AS SUBPRIME LOSSES escalate, two local plaintiffs’ firms, Page Perry and Chitwood Harley Harnes, have filed arbitration demands and a shareholder class action, respectively, against investment firms.
Nationally, subprime-related litigation is starting to swell, but the small number of Atlanta plaintiffs’ firms that handle securities litigation limits local suits.
Page Perry has joined forces with three other plaintiffs’ securities firms with offices in California, New York, Indiana and Ohio to take on subprime suits, and the group filed its first two arbitration demands for individual investors last month-one against Morgan Keegan & Co. for a fund that lost value and the other against Bear Stearns Cos. for losses in one of its offshore hedge funds that collapsed in July. The arbitrations are filed with the Financial Industry Regulatory Authority (until July, the National Association of Securities Dealers).
Meanwhile, Chitwood Harley Harnes filed a shareholder class action at the beginning of November against Merrill Lynch & Co., prompted by the firm’s late October stock drop after a last-minute announcement of an $8.4 billion write-off in the third quarter.
Lawyers at both firms say they are considering additional action against investment firms and residential mortgage lenders.
“These are pretty symbolic of what is obviously a very serious problem,” said J. Boyd Page of Page Perry. “We’ve gotten tons of phone calls over the last couple of weeks from a lot of people in very similar situations.”
“I really started following subprime about 15 months ago,” Page said. “Now I have 12 notebooks full of documents and another 10 or 12 boxes full.”
The coalition gives the plaintiffs’ firms the resources needed for the complex litigation, said Page, by creating a team of 26 attorneys. The other firms are Maddox, Hargett & Caruso of Indianapolis, Cleveland and New York; Aidikoff, Uhl & Bakhtiari of Beverly Hills, Calif., and David P. Meyer & Associates of Columbus, Ohio.
He said the four firms started talking about joining forces last winter because “we felt like this subprime situation was getting ready to explode when, suddenly, over the summer months, it did explode.”
Page Perry’s group filed an arbitration action Nov. 2 against Morgan Keegan for the Indiana Children’s Wish Fund, which gives dying children a final wish, after the charity lost almost $50,000 in two months in a Morgan Keegan bond fund.
According to the pleading, the charity had been depositing its donations into savings accounts, CDs and money market funds at an Indianapolis branch of Regions Bank for years, when a broker for Morgan Keegan suggested that it invest in one of the firm’s bond funds, the Regions Morgan Keegan Select Intermediate Bond C. Both Regions Bank and Morgan Keegan are subsidiaries of Regions Financial Corp., based in Memphis, Tenn.
In late July, the charity placed about $223,000 in the fund. In late September, it closed the account after loosing $48,500-almost 22 percent of its investment, and enough money, according to the pleading, to grant wishes to 10 children.
Page emphasized that the charity had been looking for a very conservative investment. “It was marketed as being this completely safe and smart business decision. Safety was discussed at length in meetings between the Wish Fund and Morgan Keegan,” he said.
But upon closer inspection, said Page, it turned out the fund was “loaded to the gills with subprime debt.” By June 30, subprime mortgage-related investments made up 55 percent of the fund, according to the complaint.
A spokesperson for Morgan Keegan said the firm does not comment on pending litigation.
Page Perry’s group filed another arbitration action Nov. 30 against Bear Stearns for an Irish fund manager, whom Page said did not want to be named, to recover $1 million invested in one of the two Bear Stearns subprime hedge funds
that went belly up in July-less than a year after launching in August 2006.
The fund (called the Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage (Overseas) Fund) invested heavily in triple-A and double-A rated collateralized debt obligations, called CDOs, and mortgage-backed securities, which are put together from pools of subprime residential mortgages.
In July, Bear Stearns informed the hedge fund’s investors that the fund was virtually worthless and would be shut down. “The fund’s reported performance, in part, reflects the unprecedented declines in the valuations of a number of highly-rated (AA and AAA) securities,” said the firm in a July 17 letter to investors.
The Wall Street Journal has estimated that the fund lost as much as $1.6 billion.
Bear Stearns did not respond to requests for comment.
From writedown to class action
Chitwood Harley’s shareholder class action against Merrill Lynch, filed Nov. 6, represents those who bought Merrill’s stock between Feb. 26 and Oct. 23-the day before the firm announced that it would take a third quarter writedown of $8.4 billion from subprime-related investments instead of $5 billion, as previously announced, making it the only major Wall Street investment bank to end the quarter with a net loss.
Merrill had been the biggest CDO underwriter on Wall Street. The company’s recently ousted CEO, Stan O’Neal, said
Oct. 24 that it was “overexposed to subprime” and that “both our assessment of the potential risk and our mitigation strategies were inadequate,” according to The Wall Street Journal.
A spokesperson for Merrill said the suit has no merit.
Chitwood Harley’s Nov. 6 filing in U.S. District Court for the Southern District of New York followed a similar class action against Merrill filed Oct. 30 by Coughlin Stoia Geller Rudman & Robbins-the firm started three years ago by class action king William S. Lerach-plus several other plaintiffs’ securities firms.
