'07 Stock-Drop Cases To Be Filed In '09

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

Mr. Rudman said the answer was yes, predicting that "you are going to see a whole rash of cases" dating back to events that took place in 2007 coming in 2009.

One reason for this is that the Sarbanes-Oxley Act of 2002 extended the timeframe for bringing securities cases to two years. "Before SOX, you had to make a decision relatively quickly," he noted.

Without the extension, if a stock went down in 2007 and the law firm had some indication from an investor or client that there was reason to bring a suit, "you would have seen those cases undoubtedly in 2008."

Every year, he continued, plaintiff firms evaluate their businesses. "This time around, the firms are looking at their pools of potential cases from the past and realizing that they don't know what's going to happen in the future," he said, adding that for there to be litigation potential for new stock-drop cases over the next two years, "there needs to be a major re-inflation of the stock market."

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

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

Ms. Savett, an attorney with Berger & Montague, P.C. in Philadelphia, said, "The very first thing you look at is, was there a very significant and sudden stock drop. But that's just where the analysis begins. Then you have to look at the statements that were made during a prior period [and] you have to look at what caused the stock price to decline at the end."

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

Then, she said, lawyers start to look at whether there was insider selling by any of the executives. "But even if there wasn't, was it the kind of problem that was really embedded in the company–that it had to be there [yet] their statements were so optimistic as to be incredible."

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

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

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

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

Ms. Savett reported that a number of cases with similar facts have already prevailed against the initial attack of motions to dismiss, including those against Countrywide Financial, IndyMac Bancorp and Toll Brothers.

"We engage in very serious investigations, trying to look into businesses and talking to former employees. We talk to experts in the industry, who say [potential defendants] couldn't have had good controls for this to happen so suddenly," she said.

Experts can outline accounting principles, telling the lawyers that when delinquencies are going up and there are mortgage failures, the defendants could not have had their reserves the same over that year and been in compliance with accounting standards.

Going back to his cocktail party analysis, Mr. Grant said he holds up someone like Angelo Mazilo, former chair of Countrywide, to make his case. While Mr. Mazilo asserted that he shouldn't be blamed because the entire mortgage market was going down, "he sold a quarter of a billion dollars worth of stock while he was telling everyone that everything was great," Mr. Grant reported. "When you tell people that, it makes them want to say, 'You got to get that guy.'"

Boris Feldman, a defense attorney and partner with Wilson Sonsini Goodrich and Rosati in Palo Alto, Calif., who moderated the session on trends in securities litigation, said that despite all the analysis that "cream of the crop" plaintiffs' attorneys like Ms. Savett and Mr. Grant put into their class-action filings, he still sees 10-to-50 plaintiffs' firms file complaints as soon as a stock price tumbles.

For 2008 and 2009, he noted, a large proportion of filings relate to financial meltdown cases. (Editors note: Sources such as Stanford Law School in Palo Alto, Calif., Cornerstone Research in Boston, and New York-based NERA Economic Consulting put the percentage of filings related to the subprime and credit crises over 40 percent.)

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

"I think they are, and they will have good value," Ms. Savett said–noting, however, that only a few will be in the billions because 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, she said, adding that "the insurance doesn't even come close to the losses."

"I think whether the accountants are held in will be a heavily litigated proposition," she said.

Mr. Grant said he's seen very few audit firms named in these cases so far, conjecturing that the timing of audits, rather than diligent audit work, explains their good fortune.

The crisis really started heating up in July and August last year–a time when auditors only review quarterly financials but don't sign off on statements as they do at year-end. Now, problems are "so out there in the open that even a blind squirrel can find the nut," he said.

Ms. Savett said there have never been a lot of suits against accountants–only 10 percent historically–and they won't be sued in every one of the financial meltdown cases.

Often, she explained, "it just doesn't fit the facts. But for certain banks that originated very poor-quality subprime loans, those loans were probably in serious trouble by the end of 2006 audit, and certainly by year-end 2007."

The hot topic on the lips of speakers at nearly every session of the PLUS conference speculating on emerging trends was the increasing number of bankruptcies, but the fact that assets are tapped out is not necessarily a deterrent for plaintiffs' lawyers.

During the session on emerging trends, Mr. Rudman noted that his firm–which typically represents investors in securities class actions–is now seeking to represent creditor committees and litigation trusts in bankruptcy actions.

Randall Bodner, a partner for Ropes & Gray, LLP in Boston, a former assistant district attorney who assists companies with securities regulation matters, noted that because other assets are tapped out, for companies in bankruptcy, "a material asset is frankly the claim against former directors and officer–against the D&O insurance policy that's there."

At a separate session, David Bradford, executive vice president of New York-based Advisen, noted that bankruptcy filings are set to take off, and with them securities class-action filings against large public companies that file for bankruptcy.

In 2008, the average level of bankruptcies in the United States was 41,200, Mr. Bradford said, citing data from Euler Hermes. In 2009, the same source projects the figure will leap about 50 percent, he said.

In addition, he noted that there are various estimates of defaults of corporate bonds and bank loans, ranging from $450 billion to $500 billion.

"This is interesting because this is for companies that are not otherwise in trouble. It's simply that debt is maturing and it can't be refinanced, so you have defaults," he said, later noting that bankruptcies are spread across an array of industry sectors.

Going on to reveal details of an Advisen analysis of the relationship between the number of bankruptcies and securities class-action suits, Mr. Bradford said that while there was no particularly strong correlation between the two data sets, when Advisen focused in on just the bankruptcies of large public companies–those with assets greater than $250 million–"the correlation is actually quite striking."

In addition, he said that while 35 percent of large companies filing for bankruptcy had suits filed against them within a year of the filing historically (based on statistics dating back to 1995), in the last two years, more than three-quarters of large companies (77 percent) that filed for bankruptcy were also named in a securities class-action lawsuit.