Riding Out the Subprime Storms

In a global financial crisis people face difficult tasks and many challenges. The outlook for 2009 is no exception, but the real questions are: how big will the shock waves be, how many of them should you expect, and how soon should you be expecting them? Questions of this type are difficult to answer and, depending on whom you speak to, you will get different responses. The hot topic of the subprime crisis and what it could mean financially is being forecasted as a significant earthquake to a catastrophic tsunami. This Forensic Brief is the first in a series of planned issues that will continue to address the uncertainties and challenges faced by our clients, friends and others.

A recent litigation case involving subprime assets that has continued to escalate is M&T Bank Corporation (“M&T”).¹ In this matter, M&T is suing Deutsche Bank Trust Company Americas (“Deutsche Bank”), et. al., and alleging that HBK Investments (“HBK”), et. al. wrongfully sold M&T a “series of notes known generically as collateralized debt obligations (CDO’s).”² The notes boasted a AAA rating by Standard & Poor’s (“S&P”).³ M&T claims that they were told by Deutsche Bank and HBK that the notes were “safe, secure, and nearly risk-free.” However, within nine months of the purchase, the value of the notes went from $82 million to $1.87 million, a loss of approximately 98 percent. M&T is currently seeking the $80 million of losses it suffered because of the “wrongful conduct by Deutsche Bank and HBK” as well as $100 million in damages.

A similar case involves American Eagle Outfitters Inc. in its lawsuit against Citigroup Global Markets Inc.⁴ The clothing retailer alleges it was fraudulently induced to buy $258 million worth of auction rate securities that it now can sell only at a significant loss, if at all. The suit says that Citigroup represented the securities as safe and liquid and therefore compatible with the retailer's conservative investment policies. Instead, American Eagle claims, Citigroup knew there was insufficient demand for the securities for them to be liquid. The suit claims that in February 2008 Citigroup stopped providing liquidity. Auction rate securities were once considered safe, but the market for these securities collapsed at that time amid the turmoil in the credit markets. This left thousands of investors nationwide holding damaged securities that couldn’t be readily sold for cash, according to securities regulators.

Recent financial news continues to uncover more stories about our troubled economy and has kept the subprime issues in the spotlight. As we move forward, questions and legal issues will continue to arise on such topics as:

• The allocation, use, and accountability of Trouble Asset Relief Program (“TARP”)⁵ funds;
• Will there be a combination of U.S. Generally Accepted Accounting Principles
  (“GAAP”)⁶ and International Financial Reporting Standards (“IFRS”) and how will it be effected by political pressures dealing with items like  “mark to market” and fair value accounting;
• Providers / professionals who were responsible for the sale of CDOs, collateralized mortgage obligations (“CMOs”)⁷, credit default swaps,⁸ and structured investment vehicles,⁹ among others;
• Scope and responsibilities of due diligence providers, and underwriting of the various investment vehicles;
• Professional malpractice issues related to audit, legal and other firms; and
• Director and officer duties and corporate governance.

If you are uncertain as to how the rising storms will affect your business, you are not alone. The professionals of Parente Randolph’s Financial Services Team have extensive experience in dealing with the above and other issues. For more information on how we can assist you, please don’t hesitate to contact our financial services experts – Robert Gray, James O’Brien and David Duffus.

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¹ M&T Bank Corporation v Deutsche Bank Trust Company Americas, et al, in the State of New York Supreme Court: County of Erie.
² http://www.investopedia.com/terms/c/cdo.asp
³http://www2.standardandpoors.com/
⁴ American Eagle Outfitters, Inc., et al, v CitiGroup Global Markets, Inc., Complaint, United States District Court for the Western District of Pennsylvania.
⁵ http://www.investopedia.com/
⁶http://www.investopedia.com/
⁷ http://www.investopedia.com/
⁸ http://www.investopedia.com/
⁹ http://www.investopedia.com/