Alison Frankel

In the end, it wasn’t even a close call.

Using words like “conjecture,” “bootstrapping,” and “a stretch,” Manhattan federal court judge Jed Rakoff on Thursday decimated trustee Irving Picard‘s multibillion-dollar campaign against the banks that allegedly helped Bernard Madoff engineer his fraud, in a 26-page opinion that left no room for doubt. Rakoff so thoroughly rejected each and every one of Picard’s arguments for why he had the right to bring common law fraud claims against HSBC and UniCredit that the judge didn’t even cite much legal precedent through the first half of the ruling. He simply applied what he calls “ordinary use of the English language” to conclude that no reading of the relevant laws or cases grants Picard standing to sue the banks for unjust enrichment and aiding and abetting fraud and breach of fiduciary duty. This ruling derived its power — and it is a very powerful opinion — from its simplicity.

Rakoff’s ruling immediately affected Picard’s $6.6 billion case against HSBC and a parallel $2.2 billion case against UniCredit. But it’s going to have huge repercussions beyond those suits. Judge Rakoff is also presiding over Picard’s $60 billion racketeering case against UniCredit and related defendants, and it’s a certainty that UniCredit’s lawyers at Skadden, Arps, Slate, Meagher & Flom will ask the judge to apply his ruling on Picard’s standing and bounce that suit as well.

Meanwhile, Judge Colleen McMahon, who is Judge Rakoff’s neighbor on the 14th floor of the Manhattan federal courthouse, is poised to rule on Picard’s standing in his common-law suits against UBS and JPMorgan Chase. McMahon is certainly an independent-minded judge so it would be a mistake to assume she’ll simply follow Rakoff’s lead. But Rakoff knew full well how intensely his ruling on Picard’s standing would be scrutinized, and nevertheless showed no equivocation in his opinion. It’s hard to imagine Judge McMahon reaching a contrary conclusion.

If McMahon — and, ultimately, the appellate courts — agree with Rakoff, Picard’s audacious attempt to hold the banks responsible for failing to end Madoff’s Ponzi scheme is doomed. As I reported a few weeks back, Picard’s standing to bring common-law claims against the banks is a threshold issue. To prosecute a suit, you have to be able to show that you were injured. Picard, as the bankruptcy trustee in the Madoff Chapter 11, stands in the shoes of the debtor, Bernard L. Madoff Investment Securities. But his common-law claims against the banks weren’t brought on behalf of Madoff’s now-defunct investment company — which, as Rakoff explained in Thursday’s ruling, is barred from suing alleged co-conspirators like the banks by a doctrine called in pari delicto. Instead, Picard’s lawyers at Baker & Hostetler said they were bringing claims against the banks on behalf of Madoff’s customers, who lost billions when Madoff’s scheme was exposed.

HSBC’s lawyers at Cleary Gottlieb Steen & Hamilton and UniCredit’s Skadden counsel countered that as bankruptcy trustee, Picard has no right to stand in the shoes of Madoff’s customers.

In Thursday’s ruling, Rakoff analyzed each of Baker & Hostetler’s proposed justifications. In their most basic argument, Picard’s lawyers said the trustee has the power to sue on behalf of Madoff investors under the Securities Investor Protection Act. SIPA, they said, gives the trustee the right to investigate claims against third parties, so, by extension, the trustee has the power to prosecute those claims. Rakoff said Picard was misreading the law. “Neither the language nor the structure of SIPA supports this conjecture,” he wrote. “The trustee argues that [his] investigative authority would be ‘academic’ if he could not use the information discovered in such investigations to commence law suits against third parties on behalf of defrauded customers. To say this argument is a stretch would be to give it more credence than it deserves. If Congress had intended to confer upon the trustee authority to seek contribution for payments of customer claims, it would have said so in SIPA.”

Baker & Hostetler also proposed that Picard has implied standing under the Exchange Act of 1934, which has a provision segregating customers’ assets from those of a broker-dealer to protect investors when an investment house goes under. Rakoff said he was “mystified” by the argument that the Exchange Act somehow confers powers that SIPA doesn’t. In any event, he said, the Exchange Act provision “cannot be read to grant the trustee additional standing, because the rule, which requires broker-dealers to segregate all cash in their possession for the benefit of customers, says nothing about a SIPA trustee’s standing to bring common law claims against third parties.”

Finally, Rakoff rejected Picard’s arguments that he has standing to sue the banks under the common law theory of bailment, which says someone who holds property on behalf of someone else (like a dry cleaner who has temporary possession of your clothes) can bring claims on the property owner’s behalf; and as the enforcer of the Securities Investor Protection Corporation’s derivative right to bring claims on behalf of investors. Baker & Hostetler’s support for those theories rested on an old opinion by a divided panel of the U.S. Court of Appeals for the Second Circuit in a case called Redington v. Touche-Ross. The Redington ruling was later overturned on different grounds by the U.S. Supreme Court, and at the June 23 oral argument before Judge Rakoff on Picard’s standing, lawyers for the trustee and the banks split on whether Redington’s conclusion on a bankruptcy trustee’s right to sue is still good law, given that the decision was reversed for other reasons.

Rakoff said in Thursday’s opinion that Redington is no longer good precedent — but went on to conclude that even if it were, the ruling wouldn’t confer standing on Picard in the Madoff cases because the facts aren’t parallel. “Redington does not anywhere hold that a SIPA trustee has standing to pursue common law claims against third parties as bailee of customer property,” Rakoff wrote.

