Over the holidays, I added two blog posts that readers may find particularly interesting. To make sure that readers returning to their desks after the holidays do not overlook them, I have highlighted the two posts below, with links.

 

The List: Madoff Investor and Feeder Fund Litigation (December 26, 2008): This post is the access point to a table of Madoff Investor and Feeder Fund litigation. I have updated the litigation table numerous times since the initial publication, as several readers have helpfully provided relevant additional links and documents.

 

 

I will continue to update the table as new Madoff litigation arises. Readers are strongly encouraged to let me know of any new or additional information necessary to keep the table accurate and up to date.

 

 

A Closer Look at the 2008 Securities Lawsuits (January 2, 2009): As part of an annual feature on this blog, I reviewed last year’s securities lawsuit filings. As detailed in greater length in the post, the 224 new securities filings in 2008 represents the highest annual filing total since 2004.

 

 

The post also discusses the possible impact of the 2008 securities filing activity on the D&O insurance marketplace.

 

 

2008 Year in Review: On January 6, 2008, at 2:00 p.m. EST, I will be participating in a free webcast sponsored by the Securities Docket (here) entitled “2008 Year in Review: Securities Litigation and SEC Enforcement.”

 

 

The webcast will be moderated by Bruce Carton of the Securities Docket, and will feature several of my fellow bloggers, including Francine McKenna of the re: The Auditors blog (here); Tom Gorman of the SEC Actions blog (here); and Walter Olson of the Point of Law blog (here). Additional information about the webcast can be found here.

 

 

In a development that attracted little notice at the time, on December 10, 2008, the parties to the subprime-related securities lawsuit pending in the Northern District of California against Luminent Mortgage Capital and certain of its directors and officers filed a Stipulation of Settlement (here), in which the defendants agreed to pay $8 million to settle the case.

 

As far as I am aware, the Luminent settlement is only the second of the subprime-related securities lawsuits in which the parties have reached a settlement.

 

As discussed at greater length here, the plaintiffs had alleged that in certain public statements in July 2007, the defendants has misrepresented Luminent’s liquidity, the quality of its mortgage backed securities (MBS) portfolio, and the safety of its dividend for the second quarter of 2007, payable August 8, 2007.

 

 

The plaintiffs’ Amended Complaint (here) alleged that the defendants failed to disclose margin calls on the company’s MBS portfolio, a write-down on its portfolio and significant exposure to subprime debt that negatively impacted the company’s liquidity. The company’s share price dropped over 75% after the company announced on August 6, 2007 that it was cancelling payment of the second quarter dividend.

 

 

As reflected in the Stipulation of Settlement, the parties reached an agreement to settle the case while the defendants’ motion to dismiss was pending. The settlement followed the parties’ agreement to attempt to resolve the case through court-appointed mediation. The settlement is subject to court approval. The settlement also includes defendants’ agreement to pay $100,000 administrative costs. The parties agree that plaintiffs’ counsel may apply for and receive a fee award of up to 25% of the settlement amount.

 

 

Though the Stipulation of Settlement was not filed with the court until December 10, it is dated September 10, 2008. On September 5, 2008, Luminent and its subsidiaries had filed for bankruptcy protection in the District of Maryland Bankruptcy Court. On October 3, 2008, Luminent filed a motion in the bankruptcy court to lift the automatic stay to permit the securities lawsuits settlement to be consummated and to approve the settlement as in the best interests of the debtor. On December 2, 2008, the bankruptcy court approved Luminent’s application and authorized the parties to proceed with the settlement.

 

 

The Luminent settlement follows the only other subprime-related securities lawsuit settlement of which I am aware, the $4.85 million WSB Financial Group settlement (about which refer here). I have added the Luminent settlement to my running table of subprime and credit crisis-related securities lawsuit settlements, dismissals and dismissal denials, which can be accessed here.

 

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the Stipulation of Settlement. 

As other commentators previously have noted (refer here), the pace of securities lawsuit filings increased significantly in 2008 compared to recent years. According to my tally, there were 224 new securities lawsuits filed in 2008. The 2008 total represents a 30% increase over the 172 securities lawsuits filed in 2007, and an 88% increase over the 119 securities lawsuits filed in 2006.

 

The 2008 filing total also represents the highest annual filing total since 2004. All signs seem to indicate that the heightened filing levels will continue into 2009.

 

My 2008 securities lawsuit filing tally reflects a lower number than the figures NERA Economic Consulting recently published (refer here), and in that regard I urge readers to refer to my comments below about the particular complications associated with "counting" securities lawsuits in 2008.

 

Overall Observations

The most significant factor in this year’s heightened securities litigation filing activity was the number of subprime and credit crisis-related securities lawsuit filings. Of the 224 new securities cases filed in 2008, 101 were subprime or credit crisis-related. As reflected on my running tally of subprime and credit crisis-related securities lawsuits, which can be accessed here, there have been 141 total of these cases filed overall during 2007 and 2008 combined.

 

One factor that increased the number of subprime-related lawsuit filings in 2008 was the influx of auction rate securities lawsuit filings (about which refer here). There were 21 of these auction rate securities lawsuits filed in 2008, largely in the first half of the year.

 

Another factor that increased the 2008 filings was the influx of Madoff-related litigation during December 2008. My running tally of the Madoff lawsuits can be found here. Investors have initiated Madoff-related securities class action lawsuits against at least seven distinct investment groups, and every sign is that this litigation will continue to flood in during the early weeks and months of 2009.

 

2008 Filings by SIC Code

The predominance of the subprime and credit crisis-related litigation during 2008 is borne out in the profile of the companies that were sued in securities lawsuits during the year. Though the companies targeted represent over 90 different Standard Industrial Classifications (SIC) Codes, fully 99 of the lawsuits hit companies with SIC Codes in the 6000 series (Finance, Insurance and Real Estate), including 19 in SIC Code 6021 (National Commercial Banks) and 20 in SIC Code 6211 (Security Brokers and Dealers).

