Alison Frankel

It was big news last September when Standard & Poor’s disclosed that it had received a Wells Notice in connection with the Securities and Exchange Commission’s investigation of the $1.6 billion Delphinus collateralized debt obligation. The SEC sends Wells Notices to potential targets, not mere witnesses, so there was a lot of speculation that the Delphinus investigation might be the government’s long-awaited attempt to hold a rating agency accountable for colluding with a bank to misrepresent the quality of a mortgage-backed instrument.

But based on the complaint the SEC filed Wednesday against the Delphinus sponsor, Mizuho Bank, it looks to me like S&P is off the hook.

Mizuho, which earned $10 million in fees on the Delphinus deal, agreed to pay $127.5 million to settle the SEC’s case, which claimed investors were deceived by the ratings S&P, Fitch and Moody’s gave to the CDO. Four Mizuho executives involved in Delphinus structuring and marketing also settled, via administrative proceedings that imposed sanctions and fines. The settlement documents make it clear that Delphinus investors were misled about the quality of the mortgage-backed securities that served as collateral for the CDO.

So, however, were the rating agencies, according to the narrative the SEC laid out in its complaint against Mizuho, which was filed in federal court in Manhattan. In the SEC’s telling, the Delphinus offering materials required particular ratings from S&P. The agency could issue a preliminary rating on the CDO even before the portfolio of referenced securities was finalized, but the indenture documents said that if the CDO didn’t obtain final ratings based on the actual collateral in the referenced portfolio within 30 days of the closing, Delphinus would go into a form of default known as “effective date” failure.

All of the referenced securities for the CDO were actually selected by July 17, 2007, two days before the deal closing. That’s not what Mizuho told S&P and the other rating agencies, though. According to the SEC, Mizuho knew the CDO wouldn’t receive the ratings it needed if the bank showed the actual portfolio of underlying securities to S&P, which had just toughened its CDO rating standards. So instead, on July 18, 2007, the bank sent various “dummy portfolios” containing imaginary assets to S&P, promising that it intended to back the CDO with securities of similar quality.

Reporting on the implications of the bond insurer Syncora’s $375 million settlement with Bank of America has been a Rashomon experience: Everyone I talked to had something different to say about what drove Tuesday’s settlement and what it means for MBIA, which has been litigating its own mortgage-backed securities breach-of-contract claims in parallel with Syncora. So if you were expecting a clear-cut answer on whether the Syncora settlement is good or bad for MBIA, you’re going to be disappointed. Syncora and MBIA were both litigating put-back claims against Countrywide and BofA before New York State Supreme Court Justice Eileen Bransten, who has delivered important simultaneous rulings for the bond insurers. But the similarities between Syncora and MBIA end in Bransten’s courtroom. When it comes to negotiations with BofA, they’re in very different postures.

The good news for MBIA: Bank of America’s settlement with Syncora shows that the bank remains willing and able to resolve claims that the mortgages underlying Countrywide-sponsored securities breached representations and warranties. In 2010 and 2011 Bank of America reached reps-and-warranties deals with the bond insurer Assured Guaranty; with the government-sponsored entities Fannie Mae and Freddie Mac; and with 22 institutional investors who backed a global $8.5 billion settlement of MBS investors’ put-back claims. Since then, the bank has been stuck in litigation with objectors to the proposed $8.5 billion global deal and in sniper fire with Fannie Mae. The Syncora settlement puts BofA back on the settlement track.

The settlement also shows that momentum from the litigation helps the monolines. My understanding is that Syncora and Bank of America have been in settlement talks for a long time, negotiating behind the curtain while the litigation plays out on a public stage. Specific events in the monoline cases against the banks – even developments as significant as Bransten’s loss-causation ruling or the battle over Bank of America’s successor liability for Countrywide’s wrongdoing – don’t have a direct impact on negotiations. That said, when U.S. District Judge Paul Crotty of Manhattan delivered a very insurer-friendly ruling on loss causation last month in Syncora’s case against JPMorgan, BofA took note. That’s also a positive for MBIA.

