Mortgage Backed Securities Litigation: Latest Developmentsmedia.straffordpub.com/products/mortgage-backed-securities... · Mortgage‐Backed Securities Litigation: Latest Developments

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Mortgage‐Backed Securities Mortgage Backed Securities Litigation: Latest DevelopmentsPursuing and Defending Investors, Issuers, Underwriters and Other Stakeholders in MBS Claims

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, NOVEMBER 15, 2012

Today’s faculty features:

Isaac M. Gradman, Attorney, Perry Johnson Anderson Miller & Moskowitz, Santa Rosa, Calif.

James K. Goldfarb, Partner, Murphy & McGonigle, New York

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Mortgage-Backed SecuritiesMortgage-Backed Securities Litigation: Latest Developments

Repurchase/Putback Litigation

Isaac M. Gradman, Esq.

Copyright © 2012 Isaac M. Gradman 11/15/20125


Mechanics of SecuritizationMechanics of Securitization Originate-to-sell model: lender immediately sells off loans,

with series of detailed reps and warranties, including: Compliance with guidelines & characteristics in loan tape Compliance with law No errors, omissions or untrue facts in loan file All documents in order and proper transfer of all right, title

and interest Originator sells to underwriter, which pools loans and sells

i t T tinto Trust Makes reps and warranties Makes representations in offering documents

i f d h fl h h Trustee oversees creation of Trusts and cash flows through Trust

Originator remains involved with loans as servicer


Misrepresentations Create Liabilities to I e to a d I u eto Investors and Insurers

Actions under Securities Laws and Blue Sky Laws Advantages: no intent or reliance required; provides Advantages: no intent or reliance required; provides

complete relief Disadvantages: only available to immediate purchasers;

shorter statutes of limitations Contractual Repurchase Claims (i.e., Putbacks) Advantages: loan files offer concrete evidence of breaches;

need not prove damages; longer statute of limitations Disadvantages: procedural hurdles; freerider issues; only

partial relief Tort Claims (i.e., misrepresentation) Advantages: extracontractual damages; headline risk Disadvantages: difficult to prove all elements; may be

limited by availability of contractual remedies


Obstacles to Bondholder ActionObstacles to Bondholder Action


Procedural Steps to Investor StandingStanding

1. Amass at least 25% Voting Rights2. Petition the Trustee to take action and provide reasonable

indemnity3 Cite specific evidence of breach:3. Cite specific evidence of breach: Specific loan(s) Specific provision(s) of PSA Specific evidence of breach

4. Wait 30-90 days for Trustee to take action before investors can sue on own behalfinvestors can sue on own behalf

5. Wait 60-120 days for nonperforming party to cure6. Assert Event of Default


The Importance of Loan FilesThe Importance of Loan Files

Contain all documents reviewed during gunderwriting and loan approval processprocess.

Can be used to verify several important f d i iaspects of underwriting

Files in exclusive possession of pservicers


Conflicts of InterestConflicts of Interest Servicer Conflicts: majority of time, Big Four

affiliated with entity responsible for repurchase Affects willingness to turn over loan files Affects conduct in servicing/modifying loans Affects conduct in servicing/modifying loans

Trustee Conflicts Clients are sellers and sponsorsClients are sellers and sponsors Shielded from liability and provided little incentive to act

in PSA


Early Investor Putback Efforts Receive Frosty y yReception in Courts


Early SetbacksEarly Setbacks Failure to overcome procedural hurdles.

N Y k J d B K i k di i l i i New York state Judge B. Kapnick dismisses complaint in Greenwich Financial Services v. Countrywide for lack of standing (no showing of 25%, compliance with PSA)

Judge Kapnick later dismisses complaint in Walnut Place LLC v. Countrywide for lack of standing (no allegation of Event of Default, failure to allow Trustee to pursue) p )

Trustees uncooperative/insulated Investor Clearinghouse falls apart

h i k l d $8 b l Kathy Patrick-led group structures $8.5 bn settlement with BNYM and BofA

Remaining bondholders fractured

Copyright © 2012 Isaac M. Gradman

g

11/15/201214

Investor Putback Cases Gain Steam Overview of appx. 36 investor- or trustee-led cases now

pending 2012 marked by ramp up in private label putback filings: 2012 marked by ramp-up in private label putback filings: Only 5 filed in 2011 Remaining 31 filed in 2012

Overwhelmingly brought in state court Overwhelmingly brought in state court 30 out of 36 pending in state court (26 of those in NY) 6 remaining suits split evenly between NY, CT and MN fed. courts

Overwhelmingly brought by trustees Overwhelmingly brought by trustees 32 out of 36 filed by trustees at direction of bondholders Judge Pauley decision in Retirement Board of the Policemen's

Annuity and Benefit Fund of the City of Chicago, et al v. Bank of NewAnnuity and Benefit Fund of the City of Chicago, et al v. Bank of New York Mellon holds investors can use Trust Indenture Act to sue trustees directly if they breach duties (e.g., enforce putbacks)

