Opinion

Alison Frankel

$315 ml Merrill deal shines light on damages in MBS litigation

Alison Frankel
Dec 6, 2011 23:13 UTC

A filing late Monday confirmed what I reported last month: Merrill Lynch has agreed to a $315 million settlement of a securities class action stemming from 18 Merrill mortgage-backed note offerings. This agreement is the fourth MBS securities settlement, following this summer’s landmark $125 million Wells Fargo class action deal and a pair of settlements with Citigroup and Deutsche Bank, totaling $165.5 million, that National Credit Union Agency reached in November. The Merrill agreement, negotiated by lead class counsel at Bernstein Litowitz Berger & Grossmann, is by far the biggest score so far for MBS investors in a securities suit (as opposed to contract, or put-back, litigation).

There are dozens more MBS securities suits out there, as the Merrill settlement agreement acknowledges: the deal carves out claims by AIG, the Federal Home Loan Bank of Boston, the Federal Housing Finance Agency, and other MBS investors that have already filed their own securities suits against Merrill Lynch. But one of the big mysteries of the MBS securities litigation has been how to value the cases, since there’s so little precedent in the way of settlements. The NCUA deals helped; the credit-union regulator repackaged and resold mortgage-backed securities belonging to five failed credit unions, so the agency actually knew how much the credit unions lost through their MBS investments. In its talks with Citi and Deutsche Bank (which the agency didn’t formally sue), NCUA was able to claim specific, fact-based damages.

The Merrill settlement documents provide significantly more insight for plaintiffs who don’t have the luxury of U.S. government backing to sell repackaged mortgage-backed securities. The documents don’t disclose the class’s specific damages claim; the case settled before investors filed their damages expert’s report. But the exhibits included along with the settlement brief indicate a methodology for calculating damages that other plaintiffs can use. MBS defendants, including Merrill Lynch, will undoubtedly continue to assert that MBS noteholders shouldn’t recover anything for their securities claims because they’re sophisticated investors who knew the riskiness of mortgage-backed notes. But as hundred-million-dollar settlements pile up, that’s a tougher argument to sell.

The Merrill class members, like most MBS securities plaintiffs, based their claims on Section 11 of the Securities Act of 1933, which holds that investors can recover damages if a registration statement contains false or misleading statements. (It’s a handy theory for investors, who don’t have to show fraudulent intent.) Section 11 includes three means of calculating damages. If investors sold their securities before bringing suit, their damages are the difference between what they paid for the stocks or bonds and the price the securities fetched. If they’re still holding their investment on the day the suit is filed, damages are defined as the difference between what they paid and the value of the securities on the filing date. If they sell while the litigation is underway, they’re permitted to claim the lesser of those two amounts.

That sounds simple, but when you’re trying to calculate the value of notes belonging to thousands of investors who bought and sold at different times in the illiquid MBS market, it’s not. Bernstein Litowitz and its experts did the next best thing. According to a table at the end of this exhibit to the memo in support of settlement, the class estimated the value of each tranche of every one of the 18 offerings in the class action had lost. (The table expresses the value of each MBS tranche on the day the suit was filed as a percentage of the offering price; so, for example, the most senior tranche in the table’s first-listed MBS offering was worth 58.26 percent of its par value on the day the suit was filed, while the lowest tranche was worth only 1.38 percent of its offering price.) The chart doesn’t tally up total losses based on the difference between the offering value and the value on the filing date, but Bernstein Litowitz said in the settlement memo that the calculation “amounts to billions of dollars in the aggregate.”

Why Judge Koh nixed Apple bid to bar Samsung phones and tablets

Alison Frankel
Dec 6, 2011 13:58 UTC

The standard for U.S. judges to grant a preliminary injunction is notoriously high. Plaintiffs have to show that they’re likely to succeed on the merits; that they’ll suffer irreparable harm if the injunction isn’t granted; that the injunction is in the public interest; and that the balance of fairness supports awarding the bar. In patent cases, the analysis of likely success on the merits offers two outs for defendants: they can show that the plaintiffs’ patent probably isn’t valid or that they didn’t infringe it. In other words, there’s a long list of reasons for a judge to refuse to grant a preliminary injunction (which is one reason why so many patent holders also seek injunctions overseas).

