Alison Frankel

Where’s accountability to MBS investors in $13 bln JPMorgan deal?

Alison Frankel
Oct 21, 2013 19:47 UTC

By all accounts, JPMorgan Chase is on the verge of a record-setting $13 billion settlement with the Justice Department and other state and federal regulators that will resolve the bank’s civil liability to the government for the sale of mortgage-backed securities, by JPMorgan itself and by Bear Stearns and Washington Mutual. We still don’t know precisely what admission JPMorgan will make as part of the deal, and based on the bank’s shrewd blame-taking in its London Whale trade losses settlement with the Securities and Exchange Commission, we can assume any admissions will be tailored to limit collateral damage in private litigation. Nonetheless, regardless of how JPMorgan phrases its acceptance of responsibility, the bank’s $13 billion settlement is an acknowledgment of the obvious: The mortgage-backed securities market was infested at its foundation, like a house gnawed away by termites.

So why are investors in private-label MBS still standing in the rubble of collapsed mortgage-backed trusts? We haven’t seen a final allocation plan for the $13 billion settlement, but I haven’t seen any indication that money has been set aside for private investors in JPMorgan, Bear or WaMu MBS offerings. To the contrary: Certificate holders are already asking whether the bank intends to shift the cost of the settlement’s reported relief to underwater homeowners on to MBS trusts.

Investors in private-label MBS have experienced hundreds of billions of dollars in losses. Let’s look, for instance, at JPMorgan’s description of the fate of mortgage-backed securities sold by the bank and its predecessors Bear and WaMu. According to JPMorgan’s 2012 annual report, the three entities sold a combined $450 billion in MBS to private investors (as opposed to Fannie Mae and Freddie Mac) between 2005 and 2008. More than a quarter of the original face value of the securities, or $118 billion of that $450 billion, has been liquidated, with investors suffering average losses of more than 60 percent on liquidated underlying loans. By my math, that’s about $71 billion in losses for private-label JPM, Bear and WaMu MBS trusts as of the filing of the bank’s annual report last December – with more likely, since the report also disclosed that $39 billion in underlying mortgage loans were at least 60 days overdue.

So private investors in JPMorgan MBS trusts are out at least $71 billion and possibly as much as $90 billion. Of course, JPMorgan and its predecessors aren’t to blame for all of those losses. Some of them, as MBS issuers have been proclaiming since the first MBS fraud suit was filed five or so years ago, were unquestionably due to the collapse of the economy. Homeowners who otherwise would have faithfully paid their mortgages, directing revenue to MBS investors, lost their jobs and defaulted on loans. It’s also true that MBS purchasers were supposed to be sophisticated investors with a high tolerance for risk and their own due diligence capabilities. To return to the termite analogy, MBS purchasers – in the view of MBS defendants – shouldn’t be able to claim that they relied on assurances from a seller when they didn’t take care to bring in their own home inspector.

But what we’ve learned in the last five years – partly through private MBS litigation: first, fraud suits by bond insurers and investors suing through class actions; later, fraud claims by individual investors and breach of contract suits by MBS trustees acting at the direction of certificate holders – is that the MBS process was rigged by sellers. Mortgage originators knew they were writing loans that didn’t meet their stated underwriting standards. MBS sponsors disregarded reports by their own re-underwriters about deficiencies in the loans. Credit rating agencies were more concerned with capturing their share of the lucrative market in rating complex securities than in evaluating the offerings with investors in mind. The sell side knew it was peddling heaps of junk. Many (albeit not all) on the buy side didn’t share that knowledge.

How the government has evaded constitutional test of secret wiretaps

Alison Frankel
Oct 18, 2013 22:12 UTC

If you haven’t already, please read Charlie Savage’s fascinating story, “Door May Open for Challenge to Secret Wiretaps,” in Thursday’s New York Times. Savage reported that the Justice Department is poised for the first time to notify a criminal defendant that evidence against him was obtained through the FISA Amendment Act of 2008 (FAA), which granted the Foreign Intelligence Surveillance Court the power to approve sweeping, warrantless wiretapping. The notification is significant because it will establish the defendant’s standing, under the U.S. Supreme Court’s ruling last February in Clapper v. Amnesty International, to challenge the constitutionality of warrantless wiretapping authorized under the FAA.

