Opinion

Alison Frankel

New ruling puts Fannie, Freddie in line for windfall MBS recovery

Alison Frankel
Dec 17, 2013 20:24 UTC

Has there ever been a more lopsided multibillion-dollar case than the Federal Housing Finance Agency’s fraud litigation against the banks that sold mortgage-backed securities to Fannie Mae and Freddie Mac? I don’t think U.S. District Judge Denise Cote of Manhattan, who is overseeing securities fraud suits against 11 banks that haven’t already settled with the conservator for Fannie and Freddie, has sided with the banks on any major issue, from the timeliness of FHFA’s suits to how deeply the defendants can probe Fannie and Freddie’s knowledge of MBS underwriting standards in the late stages of the housing bubble. But even in that context, Judge Cote’s summary judgment ruling Monday – gutting the banks’ defenses against FHFA’s state-law securities claims – is a doozy.

In effect, Cote’s decision will permit FHFA to recover more from MBS issuers than Fannie Mae and Freddie Mac would have made if their MBS investments had paid as promised. Of course, FHFA and its lawyers at Quinn Emanuel Urquhart & Sullivan and Kasowitz, Benson, Torres & Friedman still have to show that the banks knew or had reason to know that their offering documents misrepresented the mortgage-backed securities they were peddling to Fannie Mae and Freddie Mac. But if FHFA meets that burden, the banks can’t ward off claims under the state securities laws of Virginia and the District of Columbia by blaming Fannie and Freddie’s MBS losses on broad declines in the economy and the housing market.

What’s more, those state securities laws give FHFA the right to rescission – or restitution of the entire purchase price of the MBS Fannie and Freddie bought – plus fees, costs and, most importantly, interest. The Virginia statute mandates that securities fraudsters chip up 6 percent interest – more than the scheduled interest rate in many of the MBS trusts in which Fannie and Freddie invested. The banks, in other words, are now exposed to liability far beyond the actual losses Fannie Mae and Freddie Mac suffered – and even beyond what FHFA’s wards would have earned if the MBS trusts had performed exactly as the banks said they would at the time of sale. That extra interest would be a true windfall for FHFA.

Cote rejected the banks’ motion to ask the Virginia Supreme Court for a ruling on whether the state’s securities fraud law permits a so-called loss causation defense. As the judge explains in her ruling, when Congress passed the Private Securities Litigation Reform Act in 1995, it amended Section 12 of the Securities Act of 1933 to permit defendants to limit their liability by showing that a supposed fraud victim’s losses were not attributable to the defendant’s misrepresentations. In the FHFA cases, the banks’ lawyers – led by James Rouhandeh of Davis Polk & Wardwell, for Morgan Stanley, and Thomas Rice of Simpson, Thacher & Bartlett, for Deutsche Bank – tried to persuade Cote that because state securities laws were based on the federal Securities Act, she should look to the amended federal statute to interpret Virginia and D.C. law. Cote rejected the argument, holding that the federal law did not include a loss causation defense until it was amended in 1995. The Virginia and D.C. laws predate that amendment, Cote said, so loss causation cannot be inferred from their texts.

“As defendants concede, no federal court interpreted the ’33 Act as incorporating a loss causation defense before one was added by the PSLRA,” Cote wrote, so “there is no reason to think the Virginia Supreme Court would read a loss causation defense into the Virginia Securities Act if confronted with the question now.”

Why shield corporations from disclosing political spending?

Alison Frankel
Dec 16, 2013 21:42 UTC

I’m going to confess right here that I don’t possess the requisite statistical skills to hazard an opinion on whether shareholders benefit when their corporation engages in lobbying and campaign expenditures. If you have a more powerful appetite for numbers than I do, John Coates of Harvard Law School offers a bibliography of academic studies that conclude corporate political spending is bad for shareholders at the Harvard Forum on Corporate Governance (including his own influential 2012 paper for the Journal of Empirical Legal Studies). Want a different view? A pair of economics consultants from Sonecon disputed Coates and those who think likewise in a 2012 paper for the Manhattan Institute that found corporate political spending has “a generally positive effect” on a company’s value, in terms of market returns. You can pick whichever analysis suits you because I’m not going to argue the merits of either. I do believe, however, that regardless of the benefits of lobbying and campaign contributions, shareholders have a right to know when and how their money is being spent on politics.

