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Publications
Credit Crunch Digest
July 2009
The subprime lending crisis and ensuing credit crunch have resulted in significant losses and numerous lawsuits involving parties to the mortgage lending and securitization process. This digest collects and summarizes recent media reports and announcements regarding potential liability, government initiatives, litigation and regulatory actions arising from the subprime mortgage crisis and credit crunch, as well as the increasing number of reported cases of financial fraud.
This issue focuses on the evolving civil litigation and regulatory and criminal actions relating to subprime and other high-risk mortgages and to the collapse of the auction rate securities market, developments in the Madoff, Stanford and other Ponzi schemes and related litigation, and the government’s response to the subprime crisis and credit crunch.
Litigation and Regulatory Investigations
Ponzi Schemes
Auction Rate Securities
Government and Regulatory Intervention
Litigation and Regulatory Investigations
Investors Sue MGIC for $500 Million
An amended complaint filed on June 22, 2009 in a purported securities action in Wisconsin federal court alleges that MGIC Investment Corp. and several of its principals misled the public about the company’s health just prior to the mortgage-related meltdown and caused investors to lose more than a half-billion dollars. MGIC and its officers allegedly misrepresented or omitted information regarding the company’s escalating losses tied to mispriced insurance on a deteriorating portfolio of mortgage loans. The plaintiff also asserts that MGIC made false statements about the ability of its affiliate, Credit-Based Asset Servicing and Securitization LLC, to withstand the subprime mortgage crisis. According the lawsuit, the defendants were motivated to mask MGIC’s problems in order to obtain a good price for the sale of a large portion of the company’s stock as part of a merger. (“MGIC Hit With $500M Securities Class Action,” Securities Law 360, June 23, 2009)
State Street May Face SEC Action Over Bond Investments Backed By Subprime Mortgages
Boston-based State Street Corporation has announced that the U.S. Securities and Exchange Commission (SEC) may file litigation against the company arising out of certain bond funds that investors allege lost money as a result of bets on risky mortgage-backed securities. State Street reported that it has received a Wells notice stemming from an SEC investigation into disclosures and management of fixed-income investments through 2007. State Street already faces numerous lawsuits by investors who allege that its funds took too much risk by investing in securities tied to home mortgages. The company set aside $618 million in the fourth quarter of 2007 to settle legal claims stemming from losses linked to subprime mortgages. The top securities regulator in Massachusetts is also investigating State Street for misleading pension funds over the risk level of their investments. (“State Street Says SEC May Sue Over Bond Investments,” Bloomberg, June 29, 2009)
Ponzi Schemes
Madoff Sentenced to 150 Years in Prison
On June 29, 2009, a federal judge sentenced 71-year-old Bernard Madoff to 150 years in prison, the statutory maximum sentence, and called his crimes “extraordinarily evil.” The sentencing followed a 90-minute hearing in which several victims of Madoff’s $65 billion Ponzi scheme spoke out in front of a packed courtroom and asked the judge to show no mercy. In the days before his sentencing, Madoff’s lawyers asked for a sentence of just 12 years, citing Madoff’s life expectancy of about 13 more years. The judge rejected this request and gave Madoff one of the stiffest sentences handed out to a white-collar criminal defendant in New York federal court in recent years. (“Madoff Sentenced to 150 Years,” Wall Street Journal, June 29, 2009); (“Madoff Is Sentenced to 150 Years for Ponzi Scheme,” New York Times, June 29, 2009)
Madoff’s Sons Sued by Former Employees
On June 16, 2009, two former employees of Bernard L. Madoff Securities LLC filed lawsuits in New York state court against Madoff’s sons seeking hundreds of thousands in pay and deferred compensation. The plaintiffs allege that Mark and Andrew Madoff knew their father’s business was a massive Ponzi scheme but made fraudulent statements defending the legitimacy of the company to keep employees from leaving. (“Madoff Sons Sued for Pay by Workers at Father’s Former Firm,” Bloomberg, June 17, 2009)
SEC, Bankruptcy Trustee Accuse Brokerage, Four Individuals of Assisting Madoff; New Details About Ponzi Scheme Revealed
Three lawsuits filed on June 22, 2009 by the SEC and the bankruptcy trustee for Bernard Madoff’s firm accuse an early investor in the Madoff funds and a small brokerage firm and several of its executives of helping Bernard Madoff sustain his long-running Ponzi scheme. According to the SEC and the trustee, each of the defendants had reason to believe Madoff’s scheme was fraudulent but continued to participate because of strong financial incentives. The SEC filed civil fraud cases against Stanley Chais, a prominent California money manager and one of Madoff’s earliest investors, and three senior executives at Cohmad Securities Corporation, a small brokerage firm cofounded by Madoff. The trustee filed the third lawsuit against Cohmad in federal bankruptcy court.
