|
|
Publications
Credit Crunch Digest
December 2009
In the December 2009 Edition:
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 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 recent significant decisions in civil litigation regarding subprime and other high-risk mortgages and related securities, the growing number of reported Ponzi schemes around the world, the status of civil, criminal and regulatory actions relating to the Madoff, Petters and Dreier Ponzi schemes, and continuing government efforts to ease the economic impact of the subprime crisis and credit crunch.
Litigation and Regulatory Investigations
Lawsuits Filed Against Major Ratings Agencies Ponzi Schemes
Government and Regulatory Intervention
Litigation and Regulatory Investigations
IndyMac Bancorp Trustee Sues IndyMac Executives
On November 13, 2009, Alfred H. Siegel, the trustee of IndyMac Bancorp, filed a lawsuit in U.S. Bankruptcy Court in Los Angeles against the bank's former chief executive officer and chair of the board Michael Perry and eight other directors of the board, seeking punitive damages and $355 million in actual damages as a result of the board's alleged reckless management of the bank's funds and the improper transfer of money from the bank's holding company, IndyMac Bancorp, to IndyMac Bank. Siegel alleges that Perry failed to properly supervise management and ignored red flags regarding the bank's financial problems. In addition, Siegel alleges that Perry and the board improperly backdated capital infusions in order to misrepresent to regulators that the bank was well capitalized and delay the bank's failure, and missed critical opportunities to prevent the bank's ultimate failure. ("IndyMac Execs Slapped with Lawsuit," Pasadena Star News, November 18, 2009)
Lawsuits Filed Against Major Ratings Agencies
On November 20, 2009, the Ohio attorney general (AG), on behalf of the Ohio Police and Fire Pension Fund and others, sued Moody's Investors Service, Standard & Poor's (S&P) and Fitch alleging that state retirement and pension funds lost approximately $457 million as a result of the rating agencies' approval of various high-risk securities. In exchange for substantial fees, the ratings agencies allegedly aided and abetted misconduct by issuers and assisted in creating financial instruments that ultimately led to the collapse of the U.S. housing market. In response to the lawsuit, McGraw-Hill, which is the owner of S&P, stated that the SEC's examination of the various ratings agencies did not reveal faulty rating methodologies or models employed by the ratings agencies.
In addition to the Ohio AG action, on November 25, 2009, the Connecticut AG announced his intention to sue major credit ratings agencies in connection with their practice of systematically and intentionally giving lower ratings to states, municipalities and other public entities than corporate forms of debt with similar or worse default rates.
Since the credit crisis began in 2008, several lawsuits have been filed by investors against credit ratings agencies seeking to recover billions of dollars from now worthless mortgage-backed securities. To date, ratings agencies have successfully defended similar actions by asserting that their ratings are protected by the First Amendment as opinions on future events. Recent cases, however, allege that the ratings agencies were aware that securities they rated favorably were not safe. Plaintiffs argue that if, in exchange for fees, the agencies knowingly overstated the quality of the products they rated, then they were manipulating the market and their First Amendment protections were forfeited. ("Ohio Sues Rating Firms for Losses in Funds," The New York Times, November 21, 2009; "Ohio Files Suit Against Rating Agencies," Yahoo Finance, November 21, 2009; "Conn. May Sue Credit-Rating Firms," The Boston Globe, November 26, 2009)
SEC Charges Former New Century Executives With Fraud
On December 7, 2009, the SEC filed civil fraud charges against former executives of New Century Financial, formerly one of the country's largest subprime mortgage lenders. The SEC has brought charges against the company's co-founder and former chief executive officer Brad Morrice, former chief financial officer Patti Dodge, and former controller David Kenneally. The SEC alleges that the defendants conspired to mislead investors and conceal the true financial state of the company. Specifically, the complaint alleges that the executives failed to disclose the dramatic increase in the rate of borrowers who defaulted almost immediately on their loans, and that investors who bought mortgages from New Century were increasingly demanding that the company buy back problem loans. ("New Century Executives Charged With Fraud," CNNMoney.com, December 7, 2009; "SEC Sues Three Former Officers of Irvine Subprime Lender New Century Financial," The Los Angeles Times, December 8, 2009)