As Jonathan Stempel reported for Reuters, Picard’s spokeswoman said the trustee’s lawyers are analyzing the ruling and can’t yet comment on it. HSBC’s Cleary lawyers didn’t return my calls. UniCredit counsel Marco Schnabl of Skadden said, “We’re pleased with the decision. We’re analyzing it to see where we’ll go from here.”

(Reporting by Alison Frankel)

There are few scapegoats more overloaded with blame for all that ails the U.S. economy (at least when we’re not on the brink of defaulting on our loans) than securities class action lawyers and the Securities and Exchange Commission. You know the rap. Class action lawyers are accused of accomplishing nothing more than transferring money out the pockets of corporate shareholders and into their own wallets; the SEC, meanwhile, is derided for failing to detect flagrant fraudsters like Bernard Madoff and letting the true perpetrators of the mortgage crisis off the hook. (Reuters, incidentally, has a great story today about the SEC’s new hotline for fraud tips, so the next Bernie Madoff won’t get away with deceiving investors.) There’s precious little hard data to measure the deterrent effect of SEC enforcement or securities class actions — how can you count averted frauds? — so it’s all too easy to assume securities litigation and SEC enforcement don’t stop corporations from misbehaving.

But a new working paper by a trio of economics number-crunchers concludes not only that SEC enforcement and class action litigation are both associated with “significant deterrence,” but also that “effective deterrence requires sustained SEC activity and litigation in the industry.” In other words, corporations are likeliest to stay out of trouble when both regulators and plaintiffs lawyers are policing their industry. “We were quite surprised by that,” said study co-author Simi Kedia, an economics professor at Rutgers Business School. “In academics, class actions aren’t very well regarded.”

Kedia wrote the paper, “The Deterrence Effects of SEC Enforcement and Class Action Litigation,” with Emory accounting professor Shivaram Rajgopal and University of Washington accounting Ph.D. candidate Jared Jennings. (I heard about it at the Harvard Corporate Governance website.) She told me it’s a working paper they’ve presented at a couple of conferences but are still planning to refine before submitting for publication.

Nevertheless, it’s a provocative starting point for discussion. The authors made a momentous methodological leap in order to derive meaningful conclusions about deterrence. Because it’s impossible to measure averted fraud, Kedia explained, they decided to look at “discretionary accrual” accounting as a proxy. Accruals, as Kedia explained them to me (an admitted accounting ignoramus), represent the difference between cash and profits. A company that books sales early, for instance, may report high accruals. Accruals can be perfectly legal, Kedia said, but they’re generally an indicator of “creative” or “aggressive” accounting. The higher a company’s accruals, according to Kedia, the more “aggressive” its accounting is, particularly when its accruals exceed what she and her co-authors calculated to be normal accruals by industry.

“We can’t directly see when [corporations] stop engaging in fraud,” Kedia said. “Measuring accruals is an oblique, tangential way to make the point.” (She emphasized that accruals are not illegal, but reducing reported accruals signals that a company has become more conservative in its accounting, and, presumably, in the corporate behavior that underlies that accounting.)

Kedia and her co-authors looked at SEC and class action data from 1996 to 2006, analyzing, by industry, the impact of 474 SEC enforcement actions alleging accounting impropriety and 1,111 securities class actions. A total of 283 cases involved both SEC and class action allegations. The authors found a measurable deterrent effect on what they call “peer firms” no matter whether just the SEC, just plaintiffs lawyers, or both targeted a company in the industry. “Deterrence,” they found, “is both statistically and economically significant.” Enforcement actions and litigation had the greatest impact on creative accounting, they concluded, when targets are high profile and in competitive, densely-populated industries.

The paper explicitly says the authors’ finding should serve to redeem the reputations of both regulators and plaintiffs lawyers. “Such evidence of significant deterrence associated with SEC enforcement actions is not entirely consistent with the criticism directed at the SEC in the recent past,” Kedia and her co-authors write. “Though it is hard to say what level of deterrence the SEC should have achieved, the results clearly suggest that SEC enforcement policy has made peer firms more conservative in their reporting strategy.”

And as for class actions, they conclude: “Although often maligned as frivolous and socially wasteful [class actions] can have positive externalities by curbing aggressive reporting behavior of peer firms. Though class action litigation does not explicitly seek to deter, this byproduct of litigation has a significant impact on the reporting policies of peer firms.”

Like I said, the paper is sure to be provocative. I’d love to hear from defense-minded data analysts with a different take.

(Reporting by Alison Frankel)

When Oracle and the European software developer SAP went to trial last winter to figure out what SAP owed Oracle for infringing software copyrights, Oracle asked for the moon. SAP argued that Oracle lost only about $40 million in actual profits as a result of its infringement. Oracle’s lawyers at Bingham McCutchen and Boies, Schiller & Flexner, however, told jurors to ignore lost profits and focus on what SAP should have paid Oracle in licensing fees. They ultimately persuaded jurors that Oracle could have received $1.3 billion in hypothetical licensing negotiations for the intellectual property SAP misappropriated. The jury verdict left SAP sputtering with astonishment; in attempts to set aside the award, SAP’s lawyers at Jones Day and Durie Tangri have called Oracle’s calculations of what it might have received in licensing talks “sheer speculation.”

That’s just what San Francisco federal district court judge William Alsup seems determined to avoid in Oracle’s do-or-die patent and copyright showdown with Google, which has allegedly incorporated parts of Sun’s Java code into its Android operating system. As Dan Levine has reported for Reuters, Judge Alsup held a contentious two-hour hearing last week on a report by Oracle’s damages expert, who asserted Google should pay Oracle between $1.4 and $6.1 billion. The next day, the remarkably efficient judge issued a 16-page order that called on Oracle to come up with a new damages estimate that’s better rooted in reality. The judge instructed Oracle to start with an actual number Sun proposed to Google in 2006 licensing talks–$100 million-and adjust that number up and down based on six factors he enumerates.

