“It's an ambitious theory,” Mr. Gowen said, noting that the city is trying to hold Wall Street “industry leaders as a whole” responsible for creating a market of securities backed by subprime loans.

“Cities tried this with cases against gun manufacturers some years ago, but didn't have very good results,” the lawyer noted–referring to the fact that the Cleveland case, like the gun liability suits, hinges on the legal concept of “public nuisance.”

In a press release announcing the subprime suit on Jan. 11, Cleveland Mayor Frank Jackson explained that the nuisance theory allows recovery for “circumstances created by the defendant[s] that interfere with the public's 'rights and interests.'”

The complaint says, “Defendants are liable to the city … for public nuisance for their respective roles in proliferating toxic subprime mortgages within its borders, under circumstances that made the resulting spike in foreclosures a foreseeable and inevitable result,” noting that defendants “chose to ignore … obvious facts in pumping hundreds of millions in subprime loans” into a city where property values never skyrocketed as they did elsewhere.

The city received no financial gain as Wall Street defendants rode a “gravy train” that pushed loans to unqualified borrowers.

Cleveland was instead left to deal with the tangible costs of rising foreclosures–”increased fire and police expenditures associated with vacant properties and demolition,” and a property-tax revenue base “deeply depleted” by the severe drop in the appraised value of real estate, the complaint says.

The public nuisance theory was also at the center of lawsuits against lead paint manufacturers, but earlier this year the city of Columbus, Ohio, dropped its lead paint suit, and the Rhode Island Supreme Court threw out the only jury verdict that had been reached against the paint makers. (See NU, July 28, page 20.)

Not all such efforts have been unsuccessful, however.

Speaking at the PLUS conference, Paul Lavelle, president of LVL Claims Services in New York, noted that he has heard talk surrounding the Cleveland subprime case, comparing it to more successful efforts aimed at tobacco makers.

“Attorneys general are coordinating a little bit to see how [the theory] works and where it works best,” Mr. Lavelle said.

“What they learned from tobacco is [to] just keep going at this–'We only need to win once and then we win it all,'” he said. “If they think they're making progress–that the tone and the atmosphere are right for them–then they just need to find the right judge to try to channel [cases] through.”

Tobacco settlements reached in the early 1990s exceeded $200 billion.

The Cleveland subprime case–filed against Deutsche Bank, Bear Stearns, Citigroup, Credit Suisse, Goldman Sachs, Lehman, and 15 other financial institutions–is one of many targeting Wall Street firms, Mr. Gowen said.

He noted, however, that the majority of cases against securities issuers and underwriters are “classic shareholder claims by the entities' stockholders,” alleging that firms misrepresented exposures or failed to write down investments in time, therefore creating periods of inflated stock prices.

Continuing to describe what he repeatedly referred to as litigation “crossfire,” he noted that “the securitization entities are in the crossfire” because they not only face lawsuits from shareholders and others, but they also serve as plaintiffs themselves in cases against lenders.

Mr. Gowen said another class of plaintiffs suing the investment banks is made up of buyers of securities backed by subprime loans, giving the example of a Florida case against Credit Suisse brought by Bankers Life Insurance Company. The insurer alleges that the plaintiff misrepresented the nature of underlying loans, Mr. Gowen said.

Where the securitizers are the plaintiffs in cases against lenders, they allege breach of contract or breaches of representations and warranties–and in some cases, failure to buy back defaulting loans where provisions for buybacks were set forth in contracts, he said.

In addition to suits from securitizers, lenders face lawsuits coming from many directions, including stock-drop suits from shareholders if they're publicly traded and suits filed by homeowner borrowers, he said.

“Saddled with mortgages they can't afford, they have sued lenders under various theories, including predatory lending and race discrimination,” he said.

“The City of Baltimore brought a fairly unique case on a racial discrimination theory,” he noted, describing a “reverse redlining case” against Wells Fargo Bank.

“Redlining would be where a lender uses profiling to eliminate certain borrowers from primary credit,” he explained. “Reverse redlining, according to the theory [in this case] is the process through which lenders singled out geographically certain economically disadvantaged groups for marketing of riskier and potentially more onerous [subprime] loans.”

The complaint charges that such unfair lending practices violate the federal Fair Housing Act. It describes how the combination of two conditions–a historic practice of redlining and geographic concentrations of people by race and ethnicity–has resulted in Baltimore's African-American neighborhoods being hit hardest by reverse redlining practices.

“The legacy of historic discrimination, or redlining, often leaves residents of minority communities desperate for credit,” causing them to “respond favorably to the first offer of credit made, without regard to the fairness of the product,” the complaint said.

Such conditions made victims of historic redlining “especially vulnerable to irresponsible subprime lenders,” according to the complaint.

INSURERS IN THE CROSSFIRE

All the cases Mr. Gowen described–including another level of cases against asset managers and investment advisers that steered institutional money into mortgage-backed securities–are of concern to PLUS members, since liability insurers may ultimately be on the hook to pay damages and defense costs under professional liability (E&O) and directors and officers liability (D&O) policies.

The price tag for insurers could be $9.6 billion, according to a trio of reports by New York-based Advisen that were separately released during the PLUS conference.

