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.

 

Every day seems to bring news of a new or expanded bribery or corruption allegations and enforcement actions. In recent days alone, Avon announced that it was suspending four executives in connection with an internal investigation into alleged bribery in the company’s Chinese operations, and U.S. authorities announced they were joining German and Russian authorities in connection with an investigation involving alleged bribery by Hewlett-Packard executives in Russia.

 

If it seems as if the pace of antibribery and anticorruption activity has been picking up, that is only because it has.

 

According to an April 15, 2010 memorandum from the Wilkie Farr & Gallagher law firm (here), the level of Foreign Corrupt Practices Act (FCPA) enforcement in the first quarter of 2010 was "unprecedented." In the first three months of 2010 alone, the U.S. government brought or resolved FCPA charges against 36 companies and individuals, which is 30 more than in the first quarter of 2009 and 32 more than in the first quarter of 2008.

 

Moreover, according to the memo, the signs are that this heightened level of activity will continue for "the foreseeable future." Among other things, there are a variety of "new enforcement initiatives and prosecutorial tools" that have been initiated, including the creation within the SEC’s Enforcement Division of a new unit to focus on FCPA enforcement, and the enactment of the U.K’s Bribery Bill, which received royal assent on April 8, 2010. The Bribery Bill is similar to but broader than the FCPA. In addition, the draft financial reform bill introduced by Senator Chris Dodd contains a provision that, if enacted, would provide significant financial rewards to whistleblowers for providing information leading to a successful enforcement action.

 

These and other developments, including the recent DOJ-FBI sting operation involving individuals in the arms manufacturing industries, suggests, according to the memo, that antibribery enforcement activity is "likely to increase in both the short and the long run."

 

As I have noted in the past (refer for example here), among the risks associated with this types of investigative or regulatory actions is the possibility of follow-on civil litigations following in the wake of the governmental action. There have been many examples in the past of these kinds of follow-on actions, and a recently filed case shows that this threat of litigation following in the wake of an FCPA investigation is continuing. 

 

This most recent example involves a shareholders’ derivative complaint (here) filed on April 15, 2010 in Harris County (Texas) District Court against Pride International, as nominal defendant, and against the eight individual members of Pride’s board of directors. Pride is one of the world’s largest offshore drilling companies. The derivative action arises from "the Board lack of internal control that permitted the Company to engage in years of systematic violations of the FCPA."

 

The complaint alleges that the company’s internal investigation "revealed that Pride paid over $4 million and kickbacks to government officials in every country in which the Company does business." The complaint further alleges that on February 16, 2010, Pride announced that the company was creating a $56.2 million reserve to resolve the FCPA violations. However, the reserve "will only cover the fines, penalties, and disgorgements" and does not include the costs the company has incurred in "investigating and remedying the damages done as a result of the Board’s failure to require that the Company install and maintain a system of internal controls for compliance with the FCPA."

 

The complaint, which seeks recovery for "breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets and unjust enrichment," alleges that "none of the defendants took any steps to prevent this colossal mistake."

 

UPDATE: This new lawsuit filed against Pride apparently is the second derivative action to be filed against the company relating to these issues. The FCPA Professor Blog had an earlier post (here) describing a prior derivative action that was filed last fall in connection with these same circumstances.

 

This case provides an example of what I have described in the past as the D&O link to FCPA activity. There would not be coverage under the typical D&O policy for the fines and penalties imposed in connection with an FCPA enforcement action, although defense fees incurred in connection with the action potentially could be covered under many policies, depending on the policy wording. But the filing of a civil lawsuit against members of the board of directors, as a follow on to the FCPA action, is an event much more directly linked to the D&O policy and much more likely to give rise to covered loss under the policy.

 

As the escalating levels of FCPA enforcement actions continues to increase, this type of potential Board liability exposure will continue to be a growing concern for Boards, their advisers, and their D&O insurers.

 

Those wondering exactly why we are seeing so many antibribery actions now will want to review the April 20, 2010 post, here, on The FCPA Blog.

