Second Circuit Affirms $806 million Judgment Against Nomura and RBS

Last month, the U.S. Court of Appeals for the Second Circuit upheld a 2014 ruling holding issuers of residential mortgage-backed securities (RMBS) liable for securities fraud. In the opinion by U.S. Circuit Judge Richard C. Wesley, the court emphasized the policies underlying the passage of the Securities Act of 1933 and related state laws, which aim to protect securities purchasers by imposing a duty on sellers of securities to disclose all material information before such public offerings.

The plaintiff-appellee Federal Housing Finance Agency (FHFA) brought suit in the Southern District of New York on behalf of government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac against Nomura Holding America Inc. (Nomura) and Royal Bank of Scotland Securities Inc. (RBS, and together, Defendants). From 2005 to 2007, Defendants sold RMBS certificates to the GSEs while knowingly making false representations in the accompanying offering materials that the mortgage loans underlying the RMBS were originated in accordance with the applicable underwriting guidelines.

The FHFA initially brought 15 similar actions against other financial institutions, but these all settled, allowing the FHFA to recover more than $20 billion in total. The case against Nomura and RBS proceeded to trial before Judge Denise Cote, who held that Defendants made material misstatements to the GSEs and thus awarded the agency rescission.

Affirming Judge Cote’s decision, the Second Circuit saw “no merit in any of [Defendants’] arguments” and held that Defendants violated the Securities Act. Dismissing Defendants’ assertions that the FHFA should have been aware of the misstatements, the court found that because Nomura had access to the mortgage loan files before the securitization, it was uniquely positioned to have the most knowledge about the loans. The court also agreed that Defendants’ partial compliance with widespread industry custom was no defense, because RMBS industry standards prior to the financial crisis generally fell far short of satisfying the duty of reasonable care.

The Second Circuit further held that neither the GSEs’ general knowledge about the mortgage loan industry nor their awareness that the market contained numerous poorly underwritten loans constituted actual knowledge of any specific problems with the loans underlying the RMBS they purchased. The court agreed that the GSEs were not required to investigate the truth of Defendants’ representations; rather, it was reasonable for the GSEs to rely on Defendants’ diligence in selecting and reviewing these loans.

The appellate court also affirmed that the statement in Defendants’ offering materials that the loans underlying the RMBS “were originated generally in accordance with the underwriting criteria,” was both false and material. Expert evidence revealed that vast numbers of these loans materially deviated from the mortgage originators’ underwriting criteria to an extent that negatively affected the value of the loans. The court recognized that such defects greatly affect credit risk and that these underwriting guidelines statements are crucial to a reasonable investor’s decision to move forward in making that investment.

Finally, the court dismissed Defendants’ loss causation defense, stating that Defendants’ irresponsible practices, in aggregation, were precisely what caused the housing bubble that created the financial crisis. Echoing the trial court, the Second Circuit held that Defendants failed to disprove that their misconduct contributed to the very problem they attempted to hide behind.

The case is Federal Housing Finance Agency v. Nomura Holding America, 15-1872-cv(L).

RBS Settles RMBS Claims in FHFA Settlement

On July 12, 2017, the Royal Bank of Scotland (RBS) and the Federal Housing Finance Agency (“FHFA”) announced an agreement to settle claims arising out of RBS’s sale of allegedly faulty residential mortgage-backed securities (“RMBS”).  RBS will pay $5.5 billion to settle the claims.

The FHFA, as conservator of Fannie Mae and Freddie Mac, filed a lawsuit against RBS in 2011 in the United States District Court for the District of Connecticut, alleging that RBS violated federal and state securities laws in the sale and underwriting of approximately $32 billion in RMBS purchased by Fannie Mae and Freddie Mac from 2005 to 2007.  See Federal Housing Finance Agency v. The Royal Bank of Scotland Group plc, et al. (D. Conn., Case No. 3:11-CV-01383 (AWT)).  The FHFA alleged that in RBS’s offering documents, RBS falsely represented that the underlying mortgage loans complied with certain underwriting guidelines and standards, including representations that significantly overstated the ability of borrowers to repay their mortgage loans.  Fannie Mae and Freddie Mac alleged that they relied upon these false and misleading statements and suffered massive losses because of these misrepresentations.

