Alison Frankel

Even tobacco companies are entitled to the free speech protections of the First Amendment.

As U.S. District Judge Richard Leon of Washington, D.C. federal court explained in a fascinating ruling Monday, the Constitution grants not just the right to speak, but also the right not to. “Compelled speech” violates the First Amendment, except in a narrow commercial context; the U.S. government can require businesses to make “purely factual and uncontroversial” disclosures to protect consumers.

Judge Leon found that nine graphic images the Food and Drug Administration and the Department of Health and Human Services planned to require tobacco companies to carry on every pack of cigarettes amounted to compelled speech. He granted the tobacco companies an injunction against the requirement, finding that “unfortunately for the government, the evidence here overwhelmingly suggests that the rule’s graphic-image requirements are not the type of purely factual and uncontroversial disclosures that are [permissible].” “Indeed, the fact alone that some of the graphic images here appear to be cartoons, and others appear to be digitally enhanced or manipulated, would seem to contravene the very definition of ‘purely factual.’”

The judge said that the Justice Department simply could not show that the government’s intention in requiring the images — which are supposed to cover half of the front and back of each pack — is only to inform consumers. Instead, he found, the goals of the requirement are “to say the least, unclear.” The images appeared to have been chosen to evoke an emotional response and persuade consumers either to stop smoking or never begin, Judge Leon said. And in that, they breached the tobacco companies’ right not to be forced to advocate against the use of their own lawful product.

“He was very troubled by the question, which he asked the government several times: ‘How can I tell the difference between factual and uncontroversial material and material that constitutes advocacy?’” said Lorillard counsel Floyd Abrams of Cahill Gordon & Reindel, who shared oral argument with RJ Reynolds counsel Noel Francisco of Jones Day. “We argued that any images of the sort suggested by Congress are unconstitutional.”

On Thursday, a firm called Brower Piven filed a Manhattan federal court securities-fraud class action against Jon Corzine and three other officials of the bankrupt brokerage MF Global. The complaint, as Jon Stempel reported for Reuters, claims that beginning in May, the MF execs deliberately misled shareholders about the brokerage’s leverage and risk-management controls. It’s really a placeholder: the plaintiff is one individual investor, and the suit asserts a single count of securities fraud based only on public MF Global regulatory filings, press releases, “and other information readily obtainable on the Internet.”

But meanwhile, behind the scenes, the big players in securities litigation are busily analyzing potential claims for MF shareholders and, perhaps more importantly, MF bondholders. They’re drafting memos and talking to the clients who usually lead major securities class actions — institutional investors such as public and union pension or health-care funds. There hasn’t been a lot of juicy securities fraud litigation of late, one plaintiffs’ lawyer told me, so firms are trying to figure out how to position themselves to lead this case. “It’s going to be a bloodbath,” another lawyer said. “Everyone is looking at this.” (Almost everyone I talked to declined to be named because they haven’t firmed up their plans for the MF litigation.)

So let’s take a look at how the shareholder and bondholder cases may shape up, and what pitfalls MF investors may face.

On Thursday, the Buffalo federal court judge overseeing Paul Ceglia’s claim to own half of Facebook — by virtue of a 2003 contract he claims CEO Mark Zuckerberg signed as a Harvard undergraduate — is expected to enter an order directing Ceglia to return from Ireland to produce crucial undisclosed computer evidence, and to answer Facebook’s withering questions about the authenticity of the contract and his own failures to comply with previous court directives.

For Facebook’s lawyers at Gibson, Dunn & Crutcher, this order, which follows a three-hour hearing Wednesday, is the latest success in a string of rulings that express the judge’s concern with the evidence offered by Ceglia, an upstate New York wood-pellet salesman who decamped to Ireland in the face of Facebook’s relentless attacks. Facebook’s lead lawyer, Orin Snyder of Gibson, said that when Ceglia finally produces the evidence ordered Thursday, his purported two-page contract with Zuckerberg will be indisputably exposed as a fraud.

But Ceglia’s latest lawyer — who joined the case about two weeks ago, after four other firms resigned over the last year — told me in a long interview Wednesday evening that he and Ceglia have turned the tables on Facebook and Gibson Dunn. In the face of sanctions motions by Facebook, California solo Dean Boland filed retorts accusing Facebook and Gibson Dunn of tampering with the original contract between Ceglia and Zuckerberg, who did some coding work for Ceglia before founding Facebook, and with Zuckerberg’s Harvard email account. Facebook and Gibson have argued, very persuasively, that the Harvard email records prove Ceglia fabricated a series of emails between him and Zuckerberg to bolster his false account of their contract.