Coates does too, which prompted his post Friday at the Harvard corporate governance forum. Coates was reacting to the Securities and Exchange Commission’s decision in November to table consideration of rules that would require disclosure of corporate political spending; the Harvard prof called the SEC’s move “a policy and political mistake” that permits large corporations to lobby secretly against Dodd-Frank regulations, using other people’s money. As you probably know, corporate disclosure of political spending has been kicking around in shareholder proposals for about a decade, but the SEC was pushed into the debate in 2011, when a group of 10 law professors with varying views on the impact of such spending joined together to petition the SEC to develop disclosure rules.

The professors, led by co-chairs Lucian Bebchuk of Harvard and Robert Jackson of Columbia, argued that the U.S. Supreme Court assumed when it expanded the First Amendment rights of corporations to engage in political speech in Citizens United v. Federal Election Commission that shareholders could monitor corporate expenditures to assure themselves that such spending was in their interests. But the Supreme Court’s assumption doesn’t work without mandatory disclosures, the professors said. Thanks to nudging from public interest groups, about 600,000 shareholders asked the SEC to take up the issue, which made it as far as the agency’s rulemaking agenda in November 2012 before falling off the SEC’s priority list for the upcoming year. SEC chair Mary Jo White told reporters earlier this month not to infer that the disclosure proposal is dead and buried forever. But SEC rulemaking is shelved for at least a year.

Lawyers can’t force unwitting clients into arbitration: 9th Circuit

Alison Frankel
Dec 13, 2013 21:59 UTC

In 2011, the U.S. Supreme Court schooled the 9th Circuit Court of Appeals on the primacy of arbitration clauses in AT&T Mobility v. Concepcion. The high court’s landmark ruling reversed a 9th Circuit holding that AT&T’s prohibition of classwide arbitration was unconscionable under California law, finding instead that the Federal Arbitration Act preempts state laws restricting the use of arbitration. In combination with the Supreme Court’s ruling last term in American Express v. Italian Colors, Concepcion pretty much wiped out any hope that consumers and employees can avoid mandatory arbitration if they’ve signed contracts with arbitration provisions.

But on Thursday a three-judge 9th Circuit panel found an exception. In an opinion by Judge William Fletcher (writing for a panel that also included 9th Circuit Judge Johnnie Rawlinson and 10th Circuit Senior Judge David Ebel, sitting by designation) the appeals court held that Concepcion does not preclude law firm clients who have signed retainer agreements with arbitration provisions from suing in court if the agreements violate state-law rules. The Supreme Court’s decision, according to the 9th Circuit, doesn’t mandate enforcement of an arbitration provision that is “procedurally unconscionable” under state contract law. (Gracias to the San Francisco legal newspaper The Recorder, which first reported on the decision.)

The 9th Circuit is notably judicious about the apparently now-defunct Illinois law firm at the heart of the dispute, Macey, Aleman, Hyslip & Searns. Through the name Legal Helpers, the firm was engaged in the debt-adjustment business, which seems to mean, based on the 9th Circuit opinion, that it teamed up with companies pitching debt relief services to struggling consumers in order to permit the companies to evade state restrictions on the fees they’re permitted to charge. (Law firms are sometimes allowed to charge more for their debt relief advice than non-legal outfits.) The 9th Circuit quoted a 2011 Illinois cease and desist order against Legal Helpers: “Despite the name ‘Legal Helpers,’ the company does not provide legal representation to consumers or otherwise act in an attorney capacity.”

Class actions deliver more money to more people than arbitration: CFPB

Alison Frankel
Dec 12, 2013 21:19 UTC

What a difference a day – and a data source – makes.