There’s an antitrust conspiracy in Delaware Chancery Court. Chancellor Leo Strine and Vice Chancellor Travis Laster are engaged in a cooperative effort to restrain the trade of shareholder lawyers who file derivative suits without obtaining books and records discovery. I’ve told you about Laster’s decision in the Allergan case, in which he found that shareholders who rushed to sue in California didn’t adequately represent the corporation (the nominal plaintiff in derivative litigation); and about Laster’s follow-up explanation that “diligent plaintiffs should get to litigate,” when he certified the case for appeal. On Monday, Strine echoed Laster when he refused to appoint a lead plaintiff in the derivative litigation over Wal-Mart’s alleged bribes in Mexico.

“More energy was spent by dueling plaintiffs over who gets to be lead counsel and lead plaintiff than was spent writing the complaints,” Strine said, according to my Reuters colleague Tom Hals. The chancellor chastised the two state pension fund giants vying to be named lead plaintiff for basing their complaints on the New York Times scoop on Wal-Mart’s alleged payments rather than on their own investigations, and said everyone should come back to court after the Indiana Electrical Workers Pension Trust Fund, IBEW, and its lawyers at Grant & Eisenhofer have obtained access to Wal-Mart’s books and records through the demand they have served on Wal-Mart’s board.

The California State Retirement System (CalSTRS) and the New York City Employees’ Retirement System had moved for appointments under what was previously considered the leading Delaware case on the standard for lead plaintiffs, Hirt v. U.S. Timberlands Service. Hirt laid out six factors the court should consider in choosing a lead in derivative litigation, including the quality of the complaint and the plaintiff’s economic stake in the outcome. (Remember, there’s no statutory framework for lead plaintiffs in derivative cases, as opposed to federal securities class actions.)

Judge Richard Posner of the 7th Circuit Court of Appeals, who has lately emerged as a persuasive critic of the U.S. patent system, believes patents are stifling innovation in this country, conferring unwarranted power on inventors who spend very little money to develop their creations. The one industry Posner exempts from this general rule is the brand-name pharmaceutical business, which he described in the Atlantic as “the poster child for the patent system.” He gave three reasons why drug companies need patent protection: New drugs cost millions of dollars to develop; drugmakers don’t get to earn money from their inventions for the entire life of the patent because it takes years of post-patent testing to bring a new product to market; and it’s cheap to copy drugs once someone else has invested heavily in developing them. Without patents, Posner wrote, drug developers would never recoup their costs.

Posner, however, has never had to decide a pay-for-delay case, which pits the interests of brand-name drugmakers against the interests of consumers who want to pay less for generic medications. On Monday, the 3rd Circuit Court of Appeals issued a shocker of a ruling in a pay-for-delay case against Schering-Plough (now owned by Merck). The three-judge appellate panel split with three other federal circuits and held that when a brand-name drug manufacturer pays a generic rival to drop its challenge to the brand-name drug patent, the settlement is prima facie evidence of an illegal restraint of trade. The decision throws down the gauntlet on the legality of pay-for-delay settlements, increasing the likelihood that the U.S. Supreme Court will have to take up the issue.

The controversy over pay-for-delay pharma settlements has been simmering for decades, since Congress attempted to balance the needs of brand-name drug manufacturers with the needs of consumers, who want access to cheaper generics, in the Hatch-Waxman Act of 1984. Hatch-Waxman established a regulatory framework for generics to bring their products to the market by filing new drug applications with the Food and Drug Administration, then litigating with brand manufacturers over the validity of brand-name patents. But lawmakers were quickly outsmarted by drug companies, which realized they could prolong their monopolies by paying generics to drop litigation over the validity of their patents. According to the Federal Trade Commission, which has spent years fulminating about these so-called reverse payment, or pay-for-delay settlements, the deals cost American consumers something like $3.5 billion a year.

The great thing for plaintiffs about claims under the Securities Act of 1933 (as opposed to the Exchange Act of 1934) is that you usually don’t have to show that defendants intentionally misled investors. The Securities Act carries strict liability for factual misstatements in offering documents, so plaintiffs get to slip under the high bar for establishing fraud.

There’s an exception, however, for statements that are deemed to be opinions. To proceed with Securities Act claims based on opinions in offering materials, investors do have to establish that the speaker (typically the corporation raising capital) knew the opinions were false. The 2nd Circuit Court of Appeals confirmed that distinction in August 2011 in a ruling called Fait v. Regions Financial, which held that, to be actionable under the Securities Act, opinions must falsely represent the speaker’s beliefs at the time they were expressed.