Arbitration Panel Finds in Favor of Investor Regarding Purchase of Lehman Note
A Financial Industry Regulation Authority (FINRA) arbitration panel recently awarded $200,000 in favor of an investor who alleged that her UBS AG broker inappropriately sold her an unsuitable and risky principal-protected note issued by Lehman Brothers Holdings, Inc. (LBHI). The investor brought the arbitration claim against UBS Financial Services, which is currently being investigated by various regulatory agencies in connection with its sale of LBHI notes. The investor sought compensatory damages as a result of losses sustained due to her broker's recommendation that she purchase the "speculative derivative securities." UBS maintains that the investor's loss is the result of the unexpected failure of LBHI. Although the arbitration panel did not give reasons for its findings, the decision sheds light on how other claims may be decided in the future. ("Investor Wins Lehman Note Arbitration," The Wall Street Journal, December 4, 2009)
New Lawsuits Related to the Credit Crisis Continue to Be Filed
On November 10, 2009, a new securities class action lawsuit was filed in the U.S. District Court for the Southern District of New York against former officers of VeraSun Energy Corp., a South-Dakota based ethanol producer that filed for bankruptcy on October 31, 2008. Among other claims, the plaintiff alleges that the defendants failed to disclose speculative and risky derivative transactions that exposed the company to substantial financial and liquidity risk. The lawsuit is significant in that the alleged class period and the dates of the alleged unlawful acts took place far before the filing of the class action suit, leading some observers to speculate that many plaintiffs' lawyers were backlogged with subprime related lawsuits and that litigation will continue in the months ahead as the fallout from the global financial crisis continues. ("The Brualdi Law Firm, P.C. Announces Class Action Lawsuit Against VeraSun Energy Corp.," StreetInsider.com, November 20, 2009; "Credit Crisis Securities Suits Still Coming In," The D&O Diary, November 12, 2009)
Ponzi Schemes
Ex-SEC Lawyer Pleads Guilty to Conspiring With Marc Dreier
On November 9, 2009, Robert Miller pleaded guilty to conspiracy and securities fraud charges in a cooperation deal with prosecutors in connection with the fraud perpetrated by Marc Dreier. Dreier orchestrated a Ponzi scheme by which he defrauded investors out of $670 million between 2004 and 2008 through the sale of fictitious securities. Miller was a staff attorney for the enforcement division of the SEC from 1983 through 1986 and then worked as an analyst and money manager at various firms in the securities industry. Miller and Dreier purportedly managed an investment fund together between 1999 and 2008. Miller has admitted to conspiring with Dreier regarding the sale of $44 million in fictitious securities to hedge funds in November 2008. Dreier purportedly paid Miller $100,000 to impersonate a representative of a Canadian pension plan and falsely answer questions about a fund's reasons for selling the securities and the documents underlying the transaction. Dreier is currently serving 20 years in prison after pleading guilty to federal charges. Miller could face 25 years in prison. ("Ex-SEC Lawyer Pleads Guilty in NY Marc Dreier Case," USA Today, November 9, 2009)
Civil and Criminal Complaints Filed Against South Florida Lawyer Alleging $1 Billion Ponzi Scheme
On November 12, 2009, a civil complaint was filed in federal court in Florida against Scott Rothstein, a prominent Florida attorney. Rothstein was arrested on December 1, 2009, and a criminal complaint was filed against him by the U.S. Attorney's Office in Miami. According to the civil and criminal complaints, Rothstein received nearly $1 billion from investors between 2005 and 2009 by selling stakes in legal settlements for various employment disputes that Rothstein's firm had supposedly negotiated. However, the complaints allege that the legal settlements never existed, and that Rothstein was, in fact, operating a massive Ponzi scheme. Rothstein allegedly operated the Ponzi scheme with several co-conspirators who fabricated documents regarding the fictitious legal settlements. Rothstein allegedly drafted false orders and forged the signatures of several federal judges as part of his fraudulent legal settlement investment scheme.
