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Two Federal Courts Hold Government MBS Claims Were Untimely
On April 9, the U.S. District Court for the Central District of California dismissed claims brought by the FDIC as receiver for a failed bank against a financial institution related to 10 MBS certificates sold to the bank, holding that the FDIC’s claims were time-barred. Fed. Deposit Ins. Corp. v. Countrywide Secs. Corp., No. 12-6911, slip op. (C.D. Cal. Apr. 9, 2013). The court found that “a reasonably diligent plaintiff had enough information about false statements in the Offering Documents of [the firm’s] securities to file a well-pled complaint before” the statute of limitations expired on August 14, 2008. The court noted that deviations from stated underwriting guidelines and inflated appraisals had come to light prior to the expiration of the statute of limitations through “multiple lawsuits” and “numerous media sources.” The court found that it was irrelevant that the FDIC was named receiver for the bank because “[t]he FDIC [did] not have the power to revive expired claims.” Similarly, on April 8, the U.S. District Court for the District of Kansas granted, in part, a motion to dismiss federal and state claims brought by the NCUA on behalf of three failed credit unions against a financial institution related to certain MBS certificates sold to the credit unions, holding that certain NCUA claims were time-barred. Nat’l Credit Union Admin. Bd. v. Credit Suisse Secs. (USA) LLC, No. 12 Civ. 2648, 2013 WL 1411769 (D. Kan. Apr. 8, 2013). The court found that the applicable federal and state law statutes of limitations required claims to be filed within one or two years of discovery of the alleged misstatement or omission, and within three or five years of sale or violation, respectively. The judge dismissed the federal and state claims for 12 of the MBS certificates as untimely, but preserved federal claims as to eight certificates, determining that the statutes of limitations were tolled on those claims. In addition, the court found that (i) venue was proper because defendant engaged in activity that would constitute the transaction of business in the district for purposes of the applicable venue statute and (ii) plaintiff set forth plausible claims for relief.
Second Circuit Allows FHFA MBS Suits to Proceed
On April 5, the U.S. Court of Appeals for the Second Circuit affirmed a district court’s partial denial of a financial institution’s motion to dismiss on standing and timeliness grounds a suit brought by the FHFA. Fed. Hous. Fin. Agency v. UBS Americas, Inc., No. 12-3207, 2013 WL 1352457 (2d Cir. Apr. 5, 2013) The FHFA brought multiple suits against numerous institutions alleging that the offering documents provided to Fannie Mae and Freddie Mac in connection with the sale of $6.4 billion in residential MBS included materially false statements or omitted material information, resulting in massive losses. The institutions moved to dismiss, contending that (i) the securities claims were time-barred, (ii) FHFA had no standing to pursue the action, and (iii) a negligent misrepresentation claim failed to state a claim upon which relief could be granted. The district court denied the motion to dismiss with respect to the statutory claims and granted it only with respect to the negligent misrepresentation claim. On appeal, the Second Circuit held that the action, filed within three years after the FHFA was appointed conservator of Freddie Mac and Fannie Mae, was timely under the relevant sections of Housing and Economic Recovery Act, and that the FHFA has standing to bring the action. The decision, on interlocutory appeal from the U.S. District Court for the Southern District of New York, holds implications for more than a dozen other similar actions the FHFA has filed.
NCUA Announces Pre-Litigation MBS Settlement
On April 2, the NCUA announced that a financial institution agreed to settle allegations related to mortgage-backed securities issued to certain corporate credit unions. The NCUA has alleged on behalf of failed corporate credit unions that certain MBS issuers made numerous misrepresentations and omissions in MBS offering documents regarding adherence to the originators’ underwriting guidelines, which supposedly concealed the true risk associated with the securities and routinely overvalued them. When the allegedly risky securities lost value, the NCUA claims, the credit unions were forced into conservatorship and liquidated as a result of the losses sustained. In this settlement, the institution did not admit fault but agreed to pay $165 million to avoid threatened litigation. The settlement adds to the $170.75 million the NCUA already has obtained from four other institutions, and the agency continues to pursue additional institutions in 10 pending lawsuits.
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.
Insights Into The Financial Fraud Enforcement Task Force Priorities for 2013
On March 20, 2013, Michael Bresnick, Executive Director of DOJ’s Financial Fraud Enforcement Task Force gave a speech at the Exchequer Club of Washington, DC highlighting recent accomplishments of the Task Force and outlining its priorities for the coming year. He began by discussing a number of areas of known focus for the Task Force, including RMBS fraud, fair lending enforcement, and servicemember protection. He then outlined three additional areas of focus that the Task Force has prioritized, including (i) the “government’s ability to protect its interests and ensure that it does business only with ethical and responsible parties;” (ii) discrimination in indirect auto lending; and (iii) financial institutions’ role in fraud by their customers, which include third party payment processors and payday lenders.
The third priority, which was the focus of Mr. Bresnick’s remarks, involves the Consumer Protection Working Group’s prioritization of “the role of financial institutions in mass marketing fraud schemes -- including deceptive payday loans, false offers of debt relief, fraudulent health care discount cards, and phony government grants, among other things -- that cause billions of dollars in consumer losses and financially destroy some of our most vulnerable citizens.” He added that the Working Group also is investigating third-party payment processors, the businesses that process payments on behalf of the fraudulent merchant. Mr. Bresnick explained that “financial institutions and payment processors . . . are the so-called bottlenecks, or choke-points, in the fraud committed by so many merchants that victimize consumers and launder their illegal proceeds.” He said that “they provide the scammers with access to the national banking system and facilitate the movement of money from the victim of the fraud to the scam artist.” He further stated that “financial institutions through which these fraudulent proceeds flow . . . are not always blind to the fraud” and that the FFETF has “observed that some financial institutions actually have been complicit in these schemes, ignoring their BSA/AML obligations, and either know about -- or are willfully blind to -- the fraudulent proceeds flowing through their institutions.” Mr. Bresnick explained that “[i]f we can eliminate the mass-marketing fraudsters’ access to the U.S. financial system -- that is, if we can stop the scammers from accessing consumers’ bank accounts -- then we can protect the consumers and starve the scammers.”
