Class Action Lawsuit Against Goldman Over ABACUS CDO Signals Time Is Right For Investor Lawsuits

The legal news is not good if you are a lender or investment bank who participated in the creation of mortgage-backed securities (“MBS”) and other derivatives over the last few years.  But for investors who lost their shirts through their investments in these derivative products, the chinks appearing in the armor of the nation’s largest banks signal the time is right for aggressive legal action.

In the wake of the charges brought against Goldman Sachs last week by the SEC, Goldman already faces several lawsuits related to the ABACUS 2007-AC1 collateralized debt obligation (CDO) from investors and shareholders.  On Monday of this week, plaintiff Howard Sorkin filed a class action lawsuit (complaint available here) on behalf of all investors in Goldman Sachs common stock for losses stemming from the SEC’s action against the bank.  The suit was filed in the United States District Court for the Southern District of New York and alleges that Goldman knew of the impending SEC investigation as early as July 2009 (having received a “Wells Notice”), but concealed these facts from its investors.

A Wall Street Journal article indicates a similar class action lawsuit was also filed against Goldman this week by a shareholder named Ilene Richman.

Bloomberg reports that Goldman is also facing two derivative lawsuits related to Goldman’s involvement in the creation of subprime mortgage CDOs, with Goldman shareholders claiming that its top executives failed to provide sufficient oversight with respect to the deals.  In derivative actions, the shareholders make a demand upon the company’s board of directors to take action against its executives, and may only bring a lawsuit if the board refuses or is conflicted.  Though these actions against Goldman pertain to their participation in the creation of CDOs in general, facts regarding the SEC’s charges stemming from ABACUS 2007-AC1 should certainly figure prominently in the cases.

Bloomberg also notes that a class action is already pending against Goldman Sachs in federal court in New York.  The action, filed by Public Employees’ Retirement System of Mississippi against Goldman Sachs, Moody’s, Fitch and others (Second Amended Complaint available here), alleges that Goldman misrepresented that certain mortgage-backed securities it sold with high ratings were not of the same quality as other investments with the same ratings. This action has been pending in the United States District Court for the Southern District of New York since July 2009.

This flood of litigation against Goldman comes on the heels of a $600 million settlement entered into by Countrywide in a federal class action lawsuit brought by a group of New York retirement funds.  The deal still requires the approval of several pension boards who are plaintiffs in the case and the judge presiding over the case, but if accepted, it would be the largest settlement to arise out of the wave of subprime securities class actions filed in 2008 (and the 13th largest securities fraud class action settlement in history according to the RiskMetrics’ Group list). This result comes after Countrywide settled a lawsuit with dozens of Attorneys General for well over $8 billion in agreed-upon loan modifications (though readers familiar with this blog will remember that, pending the outcome of an investor lawsuit challenging the settlement, Countrywide stands to bear only a fraction of that cost, as it no longer owns most of the loans at issue).

All this leads me to believe that the time is right for investors with the temerity to take on the major Wall St. banks to file lawsuits to recover their losses stemming from subprime and Alt-A mortgage investment vehicles.  The evidence is overwhelming that lenders misrepresented their quality control standards and guidelines (or did not follow them at all), and thus are on the hook in most cases to buy back deficient loans or replace them with performing mortgages.  Moreover, the recent investigations into the role of investment banks in sponsoring and setting up these deals will provide an additional avenue for attack.  If investment banks knew that they were putting together a “sh***y deal,” as Goldman exec Daniel Sparks characterized a Goldman-sponsored CDO in an email produced to Congress this week, this would open the door to all kinds of claims, from Securities Act and Blue Sky statutory violations to common law contract and misrepresentation claims.

It is facts like these–showing that top bank executives knew the deals they were putting together were doomed to fail–that will turn the tide in investors’ favor.  Though banks have had some success in fending off mortgage crisis litigation thus far by using the “global financial catastrophe” defense, the argument that nobody saw this coming will carry much less water now that it is becoming clear that many–including top bank executives–saw the writing on the wall (read Michael Lewis’ new book, The Big Short, to dispel any notion that this crisis came as a total surprise).  Indeed, in suits filed pursuant to the 1933 Securities Act (even those brought before the SEC action against Goldman hit the news), investors are seeing more success than the mainstream media lets on, according to leading subprime litigation commentator, Kevin LaCroix.

So, for those investors who were waiting for the political and regulatory climate to turn before taking action, here is your wake up call.  With more and more evidence emerging that mortgage origination standards plummeted between 2005 and 2007–and that the investment banks condoned and profited from this irresponsible lending–there has never been a better time to become a mortgage crisis plaintiff.

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