Alison Frankel

ResCap creditors to bankruptcy court: Ally owes us $20 bln

Alison Frankel
Apr 12, 2013 22:18 UTC

told you this was coming: Late Thursday, the creditors committee of the bankrupt mortgage lender Residential Capital asked U.S. Bankruptcy Judge Martin Glenn of Manhattan to grant creditors permission to sue ResCap’s former parent, Ally Financial. The committee, represented by Kramer Levin Naftalis & Frankel, argues that in its short, unhappy existence ResCap functioned first as a cash magnet to boost Ally’s failing auto-lending business and then as a shield against Ally’s liability for toxic mortgages. Ally’s opportunistic manipulation of its captive onetime subsidiary, the committee said, exposes the troubled bank to ResCap’s entire $20 billion liability to creditors.

As the committee explains in its filing, ResCap has agreed to cede control of litigation against Ally to the creditors. Normally, this kind of fraud claim in a Chapter 11 bankruptcy would belong to the debtor. And in fact, before it entered bankruptcy, ResCap made a deal with Ally to resolve any of its potential claims against its former parent for $750 million. But in a dramatic turnaround earlier this year, ResCap renounced the $750 million deal and threw in with the creditors, who have been agitating for more money from Ally from the moment the bankruptcy was filed in May 2012. In Thursday’s brief, the creditors assert that ResCap can’t now sue Ally because it is “subject to the disabling conflicts of the flawed deal” and focused on developing a wind-down plan. Moreover, the creditors argue, they’ve already seen millions of documents through an evidence-sharing agreement with the court-appointed Chapter 11 trustee, so they’re positioned to jump right in to a suit against Ally.

The tale laid out in the committee’s brief is of a devious parent company that has abused its subsidiary since birth. ResCap was spun off from Ally in 2004, when mortgage lending was a much more profitable business than Ally’s traditional auto-loan financing. (Ally began its existence as the financier of GM loans.) According to the brief, however, the spinoff was never really separate from its parent. ResCap’s leadership substantially overlapped with Ally’s, and executive compensation depended on Ally’s performance. And though Ally had created the strategy of loosening mortgage-underwriting standards in the housing boom, the creditors contend that Ally used ResCap to cabin off liability for deficient loans.

“The committee has examined a series of transactions, beginning in 2006, that display a common pattern of behavior by (Ally Financial): moving assets out of ResCap and/or dumping liabilities into it, often without fair consideration or procedural safeguards to ensure arm’s length terms, with the ultimate goal – once the RMBS mess surfaced – of isolating AFI from the catastrophe it created,” the brief said. “AFI kept ResCap barely alive through this period with measured capital infusions and loans – not in a serious attempt to rehabilitate ResCap’s business, but only to prevent a premature bankruptcy that would cut short the harvesting of value and drag AFI down as well.”

The brief described a series of protests by ResCap advocates against Ally’s supposed asset-stripping, including a “stinging critique” by ResCap’s general counsel of one transfer of assets to Ally and concerns expressed by ResCap lawyers from Skadden, Arps, Slate, Meagher & Flom about a deal that effectively ended ResCap’s interest in Ally. Both of those transactions, as well as others disadvantageous to ResCap, nevertheless went through, according to the brief. Then when the housing bubble burst and loose mortgage underwriting returned to haunt Ally and ResCap, Ally forced its former subsidiary to bear all of the liability, according to the creditors. In an $800 million deal with Fannie Mae and Freddie Mac, for instance, ResCap entities “were made to shoulder the entire burden of the settlements, even though they were insolvent at the time (and) a significant portion of the underlying liability pertained to loans originated, underwritten, or acquired by Ally Bank. Finally, on the eve of ResCap’s bankruptcy filing, Ally supposedly engineered an $8.7 billion settlement between ResCap and investors in private-label mortgage-backed securities. That deal, according to creditors, served Ally’s interests at the expense of ResCap’s creditors.

New billion-dollar MBS question: Are there limits on monoline damages?