Yesterday I told you about a new study of class action outcomes that Mayer Brown conducted at the urging of clients like the U.S. Chamber of Commerce. The law firm looked at 148 consumer and employment class actions filed in federal court in 2009, and found evidence that a grand total of one case – a $1.2 billion settlement of ERISA claims rooted in Bernard Madoff’s Ponzi scheme – delivered meaningful recoveries to class members. Of the five other cases in which claims data was publicly disclosed, Mayer Brown found distressingly minimal participation in settlement funds by class members: 0.000006 percent, 0.33 percent, 1.5 percent, 9.66 percent and 12 percent.

Mayer Brown released its study in anticipation of a report by the Consumer Financial Protection Bureau, which Congress assigned in the Dodd-Frank Act to analyze the impact of mandatory arbitration clauses in consumer contracts for financial products and services like credit cards and checking accounts. Sure enough, CFPB disclosed preliminary findings from its year-long study on Thursday – and they indicate that the U.S. Chamber was right to worry. According to CFPB, exceedingly few consumers actually bring arbitration claims when they have a dispute with their credit card company, bank or payday lender. Tens of millions of consumers are subject to mandatory arbitration for disputes involving financial products and services, CFPB estimated, yet only 1,241 cases involving these products were filed with the American Arbitration Association between 2010 and 2012. Of those, according to CFPB chairman Richard Cordray, about 900 were filed by consumers. (The rest were initiated by banks and lenders.) CFPB offered some caveats, including the lack of data from JAMS Inc, which also hears consumer arbitrations, albeit far fewer than AAA. But the bureau isn’t exactly going out on a limb when it concludes that the evidence shows arbitration doesn’t provide any recovery to the overwhelming majority of consumers of financial products, especially those with small dollar claims. “Plainly, the number of arbitrations was low relative to the total populations using these products,” the report said, in a notable understatement.

So, a vanishingly small percentage of consumers who are bound by mandatory arbitration provisions win recovery from their banks and credit card companies, since hardly any of them arbitrate their claims. Would consumers obtain better results via classwide proceedings (which are explicitly barred in more than 90 percent of the arbitration agreements reviewed by CFPB)? If we were to rely exclusively on Mayer Brown’s report, we’d conclude that they would not. Mayer Brown found that consumer class actions filed in 2009 were either so flimsy that they were dismissed or that they resulted in settlements offering recoveries too small for most class members to even bother claiming.

Class action mystery: Where does the money go post-settlement?

Alison Frankel
Dec 11, 2013 22:00 UTC

I would have been shocked if Mayer Brown‘s new study of 148 federal-court class actions filed in 2009 concluded that the cases are of any real benefit to class members. Mayer Brown Supreme Court litigator Andrew Pincus, remember, is not only frequently counsel to the U.S. Chamber of Commerce, but was also the winner of the U.S. Supreme Court’s landmark 2011 endorsement of mandatory arbitration in AT&T Mobility v. Concepcion. Pincus told me that the firm decided to collect information on the outcome of consumer and employment class actions filed in 2009 at the behest of clients worried about the Consumer Financial Protection Bureau’s study of arbitration agreements. The Chamber and other clients, he said, have been frustrated at CFPB’s refusal to disclose exactly what it’s looking at. So, as the Chamber explained in a Dec. 11 letter to CFPB, Mayer Brown and its clients seized the initiative and compiled empirical evidence to show the agency what will happen if it precludes arbitration and forces consumers to litigate through class actions. “If you’re going to take away arbitration,” Pincus said, “you have to understand the alternative.”

According to the study, the alternative to arbitration is a system that is exceedingly bad at delivering recovery to class members, even as it amply rewards lawyers who bring claims on their behalf. (Like I said, no big surprise there.) Mayer Brown obtained its initial data set of 2009 class actions from case filings mentioned in the BNA Class Action Litigation Reporter and the Mealey’s Litigation Class Action Reporter. The firm screened out securities class actions and class actions asserting claims under the Fair Labor Standards Act, since both of those kinds of cases are litigated under their own unique rules. After accounting for consolidations, the study ended up analyzing outcomes in 148 consumer and employment class actions filed in or removed to federal court.