 

Special thanks to a loyal reader for providing me with a copy of the Pride International complaint.

 

In one of the most substantial settlements to date to arise out of the subprime-related securities litigation wave, the parties to the consolidated Schwab YieldPlus securities class action lawsuit have reached an agreement to settle the case for $200 million, according to an April 20, 2010 press release from The Charles Schwab Corporation. The parties’ settlement arises in the wake of several recent summary judgment rulings in the case and in advance of a looming May 10, 2010 trial date.

 

The proposed settlement is subject to definitive agreement and court approval. The settlement also does not include certain state law claims the plaintiffs had asserted, as well as other regulatory claims.

 

The plaintiffs had filed several class action complaints in 2008 that were later consolidated. As reflected in the plaintiffs’ second amended complaint, the plaintiffs alleged that Schwab and related entities, as well as certain Schwab directors and officers, violated federal and state securities laws and other state laws in representations made about Schwab’s YieldPlus Fund, a short-term fixed income mutual fund.

 

Essentially, the plaintiffs alleged that the defendants misled investors when they described the Fund as a safe alternative to cash which had "minimal" risk of a fluctuating share price. The plaintiffs allege that the Fund was not "stable" or "safe" because it was comprised of assets that were riskier than represented. Specifically, the plaintiffs alleged that the assets held by the Fund were of longer duration than represented. The plaintiffs also alleged that the asset allocation disclosures and the description of the Fund’s concentration in illiquid securities were inconsistent with the Fund’s significant and increasing concentration in mortgage-backed securities.

 

The plaintiffs allege that by extending the average duration of the portfolio and by investing in between 46% to 50% of portfolio assets in mortgage-backed securities, the defendants caused the Fund and its shareholders to incur billions of dollars in losses. The complaint alleges that the Fund’s shareholders lost up to 36% of their "supposedly safe cash investment."

 

Northern District of California Judge William Alsup had recently issued a series of orders substantially denying the defendants’ motions for summary judgment. In a March 30, 2010 order (here), Judge Alsup denied the defendants’ motion for summary judgment and granting plaintiffs’ motion for summary judgment as to plaintiffs’ claims under the Investment Company Act of 1940. In an April 8, 2010 order (here), Judge Alsup substantially denied defendants’ motions for summary judgment on ’33 Act disclosure issues and loss causation issues. In a separate April 8, 2010 order (here), Judge Alsup substantially denied the individual defendants’ motion for summary judgment as to the plaintiffs’ Section 12 claims and certain state law claims. Trial in the case had been set to begin on May 10, 2010.

 

In its April 20 press release, the company stated that it increased its contingency reserve relating to the case an additional $172 million pre-tax (beyond the $11 million the company had previously accrued in the wake of the March 30 summary judgment ruling) an amount which is "net of expected insurance coverage."

 

The proposed settlement of the Schwab YieldPlus Fund securities suit is the second largest settlement yet to arise out of the subprime-related securities litigation wave, exceeded only by the massive January 2009 settlement in the Merrill Lynch subprime-related securities lawsuit (about which refer here). In addition, according to reliable sources, this settlement is the fourth largest securities settlement in the Ninth Circuit and the second largest for a noninstitutional lead plaintiff.

 

The size of the settlement undoubtedly is a reflection of the looming trial date and recent adverse summary judgment rulings, as well as the size of the losses claimed by the plaintiff class. While many of these factors are case specific, this settlement could nevertheless potentially cast a significant shadow across the huge number of remaining subprime-related securities lawsuits. The fact that the case involved a mutual fund may also present its own differentiating characteristics, but plaintiffs may nevertheless seek to rely on fact and amount of this settlement in other cases.

 

There has been a certain amount of publicity recently about how the plaintiffs may be faring poorly in the subprime related securities litigation, at least at the motion to dismiss stage. At a minimum, the sheer magnitude of this settlement suggests the enormous stakes that may be involved in the subprime-related securities lawsuits – at least those that survive initial pleading hurdles.

 

I have in any event added the Schwab settlement to my running tally of subprime and credit crisis-related lawsuit case resolutions (including dismissal motion rulings), which can be accessed here.

