The financial reform bill now working its way through Congress will include an amendment to the securities laws allowing private civil actions for aiding and abetting liability, if an amendment Senator Arlen Specter proposed on May 4, 2010 is part of the final bill. According to the Blog of the Legal Times (here), in conjunction with a Senate Judiciary subcommittee meeting and on behalf of himself and 11 other senators, Specter introduced an amendment to the financial reform bill that would impose liability on "any person that knowingly provides substantial assistance to another person in violation of this title." The proposed amendment can be found here. (Hat Tip: Point of Law blog.)

 

Although the securities laws currently allow for the SEC to pursue aiding and abetting enforcement actions, the Supreme Court held in the Stoneridge case that there is no private right of action for aiding and abetting liability under the federal securities laws.

 

As discussed at greater length here, in July 2009, Senator Specter introduced S. 1551, "The Liability for Aiding and Abetting Securities Violations Act of 2009," which proposed to legislatively overturn Stoneridge. Although Committee hearings were held in connection with that bill, it had not made it out of the Committee. In April 2010, Representative Maxine Waters separately introduced a House version of essentially the same bill, H.R. 5042, which was referred to the House Judiciary Committee.

 

Though there are now alternative versions of the aiding and abetting liability bill in each of the two houses of Congress, neither bill had progressed out of committee. Had the bills made it out of committee on their own, they undoubtedly would have occasioned debate and discussion. Specter’s proposed amendment to the financial reform bill, which is substantially similar to the previously introduced stand-alone bills, potentially could provide a short cut way around that likely debate and discussion.

 

It remains to be seen whether Senator Specter’s initiative to add the aiding and abetting amendment to the financial reform bill will ultimately become a part of the bill that is put before the Senate. But if the amendment is incorporated into the financial reform bill, it would only be one small part of a massive and controversial piece of legislation that will occasion intense partisan debates on a wide variety of issues, most of them much higher profile that than those involved in Specter’s amendment.

 

To be sure, passage of the financial reform bill itself is by no means assured. But debate on the bill will undoubtedly focus on the proposed systemic reforms embodied in the legislation. It is unlikely that Specter’s proposed amendment, if included in the bill, would itself occasion extensive additional debate or even materially affect the ultimate passage of the bill. Indeed, the aiding and abetting liability provision arguably has a greater chance of being enacted as an accessory to a larger reform bill than it might have on its own.

 

Were the provision to be enacted into law, either on its own or as part of a larger piece of legislation, it could represent a significant increase in the potential liability exposure under the securities laws for accountants, lawyers, and other professionals who might be in a position to be alleged to have provided "substantial assistance" to a primary violator.

 

But the increase in potential liability exposure is not limited just to these outside professionals. As I discuss in greater length in my earlier post on S. 1551, the circle of persons whose liability exposure potentially could be increased by the enactment of the proposed aiding and abetting liability provision includes other public companies and their directors and officers.

 

Indeed, in the Stoneridge case itself, the defendants who were alleged to have aided and abetted Charter Communications were vendors who did business with Charter and who allegedly engaged in "round trip" transactions with Charter.

 

In other words, were Senator Specter’s bill to pass, it would not only greatly expand the potential securities liability exposure for companies’ outside professionals. It would also expand the potential securities liability exposure of all companies that transact business with public companies.

 

Were this aiding and abetting provision to be enacted into law, it would have significant implications for insurers that provide professional liability insurance for the outside professional gatekeepers. It could also have potentially significant implications for D&O insurers as well, and as I also discussed in my prior post, the definition of the term "securities claim" used in D&O insurance policies could become particularly important. The critical issue will be whether the term is defined to restrict "securities claims" to claims involving securities of the insured company, or whether the term is defined to include any alleged violation of the securities laws.

 

Finally, it should not be overlooked that the universe of companies that might potentially become the target of an aiding and abetting claim is not limited just to other public companies. Any company, including even private a private company, that does business with a public company might potentially be alleged to have provided "substantial assistance" to the public company’s securities law violations.

 

For all of these reasons, the legislative progress of the aiding and abetting liability provision should be of keen interest to the entire professional liability insurance community, including the D&O insurance community. The possibility of the provision’s inclusion in the financial reform bill will make this a particularly complicated issue to monitor.

 

Radian Group Subprime Securities Lawsuit Dismissed Again, This Time With Prejudice: As discussed at greater length here, on April 9, 2009, Eastern District of Pennsylvania Judge Mary McLaughlin granted the motion to dismiss the subprime related securities complaint that had been filed against Radian Group and certain of its directors and officers, holding that plaintiffs had failed to adequately allege scienter. However, the dismissal was without prejudice. The plaintiffs filed an amended complaint and the defendants renewed their motions to dismiss.

 

In a May 3, 2010 order (here), Judge McLaughlin again granted the defendants’ motions to dismiss, this time with prejudice.

 

The lawsuit related to an affiliate company in which Radian was a minority owner, Credit Based Servicing & Asset Securitization (C-Bass), an investor in the credit risk of subprime residential mortgages. Radian was a joint venturer in the affiliate with MGIC, with which Radian also had an agreement to merge.

 

The plaintiffs alleged that the defendants made false and misleading statements about C-Bass’s profitability and liquidity position and thus, the value of Radian’s investment in C-Bass. The statements allegedly inflated Radian’s share price, which led to losses to shareholders when Radian announced an impairment of its investment on July 30, 2007. The turbulence surrounding the C-Bass affiliate may also have undermined the pending merger with MGIC. Further background about the case can be found here.

 

In order to try to overcome the hurdles that led to the dismissal of their prior complaint, the plaintiffs amended complaint added more information regarding the defendants’ alleged knowledge of C-Bass’s troubles; more details regarding the merger of Radian and MGIC (which transaction, it was alleged, Radian was motivated to make motivations in order to preserve); and more details to bolster insider trading allegations.

 

Judge McLaughlin concluded that "the plaintiffs have failed to sufficiently amend their complaint to allege facts that give rise to a strong inference of scienter."

 

An Impertinent Remark About the Radian Group Decision: In addition to the actual holding itself, another aspect of Judge McLaughlin’s ruling is also of interest. With regard to the plaintiffs’ additional allegations about the defendants’ supposed knowledge of C-Bass’s problems, Judge McLaughlin noted instead of supporting a finding of scienter, "they serve to establish that the market at large knew of the subprime industry’s downward trend."

 

She then added "Indeed, this is not the first action to arise from the subprime mortgage crisis, nor the first to be dismissed." For the latter point she cited a number of other subprime securities suit dismissals (including the dismissal of the separate C-Bass related securities lawsuit filed against MGIC, about which refer here).

 

Judge McLaughlin is indeed correct that there have been many other subprime related lawsuits filed – over 200 by my count. In addition, as has been well-documented on this blog, there have been quite a number of dismissal motions granted in these cases. But a review of the full tally of dismissal motion rulings, which can be accessed here, shows that there also have been quite a number of dismissal motion denials, in addition to the rulings where the motions were granted.