Irving Picard has given the bankruptcy laws one hell of a workout. As trustee in the Chapter 7 bankruptcy of Bernard Madoff’s securities firm, Picard, a partner at Baker & Hostetler, has been more aggressive and creative than any bankruptcy trustee in history in his search for defendants to blame for Madoff’s epic Ponzi scheme. His most ambitious gambit, as everyone knows, was a series of megabillion-dollar suits against the international financial institutions that Picard’s team of lawyers at Baker & Hostetler accused of willfully ignoring warnings of Madoff’s fraud.

The trustee’s suits were provocative headline-grabbers — and on Tuesday, a second Manhattan federal judge concluded that they’re fatally flawed. U.S. District Court Judge Colleen McMahon dismissed Picard’s common law tort claims against JPMorgan Chase and UBS (and related defendants), finding that Picard does not have standing. Her ruling expands and reinforces a previous decision on the same issue by her Manhattan federal court colleague Judge Jed Rakoff, who in July dismissed Picard’s common law claims against HSBC and UniCredit. Tuesday’s decision wipes out about $20 billion in alleged damages, leaving Picard with about $450 million in traditional bankruptcy court clawback claims against JPMorgan and about $80 million against UBS. It’s a huge win for JPMorgan’s lawyers at Wachtell, Lipton, Rosen & Katz — who were actually the first lawyers to ask a federal district court judge to hear one of Picard’s cases — and for UBS’s lawyers at Gibson, Dunn & Crutcher.

But now the question is whether Picard’s allegations that these global banks helped Madoff perpetuate his scheme are dead. The answer is not quite. The trustee’s spokesperson has already announced that Picard’s team from Baker & Hostetler intends to appeal McMahon’s ruling to the 2nd U.S. Circuit Court of Appeals; the trustee has already filed a notice of appeal of Rakoff’s decision. Moreover, as both McMahon and Rakoff discussed in their opinions, Madoff’s customers have the standing Picard lacks. Some enterprising plaintiffs lawyer could certainly capitalize on Picard’s spade work and file a class action against the banks on behalf of Madoff victims.

It’s been a busy couple of weeks for the lawyers who filed Bank of America’s proposed $8.5 billion settlement with Countrywide mortgage-backed securities investors. On Oct. 19, as you doubtless recall, U.S. District Judge William Pauley III of Manhattan federal court ruled that the proposed settlement should be evaluated in federal court as a mass action under the Class Action Fairness Act, and not in New York State Supreme Court, where the case was filed back in June. Yesterday Bank of New York Mellon (the Countrywide MBS trustee) and the investor group that negotiated the $8.5 billion deal with BofA responded to Pauley’s ruling. In appellate briefs by Mayer Brown and Dechert (for BNY Mellon) and by Gibbs & Bruns (for the institutional investor group), the settlement’s supporters asked the U.S. Court of Appeals for the Second Circuit to step in and right Pauley’s wrongs.

On the same day, BNY Mellon filed a “joint” case management report with Pauley, in response to the judge’s instruction in the Oct. 19 ruling. The joint report is actually two divergent proposals for how the case should proceed in federal court. A group of Countrywide MBS investors who don’t like the proposed deal, led by the Walnut Place coalition and AIG, are asking Pauley to fashion an ad hoc vehicle to evaluate the settlement and permit investors who don’t like it to opt out. BNY Mellon and the Gibbs & Bruns group, as I predicted, want Pauley simply to answer the limited question they posed to New York State Supreme Court Justice Barbara Kapnick when BNY Mellon filed the case as an Article 77 proceeding under state trust law: Did BNY Mellon act unreasonably or unethically when it agreed to the settlement on behalf of MBS trust investors? The objectors, not surprisingly, want Pauley to permit them to start discovery while the appeal of his ruling is pending. BNY Mellon and the Gibbs group want Pauley to stay discovery until the Second Circuit determines whether he should keep the case.

BNY Mellon and Gibbs & Bruns also filed yet another set of briefs Monday night, these in response to an old case-management order the state court judge entered before Walnut Place’s lawyers at Grais & Ellsworth removed the settlement to federal court. The briefs, styled as consolidated answers to settlement objectors, are a bit of theater, given that Kapnick no longer controls the case. But they’re a forum for BNY Mellon and the big investors who negotiated the deal to fire back at critics who’ve complained that (among other things) the trustee is conflicted because of a side letter in which BofA indemnified BNY Mellon for costs associated with the settlement; and that Gibbs & Bruns and its clients co-opted settlement talks. Here’s BNY Mellon’s brief, and here’s the investor group’s.