All against backdrop of $8.5 bn settlement


g p

BNYM‐BAC Settlement: Key TermsBNYM‐BAC Settlement: Key Terms By the numbers

530 Countrywide RMBS Trusts $424 bn in original face value Countrywide bonds $424 bn in original face value Countrywide bonds Over $100 bn in losses at time deal announced $8.5 bn settlement amount (<8¢ per $ of then-existing losses)

Players Trustee Bank of New York Mellon Trustee – Bank of New York Mellon Originator/Issuer – Countrywide/BofA Institutional Investor Supporters – BlackRock, PIMCO, NY Fed Intervenors – AIG, Triaxx, FHLBs, NY AG, DE AG (Walnut Place dropped out)

Releases Releases All putback claims on Countrywide deals except monoline-wrapped deals Does not release fraud or securities claims Does not release claims on BofA or Merrill Lynch deals

Trustee seeks approval under Article 77 Trustee seeks approval under Article 77 Special vehicle under NY Law for approval of administrative actions in express trusts Never applied to RMBS or 530 trusts at once

Timing: discovery underway, merits hearing expected May 2013


BNYM‐BAC Settlement: Key AssumptionsAssumptions

Breach rate would approximate Freddie/Fannie putback rate GSE experienced appx. 36% of loans submitted for repurchase GSE loans generally higher quality and investors less likely to g y g q y y

be aggressive in putbacks Private label cases often assert well over 80% of loans breach No private label loan files reviewed No private label loan files reviewed

Viable defenses available to putbacks Subjectivity of underwriting decisionsj y g Loss causation requires

BAC can ring-fence Countrywide


S ttl t A ti Mi FSettlement Assumptions Mirror Four General Fallacies About Putback Claims


Fallacy #1: Guidelines Lax;

Breaches Hard to Prove


“The expansion of underwriting standards over time,

including higher loan to value ratios, lower FICOs, less loan

documentation and the fact that exceptions were made to

underwriting guidelines were disclosed to market

ti i t ”participants.”– CFO Chuck Noski, BofA Q3 2010

earnings call


“If you think about people who come back and say, I

bought a Vega, Chevy Vega, but I want it to be a Mercedes

with a 12-cylinder, we’re not putting up with that.”

– CEO Brian Moynihan, BofA Q3 2010 earnings call.



Fallacy #1: Guidelines Lax; Breaches Hard to Proveto Prove

Stated IncomeS d d i bl d i li i h i d Standard: income reasonable and in line with occupation and years of experience

Procedure if income unreasonable: Reject loan Convert to full doc Cite compensating factors

Other common breaches: Inflated appraisal Missing documents (may be cured)g ( y ) Undisclosed Debts (excessive DTI) Early Payment Defaults (EPDs)


Fallacy #1: Guidelines Lax; Breaches Hard to Proveto Prove

Blatant red flags Doctored documents Non arms-length transactions Identity theft

Fitch Special Report, The Impact of Poor Underwriting Practices and Fraud in Subprime RMBS Performance (Nov. 28, 2007):

In many instances, misrepresentations and altered documentation are evident in the physical files, and most lenders provide underwriters and other

l ith t i i t id tif d fl th t i di t f d Oftpersonnel with training to identify red flags that may indicate fraud... Often, loans containing misrepresentations have multiple problems that can be detected through a strong validation and reverification process.

Practical experience Practical experience Judge Rakoff easily spots breaches in Assured Guaranty v. Flagstar Mediations reveal similar success


Exceptions Require Compensating FactorsFactors

Sample Exception Language (CWALT 2006-9T1): “Exceptions to Countrywide Home Loans’ underwriting guidelines may be made ifCountrywide Home Loans underwriting guidelines may be made if compensating factors are demonstrated by a prospective borrower.”

Exceptions must be disclosed:Fit h S i l R t Th I f P U d i i P i Fitch Special Report, The Impact of Poor Underwriting Practices and Fraud in Subprime RMBS Performance (Nov. 28, 2007):

compensating factors are often used to override or offset loan characteristics that do not meet stated program guidelines Howevercharacteristics that do not meet stated program guidelines. However, typically a single compensating factor would not offset multiple layers of risk. Therefore, to determine acceptable and predictive levels of risk, exceptions, upgrades, and overrides to established underwriting and loan programs should be carefully documented, monitored and disclosed.


Exceptions Require Compensating Factors Investors’ Response:

No compensating factors cited. From Allstate v. Countrywide Complaint: “Exceptions were granted

b d l d i h id i f i f ”

p q p g

abundantly and without consideration of any compensating factors…” From Dexia, New York Life, TIAA-CREF, et al. v. Countrywide

Complaint: loan applications frequently, “reflect that any of borrower income, FICO score, debt, DTI or CLTV ratios, fails to meet stated Countrywide guidelines (without [disclosing] any permissibleCountrywide guidelines (without [disclosing] any permissible exception).”

Exceptions swallowed rule. Also from Allstate, “According to the SEC, at one point, 23% of

Countrywide’s subprime first lien loans were generated asCountrywide’s subprime first-lien loans were generated as “exceptions.” Similarly, according to the California Attorney General’s complaint against Countrywide and Mozilo, a former supervising underwriter at Countrywide stated that up to 15% or 20% of the loans that Countrywide generated were processed via the y g pException Processing System, of which very few were ever rejected.