 

Given that many motions have been denied, the fact that the motions have been granted in the cases she cites lacks any particularly persuasive effect (except of course with reference to the MGIC case, which undeniably is relevant). Simply referring to a few of the dismissals without referring to the motion denials represents an incomplete picture. Given the mix of case rulings, the fact that there have been some dismissals, in and of itself, does not seem particularly conclusive of anything.

 

Rating Agencies Lose Another Dismissal Motion: According to a May 4, 2009 Bloomberg article (here), a California state court judge has denied the motions of the rating agency defendants to dismiss the negligent misrepresentation claims that had been brought against them by the California Public Employees Retirement System (Calpers).

 

According to the article, Calpers had sued the rating agencies, alleging that the "faulty risk assessments on structured investment vehicles caused $1 billion in losses." Among the investment vehicles to which the rating agencies had given their highest ratings and that are the subject of the case is Cheyne Financial, which is also the subject of a separate lawsuit pending in federal court in Manhattan, in which Judge Shira Scheindlin had also denied the rating agencies’ motions to dismiss (about which refer here).

 

As detailed in Andrew Longstreth’s May 4, 2010 article on AmLaw Litigation Daily about the latest ruling, the California judge rejected the rating agencies’ argument that their rating opinions represented protected speech under the First Amendment. As Longstreth points out, the plaintiffs may be believe they now have a road map to overcoming this legal hurdle, in part due to Judge Scheindlin’s rulings in the New York case.

 

According to statistics compiled by the American Bankruptcy Institute, over 60,000 businesses filed for bankruptcy in 2009, the highest annual number of business-related bankruptcies since 1993. By way of comparison, the 2009 business bankruptcy filing levels were nearly 200% greater than in 2006. All signs are that these bankruptcy filing levels have continued unabated this year.

 

One of the frequent accompaniments of a corporate bankruptcy filing is the initiation of litigation against the directors and officers of the failed company. This litigation often leads to complex questions of D&O insurance coverage. As discussed in the April 2010 paper from ACE Insurance entitled "Financial Crisis: Bankruptcy Implications for D&O Insurance" (here), "bankruptcy poses the greatest threat of personal financial risk and the most complicated [D&O Insurance] coverage issues."

 

Yet there may be no time when D&O insurance is more important than in bankruptcy. As Paul Ferrillo of the Weil Gotshal firm notes in his April 30, 2010 memorandum "Directors and Officers Liability Insurance in Bankruptcy Settings – What Directors and Officers Really Need to Know" (here), "when a Corporation files for bankruptcy, the D&O policy becomes one of the few protections a director or officer has against lawsuits and claims targeting his or her personal assets."

 

Because, as the ACE report notes, "bankruptcy has the potential to dramatically complicate D&O coverage issues," it is important at the time the D&O insurance is put in place that these potential issues are taken into account and that the insurance is structured to try to reduce the likelihood of these complications arising in the event of a later bankruptcy.

 

The Weil Gotshal memo outlines a number of critical steps the company can take in structuring its insurance to address these bankruptcy-related concerns, including the following.

 

First, in order to avoid the possibility that the insurance is unavailable to defend individuals in bankruptcy related claims due to a policy rescission based on application misrepresentations, the company should incorporate into its insurance program a provision that the Side A coverage (protecting individuals for nonindemnifiable claims) is not rescindable. This provision specifies that the Side A coverage cannot be rescinded and will require the D&O carrier to begin advancing defense costs immediately.

 

Second, the company’s program should incorporate a Priority of Payments provision that, as described in the Weil Gotshal memo, "created a clear path that allows for the contemporaneous payment of defense costs for directors and officers." The provision specifies that payment of individuals’ defense expense or other loss costs takes priority over those of any insured entity. As the memo notes, this provision "limits the uncertainty of whether a D&O Policy will be immediately available to fund the defense costs of directors and officers who are embroiled in litigation when a company files for bankruptcy."

 

Third, the policy exclusion precluding coverage for claims against insureds brought by other insureds (known as the "insured vs. insured exclusion) should be amended to carve back coverage to ensure that the policy exclusion is not applied to preclude coverage for claims brought by "a debtor in possession, chapter 11 trustee, creditors, bondholders, all committees and other bankruptcy constituencies."

 

The Weil Gotshal memo includes a number of other policy prescriptions which, while described within the context of bankruptcy-related concerns, actually are critically important regardless whether or not a company might eventually wind up in bankruptcy, including the following.

 

First the company should ensure that there is "full severability" in connection with the policy application, so that any insured person’s knowledge of application misrepresentations "should not affect coverage for directors and officers who were unaware" of the misrepresentations.

 

Second, with respect to the D&O policy’s conduct exclusions (excluding, for example, coverage for criminal or fraudulent misconduct) should be drafted so that they are "triggered only upon a final adjudication of the prohibited …conduct."

 

Third, it is critically important for companies to attend to questions of limits adequacy and policy structure. Complex claims, of the type that often arise in bankruptcy but that can also arise without regard to bankruptcy, have the dramatic potential to substantially erode or even exhaust available insurance. The amount and structure of insurance acquired should take this dramatic possibility into account.

 

In particular, with respect to policy structure, board members will want to determine whether the company’s insurance program includes so called Excess Side A insurance or even Excess Independent Directors Liability Insurance (IDL). As the Weil Gotshal memo notes, when D&O claims are filed, the CEOs and CFOs "generally use up most of the coverage" in the Company’s D&O insurance program, "potentially leaving the independent directors with insufficient coverage to resolve the claims against them." Even though IDL policies "are the most underutilized insurance policies," it may be in the board’s interest to purchase IDL insurance as added protection in the event of significant claims against company inside management.

 

All of these concerns underscore the importance of taking all of these issues into account at the time the insurance is put in place, which in turn highlights the importance of having a knowledgeable and skill insurance professional involved in the insurance acquisition process. As the Weil Gotshal memorandum notes, "a good insurance broker may be able to assist in finding alternative primary carriers or alternative coverage solutions that will better satisfy a Corporation’s needs."

 

The complex D&O insurance coverage issues that can arise in the event of bankruptcy related claims are a recurring concern that I have previously explored in related posts, most recently here.

 

Putting Options Backdating Into Perspective: In light of the vivid events in the global financial marketplace in the last couple of years, the options backdating scandal seems both distant and even trifling, at least relatively speaking. However, as Professor Peter Henning points out in an April 30 post on the Dealbook blog (here), the government’s record in prosecuting options backdating may provide important clues to the way the government may proceed in connection with the current financial crisis.

 

As Henning notes, the options backdating results on the criminal side "were decidedly mixed," with a few trial victories but also with "notable acquittals." In particular, Henning notes, "the cases turned out to be much more difficult to win because the conduct had neither the visceral appeal nor the impact" that prior corporate scandals had. No company’s survival was threatened and the options practices involved accounting and tax issues were murky, allowing defendants to argue successfully in some cases that they did not believe they engaged in wrongdoing.

 

Henning suggests that "the experience with options backdating prosecutions may be leading prosecutors to adopt a much more cautious approach to cases involving complex financial transactions in which the accounting rules are less than clear." He concludes that "the options backdating cases show how difficult it is to win convictions against senor executives, even when they are directly involved in the transactions," as a result of which "we will see few, if any, prosecutions from the recent financial turmoil when executives can point to the markets as the reason for any harm suffered by their companies."

