Securities Suits Up in 2008, But Might They be Uphill Battles?

[WSJ_law_blog]

The mortgage crisis has given birth to a big year for securities suits. But will many of them be doomed by strong defense arguments?

According to one report, which will be issued tomorrow by Stanford Law School and Cornerstone Research, 2008 saw a total of 210 prospective securities class actions filed last year, a 19% increase over the previous year and more than 80% above the 2006 total. Many of those suits allege that financial firms overvalued their mortgage-related assets; others complain about the business practices of companies that issued subprime loans.

“The defendants are saying they didn’t know they had all this toxic debt on their balance sheets,” David Scott — a plaintiffs’ attorney in Connecticut who filed several prospective securities class actions last year alleging damages from the mortgage meltdown — told the Journal. “That is an availing argument to certain judges, because the market collapse that has occurred has taken the spotlight away from whether the companies engaged in fraud.”



Robert Giuffra Jr. (pictured above), a Sullivan & Cromwell lawyer who defends securities class actions, told the WSJ: “Plaintiffs lawyers will face an uphill battle if they claim that every bank on Wall Street was engaged in a separate internal conspiracy to commit economic suicide.”

Another interesting take on the numbers: Class action filings dipped slightly in the second half of 2008, despite the precipitous market drops that occurred during that span, the report notes. This is surprising given that stock market volatility typically is grist for securities class actions. “One possible explanation is that market volatility has been so large that plaintiffs found it difficult to isolate company-specific stock movements from the broader noise generated by the volatile market,” says John Gould, a vice president at Cornerstone.

We also recommend checking out a report by Kevin LaCroix, the indefatigable author of the D&O Diary blog. He says that the subprime mortgage mess, the credit crisis, the auction-rate securities scandal and the alleged Madoff Ponzi scheme have all contributed to the rise. According to LaCroix’s tally, securities filings jumped from 172 in 2007 to 224 in 2008. That’s a 30% jump (and an 88% increase over the 119 securities suits that LaCroix says were filed in 2006.)

And what’s ahead for 2009? Will courts remain awash is securities filings this year? Not likely, says Joseph Grundfest, the director of Stanford Law School’s Securities Class Action Clearinghouse. “I expect filings to drop in 2009 not because the severity of the credit crunch will go away, but because virtually all the major financial-services firms have already been sued,” he says. “I think for first time in history, we have a pool of defendants that is fished out.”

One reason auction rate securities fraud yielded few class-action lawsuits because brokerage customers are forced to sign away their rights to a jury trial. There were relatively few arbitrations because the thousands of small investors defrauded couldn’t afford action against well-funded banks.

One of these days, regulators will stop stacking the deck against investors. Then we’ll see how much fraud goes unchallenged in the courts.

Filings will continue at present levels — there is a two year statute of limitations so plaintiffs have time. Most subprime suits will survive motions to dismiss. In case Mr. Giuffra didn’t notice many, but not all banks, engaged in the wanton reckless practices that have caused the recent subprime scandals. Last time I checked “everyone is doing it” was not a defense. Finally, Prof. Grundfest should stop making predictions — he is always wrong. Before the recent filings when there was a six month lull, Prof. Grundfest was being quoting as saying that SarbOx and SEC enforcement had taken the fraud out the market and there was no need for securities class actions. Yeah, right.