Waiting for the Subprime Lawsuits

Defense teams are ready, but legal and financial complexities have held off the floodso far

Last year, as the mortgage market crumbled, a number of major law firms formed subprime-litigation SWAT teams, ready to tackle an expected deluge of lawsuits from both individuals and institutions. They're still waiting.

"The volume of litigation that most people expected hasn't hit yet," says Daniel T. Brown, a Washington lawyer at Mayer Brown, which announced creation of a "subprime lending response team" in October. Yet there's also a sense that the deluge is still to come. "There's a steady stream of cases," Brown says, "and the further deteriorating economy is likely to prompt more and more lawsuits."

"Very, Very Fuzzy" Picture for Investors

Compared with previous busts, this crisis is more complicated and the ­liability of potential defendants ­murkier. Typically when investors suffer financial shocks, plaintiffs' lawyers are not shy about rushing to court, suing first and asking questions later. The litigation process itself serves as a tool to extract documents and testimony that might help prove their claims. With subprime, dozens of financial institutions are under investigation by state and federal law enforcement officials, so plaintiffs may be waiting for results of those probes in hopes of obtaining grist for their own cases.

Also, the very complexity of the financial instruments spun out of mortgages means some investors have not yet begun to sort out their losses. "People don't yet appreciate the diminution in value that their portfolios have suffered," says Darren J. Robbins, an attorney at plaintiffs' firm Coughlin Stoia Geller Rudman & Robbins in San Diego. Even when the losses are totted up, coming up with legal theories to affix blame could be challenging.

"The judgment calls that led to writedowns—they're judgment calls," says Brown. "The picture's going to be very, very fuzzy."

High hurdles

Which is not to say that people haven't gone to court. By the end of last year, according to Navigant Consulting (NCI), nearly 300 subprime-related cases had been filed in federal court alone. Nearly half of those cases involve claims by home buyers, primarily alleging they got inadequate information from mortgage originators, many of which are now insolvent or in financial peril.

Pursuing similar claims against big Wall Street banks that securitized the loans will be difficult since they weren't involved in originating them. Big pension funds and other institutions that file securities suits against the banks won't find the going easy either. Recent U.S. Supreme Court decisions have raised the bar for proving securities fraud and made it next to impossible for investors to sue parties like law and accounting firms that may have known or assisted in any shenanigans.

Some of the most high-stakes litigation could involve financial institutions seeking redress from each other. In February, German lender HSH Nordbank set tongues wagging on Wall Street when it sued UBS (UBS) in New York State court, alleging mismanagement of an investment structure known as a collateralized debt obligation (CDO). UBS says it met all its contractual obligations. In general, public fights are avoided by parties who are each other's regular customers. What's more, notes Francis J. Burke Jr., a lawyer at Steptoe & Johnson in Phoenix, "financial institutions would have to be careful, because some of the claims they would be making" about problems with CDOs, for example, "could be used by investors they sold CDOs to."

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