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Contact us at [email protected]. page 1 of 14 This alert is for general guidance only and does not contain definitive legal advice. © 2008 Wilson Elser Moskowitz Edelman & Dicker LLP. All Rights Reserved. 1997093.3

The ABCs of CDOs

MANAGING CREDIT CRISIS EXPOSURES:

How to be Ready as the Subprime Meltdown Impacts Professional Liability Claims

by the Subprime Practice Group

Like the concentric ripples in a pond after a stone hits the water, liability exposures following a major financial crisis rapidly spread to cover the entire surface. That pattern has been repeated in Errors and Omissions cases, including claims against corporate directors and officers, many times during the past 30 years. The current financial downturn, triggered by the collapse of subprime mortgage lenders, is already creating its ripple effect: increased claims against many different professionals. How can lessons that the industry learned the hard way during past claim upsurges help us today to more effectively deal with claims flowing from the Credit Crisis? How can insurers, financial institutions, and the professions be ready for the day when the summons arrives? In this first in a series of White Papers, we examine the claim development through the First Quarter of 2008 and identify where the ripples in the pond may make waves for professions and other businesses. We then look to the precursors of the current Credit Crisis for clues as to the theories of liability that will most likely arise, and strategies that can control those exposures in terms of both their severity and the expense to defend against them. The key terminology in the subprime world, though full of obtuse jargon, is not all that difficult to follow. Subprime loans are packaged together as one species of asset-backed securities: a way for investors to have a stake in the financial results of a pool of mortgage loan payments. Though there are variations on the theme, most subprime loans in recent years were pooled as “collateralized debt obligations” (CDOs, or “CMOs” if the more specific term, “collateralized mortgage obligations” is used). This was often done by creating a “Special Purpose Vehicle” (SPV), such as an offshore Trust, which issued three types (“tranches”) of bonds. Buyers of the upper tranche, called the “senior” bonds, would be repaid first; buyers of the middle tranche (“mezzanine” bonds) would be repaid after obligations to the senior bondholders had been satisfied. The lowest tranche (“equity” bonds) was typically unrated, and carried the greatest financial risk. The above structure helps us to identify many of the potential players in the unfolding litigation arena:

• The Loan Originator, who developed and marketed the subprime loans.

• The Loan Servicing Agent, whose activities can directly affect profitability.

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• The Underwriter, typically an investment bank, which bought the loans and collateralized them through the use of an SPV and the issuance of the three tranches of bonds, and the bank’s attorneys, who helped create the SPV and wrote the offering materials.

• The Directors and Officers of the Originator and the Underwriter.

• The SPV and its Trustee.

• The Law Firm that put together the SPV and wrote the offering materials for the bonds, and, on the other end of the side of the transaction , the Closing Attorney for the underlying real estate purchase.

• The Accounting Firm that provided the background data upon which Rating Organizations gave the bonds their respective ratings. Many senior bonds were AAA rated, for example.

• The Rating Organizations.

• The Securities Broker who offered or recommended the SPV’s bonds to investors.

• The Mortgage Broker who offered the Originator’s subprime loans to the public.

• The Real Estate Broker who, though not typically involved in any of the above, was involved in the mortgage borrower’s purchase of the residence, and may have made representations about the loan or the real estate market.

By listing these potential targets, we do not imply that any of them are necessarily liable in a given case. We foresee that very broad nets may be cast when plaintiffs and groups of plaintiffs are looking for solvent sources of recovery. The Developing Claim Trends, and What They Tell Us The term “subprime” only entered the general public’s lexicon about a year ago. The Credit Crisis spawned by the subprime meltdown has already increased the frequency of D&O and E&O claims. Economists will debate until at least June 30, 2008, whether the U.S. is in a recession (defined as two consecutive calendar Quarters or more of a shrinking economy), but to consumers the issue is academic. What is real and tangible to them are the current effects of a weakened economy on their daily lives:

They can buy less with a dollar today than they could a year ago. (The exchange rate with the Euro was $1.35 per Euro in April 2007; it was $1.55 in April 2008.)

