Over the last few days, there have been a series of
rulings in high-profile lawsuits arising out of the subprime meltdown and
credit crisis. As discussed below, just in the past week there
were dismissal motion rulings in cases involving Freddie Mac,
Wachovia/Wells Fargo, and AIG. Though some or all of the claims in these cases
were dismissed in whole or in part, the plaintiffs have managed to live at
least for another day (if only just barely in the Freddie Mac case). At the
same time, in the AIG ERISA case, the case largely survived the dismissal
Freddie Mac: On March 30, 2011, Southern District of New
York Judge John
Keenan granted without prejudice the defendants' motion to dismiss in
the Federal Home Loan Mortgage Corp. (Freddie Mac) subprime-related securities
class action lawsuit. A copy of the March 30 order can be found here.
Freddie Mac is of course one of the government sponsored
entities that was at the center of the residential mortgage crisis in 2008. On
September 7, 2008, it was placed
in the hands of a conservator. In August 2008, shortly before the company
entered conservatorship, the company's public shareholders filed a securities
class action lawsuit against the company and certain of its directors and
officers, as discussed in greater detail here.
The plaintiffs alleged that in various public statements
the defendants had made three types of misrepresentations or omissions: (1)
about the company's exposure to "non-prime mortgage loans"; (2) about its
capital adequacy; and (3) about the strength of its due diligence and quality
control mechanisms. The defendants moved to dismiss.
In finding that the alleged misrepresentations about the
company's exposure to subprime mortgages were insufficient, Judge
Keenan found that "the Amended Complaint does not explain why Freddie Mac's
disclosures in its November 2007 Financial Reports ... were insufficient to
convey the truth that Freddie Mac was dealing in non-conforming mortgages
to the public." He added that "Plaintiffs present no theory at all about why
Freddie Mac's disclosures would not be understood by the reasonable investor
and thus part of the 'total mix' of information that determined its share
Judge Keenan also found that the alleged
misrepresentations regarding the company's capital adequacy were also
insufficient. He observed that "in a volatile economic, political and
regulatory environment like the one that existed in the summer and early fall
of 2008, with even Freddie Mac's primary regulator being replaced, Plaintiffs
must show more to plausibly claim that Freddie Mac's statements were made
without any basis in fact. " However, he concluded that "Plaintiff has not
adequately pleaded sufficient facts giving rise to a strong inference that
Freddie Mac's statements about its capital adequacy or its hope that it would
continue to function were made with intent to defraud or without factual
With respect to the alleged misrepresentations regarding
the company's internal controls and processes, Judge Keenan found that "there
are simply no facts in the Amended Complaint from which one could reasonably
infer a causal link between Freddie Mac's statements about its underwriting
standards and internal controls and any loss suffered by purchasers of its
equity securities during the Class Period." He added that "considering that the
price of Freddie Mac's stock was clearly linked to the 'marketwide phenomenon'
of the housing price collapse, there is decreased probability that Plaintiffs'
losses were caused by fraud."
Judge Keenan granted the motions to dismiss without
prejudice and allowed the plaintiffs' 60 days in which to file a Second Amended
An April 1, 2011 Bloomberg article about Judge
Keenan's decision in the Freddie Mac case can be found here.
Wachovia/Wells Fargo: On March 31, 2011, Southern
District of New York Judge Richard Sullivan
issued his rulings on the motions to dismiss in the consolidated securities
litigation that had been filed on behalf former equity shareholders and
bondholders of Wachovia Corporation. In a lengthy and detailed opinion (here),
Judge Sullivan granted the defendants' motions to dismiss the equity securities
litigation, but he denied the motion to dismiss the bondholders' action, other
than with respect to certain bond offerings in which the plaintiffs had not
actually purchased any securities.
As Judge Sullivan wrote in summarizing the various
plaintiffs' allegations, "all claims arise from the financial disintegration
Wachovia experienced between its 2006 purchase of
Golden West Financial Corporation and its 2008
merger with Wells Fargo & Company." In essence, the complaint is
based on the difficulties Wachovia experienced as a result of the Golden West
"Pick-A-Pay" mortgage portfolio. Further background regarding the equity
securities litigation can be found here and background
regarding the bondholders' litigation can be found here.
Judge Sullivan granted the defendants' motions to dismiss
the equity securities plaintiffs' '34 Act claims, finding that the plaintiffs
had not sufficiently alleged scienter. Judge Sullivan concluded that the "more
compelling inference" is that "Defendants simply did not anticipate the full
extent of the mortgage crisis and the resulting implications for the Pick-A-Pay
loan portfolio. Although a colossal blunder with grave consequences for many,
such a failure is simply not enough to support a claim for securities fraud."
He added that "bad judgment and poor management are not fraud, even when they
lead to the demise of a once venerable financial institution."
