No Bankruptcy Automatic Stay for Banks in $7.7B NovaStar MBS Fraud Action

U.S. Southern District Judge Deborah A. Batts shut down underwriter defendants’ attempt to avoid proceeding with discovery in a $7.7 billion mortgage-backed securities fraud action, by arguing that an automatic bankruptcy stay applied to the underwriter defendants in addition to the debtor defendants.

The current discovery dispute arises from a proposed class action lawsuit against the now bankrupt NovaStar Mortgage Inc. (“NMI”) and NovaStar Mortgage Funding Corporation (“NMFC”) and the investment banks that underwrote $7.7 billion of NovaStar mortgage-backed securities issued in 2006.  The underwriter defendants include RBS Securities Inc., Deutsche Bank Securities Inc., and Wells Fargo Securities LLC.  The class action alleges that the offering documents failed to disclose that NovaStar had abandoned its underwriting standards in the wake of the 2009 housing crisis, which caused significant losses for investors.

NovaStar initiated voluntary bankruptcy proceedings on July 20 in the U.S. Bankruptcy Court for the District of Maryland.  The underwriter defendants then argued that the automatic bankruptcy stay bars them from continuing with discovery in the class action.  They reasoned that the automatic stay applied because (1) continuation of the action would have an “immediate adverse economic consequence” for the debtor defendants’ reorganization and (2) the underwriter and debtor defendants are “inextricably woven” such that a finding of liability would necessarily implicate the debtor defendants.

Judge Batts rejected the underwriter defendants’ arguments, concluding that “the automatic stay provision of the bankruptcy code does not operate to stay this action except as to the Debtor Defendants [NovaStar].” The Court rejected the “immediate adverse economic consequence” argument, finding that “the mere possibility of a future indemnification claim [against debtor defendants] will not support application of the automatic stay” and neither will concerns about the creation of adverse precedent or collateral estoppel, given that the bankruptcy operates to deprive the debtor defendants of a full and fair opportunity to litigate the claims.  Finally, Judge Batts rejected the “inextricably woven” rationale because the underwriter defendants and the debtor defendants, NMI and NMFC, are separate entities and the claims against them are legally distinct; therefore, “the concern that Debtor Defendants are the ‘real party defendant’ is not present in this Action.”

The case is captioned New Jersey Carpenters Health Fund v. Royal Bank of Scotland Group, PLC, et al., case number 1:08-cv-05310, in the U.S. District Court for the Southern District of New York.

National Credit Union Administration Succeeds in RMBS Appeal to Ninth Circuit

The U.S. Court of Appeals for the Ninth Circuit recently reversed a trial court’s dismissal of the National Credit Union Administration’s (NCUA’s) residential mortgage-backed securities (RMBS) fraud claims against Nomura Home Equity Loan Inc.  The appellate court held that the Financial Institutions Reform Recovery and Enforcement Act of 1989 (FIRREA) extended all applicable deadlines for the NCUA to file any suit in its capacity as conservator or liquidating agent for a troubled credit union.  Among many other reforms, FIRREA included an “extender” provision that allows the NCUA to bring claims that would otherwise be barred by applicable statutes of limitation and statutes of repose.  Similar statutes govern claims brought by the Federal Deposit Insurance Corporation (FDIC) as conservator or receiver for a failed bank, as well as claims brought by the Federal Housing Finance Agency (FHFA) as conservator or receiver for government-sponsored entities such as Fannie Mae and Freddie Mac.

Specifically, the Ninth Circuit held that the extender provision of FIRREA applies to both statutes of limitation, which set forth deadlines by which plaintiffs must file suit, and related statutes of repose, which set absolute deadlines after which defendants may not be sued.  Thus, the NCUA’s claims, although filed in 2011, more than three years after the subject RMBS were purchased in 2006 and 2007, were still timely.

The NCUA brought the underlying suit on behalf of Western Corporate Credit Union (WesCorp), which originally purchased the securities at issue.  The complaint alleges that Nomura and other defendants falsely represented to WesCorp that these RMBS were low risk, while knowing and failing to disclose that the mortgage loans underlying the RMBS failed to meet applicable underwriting standards, in violation of Section 13 of the Securities Act of 1933.  Because WesCorp was placed into NCUA conservatorship following its failure in 2009, the appellate court concluded that NCUA’s 2011 suit was well within the three-year statute of limitations.  The Ninth Circuit’s holding follows similar rulings interpreting extender statutes by its sister courts, the Second Circuit, Fifth Circuit, and Tenth Circuit.

