Tag Archives: misrepresentation

Ain’t Misrepresentin’

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According to Wikipedia, the performers in the musical Ain’t Misbehavin’ “present an evening of rowdy, raunchy, and humorous songs that encapsulate the various moods of the era and reflect” a “view of life as a journey meant for pleasure and play.” In U.S. RMBS Roundtable: Arrangers And Investors Discuss The Role Of Representations And Warranties In U.S. RMBS Transactions, S&P does something similar with securitization. It presents the views of industry players as they try to predict and shape the future of the recently emerging private-label RMBS market, in the hopes of “achieving a healthy and sustainable RMBS market.” (2)

ACT I:  Lookin’ Good but Feelin’ Bad

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The piece contains a lot of important insights, including the following point made by investors: “standardizing R&Ws would be a step towards improving the transparency and their ease of understanding. Smaller investors noted that they can be particularly limited in distinguishing R&Ws given the complexities involved.” (3)

This point encapsulates in so many words the classic market for lemons problem, famously formalized by George Akerlof.  The lemon problem leads us to ask how a buyer is to price a purchase where the buyer has less information about the product than the seller.  Because of this information assymetry, the purchaser will assume the worst about the product and offer to buy it with that in mind.

R&Ws are an attempt to overcome that problem because the RMBS arranger or the mortgage originator promises to compensate the investor for lemons that are contained with a mortgage pool securing an RMBS. Consistent with that view, investors noted that “they expected to be compensated for losses caused by origination defects, rather than legitimate life events.” (2) In other words, origination defects are the lemons that should be borne by the arranger/originator with its superior information about the mortgages. And “legitimate life events” represent the credit risk that the investors have signed up for.

ACT II:  That Ain’t Right

Arrangers and originators made the following points:

  1. [o]ne arranger indicated that the R&W process should be governed only by the contractual obligations negotiated for each deal. (2)
  2. [o]riginators have strict underwriting guidelines and said they take great care to follow those procedures before issuing a loan. Arrangers are also currently subjecting all or almost all loans to a third-party due-diligence review. (2)
  3. arrangers said that standardizing R&Ws will not be an easy task as differences between arrangers and product types will limit the degree to which R&Ws can be homogenized. (3)

These points clearly align with the interests of the seller in a market for lemons.  To restate them a bit, 1. caveat emptor; 2. arrangers and originators don’t sell lemons (!); and (3) it is too hard to come up with provisions that consistently protect investors so don’t bother trying.

ENCORE:  Find Out What They Like

S&P notes that there “was broad agreement that one of the keys to achieving a healthy and sustainable RMBS market is aligning the interests of arrangers and investors.” (2) From that broader perspective, S&P is right that the industry should work toward a state of affairs that “minimizes the cost of unknown risks and ultimately reduces losses and related litigation.” (2) Given the spate of lawsuits over reps and warranties, we had fallen shy of that mark in the past (here, for example).  It remains to be seen if the industry can get it better next time and if the incentives are aligned enough to do so.

 

Bank of America and MERS Motion for Dismissal Granted Against Homeowner-Plaintiff in Reconsideration of Order Denying Preliminary Injunction in Foreclosure Proceeding

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In Harris v. Americas Wholesale Lender, No. 2011-659-CH (Macomb Cty. Cir. Ct. June 8, 2011) the court granted the defendant’s motion for dismissal of all the homeowner-plaintiff’s claims in foreclosure proceeding.

Defendants Countrywide, Bank of America, and MERS moved for summary disposition against plaintiff-homeowner under MCR 2.116(C)(7) and (C)(8). Plaintiff moved for reconsideration of the lower court’s denial for preliminary injunction and another motion for entry of default judgment.

Plaintiff alleged five counts; [1] fraud, [2] breach of contract, [3] collusion, [4] conversion, and finally [5] unjust enrichment. In assessing these claims the court found that they were all without merit.

In regards to the plaintiff’s alleged fraud claim the court dismissed it as frivolous as plaintiff could not, and had not, produced any evidence to support the allegation. Upon considering the second count, the court likewise dismissed as the plaintiff failed to show any cognizable allegation of a breach of contract.

The claim of collusion was also dismissed as the court found that the plaintiff failed to plead the claim with particularity. Accordingly, the claim of conversion was also dismissed as the plaintiff failed to explain, to the court’s satisfaction, how a claim of conversion could be supported. Finally, the claim of unjust enrichment was found to be without merit, as the court found that the plaintiff failed to show how an unjust enrichment took place.

