DLA Piper Among Large Firms ‘Publishing’ Frequent News, Views on Financial Tsunami

Law firms are increasingly going straight to the Web with their own brand of updates and perspectives, creating a motherlode of free legal insights.  The urgency of the credit markets crisis has put many firms into high gear with fresh content going up daily.  DLA Piper is no exception.  Below are some recent observations provided by the firm.  More info at www.dlapiper.com.

 

September 21, 2008, Implications of the Global Credit Crisis and the US Government’s Response

1.    “Participants in the global financial services industry have witnessed developments this past week unprecedented since the late 1920’s: within the span of several days, a major investment bank (Lehman Brothers) was forced to file bankruptcy, one of the premier retail and institutional broker/dealers in the United States (Merrill Lynch) was induced to be sold to Bank of America amid concerns of its own solvency and survival, and a major insurance conglomerate (American International Group (AIG)) was rescued by a direct loan and guarantee program that effectively provides for this entity to be owned and operated by the United States government.  These developments occurred within weeks of the federal rescue of two crucial government sponsored enterprises (Fannie Mae and Freddie Mac), and only months after the near collapse and government-guaranteed acquisition by JP Morgan of another prominent investment bank (Bear Sterns).”

 

2.   “The Treasury has been encouraging its counterpart agencies overseas to develop and implement comparable asset purchase programs.  The ability to extend the availability of the US purchase program to additional foreign entities having a significant presence in the US may, in turn, depend on the extent to which comparable programs are established overseas.”

 

3.   “In light of the broad ranging and dramatic nature of the proposals promulgated by the regulators and contemplated for passage by the Congress, the impact on individual businesses and their counterparties will be significant…”

 

4.   “By allowing hedge funds or other investors to hold amounts greater than 25 percent of the total contributions to the capital of a banking entity, without becoming subject to regulation as a bank holding company, banking regulators may create the potential of opening a significant amount of new sources of capital for investment in the banking industry.”

September 22, 2008, SEC Attacks Short Selling on Regulatory and Enforcement Front

1.    “With the issuance of a formal order of investigation, the Enforcement Division now has the power to subpoena documents and testimony relevant to its investigation into manipulative and ‘abusive’ short selling practices and illegal ‘rumor mongering.’”

 

2.   “According to the SEC’s press release, hedge fund managers, broker-dealers and institutional investors with significant trading activity in certain financial issuers or positions in credit default swaps will be required to disclose these positions, under oath, to the Commission.”

September 24, 2008, Update: The Global Credit Crisis and the US Government’s Response

1.   “Today the financial markets received the welcome news that investor Warren Buffett, acting through Berkshire Hathaway, Inc., is planning to invest $5 billion in Goldman Sachs.  The proposal, coupled with an additional capital raise by Goldman Sachs announced today, is being seen as a favorable indication of faith in the viability of the country’s financial system.”

 

2.   “This CDS [credit default swaps] market has been the fastest growing derivatives market worldwide in the last two years.  The sellers of CDS protection are often Insurance companies, and the risk of loss to sellers (in the event reference indebtedness is not repaid in accordance with its terms) increases exponentially.  This arguably increases systemic risk to the financial markets.”

September 29, 2008, Update: The Global Credit Crisis and the US Government’s Response

1.    “…concerns of Main Street bankers in smaller communities who are expressing anxiety at recent market turmoil, and communicating to their legislative representatives the fear that the Wall Street upheaval may result in contagion by smaller market participants in communities and industries throughout the US.  Indeed, legitimate fears exist, given European market developments, that such systemic breakdowns will accelerate beyond the shores of America to Europe and Asia, as well.”

 

2.   “Only one certainty remains: both the regulatory and the market landscape will be a radically different one in the months to come.  While once-hallowed institutions meet their demise by restructuring, liquidation, acquisition or bankruptcy, governmental authorities across the globe are calling for a new system of financial regulation amidst frank acknowledgements….that the old regulatory regimes are obsolete.”

October 1, 1008, The Global Credit Crisis and the Global Response

1.    “In the regulatory area, the Securities and Exchange Commission announced additional guidance on market-to-market accounting standards, in an effort to address concerns about the implementation of this regime and its impact on the financial services industry.  It is expected that this topic will be one of extended debate in weeks to come, as the goals advanced by such accounting treatment, providing for greater clarity and transparency in the valuation of assets, are outweighed by the difficulties of determining accurate values at times when market prices for such assets may be impossible to obtain in a deteriorating market.”

 

Credit Bubble Struggle Playing Out on Many Fronts

By J. Bruce Boisture, Managing Partner, Grais & Ellsworth LLP

The crisis in the structured finance market continues, and the legal actions to sort out its consequences are also proceeding apace.  As befits the aftermath of a credit bubble of such magnitude, the struggle is taking place on many fronts.