The judge seems pretty clear about dashing Oracle’s multibillion dollar dreams for the Google case. Oracle “simply served a [damages] report that overreached in multiple ways-each and every overreach compounding damages ever higher into the billions-evidently with the goal of seeing how much it could get away with, a ‘free bite’ as it were,” Alsup wrote. “Please be forewarned: The next bite will be for keeps.”

To be sure, the ruling has plenty of good news for Oracle as well. Judge Alsup isn’t giving up on the the prospect of Google’s liability for willful infringement, based on its decision to walk away from Java licensing talks with Sun in 2006 yet still incorporate Java IP in the Android operating system. (The notorious 2010 e-mail from a Google developer noted that the alternatives to Java “all suck” and concluded, “We need to negotiate a license for Java under the terms that we need.”) The judge also instructed Oracle to envision a damages scenario that included the possibility that Oracle could obtain a injunction against Google because of its infringement — a prospect that would certainly drive up the damages Oracle could claim. Finally, Judge Alsup said that Oracle’s damages estimate should be based on the advertising revenue Google derives as a result of cellphones that use the Android system.

But Judge Alsup orders Oracle to envision what real-world good-faith negotiations between Sun and Google might have looked like at the time Google was developing the Android system. Oracle can only claim damages based on that part of the Android system that actually depends on the Java patents, not an overarching theory that the entire system relies on the seven patents Oracle has asserted. On the other hand, Alsup said Oracle’s estimation may assume that its patents are valid and infringed. Oracle has until 35 days before the case’s scheduled October trial date to submit a revised damages report.

By my reading, though, the judge would vastly prefer that this case settle — and that seems to be the definitive subtext of his damages ruling. Judge Alsup has made it clear in previous rulings attempting to limit the case each side will be able to present to a jury that he thinks this case is a business dispute that should be resolved outside of the courts. Friday’s order is designed to pushing Google and Oracle to begin settlement talks that play around with the $100 million starting point Judge Alsup posits, but don’t stray far from it. If the two sides can’t work out a deal, Judge Alsup warns, both Google and Oracle are going to have to give up a lot of leverage as they head for that October trial date he’s sticking with.

As usual, spokespeople for Google and Oracle declined requests to comment.

(Reporting by Alison Frankel)

The whirlwind of controversy surrounding supposed securities fraud by China-based, U.S.-listed companies spins ever faster. Today’s development: an utterly fascinating libel and defamation complaint that a tiny Hong Kong research outfit called Muddy Waters filed late Thursday in Los Angeles Superior Court against yet-unidentified defendants.

Muddy Waters and its founder, a onetime Jones Day lawyer named Carson Block, have been at the red-hot center of allegations that Chinese companies are fleecing U.S. investors. Block knocked around a bit after graduating from Chicago-Kent College of Law: he practiced law in Shanghai at Jones Day, then started up a Chinese self-storage company and wrote a book about doing business in China. In 2010, Block’s father, the founder of W.A.B. Capital, was considering an investment in a company called Orient Paper and asked his son to check it out. When Carson Block and a friend visited Orient Paper’s headquarters, according to a Dealbook profile of Block, they allegedly found heaps of junk masquerading as corporate assets.

Block put out a report on Orient Paper, urging traders to dump the stock. (As OTC reported yesterday, a federal judge in Los Angeles just green-lighted a securities fraud class action against the company.) And thus a research company — and short -seller — was born. Block was inspired to call his new firm Muddy Waters, according to the company website, by an old Chinese proverb that says it’s easy to catch fish when the fish can’t see what’s going on. His research philosophy is that some Chinese businesses have been taking advantage of U.S. investors who don’t know what’s really happening on the other side of the world. Muddy Waters promised to expose fraud-racked companies through on-the-ground investigation. It also wasn’t shy about admitting that it intended to make money by shorting the stocks of the companies it was about to expose.

In the year since Block founded Muddy Waters, he’s issued negative reports on a half-dozen China-based companies, including a fair percentage of the Chinese securities fraud defendants in the U.S. Most notoriously, a Muddy Waters report sparked the enormous June sell-off of Canadian-listed shares of Sino-Forest. Sino-Forest’s swoon cost U.S. investors, including hedge fund manager John Paulson, hundreds of millions of dollars but brought Muddy Waters and its founder quite a bit of attention. Block’s newfound fame had its advantages — he was profiled in the New York Times and the Wall Street Journal — but also a dark underbelly. Critics such as Perrie Weiner of DLA Piper, who represents several Chinese companies in securities fraud cases, complained to Dealbook that short sellers like Block were engaged in rumor-mongering to make money for themselves. (Weiner didn’t return a call from me.) Orient Paper claimed Block and his father tried to blackmail the company. Sino-Forest threatened to sue Block and Muddy Waters for defamation.

And someone did much worse than that. On June 21, an anonymous poster put out a press release on a public website called Briefingwire.com, claiming that the U.S. Securities and Exchange Commission had charged Block and Muddy Waters with fraud. The press release said Block had realized $240.2 million in ill-gotten profits through manipulating stock prices of three publicly-traded Chinese companies. The document had an aura of authenticity — it quoted longtime SEC enforcement division lawyer Scott Friestad, for instance, and accused Muddy Waters of manipulating stock in companies Block short-sold, including Sino-Forest. But as Reuters reported later that day, the press release was a sheer fake.

