Opinion

Alison Frankel

SEC loses again: Agency judge clears State Street execs

Alison Frankel
Oct 31, 2011 21:06 UTC

Back when former Goldman Sachs director Rajat Gupta’s most pressing problem was the Securities and Exchange Commission’s civil case against him, his defense scored a small victory when the SEC agreed to drop an administrative proceeding against him and brought civil charges in federal court instead. Gupta’s lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, had fought to have Gupta’s case heard by a federal judge, rather than an SEC administrative law judge, because the rules of evidence in administrative proceedings favor the agency. Among other things, the SEC can admit hearsay evidence, and defendants don’t have the same rights to depose opposing witnesses. Although the SEC can’t seek the same penalties in administrative proceedings as it can in federal court, they can be an effective way for the agency to make a statement about improper conduct.

Except when the defendants win.

On Friday, the SEC’s chief administrative law judge, Brenda Murray, entered a painstaking 58-page decision that cleared former State Street executives John Flannery and James Hopkins on all of the SEC’s sprawling allegations that they misled investors about the mortgage-backed securities holdings in State Street bond funds. Murray found that the agency failed to show at trial that Flannery and Hopkins violated any securities laws in communicating with investors about the funds’ subprime MBS holdings. She went out of her way to describe the former State Street execs as candid, believable witnesses who were frustrated to be on trial.

Murray’s ruling is yet another courtroom rebuke to the SEC, which in the last few years has seen several high-profile trials end in victory for defendants. Most notably, in 2009 a San Francisco federal judge dismissed stock options backdating charges against Broadcom executives; and in 2010 a Manhattan federal judge exonerated two traders in a landmark SEC case alleging insider trading in credit-default swaps. The State Street loss is perhaps an even bigger black eye for the SEC, given that the loss came in an administrative proceeding, the agency’s home turf.

“This is a case where the SEC should never have proceeded against my client,” said Mark Pearlstein of McDermott Will & Emery, who represented former State Street Americas chief investment officer Flannery. “We felt all along that if we received a fair hearing we would prevail. Chief judge Murray gave us a very fair hearing.”

Hopkins, who was a former head of project engineering for State Street, was represented by John Sylvia of Mintz Levin. “We and our client are thrilled,” Sylvia said. “We’ve maintained from the outset that this is a case that never should have been brought.”

Delaware AG’s MERS suit should strike fear in MBS industry

Alison Frankel
Oct 28, 2011 19:44 UTC

The Mortgage Electronic Registration Systems — or MERS, as it’s known — is the business everyone loves to hate. MERS was established in the 1990s to streamline the process of packaging mortgage loans into mortgage-backed securities. Its members, all players in mortgage securitization, reasoned that it would be easier to securitize mortgages if there were a centralized electronic database of the loans, rather than physical paperwork scattered at mortgage lending institutions across the country. The MERS mortgage registry was essential to the securitization boom of the 2000s. But after the housing bust, MERS has been something of a litigation piñata. Homeowners have filed a multitude of suits challenging MERS’s legal right to foreclose and its alleged robo-signing foreclosure practices. More recently, local officials have begun suing MERS for cutting them out of the mortgage registration process and supposedly cheating them out of mortgage recording fees.

Thursday’s complaint against MERS by Delaware Attorney General Joseph Biden III includes those familiar allegations, which MERS has had a pretty good (but definitely mixed) record of defending. But Biden’s complaint goes on to raise broader questions about MERS’s role in the MBS industry. According to the Delaware AG, MERS helped MBS issuers and securitization trustees peddle securities that were flawed at their core. The suit claims that MBS trusts may not actually have owned some of the mortgages bundled into the securities they sold. If those allegations prove true, this complaint could wreak havoc in the mortgage securitization industry.

It’s no secret that the New York and Delaware AGs have a lot riding on their MBS investigations. New York Attorney General Eric Schneiderman lost his spot on the committee of attorneys general negotiating a multi-state deal with five major banks because of his insistence that the settlement address failures in mortgage securitization as well as in the foreclosure and servicing process. He’s taken considerable political heat as a result, but just this week, Schneiderman told MSNBC’s Rachel Maddow that he and Biden are committed to “looking at the conduct of individual institutions and individuals to see if there were misrepresentations made, to see if there was fraud committed, to see if criminal acts were also a part of this.” He added, “We’re determined to follow it through until we get the relief the homeowners need and hold accountable the people who caused this.”