 

There were a number of securities lawsuit defendants entities in 2008 that have no SIC Code designated. These defendants include mutual funds, private investment firms and other entities. By my count, there were as many as 23 new lawsuits filed in 2008 against entities that lack an SIC designation. In most cases, these entities are involved in investment or financial services-related businesses, which even further underscores the fact that much of the securities litigation activity in 2008 was concentrated in the financial sector.

 

But while securities suits against companies in the financial sector were a predominant factor in the 2008 securities lawsuits filings, there were other SIC Code categories that also saw significant litigation activity, including SIC Code 3674 (Semiconductors) which also saw ten filings; SIC Code 2834 (Pharmaceutical Preparations) which saw nine lawsuit filings; and SIC Code 3845 (Electromedical and Electrotherapeutic Apparatus) which had five.

 

In addition, while the credit crisis lawsuits hit the financial sector hard, the credit crisis litigation wave spread outside the financial sector as the year progressed and the financial turmoil spread. As I noted here, and as a result of the dramatic events in the financial markets during September and October 2008, a number of companies outside the financial sector were hit with credit crisis-related lawsuits, particularly those with exposure to Lehman Brothers, Fannie Mae and Freddie Mac, or those that made wrong-way bets on currencies or commodities.

 

State and Court Distribution of Filings and Defendants

The concentration of cases in the financial sector also affected the geographic distribution of the 2008 case filings. Though securities lawsuits were filed in 48 different federal district courts (as well as several state courts), 97 of the 224 securities filings in 2008 were filed in the Southern District of New York. The federal district with the second highest number of new lawsuit filings was the Northern District of California, where 12 new securities lawsuits were filed. Other districts with a significant number of filings include the District of Massachusetts (10), and the Central District of California (9).

 

Another factor contributing to the significant number of filings in the Southern District of New York was the number of lawsuits filed there against foreign-domiciled companies. Overall, there were 34 foreign companies sued in securities lawsuits in 2008, all but five of which were initiated in the Southern District of New York. The 34 foreign companies sued represented 17 different countries, with the largest number from Canada (8), China (5) and Switzerland (4).

 

The domestic U.S. companies hit with securities lawsuits were based in 31 different states, and the District of Columbia. The state with the largest number of new securities lawsuits was New York (42), followed by California (23), Massachusetts (13) and Ohio (10).

 

The Pace of Filings and Likely Future Trends

The pace of new lawsuit filings increased during the year, with 105 during the first half and 119 in the second half. The fact that the fourth quarter, with 67 new filings, was the most active quarter during the year, together with the fact that there were a significant number of filings (30) in December (typically a quiet month for securities lawsuit filings), suggests that the heightened level of securities filings will continue into 2009. Indeed, the filings in the fourth quarter of 2008 and during December 2008 represent, respectively, the highest quarterly and monthly totals in more than five years.

 

My conclusion that the increased securities litigation activity levels will continue in 2009 is reinforced by the likelihood that the credit crisis litigation wave will continue to spread outside the financial sector in 2009.

 

Some Comments about "Counting": One reason for the wide disparity in the various published versions of the 2008 securities lawsuit filings is that the seemingly simple task of counting lawsuits was particularly complicated during 2008.

 

One complication is that some companies were sued multiple different times by different sets of claimants, on different legal theories, or with respect to different sets of circumstances. For example, one historically unusual phenomenon that recurred during 2008 was the initiation of new securities lawsuits initiated by preferred shareholders or subordinate securities holders (about which refer here). The multiplication of lawsuits involving different claimants or different legal theories but related defendants raised a continuing series of questions whether or not a new action does or does not represent a separate lawsuit that should be separately counted.

 

This question whether or not a separate complaint represents a new lawsuit was particularly complicated with respect to the Madoff-related litigation that flooded in during the final weeks of December. As reflected in my running tally of these lawsuits, which can be accessed here, there have already been multiple lawsuits against related Madoff-feeder funds. Reasonable minds might well differ as to whether or not a particular complaint represents an entirely new lawsuit or simply a related or duplicate complaint.

 

Another attribute of this multiplicity of lawsuit filings is that the number of new lawsuits filed may be significantly different than the number of companies sued, as some companies were sued multiple times in multiple different lawsuits. As a result, there may be a certain amount of double counting associated with some of the lawsuit tallies or some of the analysis of lawsuit filings.

 

Yet another factor complicating the counting is that during 2008 plaintiffs initiated a number of securities class action lawsuits in state court (about which I previously commented here). In many instances these lawsuits are difficult simply to find. The inclusion of these cases, and the uncertainty around their numbers, could significantly affect the overall lawsuit tally.

 

As has been increasingly the case in recent years, it has become progressively more difficult simply to maintain definitional clarity about what exactly is being counted. To clarify what I have been tracking, I try to count class action lawsuits that allege violations of the federal securities laws. That said, I have excluded certain lawsuits that other reasonable minds might include. For example, I generally exclude merger objection lawsuits. In addition, I generally exclude lawsuits in which the securities allegation is simply that the defendants failed to register securities. On the other hand, I include lawsuits even if the defendant entity is not a publicly traded entity (for example, if the defendant is a private equity fund or a hedge fund.)

 

Because of these definitional issues, it is almost inevitable that various tallies of the 2008 securities lawsuits will differ.

 

UPDATE: The WSJ.com Law Blog has a January 5, 2009 post (here) regarding the 2008 securiteis class action filings. The Law Blog entry links to this post and includes comments from a number of commentators and practitioners in the field.

 

Impact on D&O Pricing?: The uptick in securities lawsuit filings in 2008 might well be expected to have an upward impact on D&O pricing, and indeed it may yet have that effect. But particular features of the 2008 filings might moderate that expected effect.

 

First, the concentration of the filings in the financial sector means that the impact from the heightened filing levels is not widespread throughout the D&O industry. D&O carriers are not yet experiencing the impact of the filing levels across their entire portfolio, and carriers that do not have significant financial industry exposure may not yet be experiencing elevated claims activity, although that likely will change as the credit crisis litigation wave spreads outside the financial sector.

