On February 24, 2009, Stuart Grant of Grant & Eisenhofer P.A. and Michael Young of Willkie Farr & Gallagher LLP discussed the subject of the potential liability of professionals in the financial crisis with Enforcement Action's Bruce Carton. The discussion was part of a webcast in which Grant and Young collaborated on a presentation on this topic and answered questions from the audience.
Grant and Young began by explaining that we are now in the "third phase" of securities litigation in the U.S. The first phase was from the 1970s to 1995, and was marked by the growth of such litigation in areas including who could bring a case, the number of cases filed, and the dollar amounts of settlements.
The second phase, from 1995-2006, was ushered in by the enactment of the watershed Private Securities Litigation Reform Act (PSLRA), but the growth from the first phase continued in almost every respect. The PSLRA did bring change, however, because it effectively clamped down on "fraud by hindsight" cases. A new phenomenon began in this period, as well: cases based on restatements and acting irregularities.
Young said the third phase, which began in 2006 and continues to the present, has seen a decline in the number of restatements and related litigation. This phase is marked by two key trends: (1) a restrictive view of the law governing securities class action by the U.S. Supreme Court and the federal appellate courts; and (2) the evolution of Generally Accepted Accounting Principles to be more helpful to plaintiffs.
Grant agreed that it was challenging to identify even a single recent appellate court decision in the securities litigation area that has been favorable to plaintiffs, and listed the 4
th, 5
th, 8
th and 11
th circuits as being particularly difficult circuits for plaintiffs to bring cases in. He added, however, that federal district courts were good about closely examining cases to see if there is something of substance in the plaintiffs' allegations. If there is something to the case, Grant said, the district courts will often deny a defendant's motion to dismiss and let the case proceed.
On the topic of liability for accountants in the subprime crisis, Grant wondered if accountants had dodged a bullet simply because of timing. He observed that while the subprime crisis hit in the summer of 2008, most fiscal years did not end until December 2008, so perhaps the auditors had simply been the beneficiary of good timing.
In terms of international liability for accountants, Grant discussed recent developments involving the international offices of large firms such as Deloitte and PwC that audited Parmalat and Satyam, respectively. Grant stated that accounting firms sell themselves as international organizations with seamless service until things go wrong. Then, he said, they change their tune to claim that their organization is merely a "loose affiliation" of dozens of independent accounting firms worldwide. In Parmalat, for example, Deloitte kicked the "bad apple" firm out of its organization, but the court still denied a motion for summary judgment against the Deloitte parent company. Grant stated that the situation now unfolding with PwC in India appears to be a similar fact pattern.
Young emphasized the significant exposure that Big 4 accounting firms are now facing. He believes that they may have some exposure as a defendant in as much as 25% of all securities litigation commenced. After the demise of Arthur Andersen, he said, this exposure gives rise to questions of sustainability.
Grant and Young agreed that the law, most notably the recent
Stonebridge case, now heavily favors investment banks in securities class actions. Accordingly, very few Section 10(b) cases are now filed against investment banks. Grant said that lawsuits against investment banks are now almost exclusively filed against them for their roles as underwriters, under Section 11 of the Securities Act of 1933.
Stoneridge provides similar protection for lawyers in securities class actions.
Asked whether he believed there might be other "Madoffs" lurking undetected, and whether any of the billions of dollars lost in the Madoff scheme may be insurable, Grant stated that it is in bad markets like the one we are in now that you see who is "swimming without a bathing suit." In such a market, investors often seek the return of their money, which causes Ponzi schemes to unravel. Grant stated that he did not believe there was such a thing as "Ponzi scheme insurance," but that feeder funds and funds of funds may become "de facto insurers" as it was their sole job to do due diligence on where their invested money was going.
Young added that he expects to see more rigorous SEC scrutiny in response to the barrage of recent criticism of the SEC for missing the Madoff scheme. He also stated that in his view, accountants should not be liable for losses suffered by their feeder funds clients. Feeder fund auditors, he said, should be able to accept and rely upon documentation provided by third parties such as Madoff if it appears to be legitimate. If they cannot, he asked, how else can they perform the audit?
Finally, Grant said that his institutional clients are asking themselves three key questions before bringing cases against professionals in the current environment. First, do they have the time and resources to devote to a lawsuit as opposed to trying to better manage and preserve their investment portfolios? Second, will the prospective defendants even be in existence to potentially collect from in 2 or 3 years? And third, will the current market downturn provide an effective defense for defendants on the issue of loss causation? If a potential defendant is down 85%, and its peers are down 80%, institutional investors must ask themselves if it is it worth the effort to pursue damages that may be limited to the differential of 5%.
To watch an archived version of the webcast, please visit:
http://www.securitiesdocket.com/webcasts/