Sedgwick

In the March 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 the release of the Lehman bankruptcy examiner's report, recent significant decisions in civil litigation regarding subprime and other high-risk mortgages, the status of the Stanford, Madoff and Petters Ponzi schemes and related litigation, and the status of financial regulatory reform legislation in response to the subprime crisis and credit crunch.

In the Spotlight:

Litigation & Regulatory Investigations

Bankruptcy Examiner Releases Report Detailing Lehman Collapse
On March 11, 2010, the examiner appointed by the U.S. trustee in January 2009 to investigate the causes of Lehman's bankruptcy released a voluminous report detailing the accounting practices of Lehman Brothers Holdings Inc. that led to the company's collapse in September 2008. The bankruptcy examiner's report states that Lehman engaged in "materially misleading accounting gimmicks" and "financial engineering" to conceal its debt and approximately $50 billion of troubled assets in the months immediately preceding its bankruptcy filing. Much of the report focuses on a program known internally at Lehman as "Repo 105," in which senior Lehman officials secretly transferred billions of dollars off Lehman's balance sheet. The report explains that under Repo 105, Lehman sold illiquid real estate-related securities at the end of a financial quarter, but planned to buy back the securities only a few days after the start of the next financial quarter.

According to the report, Lehman's accountants at Ernst & Young were aware of misleading accounting maneuvers at Lehman, and Richard Fuld, the former chief executive officer of Lehman, certified misleading reports. In a statement released by his attorney in response to the report, Fuld denied any knowledge of or involvement in Repo 105. The report, however, characterizes Fuld as "at least grossly negligent" and states that senior Lehman executives engaged in "actionable balance sheet manipulation." Although the report does not explicitly conclude that Lehman executives violated U.S. securities laws, it states that "colorable claims" could be made against some former Lehman executives and Ernst & Young. ("Report Details How Lehman Hid Its Woes as It Collapsed," The New York Times, March 11, 2010)

Ponzi Schemes & Fraud Actions

Prosecutors Seek 335-Year Sentence for the Petters Ponzi Scheme
In December 2009, Thomas Petters, founder of Petters Group Worldwide LLC, was found guilty by a federal jury in St. Paul, Minnesota, on 20 criminal counts, including wire fraud, mail fraud, and money laundering. Prosecutors accused Petters of running a $3.65 billion Ponzi scheme in which he used one of his companies to defraud investors who thought he was using their money to buy consumer electronics for resale to retailers such as BJ's Wholesale Club Inc. and Costco Wholesale Corp.
In a sentencing memorandum filed on March 8, 2010, prosecutors urged the court to sentence Petters to 335 years for operating the Ponzi scheme. In support of their memorandum, prosecutors stated that, "[t]he defendant's fraud is beyond comprehension" and that "[a] life sentence is wholly deserved and justified given the defendant's corrupting influence on individuals and institutions, and his strident refusal to accept any responsibility." Unlike Ponzi scheme mastermind Bernard Madoff, Petters did not plead guilty or acknowledge responsibility for operating the alleged fraudulent scheme. Attorneys for Petters have called the proposed sentence "unjustified" and have asked the court for leniency in light of Petters' health condition and to impose a sentence not exceeding 12 years and seven months, similar to the sentence imposed on Walter Forbes, former chair of Cendant Corporation, who was also ordered to pay $3.3. billion after his conviction involving an accounting scandal. ("U.S. Seeks 335 Years for Ill Petters in Ponzi Case," Reuters, March 9, 2010; "Petters Should Get 335 Years for $3.5 Billion Fraud, U.S. Says," Bloomberg.com, March 9, 2010)

Government and Regulatory Intervention

Sen. Dodd Pushes Financial Regulatory Reform Forward
After months of negotiations between Democrats and Republicans in the Senate Banking Committee, the two sides have been unable to reach an agreement over financial regulatory reform. On March 11, 2010, Senate Banking Committee Chair Chris Dodd (D-Conn.) said that he will move forward with sweeping legislation to overhaul the current financial regulatory system. With bipartisan talks having failed to produce any legislation, Sen. Dodd is attempting to place pressure on those opposed to his plan by moving the debate into the open and pushing those against his proposed legislation to make their case publicly. To date, Democrats and Republicans have been unable to agree on the scope of powers any new consumer watchdog agency would have, as well as the scope of the Federal Reserve's regulatory power over banks. Any legislation would need at least some support from both parties as Democrats control only 59 votes in the Senate, and 60 votes are needed to overcome a Republican filibuster. ("Financial Systems Reforms Won't Wait," The Washington Post, March 12, 2010)

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