The criminal complaint charges Rothstein with five counts, including racketeering conspiracy involving mail fraud, wire fraud and money laundering. The criminal complaint also alleges that Rothstein paid high-ranking law enforcement officials to prevent investigations of his Ponzi scheme. On November 23, 2009, prosecutors petitioned the court seeking to seize Rothstein's assets, including numerous residences, a yacht, luxury cars and his equity interest in dozens of companies. ("Lawyer's Alleged Fraud a Case of 'Greed Run Amok,' Says Prosecutor," Law.com, December 2, 2009; "U.S. Moves to Confiscate a Fortune in Ponzi Case," The New York Times, November 24, 2009)
Madoff Computer Programmers Charged With Playing Key Role in Ponzi Scheme
Two of Bernard Madoff's former computer programmers were arrested on November 13, 2009 in connection with their alleged involvement in creating and running special computer programs used to falsify Madoff investor records by generating phony investor data. According to court filings, a special computer program known as "House 17" enabled the programmers to produce phantom trading records based on data from a legitimate Madoff business that matched stock buyers and sellers. The programmers are the third and fourth ex-Madoff employees charged in the Ponzi scheme, which has grown to more than $21 billion in losses. Criminal and civil cases have been filed by federal prosecutors and the SEC, and the programmers face a maximum prison term of 30 years, plus millions of dollars in fines if convicted on criminal charges of conspiracy, falsifying books and records of a broker-dealer and falsifying the records of an investment advisor. ("Madoff Computer Aides O'Hara, Perez Arrested," Bloomberg.com, November 13, 2009; "Two of Madoff's Computer Programmers Charged In Ponzi Coverup," USA Today, November 13, 2009)
Madoff Investor Alleged to Have Withdrawn $1 Billion in Fake Profits
Irving Picard, the trustee for Madoff Investment Securities, is now investigating whether Carl Shapiro, one of Madoff's largest investors, knew of the ongoing fraud. Picard has been unable to reach a settlement with Shapiro over withdrawals Shapiro made over the course of his approximately 40-year investment relationship with Madoff. Picard is concerned with inconsistencies in information independently obtained by the trustee investigation into Shapiro's relationship with Madoff, and information given by Shapiro's counsel to Picard detailing the relationship. Shapiro has consistently denied that he knew of the fraud, and alleged that he was a victim, as evidenced by his family's $250 million investment with Madoff just weeks before Madoff's arrest. ("Shapiro Profited $1 Billion From Madoff, Trustee Says," Bloomberg.com, December 2, 2009)
Madoff Victims Hope for Better Recovery Through Tax Breaks
Almost a year after the Madoff fraud was uncovered, some victims of the fraud may be able to recover more of their losses than originally planned. Irving Picard, Madoff trustee, has recovered approximately $1.5 billion in assets that will go toward covering an estimated $19.4 billion in customer losses. Picard has also filed lawsuits to recover, at least partially, $15 billion from some of Madoff's institutional clients or individuals that may have profited at the expense of other clients. In addition to the trustee's work, the Internal Revenue Service recently issued new tax rules that allow victims of Ponzi schemes to deduct nearly all of their qualified losses, including any "phantom income." Before the new rules, victims would typically be required to wait years to deduct their losses and could generally only deduct their principal investment. ("News Gets a Bit Better for Victims of Madoff," The Wall Street Journal, December 9, 2009)
Prosecutors May Be Building Tax Fraud Case Against Madoff Relatives
Last month, David Friehling, an outside auditor of Madoff's businesses, pleaded guilty to signing off on sham audits and filing false tax returns for Madoff. Legal experts note that the government may be using Friehling to build tax cases against Friehling's clients, which include Bernard Madoff's sons Mark and Andrew Madoff, and brother, Peter Madoff. Additionally, legal observers note that Peter Madoff could face criminal charges if it is shown that he assisted in completing SEC filings that provided incorrect details about the firm's investment operation. According to a recent trustee lawsuit, forms filed with the SEC stated that the firm's investment arm had 23 customer accounts and $17 billion in assets as of January 2008. Allegedly, at the time of the filing, Madoff's firm had more than 4,900 accounts with a purported value of $68 billion. If Peter Madoff knew of the alleged inaccuracies, it could be sufficient for criminal prosecution as having aided and abetted fraud. ("Madoff Auditor Plea May Signal Other Probe," The Wall Street Journal, December 10, 2009)
