Why Ambac's Subprime Securities Suit Settlement Is Noteworthy

 In its December 15, 2010 filing of Form 8-K (here), Ambac Financial Group announced that it had entered a memorandum of understanding to settle the subprime-related securities class action lawsuits pending against the company and certain of its directors and officers for a payment of $27.1 million, of which $24.6 million is to be paid by the company's D&O insurers.

The settlement is interesting in and of itself, but it is also interesting for the perspective it provides on the mountain of remaining unresolved subprime and credit crisis-related securities suits, as discussed below.

As discussed in greater detail here, in January 2008 Ambac and certain of its directors and officers were sued in a series of securities class action lawsuits filed in the Southern District of New York. These actions were later consolidated. The plaintiffs' consolidated amended class action complaint can be found here. Further background regarding the case can be found here.

The plaintiffs' allegations in the case largely related to the company's provision of insurance coverage for collateralized debt obligations. The plaintiffs allege, among other things, that the defendants failed to disclose that the company lacked internal controls sufficient to ensure that the company's standards for underwriting CDOs were adequate, and that the company had a far greater exposure to CDO-related losses and defaults than the company had previously disclosed.

In addition to the consolidated securities case, a separate securities suit was filed in December 2008 in the Southern District of New York against Ambac and certain of its directors and officers on behalf of invertors in the company's Structured Repackaged Asset-Backed Trust Securities (STRATS), as reflected here. The STRATS lawsuit, which proceeded separately from the consolidated case, alleged that the defendants had issued false and misleading statements concerning Ambac's financial results and operations.

On February 22, 2010, Southern District of New York Naomi Reice Buchwald granted in part and denied in part the defendants' motion to dismiss in the consolidated securities case.

As I noted in a prior post discussing the dismissal motion ruling (here), Judge Buchwald's decision was particularly noteworthy for her rejection of defendants' attempts to argue that the company's woes were not the result of fraud but rather were the result of the global financial meltdown; among other things, she stated that "the conduct that plaintiffs' allege, if true, would make Ambac an active participant in the collapse of their own business, and of the financial markets in general, rather than merely a passive victim."

According to the company's recent 8-K, the $27.1 million would resolve both the consolidated case and the STRATS lawsuit. As noted above, $24.6 million of the settlement is to be paid by the company's D&O insurers, and the remaining $2.5 million is to be paid by Ambac. The settlement is subject to a number of conditions, including court approval.

This settlement is interesting because it would resolve one of the higher profile subprime cases, after a portion of the case survived a dismissal motion.

But the more interesting thing to me about this settlement is the fact that it has happened at all, or at least that it has happened now. My point is that even though about 230 subprime and credit crisis-related lawsuits have been filed since February 2007, very few of these cases have yet settled, even among the many cases that have survived motions to dismiss.

By my count, even taking the Ambac settlement into account, there still have been only 17 settlements of the subprime and credit crisis related securities class action lawsuits. (My list of the subprime and credit crisis-related securities lawsuit case resolutions can be accessed here.) To be sure, those settlements represent an aggregate amount of settlements of over $1.925 billion (although that impressive figure is largely a reflection of just four settlements - Countrywide, Merrill Lynch, Merrill Lynch Bond, and Schwab Yield Plus - which account for about $1.5 billion of the total.)

Regardless of the aggregate dollars involved in the 17 settlements to date, those settlements represent only a small part of the overall number of cases that have been filed. Moreover the subprime and credit crisis-related litigation wave will soon enter its fifth year, so you would start to think that more of these cases would be settled. Nevertheless, only eight subprime and credit crisis-related securities class action lawsuits have settled so far in 2010.

According to statistics the NERA Economic Consulting reported earlier this week in its 2010 study of securities class action lawsuits, of the 230 cases that NERA has identified as credit crisis-related, "only 8% have settled, 29% have been dismissed, and 63% remain unresolved."

Of course, a certain number of those 63% of all cases that are unresolved were filed fairly recently, and you wouldn't expect those later filed cases to yet be near settlement. (NERA reported that there were 31 new credit crisis-related cases filed during 2010.) But many of these cases are now several years old.

These older unresolved cases, or at least those that survive dismissal motions, will eventually start moving toward settlement. (Relatively few will actually make it to trial, although the BankAtlantic credit crisis-related securities suit, in which the jury recently returned a plaintiffs' verdict, is the rare case that did head to trial.)

I am going to go out on a limb here and predict that in 2011, there will be many more settlements of subprime and credit crisis-related securities cases than there were in 2010. We may soon get to the point that a settlement of the size of Ambac's will no longer be particularly noteworthy. But we are not there yet.

As these cases move toward settlement, the insurers aggregate claim losses will begin to mount. In that regard it is worth noting that the average settlement of the 17 cases that have settled is over $110 million (although substantially lower if the four mega settlements noted above are disregarded). The implied losses that these 160-170 unresolved subprime cases represent is enormous - and that is not even taking defense costs into account.

Yes, not all of the settlement amounts will be paid by insurance. And yes, there will be a substantial number of those cases that will be dismissed. But many will eventually settle and much of the costs of settlement will be borne by the insurers.

To the extent that the carriers have adequately reserved for these losses, the settlements will not cause a ripple in the D&O insurance industry. But if the insurers are not adequately reserved for these losses, the resolution of these cases potentially could hit the industry as losses mount.

It would be interesting to conduct a survey amongst participants in the D&O insurance industry to find out whether people think that D&O insurers (a) are adequately reserved for these future losses; (b) think they are adequately reserved but will find out in the future they are not adequately reserved; or (c) are not adequately reserved.

A Couple of Interesting Law Firm Memos: A lot of law firm memos cross my desk every day, and not all of them are worth reading. But a couple of memos I recently reviewed were of particular interest.

First, in a December 9, 2010 memo entitled "Directors' and Officers' Liability: Shareholder Derivative Litigation Developments" (here), Joseph McLaughlin of the Simpson Thacher law firm summarized important recent judicial developments in federal and Delaware state court shareholder derivative litigation.

Second, in a December 6, 2010 memo entitled "The Board's Expanded Role in an IPO" (here), David Westenberg of the WilmerHale law firm takes a brief look at the burdens and responsibilities of board of directors of companies that are going public.

Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.