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NORTHWESTERN MUTUAL LIFE INS. CO. v. BANC OF AMERICA SEC.

March 31, 2003

THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY, MASON STREET FUNDS, INC., AND NORTHWESTERN MUTUAL SERIES FUND, INC. PLAINTIFFS
v.
BANC OF AMERICA SECURITIES LLC, FIRST UNION SECURITIES, INC., AND GOLDMAN, SACHS & CO. DEFENDANTS.



The opinion of the court was delivered by: John G. Koeltl, United States District Judge

OPINION AND ORDER

This is a diversity action brought by The Northwestern Mutual Life Insurance Company ("Northwestern Life"), Mason Street Funds, Inc. ("Mason Street") and Northwestern Mutual Series Fund, Inc. ("Northwestern Mutual") (collectively "the plaintiffs") against Banc of America Securities LLC ("Banc of America"), First Union Securities, Inc. ("First Union") and Goldman, Sachs & Co. ("Goldman Sachs") (collectively "the defendants") and arises out of a Rule 144A private offering of asset backed securities. The securities were backed by consumer installment contracts entered into by The Heilig-Meyers Furniture Company ("Heilig-Meyers"), a speciality retailer of home furnishings that made substantial revenues by selling furniture through fixed-term, fixed payment installment sales contracts. After Heilig-Meyers declared Bankruptcy, the plaintiffs filed the present lawsuit, alleging Wisconsin common law and statutory claims arising out of the allegedly false and misleading statements and omissions made in Offering Memoranda and other documents that were used to promote, market and sell the securities in the private offering. The plaintiffs raise four Wisconsin common law cause of action against all of the defendants: a claim for fraud (Count 1), negligent misrepresentation (Count 2), strict responsibility (Count 3), and negligence (Count 4). In addition, the plaintiffs raise two statutory claims against Banc of America, a claim under the Wisconsin Consumer Protection Act, Wis. Stat. § 100.18 (Count 5) and a claim under the Wisconsin Blue Sky Act § 551.59 (Count 6).

This case was originally filed in the United States District Court for the Eastern District of Wisconsin, and transferred to the Southern District of New York pursuant to 28 U.S.C. § 1404(a).*fn1 The defendants have now moved to dismiss all of the claims pursuant to Fed.R.Civ.P. 9(b) and 12(b)(6).*fn2

I.

On a motion to dismiss, the allegations in the Complaint are accepted as true. See Grandon v. Merrill Lynch & Co., 147 F.3d 184, 188 (2d Cir. 1998). In deciding a motion to dismiss, all reasonable inferences are drawn in the plaintiff's favor. See Gant v. Wallingford Bd. of Educ., 69 F.3d 669, 673 (2d Cir. 1995); Cosmas v. Hassett, 886 F.2d 8, 11 (2d Cir. 1989). The Court's function on a motion to dismiss is "not to weigh the evidence that might be presented at trial but merely to determine whether the complaint itself is legally sufficient." Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir. 1985). Therefore, the defendants' motion to dismiss should only be granted if it appears that the plaintiffs can prove no set of facts in support of their claims that would entitle them to relief. See Swierkiewicz v. Sorema, N.A., 122 S.Ct. 992, 998 (2002); Conley v. Gibson, 355 U.S. 41, 45-46 (1957); Grandon, 147 F.3d at 188; Goldman, 754 F.2d at 1065.

In deciding the motion, the Court may consider documents that are referenced in the Complaint, documents that the plaintiffs relied on in bringing suit and that are either in the plaintiffs' possession or the plaintiffs knew of when bringing suit, or matters of which judicial notice may be taken. Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002); see also Brass v. Am. Film Techs., Inc., 987 F.2d 142, 150 (2d Cir. 1993); Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47-48 (2d Cir. 1991); Vtech Holdings Ltd. v. Lucent Techs., Inc., 172 F. Supp.2d 435, 437 (S.D.N.Y. 2001). "[W]hen a plaintiff chooses not to attach to the complaint or incorporate by reference a document upon which it relies and which is integral to the complaint, the court may nonetheless take the document into consideration in deciding the defendant[s'] motion to dismiss, without converting the proceeding to one for summary judgment." Int'l Audiotext Network, Inc. v. AT&T Co., 62 F.3d 69, 72 (2d Cir. 1995) (internal citation and quotation marks omitted); see Yucyco, Ltd. v. Republic of Slovenia, 984 F. Supp. 209, 215 (S.D.N.Y. 1997).*fn3

Accordingly, the following facts are alleged in the Complaint and for the purposes of this motion are accepted as true.

In 1998 Heilig-Meyers was the largest publicly held retailer of home furnishings in the United States, operating 1243 stores in 38 states, Washington D.C. and Puerto Rico. (Compl. ¶ 9.) Two years later, in August 2000, Heilig-Meyers filed a Chapter 11 Bankruptcy petition in the United States Bankruptcy Court for the Eastern District of Virginia. (Id.)

The majority of Heilig-Meyers merchandise was sold through installment sales contracts (the "Contracts"). (Compl. ¶ 10.) Each of these contracts required the customer to pay monthly installments of principal and interest due, and were secured by the merchandise purchased, giving Heilig-Meyers the right to repossess the furniture in the event of a default. (Id.