Savage’s story detailed the debate within the executive branch about whether the Justice Department is obligated to tell defendants about evidence obtained through warrantless surveillance. U.S. Solicitor General Donald Verrilli – who had assured the U.S. Supreme Court in the Clapper case that such disclosures would be made – was reportedly taken aback when he learned in June that prosecutors took a contrary position in opposing motions for disclosure by three defendants accused of terrorist acts. The defendants – two brothers charged in Ft. Lauderdale, Florida, federal court and one young suspect in a Chicago case – had asked the government to acknowledge its use of evidence from FAA-approved wiretaps, after Senator Dianne Feinstein (D-Calif) publicly cited their cases, among others, as justification for the broad data collection permitted under the FAA. Through the summer, according to Savage, the Justice Department discussed how to reconcile concerns about the national security implications of notifying defendants with defendants’ due process rights. The upcoming notification, in an unspecified case, reflects Justice’s determination that it is legally required to disclose to defendants that it has obtained evidence through warrantless wiretaps.

The Times story, as well as a Freedom of Information Act complaint filed Thursday afternoon by the American Civil Liberties Union against the Justice Department, prompted me to go back to the records in the Ft. Lauderdale and Chicago cases Savage cited, to see how the government has so far fended off notification demands. Defense lawyers in the cases deserve a lot of credit for their dedication and enterprise in making those demands. According to the ACLU complaint, 11 cases implicating FAA-derived evidence have been publicly cited in Congress. Senator Feinstein mentioned eight cases in an FAA reauthorization hearing before the Senate Select Committee on Intelligence in December, and in June FBI Deputy Director Sean Joyce mentioned three others in testimony before the House Permanent Select Committee on Intelligence. Defendants in many of the cases have already pleaded guilty, often, according to Patrick Toomey of the ACLU, before they ever knew the government was running the mass data collection operations revealed by Edward Snowden. Only Durkin & Roberts, for Chicago defendant Adel Daoud, and Ronald Chapman and Daniel Ecarius, for Ft. Lauderdale defendants Sheheryar Qazi and Raees Qazi, have demanded that government disclose whether any of its evidence is the fruit of warrantless wiretaps.

In politically charged terror finance case, Israeli bank ducks testimony

Alison Frankel
Oct 17, 2013 20:10 UTC

A young Floridian named Daniel Wultz died tragically in 2006 when he was fatally wounded in a suicide bombing at a bus stop in Tel Aviv. Wultz’s parents believe that among those responsible for their son’s death is Bank of China, which they accuse of facilitating payments to Palestine Islamic Jihad, the group said to be responsible for the attack. The Wultzes and their lawyers at Boies, Schiller & Flexner contend that Israeli counterterrorism officials warned the Chinese government at meetings in China in April 2005 that an alleged Islamic Jihad leader, Said al-Shurafa, was financing the group’s operations through his Bank of China accounts. The Wultzes’ Antiterrorism Act suit, filed in federal court in Washington but later transferred to Manhattan federal court, alleges that Chinese officials passed those warnings on to the bank.

The politically explosive case has already occasioned a diplomatic crisis for Israeli Prime Minister Benjamin Netanyahu, whose government at first encouraged the Wultzes to sue Bank of China and agreed to permit testimony about the 2005 meeting in China from a former member of the counterterrorism staff of Israel’s national security council. Netanyahu’s government has since backed away from the Wultzes’ case, reportedly under pressure from China, which has strong economic ties to Israel. The former Israeli counterterrorism official, Uzi Say, has nonetheless indicated that he is inclined to testify for the Wultzes and other bombing victims suing Bank of China, even without clearance from his government.

In that context, a dispute over Bank of China’s subpoena for third-party testimony from a corporate official of Israel’s Bank Hapoalim is definitely a tangential matter, without the emotional or geopolitical resonance of the Wultzes’ underlying claim. But the fight between Bank of China and Bank Hapoalim raises some interesting questions about the reach of a subpoena for expert corporate testimony under the Federal Rules of Civil Procedure. And a decision Tuesday by U.S. Magistrate Judge Gabriel Gorenstein that Bank Hapoalim does not have to produce a witness from Israel could severely impair Bank of China’s defense in this most sensitive of cases.

Labeling genetically modified food: regulation via litigation is back

Alison Frankel
Oct 16, 2013 20:18 UTC

Fifteen years ago, when trial lawyers were flush with cash from representing state attorneys general in their global $365 billion settlement with the tobacco industry, the phrase “regulation through litigation” was much in vogue. On the plaintiffs’ side, it was a rallying cry, a call for lawyers to use the tactics of the tobacco litigation – including their partnership with state regulators – to accomplish societal goals, such as reducing gun violence or cutting carbon emissions. Tort reformers, meanwhile, sounded alarms about ceding policy-making to unelected lawyers driven by their own potential profits. Despite the fervor on both sides, regulation through litigation turned out to be more of a slogan than a reality as ambitious cases against, for instance, gun- and lead- paint makers faltered.