 

There is Absolutely No Cause for Alarm: Tom Kirkendall on the Houston’s Clear Thinkers blog recently linked to the classic Monty Python Skit, "How to Irritate People: Airplane" which reminded me in certain air travel woes to which I have been subjected. Please remain comfortably seated while you watch this video, and be certain to reassure yourselves that no one would deliberately set out to irritate anyone like this, now would they?

 

https://youtube.com/watch?v=xJSey8HRUhU%26hl%3Den_US%26fs%3D1%26rel%3D0

The FDIC’s closure of troubled financial institutions has recently taken on a state-based theme. Last week, on April 23, 2010, the FDIC closed seven banks, all of which were in the state of Illinois. This past Friday night, on April 30, 2010, when the FDIC again closed seven banks, the list included three from Puerto Rico, as well as two from Missouri. The FDIC’s Failed Bank List can be found here.

 

With the closure of seven banks on two successive Friday nights, the pace of bank failures has definitely picked up. The most recent round of closures brings the 2010 year to date number of bank failures to 64. The 2010 closure rate is well ahead of last year’s pace, when the FDIC closed a total of 140 banks. The FDIC did not close its 64th bank during 2009 until July 24th. There have been 229 bank failures since January 1, 2008.

 

The 23 banks closed in April 2010 is the second highest monthly total during the current round of bank failures, exceeded only by the 24 banks closed in July 2009. (By way of comparison, there were only 25 banks closed in all of 2008.)

 

The seven Illinois banks closed on April 23 brings the total number of Illinois bank failures to ten, the highest number for any state during 2010. The other states with the highest numbers of bank failures during 2010 are Florida (9), Georgia (7) and Washington State (6).

 

Though Illinois leads the 2010 bank failure tables, the state with the highest numbers of bank closures since January 1, 2008 is Georgia with 37 failed banks, followed by Illinois (32), California (26), Florida (25), and Minnesota (11).

 

There has definitely been a concentration of bank failures in certain states. However, the woes besetting banks are surprisingly widespread. 38 states (as well as Puerto Rico) have each had at least one bank failure since January 1, 2008.

 

The states without any bank failures since January 1, 2008 are: Alaska, Connecticut, Delaware, Hawaii, Iowa, Maine, Mississippi, Montana, New Hampshire, North Carolina, North Dakota, Rhode Island, Tennessee, Vermont, and West Virginia. There have been no failed banks in the District of Columbia either. (Readers who think they can discern the unifying factor that explains why these states have no failed banks are invited to add their explanations using the blog’s comment feature.)

 

The costs to the FDIC from these bank failures have been enormous. The cost to the FDIC’s Depositors Insurance Fund (DIF) from the April 2010 bank closures alone was $9.4 billion, the highest monthly total so far during the current bank failure wave.

 

The April 30 closure of Westernbank in Puerto Rico cost the DIF fund $3.31 billion, the third most costly closure in the current round. Only the July 11, 2008 closure of IndyMac ($8.0 billion) and the May 21, 2009 closure of BankUnited ($4.9 billion) were more costly to the fund.

 

Roughly three quarters of the banks that have failed so far this year have involved banks with assets under $1 billion. The 2010 failed banks involve a slightly higher proportion of larger banks; in 2010, about 26% of bank failures (17 out of 64) have involved banks with assets over $1 billion, compared to about 20% in 2009 (28 out of 140).

 

The 2010 bank closures have also involved a slightly greater proportion of the smallest banks. Thus, about 23% of the 2010 bank closures (15 out of 64) have involved banks with assets under $100 million, compared to about 17% of failed banks in 2009 (24 out of 140).

 

Vivendi lost the liability phase of the securities class action jury trial, and now it has lost a rearguard action to try to have French investors excluded from the U.S. investor class. According to press reports (here and here), Judge Jean-Claude Magendie of the Court of Appeals of Paris ruled on April 28, 2010 that Vivendi can’t block French investors from participating in the U.S. class action lawsuit.

 

The U.S. class action lawsuit involved the financial impact on the company from the $46 billion December 2000 merger between Vivendi, Seagram’s entertainment businesses, and Canal Plus. The plaintiffs contended that as a result of this and other debt-financed transactions, Vivendi experienced growing liquidity problems throughout 2001 that culminated in a liquidity crisis in mid-2002, as a result of which, the plaintiffs contend, Vivendi’s CEO Jean-Marie Messier and CFO Guillaume Hannezo　were sacked.

 

The plaintiffs contended that the between October 2000 and July 2002, the defendants misled investors by causing the company to issue a series of public statements "falsely stating that Vivendi did not face an immediate and severe cash shortage that threatened the Company’s viability going forward absent an asset fire sale. It was only after Vivendi’s Board dislodged Mr. Messier that the Company’s new management disclosed the severity of the crisis and that the Company would have to secure immediately both bridge and long-term financing or default on its largest credit obligations."　

 

The long-running case resulted in a January 2010 jury verdict against the company on all 57 counts, as discussed here. Damages are yet to be awarded.

 

In the French court action, Vivendi sought to reduce the number of investors who could claim an award from the class action lawsuit. According to Bloomberg (here), about two-thirds of the members of the U.S. plaintiff class live in France. The same article states that the French court noted the "serious ties existing" between the French company, French investors and the U.S.

 

Significantly, the court restricted its opinion to the question whether the French investors could participate in the action, and did not reach the question whether French courts would enforce any eventual award.

 

This latter question of enforceability is particularly critical in this case, as Judge Richard Holwell in his March 22, 2007 order certifying the class had included investors from certain countries (including France) and excluded investors from other countries (such as German and Austria) based on his assessment of whether or not the judgment of a U.S. court in a securities class action lawsuit would be enforceable in the various countries.

 

In an April 28, 2010 press release (here), Vivendi said that it "regrets that the Court of Appeal has decided not to make a ruling at this stage on the question of whether American class actions were in accordance with French public policy."

 

The press release also states that no judgment has been rendered in the U.S. court action, which the company intends to appeal.

 

In a March 1, 2010 press release (here), the company announced that it had created a reserve of 550 million euros ($723 million) "with respect to the estimated damages, if any, that might be paid to the plaintiffs." The company added that "the amount of damages that Vivendi might have to pay the class plaintiffs could differ significantly, in either direction, from the amount of the reserve."

 

In a April 26, 2010 opinion (here) that could have significant implications for motions to dismiss in the many subprime-related securities actions pending against the rating agencies, Southern District of New York Judge Schira Scheindlin rejected the arguments of Moody’s and S&P that the action investors in the Rhinebridge structured investment vehicle (SIV) should be dismissed because the investors’ losses were caused the global credit crisis rather than those firms’ investment ratings.

 

Background

The investor plaintiffs had filed a putative class action lawsuit for common law fraud in connection with the collapse of Rhinebridge. The action was brought against IKB Deutsche Industriebank AG and related entities; the rating agency defendants, including Moody’s and S&P; and certain individuals. (If IKB’s name sounds familiar, that is because it was one of the principal buyers in the now infamous Abacus transaction at the heart of the SEC’s action against Goldman Sachs.)

