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New Jersey Carpenters Vacation Fund v. Royal Bank of Scotland Group

March 26, 2010

NEW JERSEY CARPENTERS VACATION FUND AND BOILERMAKER BLACKSMITH NATIONAL PENSION TRUST, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFFS,
v.
THE ROYAL BANK OF SCOTLAND GROUP, PLC, GREENWICH CAPITAL HOLDINGS, INC., GREENWICH CAPITAL ACCEPTANCE, INC., GREENWICH CAPITAL FINANCIAL PRODUCTS, INC., ROBERT J. MCGINNIS, CAROL P. MATHIS, JOSEPH N. WALSH, III, JOHN C. ANDERSON, JAMES M. ESPOSITO, RBS SECURITIES, INC., F/K/A GREENWICH CAPITAL MARKETS, INC., D/B/A RBS GREENWICH CAPITAL, MOODY'S INVESTOR SERVICE, INC., AND THE MCGRAW-HILL COMPANIES, INC., DEFENDANTS.



The opinion of the court was delivered by: Hon. Harold Baer, Jr., District Judge

OPINION & ORDER

Lead Plaintiffs New Jersey Carpenters Vacation Fund ("Carpenters Fund") and Boilermaker Blacksmith National Pension Trust ("Boilermaker Trust") (collectively "Lead Plaintiffs" or "Plaintiffs") bring claims charging the defendants with violations of sections 11, 12(a)(2), and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k(a), 77l(a)(2), 77o (2010). These sections, the Plaintiffs opine, were violated as a consequence of alleged omissions and misstatements in registration statements and prospectuses filed with the SEC as part of a series of mortgage-backed securities known as the Harborview Mortgage Loan Trusts. The Harborview Trust securities, or "Certificates," were issued in a series of different offerings, each with its own prospectus supplement but traceable to two primary "shelf" registration statements, between April 2006 to October 2007. Plaintiffs bring suit against essentially two groups of defendants, the "RBS Defendants," who were the primary issuers and underwriters of the Harborview Trusts, and the "Ratings Agency Defendants," the two agencies who provided credit ratings for the Certificates and also allegedly acted as underwriters based on their role in the structuring of the Certificates. For the reasons that follow, the claims against the Ratings Agency Defendants are dismissed because they cannot be held liable under this set of facts as "underwriters." Claims against the RBS Defendants related to offerings that Plaintiffs did not purchase from, are dismissed for lack of standing. Finally, claims against the RBS Defendants related to undisclosed conflicts of interest with rating agencies and to inadequate credit enhancements and outdated rating models are dismissed for failure to state a claim; Plaintiffs' claims related to misstatements and nondisclosure of mortgage originators' "disregard" of loan underwriting guidelines may proceed.

I. FACTUAL BACKGROUND*fn1

Parties

Plaintiffs are two pension funds, who purport to represent a class that "purchased or otherwise acquired interests" in mortgage-backed securities known as the Harborview Mortgage Loan Trusts (the "Harborview Trusts" or "Harborview"), which were registered pursuant or traceable to two registration statements and accompanying prospectuses filed with the SEC on March 31, 2006, and March 23, 2007. Consol. First. Am. Secs. Class Action Compl. ("Consolidated Amended Complaint" or "CAC") ¶¶ 1, 19-20. The various defendants (collectively "Defendants") can be grouped into two sets. First, there are the "RBS Defendants," made up of the defendant corporate entities The Royal Bank of Scotland Group, PLC ("RBSG"), Greenwich Capital Holdings, Inc. ("GCH"), Greenwich Capital Financial Products, Inc. ("GCFP"), Greenwich Capital Acceptance, Inc. ("GCA"), Greenwich Capital Markets, Inc. ("GCM"),*fn2 who collectively securitized and issued the Harborview Trust Certificates. The RBS Defendants also include certain individual defendants ("Individual Defendants"), Robert J. McGinnis, Carol P. Mathis, Joseph N. Walsh, III, John C. Anderson, and James C. Esposito, who were all senior employees of GCA, and signed the two registration statements filed with the SEC for the Harborview Trusts. See CAC ¶¶ 21-36. As for the second group, Plaintiffs bring claims against the "Ratings Agency Defendants," made up of The McGraw-Hill Companies, Inc., of which Standard & Poor's Rating Service is a division (hereafter "S&P") and Moody's Investors Service, Inc. ("Moody's"), both of whom provided credit ratings for the various Harborview Trusts and also allegedly acted as underwriters of the offerings. See CAC ¶¶ 37-39. Mortgage Backed Securities and the GCM Securitization Mortgage-backed securities ("MBS") come about "where mortgage loans are acquired, pooled together, and then sold to investors [in the form of a security], who acquire rights in the income flowing from the mortgage pools." CAC ¶ 40. The securities are often divided into groups ("tranches") based on the relative riskiness of the underlying loans, the order in which the Certificates are paid out, and their corresponding interest rates. Id. Due to the varying levels of risk of the individual loans -- i.e. the potential that a borrower may be delinquent or default on payment -- a MBS may be created with a degree of "credit enhancement" built into its structure. CAC ¶ 50. The enhancements enable the MBS to receive a high enough credit rating sufficient for sale, and provide a degree of protection to the investor from this risk.*fn3 Id. The issuance of these securities may be accomplished in one or more offerings based on a single "shelf" registration statement. See SEC Rule 415: Delayed or continuous offering and sale of securities, 17 C.F.R. § 230.415(1)(vii)(2010).*fn4