In the most consequential injunction case of the moment — Apple’s attempt to bar sales of three Samsung smartphones and Samsung’s new Galaxy tablet — U.S. District Judge Lucy Koh of San Jose federal court picked reasons from all over the no-injunction menu as she refused late Friday to grant the injunction. (Here’s the Reuters story from Dan Levine.) There’s no real theme running through Koh’s decision, which analyzes each asserted patent and each allegedly infringing product. That’s frustrating for anyone hoping to find a broader meaning for smartphone litigation in her ruling, but it gives Apple and Samsung a pretty clear indication of how they’re likely to fare as the merits case moves forward.

Apple asserted that two Samsung phones — the Galaxy 4G and Infuse 4G — infringe two Apple design patents. Based on the precedent established by the U.S. Court of Appeals for the Federal Circuit in a case called Egyptian Goddess v. Swisa, Koh applied an “ordinary observer” test to evaluate infringement. She concluded that although it is “a close question,” an ordinary observer would likely find Samsung’s Galaxy and Infuse phones infringe Apple’s patent on a flat, black, rectangular smartphone with a translucent face. She found that under the Durling v. Spectrum Furniture test for obviousness, Samsung was likely to succeed in challenging one of Apple’s smartphone design patents as invalid — but she found Samsung had not raised substantial questions about the validity of the other patent.

Agency scourge Gene Scalia to challenge CFTC’s swaps regulation

Alison Frankel
Dec 5, 2011 23:51 UTC

You don’t have to look very hard for an explanation of why two industry trade groups hired Eugene Scalia of Gibson, Dunn & Crutcher to bring their suit to block the Commodity Futures Trading Commission from enforcing a new rule limiting commodity speculation through derivatives trading. In July, Scalia won a ruling from the U.S. Court of Appeals for the District of Columbia that struck down the Securities and Exchange Commission’s Dodd-Frank-mandated rule requiring corporations to provide stockholders with access to proxy materials on shareholder-nominated board nominees. (The SEC subsequently announced it wouldn’t appeal the ruling.) Nor was the proxy-access victory Scalia’s first whack at federal agency rule-making: he’s managed to overturn two previous SEC rules (see here and here); mounted a landmark challenge to Sarbanes-Oxley whistleblower protections; and won cases striking down a pair of laws requiring certain employers to provide employees with health benefits. For business groups that consider themselves overregulated, Scalia is the man to see.

The suit against the CFTC, filed by the International Swaps and Derivatives Association and the Securities Industry and Financial Markets Association, or SIFMA, isn’t a surprise. The new rule, which sets strict limits on derivative contracts tied to 28 commodities, is supposed to curb speculation. The CFTC, which passed the rule by a 3-2 vote, took the position that Congress required the agency to enact the regulation in Dodd-Frank. But as Reuters has reported, banks and brokerages have fiercely opposed the rule since it was proposed. “Affected parties have been watching from the start,” said Scalia, who declined to specify when the trade groups hired Gibson to litigate.

Friday’s complaint asserts that the CFTC “grossly misinterpreted its authority,” arguing that Congress instructed the agency to set position limits only if the CFTC concluded they were necessary to control speculative trading. The trade groups alleged that the agency found no such evidence; even one of the commissioners who ultimately voted in favor of the new rule, according to the complaint, said at a public hearing that, “No one has presented this agency any reliable economic analysis to support either the contention that excessive speculation is affecting the market we regulate or that position limits will prevent the excessive speculation.”

What FCPA defendants can learn from blockbuster Lindsey win

Alison Frankel
Dec 5, 2011 15:55 UTC

In the run-up to the first trial of a corporation charged with violating the Foreign Corrupt Practices Act, Lindsey Manufacturing and its lead counsel, Jan Handzlik, put up as vigorous a defense as you can imagine. Handzlik (then at GreenbergTraurig and now at Venable) worked with Janet Levine of Crowell & Moring (counsel for Steve Lee, Lindsey’s former CFO) to challenge the government’s conduct, its evidence, even its interpretation of the FCPA’s language. It was to no avail. In May, after a five-week trial and seven hours of deliberation, a Los Angeles federal jury convicted Lindsey Manufacturing, chairman and CEO Keith Lindsey, and CFO Lee on all counts. For Handzlik and Levine, who were convinced the prosecution’s allegations that their clients funneled bribes to officials of a Mexican state-owned electric company were meritless, the conviction was devastating.