 

The plaintiffs contend that the defendants fraudulently misrepresented the value of Rhinbridge and its Senior Notes. These misrepresentations took the form of the high credit ratings assigned to the Notes. The Notes’ triple A ratings allegedly conveyed to investors that they were highly credit worthy and exceptionally strong, but also allegedly concealed that Rhinebridge’s portfolio actually consisted of toxic assets that were heavily concentrated in the structured finance and subprime mortgage industries. The Notes were downgraded in October, Rhinebridge entered receivership and the investors lost million of dollars.

 

S&P and Moody’s moved to dismiss on the grounds that plaintiffs allegations were insufficient to demonstrate loss causation, in that they failed to account for the global liquidity crisis that began in the summer of 2007.

 

The April 26 Opinion

Judge Scheindlin rejected the defendant rating agencies’ loss causation argument, observing that "to hold that plaintiffs failed to plead loss causation solely because the credit crisis occurred contemporaneously with Rhinebridge’s collapse would place too much weight on one single factor and would permit S&P and Moody’s to blame the asset-backed securities industry when the their alleged conduct plausibly caused at least some portion of plaintiffs’ losses."

 

She added that "even if the existence of the credit crisis—standing alone – could be enough to defeat a plaintiffs’ pleading of loss causation, it is not apparent that the credit crisis was the sole cause of Rhinebridge’s collapse."

 

Judge Scheindlin also noted that "S&P and Moody’s may yet prevail at a later stage in this case," adding that "if defendants ultimately prove that plaintiffs’ losses were, in fact, cause entirely by an intervening event, then defendants will prevail either at summary judgment or at trial."

 

Judge Scheidlin declined to find, as plaintiff had urged, that the rating agencies were "one of the major causes" of the global financial crisis. She observed that:

 

Blame for the financial crisis can be, and had been, spread globally – from the financial sector’s increasingly complex financial products, to mortgage originators, to the government’s loosened regulatory practices and its failure to respond to the collapse and substantial weakening of multiple financial powerhouses. While the Rating Agencies’ actions may have been a "substantial factor" causing the loss, that is not tantamount to labeling their conduct a "major cause" of the global financial crisis.

 

Discussion

While numerous subprime and credit crisis-related lawsuits have been filed against the rating agencies have been filed and are slowly working their way through the courts, the fundamental questions of whether and under what circumstances the rating agencies might be held liable to investors are yet to be worked out.

 

Even before those basic liability issues can be addressed, the threshold pleading issues still have to be sorted out. Judge Scheindlin emphatically did not hold that the rating agencies can be liable. However, her April 26 opinion does represent a strong signal that the rating agencies will not get off the hook merely because there was a larger financial crisis beyond the rating agencies’ actions in connection with the specific transactions.

 

To put everything under the heading of the credit crisis, Judge Scheindlin held, would be to permit the rating agencies to "blame the asset-backed securities industry when the alleged conduct plausibly caused at least some proportion of plaintiffs’ losses."

 

So it remains to be seen whether the rating agencies may be held liable. But Judge Scheindlin’s opinion suggests that the rating agencies will not be able to get the cases against them dismissed on the simple theory that the credit crisis and not their rating actions caused investor losses, where plaintiffs have plausibly alleged that the rating agencies cause some proportion of the losses.

 

This holding potentially removes at least one threshold barrier to the question of ultimate liability, at least for purposes of the pleading stages, and reduces the extent to which the rating agencies may be able to rely on the "coincidence" of the global credit crisis as an out from the cases against them.

 

For my discussion of Judge Scheindlin’s opinion in a separate subprime lawsuit against the rating agencies in which, on the facts alleged, she held that the rating agencies were not entitled to dismissal on the grounds that their ratings were protected by the First Amendment, refer here.

 

The WSJ.com Law Blog’s post on Judge Scheindlin’s opinion can be found here. Andrew Longstreth’s April 27, 2010 Am Law Litigation Daily article about the decision can be found here. .

　　

A unanimous U.S. Supreme Court held on April 27, 2010 that the shareholder lawsuit arising from Merck’s alleged misrepresentations regarding Vioxx is not time-barred by the applicable statute of limitations. A copy of the Court’s opinion can be found here.

 

Background

In an action filed in November 6, 2003, the plaintiffs had contended that the company knowingly misrepresented the risk of using Vioxx, and that when the risks were disclosed the company’s share price fell. Merck claims that more than two years prior to the filing the plaintiffs had or could have discovered the "facts constituting the violation, and therefore was barred by the applicable statute of limitations.

 

The District Court granted Merck’s motion to dismiss, holding that events more than two years prior to the filing should have alerted the plaintiffs to the possibility of a misrepresentation, placing the plaintiffs on "inquiry notice."

 

The Third Circuit reversed the district court, holding that while events more than two years prior to the filing constituted "storm warning," the events did not suggest scienter, and consequently did not put the plaintiffs on "inquiry notice."

 

Merck filed a petition for writ of certiorari to the U.S. Supreme Court, and the Supreme Court agreed to hear the case.

 

The Supreme Court’s Holdings

Justice Breyer’s opinion for the Court (with separate concurring opinions by Justices Stevens and Scalia) affirmed the Third Circuit and held that the plaintiffs’ complaint was timely.The Court’s opinion reflected several specific holdings.

 

First, the Court held that the statute’s requirement of filing within two years of "discovery" encompasses "not only facts plaintiff actually knew, but also those facts a reasonably diligent plaintiff would have known." (This is the portion of the opinion in which the concurring Justices did not join. Justice Stevens said this finding was not necessary to the Court’s holding. Justice Scalia, joined by Justice Thomas, disagreed with this part of the opinion while joining the Court’s holding.)

 

Second, the court held that the "discovery" of the facts that "constitute the violation" required the discovery of scienter-related facts. The Court found that "it would frustrate the very purpose of the discovery rule … if the limitations period began to run regardless of whether a plaintiff had discovered any facts suggesting scienter," as otherwise a defendant could conceal that he made a misstatement with an intend to deceive, and the two-year limitations period would expire before the plaintiff had actually discovered the fraud.

 

In reaching this conclusion about what is required to trigger the running of the statute of limitations, rejected Merck’s argument that the statute of limitations could begin to run once plaintiffs were on "inquiry notice." The court observed that the "terms such as ‘inquiry notice’ and ‘storm warnings’ may be useful to the extent that they identify a time when the facts would have prompted a reasonably diligent plaintiff to begin investigating," but in any event the "limitations period does not begin to run until the plaintiff thereafter discovers or a reasonably diligent plaintiff would have discovered the facts ‘constituting the violation,’ including scienter."

 

Finally, the Court rejected Merck’s argument that pre-November 2001 circumstances "reveal ‘facts’ indicating scienter," concluding that prior to November 6, 2001, "the plaintiffs did not discover, and Merck has not shown that a reasonably diligent plaintiff would have discovered, the ‘facts constituting the violation.’" Thus, the Court concluded, the "plaintiffs’ suit is timely."

