Not every financial meltdown fuels a securities class-action litigation crisis, say two directors and officers liability insurance experts who don't foresee major D&O market impacts from the unraveling of subprime mortgage lenders.
Stock market watchers have pointed to news that lenders would incur damaging levels of loan losses and liquidity issues as one of the sparks of a wider sell-off that plunged major stock market indices to worrisome levels last month. But the next options backdating scandal is not around the corner, D&O experts say.
So far, class-action lawsuits have been filed against at least three publicly traded subprime lenders–New Century Financial, NovaStar Financial and Accredited Home Lending–whose stocks fell after negative earnings announcements.
Common to the actions filed against all three are allegations about poor internal controls, improper accounting of allowances for loan repurchase losses, and failure to disclose volatility in the subprime market that would mean tighter underwriting and severe cutbacks in future loan production.
New Century Financial, which had to restate its financials for 2006, has seen 22 plaintiffs' law firms file class-action complaints.
While D&O experts expect nearly all publicly traded subprime lenders to face securities suits, plaintiffs' lawyers could have a tougher time moving some actions forward than others, they say.
"If we see the first trickle now, there will probably be dozens of suits before it's over," said Joseph Monteleone, partner in the New York office of Tressler, Soderstrom, Maloney & Priess as well as a former insurance claims executive, noting that the lenders' woes are a symptom of a general housing market decline.
"There's no reason for one [subprime lender] to be more immune to these things than others. I assume they're all having the same financial difficulties," he added.
For plaintiffs' firms to prevail with securities lawsuits, however, they'll need allegations beyond lack of disclosure of market volatility, according to Mr. Monteleone.
"Investors should be aware that this is a volatile, high-risk market," he said. "You don't have to tell someone not to touch a hot stove. That should be general knowledge on the part of an investor–even a relatively unsophisticated one."
"If [lenders] were misrepresenting problems in their loan portfolios, that's a different story," he said. "But under federal securities laws, plaintiffs have to back that up with specifics in their pleadings" or face successful motions to dismiss.
Steve Shappell, managing director of the claims practice of Aon Financial Service Group in Denver, Colo., had similar observations. When there are problems in an entire industry segment, and stocks move down just because people are shifting their investment dollars, that's a hard claim for the plaintiffs.
"Is the drop in the stock price related to fraud, or is it related to a shift in the marketplace and investors who don't want to be invested in that anymore?" he said.
Beyond the lenders themselves, Mr. Monteleone noted that D&O insurers will be watching for ripple effects–for example, to financial institutions that backed the lenders.
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