Judge Sweet’s 400 page decision in In re Bear Stearns Companies, Inc. takes us through the collapse of Bear Stearns from three perspectives: a Securities Fraud Complaint against Bear and its accountants, a Derivative Complaint brought by former Bear shareholders who became shareholders of JP Morgan Chase when it acquired Bear in May 30, 2008, and an ERISA complaint by Bear employees for losses in their retirement accounts.
In the fateful Spring of 2008, Bear’s common stock lost in excess of $19.8 billion in market capitalization when the scope of Bear’s investment in subprime and other “toxic” assets was revealed publicly. Bear’s total demise was averted only when it was acquired by JPMorgan at the feeble price of $10 a share. Yet, big losses don’t always add up to successful cases. Judge Sweet allowed the Securities Fraud Complaint to proceed, but he dismissed the Derivative and ERISA Complaints.
One post can’t capture the entire decision, but here’s some flavor:
The Securities Complaint: Judge Sweet rejected Bear’s defense that the complaint was a “classic fraud by hindsight case” which simply alleged “that Bear did not predict the impact of the subprime mortgage crisis.” He identifies misconduct by Bear’s senior officers and directors that was integral to Bear’s decline, and finds that the “competing inference of market implosion has not been demonstrated to overcome the strong inference of scienter developed by Plaintiffs.” That intentional misconduct included the inflation of asset values, the overestimation of Bear’s risk management protocols, the understatement of losses, and the misleading denial of a liquidity crisis. Judge Sweet gave short shrift to Bear’s claim that it disclosed the financial risks it faced in various public filings: “to caution that it is only possible for the unfavorable events to happen when they have already occurred is deceit.”
Judge Sweet also allowed securities fraud claims against Deloitte based on the allegation that Deloitte’s audits of Bear “ were so deficient that the audit[s] amounted to no audit at all …” The opinion includes the Court’s acerbic observation that although Deloitte certified Bear’s financials in 2006 and 2007 without discovering Bear’s true financial condition, “JPMorgan discovered in the course of one weekend the overvaluation of assets and underestimation of risk exposure in Bear Stearns’ financial statements.”
The Derivative Complaint. The Derivative Complaint alleged nineteen fairly scary claims against the directors and senior managers of Bear, including securities fraud, self-dealing, improper trading in Bear stock, as well as agreeing to a one-sided and conflicted fire sale to JP Morgan without proper shareholder approval. But, Judge Sweet dismissed the Complaint on the ground that “a derivative or double derivative suit is not the appropriate means to redress Individual Defendants’ alleged misconduct. The securities laws and other avenues offer adequate remedies better tailored to the circumstances of this dispute.”
Judge Sweet found that the derivative plaintiffs did not have standing to sue since they were no longer shareholders of Bear, and could not show that the merger with JP Morgan was done “solely” to extinguish derivative claims. Further, Plaintiffs could not assert “double derivative” standing against Bear and JP Morgan because they could not fairly allege that JP Morgan was injured by its acquisition of Bear.
The opinion also has a useful discussion of the Board’s business judgment in the context of derivative claims, and relies heavily on a New York state court decision by Justice Herman Cahn which found that Bear’s decision to merge with JP Morgan was protected under the business judgment rule.
The ERISA Complaint: Bear employees whose retirement Plan was devastated by Bear’s disintegration claimed that Bear and the fiduciaries appointed to administer Bear’s Plan breached their duties by allowing the Plan to invest in hold Bear’s stock. Judge Sweet dismissed the Complaint against the Plan fiduciaries on the ground that a “fiduciary who invests the assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision.” He rejected the claim that the Plan fiduciaries were required to disclose information beyond the workings of the Plan, such as information about the financial condition of Bear, because that would “transform fiduciaries into investment advisors…” The opinion also contains an important analysis of the limited fiduciary duties owed to the Plan by senior corporate managers who are not appointed as Plan fiduciaries.
For those interested in the evaporation of Bear as a major player in our financial markets, Judge Sweet’s opinion is an important read.