Thalidomide victims claim drug cos. engaged in 50-year cover-up

Alison Frankel
Oct 28, 2011 14:32 UTC

When Philip Yeatts was born in Brownfield, Texas, in September 1962, he had no right leg. His right arm ended in a stump above his elbow, and he had a cleft palate and deformed tongue. Annette Manning, born in Green Bay in 1960, had only buds of fingers and an arm that ended in a stump — just like Mary Hurson, born the same year in New York City, and Tammy Jackson, a 1962 baby in Ranger, Texas. In a heartbreaking new complaint against GlaxoSmithKline, Sanofi-Aventis, Aventor, and Grunenthal, these four plaintiffs, along with eight others (in three parts here, here, and here) claim that their birth defects resulted from their mothers’ use of the now-notorious anti-nausea drug Thalidomide — and that the drug companies engaged in a 50-year scheme to cover up how widely Thalidomide was prescribed in the U.S., and how varied were the birth defects that could result from the drug.

“The question is going to be, ‘Why now?’” said Steve Berman of Hagens Berman. “The answer is that medical science has advanced. We now understand the mechanism by which Thalidomide works. There’s been a complete change in the knowledge of how it caused birth defects.”

Thalidomide was widely prescribed as a treatment for morning sickness in Europe in the late 1950s and early 1960s, until evidence emerged that the drug resulted in grave birth defects. Some countries, including England and Germany, established compensation systems for Thalidomide victims. There was no such plan in the U.S., where drug companies said Thalidomide had only been prescribed in a very restricted controlled study. According to Berman, after the awful consequences of Thalidomide came to light in the 1960s, fewer than a dozen American families sued and reached settlement with the drug companies that made and marketed the drug.

Gupta’s best defense? Raj broke ‘relationship of trust’

Alison Frankel
Oct 26, 2011 21:02 UTC

The Justice Department and the Securities and Exchange Commission apparently do not have the evidence to assert a classic insider-trading case against former Goldman Sachs and Procter & Gamble director Rajat Gupta. Typically, the government brings insider-trading cases against people who profited directly from trades based on confidential information. Gupta doesn’t fall into that category. Neither the SEC nor the DOJ claims that he realized any direct profits from the trades Galleon Group chief Raj Rajaratnam allegedly made based on his tips. Indeed, Gupta’s lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, has said many times that Gupta “lost his entire investment” in Rajaratnam’s hedge fund. “[Gupta] did not trade in any securities, did not tip Mr. Rajaratnam so he could trade, and did not share in any profits as part of any quid pro quo,” Naftalis told Reuters in a statement.

But while the absence of a direct profit motive complicates the Justice Department and SEC cases against Gupta, it doesn’t preclude them. The government doesn’t have to show that Gupta directly profited by tipping Rajaratnam, only that he benefited in some way from passing along inside information. “It’s not your standard model, but it’s not unprecedented,” said Thomas Gorman of Dorsey & Whitney, who represented an Ohio State business-school professor convicted in a no-profits insider-trading case in 2005.

The government, in fact, has broad leeway to define the benefits a tipster derived from disclosing confidential information, Gorman said. Benefits can be as amorphous as enhancing a friendship or angling for future favors. In the Gupta case, the SEC and the Manhattan U.S. Attorney are so far offering only vague motives for his alleged insider trading. The SEC’s new complaint asserted that Gupta received indirect profits from Rajaratnam’s illicit trades, since he was an investor in Galleon funds. The complaint also refers to Gupta’s “variety of business dealings with Rajaratnam,” and alleges that the former McKinsey chief “stood to benefit from his relationship with Rajaratnam.” Similarly, the U.S. Attorney’s indictment said Gupta revealed inside information to Rajaratnam to deepen his relationship with the Galleon chief. “Gupta benefited and hoped to benefit from his friendship and business relationships with Rajaratnam in various ways, some of which were financial,” the indictment said.

Pauley’s BofA MBS ruling is boon to New York, Delaware AGs

Alison Frankel
Oct 25, 2011 21:31 UTC

In 1998, 400 investors in a trust that distributed revenue from a communications satellite got word that their securitization trustee had settled a $41 million suit against the satellite’s fuel supplier. The trustee, IBJ Schroeder, filed a New York State Article 77 proceeding to obtain a judge’s endorsement of the $8.5 million settlement. Some of the investors protested the deal, arguing that the trustee didn’t have the power to settle the case without consulting them. In 2000, a New York appeals court ruled that, in fact, IBJ Schroeder did have that power, under both New York law and the contract governing the satellite revenue trust. The lower court ultimately ruled in the Article 77 case that even if investors considered the settlement amount too low, Schroeder hadn’t acted unreasonably or imprudently in striking the deal.