Alison Frankel
Apr 11, 2013 21:58 UTC

Countrywide’s new lawyers in New York State Supreme Court litigation with MBIA have come out firing. In a pair of letters interpreting last week’s ruling by the Appellate Division, FirstDepartment, the bank’s counsel from Simpson Thacher & Bartlett are asserting an aggressive argument that the appellate opinion limits MBIA’s potential recovery to the repurchase of materially deficient underlying mortgage loans – a restriction that would prevent MBIA from collecting from the bank the full amount of insurance claims it has paid on underperforming Countrywide mortgage-backed securities. If Countrywide is correct – and that’s far from certain – bond insurers could have a much tougher route to recovery against MBS issuers than we’ve assumed in the wake of Assured Guaranty’s decisive win against Flagstar in February.

Here’s Countrywide’s argument, which the bank first staked out in an April 3 letter to New York State Supreme Court Justice Eileen Bransten of Manhattan, who is overseeing the MBIA case. The state appeals court, as you probably recall, ruled last week that MBIA may not recover rescissory damages, which the opinion called “a very rarely used equitable tool.” MBIA’s rescissory theory would have required Countrywide to, in essence, make MBIA whole, as if it had never agreed to insure Countrywide MBS in the first place. By knocking out that route to recovery, Countrywide argued, the appeals court left MBIA without any claim for compensatory damages. Instead, the bank said, under the terms of its agreements with the bond insurer, MBIA’s sole remedy is the repurchase of materially deficient underlying mortgage loans. “Any other interpretation is flatly contradicted by the First Department’s decision,” the bank said. “The First Department made clear that MBIA is not entitled to unwind the contract and receive all of its claims payments merely upon proving that it would not have entered the contract but for Countrywide’s alleged misrepresentations – this is the very rescissory relief that the First Department held unavailable to MBIA.”

MBIA’s lawyers at Quinn Emanuel Urquhart & Sullivan, you will not be surprised to hear, disputed Countrywide’s interpretation of the appellate ruling in their April 8 letterto Bransten, which offers what we English majors might call a close text analysis of the First Department’s cryptic missive. The bond insurer pointed to a sentence in which the appeals court said that MBIA can seek “recovery of payments made pursuant to an insurance policy without resort to rescission.” Why, MBIA asked, would the appeals court refer to recovery of those payments if MBIA’s sole remedy were repurchase? That’s especially true, MBIA argued, because the opinion cited insurance law provisions that provide for broad recovery. If the First Department had wanted to restrict MBIA’s damages to the “sole remedy” of repurchase – which is specified in only one paragraph of MBIA’s agreements with Countrywide – it would have said so.

Chaos of rulings on toxic CDOs means uncertainty for investors

Alison Frankel
Apr 10, 2013 21:35 UTC

One of the notable losers in the U.S. housing crash was a set of special purpose entities organized in the UK island of Jersey and collectively known as Loreley. Loreley erroneously believed in the long-term health of the subprime mortgage market in the United States. So as banks stuffed toxic mortgage-backed securities into collateralized debt obligations and sold the CDOs to offload their subprime exposure, Loreley was a buyer. The funds invested hundreds of millions of dollars in mortgage-referenced CDOs in late 2006 and 2007.

That turned out, of course, to be a very bad bet. But Loreley has since claimed that it was something else as well. According to suits Loreley has filed against Citigroup, Wells Fargo, UBS and Merrill Lynch, the investment vehicle was the unwitting dupe of a scheme between the banks and a Chicago hedge fund called Magnetar, which Loreley accuses of secretly selecting the underlying mortgage-backed securities referenced in the CDOs the banks marketed and it bought. If you remember the Goldman Sachs Abacus deal involving Paulson & Co, you can predict Magnetar’s supposed motive: The hedge fund, according to Loreley, picked securities that doomed the CDOs to fail because it had shorted them via credit default swaps.

