to pursue claims against the auditors. Thus, for example, the trustee for New Century Financial Corp. has initiated a claim against KPMG, the company’s former auditor (refer here). KPMG is also named as a defendant in the New Century subprime securities lawsuit, and the district court in that case specifically denied KPMG’s motion to dismiss (refer here). In addition, in the Countrywide subprime-related securities lawsuit, the district court found denied KPMG’s renewed motion to dismiss the claims against KPMG in the plaintiffs’ amended complaint (refer here, scroll down).


The possibility that these gatekeeper claims could prove valuable for claimants was highlighted in the recent $37.25 million American Home settlement. As here, the total settlement fund included contributions of $8.5 million from the seven offering underwriter defendants and $4.75 million from the company’s auditor, Deloitte & Touche. While it is always dangerous to try to generalize from a single settlement, the American Home settlement does at least suggest the possibility that resolving gatekeeper liability could be an important and costly part of subprime and credit crisis litigation wave’s overall consequences.


Another significant development in terms of gatekeeper liability is Judge Schira Scheindlin’s September 2, 2009 ruling in the Cheyne Financial case denying the rating agency defendants’ motions to dismiss. Although, as discussed at length here, there could be limitations on the overall impact of Judge Scheindlin’s ruling, the ruling could influence the many other cases in which plaintiffs are seeking to impose gatekeeper liability on the rating agencies.


One final note about the gatekeeper liability developments is that at least so far the claimants seem to have shown little inclination to try to pursue claims against the attorneys that may have been involved in the underlying circumstances. There is precedent for plaintiffs to pursue these kinds of claims against the attorneys; in a case involving a commercial mortgage backed securities transaction that took place in the 90’s, certain claimants are now pursuing claims against the Cadwalader firm, which had been the law firm that created the transaction documents (refer here for more details about this case). Significantly, the claimants did not initiate that claim until many years after the fact and only after extensive litigation involving other parties. All of which suggests that the claims against the attorneys, even if not yet filed, could be yet to come.


Defense Expense

In addition to the potential costs of settlement, these cases are in most instances proving enormously expensive to defend. The most substantial illustration of this proposition is the State Street’s August 10, 2009 announcement (here) that the approximately $625 million subprime-related litigation expense reserve the company had established in January 2008 was as of June 30, 2009 already down to $193 million, and further that there could be no assurances that the remaining amount would be adequate for the company’s continuing litigation.


The potential cost of serious corporate litigation was also highlighted in the recent Broadcom options backdating derivative lawsuit settlement (about which refer here). Among other things, the settlement papers reflected recitals that the company’s litigation expense to date in connection with company’s various options backdating related legal proceedings was in excess of $130 million. Even though the Broadcom case related to options backdating and not to subprime litigation, the defense expenses accumulated in that case underscores how expensive serious corporate litigation can become.


Many of the subprime and credit crisis related cases are equally as complicated and equally serious. And while the $130 million in litigation expense in the Broadcom case may be an extreme case, it is not unusual any more for costs of litigation in complex corporate and securities cases to run into the tens of millions of dollars. The costs of litigation alone have become staggering.


All of which is a long way of saying that in addition to the costs associated with settling these cases, the overall cost of these lawsuit also will include massive amounts of defense expense. These enormous defense expenses will add to the overall aggregate burdens of this litigation for the D&O insurance industry, as well as for the company’s themselves. Though it has been a while since anyone has attempted to calculate the overall cost to the D&O insurance industry from the subprime and credit crisis litigation wave, by any measure the aggregate cost included defense and settlement amounts will be enormous.