Fallacy #2: Investors Must

Prove Causation


“We believe many of the losses observed in these deals have

been, and continue to be, driven by external factors, like the y

substantial depreciation in [home] prices, persistently high

unemployment and other economic trends, diminishing the

likelihood that any loan defect should one exist at all, was

the cause of the loan’s default.”

– CFO Chuck Noski, BofA Q3 earnings callg


Fallacy #2: Investors Must Prove CausationCausation

Standard: “materially and adversely affects” value of loan or stakeholder’s interest in loan

No language suggesting causationPSA d h l b PSAs provide situations where current loans may be put back.

Most straightforward interpretation is some substantive Most straightforward interpretation is some substantive impact on: Risk profile;p Value of loan; or Investor’s interest in loan.


Fallacy #2: Investors Must Prove CausationC d i i h b i d i h f d i i Court decisions have substantiated most straightforward interpretation MBIA v. Countrywide – Judge Bransten sides with plaintiffs in

analogous contexts, indicates leaning toward same on putbacks, but punts

Syncora v. EMC – Judge Crotty sides with plaintiffs, finding increased risk of loss is material adverse affect in insurance context

Assured v. Flagstar – Judge Rakoff finds no causation language and issues broadest holding yet in favor of plaintiffs’ materiality g y p yinterpretation

Impact – extremely tough to prove causation; relatively easy to prove increased risk Keith Johnson testimony before FCIC sellers used exception reports to Keith Johnson testimony before FCIC – sellers used exception reports to

bargain down loan prices. Expert testimony from underwriters and insurers that reps and

warranties relate to risk profileR k ff t th t i l f il t h k i i k dl f Rakoff suggests that simple failure to check increases risk, regardless of whether guidelines were actually met

Investors and bond insurers have similar interests


Fallacy #3: BofA Can Easily

Ring-Fence Countrywide


Fallacy #3: BofA Can Easily Ring‐Fence CountrywideCountrywide

Two prominent theories of successor liability De facto merger – BofA acquisition of Countrywide amounted

to merger Turns on which state’s law applies

New York asks if it was intent of successor to absorb and continue operation of predecessoroperation of predecessor

Delaware requires some bad faith or intent to defraud creditors Judge Bransten in MBIA v. Countrywide denied motion to dismiss de

facto merger claim, applying New York lawJ d Pf l i All t t C t id d M M t l Judge Pfaelzer in Allstate v. Countrywide and Mass Mutual v. Countrywide dismissed claims under Delaware law

Assumption of liabilities – BofA implicitly or by admission assumed liabilities after fact Judge Bransten in MBIA v. Countrywide denied motion to dismiss

assumption claim Rarely found by courts, but some good facts here


“At the end of the day, we will pay for the things that

C id did ”Countrywide did.”

– CEO Brian Moynihan, Nov. 2010 BofA investor conference in NYC (Bloomberg News).

“Our company bought it [Countrywide] and we’ll stand up,

g

we’ll clean it up.”

– CEO Brian Moynihan, Dec. 2010 (N Y k Ti )(New York Times).


“We bought the company [Countrywide] and all of its

assets and liabilities… We are aware of the claims and

potential claims against the company and have factored

th i t th h ”those into the purchase.– BofA Spokesman Scott Silvestri,

March 1, 2008

“We looked at every aspect of the deal, from

[Countrywide’s] assets to potential lawsuits and we think we y p

have a price that is a good price.”

– Former BofA CEO Kenneth Lay, Jan. 23, 2008


Fallacy #3: BofA Can Easily Ring‐Fence Cou t y ideCountrywide

Latest developments Summary judgment motions filed in MBIA v Countrywide Summary judgment motions filed in MBIA v. Countrywide MBIA drawing on 3+ years of discovery and deposition of

executives, including Moynihan; argues New York law applies BofA argues Delaware law should apply and no genuine issue of fact BofA argues Delaware law should apply and no genuine issue of fact Hearings in December, decision likely in Q1 2013

DOJ, in suit filed by New York U.S. Attorney’s office against C t id /B fA i MBIA j d t tiCountrywide/BofA, mirrors MBIA summary judgment motion Alleges de facto merger and assumption claims Cites ongoing funding of Countrywide liabilities by BofA

BofA issued side letter to BNYM as part of settlement, agrees to backstop Countrywide indemnity


Fallacy #4: Banks Can Force

Loan by Loan Battle


“We’ll just drag out these losses as these things play

h l ”themselves out.”

–– CEO Jamie Dimon, JPM 3Q 2010 earnings callearnings call.

“You’ve got to do it loan by loan. This could be a long,

ugly mess.” CEO J D JPM Qugly mess. –– CEO Jamie Dimon, JPM 4Q 2010 earnings call.


“This really gets down to a loan-by-loan determination and

we have, we believe, the resources to deploy against that

kind of a review... we will go in and fight this. It’s worked

t b fit t h th d f l illi tto our benefit to—we have thousands of people willing to

stand and look at every one of these loans.”–– CEO CEO Brian Moynihan, BofA third y

quarter 2010 earnings call.