But suits over food companies’ labeling of genetically modified ingredients may prove to be a rare example of litigation forcing industrywide change, even as the federal government dithers on policy.

Last week, Frito-Lay’s lawyers at Gibson, Dunn & Crutcher filed an answer to a consolidated class action complaint in multidistrict litigation over Frito’s allegedly misleading use of “all natural” labeling on products that contain genetically modified corn. Like their defense counterparts in similar bioengineered food labeling litigation against Conagra Foods and Campbell Soup, the Gibson lawyers insisted that consumer claims should be barred by the “primary jurisdiction doctrine,” which says that courts must wait for federal agencies to apply their regulatory expertise before hearing claims in litigation. Food industry lawyers contend that it’s premature for judges to consider class actions over bioengineered food labeling because the Food and Drug Administration has not issued binding policy on whether genetically modified ingredients are “natural” (or, for that matter, on any definition of “natural” in food labels).

Thwarting Morrison, BP shareholders win right to proceed in Texas

Alison Frankel
Oct 15, 2013 21:08 UTC

When Matthew Mustokoff of Kessler Topaz Meltzer & Check walked out of oral arguments before U.S. District Judge Keith Ellison of Houston last November, he wasn’t at all sure that his case – a suit by individual pension funds claiming to have been duped by BP – would survive BP’s motion to dismiss. The judge had expressed sympathy for holders of London-listed BP common shares, whose federal securities claims are barred by the U.S. Supreme Court’s 2010 ruling in Morrison v. National Australia Bank. Mustokoff and co-counsel from Jason Cowart of Pomerantz Hufford Dahlstrom & Gross were attempting to plead around Morrison by asserting fraud and misrepresentation claims under state and common law. But Judge Ellison seemed to be very interested in a novel constitutional argument BP’s lawyers at Sullivan & Cromwell had crafted in response to the pension funds’ Morrison-dodging. BP said that the funds’ case violated the dormant Commerce Clause as it applies to international commerce because state laws may not exceed the bounds of federal law. Funds couldn’t assert claims under state law, according to BP, when parallel federal-law claims were barred. Ellison was so intrigued by S&C’s Commerce Clause argument that at least half of the hearing on BP’s motion to dismiss the funds’ two related suits, Mustokoff told me, was dedicated to that defense.

But when Ellison entered his 97-page opinion on the docket of the BP multidistrict securities litigation last Thursday, his analysis of the Commerce Clause argument was reduced to a footnote. The judge entirely side-stepped the question of whether state or common law can give U.S. investors rights they don’t have under federal law by concluding that English law – and not American common law – applies to the pension funds’ claims. BP had asked the judge to choose English law, but it also wanted him to find that an English court is the preferable forum for a matter of English law. Instead, Ellison said that he’s perfectly capable of applying English law on fraud, which “shares so many strong similarities with U.S. law due to a common heritage.” And since the conduct at issue in the pension funds’ case involves BP’s U.S. operations – and since he’s already overseeing a class action by holders of BP American Depository Shares, who are raising arguments similar to those of the pension funds – Ellison said it makes sense for him to hear the funds’ suits.

Ellison’s ruling, as Kevin LaCroix at D&O Diary noted Tuesday, is an extremely rare example of shareholders of a foreign-listed stock finding a way around Morrison. But before the securities class action bar starts boning up on English law on fraud (or, as it’s known over the pond, “deceit,”), there are a couple things to keep in mind. First, this case isn’t a class action. It’s two suits by nine pension funds that had large enough BP holdings to make it worth their while to pursue individual actions. Second, Ellison based his decision to retain jurisdiction on some factors that might not figure in other investor fraud suits. And third, BP and Sullivan & Cromwell will get at least one more chance to present their dormant Commerce Clause argument, which could still erase investor claims.

Time to undo fraud-on-the-market presumption in securities class actions?