Back when former Goldman Sachs director Rajat Gupta’s most pressing problem was the Securities and Exchange Commission’s civil case against him, his defense scored a small victory when the SEC agreed to drop an administrative proceeding against him and brought civil charges in federal court instead. Gupta’s lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, had fought to have Gupta’s case heard by a federal judge, rather than an SEC administrative law judge, because the rules of evidence in administrative proceedings favor the agency. Among other things, the SEC can admit hearsay evidence, and defendants don’t have the same rights to depose opposing witnesses. Although the SEC can’t seek the same penalties in administrative proceedings as it can in federal court, they can be an effective way for the agency to make a statement about improper conduct.

Except when the defendants win.

On Friday, the SEC’s chief administrative law judge, Brenda Murray, entered a painstaking 58-page decision that cleared former State Street executives John Flannery and James Hopkins on all of the SEC’s sprawling allegations that they misled investors about the mortgage-backed securities holdings in State Street bond funds. Murray found that the agency failed to show at trial that Flannery and Hopkins violated any securities laws in communicating with investors about the funds’ subprime MBS holdings. She went out of her way to describe the former State Street execs as candid, believable witnesses who were frustrated to be on trial.

Murray’s ruling is yet another courtroom rebuke to the SEC, which in the last few years has seen several high-profile trials end in victory for defendants. Most notably, in 2009 a San Francisco federal judge dismissed stock options backdating charges against Broadcom executives; and in 2010 a Manhattan federal judge exonerated two traders in a landmark SEC case alleging insider trading in credit-default swaps. The State Street loss is perhaps an even bigger black eye for the SEC, given that the loss came in an administrative proceeding, the agency’s home turf.

The Mortgage Electronic Registration Systems — or MERS, as it’s known — is the business everyone loves to hate. MERS was established in the 1990s to streamline the process of packaging mortgage loans into mortgage-backed securities. Its members, all players in mortgage securitization, reasoned that it would be easier to securitize mortgages if there were a centralized electronic database of the loans, rather than physical paperwork scattered at mortgage lending institutions across the country. The MERS mortgage registry was essential to the securitization boom of the 2000s. But after the housing bust, MERS has been something of a litigation piñata. Homeowners have filed a multitude of suits challenging MERS’s legal right to foreclose and its alleged robo-signing foreclosure practices. More recently, local officials have begun suing MERS for cutting them out of the mortgage registration process and supposedly cheating them out of mortgage recording fees.

Thursday’s complaint against MERS by Delaware Attorney General Joseph Biden III includes those familiar allegations, which MERS has had a pretty good (but definitely mixed) record of defending. But Biden’s complaint goes on to raise broader questions about MERS’s role in the MBS industry. According to the Delaware AG, MERS helped MBS issuers and securitization trustees peddle securities that were flawed at their core. The suit claims that MBS trusts may not actually have owned some of the mortgages bundled into the securities they sold. If those allegations prove true, this complaint could wreak havoc in the mortgage securitization industry.

It’s no secret that the New York and Delaware AGs have a lot riding on their MBS investigations. New York Attorney General Eric Schneiderman lost his spot on the committee of attorneys general negotiating a multi-state deal with five major banks because of his insistence that the settlement address failures in mortgage securitization as well as in the foreclosure and servicing process. He’s taken considerable political heat as a result, but just this week, Schneiderman told MSNBC’s Rachel Maddow that he and Biden are committed to “looking at the conduct of individual institutions and individuals to see if there were misrepresentations made, to see if there was fraud committed, to see if criminal acts were also a part of this.” He added, “We’re determined to follow it through until we get the relief the homeowners need and hold accountable the people who caused this.”

When Philip Yeatts was born in Brownfield, Texas, in September 1962, he had no right leg. His right arm ended in a stump above his elbow, and he had a cleft palate and deformed tongue. Annette Manning, born in Green Bay in 1960, had only buds of fingers and an arm that ended in a stump — just like Mary Hurson, born the same year in New York City, and Tammy Jackson, a 1962 baby in Ranger, Texas. In a heartbreaking new complaint against GlaxoSmithKline, Sanofi-Aventis, Aventor, and Grunenthal, these four plaintiffs, along with eight others (in three parts here, here, and here) claim that their birth defects resulted from their mothers’ use of the now-notorious anti-nausea drug Thalidomide — and that the drug companies engaged in a 50-year scheme to cover up how widely Thalidomide was prescribed in the U.S., and how varied were the birth defects that could result from the drug.

“The question is going to be, ‘Why now?’” said Steve Berman of Hagens Berman. “The answer is that medical science has advanced. We now understand the mechanism by which Thalidomide works. There’s been a complete change in the knowledge of how it caused birth defects.”

Thalidomide was widely prescribed as a treatment for morning sickness in Europe in the late 1950s and early 1960s, until evidence emerged that the drug resulted in grave birth defects. Some countries, including England and Germany, established compensation systems for Thalidomide victims. There was no such plan in the U.S., where drug companies said Thalidomide had only been prescribed in a very restricted controlled study. According to Berman, after the awful consequences of Thalidomide came to light in the 1960s, fewer than a dozen American families sued and reached settlement with the drug companies that made and marketed the drug.

