Wednesday, September 26, 2007

Will Subprime Gatekeeper Blame Reach Lawyers, Too?

In an earlier post (here), I discussed a recent case in which investors sued a subprime mortgage lender’s auditor, as one example of the ways in which aggreived parties may seek to impose gatekeeper blame on professionals for the subprime lending mess. A recent lawsuit filed against the prominent New York law firm of Cadwalader, Wickersham & Taft, though it arises in the context of commercial mortgages, may suggest a way that law firms may also get drawn into litigation arising from the subprime lending mess.

According to a September 26, 2007 Law.com article entitled “$70 Million Suit Against Cadwalader Reflects Risks of Practice in Mortgage-Backed Securities” (here), in October 2006, Nomura Asset Capital Corp. filed a state court lawsuit in Manhattan “over documents the law firm drafted for a 1997 securitization transaction in which Nomura pooled 156 commercial mortgages worth around $1.8 billion.”

The securitization documents warranted that the pool “qualified” for special tax treatment, and also warranted that that this qualification meant that the mortgages were backed by properties worth at least 80% of the mortgage amounts. After some of the mortgages in the pool defaulted, LaSalle Bank, which held the pool in trust, sued Nomura, alleging that the mortgage loans were not “qualified” because one large property in the pool was worth substantially less than 80% of the loan value.

Ultimately, the Second Circuit held (here) that the inclusion of the 80% warranty, in addition to the warranty that the pool was “qualified,” imposed additional duties on Nomura. Nomura later settled with LaSalle for $67.5 million, and subsequently filed the legal malpractice action against Cadwalader for the inclusion of the 80% warranty in the securitization documents. According to the Law.com article, Cadwalader’s motion to dismiss remains pending.

Though Nomura’s lawsuit against Cadwalader grows out of the commercial mortgage context and relates to transactions from ten years ago, it is, as the article states, “unfolding against a backdrop of a credit crisis centering on such securities and the default of mortgages behind them.” The article notes that “the situation is worrisome to those law firms that have large securitization practices.”

As losses on subprime mortgage-backed securities mount, aggrieved parties will cast about for deep pockets to target, and if the Nomura case is any indication, aggrieved parties may well attempt to seize on purported defects in the securitization documents to attempt to target the law firms that drafted the documents. To the extent law firms’ clients and former clients are compelled to pay investor losses on securities they sold to investors, the clients and former clients may attempt to shift those losses to the lawyers that drafted the securitization documents.

To be sure, the Nomura case against Cadwalader involves the unusual circumstance that the presence of a single phrase in the documentation is allegedly linked to Nomura’s obligation to have to pay the prior settlement to LaSalle. Other potential litigants will face greater difficulties showing how the the lawyer’s conduct supposedly caused their losses. But clearly the gatekeepers on whom aggrieved parties will attempt to pin the blame for subprime-lending losses will include lawyers, as well as other professionals.

Hat tip to alert reader Kelly Reyher for the link to the Law.com article.

SEC to Convene Securities Lawsuit Roundtable: According to a September 24, 2007 Wall Street Journal article entitled “SEC to Study Revamp to Shareholder Suits” (here), the SEC will be convening a roundtable in the first quarter of 2008 to explore possible revisions to the U.S. system of private securities litigation.

The SEC’s decision to convene the roundtable is in response to an August 2, 2007 letter to the SEC from six prominent law professors, who suggested that the SEC “take a leadership role in studying [private securities litigation] and making or recommending policy changes if and where appropriate.”

The professors initiative, and the SEC decision to convene a roundtable, follows the suggestions of the Paulson Committee (refer here) and the Bloomberg/Schumer report (refer here) that the litigiousness in the U.S. is harming the competitiveness of U.S. capital markets.

In addition to their letter, the professors also provided a list of fifteen suggested discussion topics (here). Readers of this blog will be interested to note that among the topics that the professors suggested to be discussed is the following:
What is the role of insurance in [private securities class action] settlements? What portion of the settlements (and the costs associated with the litigation) is funded by insurance carriers? What is the impact on investors of the insurers’ role, including the impact of any insurance rate increases?
The list of questions also includes an extended bibliography of academic papers on related topics, which may also be of interest to readers of this blog.

The D & O Diary sincerely hopes that if the SEC is going to examine this question about the role of insurance that the SEC will consult persons who are actually involved in the D & O insurance industry. All too often, commentators prefer to theorize based on economic models (or even worse, nothing more than their own assumptions) about how D & O insurance functions, without actually talking to anybody who is directly involved with the operation of D & O insurance within the U.S. litigation system. I know a few people in the D & O industry who would have quite a lot to say about the professors' proposed D & O insurance question.

Hat tip to the 10b5-Daily (here) for the links to the professors’ letter and list of questions.

Did the Expert Say Why the Airport Police Don’t Plan on Doing Things Correctly?: The front page of the September 26, 2007 Cleveland Plain Dealer carried the following headline: “Airport Police Plan a Mistake, Expert Says.”

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