The revelation came from Samuel Rudman, a partner with CouhglinStoia Geller Rudman Robbins in New York, at the PLUS D&OSymposium late last month during a session highlighting emergingtrends that could impact directors and officers liabilityinsurers.

Michael Price, vice president of Hartford Financial Products inNew York, who moderated the session at the Minneapolis-basedProfessional Liability Underwriting Society's symposium held in NewYork, noted the low overall frequency of securities class actionslawsuits against nonfinancial companies in recent months. Still,Mr. Price said, one of his firm's policyholders, which doesbusiness outside the financial sector, was sued earlier thisyear--two years after the disclosure that prompted the lawsuit.

Referring to financial meltdown situations as the "pig in thepython" that is fueling increases in securities class actions filedin 2008 and 2009, Mr. Price asked the plaintiffs' lawyer, "Are younow going to circle back to what were once thought to be good casesthat just weren't brought because you were too busy, [and] shouldwe think about stock drops longer than two years?"

Mr. Rudman said yes. "You are going to see a whole rash ofcases" dating back to events that took place in 2007 coming in2009, he said. One reason for this is that the Sarbanes-Oxley Actof 2002 extended the timeframe for bringing securities cases to twoyears. "Before SOX, you had to make a decision relatively quickly,"he said.

Without the extension, if a stock went down in 2007 and the lawfirm had some indication from an investor or client that there wasreason to bring a suit, "you would have seen those casesundoubtedly in 2008."

Every year, he continued, plaintiffs firms evaluate theirbusinesses. "This time around, the firms are looking at their poolsof potential cases from the past and realizing that they don't knowwhat's going to happen in the future. For there to be litigationpotential for new stock drop cases over the next two years, "thereneeds to be a major re-inflation of the stock market," he said.

With the overall stock market falling so far down in 2008,typical stock-drop cases wouldn't survive in Mr. Rudman's view.

GOOD CASES IDENTIFIED

Still, a broker in the audience of an earlier session worriedthat her clients, who were caught in the stock market downdraft,could face securities lawsuits. "What should I tell them? What doyou consider to be a good case?" she asked plaintiffs' lawyer,Sherrie Savett.

Ms. Savett, an attorney with Berger & Montague, P.C. inPhiladelphia, said, "The very first thing you look at is was therea very significant and sudden stock drop. But that's just where theanalysis begins."

"Then you have to look at the statements that were made during aprior period [and] you have to look at what caused the stock priceto decline at the end."

From a plaintiffs' lawyers' perspective, "good cases" exist insituations where the reason for the decline relates to acompany-specific problem that "had to have been going on for anumber of years. If it was an endemic problem and it couldn't havehappened overnight because of swift changes in the overall market,"she said.

Then, she said, lawyers start to look at whether there wasinsider selling by any of the executives. "But even if therewasn't, was it the kind of problem that was really embedded in thecompany--that it had to be there [yet] their statements were sooptimistic as to be incredible."

Stuart Grant, managing director or Grant & Eisenhofer, P.A.in Wilmington, Del., who also represents plaintiffs, said he has asimple "cocktail party test" that helps him decide whether he hasgood ammunition for a securities lawsuit.

"If I can't in 30-45 seconds tell you a compelling story asyou're sitting there with a cocktail and have you say, 'Damn, we'vegot to go get [them],' then I don't have a good case," he said. Hereasoned that while lawyers get more than 45 seconds before adistrict court, the judges probably make their minds up faster. Hesaid he has to be able to present a convincing set of facts on thefirst page of the opening brief or complaint that the judge isgoing to read.

Ms. Savett gave a specific example of a "good case" from thelatest round relating to subprime issues. An attractive casetarget, she said, is a bank that was originating loans for years,in a situation where almost all of the loans turned out to be badleading to a takeover of the bank by a receiver.

The bank had been saying for the prior two years that itsunderwriting standards were excellent, its controls were excellentand its reserves were very much in line, "and suddenly there's acomplete disaster and a complete write-down of all the assets."

Ms. Savett reported that a number of cases with similar factshave already prevailed against the initial attack of motion todismiss, including those against Countrywide Financial, IndyMacBancorp and Toll Brothers.

"We engage in very serious investigations, trying to look intobusinesses and talking to former employees. We talk to experts inthe industry who say [potential defendants] couldn't have had goodcontrols for this to happen so suddenly," she said. Experts canoutline accounting principles, telling the lawyers that whendelinquencies are going up and there are mortgage failures, thedefendants could not have had their reserves the same over thatyear and been in compliance with accounting standards.

Going back to his cocktail party analysis, Mr. Grant said heholds up someone like Angelo Mazilo, former chairman ofCountrywide, to make his case. While Mr. Mazilo asserted heshouldn't be blamed because the entire mortgage market was goingdown, "he sold a quarter of a billion dollars worth of stock whilehe was telling everyone that everything was great."

"When you tell people that, it makes them want to say, 'You gotto get that guy.'"

LOOK OUT AUDITORS!

Boris Feldman, a defense attorney and partner with WilsonSonsini Goodrich and Rosati in Palo Alto, Calif., who moderated thesession, said that despite all the analysis "cream of the crop"plaintiffs' attorneys like Ms. Savett and Mr. Grant put into theirclass action filings, he still sees 10-50 plaintiffs' firms filecomplaints on soon as a stock prices tumble.

For 2008 and 2009, he noted, a large proportion of filingsrelate to financial meltdown cases. (Editors note: Sources likeStanford Law School in Palo Alto, Calif., Cornerstone Research inBoston, and New York-based NERA Economic Consulting put thepercentage of filings related to the subprime and credit crisesover 40 percent.)

