Alison Frankel

Corporate criminals beware: Morgan Stanley wants to make you pay

Alison Frankel
Nov 13, 2012 23:32 UTC

In April 2011, Morgan Stanley paid $32 million to resolve a Securities and Exchange Commission case against Joseph “Chip” Skowron, the Morgan Stanley hedge fund manager who pled guilty to insider trading charges in August 2011. Skowron, who trained as a physician, ran a healthcare hedge fund called FrontPoint, which Morgan Stanley acquired in 2006. Over the next four years, until he was fired in December 2010, Skowron earned more than $32 million from Morgan Stanley, which also fronted almost $5 million in legal fees to defend its erstwhile trading star before he finally admitted his guilt.

Morgan Stanley believes that Skowron owes the bank all of that money: the legal fees, the compensation and the cost of the SEC settlement. In an unusual complaint filed in federal court in Manhattan on Oct. 31 (but first disclosed Nov. 9), Morgan Stanley’s lawyers at Marino, Tortorella & Boyle asserted that Skowron was a faithless employee who defrauded Morgan Stanley, breaching his employment contract and his fiduciary duty. That misconduct, the bank argued, entitle Morgan Stanley to recover from Skowron every penny that his insider trading cost the bank.

It’s not unusual for employers (or their insurers) to demand repayment of the legal fees they put up for defendants who turned out to be guilty; in a piece last June on Goldman Sachs footing the legal bill for former director Rajat Gupta, Peter Lattman of The New York Times reported on several examples of white-collar legal fee reimbursement cases, including Hollinger’s suit against former chairman Conrad Black and Computer Associates’ claim against former CEO Sanjay Kumar. Since indemnification agreements often feature a repayment provision in the event of a conviction or guilty plea, suits to recover legal fees make sense as long as you’re suing someone who still has assets. But demanding repayment of compensation — and especially demanding repayment of the cost of an SEC settlement — is quite rare. In fact, Karen Mariscal of White and Williams, who represents D&O insurers seeking to recoup legal fees from convicted defendants, told me she has never before seen a case in which a former employer (or insurer) sues for repayment of the cost of an SEC settlement.

There is precedent for Morgan Stanley’s demand, but it comes from the bank’s own previous attempt, in Skowron’s criminal proceeding, to recoup the cost of the SEC settlement. That’s right: This is Morgan Stanley’s second crack at Skowron. The civil suit is a reformulation of arguments the bank already made earlier this year before U.S. District Judge Denise Cote of Manhattan, when it claimed $44 million in restitution, including the $32 million cost of the SEC settlement, as a purported victim of Skowron’s crimes.

In a thoughtful 28-page opinion in March, Cote found Morgan Stanley was indeed a victim of Skowron’s insider trading. She awarded the bank $3.8 million for Skowron’s defense fees and $6.4 million (or 20 percent) of his compensation, calculating that Skowron had deprived Morgan Stanley of his honest services. The judge denied Morgan Stanley’s claim to repayment of the SEC settlement, however. She said that the money Morgan Stanley paid to the SEC represented the losses Skowron avoided when he dumped stock based on inside information. Morgan Stanley was never entitled to that $32 million, Cote wrote, and permitting the bank to recover it would undermine the public interest in disgorgement.

New cert petition: End bar on direct corporate campaign giving

Alison Frankel
Nov 13, 2012 00:17 UTC

In the age of extravagant spending by Super PACs and politically active non-profits like the U.S. Chamber of Commerce, why do our election laws still distinguish between independent political expenditures by business interests — which are permissible under the U.S. Supreme Court’s 2010 ruling in Citizens United v. Federal Election Commission – and direct corporate donations to candidates, which remain illegal?

As the post-election discussion of the impact of spending by outside pro-business groups rages ona new petition for Supreme Court review argues that if corporations have a First Amendment right to support candidates indirectly, that same right should extend to direct contributions to political campaigns.

The petition was filed by Williams Danielczyk, who, as we’ve reported, is facing criminal prosecution for funneling corporate funds to Hillary Clinton in her 2006 and 2008 campaigns. Last year, U.S. District JudgeJames Cacheris of Alexandria, Virginia, dismissed that part of the federal indictment against Danielczyk and co-defendant Eugene Biagi, ruling that the bar on direct corporate campaign contributions is unconstitutional under the Supreme Court’s reasoning in Citizens United. But in June, the 4th Circuit Court of Appeals reversed, holding that the controlling precedent on direct corporate campaign contributions is not Citizens United but the Supreme Court’s 2003 ruling in Federal Election Commission v. Beaumont, in which the justices said explicitly that corporations do not have a First Amendment right to contribute directly to political candidates.