Loreley certainly wasn’t the only one to suspect that Magnetar and the banks had rigged the CDOs they peddled in 2006 and 2007; in 2011, JPMorgan agreed to pay $153.6 million to resolve allegations by the Securities and Exchange Commission that it marketed the Squared CDO without telling investors that Magnetar had a hand in selecting the CDO’s reference portfolio while simultaneously shorting the deal. Since then, State Street, Mizuho and Deutsche Bank have all reached regulatory settlements over undisclosed Magnetar involvement in CDO deals. According to ProPublica, Magnetar had a role in about 30 deals in which it bought equity tranches of mortgage-referenced CDOs while at the same time shorting the same or similar CDOs through swaps. (I should note here that Magnetar, like Paulson in the Goldman deal, has not been accused of wrongdoing by the SEC. Magnetar has always maintained that its short positions were a hedge against equity tranche investments.)

The near-impossible standard for showing auditor fraud

Alison Frankel
Apr 9, 2013 20:47 UTC

A couple weeks back, Dena Aubin of the Reuters tax team had a very insightful story about the risks auditors face as more countries permit some form of mass shareholder litigation. With class actions or their like now permitted in more than 20 countries, Aubin said, auditors’ structural firewall – in which national operating units are legally isolated from each other and from the parent firm – isn’t as liability-proof as it once seemed. Aubin cited Ernst & Young’s recent $118 million settlement of a Canadian class action stemming from its audits of the collapsed Chinese forestry company Sino Forest as a possible preview of what’s in store for the Big 4 accounting shops, thanks to a surge in international litigation. Their potential exposure is so large, according to Aubin, that commercial insurers no longer offer affordable liability coverage to audit firms, which have shifted to a self-insured model.

That’s outside of the United States, though. In this country, Aubin found, shareholders rarely even bother to name audit firms as defendants in class actions: Only two securities class actions filed in 2012 made claims against top audit firms. And if you want to know why, read U.S. District Judge Shira Scheindlin’s 72-page opinion Monday dismissing allegations that the Chinese unit of Deloitte Touche failed investors in its audits of the Chinese financial software firm Longtop Financial Technologies, which admitted in 2011 to cooking its books and was subsequently sued by the Securities and Exchange Commission. Scheindlin concluded that Deloitte may have been lazy, at worst, but under U.S. laws and accounting standards, the audit firm should be considered a victim of Longtop’s fraud, not an abetter of it.

What’s unusual in this case, as Scheindlin explained, is that shareholder lawyers from Grant & Eisenhofer andKessler Topaz Meltzer & Check had more evidence than plaintiffs usually get in securities class actions. The judge had previously refused to dismiss claims against Longtop’s CFO, who then had to produce millions of pages of documents and emails to shareholders. They argued in an amended complaint that evidence obtained from the CFO showed that Deloitte had red-flag warnings of Longtop’s internal control problems, misreporting of revenue and underpayment of social welfare obligations. The audit firm, plaintiffs claimed, confronted Longtop officials about some of the issues but never disclosed problems to investors. In a brief opposing dismissal of their claims, the plaintiffs said Deloitte “chose the path of least resistance” and abdicated “its corporate watchdog responsibilities.”

S&P: State AGs trying to usurp federal regulation of rating agencies

Alison Frankel
Apr 8, 2013 21:20 UTC

Over the next few weeks, federal courts in more than a dozen states are going to begin to consider a very interesting question: Does coordination between and among state attorneys general and the U.S. Department of Justice constitute an improper attempt to override federal regulation?

The credit rating agency Standard & Poor’s is asserting that it does, in an argument that could affect how state AGs enforce consumer laws against defendants in regulated industries. You’ll recall that when the Justice Department announced its $5 billion suit against S&P in February, seven state AGs were in attendance to announce their own parallel state-court claims that the rating agency lied about its independence and objectivity, in violation of state consumer protection and trade practice laws. Three such suits, by Connecticut, Illinois and Mississippi, were already under way at the time of the Justice Department filing, and several more states have since brought claims in their home courts. S&P has now removed all of the state-court AG cases to federal court and has asked the Judicial Panel on Multidistrict Litigation to consolidate the proceedings before one of two judges in federal court in Manhattan.