Purchasers of collateralized debt obligations, or CDOs, are pursuing claims against CDO issuers, underwriters, sellers, and others under federal securities laws and various state laws.  In cases such as Plumbers Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., No. 08-0544, complaint filed (Mass. Super. Ct., Suffolk County, Jan. 31, 2008), Bankers Life Ins. Co. v. Credit Suisse First Boston Corp., No 8:07-cv-00690, complaint filed (M.D. Fla. April 23, 2007), disappointed CDO owners are asserting that the disclosures made to them were incomplete, careless, or fraudulent.  Often in the same actions, the CDO owners also complain of the mismanagement or looting of the collateral pool by loan servicers and collateral managers affiliated with the same issuers and underwriters, as in HSH Nordbank AG v. UBS AG, No. 08600562, complaint filed (N.Y. Sup. Ct., N.Y. County Feb. 25, 2008).

Structured Finance & Derivatives Litigation Conference October 15-16

On another front, participants in the CDO structures are waging an intense internecine struggle over whatever value remains in the underlying collateral.  The “waterfall” provisions for ordering the priority of payments among various tranches after a credit event, rights of warehouse lenders to streams of principal and interest payments on loans they were left holding after the bankruptcy of the loan originator/servicer, and the “true” value of CDOs in a barely functioning CDO market are being examined in cases such as Deutsche Bank Trust Co. v. Victoria Fin., No. 08600071, complaint filed (N.Y. Sup. Ct., N.Y. County, Jan. 9, 2008), UBS Real Estate Securities v. New Century Mortgage [citation], and Luminent Mortgage Capital Inc. et al. v. HSBC Securities (USA) Inc., No. 07-CV-9340, complaint filed, (S.D.N.Y. Oct. 18, 2007).

Retail sub-prime borrowers were the cannon fodder for the subprime ABS debacle.  Predatory lending practices of mortgage brokers and lenders have left many individuals in debt far beyond their means as well as beyond the true value of the properties they purchased.  Some contend that the lending practices prevalent during the subprime ABS heyday even left whole neighborhoods blighted by high foreclosure rates.  Liability, if any, at this level in the subprime ABS pipeline is being sorted out in cases such as Samuel et al. v. Countrywide KB Home Loans et al., No. 08-cv-350m complaint filed (D.S.C. Jan. 31, 2008).

Perhaps most intriguing, though, are a series of cases in which customers are complaining of the investments their investment managers made in subprime ABSs.  Because every corner of the investment world seems to have participated in sopping up the output of the subprime ABS mill, these actions are arising in a variety of contexts.  ERISA-based claims against providers of investment vehicles that invested heavily in subprime ABSs (Prudential Re. Ins. & Annuity Co. v. State Street Bank & Trust Co., No. 07-CV-8488, complaint filed (S.D.N.Y. Oct. 1, 2007)) and against fiduciaries of company plans affected by the crisis (Gray v. Citigroup Inc., No. 07 Civ. 9790, complaint filed (S.D.N.Y. Nov. 6, 2007) seem likely to follow familiar ERISA tracks.    

 

Surprising Outcomes

Similar claims in different contexts, however, have already yielded and may continue to yield some surprising outcomes.  Political pressure brought Merrill Lynch quickly to heel when the City of Springfield complained of subprime ABS investments made on its behalf.  In re Merrill Lynch et al., No. 2008-0001, administrative complaint filed (Office of the Sec’y of the Commw., Sec. Div. Feb. 1, 2008); “Merrill Pays Back Springfield, Mass., For CDO Purchase,” Wall Street Journal, Feb. 1, 2008.  In Wilmington Trust Co. v. Metro. Life Ins. Co., No. 08600242, complaint filed (N.Y. Sup. Ct., N.Y. County, Jan. 25, 2008), a corporate holder of an insurance policy meant to fund non-pension retirement benefits complained that the insurance company had improperly and imprudently invested its premiums in subprime ABSs, to the detriment of the policyholder, exactly paralleling the claims in the ERISA suits.  Dismissing the complaint, the court held that under New York insurance law the policyholder had no legally protected interest in the nature of the investments made by the insurance company or its investment manager – a striking contrast to the likely outcome in the ERISA context.  Still other nuances are likely to emerge when claims under the Investment Company Act are leveled against mutual fund managers for plunging their bond funds into excessive (and costly) subprime ABS exposure.  Atkinson v. Morgan Asset Mgmt., No. 07-2784, first amended complaint filed (W.D. Tenn. Feb. 1, 2008).

And on top of all of this, there is the usual spate of class-action stock-drop cases.

Note: Bruce Boisture and his partner David J. Grais are speaking at Structured Finance & Derivatives Litigation Oct. 15-16 in New York, a BVR Legal / Mealey’s event.