March 15, 2007 / 5:29 AM / 11 years ago

Class-action lawyers pounce in subprime crisis

NEW YORK (Reuters) - Lawyers for investors hurt by the meltdown of mortgage lenders that cater to risky borrowers are likely to file a wave of class-action lawsuits against the lenders and possibly their auditors and bankers as well.

U.S. lawyers have already sued subprime lenders including New Century Financial Corp. and NovaStar Financial Inc. and their top executives for securities fraud, claiming they misled investors about the companies’ finances and had lax guidelines for approving mortgages for borrowers with poor credit histories.

Prominent plaintiffs’ firm Lerach Coughlin, which already has brought suits on behalf of investors in New Century and NovaStar, is looking at bringing cases against other subprime lenders, said David Walton, a partner at the San Diego-based firm.

“We’ve had clients contact us about other companies they’d like us to investigate,” he said. “I do anticipate there will be additional companies sued.”

Some legal experts say, however, that plaintiffs may have an uphill battle in proving these cases, because investors need to show evidence of intentional deception, not just that the stock price plummeted because of market conditions that led to rising defaults among subprime borrowers.

The government is examining whether any wrongdoing occurred among subprime lenders, and any criminal charges could help private litigation. Criminal cases are seen as gold mines for plaintiffs’ lawyers, who use information gleaned from indictments or court testimony when pursuing civil claims.

New Century, the largest independent subprime lender, has received notice from federal prosecutors in California of a criminal probe looking at trading in the company’s securities.

Separately, Massachusetts state authorities have subpoenaed UBS AG’s UBS Securities and Bear Stearns over research reports on subprime lenders, saying they want to know if there were any conflicts of interest involving the brokers and the lenders.

LOOKING AT AUDITORS, BANKERS

Legal experts say that with many subprime borrowers in deep financial trouble, they expect class-action plaintiffs will also take a close look at other possible defendants such as the auditors who signed off on the companies’ books and the bankers who had financial relationships with them.

But they say it may be difficult to successfully argue that outside parties should be held liable unless evidence emerges that they participated in a scheme to defraud.

“I do not see substantial risk at this point for the investment banks or the accounting firms, because what you have here is a situation where losses were created by the making of risky loans to subprime borrowers,” said Scott Tross, a partner at law firm Herrick Feinstein in Newark, New Jersey who handles securities and real estate cases.

“Everybody who is connected with that business knows that you get high returns because you are taking high risk,” he said.

Auditors and banks were a key target of investor lawsuits following the WorldCom and Enron frauds. Banks paid billions of dollars to settle claims they had helped the companies hide financial misdeeds.

“To me, this is fundamentally different. The losses are not coming from internal accounting fraud,” Tross said. “They are coming from defaults on risky loans.”

But Gerald Silk, a partner at plaintiffs’ firm Bernstein Litowitz Berger & Grossmann LLP in New York, said investors will probably zero in on the companies’ internal controls and whether there were deliberate misstatements in their financial filings. Under the 2002 Sarbanes-Oxley corporate reform law, top corporate officers must certify financial statements.

“There is no question that there are lots of bells and red flags as to where were the third parties and what was their role in this,” he said. “What about the auditors? What about the banks. These are questions that the investors that bring these cases are going to have to really work hard to figure out.”

Silk’s firm has not brought any subprime class-action cases but is looking closely at the issue on behalf of some big pension funds that could serve as plaintiffs, he said.

“We are considering litigation, no question,” he said. “We have already had numerous discussions with some very, very large pension systems throughout the country on this.”

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