Credit Crisis Caused Rise In Class-Action Fraud Suits

By Carrie Johnson
Washington Post Staff Writer
Friday, January 4, 2008

Class-action lawsuits that accuse companies of defrauding investors increased more than 40 percent last year, fueled by troubled mortgage investments and a volatile stock market, according to a study released yesterday.

Researchers said the rise reflected a surge in lawsuits in the last six months of the year, when the markets bounced on reports of tightened credit access and widening troubles with housing investments. Absent what the study's authors call "systemic shocks" from the credit crisis, the number of class-action cases filed last year would have fallen below recent averages.

Plaintiff lawyers targeted 166 companies last year, including 47 financial services businesses, which have been among the hardest hit by losses in subprime mortgages, according to the report by Stanford University and Cornerstone Research. The 2007 tally contrasts with 116 cases during the comparable period a year earlier. A separate study issued yesterday by NERA Economic Consulting drew similar conclusions.

Word of the spike in litigation came as State Street Corp., which manages money for major institutions, yesterday set aside $618 million to cover legal and other costs related to its subprime mortgage portfolio. The Boston company is one of dozens of industry players fending off investor allegations that it downplayed the risks of mortgage securities that later produced steep losses.

Disputes over bum housing investments are likely to continue, as analysts predict Wall Street banks and lenders will post more losses in the months to come.

"There will be additional companies sued because of subprime in 2008," said Stanford law professor Joseph Grundfest. "I think you can take that to the bank."

At the same time, law enforcement authorities are investigating possible wrongdoing among brokers, lenders, credit-rating agencies and financial institutions. Investigations of dozens of companies by officials in several states, the Securities and Exchange Commission and federal prosecutors are looking to see if mortgage losses were not disclosed and problems or risks were hidden from shareholders. In some cases, investigators are trying to determine whether corporate executives may have dumped their own stock when they knew of approaching problems.

The surge in investor lawsuits bucks a series of setbacks last year for plaintiff lawyers, including a Supreme Court ruling that raised the hurdle for shareholders to proceed with securities cases. One closely monitored 2007 civil fraud case involving California telecommunications company JDS Uniphase ended with a victory for the company last November after a rare, month-long trial.

And two of the nation's most prominent lawyers representing shareholders faced criminal charges for their alleged roles in a decades-long kickback scheme. William S. Lerach, who led the case involving Enron investors, will be sentenced next month after he pleaded guilty last fall to a single criminal conspiracy charge. His former law partner, Melvyn I. Weiss, awaits trial on multiple criminal charges and is fighting the government case.

Although Lerach and Weiss were distracted by their own legal woes, other plaintiff lawyers more than picked up the slack last year.

"Reports of the death of securities class actions are premature," said Columbia University law professor John C. Coffee Jr.

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