If you’re wondering why I’m telling you about an 11-year old ruling involving a defunct communications satellite, it’s because the IBJ Schroeder opinion is sure to be invoked by Bank of New York Mellon, the trustee of those Countrywide mortgage-backed securities, as well as the 22 Countrywide MBS investors represented by Gibbs & Bruns as they appeal last week’s decision by U.S. District Judge William Pauley III of Manhattan federal court. In holding that the federal courts have jurisdiction over Bank of America’s proposed $8.5 billion settlement, Pauley took issue with BNY Mellon’s use of an Article 77 proceeding to get the deal approved. The judge wrote that Article 77 is usually employed to resolve garden-variety trust administration issues; BNY Mellon and Gibbs & Bruns will use the IBJ Schroeder ruling to argue at the U.S. Court of Appeals for the Second Circuit that, contrary to Pauley’s assertion, there’s precedent for using Article 77 exactly as they did in the BofA MBS case.

But even as the Second Circuit decides whether to take up the issue of the rights and responsibilities of securitization trustees, state attorneys general are likely to pounce upon some of the language in Pauley’s 21-page ruling. I warned that there might be unintended consequences for indentured trustees when the judge asked for briefing on the BNY Mellon’s duties. After Pauley’s ruling, that warning is now a red alert. New York attorney general Eric Schneiderman and his faithful follower, Joseph Biden III of Delaware, have both announced that they’re investigating MBS securitization trustees. Schneiderman showed he’s serious by filing state-law fraud claims against BNY Mellon along with his petition to intervene in the BofA Article 77 proceeding. In his complaint against BNY, Schneiderman argued that once an investment goes south, as many of the MBS trusts have, the indentured trustee has a fiduciary duty to trust beneficiaries under New York common law.

Whither BofA MBS deal: Can banks walk if case stays with Pauley?

Alison Frankel
Oct 21, 2011 21:50 UTC

It’s way too early to assume that Manhattan federal judge William Pauley III will end up deciding the fate of Bank of America’s proposed $8.5 billion settlement with investors in Countrywide mortgage-backed securities. But that doesn’t mean it’s too early to start wondering what will happen to the proposed deal if he does.

First, a caveat: Bank of New York Mellon, the Countrywide securitization trustee that filed the case in New York state Supreme Court , has the right to request appellate review of Pauley’s ruling that the case belongs instead in federal court under the Class Action Fairness Act. And when BNY Mellon asks the U.S. Court of Appeals for the Second Circuit to hear the appeal, the bank will surely remind the appellate court of its own language in a previous Countrywide MBS case, in which the Second Circuit decided the suit should go back to state court. In his ruling Wednesday, Pauley cited the “paramount federal interests” at stake in the BofA MBS settlement. But the previous Second Circuit MBS ruling expressly rejected that rationale. “If Congress meant the consideration of a class action’s importance to the nation as a whole to trump these limiting provisions [under CAFA], it would have indicated that intent,” the Second Circuit panel wrote in Greenwich Financial v. Countrywide. “Congress wisely chose not to leave it to the federal courts to assert jurisdiction over whatever class actions seemed to judges to be ‘of national importance’ — a standard much too amorphous to admit of consistent judicial application — but instead to define concrete criteria for federal jurisdiction under CAFA.”

That language doesn’t seem to bode well for the Countrywide MBS investors who want Pauley to evaluate the proposed settlement. But this is a weird, unpredictable case. I wouldn’t bet anything more valuable than an ice cream sundae on whether the Second Circuit will take the appeal and overturn Pauley.

Calif. court says no to importing NY standard for auditor suits

Alison Frankel
Oct 20, 2011 21:52 UTC

A year ago, the New York Court of Appeals gave a big, shiny gift to accounting firms facing fraud claims. Both the Delaware Chancery Court and the U.S. Court of Appeals for the Second Circuit had asked New York’s high court to clarify its application of the common-law doctrine of in pari delicto, which basically holds that wrongdoers can’t demand compensation from their partners-in-crime. Trustees for two companies shattered by internal fraud had sued their auditors, claiming that the auditors failed to detect, and maybe even helped cover up, the wrongdoing by corporate insiders. But the Court of Appeals, in its October 2010 ruling in Kirschner v. KPMG, said that if the corporation benefited in any way from the insider’s fraud, in pari delicto shields the auditors.

“So long as the corporate wrongdoer’s fraudulent conduct enables the business to survive — to attract investors and customers and raise funds for corporate purposes,” the New York court wrote, the doctrine applies.

Lawyers from Boies, Schiller & Flexner relied heavily on New York’s Kirschner ruling in their Aug. 31 motion to dismiss claims against the boutique auditor Rothstein, Kass & Company. It’s easy to see why: The case against RKC seems to fit exactly the scenario the Court of Appeals described.

