In a January 12, 2012 opinion that quotes from (and relies upon) former Treasury Secretary Henry Paulson’s credit crisis memoirs, Southern District of New York Judge Richard Holwell granted in part and denied in part the motion to dismiss in the subprime and credit crisis related securities class action lawsuit that investors had filed against General Electric, certain of its directors and officers, and its offering underwriters. A copy of Judge Holwell’s opinion can be found here.



As discussed in greater detail here, the plaintiffs first filed their action in March 2009, alleging that the company had failed to disclose information regarding the company’s health and the health of its financial subsidiary, GE Capital, at the height of the financial crisis. As Judge Holwell summarized it, the plaintiffs allege that “during a time when the financial markets were crumbling and companies across the United States were scrambling to disclose their holdings in subprime loans, GE withheld information regarding its substantial holdings in subprime and non-investment grade loans and touted GE as safe in comparison to its competitors, despite the fact that GE was also feeling the impact of the financial crisis.”


Specifically, the plaintiffs allege that GE made misstatements about its ability to fund itself through commercial paper; the quality of its loan portfolio; its ability to maintain its dividend; and its projected 2009 profits. The plaintiffs also alleged that GE violated GAAP by improperly recharacterizing certain of its assets from short-term to long term and by maintaining inadequate loan loss reserves. The plaintiffs allege that the defendants made misleading statements on these topics throughout the class period from September 25, 2008 to March 19, 2009, in violation of the Section 10 (b) of the ’34 Act; and in connection with GE’s October 7, 2008 stock offering, in violation of Section 11 of the ’33 Act.


Three particular alleged statements on which the plaintiffs sought to rely proved to be particularly important in Judge Holwell’s rulings on the motion to dismiss. First, with respect to the plaintiffs’ allegations regarding the company’s ability to rely on commercial paper as the credit crisis peaked in September 2008, the plaintiffs’ rely on statements in Henry Paulson’s book, On the Brink, in which Paulson states that GE CEO Jeffrey Immelt called Paulson at least twice that month  allegedly to report that the company was finding it very difficult to sell its commercial paper for any term longer than overnight.


Second, the plaintiffs’ relied on Immelt’s statements in December 2008 with respect to the company’s $1.24 annual dividend: “What can you count on? You can count on a great dividend,” specifically referencing the $1.24 dividend level. The company later cut its quarterly dividend for the second half of 2009 from 31 cents a quarter to ten cents per quarter.


Third, according the plaintiffs, throughout the class period the defendants made statements describing their loan asset portfolio as “very high quality” and using various similar descriptions. The plaintiffs contrasted this with GE’s March 2009 release in which it specified that 42% of GE Capital’s $183 billion in consumer loans were made to non-prime borrowers and at least $145 billion of its $230 billion commercial lending and leasing portfolio consisted of loans to non-investment grade companies.


Judge Holwell’s Opinion

In his January 12 opinion, Judge Holwell held that the plaintiffs had adequately alleged falsity as to their allegations about the GE’s ability to access the commercial paper marketplace; as to the quality of its loan asset portfolio (and in particular its exposure to subprime credits); and with respect to the reliability of the company’s annual dividend. He concluded that the plaintiffs had not adequately alleged falsity as to the other allegations.


In concluding that the plaintiffs had adequately alleged that Immelt had acted with scienter, Judge Holwell found, in reliance on the statements from Paulson’s book, that the plaintiffs had adequately alleged that Immelt himself made “contradictory statements to Henry Paulson.” With respect to Immelt’s December 2008 statements about the reliability of GE’s dividend, Judge Holwell rejected the competing inference that Immelt made the statements while struggling to come to terms with a rapidly changing environment:


Immelt’s categorical statements that investors could “count on” a dividend and that GE was having “no difficulties issuing commercial paper are not the sort of cautious statements one would expect of a CEO attempting to come to grips with the effects of the economic crisis on his company. Instead, it can be argued that Immelt was attempting to convince the public that the economic crisis was not affecting GE too drastically and that they should continue to invest in GE. Of course, a CEO is allowed to convince the public to invest in his company, but not at the expense of providing it with accurate information about the company’s financial health.