Those who have put their houses on the market are, by and large, waiting longer to find buyers, and getting less for their homes than last year. (In Washington State, for example, the average sales price has dropped between 5% and 10%, depending on locale.1) It is estimated that over 81,000 mortgage loan default notices were sent out by lenders to home owners in California during the last Quarter of 2007, more than twice the number during the same period in 2006. One source estimates that two out of every five loans originated from 2004 to 2006 will terminate

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“We are still in the first leg of the race here from the litigation standpoint. There is a long road ahead as far as litigation goes and this is a process that's likely to drag on for some years to come.” – Jeff Nielsen, Navigant Consulting

through foreclosure.2 Subprime-related foreclosures affect not only the subprime borrower, but also the “traditional” mortgage borrowers who find it harder to get as good a price for their homes as they could have a year ago. The National Association of Realtors reported on April 22, 2008, that sales of existing homes had fallen 19.3% off the pace of March 2007.3

As foreclosures increase, so does the likelihood of individual or class action borrower lawsuits. As we look at current claim trends, it is also important to bear in mind the public climate. The couple that just sold their home for 10% less than they could have last year will be in our potential jury pool. Claims Directly Against Lenders Each of the top ten subprime mortgage lenders was sued at least once in U.S. federal courts in 2007. Still, suits brought directly by borrowers against lenders represent less than half of the subprime-related litigation to date. A Navigant Consulting review of federal court lawsuits filed in 2007 and alleging damages caused by subprime lending counts 278 such suits. 4 Of those:

• 43% were class actions brought by borrowers against lenders • 27% were securities cases brought by corporate shareholders,

and in all but one of those suits at least one corporate director or officer was named as an individual defendant

• 22% were commercial contract disputes

• 9% were employee class actions

The First Quarter of 2008 has shown an upturn in these filings. Between January 1 and March 31, 2008, 170 new federal court subprime lawsuits were filed, bringing the total to 448. About half of all these suits were filed in two states: New York and California. If the trend continues, it is clear that subprime lawsuits will surpass the 559 federal suits filed as a result of the Savings & Loan crisis of the early 1990s.5 As Jeff Nielsen, Managing Director of Navigant, stated when releasing the updated figures, “We are still in the first leg of the race here from the litigation standpoint. There is a long road ahead as far as litigation goes and this is a process that's likely to drag on for some years to come.” Financial Institutions’ Reported Losses on Subprime Holdings The litigation trend, while sharply increasing, has not kept pace with the increase in write-offs by major banks and other financial institutions caused by their subprime-related holdings. On April 22, 2008, the New York Times reported major losses and write downs by major U.S. and international banks due to the subprime collapse:

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Bank Losses/Write downs (billions) Citigroup -$40.9 UBS -$38.0 Merrill Lynch -$31.7 Bank of America -$14.9 Morgan Stanley -$12.6 HSBC -$12.4 JPMorgan Chase -$9.7 IKB Deutsche -$9.1 Washington Mutual -$8.3 Deutsche Bank -$7.5 Wachovia -$7.3 Crédit Agricole -$6.6 Credit Suisse -$6.3 Mizuho Financial Group -$5.5 Canadian Imperial -$4.1 Société Générale -$3.9 Total -$218.8

As large as the losses to date may seem, they represent about 17% of the total of $1.3 trillion in subprime mortgage-backed collateralized debt obligations (“CDOs”) that were circulating in the market. An Advisen forecast, dated February 22, 2008, estimated that subprime write downs “could climb to $450 billion or more.”6 Financial E&O Cases on the Rise Though there is not an accurate case count on State Court filings, claims against financial institutions and allied professions provide a fairly reliable predictor of trends. The Financial Industry Regulatory Authority (FINRA) reports a 9% increase in filings of arbitration claims against securities broker-dealers and their registered representatives in March 2008 as compared to March 2007. Arbitration filings had declined steadily since 2003, at the low point of the tech-driven market slump (8,945 filings) to 2007 (3,238 filings), as the broad equities markets have recovered.7 The recent up-tick in filings, while not dramatic, may herald a trend back towards more arbitrations being initiated by disgruntled investors, which may reflect the relative stability of diversified investment portfolios as compared to those that are more heavily in financial sector positions. One broad indicator of that sector, the electronically traded XLF fund (the blue line in the chart below), shows a 30% loss in value over the twelve months ending March 31, 2008. In comparison, the Dow Jones Industrial Average (the orange line), though volatile, began and ended the same period at about even.