MassMutual Agrees to Settle $235 Million RMBS Suit Against RBS

Massachusetts Mutual Life Insurance Company (MassMutual) and RBS Securities Inc. (RBS) have reached a confidential agreement to settle MassMutual’s claims that RBS misrepresented the quality of $235 million in residential mortgage-backed securities (RMBS) sold to MassMutual between 2005 and 2007. MassMutual’s complaint alleges that RBS Financial Products Inc. (then operating as Greenwich Capital Financial Products Inc.) made knowingly false representations as to the quality of the loans serving as collateral for the 10 securities RBS sold to MassMutual.

Because MassMutual had no access to the loan-level data underlying the deals, it relied on RBS’s allegedly false representations that the loans were underwritten in accordance with market standards.  MassMutual claims that RBS knew that the loans were issued based on overstated income, false verification of employment, and inflated appraisals, among other defects.  Additionally, the insurer claims that RBS routinely allowed exceptions to underwriting guidelines to approve loans for no reason other than its bottom line.

The parties filed a joint request to dismiss the case with prejudice, noting that they had reached a confidential settlement that would resolve all of MassMutual’s claims against RBS and related entities. The case was filed in U.S. District Court for the District of Massachusetts.

MassMutual has recently settled numerous other RMBS suits against big banks.  In March, it reached a settlement with Barclays Capital Inc. concerning the purchase of $175 million of RMBS.  And in October 2015, MassMutual settled with JPMorgan Chase & Co. regarding more than $2.3 billion worth of RMBS.  Additionally, the insurer has settled claims against HSBC Bank PLC, Bank of America Corp., UBS, and Deutsche Bank AG.  However, its claims against Credit Suisse Group Inc. and Goldman Sachs Group Inc. are still active.

Morgan Stanley Cannot Avoid Litigating Its Alleged RMBS Misconduct

Morgan Stanley continues to face the legal consequences of its actions leading up to and during the financial crisis. On August 11, the First Department of the Appellate Division in New York issued two decisions against the bank, both holding that claims against Morgan Stanley for its alleged misconduct involving residential mortgage backed securities (“RMBS”) should proceed.

In a case brought by trustee US Bank National Association (“US Bank”), the Appellate Division revived breach of contract and gross negligence claims against Morgan Stanley that had been dismissed by the New York Supreme Court in 2014. US Bank alleged that Morgan Stanley breached its contractual duty to notify the trustee of defects in the loans underlying the trust. On behalf of the trust, US Bank also claimed that Morgan Stanley failed to repurchase the loans after being made aware of numerous breaches of its own representations and warranties regarding the quality of the loans in the trust.

In another case brought by IKB International SA (“IKB”), a Luxembourg subsidiary of German lender and bank IKB Deutsche International AG, the First Department upheld the lower court’s 2014 denial of Morgan Stanley’s motion to dismiss IKB’s fraud claims. The court found that IKB had plausibly stated facts sufficient to show that Morgan Stanley, as underwriter of the RMBS whose name appeared on the offering documents, not only knew about the poor quality of the loans but also actively participated in the securitization process.

Morgan Stanley faces hundreds of millions of dollars in damages in both cases: the trust in the US Bank contract case suffered $111 million in losses and IKB alleges losses over $147 million in its fraud case.


The cases are: Morgan Stanley Mtge. Loan Trust 2006-13ARX v. Morgan Stanley Mtge. Capital Holdings LLC, case number 2016 NY Slip Op 05781; and IKB International SA in Liquidation et al. v. Morgan Stanley et al., case number 653964/2012.

PwC Fails in Bid to Terminate MF Global $1B Malpractice Suit

On August 5, U.S. Southern District Judge Victor Marrero denied PricewaterhouseCoopers’ (PwC) motion for summary judgment with respect to a $1 billion professional malpractice suit filed by the plan administrator for the now-defunct MF Global Holdings Ltd. (MF Global).

The suit accuses PwC of dispensing negligent accounting advice to MF Global on how to handle European sovereign debt deals that generated short-term income but saddled it with significant future liabilities.  The malpractice cause of action is the last remaining piece of MF Global’s three-claim lawsuit filed against PwC in August 2014 following MF Global’s collapse and Chapter 11 filing in October 2011.  PwC had acted as an outside auditor and accountant for MG Global before it went bankrupt.  MF Global is seeking at least $1 billion for PwC’s “extraordinary and egregious professional malpractice and negligence,” claiming that the accounting decisions PwC approved were substantial causes of MF Global’s bankruptcy.