The lawsuit against RBS is one of eighteen similar lawsuits that the FHFA filed against participants in the mortgage finance sector, including Bank of America, JPMorgan Chase, Deutsche Bank, and HSBC.  The settlement with RBS is the FHFA’s seventeenth settlement in these eighteen cases.  In the eighteenth case, the FHFA prevailed against Nomura at trial; that verdict is currently the subject of an appeal.

RBS is still the subject of a separate U.S. Department of Justice (“DOJ”) investigation and is seeking to enter settlement negotiations with the DOJ.  RBS’s chief financial officer, Ewen Stevenson, commented that there have been “no discussions with the DOJ of any substance so far” but that RBS “would still like to get it resolved, if [it] could, during this calendar year.”

Credit Suisse and UBS Settle RMBS Claims with National Credit Union Administration

On May 1 and 3, UBS Securities LLC and Credit Suisse Securities USA LLC announced settlements of significant claims brought against them by the National Credit Union Administration (“NCUA”), the federal agency serving as liquidation agent for credit unions that folded during the economic crisis. Credit Suisse will pay $400 million and UBS $445 million to settle the NCUA claims.

The NCUA brought RMBS fraud claims against Credit Suisse, alleging that the bank made false and misleading statements about the quality of the mortgage loans underlying the RMBS it sold to three credit unions that later failed. In January, Judge John W. Lungstrum of the District of Kansas denied the NCUA’s motion for summary judgment, holding that there were triable issues of fact concerning whether the bank’s due diligence with respect to the mortgage loans could be a defense to the NCUA’s allegations.

Similar to its claims against Credit Suisse, the NCUA alleged that UBS made false and misleading statements in underwriting and selling RMBS to the U.S. Central Federal Credit Union and the Western Corporate Federal Credit Union. Those two defunct entities were the largest corporate credit unions in the country before being placed under NCUA conservatorship, largely due to losses on mortgage-backed securities. The NCUA alleged, among other things, that the originators of the mortgages underlying the UBS-sponsored RMBS “systematically abandoned” underwriting guidelines, resulting in significantly higher risk for the RMBS than indicated by its AAA ratings.

Including these recoveries, the NCUA has now amassed more than $5 billion in settlements from Wall Street banks stemming from the collapse of corporate credit unions that invested in toxic RMBS. The cases are National Credit Union Administration Board v. Credit Suisse Securities USA LLC et al., number 12-cv-2648, and National Credit Union Administration v. UBS Securities LLC, number 12-cv-02591, both venued in the District of Kansas.

RMBS Cases Seeking $3.7 Billion Dismissed for Lack of Standing

On Wednesday, April 12, Justice Ramos of the Commercial Division of the New York Supreme Court dismissed with prejudice four lawsuits filed by Royal Park Investments SA/NV (“Royal Park”).  The lawsuits alleged fraud and negligent misrepresentation with respect to residential mortgage-backed securities (“RMBS”) sold to Fortis NV/SA (“Fortis”) – formerly an independent Belgian bank that was sold off to BNP Paribas during the financial crisis – between 2005 and 2007.  The claims sought damages totaling $3.7 billion from four of the world’s largest banks: Morgan Stanley, Credit Suisse, Deutsche Bank, and UBS.

In 2009, Fortis and its affiliates transferred “all right, title and interest in and to” their RMBS holdings to Royal Park through the use of a portfolio transfer agreement (“PTA”), which did not expressly address the right to assert legal causes of action.  The four defendant banks moved to dismiss the complaints, contending that the representations made in the RMBS transaction documents were only made to the original purchaser (Fortis) and, under both New York and Belgian law, no transfer of the rights to sue for breaches of such representations had been made in the PTA, as the transfer of such rights must be explicit.

Justice Ramos agreed and – after determining New York law should be applied to the dispute – found that the only rights that had been explicitly transferred under the PTA were contractual rights unrelated to the right to assert legal causes of action, with no express assignment of the right to bring the common law misrepresentation claims.

Royal Park attempted to introduce a 2013 letter as extrinsic evidence purporting to show the intent to transfer all rights at law to sue over the RMBS holdings, but Justice Ramos found any such evidence was barred, holding that “[Royal Park] has failed to persuade this court that the plain terms of the [PTA] are ambiguous . . . [t]here is simply no language in the documents evidencing an outward expression of intent to assign the tort claims at issue.”

