March 1, 2013
Judge Rakoff explains his denial of the defendants’ (various Bear Stearns, JPMorgan and WAMU entities) motion to dismiss the suit. The suit alleges that the defendants “made fraudulent representations regarding the riskiness of he securitizations and the underlying loans” upon which the plaintiffs (Dexia and FSA entities) relied to their detriment. (5)
A judge does not typically do much fact-finding in a denial of a motion to dismiss, but there are still some interesting bits:
- “a reasonable fact-finder could conclude that” disclosures about exceptions to underwriting guidelines “suggested to a reasonable investor not the systematic deviation from established underwriting standards alleged by plaintiffs, but rather a low level of occasionally non-compliant loans in the loan pools that could be subject o repurchase.” (11-12) This is important. It means that disclosures must be relatively specific as to the level of risk that the investor will face by deviations from stated underwriting objectives.
- Judge Rakoff also reiterates that underwriters and others involved in securitizations must at least believe themselves the representations that they make. (15) The fact that the investors are sophisticated does not matter: “even a sophisticated party may reply on the representations of another where the facts misrepresented were ‘peculiarly within the Defendants’ knowledge.'” (19, quoting Allied Irish Banks, PL.C. v. Bank of Am., N.A., No. 03-Civ. 3748, 2006 WL 278138 (S.D.N.Y. Feb. 2, 2006))
- “Judge Rakoff did make one tentative finding of fact: “the confidential witness statements incorporated into the Amended Complaint, combined with the documentary sources, support a strong inference that the defendants knew that the mortgages included within the loan pools were not of the quality represented in the offering documents.” (17)
The cases arising from the financial crisis stand for the important (but hopefully uncontroversial) principle that material lies and omissions can be fraudulent even among sophisticated parties. This might make the most sense in Latin: caveat emptor for sure, but there has to be some bona fides.
(Hat tip to Peter Liem)