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					CDOs, E&O and
D&O:
Insurance and the
Subprime Crisis
Lon A. Berk
Hunton & Williams LLP
Phone: 703-714-7555
Email: lberk@hunton.com
THE TRANSACTIONS AND PLAYERS


 What is a subprime loan?
      A type of loan that is offered at a rate above prime
       to individuals who do not qualify for prime rate
       loans. www.investopedia.com
      Typically, subprime loans are for persons with
       blemished or limited credit histories. The loans
       carry a higher rate of interest than prime loans to
       compensate for increased credit risks.
       www.hud.gov/offices/theo/lending/subprime.cfm
THE TRANSACTIONS AND PLAYERS
(cont’d)


 Estimates:
       In 2006 subprime loans accounted for 13.5% of US
        mortgages compared to 2.6% in 2000. Fortune
        (March 1, 2007)
       In 2006, the subprime market was
        $600,000,000,000 –20% of the total mortgage
        market. Id.
       In 2001 subprime loans were 5.6% of mortgage
        dollars
       Between 2003 and 2007, outstanding subprime
        debt was $1.3 trillion
THE TRANSACTIONS AND PLAYERS
(cont’d)



     The Loans


     The MBS
                     LAWSUIT?
     The CMO


     The CDO
     THE TRANSACTIONS AND PLAYERS
     (cont’d)



 Lender loans consumer
 Lender sells loan to intermediary company
 Intermediary company packages loans to
  investors
 Lender payments go through intermediary to
  investors
THE TRANSACTIONS AND PLAYERS
(cont’d)

 CMOs – Collateralized Mortgage
   Obligations
       Bonds that represent claims to specific
        cash flows from large pools of home
        mortgages. The streams of principal and
        interest payments on the mortgages are
        distributed to the different classes of CMO
        interests (tranches) according to a deal
        structure. Each tranche has different
        principal balances, coupon rates,
        prepayment risks and maturity dates.
        www.sec.gov/answers/tcmos.htm
THE TRANSACTIONS AND PLAYERS
(cont’d)




 Collateralized Debt Obligations
       CMOs and other securitized debt
        combined
THE TRANSACTIONS AND PLAYERS
(cont’d)


 Risks
       Default of underlying loans
       Prepayment
THE TRANSACTIONS AND PLAYERS
(cont’d)


 An example:
       Three classes of investors in CMO (A, B
        and C)
       Each class receives interest payments until
        principal is completely paid off
       Class A receives payments first
       Class B receives payments second
       Class C receives payments third
TYPES OF UNDERLYING CLAIMS


 Potential parties
      Financial institutions
      Appraisers
      Investors
      Sellers
      Bond Insurers
      Rating Agencies
   
TYPES OF UNDERLYING CLAIMS
(cont’d)


 Potential parties
       Borrowers
       Mortgage brokers
       Conduits
       Directors
       Trustees
       Professionals
TYPES OF UNDERLYING CLAIMS
(cont’d)

   Administrative actions
   Class actions
   Individual consumer actions
   Commercial disputes
TYPES OF UNDERLYING CLAIMS
(cont’d)




 Claims by borrowers
       Predatory lending
       Misrepresentations by mortgage brokers
       False credit information
       Settlement overcharges
TYPES OF UNDERLYING CLAIMS
(cont’d)


 Claims by investors
       Misrepresentation
       Violations of securities law
       Lack of due diligence
       Accounting malpractice
       Violations of fiduciary duties
            Also   implicates beneficiaries of pension funds
TYPES OF UNDERLYING CLAIMS
(cont’d)


 Claims by underwriters
       Misrepresentations
       Breach of buy back obligations and
        warranties
POLICIES IMPLICATED

 General liability
 Directors and Officers Liability
 Trustee and Fiduciary Liability
 Professional Errors and Omission
 Fidelity and Dishonesty
 Credit Risk
Potential Coverage Issues

 Notice
 Economic Loss
 Prior Knowledge/Rescission
 Intentional Acts and Personal Profit
 Known Loss
 Absence of Professional Services
 Allocation
Potential Coverage Issues
(cont’d)

 Is there a claim?
      Fiduciary liability, D&O and E&O policies
       generally “claims made”
      What is a “claim”?
Potential Coverage Issues
(cont’d)

Example: “Claim” defined as:
        a. a written demand for monetary damages,
        b. a civil proceeding commenced by the service of a
       complaint or similar pleading,
        c. a criminal proceeding commenced by a return of
       an indictment, or
        d. a formal administrative or regulatory proceeding
       commenced by the filing of a notice of charges,
       formal investigative order or similar document,
       against any Insured Person for a Wrongful Act,
       including any appeal therefrom.
Potential Coverage Issues
(cont’d)

 When was it “made”?
      National Stock Exchange v. Federal
       Insurance Co., 2007 WL 1030293 (N.D. Ill.
       March 30, 2007) (SEC notice of
       administrative proceeding constitutes
       claim)
Potential Coverage Issues
(cont’d)

 Is there “prior knowledge”?
      Cement and Concrete Worker District
       Council Pension Fund v. Ulico Cas. Co.,
       199 Fed. Appx 29 (2006) (knowledge of
       claim where class action was foreseeable).
Potential Coverage Issues
(cont’d)

 Is there a “Wrongful Act”?
      Different definitions in E&O, D&O and
       Trustee and Fiduciary policies
      “an actual or alleged breach of duty””
      “a breach of obligations imposed upon
       fiduciaries”
      “a negligent act, error or omission”
Potential Coverage Issues
(cont’d)

 Professional Services:
      “in the rendering or failure to render
       Professional Services as defined in the
       Declarations”
      Industry specific
Potential Coverage Issues
(cont’d)

 Fraud exclusions
      Duty to defend vs. duty to indemnify
      Adjudicated vs. “in fact” vs. alleged
Potential Coverage Issues
(cont’d)

 Fidelity coverages
      Employee dishonesty
      Manifest intent
      Personal profit
Thank you.