Meanwhile, another Muddy Waters-hater is out there pretending to be a Muddy Waters employee issuing blackmail demands. According to the libel complaint the company filed Thursday, a third party informed Muddy Waters that someone calling himself “Shaun Coffey of Muddy Waters” left “Mr. Wong” a phone message in Hong Kong that said, “Have you reported out [sic] meeting to your bosses? Now they only have 2 choices, to either pay us 2 millions [sic] U.S. dollar or we will release our initial research report to public. You must reply or within 2 days!” (The former federal prosecutor, Sean Coffey, now running a start-up litigation funding company called BlackRobe Capital, told OTC he has no ties to Muddy Waters.) In a Muddy Waters press release announcing the suit, the company says the extortion demand was made to a public company.

Block and Muddy Waters are represented by Donald Burris of Burris, Schoenberg & Walden, who met Carson Block through Block’s father, a Burris client. The law clearly has some work ahead of it if Muddy Waters is going to make a go of the case. The defendants are now listed as Does 1-100 because Muddy Waters doesn’t know who was behind the fake press release or the alleged blackmail threat. Burris told me Friday that Block — who says he has received death threats because of his research reports — suspects the fake release and the fake extortion threat were made by people with similar motives, but he’s not sure. In announcing the suit, Block said the case “enables us to begin an investigation to which we will direct significant resources.”

Briefingwire.com is protected by the Digital Millenium Copyright Act, but Burris said he plans to ask the Internet site to turn over whatever information it has on the poster of the fake press release. “There’s no reason to go after the website, although we think they were awfully sloppy,” Burris said. “We believe when we request information through litigation, they will need to identify [the poster].” (Briefingwire didn’t respond to Reuters e-mails when it first published the fake release.) Block’s announcement of the litigation says that he is hoping the case “will lead to better controls, consistent with the legitimate First Amendment constraints, on the publication and dissemination of defamatory material by anonymous or ill-defined authors.”

Burris also said Muddy Waters is going to investigate whatever can be gleaned from the fake press release itself. The faux document, which the libel complaint quotes in its entirety, says Block “carried out the market manipulation schemes with others he met through a stock web site, which is operated by Matthew Brown of Aliso Viejo, Calif. Block, Brown, and other participants in the schemes often timed the manipulative trading to coincide with the false and misleading press releases issued by Muddy Waters.” The fake release claims the SEC lodged charges in Delaware federal court.

Here’s the weird thing: A Californian named Matthew Brown, who once ran a penny stock website called InvestorsHub, really was charged in Delaware civil and criminal stock manipulation cases. (Here’s the 2009 SEC complaint; the case was stayed for criminal proceedings.) According to the docket in the criminal case against him, Brown pled guilty to four fraud-related counts in February 2010 and was sentenced in May to four years in prison. I called Brown’s lawyer, Delaware solo John Garey, to ask about his possible ties to Muddy Waters but didn’t hear back.

This is going to be a wild case if Muddy Waters and Burris can make headway in their investigation. Turns out there aren’t just fish swimming in the muddy waters of China stock research: there are also sharks.

(Reporting by Alison Frankel)

For vulture funds holding defaulted Argentinean bonds, the U.S. Court of Appeals for the Second Circuit has been a brick wall with only the tiniest of chinks. In recent years, the appellate court has rejected all sorts of clever stratagems the bondholders and their lawyers have dreamed up in an effort to get their hands on Argentine assets, including an attempt to attach assets belonging to Argentina’s central bank and pension system.

One notable exception to the rule of bondholder frustration at the Second Circuit was the appellate court’s 2006 ruling that a holder called Capital Ventures International had the right to attach Argentine collateral (in the form of U.S. and German government securities) held by the Federal Reserve Bank in New York. Argentina put up the securities to back its 1992 issuance of so-called “Brady bonds,” which, under a plan pushed by then-Treasury Secretary Nicholas Brady, exchanged $28.5 billion in defaulted bonds for collateralized Brady bonds due in 2023. The Second Circuit’s 2006 ruling meant that if Argentina attempted to restructure or exchange the Brady bonds before their 2023 maturity, CVI was first in line to get its hand on the securities held at the Fed.

There was just one big problem with the 2006 appellate ruling for CVI and its lawyers at Ballard Spahr and Cozen O’Connor: it came too late. By the time the Second Circuit overturned a lower court ruling and granted CVI a right to the Fed-held collateral, Argentina had already completed an exchange of $2.8 billion in Brady bonds. Because CVI only had a right to the collateral at the Fed if Argentina was engaged in a Brady bond exchange, CVI was out of luck, despite its appellate win. CVI was left holding a big-money judgment against Argentina — more than $200 million in CVI’s case — with no foreseeable way to collect on it.

Then Argentina pushed its luck. In 2010, the country proposed another exchange for holders of the collateral-backed Brady bonds. Mindful of CVI’s rights under the 2006 Second Circuit ruling, Argentina’s lawyers at Cleary Gottlieb Steen & Hamilton asked Manhattan federal court judge Thomas Griesa to modify CVI’s attachment order to permit the $100 million Brady exchange to go forward without giving CVI a chance to snare the collateral held at the Fed. Judge Griesa, who oversees all of the litigation between Argentina and its disgruntled bondholders, agreed to the modification. But he also stayed his order so CVI could return to the Second Circuit.

On Wednesday a three-judge appellate panel once again ruled in CVI’s favor. (Here’s Reuters’ story on the ruling; here’s the 23-page opinion by Judge Gerard Lynch for a panel that also included Judges Pierre Leval and Guido Calabresi.) The Second Circuit concluded that CVI is entitled to maintain its right to attach the collateral, even if that means Argentina’s $100 million Brady bond exchange will be blocked. The appeals court rejected various arguments by Cleary’s Carmine Boccuzzi Jr. about the Brady bondholders’ senior lien on the collateral and unilateral right to amend the original Brady exchange agreement. The judges also said Argentina’s situation wasn’t dire enough to justify curtailing CVI’s rights.