The cases are Royal Park Investments SA/NV v. Morgan Stanley et al., index number 653695/2013, Royal Park Investments SA/NV v. Deutsche Bank AG et al., index number 652732/2013, Royal Park Investments SA/NV v. Credit Suisse AG et al., index number 653335/2013, and Royal Park Investments SA/NV v. UBS AG et al., index number 653901/2013, in the Supreme Court of the State of New York, County of New York.

Appellate Decision on Loss Causation Is a Warning to RMBS Fraud Plaintiffs

Investment advisor TCW Asset Management Company (“TCW”) scored a major victory last week when an appellate court dismissed a $128 million RMBS fraud suit that was filed against it by two Australian-based Cayman Island hedge funds: Basis Pac-Rim Opportunity Fund (Master) and Basis Yield Alpha Fund (Master) (together, “Basis”).  Basis sued TCW for alleged fraud in selecting RMBS assets for, and recommending an investment in, a $400 million investment vehicle called Dutch Hill II.

On March 2, a five-judge panel of the First Department Appellate Division in New York reversed Justice Kornreich’s October 19, 2015, denial of TCW’s motion for summary judgment.  The panel found that Basis failed to present evidence of loss causation, i.e., that TCW’s alleged fraud caused Basis’ loss.  Once TCW made a showing that Basis’ loss was not due to any misrepresentations or omissions by TCW and that Dutch Hill II would have collapsed regardless as a result of the market crash, the burden shifted back to Basis to raise an issue of fact on loss causation.  The appellate panel’s decision turned on Basis’ “complete failure” to show that its loss was caused directly by TCW’s alleged fraud, and not by intervening economic forces such as the housing market crash.

RMBS fraud plaintiffs should heed the warning of the appeals court: in the event of a market collapse coincident with loss, investors must demonstrate loss causation by showing that misstatements rather than macroeconomic forces ultimately caused the loss.

The case is Basis Pac-Rim Opportunity Fund (Master) v. TCW Asset Management Co., docket number 654033/12, in the Supreme Court of the state of New York, Appellate Division, First Department.

Trustee Seeks Revival of Morgan Stanley Putback Claims

Attorneys for Deutsche Bank National Trust Co. argued recently to a First Department panel that several of the RMBS putback claims that it was pursuing as trustee against Morgan Stanley should be revived after they were dismissed in April for being untimely.  The claims were originally commenced when the Federal Housing Finance Agency filed summonses with notice on the final day before the expiration of the statute of limitations.  However, Deutsche Bank, as trustee, subsequently filed the complaints for the claims.  The trial court threw out the claims, finding that certificate holders lacked standing to sue and that the trustee could not benefit from tolling agreements entered into by Morgan Stanley and certain other certificate holders.

At the recent argument, Deutsche Bank’s attorney argued that the certificate holders were not barred from filing the summonses with notice and that the trustee could benefit from them, because they were filed derivatively.  In addition, he argued that Deutsche Bank was a third-party beneficiary of the tolling agreements at issue because the agreements applied to representatives of the certificate holders and that Deutsche Bank, as trustee, was a representative.  Morgan Stanley’s attorney argued that “merely purporting” to file derivatively did not allow the certificate holders to sidestep contractual provisions that deprived them of standing to sue.  He also argued that Deutsche Bank’s reliance on the word “representative” in the tolling agreements was misplaced because, read in its entirety, the provision at issue did not apply to the trustee, and the trustee represents the whole group of certificate holders, not any individual one.

The panel did not render a decision at the hearing.

$500 Million Suit Against UBS Dismissed on Jurisdictional Grounds

On December 7, New York Supreme Court Justice Eileen Bransten dismissed a $500 million lawsuit against UBS AG (“UBS”) brought by Ace Decade Holdings Limited (“Ace Decade”), a British Virgin Islands company, for lack of personal jurisdiction and forum non conveniens.  Ace Decade alleged that UBS fraudulently induced it to invest in shares of a company publicly traded in Hong Kong through a UBS-affiliated intermediary in Hong Kong, an affiliation that UBS concealed.  Ace Decade’s investment allegedly resulted in a loss of more than $500 million.

Ace Decade pled that both general and specific jurisdiction existed because UBS had systematic contact with New York and transacted business in New York that gave rise to the claims: the “cause of action [arose] from a transaction that UBS induced Ace Decade to make…months after Ace Decade moved to New York,” “UBS made misrepresentations to Ace Decade over several months while they were in New York,” and “UBS’s tortious acts injured Ace Decade in New York.”