 

Discussion

In a sense the issues addressed in the Court’s opinion are narrow and technical. In the vast scheme of things, statutes of limitations issues arguably might not affect many securities lawsuits, many of which historically have been filed shortly after the news triggering a sharp stock price drop, when, as is usually alleged, the truth was revealed to the marketplace.

 

However, there are at least a couple of current circumstances that may make the Supreme Court’s opinion in the Merck case particularly relevant just now.

 

First, since the second half of 2009, there have been an increasing number of case filings in which the filing date has come well after the proposed class period cutoff date. The later in time the filing date occurs, the likelier it is that statute of limitations issues could become relevant. Clarity around the issue of what triggers the running of the ’34 Act’s two-year statute of limitations, and particularly the clarification of the requirement for the discovery of facts constituting scienter, may help courts dealing with these belated cases to determine timeliness issues.

 

A second and perhaps more important reason the Court’s holding in Merck could prove relevant just now has to do with the continuing litigation arising out of the subprime meltdown and the credit crisis. As we move forward in time and the crisis-related events recede further into the past, additional filings increasingly may raise questions of timeliness. Statute of limitations questions are already arising in some of these cases, as I discussed in a recent post (here), and they are increasingly likely to arise in future cases.

 

The Merck opinion’s clarification of what is required to trigger the running of the statutue of limitations will help sort out these issues. In particular, the Court’s clarification that facts constituting "inquiry notice" and "storm warnings" alone are not sufficient to trigger the running of the statute could be particularly significant.

 

One final thought about this case is that the Court’s opinion definitely is helpful to the plaintiffs. In recent years, the Court has developed a reputation as hostile to private securities lawsuits. Without a doubt, the Court has issued a series of decisions (Tellabs, Stonridge, Twombley/Iqbal, Dura, etc.) that have proved helpful to defendants. But the Court’s opinion in the Merck case is not only helpful to the plaintiffs in that case but it likely will prove useful to plaintiffs in other cases as well.

 

Honestly, I didn’t see this coming. I thought, given the Court’s recent track record and given what I thought was the common sense notion that the Court would not grant cert just to affirm the Third Circuit, I thought this case would likely lead to a victory for Merck in another defense friendly decision. Instead, the plaintiffs prevailed in a unanimous holding. Maybe my presumptions were completely off base, but I still find the outcome interesting and a little unexpected.

 

Special thanks to the several readers who sent me copies of the opinion.

 

The SEC’s high-profile enforcement action against Goldman Sachs and one of its investment bankers may or may not revitalize the waning subprime and credit crisis-related litigation wave, but it has at least sparked an outbreak of follow on civil litigation against Goldman Sachs.

 

According to their April 26, 2010 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York against Goldman and certain of its directors and officers. According to the press release, the complaint (which can be found here) alleges that the defendants failed to disclose that:

 

(i) the Company had, in violation of applicable law, not fully disclosed the facts and circumstances concerning the formation and sale of the ABACUS 2007-AC1 deal to investors such that it had engaged in misleading conduct; (ii) the Company had, in fact, bet against its clients and constructed collateralized debt obligations that were likely, if not designed, to fail; and (ii) the Company had received a Wells Notice from the SEC about the ABACUS transaction but failed to inform shareholders of this fact.

 

The complaint further alleges that April 16, 2010, Goldman was sued by the SEC "for making materially misleading statements and omissions in connection" with ABACUS 2007-AC1. Following this announcement, Goldman’s stock price fell $24.05, declining from $184.27 per share on April 15, 2010 to close at $160.70 per share on April 16, 2010.

 

A key issue in this new lawsuit will be Goldman’s alleged failure to disclosure the existence of the Wells Notice. Which of course begs the question of whether or not Goldman had any obligation to disclosure the existence of the Wells Notice. There is no bright line rule on this issue, it is a question of materiality. But as Michelle Leder points out on the Footnoted blog (here), lost of other companies do routinely disclose Wells Notices. A post on the Westlaw Business Currents blog (here) is very much to the same effect, that is, that whether or not Wells Notice disclosure is requrired, many companies do disclose Wells Notices.

 

The securities class action lawsuit filing follows close on the heels of the filing late last week of two separate New York state court shareholders’ derivative lawsuits against Goldman, as nominal defendant, and certain of its directors and officers. According to April 23, 2010 press reports (refer here), the complaints allege that:

 

　

The individual defendants engaged in a systematic failure to exercise oversight of the company’s 23 Abacus transactions, which were completed over a three and half year period. As a direct and legal result of the individual defendants’ wrongful conduct, Goldman Sachs has been significantly and materially damaged, faces billions of dollars of liability, has incurred and will continue to incur millions of dollars of expense in defending claims against the SEC and investors, and has suffered serious damage to its reputation and image.

 

The same press reports also quote a leading plaintiffs’ securities class action attorney as saying that "I suspect every major pension fund in America" is considering suing Goldman Sachs "over the conduct that occurred."

 

I have added the new Goldman lawsuit to my running list of subprime and credit crisis-related securities class action lawsuits, which can be accessed here. SInce I first began compiling the list almost exactly four years ago, there have been a total of 210 subprime and credit crisis-related securities suits filed, of which eight have been filed so far this year.

 

A WSJ.com Law Blog post about the Goldman securities class action lawsuit can be found here. Bloomberg’s article about the lawsuit can be found here.

 

More About Goldman Sachs and D&O Claims: An April 26, 2010 National Underwriter article by Susanne Sclafane entitled "Long-Awaited SEC Action Emphasizes Need for More D&O Cover, Lawyer Says" (here) presents a lengthy discussion of the possible D&O claims implications from the recent SEC action against Goldman Sachs, as well as any follow on private litigation. The article also contains an extensive summary of the recent Advisen conference call regarding first quarter securities litigation trends.

 

As for the question of potential insurance coverage for the SEC’s claims and for other claims that filed against Goldman Sachs, an April 26, 2010 Business Insurance article by Roberto Ceniceros entitled "Goldman Legal Woes Could Hit Insurers" (here) explores the issues that could affect the availability of coverage under Goldman’s D&O insurance program. An April 24, 2010 Bloomberg article on the same topic can be found here.

 

The April 26, 2010 issue of Business Insurance also has an article by Zack Phillips entitled "Subprime Rulings Favor Defendants" (here), discussing recent trends in subprime and credit crisis lawsuit dismissal motion rulings.

 

Developments on the D&O Claims Front: In Chubb’s April 22, 2010 quarterly earnings conference call (a transcript of which can be found here), Chubb Vice-Chairman John Degnan had the following to say about D&O claims trends:

 

　

I am particularly pleased about developments in two areas I want to mention specifically, the frequency of non-credit crisis security class action claims and the recent rulings in credit crisis derivative actions.

 

For the second straight quarter, even as the number of new credit crisis security class actions virtually disappeared we did not see a corresponding increase in the number of non-credit crisis class actions. So for those observers who have speculated that there was a substantial number of backlog claims waiting to be filed, the evidence so far doesn’t support that. And, the two year statute of limitations is already a bar to actions in which the triggering event, typically a corrective disclosure took place in 2007 and early 2008, the years in which that presumed backlog would have been building.