 

An April 20, 2010 Business Week article discussing the settlement can be found here. A Net Worth Plus blog post about the settlement can be found here.

 

Special thanks to  Reed Kathrein  of the Hagens Berman firm, which is lead plaintiffs’ counsel in the YieldPlus lawsuit, for providing me with copies of the summary judgment motion rulings.

　

The SEC’s blockbuster announcement last Friday of its civil enforcement action against Goldman Sachs and one of its investment bankers rocked the securities markets and made headlines in the financial press around the world. Undoubtedly because of Goldman’s prominence and perhaps also because of the nature of the allegations, the SEC’s action is widely seen as a watershed event.

 

Beyond the implications for Goldman itself, however, the development may be even more significant for what it may portend about possible future actions and claims, both by the SEC and by aggrieved investors. Here are some questions about what may be coming next.

 

Can we Expect Further SEC Enforcement Actions involved Subprime-Related Financial Instruments?:

According a March 29, 2010 CNBC interview with SEC Chairman Mary Shapiro (here), the agency has been working since the subprime meltdown emerged to build up staff with the right skill and experience to pursue financial-crisis related cases. Now that the SEC has staffed up, she advised, we can expect to see more crisis-related enforcement actions. She said, with reference to these actions, "there are more in the pipeline."

 

Indeed, in its April 16, 2010 Litigation Release related to the Goldman Sachs action (here), the SEC specifically said that its "investigation is continuing into the practices of investment banks and others that purchased and securitized pools of subprime mortgages and the resecuritized CDO market with a focus on products structured and marketed in late 2006 and early 2007 as the U.S. housing market was beginning to show signs of distress."

 

There has already been extensive press coverage raising questions some other transactions that may be under scrutiny. Gretchen Morgenson’s December 23, 2009 New York Times article raising questions about many of these transactions, including in particular the so-called Abacus transaction that is at the heart of the SEC’s action against Goldman, refers to numerous other transactions at Goldman and elsewhere where, as in the Abacus transaction, the investment banks created investment securities that were structured so that the banks and others could profit on financial bets that the investments would lose money.

 

There have also been a number of press articles (refer here for example) about Illinois-based hedge fund Magnetar, which sponsored over 30 CDO transactions in late 2006 and early 2007, which the hedge fund itself shorted, allowing it to make significant profits when the underlying mortgages began to default.

 

As the New York Times stated in an article on Sunday, the Goldman Sachs action is the SEC’s "the first big case — but probably not the last." Whether or not there may be more SEC actions relating to the toxic subprime-related transactions remains to be seen, but in the meantime concerned parties seem to be taking defensive measures. By way of illustration, when J.P. Morgan Chase released its first quarter financial results on April 14, 2010 (refer here), the firm disclosed that it "$2.3 billion in additional litigation reserves, including those for mortgage-related matters"

 

It should be noted that further regulatory action may come not just from officials in the U.S. According to press reports (here), German and U.K. government officials are conferring about possible regulatory actions against Goldman, in light of the revelations in the SEC’s complaint against the firm.

 

Finally, it should probably also be noted quite a number of observers have commented that the SEC’s case is far from a slam dunk, and the SEC could face formidable hurdles in attempting to sustain its allegation. The most balanced of these types of commentaries, by Professors Henning and Davidoff, appears in the Dealbook blog (here). An April 18, 2010 Wall Street Journal article (here) raises many of the same questions.

 

Will More Senior Officials Get Dragged In?:

The SEC named 31-year old Fabrice Tourre as a defendant because, the SEC alleged, Tourre was "principally responsible" for the Abacus transaction," having "devised the transaction, prepared the marketing materials and communicated directly investors." He also drew a big bull’s-eye on himself in an email suggesting that he ("the fabulous Fab") is the "only potential survivor" of the coming collapse, standing in the middle of "monstrosities" he had "created without necessarily understanding." (Note to file: It is never a good thing to have a personal email reproduced on the front page of the Wall Street Journal, above the fold.)

