Editor : What is your professional background?
King : I've been a commercial litigator at King & Spalding for most of my professional career, having come to the firm in 1985. I was part of the group that opened our New York office in the early '90s and spent about four years there. Until this year, I served as practice group leader of our business litigation unit, a position that I had for many years. This unit includes representation of financial institutions in securities litigation.
Editor : When did your firm realize the magnitude of the subprime mortgage crisis and that it had a role to play representing the parties?
King : In the fall of 2007 in the wake of the then roiling subprime market, we developed considerable interest in this topic. We organized our working group in January 2008 around a discussion that we held at our annual partner's retreat.
King & Spalding's structured finance practice had not been involved in the securitized market associated with residential mortgages and therefore we were not conflicted whereas many firms of our size were.
Our perspective early on was, "This is likely to have significant implications across a spectrum of issues on which we are particularly well-suited to advise clients." For example, we had significant experience working with the monoline insurers and with those involved in the municipal finance markets. The failure of confidence associated with the credit crisis led to the failures in the market for auction rate securities that occurred in February and the related litigation that's followed from that.
We are fortunate in having highly talented lawyers who had no direct involvement in the securitization issues involved in the subprime meltdown. Therefore, they're in a position to give sound, unconflicted advice with respect to matters arising from the crisis. They have the professional expertise to advise and provide representation on any aspect of the crisis. Just a few examples are providing representation on governmental inquiries and investigations of all kinds, issues relating to bankruptcy, insurance coverage issues, and issues involving corporate investments and pension funds - including the whole range of ERISA issues triggered by the crisis - and, of course, conducting investigations and handling litigation.
Editor: What is your role in the subprime group?
King: My function has been to facilitate discussions within the firm and look for ways we can serve clients in need of our services. In this role, I work closely with Sarah Borders, the former head of our insolvency practice, who has a lot of experience in these areas. We've organized a group of lawyers in our domestic offices in Houston, Washington, D.C., Charlotte, Atlanta and New York who are specialists in litigation, insurance coverage, ERISA, insolvency, finance and special matters, which are our governmental and congressional investigations units and our public affairs group. There has been strong participation from our New York office, including litigators (some of whom have high-level Justice Department experience), finance lawyers, lawyers involved in municipal finance and those representing monoline insurers.
Editor: What triggered the current credit crisis?
King: If you look at the history of the litigation being brought, there's a sequence. The first phase was in the subprime mortgage space. The housing market cooled in 2006 and in 2007 the price of homes dropped. At the same time, higher monthly mortgage payments were required as rates of adjustable rate mortgages were reset.
Homeowners couldn't make the higher payments because the collapse of the real estate market dashed their expectations of refinancing their mortgages from the appreciation in the values of their homes. So you suddenly had defaults or non-performance on mortgages that had been bundled into securitized packages. Organizations having investments in securities collateralized with mortgages that became non-performing sought recourse against the issuers of those securities, who, in turn, sought recourse against the originators of these mortgages.
The originators who had participated in an unprecedented level of subprime issuance, including low-document and no-document mortgages, frequently with rates that reset, were beset with lawsuits by homeowners and suffered reduced cash flow as a result of both the failures to pay and bankruptcies of homeowners. Many of the originators became bankrupt, while some of the larger and better capitalized originators were able to borrow enough money to keep themselves afloat - temporarily
Editor : Are the investigations and litigations growing out of the subprime mortgage crisis starting to accelerate in number and variety?
King : There already is a significant amount of litigation. A total of 559 lawsuits came out of the S & L crisis in the 1990s, which lasted a period of years. Now almost as many suits have been filed through the first quarter of this year. The number of cases involving subprime mortgage and related credit market issues (including cases involving auction rate securities) from January 1, 2007, through March 31, 2008, was 448. And the number of cases continues to rise rapidly. During the first quarter of 2008, 170 such cases were filed, compared to a total of 181 cases for the entire second half of 2007.