Only 21 cases (14 percent of the sample) remained unresolved when the study closed on Sept. 1. Of the 127 class actions that reached a resolution, Mayer Brown researchers found, 45 (or 35 percent) were dismissed voluntarily. (One-third of those voluntary dismissals included individual settlements for the name plaintiffs, according to the firm.) Another 41 cases (31 percent) were dismissed by the courts on motions to dismiss or summary judgment motions. Mayer Brown adds up those percentages and trumpets the conclusion that two-thirds of the resolved cases resulted in no relief whatsoever for class members.

FHLB demands DOJ draft complaint: ‘What is JPMorgan trying to hide?’

Alison Frankel
Dec 10, 2013 19:23 UTC

If JPMorgan Chase and the Justice Department thought that all the zeroes at the end of the bank’s multibillion-dollar settlement for mortgage securitization failures would foreclose questions about the bank’s actual wrongdoing, clearly they thought wrong. Days after the much-leaked-about $13 billion deal was finally announced, New York Times columnist Gretchen Morgenson looked at the admissions accompanying the settlement and wondered why it had taken the federal government so long to hold the bank accountable for conduct that’s been in the public domain for years. Morgenson’s column echoed posts at Bloomberg and Slate that also scoffed at JPMorgan “admissions.” On Monday, even a commissioner of the Securities and Exchange Commission piled on. Dan Gallagher, a Republican, criticized the settlement as a penalty on the bank’s current shareholders that’s not justified by JPMorgan’s admitted conduct. “It is not rational,” Gallagher told an audience in Frankfurt at an event organized by the American Chamber of Commerce in Germany.

At the heart of all of this criticism is a nagging suspicion that we don’t really know what the Justice Department had – or didn’t have – on JPMorgan, that the $13 billion settlement was not pegged to the bank’s actual misconduct but to the public relations benefits to both sides from a supposedly record-setting deal. Attorney General Eric Holder has called the size of the settlement a proportionate response to JPMorgan’s wrongdoing, but it’s tough to take that assertion on faith when the statement of facts that accompanied the settlement revealed so little about the government’s evidence.

The Federal Home Loan Bank of Pittsburgh believes that the government knows a lot more about JPMorgan’s securitization practices than it disclosed in the settlement agreement – and the FHLB’s lawyers at Robins, Kaplan, Miller & Ciresi are pretty sure those additional details are contained in a civil complaint against the bank that was drafted by the U.S. Attorney in Sacramento, California. At a closed-door hearing last Friday, Judge Stanton Wettick of the Allegheny County Court of Common Pleas heard Robins Kaplan argue that release of this “rich source of detailed facts about JPMorgan’s conduct” would serve the public’s interest in understanding the basis of the $13 billion settlement. JPMorgan’s lawyers at Sidley Austin, meanwhile, contend that the Justice Department never intended the complaint to be public but used it only as leverage in negotiations with the bank. Turning the document over to FHLB and the public, the bank asserts, would be contrary to Pennsylvania’s interest in promoting settlements, would violate attorney-client privilege and would accomplish nothing because Justice’s allegations are not related to claims by the FHLB. Judge Wettick did not issue a public ruling from the bench Friday and lawyers for JPMorgan and FHLB didn’t respond to my emails requesting comment. But if we’re ever going to find out more about the government’s dirt on JPMorgan, there’s a good chance it will be in the FHLB litigation.

The Supreme Court, moldy washers and the future of consumer class actions

Alison Frankel
Dec 6, 2013 23:11 UTC

Are Sears and Whirlpool trying to hoodwink the justices of the U.S. Supreme Court about cases that could devastate consumer class action litigation?

