An Update On The Credit Crisis Litigation: A Turn Towards Structured Products And Asset Management Firms


Part VI Of A NERA Insights Series

Article by Dr. Faten Sabry, Anmol Sinha, and

Sungi Lee*


Since the start of the ongoing credit crisis, financial

institutions have taken over $1 trillion in credit losses and

write-downs, 48 banks in the US have been taken over by the FDIC,

and markets around the world remain highly volatile.1,2

The financial crisis, which first manifested in the subprime

mortgage market, soon became a full blown credit crisis with

unprecedented disruptions in financial markets around the


As the crisis has deepened, the allegations in and parties

related to the resulting litigation have changed. During late 2006

and most of 2007, many of the suits were filed against lenders,

originators, and home builders. The key allegations in this early

wave of litigation included (i) concealment of, and failure to

adequately reserve for, subprime risk exposure; (ii)

misrepresentation of subprime exposure and failure to write down

assets in a timely manner; and (iii) misrepresentation of the

collateral underlying the securities.3 As the credit

crisis grew more severe, an increasing number of the suits targeted

asset management firms and involved complex financial instruments

such as collateralized debt obligations (CDOs) and credit default

swaps (CDS).

In this article, we provide an update on the credit

crisis-related securities litigation in terms of filings,

percentage of cases involving directors and officers, types of

defendants and plaintiffs, and recent decisions with emphasis on

cases involving complex financial products such as CDOs and CDS. We

compile the data from various sources including Bloomberg, Factiva,

RiskMetrics Group/Securities Class Action Services, SEC filings,

and case dockets from January 2007 to March 2009. We focus

exclusively on securities cases—cases in which the

allegations relate to the purchase, ownership, or sale of

securities. We also catalog, among others, ERISA claims,

shareholder derivative actions, individual state and federal cases,

international cases, and state and federal shareholder class

actions.4 Collectively, we will call these lawsuits

"credit crisis filings." If any cases are consolidated,

the duplicate filings are removed and the data are adjusted.

We find that credit crisis filings increased 172% in 2008

relative to 2007, rising to 188 cases from 69. The percentage of

cases in which Directors and Officers (D&O) are named as

defendants remains high, with 62% named in suits in 2008 as

compared to 68% in 2007. Asset management firms became the main

defendants in litigation in 2008 as opposed to lenders and home

builders, and lawsuits involving structured products are on the

rise. In 2007, 35% of the lawsuits were filed against lenders and

home builders while 14% were filed against asset management firms.

In 2008, 17% of the lawsuits were filed against lenders and home

builders while 33% were filed against asset management firms.

Structured products were involved in 3% of the lawsuits in 2007 and

22% of the lawsuits in 2008. Since late 2007, there have been 23

motions to dismiss granted and 10 denied; the more high-profile

denials have been in the New Century and Countrywide cases.

The article is organized as follows. First, we briefly review

the trends in total filings by quarter and the percentage of claims

naming D&O. Second, we discuss the changing trends in the

plaintiffs and defendants named in the litigation and the emergence

of cases involving structured products. We then examine the types

of allegations brought against defendants in cases involving

structured products, in particular CDOs and CDS. Finally, we

conclude with a discussion of recent decisions in the credit crisis


The Number Of Credit Crisis Filings In 2008 Increased 172% From


From January 2007 until 17 March 2009, we recorded 303 credit

crisis filings. Exhibit 1 presents the number of credit crisis

filings by quarter.

Exhibit 1. Credit Crisis Filings By Quarter

Total filings in 2008 (188) exceeded 2007 (69) by 172%. The high

filing activity seen in 2008 shows no signs of slowing in


The Percentage Of Credit Crisis Filings Naming Directors And

Officers Remains High

D&O insurance is an important component of corporate

insurance, as approximately 95% of the Fortune 500 companies

maintain D&O liability insurance.6 In the wake of

the subprime and credit crisis and the rising number of lawsuits,

the impact of D&O insurance liability on the insurance industry

could prove severe. Guy Carpenter estimated in November 2007 that

insured D&O losses could exceed $2 billion.7

The percentage of credit crisis filings that name D&O

defendants remains high—on average 62% in 2008 and 72% in

  1. Exhibit 2 presents the share of credit crisis filings that

    have D&O exposure.