The RBS Defendants, specifically GCH, GCA, GCFP, and GCM (collectively "Greenwich Capital"), derived their profit through the sale of the Certificates at an excess of the purchase price for the underlying mortgages they used to create the MBS. CAC ¶ 45. They would purchase the loans in bulk from a mortgage originator at an auction. CAC ¶¶ 47-49. Prior to this purchase, Greenwich Capital would perform due diligence, typically through a subcontractor firm, to get a sense of the loans and determine that they "conformed to the Originators' underwriting guidelines and contained the requisite legal documentation." CAC ¶57. The auction process allegedly incentivized Greenwich Capital not to "kick out" too many "faulty" loans, because then the mortgage originator was less likely to sell loan pools to them in the future. Id. Before they would sell a MBS, Greenwich Capital would have the securities rated by S&P or Moody's. For the securitization process to be worthwhile to Greenwich Capital, "approximately 80% of the securitization had to have the highest rating by the rating agencies." CAC ¶ 46. Consequently, they sought to sell as many certificates with an "AAA" (or "Aaa") rating since they were "significantly more profitable," and also sought to limit the amount of costly overcollateralization. CAC ¶ 51.

In order to secure the highest ratings possible, Greenwich Capital would allegedly engage in "ratings shopping" between the rating agencies. CAC ¶ 58-61. First, they would provide the rating agencies with a preliminary deal structure. Then, the agencies would analyze the structure, advise Greenwich Capital how much of the securitization could be given a top credit rating, and help decide what credit enhancements were needed to maximize high ratings. CAC ¶ 59. For example, "S&P would advise Greenwich Capital.that 94.25% of the Certificates would be rated AAA as long as 5.75% of the total collateral balance supporting those Certificates were subordinate [i.e. given a lower credit rating and subordinating their payment to the higher-rated certificates]." Id. Greenwich Capital would then negotiate with the rating agencies to reduce the amount of credit enhancement needed, and would ultimately select the agency who provided the highest rating for the most certificates in the securitization. Id. According to Plaintiffs, the shopping process allowed Greenwich Capital to pressure rating agencies to provide high ratings and minimum credit enhancements in order to receive the profitable rating business.

According to Plaintiffs, the Rating Agency Defendants played a substantial role in the securitization process. They provided Greenwich with guidance on the selection of loans at the loan auction, so that there would be sufficient collateral to support a high credit rating; they likewise played a role in suggesting the bid price for those loans. CAC ¶¶ 50, 54. This "bid package" was done without compensation in the hope of being engaged to rate the loans at the underwriting stage. CAC ¶ 55. As stated, supra, at the underwriting stage they would provide a preliminary rating and determine the necessary credit enhancement as part of the "ratings shopping" process. CAC ¶ 58-61. Through this procedure, "the Rating Agencies assisted in determining which of the purchased loans were to be included in the mortgage pools underlying the Certificates and thereafter the structure of the Certificates themselves." CAC ¶ 7. After being selected, they would provide the actual rating given to the mortgage-backed certificates.