That’s what purchasers of front-loading Whirlpool washing machines with an (allegedly) unfortunate propensity to develop a musty odor assert in a new brief opposing petitions for certiorari that were filed by Sears and Whirlpool in October. Members of separate class actions certified by the 6th and 7th Circuit Courts of Appeal argue in a brief filed Friday that Sears, Whirlpool and their 12 pro-business friends urging Supreme Court review have engaged in a “fundamental mischaracterization” of the cases. The defendants “totemically” represent the moldy washer classes to be an untenable mishmash of consumers, some of whom own machines supposedly developed the moldy smell and others who have no problems with their machines and have – according to the defendants – suffered no injury. The cases are no such thing, according to the classes’ Supreme Court counsel, New York University professor Samuel Issacharoff.

Instead, the new brief argues, the moldy washer class actions are “hornbook” warranty suits that allege the same cause of action for every member of the classes. When defendants and their amici harp on uninjured claimants, the brief contends, they’re attacking a strawman: Everyone in the certified classes claims the same injury. “These cases allege only a single, uniform defect causing a uniform harm, in which a seller delivered a substandard product that does not perform as warranted and is not fit for its ordinary purpose, and thereby does not satisfy the terms of the bargain,” the brief said. “That is the only liability theory presented, and it applies to all class members.”

Board independence is just cheap way to appease Congress: new paper

Alison Frankel
Dec 5, 2013 21:28 UTC

If there’s one assumption that underlies the shareholder litigation I’ve covered over the years, it’s that truly independent boards serve shareholder interests. Plaintiffs lawyers often don’t agree with defendants about whether particular directors are actually independent, but the corporate governance ideal of a disinterested board is rarely questioned by either side. Changes in the composition of corporate boards seem to reflect that assumption. In 1998, according to a forthcoming article by Emory University School of Law professor Urska Velikonja for the North Carolina Law Review, S&P 500 companies reported that 78 percent of their board members were independent. By 2012 the number was up to 84 percent. Even more dramatic, according to Velikonja, has been the rise of boards with only one insider – the CEO – on the board. As recently as 2000, Velikonja found, these so-called supermajority independent boards represented only 20 percent of public companies. In 2012, by contrast, 59 percent of public company boards had only one non-independent director.

But are supermajority independent boards actually good for shareholders? That turns out to be a complicated question, teased out in Velikonja’s paper. She concludes, as a threshold matter, that it is shareholders who have driven the trend toward increasingly independent boards. “That is what investors want, encouraged by proxy advisors and unopposed by managers resigned to more vigilant shareholders,” the professor writes. Yet her survey of the literature on board independence and shareholder value showed “substantial academic backlash against increasingly independent boards.” As Velikonja explains, once the majority of directors on a board is independent, shareholders experience diminishing marginal returns from replacing insiders with outsiders, and increasing marginal costs because the board receives less inside information about the company. “Empirical studies seem to support the theoretical intuition that majority independent boards are a good development, but supermajority independent ones are not,” Velikonja writes.

So why, she asks, do shareholders – largely through institutional investors – continue to press for increasingly independent boards? As she notes, two theories for the phenomenon have previously been suggested. Sanjai Bhagat of the University of Colorado and Bernard Black of Northwestern hypothesized back in 1999 that unfounded conventional wisdom about a correlation between board independence and corporate performance was driving the move against inside directors. Several years later, Jeffrey Gordon of Columbia argued that board independence is (in Velikonja’s description) “a positive development made possible by better securities disclosure and the rise of shareholder primacy as the goal of corporate governance.”

