The suits

In the wake of the credit market crisis, Wall Street layoffs at Morgan Stanley, Merrill Lynch & Co., UBS and Citigroup Inc. are estimated to exceed 32,000 employees. Bear Stearns Cos. is gone. Despite having very recently raised $6 billion in capital, Lehman Brothers Inc. continues to struggle. Dealflow is significantly off -- investment banking, private equity, bonds and mergers and acquisitions all are failing to generate the deals of the past.

At the same time, the litigation engine has cranked up to record volume. Compared with all the litigation filed in the 1990s on the S&L crisis, more than half as many subprime-related cases had been filed in federal courts just by the end of the first four months of 2008.

What are these lawsuits about? Navigant Consulting Inc. reports that borrower class actions dominate the filings -- the individuals who bought homes with bad credit and little or no money down, or who took perceived equity out of their homes, are suing to hang on to what they can. These suits allege inadequate disclosures of the nature and risk of loans and discriminatory mortgage practices.

Securities class actions are about a quarter of the filings. These cases focus on inflation or deflation of a target company's stock price due to willful misrepresentations and inaccurate or incomplete disclosure to stockholders. Shareholders' derivative claims and Erisa actions by company-sponsored plans constitute a further 20% of the federal court filings. Fully half of these lawsuits are proceeding in California and New York. Insurance brokerage Guy Carpenter & Co. LLC reports there is little connection between the volume of mortgage foreclosures in a particular state and the filing of litigation there. The venue for these suits certainly appears lawyer-driven.

Who is being sued? Obviously, the financial institutions, issuers and underwriting firms that were heavily engaged in the subprime market have been hit hard. Lawsuits allege negligent underwriting, willful failure to adhere to posted underwriting standards, misleading statements to investors and other related theories. Loan originators, brokers and appraisers, too, have been sued on theories related to their business practices. Insurers who wrote credit enhancement or wrap products have been sued for failure to pay on claims, but they too have claimed to have been defrauded in the issuance of policies. Boards of directors and officers of companies that created structured financial products face breach of fiduciary duty claims. Boards and officers of companies that invested heavily in structured products also face claims of negligence. The list will likely continue to expand the way the list of asbestos defendants expanded as one class of defendant used up its available insurance or filed for bankruptcy protection.

The recent wave of financial market lawsuits is not limited to subprime housing players. SLM Corp., or Sallie Mae, is defending a securities class action in the Southern District of New York brought on behalf of a putative class of purchasers of SLM Corp. stock during 2007. The complaint alleges that the stock traded at artificially high levels due to false upbeat statements made to investors. The product here was securitized "subprime" student loans made to students at nontraditional and unaccredited schools with lower graduation rates that decreased the likelihood of repayment.

Banks that issue credit cards like Visa and MasterCard, as well as the American Express Co., reportedly have been cutting back on credit limits previously granted to customers with spotty credit records. The New York Times has reported that Washington Mutual Inc., HSBC Bank USA Inc., Target Corp. and Wells Fargo & Co. reduced their credit lines by a collective $15 billion in the first quarter. It isn't difficult to predict lawsuits in this area of the lending industry.

Until the financial system digests all the as yet unacknowledged write-downs from losses related to unsuccessful financial products, and until this tidal wave of litigation is resolved -- and it will be several years -- the likelihood of a significant uptick in dealflow is uncertain at best. A safe bet: If and when that happens, the deals will not involve the complex and lucrative products that generated this mess.

Linda Dakin-Grimm is a litigation partner at the international law firm of Milbank, Tweed, Hadley & McCloy LLP.