“It’ d t d h d t h d b t ”“It’s a day-to-day, hand-to-hand combat.”

–– CEO CEO Brian Moynihan, 11-16-10 BofA investor conference in New York (Bloomberg News).


Fallacy #4: Banks Can Force Loan by Loan BattleBattle

NY State Judge Bransten hands down 12-22-10 sampling order in MBIA v. Countrywide: MBIA “will be allowed to use and present evidence for its case through statisticalMBIA will be allowed to use and present evidence for its case through statistical

sampling.” This decision, “has the possibility of saving the parties and the court from

significant litigation time and may significantly streamline the action…" MBIA proposes using sample of 6,000 out of 368,000 loans (only 1.6%). Claims

confidence level of appx. 95% with 5% margin of error. Trier of fact to evaluate methodology/weight of evidence.

District Court Judge Crotty in Syncora v. EMC follows suit, holds bond insurer can take advantage of pool-wide remedy:g p y

EMC cannot reasonably expect the Court to examine each of the 9,871 transactions to determine whether there has been a breach, with the sole remedy of putting them back one by one.

District Court Judge Rakoff in Assured v Flagstar defers ruling on District Court Judge Rakoff in Assured v. Flagstar defers ruling on sampling until end of trial, but allows presentation of evidence in consolidated manner; appears likely to allow extrapolation.


Additional Developments in 2012p Fraud claims gain steam MBIA, Syncora and Ambac advance claims againstMBIA, Syncora and Ambac advance claims against

Credit Suisse & EMC/Bear Stearns over double dipping AG Schneiderman files People v. J.P. Morgan Securities

LLC l ll i M i A l i dLLC, et al., alleging Martin Act claims on same grounds In MBIA v. JP Morgan, MBIA reveals evidence that Bear

Stearns “scrubbed” due diligence reports of adverse S e s sc ubbed due d ge ce epo s o dve sefindings

DOJ gets active: in U.S. ex rel. O’Donnell v. Bank of America, asserts FCA claims based on sale of defective loans to GSEs


Additional Developments in 2012 (cont.) FHFA, FDIC, NCUA and FHLBs continue aggressive legal action Other notable legal decisions

MBIA C id i b i i d f d MBIA v. Countrywide – insurer can obtain rescissory damages, assert fraud & breach claims without causal link between payments & false statements. Full summary judgment motions now pending.

Assured v Flagstar – Rakoff rejects argument that due diligence reviews Assured v. Flagstar – Rakoff rejects argument that due diligence reviews defined materiality or waived Assured’s rights to putbacks

US Bank v. WMC Mortgage Corp. – Judge Tunheim rules loans liquidated with loss cannot be repurchased (aberration)p ( )

Assured v. DLJ – monolines waived rescissory damages by cont. to accept premiums

BofA begins settling legacy claimsBofA begins settling legacy claims GSE settlement for $2.8 bn Assured settlement for $1.6 bn S ttl t f $400 illi


Syncora settlement for $400 million

Forecasts for 2013Forecasts for 2013 Statutes of limitations will force parties’ hands Under Structured Mortg. Trust 1997-2 v. Daiwa Fin. Corp., U de St uctu ed o tg. ust 997 v. aiwa in. Co p.,

SOL for putbacks = six years from closing 60% of 2011 cases pertain to RMBS issued in 2005; 27 out of

the 31 cases (87%) of 2012 cases pertain to 2006-vintage ( ) p gRMBS.

Strong evidence that time bar motivates filings & means likely influx of cases on 2007-vintage bonds in 2013g

Monoline cases will settle after Assured v. Flagstar trial BNYM settlement likely to be approved

D i ill f d f b k Desperate times will force desperate measures for banks with largest exposure – additional global deals


ContactIsaac M. GradmanAttorneyPerry Johnson Anderson Miller & Moskowitz LLP(707) [email protected]://www.perrylaw.net/attorneys/gradman.asp

Isaac Gradman is a nationally-recognized expert in mortgage-backed securities litigation and other legal issues stemming from the mortgage crisis. While practicing as a commercial litigator at Arnold & Porter (formerly Howard Rice) in San Francisco, Mr. Gradman was involved in some of the earliest litigation arising from the subprime mortgage crisis, including the representation of PMI Mortgage Insurance Co. in a suit against WMC Mortgage Corp. and its parent, GE Money Bank, over misrepresentations relating to a $1 billion pool of subprime mortgages. In 2008, he launched The Subprime Shakeout law blog (www.subprimeshakeout.com), where he has been covering the latest MBS litigation developments for over four years. Prior to joining Perry Johnson in 2012, Isaac was the managing member of Gradman Law, where he represented clients in loss mitigation, litigation and putback efforts in connection with mortgage derivatives and insurance products In addition to providing MBSputback efforts in connection with mortgage derivatives and insurance products. In addition to providing MBS legal services, Isaac provides services to clients in general litigation and business law.

