Thursday, September 13, 2007

More Subprime Lawsuits

Regular readers know that I have been maintaining a list (here) of subprime lending-related securities class action lawsuits. A cluster of new subprime lending lawsuits arrived this week, and these new lawsuits suggest additional directions in which the suprime lending litigation wave may be heading.

First, a lawsuit filed in behalf of employees of Countrywide Financial Corporation alleges that actions by the company and its executives caused 401(k) plan participants to lose millions of dollars. News articles describing the Countrywide employees’ 401(k) plan lawsuit can be found here and here. Under the company match component of the plan, many employees received a 50 percent match of up to six percent of their plan contribution, which during 2005 and 2006 was paid in the form of company stock. The Complaint alleges that the defendants had a duty to warn employees’ of the company’s precarious financial condition and that the defendants intentionally concealed information from plan participants. (Many of the putative class members potentially are also part of the Company’s recently announced plan to eliminate 12,000 jobs.)

Second, the Coughlin, Stoia, Geller, Rudman & Robbins firm recently filed a securities class action lawsuit against Tarragon Corporation. Even though Tarragon is not itself a subprime lender (the company develops, renovates, and builds condominiums), the allegations in the complaint derive from the turbulence in the residential real estate sector and in the credit markets that has followed the subprime meltdown. A copy of the Complaint can be found here and the press release describing the complaint can be found here.

The Complaint alleges that Tarragon had failed to consolidate an unprofitable variable interest entity into its consolidated financial statements; had failed to take timely impairment charges and other write downs; and "due to a deterioration in the real estate credit markets … was experiencing liquidity issues due to its inability to obtain loan modifications and additional financing and there was serious doubt about Tarragon’s ability to continue as a going concern." The Complaint also alleges that "given the increased volatility in the homebuilding industry and the real estate credit markets, the Company had no reasonable basis to make projections about its 2007 results."

Third, on September 12, 2007, the Sheet Metal Workers’ National Pension Fund filed a shareholders’ derivative lawsuit against Beazer Homes as nominal defendant, and several of the company’s current and former directors and officers. (Refer here for a copy of the Complaint.) The Complaint alleges that the defendants breached their duties by failing to implement internal controls to prevent the operation of the company’s mortgage origination and brokerage subsidiary in an illegal manner; caused the company to issue false financial statements, and failed to prevent improper insider trading and the improper grant of bonuses to senior management.

None of these new lawsuits are straightforward securities class action lawsuits filed against subprime mortgage lenders of the kind that I have been tracking. But they are all consequentially related to the subprime mortgage mess. The Countryside 401(k) lawsuit is the most obvious example, since it involves a subprime lender, and the plaintiffs’ are merely pursuing alternative legal approaches after other plaintiffs’ lawyers have already occupied the securities class action space with relation to Countrywide. I have added the Countywide suit to my list of subprime lender 401(k) lawsuits, here.

The Beazer Homes derivative lawsuit is a related example. Beazer has also already been sued in a subprime lending-related securities class action lawsuit (refer here), but just as happened with the options backdating scandal, plaintiffs’ lawyers who are preempted from filing a securities lawsuit are suing the same companies under shareholders’ derivative theories. And as also happened in the options backdating cases, the derivative cases may be attracting attorneys from outside the traditional plaintiffs’ securities bar. The lead counsel in the Beazer Homes derivative case is the Motley Rice law firm, which is better known for its involvement in asbestos and tobacco litigation.

The Tarragon lawsuit is interesting because, while it is not directly related to subprime lending per se, it is directly related to the turbulence that has hit the larger residential real estate sector, and is largely due to more generalized disruptions in the credit marketplace. The worrisome implication is that the contagion effect of the subprime mess is not only having an adverse impact on larger segments of the economy, but those adverse effects could produce additional shareholder litigation outside the subprime arena itself. And on an even more general level, the heightened level of plaintiffs’ lawyer activity manifest in these three cases may perhaps bespeaks a broader litigation threat to a broader spectrum of companies.

More About Alternatives to Auditor Liability Caps: In a prior post (here), I reviewed a recent article in which Professor Lawrence Cunningham proposed a capital markets-based alternative to auditor liability caps. My post provoked a very detailed and thoughtful response from Professor Cunningham, which I have incorporated as an update in my prior post (please refer to the italicized text, here).

As an aside, this type of exchange of ideas is exactly what I had hoped would happen when I started this blog. Although idea exchanges have arisen from time to time, I wish it would happen even more frequently. And along those lines, I would like to emphasize that readers are cordially invited to post comments to any of my blog posts (using the "comment" link at the foot of the post). Readers who feel compelled to prepare a lengthier or more formal response to one of my post should just let me know, and it if makes sense, I will try to incorporate responsible commentary, just as I have incorporated Professor Cunningham’s response to my comments about his article.

Tarragon: Most readers likely will associate the name "Tarragon" with the familiar herb, sometimes known as "dragon’s wort." Perhaps I associate more freely than others, but to me the company’s name brings to mind Professor Hercules Tarragon (pictured to the left), one of the members of the ill-fated Sanders-Hardiman expedition in Hergè’s classic Tintin comic book, The Seven Crystal Balls. Professor Tarragon was one of several men who suffer the curse of Rascar Capac for transporting Capac’s mummified remains from Peru to Europe.

Another classic Tintin character is the garrulous and irrepressible insurance agent, Jolyon Wagg (pictured to the right), whose caricature of a backslapping, glad-handing insurance salesman is the humorous essence of the negative stereotype those of us in the insurance industry must live with on a daily basis.

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