First Circuit Grants Wells Fargo’s Motion to Dismiss Plaintiff-Homeowner’s Suit to Preclude Foreclosure Sale

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The court in McKenna v Wells Fargo Bank, N.A. Case No. 11-1650 (C.A. 1, Aug. 16, 2012) was faced with questions relating to the district court’s subject matter jurisdiction. Here, Wells Fargo’s primary assertion in its removal papers – “that there was federal question jurisdiction present in the case” – turned out to be mistaken as no federal claim was present. However, diversity jurisdiction was found to be sufficient enough to support the state statutory claims that were asserted in the complaint.

Wells Fargo brought a foreclosure action against the plaintiff [McKenna], the plaintiff responded by asserting a right to rescind the mortgage and then filed suit to preclude the foreclosure sale.

The plaintiff claimed a right to rescind on the grounds that [1] Wells Fargo had provided her with only one Truth in Lending disclosure statement at the time of the loan rather than two copies, and [2] Wells Fargo had understated the finance charge in its Truth in Lending statement by more than $35. The lower court then issued a preliminary injunction restraining Wells Fargo from taking further action to sell the plaintiff’s home.

On March 10, 2010, Wells Fargo removed the case to the federal district court in Massachusetts. Wells Fargo asserted that federal question jurisdiction existed. The bank then moved to dismiss for failure to state a claim, and the district court granted the motion. On review, the court found that diversity jurisdiction existed as Wells Fargo was a bank and a citizen of the state where it is “located.” The bank’s location being North Dakota, and the plaintiff being a citizen of Massachusetts, allowed for diversity jurisdiction.

On review the court determined that the plaintiff’s complaint alleged that Wells Fargo made certain misrepresentations. However, the court found that the plaintiff failed to specify the time or place of these misrepresentations or their real content and, as the district court held, these assertions were “too vague to meet the particularity requirement of Rule 9.” The First Circuit affirmed the lower court’s ruling. Further, the suit was not timely under the federal Truth in Lending Act, 15 U.S.C. 1635(a), and the complaint failed to state claims under the equivalent state law.

More Misrepresentations, More Litigation

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Judge Pfaelzer (C.D. Cal.) issued an order in American International Group Inc. v. Bank of America Corp., No. 2:11-CV-10549 (May 6, 2013), which allowed AIG to proceed with its claim that it was fraudulently induced to buy MBS by Countrywide (now a part of BoA). This case joins a long list of cases where judges have allowed fraud and misrepresentation allegations to proceed in the context of MBS issuances (for instance, here, here and here).  AIG claims that the deal documents for the MBS “fraudulently misrepresented and concealed the actual credit quality of the mortgages by providing false quantitative data about the loans, thus masking the true credit risk of AIG’s investments.” (5, quoting the Amended Complaint)

in allowing some of the claims to proceed, the Court notes that  AIG “plausibly alleges that the underwriting guidelines stated in the Offering Documents were false. The Amended Complaint describes a company-wide culture of abandonment of underwriting standards and wholesale use of ‘exceptions’ to the normal standards. This raises an inference, however strong, that the loans in AIG’s RMBS deviated from the underwriting standards.” (28, citations omitted)

Judge Pfaelzer notes that she has repeatedly issued similar rulings regarding Countrywide’s behavior in other cases, so this comes as no surprise.  But once all of these MBS cases alleging fraud misrepresentation are decided, it will be interesting to see just what the contours of this body of law will look like.  Clearly, issuers can’t avoid liability by means of general disclaimers in the offering documents.  Will they provide clearer, more explicit disclaimers and carve-outs in the hopes of  avoiding liability in future deals or will they ensure that future deals hew more closely to the deal documents?  Time will tell.

Motion to Dismay

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A recent Opinion and Order by Judge Forrest (SDNY) in IBEW Local 90 Pension Fund v. Deutsche Bank AG gives hints of some of the challenges facing plaintiffs in cases alleging misrepresentations and a scheme to defraud investors.