Banks should fear ominous new rulings in Fannie/Freddie MBS cases

Alison Frankel
Nov 9, 2012 23:19 UTC

JPMorgan Chase filed quite a remarkable quarterly report with the Securities and Exchange Commission on Thursday, crammed with far more details about its exposure to litigation and mortgage repurchase demands than the earnings report the bank issued in mid-October. Among the revelations: JPMorgan has reached an agreement in principle to settle two SEC investigations, one involving a single unidentified JPMorgan securitization, the other involving Bear Stearns’s crafty (alleged) trick of keeping put-back recoveries from mortgage originators for itself instead of passing them on to investors in mortgage-backed securities trusts. The SEC deal has been long rumored, and though we still don’t know any of its terms, the bank’s filing confirms it.

JPMorgan also disclosed that it is now facing put-back claims, in one form or another, on $140 billion in mortgage-backed notes. Yes, you read that right: $140 billion. That doesn’t mean there are $140 billion in claims, but it means that holders of $140 billion in MBS notes have asserted, in litigation or through contractual demands, that the bank must buy back deficient mortgages in their trusts. Given that MBS investors generally claim breach rates in excess of 50 percent, JPMorgan’s exposure to mortgage put-backs is tens of billions of dollars.

The bank, of course, thinks the put-back demands are meritless and its entire litigation exposure is a trifling matter. The SEC filing’s 10-page discussion of the various litigation headaches facing JPMorgan — which include really serious matters, such as the securities class action over its CIO losses, various Libor suits and the Federal Energy Commission’s market manipulation case – begins with the brash assertion that the bank’s “reasonable possible losses” in all of this litigation (aside from its litigation reserves) range from zero dollars to $6 billion.

Can customers sue power companies for outages? Yes, but it’s hard to win

Alison Frankel
Nov 9, 2012 00:13 UTC

Scott Kreppein of Hagney, Quatela, Hargraves & Mari lives and works on Long Island, where about 90 percent of the customers of the Long Island Power Authority lost power in last week’s storm. Kreppein still doesn’t have electricity or heat at his house in Smithtown. Last week he got by on flashlights and a small gas-powered generator. Over the weekend, he and his wife fled to a hotel in Pennsylvania, and since they came back home, they’ve been living with relatives who have heat and light. Kreppein, in other words, has a personal interest in holding LIPA accountable for any failures in its restoration of power across Long Island.

But Kreppein also knows that the odds are very low of establishing LIPA’s liability through a class action by disgruntled customers of the power company. In 2006, when he was working at Morelli Ratner, Kreppein represented several businesses in Queens, New York, that sued Consolidated Edison in state court for millions of dollars in damages that resulted from a week-long blackout in Astoria, Woodside and neighboring communities. According to Kreppein, there’s nothing barring customers — whether they’re businesses or individual ratepayers — from bringing such suits against power companies, even though utilities are state-regulated. To win, however, New York ratepayers have to show that their power company was not just slow or inefficient. Instead, Kreppein said, under a 1985 New York Court of Appeals ruling called Strauss v. Belle Realty, electric company customers must establish that the utility was grossly negligent — that its conduct was way outside the bounds of reasonableness.

In the Queens power outage case, that question was not answered in court. Litigation over Con Ed’s alleged negligence proceeded alongside an investigation by the New York Public Service Commission, which regulates power companies and other utilities. With intense pressure from politicians and local activists accelerating the process, Con Ed reached a global settlement in 2008, agreeing to put up $17 million for affected homes and businesses and to waive rate increases intended to pay for $40 million in plant repairs associated with the blackout.

Election results raise questions about impact of Citizens United

Alison Frankel
Nov 8, 2012 15:32 UTC

Fewer than one million people live in the great state of Montana, where per capita income in 2010 was less than $25,000. Now try to guess how much money Super PACs and politically involved non-profits spent on the race for a U.S. Senate seat in Montana in the 2012 election cycle. Would you believe $25 million? According to the most recent data assembled by The Center for Public Integrity, Republican challenger Denny Rheberg attracted $11.9 million in outside spending on his campaign, slightly less than the $12.8 million in outside money that went to the Democratic incumbent, Jon Tester. Do the math: That’s more than $25 per voter, in an outlay that significantly added to Montana’s bottom line. In neighboring North Dakota, population 684,000, candidates Heidi Heitkamp (Democrat) and Rick Berg (Republican) attracted $16 million in outside spending in their race to fill an open Senate seat.

Both races were squeakers, but as of Wednesday afternoon, both Tester and Heitkamp appear to have won Senate seats, providing two more important data points along the trend line that’s emerging from the 2012 campaign results: Despite the U.S. Supreme Court’s unleashing of corporate campaign spending in its 2010 ruling in Citizens United v. Federal Election Commission, big business does not seem to be able to buy elections. That conclusion contradicts the doomsday predictions that followed Citizens United and the 2010 campaign cycle.