 

Second, even with respect to the heightened activity levels, the impact is muted somewhat by the multiple different lawsuit filings against the same companies. The D&O impact from the third, fourth or fifth new lawsuit against the same company may not increase the aggregate losses to which insurance applies. Because the number of companies sued is less than the number of new lawsuits initiated, the aggregate claims frequency level is less than the overall filing levels might indicate.

 

Third, many of the defendant entities are not publicly traded companies. As I noted above, many of the defendant entities in new 2008 lawsuits were mutual funds, investment partnerships, hedge funds, or other investment vehicles. The incidence of litigation against these types of entities would have only an indirect impact at most on the market for public company D&O insurance.

 

Fourth, a significant amount of the securities litigation activity in 2008 involved claims likelier to create errors and omissions (E&O) insurance losses, rather than D&O losses. For example, the Madoff-related litigation and the auction rate securities litigation may or may not produce D&O insurance losses, but may well produce significant E&O losses. The spread of losses to other insurance lines could dilute the overall impact from the 2008 litigation on the D&O carriers.

 

Fifth, most of these cases are still in their earliest stages, and it will be some time yet before the losses begin to accrue. Until loss payments begin to mount, D&O pricing is unlikely to make dramatic changes (at least as a result of securities filing activity levels).

 

All of that said, the increase in litigation activity in 2008, together with the disruption involving market leader AIG and other leading carriers, as well as the prospect for continued significant litigation activity in 2009, are likely to create uncertain conditions in the D&O marketplace and could lead to increased carrier caution as 2009 progresses. Indeed, Advisen, a leading industry observer, is predicting that a hard market for insurance will develop toward the end of 2009 (about which refer here).

 

2008: The Year in Review: Readers interested in learning more about the 2008 securities litigation trends will want to the January 6, 2009 webcast sponsored by Securities Docket.

 

I will be participating in this free webcast, which will begin at 2 pm EST, along with a number of my esteemed fellow bloggers, including the Securities Docket’s own Bruce Carton; Walter Olson of the Point of Law blog; Tom Gorman of the SEC Actions blog; Francine McKenna of the Re: The Auditors blog; and Lyle Roberts of the 10b-5 Daily blog. Further information about the podcast can be found here.

 

THE TABLE OF CASES LINKED BELOW WAS LAST UPDATED ON September 28,  2010.

All signs are that the collapse of Bernard Madoff’s Ponzi scheme will produce a flood of litigation. By my count, there have already been at least seven federal securities class action lawsuits against Madoff, his firm, or the "feeder firms" that invested their clients’ funds with Madoff. There have also been a number of state court lawsuits as well.

 

It is already difficult to keep track of the lawsuits that have been filed. In all likelihood, there will be extensive additional litigation against other feeder funds and other third party defendants, which will make it even more difficult to keep track.

 

In order to monitor the Madoff-related litigation in a more orderly way, I have created a table of the lawsuits that have been filed to date.

 

The table can be found here.

 

I believe the table is complete, but I welcome any additional or clarifying information that readers may wish to bring to my attention.

 

I will update the table as new or different lawsuits emerge. Readers are strongly encouraged to let me know about any additional litigation I may have missed or to provide me with any information necessary to make the table more accurate.

 

UPDATE: A regularly updated list of all Madoff investor litigation, including in particular Madoff "feeder fund" litigation, can be accessed here.

As further proof that the losses associated with the Madoff fraud scheme will trigger a wave of litigation, on December 23, 2008, plaintiffs’ lawyers initiated a lawsuit in the Southern District of New York on behalf of investors in the FM Low Volatility Fund, against Family Management Corporation ( the Fund’s general partner and manager) and certain of FMC’s directors and officers; three "fund of funds" in which FMC invested investor funds (Andover, Beacon and Maxam); and the Funds’ auditor.

 

The complaint, which can be found here, alleges violations of the federal securities laws and related stated and common law violations, and also asserts derivative breach of fiduciary duties on behalf of the Funds.

 

According to the plaintiffs’ lawyers’ December 24, 2008 press release (here), FMC

 

concentrated more than half of the Fund’s investment capital with at least three funds of funds ("FOFs") — Andover, Beacon and Maxam — that, in turn, all heavily invested in entities managed by Bernard Madoff ("Madoff") or Madoff-related entities. Investors who entrusted their savings to FMC suffered millions in damages as a result of Madoff’s fraudulent scheme.
 

 

The complaint further alleges that the defendants failed to perform requisite "due diligence" and "knew or should have known" about Madoff’s Ponzi scheme.

 

The plaintiffs’ also allege that FMC and its defendant directors and officers issued misleading offering documents that

 

falsely stated that FMC would not invest more than 35% of the Fund’s net asset value with any one investment vehicle, but, in reality, more than 60% of the Fund’s assets were funneled through three FOFs – Defendants Andover, Beacon and Maxam – and invested in Madoff-related entities. The Offering Memorandum also falsely stated that FMC would (i) endeavor to verify the integrity of each manager of a FOF in which the Fund was invested; (ii) attempt to monitor the performance of each manager; and (iii) request detailed information regarding the historical performance and investment strategy of each of the selected investments for the Fund. Plaintiffs allege that Defendants, with no or inadequate due diligence or oversight, abdicated their responsibilities and entrusted the Fund’s assets to Madoff-run investment vehicles.

 

Even More Madoff Investor Litigation: In earlier post (here), I noted the class action lawsuit that had been filed against Tremont Group Holdings, certain of its directors and officers, and its corporate parents, on behalf of investors in the American Masters Prime Fund, whose assets Tremont managed and that had suffered losses due to Tremont’s investment of those funds with Bernard Madoff and his firm.