 

In addition, we’re encouraged by the continuing relatively high dismissal rate in the first quarter of derivative actions which might otherwise trigger our side A coverages. Unlike the stock option back dating claims which were heavily weighted towards derivative actions, credit crisis claims have been predominately securities class actions. However, in connection with the credit crisis derivative claims which have been brought, we are seeing the allocation of well established legal protections governing mismanagement allocations and the defendants are having great, in some cases even unexpected success in defending those claims.

 

For example, in the recent decision involving AIG’s credit crisis woes, the court has made it clear that they will not engage in second guessing managements’ legitimate business decisions regardless of how badly those decisions played out. So, although some observers have asserted that credit crisis derivative claims have the potential to impact side A coverages, we are not currently seeing an increased level of exposure as a result of them.

 

Ordinarily I would not include on this blog anything as insurer-specific as a single company’s earnings conference call transcript, and I do not intend to comment on Chubb’s quarterly results here. I included this selection from the conference call transcript because I have a couple of thoughts about Mr. Degnan’s claims trend observations.

 

I should emphasize at the outset that in adding my comments that I mean no disrespect to Mr. Degnan, for whom I have nothing but the highest admiration and respect. Moreover, I fully recognize that Mr. Degnan’s comments were made in reference to his own company’s experience, rather than as a general matter. But with respect to more general trends, I do have a few observations.

 

There is no doubt that securities class action lawsuit filings were down during the first quarter as has been noted elsewhere. However, by my count there have been eight securities class action lawsuits filed so far in 2010 (out of about 40 lawsuit total YTD) in which the filing date was more than a year after the proposed class period cutoff. That 20% of all filings YTD were belated suggests to me that the belatedness of securities lawsuit filing, which first became pronounced in the second half of 2009, has continued into 2010. My earlier post about belated 2010 securities lawsuit filings can be found here.

 

I agree with Mr. Degnan that so far the credit crisis-related derivative suits have not gone particularly well for the plaintiffs. But as for the potential risks for the Side A product line in general as a result of derivative litigation activity, it is important to note that when derivative cases survive the initial pleading hurdles, they are increasingly costly to settle, and when they do settle, increasingly they are producing Side A losses.

 

The best illustration of this latter point is the $118 million settlement in the Broadcom options backdating derivative lawsuit, to which Excess Side A insurers contributed $40 million. Admittedly, the Broadcom settlement was not credit crisis related but it still represents a very significant development. (Perhaps Mr. Degnan can be forgiven for neglecting to mention the case, however, since his company is one of the few D&O insurers that did not participate in the Broadcom’s Side A tower.)

 

In any event, the most significant risk to the Side A product line is from insolvency related claims, not derivative claims. In the current economic environment, bankruptcy related claims remain a significant threat.

 

The conventional view is that plaintiffs may be faring poorly in many of the subprime-related cases. However, plaintiffs have in fact been doing relatively better in ’33 Act claims brought by purchasers of mortgage-backed securities. A recent ruling in the Wells Fargo Mortgage-Backed Certificates Litigation, in which a significant number of plaintiffs’ claims survived the defendants’ motions to dismiss, continues this trend of relatively favorable rulings in these cases. In addition, as also discussed below, the plaintiffs in the Lincoln National subprime related ERISA class action also recently survived dismissal motions.

 

Wells Fargo Mortage-Backed Certificates: In an April 22, 2010 order (here), Northern District of California Judge Susan Illston granted in part and denied in part the defendants motions to dismiss in the subprime-related Wells Fargo Mortgage-Backed Certificates securities class action lawsuit.

 

Purchasers of the mortgage pass-through certificates had filed their lawsuit in March 2009, alleging that the offering documents contained misrepresentations and omissions. The plaintiffs alleged that the documents misstated Wells Fargo’s underwriting processes and loan standards; falsely stated the appraisal value of the underlying mortgaged properties; and misstated the investment quality of the securities, which had been assigned the highest ratings regardless of the lower quality of the underlying mortgages.

 

In her April 22, 2010 order, Judge Illston granted the defendants motions to dismiss, for lack of standing, plaintiffs’ claims based relating to 37 out of the 54 referenced offerings in which the named plaintiffs had not purchased securities. She also granted the rating agency defendants’ motions to dismiss the plaintiffs’ claims against them, holding (in reliance on Judge Lewis Kaplan’s February 1, 2010 ruling in the Lehman Brothers case) that the rating agencies were not underwriters within the meaning of the ’33 Act.

 

As to the 17 offerings in which the plaintiffs had purchased securities, Judge Illston denied the remaining defendants’ motions to dismiss, holding that the plaintiffs, in reliance on confidential witness testimony, had adequately alleged misrepresentations in connection with the defendants’ underwriting practices, improper appraisal practices, and the process by which the securities obtained their investment ratings.

 

One particularly interesting part of Judge Illston’s opinion related to the defendants’ motions to dismiss the plaintiffs’ claims based on the statute of limitations. Plaintiffs first filed their complaint in March 2009. In order to avoid the statute, the plaintiff claims would "have to have accrued no earlier than March 27, 2008 to be timely." The defendants argued that due to widespread press coverage the plaintiffs were put on inquiry notice of problems involving mortgage-backed securities well before March 2008. Judge Illston found these arguments "unpersuasive" noting that the news articles on which the defendants relied "give rise to competing inferences."

　

Lincoln National ERISA Class Action: In an April 20, 2010 order (here), Eastern District of Pennsylvania Judge Anita Brody denied the defendants’ motions to dismiss the subprime related ERISA lawsuit that had been brought on behalf of two Lincoln National benefit plans.

 

During 2008 and 2009, Lincoln National had sustained heavy losses in its investment portfolio because of investments in mortgage-backed securities, structured investment products, and other derivative securities, including collateralized debt obligations. As the company sustained these investment losses, its share price declined substantially. The plaintiff alleged that because the defendants knew or should have known of the company’s exposure to investment losses, it was imprudent to continue to invest plan assets in the company’s stock. The plaintiff also alleged that the defendants’ failure to disclose the company’s exposure to investment losses prevented the plan participants from making informed investment decisions.

 

The defendants moved to dismiss, arguing first that because the plans were Employee Stock Ownership Plans, the plan fiduciaries are entitled to a presumption of prudence for the decision to invest in employer securities. The plaintiff argued that the presumption was inapplicable because the plan fiduciaries had discretion whether to offer the company stock as an investment options. The court found that the plaintiff had alleged sufficient facts to overcome the presumption, citing the alleged precipitous decline in the company’s stock, the defendants’ knowledge of the impending collapse and the defendants’ conflicted status.

 

In reaching this conclusion, Judge Brody noted that the complaint contains "specific allegations explaining why Defendants knew or should have known that the value of the LNC common stock would seriously deteriorate." She specifically referred to the complaint’s allegations that "Defendants knew or should have known of the Company’s exposure to losses in its investment portfolio due to declines in subprime and Alt-A residential mortgage-backed securities, the Company’s exposure to losses in its investment portfolio due to equity investments in troubled markets, and the Company’s exposure to decreasing capital levels."