The Justice Department and the Securities and Exchange Commission apparently do not have the evidence to assert a classic insider-trading case against former Goldman Sachs and Procter & Gamble director Rajat Gupta. Typically, the government brings insider-trading cases against people who profited directly from trades based on confidential information. Gupta doesn’t fall into that category. Neither the SEC nor the DOJ claims that he realized any direct profits from the trades Galleon Group chief Raj Rajaratnam allegedly made based on his tips. Indeed, Gupta’s lawyer, Gary Naftalis of Kramer Levin Naftalis & Frankel, has said many times that Gupta “lost his entire investment” in Rajaratnam’s hedge fund. “[Gupta] did not trade in any securities, did not tip Mr. Rajaratnam so he could trade, and did not share in any profits as part of any quid pro quo,” Naftalis told Reuters in a statement.

But while the absence of a direct profit motive complicates the Justice Department and SEC cases against Gupta, it doesn’t preclude them. The government doesn’t have to show that Gupta directly profited by tipping Rajaratnam, only that he benefited in some way from passing along inside information. “It’s not your standard model, but it’s not unprecedented,” said Thomas Gorman of Dorsey & Whitney, who represented an Ohio State business-school professor convicted in a no-profits insider-trading case in 2005.

The government, in fact, has broad leeway to define the benefits a tipster derived from disclosing confidential information, Gorman said. Benefits can be as amorphous as enhancing a friendship or angling for future favors. In the Gupta case, the SEC and the Manhattan U.S. Attorney are so far offering only vague motives for his alleged insider trading. The SEC’s new complaint asserted that Gupta received indirect profits from Rajaratnam’s illicit trades, since he was an investor in Galleon funds. The complaint also refers to Gupta’s “variety of business dealings with Rajaratnam,” and alleges that the former McKinsey chief “stood to benefit from his relationship with Rajaratnam.” Similarly, the U.S. Attorney’s indictment said Gupta revealed inside information to Rajaratnam to deepen his relationship with the Galleon chief. “Gupta benefited and hoped to benefit from his friendship and business relationships with Rajaratnam in various ways, some of which were financial,” the indictment said.

In 1998, 400 investors in a trust that distributed revenue from a communications satellite got word that their securitization trustee had settled a $41 million suit against the satellite’s fuel supplier. The trustee, IBJ Schroeder, filed a New York State Article 77 proceeding to obtain a judge’s endorsement of the $8.5 million settlement. Some of the investors protested the deal, arguing that the trustee didn’t have the power to settle the case without consulting them. In 2000, a New York appeals court ruled that, in fact, IBJ Schroeder did have that power, under both New York law and the contract governing the satellite revenue trust. The lower court ultimately ruled in the Article 77 case that even if investors considered the settlement amount too low, Schroeder hadn’t acted unreasonably or imprudently in striking the deal.

If you’re wondering why I’m telling you about an 11-year old ruling involving a defunct communications satellite, it’s because the IBJ Schroeder opinion is sure to be invoked by Bank of New York Mellon, the trustee of those Countrywide mortgage-backed securities, as well as the 22 Countrywide MBS investors represented by Gibbs & Bruns as they appeal last week’s decision by U.S. District Judge William Pauley III of Manhattan federal court. In holding that the federal courts have jurisdiction over Bank of America’s proposed $8.5 billion settlement, Pauley took issue with BNY Mellon’s use of an Article 77 proceeding to get the deal approved. The judge wrote that Article 77 is usually employed to resolve garden-variety trust administration issues; BNY Mellon and Gibbs & Bruns will use the IBJ Schroeder ruling to argue at the U.S. Court of Appeals for the Second Circuit that, contrary to Pauley’s assertion, there’s precedent for using Article 77 exactly as they did in the BofA MBS case.

But even as the Second Circuit decides whether to take up the issue of the rights and responsibilities of securitization trustees, state attorneys general are likely to pounce upon some of the language in Pauley’s 21-page ruling. I warned that there might be unintended consequences for indentured trustees when the judge asked for briefing on the BNY Mellon’s duties. After Pauley’s ruling, that warning is now a red alert. New York attorney general Eric Schneiderman and his faithful follower, Joseph Biden III of Delaware, have both announced that they’re investigating MBS securitization trustees. Schneiderman showed he’s serious by filing state-law fraud claims against BNY Mellon along with his petition to intervene in the BofA Article 77 proceeding. In his complaint against BNY, Schneiderman argued that once an investment goes south, as many of the MBS trusts have, the indentured trustee has a fiduciary duty to trust beneficiaries under New York common law.