On February 26, 1997, Heilig-Meyers, along with the MacSaver Funding Corporation ("MacSaver") and First Union National Bank, an affiliate of First Union, entered into the Master Pooling and Servicing Agreement, which established the Heilig-Meyers Master Trust (the "Trust"). (Compl. ¶ 12.) The Trust was created to hold the Contracts, the monies due under those Contracts, the security interests in the goods sold pursuant to the Contracts, and certain reserve funds. (Compl ¶ 11.) Under the Master Pooling and Servicing Agreement, Heilig-Meyers was to act as the Servicer of the Contracts, a role that required it, among other things, to maintain accurate records of the Contracts and related payment activity, to collect all principal and interest due on the Contracts, to investigate payment delinquencies, to maximize recoveries on delinquent and defaulted Contracts, and to remit all proceeds to the Trust. (Compl. ¶ 13.) MacSaver was the Transferor of the Contracts, meaning that it purchased the Contracts from Heilig-Meyers and transferred them to the Trust. (Compl. ¶ 14.) First Union Bank served as the Trust's Trustee, a role that required it to preserve Trust assets, make distributions to certificate holders, monitor the performance of Heilig-Meyers, the Servicer, ensure a smooth transition to a new servicer, and serve as a replacement servicer, if necessary. (Compl. ¶ 15.)

During 1997 and 1998, the Trust issued a series of asset-backed securities (the "Certificates"), and each Certificate represented an undivided interest in the Trust and the right to receive a portion of the collections on the Contracts. (Compl. ¶ 18.) On February 28, 1997 the Trust issued the 1997-1 Certificates, in the principal amount of $592,000,000, and a substantial amount of these securities were purchased by Banc of America and First Union, who held those Certificates until at least February 28, 1998. (Compl. ¶ 19.)

In February 1998, the Trust issued the 1998-1 Certificates. (Compl. ¶ 20.) These Certificates were divided into four classes of interests, namely (1) Class A 6.125% Asset-Backed Certificates ("1998-1 Class A Certificates"), in the aggregate principal amount of $307,000,000; (2) Class B 6.35% Asset-Backed Certificates ("1998-1 Class B Certificates"), in the aggregate principal amount of $61,000,000; (3) the Collateral Indebtedness Interest (the "Class C interests") in the aggregate principal amount of $32,000,000; and (4) the Class D Asset-Backed Certificates in the principal amount of $35,500,000. (Compl. ¶ 20.) The defendants purchased all of the 1998-1 Class A and B Certificates from the Trust and resold some or all of them through a February 20, 1998 Offering (the "1998-1 Offering") (Compl. ¶ 21.) The defendants served as underwriters for the 1998-1 Offering, controlling the structure and pricing of the Certificates, drafting the Preliminary and Final Offering Memoranda, and making oral representations. (Compl. ¶ 22.) The plaintiffs, including Northwestern Mutual, Northwestern Life, and Mason Street, purchased a total amount of Class A and Class B Certificates with a face value of $88,000,000, from the various defendants over a period from February 20, 1998 to January 26, 2000. (Compl. ¶ 25.) The Class C interests were not sold to the plaintiffs, but to Bayerische Hypo-und Vereinsbank AG, New York Branch. The Class D interests were retained by the Transferor. (Compl. ¶¶ 23-24.)

The plaintiffs allege that the defendants in the course of selling the 1998-1 Certificates made various misrepresentations and omissions, and these alleged misrepresentations and omissions form the basis of the claims in the Complaint. The alleged misrepresentations involve several broad categories of facts and circumstances and relate to the practices of Heilig-Meyers, the nature of the securities being sold in the two offerings, and the duties to be performed by the defendants in the case of a Heilig-Meyers bankruptcy.

First, the plaintiffs allege that the defendants failed to disclose alleged self-dealing by Banc of America and First Union. Specifically, they allege that neither Banc of America nor First Union disclosed the fact that they held all or substantially all of the 1997-1 Certificates, that none of the defendants, including Goldman Sachs, disclosed the fact that the proceeds from the 1998-1 Offering would be used to pay back all, rather than merely a portion, of the 1997-1 Certificates, and that the Offering Memoranda created the false impression that the proceeds from the 1998-1 Offering would be used by the Trust to purchase additional Contracts, and thereby provide additional financing for Heilig-Meyers. (See Compl. ¶¶ 31-37.)

Second, the plaintiffs allege that the defendants misrepresented the amounts due under the Contracts. Specifically, the plaintiffs allege that the defendants falsely represented that the Certificates were low-risk investments, that the defendants knew or were reckless in not knowing that the aggregate total balances due under the Credit Agreements, as reported in the Offering Memoranda, were overstated by approximately $40 million, and that because the Contract balances served at the collateral securing the Certificates, the effect of overstating the balances due under the Contracts amounted to a failure to disclose that the Certificates were under-collateralized. (Compl. ¶¶ 38-44.)

Third, the plaintiffs allege that the defendants' representations that the loss and delinquency rates for collections under the Contracts were comparable to those of other major retailers were misleading, because the defendants failed to disclose that Heilig-Meyers' rates were calculated by using unorthodox accounting measures, including recency accounting, that resulted in lower loss and delinquency figures. (Compl. ¶¶ 45-58.)

Fourth, the plaintiffs allege that the defendants failed to disclose the fact that Heilig-Meyers routinely extended additional credit to delinquent customers by rewriting Contract terms if the customer was a repeat purchaser and bought new furniture, thereby altering and lowering loss and delinquency rates, and the fact that such practices deviated from conventional underwriting, collection and accounting practices. (Compl. ¶¶ 59-66.)

Fifth, the plaintiffs allege that the defendants misrepresented the ways in which Heilig-Meyers conducted its servicing of the Contracts, by failing to inform the plaintiffs that Heilig-Meyers stores often failed to obtain critical information from obligors, including names, telephone numbers, addresses, and other information that significantly ...


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