There's no clear answer as to whether fraud litigation brought against Goldman Sachs by the U.S. Securities and Exchange Commission will fuel a new wave of credit crisis lawsuits, but insurance experts are sounding alarms about the possibility.
"We've all been waiting for the shoe to drop on SEC enforcement actions. We just didn't know whose head it was going to come down on," said Michael Young, a litigation partner with Willkie Farr & Gallagher in New York, who represents defendants in securities cases. "It looks like it's landed on Goldman Sachs," he added.
Mr. Young noted longtime speculation among securities litigation experts that "the SEC, much humbled by Madoff, [would] try to come roaring back," referring to the perception that the SEC did not do enough to react to warning signs of a Ponzi scheme orchestrated by Bernard Madoff.
"All the fanfare surrounding Goldman suggests this may just be the first in a series of SEC actions," he warned.
Kevin LaCroix, a broker for OakBridge Insurance Services in Beachwood, Ohio, said he is "concerned there might be another wave" of credit crisis lawsuits emerging in the wake of the SEC's April 16 suit, charging Goldman Sachs and one of its vice presidents, Fabrice Tourre, with defrauding investors in structuring and marketing a collateralized debt obligation known as ABACUS 2007-AC1.
Apart from European banks ABN AMRO, IKB and other investors in ABACUS, who the SEC says collectively lost $1 billion on the deal, Mr. LaCroix said there are many other investors in CDOs who may now ask whether their investments were tainted by the type of conflict of interest allegedly involved in the Goldman transaction.
Mr. LaCroix, an attorney and author of the "D&O Diary" blog (www.dandodiary.com/), expressed similar concerns in an April 19 entry, which also links to wire service reports quoting plaintiffs lawyers who say they've already gotten inquiries from potential litigants, and to a description of an ongoing case against Merrill Lynch with similar allegations.
"Up to now, it seemed as if new filings from the credit crisis were dwindling," Mr. LaCroix said, referring to his own counts and to an analysis from New York-based Advisen reporting only one new case in first-quarter 2010. "This may revitalize interest," he predicted.
Mr. Young and Mr. LaCroix spoke to NU a few days after participating on a webinar about securities litigation trends hosted by Advisen and sponsored by ACE.
Although the topic of the Advisen webinar was a recent steep decline in securities suits related to the credit crisis cited in its recent report, webinar participants speculated on other events that could send suit-filing counts back up again, potentially eroding limits of directors and officers liability insurance policies covering defendants. (For more details about the report, see a related article in NU's E&S Extra at www.property-casualty.com.)
With news of the SEC suit coincidentally breaking as the webinar was broadcast, Jim Blinn, the moderator and an Advisen principal, observed that the Obama administration has started to increase the significance of SEC enforcement, asking Mr. Young about the D&O implications.
"SEC enforcement activity can often be the match on top of the gasoline igniting [private] litigation," he responded.
"In a highly charged environment, proceedings tend not to happen in isolation," Mr. Young later told NU. "Increasingly, we encounter a full spectrum of adversarial theaters, such as the SEC, attorneys general, the Department of Justice and even Congress, along with civil litigation. That often means defendants are simultaneously fighting battles on numerous fronts and that resources have to be thrown into action quickly."
"That's not the scenario often contemplated when a company is buying [D&O] insurance," he said, suggesting that "it may be time to recalibrate the thinking on how much insurance [limit] is needed."
Separately, details of the case against Goldman emerged, with the SEC alleging that Goldman marketed the ABACUS CDO tied to subprime mortgages without disclosing to investors that a hedge fund with economic interests adverse to theirs–Paulson & Company–played a key role in the portfolio selection process for the CDO.
The timing of the SEC case after the release of Advisen's analysis revealing a 39 percent plunge in first-quarter securities suit filings (including regulatory actions) was not lost on David Bradford, executive vice president at Advisen. "Within a week of the report, there's been this significant new development that could very much change the picture going forward," he told NU.
"The usual progression is that private actions follow regulatory actions," he said, predicting further regulatory actions and noting that private suits could expand beyond investors in the CDOs to investors in Goldman who saw the share price plunge more than 20 points (12.5 percent) on the day of the SEC announcement.
Mr. LaCroix and Mr. Bradford said they are uncertain whether the SEC's action against Goldman will have any impact on high dismissal rates they're currently witnessing for credit-crisis suits.
"One question in my mind is whether the accusations against Goldman, taken together with the recent examiner's report on the Lehman bankruptcy and revelations on Capitol Hill [during hearings over the last two weeks] will hearten prospective plaintiffs," Mr. LaCroix said. "Will they somewhat change the dynamic and counterbalance the skepticism some judges have shown for this type of litigation?"
Mr. Bradford noted that "the allegations in the Goldman suit are pretty flagrantly fraudulent." The SEC suit "is a different character than a lot of suits being dismissed at this point, so I'm not sure it would have any particular impact."
Postulating that any forthcoming wave of securities suits will be smaller than the one that produced 348 credit crisis suits to date by Advisen's count (including shareholder class actions, regulatory actions and other suits), Mr. LaCroix said "the most attractive suits from the plaintiffs' prospective have probably already been filed."
"Eventually you start running into statute-of-limitation issues," he added–noting, for example, that if any of the few investors in ABACUS 2007-AC1 were to file suit, they would likely bring the action under the Securities Act of 1933, allowing them to allege misrepresentation in connection with an offering.
Under the 1933 Act, the statute of limitations is one year from discovery of a misrepresentation or three years from the offer date, he said–noting that the offering date for ABACUS was April 27, 2007.
Mr. LaCroix also pointed to the unusual scenario in the SEC's case against Goldman–specifically the allegation that Mr. Tourre actively misled investors by telling them that Paulson was investing long (with an interest in seeing the investment prosper) when the hedge fund actually was taking a short position (making money if investment lost money).
"That's an unusual scenario and very case-specific. It's going to boil down to who said what to whom in various conversations," Mr. LaCroix said.
There's also the question of whether it would even make a difference to investors if they had known Paulson was shorting the investment, he added. "It's not news that there would have been investors shorting this investment."
© Arc, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to TMSalesOperations@arc-network.com. For more information visit Asset & Logo Licensing.