 

On December 23, 2008, plaintiffs filed a similar but separate lawsuit against Tremont and related entities, but on behalf of the class of investors in the Rye Funds, who also claim that they lost their investment due to Tremont’s investment with Madoff and his firm. The Rye Funds complaint also includes as a defendant Tremont’s auditor, KPMG. A copy of the Rye Funds’ investors’ complaint can be found here. A copy of the plaintiffs’ lawyers December 23 press release can be found here.

 

In addition, according to a December 24, 2008 Bloomberg article (here), New York University has initiated a New York state court lawsuit against J. Ezra Merkin, Gabriel Capital, and Ariel Fund, in which it alleges that $24 million of endowment investments due to the defendants’ investment of the assets with Madoff and his firm. A copy of the NYU lawsuit complaint can be found here.

 

An earlier class action lawsuit that previously had been filed against Gabriel and related defendants can be found here.

 

Special thank to Adam Savett of the Securities Litigation Watch (here) for providing a copy of the Rye Funds Complaint.

 

Keeping Track: By my tally, the Family Management Corporation case is at least the seventh federal class action lawsuit filed in the wake of the revelation of the Madoff fraud. Of these, six of these seven are directed against so-called "feeder funds," the seventh directly against Madoff and his firm. In addition, there are several other state court lawsuits, including the one identified above and the earlier lawsuit filed against the Fairfield Greenwich fund firm (about which refer here).

 

If the early returns are any indication, there could be a flood of litigation yet to come. Of course it remains to be seen whether or to what extent any of these claims succeed. But in the meantime, indications are that these Madoff-related lawsuits will continue to mount.

 

In the latest ruling on a motion to dismiss in a subprime-related securities lawsuit, on December 22, 2008, Judge Legrome Davis of the Eastern District of Pennsylvania granted in part and denied in part defendants’ motion to dismiss the suit that plaintiffs’ filed in August 2007 against RAIT Financial Trust and certain of its officers and trustees. The opinion can be found here.

 

Judge Davis’s ruling largely denied defendants’ motions, other than with respect to the plaintiffs’ ’33 Act claims concerning the company’s July 2007 secondary offering, which were dismissed due to the plaintiffs’ lack of standing. Otherwise, Judge Davis ruled in plaintiffs favor. The plaintiffs’ remaining ’33 Act claims and all of the plaintiffs’ ’34 Act claims will now go forward.

 

Background

RAIT is a real estate investment trust providing debt financing to home builders, mortgage lenders and other real estate companies. As more fully set forth here, plaintiffs’ complaint relates to the July 30, 2007 failure of American Home Mortgage to make a payment due under certain trust preferred securities, resulting in a net equity exposure to RAIT of at least $95 million. Shortly thereafter, the company disclosed that it had $373 million of similar exposures. The plaintiffs allege that the defendants failed to disclose its exposure to these types of investments and failed to reserve adequately for the risk of nonpayment or default.

 

The plaintiffs’ complaint asserts claims under both the ’33 Act and the ’34 Act. The defendants in the ’33 Act claims include the offering underwriters that facilitated RAIT’s January 2007 common stock offering and July 2007 preferred stock offering, as well as the company’s auditor, Grant Thornton. The defendants’ moved to dismiss.

 

The December 22 Opinion

First, the court dismissed the ’33 Act claims relating to the July 2007 preferred stock offering due to lack of standing, because none of the named plaintiffs purchased securities traceable to the offering.

 

However, the court denied the defendants’ motion to dismiss the ’33 Act claims raised in connection with the January 2007 offering. Judge Davis found that the plaintiffs had adequately alleged falsity and materiality, and rejected defendants’ contentions that the plaintiffs’ arguments represented nothing more than "fraud by hindsight." Judge Davis also rejected the defendants’ contentions that the alleged misrepresentations "bespoke caution" or were "mere puffery."

 

Judge Davis also found that his rulings that the plaintiffs had adequately pled falsity and materiality applied to the plaintiffs’ ’34 Act claims as well.The defendants nevertheless sought to have the ’34 Act claims dismissed, arguing that the plaintiffs had not adequately pled scienter.

 

Judge Davis found that "despite the demanding standard of recklessness imposed in pleading a strong inference of scienter," the plaintiffs nevertheless had adequately pled scienter. His ruling depended on the "core business operations" theory, with respect to which he stated:

 

Because the alleged misstatements involved RAIT’s core business operations and because the Officer Defendants had ample reason to know of the falsity of the statements, there is a strong inference of scienter in this case.

 

Judge Davis also found that though the core business operations allegations alone were sufficient, other allegations also supported the inference of scienter, including "the sheer size of the impairment eventually taken by RAIT," which he found adds to "the imputation" that defendants "must have had some awareness that problems were brewing." Judge Davis also found that "familial and business relationships involved" in a RAIT acquisition were "relevant in our consideration of scienter."

 

Discussion

Other than the ’33 Act claims relating to the July 2007 offering (which was dismissed for lack of standing), the plaintiffs largely prevailed on the dismissal motions. Judge Davis’s ruling is significant not only because it seems to run counter to the early trend other courts arguably have established (albeit with some notable exceptions) of general skepticism toward subprime-related allegations. Judge Davis’s ruling is noteworthy in that regard for its rejection of the defendants’ "fraud by hindsight" arguments.

 

Judge Davis’s opinion is perhaps most noteworthy in its acceptance of the "core business operations" theory in concluding that the plaintiffs had adequately pled scienter. Though earlier courts had rejected this theory as inconsistent with the PSLRA’s pleading requirements, more recently courts, for example, in the Ninth Circuit (refer here) and the Seventh Circuit (refer here), have taken it up. As noted in a recent commentary by the Katten Muchin law firm entitled "Reform Act Under Attack?" (here), the core operations theory "has made a comeback in 2008," which the authors contend is inconsistent with the PSLRA’s meaning and intent.

 

Were other courts similarly willing to take up the core operations doctrine, it could substantially impact the many pending dismissal motions in various subprime-related securities lawsuits.

 

In any event, I have added the RAIT opinion to my table of subprime and credit crisis-related securities lawsuit settlements, dismissals, and dismissal denials, which can be accessed here.