Judge Sullivan also granted the defendants' motion to
dismiss the equity securities plaintiffs' '33 Act claims, finding that their
"scattershot pleadings" failed to "afford proper notice, much less provide
facially plausible factual allegations." He added that he could not conclude
"that the relevant offering documents contained material omissions in violation
of affirmative disclosure obligations."
However, Judge Sullivan denied the defendants' motions to
dismiss the bondholders' '33 Act claims (other than with respect to the
offerings in which the plaintiffs had not purchased shares, with respect to
which the motion was granted). In concluding that the bondholders' allegations
were sufficient when the equity securities plaintiffs' allegations were not,
Judge Sullivan found that the bondholder plaintiffs had adequately alleged
misrepresentation in the relevant offering documents with respect to loan to
value rations maintained in the mortgage portfolio and with respect to the
alleged manipulation of the appraisal process to produce inflated appraisal
On the strength of these alleged misrepresentations in
the offering documents, Judge Sullivan also denied defendant KPMG's motion to
dismiss the bondholders' 33 Act claims.
Susan Beck's April 1, 2011 Am Law Litigation Daily
detailed article about Judge Sullivan's ruling can be found here.
AIG ERISA Action: In a March 31, 2011 order (here) in the
AIG subprime-related ERISA action, Southern District of New York Judge Laura Taylor Swain,
denied the defendants' motion to dismiss, other than with respect to plan
organized on behalf of Puerto Rico employees with respect to which the motion
was granted on the ground that because none of the name plaintiffs participated
in that plan, they lacked standing to pursue those claims.
The plaintiffs are participants or beneficiaries in I two
AIG plans, the AIG Incentive Savings Plan and the American General
Agents' & Managers' Thrift Plan between June 15, 2007 and the present.
Each plan offered participants a menu of investment options, one of which was
the AIG Stock Fund, which invested in AIG stock.
The plaintiffs alleged that the defendant plan
fiduciaries breached the duty of prudence by continuing to offer the AIG Stock
Fund as an investment option, even when they knew or should have known that AIG
stock was no longer a suitable and appropriate investment. The plaintiffs
further alleged that the defendants failed to disclose to fellow fiduciaries
nonpublic information that was need to protect the interests of the Plans. The
plaintiffs also alleged that the defendant fiduciaries failed to monitor the
investments and failed to provide complete and accurate information regarding
AIG's mismanagement and improper business practices.
Judge Swain rejected all of the grounds on which the
defendants' sought to dismiss the allegations asserted on behalf of
participants and beneficiaries of the AIG Incentive Saving Plan and the
American Genera Agents' and Managers' Thrift Plan. Judge Swain held that
Plaintiffs had sufficiently alleged that had there been an investigation
triggered by the "warning signs" regarding problems in AIG's Financial
Products Unit, "it would have demonstrated that AIG stock had become an
Judge Swain also found that the Plaintiffs "have
adequately alleged that Defendants failed to disclose the true extent of the
risk facing AIG as a result of its financial decisions and the decline of the
residential housing market, and that Defendants affirmatively misrepresented
the strength and extent of the processes AIG had in place to mitigate this
Finally, she found that the plaintiffs "have sufficiently
alleged that AIG and the director defendants were aware of the increasingly
risky financial position maintained by AIG, material weaknesses in AIG's
financial health and the potential impending erosion of the value of AIG's
An April 1, 2011 Bloomberg article about Judge
Swain's rulings can be found here.
I have in any event added these rulings to my
running tally of subprime-related lawsuit dismissal motion rulings, which can
be found here.
It has been quite a while since the subprime and credit
crisis litigation wave first started in early 2007. Yet many of the cases are
still working their way through the system. The cases discussed above involve
some of the highest profile participants in many of the events surrounding the
credit crisis. One thing that is striking, at least about the Freddie Mac and
the Wachovia cases, is the extent to which the courts seemed influenced by the
comprehensiveness of the credit crisis. It seems that in the context of a
global economic crisis - particularly one that caught so many by surprise - the
courts continue to be skeptical of fraud claims, absent concrete support for
These rulings suggest that the barrier to overcome the
initial judicial skepticism may be substantial. Indeed, the plaintiffs in the
Wachovia case failed to overcome the court's concerns despite having
assembled 50 confidential witnesses, and despite the fact that the aggregate
market cap drop on which the equity shareholders was approximately $109
On the other hand, the hurdle the plaintiffs must
overcome is not insurmountable. The Wachovia bondholders' Section 11 claims are
going forward. And even the plaintiffs in the Freddie Mac case will have
at least another chance to replead to try to overcome the initial pleading
Judge Swain's ruling in the AIG ERISA case seemed more
receptive. But it is worth keeping in mind that ERISA plaintiffs do not face
the same heightened pleading standards that securities lawsuit plaintiffs face
under the PSLRA. Perhaps even more significantly, the ERISA plaintiffs do not
have to plead scienter.
In any event, all three of these cases will be worth
watching as they continue to work their way through the system.
Special thanks to the loyal readers who provided me with
copies of these rulings.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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