Detroit judge’s pension ruling is no panacea for beleaguered cities

Alison Frankel
Dec 4, 2013 21:41 UTC

In Tuesday’s ruling that Detroit is eligible for federal bankruptcy protection, U.S. bankruptcy judge Steven Rhodes set crucial precedent on a municipality’s right to cut pension benefits through the Chapter 9 process. Michigan’s state constitution, like those of many other states, specifically protects the pension rights of public employees. Before Detroit even filed for Chapter 9 in July, some of its pensioners went to state court to block the bankruptcy, arguing that it’s a violation of the state constitution to tamper with their benefits. Rhodes squelched that litigation and asserted his federal-court jurisdiction, but retirees and unions continued their challenge to the city’s right to meddle with their pensions, just as California’s vast public pension fund, Calpers, has relentlessly resisted any suggestion that the bankrupt cities of Stockton and San Bernardino might reduce their pension obligations. In a first-ever ruling on the impairment of pension obligations in a Chapter 9 proceeding, Judge Rhodes held Tuesday that neither the Contracts Clause nor the Tenth Amendment of the U.S. Constitution prohibits Detroit from cutting pension benefits, even if those benefits are protected in the state constitution.

“Municipal pension rights are contract rights, and…the impairment of such contract rights in a municipal bankruptcy case is a regular part of the process,” Rhodes concluded, according to a court-issued summary of his findings. “Because the State of Michigan authorized the filing of this case, municipal pension rights in Michigan can be impaired in this bankruptcy case, just like any other contract rights.” (Rhodes read his eligibility ruling from the bench; a written opinion is to follow.)

With that finding, Rhodes gave a definitive answer to a constitutional question that the judges overseeing the Stockton and San Bernardino Chapter 9 cases have skirted: Can insolvent cities legally reduce their pension obligations through the federal bankruptcy process? Rhodes has supplied critical precedent that changes the balance of power in municipal bankruptcies. “Pensions can no longer count on getting 100 cents on the dollar in every municipal bankruptcy due to their recognized super-senior status,” wrote analyst Mark Palmer in a blog post for BTIG. “Now, they may be subject to cuts or to being treated as unsecured creditors in the same claim pool as the bond insurers.”

5th Circuit gives state AGs a new way to evade federal court

Alison Frankel
Dec 3, 2013 19:29 UTC

Last month, the U.S. Supreme Court heard arguments in Hood v. AU Optronics, the case that will determine whether consumer suits by state attorneys general must be litigated in federal court under the Class Action Fairness Act or may be tried in the plaintiffs-friendly confines of state court. I’ve been harping on these AG cases, known as parens patriae suits, because they’re increasingly the most viable way to hold corporations accountable in court to consumers, thanks to the Supreme Court’s predilection for arbitration and skepticism about class actions. An array of pro-business groups seized the opportunity of the AU Optronics case – in which the 5th Circuit Court of Appeals split with several other federal circuits and held that parens patriae suits are removable to federal court under CAFA – to ask the Supreme Court to rein in state AGs, just as the justices last term curbed class action lawyers who tried to stipulate their way out of federal court.

The Supreme Court hasn’t yet decided the AU Optronics case, and the justices’ questions at oral argument didn’t offer a clear indication of which way most of them are leaning. But if the high court determines that AG suits based on alleged harm to state residents are class actions or mass actions in all but name, a new ruling by the 5th Circuit could undermine the significance of that decision. For parens patriae defendants, it turns out, the 5th Circuit giveth but it also taketh away.

Monday’s per curiam opinion, by Judges Priscilla Owen, Jennifer Elrod and Catharina Haynes, said that six parens patriae suits filed by Mississippi Attorney General Jim Hood must be remanded to state court, despite arguments by the bank defendants that under the 5th Circuit’s own AU Optronics precedent, the suits are class or mass actions under CAFA. The AU Optronics precedent, the new opinion said, is based on the premise that state AG suits are actually prosecuted on behalf of hundreds or thousands of consumers, even though the cases are brought in the name of the state. If that premise is correct, the 5th Circuit judges said (noting the Supreme Court will have to decide if it is), then in order to keep a parens patriae case in federal court under CAFA, defendants must satisfy two elements: They must be able to show that the case’s aggregated potential claims exceed $5 million and that at least one plaintiff’s individual claims exceed $75,000.

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