 

Special thanks to a loyal reader for alerting me to the RAIT opinion.

 

In the latest of what undoubtedly will prove to be a surge of Madoff-related litigation, investors have filed two more lawsuits against investment firms that invested their clients’ money with Bernie Madoff, resulting in massive investor losses.

 

UPDATE: Please note that a regularly updated table of all Madoff investor litigation, including in particular Madoff "feeder fund" litigation, can be accessed here.

 

The Tremont Lawsuit

First, as reflected in their December 22, 2008 press release (here), plaintiffs’ lawyers have filed a securities class action lawsuit in the Southern District of New York on behalf of investors in the American Masters Broad Market Prime Fund, L.P., a Delaware limited partnership which is managed by Tremont Group Holdings, which is also the Fund’s General Partner. The defendants in the lawsuit include Tremont; Oppenheimer Acquisition Corporation, which acquired Tremont in 2001; Massachusetts Mutual Life Insurance Company, Oppenheimer’s parent; and Ernst & Young, the Fund’s auditor.

 

The complaint (which can be found here) alleges violations of the federal securities laws as well as state common law fraud, negligence and breach of fiduciary duty. The complaint also assets derivative breach of fiduciary duty claims on behalf of the Fund.

 

According to the plaintiffs’ lawyers’ press release, the complaint alleges that

 

defendant Tremont, general partner of the Fund, concentrated over half of its investment capital with entities that participated in the massive, fraudulent scheme perpetrated by Bernard Madoff ("Madoff"). Investors who entrusted their savings to Tremont have suffered millions in damages and are faced with financial ruin.
 

 

The complaint also alleges that the defendants "failed to perform the necessary due diligence that they were being compensated to perform as investment managers and fiduciaries" and that the defendants "either knew or should have known that the Fund’s assets were employed as part of a massive Ponzi scheme and took no steps in a good faith effort to prevent or remedy that situation, proximately causing billions of dollars of losses and possible complete collapse of the Fund." Oppenheimer and Mass Mutual are named defendants as controlling persons of the Fund.

 

The complaint alleges with respect to Ernst & Young that the firm was "reckless or grossly negligent" in connection with its performance of its auditing duties, and specifically that the firm failed to detect "a myriad of ‘red flags’ indicating a high risk to Tremont from concentrating its investment exposure in Madoff."

 

The complaint alleges that the defendants allowed Tremont to invest $3.3 billion, over half of its assets, with Madoff.

 

The Fairfield Lawsuit

In addition, investors have also initiated a lawsuit in New York County (New York) Supreme Court against the Fairfield Greenwich Group, the hedge fund firm that has as much as $7.5 billion invested with Madoff. A December 22, 2008 Bloomberg article describing the Fairfield lawsuit can be found here. A copy of the complaint can be found here.

 

The lawsuit, which is filed as a class action on behalf of in the Fairfield Sentry fund, names as defendants Fairfield itself; Fairfield’s founding partners, as well as two principals of a Bermuda affiliate of Fairfield. It alleges breach of fiduciary duty, negligence, and unjust enrichment.

 

According to the news reports, the complaint alleges that the fund’s managers "had an obligation to look into Madoff’s investment methods and that the team ignored the ‘red-flag warning’ that Madoff’s investment produced small, steady gains in a declining market." The article also quotes the plaintiffs’ attorney as saying that the case has been filed in state court rather than federal court so that discovery can go forward quickly.

 

The arrival of these new lawsuits, following closely in the wake of the prior Madoff-related litigation suggests that there could substantial associated litigation yet to come, particularly with respect to the so-called feeder funds that invested clients’ assets with Madoff. The press coverage certainly suggests that there will be extensive additional litigation, as reflected, for example, in the December 22, 2008 National Law Journal article entitled "Lawyers from Florida to New York Besieged by Madoff Investors" (here).

 

The Tremont lawsuit’s inclusion of Ernst & Young corroborates an article published in the December 22, 2008 New York Times entitled "In Madoff’s Wake, Scrutiny of Accounting Firms" (here), which suggests that investors suffering losses from their investments in Madoff feeder funds may attempt to target the firms’ auditors. As noted in the article, the lawsuit filed last week against Madoff feeder fund Ascot Partners (about which I wrote here) also named the fund’s auditor, BDO Seidman, as a defendant in that case.

 

Credit Crisis Litigation Issues: A November 17, 2008 paper entitled "Legal and Economic Issues is Litigation Arising from the 2007-2008 Credit Crisis" (here) written by Harvard Law Professor Allen Ferrell, and Jennifer Bethel and Gang Hu of the Babson Business School surveys the marketplace conditions behind the credit crisis litigation and reviews the legal issues that are likely to arise as the litigation goes forward.

 

The article focuses on three principles that the authors believe will be critical in the credit crisis related securities litigation (1) no fraud by hindsight; (2) truth on the market defenses; and (3) loss causation issues.

 

With respect to the truth on the market defense, for example, the authors contend that "the quality of disclosures in the mortgage backed securities registration statements (and virtually all mortgage backed securities were registered) actually improved between 2001 to 2006 (in part due to the promulgation of Regulation AB in 2004) and that it was quite clear from these registration statements that the quality of the underwriting in a number of instances had declined."

 

With respect to the "loss causation issue," the authors contend with respect to the banks that suffered massive writedowns during 2007 and 2008, that the banks"suffered substantial losses due to their ‘super senior’ positions in CDOs and various liquidity guarantees to asset backed commercial paper conduits, rather than directly on their mortgage-backed security holdings."

 

Hat tip to The Harvard Law School Corporate Governance Blog (here) for the link to the authors’ paper.

 

The initiation of a criminal investigation against a company or its directors and officers can be a watershed moment in the life of any company. In addition to the question of how it will respond, the company must also determine how it will fund the associated legal expense. It is at this critical juncture that the company confronts issues surrounding the availability and limitation of D&O insurance in connection with criminal investigations.