So can CVI collect the more than $200 million it’s owed via the Fed collateral? Not so fast, said M. Norman Goldberger of Ballard Spahr, who argued at the Second Circuit for CVI. If Argentina calls off the exchange and leaves the Brady bonds in place until the mature in 2023, CVI won’t be able to get its hands on the collateral held at the Fed.

“I wish [the ruling] meant I’d get CVI’s money right away, but it doesn’t,” Goldberger said. What it might mean, though, is that CVI can persuade Argentina to enter negotiations, Goldberger added. “We don’t have any interest in screwing [Brady bondholders],” he said. “We want Argentina to talk to us, and they won’t. We weren’t in this for leverage. We’re just playing by the rules.”

(Reporting by Alison Frankel)

The damages claims in Irving Picard’s pursuit of the banks that allegedly helped Ponzi schemer Bernard Madoff are so outsized that even a simple two-page letter from a federal judge can lead to a $2 billion kerfuffle. On Tuesday, Manhattan federal district court judge Colleen McMahon sent a letter to lawyers for Picard, the bankruptcy trustee for Bernard L. Madoff Investment Securities, and to lawyers for UBS, which is a defendant in two of Picard’s suits. UBS’s counsel at Gibson, Dunn & Crutcher had moved in June to transfer two Picard suits naming the bank as a defendant out of bankruptcy court and into federal court; Judge McMahon, who is overseeing Picard’s case against JPMorgan Chase, agreed to take the cases on July 7 and began requesting information, by letter, from Picard counsel at Baker & Hostetler and UBS counsel at Gibson Dunn.

To understand Judge McMahon’s July 19 letter — and how it was misinterpreted — it’s important to know that in the two actions naming UBS defendants, Picard is asserting different causes of action and seeking different amounts of money. In the case known as Luxalpha, Picard and Baker & Hostetler claim that UBS breached its fiduciary duty and aided and abetted fraud. That suit demands $2 billion from UBS and other defendants. The other case, known as LIF, is a clawback action demanding the return of all the money the bank and other defendants redeemed from Madoff or earned in fees, a total of $550 million, according to Picard. Though the press release announcing the LIF suit refers to “alleged financial fraud” by UBS, the suit actually claims only unjust enrichment and another common-law cause of action as an alternative to the clawback theory.

In a July 14 letter, Judge McMahon told Baker & Hostetler and Gibson Dunn that she needed more explanation of how the LIF and Luxalpha cases intersected and overlapped, and warned the lawyers that she wasn’t going to slow down the JPMorgan case to address complications in the UBS suit. In response, the Picard lawyers decided to simplify matters, reasoning that if they dropped the alternative-theory common law claims in the $550 million LIF case, there would be no reason for the case to stay in federal court. Picard could simply go after the $550 million in a bankruptcy court clawback action.

Baker & Hostetler’s letter explaining its decision to drop LIF claims to Judge McMahon isn’t in the docket. But the judge entered into the record her July 19 letter, in which she notes (rather cryptically unless you know the background) that Picard “has withdrawn his non-bankruptcy claims.”

On Wednesday morning, Bloomberg put out a hot story, reporting that Picard “may drop $2 billion in claims against UBS AG,” and quoting a bankruptcy lawyer who’s not involved in the Madoff litigation saying that Picard may have made a tactical decision to retreat from bigger claims. Bloggers who picked up the story reported that Picard was only going to pursue clawback claims against UBS. (See here and here.) Bloomberg updated its story to indicate that UBS’s shares were up in both Switzerland and the United States “after the withdrawal of Picard’s claims was reported.”

But according to Picard’s lawyers, he hasn’t given up a penny of his demands against UBS. Oren Warshavsky of Baker & Hostetler told OTC Wednesday that the common-law claims Picard dropped from the $550 million LIF suit “were alternative theories of recovery,” to the bankruptcy-court clawback theory. “By dismissing the two common-law causes of action, our goal is to streamline the case and effect judicial economy. We did not diminish the amount sought in any way,” he said.

Moreover, Picard hasn’t dropped any claims in the $2 billion Luxalpha fraud case against UBS, in which both sides will now presumably brief the very serious questions of standing and pre-emption that Judge McMahon is considering in Picard’s JPMorgan case.

I contacted the editor of the Bloomberg story, asking for comment on my reporting that Picard hadn’t, in fact, dropped any valuable claims. “Our story is based on Judge McMahon’s letter to counsel filed in the district court docket yesterday,” he replied in an e-mail. Bloomberg updated its story Wednesday afternoon to include a comment from Picard’s spokesperson stating that the dropped claims don’t impact the damages sought against UBS. Bloomberg also reports that the bankruptcy lawyer quoted in early versions of the story had reviewed “Picard’s original suit against UBS” (it doesn’t say which one) and concluded, “The trustee ‘will get large sums of money using garden bankruptcy law, but he is giving up at least $2 billion based on common and state law claims.’”

UBS’s lawyers at Gibson Dunn didn’t respond to requests for comment.

There’s going to be big news coming soon in Picard’s cases against the banks. Judge Jed Rakoff has promised to rule by the end of this month on the threshold question of whether the trustee has standing to sue the banks that allegedly abetted Madoff’s fraud. If Rakoff agrees with the banks, that’s a titanic defeat for Picard.