The rating agency’s lawyers at Cahill Gordon & Reindel argue that the coordinated attack by the Justice Department and the state AGs is a de facto pre-emption of the Credit Rating Agency Reform Act of 2006, which gave oversight of S&P and its competitors to the Securities and Exchange Commission. “Taken as a whole, the actions represent a concerted effort to undermine, if not supplant, a detailed, comprehensive and carefully balanced federal scheme through patchwork and inevitably conflicting rulings across the country,” Cahill wrote in S&P’s brief to the JPMDL. “These nominally separate actions – the vast majority of which were filed on the same day and touted as the result of a ‘coordinated’ effort at a joint press conference held by several of the Attorneys General to announce their filing – are, in effect, a single hindsight-infused attempt by the states to lay blame with S&P for failing to predict the financial crisis and they should be treated collectively.”

Delaware Supreme Court rebukes Chancery for litigation territorialism

Alison Frankel
Apr 5, 2013 21:11 UTC

There is little doubt that the judges on Delaware’s Chancery Court believe they are unrivalled in the business of overseeing corporate litigation. Their challenge in recent years has been to persuade plaintiffs’ lawyers – who, after all, decide where to file their cases – of Delaware’s primacy. Chancery’s waxing and waning share of the booming market in shareholder M&A and derivative suits is an issue that gets considerable attention at securities conferences, and Chancellor Leo Strine in particular has been so unabashed an advocate for his court that New York State Supreme Court Justice Shirley Kornreich recently complained to my Reuters colleague Tom Hals about Delaware’s proprietary attitude.

Chancery’s grabby ways reached their apex last year with Vice Chancellor’s Travis Laster’s controversial ruling in derivative litigation against the board of Allergan, which was sued in connection with the company’s off-label marketing of Botox. Competing plaintiffs’ firms brought cases in both Delaware Chancery and California federal court. Before Chancery ruled on Allergan’s motion to dismiss, the judge in California tossed the case in his court, finding that shareholders hadn’t established the futility of demanding action from the board before bringing their suit. The Allergan defendants argued before Laster that the Delaware case should also be tossed under the doctrine of collateral estoppel. The vice chancellor disagreed, finding that the Delaware plaintiffs and California plaintiffs weren’t equivalent under the internal affairs doctrine, and that the California shareholders weren’t adequate representatives because they didn’t conduct a presuit books-and-records investigation.

The ruling created considerable furor, with defendants complaining that Laster’s reasoning would give shareholders a chance to relitigate derivative claims in Delaware after they failed in other jurisdictions. In July, Laster said in an extraordinary transcript decision that he’d been misconstrued, but nevertheless granted the Allergan defendants – who are represented by Gibson, Dunn & Crutcher and Morris, Nichols, Arsht & Tunnell- leave to seek an interlocutory appeal.

Repercussions from Rakoff ruling in Dexia MBS case vs JPMorgan?

Alison Frankel
Apr 4, 2013 22:20 UTC

Amid the fusillade of securities suits against the banks that sponsored and underwrote mortgage-backed notes, there have been a couple of reasons to pay particular attention to the Franco-Belgian bank Dexia’s case against JPMorgan Chase and its predecessors Bear Stearns and WaMu Mortgage. For starters, it was a big case: $1.6 billion in MBS and supposed damages of about $800 million. Moreover, Dexia’s lawyers at Bernstein Litowitz Berger & Grossmann had piled allegations into an amended complaint so apparently damning that it was the basis of a splashy story in The New York Times. And finally, the case was shaping up as a bellwether for MBS claims by individual investors. The litigation was on the rocket docket of U.S. Senior District Judge Jed Rakoff of Manhattan, who denied the bank’s motion to dismiss last September and talked in a recent hearing about a July trial date on Dexia’s claims. Given the resounding victory Rakoff delivered in February to the bond insurer Assured Guaranty in Assured’s MBS case against Flagstar Bank, the Dexia case seemed like it could be a perfect storm for defendants: a strong plaintiffs’ firm trying a high-profile case before a judge with demonstrated skepticism for bank defenses.