For a representative list of Isaac’s publications, presentations and media references, please visit http://www.subprimeshakeout.com/media-references-2


p p

November 15, 2012James K. Goldfarb

Landscape of RMBS securities litigation Class action developments Merits developments Enforcement actions Enforcement actions Indemnification Issues to watch in 2013

45

Plaintiffs◦ Governmental actions FHFA, FHLB, FDIC, NCUA U.S. and state attorneys generaly g SEC

◦ Private actions Defendants Defendants◦ Sponsors◦ Underwriters◦ Depositors◦ “Control Persons”

46

Allegations◦ Misrepresentations that the loans complied with underwriting guidelines◦ Misrepresentations about loan-level data Owner-occupancy rates overstatedOwner occupancy rates overstated Loan-to-value ratio understated Debt-to-income ratio

Claims Claims◦ 1933 Act◦ Blue Skyy◦ Fraud◦ Aiding & abetting fraud◦ Negligent misrepresentation◦ Negligent misrepresentation

47

“Class” standing American Pipe tolling Class certification

48

Offering-level standing A putative class may pursue claims arising only from the offerings in which the named plaintiff invested. Plumbers’ Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., 632 F.3d 762 (1st Cir. 2011); Me. State p p ( )Ret. Sys. v. Countrywide Fin. Corp., 722 F. Supp. 2d 1157, 1164 (C.D. Cal. 2010) (“Maine State I”) (citing cases).

Tranche-level standing Tranche level standingA putative class may pursue claims arising only from the specific tranches in those offerings in which the named plaintiff invested. Me. State Ret. Sys.

C t id Fi C N 10 0302 2011 WL 4389689 t *5 6 (C D v. Countrywide Fin. Corp., No. 10-cv-0302, 2011 WL 4389689, at *5-6 (C.D. Cal. May 5, 2011) (“Maine State III”).

49

NECA-IBEW Health & Welfare Fund v. Goldman, Sachs & Co., 693 F.3d 145 (2d Cir. 2012) Background◦ Appeal from district court decision dismissing 1933 Act claims arising ◦ Appeal from district court decision dismissing 1933 Act claims arising

from 15 of 17 offerings◦ District court applied offering- and tranche-standing rules

50

NECA (cont’d) Second Circuit reversed◦ Class standing to pursue claims for offerings (or tranches) in which it did

not invest is not a function of Article III or statutory standingnot invest is not a function of Article III or statutory standing◦ “Common concerns” rule: named plaintiff can pursue claims for offerings

it did not invest in, provided that the other offerings are backed by loans made by the same originator that made the loans backing the offerings in made by the same originator that made the loans backing the offerings in which the named plaintiff invested◦ Tranche-level standing: difference in tranche holdings does not implicate

h “f d t ll diff t t f ” t d f t l such a “fundamentally different set of concerns” so as to defeat class standing.

51

NECA (cont’d) Implications◦ It adds to the in terrorem threat of 1933 Act claims. But statute of

limitations have run on claims arising from the critical vintageslimitations have run on claims arising from the critical vintages.◦ It has prompted reconsideration of previously dismissed claims. But

many actions have settled. S Pl b ’ & Pi fitt ’ L l N 562 S Pl & T t J P M See Plumbers’ & Pipefitters’ Local No. 562 Supp. Plan & Trust v. J.P. Morgan Acceptance Corp. I, No. 08-cv-1713, 2012 WL 4053716 (E.D.N.Y. Sept. 14, 2012) (sua sponte reinstating 22 offerings, and tranches in eight offerings in which named plaintiffs had invested); see also In re IndyMac Mortgagewhich named plaintiffs had invested); see also In re IndyMac Mortgage-Backed Sec. Litig., No. 09-cv-4583 (S.D.N.Y. Oct. 12, 2012) (ECF No. 376) (moving for reconsideration; seeking to reinstate claims arising from 42 of 85 previously-dismissed offerings).previously dismissed offerings).

52

NECA (cont’d) Implications (cont’d)◦ It does not dismantle serious barriers to plaintiffs’ claims, including

originator-specific allegations and class certificationoriginator-specific allegations and class certification.◦ It is not the only or necessarily the final word – Goldman already has filed

a petition for a writ of certiorari. See Goldman, Sachs & Co. v. NECA-IBEW Health & Welfare Fund No 15 528 (U S Oct 26 2012) IBEW Health & Welfare Fund, No. 15-528 (U.S. Oct. 26, 2012).

53

American Pipe rule: statutes of limitation toll for putative members of an unsuccessful class who subsequently pursue the claims that the class sought to pursue.

Two issues Two issues◦ Applies to statutes of repose. See In re Morgan Stanley Pass-Through

Certificates Litig., 810 F. Supp. 2d 650 (S.D.N.Y. 2011) (noting that a i it f t h ld th i )minority of courts hold otherwise).

◦ Does not require that the putative class members advance the same legal theories in subsequent litigation. See Maine State III, 2011 WL 4389689, at *16.

