By J. Bruce Boisture, Managing Partner, Grais & Ellsworth LLP

The crisis in the structured finance market continues, and the legal actions to sort out its consequences are also proceeding apace.  As befits the aftermath of a credit bubble of such magnitude, the struggle is taking place on many fronts.

Purchasers of collateralized debt obligations, or CDOs, are pursuing claims against CDO issuers, underwriters, sellers, and others under federal securities laws and various state laws.  In cases such as Plumbers Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., No. 08-0544, complaint filed (Mass. Super. Ct., Suffolk County, Jan. 31, 2008), Bankers Life Ins. Co. v. Credit Suisse First Boston Corp., No 8:07-cv-00690, complaint filed (M.D. Fla. April 23, 2007), disappointed CDO owners are asserting that the disclosures made to them were incomplete, careless, or fraudulent.  Often in the same actions, the CDO owners also complain of the mismanagement or looting of the collateral pool by loan servicers and collateral managers affiliated with the same issuers and underwriters, as in HSH Nordbank AG v. UBS AG, No. 08600562, complaint filed (N.Y. Sup. Ct., N.Y. County Feb. 25, 2008).

Structured Finance & Derivatives Litigation Conference October 15-16

On another front, participants in the CDO structures are waging an intense internecine struggle over whatever value remains in the underlying collateral.  The “waterfall” provisions for ordering the priority of payments among various tranches after a credit event, rights of warehouse lenders to streams of principal and interest payments on loans they were left holding after the bankruptcy of the loan originator/servicer, and the “true” value of CDOs in a barely functioning CDO market are being examined in cases such as Deutsche Bank Trust Co. v. Victoria Fin., No. 08600071, complaint filed (N.Y. Sup. Ct., N.Y. County, Jan. 9, 2008), UBS Real Estate Securities v. New Century Mortgage [citation], and Luminent Mortgage Capital Inc. et al. v. HSBC Securities (USA) Inc., No. 07-CV-9340, complaint filed, (S.D.N.Y. Oct. 18, 2007).

Retail sub-prime borrowers were the cannon fodder for the subprime ABS debacle.  Predatory lending practices of mortgage brokers and lenders have left many individuals in debt far beyond their means as well as beyond the true value of the properties they purchased.  Some contend that the lending practices prevalent during the subprime ABS heyday even left whole neighborhoods blighted by high foreclosure rates.  Liability, if any, at this level in the subprime ABS pipeline is being sorted out in cases such as Samuel et al. v. Countrywide KB Home Loans et al., No. 08-cv-350m complaint filed (D.S.C. Jan. 31, 2008).

Perhaps most intriguing, though, are a series of cases in which customers are complaining of the investments their investment managers made in subprime ABSs.  Because every corner of the investment world seems to have participated in sopping up the output of the subprime ABS mill, these actions are arising in a variety of contexts.  ERISA-based claims against providers of investment vehicles that invested heavily in subprime ABSs (Prudential Re. Ins. & Annuity Co. v. State Street Bank & Trust Co., No. 07-CV-8488, complaint filed (S.D.N.Y. Oct. 1, 2007)) and against fiduciaries of company plans affected by the crisis (Gray v. Citigroup Inc., No. 07 Civ. 9790, complaint filed (S.D.N.Y. Nov. 6, 2007) seem likely to follow familiar ERISA tracks.    


Surprising Outcomes

Similar claims in different contexts, however, have already yielded and may continue to yield some surprising outcomes.  Political pressure brought Merrill Lynch quickly to heel when the City of Springfield complained of subprime ABS investments made on its behalf.  In re Merrill Lynch et al., No. 2008-0001, administrative complaint filed (Office of the Sec’y of the Commw., Sec. Div. Feb. 1, 2008); “Merrill Pays Back Springfield, Mass., For CDO Purchase,” Wall Street Journal, Feb. 1, 2008.  In Wilmington Trust Co. v. Metro. Life Ins. Co., No. 08600242, complaint filed (N.Y. Sup. Ct., N.Y. County, Jan. 25, 2008), a corporate holder of an insurance policy meant to fund non-pension retirement benefits complained that the insurance company had improperly and imprudently invested its premiums in subprime ABSs, to the detriment of the policyholder, exactly paralleling the claims in the ERISA suits.  Dismissing the complaint, the court held that under New York insurance law the policyholder had no legally protected interest in the nature of the investments made by the insurance company or its investment manager – a striking contrast to the likely outcome in the ERISA context.  Still other nuances are likely to emerge when claims under the Investment Company Act are leveled against mutual fund managers for plunging their bond funds into excessive (and costly) subprime ABS exposure.  Atkinson v. Morgan Asset Mgmt., No. 07-2784, first amended complaint filed (W.D. Tenn. Feb. 1, 2008).

And on top of all of this, there is the usual spate of class-action stock-drop cases.

Note: Bruce Boisture and his partner David J. Grais are speaking at Structured Finance & Derivatives Litigation Oct. 15-16 in New York, a BVR Legal / Mealey’s event.