There may still be a Dexia trial in July, but it will be of considerably less interest after a ruling Wednesday in which Rakoff granted summary judgment to JPMorgan on claims stemming from 60 of the 65 MBS certificates in Dexia’s case. According to a statement by JPMorgan’s lawyers at Cravath, Swaine & Moore, Dexia’s potential losses are now only about $5.7 million, down $769 million from Dexia’s original claims. In a case that had the potential to set settlement standards for individual MBS suits, $6 million in exposure isn’t the kind of leverage MBS investors were hoping for.

What’s worse, Rakoff’s ruling could put new obstacles in the way of MBS plaintiffs who didn’t purchase their notes directly from sponsors. Lots of individual investor claims are based on certificates that have changed hands over the years. Rakoff’s reasoning could complicate those cases.

The future of securities litigation? Shareholders sue RBS (in London)

Alison Frankel
Apr 3, 2013 20:29 UTC

There may be no more glaring example of the shifting terrain for securities litigation than the case against the Royal Bank of Scotland. Back in January 2011, RBS was one of the early beneficiaries of the U.S. Supreme Court’s bar on shareholder suits against foreign defendants. U.S. District Judge Deborah Batts of Manhattan dismissed most of a class action claiming that the bank misled investors about its subprime exposure and the success of its ABN Amro deal. The judge tossed the few remaining claims last September, erasing any chance that RBS would be held liable to shareholders in U.S. courts. The American plaintiffs’ firms that sued RBS and the U.S. pension fund clients that vied to lead the litigation were plumb out of options.

But their counterparts in the United Kingdom pressed on. Shareholder litigation has been a relative rarity in England, not least because of the loser-pays rule, said London lawyer Robin Ellison of Pinsent Masons, who counsels pension funds, insurance companies and other institutional investors on their litigation rights. But in recent years, as England has relaxed old prohibitions on outside investment in litigation, insurers have begun issuing so-called After the Event policies, taking over the risk that plaintiffs will have to pay defendants’ fees if they lose. That innovation, Ellison told me, has made shareholder litigation a realistic prospect in the UK. His group, the Institutional Investors Tort Recovery Association, evaluates about 20 or 30 potential claims a year, Ellison said, and follows up with a suit in about one-third of the cases. Ellison informally refers to shareholder suits in the UK as class actions, but they’re really not class actions in the U.S. sense. The cases are akin to American mass tort or consolidated litigation.

In the last week, two shareholder groups have initiated actions against RBS in the UK, claiming that the bank’s prospectus for a $23 billion offering in April 2008 contained material misstatements. One of the groups consists of British and international institutional investors represented by Stewarts, which filed a one-page claim on their behalf at London’s High Court last week. The second group filed an actual complaint against RBS and several board members at the High Court on Wednesday. That group, which is represented by Bird & Bird and includes about 12,000 individual RBS shareholders and more than 100 institutional investors, has said that its claims could top 4 billion pounds. Ellison, who said he has clients “across the board in this litigation,” told me that these are the biggest claims in UK history.

Justices throw up Comcast obstacle in two more class actions

Alison Frankel
Apr 2, 2013 21:31 UTC

Last week, after the U.S. Supreme Court issued its deeply divided 5-to-4 ruling in Comcast v. Behrend, the antitrust class action bar breathed a sigh of relief. Lawyers had been worried the court would rule broadly that in order to be certified, classes must show that they are “susceptible to awarding damages on a classwide basis,” which was the question the Supreme Court had asked Comcast counsel to address. The majority, in an opinion written by Justice Antonin Scalia, seemed to answer the somewhat different question of whether trial and appellate courts may delve into the merits of the plaintiffs’ damages theory before certifying the class. Antitrust plaintiffs’ lawyers told my Reuters colleague Andrew Longstreth that the Comcast decision would have little impact on class certification because they could tailor damages allegations to match their theories of liability.

