Opinion

Alison Frankel

Fait accompli: the securities defense bar’s favorite new weapon

Alison Frankel
Aug 13, 2012 22:09 UTC

On Friday, U.S. District Judge Deborah Batts dismissed a securities class action against Deutsche Bank and its underwriters on a $5.6 billion offering of preferred securities. The judge ruled on a defense motion for reconsideration that under the 2nd Circuit Court of Appeals’ 2011 ruling in Fait v. Regions Financial, the defendants’ valuation of Deutsche Bank’s exposure to subprime mortgages was an opinion, and the plaintiffs couldn’t show that the defendants didn’t believe that opinion when offering materials were published. Batts’s ruling was a big win for Deutsche Bank’s lawyers at Cahill Gordon & Reindel and the underwriting syndicate’s counsel at Skadden, Arps, Slate, Meagher & Flom.

It’s also the latest indication that as Fait approaches its one-year anniversary on Aug. 23, it’s shaping up to be one of the most powerful tool for securities defendants since Morrison v. National Australia Bank. In Fait, 2nd Circuit judges Rosemary Pooler, Barrington Parker and Raymond Lohier held that statements in offering materials about an issuer’s goodwill and loan loss reserves are not matters of objective fact, but opinions. And as opinions, they can’t be the basis of liability under the Securities Act unless investors can show that defendants didn’t actually believe what they were saying when they said it. “When a plaintiff asserts a claim under Section 11 or 12 [of the Securities Act] based upon a belief or opinion alleged to have been communicated by a defendant,” Parker wrote for the panel, “liability lies only to the extent that the statement was both objectively false and disbelieved by the defendant at the time it was expressed.”

That language raised the bar for investors, and some cases haven’t been able to clear it. You want examples? In July, U.S. District judges Denise Cote and William Pauley both cited Fait in opinions dismissing investor claims, Pauley in a partial dismissal of a case claiming Bank of America misrepresented its liability for breaches of representations on mortgage-backed securities and Cote in refusing to permit investors to file a new complaint against General Electric in connection with $12 billion in stock offerings. In February, U.S. Magistrate Judge Henry Pitman of Manhattan cited Fait in recommending the dismissal of another class action against BofA, this one involving alleged misrepresentations in three 2008 stock offerings. According to a Westlaw search, Fait has been cited in more than 50 trial and appellate court briefs in securities cases since last August, so we should be seeing more decisions based on Fait in coming months.

The ruling isn’t a free pass for defendants facing claims under the Securities Act of 1933. In the Federal Housing Finance Agency’s case against UBS, for instance, Cote refused in May to dismiss allegations that the bank misled mortgage-backed securities investors about the quality of underlying loans, rejecting Fait arguments by UBS’s lawyers at Skadden. “There is dictum in Fait that superficially supports defendants’ claims,” she wrote, noting “confusion” about the 2nd Circuit’s holding. ” upon closer examination of that decision and its reasoning,” Cote continued, “the court is convinced that [the FHFA] has the better of the argument.” Similarly, in June U.S. District Judge Shira Scheindlin denied the credit rating agencies’ Fait-based motion to reconsider her refusal to dismiss a special purpose vehicle investor’s negligent misrepresentation claims.

But the 2nd Circuit believes so strongly in the decision that in May, in a per curiam ruling, the appellate court extended its reasoning in Fait from claims under the Securities Act to fraud claims under the Exchange Act of 1934. “Even if the [plaintiffs'] second amended complaint did plausibly plead that defendants were aware of facts that should have led them to [revise accounting], such pleading alone would not suffice to state a securities fraud claim after Fait,” the 2nd Circuit said in City of Omaha v. CBS. “Plaintiffs’ second amended complaint is devoid even of conclusory allegations that defendants did not believe in their statements of opinion regarding CBS’s goodwill at the time they made them.”

