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New York Appellate Division Holds Bond Insurer Can Pursue Repurchase Obligations on Performing Loans
On April 2, the Supreme Court of New York, Appellate Division, held that loans underlying mortgage-backed securities need not be in default to trigger the lender’s repurchase obligations. MBIA Ins. Corp. v. Countrywide Home Loans Inc., No. 602825/2008, 2013 WL 1296525 (N.Y. Sup. Ct. App. Div. Apr. 2, 2013). The trial court granted partial summary judgment in favor of a bond insurer who alleges that a lender (i) fraudulently induced the insurer to insure securitized loans and (ii) breached representations and warranties in the transaction documents. On appeal, the court held that the contract at issue does not require a loan to be in default to trigger the defendant’s repurchase obligation. The court found that the relevant clause requires only that the inaccuracy underlying the repurchase request materially and adversely affect the interest of the insurer. If the insurer can prove that a loan which continues to perform materially and adversely affected its interests, it is entitled to have the lender repurchase the loan. The Appellate Division also (i) affirmed the trial court’s holding that causation is not required under New York insurance law to prevail on a fraud and breach of contract claim, and (ii) determined that the trial court erred in granting summary judgment on the issue of rescissory damages, holding instead that rescission is not warranted in this case.
SEC Approves Use of Social Media for Company Announcements
On April 2, the SEC issued a report that allows companies to use social media outlets to announce key information in compliance with Regulation Fair Disclosure (Regulation FD), provided investors have been alerted about which social media will be used to disseminate such information. The report reviews 2008 SEC guidance that clarified that websites can serve as an effective means for disseminating information to investors if the investors have been made aware in advance. The report determined that the policy is equally applicable to current and evolving social media communication channels. The report states that disclosure of material, nonpublic information on the personal social media site of an individual corporate officer, without advance notice to investors that the site may be used for this purpose, is unlikely to comply with existing regulations, even if the individual in question has a large number of subscribers, friends, or other social media contacts, such that the information is likely to reach a broader audience over time.
New York Federal Court Holds Dodd-Frank Rule Does Not Bar Late SEC Suits
On March 24, the U.S. District Court for the Eastern District of New York held that a Dodd-Frank Act rule requiring the SEC, within 180 days of notifying a target of the pendency of an investigation, to file an action or obtain an extension of time from an SEC director, does not provide for the dismissal of an enforcement action that does not comply with the rule. SEC v. NIR Group, LLC, No. 11-4723, slip op. (E.D.N.Y. Mar. 24, 2013). In deciding a motion in which the SEC sought to halt discovery into its compliance with the rule, the court explained that the statute does not explicitly provide for dismissal of an enforcement action that does not comply with the 180-day requirement, but that the absence of such a remedy does not render the provision superfluous. The court determined that evidence concerning compliance with the internal deadline is not relevant to the action. For that and other reasons, the court held that the evidence sought was not discoverable.
Senate Banking Committee Approves Nominees for Top CFPB, SEC Spots
On March 19, the Senate Banking Committee approved Mary Jo White to serve as SEC Commissioner/Chair through June 2014, and Richard Cordray to serve a five-year term as CFPB Director. The vote on Ms. White was 20-1. Senator Sherrod Brown (D-OH) was the lone dissenter, citing his general concern with nominees who previously worked for the industry they are intended to regulate. Mr. Cordray was approved on party lines, 12-10. In an opening statement Ranking Member Michael Crapo (R-ID) reiterated Republican opposition to any nominee until structural changes are made to the CFPB.
Supreme Court Declines Review of Second Circuit Decision Reinstating MBS Class Action
On March 18, the U.S. Supreme Court denied a petition seeking review of a Second Circuit decision that reinstated a class action against an underwriter and an issuer of mortgage-backed securities. Goldman Sachs & Co. v. NECA-IBEW, No. 12-528, 2013 WL 1091772 (2013). An institutional purchaser of certain MBS filed suit on behalf of a putative class alleging that the offering documents contained material misstatements regarding the mortgage loan originators’ underwriting guidelines, the property appraisals of the loans, and the risks associated with the certificates. After the district court dismissed the case, the Second Circuit reinstated and held that the plaintiff had standing to assert the claims of the class, even when the securities were purchased from different trusts, because the named plaintiff raised a “sufficiently similar set of concerns” to allow it to seek to represent proposed class members who purchased securities backed by loans made by common originators. With regard to the plaintiff’s ability to plead a cognizable injury, the court reasoned that while it may be difficult to value illiquid assets, “the value of a security is not unascertainable simply because it trades in an illiquid market.”
Senate Banking Committee Holds Confirmation Hearing for CFPB Director, SEC Commissioner
On March 12, the Senate Banking Committee held a confirmation hearing for Richard Cordray to serve as CFPB Director, and for Mary Jo White to serve as SEC Commissioner/Chairman. While majority and minority committee members commended Mr. Cordray for his leadership of the CFPB to date, the basic disagreement over the structure of the agency itself remains. Democrats maintain that Mr. Cordray deserves a confirmation vote, citing the facts that Congress already approved the structure of the CFPB, that it is the only financial regulator subject to a funding cap and whose rules are subject to a veto. Republicans argue that the CFPB lacks transparency and accountability, and that it should be changed to a commission structure and subject to congressional appropriations. In his testimony, Mr. Cordray stressed his efforts to be transparent and accountable, and Chairman Johnson (D-ND) entered into the record a letter from Rep. Stivers (R-OH) to the Committee calling on members to confirm Mr. Cordray as someone who could help bridge the gap on policy differences. Committee members also generally supported Ms. White. In her testimony, Ms. White addressed concerns from Senators on both sides about potential conflicts of interest given her recent work as a defense attorney, and stated her primary focus will be to finalize rules required by the Dodd-Frank Act and the JOBS Act. Additional priorities identified by committee members that Ms. White agreed should be agency priorities included finalizing rules for (i) credit rating agency conflicts of interest, (ii) money market funds, (iii) CEO pay versus median employee pay disclosures, (iv) high frequency trading, and (vi) crowd funding. Ms. White also pledged to vigorously enforce existing laws. The committee is scheduled to vote on both nominees on March 19, 2013.
