www.rli-epg.com/articles/Subprime-Mortgage-Crisis.pdf
Although it appears to be in its early stages, a significant number of governmental and regulatory actions and civil lawsuits have already resulted from the subprime mortgage crisis.
1. Regulatory and Governmental
The U.S. Senate, the Securities and Exchange Commission, the Attorneys General for Ohio and New York, and the Massachusetts Secretary of State have each announced investigations into the subprime lending industry.vii It is likely that other federal and state regulators will investigate the subprime crisis, and that there will be increased regulation of the mortgage industry.
2. Private Civil Litigation
A number of lawsuits involving lenders/originators, warehouse lenders, loan purchasers, underwriters of MBSs, rating agencies and their directors and officers have been filed, and more are expected. Other professionals who played some role in the lending or securitization process may be targeted in lawsuits, including mortgage brokers, lawyers, accountants, auditors, investment advisors and investment fund managers, among others.
a. Repurchase or Misrepresentation Lawsuits Against Lenders
Purchasers of subprime mortgages have filed numerous lawsuits against lenders/originators alleging that they failed to comply with repurchase obligations. The purchasers generally allege causes of action for breach of contract, fraud, fraudulent inducement and negligent misrepresentation.
Liability in repurchase lawsuits may turn on the representations and warranties of the contract pursuant to which the mortgages were purchased.
b. Shareholder Class Actions Against Lenders/Originators
Shareholders have filed securities class actions against at least six lenders/originators and related companies and their directors and officers. Investment banks that underwrote the securities offerings of the lenders/originators have also been named as defendants in some of these actions.
Class actions alleging violations of the Employee Retirement Income Security Act may also be filed on behalf of employees of companies whose pension plans invested in the company’s own stock despite knowledge of exposure to subprime lending.
c. Investor Lawsuits Against Rating Agencies
Rating agencies have been the target of substantial criticism for their alleged failure to properly rate MBSs and CDOs backed by subprime mortgages, and their delay in downgrading the bonds as default and foreclosure rates rose.viii
Investors may allege that they would not have bought the bonds had the agencies properly rated them, or that they would have sold them sooner had they known the true value of the bonds. To date, however, rating agencies have successfully avoided liability in securities lawsuits on the grounds that their ratings are protected d. Investor Actions Against Underwriters and Investment Managers
Investors in MBSs and CDOs backed by subprime mortgages may sue the underwriters of those securities, as well as brokers and hedge funds that managed their investments.
For example, on April 23, 2007, an institutional investor filed a lawsuit against Credit Suisse, certain of its affiliates and others in connection with their underwriting and servicing of certain MBSs.x The plaintiff essentially alleges that Credit Suisse failed to perform due diligence on the low quality mortgages collateralizing the MBSs.
e. Borrower Actions Against Lenders/Originators and Warehouse Lenders
Numerous lawsuits alleging predatory lending and misrepresentations about the terms of subprime mortgages have been filed by borrowers against lenders/originators, as well as warehouse lenders and other parties. For example, the NAACP recently filed a lawsuit against lenders/originators alleging that they discriminated against African Americans by steering them toward mortgages with higher rates.
Borrowers may assert that recent decisions support their claims against lenders/originators and other entities for violations of the Truth in Lending Act (TILA) and other consumer protection statutes. On January 16, 2007, a federal court in Wisconsin found that Chevy Chase Bank violated TILA by failing to clearly and conspicuously disclose the ARM loan payment period, annual percentage rate and variable interest rate features of the mortgages.xi
Further, courts may hold warehouse lenders and other parties liable for aiding and abetting improper practices by lenders/originators. In re First Alliance Mortgage Co.xii, the Ninth U.S. Circuit Court of Appeals upheld a jury verdict in a class action brought on behalf of borrowers against Lehman Brothers, which had provided a line of credit to the subprime lender. The court found that Lehman Brothers could be held liable because it knew of the lender’s fraudulent practices, but continued to finance the mortgages. Significantly, the Ninth Circuit rejected Lehman Brothers’ argument that the plaintiffs were required to prove specific intent, rather than mere knowledge of the fraud.f. Derivative Actions
Shareholders may also file derivative actions against officers and directors of lenders/originators on the grounds that the officers violated their fiduciary duties by misleading investors about the company’s loan delinquency rate and preparedness for a downturn in the mortgage market while selling their own personal holdings in the company.
g. Bankruptcy-Related Litigation
Several subprime lenders have already filed for bankruptcy protection as a result of the termination of funding by warehouse lenders and the significant increase in repurchase demands by purchasers of the mortgages. As bankruptcy filings will stay other litigation against the companies, it appears that many of the liability issues relating to the subprime crisis may be determined in the bankruptcy claims process and adversary actions filed in bankruptcy courts.
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