Federalism fight in Stockton’s Chapter 9

Alison Frankel
Aug 11, 2012 05:15 UTC

Municipal bankruptcies under Chapter 9 of the federal bankruptcy code are such rarities that every case seems to pose issues of first impression. There was the question of who bore the burden of showing Bridgeport, Connecticut, was insolvent in 1991; the breaking of a collective bargaining agreement in Vallejo, California, in 2009; and being too big for bankruptcy protection in a botched bid by Harrisburg, Pennsylvania, last fall. The same is true of the doozy of a legal fight brewing between the California Public Employees’ Retirement System and the bond insurers MBIA and Assured Guaranty in Stockton, California. Before this case is over, we should know whether the federal bankruptcy code trumps state constitutional protection for pension benefits.

This week, both MBIA and Assured filed objections to Stockton’s Chapter 9, arguing that the city is not eligible for protection from its creditors under the plan it has filed with the federal bankruptcy court in Sacramento. The bond insurers, which are responsible for making good on any shortfalls between what certain municipal bondholders were promised and what Stockton delivers, made slightly different but substantially overlapping arguments. MBIA’s lawyers at Winston & Strawn asserted in a 23-page brief that Stockton did not negotiate in good faith with its creditors and did not file its Chapter 9 petition in good faith. Assured, represented by Sidley Austin, added an argument in its 25-page brief that Stockton does not meet the definition of insolvency.

At the heart of both insurers’ objections is CalPERS, the pension system that is Stockton’s biggest unsecured creditor. According to MBIA, Stockton’s obligation to CalPERS totals $245 million over the next 10 years. Yet Stockton made no attempt to negotiate a reduction in that obligation with CalPERS before filing its bankruptcy petition, according to both bond insurers. Nor does the city’s proposed plan for resolving its financial shortfall call for any reduction in what Stockton owes CalPERS. Instead, the bond insurers argue, Stockton wants to shift a disproportionate share of the pain of its financial problems onto bondholders (and, by extension, to the insurers). That not only makes Stockton’s Chapter 9 filing an exercise in bad faith, according to MBIA and Assured, but also means the city won’t be able to solve its problems through bankruptcy. The $10 million or so Stockton will save on the backs of bondholders, plus other savings the plan proposes, won’t be enough to satisfy the city’s pension obligations, the insurers argued.

Hedge funds dodge Morrison in state-court case against Porsche

Alison Frankel
Aug 10, 2012 19:29 UTC

In what appears to be the first example of securities plaintiffs getting a green light to litigate in state court after their federal court case was bounced under the U.S. Supreme Court ruling in Morrison v. National Australia Bank, New York State Supreme Court Justice Charles Ramos ruled Wednesday that several hedge funds can proceed with claims that they lost more than $1 billion as a result of Porsche’s allegedly deceptive manipulation of the market for Volkswagen shares in 2008. But the 22-page opinion isn’t just good news for investors with fraud claims against foreign defendants. It’s also a rare judicial boost for so-called sophisticated investors, who’ve been smacked down this year by New York state and federal appeals courts.

The hedge funds originally sued Porsche in federal court in Manhattan, claiming that Porsche deceived them and the rest of the market when it denied intentions to buy up more than a simple majority of Volkswagen shares. Based on those reports – and significant additional due diligence – the hedge funds shorted Volkswagen, believing its share price to be inflated. When Porsche subsequently announced its intention to buy up essentially all of the Volkswagen shares on the open market in a takeover bid, the price skyrocketed and the short-sellers were squeezed. Their lawyers – including Bartlit Beck Herman Palenchar & Scott; KleinbergKaplan, Wolff & CohenDowd Bennett; and Quinn Emanuel Urquhart & Sullivan – asserted state-law fraud as well as federal securities claims, but when U.S. District Judge Harold Baer ruled in 2010 that the securities claims were barred by Morrison, he dismissed the entire case.

