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Class Action Crisis

Stanford Law School, Cornerstone Research release report

January 3, 2008


Eight consecutive quarters of fewer securities class action lawsuits were reversed by the subprime mortgage crisis, according to a new report.

During the second half of 2007, 100 companies were sued in securities fraud class action litigation, according to the Stanford Law School and Cornerstone Research Release Annual Securities Fraud Class Action Filings Report announced today. The figure compares to 66 actions filed in the first half of last year and 116 cases for all of 2006.

Between 1997 and 2006, an average of 194 companies per year were sued, the report said.

"For the past two years, securities fraud class action litigation has been driven by market-wide events, such as the 2006 backdating scandals and the 2007 subprime crisis," Stanford Law Professor Joseph Grundfest said in the announcement. "If these systemic shocks are excluded from consideration, the 'core' litigation rate continues to be remarkably low. When litigation related to the subprime crisis is excluded from the calculation -- on the assumption that the subprime crisis is a nonrecurring event -- the resulting core litigation rate remains well below historical norms."

Of the 166 companies sued last year, 47 were in the finance sector -- with more than half associated with subprime market disclosure issues, the report said. Just 11 finance sector companies were sued in 2006.

The report indicated securities class actions rarely make it to trial, though almost 20 percent of the 2,218 securities class action cases filed since 1996 are still active, 41 percent were dismissed and 59 percent settled.

But one landmark case cited against JDS Uniphase claiming $20 billion in damages went to trail and was lost by the company, indicating that every case that progresses past summary judgment has merit. There were nine cases filed for at least $5 billion last year.

The report found that, on average, a 10 point increase in the quarterly average Standard and Poor's 500 Implied Volatility Index was associated with 12 additional lawsuits each quarter. For example, cases filed jumped around 50 percent from the first half of 2007 to the second half as stock market volatility, fueled in part by the subprime crisis, rose dramatically from historically low levels.

Among mortgage companies recently facing securities class actions are Washington Mutual Inc., which is being sued by employees whose 401(k) plan accounts include investments in company stock; Countrywide Financial Corp., which is accused by New York state's comptroller and New York City's comptroller in a consolidated class action of inflating its stock price; Freddie Mac, which is being sued on behalf of investors of its publicly traded securities; and Citigroup Inc., which is accused of issuing materially false and misleading statements about its results.

"Just a few months ago we were trying to pin down the cause of the two-year lull in class action activity that began in mid-2005," Cornerstone executive John Gould stated. "While it is likely that both the subprime crisis and the increase in stock market volatility contributed to the increase in filings in the second half of the year, it is not possible, as a technical matter, to separate these two effects."

The Second Circuit in New York saw 58 of last year's filings -- more than any other circuit; followed by the Ninth Circuit in California with 39 filings; and the Eleventh Circuit in the Southeast, which includes Alabama, Florida and Georgia, with 18 filings, the report said.

In contrast, a report last month from Guy Carpenter & Co. LLC measuring the risk of litigation by state indicated that only Alabama and Georgia were "Very High" risk, while Florida was "High" risk and California and New York were "Medium" risk.

"The unfortunate reality is that we are seeing more class actions filed against lenders as a result of the subprime crises," Mitch Kider, Managing Partner at the Washington, D.C.-based law firm of Weiner Brodsky Sidman Kider PC, told MortgageDaily.com. "Homeowners facing foreclosure, as well as investors and shareholders, are desperately trying to mitigate their losses by pointing their fingers at those who provided financing. The cases range from allegations of technical violations of the Truth in Lending Act to mismanagement and failure to supervise employees properly.

"Obviously, we anticipate that this trend will continue for quite some time."

Sam Garcia worked in mortgage lending for twenty years prior to becoming publisher of MortgageDaily.com.

e-mail: [email protected]

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