Sunday, January 27, 2008

Subprime Tsunami Time

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Since I first began chronicling the subprime litigation wave in April 2007 (here), the wave has gained amplitude and speed. But a spate of recent subprime-related litigation developments, seemingly unrelated, suggest that the litigation wave's magnitude has crossed a significant threshold. Things seemingly have changed, decidedly for the worse.

The first development that makes me think things have worsened is the lawsuit that has been filed against Levitt Corp., which is described in the plaintiffs’ counsel’s January 25, 2008 press release (here). Although there are several noteworthy things about this lawsuit (as discussed further below), the significance to me of this lawsuit for the larger issue of the subprime litigation generally is the lawsuit’s purported class period, which extends from January 31, 2007 to August 14, 2007. That is, the allegations in the complaint related to events that took place several months ago.

Most of the prior subprime-related lawsuits up until now have been filed in the immediate flash of dramatic subprime-related disclosures, on some occasions even on the same day. The arrival of a lawsuit based on more remote events suggests that plaintiffs’ lawyers have now begun a grim process of backing and filling, completing a more comprehensive sweep of the subprime landscape.

The impression that we have entered a backing and filling phase that will entail an expansion in the scope of subprime litigation is reinforced by recent developments in the subprime-related securities lawsuit pending against Countrywide Financial Corporation. According to a January 25, 2008 press release (here), issued by New York Comptroller Thomas DiNapoli, who is one of the co-lead plaintiffs in the Countrywide securities lawsuit, the plaintiffs in that case have filed an amended complaint that, among other things, adds as defendants "26 different financial services companies that underwrote Countrywide stock and bond offerings, [and] two global accounting firms."

The 26 financial services companies are listed in the press release. The two accounting firms named are Grant Thornton LLP and KPMG LLP. According to the press release, by expanding the suit, the plaintiffs "seek to ensure that the underwriters and accounting firms who participated in the marketing of Countrywide securities to the public are held accountable for their actions." A copy of the Countrwide complaint can be found here. Special thanks to Adam Savett of the Securities Litigation Watch blog for supplying a copy of the complaint.

A third development suggesting that the stretch and sweep of the subprime litigation wave has amplified is the subprime-related securities lawsuit I previously noted (here) and that was filed last week against National City Corporation, a regional bank holding company based in Cleveland. Unlike many other subprime-related lawsuits, which have largely (although not, of course, exclusively) involved financial firms in New York, Florida and California that have experienced gargantuan writedowns or losses, the National City lawsuit involves a company in the hinterlands that experienced substantial but not nearly as massive writedowns and losses.

These disparate events are at one level unrelated. But the pattern I detect is the suggestion that plaintiffs are expanding the field of the companies and defendants they are targeting. Companies like Levitt, that seemingly were bypassed in the earliest stages. Defendants like the financial services companies and accountants in the Countrywide case, whom the plaintiffs’ lawyers just didn’t get to in the initial pleadings. And secondary targets like National City.

All of this suggests to me that the subprime litigation wave has entered a more encompassing and potentially more devastating phase. Up until now, plaintiffs have concentrated on what one plaintiffs’ attorney recently called the "low hanging fruit." But these most recent lawsuits suggest that the threat now extends more broadly. The impression is that the subprime wave will hit not just the biggest obstacles but could inundate a much broader area of the landscape. The destructive force of the wave could prove to be even more catastrophic than seemed likely, even a short time ago.

One final observation about the changing menace of the subprime wave actually relates to a consequence from subprime litigation. That is, this past week saw the first subprime-related downgrade of a mainstream property and casualty insurer (about which refer here), in part because of the carrier’s exposure to mortgage default risk though a former bond insurer affiliate, and in part because, as one rating agency noted, of the insurer’s "subprime exposure through its D&O and E&O liability portfolio on both a primary and reinsurance basis."

The rating agency went on to note that this D & O and E & O exposure "gives rise to concerns that there may be a potential resurgence in claims for these lines as they relate to subprime issues in the future." More ominously, the rating agency noted that "adverse developments" in these insurance lines beyond the rating agency’s expectations "will result in further rating actions." Clearly I am not the only one concerned that things have gotten bad, and could get worse.