 

These issues are explored in a December 2008 article by Patricia Bronte of the Jenner & Block firm entitled "D&O Coverage for Corporate Criminal Investigations" (here). As Bronte notes, the availability of coverage for a criminal investigation depends upon the particular language in the applicable policy, particularly the policy’s definition of the term "claim." The critical question will be whether or not the particular circumstances presented constitute a "claim."

 

The article opens with a review of case law from an earlier era, when D&O policies did not routinely define the term "claim." However, as the article discusses, the typical D&O policy now defines the term and includes within its definition a specific reference to a "criminal proceeding," which usually is further defined as having been "commenced by the return of an indictment."

 

One of the useful things Bronte’s article does is that by reviewing the early case law, she shows how the carriers came to insert the language limiting coverage for criminal proceedings to post-indictment matters. Prior cases where carriers were compelled to fund a wide range of expenses related to investigations and other pre-indictment matters clearly led to this change.

 

However, Bronte’s article also illustrates the difficulties, from the policyholder’s perspective, of this post-indictment limitation of coverage for criminal matters. That is, "a corporation’s best hope for a favorable outcome – and sometimes the best way to avoid disaster – is to persuade the prosecutor not to file any formal criminal charges at all."

 

As a consequence of this need to try to avert indictment, the corporation can incur considerable expense pre-indictment in respond to subpoenas, addressing a grand jury investigation, or otherwise attempting to answer the investigative threat. Costs incurred in connection with these efforts represent defense expenses, whether or the investigation ultimately results in an indictment.

 

Disputes over these kinds of legal costs are among the perennial battles in the D&O claims arena. Invariably, policyholders will argue that these expenses were indispensible to their post-indictment defenses, or even that they helped avert an indictment. Further complicating these discussions is the fact that these expenses associated with the pre-indictment criminal investigation often are being incurred at the same time that the company is also incurring legal expense in connection with an SEC investigation and also separate civil litigation. These various proceedings may be covered in whole or in part under the policy.

 

Because all of these various legal matters are going forward simultaneously and usually pertain to a single set of circumstances, sorting out which legal expenses relate to which proceeding (and therefore which expenses are covered under the policy) can become a vexing problem and source of tension between the policyholder and the carrier.

 

Exacerbating these problems is the fact that among all these proceedings, the criminal matter usually looms the largest and therefore may consume the larges amount of legal effort and expense. This is particularly true if, as is often the case, the individuals involved each retain separate counsel. The potentially massive expense associated with the criminal investigation underscores why these issues can be so critical.

 

In light of these considerations, the article offers some practical suggestions. Bronte notes:

 

Brokers and risk managers should press for "claim" definitions and coverage limits that adequately protect the corporate entity from the expense of criminal investigations, which almost inevitably involve multiple teams of lawyers defending the corporation and its employees.

 

In that regard, many D&O insurers now include within the definition of the term "claim" not only a reference to post-indictment (or post-information) criminal proceedings, but also a separate explicit reference to "investigations" (including criminal investigations), usually delimited in some way around the requirement for the naming of an insured person as a target of a possible indictment. The precise wording of the definitional provisions relating to "investigations" potentially could be critical.

 

In addition, at least one major carrier now has a form that removes any reference to an indictment requirement, and instead refers simply to "criminal proceedings." The removal of the indictment requirement, together with the reference to "proceedings," at least potentially opens the door to coverage for grand jury investigations, subpoenas, and other matters. While this alternative wording is not universally or even widely available, it does present an alternative for consideration.

 

The article also notes, in connection with efforts to secure coverage for criminal proceedings that "policyholders do not advance their position if they or their brokers characterize the criminal investigation as merely a ‘potential claim.’" An alternative possibility is to refer to the matters involved as a claim, or, in the alternative, a potential claim.

 

The article correctly points out that "the high cost of defending against accusations of criminal wrongdoing is one of the reasons that corporations purchase D&O insurance." Nevertheless, the extent of coverage for criminal proceedings remains one of the perennially disputed claims issues. The further development of D&O policy wordings that better address policyholder expectations is a continuing challenge for the D&O insurance industry and one on which there are fruitful areas for further discussion.

 

More About NERA’s Year-End Securities Litigation Study: In a prior post (here), I linked to NERA Economic Consulting’s year-end report on 2008 securities litigation activity. (The report itself can be found here). In a December 19, 2008 post (here), the Securities Docket has an interesting interview with the report’s authors, my good friends Stephanie Plancich and Svetlana Starykh. Among other things, the interview quotes the authors as saying, with respect to their projections for litigation activity in 2009:

While our paper does not forecast trends into the next year, our best guess is that filing activity will remain high into 2009. As mentioned above, there have been a number of new filings in late December — traditionally a slow time for litigation activity — indicating that the rate of filings has yet to decrease.

And while the first credit crisis cases were concentrated in the financial industry, there has been an emerging trend of credit crisis- and recession-related filings emerge outside of the financial sector.

 

Ghost of Christmas Preset, 2008 Version: With apologies to Charles Dickens, I excerpt below an imagined version of his holiday classic, updated for current circumstances. We can only hope that the Ghost of Christmases Yet-to-Come bears happier tidings. 

 

And taking Scrooge by the arm, the Spirit lifted him high above the financial landscape. Below him, Scrooge could see a parade of spectacles he scarcely could have imagined: the largest bank failure ever; the largest bankruptcy ever; the largest government bailout; the collapse of the housing market and the near-collapse of the entire financial system. 

"Spirit!" said Scrooge. "Show me no more! Conduct me home. Why do you delight to torture me?"

"One Shadow More!" exclaimed the Ghost.

And below, in the mist, Scrooge could see an avuncular man. Oddly and incongruously, the man wore a baseball cap. 

"Who is that man, Spirit?" Scrooge asked.

"Those who used to think of themselves as his friends called him ‘Bernie’" the Spirit said.

"No more!" cried Scrooge. "No more, I don’t wish to see it. Show me no more!"