54

District courts have “broad discretion” to certify classes of investors from different offerings or in different tranches within the same offering. See NECA, 693 F.3d 145, 165 n.13.◦ Individual issues predominate. See N.J. Carpenters Health Fund v. d dua ssues p edo a e See J Ca pe te s ea t u d

Residential Capital, LLC, 272 F.R.D. 160 (S.D.N.Y. 2011) (Baer, J.), aff’d sub nom. N.J. Carpenters Health Fund v. Rali Series 2006 QO1 Trust, Nos. 11-1683-cv, 11684-cv, 2012 WL 1481519 (2d Cir. Apr. 30, 2012) Nos. 11 1683 cv, 11684 cv, 2012 WL 1481519 (2d Cir. Apr. 30, 2012) ◦ Individual issues do not predominate. Pub. Employees’ Ret. Sys. of

Miss. v. Goldman Sachs Group, Inc., 280 F.R.D. 130, 37 (S.D.N.Y. 2012) (Baer J )(Baer, J.)

55

Fraud claims 1933 Act claims Negligent misrepresentation claims Blue Sky claims Blue Sky claims

56

FHFA Actions Background◦ 18 actions filed in mid-2011 by the FHFA as conservator for Freddie Mac

and Fannie Maeand Fannie Mae 16 cases now venued in the S.D.N.Y. before Judge Cote 1 case (RBS) venued in the D. Conn. before Judge Thompson

1 (C t id ) d i th C D C l B f J d Pf l 1 case (Countrywide) venued in the C.D. Cal. Before Judge Pfaelzer◦ Defendants include major financial institutions that sponsored,

underwrote, and acted as depositor for RMBS that the GSE’s invested in; findividual defendants

◦ FHFA asserts claims under the 1933 Act, the Blue Sky laws of Virginia and D.C., negligent misrepresentation and, in seven cases, fraud

57

FHFA Actions (cont’d) Procedural history (S.D.N.Y.)◦ Court denies in part motions to dismiss 1933 Act claims. See FHFA v.

UBS Ams Inc 858 F Sup 2d 306 (S D N Y 2012) (“UBS I”)UBS Ams., Inc., 858 F. Sup. 2d 306 (S.D.N.Y. 2012) ( UBS I ).◦ Court resolves additional securities law issues. See FHFA v. UBS Ams.,

Inc., No. 11-cv-5201, 2012 WL 2400263 (S.D.N.Y. June 26 2012) (“UBS II”)II ).◦ June 14 scheduling order sets briefing schedule for motions to dismiss

six fraud cases, motions to address outstanding issues in remaining nine cases.◦ Court begins issuing decisions in fraud cases. See FHFA v. JPMorgan

Chase & Co., No. 11-cv-6188, 2012 WL 5395646 (S.D.N.Y. Nov. 5, 2012).

58

Misrepresentation and omission◦ Rule 9(b) Allegations concerning “disregard” of underwriting standards sufficient –

FHFA’s forensic review, government and private investigations, confidential , g p g ,witness accounts, and the “surge” of defaults and “collapse” of the ratings

A forensic review is not necessary to state a claim But allegations based on the results of governmental investigations are But allegations based on the results of governmental investigations are

insufficient, standing alone◦ “Janus” argument rejected because the concerns animating the Supreme

Court’s decision do not apply to New York’s common law See Fed Court s decision do not apply to New York s common law. See Fed. Hous. Fin. Ag. v. Goldman, Sachs & Co., No. 11-cv-6198, slip op. (S.D.N.Y. Nov. 12, 2012) (ECF No. 156).

59

Misrepresentation and omission (cont’d)◦ Observations Policy-oriented: the allegations were sufficient to satisfy the goals of Rule

9(b) The default rates were for loans in the loan groups supporting the highest-

rated certificates No attention to AVMs, but the issue might be addressed in American , g

International Group, Inc. v. Bank of America Corp., No. 11-cv-10549 (C.D. Cal.).

60

Scienter◦ Allegations related to underwriting guidelines are sufficient given the

“variety” of supporting allegations Discrepancy in owner-occupancy rates, loan-to-value ratios Discrepancy in owner occupancy rates, loan to value ratios Waiving into securitizations high percentage of defect-loans, as identified by

third-party due diligence firm, Clayton Affiliated-originators and damning internal communicationsAffiliated originators, and damning internal communications

◦ But allegations relating to owner-occupancy and LTV are insufficient to demonstrate recklessness, standing alone, particularly when the information (i) comes from a third party and (ii) defendant has no information (i) comes from a third-party, and (ii) defendant has no affirmative duty to verify it.

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Scienter (cont’d)◦ Observations Magnitude-based scienter is a steep slope absent supporting, non-

quantitative allegations For scienter as to underwriting guideline allegations, the absence of damning

internal communications, third-party diligence reports, and the like might raise make it more difficult to prevail against less target-rich defendants

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Reasonable reliance◦ GSEs sophistication does not undercut reasonable reliance Factual, and unable to be determined as a matter of law GSEs entitled to rely on representations as to loans backing the particular y p g p

certificates it purchased GSEs lacked same access as defendants to data

◦ Risk factors potentially insulate forward-looking statements but not Risk factors potentially insulate forward looking statements, but not statements the falsity of which was ascertainable when made◦ Failure to review the ProSupp before purchase does not bar reasonable

reliance if the ProSupp incorporates the “very same data” in preliminary reliance if the ProSupp incorporates the very same data in preliminary material that plaintiffs did review. Fed. Hous. Fin. Ag. v. Deutsche Bank AG, 11-cv-6192, 2012 WL 5471864 (S.D.N.Y. Nov. 12, 2012) (ECF No. 140)140).