 

In denying the motion to dismiss on this ground, Judge Brody commented that the plaintiff "faces a heavy burden going forward" as the "presumption of prudence is a difficult standard to overcome." She noted that the complaint "alleges sufficiently dire circumstances that might cause a prudent plan fiduciary to discontinue" the investment option in company stock.

 

Judge Brody also found that the plaintiff had adequately alleged claims that the documents distributed to plan participants contained materially misleading statements. However Judge Brody granted the defendants’ motion to dismiss on the plaintiff’s failure to disclose claim, holding that the plan documents "adequately informed plan participants about the risk inherent in investing solely in employer securities."

 

Discussion

The court’s holding in the Wells Fargo case is largely consistent with other recent dismissal motion rulings in ’33 Act claims involving mortgage-backed securities. It now seems to be fairly well established that plaintiffs are not going to be allowed to assert claims in connection with offerings in which they did not purchase securities. However, dismissal motions apparently will be denied where the plaintiffs have alleged that offering document statements about mortgage originating practices were misleading, at least when the plaintiffs allege in reliance on confidential witness testimony that the mortgage originator systematically disregarded its underwriting guidelines.

 

The statute of limitations issue in the Wells Fargo case is interesting. Judge Illston’s holding that the plaintiffs had not been put on inquiry notice in March 2008 raises the interesting question of when prospective plaintiffs were put on inquiry notice. At some point during 2008, as the financial markets deteriorated and then nearly collapsed, mortgage-backed securities investors clearly were on inquiry notice about possible problems in the mortgage securitization industry. Perhaps another case will narrow down that 2008 inquiry notice date. At a minimum by September 2008 when Lehman Brother collapsed and AIG had to be bailed out, the cat was clearly out of the bag.

 

The practical reality that there is some date during 2008 when the plaintiffs undeniably were on inquiry notice provides at least one explanation why the number of new subprime-related securities class action lawsuit filings began to decline. Clearly, the plaintiffs’ lawyers have no interest in brining claims that will likely be found to be time barred. Of course, as time goes on, the dates on which the toxic offerings took place recedes further and further into the past, and so that is one reason why, notwithstanding the dramatic recent allegations in the SEC’s enforcement action against Goldman Sachs may unlikely to generate a wave of new subprime related securities suits.

 

There is one interesting side note in the SEC’s complaint against Goldman Sachs that is tangentially related here. The SEC alleges that as Paulson company representative and ACA, the portfolio selection manager, worked out which securities would be included in the Abacus CDO, the Paulson representative deleted eight mortgage backed securities that had been issued by Wells Fargo. The SEC’s complaint alleges in paragraph 34 that "Wells Fargo was generally perceived as one of the higher-quality subprime loan originators."

 

It is probably cold consolation to the investors in the Wells Fargo securities that Wells Fargo’s mortgages were then perceived as sufficiently durable that Paulson didn’t want securities backed by those mortgages in his "built to fail" CDO. The money those investors lost on their investment hurt them every bit as badly as the money that investors in other securities lost hurt them. It is probably some measure of how widespread the subprime meltdown was that even securities perceived as stronger still produced significant losses for their investors.

 

As for the Lincoln National decision, this is the latest in a series of subprime-related ERISA class action lawsuit dismissal motion rulings suggesting that ERISA claims may be more likely to survive dismissal motion rulings. The most extreme example of this is in connection with NovaStar Financial, where the securities class action lawsuit was dismissed (and indeed the dismissal was affirmed by the Eighth Circuit), yet the NovaStar ERISA lawsuit survived the dismissal motion. At one level this is hardly surprising since ERISA plaintiffs, unlike securities plaintiffs, do not have to allege scienter, among other things.

 

The Lincoln National case does represent an interesting example of a lawsuit against a company not for its involvement as a mortgage industry participant or a mortgage securitization producer, but rather as a mortgage backed security investor. When losses are sufficiently widespread, the lawsuits go in every direction. Though Lincoln National is among the defendants in this ERISA case, it could well be a claimant in other mortgage-backed securities lawsuits, owing to the losses in its investment portfolio.

 

I have in any event added these two decisions to my running tally of subprime-related lawsuit dismissal motion rulings, which can be accessed here.　

 

Madoff Investor Lawsuit Against the SEC Dismissed: In an April 20, 2010 order (here), Central District of California Judge Stephen V. Wilson granted the motion of the SEC to dismiss the suit brought against the agency by Madoff investors under the Federal Tort Claims Act.

 

The investors had alleged that the SEC "owed a duty of reasonable care to all members of the general public" and that the agency’s negligent acts and omissions "caused Madoff’s scheme to continue, perpetuate and expand," alleging specifically that the SEC "failed to terminate Madoff’s Ponzi scheme despite multiple opportunities to do so."

 

The SEC moved to dismiss arguing that the court lacked jurisdiction over the FTCA claims, due to the statute’s "discretionary function exception," which bars federal courts from adjudicating tort actions arising out of federal officers’ discretionary acts.

 

Judge Wilson said that the plaintiffs’ allegations "identify decisions that, in hindsight, could have and should have been made differently," while others "reveal the SEC’s sheer incompetence." However, Judge Wilson also found that the complaint lacks "any plausible allegation revealing that the SEC violated its clear, non-discretionary duties." Judge Wilson granted the motion to dismiss, but did grant the plaintiffs 30 days leave to amend their complaint to attempt to allege that "the SEC failed to conform to its mandatory duties."

 

It won’t help them overcome the jurisdictional hurdle, but the plaintiffs undoubtedly will be tempted to allege in their amended complaint that at the same time the agency failed to investigate Madoff, senior SEC enforcement department attorneys were spending up to eight hours a day viewing pornography on their work computers.

 

An April 22, 2010 Law.com article about the ruling in the Madoff investors’ lawsuit against the SEC can be found here.

 

D&O Dispute Over Stanford Defense Fees to be Heard in September: In an April 21, 2010 order (here), Southern District of Texas Judge Nancy Atlas set a September 1, 2010 date for the commencement of the hearing on the motion for preliminary injunction of jailed financier R. Allen Stanford and three others to compel the Stanford Group’s D&O insurers to fund the individuals’ defense against criminal allegations. The insurers contend that coverage under the policy is precluded by the policy’s money laundering exclusion.

 

As readers will recall, on March 15, 2010, the Fifth Circuit had remanded the coverage dispute back to the district court for a factual determination whether or not the money laundering exclusion has been triggered (that is, whether or not there has "in fact" been money laundering as that term is defined in the policy). The Fifth Circuit also ruled that the insurers must continue to advance defense expense until the factual determination has been made.

 

Judge Atlas’s scheduling order not only establishes the schedule for the evidentiary ruling but also sets a schedule for factual discovery as well. It seems probable that at some point fairly early in the discovery process, one of the individual defendants will feel compelled to take the fifth in response to a deposition question. Similarly the individuals are likely at the September hearing to assert their Fifth Amendment rights from the witness stand.

 

While an individual’s assertion of their Fifth Amendment rights cannot be held against them in a criminal trial, there is substantial precedent that in a civil trial a finder of fact can draw "adverse inferences" from an individual’s assertion of their Fifth Amendment rights. The individuals and their attorneys will face the formidable challenge of attempting to establish that there was no money laundering within the meaning of the policy without themselves being able to testify on their own behalf.