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Securities brokers and investment advisors may take solace in the fact that the broad equity markets have not, thus far, followed the financial sector’s plunge in the same way that many “brick and mortar” companies’ stocks followed the tech sector’s fall from glory in the first three years of the new century. The Insurance Industry’s Exposure The insurance industry faces two types of exposure resulting from the subprime-driven financial decline:

• First, and most direct, is the industry’s own investment in obligations backed by collateralized subprime loans. In an April 9, 2008, report, “Subprime Mortgage Exposures for Property/Casualty Insurers,” Fitch Ratings Ltd. summarized the capital positions of 51 publicly traded P&C insurers, predicting a 12.5% after-tax loss on the carriers’ combined Subprime and Alt-A holdings. The percentage does not sound very ominous, but the resulting figure, an after-tax loss of over $8 billion, does, especially in times of soft-market underwriting. (The Fitch Ratings report suggests that subprime exposures may lead to “a stabilizing or modestly positive effect on professional liability rates, especially within the financial services sector, but are unlikely to result in broad hardening.”)

• Second, the industry faces less readily quantifiable risks from D&O and E&O claims. The Fitch

report predicts increased liability exposures under those types of policies, and “to a lesser extent, surety and fiduciary insurance claims,” and notes that estimates of the industry-wide insured losses range from $3 billion to $9 billion, a rather broad range, and warns, “Fitch believes that if

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the credit contagion spreads into sectors not directly tied to the subprime mortgage market or if a weakening economy leads to increased bankruptcies, current loss estimates will prove to be inadequate[.]”

For its part, A.M. Best opined on December 14, 2007, “Although the majority of property and casualty insurers' investment portfolios will not be materially affected, A.M. Best believes companies actively writing professional liability coverage are likely to face higher claims activity due to bankruptcies and class-action lawsuits related to the subprime mortgage crisis.” 8 Other Professionals at Risk

Many other professionals who were involved in various aspects of subprime loan transactions are at risk and some lawsuits already have been commenced against numerous professionals. Given the various participants in subprime loan and finance transactions, the list of potential lawsuit targets becomes large:

Since mid-2007, E&O Claims have been asserted against the following categories of professionals:

• Law Firms: In September 2007 the Cadwalader firm was sued by the trustee of a pool of commercial property-backed mortgages. The alleged malpractice involved the Tax Opinion issued by the firm that addressed potential tax advantages that apparently were not realized.

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It is the Fundamentals.

• Accountants: o American Home Mortgage had a secondary offering in April 2007 and went bankrupt in

August 2007. The Bankruptcy Trustee sued Deloitte who had given a clean audit opinion. o Investors sued Morgan Keegan whose mutual fund family lost 50% value. Included were

claims against PricewaterhouseCoopers who was the fund’s auditor.

• Real Estate Professionals: o Real Estate Brokers – mostly out of pre-qualifying purchasers. o Mortgage Brokers – alleging predatory practices, misrepresentations and various

common law consumer protection claims. o Real Estate Appraisers – alleging the issuance of inflated appraisals to make deals

happen.

• Investment Bankers – the allegation is that these professionals did not structure CDOs in a way that provided investor protection.

• Lenders – Numerous 401K/ERISA claims by employees of lenders in the subprime business

have been commenced alleging that while the 401Ks were often invested in company stock, insiders/management dumped the stock but left the 401K invested in risky positions.

• Rating Agencies for CDOs.

• Asset Management Companies.