But yesterday the Supreme Court signaled that, at the very least, class action lawyers – and not just those in the antitrust bar – will have to address the Comcast opinion if they’re going to win certification rulings. In two different cases, one involving consumer product defect claims against Whirlpool, the other over alleged wage-and-hour violations by Charter One bank, the justices granted certioriari, vacated class certification rulings by the federal circuits and sent the cases back to the appellate courts for reconsideration in light of Comcast. The dissent in Comcast, written jointly by Justices Ruth Ginsburg and Stephen Breyer, said that the majority’s holding “should not be read to require, as a prerequisite to certification, that damages attributable to a classwide injury be measurable ‘on a class-wide basis,’ (since) recognition that individual damages calculations do not preclude class certification under Rule 23(b)(3) is well nigh universal.” Nevertheless, it’s now going to be up to the federal circuits to confirm the Comcast dissenters’ reading of the majority opinion.

The Whirlpool case, which comes out of the 6th Circuit Court of Appeals, is precisely the sort of class action the dissent was concerned about. The trial court, and then the appeals court, certified a statewide class of about 200,000 Ohio consumers who purchased front-loading Whirlpool washing machines that are allegedly prone to develop mold or emit a moldy smell. (The litigation is part of a much broader consumer offensive against makers and sellers of supposedly defective washing machines, as Whirlpool discusses in its petition requesting Supreme Court review.) The class contains some members who claim that their machines developed mold or a moldy smell and others whose machines are still fine, so obviously there are disparities in the damages class members may ultimately be entitled to. The trial judge dealt with that issue by certifying the class only for the purpose of determining whether Whirlpool’s machines are defective. Damages, he said, would be determined individually after any finding of Whirlpool’s classwide liability. The class affirmed by the 6th Circuit, in other words, is a liability-only class, though the appeals court said that all Whirlpool buyers could show injury, and thus standing to sue, if they paid a premium price for a defect-prone product.

What remains of Libor litigation with antitrust, RICO knocked out?

Alison Frankel
Apr 1, 2013 21:10 UTC

Make no mistake: A 161-page ruling late Friday by the New York federal court judge overseeing private litigation stemming from manipulation of the benchmark London Interbank Offered Rate (Libor) has devastated investor claims that they were the victims of artificially suppressed Libor rates. U.S. District Judge Naomi Reice Buchwald of Manhattan ruled that owners of fixed and floating-rate securities do not have standing to bring antitrust claims against the banks that participated in the Libor rate-setting process, even though some of those banks have admitted to collusion in megabucks settlements with regulators. If that result, which Buchwald herself called “incongruous,” weren’t bad enough, the judge also cut off an alternative route to treble damages for supposed Libor victims when she held that federal racketeering claims of fraud by the panel banks are precluded under two different defense theories.

Buchwald’s opinion didn’t address every Libor case that’s been filed, since she only ruled on bank motions to dismiss two class actions (one by owners of Libor-pegged securities and the other by derivatives traders) and individual claims by Charles Schwab entities. She held, moreover, that some claims based on the banks’ supposed violations of the Commodity Exchange Act may go forward, although she also said she had doubts that Eurodollar contract traders would ultimately be able to tie losses to misconduct by the Libor banks. But unless and until the 2nd Circuit Court of Appeals reverses Buchwald, Libor antitrust and RICO claims in federal court seem to me to be dead.

That’s because Buchwald’s ruling is based on her interpretation of the law, not on facts. The judge said investors simply couldn’t show that any injury they received from manipulation of the Libor process was the result of anticompetitive behavior by panel banks because the rate-setting process was collaborative, not competitive. (In that process, 12 or so banks would report their own interbank borrowing rate to Thomson Reuters, which would calculate the daily mean rate to be disseminated by the British Bankers’ Association.) And though plaintiffs argued that the banks colluded to suppress Libor in order to lower the interest rates they would have to pay on securities pegged to the interbank rate, Buchwald said that the manipulation was not designed to hamper competition between the banks, which she said was a necessary element of antitrust standing.