Marsh UK advises on liabilities from U.S. subprime crisis

Insurance broker Marsh UK warned the European financial services sector, including insurers, hedge funds, banks and ratings agencies, that “they may be exposed to greater D&O and E&O liability claims” from the subprime mortgage crisis in the U.S.

Marsh listed the following scenarios as creating potential litigation:

Lenders’ lawsuits versus the banks: Many lenders have been forced to file bankruptcy when they asked to buy back loans. It is likely that there will be claims of improper margin calls and flawed valuation of underlying collateral on the part of banks and other institutions that purchased or financed the loans.

Shareholders’ lawsuits versus lenders, accountants, trustees, and underwriters: Sub-prime lenders that have gone into bankruptcy may well face extensive accusations. Shareholders could make claims of misrepresentation and omission related to accounting for residuals, as well as claims of bad valuation and poor underwriting standards.

Insurers’ lawsuits versus lenders: Large claims on failed sub-prime collateral may lead to accusations of poor underwriting (misrepresentations and omissions) on the part of lenders.

Investors’ lawsuits versus trustees: To the extent that bondholders are not paid, there will be claims of breach of fiduciary duty on the part of the trustees responsible for cash flow.

Trustees’ lawsuits versus lenders and underwriters on behalf of investors: Trustees might seek damages from lenders and underwriters. The claims are likely to be along the lines of fraudulent conveyance and breach of contract related to loan servicing.

Individual investors’ lawsuits: If and when the investors in mortgage-backed securities post poor returns as a result of failing sub-prime backed investments, the individual investors may accuse the funds of not taking on suitable and prudent investments and failing to follow investment guidelines and standard risk management procedures. There will also be claims of misrepresentations, omissions, bad pricing and mark-ups.

Siobhan O’Brien, a senior vice president in Marsh’s Financial Institutions Practice, said Europeans firms are recognizing the risks. Some banks have frozen certain funds and the European Commission said it will review the credit ratings industry’s voluntary code of practice.

O’Brien urged the firms to “continually assess the risks” raised by the subprime crisis and examine their D&O and E&O exposures. “Potential claims are likely to arise from wrongful acts by the company and the directors and officers in the form of allegations of mismanagement with respect to subprime lending or their investment portfolios, their lending and foreclosure practices and the suitability of the products sold. The potential of regulatory investigations may bring about claims by shareholders or borrowers.”

Noting that the European D&O market has been largely stable, O’Brien advised that this could change if there are lots of of costly D&O and E&O claims.