In concluding that GE’s CFO Keith Sherin acted with scienter with respect to certain statements about the quality of the company’s loan asset portfolio, Judge Holwell essentially said that the plaintiffs had adequately alleged that Sherin should have known the extent to which GE Capital had made extensive loans to lower quality borrowers. Judge Holwell said “it is highly improbable that Sherin, the CFO of a company 50% of whose revenues were derived from financial services in 2008, would not inquire whether his company was exposed to the subprime consumer borrower and its counterpart in the commercial sector.”


Significant parts of the plaintiffs’ ’33 Act claims also survived the motion to dismiss, including in particular plaintiffs’ allegations about the company’s ability to access commercial paper and the quality of the company’s loan asset portfolio and its exposure to subprime credits. Judge Holwell found that the plaintiffs’ remaining ’33 Act allegations were insufficient, but his denial of the motion to dismiss with respect to at least some of plaintiffs’ allegations means that the offering underwriter defendants remain in the case.


Victor Li’s January 13, 2012 Am Law Litigation Daily article about Judge Holwell’s ruling can be found here.



At least a part of plaintiffs’ case would have survived the defendants’ motions to dismiss even without the benefit of Henry Paulson’s statements in his book about his September 2008 telephone conversations with Jeffrey Immelt. But Paulson’s account of the conversations clearly had an impact. At a minimum, Judge Holwell referenced the Paulson’s account of the conversations several different times in his opinion.


I am not aware of a prior case where the statements of a former cabinet secretary in his or her memoirs has provided even a partial basis for the denial of a motion to dismiss in a securities class action lawsuit. The plaintiffs’ reliance on Paulson’s memoirs has to qualify as one of the more unusual ways that plaintiffs have established (at least for pleading purposes) that there was a difference between what the company was saying publicly and what its officials were saying behind closed doors. (The defendants will of course argue that there was no difference or if there was it is entirely explainable, which of course are arguments they will raise as the case goes forward.)


It is interesting to reflect on the sheer fortuity of the fact that Paulson chose to report on those conversations in his book, and that his book was published at a time that allowed the plaintiffs to be able to rely on those statements in their amended complaint. Of course, all of this does mean that as (or perhaps if) the case goes forward, Paulson’s deposition in this case would appear to be inevitable. (Of course, this case is not the only one in which the underlying narrative involved Paulson; Paulson’s conversations with BofA CEO Ken Lewis in December 2008 also play a central role in the securities class action lawsuit arising out of the BofA/Merrill Lynch merger.)


It is also interesting to reflect that in the middle of one of the worst financial crises in the country’s history, Immelt could pick up the telephone and call the Treasury Secretary to tell him about the problems his company was having. The CEOs of a vast number of companies were also going through crises at that very moment, but very few of them had the option to call the Treasury Secretary to complain to him about their companies’ problems. It is rather remarkable, even given how large a company GE is, that Immelt had this option. Indeed, given what we know about what else Paulson had on his plate during September 2008 (i.e., avoiding the collapse of the entire  global financial system), it really is kind of astonishing that Immelt could just call him up and that Paulson could take his call.


In any event, this case will now be going forward. Given the size and prominence of the company, and the fact that the case has now survived the motion to dismiss, this case has to be added to the list of pending high-profile subprime and credit crisis-cases worth watching. Very few of these cases go to trial; most settle. In this and some of the other high profile credit crisis cases – Citigroup; the BofA/Merrill Lynch merger case; Bear Stearns; AIG – it will be very interesting to see how the likely settlements of these cases will unfold. Without knowing for sure how any one of them ultimately will turn out, there undoubtedly will be some very interesting settlements from among these cases.


I have added Judge Holwell’s ruling to my tally of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.


More About the $40 Million Lehman Brothers Mortgage Backed Securities Settlement: The news that the parties to the Lehman Brothers mortgage-backed securities case had settled the suit for $40 million was announced in November 2011 (refer here). But the complete papers related to the settlement have only just been filed in the court docket. The papers reveal a few interesting details about the settlement.