 

Break in the Action: I think we could all use a break. I will discontinue my regular publishing schedule for the next few days. Regular publication will resume after the New Year.

 

Securities lawsuit filings reached a six-year high in 2008, according to a year-end report released today by NERA Economic Consulting. The report, entitled "2008 Trends in Securities Class Actions" (here), was written by NERA economists Stephanie Plancich and Svetlana Starykh, and reports that through December 14, 2008, there were 255 securities class action filings, up from only 131 filings in 2006 and 195 filings in 2007. NERA’s December 18, 2008 press release regarding the report can be found here.

 

If the "atypical" cases (e.g., IPO laddering) are excluded from the comparison, the 2008 filings are "on pace to reach a 10-year high." The filings are also on pace for a 37% increase over 2007 and the highest annual increase since 2002 (the year of the corporate scandals).

 

The report attributes the "surge" in filings to the credit crisis. Of the 255 YTD filings, 110 were credit crisis related, and almost 50% of cases involved defendants in the financial sector, as compared to only 16% of cases in the 2005-06 period. (My table of the credit crisis-related securities lawsuit filings can be accessed  here.)

 

But while the financial sector saw increased litigation activity, "other sectors also saw continued filing activity." For example, though lawsuits against companies in the health technology sector declined as a percentage of all filings, the absolute number of filings against companies in the health technology sector increased, as there were 29 filings against health technology companies in 2008, compared to only 19 in 2006.

 

The 2008 filings have been concentrated in the second and ninth circuits. The second circuit filings were increased by the large number of filings in the Southern District of New York, particularly financial companies domiciled there.

 

Though the pattern of increased filing activity in 2008 is clear, "there have been no clear increasing or decreasing trends in the patter of resolutions." The report notes that median settlements have "remained relatively stable." The 2008 median settlement of $7.5 million is slightly below the 2007 median of $9.4 million, but above the 2006 median of $7.0 milllion.

 

Average settlements, which can be substantially affected by large settlements, were up in 2008 relative to 2007. The average settlement in 2008 was $38 million, up from $31 million in 2007, but well below the post-Sarbanes Oxley average from 2003 to 2008 of $45 million. (The annual average settlement has ranged from $21 million to $82 million during this six-year period.)

 

The report does observe that over time there has been an increase in the dollar value of claimed investor losses, from about $120 million ten years ago, to around $340 million during 2008. However, the ratio of median settlement to median investor losses has "stayed relatively steady in the 2-3% range over the past few years."

 

Looking forward, the report notes that there could be "two opposing factors" that could determine whether or not average or median settlements will increase in the future. On the one hand, investor losses associated with the credit crisis lawsuits in 2008 are very large, which could be "an indicator of big settlements to come." On the other hand, the credit crisis has "dramatically shrunk the size of many defendants’ pockets." Lower financial wherewithal might operate as a downward force on settlement values.

 

The report concludes that "only time will tell if the huge investor losses for credit crisis filings may put upward press on median settlements in the future, or if the financial distress faced by defendant companies may pull median settlement values down."

 

My own observations on the 2008 securities litigation activity will be detailed in my year-end analysis, which will be forthcoming after the first of the new year. UPDATE: My year end analysis can be found here. For now, I note a few things.

 

First, this has been an extraordinarily difficult year in which to just try and count the cases. For example, many litigation targets have been sued multiple times by different claimants, whether they are shareholders who acquired their shares over different time periods, or they are security holders with different classes of equity interests. Whether a new filing should or should not be "counted" has been difficult. Further complicating this has been the large number of state court filings, which are difficult just to find. I emphasize this point simply because there is going to be a significant variation in the various commentators’ year-end reports about how many filings there were this year. My own count is lower than NERA’s.

 

Second, while the 2008 filings were significantly increased by filings against companies in the financial sector, as the year has progressed and the impact of the credit crisis has become more widespread, the credit crisis-related filings have spread outside the financial sector (refer for example here).

 

Third, you may see comments elsewhere that the 2008 filings were inflated by one-time sector events, like the auction rate securities lawsuits. While this is true, the recent surge of litigation activity involving the Madoff victims demonstrates that in many ways the pace of securities litigation activity is simply a reflection of a series of supposed one-time events. The mere fact that there is an identifiable event arguably may be irrelevant to analyses of current or future filing trends.

 

Fourth, the NERA report makes no projections about what is likely to happen to the pace of filing activity in 2009. My own view is that the current active filing pace is likely to continue well into 2009 and perhaps beyond. Among other things, filing activity has been elevated over the last several weeks, which is unusual for December, historically a slow month. The continued spread of credit crisis filings outside the financial sector is likely to continue in 2009. Moreover, the impacts of the financial downturn will begin to emerge as company’s report their 2008 results and as the year progresses, which could contribute to litigation activity.

 

As I said, my own report will be forthcoming. I am very interested in hearing readers’ thoughts and reactions in the interim.

 

Special thanks to Ben Seggerson of NERA for providing me with a copy of the NERA report.

 

If today’s filings are any indication, a huge wave of Madoff victim lawsuits could be coming. Madoff investors were quick to sue Madoff and his firm, with the first complaint filed last Friday (as noted here). But with Madoff’s firm in liquidation and the money likely long gone, investors who lost money as a result of Madoff’s scheme are casting around for other targets from whom to try to recover their losses. Early returns suggest that investment firms and Madoff "feeder funds" could find themselves facing substantial Madoff victim litigation.

 

UPDATE: Please note that a regularly updated table of Madoff investor litigation, including "feeder fund" litigation can be accessed  here.

 

First, as reflected in their December 16, 2008 press release (here), plaintiffs’ lawyers have filed a securities lawsuit in the Southern District of New York against investment partnership Ascot Partners L.P., its founder and general partner (Merkin), and its auditor, BDO Seidman. The class members are persons who purchased limited partnership interests in Ascot.

