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Blame to Go Around

In the annals of financial fiascoes, the subprime-lending crisis has been especially big, messy and legally complex. What's more, people could end up going to jail.

Bonnie Glantz Fatell at Blank Rome. (April Saul/Inquirer)
Bonnie Glantz Fatell at Blank Rome. (April Saul/Inquirer)Read more

In the annals of financial fiascoes, the subprime-lending crisis has been especially big, messy and legally complex.

What's more, people could end up going to jail.

A propitious moment, in other words, for entrepreneurial law firms looking to add clients and generate new revenue, even as the larger economy evinces signs of weakness.

For weeks, a drumbeat has emerged from Philadelphia law firms calling attention to new or existing practice groups focusing on the subprime mess.

As a general rule, it amounts to a repackaging of mortgage-lending, insurance, white-collar defense, bankruptcy and litigation services that firms have been providing for decades. But this repositioning is occurring in an entirely new and somewhat unfathomable context: an explosion of lawsuits, coverage disputes, and now criminal investigations resulting from the collapse of credit and housing markets.

"There have been a lot of borrowers who have been hurt by what has happened here, and there is no doubt that foreclosures are skyrocketing, and now you see what is happening in the stock market. . . . So there is a natural urge to figure out who is at fault, and that results in a lot of litigation," said Alan Kaplinsky of Ballard Spahr Andrews & Ingersoll L.L.P., one of the firms to set up a subprime-practice group.

Ballard Spahr's new practice group expects to focus partly on regions that have been hit inordinately by mortgage foreclosures - Arizona and Nevada - and where the firm has offices.

Tad Decker, chief executive officer of Cozen O'Connor, said his firm was pulling together lawyers who focused on litigation, white-collar defense and bankruptcy to respond to diverse clients facing subprime problems. The firm's long-standing insurance practice also has found a niche interpreting coverage contracts for insurers facing payouts for the actions of corporate officers of companies sued by burned subprime investors.

"This is a very visible, public problem that is affecting almost everyone," Decker said.

Cozen and Ballard are doing mostly defense work, representing large and midsize corporate clients that have become entangled in the subprime imbroglio. Of course, plaintiffs firms across the nation are busy, too, looking to represent disgruntled shareholders and mortgage borrowers.

The current crisis is the bitter fruit of hundreds of billions of dollars in mortgages made since 2005 to borrowers with blemished credit ratings, the so-called subprime borrowers. The mortgages were sold by banks to investment-banking firms that repackaged them as securities and sold them to investors anticipating healthy returns as the borrowers repaid their mortgages.

For a time, the securities appeared especially attractive because the returns were based on higher mortgage rates paid by the subprime borrowers and the belief that houses, on average, always go up in value.

But many of those mortgages are now going into default as the loans' initial low interest rates expire and high rates kick in. But an option once available to stretched homeowners, refinancing, is no longer possible because home values in some parts of the country are plunging.

That has led to accusations by borrowers that mortgage brokers misrepresented the loans, and charges by investors that brokerages failed to disclose the risky nature of the investments, among other disputes.

Most intriguing to law firms seeking to carve out a space in this market is that no one knows where and when the fallout will end. Its impact on the financial-services sector is potentially so widespread that burned investors, investment banks and other players could be fighting for years over who is to blame.

In this regard, the problems seem more far-reaching than the financial fallout from the nation's last major financial crisis: the collapse in confidence over publicly traded companies after disclosures that Enron Corp. and WorldCom Inc. had falsified their financial statements. When the truth of their finances became known, the value of their stocks nose-dived along with the wider market.

Voters reacted with outrage, the Bush administration initiated multiple criminal probes, and Congress passed the Sarbanes-Oxley Act, increasing financial-reporting requirements for publicly traded companies.

The difference this time around is that so many different players were involved in making, brokering, repackaging and reselling subprime loans that the economic impact - and the likelihood of courtroom disputes - is much broader.

"In these kinds of situations, there are always fingers being pointed, and deep pockets sought, and scalps to try and obtain," said Hank Hockeimer, a former federal prosecutor who now is a white-collar defense lawyer with the subprime group at Ballard Spahr.

Also setting the current mess apart from the Enron crisis of 2002, said Hockeimer, is that there has yet to emerge an identifiable bad actor, like Enron, that could serve to encapsulate all of the alleged wrongdoing leading up to the scandal.

In fact, it is not even clear that there was much criminal wrongdoing, even though there are a number of investigations under way by the FBI, the Securities and Exchange Commission, and New York Attorney General Andrew Cuomo.

Even so, there has been an upsurge in litigation related to mortgage lending.

Bonnie Glantz Fatell, leader of the business-restructuring and bankruptcy group at Blank Rome L.L.P., said the firm had been representing commercial clients for years in lending disputes, mortgage and white-collar defense, and is now applying that knowledge base on behalf of clients embroiled in the subprime debacle.

Currently, the firm's bankruptcy group serves as lead or cocounsel to creditor committees in bankruptcy filings of lenders American Home Financial, New Century Financial Corp., and others.

Paul Schieber, head of Blank Rome's consumer financial-services group, said that the firm had been representing subprime lenders before regulatory agencies for many years and that that experience was transferable to the current crisis.

Fatell said she expected white-collar defense lawyers at the firm to play a significant role, as various investigations get under way. But she is not convinced the subprime collapse will be mainly a criminal matter.

"I don't think you can point to one person's scheming or fraudulent behavior as causing this," she said. "Housing values were going up, and there was a lot of money in the market, and people were getting very creative in how to offer financing to people with all levels of qualification."