Sunday, December 09, 2007

Subprime Litigation Wave Hits Another Financial Guarantor

To see this page on The D & O Diary's new website, refer here. To go to the home page of The D & O Diary's new website, refer here.

In an earlier post (here), I noted how the subprime related securities litigation wave has reached the bond insurance sector. The forces creating turmoil for the bond insurers have now reached another company in the credit enhancement business, leading to a further subprime-related litigation.

According to its December 7, 2007 press release (here), the Coughlin Stoia firm filed a securities lawsuit against Security Capital Assurance, a Bermuda-based provider of financial guaranty insurance, reinsurance and other credit enhancement products. A copy of the complaint can be found here. According to the press release, the complaint alleges that in connection with the company’s June 6, 2007 secondary offering, the company’s Prospectus failed to disclose that:
(i) the Company was materially exposed to extremely risky structured financial credit derivatives; and (ii) the Company was materially exposed to residential
mortgage-backed securities relating to sub-prime real estate mortgages.
The lawsuit follows the company’s October 16,2007 announcement (here) that its third-quarter results would be affected by an unrealized mark-to-market loss of $145 million with respect to its credit derivatives portfolio. The lawsuit also follows Fitch’s November 13, 2007 downgrade (here) of two transactions insured by the company and representing $792 million in net par insured. On the date the complaint was filed, the company’s share price was 80% lower than the share price in the secondary offering.

With the addition of the Security Capital Assurance lawsuit, the tally of the subprime-related lawsuits that I am maintaining here now stands at 24, not counting the four residential home construction companies that have been sued in subprime-related lawsuits and the two rating agencies that have been sued in subprime lawsuits. These three categories together represent a total of 30 subprime-related securities lawsuits.

The Thought Bubble Over Gregory Reyes’s Head Says "Whatever Happened to ‘No Harm, No Foul’?": On August 7, 2007, Gregory Reyes, Brocade Communications' former CEO was convicted of ten felonies in connection with the company’s stock options practices. The court is now faced with determining Reyes’s sentencing under the federal Sentencing Guidelines. Under the Guidelines, the most significant factor in determining the sentence for the crimes of which Reyes is convicted is the extent of the pecuniary loss attributed to his conduct.

In a November 27, 2007 order (here), Judge Charles Breyer found that the government had failed to "quantify any amount of loss that can be attributed to Reyes’ conduct." As a result, Judge Breyer calculated Reyes’s recommended sentence to be in the range of 15-21 months, far below the government’s recommended range of 292-365 months.

As discussed at greater length in the Legal Pad blog (here), the court rejected the government’s arguments that the loss could be calculated based on a single-day drop in the company’s market capitalization; based on the amount of the fines and penalties the company paid; based on the shareholders’ "rescissory loss" (because the fluctuating share price was affected by so many factors); or based on Reyes’s own personal gains – because, Judge Breyer concluded, there weren’t any gains that could be proven with clear and convincing evidence.

The date of Reyes’s sentencing is not yet scheduled.

More About the UnitedHealth Derivative Settlement: The record-setting settlement in the UnitedHealth options backdating derivative lawsuit (about which refer here) has continued to provoke commentary.

The Lex column in the December 8, 2007 Financial Times (here), commenting on the fact that William McGuire’s settlement contribution represented the first exercise of the statutory clawback provisions under the Sarbanes Oxley Act, observed that:

By in effect activating Sarbox’s clawback provision, the settlements may spur other shareholder committees to extend their talons in search of reimbursement for backdated options. Companies have long whinged about the onerous requirements imposed on them after the Enron and WorldCom accounting scandals. But here, at least, is an instance where Sarbox seems to have done exactly what it is meant to in protecting shareholders. For once, executives will find it tough to complain and expect any sympathy.
Gretchen Morgenson, writing in the December 9, 2007 New York Times (here), commented that the UnitedHealth settlement demonstrates the importance of special litigation committees. But, she commented, "that the outcome of the UnitedHealth case is so remarkable is a distressing indication of how far shareholders still have to go to hold executives and directors accountable."

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