Second Circuit Reinstates MBS Suit, Easing Standing Hurdle for Investors
On March 1, the U. S. Court of Appeals for the Second Circuit held that an investor plaintiff may be able to assert claims on behalf of a class for securities in which it had not invested, and additionally found that the investor had alleged sufficient facts of abandoned mortgage underwriting standards to survive defendants' motion to dismiss. N.J. Carpenters Health Fund v. The Royal Bank of Scot. Grp., PLC, No. 12-1701, 2013 WL 765178 (2d Cir. Mar. 1, 2013). An investor claimed on behalf of a putative class that the offering documents for six mortgage-backed securities (MBS) materially misrepresented the standards used to underwrite the loans. The district court initially dismissed the case as to five of the trusts, holding that the investor could not bring claims on securities in which it had not invested. The investor amended its complaint and focused on the one trust in which it had invested. The district court then held that the allegations were not specific enough to the loans at issue, and that the risks were sufficiently disclosed and known at the time of the transaction. After the district court's rulings, the Second Circuit held in another case, NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145 (2d Cir. 2012), that where an issuer had issued multiple securities under the same shelf registration statement, an investor who invested in at least some of those securities could, on behalf of a putative class, bring claims on securities in which it had not invested so long as all of the relevant claims involved "the same set of concerns." On appeal in the instant case, the Second Circuit held that in light of its decision in NECA-IBEW, the investor had standing to bring its claims as to all six of the original MBS. The court also held that the "allegations in the complaint-principally, that a disproportionately high number of the mortgages in a security defaulted, that rating agencies downgraded the security's ratings after changing their methodologies to account for lax underwriting, and that prior employees of the relevant underwriter had attested to systematic disregard of underwriting standards-state a plausible claim that the offering documents" violated the 1933 Securities Act. The court remanded the case for further proceedings.
U.S. Supreme Court Rejects SEC's Bid for More Time to Bring Civil Fraud Enforcement Action
On February 27, the U.S. Supreme Court held that the clock on the five-year statute of limitations for the SEC to pursue civil fraud claims under the Investment Advisers Act begins to run when the fraud occurs, and not when it is discovered, because the “discovery rule” does not apply to government enforcement actions for civil penalties. Gabelli v. SEC, No. 11-1274, 2013 WL 691002 (Feb. 27, 2013). The Court’s holding followed an investment adviser’s appeal from a Second Circuit decision that, under the discovery rule, the statute of limitations had not accrued until the fraud was discovered or could have been discovered with reasonable diligence because the claims sounded in fraud. The Court reversed the Second Circuit’s decision and remanded for further proceedings on the basis that extending the fraud discovery rule to government civil penalty enforcement actions would improperly leave defendants exposed to government action for an uncertain period beyond the five years after their alleged misdeeds. The Court explained that the discovery rule is meant to preserve the claims of parties who have no reason to suspect fraud, but that the government, here the SEC, is different insofar as it is specifically tasked with rooting out fraud and possesses several legal tools to that end. The Court also observed that, unlike a standard victim of fraud seeking only recompense, the government also seeks remedies intended to punish.
SEC National Examination Program Publishes 2013 Examination Priorities
On February 21, the NEP published its examination priorities for 2013. The NEP’s market-wide priorities include (i) fraud detection and prevention, (ii) corporate governance and enterprise risk management, (iii) conflicts of interest, and (iv) technology. The NEP also identifies priorities for its (i) investment advisers and investment companies, (ii) broker-dealers, (iii) clearing and transfer agents, and (iv) market oversight program areas. For example, for the investment advisers and investment companies program area, the NEP plans to focus on certain ongoing risks including (i) safety of assets, (ii) marketing and performance advertising, and (iii) fund governance, as well as certain new and emerging risks.
Federal District Court Issues First Ever Post-Trial Order Requiring Bank to Reimburse Monoline Insurer over Loans Backing MBS
On February 6, the U.S. District Court for the Southern District of New York found that loans underlying two trusts issued by a Michigan bank breached the representations and warranties in the contracts the bank entered with its bond insurer, and ordered the bank to pay over $90 million, plus interest and attorneys’ fees, to reimburse the insurer for payments made to the bond holders for losses incurred when the loans underlying the trusts defaulted. Assured Guaranty Municipal Corp. v. Flagstar Bank, 11-cv-02375, 2013 WL 440114 (S.D.N.Y. Feb. 6, 2013). The order is the first to impose lender liability for monoline insurer losses based on alleged underwriting defects. The order followed a 12-day bench trial in October 2012 that featured expert testimony presented by the insurer that relied on a statistical sample of the loans in the two pools at issue, and a separate review of certain loan files by the court. The court held that, “despite the unique characteristics of the individual members populating the underlying pool, the sample is nonetheless reflective of the proportion of the individual members in the entire pool exhibiting any given characteristic.” The court then adopted the insurer’s expert’s conclusion that 606 of the 800 loans reviewed were materially defective, while the court determined that the bank was unable to show actual instances where the loan files did not contain material breaches of the underwriting guidelines. Based on the sample loan evidence, the court held that the bank failed to meet its own underwriting requirements in originating the home equity loans that it subsequently pooled and securitized, which eventually defaulted, yielding losses for the insurer. Further, the court held that the bank was made “constructively aware” of the breaches through the insurer’s repurchase demand, yet the bank failed to cure or repurchase.