But the trustee dropping duplicative claims to keep his case in the friendlier confines of bankruptcy court? Not so much.

(Reporting by Alison Frankel)

Well, here’s a big shocker: Grant & Eisenhofer and Bernstein Litowitz Berger & Grossmann aren’t the only shareholders’ firms that think Rupert Murdoch’s News Corp is ripe for the picking. It’s been a little more than a week since G&E and Bernstein amended the complaint in their already-underway Delaware Chancery Court shareholder derivative suit against the News Corp board to include allegations from the British phone-hacking and bribe-paying scandal. Turns out that’s plenty of time for other shareholder lawyers to fire up their word processors and lodge their own complaints.

On Friday, a Massachusetts union pension fund represented by Labaton Sucharow filed a Delaware derivative suit. And on Monday, Manhattan federal court docketed a derivative complaint filed by Glancy Binkow & Goldberg on behalf of an individual News Corp shareholder. So now what? Who gets to control the shareholder litigation against Murdoch’s embattled company?

There’s no clear answer to that question, which means we may be in for a tussle between the Delaware and New York plaintiffs firms. As I mentioned in a post yesterday, Chancery Court judges are increasingly irritated that shareholders are filing mergers and acquisition and corporate governance suits in courts outside of Delaware. But there’s no formal framework for determining where cases like this should proceed. (That’s in contrast to federal securities class actions, in which the litigation process is strictly governed by the Private Securities Litigation Reform Act.)

As an initial matter, Labaton Sucharow’s Delaware case will be consolidated with the pending News Corp derivative suit, under the judicial order that first combined Grant & Eisenhofer’s case with Bernstein Litowitz’s back in March. Labaton partner Christine Azar told OTC that the firm won’t oppose consolidation and plans to work with G&E and Bernstein Litowitz. I asked Azar if she filed a separate suit just to get the Massachusetts fund a seat at the table alongside the other plaintiffs firms. “My client very much wanted to get involved in this one, as you might imagine,” she said. “A seat at the table may be putting it mildly.”

The New York case, unlike the Labaton suit, isn’t an exact parallel to the pending Delaware suit. The Glancy firm’s complaint includes a federal law claim that News Corp. failed to disclose the true nature of its internal controls to shareholders in proxy materials, and calls for a new board election.

Typically, in these kinds of jurisdictional duels, the defendant makes the opening move, asking for one of the cases to be stayed in favor of the other. (News Corp’s counsel in the Delaware suit, Edward Welch of Skadden, Arps, Slate, Meagher & Flom, didn’t return a call.) Then it’s really up to the judges presiding over the cases to decide which case to stay. Vice-Chancellor John Noble, who’s overseeing the Delaware suit, certainly has a good justification for letting Delaware lead the way, since the Chancery Court suit has been underway for months and Delaware law will govern any court’s consideration of allegations against the Delaware-chartered News Corp.

Bernstein Litowitz, moreover, plans to stay in control, along with Grant & Eisenhofer, of the litigation against News Corp. “My firm and our co-counsel are representing institutions that decided months ago that enough is enough,” said partner Mark Lebovitch. “We have every intention of pursuing our claims and righting the ship at News Corp.”

Lebovitch told OTC he’s all the more fired up about the derivative suit because of comments Monday by News Corp. independent board member Thomas Perkins, the Silicon Valley venture capitalist. Perkins reportedly said that the News Corp. board solidly supports the company’s top officers, including Rupert Murdoch. “I can assure you, there has been no discussion at the board level in connection with this current scandal of making any changes,” Perkins said. “Mr. Perkins’ quote shows what we’ve been saying all along,” Lebovitch said. “So much for any semblance of this board acting like it’s going to conduct a fair and independent inquiry.”

But Glancy Binkow contends the Delaware suit should be halted so it can proceed with the New York case. Glancy associate Louis Boyarsky told OTC the Delaware case originally focused on blocking News Corp’s acquisition of Shine Limited, the production company owned by Elisabeth Murdoch (one of Rupert’s daughters), and not on the phone hacking allegations. “The derivative claims with regard to the hacking scandal are add-ons [in that suit],” Boyarsky said. By contrast, he said, those claims are central to the New York suit. “We believe a stay would be inappropriate in our case,” he said. “We believe the court will look at how aggressively we’re litigating the action and the comprehensiveness of our complaint.” I asked how the firm has demonstrated its aggressiveness; he declined to disclose Glancy’s strategy but said, “We’re prepared to move swiftly.”

Meanwhile, Forbes columnist Robert Lenzner is floating a intriguing idea that could end all of this shareholder trouble for News Corp. Murdoch and his family already own 47 percent of the News Corp voting rights, Lenzner said in a Huffington Post item. The company’s just-announced $5 billion buyback plan will deliver another 6 percent into Murdoch hands. “This $5 billion move,” Lenzner wrote, “could be the first step in taking out the public shareholders-and ensuring that the media and entertainment empire stays in the control of his children.” If Murdoch took the company private, under Chancellor Strine’s reasoning in the recent (and controversial) Massey ruling, shareholders’ derivative claims could essentially be wiped out.

(Reporting by Alison Frankel)

Back in March 2010, Apple filed separate suits at the U.S. International Trade Commission against Nokia and HTC, accusing both cellphone makers of infringing Apple’s smartphone patents. In April, the ITC staff recommended that the patents Apple had asserted against both Nokia and HTC should be tested in a consolidated case. Nokia and HTC supported the proposal. Apple’s lawyers at Kirkland & Ellis complained that the partial consolidation would aid Nokia and HTC by creating “complexity and delay,” but the lawyers didn’t fight hard against it because they didn’t want the case — which had the potential to knock iPhone competitors out of the U.S. market — to get bogged down.

