Sedgwick

In the January 2010 Edition:

The subprime lending crisis and ensuing credit crunch have resulted in significant losses and numerous lawsuits involving parties to the mortgage lending and securitization process. This digest collects and summarizes recent media reports regarding potential liability, government initiatives, litigation and regulatory actions arising from the subprime mortgage crisis and credit crunch, as well as the increasing number of reported cases of financial fraud.

This issue focuses on recent significant decisions in civil litigation regarding subprime and other high-risk mortgages, auction rate and related securities, the growing number of reported Ponzi and financial fraud schemes around the world, the status of civil, criminal and regulatory actions relating to the Madoff, Stanford and Rothstein Ponzi schemes, and continuing government efforts to ease the economic impact of the subprime crisis and credit crunch.

In the Spotlight:

Litigation & Regulatory Investigations

Regulators Scrutinizing Banks That Sold CDOs and Then Bet Against Them
Investigators in Congress, the Securities and Exchange Commission (SEC) and at the Financial Industry Regulatory Authority (FINRA) are reportedly investigating whether banks violated securities laws by creating and selling to clients complex mortgage-linked debt securities that they subsequently shorted. According to Wall Street traders, the mortgage-related instruments, known as synthetic collateralized debt obligations, or CDOs, were peddled by large banks such as Goldman Sachs, Deutsche Bank and Morgan Stanley, which then bet against the same CDOs they had sold. Goldman and other Wall Street firms maintain that there is nothing improper about their transactions, arguing that they typically employ many trading techniques to hedge investments and protect against losses. Investigators are apparently examining whether the firms purposefully selected especially risky mortgage-linked assets to back the securities and set their clients up to lose billions of dollars if the housing market collapsed. ("Banks Bundled Bad Debt, Bet Against It and Won," The New York Times, December 24, 2009)

Ponzi Schemes & Fraud Actions

Accused Florida Ponzi Scheme Mastermind to Plead Guilty
On January 6, 2010, authorities disclosed that Scott Rothstein, a former Florida lawyer, intends to plead guilty to charges that he ran an investment scheme that defrauded clients out of more than $1 billion. In December, federal prosecutors charged Rothstein with five felony counts, including wire fraud and racketeering, for allegedly running a scheme in which he sold stakes in fictitious legal settlements he claimed his law firm had struck in employment disputes. According to court filings, Rothstein is alleged to have acted with co-conspirators to carry out the $1.2

billion scheme, to create false bank documents that conned investors while providing "gratuities to high-ranking members of police agencies" in order to deflect law enforcement scrutiny. Rothstein, whose license to practice law was revoked last year by the Florida bar, built a prominent 70-lawyer Fort Lauderdale firm that is currently undergoing liquidation in bankruptcy court. ("Rothstein to Revise Plea to Guilty," The Wall Street Journal, January 7, 2010; "Fla. Lawyer to Plead Guilty in $1 Bln Ponzi Case," Reuters.com, January 6, 2010)

Government and Regulatory Intervention

Senate Bill on Financial Reform Moves Ahead
On December 23, 2009, Sens. Chris Dodd (D-Conn.) and Richard Shelby (R-Ala.) issued a joint statement saying that Senate discussions in recent weeks between Democrats and Republicans had been "extremely positive." Currently, the

Senate is drafting legislation that could drastically change how U.S. financial markets are regulated. Although both Democrats and Republicans agree on no longer treating firms as "too big to fail" and on strengthening consumer protections, the means to achieve such consumer protections are being debated by both sides. The White House has proposed that a new Consumer Financial Protection Agency be created, an idea Sen. Dodd says is key to any regulatory overhaul. The proposed agency would write, examine and enforce rules related to financial products such as mortgages and credit cards. Republicans have expressed concern with the proposed agency's powers, and a compromise under consideration would leave enforcement and examination to federal bank regulators. Additionally, Sen. Dodd has proposed creating a single bank regulator to replace the four agencies that now oversee different parts of the banking sector. Sen. Shelby is not in favor of consolidation and would like to keep the FDIC in charge of the oversight of state-chartered banks. A final Senate bill is expected to be finalized by the Senate Banking Committee and introduced to the full Senate in the coming weeks. ("Bipartisan Duo Moves Ahead on Finance Bill," The Wall Street Journal,

December 24, 2009)

Auction Rate Securities

Investors Seeking Recovery of ARS Losses Get a Second Chance

OCourts presiding over three lawsuits brought by investors seeking recovery for losses incurred as a result of investments in auction rate securities (ARS) recently permitted plaintiffs to refile their complaints against Citigroup, Inc., UBS AG, and Raymond James Financial, Inc. after granting defendants' motion to dismiss. On October 15, 2009, investors filed an amended complaint against Citigroup, which includes additional allegations based on the company's December 2008 regulatory settlement to illustrate that the company failed to disclose problems with the ARS

market despite knowledge that the market was in trouble. In addition, on October 16, 2009, investors filed an amended complaint against Raymond James, which includes an additional 20 pages detailing how the company marketed and sold ARS.

Citigroup and Raymond James have renewed their motions to dismiss. Although the court dismissed a consolidated action against UBS after it reached an agreement with regulators for the repurchase of $19.4 billion of ARS, the litigation has been taken over by investors not covered by the regulatory settlement. Since the $330 billion ARS market collapsed in February 2008, investors sued approximately 19 broker-dealers. SunTrust Banks Inc. and Northern Trust Corp. won permanent dismissals last year and actions against Goldman Sachs were voluntarily dismissed after Goldman agreed to buy back $1.5 billion of ARS. Financial firms have agreed to buy back $61 billion in ARS consisting of 18.5 percent of the original market in an effort to settle regulatory investigations regarding their ARS practices. Analysts estimate that there are still $149 billion in outstanding ARS. ("Auction-Rate Investors Get Redo After Loss of First Fraud Suits," Bloomberg.com, December 17, 2009)

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