Mr. Bresnick stated that the Task Force’s message to banks is this: “Maintaining robust BSA/AML policies and procedures is not merely optional or a polite suggestion. It is absolutely necessary, and required by law. Failure to do so can result in significant civil, or even criminal, penalties under the Bank Secrecy Act, FIRREA, and other statutes.” He noted that banks should endeavor not only to know their customers, but also to know their customers’ customers: “Before they agree to do business with a third-party payment processor, banks should strive to learn more about the processors’ merchant-clients, including the names of the principals, the location of the business, and the products being sold, among other things.” They further should be aware of glaring red flags indicative of fraud, such as high return rates on the processor’s accounts: “High return rates trigger a duty by the bank and the third-party payment processor to inquire into the reasons for the high rate of returns, in particular whether the merchant is engaged in fraud.” (See BuckleySandler’s previous Spotlight on Anti-Money Laundering posts here, here and here.) Mr. Bresnick underscored this point by mentioning a recent complaint filed by the DOJ in the Eastern District of Pennsylvania.
With respect to the financial institutions’ relationships with the payday lending industry, Mr. Bresnick stated that “the Bank Secrecy Act required banks to have an effective compliance program to prevent illegal use of the banking system by the banks’ clients.” He explained that financial institutions “should consider whether originating debit transactions on behalf of Internet payday lenders – particularly where the loans may violate state laws – is consistent with their BSA obligations.” Although he acknowledged that it was not a simple task for a financial institution to determine whether the loans being processed through it are in violation of the state law where the borrower resides, he suggested “at a minimum, banks might consider determining the states where the payday lender makes loans, as well as what types of loans it offers, the APR of the loans, and whether it makes loans to consumers in violation of state, as well as federal, laws.”
In concluding, Mr. Bresnick said, “It comes down to this: When a bank allows its customers, and even its customers’ customers, access to the national banking system, it should endeavor to understand the true nature of the business that it will allow to access the payment system, and the risks posed to consumers and society regarding criminal or other unlawful conduct.”
The agenda outlined by Mr. Bresnick reinforces ongoing efforts by FinCEN and the FDIC, and adds to the priorities recently sketched out by CFPB and the OCC. Together they describe an ambitious, and increasingly aggressive, financial services enforcement agenda for federal regulators and enforcement authorities.
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.”
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.
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.
DOJ, State AGs File Civil Fraud Suits against Ratings Agency over RMBS Ratings; Buckley Offers Complimentary FIRREA Webinar
On February 5, the DOJ filed a lawsuit in the Central District of California against a major credit rating agency, alleging that the firm defrauded investors in residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) by issuing inflated ratings that misrepresented the securities’ true credit risks, and by falsely representing that its ratings were uninfluenced by its relationships with investment banks. According to the complaint, the agency publicly represented that its ratings of RMBS and CDOs were objective and independent, notwithstanding the potential conflict of interest posed by the agency being selected to rate securities by the investment banks that sold those securities. The complaint alleges that, in fact, fear of losing market share and profits led the company to (i) weaken the ratings criteria and analytical models it used to assess credit risks posed by RMBS and CDOs, and (ii) issue inflated ratings on hundreds of billions of dollars’ worth of CDOs. When CDO’s rated by the agency failed, investors lost billions of dollars. The DOJ brings claims under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), alleging that the company engaged in (i) mail fraud affecting federally insured financial institutions, (ii) wire fraud affecting federally insured financial institution, and (iii) financial institution fraud, and seeks civil penalties up to the amount of the losses suffered as a result of the alleged violations. The DOJ believes such losses total $5 billion to date.
Also on February 5, the attorneys general for at least 12 states and the District of Columbia announced state court actions against a ratings agency in coordination with a parallel federal suit filed on the same day, as described above. The actions announced by the AGs for Arizona, Arkansas, California, Colorado, Delaware, the District of Columbia, Iowa, Maine, Missouri, North Carolina, Pennsylvania, Tennessee, and Washington, allege violations of various state laws related to the same general conduct outlined in the federal complaint, i.e. that the ratings agency defrauded investors, including state pension funds, by inflating ratings of certain RMBS and CDOs for private gain, while publicly maintaining that the ratings were objective assessments of the risks posed by the securities. At least three states, Connecticut, Illinois, and Mississippi, are continuing to pursue similar, previously filed, suits against the same agency.
FHFA Settles One of Many Pending MBS Suits
On January 23, the FHFA settled and voluntarily dismissed one of the lawsuits it initiated in 2011 as conservator for Fannie Mae and Freddie Mac, alleging against many parties that billions of dollars of MBS purchased by the GSEs were based on offering documents that contained materially false statements and omissions. FHFA v. Gen. Elec. Co., No. 11-7048, Notice of Dismissal (Jan. 23, 2013). This is the first settlement to be announced in connection with this series of cases; the lead case currently is on appeal to the U.S. Court of Appeals for the Second Circuit. Although the FHFA did not release any details related to the settlement, in reports the FHFA’s general counsel described the resolution as “consistent with FHFA’s responsibilities as conservator.”