The claims trends and historical precedents tell us that all of these types of companies and professions will experience increased liability claims to varying degrees. The frequency of these claims will likely be a function of their proximity to either the real estate transaction or the investment transaction. In addition, some state regulators, political leaders, and prosecutors have begun to issue demands that documents be produced and witnesses testify in the course of investigations.9 These matters may also lead to additional theories of civil litigation depending on the content and scope of any potential prosecutorial activities. How Did We Get Here, and How Do We Avoid it Next Time? If all this sounds vaguely familiar – financial upheaval, investigations, prosecutions, professions being targeted with increased lawsuits – it should. We have been through this together before, and there are valuable lessons that we can learn from those experiences. It is the Fundamentals. Somehow, people keep forgetting them. It is like bunting and hitting singles – you win more games with a lot of players trying to advance one base at a time, rather than everyone always swinging for fences.

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“The largest and costliest venture in public misfeasance, malfeasance and larceny of all time.”—John Kenneth Galbraith on the Bailout of the S&L industry

In 1986, it was Congress that forgot the fundamentals when it passed the Tax Reform Act, and did not realize the devastating effects that legislation would have on the commercial real estate market. Investors had for years been enjoying tax benefits from real estate limited partnerships, which were responsible for much commercial development. In the 1986 Act, Congress took away existing partnerships’ tax benefits, forcing the limited partners to sell their interests while making those interests essentially unmarketable, except to the so-called “vulture funds” that swooped in to buy the partnerships for a small fraction of their share of their real estate’s value. The results: empty, unfinished commercial buildings, and angry investors who blamed their professional advisors, who can be sued, rather than their Congressman, who cannot. Investigations, lawsuits, and prosecutions then followed. The 1986 Tax Reform Act debacle was closely followed by another financial meltdown: the Savings & Loan Crisis of the late 1980s and early 1990s. Once again, forgetting the fundamentals. This time it was the S&L industry, lending far beyond the leveraging that ordinary banks were permitted, with little attention to the borrower’s ability to pay. More than 1,000 Savings & Loan institutions closed their doors when the house of cards toppled, resulting in a $160 billion loss. Economist John Kenneth Galbraith called the ensuing public bailout of the S&L industry, to the tune of $124.6 billion, “The largest and costliest venture in public misfeasance, malfeasance and larceny of all time.”10 Again, investigations, lawsuits, and prosecutions followed. The Federal government’s partial bail out of investment banks in the current credit crunch is receiving similar reviews from some commentators.11 More recently, we all watched the high-tech run-up of the stock market in the late 1990s, followed by the “market correction” in 2000 to 2003. From March 2000 to March 2002, the tech-heavy NASDAQ index fell from 5,048 to 1,800, a 64% loss of equity. The premature rise and precipitous fall of high-tech had been foretold by Federal Reserve Chairman Alan Greenspan, who on December 5, 1996, warned, “How do we know when irrational exuberance has unduly escalated asset values which then become the subject of unexpected and prolonged contractions as they have in Japan over the past decade?” But answering his question would have required a return to the Fundamentals of stock valuation, and the asset-thin, stock-price-heavy tech market was, in another famous phrase of the time, “the new paradigm.” But the aftermath of the market drop brought out the old paradigm: investigations, lawsuits, and prosecutions, though the latter were more tied to corporate scandals in the energy and telecommunications sector. In the subprime-fueled Credit Crisis, it is difficult to remember that when alternative mortgage loans were introduced into the market, they were fairly conservative. The Alt-A and Alt-B loans, as they were then called, had all the fundamentals in place – they were only “subprime” in the sense that the borrowers typically had imperfect credit scores. The biggest risk to the lenders was not borrower default, it was poor loan servicing, as became all too common as small lenders outsourced their servicing functions to companies with a greater incentive to charge servicing fees than to do actual servicing.

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“You could get a mortgage loan even if you had no job, had a 620 credit score, and could fog a mirror.”