Like many other cases alleging misrepresentation (here, here and here for instance), this case has some juicy examples/.  They include the following:

  • Greg Lippmann, Deutsche Bank’s top gobal RMBS trader, described Deutsche Bank’s RMBS products as “crap” and shorted it to the tune of billions of dollars. (6)
  • Lippmann described the process of selling CDOs based on RMBS as a “ponzi scheme.” (7)
  • Lippmann described some Deutsche Bank CDOs as “generally horrible.” (8)

Because this Opinion and Order is considering a motion to dismiss, it treats the allegations as true for the purposes of the motion. But the opinion does not consider the back story here (not that it should). And the back story undercuts the plaintiff’s case quite a bit, such that it illustrates the markedly different standards that would apply if this case were to be decided on a motion for summary judgment or if it went to trial.

So what is the back story?  Well, Greg Lippmann is no faceless Wall Street operator. Rather, he is one the handful of Wall Street rebels who bet big against the conventional wisdom about subprime mortgages and was profiled by Michael Lewis in the Big Short.

So imagine how the defense will contextualize these alleged statements.  Lippmann has been well-documented to have been a lone wolf within Deutsche Bank.  In fact, Deutsche Bank was overall long on these products.  Deutsche Bank was acting responsibly by hedging its exposure across the whole bank, even if some desks and units were at odds with each other.

Bottom line:  this plaintiff will have a tough row to hoe as this case proceeds past the motion to dismiss phase.

 

Bransten Trio: Part Tres

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The last of the Bransten Trio of cases (previously, I wrote of Part Un and Part Deux) dealing with Allstate’s complaint against Morgan Stanley has some of the allegedly misrepresentative language at issues in such cases.  A sampling includes

  • “These mortgage loans may be considered to be of a riskier nature than mortgage loans made by traditional sources of financing . . ..  The underwriting standards used in the origination of [these loans] are generally less stringent than those of Fannie Mae or Freddie Mac with respect to a borrower’s credit history and in certain other respects . . . . As a result of this less stringent approach to underwriting, the mortgage loans purchased by the trust may experience higher rates of delinquencies, defaults and foreclosures . . ..” (24)
  • “It is expected that a substantial portion of the mortgage loans will represent”  a DTI ratio exception, a pricing exception, a LTV ratio exception or “an exception from certain requirements of a particular risk category.” (25)
  • The court noted that the Morgan Stanley defendants indicated that in connection with various MBS certificates they issued, “‘a significant number,’ ‘a substantial portion,’ or a ‘substantial number’ of the loans represented underwriting exceptions.” (25)

Justice Bransten found, as she did in the other two cases referenced above, that such warnings are “ineffective.” (26) She further notes that the defendants’ “statements are misleading to the extent that they imply that defendants would act in accordance with, rather that [sic] completely disregard, the results of their findings” from their reviews of the loans securing the MBS certificates at issue in the case. (29)

 

Bransten Trio: Part Deux

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As I work through the Bransten Trio of cases on misrepresentation in the securitization process, I am struck by the arguments of the defendants, arguments that do not seem to carry much weight with judges who hear them.  In the Merrill Lynch case, the defendants (all Merrill-affiliated entities) “argue that it was not reasonable for plaintiffs, as sophisticated investors in the mortgage-backed security market, to rely on ‘unverified information.'” from the mortgage originators that was repeated by the defendants with the defendants making “no representations or warranties as to the accuracy or completeness of that information.”. (22)

This court, like others, does not treat “boilerplate disclaimers and disclosures” as Get Out of Jail Free Cards” for underwriters. (22) The court reviews a number of cases in which courts similarly refuse to treat such disclaimers as such, including

  • Plumbers’ Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., 632 F.3d 762, 773 (1st Cir. 2011)
  • In re Morgan Stanley Mortgage Pass-Through Certificates Litig., 810 F. Supp. 2d 650, 672 (S.D.N.Y. 2011)
  • New Jersey Carpenters Vacation Fund v. Royal Bank of Scotland Group, PLC, 720 F. Supp. 254, 270 (S.D.N.Y. 2010)
  • Pub. Employees’ Ret. Sys. of Mississippi v. Merrill Lynch & Co., Inc., 714 F. Supp. 2d 475, 483 (S.D.N.Y 2010)
  • In re IndyMac Mortgage-Backed Sec. Litig., 718 F. Supp. 2d 495, 509 (S.D.N.Y. 2010)

It will be interesting to see how disclaimers will be modified to offer increased protection to underwriters in the future.  Could an underwriter protect itself by saying that “there is a high likelihood that the representations and warranties contained in offering materials are false and intended solely to convince potential purchasers of the securities to purchase them?”