The hedge funds then refiled the fraud claims in state court, blazing a path that other Morrison refugees have since traveledJ.B. Heaton of Bartlit Beck, who represents Glenhill Capital, Greenlight Capital, Royal Capital and Tiger Global in this case, said that the state-court route doesn’t make sense for every securities plaintiff bounced out of federal court, since, generally speaking, investors can’t band together in a securities class action in state court. But for investors like his clients, who have sizable damages claims and the resources to litigate them, state court presented a viable alternative forum.

Sheldon Adelson and the fine art of libel litigation

Alison Frankel
Aug 9, 2012 14:57 UTC

When it comes to making good on threats to sue his detractors for libel, Las Vegas gaming mogul Sheldon Adelson puts his money where his mouth is. And given that he has $24.9 billion as of the last accounting by Forbes, the Republican money man can afford to have a very big mouth. On Tuesday, his lawyers at Wood, Hernacki & Evans and Olasov & Hollander filed a complaint in federal court in Manhattan against the Jewish Democratic Council, seeking $60 million, based on assertions that the group libeled Adelson when it repeated unfounded claims that he abetted prostitution at his resort in Macau.

Adelson’s complaint said the only source of that allegation is a disgruntled former employee with whom the mogul is also engaged in multifaceted litigation — including a libel suit Adelson brought against the former employee, Steven Jacobs, in state court in Miami. (Kendell Coffey of Coffey & Wright filed that one in July, according to court records.) In between the two recent libel suits, Adelson counsel Lewis Clayton of Paul, Weiss, Rifkind, Wharton & Garrison wrote a threatening letter about the prostitution allegations (as well as claims Adelson has ties to the Chinese mafia) to the Democratic Congressional Campaign Committee, which soon thereafter issued an abject apology to Adelson.

Are you beginning to see a pattern? Libel suits are a relative rarity, even by rich celebrities. Adelson, on the other hand, brought at least three previous libel cases before the recent crop, always using top firms or celebrity lawyers like Kendall Coffey and Lin Wood to hunt down his alleged defamers.

Blame Standard Chartered in-house lawyers in money-laundering mess

Alison Frankel
Aug 8, 2012 14:35 UTC

In June of 1995, Standard Chartered Bank’s general counsel in London sent an email to the bank’s compliance officer that “embraced a framework for regulatory evasion,” according to the case against Standard filed Monday by New York’s top financial regulator. The GC’s email was allegedly in response to a U.S. executive order imposing economic sanctions against Iran and prohibiting U.S. banks from converting Iranian wire transfers into dollars. But the Standard GC, working with the bank’s compliance staff, suggested that the bank simply cut its American operation out of the loop. Even if regulators figured out that Standard’s London headquarters was evading the U.S. executive order, the GC allegedly wrote in a “highly confidential” email, “there is nothing they could do.”

That sort of evasion and obfuscation typifies the Standard Chartered legal department’s attitude toward U.S. restrictions on Iranian dollar transfers, at least as the in-house lawyers are depicted in the New York regulator’s filing. The New York Department of Financial Services described a legal department that not only looked the other way when the bank enacted a system to work around restrictions on dollar transfers to and from Iranian clients but even ignored a warning from outside counsel that the work-around violated U.S. banking regulations. A Standard Chartered spokeswoman declined to comment specifically on the regulator’s allegations about the bank’s legal department, directing me instead to the statement Standard issued Monday night, rejecting the allegations by New York regulators. Nevertheless, if the New York account is correct – and it does appear to be backed by internal bank documents – Standard Chartered is an object lesson in how in-house lawyers can fail their clients by refusing to say no.

The GC in 1995 – who is unnamed in the DFS filing, like all of the Standard Chartered lawyers mentioned in the order – suggested that the bank might refer certain prohibited currency transfer business to National Westminster Bank, which “would expose to a penalty” if it breached the regulations Standard was trying to evade. There’s no indication in the regulator’s filing that Standard ever acted on the 1995 email from the general counsel, but in March 2001 the bank’s Group Legal Advisor informed bank officers that “our payment instructions [for Iranian clients] should not identify the client or the purpose of the payment.”