As in other financial fiascoes, the subprime loan sector lost track of the fundamentals. Five or so years ago, underwriting discipline eroded in several ways:

• Lenders began issuing more loans on a “stated income” or “no doc” basis, meaning that the borrower’s ability to pay was not verified.

• 100% loans (and even higher) became more commonplace, but were made

to look less speculative through the use of a 20% HELOC (home equity line of credit), separately packaged and sold to Wall Street investment banks.

• The borrowers’ qualifications became nearly irrelevant to the underwriting decision. As one

prominent mortgage broker has stated, “You could get a mortgage loan even if you had no job, had a 620 credit score, and could fog a mirror.”

That is how we got here. Investigations, lawsuits, and prosecutions will follow. The SEC and FBI have already been planning the actions for several months.12 They are not alone. There is a new best-seller at law firms, generating nearly as much pre-release excitement among lawyers as a new Harry Potter book would among teens. The topic of attention is a 551-page report (plus appendices) dated February 29, 2008, authored by attorney Michael Missal, a Bankruptcy Court-appointed investigator in the New Century Financial bankruptcy action in Delaware. This tome essentially provides a road map of allegations against New Century’s executives, with a high level of criticism aimed at the company’s outside auditors. New Century had been the nation’s second-largest subprime lender. We have become good at predicting debacle aftermaths, not so good at predicting the next debacle, and not good at all about preventing it. What should we be looking for? What are the signs that the train is about to derail? We have learned that the regulators, even with the best intentions, will always be one step behind the financial innovators. Political institutions likewise react after the problem becomes endemic. There is more newsprint devoted to Congressional oversight of steroid use in professional baseball than to the growing ownership of U.S. government and corporate debt by potentially unfriendly countries.13 Ironically, the answer to preventing the next financial debacle may be in insurance underwriting – good, old-fashioned, risk-based underwriting of financial institutions and professions, and the discipline to price premiums accordingly. That is fundamental, too.

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A National Tort Problem Requires a Nationwide Strategic Approach to Tame Credit Crunch Liability Exposures So, here we are, with an open-ended risk exposure and mounting litigation. Professionals and executives are going to be charged with statutory, regulatory, and common law violations of duty. How can we climb on top of this mound of complex information and impose order on the litigation chaos? Let’s begin by recognizing the most important features of the coming litigation:

These will be tort cases – civil actions for damages. They will not be proxy fights, trademark disputes, or international trade negotiations. Despite all the complex terminology, these will be lawsuits alleging that someone violated the applicable standard of care; in other words, tort actions. If the target is an accounting firm, hire a defense firm that has defended accountants throughout the country. The same goes for securities brokers, lawyers, mortgage brokers, real estate professionals, and business executives.

These cases will be national in venue. New York and California already represent roughly half

of all the federal court Credit Crisis lawsuits. Other major States, including Texas, Florida, Massachusetts, New Jersey, Pennsylvania, Virginia, and Illinois, will also be in the litigation mix. These cases will thus need close coordination, so that discovery in one venue does not sink the battleship in another venue.

These cases will be document-intensive, like the transactions that spawned them. When any

company is targeted in a lawsuit, an early and thorough effort must be made to locate and review the written record, especially the electronic communications. Businesses that operate nationally can save money and effort by doing this just once, rather than reinventing the wheel in each jurisdiction.

The first volley in the battle may not come by way of a Summons, but by a regulatory Subpoena.

That Subpoena might be served in Biloxi or Bangor or Boise. A national firm that has a strong network of local counsel across the country is in the best position to ensure that the defendant does not trip up during the first volley.

The transactional firms that put these financial structures in place will be witnesses. They

cannot also be advocates. Whether it is Wilson Elser or another firm handling the cases, these basic facts will need to be at the center of a nationally coordinated, efficient resolution strategy. Containing Credit Crisis exposures is one half of the strategy. Containing litigation expenses is the other. It will not be inexpensive – one financial institution has set aside $618 million to protect itself against liability and defense costs in Credit Crisis lawsuits.14

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We can help.

