Update on Subprime Class Actions and Derivative Suits Trends

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The crisis in the subprime (or mortgage-backed securities) market has spawned several types of class actions and derivative suits of which corporations should be aware.   

First, shareholders have initiated lawsuits against companies with significant investments in the subprime market.  E.g., Owens v. Novastar Fin., No. 07-0166-cv-W-FJC (W.D. Mo. Mar. 1, 2007).  These types of suits typically allege securities class actions against the corporations, and certain officers and directors, for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 (the 1934 Act”) and Rule 10b-5.

Another shareholder securities class action was filed against Moody’s Corporation when its own stock price declined from trading above $70 per share in July 2007 to below $45 per share in August 2007.  Teamsters Local 282 Pension Trust Fund v. Moody’s Corp., No. 07 Civ. 8375 (S.D.N.Y. Sept. 26, 2007).  As part of plaintiffs’ shareholder claims made under Sections 10(b) and 20(a) of the 1934 Act and Rule 10b-5, this lawsuit alleges, in part, that the “Company assigned excessively high ratings to bonds backed by risky subprime mortgages – including bonds packaged as collateralized dept obligations.”  The Complaint further alleges that Moody’s own role in the rating and packaging of subprime loan securities caused its stock to plummet.

Second, a derivative suit was filed against certain officers and directors of Merrill Lynch related to the $8 billion write-down on the value of its Collateralized Debt Offerings (“CDOs”) that were secured by subprime mortgages.  Arthur v. O’Neal, et al., Case No. 07-CV-9696 (S.D.N.Y.  November 1, 2007).  The plaintiff alleges, in part, breach of fiduciary duties of care, loyalty and good faith, and further alleges gross mismanagement and the issuance of false and misleading financial statements.             

Third, an ERISA class action complaint was initiated against Fremont General Corporation (“Fremont”), the Plan Committee, and certain individual members of the Plan Committee and members of the company’s Board of Directors, in connection with two pension plans sponsored by Fremont.  McCoy v. Plan Committee, No. CV07-02693 FMC (FFMx) (C.D. Cal. Apr. 24, 2007).  Fremont is a financial services holding company engaged, in part, in brokered subprime mortgage lending through its wholly-owned subsidiary, Freemont Investment & Loan (“FIL”).  The Complaint generally alleges, in part, that FIL’s stock declined fifty percent in early 2007 when many borrowers began defaulting on subprime loans; this declination resulted in losses to the pension plans that had substantial stock investment in FIL.

Local municipalities are also evaluating claims.  Recently, the city of Springfield, Massachusetts was paid $13.9 million by Merrill Lynch & Co., to reimburse Springfield for the cost of CDOs, which are securities that are tied to home loans and other debts that declined dramatically in value in connection with the subprime losses.  According to an article published on Bloomberg.com, Merrill Lynch stated publicly that it made purchases of the CDOs on Springfield’s behalf without “express permission of the city.”  Other cities, such as Minneapolis, are evaluating lawsuits against lenders for predatory lending practices. 

Additionally, the FBI announced late last month that it was investigating 14 companies for possible accounting fraud, insider trading or other violations in connection with home loans made to risky borrowers.  And the Justice Department’s U.S. Attorney’s office in Manhattan recently notified the SEC that it wants to see information that the SEC is gathering in connection with an investigation of Merrill Lynch & Co., related in part to whether the firm inflated prices of mortgage bonds.             

More lawsuits, some possibly alleging novel legal theories, continue to be expected.  For more information, visit the CADS homepage, www.abanet.org/litigation/committees/classactions.