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Reasonable reliance (cont’d)◦ Observations Court acknowledged that, ultimately, a jury will have to decide these issues The court’s reasoning on the “failure to review the ProSupp” issue seems g pp

inconsistent with NECA

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Loss causation◦ Generally, courts have declined to distinguish at the motion to dismiss

stage between losses caused by alleged underwriting practices and losses caused by the financial crisis◦ Some non-New York courts have sown confusion about the proper legal

standard for proving causation under New York law, but Judge Cote was clear:clear:

“‘FHFA must prove that misrepresentations by the defendants ‘directly causes the loss about which [it] complains.’ Laub v. Faessel, 745 N.Y.S.2d 534, 536 (App. Div. 1st Dep’t 2002). ‘A fraudulent misrepresentation is a legal cause of a pecuniary loss resulting from action or inaction in reliance upon it if, but only if, the loss might reasonably be expected to result from the reliance.’ Stutman v. Chemical Bank, 731 N.E.2d 608, 612 (N.Y. 2000).

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Damages◦ Low pleading standard. See Dexia Holdings, Inc. v. Countrywide Fin.

Corp., No 11-cv-07165, 2012 WL 1798997 (C.D. Cal. Feb. 17, 2012) (“Plaintiffs adequately alleged that the underlying loans were riskier than advertised. A riskier loan carries with it an increased chance of default and therefore a lower value.”).◦ Rescission – for fraud claims, equitable, delay-based defenses are an Rescission for fraud claims, equitable, delay based defenses are an

affirmative defense to rescission, but defendants must prove unreasonable delay. See Fed. Hous. Fin. Auth. v. Merrill Lynch & Co., 11-cv-6202 2012 WL 5451188 (S D N Y Nov 8 2012) 11 cv 6202, 2012 WL 5451188 (S.D.N.Y. Nov. 8, 2012). ◦ Punitive damages New York law sets a high bar – public harm

Id tif f l i tiff i ht b k Identify of plaintiff might be key

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Section 11 claims◦ Misrepresentations & Omissions Allegations that originators “systematically abandoned” the underwriting

generally sufficient. See Maine State III, 2011 WL 4389689, at *9 (allegations of “high default and delinquency rates and a widespread downgrade of the Certificates from investment grade to junk bond levels” “give rise to an inference” that the originator “systematically disregarded its underwriting guidelines and that such information systematically disregarded its underwriting guidelines and that such information was withheld from the offering documents.”); UBS I at 332.

Plaintiffs generally are not required to plead defects in specific loans. “In effect Plaintiffs allege that the misstatements and omissions were made with effect, Plaintiffs allege that the misstatements and omissions were made with respect to all of the loans and all of the loans were issued by deviating from the underwriting guidelines.” Maine State III, 2011 WL 4389689, at *17.

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Section 11 claims (cont’d)◦ Misrepresentations & Omissions (cont’d) Allegations that originators “systematically abandoned” the underwriting

generally sufficient. See Maine State III, 2011 WL 4389689, at *9; UBS I at 332.

Plaintiffs generally are not required to plead defects in specific loans. Maine State III, 2011 WL 4389689, at *17.

Courts split on whether LTV allegations – based on appraisals – are actionable opinions.

Courts split on whether defendants can defeat liability for owner-occupancy p y p ymisstatements, which come from borrowers, not underwriters.

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Section 11 claims (cont’d)◦ Damages: diminution of market value is sufficient to satisfy the “injury”

element; claims are not barred merely because certificates still are cash flowing and plaintiffs have not locked in (“realized”) their alleged losses through a sale.

See NECA-IBEW Health & Welfare Fund v. Goldman, Sachs & Co., 693 F.3d 145 (2d Cir. 2012); but see Maine State III, 2011 WL 4389689, at *19 ( )(decided before NECA) (“Whether there is a secondary market for these Certificates, whether such a market is liquid, whether Plaintiffs were sufficiently warned in each and every prospectus supplement that they would not be able to resell the Certificates in the secondary market, and whether Plaintiffs have suffered loss in market value are all questions which are better resolved at the summary judgment stage.”).

◦

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Section 12(a)(2)◦ “Statutory-seller” requirement generally protects originators and depositor y q g y p g p

because they lack direct contact with the investors. See Maine State III, 2011 WL 4389689, at *9 (C.D. Cal. May 5, 2011).◦ Courts have rejected the argument that non-underwriters “solicit” Courts have rejected the argument that non underwriters solicit

purchases by creating the Certificates and helping to draft the marketing material; or that they have a financial stake in the underwriters’ solicitation due to a corporate affiliation with the underwriters See Me solicitation due to a corporate affiliation with the underwriters. See Me. State Ret. Sys. v. Countrywide Fin. Corp., No. 10-cv-00302, 2011 WL 4389689, at *10 (C.D. Cal. May 5, 2011) (“Maine State II”).Courts split on whether an issuer is a statutory seller Compare Maine ◦ Courts split on whether an issuer is a statutory seller. Compare Maine State III, 2011 WL 4389689, at *9 (issuer not a statutory seller, notwithstanding SEC Rule 159), with UBS I at 333 (issuer a statutory

ll ) seller).