There is a myth that says only transactional counsel can defend tort cases arising from complex transactions. There is another myth that says that a law firm needs to send three timekeepers to a court appearance or deposition. There is a third myth that says that $600 or more per hour is a “reasonable” defense fee in a tort case, even a big one. Let’s Get Started At Wilson Elser, we have assembled a select, multidisciplinary team of our best defense counsel from our 20 national offices to help clients evaluate and control their exposures in Credit Crisis claims. We have a unified, national presence with an electronic litigation support system that provides our clients ready access to our work and the fruits of our discovery. For more than a quarter of a century, our attorneys have defended securities brokers, real estate professionals, investment advisors, accountants, law firms, and other professionals in complex litigation and commercial tort cases. Many of these professionals now find themselves potentially embroiled in the subprime lending crisis. We have been litigating subprime lending cases in the Federal and State courts for more than ten years. Given our in-depth experience and the urgent needs of our clients in this current business climate, we are more than ready, willing and able to assist in mitigating any potential litigation. We can help. Let’s get started.

For additional information, please contact one of the leaders of our Subprime Practice Group:

Louis H. Castoria Stefan R. Dandelles Fred N. Knopf Partner-San Francisco Partner-Chicago Partner-New York [email protected] [email protected] [email protected]

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Sources Cited 1 Washington Real Estate Market Report, April 2008. 2 “At the end of 2006, various public interest groups were forecasting dire predictions for the housing market. According to the Center for Responsible Lending, from 1994 through 2005, the subprime market grew from $35 billion to $665 billion. At the end of 2006, subprime mortgages comprised 23 percent of the nation's mortgages. Equally impressive, or horrifying, is the economic backlash behind these figures. It is predicted that 2.2 million U.S. homeowners will lose their homes: one out of five homeowners who borrowed between 2004 and 2006, and an incredible two out of five for loans originated between 2002 and 2004.” New York Law Journal, “Subprime Litigation,: New Theories, Same Rules,” January 30, 2008. 3 NAR website, www.realtor.org, “Existing Home Sales Slip in March,” April 22, 2008. 4 Navigant Consulting, “Subprime Mortgage and Related Litigation: 2007, Looking Back and What’s Ahead.” 5 Navigant Consulting, “First Quarter 2008 Update: Reaching New Heights,” April 23, 2008. 6 “Impact of subprime crisis becomes evident,” Business Insurance, February 22, 2008. 7 FINRA website, www.finra.org, “Dispute Resolution Statistics.” 8 “A.M. Best: Subprime Exposure Modest, But Contagion a Concern,” Insurance Journal, December 14, 2007. 9 Some examples:

• “State breaks up alleged sub-prime fraud ring,” Los Angeles Times, March 19, 2008. • “New York Subprime Probe Takes New Tack,” Wall Street Journal, January 31, 2008:

The New York attorney general's office, pursuing an investigation into whether Wall Street firms improperly packaged and sold mortgage securities, is latching onto a powerful regulatory tool: the 1921 Martin Act.

The state law, considered one of the most potent legal tools in the nation, spells out a broad definition of securities fraud without requiring that prosecutors prove intent to defraud. As a result, the act has become an influential hammer in recent years for New York state prosecutors in cracking down on securities manipulation, improper allocation of initial public offerings of stock and misleading stock research on Wall Street.

Now the staff of New York Attorney General Andrew Cuomo is looking to use this legal tool as it examines whether firms might have committed securities fraud by glossing over warning signs of bad mortgage loans they packaged into securities, people familiar with the matter say.

• “FBI probes 14 companies over home loans,” Associated Press, Washington, January 29, 2008.

• “Connecticut sues brokers, realtors in alleged subprime scam,” ConsumerAffairs.com, September 6, 2007:

Connecticut Attorney General Richard Blumenthal has filed suit against several mortgage brokers and realtors alleging an extensive statewide predatory lending scheme that devastated dozens of consumers. . . .

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“This pervasive predatory lending scheme left a trail of shattered lives and lies – false promises to first-time homebuyers about property values, loan terms, and income levels,” Blumenthal said. “Our investigation has uncovered consumers who sought the American Dream – but bought a financial nightmare.’

