Tuesday, September 04, 2007

The Subprime Lending Mess: Blame the Gatekeeper Time Already?

As I noted in prior posts (most recently here), the long-running options backdating blame game eventually morphed into an exercise that included suing the gatekeepers. Even though the subprime mortgage lending litigation machine has only recently gotten cranked up, it has already turned into yet another round of gatekeeper scapegoating. According to a September 3, 2007 International Herald Tribune article entitled "Citigroup Unit and Deloitte are Sued over Subprime Lender’s Share Issue" (here), a lawsuit filed on August 27, 2007 relating to American Home Mortgage’s April 2007 secondary offering (about which refer here) seeks to extend the blame to the company’s auditors and offering underwriters. A copy of the complaint can be found here. (Hat tip to Adam Savett at the Securities Litigation Watch for the link to the complaint.)

The lawsuit is brought on behalf of shareholders who purchased shares in American Home’s secondary offering of 4 million shares, which was completed on April 30, 2007, less than four months before American Home’s August 6, 2007 bankruptcy filing. The shares sold in the offering at $23.75/share. American Home’s shares closed today at 27 cents a share. The defendants include ten present or former directors and officers of American Home, as well as Deloitte & Touche, which allegedly prepared and certified certain reports and statements used in the offering materials, and Citigroup Global Markets, which allegedly was the sole underwriter for the offering.

According to an August 31, 2007 press release describing the lawsuit (here), the complaint alleges that the offering materials failed to disclose that at the time of the offering, American Home was experiencing an increasing number of loan delinquencies, and that it had failed to establish adequate reserves against future loan losses and failed to write down the value of delinquent loans. The complaint also alleges that at the time of the offering American Home was increasingly unable to sell its loans, even at sharp discounts, increasing its mortgage lending related exposure. The complaint alleges that the defendants withheld this information from the investing public and that as a result the defendants violated Sections 11, 12 and 15 of the Securities Act of 1933.

As I previously noted (here), Jonathan Weil at Bloomberg.com wrote on August 15, 2007 (here) about what he called the "poor schlimazels at Deloitte & Touche LLP who blessed the books at American Home…mere months before it went belly up." Weil noted the unenviable position that the auditors were in, given that a "going concern" audit opinion would have represented a default under American Home’s credit facility. A going concern opinion would almost certainly have been a self-fulfilling prophecy, but as Weil noted, "a self-fulfilling prophecy would have spared investors from the Company’s April 30 offering of 4 million shares." Weil’s article also cites other instances where auditors issued clean opinions shortly before a subprime lender’s failure.

While there is no apparent reason to think its actions are in any way related to these prior events involving American Home Mortgage, Deloitte appears to have taken a different approach in connection with NovaStar Financial's more recent financing attempts. A September 4, 2007 CFO.com article entitled "Deloitte Forecloses on NovaStar Stock Offerings" (here) states that Deloitte "torpedoed" NovaStar's efforts to sell $150 million in preferred stock. According to NovaStar's own September 4 news release (here), the company was unable to meet the offering requirements of filing a registration statement by August 30, essentially because. as the press release states,
Deloitte & Touche LLP, NovaStar's independent auditors ("Deloitte"), advised NovaStar in the last week of August 2007 that it was not willing to issue a consent or otherwise be associated with the rights offering unless the Company reissued its 2006 financial statements to include footnote disclosures regarding these matters. In addition, Deloitte further advised NovaStar that its reissued report on such financial statements would include an explanatory paragraph about the uncertainty of NovaStar's ability to continue as a "going concern". NovaStar determined that work necessary for the reissuance of its 2006 financial statements and the reissuance of
Deloitte's audit report would not be completed by August 30, 2007, and [the offering managers] indicated that they were not willing to waive or extend this requirement.
As I have noted before (refer here), the subprime lending litigation wave is likely to sweep in a broad variety of defendants, as would-be plaintiffs seek an ever-broader variety of defendants to try and stick with plaintiffs’ losses. The circle of blame has already encompassed not only the subprime lenders and their directors and officers (here), but also credit rating agencies (here), real estate brokers and home builders (here), mortgage brokers and real estate appraisers (here), as well as auditors and offering underwriters, as noted above. The wave is likely to continue to spread outward.

One final note: according to news reports (here) the U.S. Trustee in Wilmington, Delaware reportedly has moved to preclude the law firm of Cadwalader, Wickersham & Taft from acting as American Home’s special counsel in connection with the company’s bankruptcy because the firm acted as the company’s counsel in connection with the April 2007 stock offering.

It's Official: For those of you who were unsure whether the news of Bill Lerach's retirement would prove to have been greatly exaggerated, you may want to check out the revamped website (here) of the newly renamed law firm of Coughlin Stoia Geller Rudman and Robbins LLP. Lerach's name has been removed from the roster of attorneys at the firm. The firm with the new name is apparently eager to prove it will move just as quickly as it did under its old guise; the firm announced today (here) that it had launched a securities class action against Jones Soda Company and several of its directors and officers.

And for those of you interesting in such things (there must be some of you out there), the Houston Chronicle has an article (here) that praises Lerach's work on behalf of Enron's shareholder, and honors his "unblemished" legacy. That's what the article says.

Predicting the First Climate Change-Related Securities Lawsuit?: In earlier posts (refer here), as well as separate publications (here), I have written about the possibility of D & O claims arising out of climate change issues, particularly climate change related disclosures. Admittedly, the discussion of these issues has been somewhat abstract, as there have yet been no D & O claims related to climate change issues. I still believe that it is prudent to consider these exposures, because I believe it is only a matter of time before these claims begin to emerge.

Of course, the mere assertion that it is only a matter of time begs the question – when will these claims emerge? While I would hesitate to make any specific prediction myself, Adam Savett at the Securities Litigation Watch (here) has, in light of the "proliferation of corporate sustainability reports," boldly put the over/under at "June 30, 2008 for the first securities class action lawsuit to include allegations from a corporate sustainability report." We won’t have long to wait to see whether Adam is correct, as his target date is only ten months away. We’ll be watching closely…

Blogger Move: We here at The D & O Diary are big fans of the Drug and Device Law Blog (here), and so we noted with interest that Mark Herrmann, one of the blog’s co-authors (the other author is Jim Beck), has relocated (refer here) from Cleveland to Chicago. Mark not only was at Michigan Law School with me, but he was – prior to his move – part of the well-known blogging elite here in Cleveland. While the shores of Lake Erie will miss Mark (and his wife Brenda, who happened to be my dentist), we wish him every success on the shores of Lake Michigan. All I can say is – Mark, how could you leave in a year when it looks like the Indians might finally make the playoffs?

Speakers' Corner: On September 12, 2007, I will be moderating a panel at a Professional Liability Underwriting Society (PLUS) Midwest Chapter Event, to be held at the Cincinnati Hyatt at 3 pm. The panel, entitled "Current Issues in Directors and Officers Liability Insurance" includes noted D & O commentator Dan Bailey, policyholder attorney Tom Reiter, leading broker Jim Lash, and Mark Lamendola of Travelers. Details about the event can be found here. The panel will be followed by at cocktail reception at 5 pm. I hope readers in the Great Lakes and Ohio Valley regions will plan to attend.

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