After unsuccessfully moving to dismiss and upon conclusion of discovery, PwC moved for summary judgment.  PwC argued that MF Global could not overcome the affirmative defense of in pari delicto, i.e., that MF Global was equally responsible for the alleged malpractice because of its decision to implement PwC’s strategies, and that it could not show that PwC’s accounting advice caused MF Global’s collapse and subsequent harm to shareholders.  Judge Marrero denied summary judgment on both the equal fault and causation grounds, finding that “PwC has not satisfied its burden of demonstrating the absence of any genuine issue of material fact.”

Under the in pari delicto doctrine, “the pleadings and undisputed facts presented in the course of litigation must establish intentional wrongdoing by the plaintiff that is the subject of the litigation,” Judge Marrero wrote.  Judge Marrero held that PwC’s “broad reading of the doctrine” was “not in line” with New York law and would “insulate an auditor from liability whenever a company pursues a failed investment strategy after receiving wrongful advice from an accountant.”  The court concluded that “the record presented by [MF Global] could support a reasonable jury finding that MF Global developed preliminary conclusions about sale accounting in good faith and consistently asked PwC to review its conclusions,” but that MF Global still must prove that it “innocently accepted PwC’s negligent advice.”  On the causation issue, Judge Marrero found that the “resulting complex factual determination as to what harm to MF Global was caused by the negligent accounting advice and what harm was caused by the [company’s European sovereign debt strategy] is one for a factfinder to resolve.”

The case is captioned MF Global Holdings Ltd. v. PricewaterhouseCoopers LLP, case number 1:14-cv-02197, in the United States District Court for the Southern District of New York.

Barclays Agrees to $100 Million Settlement in LIBOR Manipulation Investigation

On August 8, Barclays Bank PLC and Barclays Capital Inc. (collectively “Barclays”) reached a $100 million settlement to resolve a 44-state multistate investigation that exposed Barclays’ fraudulent and anticompetitive schemes to manipulate the London Interbank Offered Rate (“LIBOR”) from 2005 to 2009.  The investigation, led by Attorney General Eric T. Schneiderman of New York and Attorney General George Jepsen of Connecticut, revealed that Barclays’ managers instructed LIBOR rate submitters to artificially lower their LIBOR submissions in order to avoid the appearance that Barclays was in financial difficulty.  Also, Barclays’ traders asked LIBOR rate submitters to adjust the submissions to benefit the traders’ positions.

LIBOR is a benchmark that is designed to reflect the cost of borrowing funds in the market, and it is applied to many types of financial instruments, including futures, swaps, options, and bonds.  It is also referenced by consumer lending products such as mortgages, credit cards, and student loans.  LIBOR manipulation had a widespread impact on global markets and consumers, including government entities and not-for-profit organizations.

New Jersey Attorney General Chris Porrino highlighted the importance of this settlement: “As we all recognize, when public confidence in banks and the practice of investing erodes, the entire economy can suffer.  This is an important settlement, not only for the recovery it provides for government entities and nonprofit organizations that were harmed, but also for the message it sends — that manipulation of financial markets is not acceptable and will not be tolerated.”

While Barclays is the first big bank to reach a settlement for LIBOR manipulation, it will likely not be the last.  Connecticut Attorney General George Jepsen stated that the multistate investigation “developed significant evidence that some banks, like Barclays, that were responsible for setting LIBOR rates intentionally manipulated LIBOR in order to protect their public image and to help the business side of their operations be more profitable.”

Shareholder Suits Against Volkswagen Advance in German Courts

Last week, a German regional court in Braunschweig ordered that shareholder litigation against Volkswagen AG proceed to a German court of appeals.  The 170 separate shareholder suits allege that Volkswagen defrauded investors when it concealed that the company falsified emissions data in 11 million of its diesel vehicles.   Together, the suits bring claims of nearly €4 billion.

Although German law does not provide for traditional American-style class action litigation, the Capital Markets Model Case Act allows a German trial court to refer multiple investor suits with common questions of fact or law to a court of appeals.  The appellate court then selects a bellwether case to try, the outcome of which will be binding on the remaining cases.