As I noted above, there are other interesting things about the Levitt Corp. lawsuit. The first is that the lawsuit combines not just one, but two of the recent securities litigation trends. That is, it is not only a subprime-related securities lawsuit, but it is also a securities lawsuit arising out of a failed merger. I have previously noted, most recently here, there has been a recent surge of lawsuits arising from failed deals.

According to the plaintiffs’ lawyers’ press release (here), the Levitt Corp. lawsuit relates to the failed 2007 merger of the company with BFC Financial Corp. Levitt had announced the planned merger to great fanfare on January 31, 2007 (here), but on August 15, 2007, the company announced (here) that the merger agreement had been terminated (according to the plaintiff’s lawyers’ lawsuit press release, "without giving any explanation.").

The plaintiff’s lawyers’ press release goes on to state that the complaint alleges that

during the Class Period, defendants issued materially false and misleading statements and failed to disclose: (i) that the Company’s Levitt and Sons subsidiary was in much worse financial condition than publicly represented. Levitt and Sons was saddled with excessive amounts of unneeded and overpriced land which would not be feasible to develop for some time. Furthermore, Levitt and Sons was struggling to complete projects it had already begun and in many instances was failing to complete construction of homes that it had already sold as it lacked the financial resources to follow through on its contracts; (ii) that as a result of the foregoing, the Company was materially overstating its financial results because it was failing to timely record an impairment in the value of its homebuilding inventory at Levitt and Sons. Although Defendants acknowledged the difficult housing market, their public statements failed to advise investors of the true financial condition of the Company; (iii) that the company’s loans and advances to Levitt and Sons would not be recovered as the subsidiary lacked the financial resources to pay now and in the foreseeable future; and (iv) that Levitt and Sons was insolvent.
A copy of the Levitt lawsuit complaint can be found here.

The joinder of the additional defendants in the Countrywide securities lawsuit illustrates one of the reasons why commentators have struggled to quantify what the subprime litigation wave ultimately will mean for liability insurers. That is, the subprime litigation wave represents a significant threat to both D & O and E & O insurers, sometimes (as illustrated in the amended Countrywide complaint) in the same case. The subprime litigation exposure encompasses a wide variety of professionals and entities, not just issuing companies and their directors and officers. For that reason, many of the estimates of the insurers’ exposure have blended together the D & O and E & O exposures. But the sheer spread of the potential exposure underscores how difficult it is now to try to estimate the insurers’ ultimate aggregate exposure (or even one insurer’s exposure) – the scope of the exposure (which seemingly is expanding exponentially) makes estimation particularly difficult, which would explain the dramatic variance in the various estimates.

The Countrywide plaintiffs’ attempt to join the third party defendants looks interesting in light of the Supreme Court’s recent decision in the Stoneridge case. The Countrywide plaintiffs apparently will be arguing that their claims against the third parties, unlike the investors’ claims in Stoneridge, are not based on a theory of secondary liability , but rather are based on alleged primary violations of the Securities laws, under the ’33 Act.

In any event, the addition of the Levitt Corp. case brings the total number of subprime-related securities lawsuits to 41, as reflected in my running tally of subprime-related securities lawsuits, which can be found here. The Levitt Corp. lawsuit also brings the number of subprime-related securities lawsuits against residential home building and development companies to six. The lawsuit also brings the number of subprime related securities lawsuits so far in 2008 to four.

And In This Week’s Headlines: At a minimum, a headline should identify an article’s basic subject. A good headline will encourage the reader to actually read the article. A great headline does both of these things and is at the same time clever, funny or interesting. By these standards, the January 25, 2008 issue of the Wall Street Journal scored two great headlines.

The first headline, "The Hoarse Race" (here) led an article about the presidential candidates' campaign-trail struggles with voice fatigue. The second headline, "The Wait of the World’s on Dan Brown" (here), describes the beleaguered publishing industry’s impatient anticipation of DaVinci Code author Dan Brown’s next book.

All I can say is: "Journal’s Headline Designs Not Just Fine, But Divine." Or something even cleverer than that, if only I had the crackerjack cunning of the Journal’s editors.

Now This: Am I the only one who thinks the whole Davos "World Economic Forum" is a colossal bore?

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