Mortgage Meltdown

Bear Sterns And ERISA Litigation

As posted yesterday, "JP Morgan Chase Co. and the Federal government stepped in to avoid a bankruptcy" for Bear Stearns.  Today we note that litigation follows. 

Marketwatch has reported that both ERISA and Securities Class Action lawsuits have been filed against the company.  The ERISA lawsuit was filed in U.S. District Court in Manhattan, and alleges that Bear Stearns and its executives breached their fiduciary duties to plan participants by allowing their retirement savings to be invested in the company's stock despite knowing such an investment was imprudent.  According to Workforce Management, approximately one-third of Bear Sterns outstanding stock is owned by its employees through its ESOP.  (Article here.)  A similar lawsuit was filed earlier Monday in U.S. District Court in Manhattan on behalf of Bear Stearns shareholders.

The litigation reserves for class action lawsuits by shareholders is one of the primary drivers of decreased share price paid to shareholders by JP Morgan in its bail-out.  Potential ERISA litigation also may have factored into the share price.  It's hard not to notice how tied together we all are in this tough economic time.

Countrywide Suits Expand

Countrywide Financial Corporation was sued in three ERISA class action lawsuits arising from its subprime mortgage lending, as noted in our November 6, 2007 post.  Public pension plans are also targeting Countrywide for their investment losses.  In addition, however, investment banks and accounting firms have also been added to the list of named defendants, widening the pool of potentially liable parties.

Last fall, New York State Comptroller, Thomas P. DiNapoli, and New York City Comptroller, William C. Thompson Jr., sued Countrywide alleging securities violations.  The New York City Pension Funds were selected on November 28, 2007 by the United States District Court for the Central District of California to serve as co-lead plaintiffs in the securities class action.

DiNapoli and Thompson recently named additional defendants to the lawsuit, including Countrywide's auditors and twenty-six investment banks that underwrote Countrywide's loans.  According to the Comptrollers, "Countrywide's underwriters had a duty to investigate whether Countrywide was acting honestly," DiNapoli said. "Investors lost millions and New Yorkers lost their homes. We can't sit idly by."  Among the banks named are major market players such as Citigroup Global Markets Inc., JPMorgan Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Inc.  KPMG and Grant Thornton are the named Countrywide auditors.  You can read the full Comptroller press release here.

DiNapoli and Thompson oversee several large government pension funds that invested in Countrywide securities.  Given the size of the plans, the losses resulting from Countrywide's subprime mortgage lending may be significant. 

Countrywide is currently in acquisition negotiations with Bank of America Corporation.  The naming of additional defendants could be a positive development for Countrywide, if it deflects some of the potential liability away from it.  Whether Bank of America sees it that way remains to be seen. 

Ohio Public Pension Fund Sues Freddie Mac

The Ohio Public Employees Retirement System has sued Freddie Mac in the U.S. District Court, Northern District of Ohio, alleging securities violations stemming from Freddie Mac's involvement in the subprime mortgage market.  According to the allegations, Freddie Mac "secretly and intentionally participated in one of the largest housing investment deceptions in modern U.S. economic times."  According to Ohio Attorney General Marc Dann who filed the suit, Freddie Mac "deeply invested in the subprime mortgage industry and failed to disclose that it was not protecting itself from the billion-dollar risks it incurred." 

The suit has been filed as a class action on behalf of all purchasers of Freddie Mac stock between August 1, 2006, and November 23, 2007.  The pension fund seeks to be the lead plaintiff.

This suit alleges securities violations.  It does not allege breach of ERISA's fiduciary duties; ERISA doesn't apply to public benefit plans.  In the private retirement plan context, ERISA claims might also have been brought against Freddie Mac if facts support its fiduciary status.  In any event, trustees both public and private will likely be watching this suit to see how it develops, as they also are threatened with suit for losses stemming from the subprime mortgage crisis. 

Wisconsin State Investment Fund Is Subprime Free

As noted in Monday's Journal Sentinel, Milwaukee's daily newspaper, the State of Wisconsin Investment Board's ("SWIB") State Investment Fund is subprime free (article here).  As described on SWIB's website, "[t]he State Investment Fund (SIF) is a pool of cash balances of various state and local governmental units created by the State under section 25.15 of the State statutes."  Current assets in the SIF total $6.7 billion, and it does not contain any subprime-related investments, according to a recent statement on SWIB's website for SIF participants. 

