Consider the developments of the past 10 days: collapsing share prices, huge investor losses, allegations of financial obfuscation and mismanagement. It would seem a likely setup for a new wave of litigation and a boon for the plaintiffs' bar. The reality, however, is far more muted. Legal rulings have made it significantly harder to press shareholder claims. And since the victims of the current financial carnage include some of the primary defendants themselves, investors may find themselves reaching into empty pockets for redress.
Yes, lawsuits stemming directly from the turmoil of recent days have been filed. On Sept. 19, for example, an investment firm sued the Reserve Fund, a money-market fund that serves institutions, for "breaking the buck" and causing a flood of investors to cash out at less than $1 per share. A former employee sued American International Group for losses in AIG's pension resulting from the collapse of the insurer's stock. And a Merrill Lynch shareholder sued the investment firm, claiming the terms of its proposed acquisition by Bank of America are unfair.
Reserve Fund representatives could not be reached over the weekend for comment. An AIG spokesman says the company does not discuss pending litigation, and Bank of America said it has no comment. Merrill Lynch did not immediately respond to requests for comment.
Tough slog for plaintiffs
The fact is, though, many of the nation's major financial-service firms were sued months ago for losses stemming from the subprime mortgage crisis. Plaintiffs already faced tough slogging in those cases due to U.S. Supreme Court decisions in recent years that raised the bar for investor claims. To avoid having their cases dismissed, for instance, investors must now come forth with very specific allegations about what defendant companies did to knowingly deceive the market — a high hurdle. And a ruling in January of this year made it virtually impossible to try to hold corporate advisers, such as accountants and lawyers, responsible for a stock issuers' securities fraud, putting any insurance they have beyond reach.
Recent events raise additional obstacles. With Lehman Brothers in bankruptcy, all lawsuits against the firm are frozen and funds to pay out on any claims will be severely limited. Squeezing money out of institutions that have been effectively nationalized, such as AIG, Fannie Mae, and Freddie Mac, will also be no easy task. "It's going to make it more challenging for investors to recover assets that have basically gone into thin air," says Gerald H. Silk, an attorney with Bernstein Litowitz Berger & Grossmann, the New York firm that filed suit against the Reserve Fund. As for losses incurred in recent days, defendants may assert they were due not to any misleading statements or mismanagement on their part but by the calamitous state of the markets. Courts don't award damages for market-related price drops.
Next target: rating agencies?
Plaintiffs' attorneys vow to press forward, including with new cases. Rating agencies may once again come within their sites, says John P. "Sean" Coffey, another Bernstein Litowitz lawyer. They "are very complicit in this disaster," he maintains. "They were putting the Good Housekeeping seal of approval on crap." Courts have rejected past efforts to hold bond raters liable, in part based on the notion that ratings are expressions of opinion protected as free speech. Fitch Ratings said it had no comment; Moody's Investors Services did not respond to a request for comment; Standard & Poor's, which, like BusinessWeek, is a division of The McGraw-Hill Companies, declined to comment.
The phenomenon of investors losing money in supposedly highly secure money-market funds may also prompt additional litigation. Says Darren J. Robbins, an attorney at Coughlin Stoia Geller Rudman & Robbins in San Diego: "You cannot overstate the concern that our pension fund clients have concerning those investment vehicles marketed as conservative" turning out to hold "substantial amounts of high-risk, mortgage-backed products."