Vulture investors feed on subprime carrion: The lawyers
And don’t forget the lawyers: Suits alleging bad, bad things hit lenders, packagers, raters
August 6, 2007
Here come the lawyers. With the casulties mounting from turmoil in the subprime lending sector and mortgage-backed securities markets, plaintiffs’ lawyers and defense counsel are gearing up for the inevitable lawsuits. They’ll have plenty of clients to choose from.
“The business cycle is one of boom, bust and recrimination; we’re now observing the bust and moving toward the recrimination stage,” said Donald Lampe, a partner with law firm Womble Carlyle Sandridge & Rice in Charlotte, N.C. “We expect that people who lose money will look for other people to take responsibility.”
Virtually every party involved in the huge Wall Street securitization machine that financed the late, great housing boom is a potential target—the lenders who originated the loans, the brokers who bought them, the underwriters who pooled them and carved them up into securities, the rating agencies that rated the securities, and the bond insurance companies that guaranteed them.
“The law firms are assembling their subprime litigation teams in anticipation,” said Allan Krinsman, a partner at New York law firm Stroock & Stroock & Lavan.
On the borrower front, claims—some of them already approved as class actions—have been filed against what litigants like to call “predatory” lenders for a variety of dodgy practices, such as inflating property appraisals, hiding closing costs or using bait and switch tactics in which companies promise a low teaser rate and ultimately offer another.
A consolidated class action suit pending against Ameriquest Mortgage Co. in U.S. District Court in Chicago is a prime example of subprime litigation, with some of the original claims dating back three years. And with state attorneys general like Marc Dann of Ohio now focused on foreclosures, claims seem sure to mount. In June, Mr. Dann filed 10 complaints against lenders and mortgage brokers operating in his state, blaming them for “driving Ohio’s shameful home foreclosure rate.” He’s also reportedly sniffing around credit raters Fitch, Moody’s and Standard & Poor’s, who put their imprimatur on subprime securitizations and then belatedly downgraded them in recent months.
The investment banks—including Bear Stearns, Lehman Brothers, Merrill Lynch and Morgan Stanley—are also going after the loan originators, filing claims against the likes of now-bankrupt mortgage originator New Century Financial and teetering Accredited Home Lenders to force them to buy back some of the worst loans that fed the bankers’ securitization departments.
Claims against the lenders, however, are small stuff, since many of them are now either bankrupt or close to it. The deep pockets are on Wall Street, of course.
Already, a 73-year-old investor in Wisconsin claims to have lost $500,000 in the subprime-soaked Bear Stearns High Grade Structured Credit Fund and has filed an arbitration claim with the National Association of Securities Dealers against the investment bank. The fund has lost almost all of its value, the company recently told clients. In the claim, the investor alleges that Bear Stearns “deceived” him into investing in the fund, “which was far riskier and more speculative than represented,” and that he was also “misled into holding on to his investment.” (Bear Stearns declined to comment.)
Meanwhile, a Moody’s shareholder filed a suit earlier this month alleging that Moody’s CFO Linda Huber had misled investors about ratings of subprime debt, reports Financial Week sister publication Crain’s New York Business. Lawyers for the holders of billions of dollars worth of those securities told the newspaper they are preparing to do the same. (Moody’s did not return calls for comment.)
The cases won’t be slam dunks. Unlike complaints against the lenders, which involve illegal business practices or breach of contract, these claims will allege securities fraud—a difficult allegation to prove, especially as courts have set higher standards to weed out frivolous securities lawsuits.
“Plaintiffs will have to prove the banks had knowledge of the improper conduct and continued to lend to the originator,” said Keith Miller, a lawyer with the Paul Hastings firm in New York. “Those are difficult facts to come by.” If there is evidence that the banks knew of the lousy lending practices and the deteriorating quality of the loans made and didn’t make proper disclosures in the securities prospectuses, they could be vulnerable.
A case being closely followed by the legal community is a claim filed in the middle district court of Florida in April by Bankers Life Insurance against Credit Suisse and a number of other defendants, including Bank of New York, which served as a trustee for bondholders, and companies that insured the bonds and serviced the underlying loans. Bankers Life purchased several investment-grade pieces of a mortgage-backed securitization originally packaged by Credit Suisse in 2001. During the ensuing years, delinquencies and defaults on the loans increased and the securities suffered through multiple credit downgrades. Bankers Life ultimately lost most of its $1.4 million investment.
The complaint, originally filed on April 23 and currently in the process of being amended, alleges that the investment bank misrepresented the quality of the underlying loans and even took actions to disguise the increasing delinquencies in the pool. “This involves a combination of fraudulent collateral and illusory credit enhancements,” said Dale Ledbetter, lead attorney for Bankers Life. “The investors were forced to take the losses.”
Credit Suisse, Bank of New York and other named players in the suit deny wrongdoing. If the suit isn’t dismissed and Mr. Ledbetter is granted discovery privileges to make his case, the seamy side of Wall Street’s contribution to the subprime crisis could be bared for all. A single e-mail could launch 1,000 suits.
Fed chairman Ben Bernanke has suggested that investor losses could be between $50 billion and $100 billion. Given the ongoing rout in the credit markets, that could be a conservative estimate. With the subprime crisis fast approaching the proportions seen in the savings and loan industry collapse of the late 1980s, the legal sharks are circling.
“We’ve seen a couple of complaints in each area, but it seems there’s a calm before the storm as people are considering their potential targets,” said Jeff Nielsen, a managing director at Navigant Consulting. “We haven’t seen the floodgates open yet.” FW
Vulture investors feed on subprime carrion: The lawyers - Financial Week