The new lawsuits expand on what regulators previously disclosed about the scheme. The SEC action against Chais alleges that he demanded that none of his accounts with Madoff should ever report losing a trade – a request that regulators say, once complied with, should have tipped Chais off about the scheme. Both lawsuits against Cohmad assert that, while its executives were being paid fees for the customers it delivered to Madoff, the fees reflected the actual cash status of customer accounts, rather than the fictional profits shown in the statements provided to those customers. (“Madoff Suits Add Details About Fraud,” New York Times, June 22, 2009)
SEC Promises to Release Details on Madoff Investigation
The SEC plans to issue at least three comprehensive reports detailing the inspector general’s investigation into Bernard Madoff’s $65 billion Ponzi scheme by the end of September 2009. SEC Inspector General David Kotz reportedly has interviewed more than 100 witnesses and reviewed millions of emails and documents in connection with the investigation. The SEC intends to issue by August 31, 2009 a comprehensive report detailing all of the examinations and investigations into Madoff since 1992. In addition, the Inspector General’s Office will issue two more reports by September 30, 2009 providing specific, detailed recommendations for improving the SEC’s Division of Enforcement and Office of Compliance Inspections and Examinations. The Inspector General’s Office reportedly has been working with a consulting firm with expertise in the examination of broker-dealers to help determine whether SEC examiners missed red flags that should have alerted them to the Madoff Ponzi scheme. (“SEC Will Release Three Reports on Madoff Fraud by September,” Investment News, June 15, 2009)
Stanford Pleads Not Guilty to $7 Billion Ponzi Scheme; Court Revokes Bail
On June 25, 2009, Texas billionaire R. Allen Stanford pleaded not guilty to accusations that he swindled investors in a $7 billion Ponzi scheme. Stanford and four others, including Antigua’s top banking regulator Leroy King, were indicted on June 19, 2009 and accused of operating, or helping to operate, the multibillion-dollar fraud. King was arrested in Antigua and prosecutors have begun extradition proceedings to bring him to the United States. The U.S. Department of Justice has stated that, while Stanford was defrauding 30,000 investors out of $7 billion, he was paying King thousands of dollars a month to conduct fake audits aimed at assuring investors and American regulators that the bank’s finances were sound. King also is accused of showing Stanford the inquiries by the SEC as they came in so that Stanford could dictate the content of the responses.
On June 30, 2009, a federal judge revoked Stanford’s bond, sending him back to jail to await trial. Just one week earlier, a federal magistrate judge had set bail at $500,000, but prosecutors immediately challenged the decision by arguing that Stanford had the motivation and the ability to flee. Prosecutors noted that Stanford had extensive international contacts, held Antiguan citizenship, and had been willing to bribe foreign officials.
The indictments and arrests came four months after the SEC filed complaints against Stanford and other senior executives at Stanford International Bank in Houston in February 2009. If convicted on all charges of conspiracy, fraud, obstruction and money laundering, Stanford faces up to 250 years in prison. (“Stanford Pleads Not Guilty, May Be Released on Bail,” Bloomberg, June 26, 2009); (“Bail Revoked for Financier Accused of Fraud,” New York Times, June 30, 2009)
Libya Reportedly Invested $500 Million with Stanford; Stanford Asks Judge to Reconsider Detention Order
On July 7, 2009, court documents filed in Texas federal court reported that the Libyan government invested $500 million with Stanford Financial Group. The filings show that R. Allen Stanford and his girlfriend flew to Tripoli on January 25, 2009 because Libyan officials were considering increasing the amount they invested. It was not clear whether the investment was recouped before the U.S. government shuttered Stanford’s network of financial firms.
Stanford’s attorney has filed a 48-page motion asking the federal judge to reconsider the June 30, 2009 detention order that revoked Stanford’s bail and left him behind bars awaiting trial. Stanford also reportedly plans to appeal the detention order. (“Libya Invested $500 Million with Allen Stanford,” Reuters, July 7, 2009)
U.K. Freezes $100 Million Linked to Stanford
On June 30, 2009, Britain’s Serious Fraud Office (SFO) revealed that it froze $100 million worth of assets linked to R. Allen Stanford within five hours of receiving the request from the U.S. Department of Justice on April 7, 2009. The agency could not reveal its actions until after Stanford’s indictment and arrest. According to the SFO, the funds are being held at several London financial institutions. Britain’s Crown Protection Service and London police also reportedly assisted U.S. authorities with their inquiries. (“Britain Froze $100M Linked to Allen Stanford,” Guardian (U.K.), June 30, 2009)
Former Stanford Financial CFO to Plead Guilty
On July 1, 2009, an attorney for James Davis, who was the chief financial officer for Stanford Financial Group, announced that his client reached an agreement with federal prosecutors and will plead guilty to fraud and conspiracy as early as July 13, 2009. Davis was involved in critical decision-making at the Stanford Financial Group and was knowledgeable about the intricacies of Stanford’s international empire. He also oversaw billions worth of certificates of deposit at the Stanford International Bank based in Antigua, which are at the center of the U.S. government’s fraud case. As part of the plea deal, Davis reportedly will help federal investigators locate the proceeds Stanford sent overseas. (“Stanford Executive to Plead Guilty, Lawyer Says,” New York Times, July 1, 2009)
