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New Jersey AG Files RMBS Suit
On December 18, New Jersey’s Acting Attorney General John Hoffman announced a lawsuit against a mortgage securitizer and related firms for allegedly violating state securities law by making fraudulent misrepresentations and omissions to promote the sale of RMBS to private investors. Specifically, the suit alleges that the firms misrepresented in the offering documents that mortgages underlying certain securities offered over a 12-month period in 2006-7: (i) were in substantial compliance with the underwriting standards of the originators of the loans; (ii) were originated "in accordance with accepted practices and prudent guidelines;" and (iii) did not have a negative equity. The suit alleges that the firms’ traders warned about the high risks of certain types of loans being securitized. The state claims that after the securities were issued, delinquency rates in the underlying pools increased substantially, and resulted in significantly reduced distributions to investors and write downs in the principal of underlying loans. The New Jersey AG is at least the second state attorney general to file such a suit as part of the federal-state RMBS)Working Group. New York Attorney General Schneiderman filed similar suits under New York law last year.
New York Appellate Court Resolves Trial Court Split Over Statute Of Limitations For Repurchase Suits
On December 19, the Supreme Court of New York, Appellate Division, held that the statute of limitations on claims related to mortgage repurchase obligations begins to run as of the date of closing of the loan purchase agreement. Ace Securities Corp v. DB Structured Prods., Inc., No. 650980/12, 2013 WL 6670379 (N.Y. App. Div. Dec. 19, 2013). The decision resolves a split at the trial court level that resulted from diverging opinions issued earlier this year, in which one court held that the clock on claims by trustees that a securitizer breached its contract by failing to repurchase began to run on the date the representations were made (i.e. the date the pooling and servicing agreement closed), while another court held that the statute did not begin to run until the securitizers improperly rejected the trustee’s repurchase demand, i.e. the breach is the failure to comply, not the date of the representation. On appeal of the latter holding, the court rejected the trustee’s and investors’ argument that the statute does not begin to run until the lender refused to cure or repurchase the defective loans, and held that the claims accrued on the closing date of the pooling and servicing agreement, at which time any alleged breach of the representations and warranties contained therein occurred.
Federal Agencies Finalize Volcker Rule
On December 10, the Federal Reserve Board, the OCC, the FDIC, the SEC, and the CFTC issued a final rule to implement Section 619 of the Dodd-Frank Act, the so-called Volcker Rule. Section 619 was a central component of the Dodd-Frank Act reforms, and the final rule and its preamble are lengthy and complex. The Federal Reserve Board released a fact sheet, as well as a guide for community banks. Generally, the final rule implements statutory requirements prohibiting certain banking entities from (i) engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity's own account, (ii) owning, sponsoring, or having certain relationships with a hedge fund or private equity fund, (iii) engaging in an exempted transaction or activity if it would involve or result in a material conflict of interest between the banking entity and its clients, customers, or counterparties, or that would result in a material exposure to high-risk assets or trading strategies, and (iv) engaging in an exempted transaction or activity if it would pose a threat to the safety and soundness of the banking entity or to the financial stability of the U.S. Exempted activities include: (i) market making; (ii) underwriting; (iii) risk-mitigating hedging; (iv) trading in certain government obligations; (v) certain trading activities of foreign banking entities; and (vi) certain other permitted activities. The compliance requirements under the final rules vary based on the size of the institution and the scope of activities conducted. Those with significant trading operations will be required to establish a detailed compliance program, which will be subject to independent testing and analysis, and their CEOs will be required to attest that the program is reasonably designed to achieve compliance with the final rule. The regulators state that the final rules reduce the burden on smaller, less-complex, institutions by limiting their compliance and reporting requirements. The rule takes effect on April 1 2014; however, the Federal Reserve Board announced that banking organizations covered by section 619 will not be required to fully conform their activities and investments until July 21, 2015.
SDNY Holds 2005 SEC Rule Change Did Not Alter Directors' Potential MBS Liability
On December 10, the U.S. District Court for the Southern District of New York held that the SEC’s promulgation of Rule 430B in 2005—which, among other things, broadened the category of disclosures that can be made in prospectus supplements rather than post-effective amendments to registration statements—did not alter the "liability date" for Section 11 liability for individuals who sign registration statements in the context of the shelf registration process. Fed.Hous. Fin. Agency v. HSBC N. Am. Holdings Inc., No. 1:11-cv-06201 (S.D.N.Y. Dec. 10, 2013). The ruling comes in the consolidated federal cases brought by the FHFA alleging numerous institutions misled Fannie Mae and Freddie Mac in connection with the packaging, marketing, sale and issuance of certain RMBS. The FHFA suits also named numerous individuals as a “control person[s]” under Section 15 of the Securities Act of 1933, or as directors or signing officers under Section 11 of the Securities Act. In response to a motion filed by more than 90 directors who signed the original registration statements but not the subsequent prospectus supplements, the court explained that Rule 430B deems newly disclosed information to be included in the registration statement, and Section 11 creates liability for signers whenever “any part of the registration statement, when such part became effective, contained an untrue statement of material fact or [omission].” The court interpreted the rule to mean that a prospectus supplement containing information representing a fundamental change in the information provided in the registration statement creates Section 11 liability for directors based on that new information. The court held that, as such, where there is a fundamental change in the information provided to the marketplace through the filing of a prospectus supplement, the new trigger dates for Section 11 liability will apply to those persons.