Pricewaterhouse Coopers Named in Madoff Lawsuit
On October 26, 2009, Pricewaterhouse Coopers (Bermuda) and Pricewaterhouse Coopers (USA) (collectively "PWC") were added as defendants to a class action lawsuit pending in the U.S. District Court for the Southern District of Florida brought by investors in Madoff's Ponzi scheme. The plaintiffs allege that in 2004, PWC partners Scott Watson-Brown and Linda McGowen met with Madoff at his offices in New York to conduct due diligence for at least nine feeder funds audited by PWC. Watson-Brown and McGowen subsequently produced a report for internal use at PWC describing their purported "thorough" discussion with Madoff regarding his business practices and indicating that they did not encounter any instances or cases of fraud as a result of their due diligence examination. After investors obtained a copy of the internal report, they named PWC in the lawsuit alleging that PWC "blindly accepted" and failed to investigate information provided by Madoff regarding his business, despite concerns about the plaintiffs' assets invested with Madoff. As of December 2008, PWC purportedly had $17 billion invested with Madoff. ("Bermuda Audit Firm Is Named in Madoff Lawsuit," The Royal Gazette, November 20, 2009)
Motion Seeks Determination of Madoff Ponzi Scheme Start Date
Magnify, Inc., an insolvent company that directly invested in Madoff's Ponzi scheme, has filed a motion asking the U.S. Bankruptcy Court in New York to order Irving Picard, the trustee overseeing the liquidation of the Madoff estate for the Securities Investor Protection Corporation (SIPC), to determine the date that Madoff began operating his fraudulent Ponzi scheme. Although Madoff has stated that his fraud began in the early 1990s, his key lieutenant, Frank DiPascali, Jr., has stated to a judge that the fraud began as early as 1989. Federal prosecutors have consistently argued that Madoff began operating the Ponzi scheme "at least by the 1980s."
In its motion, Magnify argued that Picard cannot begin calculating the losses suffered by long-term investors in the Ponzi scheme until the start date of the scheme is determined because some of those long-term investors may have legitimately earned profits during the early years of Madoff's investment business. SIPC is currently calculating investor losses as the difference between the amount paid into an account and the amount taken out of that account, but Magnify contends that the calculation of investor losses must include the amount of early legitimate profits as an amount paid into an account. According to the SIPC's liquidation plan, only "net loser" investors, those investors who paid more into their accounts than they took out of those accounts, have a valid claim to receive compensation from SIPC. Currently, 2,568 of the almost 5,000 recorded investor accounts qualify as "net winners" and do not stand to recover any funds from SIPC or the liquidation of Madoff's assets. However, the number of "net winners" could be significantly reduced if it is determined that the Ponzi scheme did not begin until the early 1990s, the timeframe that Magnify argues "the information available to date" evidences as the beginning of the fraud. ("Start Date of Ponzi Scheme Is Critical to Claims," The New York Times, November 24, 2009)
Banco Santander Files Motion to Dismiss in Madoff-Related Litigation
On November 20, 2009, Banco Santander SA filed a motion to dismiss a purported class action lawsuit brought by investors alleging that Banco Santander failed to protect their funds managed by Optimal Investment Services, a Swiss-based division of Banco Santander. Optimal invested those funds with Madoff. In its motion to dismiss, Banco Santander asserted that the "[d]efendants' failure to detect Madoff's fraud was not due to their intentional or severely reckless failure." Banco Santander argued that it was defrauded by Madoff like "thousands of other sophisticated investors around the world." Additionally Banco Santander asserted that several plaintiffs in the class action are precluded from bringing lawsuits in the U.S. because their account agreements require disputes to be resolved in the countries where their accounts are located. Banco Santander agreed in May 2009 to pay approximately $235 million to Picard to settle claims related to its profit from the Madoff Ponzi scheme. ("Banco Santander Seeks to End U.S. Lawsuit Over Madoff Losses," Bloomberg.com, November 20, 2009)