Chitwood Harley is representing individual investors, said Martin D. Chitwood. He predicted that big pension funds will join the suit by the end of the year, when the lead counsel will be decided.
Chitwood said his firm is considering additional class actions against Citigroup and Washington Mutual, among others.
“There are a lot more out there,” he said.
In addition to the Merrill class action in late October, four new subprime-related class actions were filed in the Southern District of New York in November, against Citigroup Inc., ACA Capital Holdings Inc., the Federal Home Loan Mortgage Corp. (Freddie Mac) and Washington Mutual Inc.
Coughlin Stoia is involved in all five New York class actions and has also filed subprime-related class actions against Countrywide Financial Corp. and American Home Mortgage Investment Corp.
Chitwood Harley also is lead counsel in a subprime-related shareholder class action filed last spring against Beazer Homes USA Inc. in U.S. District Court for the Northern District of Georgia accusing the homebuilder, which also made home loans, of shoddy lending practices to low-income borrowers that artificially inflated sales and, thus, the stock price. By the spring, sales had dropped and foreclosures had shot up, causing stockholders to lose money, according to the suit.
Beazer is under federal investigation for lending and investment fraud.
Other firms in on the class action against Beazer include Coughlin Stoia and the local firms Motley Rice and Holzer & Holzer.
Motley Rice, based in South Carolina, recently closed its Atlanta office but its local lawyers handling plaintiffs securities litigation plan to stay put. One of them, David J. Worley, said he and his colleagues are considering several subprime-related suits but haven’t yet filed anything.
Corey D. Holzer of Holzer & Holzer also filed a shareholders’ derivative action in August against Countrywide in California state court, in conjunction with a California and a Pennsylvania firm.
New to Georgia
The 11th U.S. Circuit Court of Appeals historically has not attracted a lot of securities class actions, said a securities litigator on the defense side, J. Allen Maines of Paul, Hastings, Janofsky & Walker.
Maines said most of his securities cases are in south Florida and New York. “The Southern District of Florida probably gets more securities class actions filed in a year than all the rest of the 11th together,” he said.
For securities class actions locally, he said, Chitwood Harley has seemed to have a “lock on the club.”
“For the past six or seven years, it sure seemed that they were the only game in town,” he said, adding that he thought Motley Rice’s entry into Atlanta almost two years ago “might stir things up the way things are being stirred up in Florida.”
Maines predicted that there will be more subprime-related plaintiffs’ suits if the financial markets continue to drop.
“You’re only going to have securities fraud suits if you have damages, measured as the difference in stock trading at the day ‘the truth came to light’ and the mean the stock was trading at in the prior 90 days,” he said. “If the stock does not drop, it’s pretty hard to establish damages.”
Class action filings nationally have been “way down” over the past couple of years, Maines said, but several have been filed since the Dow Jones Industrial Average dropped about 1,000 points last month.
“Nobody knows how much subprime exposure is out there,” he said. “The derivative instruments that were packaged by
the banks all contained a certain percentage of subprime and high-risk mortgages-and everybody was playing the percentages [as to the risk].”
“When the market trend is up, no one seems to care that they’re operating on the margin. When the trend turns down, excesses come to light. That’s when you get scandals, recrimination, lawsuits and blame,” said Robert R. Prechter Jr., who has been following the securities market for more than 30 years. Based in Gainesville, Prechter publishes the Elliott Wave Theorist, a monthly newsletter providing market forecasts, and is the author of “Conquer the Crash.”
Prechter said investment losses to date from overexposure to subprime mortgages are just the tip of the iceberg-or, rather, the debt pyramid.
“Mortgage brokers had a lot of IOUs that were not triple-A and they had to figure out how to make them attractive,” he said. To mitigate the risk of investing in subprime loans, the banks assembling them into securities did two things: divided them into tranches, with the top, higher-rated tranches paying out before the lower, more risky ones and lined up insurance to cover the bonds if they went bad.
But “very few people looked into the ability of the insurer to actually cover what the policy covered,” he said. “People did not realize that the triple-A ratings were made on such rosy assumptions about risk.”
The losses might go beyond what the bond insurers can cover, he cautioned. “If there’s nothing left in the fund and if the insurer is bankrupt, who’s left to sue?”
Prechter added that big lawsuits against lenders and investment firms, if successful, could help tip some of them into bankruptcy.
“The current excesses are unprecedented. We’ve never had such a volume of subprime mortgages sold,” said Prechter. “There has never been a time in history when people could buy houses with absolutely no money.”
At the moment, he noted, there is no market for securities based on subprime residential mortgages. “Practically speaking, their value is zero.”
When the bonds can be sold and at what price, he said, largely depends on what happens to the economy. “What people are trying to figure out right now is if the economy is going to recover right away, or if it’s going into a recession.”
If a recession is ahead, he noted, buying subprime mortgage securities “would be useless,” since their value would continue to drop.