 

Tourre, who was 28- years old at the time of the Abacus deal, was not, however, simply off on a personal frolic in putting together this $2 billion transaction. Indeed, "senior level management" of Goldman Sachs is alleged, in paragraph 40 of the SEC’s complaint, to have approved the transaction. The referenced individuals, apparently members of Goldman’s Mortgage Capital Committee, were neither identified by name in the complaint, nor were they named as defendants.

 

Gretchen Morgenson’s April 18, 2010 New York Times article (here) suggests that the SEC may try to use Tourre to "get" more senior officials. Morgenson also suggests that as the subprime market began to unravel in 2007, senior Goldman officials became more directly involved in the firm’s mortgage department. A separate April 19, 2010 New York Times article talking about senior Goldman executives’ supervision of and involvement in the mortgage unit can be found here.

 

Susan Beck, in her April 16, 2010 Am Law Litigation Daily article about the SEC’s action against Goldman (here), suggests that perhaps New York Attorney General Andrew Cuomo may "start rooting around and come up with other individuals," noting that Cuomo has had not been afraid to name top executives as defendants in his action against BofA.

 

The pressure the SEC faced from Judge Jed Rakoff in attempting to settle its enforcement action against BofA, among other reasons for its failure to name the specific individuals responsible for the alleged violations, suggests the likelihood that any future SEC enforcement actions will include individuals among those targeted. But the question remains, both with respect to any further regulatory against, whether against Goldman or other financial players, more senior company officials will become involved.

 

Will the SEC’s Action Against Goldman Spawn Further Investor Litigation?:

In an April 17, 2010 post on WSJ.com Law Blog (here), Amir Efrati quotes a leading plaintiffs’ securities class action attorney as saying that "private lawyers are foaming at the mouth" over the prospects of pursuing claims against Goldman. (Presumably, this expression was merely a figure of speech.). An April 17, 2010 Reuters story (here) quote one plaintiffs’ attorney as saying that Goldman investors have already contacted him about pursing actions to recover their losses.

 

These developments also suggest that investors who lost money in other subprime-related investments may be asking whether their transaction involved the same kind of undisclosed conflict of interest as the SEC alleges in the Abacus deal. Indeed, one claimant that has a case pending against Merrill Lynch based on a subprime-backed security has alleged (refer here) that Merrill failed to disclose that it had a relationship with another client that was betting against the investment, similar to what happened at Goldman Sachs.

 

These developments arise just as the long-running subprime and credit crisis-related litigation wave appeared that it might be losing momentum. Many commentators recently have noted the dwindling numbers of new subprime related securities class action lawsuits. Moreover, in an April 8, 2010 Wall Street Journal article entitled "Banks Winning When Investors Sue" (here), Ashby Jones suggested that plaintiffs were faring poorly on dismissal motions in subprime-related securities lawsuits against previously filed against financial firms.

 

In light of popular and press reaction to the SEC’s allegations against Goldman, it is possible that these revelations in the Goldman complaint could revitalize the subprime litigation wave. Indeed, the SEC’s action may be only one of several recent developments that could reinforce a renewed interest in pursuing claims against Wall Street firms. The examiner’s report in the Lehman bankruptcy and the revelations of the Senate subcommittee investigation into the financial crisis could drive a renewed interest in holding financial firms accountable. These accumulating developments could also counterbalance the apparent judicial skepticism of fraud claims raised in the wake of the financial crisis.

 

The bottom line is that the SEC’s enforcement action is a significant event with important implications. How all of this will unfold remains to be seen, but it seems possible in the wake of the SEC’s complaint there could be a cascade of consequences.

 

National Public Radio’s April 16, 2010 "All Thing Considered" report about the SEC’s complaint against Goldman Sachs can be found below. The report includes my recorded comments about these developments.

 

Another Surge of Failed Banks: Amidst all of the hoopla surrounding the Goldman Sachs enforcement action you may not have noticed that on Friday, April 16, 2010, after the close of business, the FDIC took control of eight more banks, bringing the year to date total of bank closures to 50. During 2009, when there were a total of 140 failed banks, the FDIC did not close its 50th bank until July 2, 2009, suggesting that the pace of bank failures is well ahead of last year’s pace.