The carve-out for opinions puts investors with Securities Act claims in a bit of a pickle. Their best option is to disclaim assertions that misstatements were intentional, since then they don’t have to offer detailed allegations of fraud in their complaints. But if the statements are eventually determined to be opinions, plaintiffs risk having their cases dismissed because they’ve disclaimed the speaker’s knowledge and intent.

There’s a new entry in the category of no-brainers: A holder of Barclays American Depository Receipts has brought the first of what is sure to be a string of Libor-related securities fraud class actions. The 47-page complaint, filed by Wolf Haldenstein Adler Freeman & Herz in federal court in Manhattan, asserts that Barclays and its former CEO, Bob Diamond, and outgoing chairman, Marcus Agius, lied to shareholders when they failed to disclose the bank’s manipulation of reports to the authorities who calculate the daily London interbank offered rate (or Libor), a benchmark for short-term interest rates.

Barclays told shareholders that it was a model corporate citizen even though since at least 2007 it was “participating in an illegal scheme to manipulate rates in a way that would allow defendants and other bankers to exploit the market,” the complaint asserted. On the day Barclays’ settlements with U.S. and British financial regulators were announced, the complaint said, the price of its ADRs fell 12 percent; the next day the ADRs tumbled an additional 5 percent. (If you’re wondering why the complaint was filed by ADR holders, it’s because Morrison v. National Australia Bank bars claims in the United States by common stockholders in the British-listed bank.)

Barclays obviously has far bigger problems than a securities class action, what with Libor hearings in Parliament, talk of criminal actions, and billions of dollars in potential exposure in a Libor antitrust class action that’s already under way in federal court in Manhattan, plus the recently filed antitrust class action based on Barclays’ admitted manipulation of the European interbank offered rate.

If you’re already inclined to suspect governments of overreaching, boy will you hate the plan San Bernardino is contemplating.

About half of the homeowners in the newly bankrupt California city are underwater, which means they owe more on their mortgages than their homes are worth. In conjunction with a San Francisco outfit called Mortgage Resolution Partners, San Bernardino is considering a plan to exercise eminent domain and seize mortgage liens on some of those underwater homes. As my Reuters colleagues Matt Goldstein and Jennifer Ablan were the first to report, the eminent domain scheme works like this: With financing from an outside operation such as MRP, the city would condemn underwater mortgages and purchase them in the name of the public good for a court-determined fair market price. The financier would then make new mortgage loans to homeowners under modified terms before turning around and selling the modified loans to outside investors. As eminent domain proponents describe the plan, it’s a winner for everyone: Homeowners see their loan principal reduced and get to keep their houses, financiers turn a profit on the resold mortgages and the city avoids the blight of foreclosed homes, which drive down property values and destroy neighborhoods.

But there are also losers in the eminent domain model: investors in mortgage-backed securities. San Bernardino is talking about exercising eminent domain only over mortgage loans that have been bundled into private securitizations. Those mortgages are owned by MBS trusts, which, under eminent domain, would be forced to accept fair market value for underlying loans they don’t want to sell. To add insult to injury, the San Bernardino plan proposes that only performing loans be part of the initial wave of eminent domain seizures. That’s to reward homeowners who have managed to live up to their mortgage obligations. But from the perspective of MBS investors, seizing loans that are still being paid on time means they’re being stripped of an ongoing revenue stream.

More than four years after the Financial Accounting Standards Board first proposed a stringent new standard for corporate disclosure of litigation loss contingencies, it voted Monday to drop the effort, citing increased scrutiny of litigation exposure by the Securities and Exchange Commission and the Public Company Accounting Oversight Board. The accounting rulemaker’s decision has to be considered a relief for public corporations, many of which have bitterly opposed the FASB’s litigation disclosure proposals as a gift to plaintiffs’ lawyers.