This was confirmed in a recent conversation with Vicki Hearing, SWIB's Public Information Officer.  Hearing confirmed that the SIF has no subprime-related investments, and, in fact, has not invested in mortgage backed securities of any kind for the last six years.  "SWIB's staff looked at MBSs and felt it was difficult to figure out what was backing up the securities, and so chose not to invest," said Hearing.

According to Keith L. Johnson, an attorney with Reinhart Boerner Van Deuren's Madison office, the lack of subprime-related investments in the SIF was "a conscious decision" on SWIB's part, part of their conservative investment policy for the SIF.  Johnson served as SWIB's legal counsel for over 21 years, including almost seven as Chief Legal Counsel.  Johnson notes that SWIB employs in-house investment and risk management staff, whose goal is sound investing on SWIB's part, without the kinds of conflicts of interest that can affect outside consultants. 

Lack of transparency is a common theme in both ERISA and securities litigation.  Greater transparency is regularly urged for the investment market, and currently is being urged in relation to subprime-related investments.  Current examples include John Thain, who heads the NYSE Euronext exchange (article here), and Caroline Baum, in a recent article for Bloomberg.com.

SWIB did well to balk at the lack of transparency for the SIF.  Other institutional investors who did the same must be equally pleased.

ERISA Subprime Related Suit Against Washington Mutual

Hagens Berman Sobol Shapiro LLP announced in a press release yesterday that employee participants in the 401(k) plan of Washington Mutual, Inc. have filed suit for breach of ERISA's fiduciary duties.  The plaintiffs allege that Washington Mutual's involvement in the subprime mortgage industry contributed to losses in its 401(k) plans.  According to the complaint, Washington Mutual originated and held billions of dollars in subprime mortgages, many of which are now in foreclosure.  The complaint also alleges that Washington Mutual engaged in a fraudulent appraisal scheme by which it artificially inflated the appraised values of homes.  According to Hagens Berman,

This means the loans in WaMu's portfolio were inherently overvalued but when WaMu securitized those loans and sold them to investors they were perpetuating a massive fraud on investors that created another risk - WaMu would have to re-assume ownership of those loans if the scheme was revealed.   

As suggested in our recent post, Fund Fiduciary Defendants In Subprime Litigation, ERISA claimants are seeking to cast a wide fiduciary net, and the Washington Mutual suit is evidence of that.  The complaint names the full range of potential defendants: the company, it directors and officers, its human resources officials, its investment committee members and the plan administrators.

This case involves serious allegations against a wide range of potential Washington Mutual ERISA fiduciaries and is an example of the continued potential litigation exposure for ERISA fiduciaries as a result of the subprime mortgage crisis.

Foreclosure Prevention Plan And Fiduciary Litigation

As the details of the Bush Administration's foreclosure prevention plan are revealed, its scope and effect will become clearer.  At the outset, however, U.S. Treasurer, Henry Paulson, is predicting that the plan will have the effect of limiting subprime-related litigation.  As stated by the Treasurer and quoted in Forbes.com:

With the investor community on board and as a clear beneficiary of this approach, the risk of litigation should be manageable.

This was perhaps partly in response to legislation being debated in the U.S. House of Representatives that would have prevented lawsuits by investors in mortgage-backed securities against entities that modify the underlying mortgages.  According to Paulson, that shouldn't be necessary.

The buy-in of investors in the foreclosure prevention plan, however, does not mean ERISA retirement and public pension plan participants and beneficiaries will buy in and not continue to bring suit.  Such litigation may well continue, and if it does, ERISA and pension fund fiduciaries may sue their investment advisors in an attempt to pass the blame.  That pressure could, in turn, lead investors in mortgage-backed securities to rethink their tactic agreement not to sue loan servicers.

But, here's the silver lining:  Hopefully, the foreclosure prevention plan will decrease the number of foreclosures, and thereby put a floor on the falling value of mortgage backed investments.  That would be a good thing for not only investors but ERISA and pension fund participants and beneficiaries.  In addition, many of those participants and beneficiaries may themselves have subprime mortgages due to reset, and may be assisted by the foreclosure prevention plan.

If it works out that way, that could be a win-win for everybody.

LaRue and Subprime Litigation

While this is not an ERISA blog per se, an important ERISA case recently argued before the Supreme Court may turn out to be relevant here.  In LaRue v DeWolff, Broberg & Associates, the issue before the Supreme Court is whether a 401(k) plan participant who claims his employer mishandled his account can bring a section 502(a)(2) claim under ERISA.  Prior case law has suggested (but suggested only) that, as an individual participant, he cannot.  The Fourth Circuit ruled against him, opinions here and here.