 

Three of the banks closed on April 16 were based in Florida, bringing the number of 2010 bank closures in that state to nine, the highest for any state this year. Since the beginning of 2008, there have 25 bank failures in Florida. The state with the highest number of bank failures during the period 2008-10 is Georgia with 37, including seven in 2010, the second highest number for any state this year. Other states with the highest numbers of bank failures this year include Washington (5), California (4), and Minnesota (3).

 

Congressional fact-finding hearings are generally unedifying spectacles, involving as they do the weird rite of ritual public witness humiliation and accomplishing little except the suggestion of troubling questions about the kind of person who manages to get elected to Congress. Some might say that the series of hearings about Wall Street and the Financial Crisis recently launched by the Senate Permanent Subcommittee on Investigations represents no exception to these usual rules about Congressional investigations.

 

Whether or not the hearings accomplish anything of durable value remains to be seen, but at a minimum, public statements accompanying the hearings contain assertions that could provide at least rhetorical aid for plaintiffs in some credit crisis related lawsuits.

 

As reflected in the Subcommittee’s April 12, 2010 press release (here), the Subcommittee will be hosting four hearings in April, the first of which took place this past Tuesday, when former Washington Mutual executive were called to testify. The second session will convene on Friday, April 16.

 

Most press reports about the first hearing focused on the claims by WaMu’s chief executive that the bank was permitted to fail because it was not part of the "inner circle" of financial institutions that were "too clubby to fail." For example, the New York Times’ April 13, 2010 article about the hearings was headlined "Ex-Chief Claims WaMu was Not Treated Fairly" (here).

 

Whatever else you might want to say about the CEO’s statements, they did manage to shift media attention away from the perhaps equally provocative statements the Subcommittee published in advance of the hearing, some of which undoubtedly will make their way into complaints in litigation arising out of the financial crisis.

 

The Subcommittee’s press release not only asserts that "the bank [WaMu] contributed to the financial crisis by making hundreds of billions of dollars in shoddy, high risk mortgage loans, packaging them, and selling them to investors as mortgage backed securities," but it also quotes Subcommittee Chairman and Michigan Senator Carl Levin as saying that WaMu "built a conveyor belt that dumped toxic mortgage assets into the financial system like a polluter dumping poison in a river."

 

A separate Committee document (here) purports to document WaMu lending practices that "created a mortgage time bomb."

 

Contrary to the immediate impression that might be conveyed, the hearings had a purpose other than to provide a forum for high-octane rhetoric (not to mention mixed metaphors). According Levin’s statements in the press release, the hearings are intended to "provide a public record of what went wrong, who should be held accountable, and the ongoing need to protect Main Street from the excesses of Wall Street."

 

The press release does not expressly address the question of "who should be held accountable," but the press release, the initial hearing itself and the committee documents do tend to isolate the Committee’s message, as was captured in the April 13, 2010 Seattle Times article about the hearings entitled "WaMu Execs Saw Warning Signs of Deteriorating Loans" (here).

 

The Committee’s press release suggests a number of ways the Committee faults the bank’s executives for its failure, and even perhaps for damage to the larger economy. First, again quoting Levin, the press release states that "examining how Washington Mutual operated, and what its insiders were saying to each other, begins to open a window into the troubling mortgage lending and securitization practices that took our economy over a cliff." This reference to what "insiders were saying to each other" is the very sentiment that often makes its way into securities class action lawsuit complaints.

 

The press release further targets the company’s management for its "conscious decision to focus on high risk mortgages, because higher risk loans offered greater profits." At the same time, the report claims, internal reports show that the bank’s loans "did not comply with the bank’s own credit requirements, contained fraudulent or erroneous borrower information and suffered from large numbers of early defaults."

