Securities Litigation and the Financial Crisis Fulbright & Jaworski L.L.P.
Financial Crisis Securities Litigation: Tale of the Tape • After spawning hundreds of shareholder class and derivative actions, the financial crisis litigation engine is winding down • At least 206 subprime-related and credit crisis-related federal Rule 10b-5 lawsuits have been filed since 2008, with 102 in 2008, 62 in 2009, 22 in 2010, and at least 2 thus far in 2011 • Source: The D&O Diary • While new credit crisis-related cases have declined, the total number of securities fraud class action filings increased from 168 in 2009 to 176 in 2010 as more non-crisis cases were filed • Source: Cornerstone Research • Credit crisis filings declined from 32.7% of total class action filings for 2009 to 7.4% of total filings for 2010 • Source: Cornerstone Research • There have also been at least 25 ERISA class actions related to the financial crisis, as well as many shareholder derivative suits • Source: The D&O Diary
Typical Allegations In Financial Crisis Lawsuits • Inadequate and misleading risk disclosures • Misrepresentation of loan portfolio quality and extent of reliance on subprime or other high-risk loans • False financial statements, improper accounting, and exaggerated valuations of loan portfolios • Inadequate/understated reserves • Market manipulation by large financial institutions • Lack of internal controls • Improper foreclosure practices • E.g., Pipefitters Local No. 636 v. Bank of America Corporation, No. 11 CIV 0733 (S.D.N.Y. filed Feb. 2, 2011): Securities fraud class action against BofA based on defective foreclosure paperwork • Excessive executive compensation • Insider stock sales
How Have Credit Crisis Class Actions Fared? • At least 70 motions to dismiss have been granted for failure to satisfy federal pleading requirements, although some defendants were permitted to amend • Source: D&O Diary • At least 50 motions to dismiss have been denied • Source: D&O Diary • This ratio is similar to the overall dismissal ratio in the years after the Supreme Court’s Tellabs opinion, which reaffirmed stringent pleading requirements • Recent Matrixx Initiatives Supreme Court decision could, however, lead to more denials of motions to dismiss • First crisis-related securities class action jury trial resulted in $40+ million verdict against BankAtlantic Bancorp for allegedly misrepresenting quality of loan portfolio
Class Action Settlement Values • Only 19 of the 200+ credit crisis federal class actions have settled • Source: D&O Diary • Median and average settlements for credit crisis cases through 2010 have been $31.3 million and $103.1 million, respectively, which is three times greater than for non-credit-crisis settlements, although small sample size may skew results • Source: Cornerstone Research • Significant settlements: • Countrywide Financial ($624 million) • Merrill Lynch ($475 million) • New Century Financial ($124.8 million) • MoneyGram International ($80 million) • Credit Suisse ($70 million) • American Home Mortgage ($37.3 million) • Ambac Financial ($33 million)
SEC Enforcement Actions • SEC brought more than two dozen crisis-related enforcement actions and has recovered more than $1 billion in settlements. • Highlights include: • SEC v. Citigroup, Inc., No. 10-CV-01277 (D.D.C. filed 2010) ($75 million penalty for allegedly misrepresenting subprime risk) • SEC v. Bank of America, No. 09 cv 6829 (S.D.N.Y. filed 2009) ($150 million penalty for failing to disclose Merrill Lynch bonuses; penalty increased from $33 million after court rejected initial settlement) • SEC v. Goldman Sachs, No. 10-CV-3229 (S.D.N.Y. filed 2010) ($535 million penalty/$15 million disgorgement for not disclosing Paulson role in constructing CDO investment) • SEC v. Mozilo, No. CV 09-03994 (C.D. Cal. filed 2009) ($67.5 million disgorgement/penalties against ex-Countrywide CEO for allegedly concealing subprime risk exposure and insider trading) • SEC v. Morrice, No. CV 09-01426 (C.D. Cal. filed 2009) (injunction and $700,000+ disgorgement/penalties against ex-New Century Fin. CEO for misrepresenting financial condition)
Auction Rate Securities Litigation • Scores of lawsuits and numerous arbitrations and state and federal regulatory enforcement actions have been filed against brokers and underwriters of auction rate securities • Regulators have secured more than $60 billion in ARS settlements • Claimants and regulators typically allege that firms misrepresented liquidity of ARS markets, manipulated markets by creating illusion of liquidity, and/or failed to disclose degree of dependence on “support bids” to prevent auction failures • ARS cases in federal court have routinely been dismissed for failure to allege falsity, scienter, and reasonable reliance • E.g., In re Citigroup, Inc., No. 08 Civ. 3095, 2011 WL 744745 (S.D.N.Y. Mar. 1, 2011) (dismissing claims that defendants manipulated market by creating illusion of liquidity); In re Merrill Lynch ARS Litig., No. 09 MD 2030, 2011 WL 536437 (S.D.N.Y. Feb. 9, 2011) (dismissing case and noting “robust” risk disclosures) • Some courts, however, have denied motions to dismiss • E.g., Akamai Technologies, Inc. v. Deutsche Bank AG, _ F. Supp. 2d _, 2011 WL 537511 (D. Mass. Feb. 15, 2011) (denying dismissal in misrepresentation case and holding that defendant did not adequately disclose liquidity risks) • Arbitration results have been mixed, with a number of significant awards against financial institutions
FDIC Litigation • The FDIC has sent hundreds of demand letters and has authorized more than 150 lawsuits against officers and directors of failed banks • At least six suits against 40 individuals have been filed to date: • IndyMac Bank Homebuilder Division (filed July 2, 2010) (fiduciary duty and negligence claims against 4 former officers) • Heritage Bank (filed Nov. 1, 2010): Alleges that 11 officers and directors breached fiduciaries and were grossly negligent in failing to manage and superrvise commercial real estate lending • Integrity Bank (filed Jan. 14, 2011): $70 million receivership suit against 8 former officials for losses incurred in high-risk loans • 1st Centential Bancorp (filed Jan. 14 2011): Alleges that 12 former officers and directors caused at least $26.8 million in losses through 16 high-risk residential construction loans • Corn Belt Bank (filed March 1, 2011): Seeks at least $10.4 million from 4 former officers/directors for imprudent lending practices • Washington Mutual (filed March 16, 2011): Alleges that former CEO, COO, and home lending chief committed “gross mismanagement” by pursuing high-risk lending strategies with inadequate risk management; spouses of CEO and COO also sued for fraudulent conveyances)