First, the $40 million settlement is to be funded in two ways; $31.7 million of the settlement is to come from the company’s D&O insurance and $8.3 million is to come from Lehman Brothers Holdings itself. As the January 13, 2012 memorandum in support of the plaintiffs’ unopposed motion for preliminary approval of the settlement states, the bankruptcy court supervising the Lehman bankruptcy has approved the release of funds for these purposes.


Second, the parties’ settlement stipulation contains in interesting detail about the source of the D&O insurance funds for the settlement. The stipulation states (at page 15) that the $31.7 million insurance contribution to the settlement is to be paid by “certain insurers (‘Insurers’) that issued directors and officers insurance policies to LBHI, for the 2007-2008 and 2008-2009 policy periods.” What is interesting about this statement is that it suggests that the funds for this settlement are coming from two different policy periods.


In an earlier post (here), in which I discussed the $90 million settlement of the securities suit involving former Lehman executives, I had determined that the $90 million amount, together with defense expenses and other amounts, exhausted about $200 million of the applicable $250 million insurance tower. Based on that analysis of Lehman’s insurance, I would have assumed that the $31.7 million insurer contribution was drawn from what was left of the $250 million tower.


However, the reference in the parties’ settlement stipulation to the two different policy years suggests that a second tower of insurance has been broached and is being drawn upon in payment of losses arising from Lehman’s collapse.


In an earlier post (here) about how rapidly defense expenses were eroding Lehman’s D&O insurance, I had determined that during the 2007-08 policy period, Lehman carried a total of $250 million in insurance. I had noted that, though Lehman did not file for bankruptcy until September 2008, the May 2007-May 2008 insurance tower was the one implicated, because the first of the securities class action lawsuits was filed during that policy period and the subsequent matters related back to that initial filing (or so the insurers) argued. I noted that Lehman carried a separate $250 million tower of insurance for the May 2008 to May 2008 policy period, but that up to that point the losses had accumulated only with respect to the earlier of the two insurance programs. When I later analyzed the $90 million settlement on behalf of the directors and officers, I assumed for purposes of analysis that only a single $250 million tower was available for all purposes in connection with the Lehman collapse.


The cryptic note in the parties’ settlement stipulation in connection with the $40 million Lehman Brothers mortgage-backed securities settlement suggests, for the first time to my knowledge, that the second tower of insurance had been drawn in and is funding losses attributable to the events surrounding Lehman’s collapse. It would certainly change things (for example, the way that the prior $90 million settlement looks) if there were to be two insurance towers totaling $500 million potentially available in connection with these matters, rather than only a single $250 million tower.


If there were to be two towers rather than just one, the losses from the Lehman debacle could wind up being far more costly for the D&O insurance industry than has been assumed (depending of course on how extensive the second tower’s involvement ultimately proves to be). I suspect there are a number of readers out there who may have additional insight on these issues. I welcome additional perspective that any reader may be willing to provide (anonymously if that is the preferred approach).


In any event, this settlement is just further corroboration for a point I have long made about the litigation arising out of the subprime meltdown and credit crisis – that is, when all is said and done, this litigation, taken collectively, will prove to have been a massive loss event for the D&O insurance industry.


The Totally Awesome Sledding Crow: Here at The D&O Diary, we never, ever waste our time looking at Internet videos of animals doing amusing things. Just the same, we were distracted by this video of a crow that to all appearances is engaged in trying to perfect his snowboarding style. Watch this video carefully. The crow, standing at the apex of a snow covered roof, slides down the incline on a plastic lid. The crow then picks up the lid and tries to slide down another part of the roof. But when that doesn’t work, the crow picks up the lid, returns to the original spot, and slides down the roof again.


A scientific discussion of the crow’s behavior can be found in this January 13, 2012 article in The Atlantic (here). While science cautions against ascribing anthropomorphic explanations for animal behavior, I find myself imagining that as the crow is sliding down the roof, he is singing to himself “If everybody had an ocean/across the U.S.A./then everybody’d be surfin’/like Caiforn-Aye-Yay…”