• Congressman Gary Ackerman, Senior Member of the House Financial Services Committee, on the record, September 17, 2007:

“Mr. Chairman, much of the blame for the current economic mess can surely be placed on the shoulders of the subprime mortgage business. Too many brokers sold these complex and inherently risky financial products to people who had no business being approved for black and white TV loans, let alone six-figure mortgages. A handful of these institutions even went so far as to offer mortgages with the promise of “no background checks,” and “no income verification,” and advertised in low-income areas saying that no one could be turned down for a loan. In my view, such business practices, very clearly designed to bait the hook at the American dream, to entrap economically strapped and often less-financially savvy customers into mortgages that they could not afford, were not simply irresponsible; they were reprehensible if not criminal.

“But there’s still more blame to be apportioned. Loan originators took these junk mortgages, packaged them into securitizations, and then marketed the collateralized debt obligations, or CDOs, on the secondary mortgage market after absent transparency. We now know that credit rating agencies, by their own admission, assigned overly-favorable ratings to many of these products. The why of it is very simple: some of these firms were double-dipping. First they profited by helping the originators put these shady securities together, and then they collected fees for deliberately mis-rating these risky products at a higher value than they were worth. This is what the Arthur Andersons did for the Enrons and the Worldcoms. The credit raters helped put the Spam in the can, made it sizzle, then they helped sell it as steak. As I noted at a hearing earlier this month, that's not the free market at work. That's fraud. And fraud is a crime, not a correction.”

10 John Kenneth Galbraith, The Culture of Contentment. (Houghton Mifflin, 1992). 11 Example: “The Banker’s Bailout,” Conde Nast Portfolio, March 2008. 12 “FBI, SEC Join Complex Probe of Housing Crisis,” Washington Post, February 14, 2008:

FBI officials said yesterday that they are conducting criminal investigations of 16 companies, while their partners at the Securities and Exchange Commission are probing nearly two dozen more. Those federal investigations follow subpoenas from attorneys general in at least four states and class-action lawsuits that target home builders, lenders, credit-rating agencies and the banks that packaged groups of mortgages into securities. "These are going to be complex investigations," FBI section chief Sharon E. Ormsby said in an interview. Policing mortgage and credit-related fraud is the "number one priority" of the FBI's financial crimes unit, she added. FBI agents are working hand-in-hand with the SEC, which has enlisted 100 lawyers as part of its nationwide subprime mortgage working group and which has made criminal referrals to other government agencies. Legal experts say most probes are in early stages and that if the economic downturn continues, they could widen.

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13 “Citigroup is raising $14.5 billion and Merrill $6.6 billion, largely from private investors and governments in the Middle East and Asia, representing the biggest single transfer of capital to US banks from abroad. It could raise pressure from US politicians concerned about foreign influence on US banking.” Financial Times, January 16, 2008.

14 Market Watch, January 3, 2008:

State Street Corp's decision to set aside $618 million to cover subprime litigation costs has increased concern that insurers offering policies covering such expenses could be hit with big claims from the credit crisis. State Street said the reserve was needed to pay for lawsuits and possible settlements stemming from complaints about the fixed-income strategies managed by its State Street Global Advisors investment arm. The funds were hit by exposure to falling subprime mortgage markets and a lack of liquidity, the company explained. State Street has insurance covering legal costs and expects to get some of the money back from claiming on the policy, Ronald Logue, chief executive of State Street, told analysts and investors during a conference call on Thursday. The value of that coverage was not included in the reserve for accounting reasons, he added. Logue was likely referring to directors and officers insurance. These D&O policies protect executives and members of a company's board from liability in the event of a lawsuit against them claiming wrongdoing in connection with their firm's business. The coverage usually pays for the cost of defending lawsuits, after a deductible, and also a portion of any settlement. Errors and omissions policies offer similar professional liability coverage.

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anaging redit xposures€¦ · most likely arise, and strategies that can control those exposures...

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