Why Judge Pauley kept $8.5bn BofA MBS case in federal court

Alison Frankel
Oct 20, 2011 18:59 UTC

The key paragraph in Manhattan federal judge William Pauley III‘s 21-page ruling Wednesday in Bank of America’s proposed $8.5 billion settlement with Countrywide mortgage-backed-securities investors is the last one.

“The settlement agreement at issue here implicates core federal interests in the integrity of nationally chartered banks and the vitality of the national securities markets,” Pauley wrote. “A controversy touching on these paramount federal interests should proceed in federal court.”

That sentiment infuses the judge’s analysis of where BofA’s proposed deal should be evaluated: Before Justice Barbara Kapnick in Manhattan state Supreme Court, where Countrywide MBS trustee Bank of New York Mellon filed the case as a special proceeding under an obscure state law; or before Pauley in federal court, where there’s no analogous procedure for binding thousands of investors in 530 trustees to a settlement only 22 of them had a hand in negotiating. Pauley’s decision to keep the case in federal court throws the settlement off the carefully-designed track the bank, the trustee, and the investor group that supports the deal hoped to keep it on.

BofA moves to toss Quinn Emanuel off $10 bln AIG MBS case

Alison Frankel
Oct 18, 2011 15:41 UTC

Bank of America filed a motion late Monday to disqualify Quinn Emanuel Urquhart & Sullivan as counsel to AIG in the insurer’s $10 billion suit claiming BofA, Merrill Lynch, First Franklin Financial, and Countrywide misrepresented the mortgage-backed securities they sold AIG. According to BofA’s lawyers at Munger, Tolles & Olson, a Quinn Emanuel partner who reviewed a draft of AIG’s complaint previously worked at Munger — and was privy to confidential information about how Merrill Lynch and its mortgage origination unit First Franklin intended to defend against MBS claims. Munger asserted that its former partner, Marc Becker, has a direct conflict of interest that should result in Quinn Emanuel’s removal from the AIG case.

“Quinn undertook this representation without even requesting a conflict waiver and screened Becker from involvement in this case only after defendants raised the issue,” the Munger disqualification motion said. “By then it was too late — Quinn had represented AIG in preparing this lawsuit for months, and Becker had already been involved in drafting the complaint and a significant motion in the case. Quinn’s flouting of the ethical rules mandates disqualification.”

Munger’s filings, first spotted by my Reuters colleague Noeleen Walder, disclose a trove of information about what happened between AIG and BofA in the months before AIG filed its $10 billion suit in July. They also raise the possibility that Bank of America will move to disqualify Quinn Emanuel in other cases involving MBS allegations against Merrill or First Franklin, including suits by the Federal Housing Finance Agency, Allstate, and Massachusetts Mutual.

$1.3bn Grupo ruling is Strine v. Goldman, ex-Wachtell partner

Alison Frankel
Oct 17, 2011 22:00 UTC

Grupo Mexico’s lead lawyer, Alan Stone of Milbank, Tweed, Hadley & McCloy, told me Monday that the company was “shocked” by Chancellor Leo Strine’s 106-page Oct. 14 ruling that the company owes $1.26 billion to the shareholders of Southern Peru Copper Company — the second-biggest shareholder derivative award in history.

It is a pretty shocking ruling. Strine found that Grupo Mexico, which at the time owned more than 50 percent of the shares of Southern Peru, basically forced the publicly-traded company to overpay, in stock, for Minera, Grupo’s privately-held Mexican mining company. In reaching that conclusion, the Chancellor managed to do three remarkable things: He rejected the judgment of Goldman Sachs, which advised Southern Peru on the deal; he questioned decisions by former Wachtell, Lipton, Rosen & Katz partner Harold Handelsman, who represented a minority owner of Southern Peru that was eager to cash out its stake; and he concluded that a special board committee of investment bankers conducted a tainted analysis. From the lead judge in a court that’s best known for making it almost impossible to prosecute a shareholder derivative suit successfully, this is a ruling every securities and corporate lawyer should read. (Plus, it’s written in Strine’s usual fluent, engaging style.)

Don’t cry too hard for Grupo Mexico (if you happen to be the sort of person who cries for corporate defendants found liable of breaching their duty to shareholders). Not only is it planning to appeal, according to Milbank’s Stone, but it now owns about 80 percent of the shares of Southern Peru, so even if it loses on appeal and has to pay up, it’s basically moving money from one pocket of Grupo Mexico’s fat wallet to another.

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