In its motion to dismiss, UBS argued that under Daimler AG v. Bauman, 134 S. Ct. 746, 754 (2014), UBS is not subject to general jurisdiction in New York because UBS is incorporated in and has its principal place of business in Switzerland.  Furthermore, UBS argued that New York lacked specific jurisdiction because the transactions giving rise to Ace Decade’s claims occurred in Hong Kong, not New York.  Lastly, UBS argued that New York was not a convenient forum for several reasons, including the fact that trying the case in New York would impose undue hardship on UBS because almost all relevant witnesses and documents were abroad.

Justice Bransten agreed with UBS and held that the Court lacked personal jurisdiction.  She stated that “the record makes clear that the ‘original critical events’ associated with the [i]nvestment occurred in Hong Kong.”  The fact that Ace Decade moved to New York after entering into all relevant agreements and committing to make an investment was not a sufficient basis for jurisdiction.  The Court also concluded that even if it could properly exercise jurisdiction, the action would be dismissed based on forum non conveniens because all relevant documents and witnesses are located in Hong Kong.

Dismissal Affirmed in CIFG’s $100M CDO Suit Against Bear Stearns

On November 29, a five-judge panel of New York’s Appellate Division affirmed the dismissal of CIFG Assurance North America, Inc.’s (“CIFG”) claims against Bear Stearns & Co. (now known as J.P. Morgan Securities LLC (“J.P. Morgan”)) based on alleged material misrepresentations in connection with an insurance contract.  However, the panel found that CIFG’s claims should not have been dismissed with prejudice because CIFG should have been given an opportunity to replead.

The complaint alleged that Bear Stearns & Co. (“Bear Stearns”) made material misrepresentations that induced CIFG to provide financial guaranty insurance in connection with two collateralized debt obligations (“CDOs”).  According to CIFG, Bear Stearns created the CDOs to rid itself of toxic, high-risk residential mortgage-backed securities (“RMBS”) that it was carrying on its books.  CIFG alleged that Bear Stearns needed a third party to insure the CDOs’ senior tranches to make them marketable to investors.  Bear Stearns approached CIFG to provide financial guaranty insurance on certain senior notes issued by the CDOs and made material misrepresentations to induce CIFG to do so.  Specifically, Bear Stearns allegedly represented to CIFG that the CDOs’ assets would be selected by independent and reputable collateral managers when, in reality, Bear Stearns allegedly paid off the managers to allow itself to choose the collateral and load the CDOs with the toxic RMBS from its own books.  CIFG also claimed that Bear Stearns held a number of short positions against the CDOs’ portfolios and profited substantially therefrom.  Due to the large volume of toxic RMBS in the portfolios, both CDOs collapsed within a year of closing, which forced CIFG to pay over $100 million to discharge its liabilities under the insurance.  CIFG alleges that it would have never issued the insurance had it known that the collateral managers would be taking direction from Bear Stearns.

In affirming the dismissal, the Appellate Division found that the “complaint contains insufficient information about the insurance policies CIFG was allegedly fraudulently induced to issue, and the circumstances under which those policies were issued.”  Furthermore, the Appellate Division found that the complaint failed to include any detail as to how Bear Stearns “solicited” the insurance from CIFG and was void of any information about the underlying CDO transaction.  Lastly, the panel noted that “the complaint merely states that CIFG paid over $100 million to discharge its liabilities under the insurance, but does not identify to whom those payments were made, or the events that triggered the payments.”  Based on all of these deficiencies, the panel held that CIFG’s misrepresentation claim did “not clearly inform defendant as to the complained-of incidents, and it was properly dismissed.”  Nonetheless, the Appellate Division held that CIFG should be given an opportunity to replead and rejected J.P. Morgan’s argument to dismiss the claim as time-barred.

The case is captioned CIFG Assurance North America Inc. v. J.P. Morgan Securities LLC, index number 654074/2012, in the New York Supreme Court, Appellate Division, First Department.