"Are those really going to be litigated?" Mr. Feldman asked

"I think they are and they will have good value," Ms. Savettsaid, noting, however that only a few will be in the billionsbecause of the poor financial condition of companies involved.

"I think the insurance in good cases will be all used up, and[defendants] are going to have to pay" out of their pockets, shesaid. "The insurance doesn't even come close to the losses," shesaid.

"I think whether the accountants are held in will be a heavilylitigated proposition," she added.

Mr. Grant said he's seen very few audit firms named in thesecases so far, conjecturing that the timing of audits, rather thandiligent audit work explains their good fortune. The crisis reallystarted heating up in July and August last year, a time whenauditors only review quarterly financials but don't sign off onstatements like they do at year-end. Now, problems are "so outthere in the open that even a blind squirrel can find the nut," hesaid.

Ms. Savett said there have never been a lot of suits againstaccountants--only 10 percent historically--and they won't be suedin every one of the financial meltdown cases. Often, "it justdoesn't fit the facts. But for certain banks that originated verypoor-quality subprime loans, those loans were probably in serioustrouble by the end of 2006 audit, and certainly by year-end2007."

THE SPECIAL CASE OF MADOFF

Noting that another crop of recent securities cases has arisenout of the massive Ponzi scheme orchestrated by Bernard Madoff, Mr.Feldman asked the attorneys to gauge the odds of recovering lostinvestments through litigation.

"While these cases are very difficult, there are possiblesources of recovery," Ms. Savett asserted. She explained that themain source of recovery cannot be Madoff Investment Securities,"because there's very little left there and trustees will becollecting those assets and distributing them."

Instead, plaintiffs' attorneys will have to find out, "How didsomeone get into a Madoff investment? Was it through a hedge fund?Is the hedge fund still solvent? Is the fund backed up by aninsurance company?"

"The theory is there was a lack of due diligence by those fundsand that they're responsible for that reason," she said.

Accountants that audited the hedge funds are another potentialtarget, she said. "How could they have done a proper audit of theassets of a hedge fund if assets weren't really there? We now knowMadoff didn't even trade for the last 13 years, so there was a reallack of due diligence on the part of the hedge funds and theirauditors."

In the same vein, she said there are also good cases to bebrought against bank custodians that were supposed to make sure theassets were there.

While Ms. Savett said the parties with dimmest hope ofsubstantial recovery are those that dealt directly with Madoffthrough brokerage accounts, Professor John Coffee of ColumbiaUniversity also foresees obstacles for those who invested in feederfunds that put assets in Madoff investments.

Direct investors, Ms. Savett said, are limited to a $500,000recovery from the Securities Investor Protection Corporation or atax benefit for writing off a theft loss.

Mr. Coffee, while agreeing that funds are the deep pockets to betapped in Madoff-related litigation, said the funds' defenses arebolstered by a 2007 district court ruling in South CherryStreet LLC vs. Hennessee Group, currently on appeal in theSecond Circuit.

In that case, an investment advisory firm, Hennessee, gave asophisticated hedge fund known as Bayou Group "an absolutely strongrating," Mr. Coffee said, adding that Bayou was the last big Ponzischeme before Madoff. Judge Colleen McMahon in the SouthernDistrict of New York ruled, however, that as long as the Hennesseedid not know the Bayou Group was a total fraud, and so long as theyonly made misstatements about their own due diligence, they couldnot be on the hook for liability, he reported.

Indeed, he said, the advisor may not have looked even at otherfunds when it advised investors to put all their money in Bayou,but the case is dismissed because the judge held that "the realloss causation event was the fraud at Bayou and not lack of duediligence of the advisory group."

Should the decision be held up on appeal in the next few months,that could be a controlling force in limiting liability for theMadoff feeder fund litigation, Mr. Coffee predicted.

He said another obstacle to plaintiffs in New York, where manycases will be brought, is a state law known as the Martin Act,which preempts suits alleging breaches of fiduciary duty and doesnot permit private actions. The law gives exclusive jurisdictionover state law claims involving the purchase or sale of securitiesto the attorney general.

Professor Coffee predicted that in spite of the obstacles, therewill be some recoveries against the feeder funds. "They don't haveunlimited resources," however, he said, speculating that they'llbring at most $200 million--not billions--to the table.

Mr. Grant, who said his firm is already representing "asubstantial number of people with losses of over nine figures" inMadoff-related cases, agreed that feeder funds are the "low-hangingfruits" among possible defendants.

"If you have a fund that's taking 1 percent of assets undermanagement and 20 percent of the profits, and you find out thatthey've done no due diligence [and] just acted as a conduit, that'sthe kind of thing that ticks people off," he said, puttingpotential stories of fund managers with houses in affluent areaslike Greenwich, Conn., and numerous summer homes through hiscocktail party analysis.

"That's the type of story I want to tell to a jury. It's anattractive case," he said, adding that the funds have a surprisinglevel of assets. "I don't think we're talking about millions, butbillions or tens of billions combined," he said.

One interesting debate to be played out in the Madoff cases willbe over the issue of damages. "If you invested $10 million 15 yearsago and thought you made $100 million, did you lose $10 million or$100 million?" he asked. "Had you put it in the stock market, youwould have $8 million now, so maybe the loss is only $8 million,"he said, giving an alternative view that defendants mightoffer.

For more information on Madoff-related litigation and additionalperspectives, see a related story, "Madoff Fallout To Cost D&O,E&O Insurers Nearly $2 Billion: Aon Benfield," which appearedin the January edition of NU's e-newsletter,E&S/Specialty Lines Extra.

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