Editor: Are there indications that litigation will continue to build up in numbers and possible damages, settlements and other adverse consequences?
King: Yes, there is good reason to believe that we have seen only the leading edge of the ultimate amount of litigation and its costs.
A primary trigger for this future wave of litigation will be the numerous inquiries and investigations that are currently underway at the federal level by the Department of Justice, federal regulatory authorities like the SEC and those involved with financial institutions. Activity is also taking place at the state level, with the New York attorney general's office and the insurance commissioner's office at the forefront. These offices have sent out formal and informal inquiries to companies involved. We are already seeing civil litigation being launched on the heels of such inquiries.
The information uncovered by federal and state regulators will spur a wave of additional civil private litigation. It's fair to say that this brooding black cloud of potential litigation has gotten full attention of the companies most directly involved, particularly at the board and CEO level, and by their general counsel.
As to the direct and indirect costs of direct litigation, many of the cases that have been brought are still at an early stage so that there is no way to measure the ultimate costs. Take, for example, securities litigation and class actions. Most of these cases have yet to get through the motion practice. There have been rulings on motions to dismiss in only 15 of the cases filed in 2007, and no rulings on the cases filed in 2008. So the securities cases continue to be in their infancy, and the same is true of class actions. Of the 191 class actions filed in 2007, only four have been certified to date.
Editor: In the light of your forecast of additional litigation to come, what would you recommend that companies who might be exposed to litigation do to improve their ability to defend or avoid litigation?
King: I would recommend that they consider taking steps now to strengthen their position. Our firm has a number of lawyers who rose to senior positions in the DOJ and have gained great respect among regulators and prosecutors throughout the country for their neutrality and integrity. If it should prove desirable, they are in a position to undertake an investigation that would enable a company to evaluate possible vulnerabilities, to advise with respect to next steps and to engage in negotiations with prosecutors or regulators, if necessary.
Editor : In what courts is the litigation you mentioned taking place?
King : Most securities cases are being pursued in federal courts. Many matters that have been filed as state court actions have been removed to federal courts. In 2007 and the first quarter of 2008, state court cases were being filed predominately in New York and California. California is the most popular venue for borrower class-actions. New York has been the most popular venue for the securities litigation.
Editor : Are bankruptcies triggering litigation?
King : Litigation is the most likely legacy of the bankruptcy of mortgage originators. Many of them have very few assets. What's going to emerge is an effort by examiners or trustees to pursue claims against third parties with "deep pockets." The examiner's report in the New Century bankruptcy case is getting a fair degree of attention. It lays out a roadmap for several specific causes of actions that might be pursued against the company's auditors, as well as its officers and directors. It remains to be seen whether litigation will result, and how successful it will be.
Editor : What about lender liability and other claims brought by homeowners against mortgage originators?
King : The claims of inadequate disclosure, including those under the federal Truth in Lending Act and even more far-reaching state laws, are significant. They form the basis for many of the borrower class actions, of which the predominant number have been filed in California. They're mostly directed against mortgage bankers and others primarily in the business of mortgage origination
Cases against mortgage bankers and others who specialize in originating mortgages make up about a third of the subprime lawsuits. Banks and savings and loans are each defendants in about 10 percent of these cases.
Editor : What derivative litigation has been brought, if any?
King : I think we are going to see many more cases. We sense - and this has been reinforced by discussions we've had with other professionals - that many plaintiffs' counsel are still trying to figure out what theories are going to be used.
Editor : What is the state of play with respect to litigation against insurers and involving auction rate securities?
King : We have seen a lot of activity related to the entire monoline insurer industry. Its financial distress has been widely reported. This industry is front and center in a number of these disputes. It leads into some of the issues associated with the auction rate securities. If you look at the developing trends, auction rate security litigation has ballooned since February of this year. That's another casualty of the subprime debacle, even though they're not intertwined, other than in the loss of confidence and financial distress that had arisen.