Alison Frankel
Oct 14, 2013 20:03 UTC

The U.S. Supreme Court created securities class actions as we now know them in 1987, when an unusual four-justice majority held in Basic v. Levinson that investors in securities fraud cases may be presumed to rely on public misrepresentations about stock trading in an efficient market. Basic’s fraud-on-the-market theory made it possible for shareholders to win class certification without proving that class members made investment decisions based on the defendants’ alleged misstatements – a momentum-shifting boon to shareholders. The ruling has become such an essential building block of securities fraud litigation that since 1987, according to Westlaw, Basic has been cited almost 17,000 times.

But now the Supreme Court is being asked to topple its own creation. In a petition for certiorari last month, Halliburton’s lawyers at Baker Botts argued that Basic’s “naive” and “simplistic” efficient-market theory has been repudiated by economists and is inconsistent with the court’s recent precedent in other sorts of class actions. The Halliburton petition capitalized on dissents in the Supreme Court decision last term in Amgen v. Connecticut Retirement Plans, in which the three justices in the minority – Clarence Thomas, Antonin Scalia and Anthony Kennedy - noted the “questionable” premise of fraud-on-the-market theory. Justice Samuel Alito, in a concurrence, specifically asked whether the court’s ruling in Basic should be reconsidered; Halliburton’s petition takes him up on the offer.

On Friday, class counsel at Boies, Schiller & Flexner shot back at Halliburton and Basic’s critics. In a brief opposing cert, Halliburton shareholders argued that Congress and the Supreme Court have had plenty of opportunities over the last 25 years to dismantle Basic’s fraud-on-the-market framework yet they have consistently refused to do so. According to the opposition brief, Basic remains good law, and even if the Supreme Court wanted to revisit efficient-market theory, the Halliburton case isn’t the right vehicle.

Business groups to SCOTUS: Protect us from whistleblowers!

Alison Frankel
Oct 10, 2013 20:32 UTC

Sarbanes-Oxley was enacted as a response to the collapse of Enron, and one of its intentions was to encourage employees to keep their companies honest. SOX included specific provisions for whistleblower reporting, as well as prohibitions on corporate retaliation against employees who bring concerns to their supervisors. That’s all straightforward enough when the purported whistleblowers are employees of public companies. But what about employees of private businesses doing work for public companies – like, say, the audit firm Arthur Andersen in the Enron scandal? If an accountant or any other employee of a private business is fired after detecting and reporting supposed wrongdoing uncovered in the course of providing services to a public company, can the employee sue under SOX?

That question is now before the U.S. Supreme Court in Lawson v. FMR, which is scheduled for oral argument on Nov. 12. The case turns on a hypertechnical point of statutory interpretation: When Congress barred retaliation against “an employee of such company” did it mean just an employee of a public company, or did it intend the words also to encompass employees of contractors or subcontractors? The law clearly prohibits retaliation by private contractors and subcontractors working for public companies, but the dispute involves whether the private companies are barred only from acting against employees of the public companies or also against their own employees.

In a split decision in February 2012, the 1st Circuit Court of Appeals ruled SOX anti-retaliation protections apply only to employees of public companies, tossing whistleblower anti-retaliation suits by two former employees of private Fidelity investment advisory companies that provide services to Fidelity mutual funds. (Mutual funds are covered by SOX because they file reports to the Securities and Exchange Commission.) But the Department of Labor, in an Administrative Review Board ruling in May 2012, advised that SOX’s whistleblower protections apply broadly and cover private employees. The Supreme Court granted certiorari to the former Fidelity employees, Jackie Lawson and Jonathan Zang, last May.

If U.S. defaults, can debt holders sue for payment?

Alison Frankel
Oct 9, 2013 21:22 UTC

To the long list of dire consequences if the United States defaults on debt obligations, here’s an addition you probably haven’t considered: litigation against the U.S. government for missed payments.

Let’s establish at the outset that if American owners of Treasury bills or U.S. bonds are counting on a suit against the U.S. government to recover any losses stemming from a default, their faith is misplaced. Litigation takes a long time in this country, especially when you’re talking about completely unprecedented claims arising from unique, unforeseeable circumstances. It’s just about unfathomable that the United States will fail to meet its obligations to bondholders for as long as it would take them to obtain a judgment, even assuming that bondholders somehow defied all reasonable expectations and managed to win their case. For that hypothetical to be realized, our economy would have to be so devastated that bondholder litigation would be a relatively small worry.

But what about a suit by foreigners who own U.S. debt? Or even foreign sovereigns? I talked Wednesday with several foreign debt and constitutional experts, both in academia and private practice. They outlined a set of hypotheticals under which foreign owners of U.S. debt could sue the U.S. government in their own courts and even attempt to enforce judgment against the United States by seizing U.S. assets. Granted, the scenario is based on speculation that’s incredibly unlikely to come to pass. In these strange days, though, a little mind-bending is good exercise.