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UBS I – Timeliness of claims◦ Statutes of repose: Statutory intent trumps plain language◦ Statute of limitations – inquiry notice Applying inquiry notice rule of Merck & Co. v. Reynolds, 130 S. Ct. 1784 pp y g q y y ,

(2010), to 1933 Act claims – the limitations period runs from the date a reasonably diligent plaintiff discovers facts sufficient to plead a claim that would a motion to dismiss; mere notice insufficient

Rating downgrades in February and March 2008 is the “date” because the downgrades link the alleged origination problems to the underwriting of the certificates at issue

Rejecting earlier “indicia” in public reports and other lawsuits Appeal pending in the Second Circuit has implications for FHFA,

NCUA and FDIC actionsNCUA, and FDIC actions

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Tough sell under New York law due to “special relationship” requirement

Majority of courts have dismissed negligent misrepresentation claims because the transactions between underwriter- and depositor-because the transactions between underwriter and depositordefendants are arms-length. See, e.g., UBS I at 334; Dexia Holdings, Inc. v. Countrywide Fin. Corp., No. 11-cv-07165, 2012 WL 1798997 at *7 (C D Cal Feb 17 2012)1798997, at *7 (C.D. Cal. Feb. 17, 2012).

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Background◦ State statutes designed to regulate the issuance and secondary market

transactions in, into, and out of a state ◦ Generally parallel the federal 1933 and 1934 Actsy p◦ Every state and D.C. permits a private right of action, except New York

Two main issuesJ i di ti l N◦ Jurisdictional Nexus◦ Not mutually exclusive

Courts generally have denied motions to dismiss on the merits Courts generally have denied motions to dismiss on the merits. See, e.g., Mass. Mut. Life Ins. Co. v. Res. Funding Co., LLC, 843 F. Supp. 2d 191 (D. Mass. 2012); Cambridge Place Inv. Mgmt., Inc. v. Morgan Stanley & Co., Nos. 10-2741 BLS1, 11-0555-BLS1, 2012 WL 5351233 (D. Mass. Sept. 28, 2012). 10 2741 BLS1, 11 0555 BLS1, 2012 WL 5351233 (D. Mass. Sept. 28, 2012).

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Government initiatives◦ Mortgage Fraud Task Force◦ Securities & Exchange Commission◦ Department of JusticeDepartment of Justice◦ State Attorneys General

U.S.A. ex rel. O’Donnell v. Bank of Am. Corp., No. 12-cv-1422 (S D N Y )(S.D.N.Y.)o Not an RMBS actiono But allegations arguably conflict with the FHFA actionsg g y

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New York v. J.P. Morgan Sec. LLC, Index No. 451556/2012 (N.Y. Sup. Ct., N.Y. County) Background

B ht b N Y k’ AG d N Y k’ Bl Sk l th M ti ◦ Brought by New York’s AG under New York’s Blue Sky law, the Martin Act, and New York’s Executive Law◦ Principal defendant is Bear Stearns◦ Allegations parallel those in several other RMBS securities actions,

including the FHFA’s action against JPMorgan◦ Alleges more than $22.5 billion in losses on more than 100 securitization Alleges more than $22.5 billion in losses on more than 100 securitization

transactions

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NYAG (cont’d) Observations◦ Highly derivative, yet far less particularized◦ “Common sense” causation theory high rates of delinquencies and ◦ Common sense causation theory -- high rates of delinquencies and

defaults are evidence of faulty underwriter -- likely to be major source of disputeAll ti t ti l b t i i t◦ Allegations are a potential boon to originators Bear Stearns and its third-party diligence firm knew the diligence process was

compromised but did not rectify it Bear Stearns allegedly reached agreement with originators concerning put

backs, but pocketed the money Acknowledges that “exception” lending is a matter of professional judgment

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Underwriter claims against originator for indemnification Generally, contract-based, but with a common law overlay◦ Indemnitees may not take steps to increase the indemnitors liability◦ “Conflict” rulesConflict rules

Robust defenses exist◦ Complaints are replete with damning allegations; time will tell whether the

ffactual record bears those allegations out◦ Fraud is not indemnifiable as a matter of law◦ Sound argument that securities law violations are not indemnifiable as a g

matter of law. See Globus v. Law Research Service, Inc., 418 F.2d 1276 (2d Cir. 1969).

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Implications of NECA for class and tolling issues Developments in the FHFA actions Summary judgment Settlement developments Settlement developments Successor liability Indemnification

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James K. GoldfarbPartnerMurphy & McGonigle, P.C.(212) [email protected]@mmlawus.com

Murphy & McGonigle provides litigation and enforcement defense, and regulatory andcompliance counseling to public companies, financial institutions, accounting firms, and theirexecutives The views expressed in this presentation are those of the presenter and do notexecutives. The views expressed in this presentation are those of the presenter and do notnecessarily reflect the views of the firm or its clients.

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