New study says SEC revolving door not important. Don’t believe it.

Alison Frankel
Aug 7, 2012 15:13 UTC

My hat is off to the four authors of a new study called “Does the Revolving Door Affect the SEC’s Enforcement Outcomes?” which was to be presented Monday at the American Accounting Association. As the New York Times was the first to report, researchers from Emory, Rutgers, the University of Washington and Singapore’s Nanyang Technological University set out to reach a quantitative answer to a question everyone thinks they already know the answer to. Instead, the study found that there’s no measurable impact on enforcement from lawyers moving in and out of the SEC.

I wasn’t surprised that there’s scant statistical evidence of ambitious lawyers at the Securities and Exchange Commission punting on cases to curry favor with future clients; most SEC lawyers expect to go work for law firms, and firms like to hire regulators with a reputation for toughness, not laxity. (Remember the bidding wars for former Enron prosecutors?) But I was taken aback by a secondary finding in the study: Firms with a high concentration of SEC alumni don’t achieve measurably better results than other firms for clients in enforcement actions. That should cause some eyebrows to rise among the clientele of firms like Wilmer Cutler Pickering Hale and Dorr and Paul, Weiss, Rifkind, Wharton & Garrison, which pride themselves on offering clients counsel based on the collective experience of their corps of SEC alums. If clients really aren’t faring any better when they hire firms with specialized SEC enforcement defense practices, why bother to pay for their experience?

But there’s one big reason to take that aspect of the study with a grain of salt. It comes down to the inability of even the most nuanced statistical analysis to measure the unmeasurable.

Shell: Alien Tort Statute not meant for international human rights

Alison Frankel
Aug 3, 2012 01:36 UTC

The first case the U.S. Supreme Court will hear when the justices return in October is a reprise of Kiobel v. Royal Dutch Petroleum, which the high court originally heard in February but tossed back to the parties for rebriefing. The new question before the high court is this: Does the Alien Tort Statute, passed as part of the Judiciary Act of 1789 and revived from obscurity in the 1990s to become a tool of international human rights advocates, apply to conduct that took place outside of the United States? For the human rights community, this is a do-or-die moment. The Alien Tort Statute, which holds simply that federal courts may hear “any civil action by an alien for a tort only, committed in violation of the law of nations or a treaty of the United States,” has become a means for victims to seek retribution from perpetrators and abettors of atrocities. The stakes are so high that the State Department’s legal adviser, former human rights litigator Harold Koh, refused to sign the Justice Department’s recent amicus brief advocating certain limits on the ATS’s reach overseas.

Late Wednesday, Royal Dutch’s corporate successor, Shell Petroleum, filed its brief on the extraterritorial application of the ATS. You will not be surprised to hear that Shell’s lawyers at Quinn Emanuel Urquhart & Sullivan cite Morrison v. National Australia Bank in arguing that because the 1789 law makes no mention of extraterritorial application, it’s presumed not to extend to conduct on foreign soil. To answer arguments by the Kiobel plaintiffs that the ATS was specifically drafted to address piracy claims, which, by definition, involve offshore conduct, Shell contended that the high seas are not the same as foreign soil since no nation is sovereign in international waters.

Shell’s brief, elegantly written by former Stanford Law School Dean Kathleen Sullivan, goes quite a bit further, though. It implies that federal appeals courts have erred in rulings that permitted the Alien Tort Statute to be asserted by victims of overseas acts that allegedly violate the “law of nations.” It’s Congress’s job to decide how far its laws extend, Shell argued, and Congress has shown its willingness to extend the reach of some laws, including a civil cause of action against terrorists, to conduct on foreign soil. So if Congress wants the Alien Tort Statute to have the same reach, it should amend the law. Or if it wants some other human rights law to take the place of the ATS, it can pass one.