As noted by the Wall Street Journal's Law Blog:

James LaRue says he lost about $100,000 in his 401(k) after his former employer, Dallas consulting firm DeWolff Broberg, failed to heed his investment instructions. He claims that DeWolff Broberg improperly invested his money in dot-com bombs rather than government bonds.

Change those facts just a pinch, to a claim that an ERISA fiduciary improperly invested an ERISA plan participant's money in subprime-backed securities rather than government bonds, and you may have a recipe for a wave of individual participant claims related to subprime mortgage losses -- if the Supreme Court finds in favor of LaRue. 

Such a wave, should it come, could have some limitations, however.  Perhaps the key fact in the LaRue fact pattern is that LaRue directed the plan administrator to divest of a particular investment in favor of a more conservative one, and that directive was not followed.  This is different from an allegation of imprudent investment management as a whole (discussed in my past blog posts here).  The number of ERISA participants who can make the same allegation will be a subset of potential claimants. 

As aptly noted by Stephen Rosenberg in his analysis of LaRue, a finding in favor of LaRue may correspond to the realities of self-directed 401(k) plans.  I would add the observation that section 404(c) of ERISA provides a limited affirmative defense to plan administrators who merely follow participant investment directives.  Where participant directions are not followed, the implicit message of section 404(c) may be that liability attaches and a remedy follows.  But it's up to the Supreme Court to decide that.

Fund Fiduciary Defendants In Subprime Litigation

The subprime mortgage crisis has predictably lead to litigation, and the pace does not appear to be slowing yet.  Susan Mangiero, president of Pension Governance LLC believes there are approximately 1,500 lawsuits currently pending against fiduciaries (although not all of them subprime related, presumably).  This seems an astronomical number to me -- far more than I would have suspected even beyond just subprime-related litigation -- but Ms. Mangiero will be tracking the suits in what will likely be a very helpful resource, the pensionlitigationdata.com website.

Among the possible defendants are financial advisers and consultants and the pension and retirement fund fiduciaries they advise.  Liz Peek, in a recent article on subprime litigation, posits that pension and retirement fiduciaries may get stuck holding the bag. 

As noted by Peek, The American Institute of Certified Public Accountants, in an interpretation issued in 2006, has opined for the first time that fund fiduciaries -- not their financial advisers, consultants or managers -- should be responsible for the content of their portfolios.  And, as noted by Stephen Rosenberg is his December 4 post, Looking Under the Hood of Pension Plan Investments, litigation against pension and retirement fiduciaries is spreading -- in both real numbers and in breadth, as claimants seek to pull corporate executives into the ERISA fiduciary net.  Nancy G. Ross and Chris C. Scheithauer, in a recent Midwest In-House article note the same. 

It's a tough time for fiduciaries, as well as their advisers.  The subprime crisis is difficult and complex and continues to develop and expand.  Time will tell who will ultimately be left with the bulk of the liabilities.

Fiduciaries Could Try To Pass The Buck To Rating Agencies

In recent posts (here) our blog discusses how ERISA and public pension plan fiduciaries might get caught up in subprime mortgage litigation.  In an excellent post pulling together much useful information, Kevin LaCroix in his D&O Diary blog notes (here) that the rating agencies might be targets for blame by investors facing subprime-related losses.  I postulate that some fiduciaries also may seek to blame the rating agencies, as a way to deflect fiduciary breach allegations.  I have yet to find evidence supporting this hypothesis, but it may follow as litigation unfolds.

Subprime Litigation and ERISA Stock Drop Cases

            Stephen Rosenberg, in his Boston ERISA & Insurance Litigation Blog gets it right, in a post discussing stock drop cases and ERISA litigation arising from the subprime mortgage crisis.  As noted in our posts of two days ago, the subprime mortgage crisis is likely to lead to ERISA litigation.  Rosenberg cites the Unisystems suit (see our recent post, State Street Faces More Litigation) against State Street as his example of what may be more to come.  The Unisystems complaint alleges State Street mislead ERISA plan trustees when it told them its funds were prudent investments for their participants' retirement investments.  The Countrywide, Beazer Homes and Citigroup actions discussed in our recent posts focus more on plan investments in company stock, rather than plan investments in managed funds, such as those provided by State Street.  But they represent similar ERISA litigation arising out of subprime mortgages.  Whether "the scope of this area of liability and potential litigation . . . is as big as you would expect" (Rosenberg's words) remains to be seen, but it does seem likely.