Since the outset of the subprime securities class action litigation wave I have tried to keep track both of the lawsuits as they are filed (refer here) and on the outcome of the cases as they are resolved, including in particular the outcome of the defendants’ motions to dismiss (refer here). But these tabulations alone don’t tell you who is winning and who is losing, or why.


Those questions are the subject of a thorough and interesting December 30, 2009 article by Jon Eisenberg of the Skadden Arps law firm entitled "Subprime Securities Class Action Decisions: Who’s Winning, Who’s Losing and Why?" (here).


Eisenberg looks at dismissal motion rulings in 16 of the cases that have reached the dismissal motions stage. (Eisenberg explains that he narrowed the pool of decisions he reviewed from the universe of all subprime and credit crisis-related dismissal motion rulings in order "to focus exclusively on subprime cases…in which plaintiffs have alleged that defendants misrepresented or omitted material facts regarding the quality of subprime loans that the defendant company was making or financing or rating.")


He found that out of the 16 decisions, plaintiffs’ complaints survived motions to dismiss in ten cases and failed to survive in six cases.


Eisenberg has a number of observations about these dismissal motion rulings. First, he noted that all seven cases that asserted claims under Sections 11 and 12 (a)(2) of the Securities Act survived motions to dismiss. Indeed, even in cases in which ’33 Act claims were combined with claims under Section 10(b) of the ’34 Act, the Section 10(b) claims survived as well. By contrast, in the nine decisions involving standalone Section 10(b) claims, the dismissal motions were denied in only three cases.


Although the defendants asserted a number of defenses in their dismissal motions, scienter "turns out to be the perfect predictor of outcomes across all 16 cases." If plaintiffs were not relying on claims that required pleading scienter (i.e., the ’33 Act claims) or convinced the court that the scienter allegations were sufficient, they survived the motion to dismiss. And in the Section 10(b) cases in which the plaintiffs met the standard for pleading scienter, "they also convinced the court to reject the merits of the other defenses asserted in the motion to dismiss."


Plaintiffs were successful in pleading scienter when relying on statements by confidential witnesses that "allegedly detail executives’ knowledge of facts inconsistent with public statement" and when relying on "reliable external sources of information," such as bankruptcy examiner’s report, as well as when relying on "market events linked with questionable internal practices and representations fundamentally at odds with a company’s core business."


Plaintiffs were unsuccessful in pleading scienter when the factual allegations on which the plaintiffs are relying might "easily coincide with non-fraudulent misstatements or omissions." For example allegations such as senior level positions, certifications under Sarbanes-Oxley, resignations of senior executives, normal selling by insiders, GAAP violations, restatements and even decisions by auditors to not continue as auditors were found not to create a strong inference of scienter.


Eisenberg found further that massive complaints do not necessarily establish scienter and often backfire on plaintiffs. Similarly, though many complaints seek to rely on confidential witnesses, confidential witness statements "do not ensure that a complaint will survive." Courts have dismissed fraud claims where "the confidential witness statements failed to show what the executives knew or how the confidential witnesses knew what the executives knew."


Eisenberg concludes his article with an analysis of the problem of "hindsight bias" – the tendency for people with knowledge of an outcome to exaggerate the extent to which they believe the outcome should have been predicted. The risk of hindsight bias in the subprime cases exists because of the competing narratives; that is, the plaintiffs argue that defendants were reckless in not seeing what was coming and adjusting their business practices accordingly, and defendants argue that they, along with the entire rest of the global financial marketplace, were blindsided by events "so severe, unexpected and unprecedented" that no one saw them coming.


"The good news for defendants," Eisenberg concludes is that at least in cases involving standalone Section 10(b) cases, "defendants’ narrative is often persuasive and courts have granted motions to dismiss because they are not convinced that defendants knew, or were reckless in not knowing, of the calamity that lay ahead."


Very special thanks to Jon Eisenberg for providing me with a copy of his article.


My own status report, as of September 2009, on the subprime and credit crisis-related securities lawsuits can be found here.