The Legal Aftermath of the Credit Crisis

How funds disclosed their holdings of certain types of securities spawned a number of class action suits in the wake of the credit crisis. Matthew Larrabee, partner at Dechert, discusses disclosure trends post–credit crisis as well as the symbiotic relationship between the SEC and class action lawyers, in this exclusive interview with Ignites associate editor Beagan Wilcox Volz.

Ignites: “Moving away from the Janus case, are there other trends in disclosure that you’re seeing in terms of how the courts are dealing with disclosure cases? And also how the SEC is dealing with disclosure through enforcement actions?”

Larrabee: “Yes, at the SEC level and OC and enforcement proceedings in district courts, the most important disclosure-related developments are all around the aftermath of the credit crisis. We’re now, depending on how you count, a couple, two or three years into that and there are still more than a hundred credit-crisis-related cases that have yet to be resolved.”

Ignites: “And those related to mutual funds or just more broadly?”

Larrabee: “More broadly. A significant number of them involve mutual funds. If you go back and look at the most expensive SEC settlements and the biggest class action settlements in the last couple of years, they’re all focused on disclosures and they all touch on things that happened in the credit crisis. Use of mortgage-backed securities, use of new forms of derivatives that were very successful in 2006 and in 2007 and, obviously, with the credit crisis were unsuccessful strategies in 2008.”

Ignites: “So what kind of trends are you seeing emerging from court decisions and enforcement actions?”

Larrabee: “Well, some of the things you’re seeing are similar to what happened in Janus. You’re seeing the class action plaintiffs and the SEC reinforce each other. So it’s obvious to those of us working in the industry that the SEC does look at and analyze class action complaints. They examine the disclosure theories and the facts that are alleged in those complaints. And it’s been true for a long time that the class action bar examines SEC settlements and they examine Wells notices and actually even the SEC testimony often gets disclosed in class action proceedings. So there is an alignment, if you will, very often of what the SEC is pressing on mutual funds and what the class action plaintiffs are pressing on mutual funds.”

Ignites: “So, given that alignment, are you seeing changes in how firms are dealing with disclosure?”

Larrabee: “There’s a lot of examination of that. The reality is there’s no particular bright line rule that’s emerged from any of this. I mean, the industry is still examining how to disclose risk in a simple and clear way.”

“What the SEC has been doing for the last — for a long time — is trying to simplify and distill down the disclosures. We’re now using a summary prospectus methodology. And what funds are struggling with is how to use that notion that we should simplify things so investors will have maybe less to digest and will understand more, how do we use that idea with the notion that, if there’s a loss, if an investment strategy fails, you certainly face the disclosure claims after the fact with the benefit of hindsight that a particular fact or a particular strategy should have been disclosed in more detail.”

Ignites: “So they’re contrary forces.”

Larrabee: “Very contrary forces. And it’s a really significant conflict. And that’s why every time historically over the last more than 10 years you see prospectuses begin to get simpler and they get what they call disclosure creep. Where there’s a little more information and a little more information, a little more detail to try to limit the liability by making sure that everything anyone would claim should have been disclosed is in fact disclosed.”