3rd Circuit appeal throws light on shadowy class action claims process

Alison Frankel
Oct 8, 2013 20:15 UTC

In all my long years of reporting on class actions, I can’t remember ever writing a story about one of the handful of U.S. companies in the business of administering settlements. Sure, I’ve covered BP’s recent feud with court-appointed claims administrator Patrick Juneau and the alleged misconduct of some of Juneau’s staff. But not about Garden City Group, PricewaterhouseCoopers or Brown Greer, the companies that are actually processing claims from the Deepwater Horizon oil spill litigation, under both Juneau and his predecessor at the Gulf Coast Claims Facility, Kenneth Feinberg of Feinberg Rozen. I’ve written about U.S. District Judge William Pauley chastising the Securities and Exchange Commission for failing to exercise strict supervision over the investors’ compensation fund established in the SEC’s 2009 settlement with Zurich Financial, but not about the fees Garden City Group charged to administer the investor fund. Claims administrators are an essential part of the class action mechanism. They’re the businesses that help lawyers figure out how to inform potential class members that they may have claims and subsequently evaluate the claims that are submitted. Yet there’s scant scrutiny of the claims administration business by journalists, or, for that matter, judges.

For its part, the industry treasures its reputation for neutrality, according to Steven Weisbrot, an executive vice president at the recently-formed claims administration firm Angeion Group, which was founded by longtime executives from other firms in the business. “Both sides have to trust claims administrators,” Weisbrot said. “Trust allows the system to work.” So as a rule, he told me, businesses that make their money administering class actions prefer a low profile. Sometimes courts will ask a claims administrator to submit declarations explaining a class notice plan, Weisbrot said, and some judges insist on competitive bidding for settlement administration gigs. Generally, though, claims administrators would rather not attract attention.

That’s why I was surprised to see an amicus brief from Angeion in support of reconsideration of a ruling by the 3rd Circuit Court of Appeals that decertified a class of Florida purchasers of Bayer’s One-A-Day WeightSmart diet supplement. As I suspected it would, the reconsideration motion, filed by Deepak Gupta of Gupta Beck, has generated some impressive amicus support. Last week, Public Citizen and Public Justice both joined the Florida class in arguments that the 3rd Circuit panel set an impossible – and unnecessary – standard of ascertainability when it said that the class couldn’t be certified without a rock-solid plan to determine purchasers of the Bayer diet supplement. A group of 10 law professors specializing in civil procedure, led by Arthur Miller of Harvard Law School, asserted in another amicus brief advocating reconsideration that the appellate panel’s new ascertainability standard is “a notion entirely divorced from the text and purposes of Rule 23″ and a “doctrinal error (that) threatens to render the class action procedure unavailable in the very small-value consumer cases that necessitated Rule 23 in the first instance.”

Dish Network lesson: Risk lurks if majority shareholder grips power

Alison Frankel
Oct 7, 2013 20:38 UTC

In an order issued late Friday, Judge Elizabeth Gonzalez of Nevada state court in Las Vegas effectively informed Dish Network Chairman Charles Ergen and his fellow board members that Dish’s peculiar corporate governance practices pose real risks to them and the company.

Gonzalez, who is presiding over a shareholder derivative suit against Dish’s board, granted expedited discovery to minority shareholders who claim that Ergen is conflicted in Dish’s $2.2 billion stalking horse bid for spectrum licenses belonging to the bankrupt wireless communications company LightSquared. The judge also scheduled a Nov. 12 hearing on the shareholders’ motion for a preliminary injunction to bar Ergen – who is LightSquared’s largest creditor, holding $850 million in debt acquired through a personal investment vehicle – from participating in Dish’s attempt to acquire the LightSquared licenses.

Gonzalez’s order comes despite Dish’s 11th-hour attempt last month to forestall the minority shareholders’ suit by appointing a purportedly independent litigation committee, and despite arguments by the special committee’s counsel at Young Conaway Stargatt & Taylor and Holland & Hart that permitting the shareholders to proceed would interfere with Dish’s ability to acquire those strategically crucial LightSquared assets. It seems clear to me that after a scant two months of litigation in the derivative suit, the judge is skeptical that Dish can muster an independent board committee – or even that its directors are trying very hard to assure any such committee’s independence.