Stanford’s Customers Sue Insurance Brokers
Latin American customers of Stanford Financial Group have filed a purported class action lawsuit against U.K. insurance broker Willis Group Holdings Ltd., alleging that it is partly responsible for their losses in connection with Stanford’s Ponzi scheme. According to the lawsuit, Willis sent letters attesting to the validity of Stanford Financial investments, which were used to market the firm to more than 30,000 clients around the world. The lawsuit also names smaller insurance broker Bowen, Miclette & Britt Inc. (“Customers of Stanford Financial Sue Insurance Brokers,” Wall Street Journal, July 3, 2009)
SEC Accuses Texas Company of $485 Million Ponzi Scheme, Freezes Assets
On July 7, 2009, the SEC announced that it had obtained an emergency asset freeze against Dallas-based energy investment firm Provident Royalties LLC and three of its founding members amid allegations the company ran a $485 million Ponzi scheme. The SEC filed a lawsuit in Texas federal court accusing Provident of making fraudulent securities offerings involving oil and gas assets between June 2006 and January 2009 to nearly 8,000 investors. The complaint alleges that Provident falsely promised yearly returns of up to 18 percent and misrepresented that 85 percent of the funds raised in offerings would be used to purchase oil and gas real estate. (“Authorities Say Texas Company Ran Ponzi Scheme,” Wall Street Journal, July 8, 2009)
Judge Retains Freeze on Accused Ponzi Schemer’s Assets; Pang Asks Judge to Dismiss Suit
On July 2, 2009, a federal judge ordered the appointment of a permanent receiver over Danny Pang’s companies and ruled that there was sufficient evidence of fraud to justify a continued freeze on Pang’s assets. Pang’s firm, Private Equity Management Group Inc. (PEM Group), was seized by the SEC in April 2009, and regulators have charged him with a massive international fraud involving hundreds of millions. The court found that there is sufficient evidence that Pang presented investors with falsified documents, misrepresented the source of interest payments made to investors, and misappropriated millions in investor funds for Pang’s personal use. On July 6, 2009, Pang filed a motion to dismiss the case, alleging that the SEC had failed to plead fraud with sufficient particularity. (“Judge in Pang Case Rules in Favor of SEC,” Wall Street Journal, July 3, 2009)
South African Law Enforcement Agencies Partner to Investigate $1 Billion Ponzi Scheme
South Africa’s top financial and law enforcement agencies are joining forces to investigate the more than $1 billion pyramid scheme allegedly operated by Barry Tannenbaum. The joint investigation by the South Africa Reserve Bank, the South African Revenue Service, the Asset Forfeiture Unit, the Financial Intelligence Center and the police department’s Serious Economic Affairs Unit is unprecedented. It marks the first time that these South African authorities have acted together. The investigating team plans to freeze accounts, attach goods and obtain preservation orders to ensure assets are protected. Tannenbaum is accused of persuading investors to put their money into a pharmaceutical ingredient import business by faking purchase orders from Africa’s biggest generic drug maker, Aspen, and offering them returns of up to 200 percent. The investigation into Tannenbaum began when investors demanded to be repaid and new funds could not be found. (“Agencies Join Forces for Ponzi Probe,” The Times (South Africa), June 13, 2009)
Auction Rate Securities
New York State Settles with Merrill, Credit Suisse
On July 7, 2009, New York’s attorney general announced final settlements with Credit Suisse Securities LLC and Merrill Lynch & Co. following an investigation into the sale of auction rate securities in the months leading up to the market collapse. Credit Suisse and Merrill reportedly marketed the securities as being as safe as cash, but investors were stuck with illiquid assets when the auction rate securities market froze in February 2008. The firms are the last of 11 securities firms that have agreed to buy back more than $61 billion in auction rate securities. (“New York State Settles with Merrill, Credit Suisse,” Reuters, July 7, 2009)
Government and Regulatory Intervention
Largest Number of U.S. Bank Failures in a Single Day Since Early 1990s June 26, 2009 marked the highest number of U.S. bank closures in a single day since 1992, bringing the total number of failed banks to 45 this year, compared to 25 in all of 2008. On that day, the Federal Deposit Insurance Corporation (FDIC) assumed control of five community banks in California, Georgia and Missouri. The bank failures continue to be concentrated in the community banking sector. Of the 45 bank failures so far this year, 39 have involved institutions with assets of less than $1 billion. According to reports from the FDIC, it is likely that the number of bank failures will continue to grow in the coming months. In the agency’s most recent quarterly banking profile from March 31, 2009, it counted 305 institutions with assets of $220 billion on its problem list. That statistic is up from 252 institutions with $118 billion in assets at the end of the third quarter of 2008 and 117 institutions with $78.3 billion in assets at the end of the second quarter of 2008. (“Bank Failures Surge, D&O Claims Emerge,” D&O Diary, June 29, 2009)
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