The number crunching has only just begun, but Public Integrity tracked results in the Senate and House races that attracted the most outside spending from Super PACs and non-profits. In most of the contests, Democrats matched Republicans in outside spending, which suggests that business groups aren’t the only special interests engaged in serious campaign contributions. That’s good news for anyone concerned about the influence of big business on political campaigns. Here’s more: According to Public Integrity’s early data, there isn’t a clear correlation between outside spending and election results. In the Florida Senate campaign, for instance, Republican challenger Connie Mack attracted vastly more outside money ($15.2 million) than Democratic incumbent Bill Nelson ($4.8 million), in one of the few lopsided contests for outside dollars on the Public Integrity list. Yet for all his outside support, Mack lost. In another relatively lopsided contest, the Illinois congressional candidate Judy Biggart, a Republican, received $4.7 million in outside support, compared to the $2.5 million incumbent Bill Foster received. But Foster won the seat.

How Apple botched its fair rate case against Motorola

Alison Frankel
Nov 6, 2012 23:50 UTC

I know Apple is a brilliantly managed company represented by brilliant outside counsel. But I cannot for the life of me figure out Apple’s endgame strategy in its breach-of-contract case against Motorola in federal court in Madison, Wisconsin.

Apple had a chance to mitigate Google’s leverage from Motorola’s standard-essential patents in the smartphone wars. Instead, it squandered more than 18 months of litigation, refusing on the eve of trial to agree to abide by the court’s determination of a fair and reasonable royalty rate for Motorola’s IP unless U.S. District Judge Barbara Crabb set a rate of no more than $1 per iPhone. As a result, Crabb dismissed Apple’s case Monday, on the day she was to have begun a bench trial on Apple’s breach-of-contract claim. Her ruling means Apple may not be able to bring similar claims against Motorola in any other U.S. court, which robs the iPhone maker of powerful leverage in the global smart device war.

From my reading of Crabb’s orders and Apple’s responses in the week leading to Monday’s dismissal, Apple must have known it was at extreme risk of this outcome. The chain of events began with Crabb’s 57-page decision on Oct. 29, which outlined the scope of the trial that was scheduled to begin the following week. Apple’s lawyers at Covington & Burling and Tensegrity Law Group should have been happy with Crabb’s ruling, which held that Apple could, indeed, compel Motorola to offer Apple a license for its standard-essential IP on fair and reasonable terms. Specific performance, as that relief is known, is extraordinary in a breach-of-contract case, Crabb acknowledged, but she said that the circumstances of this dispute, in which the two sides are manifestly incapable of negotiation, justify it. Crabb went on to say (like U.S. District Judge James Robartof Seattle in Microsoft’s parallel breach-of-contract case against Motorola) that she would first have todetermine a fair licensing rate for Motorola’s patents and would then decide whether Motorola breached its obligation to license the IP to Apple on reasonable terms. If she found Motorola in breach, she said, she might order it to offer its IP to Apple on the terms she set.

In ruling against Barclays, NY judge rejects 2nd Circuit holding

Alison Frankel
Nov 5, 2012 23:46 UTC

Last March, U.S. District Judge Louis Stanton of Manhattan refused to dismiss a case against Barclays by a Florida credit union that claimed it had been defrauded by the bank’s misrepresentations about the collateral underlying a CDO called Markov. According to the credit union’s all-too-familiar allegations, Barclays stuffed the CDO with doomed-to-fail mortgage-backed securities, then shorted the vehicle even as it flogged the CDO to investors. Stanton said that the credit union had shown enough evidence in its complaint to proceed with discovery on its claims.

You might think, based on Stanton’s ruling in that case, that Bayerische Landesbank, a fellow Markov investor, had a slam-dunk case against Barclays, at least as far as surviving the bank’s motion to dismiss. But Barclays and its lawyers at Cleary Gottlieb Steen & Hamilton thought they had a game changer in the case: a ruling last April by the 2nd Circuit Court of Appeals. The appeals court upheld U.S. District Judge William Pauley‘s dismissal of claims by the investor Landesbank Baden-Wuerttemberg that Goldman Sachs rigged an MBS-stuffed CDO to fail.

Even though the 2nd Circuit’s ruling was a summary order that involved a CDO sponsored by a different bank, Barclays argued in its motion to dismiss the Bayerische case last August that the appellate decision was directly on point. “The circuit held that dismissal under (the pleading standard for fraud) was required because the plaintiff failed to identify specifically any reports or statements that allegedly provided the defendants with such contrary information at the time the CDO was issued,” Cleary wrote. “The same is true here. Indeed, plaintiff relies on the very same generalized allegations as in Landesbank when insisting that Barclays ‘knew’ Markov’s collateral would fail.”