    Exhibit 2. Percentage Of Credit Crisis Filings Naming

    Directors And Officers

    Credit Crisis Lawsuits By Shareholders Are No Longer The

    Majority Of The Filings

    We classify the plaintiffs in the credit crisis filings as

    shareholders, auction-rate securities (ARS) investors, non-ARS

    investors, plan participants, and other plaintiffs. We define

    shareholders as common stock owners. ARS investors are those who

    invested in long-term variable-rate instruments (usually municipal

    or corporate bonds) whose interest rates are reset through

    auctions. The non-ARS investors are those who invested in preferred

    securities, corporate bonds, mortgage-backed securities (MBS),

    asset-backed securities (ABS), mutual funds, and money market

    funds. Plan participants are generally employees that file ERISA

    claims. Other plaintiffs include swap counterparties, CDS

    counterparties, insurance companies, and state attorneys general.

    The credit crisis filings include both class actions and individual


    Some of the recent allegations in the investor suits include (i)

    misrepresentations of the investment characteristics of the

    securities in terms of liquidity and/or exposure to nonprime loans;

    (ii) false and misleading registration statements for newly issued

    securities due to omissions regarding exposure to subprime loans,

    CDOs, and CDS; and (iii) misrepresentations about investments in

    Lehman Brothers securities.

    The percentage of credit crisis suits by shareholders decreased

    from 59% in 2007 to 37% in 2008 to 33% in 2009. In turn, credit

    crisis suits by ARS investors were nonexistent in 2007 but

    represented 19% of the credit crisis lawsuits in 2008 and 9% of the

    lawsuits in 2009. Similarly, suits by non-ARS investors have also

    increased, making up 19% of the credit crisis filings in 2007, 34%

    in 2008, and 49% in 2009. Credit crisis suits by plan participants

    have dropped from 12% of suits in 2007 to 5% of suits in 2008.

    Exhibit 3 shows the number and percent of filings by type of


    Exhibit 3. Credit Crisis Filings By Type Of


    Asset Management Firms, Issuers, And Underwriters Are The Main

    Defendants In 2008 And 2009

    We classify the defendants in the credit crisis filings as

    securities issuers/underwriters, asset management firms, mortgage

    lenders, insurers, home builders, and others. The defendants'

    classifications are based on the allegations and the role of the

    defendants in each case. For example, one firm may be categorized

    as a securities issuer/underwriter in one lawsuit for packaging and

    selling MBS. The same firm may then be categorized as an asset

    management firm in another lawsuit for managing and advising a

    mutual fund. Asset management firm defendants may include broker

    dealers, hedge funds, private equity firms, and investment

    advisors, among others. Insurers include mortgage and bond

    insurers. Other defendants include CDO and CDS counterparties.

    As the credit crisis moved from the mortgage-related markets to

    the overall credit markets, the focus of the related litigation

    also shifted towards more complex financial instruments and

    different market participants. Asset management firms and

    issuers/underwriters now represent the majority of the defendants.

    The percentage of asset management firms that were named as

    defendants more than doubled between 2007 (14%) and 2008 (33%). The

    percentage of filings that named securities issuers/underwriters as

    defendants also increased during this period, from 22% in 2007 to

    27% in 2008. Exhibit 4 shows the number and percent of filings by

    type of defendant.

    Exhibit 4. Credit Crisis Filings By Type Of


    Credit crisis filings in the first three quarters of 2007

    focused on lenders and home builders. By the end of 2007, as losses

    spread to markets well beyond mortgages, an increasing number of

    the lawsuits focused on investment management firms and structured

    products. These include 34 cases involving mutual funds and/or

    investment advisers. Exhibit 5 illustrates the changing trend in

    the litigation.

    Exhibit 5. Credit Crisis Lawsuits By Type Of Market


    Lawsuits Involving CDOs Are On The Rise As Losses Mount

    Mortgage-backed securities are also the focus of suits involving

    collateralized debt obligations. CDOs often held mortgage-backed

    securities as assets that supported their tranched liabilities. As

    the mortgage-backed securities dropped in value, so did CDO

    issuance and values. We examined Merrill Lynch's,

    Citigroup's, and UBS' recent SEC filings and found that

    approximately 40% of write-downs and/or credit losses were

    attributable to CDOs between Q1 2007 and Q3 2008.8 It is

    not surprising then, that the litigation is heading towards CDOs

    and other structured finance products.

    In the following sections, we briefly examine the state of the

    CDO market and then turn to lawsuits involving them.

    Trends In CDO Losses

    CDOs showed signs of trouble beginning in 2007. Signs of trouble

    include events of default (EOD), notices of acceleration, and

    liquidation. An event of default indicates the possibility of

    imperiled cash flows and may mean losses to the note holders. A

    notice of acceleration is when the controlling note holders have

    voted to...

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