 

The company’s management also comes in for criticism in the press release for the company’s compensation practices, which "rewarded loan officers and loan processors for originating large volumes of high risk loans, [and] paid extra to loan officers who overcharged borrowers or added stiff prepayment penalties." The press release dials all of these compensation problems back to management, noting that the company’s compensation system "gave executives millions of dollars even when its high risk lending strategy placed the bank in financial jeopardy."

 

These kinds of assertions undoubtedly could provide at least rhetorical support for investors pursuing claims against the company’s former executives. But there are additional assertions in the press release that could prove useful for claimants in cases filed against the financial institutions that were securitizing the WaMu-originated mortgages into mortgage-backed securities. Certainly the allegations about WaMu’s mortgage practices are very much like the supposed "systematic disregard" of underwriting guidelines by mortgage originators that has proven to be a relatively successful allegation in other lawsuits filed against mortgage securitizers (about which refer here).

 

The press release also asserts that "WaMu selected and securitized loans that it had identified as likely to go delinquent, without disclosing its analysis to investors who bought the securities." The press release also states that "an internal 2008 report found that lax controls had allowed loans that had been identified as fraudulent to be sold to investors." Investors who purchased securities collateralized by WaMu mortgages undoubtedly will be aggrieved to hear these kinds of assertions.

 

Whether or not the hearings lead to anything useful is a story yet to be told. However, it does seem that the process is calculated to identify (and even vilify) purported culprits. As my review of the press release suggests, this process may have implications for continuing credit crisis-related litigation, whatever else may happen.

 

In any event, it looks like the cast of culprits will be expanding. According to an April 16, 2010 Wall Street Journal article entitled "Spreading Around the WaMu Blame" (here), further Subcommittee hearings to take place on Friday (April 16) will include testimony that a turf war between banking regulators contributed to WaMu’s collapse. Apparently the report will suggest that the Office of Thrift Supervision failed to follow up on deficiencies and resisted FDIC efforts to be more aggressive.

 

Lerach: Coming Back?: At least according to Ben Halliman in the AmLaw Litigation Daily (here), former securities class action attorney and convicted felon Bill Lerach may have launched his comeback tour. As Halliman notes, Lerach recently sat for an interview in the San Diego Union-Tribune, here.

 

It seems fair to say that Lerach is bloody but unbowed. He remains "very proud of the work we did representing people who were taken advantage of by rich and powerful interests. We recovered substantial sums for these people and, more importantly, gave them a sense that someone in the legal system cared about them." More pointedly, he says that "I would not have done anything differently," noting that the system of paying plaintiffs predated his involvement, yet conceding that "we were wrong to think the ends justified the means."

 

The interviewer did also ask him about the recent book focused on his professional career, "Circle of Greed" (which I reviewed here). Lerach said:

 

The book is very tough on me, and it certainly exposes a lot of my faults and mistakes. I guess we all wish we were perfect but we are not, and when you have two very good investigative reporters comb through 35 years, it comes out with some blemishes for sure. On the other hand, the book presents how hard my law firm worked on behalf of our clients and how much we achieved against extremely powerful and influential interests. So, I can’t complain about the way the book came out even if I might want to change some things.

 

For those who may be interested, my interview of the authors of "Circle of Greed" can be found here.

　

 

PLUS Webinar: On April 22, 2010, at 2:00 P.M. EDT, I will be participating in a free webinar sponsored by the Professional Liability Underwriting Society (PLUS) entitled "D&O Insurance and the Outcome and Timing of Securities Class Action Resolution: What New Data Shows." The purpose of the webinar is to discuss recent research completed by Stanford Law School Professor Michael Klausner on the impact of D&O insurance on securities class action resolutions. Professor Klausner’s research also addresses the timing of case resolution and factors affecting the eventual outcomes.

　

Joining me on the discussion panel, in addition to Professor Klausner, will be Steve Anderson of Beecher Carlson and Todd Greeley of C N A. The session will be moderated by Paul Lavelle of LVL Claims Services. Additional Information and Registration Instructions for this webinar can be found here.

 

My Nomination for Funniest Roomate Ad of All Times: Where to go if you are looking for a place to live in Santa Cruz, and you happen to be a tetrahedron? No worries, find it here.