The consolidation had clear advantages for the defendants and disadvantages for Apple. Nokia and HTC could mount a joint challenge to the validity of the Apple patents, pooling ideas and resources. Meanwhile, on the infringement side of the case, Apple’s Kirkland lawyers had a doubled workload to master the technology in phones made by both Nokia and HTC.

When the case was tried before ITC administrative law judge Carl Charneski in April and May, Nokia and HTC both had A-list defense counsel: Alston & Bird for Nokia; Keker & Van Nest and Quinn Emanuel Urquhart & Sullivan for HTC. (Quinn, remember, regularly represents Google; HTC phones run on Google’s Android platform.) The three defense firms worked together, incorporating one another’s briefs and presenting joint expert witnesses to opine on the validity of the Apple patents.

And then the fates of Nokia and HTC diverged dramatically. In June, Nokia announced that it had reached a global megadeal with Apple, with Apple agreeing to pay hundreds of millions of dollars for Nokia IP. HTC waited for Judge Charneski. His initial determination, issued Friday afternoon, found HTC to infringe two valid Apple patents. (HTC is off the hook with respect to two others.) Though the administrative law judge’s determination can be appealed to the full ITC, the preliminary ruling sent HTC’s share price off a precipice.

How did two defendants end up with such different results?

The answer to that question lies in litigation’s increasingly strategic significance for big businesses. Apple’s consolidated ITC case against HTC and Nokia was just one piece in the litigation chess game Apple is playing with every cell phone maker. Consider Apple’s smartphone litigation history with Nokia, a company which is allied with Microsoft in the great smartphone showdown. Nokia has a vast patent portfolio, including crucial 3G intellectual property. It initiated a patent war with Apple; Apple’s ITC complaint against Nokia was in retaliation for Nokia’s infringement claims against Apple. The litigation between the companies was more important in determining how big a licensing deal Apple would sign than in determining whether Apple would sign any deal at all.

HTC has far less leverage with Apple, which is why its loss in the ITC consolidated case looms so large. HTC is a young company without much IP Apple needs. It’s also closely allied with Google — Apple’s sworn smartphone enemy, thanks to Android. If Apple was unlikely to work out a licensing deal with HTC before Judge Charneski’s ruling, it’s even less likely to do so now. (Things can change, of course. HTC has said it will ask the full ITC to review Friday’s initial determination, and its own ITC infringement suit against Apple, tried right after the completion of the consolidated case, has not yet been decided.)

Apple still has major pending smartphone cases in the works with Motorola and Samsung. Both are veteran cellphone pioneers with valuable technology, a la Nokia; both also use Google’s android operating system, like HTC. Should be very interesting to see whether they end up like Nokia or HTC.

(Reporting by Alison Frankel)

Kathy Patrick wants to set the world straight.

The Gibbs & Bruns partner, who represented 22 major Countrywide mortgage-backed securities investors in the negotiations that led to the June 29 proposed $8.5 billion Bank of America deal, has come East from her home office in Houston to sell Countrywide MBS noteholders and anyone else who will listen on the settlement she and her partner Scott Humphries negotiated with BofA and Countrywide MBS trustee Bank of New York Mellon.

In the face of questions about the deal from six Federal Home Loan Banks, the New York State Attorney General, and a North Carolina Congressman, Patrick and Humphries spent Thursday in Washington and Friday in New York, meeting with MBS investors and “other interested parties” they declined to identify. The Gibbs lawyers’ message: The proposed BofA settlement represents a far better outcome for noteholders than continued litigation of loan-by-loan breach of contract claims against Countrywide. In that scenario, they insist, there would be no guaranteed outcome, no assurance investors can obtain a judgment against BofA as Countrywide’s successor, and none of the mortgage loan-servicing provisions that are a big part of the proposed deal. (The Gibbs & Bruns lawyers and some of their institutional investor clients argue that the servicing component of the deal, in which Bank of America has agreed to outsource loan servicing to specialists tasked with renegotiating troubled mortgages, could end up being as valuable as the cash part of the settlement.)

Patrick is particularly exercised that one objector to the proposed settlement has asserted that the deal “fails to address” securities claims pending against Countrywide. The settlement agreement specifically states that securities fraud claims are not part of the deal, and even if BNY Mellon, as trustee, wanted to give away investors’ right to sue for securities fraud, it has no power to do so. Patrick said she was so determined to preserve her own clients’ securities law claims that Gibbs & Bruns very nearly walked away from late-stage negotiations when Bank of America’s lawyers from Wachtell, Lipton, Rosen & Katz demanded a release. “We said not only no, but hell no,” Patrick said, adding that she was ready to leave $8.5 billion on the table.

Patrick said that so far, the only announced objectors to the settlement-as opposed to the New York AG, the Federal Home Loan Banks, and others who’ve said they want more information– are clients of Grais & Ellsworth, including a coalition of MBS investors that sued Bank of America after David Grais learned of the Gibbs & Bruns group’s settlement discussions. “There’s a misperception out there that lots of investors are unhappy with the deal,” Patrick said. “Look very carefully: They’re all represented by one lawyer at one law firm,” she said. Moreover, she added, no objector has suggested a viable alternative to the proposed settlement.

“Here’s a fundamental question any of these objectors will have to answer,” Patrick said. “What’s your plan? What is your plan to fix the servicing?…Unless you have a credible plan, unless you’re going to indemnify all of us against losing this bird in the hand, then you have nothing.”

OTC reached out to David Grais and Owen Cyrulnik for a response. Grais declined comment.