SCOTUS Agrees To Hear Challenge To Securities Class Actions "Fraud On The Market" Theory
On November 15, the U.S. Supreme Court agreed to hear a challenge to the long-standing “fraud-on-the-market” theory, on which securities class actions often are based. Halliburton v. Erica P. John Fund Inc., No. 13-317, 2013 WL 4858670 (Nov. 15, 2013). Halliburton petitioned the Court after an appeals court relied on the theory to affirm class certification in a securities suit against the company, even after the appeals court acknowledged that no company misrepresentation affected its stock process. As explained in the petition, the theory at issue derives from the Court’s holding in Basic Inc. v. Levinson, 485 U.S. 224 (1988) that a putative class of investors should not be required to prove that they actually relied in common on a misrepresentation in order to obtain class certification and prevail on the merits. The petitioner argues that Basic instead allows putative class members to invoke a classwide presumption of reliance based on the concept that all investors relied on the misrepresentations when they purchased stock at a price distorted by those misrepresentations. Halliburton has asked the Court to determine (i) whether the Court should overrule or substantially modify the holding of Basic, to the extent that it recognizes a presumption of classwide reliance derived from the fraud-on-the-market theory; and (ii) whether, in a case where the plaintiff invokes the presumption of reliance to seek class certification, the defendant may rebut the presumption and prevent class certification by introducing evidence that the alleged misrepresentations did not distort the market price of its stock.
SEC Announces Its First Ever Deferred Prosecution Agreement With An Individual
On November 12, the SEC announced a deferred prosecution agreement (DPA) with a former hedge fund administrator, the agency’s first ever DPA with an individual. The DPA follows a November 2012 SEC enforcement action against a hedge fund and its manager, who allegedly misappropriated more than $1.5 million from the hedge fund and overstated its performance to investors. The SEC action derived from and was aided by information provided by the hedge fund administrator. In return for the assistance provided, the SEC agreed to enter the DPA instead of pursuing allegations that the settling administrator aided and abetted the fund’s securities law violations. The DPA requires the administrator to disgorge $50,000, and prohibits the administrator from, (i) serving as a fund administrator or otherwise providing any services to any hedge fund for a period of five years, and (ii) associating with any broker, dealer, investment adviser, or registered investment company. The SEC states the agreement demonstrates its commitment to rewarding proactive cooperation. According to the SEC, the agreement strikes a balance between holding the administrator accountable for his part in the alleged misconduct, while giving him credit for reporting the fraud and providing full cooperation without any assurances of leniency.
Federal Magistrate Recommends Court Order Diligence Firm To Respond To RMBS Working Group Subpoena
On November 11, a U.S. Magistrate Judge for the U.S. District Court for the District of Connecticut recommended that the District Court grant the U.S. Attorney’s motion, filed on behalf of the federal-state RMBS Working Group, to enforce a subpoena seeking information and documents from a firm that performed due-diligence work on mortgage loans and loan pools for numerous financial institutions. U.S. v. Clayton Holdings, No. 3:13mc116 (D. Conn. Nov. 11, 2013). In its opposition, the diligence firm objected to the subpoena as a “fishing expedition” that would require it to produce information for all 193 of its clients, even after it has cooperated as a third-party witness in connection with 16 companies the Working Group has identified as subjects of its RMBS investigations. Generally, the magistrate determined that the government’s request was not overly broad and burdensome, and recommended that the court order the firm to produce, for the period 2005 through 2007, (i) its entire database and all data used, maintained, or accessed in connection with due diligence services on mortgage loans and mortgage loan pools, and (ii) all communications, including e-mails, instant messages, or Bloomberg messages, concerning the provision of due diligence services on mortgage loans and mortgage loan pools. The recommended ruling does restrict the response to information and documents related to work performed for specific financial institution clients. The parties have until November 25 to object to the recommendation.
FINRA Launches Enhanced BrokerCheck
On November 12, FINRA released an enhanced version of BrokerCheck, its online system that allows investors to research the professional background of investment professionals. The enhancements allow investors to search both the BrokerCheck and Investment Adviser Public Disclosure record of any securities professional or firm directly on the FINRA homepage. Additional changes were made to present data in a more user-friendly format.
FHFA Announces Substantial RMBS Settlement
On October 25, the FHFA announced that a large bank agreed to pay $4 billion to avoid further litigation over allegations that the offering documents it provided to Fannie Mae and Freddie Mac in connection with the sale of billions of dollars in RMBS included materially false statements or material omissions, resulting in massive losses to the enterprises. The FHFA has now resolved four of the 18 RMBS suits it filed in 2011. The FHFA announcement also noted that the bank had reached separate settlements with Fannie Mae and Freddie Mac totaling $1.1 billion to resolve disputes over representation and warranties in whole loans purchased by those entities.
SEC Action Targets Investment Adviser Custody Rule Violations
On October 28, the SEC announced enforcement actions against three investment advisory firms and certain executives for allegedly violating the “custody rule,” which was updated in 2010 and applies to SEC-registered investment advisory firms that have legal ownership or access to client assets or an arrangement permitting them to withdraw client assets. According to the SEC, in addition to other alleged securities violations, the firms allegedly failed to maintain client assets with a qualified custodian or engage an independent public accountant to conduct required surprise exams. To avoid further administrative proceedings, the firms and executives agreed to settle but did not admit the allegations. The firms and individuals collectively agreed to pay $535,000 in penalties, and one firm was required to disgorge nearly $350,000, inclusive of prejudgment interest. The firms also must submit to independent compliance reviews and implement certain specified compliance enhancements.