Alison Frankel

Late Tuesday, U.S. District Judge Barbara Jones of Manhattan federal court denied Bank of America’s motion to disqualify Quinn Emanuel Urquhart & Sullivan from representing AIG in its $10 billion mortgage-backed securities case against BofA, Merrill, and other bank subsidiaries. BofA’s lawyers at Munger, Tolles & Olson had argued that a former Munger partner, Marc Becker, acquired confidential information about Merrill’s MBS litigation strategy before departing to join Quinn Emanuel in 2008, then proceeded to work on AIG’s case against BofA and Merrill. The judge faulted Quinn’s screening process for failing to identify Becker’s potential conflict. But she said Becker had performed only non-substantive editorial work on AIG’s complaint and remand motion, didn’t share any confidences, and took steps to segregate himself from the AIG case as soon as he was reminded of his previous work for Merrill Lynch and its former mortgage unit. “There is no meaningful showing here that the trial process will be tainted,” Jones wrote. “The court finds that it would be unduly prejudicial to disqualify Quinn.”

But what about Marc Becker?

In October, after learning that Munger Tolles had raised the issue of his previous work for Merrill Lynch and First Franklin Financial, Becker resigned from Quinn Emanuel’s London office. In a Nov. 3 declaration, Becker said that he hadn’t remembered working for First Franklin when he spent a total of 5.8 hours reviewing the two AIG documents. “Had I remembered it, I never would have had anything to do with the [BofA] action,” he wrote. “None of what I did during those 5.8 hours on the [BofA] action was in any way focused on, or specific to, First Franklin or Merrill Lynch. I did not use or disclose any confidential information of First Franklin or Merrill Lynch. In fact, I did not at that time, and do not now, recall any confidential information of First Franklin or Merrill Lynch.” Becker asserted that Munger’s account of his work for Merrill — which cast him as a lead partner in Merrill and First Franklin’s MBS defense strategizing — didn’t jibe with his refreshed recollection of a “far more limited” role.

Becker remained at Quinn Emanuel for a month after Munger first alerted the firm of his potential conflict. During that time, according to his declaration, he met with Quinn’s outside counsel, Gregory Joseph, to discuss his work for Merrill, without any Quinn partners present. “Thus, even if I had recalled any confidential information regarding Merrill Lynch or First Franklin, which I did not, Quinn Emanuel would not have been exposed to it,” he wrote. “I understand that defendants have suggested that I was aware of and deliberately ignored the existence of a conflict of interest arising from my work on the First Franklin matter. That is totally untrue.”

Nevertheless, on Oct. 19, Becker resigned from Quinn Emanuel. “The firm and I agreed to take this step because … we wanted to do everything in our power to eliminate any possible basis for disqualification,” Becker wrote. Quinn Emanuel name partner John Quinn had told Munger Tolles in an email when he first learned of the potential Becker conflict that Becker might have to resign if Munger pressed for Quinn’s disqualification. So Becker’s declaration includes a poignant paragraph hinting at his sense of betrayal: “I am deeply disappointed that my former partners at [Munger] — with whom I worked as a trusted and respected colleague and partner for almost 20 years — would contend that I improperly shared client confidences. I do not believe that they genuinely believe that I did or ever would do so. But by having claimed that there is a risk of future disclosure of confidences by me, they precipitated my departure from Quinn Emanuel, and have caused me great professional and personal hardship.”

Becker said in the declaration that he was planning to start up a solo practice as a solicitor in London, but hoped to be able to return to Quinn Emanuel when the conflict question was resolved. Quinn Emanuel, in its response to the disqualification motion, reiterated that Becker’s resignation was voluntary. “This step was not taken because of any doubt as to the fact that no confidences were or would be shared, or as to the efficacy of the firm’s screen,” the firm’s response said.

In fact, according to Jones’s decision denying the disqualification motion, Quinn Emanuel asked the judge to rule that the firm’s ethical wall between Becker and the AIG case is sufficient to permit Becker to return to the firm. Unfortunately for Becker, the judge said she “declines to do so.”

That would appear to leave Becker in limbo, unless BofA agrees he’s adequately walled off from the case against it. Quinn Emanuel, after all, is engaged in other cases against BofA and Merrill Lynch — most notably the Federal Housing Finance Agency’s suits — and the firm doesn’t want to face another disqualification motion based on Becker’s previous work for Merrill.