First Department Reverses Dismissal of RMBS Claims Against Morgan Stanley and Credit Suisse

Earlier last month, the Appellate Division, First Department, reversed a trial court’s dismissal of investment fund Phoenix Light’s $700 million residential mortgage-backed securities (RMBS) fraud suits against Credit Suisse and Morgan Stanley. In a brief opinion, the appellate court held that Phoenix Light’s allegations that it relied on defendants’ misrepresentations and omissions in their respective RMBS offering materials were sufficient to state a fraud claim.

Justice Ramos of the Supreme Court of the State of New York, Commercial Division, had previously granted the defendants’ motions to dismiss Phoenix Light’s common law fraud, fraudulent inducement, and aiding and abetting fraud claims. In so holding, Justice Ramos relied on the fact that Phoenix Light never alleged that it requested mortgage loan files or due diligence reports from the defendants to conduct independent analysis of the loans underlying the RMBS. Phoenix Light argued that such requests to the defendants would have been futile, but the trial court held that a sophisticated investor should have done so.

The Appellate Division disagreed, relying on its prior decision in IKB International S.A. v. Morgan Stanley, 142 A.D.3d 447 (1st Dept. 2016), among other authority. In IKB’s case against Morgan Stanley, the First Department concluded that even if the plaintiff bank had demanded loan files from Morgan Stanley, the defendant would not have provided said files. Thus, IKB’s allegations of justifiable reliance were sufficient as pleaded. Further, in the Phoenix Light opinion, the court noted that RMBS plaintiffs are not required to plead that they received representations and warranties made directly by defendants concerning the underlying loans, merely that such representations and warranties were made to the defendants by third parties with the relevant information. As such, Phoenix Light’s pleaded reliance on the defendants’ offering materials was sufficient.

The cases are captioned Phoenix Light SF Ltd. et al. v. Credit Suisse AG et al., index number 653123/2013, and Phoenix Light SF Ltd. et al. v. Morgan Stanley et al., index number 652986/2013.

JPMorgan Chase & Co. Settles for $264 Million After Allegedly Catering to Asia’s Elite Through Its “Sons & Daughters Program”

JPMorgan Chase & Co. (“JPMorgan”), the largest U.S. bank based on assets, has agreed to pay a $264 million fine to settle Foreign Corrupt Practices Act (“FCPA”) investigations into its preferential hiring program. The program, known internally as the Sons & Daughters Program, was created by investment bankers at its subsidiary, JPMorgan Securities Asia Pacific Limited.  The FCPA, enacted in 1977, prohibits companies from paying money or “anything of value” to foreign officials in order to “obtain or retain business.”

The investigation, launched by the Securities and Exchange Commission (“SEC”) in 2013, probed whether JPMorgan violated the FCPA by giving jobs and internships to the friends and relatives of clients and government officials in the Asia-Pacific region, particularly in China, to win lucrative business deals. The investigation found that, between 2006 and 2013, JPMorgan hired hundreds of (typically unqualified) interns and employees at the behest of government officials and clients in Asia, and generated $100 million in revenues.

The $264 million settlement will be split among three U.S. government regulatory agencies: $130 million to the SEC; $72 million to the Department of Justice (“DOJ”); and $61.9 million to the Federal Reserve. By cooperating with the investigation, JPMorgan avoided criminal prosecution by the DOJ and entered into a three-year “non-prosecution” agreement requiring the bank to implement enhanced internal compliance programs. After the investigation, JPMorgan fired six employees who engaged in misconduct or failed to identify the problem. It also disciplined 23 additional employees who failed to detect the prohibited practices or acted at the direction of supervisors. The bank also penalized current and former employees $18.3 million for their actions.

In addition to investigating JPMorgan, government regulators reportedly contacted other big banks, including HSBC, Goldman Sachs, Deutsche Bank, Citigroup, and Morgan Stanley. The global banking community was put on edge by the investigation, as hiring well-connected people for financial jobs has been common in China.

“The so-called Sons and Daughters Program was nothing more than bribery by another name,” said Assistant Attorney General Leslie Caldwell. The assistant AG further stated that “[a]warding prestigious employment opportunities to unqualified individuals in order to influence government officials is corruption, plain and simple.”

JPMorgan spokesperson Brian Marchiony, said in a statement that “[w]e’re pleased that our cooperation was acknowledged in resolving these investigations. The conduct was unacceptable.” Marchiony added, “[W]e have also made improvements to our hiring procedures, and reinforced the high standards of conduct expected of our people,” noting that the bank’s commitment to the Asia-Pacific region “is as strong as ever.”