Rush of Mortgage Lawsuits Expected, But Winning May be Tough

By | April 11, 2008

U.S. law offices plan a hiring spree as they ready a new volley of lawsuits for consumers who lost houses and investments in the mortgage industry meltdown.

But new legal rules make it tougher to win than in the days of high-dollar class action victories over companies such as Enron Corp. and WorldCom Inc.

Bank failures and allegations of suspect lending practices and risky investments in mortgage-backed securities should “easily keep lawyers busy for a decade,” said Joseph Grundfest, Stanford University law professor and former commissioner with the U.S. Securities and Exchange Commission.

Nearly half of U.S. law firms plan to hire in the next 12 months, with bankruptcy, litigation, and ethics and corporate governance attorneys on the top of wish lists, according to a survey by Robert Half International Inc.’s Robert Half Legal, a legal staffing service.

With the drop in stock and property values, investors lost some $5 trillion in value — a total that dwarfs the dotcom bust, Grundfest said.

“I think the strong claims will have no problem surviving,” Grundfest said. “To the extent that lawyers are looking to recover on weaker claims, they may well have a more difficult time; but perhaps that’s the more appropriate result.”

Wall Street ‘Run Wild’

Among the new legal bugbears for plaintiffs’ attorneys are U.S. Supreme Court decisions that could block investors from reaching into the pockets of companies not directly involved with fraud (Stoneridge Investment versus Scientific-Atlanta) and that stop consumers from suing federally regulated industries (Riegel versus Medtronic).

Plaintiffs also could have a tougher time keeping lawsuits from being dismissed for lack of evidence as a result of Bell Atlantic versus Twombly and Makor versus Tellabs. Up until those cases, courts that saw strong arguments had wide discretion to give plaintiffs access to company information to make their cases.

Also weighing on lawyers’ minds is a 2005 federal law, the Class Action Fairness Act, that pushes more class-action litigation onto crowded dockets of federal courts to curb “forum shopping,” in which attorneys choose to file lawsuits in states with the most advantageous laws for investors.

The plaintiffs’ bar was already reeling from recent guilty pleas by former attorneys at class action powerhouse Milberg LLP, including firm co-founder Melvyn Weiss and former senior partner William Lerach, to charges stemming from a client kickbacks scheme.

Joseph Cotchett, who represented investors in the failed Lincoln Savings and Loan in the early 1990s, said loss recovery this time around will be “hugely difficult because of the roadblocks that the administration put in the way of lawsuits.

“This crisis came about because nobody was regulating,” said Cotchett, of Cotchett Pitre & McCarthy LLP in Burlingame, California. “Isn’t it amazing how all of the oversight (resulting from the dotcom bust) has dissipated and Wall Street just continued to run wild?”

Cotchett added, however, that the “greed of certain lawyers” played a role in “the closing of the courthouse doors” to investors.

No Viable Source of Recovery

Cotchett recovered some $200 million in settlements from law and accounting firms that he argued had helped Lincoln dupe thousands of small investors into buying risky junk bonds.

Those settlements nearly covered what investors would have lost when Lincoln failed and its parent company went bankrupt.

The Stoneridge case, which limits liability by third parties, such as Lincoln’s accountants, appears to pose the biggest challenge of the new rulings.

Attorney Ira Press sees Stoneridge dampening lawsuit filings in cases involving bad securities from failed issuers.

“It does us and our client no good to pursue a claim where there is ultimately no viable source of recovery,” Press, of Kirby McInerney LLP in New York, said. “(Stoneridge) is going to have a real-world impact on some of these cases.”

Cliff Hyatt of defense firm Pillsbury Winthrop Shaw Pittman LLP in Los Angeles, agreed that “Stoneridge is the most difficult case for plaintiffs” going after third parties but said: “It’s not impossible to bring those deep-pockets” lawsuits under a different legal theory.

“What has been going on (on Wall Street) over the past few weeks has given a lot of opportunities for the plaintiffs,” Hyatt, a former SEC enforcement attorney, said.

The Twombly case, with its plausibility test for antitrust conspiracy claims, “could be read to heighten pleading standards for all cases filed in federal courts,” attorney Mark Edwards of corporate defense firm Morgan Lewis & Bockius in Philadelphia, wrote in a May 2007 note to clients.

Likewise, the Tellabs case sets a national test for liability requiring that companies and officers “acted with a particular state of mind” and intended to violate the law.

The Medtronic case, in which the high court found that federal regulatory approval of a heart device precluded a patient from suing the device maker in state court, acts as “an assault on state common law” and “a total reversal of state’s rights,” Cotchett said.

“If legislatures want to protect consumers against the drug industry, the banking industry, manufacturing … if the government has looked at them, any lawsuit against them in state court is (preempted),” Cotchett said.

(Reporting by Gina Keating, editing by Gerald E. McCormick)

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