In a brief phone interview, Becker told me he’s pleased that Jones found he behaved ethically. “I am deeply gratified that the court agreed I did not share any client confidences,” he said, adding, “I believe this motion was a tactic move to [by Munger] to eliminate an adversary that they would prefer not to face.” Becker declined any additional comment, but it’s well-known that Munger Tolles and Quinn Emanuel have butted heads in two big trials in the last year: star bond-trader Jeffrey Gundlach’s dispute with his former employer TCW, which resulted in a split verdict in September; and Rambus’s antitrust trial against Micron and Hynix, in which a jury last month cleared Quinn client Micron.

Quinn Emanuel declined comment on the Becker matter. Munger partner Marc Dworsky didn’t respond to Reuters’ request for comment.

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A filing late Monday confirmed what I reported last month: Merrill Lynch has agreed to a $315 million settlement of a securities class action stemming from 18 Merrill mortgage-backed note offerings. This agreement is the fourth MBS securities settlement, following this summer’s landmark $125 million Wells Fargo class action deal and a pair of settlements with Citigroup and Deutsche Bank, totaling $165.5 million, that National Credit Union Agency reached in November. The Merrill agreement, negotiated by lead class counsel at Bernstein Litowitz Berger & Grossmann, is by far the biggest score so far for MBS investors in a securities suit (as opposed to contract, or put-back, litigation).

There are dozens more MBS securities suits out there, as the Merrill settlement agreement acknowledges: the deal carves out claims by AIG, the Federal Home Loan Bank of Boston, the Federal Housing Finance Agency, and other MBS investors that have already filed their own securities suits against Merrill Lynch. But one of the big mysteries of the MBS securities litigation has been how to value the cases, since there’s so little precedent in the way of settlements. The NCUA deals helped; the credit-union regulator repackaged and resold mortgage-backed securities belonging to five failed credit unions, so the agency actually knew how much the credit unions lost through their MBS investments. In its talks with Citi and Deutsche Bank (which the agency didn’t formally sue), NCUA was able to claim specific, fact-based damages.

The Merrill settlement documents provide significantly more insight for plaintiffs who don’t have the luxury of U.S. government backing to sell repackaged mortgage-backed securities. The documents don’t disclose the class’s specific damages claim; the case settled before investors filed their damages expert’s report. But the exhibits included along with the settlement brief indicate a methodology for calculating damages that other plaintiffs can use. MBS defendants, including Merrill Lynch, will undoubtedly continue to assert that MBS noteholders shouldn’t recover anything for their securities claims because they’re sophisticated investors who knew the riskiness of mortgage-backed notes. But as hundred-million-dollar settlements pile up, that’s a tougher argument to sell.

The Merrill class members, like most MBS securities plaintiffs, based their claims on Section 11 of the Securities Act of 1933, which holds that investors can recover damages if a registration statement contains false or misleading statements. (It’s a handy theory for investors, who don’t have to show fraudulent intent.) Section 11 includes three means of calculating damages. If investors sold their securities before bringing suit, their damages are the difference between what they paid for the stocks or bonds and the price the securities fetched. If they’re still holding their investment on the day the suit is filed, damages are defined as the difference between what they paid and the value of the securities on the filing date. If they sell while the litigation is underway, they’re permitted to claim the lesser of those two amounts.

That sounds simple, but when you’re trying to calculate the value of notes belonging to thousands of investors who bought and sold at different times in the illiquid MBS market, it’s not. Bernstein Litowitz and its experts did the next best thing. According to a table at the end of this exhibit to the memo in support of settlement, the class estimated the value of each tranche of every one of the 18 offerings in the class action had lost. (The table expresses the value of each MBS tranche on the day the suit was filed as a percentage of the offering price; so, for example, the most senior tranche in the table’s first-listed MBS offering was worth 58.26 percent of its par value on the day the suit was filed, while the lowest tranche was worth only 1.38 percent of its offering price.) The chart doesn’t tally up total losses based on the difference between the offering value and the value on the filing date, but Bernstein Litowitz said in the settlement memo that the calculation “amounts to billions of dollars in the aggregate.”

So why did the plaintiffs firm settle for $315 million? For starters, if the case had gone to summary judgment and then trial, Merrill and its parent, Bank of America, would have disputed the class’s estimate of the value of investors’ securities on the day the suit was filed (and thus, the class’s damages). Mortgage-backed notes aren’t like stocks trading in a robust market, so there’s a lot of wiggle room in pricing them. The notes are also unlike stocks in that many of them are still paying principal and interest, at least in the senior tranches, so the defense could assert price declines are illusory.

