Next come the lawsuits

The bailout is only phase one; Guy Carpenter suggests many lawsuits will follow

By Phil Zinkewicz

In September 2008, as the year was heading into its fall season, it seemed more like the fall of the American economy. “Unbelievable,” “impossible” and “incomprehensible” were just a few of the adjectives that were being tossed around as giants in the financial services industry were crumbling before our very eyes.

Lehman Brothers went into bankruptcy. Those cute, little-sounding government-sponsored Fannie and Freddie vehicles were being bailed out, as was the not-so-cute and not-so-little monolith, American International Group (AIG).

Were foreign insurance and banking markets and other financial institutions, as well as regulatory bodies, looking at us with disdain, or were they fearful that they were going to be the next to burn? Interesting question because, in the last few years, the European Community has been concerned about their markets and regulatory structures tracing our steps.

Recently, Guy Carpenter & Co., LLC, the leading global risk and reinsurance specialist, issued its 2008 “Casualty Specialty Update,” which lists liability developments around the globe and how they may have been affected by the U.S. casualty market.

Says the report: “A lot of ink has already been spilt over Europe’s changing claims landscape and the possible consequences for insurers and reinsurers. Recent developments not only suggest that the doors are open for European investors to participate in (and have the benefit of) U.S. securities class actions, but also that the very beast itself eventually will find its way into the European legal system.”

Given the uncertainty that surrounded September’s governmental actions regarding AIG alone, there could be many lawsuits down the line.

According to Carpenter, legal theorists disagree over the question of whether the European legal system, with its peculiar fostering of two distinguished legal traditions (common and civil law), can effectively prevent substantial Americanization. It has been argued that although developments at the EU level may indicate a shift towards a U.S. legal style, Europe’s fragmented legal culture will, at a minimum, delay drastic changes—if not prevent them entirely.

While countries with a common law tradition share the adversarial system of the U.S., the practice of juries determining awards has never been adopted. This is an important distinction, as the jury system often has been cited as one of the major reasons for exploding tort costs here, the report notes.

Nevertheless, Carpenter says that the legal landscape in Europe is changing. “The recent debate over the introduction and application of collective litigation (class action) may be seen as evidence that national legislators are embracing new concepts. Although collective redress may not be an altogether new concept, only in recent years has legislation made class action lawsuits possible in some European countries. Others are yet to follow.

“The likely cost, the prevalence of the ‘loser pays’ concept (i.e., the principle that the losing side should bear the litigation cost of the prevailing party), and the opt-in system (i.e., the process where all claimants have to take positive steps if they are to be included in the class) are the main reasons why this new mechanism has not yet been commonly adopted,” says the report.

However, another part of the Guy Carpenter report addresses the issues that hit the United States last September. The report says that, by the last quarter of 2007, the subprime crisis looked like an American issue. “Soon it became apparent that, in a global financial system, European companies would also fall victim to subprime exposure,” the report notes.

“Throughout the first quarter of 2008, European insurance and reinsurance carriers began adding up their potential for subprime-related losses. European banks were the most obvious area of concern. Some had purchased, seemingly unwittingly, a great many of the U.S. subprime loans that had been wrapped up and packaged into collateralized debt obligations (CDOs) or took the form of mortgage-backed securities.”

However, according to Guy Carpenter, banks were not the only institutions affected by the first wave of the subprime meltdown. Bond insurers, insurers and reinsurers all had significant write-downs on the asset side of their balance sheets, according to the report.

“Obviously, the loss of all this money worried insurers and they began to collect data on their liabilities on financial institution clients that had exposure to subprime credit, primarily looking at exposures under directors and officers (D&O) and errors and omissions (E&O) covers.”

Carpenter says that securities class action filings began in late 2007 in the United States. “Credit Suisse, Deutsche Bank, Societe Generale, Swiss Re and UBS AG are among the European banks named as defendants so far,” according to Carpenter. “Despite the high number of non-U.S. financial institutions involved in the write-downs, only a handful has been involved in lawsuits so far.

“This is in contract to the much higher number of U.S. financial institutions that have been sued. In an interesting turn, European plaintiffs are attempting to use the U.S. legal system as the battleground for subprime-related suits. For instance, in February 2008, HSH Nordbank AG filed a suit in the New York State Supreme Court against UBS, alleging misrepresentation regarding the quality of debt included within a $500 million portfolio of CDOs sold to HSH Nordbank by UBS in 2007.”

The Carpenter report says that the range of lawsuits related directly to subprime mortgages and the credit crunch that followed continues to expand. “While lawsuits stemming directly from the subprime crisis began with mortgage lenders and securities issuers, litigation has spread to ratings agencies, bond insurers, and asset managers. We are now seeing a further wave of lawsuits against professional advisors that is focusing on asset-backed commercial paper, failed merger and acquisition deals, corporate debt losses, and auction rate securities.”

“How long will it take to get to the next tier?” asked Carpenter in its report and perhaps got its answer in the September 2008 debacles in the United States. There can be little doubt that further lawsuits will result from the Lehman bankruptcy and the takeovers of AIG and Fannie and Freddie.

At the time of this writing, speculations are being made as to whether AIG should or should not have been bailed out, whether the U.S. government has the wherewithal to guarantee its position in the global financial community and how far into the global community this financially horrific situation will stretch. Given the impact that U.S. developments have had on the European Community in the past, the EC is watching, not too patiently, to see how things work out on this side of the Atlantic.