FDIC files first lawsuit against auditor of failed bank, targets PwC

Alison Frankel
Nov 2, 2012 22:45 UTC

Way back in February 2011, the crackerjack blogger Francine McKenna of re: The Auditors asked an interesting question in a column for Forbes: Given the widespread failures of small and regional banks in the financial crisis, why hadn’t the Federal Deposit Insurance Corporation brought any lawsuits against the audit firms that signed off on reports that turned out to be materially misleading? McKenna noted that two private lawyers had predicted such suits were coming in a column for the Legal Intelligencer, but said so far none had been filed. By then the FDIC was actively pursuing directors and officers of failed banks, but auditors seemed to be off the hook.

That’s no longer true. On Wednesday the FDIC, as receiver for the Colonial Bank of Montgomery, Alabama,sued PricewaterhouseCoopers and Crowe Horwath in federal court in Montgomery, claiming that they committed professional malpractice and breach of contract by failing to detect that two Colonial employees helped the notorious (and defunct) mortgage lender Taylor Bean poke hundred-million-dollar holes in Colonial’s balance sheet. (PwC was the external auditor and Crowe Horwath performed internal audits.)

“All the time that (Taylor Bean) was carrying out an increasingly brazen and costly fraud against Colonial, PwC and Crowe never realized that many hundreds of millions of dollars of bank assets did not exist, had been sold to others, or were worthless,” wrote the FDIC’s counsel at Bailey & Glasser and Mullin, Hoard & Brown. “Missing huge holes in Colonial’s balance sheet and serious gaps in internal control, PwC and Crowe continued to perform auditing services for Colonial without ever detecting the (Taylor Bean) fraud. Had they performed their auditing work in accordance with applicable professional standards, they would have learned of the TBW fraud in time to prevent additional losses suffered by Colonial.”

Can governors bar insurers from charging hurricane deductibles?

Alison Frankel
Nov 1, 2012 19:33 UTC

On Wednesday night, New York Governor Andrew Cuomo made a startling announcement: Homeowners “will not have to pay” so-called hurricane deductibles when they file insurance claims for damages caused by Sandy. In a follow-up press release Thursday morning, after other governors joined Cuomo in outlawing hurricane deductibles related to Sandy, Cuomo’s Department of Financial Services, which regulates insurance companies, said that it had “informed the insurance industry that hurricane deductibles should not be triggered for this storm.”

Can Cuomo and his DFS chief, Benjamin Lawsky, do that? Are state governors empowered to determine, by executive fiat, what constitutes a hurricane? The answer to that question, according to three insurance lawyers, is no — and yes.

Here’s why. The insurance industry, as you know, is state-regulated. In New York, insurance policy language on hurricane provisions — which typically impose deductibles of between one and five percent of a home’s value for damages caused by hurricanes — must be approved by the Department of Financial Services, according to Marshall Gilinsky of Anderson Kill & Olick, who represents policyholders in disputes with insurers. So, in a way, state insurance regulators have already decided what constitutes a hurricane, for the purposes of insurance coverage, by regulating the provisions that define hurricanes.

SCOTUS amicus brief could radically alter class action landscape

Alison Frankel
Nov 1, 2012 12:11 UTC

On my way to work today at Reuters’ satellite office in Suffolk County, New York, I had a chance to witness the devastation Hurricane Sandy wreaked on Long Island, where I live and where 90 percent of us lost power in the storm. Wending around downed trees and power lines turned what should have been a half-hour drive on major roads into an hour-long trek through police-directed detours and past huge piles of branches already cleared by road crews. In some neighborhoods there’s not a power line still attached to utility poles — unless the pole itself has been toppled.

I was traveling east, so at least I eventually arrived at a functioning office with a phone and Internet. Had I tried to head west, to Manhattan, I would never have made it to work. The Queens Midtown Tunnel, which is the primary artery between Long Island and the rest of the world, is closed, and traffic was so thick in the approach to the Queensboro Bridge, the next-best alternative, that it was for all intents and purposes closed as well. As of Wednesday afternoon, Long Islanders have virtually no way out.

Believe it or not, my little tale of woe is actually an extended metaphor for the story I bring you today of an amicus brief that could block class action lawyers from state court as effectively as the hurricane has sealed off Long Island from the rest of the world. Remember the case known as Standard Fire v.Knowles, in which the U.S. Supreme Court granted certiorari in August? Both sides in the case say the question it presents is whether a class action plaintiff can defeat removal to federal court under the Class Action Fairness Act by stipulating on behalf of the entire class to seek less than $5 million, the statutory cut-off for a state-court class action. That’s an important question, since class action lawyers in certain jurisdictions (most notably in the 8th Circuit) have used such stipulations to stay in state court, where they’ve been able to force defendants into settlements of more than $5 million in litigation before plaintiff-friendly judges.