Legal Commentary

The main stream media continues to beat the drum about how no one will benefit from the subprime mortgage crisis but those damned lawyers. One of the most recent examples was an article in The Economist that warned of a "wave of litigation" that threatens financial firms. I guess that a "wave of litigation" isn't as bad as a "tsunami of foreclosures," although as trite phrases go, it's bas enough.

According to RiskMetrics, a consulting firm, between August and October federal securities class-action lawsuits were filed in America at an annualised pace of around 270?more than double last year's total and well above the historical average. At this rate, claims could easily exceed those of the dotcom bust and options-backdating scandal combined.

At most risk are banks that peddled mortgages or mortgage-backed securities. Investors have handed several writs to Citigroup and Merrill Lynch. Bear Stearns has received dozens over the collapse of two leveraged hedge funds. A typical complaint accuses it of failing to make adequate reserves or to explain the risks of its subprime investments, and of dubious related-party transactions with the funds. Several firms, including E*Trade, a discount broker with a banking arm sitting on a radioactive pile of mortgage debt, are being sued for allegedly failing to disclose problems as they became apparent to managers.

The list of potential defendants is large, according to The Economist, and in addition to lenders, brokers and investment banks, it includes insurers, bond funds, rating agencies and homebuilders.

Borrowers, too, are suing both their lenders and the Wall Street firms that wrapped up their loans. Several groups of employees and pension-fund participants have filed so-called ERISA/401(k) suits against their own firms. Local councils in Australia are threatening to sue a subsidiary of Lehman Brothers over the sale of collateralised-debt obligations (CDOs), the Financial Times has reported. Lenders are even turning on each other; Deutsche Bank has filed large numbers of lawsuits against mortgage firms, claiming they owe money for failing to buy back loans that soured within months of being made.

The article also contends that investigations by state attorneys general and the SEC not only pose risks of state sanctions, but will encourage new litigation and add support to existing litigation by private parties. The author refers to one of our favorite punching bags, Eliot Mess Spitzer, whose pursuit of Wall Street after the burst of the Internet stock bubble, whose publicity-hounding lent strong support to other litigation. Andy ("Mini-Me") Cuomo  seems to be following the blueprint of his Master in Crime (Fighting).

Naturally, the legal profession is drooling all over its bib.

In readiness, law firms have been rushing to set up dedicated subprime practices. These are working not only on disputes but also on helping clients to unwind leveraged transactions. ?Securitisation is the particle physics of finance, which makes it much richer legally than technology stocks,? says John Rosenthal, head of Nixon Peabody's subprime team.

All that complexity! So many hours to bill! To a law firm, this has got to be better than kinky sex with Angelina Jolie.

When shown the litigation budget for just one "unwinding," Mr. Rosenthal was heard to scream "Unleash the hounds!" before his eyeballs rolled upward and he emitted a scream of orgasmic ecstasy at the prospect of the profits-per-partner that would result from scores of contract attorneys and paralegals spending months "parsing the nuances" in tenths-of-an-hour.

Our motto: "Clients: They're What's For Dinner."

For those of us who would rather not plow through a multi-paragraph article, financial consulting firm Fulcrum Inquiry (which also works with law firms on litigation involving complex financial issues) has helpfully compiled a "Top Ten List" of "targets of opportunity" for litigators who want to sue somebody for something related to this crisis. Lawyers always appreciate a shortcut, and I'd recommend that if this subject floats your boat, you give it a look. I'd also add to Fulcrum Inquiry's list something of  interest to bank regulatory lawyers, namely, representing banks in connection with all the wonderful adverse regulatory actions that could ensue from either a bank's involvement in any aspect of subprime lending or from the broader consequences to the economy that could very well flow from the subprime meltdown. Some big banks are already being punished, but as the pain spreads to other portions of the residential and commercial real estate markets, and if a recession does occur within the next year, banks of all sizes and types, many if not most of whom never made or purchased a subprime loan or a security secured by one, could also be adversely affected and find concerned examiners "parsing the nuances" of their operations. That activity, as every experienced bank lawyer knows, often results in all kinds of mischief.

UPDATE: A friend, an old hand who represents banks and bank trade associations, agrees with this post, but suggests an alternate title: "Unleash The Regulators!" As he puts it:

We are already seeing exams that reflect the panic and ensuing conclusion on the part of regulators that all banks must suffer for the transgressions of Wall Street without regard to the fact that the banks did not participate in subprime lending or have any subprime loans in their portfolios.

A version of this post cross-posted on Bank Lawyer's Blog