Advisen Co-Founder David Bradford, in the reports and in a pre-release interview, noted some trends that could keep a lid on insurance losses–including economic troubles at law firms that bring the cases, as well as coverage issues like conduct exclusions. Still, the nearly $10 billion figure for insurance losses arising from the subprime and ensuing credit crisis is much higher than earlier estimate by the firm.

One key difference from the $3.6 billion figure that Advisen published in February is that the earlier estimate was only for D&O losses. The latest reports put the D&O portion of the overall insurance bill at $5.9 billion, while E&O losses are estimated at $3.7 billion. The $9.6 billion forecast falls in a range for combined D&O and E&O losses of $6.8-to-$12.1 billion, Advisen said.

“Since February, the credit crisis has mushroomed into a global financial calamity,” Advisen noted in the latest reports, partly explaining the $2.3 billion jump in the midrange D&O value from the earlier estimate.

Back in February, Advisen had tallied 181 subprime-related suits–there are now 420, Mr. Bradford said at PLUS on Nov. 7, updating a figure of 418 published in the latest report on Nov. 5.

The 420-suit total includes 124 securities class-action lawsuits, which fuel part of the D&O insurance loss total. While Advisen's earlier D&O estimate only contemplated costs of such class actions, the latest one:

o Adds insured losses for derivative suits (filed by shareholders on behalf of the company alleging board-level breaches of duty), and securities fraud suits brought by regulators and law enforcements agencies.

o Adds an estimate of defense costs associated with dismissed claims.

o Differentiates between traditional D&O coverage and Side-A-only coverage, which directly covers directors and officers when the company cannot indemnify claims.

As the number of bankruptcies grows, Side-A policies are increasingly exposed, Advisen said, noting that in many cases, Side-A limits for large financial institutions, in particular, are many multiples of traditional D&O policy limits.

Even with that methodology refinement, the estimate of the insured portion of class-action settlements falls far short of the expected total cost to defendants–$27 billion, according to Advisen, which notes that the insured loss estimate specifically takes into account average retentions and program limits, as well as historical ratios of class-action settlements to market-capitalization drops.

Turning to E&O, Advisen said that unlike D&O losses, which will fall most significantly on large, publicly-traded financial institutions, E&O losses will be widely distributed–with insureds ranging from small mortgage brokers to the largest global diversified financial services firms.

In its E&O report, Advisen derived insurance loss forecasts of $1.5 billion for mortgage brokers and $1.0 billion for investment banks, with mortgage lenders, securities brokers, commercial banks, rating agencies and other types of firms making up the rest of the $3.7 billion total.

The mortgage broker category produced the greatest volume of losses because of the very high number of lawsuits by borrowers, Advisen said, noting, however, that individual mortgage broker E&O settlements tend to be small–typically in the tens of thousands of dollars.

As a result, the $1.5 billion insured loss estimate is just a fraction of the limits at risk, Advisen said, estimating that about 21,000 brokers carry E&O insurance with average policy limits of $1.275 million, or $27 billion in total.

In contrast, Advisen expects full policy limit losses for the banks that buy insurance, but notes that most investment banks are self-insured. Those that do buy coverage carry an average limit of $100 million, the report said.

MITIGATING FACTORS?

In addition to self-insurance, there are other factors at work that may serve to lower ultimate damage totals and payouts by D&O and E&O insurers, experts say.

“A lot of law firms subsidize the upfront costs for securities class-actions with income from their corporate practices, and that has fallen off dramatically,” Mr. Bradford noted. “Firms are laying people off, so they're probably being more selective about cases they're going after.”

There are legal barriers for plaintiffs and their lawyers as well. “For companies that were just caught in the domino effect of a global financial crisis, they have to prove there was intent on the part of the directors and officers to commit fraud or deceive–and that may be something that will be relatively difficult to prove in a lot of all these cases,” he said.

These factors are helping to keep total securities class-actions for 2008 below the annual average of 234 actions for 1997-to-2005 (excluding 2001, which was further inflated by cases related to a scandal involving initial public offerings), the Advisen report notes.

Total securities class-actions now stand at roughly 180 for subprime and non-subprime cases combined, falling well below midyear forecasts by NERA Consulting and Stanford Law School of 280 and 220, respectively.

Historically, one-third of securities class-action suits filed are dismissed, Advisen reported, suggesting that because of the greater obstacles plaintiffs will encounter in pursuing subprime and credit crisis suits, it is likely that a higher percentage of these suits will be dismissed.

(For more pessimistic predictions about subprime-related litigation, see a related article–”No End In Sight To Investor Lawsuits Emerging From Subprime Crisis Fallout”–in National Underwriter's Nov. 3 edition, on page 12.)

For additional information on D&O and E&O insurance trends, see related articles in this issue of E&S Extra

o Mortgage-Related Claims Leave Most Players Feeling Insurance Cover Squeeze

o $9.6 Billion In Subprime, Credit D&O And E&O Losses Predicted

o D&O Market Turn Looming

o Brokers, Carriers Develop D&O Lifeboats To Rescue Policyholders If Insurer Sinks