U.K. Prosecutors Unlikely to Charge Former Madoff Employees
The U.K.'s Serious Fraud Office (SFO) has been investigating whether former Madoff Securities International Ltd. Chief Executive Officer Stephen Raven or any London employee of Madoff had knowledge of Madoff's Ponzi scheme. Those familiar with the investigation have commented that the U.K. is unlikely to prosecute anyone at Madoff's London operation because the SFO does not have enough evidence at this time to prove that any employee had knowledge of the fraud. In addition, the SFO is currently probing whether anyone at London-based FIM Advisors LLP or 20.20 Medici AG Chair Sonja Kohn knew of Madoff's scheme when they sent him money. FIM Advisors managed Kingate Global Fund Ltd., which invested $2.8 billion with Madoff. ("Madoff London Employees Said to Avoid Facing U.K. Fraud Charges," Bloomberg.com, December 1, 2009)
Petters Convicted of $3.6 Billion Ponzi Scheme
On December 2, 2009, a jury in Minnesota federal court convicted Tom Petters on 20 counts, including wire fraud, mail fraud and money laundering. Petters was accused of using one of his companies to defraud investors who believed that he was using their investments to buy consumer electronics for resale to retailers. Petters pleaded not guilty and argued that he had no knowledge of the fraud until his offices were raided. In addition, he argued that others were responsible for orchestrating the $3.6 billion fraud, including whistleblower Deanna Coleman and Bob White. Both Coleman and White pleaded guilty. ("Minnesota Man Convicted in $3.6 Billion Ponzi Scheme," The New York Times, December 3, 2009)
Tennessee Ponzi Schemer Pleads Guilty
On November 10, 2009, Dennis Bolze pleaded guilty to all charges, including wire fraud and money laundering, filed in connection with his operation of a $21 million Ponzi scheme. From 2002 to 2008, Bolze operated a scheme whereby investors believed they were receiving a return on their investment from Bolze's day-trading of futures contracts. Bolze allegedly posted false day-trading results on the Internet in an effort to disguise his scheme. Approximately 100 people were defrauded in 12 countries. Although the amount lost by investors is unclear at this time, Bolze has agreed to be held accountable for the money investors lost. Bolze faces up to 90 years in prison and sentencing is scheduled for April 15, 2010. ("Tennessee Trader Pleads Guilty in $21 Million Ponzi Scheme," Investment News, November 11, 2009)
Government and Regulatory Intervention
FDIC Posts Negative Balance
For the first time since the savings-and-loan crisis of the early 1990s, the government administered Federal Insurance Deposit Corporation (FDIC) has posted a negative balance. On November 24, 2009, the FDIC posted a third-quarter negative balance of $8.2 billion. Bank customers are being told to remain confident that their deposits would be protected since most of the amount reflects money that the FDIC has already set aside to cover the losses from future bank failures. The FDIC purportedly remains optimistic that it will see signs of improvement in bank earnings and lending in 2010. Federal regulators have seized 50 banks in the third quarter alone, approximately twice the total number of banks that failed in 2008. ("As Bank Failures Rise, F.D.I.C. Fund Falls Into Red," The New York Times, November 25, 2009)
Special Report Faults New York Feds Handling of AIG Bailout
In a report issued on November 17, 2009, Neil Barofsky, the special inspector general for the Troubled Asset Relief Program, reported that the Federal Reserve Bank of New York (Fed) "refused to use its considerable leverage" when it made American International Group (AIG) counterparties, such as Goldman Sachs, whole in exchange for tearing up their contracts with the company. The report stated that the Fed acted as a creditor of AIG, rather than a regulator that could impose its will on the banks. The report notes that, instead of negotiating aggressively for concessions from creditors as the government did in its role in the auto industry, the Fed approached AIG's trading partners with requests for "voluntary" concessions. The report also found that the Fed was caught in a "no-win situation," because, while it might have been able to win concessions by threatening to withdraw support from AIG, it also ran the risk that the credit agencies would take the threat too seriously and impose another catastrophic downgrade on AIG. ("Audit Faults New York Fed in A.I.G. Bailout," The New York Times, November 17, 2009)
|
Related People
Related Offices
Related Practices
|