In the June 2010 Edition:
The subprime lending crisis and ensuing credit crunch have resulted in significant losses and numerous lawsuits involving parties to the mortgage lending and securitization process. This digest collects and summarizes recent media reports regarding potential liability, government initiatives, litigation and regulatory actions arising from the subprime mortgage crisis and credit crunch, as well as the increasing number of reported cases of financial fraud.
This issue focuses on recent decisions in civil litigation regarding subprime and other high-risk mortgages, the status of the Madoff, Rothstein and Starr schemes and related litigation, and the status of financial regulatory reform legislation in response to the subprime crisis and credit crunch.
In the Spotlight:
Litigation & Regulatory Investigations
Opinion Issued in Credit-Based Asset Servicing and Securitization Subprime Securities Lawsuit
On June 1, 2010, Judge Jed Rakoff of the U.S. District Court for the Southern District of New York (SDNY) issued an opinion substantiating a prior order issued on March 31, 2010, denying in part and granting in part the defendants' motions to dismiss a lawsuit filed against Merrill Lynch, Credit-Based Asset Servicing and Securitization, LLC and others. The plaintiffs alleged that the defendants violated federal securities laws by making certain misrepresentations regarding the mortgages underlying the securitizations that were purchased by the plaintiffs. In his June 1, 2010 opinion, Judge Rakoff granted the rating agency defendants' motion to dismiss, finding that rating agencies are not underwriters as defined by the Securities Act of 1933. Similarly, Judge Rakoff found that certain alleged underwriter defendants who originated the mortgages underlying the securitizations were not underwriters as defined by the Securities Act, but only "sponsors" of the offerings. With respect to the remaining alleged underwriter defendants, Judge Rakoff found that the plaintiffs had sufficiently alleged that the offering documents made misrepresentations regarding the mortgage originators' compliance with mortgage underwriting guidelines. However, the court dismissed the plaintiffs' claims in connection with 65 of the 84 securities offerings specified in the complaint, finding that the named plaintiffs lacked standing to bring those claims because they had not purchased securities in those offerings.
Additionally, Judge Rakoff found that the plaintiffs' claims were not barred by the statute of limitations as the defendants had argued in their motions to dismiss. According to the defendants, the plaintiffs were on inquiry notice prior to a year before the first complaint was filed because "questions about the bona fides of mortgage-backed securities were the subject of news reports, government investigations, public hearings and civil complaints." Judge Rakoff found that it was not appropriate to resolve the issue of inquiry notice at the motion to dismiss stage of the case. ("Two Subprime Suit Dismissal Motion Rulings," The D&O Diary, June 2, 2010; Public Employees' Retirement System of Mississippi et al. v. Merrill Lynch & Co. Inc. et al., 08-Civ-10841 (S.D.N.Y. June 1, 2010))
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Ponzi Schemes & Fraud Actions
Celebrity Investment Advisor Charged in Ponzi Scheme
On May 27, 2010, Kenneth Starr (not the same Kenneth Starr who served as a special prosecutor during the Clinton administration), a New York investment advisor to well-known Hollywood celebrities, was arrested on charges of running a $30 million Ponzi scheme. According to the criminal complaint, Starr, through his investment advisory firms Starr Investment Advisors and Starr & Co., gave financial advice to wealthy celebrities, including Martin Scorsese, Wesley Snipes, Sylvester Stallone, Goldie Hawn and Uma Thurman. Starr allegedly marketed "his services as an account and financial advisor to clients, gained control over millions of dollars belonging to his clients, and then misappropriated millions of dollars of his clients' assets for his own personal use," including a sprawling $7.5 million Upper East Side Manhattan condominium. According to the complaint, at one point Starr managed assets in excess of $700 million. Starr has been denied bail and deemed a "serious flight risk." The case is United States v. Kenneth Starr, et al., in the U.S. District Court for the SDNY, No. 10-MJ-1135. ("Starr, Investment Advisor to Stars, Denied Bail in $30 Million Ponzi Scheme," International Business Advisor, May 28, 2010)
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Government & Regulatory Investigations
Financial Crisis Inquiry Commission Issues Subpoena to Goldman Sachs
On June 7, 2010, the Financial Crisis Inquiry Commission issued a subpoena to Goldman Sachs for "failing to comply with a request for documents and interviews in a timely manner." The Financial Crisis Inquiry Commission, established by Congress to investigate the causes of the current financial crisis, is required to deliver a final report by December 2010. The commission has been criticized in the past for not being aggressive enough in its use of the subpoena powers granted to it by Congress last year. According to a spokesman for the commission, "Goldman Sachs has not, in our view, been cooperative with our requests for information, or forthcoming with respect to documents, information or interviews." Sources involved with the investigation say that Goldman has already provided more than 20 million pages of documents, and the commission has already begun interviewing witnesses on a range of issues, including derivatives. ("Financial Panel Issues a Subpoena to Goldman Sachs," The New York Times, June 7, 2010)
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