Moreover, Merrill’s lawyers at Skadden, Arps, Slate, Meagher & Flom would also have argued that any lost value in the securities was due to the economic downturn, not to misrepresentations in the registration materials. As Bernstein Litowitz wrote in the settlement memo: “Defendants asserted throughout the litigation — and were expected to continue to assert through summary judgment and trial — that the overall economic downturn, housing price declines, and reduced liquidity, not the alleged untrue statements and omissions, were to blame for the decline in the certificates’ value. … If successful in establishing their negative causation defense or other affirmative defenses, it is anticipated that defendants would argue that estimated damages were substantially less or zero.”

The $315 million proposed settlement still has to be approved by U.S. District Judge Jed Rakoff, who is overseeing the Merrill MBS class action. Bernstein Litowitz did not file a fee request as part of the settlement agreement.

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One of the most controversial aspects of the U.S. Supreme Court’s June 2011 ruling in Janus v. First Derivative Traders was that the Justices rejected the Securities and Exchange Commission’s interpretation of federal securities laws. The SEC said Janus Capital wasn’t liable for the allegedly misleading statements in a prospectus issued by a Janus mutual fund, even though the SEC argued that it was — and even though federal courts traditionally pay deference when they ask agencies to offer their expertise in interpreting the law.

The SEC took another blow Monday, when a three-judge panel of the U.S. Court of Appeals for the Second Circuit affirmed the dismissal of an auction-rate securities class action against Merrill Lynch, despite an SEC brief arguing the case should proceed. The SEC agreed with a Merrill ARS investor who asserted that the boilerplate disclosure Merrill posted after a 2006 SEC consent decree shouldn’t shield it from claims it manipulated the market for ARS. The Second Circuit panel felt otherwise.

To be sure, Judge Robert Katzmann, writing for a panel that also included Judges Robert Sack and Amalya Kearse, said that the Merrill opinion should be read narrowly. “We see no need to fix the ‘exact molecular weight’ of the deference that we owe to the SEC’s position,” Katzmann wrote. “We readily acknowledge that at least some deference to the agency’s position is appropriate, given the SEC’s expertise and accountability. Here, however, we are unable to agree with the SEC’s application of the legal principles governing Merrill’s disclosures.”

But it’s notable that the appeals court declined to adopt the SEC’s view after expressly asking the agency to weigh in. U.S. District Judge Loretta Preska of Manhattan federal court had dismissed the class action in March 2010, ruling that Merrill’s posted disclosures, which followed an SEC investigation of the ARS market, were an adequate warning that the firm bid on its own securities to prop up prices. The Second Circuit already had considered the post-2006 disclosures all ARS issuers agreed to in a July 2011 ruling, Ashland v. Oppenheimer, but hadn’t asked the SEC about the reach of the disclosures. So after Girard Gibbs appealed Preska’s dismissal of the Merrill class action, the appeals court sought a letter brief from the agency.

The SEC, like the class, asserted that Merrill’s disclosure didn’t go far enough in disclosing its interference in the ARS market. The Second Circuit said that it did. “We find no error in the district court’s conclusion that Merrill’s disclosures of its support bidding practices sufficed to preclude [the class's] claim that these practices were manipulative,” the opinion said. “These disclosures revealed, at the very least, the possibility that Merrill would place support bids in some auctions that it managed and that in the absence of these bids, some of these auctions might fail.”

I asked an SEC spokesman for the agency’s response but didn’t hear back. Class counsel Jonathan Levine of Girard Gibbs said, “We’re disappointed that the Court of Appeals disagreed with the SEC conclusion that investors should have been allowed to proceed with claims.”

Merrill was represented by Jay Kasner, Scott Musoff, and Paul Lockwood of Skadden, Arps, Slate, Meagher & Flom, which also prevailed in the appeals court’s Ashland ruling in July.

Even though the Second Circuit has now upheld the dismissal of two ARS cases, that’s not the end of all ARS litigation, according to George Carpinello and Adam Shaw of Boies, Schiller & Flexner. They represent individual plaintiffs in two ARS cases brought by individual investors, including a case against Merrill that Preska — the judge who dismissed the Merrill case at issue before the Second Circuit — greenlighted. “The court made it clear that this is a limited ruling,” said Carpinello. “It clearly had problems with the way the facts were pled…Our cases are about what was said to our clients at a particular point in time when the broker had knowledge of what was going on.”

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