So you can image their joy Thursday, when U.S. District Judge A. Howard Matz in Los Angeles vacated the convictions and threw out the indictment against their clients. Matz dismissed the government’s case with prejudice, which means that unless the U.S. Court of Appeals for the Ninth Circuit overturns his ruling, the Lindsey defendants cannot be recharged.

Matz based his decision on numerous examples of government misconduct, beginning with falsehoods in search-and-seizure warrant applications, extending to false and misleading grand jury testimony by an FBI agent, and compounded by prosecutors’ failure to turn over some of that testimony to the defense. Handzlik, Levine, and their teams had alerted the judge to much of the misconduct before the jury reached a verdict, but Matz said the magnitude of the government’s behavior became clear only in retrospect.

Bond insurers drop MBS letter bomb on UBS

Alison Frankel
Dec 2, 2011 15:44 UTC

Last month, as U.S. banks began reporting their third-quarter financials, I noted that the banks had beefed up their disclosure of potential liability for mortgage-backed securities activity. Morgan Stanley revealed that it had received a demand letter from Gibbs & Bruns, the firm that represents the big funds that negotiated the proposed $8.5 billion MBS breach-of-contract settlement with Bank of America. Goldman upped its reported MBS exposure to $15.8 billion, from a mere $485 million in the second quarter. The new emphasis on disclosure, I said, was partly the result of more claims, but also partly due to pressure from the Securities and Exchange Commission and the Public Company Accounting Oversight Board to improve MBS disclosures.

The bond insurers’ trade group, the Association of Financial Guaranty Insurers, has also been agitating for banks to acknowledge their MBS exposure — and particularly their exposure to MBS breach-of-contract (or put-back) claims. In September 2010 AFGI sent a blistering letter asserting that Bank of America’s MBS put-back liability to its members was more than $10 billion. This September the bond insurers targeted Credit Suisse, which, according to AFGI, had failed to account for billions in put-back claims.

Late Wednesday AFGI struck again. The recipient this time was UBS. According to the letter AFGI sent to UBS CEO Sergio Ermotti, the Swiss bank has reported a $93 million reserve for put-back claims in its most recent financial report — even though it has received more than $800 million in put-back claims from just one bond insurer, and that insurer (presumably Assured Guaranty) has indicated its intention of demanding a total of $4 billion in put-backs from UBS.

Rakoff’s rules: What if other judges did it?

Alison Frankel
Dec 1, 2011 14:59 UTC

On Tuesday, as you probably heard, Facebook reached a settlement with the Federal Trade Commission to resolve allegations that it deceived users about how it used their personal information. Facebook CEO Mark Zuckerberg said publicly that “we made a bunch of mistakes.” But you won’t find any such admission in Facebook’s proposed settlement agreement with the FTC. In that document, Facebook “expressly denies the allegations set forth in the [FTC] complaint.”

There’s a similar denial of wrongdoing from Merck, which last week reached a $950 million resolution of the Justice Department’s civil and criminal allegations that it falsely marketed the painkiller Vioxx. Even though Merck pled guilty to a misdemeanor violation for off-label marketing and agreed to pay a $322 million criminal penalty, the company said it wasn’t admitting liability or wrongdoing in the civil portion of the DOJ settlement, for which it agreed to pony up $628 million.

Over at the Commodity Futures Trading Commission, meanwhile, regulators obtained a $24 million settlement in early November with a North Carolina company called Queen Shoals. But if you check out the Queen Shoals consent order entered by a North Carolina federal judge, you’ll see that the defendants “neither admit nor deny” the CFTC’s allegations. And in the Federal Depositors Insurance Corporation’s most recently disclosed enforcement agreement, an October 20 settlement with the First Community Bank of Santa Rosa, Calif., the bank resolved allegations “without admitting or denying any [FDIC] charges of unsafe or unsound banking practices.”

  •