 

In any event, as reflected in the April 22, 2010 Law.com article about Judge Atlas’s scheduling order (here), the September hearing "could give a preview of the criminal trial in January."

 

Abacus: Sung to the Tune of "Springtime for Hitler"?: A loyal reader alerted me to the following letter to the editor that appeared in the April 24, 2010 New York Times:

 

The investment deal that Goldman Sachs created sounds like something out of the Mel Brooks show "The Producers": plotting to make more money with a flop than with a hit!

Daniel Pitt Stoller
Bayside, Queens, April 19, 2010

 

Mr. Stoller’s letter is pretty funny. While I appreciate the humor of his comment, I do think it unintentionally points out something about the infamous Abacus deal that, in light of intervening events, might be easy to overlook.

 

The fact is that, in the Mel Brooks movie, "Springtime for Hitler" turned into an unexpected hit, even though, like the Abacus CDO, it was "built to fail."

 

John Paulson may well have felt confident that a mortgage meltdown was coming, but as Max Bialystock found out in the movie, fate and fortune can be fickle. It all turned out great for Paulson and he became a wealthy man, but there were no guarantees. Sometimes unexpected things can happen. Neither Abacus nor Springtime for Hitler, as truly awful as they both were, were guaranteed to fail.

 

In any event, all of this calls for a "built to fail" video tribute. Keep a close watch for Mel Brooks (who won an academy award for the movie screenplay), appearing briefly to sing "Don’t be stupid, be a smarty/Come and join the Nazi Party."

 

And if you consider this video from just the right perspective, I am sure you will find a whole lot of Fabrice ("Fabulous Fab") Tourre in it, too.

 

https://youtube.com/watch?v=ZGp0hCxSg98%26hl%3Den_US%26fs%3D1%26rel%3D0

In the largest subprime-related securities suit settlement to date, Countrywide Financial has reached an agreement to pay $600 million to settle the securities class action pending against the company and certain of its directors and officers, according to an April 23, 2010 article by Gabe Friedman in The Daily Journal (here, subscription required). The settlement reportedly is still confidential and is also subject to the approval of several pension boards.

 

The settlement agreement would include the release several top Countrywide executives, including former CEO Angelo Mozillo.

 

The settlement is also subject to court approval; however, the agreement reportedly was the product of mediation before U.S. District Judge Howard Matz, and accordingly it seems unlikely that it would be set aside by the court, assuming it ultimately is approved by all parties.

 

The consolidated securities class action lawsuit against Countrywide is pending before Central District of California Judge Mariana R. Pfaelzer. In a massive December 1, 2008 opinion, about which refer here, Judge Pfaelzer had denied the defendants’ motion to dismiss. The Countrywide case remains one of the most prominent subprime-related securities cases in which the motions to dismiss were denied.

 

The settlement reportedly only relates to the securities class action lawsuit; the separate California-based shareholders’ derivative lawsuit, which also survived a motion to dismiss (refer here), apparently remains pending. The separate Countrywide ERISA class action lawsuit previously settled for $55 million (refer here).

 

In addition to these actions brought by private litigants, the SEC has also separately filed an enforcement action against former CEO Angelo Mozillo, as well as the company’s former CFO and COO, as discussed here. In addition, a recent report in the Wall Street Journal suggested that a Central District of California grand jury is also looking into the possibility of criminal misconduct at Countrywide.

 

By any measure, this is a very large settlement – should it in fact be finalized. According to the RiskMetrics’ Top 100 Settlements report (here), the $600 million Countrywide settlement would be tied for 13th largest securities settlement of all times.

 

The $600 million Countrywide settlement is also by far the largest subprime-related securities class action lawsuit settlement, by far eclipsing the $475 million that Merrill Lynch agreed to pay to settle its subprime related securities class action lawsuit (about which refer here).

 

Despite the sheer size of the Countrywide settlement and its relative high ranking on the settlement tables, there may be some who may question the settlement at this dollar figure. Shareholders lost billions of dollars when Countrywide’s stock price plunged before the company’s acquisition by Bank of America. In addition, Angelo Mozillo sold hundreds of millions of dollars in his personal holdings in the company’s stock before the share price began its plunge.

 

As the post mortem on the subprime meltdown has developed, Countrywide has become the preferred example of many of the excesses that preceded the subprime meltdown. Accordingly, there may well be some who question whether $600 million, as big of a number as it is, is "enough."

 

The problem with arguments about what is "enough" is that it immediately begs the question of "compared to what?" Those who contend that it is not "enough" may well point to the magnitude of the investor losses (although clearly not all of the drop in Countrywide’s market capitalization is attributable to the alleged fraud). They may also point out that even just with respect to options backdating, there was at least one securities lawsuit settlement greater than $600 million (the UnitedHealth Group case, which settled for a total $925.5 million, taking all settlements into account).

 

On the other hand, there have only been a dozen cases in the entire history of securities litigation that have settled for more than $600 million and many of those involved companies that were brought down due to criminally fraudulent misconduct (e.g., Enron, WorldCom, Cendant). Other cases just involved criminal misconduct (e.g., Tyco). But WorldCom was acquired, it didn’t go bust and so far there have been no criminal allegations.

 

There may be those who feel so strongly that that the investors’ recovery should have been larger that they may object to the settlement; indeed, there could be those who feel they could do better on their own and who choose therefore to opt-out of the class settlement. As I have detailed elsewhere, even in many of the prior settlements that were larger even than the Countywide settlement, there were significant numbers of individual opt outs and in many cases, the aggregate amount of the opt-outs’ recovery represented a very significant percentage of the class settlement amount.

 

But whatever else may be said, $600 million is a lot of money. The Countrywide settlement comes close on the heels of the $200 million Schwab YieldPlus settlement. The quick succession of these two settlements suggests that the evolution of the subprime litigation wave may have reached a critical point. We may now begin to see other settlements emerge, particular in those cases that have survived dismissal motions.

 

The Countrywide and Schwab settlements, taken together with the $475 Merrill Lynch settlement, represent over $1.2 billion. These few data points suggest that the aggregate costs of resolving all of the subprime and credit crisis related litigation could be staggering.

 

But as impressive as these three settlements are, both individually and collectively, they all share one trait that may make them irrelevant in many cases. That is, in each of these three cases, there was a solvent and relatively strong entity available to fund a significant settlement. (Indeed, by the time the cases settled, the relevant entity with respect to both the Merrill Lynch and Countrywide settlements happened to be Bank of America.)

 

In many other pending cases, the relevant entity has long since folded (e.g., New Century Financial), and other than quickly dwindling insurance proceeds, there may be relatively few sources out of which to fund settlements. These eye-poppingly large settlements may represent nothing so much as what may be possible where there are deep pockets available, but they may not represent relevant reference points for many other cases.

 

In any event, my running tally of the subprime and credit crisis related lawsuit resolutions can be accessed here. However, readers should be aware that I will not be entering the data on the Countywide settlement until I have complete data and a link to a primary source that is not behind a firewall.