Responsible Investor

The credit crunch goes to court

Investors look to recoup sub-prime losses.

The global economy is showing tentative signs of recovery from the paralysis that has been gripping the financial sector. Credit has been loosened, and losses in real estate values appear to have bottomed out in some international markets. However, investors may be unaware that many of our crises may simply be changing battlegrounds, from the economy to the courts. In fact, the legal cases spawned by the securitised debt imbroglio of the last two years may long outlive the problems that caused them, and understanding the nature and scope of these suits are key to any investor’s assessment of the future. The new crop of securitised debt cases falls into three general camps. First, there are actions brought on behalf of investors who purchased overvalued securities on the open market. Plaintiffs in these cases usually allege that they had paid too much for stock because companies failed to properly write down securitised debt assets to market value. When these asset declines are finally revealed, share prices plummet, leaving investors with huge losses.
The revelation of the truth about a company’s true exposure to loss in the securitized debt market is the key to success in these actions.

If a company’s books are still not transparent, and it continues to hide the extent of its imperiled assets, these actions are difficult to maintain. On the other hand, these suits may prove to be many beleaguered investors’ best hope for recovery of damages. In a May 2008 lawsuit, the State Retirement System of Ohio alleged that Merrill Lynch & Co. made false and misleading statements concerning its exposure to subprime debt, leading to massive shareholder losses. On January 19, 2009, Merrill announced that it would pay $475 million to settle the suit. In re Merrill Lynch & Co. Inc. Sec., Derivative and ERISA Litig., No. MDL-1933 (S.D.N.Y). Then there are actions brought on behalf of large purchasers such as institutions and pension funds who bought interests in CMOs and CDOs via prospectuses. In these cases, the plaintiffs were induced to purchase interests in CDOs or CMOs because of false and misleading information in the prospectuses regarding the quality of the underlying collateral. A frequent complication in these cases is that many of the banks issuing the prospectuses are now bankrupt, leaving plaintiffs to seek damages from underwriters and from former officers and directors.

Not a member? Register here »