(Reporting by Alison Frankel)

Faced with a barrage of investor criticism (see here, here, and here) of its proposed $8.5 billion mortgage-backed securities settlement with Bank of America, Bank of New York Mellon, the MBS trustee, has released the expert reports underlying the agreement. The reports—in particular the valuation report by Brian Lin, the managing director of RRMS Advisors—provide an extraordinary window into how this deal got done. They may not change anyone’s mind about the fairness of the settlement proposal, but they answer a lot of the questions that challengers of the deal have raised.

Let’s start with the numbers that were on the table when Gibbs & Bruns and its group of 22 major Countrywide MBS investors sat down across from Bank of America and its lawyers from Wachtell, Lipton, Rosen & Katz. The outside range of the investor group’s demands was $52.6 billion, according to Lin’s report. At the low end, the investors asked for $27 billion. Bank of America, according to the Lin report, calculated that investors could claim no more than $4 billion.

Lin began his evaluation of the investors’ Countrywide MBS claims by reviewing the presentations that the Gibbs group and BofA made to one another. (His company, RRMS, is a mortgage-backed securities consultant that advises MBS investors, packagers, and issuers. BoNY and its Mayer Brown lawyers selected Lin’s firm to provide an expert opinion after beauty contest interviews with several candidates, which had to have MBS expertise but couldn’t have a significant relationship with Bank of America.) Interestingly, Lin’s report indicates that the valuation methodology employed by both the investors and BofA was almost the same, although the two sides obviously plugged different assumptions into the basic formula.

Here’s how the investors and the bank came to their numbers. As OTC explained earlier this week, the key metric is the value of the investors’ valid claims that Countrywide breached its representations and warranties on the mortgage loans underlying the securities. To determine that number, both the bank and the investor group began with a calculation of how many of the mortgages in the underlying pools would go into default. They next considered what percentage of the value of a defaulted underlying mortgage would be lost to investors—a figure Lin calls the “severity rate.” (If, for instance, a homeowner defaulted on a $100,000 mortgage and the mortgage-holder was later able to sell the mortgaged property for $75,000, the severity rate would be 25 percent.) Two more numbers then come into play: the breach rate, which represents the percentage of mortgages in the pool that breached Countrywide’s assurances to investors; and the success rate, which is the percentage of claims on which investors could successfully demand a bank buyback.

To arrive at its demand of $27 billion to $52.6 billion, the Gibbs & Bruns group asserted that $107.8 billion of the underlying mortgage pool would go into default. The investors applied a severity rate of 66 percent, a breach rate of 60 percent, and a success rate of 50 to 75 percent. (Lin said the latter two rates were too high, based on his “industry knowledge.”) The bank used different figures to reach its $4 billion estimate of investors’ claims, but Lin didn’t spell out BofA’s exact numbers.

In any event, Lin and his team arrived at their own conclusions for default, severity, breach, and success rates, based on the two sides’ presentations and their own expertise. RRMS said 36 percent of the defaulted underlying loans breached Countrywide’s representations and warranties, and investors would prevail on 40 percent of their buy-back claims on those loans. Lin made calculations using two different severity rate models—one estimating that investors would recover only 40 percent of the value of defaulted underlying mortgages; the other estimating a 55 percent recovery. He also offered two different default models.

In the end, Lin arrived at a range of $8.8 billion to $11 billion for investors’ claims. Importantly, he reached those results without knowing that negotiations between BofA, BoNY, and the Gibbs & Bruns group had produced a tentative $8.5 billion settlement agreement. In a second opinion, Lin says the servicing aspects of the proposed settlement “can be viewed as an industry precedent-setting, pro-active approach in regard to establishing a framework to enhance recovery efforts.” (Supporters of the proposed settlement assert that the servicing provisions, which require BofA to hand off responsibility for renegotiating troubled mortgage loans, could be worth as much or more to investors as the cash part of the deal.)

When Mayer Brown submitted BoNY’s petition for court approval of the $8.5 billion settlement proposal, partners Jason Kravitt and Matthew Ingber said that their expert’s valuation didn’t include discounts for BofA’s legal defenses against the investors’ claims. The other three expert reports released Tuesday explain what those legal defenses would have been—and may still be if the proposed settlement isn’t approved.

First off, Mayer Brown obtained an opinion from Capstone that said the trustee could recover no more than $4.8 billion from Countrywide, based on Countrywide’s assets. That’s important because in another expert opinion, Stanford Law School professor Robert Daines said it would be “difficult” for MBS investors to prevail in claims that Bank of America is responsible for Countrywide’s breaches of representations and warranties on the underlying mortgages. (There’s a lot more nuance in Professor Daines’s scholarly 58-page analysis, but the takeaway is that investors can’t be sure they could pierce the corporate veil and hit Bank of America for Countrywide’s failings.)

Finally, New York University School of Law professor Barry Adler opined on the standard for investor breach of contract claims against MBS issuers. Bank of America asserted in negotiations that unless the breaches were material—meaning that Countrywide misrepresented the facts that led to the mortgage’s default—the bank isn’t liable. Investors argued that every breach is material because they wouldn’t have purchased the securities without Countrywide’s representations and warranties about the underlying mortgages. Professor Adler’s 13-page opinion concludes that the law is unsettled but that the bank “appears to [have] a reasonable position.”

Kathy Patrick of Gibbs & Bruns, who represents the investor group that negotiated the deal, told OTC she’s glad the expert reports have come out. “We believe investors will find it very helpful ,” she said. “The trustee’s expert opinions… confirm and support the trustee’s decision to enter into the settlement.”