The Stoker verdict and Citi’s settlement with the SEC

Alison Frankel
Aug 2, 2012 15:10 UTC

If you’re the Securities and Exchange Commission, it’s tough to find a silver lining in Tuesday’s jury verdict for Brian Stoker, a onetime midlevel banker at Citigroup. Not only did the eight jurors in federal court in Manhattan determine that Stoker was not liable for misleading investors in a $1 billion collateralized debt obligation, they also offered a backhanded slap at the SEC. “This verdict should not deter the SEC from continuing to investigate the financial industry, to review current regulations, and modify existing regulations as necessary,” the jury said in a highly unusual note accompanying the verdict. For the SEC, which has been roundly criticized for its failure to bring civil charges against executives implicated in the financial crisis, the jury’s note has to read like one more reminder that the public is still waiting for corporate accountability.

But, ironically, the verdict could improve the odds of a 2nd Circuit Court of Appeals ruling that U.S. Senior District Judge Jed Rakoff improperly rejected the SEC’s $285 million settlement with Citi in the agency’s parallel suit against the bank.

As you probably recall, the appeals court has already expressed considerable skepticism about Rakoff’s decision last November to reject the settlement. At the time, Rakoff said he had the right to determine whether the deal was in the public interest. And it wasn’t, he said, because Citi hadn’t acknowledged wrongdoing and was paying what amounted to “pocket change” to make the SEC case go away. The truth matters, Rakoff said in his opinion, and for all he and the public knew, the truth of this case could be that Citi hadn’t actually done anything wrong. For good measure, Rakoff ruled in December that the SEC must proceed with its case even though the agency and Citi filed a joint appeal of his November ruling to the 2nd Circuit.

The megabillions tax claims facing Fannie Mae and Freddie Mac

Alison Frankel
Aug 1, 2012 00:02 UTC

We all know that the foreclosure crisis has been a disaster for state and county governments. When homeowners lose their houses, they stop paying property taxes, which is one of the reasons why municipal governments have been driven to consider ideas like seizing underwater mortgages through the use of eminent domain. We’ve also seen state and local officials file lawsuits against the Mortgage Electronic Registration Systems, claiming that MERS and its member banks have cheated governments out of mortgage recording fees in the securitization process. MERS has had mixed results in shutting down those cases but so far hasn’t been found liable.

There’s another tranche of litigation that’s gotten much less attention but could result in billions of dollars for state and county governments, courtesy of Fannie Mae and Freddie Mac, the government-sponsored mortgage guarantors that have taken ownership of thousands and thousands of foreclosed homes. The Judicial Panel on Multidistrict Litigation is weighing a motion to consolidate 23 suits from around the country that claim Fannie and Freddie owe real estate transfer taxes on foreclosed homes they resold. The total exposure for Fannie and Freddie, which are now in federal conservatorship, hasn’t been publicly tabulated, but in the two cases that sparked the MDL motion, the Michigan attorney general and the county government of Oakland, Michigan, claimed that Fannie and Freddie owe millions in transfer taxes just to Oakland County. Class actions already on the dockets have asserted claims on behalf of 13 states, but according to a consolidation motion filed by Genesee County, Michigan, 35 states have real estate transfer tax statutes that could be asserted against Fannie and Freddie. I’d be surprised if most of them (including California and Nevada, which haven’t yet brought cases) don’t end up filing claims.

Fannie and Freddie, which are represented at the JPMDL by King & SpaldingFoley & Lardner and Arnold & Porter, argued in the Michigan litigation that they are exempt from all state taxes by the federal charters that created them. But in a summary judgment ruling in March, U.S. District Judge Victoria Roberts of Detroit said the transfer tax is an excise fee that’s not covered by the charter exemption. She also said Fannie and Freddie are not “federal instrumentalities,” so they’re not shielded by a Michigan law exempting government entities from taxation. The judge granted the county and state summary judgment on Fannie and Freddie’s excise tax liability. (Lawyers for Fannie and Freddie have asked the 6th Circuit Court of Appeals to take an interlocutory appeal of the ruling.)

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