 

According to the press release, the complaint alleges that Ascot and Merkin

 

caused and permitted $1.8 billion — virtually the entire investment capital of Ascot — to be handed over to Madoff to be "invested" for the benefit of plaintiff and the other limited partners of Ascot. Plaintiff’s investment in Ascot has been wiped out, as a direct result of: (a) defendant Merkin’s abdication of his responsibilities and duties as General Partner and Manager of Ascot and its investment funds and; (b) the failure of Ascot’s auditor Seidman, in light of "red flags" indicating a high risk to Ascot from concentrating its investment exposure in Madoff as sole third-party investment manager for all of the Partnership’s assets, to perform its audits and provide its annual audit reports in conformance with generally accepted auditing standards.

 

The press release states that the complaint alleges ’34 Act violations as well as related statutory and common law breaches. A copy of the complaint can be found here.

 

UPDATE: On December 16, 2008, investors also filed a separate lawsuit against a different fund affiliated with Merkin, Gabriel Partners. A copy of the December 17, 2008 press release can be found here.  A copy of the complaint can be found here.  A WSJ.com Law Blog post about the Ascot and Gabriel lawsuits can be found here.

 

Second, and also on December 16, another plaintiffs’ firm initiated a separate securities lawsuit in the Central District of California. The lawsuit is filed against Madoff and his firm, but also names as defendants Brighton Company, a California limited partnership and a so-called "feeder fund," and its principal ( Stanley Chais). The firm’s press release (here) states that Brighton was "one of the many feeder funds that directed investor capital" to Madoff and his firm. The press release says that Chais "managed several investment groups [including Brighton], the monies for which were given to Madoff" and his firm.

 

The complaint (here) alleges that the plaintiff invested money through CMG Ltd., a California limited partnership. The complaint alleges that CMG provided all of its investment capital to Chais as general partner for Brighton, which in turn invested all of CMG’s money with Madoff. The complaint alleges that "all defendants contributed to the false, misleading, unlawful, unfair and fraudulent acts and practices associated with the Ponzi scheme."

 

The purported class consists of two groups; all persons who invested capital with Chais and Brighton, and all persons who invested with Madoff and his firm. The complaint alleges violations of the ’34 Act.

 

The press release also states that "the firm is investigating the actions of other feeder firms on behalf of investors." The December 17, 2008 Wall Street Journal has an article (here) discussing Stanley Chais and his investment funds’  (and charitable organizations’) relation to Madoff
 

 

Given the magnitude and widespread dispersion of the Madoff losses, and given the fact that there appears to be little money left with Madoff and his fund, it seems highly likely that there will be other (perhaps many other) investment funds, "feeder funds," hedge funds, funds of funds, and other entitles, targeted by Madoff victims. The attention in the press (for example, here) to alleged failures of investment firms to catch supposed red flags or to conduct due diligence will only increase the likelihood of this kind of litigation. The inclusion of the auditor in the Ascot lawsuit suggests that some of these claims could range pretty far afield.

 

A December 16, 2008 Business Week article discussing the likelihood of Madoff investor claims against hedge funds and others, also discussing the Ascot lawsuit, can be found here.

 

The Wall Street Journal is helpfully collecting a list of Madoff’s victims here. It is a long list but it is also clearly incomplete; for example, Fairfield Greenwich Advisors may have been hit with $7.5 billion in losses, but those amounts in reality represent the losses of Fairfield’s own investors. The list would be substantially longer if all of these and other fund investors and customers were listed individually. The fund investors are the ones, like the plaintiffs in the cases described above, that will likely target the investment funds.A December 17, 2008 Wall Street Journal article entitled "Fairfiled Group Forced to Confront its Madoff Ties" (here) conveys some pretty strong suggestions along those lines.

 

In any event, going forward, the number one question D&O insurance underwriters will be asking financial institution applicants will be whether the applicant invested funds with Madoff.

 

Meanwhile, the Credit Crisis Litigation Wave Churns On: It seems as if the plaintiffs’ lawyers have kicked it into high gear as the year end approaches. There has been a flood of new securities lawsuit filings so far in December. By my informal count, there have already been at least 20 new securities lawsuit filings so far this month (if you count the two cases described above), an unusually high number for December, which historically is a quiet month for securities filings.

 

And though the filings have included a diversity of cases (as I discussed here), the filings have also included a number of new subprime and credit crisis related lawsuits, including at least four new cases that have been filed or become public this week.

 

For example, as reflected in their press release (here) on December 16, 2008, plaintiffs’ lawyers initiated a securities class action lawsuit in the Southern District of New York against investors in the C-Bass Trust Certificates backed by residential mortgage loans and issued by Credit-Based Asset Servicing and Securitization LLC. The defendants include C-Bass, the issuing trusts, and the offering underwriters. The complaint, which can be found here, asserts claims under the ’33 Act.

 

In addition, on December 4, 2008, plaintiffs’ initiated a securities class action on behalf of investors who purchased AIG shares in shelf offerings conducted during the period 2003 to 2007. The complaint (here) asserts claims against AIG, certain of its directors and officers, and its offering underwriters under the ’33 Act.

 

And on December 8, 2008, defendants removed to federal court a lawsuit that previously had been filed in New York County (New York) Supreme Court against Residential Asset Securitization Trust (which issued certain residential mortgage pass-through certificate), its offering underwriter, and two rating agencies. A copy of the removal petition, to which the original complaint is attached, can be found here.

 

Finally, plaintiff shareholders have initiated a securities class action lawsuit (here) against private equity firm American Capital Ltd. in the District Court of Maryland, alleging among other things that the firm failed to disclose its exposure to disruptions in the credit market.

 

I have added these new lawsuits to my running tally of subprime and credit-crisis related litigation, which can be accessed here. With the addition of these new lawsuits, the running tally of subprime and credit-crisis securities lawsuits now stands at 138, of which 98 have been filed during 2008.

 

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing information and links about these new lawsuits.

 

And Finally: Before writing this post, I had no prior acquaintance with the phrases "Madoff victims" and "feeder funds." I guess I better get used to them.