The controversy over exactly what corporations must say in their financial statements about potential litigation losses actually dates back to the 1970s, when accountants and defense lawyers compromised on a standard mandating the disclosure of a litigation contingency when there’s a “reasonable possibility” of a loss. The FASB – which is responsible for setting generally accepted accounting principles – eventually decided that there was too much wiggle room in the “reasonable possibility” standard. In 2008, the accounting board proposed new rules that called for corporations to disclose virtually all litigation exposure, including the company’s assessment of its maximum exposure. Defense lawyers, according to Eric Roth of Wachtell, Lipton, Rosen & Katz, read the proposal as a dangerous encroachment on privileged communications about litigation prospects. “You can’t adopt a rule that strips companies of attorney-client privilege,” Roth said. “That was seen as an attack on the adversary system.”

Michael Young of Willkie Farr & Gallagher, who has been talking to FASB board members about litigation contingency disclosure for years, said that if the 2008 proposal had been adopted, plaintiffs’ lawyers arguing for damages could simply have shown juries excerpts on maximum exposure from a defendant’s own financial statements. “To the FASB’s credit, it took the board about two minutes to understand the problem,” Young said.

The New York Times had a great front-page story on Sunday about corporations contributing to politically active non-profits in order to shield their campaign contributions from public view. That’s not a revelatory thesis – I’ve written about a suit by campaign-spending reformers to force such non-profits as Karl Rove’s Crossroads GPS to disclose corporate donors – but the Times dug deep for examples of specific corporate contributions, such as the $3 million that Aetna gave to the U.S. Chamber of Commerce, which was initially described in a regulatory filing as a “lobbying expense.”

Bruce Freed of the Center for Political Accountability read about Aetna’s donation to the Chamber with great interest. Aetna, you see, is one of more than 100 large public companies that have agreed in the last several years to disclose their political spending. Most of those disclosure agreements have come under pressure from shareholders, who (often with CPA’s help) have demanded proxy votes on resolutions calling for corporations not only to disclose their policies and procedures for political spending but also to itemize all contributions, direct or indirect, that are intended to influence an election or referendum.

These shareholder demands for disclosure have become increasingly common, thanks to the U.S. Supreme Court’s 2010 holding in Citizens United v. Federal Election Commission, which said indirect corporate political spending is protected by the First Amendment. (Direct spending, as we’ve reported, may be another story.) Forcing companies to own up to their political involvement “has become even more critical,” the CPA website says, because Citizens United means “companies face greater pressure to spend corporate dollars either directly or indirectly through conduits such as trade associations and [non-profits].”

Jennifer Barker of Louisville, Kentucky, insists she has never downloaded a pornographic movie from the Internet and has certainly never infringed anyone’s copyright through illegal porn downloading. So you can imagine her dismay when, according to a complaint filed Thursday by her lawyers at Henry & Associates, Barker was contacted in May by a woman asking her to settle an illegal porn-downloading claim that had been asserted against her in Florida. Barker was told that Internet records indicated she had downloaded several titles from the website X-Art, and that if she didn’t pay up she’d be subject to hundreds of thousands of dollars in judgments and would be publicly revealed as a porn downloader. When Barker refused, according to the complaint, she was harassed about the supposed claim, with messages left on her personal and work phones.

Barker is one of tens of thousands of people who’ve received settlement demands from porn movie producers and their lawyers in the last few years. As I’ve reported here, these piracy cases have become a flash point in copyright litigation. No one disputes the scourge of illegal downloading, but public interest advocates assert that piracy cases in which porn producers and their lawyers sue thousands of unknown downloaders at a time are more akin to extortion than litigation. The copyright holders aren’t really interested in protecting their rights, according to Public Citizen and the Electronic Frontier Foundation. They’re interested in scaring accused downloaders into forking over a couple thousand dollars apiece to make the accusations go away. The public interest groups assert that even people like Barker, who say they never downloaded illegal porn, often assume it’s cheaper and easier to pay the settlement than to hire a lawyer and defend the litigation.

Barker did better than that, however. With Thursday’s filing, she became one of a handful of accused porn downloaders to go on offense against her attackers. She brought class action fraud, defamation and racketeering claims in federal court in Louisville on behalf of everyone who has been “subjected to the unlawful extortion attempts” of the defendants – Patrick Collins, Inc, Malibu Media, Raw Films, K-Beech and Third Degree Films – since 2007.