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On August 10, the FDIC filed five actions that collectively seek to recover over $740 million from numerous financial institutions based on claims that the institutions violated federal and state securities laws in the offering of certain residential mortgage-backed securities to a now failed bank. As receiver for the failed bank, the FDIC alleges that the institutions omitted key facts and made numerous false statements of material fact about the securities, including about the credit quality of the mortgage loans that backed the securities. The material misstatements and omissions, according to the FDIC, contributed to substantial losses at the failed bank and subsequent costs to the Federal Deposit Insurance Fund. The suits, which were filed in the U.S. District Courts for the Central District of California (Case No. 12-06911) and the Southern District of New York (Case No. 12-6166), as well as the Circuit Court for Montgomery County, Alabama (Case Nos. 03-CV-2012-901035.00,03-CV-2012-901036.00,03-CV-2012-901037.00), are similar to others filed by the FDIC, the NCUA, and the FHFA.
Second Circuit Holds that Allegation of Actual Knowledge Not Necessary for SEC to State Claim Against Aiders and Abettors
On August 8, the U.S. Court of Appeals for the Second Circuit overturned a district court holding that an individual must be a proximate cause of harm to be found liable as an aider and abettor of securities misconduct. SEC v. Apuzzo, No. 11-696, 2012 WL 3194303 (2nd Cir. Aug. 8, 2012). The SEC's civil enforcement action alleges that the individual defendant assisted another firm and its CFO (the primary violators) in carrying out fraudulent securities transactions. In his motion to dismiss, the defendant argued that the SEC did not adequately allege that he had actual knowledge of the violation or that he rendered substantial assistance to the primary violators. The district court dismissed the case, holding that to properly claim substantial assistance, the SEC must allege facts that support the conclusion that the defendant was a proximate cause of the violation. On appeal, the court invalidated the district court’s proximate cause test and held that to properly allege substantial assistance in support of securities misconduct, the SEC need only allege that the individual associated himself with the undertaking and willfully participated in efforts to make it succeed. After applying this lower threshold, the appeals court reversed and remanded the case, concluding that the SEC sufficiently pled that the defendant aided and abetted the primary violators.
On July 25, the U.S. District Court for the District of Kansas denied a motion to dismiss that sought to dispose of allegations that the defendant financial institutions misled investors in connection with the sale of certain mortgage-backed securities (MBS). Nat. Credit Union Admin. Bd. v. RBS Secs., Inc., No. 11-2340, 2012 WL 3028803 (D. Kan. Jul. 25, 2012). The NCUA brought the suit against several MBS-issuers on behalf of a failed credit union for which it had been appointed conservator, arguing that the MBS issuers’ documents used in offering the MBS contained material misstatements and omissions that led to substantial losses to the investor credit union and the NCUA Stabilization Fund. The facts and arguments are similar to those NCUA has presented in several cases around the country in an effort to recover MBS-related losses for failed institutions. Here, the MBS issuers argued that the NCUA complaint exceeded the statute of limitations, having been filed more than three years from the issuance of the securities. The issuers maintained that the failed institution should have been able to identify the issues within the statutory limit. The court disagreed and held that the federal extender statute applied, allowing NCUA to bring the case beyond the three year limit. Because the government could not have known the details of the offerings until after it became conservator, and given that ambiguous statutes of limitations should be construed in favor of the government, the court determined the NCUA claims were timely. The court also held that the NCUA presented evidence sufficient to maintain a plausible claim of misrepresentation, except with regard to certain credit enhancement language that the NCUA charged was untrue and material.
Senators Unveil Bill to Increase SEC Civil Penalties; House Members Propose Competing Bills to Enhance the SEC's Investment Adviser Oversight
On July 23, Senators Reed (D-RI) and Grassley (R-IA) unveiled legislation to increase statutory limits on SEC civil monetary penalties to $1 million per violation for individuals, and $10 million per violation for entities. The bill, S. 3416, would also allow for the size of penalties to be linked to the scope of harm and associated investor losses, and provide substantially higher penalties for repeat offenders. The legislation follows a letter SEC Chairman Shapiro sent to Senators Reed and Crapo (R-ID) in November 2011, seeking reforms to the SEC’s authority to impose civil penalties.
On July 24, Representatives Waters (D-CA), Frank (D-MA), and Capuano (D-MA) announced new legislation, H.R. 6204, that would provide the SEC with the authority to impose user fees on investment advisers for the purpose of funding an increase in the number and frequency of SEC examinations. This bill follows an earlier bill from Reps. Bachus (R-AL) and McCarthy (D-NY), H.R. 4624, which also seeks to improve oversight of investment advisers, but through the establishment of self-regulatory organizations overseen by the SEC that investment advisers with retail customers would be required to join.