In the Volkswagen cases, the plaintiff private and institutional investors allege that the company evaded emissions standards by rigging the software in millions of its diesel cars to allow those vehicles to emit more pollution after initial testing by government regulators was complete, when the vehicles were sold to consumers.  The investors claim that Volkswagen decided to manipulate the emissions readings as early as 2005, and was put on notice of the fraud by both its suppliers and technicians in 2007.  Additionally, they allege that Volkswagen was aware of potential U.S. regulatory exposure as early as 2008, and further, that the company should have disclosed the issue after the EPA began investigating it in 2014.

Ultimately, the plaintiffs allege that Volkswagen had a duty to disclose both its fraud and the risk of ultimate government action against the automaker.  Without such disclosures, the investors were deprived of the opportunity to decide whether and when to sell their Volkswagen stock.  They allege that they were damaged in September 2015, when the company disclosed that it had rigged the emissions software.

Progress in the German suit could further encourage the plaintiffs of the shareholder class action pending against Volkswagen in California, where the company’s motion to dismiss is also pending.  Volkswagen has separately settled with the U.S. government, agreeing to pay $15 billion, repurchase or repair vehicles, repay car owners, and pay to promote zero-emission vehicles.

Class Action Accuses Big Banks of Colluding to Drive Up Treasury Yields

A Connecticut-based trading firm filed a class action lawsuit against 25 large banks, alleging they used their “privileged position” as primary dealers to collude to artificially depress the auction prices of U.S. Treasury securities at the expense of the Treasury and secondary market participants.  According to the complaint, the plaintiff, Torus Capital, LLC, performed a statistical analysis that revealed the Treasury auction yields were artificially high (and prices correspondingly low) “from at least 2007 through early June 2015,” when the Department of Justice (DOJ) announced it “had commenced an investigation into Defendants’ misconduct within the Treasuries markets.”  The DOJ investigation is ongoing.

The complaint describes findings from the analysis of “reissued Treasuries,” or securities auctioned by the Treasury that are identical in principal amount and maturity date to securities previously auctioned.  In a competitive market, since the reissued Treasuries are identical to those previously issued, the price and yield of the reissued securities and the previously auctioned securities trading on the secondary market should be the same or similar.  According to the complaint, the plaintiffs’ analysis found the yields “were inflated in 69% of the auctions, by 0.91 basis points,” a result the complaint alleges “cannot be explained as a result of random chance.”

The complaint seeks to certify a class of “many thousands” who sold Treasury securities or Treasury futures “around the time of a Treasury auction” and others who were parties to swaps, contracts, or other instruments where “cash flows were tied to a Treasury Security auction result” since January 1, 2007.  The action was filed on July 7 in the U.S. District Court for the Southern District of New York.

Former Barclays Traders Sentenced to Prison for LIBOR Manipulation

On July 7, the Southwark Crown Court in London sentenced four former Barclays traders to prison sentences, ranging from just under three years to six and a half years, for their involvement in a conspiracy to manipulate the London InterBank Offered Rate (“LIBOR”) between 2005 and 2007.  This trial was the third in Britain to focus on the global manipulation scandal.

The four traders, Peter Johnson, Jonathan Mathew, Jay Merchant, and Alex Pabon, and their colleagues, Stelios Contogoulas and Ryan Reich, were charged by the United Kingdom’s Serious Fraud Office (“SFO”) in 2014.  After an 11-week jury trial, the four traders were convicted of conspiring with each other and others to procure or make submissions of rates into the US Dollar LIBOR setting process.  The jury was unable to reach a verdict regarding Contogoulas and Reich, who will be retried in February 2017.

Former head of Barclays PLC dollar swaps desk in New York, Jay Merchant was portrayed as the ringleader of the conspiracy and received the longest sentence of six and a half years.  In Judge Anthony James Leonard QC’s Sentencing Remarks, he stated that Merchant “[bore] the greatest responsibility…It was under [his] leadership on the desk that the requests to the Libor submitters really took off.”  Even though Merchant received the longest sentence, the judge stated that he was “left in no doubt that [they] were all, for varying amounts of time, involved in a deliberate plan to manipulate the rates for [their] benefit and that of Barclays…”

Director of the SFO, David Green CB QC, commented that the “key issue in this case was dishonesty.”  He also explained how this trial illustrated the international effect of the LIBOR manipulation scandal: “The trial in this country of American nationals also demonstrates the extent to which the response to LIBOR manipulation has been international and the subject of extensive cooperation between US and UK authorities.”

