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 Business News | May 2008 
Wave of Lawsuits Over Losses Could Hit a Wall
 Jonathan D. Glater - NYTimes
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Finding someone to sue over losses in the mortgage market and the credit crisis is easy. Winning in court, lawyers say, will be hard.
Shareholders in big financial firms have accused UBS, Merrill Lynch, MBIA and Morgan Stanley, among others, of trying to hide their home loan problems, which later led to declines in their stock prices.
Institutional investors have sued investment firms, including UBS, saying that they were misled into buying risky securities that later fell sharply in value. And there are more possible defendants, like the rating agencies that were supposed to evaluate these mortgage securities and the accounting firms that audited these companies.
“The wave of litigation that we’ve seen, and certainly the current momentum, is going to eclipse what we saw out of the savings and loan crisis” of the early 1990s, said Jeff Nielsen, managing director at Navigant Consulting. “Some of those cases are still ongoing.”
A recent study by Navigant found that 170 lawsuits — 44 of which were securities suits — had been filed because of subprime mortgage losses in the first three months of this year, up from 89 in the last quarter of 2007.
The legal landscape, however, has changed since the class-action bonanza that followed corporate fraud at Enron, WorldCom and Tyco. The Supreme Court in recent opinions has raised the bar for aggrieved shareholders, requiring them to provide more detailed evidence of wrongdoing when they sue, before the discovery phase, when lawyers have a chance to gather information.
Institutional investors face a different set of burdens. They must show that wrongdoing by the seller, not just a decline in the market, caused their losses. Given the speed and breadth of the decline in the real estate market, that may be hard. The institutions also will try to contend that they were fooled — a tricky argument for a large and prolific investor.
The difficulties do not mean these suits will founder, of course. And if an enterprising state attorney general turns up a few explosive e-mail messages from investment bankers, a fraud case can become a lot stronger.
Most shareholder class-action claims follow a pattern. For example, in a suit filed in federal court in Los Angeles in February against Morgan Stanley’s chief legal officer, shareholders charged that the company had delayed disclosing its exposure to mortgage-backed securities.
Morgan Stanley announced on Nov. 7 that it was taking a $3.7 billion charge against earnings because of the shrinking value of its securities backed by home loans, a market that began to implode last summer. The announcement sent the price of Morgan Stanley’s shares down by more than 6 percent, according to the complaint.
“Defendant’s material representations and/or omissions were done knowingly or recklessly and for the purpose and effect of concealing Morgan Stanley’s operations and business affairs from the investing public,” the complaint said, “thereby supporting the artificially inflated price of Morgan Stanley securities.”
That is a claim for “classic securities fraud,” said John P. Coffey, a lawyer at the shareholder firm Bernstein Litowitz Berger & Grossmann, who was not involved in the case. “I went to the marketplace to buy a security, I read what you had to say, what you said was false, and when the truth came out, my stock dropped, so I have a claim.”
But recent Supreme Court decisions have put obstacles in the way of such claims. Last May, in a class-action suit by consumers accusing local telephone companies of a conspiracy to raise prices — in violation of antitrust laws — the court described a standard for civil complaints that defense lawyers describe as a strong new barrier to lawsuits.
The plaintiffs must show that misconduct was plausible, not just possible, and must include “enough factual matter” to suggest that a wrongful act occurred, the court ruled. The court concluded that the plaintiffs’ claims in the case, Bell Atlantic v. Twombly, did not meet that test.
A month later, deciding a shareholder suit that accused a chief executive of overstating the business prospects of his telecommunications company, the court raised the bar in a different way. In addition to showing that the executive’s statements were misleading, the court wrote in the case, Tellabs v. Makor Issues & Rights, a shareholder’s claim that the executive had wrongful intent had to be “more than merely plausible or reasonable — it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.”
The language in the opinions still has to be interpreted by lower courts, but corporate defendants assert — and the Supreme Court’s tone indicates — that the decisions require plaintiffs’ claims to be stronger and more specific. That can be a tall order when plaintiffs have not yet had the chance to gather evidence — e-mail messages showing an executive’s state of mind, for example — that could help their case.
“It’s definitely more difficult,” said Jill E. Fisch, a law professor at Fordham. “And each Supreme Court case seems to go further in that direction.”
Institutional investors suing companies that sold them securities backed by home loans will be trying to show they received bad information.
“At the crux of these kinds of claims is getting information that you contend to be false,” said Michael R. Young, a lawyer at Willkie Farr & Gallagher. “The cold reality is, institutional investors have a level of sophistication that can make it harder for them to prove as plaintiffs that they were unwittingly duped.”
In a complaint filed in state court in New York in February, HSH Nordbank, a German bank, charged that “UBS knowingly and deliberately created a compromised structure based upon less desirable collateral” — that is, that the investment sold by UBS relied on much lower-quality assets than the company had described. HSH said the value of its investment had fallen more than $275 million.
The case raises the question of what level of disclosure and due diligence is required in complex transactions between financial institutions when one side has access to more information about the assets underlying the transaction, said Philippe Z. Selendy, a lawyer at Quinn Emanuel who represents HSH. “This type of litigation is novel.”
Even if a plaintiff can show that a seller gave misleading information about the value of mortgage-backed securities, it must also prove that the misstatements caused the plaintiff’s losses.
Defendants will probably argue that “it wasn’t that we misrepresented the risk, it’s that these instruments were affected” by a broader market downturn, Professor Fisch said. “It’s not clear how the court would analyze that.” |
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