On July 11, the U.S. District Court for the Southern District of New York declined to dismiss the majority of the claims brought by a putative class alleging that a national bank, certain of its current and former officers and directors, multiple underwriters, and the bank’s third-party accounting auditor, deliberately concealed the bank’s reliance on an electronic registry system and its exposure to MBS loan repurchase claims. Pa. Pub. Sch. Employee’s Ret. Sys. v. Bank of Am. Corp. No. 11-733, 2012 WL 2847732 (S.D.N.Y. Jul. 11, 2012). In this case, a state retirement system alleges on behalf of similarly situated shareholders that the bank misrepresented that it had “good title” to loans even though multiple courts had blocked the bank’s attempts to foreclosure based on the bank’s use of an electronic registry system. The court, in declining to dismiss these claims, held that the use of the registry system “clouded” the bank’s ownership of many loans, thereby causing the bank to publish misleading shareholder information. The court also declined to dismiss allegations that the defendants misstated or omitted the bank’s exposure to repurchase claims. Further, claims that the bank misled investors about its internal controls also survived. Several other claims, including certain claims against the directors and officers were dismissed without prejudice, while other certain other claims against the defendants were dismissed with prejudice.
On July 5, the SEC announced Norm Champ as the new Director of the SEC’s Division of Investment Management. Mr. Champ has been serving as Deputy Director of the SEC’s Office of Compliance Inspections and Examinations. Prior to joining the SEC in 2010, Mr. Champ was general counsel and a partner at investment management firm Chilton Investment Company. On July 9, the SEC announced that beginning August 6, 2012, Paula Drake will serve as Associate Director, Chief Counsel and Chief Compliance and Ethics Officer. Ms. Drake joins the SEC from Oechsle International Advisors, LLC, where she served as General Counsel and Chief Operating Officer.
This week the CFTC and the SEC approved jointly written rules and guidance to further define “swap”, “security-based swap,” and other related terms for use in regulating over-the-counter (OTC) derivatives. The Dodd-Frank Act defines these terms but also requires both the SEC and CFTC to jointly define the terms further and jointly establish regulations regarding “mixed swaps” as may be necessary to carry out the purposes of swap and security-based swap regulation under the Act. The SEC and CFTC final rules and guidance identify specific products and services that do and do not fall within the further-defined terms. The approved rules will take effect 60 days after being published in the Federal Register. The approval of the definitions also triggers the period for swap dealers to comply with other Dodd-Frank Act rules put in place to regulate the OTC derivatives markets. The CFTC also approved a final rule that implements an exemption to the clearing requirement for non-financial entities and financial institutions with total assets of $10 billion or less that hedge or mitigate business risk through swaps.
On June 29, the U.S. District Court for the Southern District of New York granted the plaintiffs motion to certify a class in a putative class action concerning the sale of mortgage backed securities (MBS) by an investment bank. Tsereteli v. Residential Asset Securitization Trust 2006-A8, No. 08 Civ. 10637, 2012 WL 2532172 (S.D.N.Y. June 29, 2012). In Tsereteli, the plaintiffs alleged that the sale of the MBS violated the Securities Act of 1933, because the offering documents falsely represented that the underlying mortgage loans were originated in accordance with the lenders underwriting standards. According to the plaintiffs, the lender had in fact abandoned its underwriting standards and routinely made loans to borrowers who were unable to meet their repayment obligations. The bank, among other things, argued that Rule 23s predominance requirement was not met because certain sophisticated investors were aware of the alleged misstatements when they purchased the securities. The court, however, found that [g]eneral investment sophistication of certain class members does not show that any of the class members knew anything at all about [the lenders] alleged deviation from its underwriting guidelines.
On June 28, the Appellate Division of the Supreme Court of New York, First Department unanimously confirmed the New York Supreme Courts dismissal of a mortgage-buyback lawsuit brought by investors against a bank, holding that the investors action was barred by the no-action clause in the Pooling and Servicing Agreements (PSAs). Walnut Place LLC v. Countrywide Home Loans, Inc., No. 8046, 650497/11, 2012 slip op. 0521 (N.Y. App. Div. June 28, 2012). The Appellate Division found that the no-action clausea clause limiting the right to suewas not ambiguous and only allowed investors to sue under an event of default provision which was not applicable under the set of facts before the court. The case was brought by several entities collectively known as Walnut Place LLC, who had invested more than $1 billion in securities backed by the banks mortgages. The investors claimed that the bank made false representations about the characteristics and credit quality of loans underlying the securities in the PSAs.
On July 3, the SEC announced that Ken C. Joseph will lead the Investment Adviser/Investment Company Examination Program for the New York Regional Office. Mr. Joseph previously served for 16 years as a Staff Attorney, Branch Chief, and Assistant Director in the SEC’s Division of Enforcement in Washington, DC and New York.
On July 2, the FDIC announced that Doreen R. Eberley will oversee all examination activities of the FDIC’s regional and field supervisory operations as Senior Deputy Director for Supervisory Examinations in the Division of Risk Management Supervision. Ms. Eberley currently serves as New York Regional Director and has been with the FDIC for 25 years. The FDIC also announced that Andrew Gray will serve as Deputy to the Chairman for Communications and Eric Spitler will serve as Director of the Office of Legislative Affairs.