While this verdict was a great victory for the SFO, it was by no means an end to their LIBOR investigation.  So far, a total of 19 individuals have been charged.  The SFO continues with its investigation, with six individuals awaiting trial on September 4, 2017, for the alleged manipulation of the Euro Interbank Offered Rate (“EURIBOR”).

Second Circuit Affirms Insurance Coverage Available for Lawsuits Alleging Intentional Misconduct

Financial services companies and their directors and officers are frequently the target of lawsuits alleging dishonest or fraudulent conduct.  Additionally, federal and state agencies increasingly target directors and officers for misconduct in the management of corporations and are devoting significant resources to investigating companies in the finance sector.

When properly structured, insurance provides one way to address the risk of such claims.  Although there is a common misconception that there can be no coverage for claims alleging intentional misconduct, insurance policies commonly provide such coverage.  For example, directors and officers liability insurance policies provide coverage for securities fraud and breach of fiduciary duty while employment practices liability policies provide coverage for claims alleging discrimination and wrongful termination.

A recent opinion by the United States Court of Appeals for the Second Circuit affirms this important point:  Nat’l Fire Ins. Co. v. E. Mishan & Sons, Inc. (“Emson”), 2016 U.S. App. LEXIS 10151 (2d Cir. June 1, 2016).  In the case, Emson faced two class action lawsuits alleging that it conspired with two other companies to deceptively trap customers into recurring credit card charges. The causes of action in the lawsuits included claims for fraud, violations of state consumer protection acts, violations of the Telephone Consumer Protection Act, and unjust enrichment.  After Emson sought coverage under its liability insurance policy, the trial court held that coverage was barred by a knowing violation exclusion because all of the allegations were caused by knowing violations of another’s rights.  On appeal, the Second Circuit reversed.  The court reasoned that it could not conclude “that the policy does not provide coverage, because the conduct triggering the knowing violation policy exclusion [was] not an element of each cause of action.”  The court noted that Emson could be liable even absent evidence “that it knowingly violated its customers’ right to privacy,” because “the actual conduct described [did] not rule out the possibility that Emson acted without intent to harm.”  The court, therefore, found that the insurer had an obligation to fully defend Emson in both lawsuits.

Given that they are frequently the target of suits alleging fraud, conspiracy, and other intentional wrongdoing, the case has broad implications for sophisticated companies engaged in the global capital markets.  The bottom line is that policyholders should not assume that a claim is not covered simply because it alleges intentional misconduct.  See also J.P. Morgan Sec. Inc. v. Vigilant Ins. Co., 126 A.D.3d 76, 82, 2 N.Y.S.3d 415, 419 (N.Y. App. Div. 2015) (payments by Bear Sterns to settle claim with SEC were not excluded by dishonest acts exclusion since settlement did not constitute adjudication of wrongdoing within meaning of exclusion).

Policyholders, however, are well-advised to make sure that their liability insurance policies are written to maximize the likelihood that such claims will be covered.  As highlighted by the Emson decision, exclusions that purport to bar coverage for dishonest or fraudulent conduct are one common obstacle to coverage for claims against financial institutions and financial services companies.  See, e.g., Dupree v. Scottsdale Ins. Co., 129 A.D.3d 586, 587, 12 N.Y.S.3d 62 (N.Y. App. Div.) (claims against chief investment officer alleging conspiracy to commit bank fraud, bank fraud, and making false statements were not covered following criminal conviction); see also Millennium Partners, L.P. v. Select Ins. Co., 24 Misc. 3d 212, 217, 882 N.Y.S.2d 849, 854 (Sup. Ct.) (funds paid by hedge fund to settle claim constituted disgorgement of improperly obtained funds and were not insurable).

To minimize the scope and effect of these types of exclusions, policyholders should carefully consider the way their insurance policies are drafted and address, among other things, the following three issues:

  • Make sure that the language of any dishonesty exclusion specifically identifies the conduct that will be excluded.  The exclusion should not bar coverage for “reckless” or “criminal” conduct, as that could limit coverage for a variety of common claims.
  • The application of any dishonesty exclusion should be tied to a final adjudication in the underlying case.  Including this language will help preserve coverage for defense costs and possibly settlements, and will help avoid a scenario where you are re-litigating the merits of the underlying claim in a subsequent coverage suit.
  • Include a severability clause in any dishonesty exclusion so that the exclusion applies only to the bad actor.  This way the exclusion does not bar coverage for any innocent insureds.