See CAC ¶ 58-61. In sum, Plaintiffs allege that the Rating Agencies "directly participate[d] in the formation and structuring of the Certificates prior to issuance." CAC ¶ 7.

The Harborview Trust Securitization

The MBS created by Greenwich Capital at issue here, the Harborview Trust securitization, is made up of mortgage collateral from a variety of mortgage originators. The names of some are now synonymous with sub-prime lending and the housing market collapse: "principally Countrywide Home Loans, Inc. ("Countrywide"), American Home Mortgage Corporation ("American Home"), IndyMac Bank, F.S.B. ("IndyMac"), Bank United, FSB ("BankUnited"), and Downey Savings & Loan Association ("Downey")." CAC ¶ 6. Many, if not most, of the underlying loans were some form of sub-prime or otherwise risky "low documentation" or "no documentation" loans -- i.e. loans where there was a higher risk of default based on weak credit history and personal finances, or fraud because borrowers either self-reported their income or were allowed to provide less information than in a typical loan. CAC ¶ 13. The certificates were sold in fifteen separate offerings between April 26, 2006 and October 1, 2007 -- Harborview Mortgage Loan Trust ("HVMLT") Series 2006-4 through 2006-14, and Series 2007-1, -2, -5, and -7. CAC ¶¶ 34-35. Collectively, the RBS Defendants "underwrote and sold to Plaintiffs and the Class $25.78 billion of Mortgage Loan Pass-Through Certificates." CAC ¶ 2.

The Certificates were filed with the SEC pursuant to two registration statements, in 2006 and 2007, each of which contained a base prospectus, along with subsequently filed prospectus supplements (collectively the "Offering Documents") for each particular HVMLT offering. CAC ¶ 1. The registration statements and prospectus supplements contained detailed information about the securitization and the underlying loan pools. This included, among other things, (1) "descriptions of the loan origination practices" of the mortgage originators, including the "underwriting guidelines"*fn5 of the originators, see, e.g., CAC ¶ 10; (2) details about the underlying loans themselves, such as delinquency rates and loan-to-value ("LTV") ratios, see, e.g., CAC ¶ 241; (3) the credit ratings given to the various classes of Certificates, see, e.g., CAC ¶ 37, and; (4) the credit enhancement for the Certificates, see, e.g., CAC ¶ 51. As with a typical MBS, "the value of the Certificates was directly tied to repayment of the underlying mortgage loans since the principal and interest payments due to investors were secured and derived from cash flows from those loans." CAC ¶ 5. According to Plaintiffs, the RBS Defendants engaged in "ratings shopping" in the Harborview Trust securitization process, seeking the highest rating for the most Certificates, and the least necessary credit enhancements. CAC ¶ 7.

Upon issuance, the great majority of Certificates originally received high credit ratings from the Rating Agency Defendants -- Moody's assigned its highest investment grade, "Aaa," to 92.7% of the Certificates it rated, while S&P assigned its highest grade, "AAA," to 92.2% of the Certificates it rated. CAC ¶ 8. None initially were rated below "investment grade" ("Ba1" for Moody's, "BB" for S&P). Id. Shortly after their sale, however, defaults and delinquencies on the underlying mortgage collateral quickly piled up, and as a result, "the value of the Certificates collapsed." CAC ¶ 9. As a result of the "massive increases in borrower delinquency, foreclosure, repossession and bankruptcy in the underlying Certificate collateral" Plaintiffs claim the Certificates have lost "a combined 68% of their initial value." Id. Today, over 39% of the underlying loans are delinquent, or in default, foreclosure or bankruptcy. Id. In mid-2007, both Moody's and S&P revised their rating method, re-analyzed the Harborview Trusts, and downgraded almost all of the Certificates, some many levels below their original rating. CAC ¶¶ 155-56. According to Plaintiffs, the rating agencies downgraded the certificates due to the "aggressive underwriting used in the origination of the collateral." CAC ¶ 156. More than 95% of the Certificates have been "downgraded to speculative junk bond investments." CAC ¶ 9.

Causes of Action & Allegations

Plaintiffs allege that the Offering Documents for the Harborview Trust Certificates violated section 11 of the Securities Act, due to the Individual Defendants, GCA, GCM, and the Rating Agency Defendants' omissions and misstatements of material information from the two registration statements and various prospectus supplements. CAC ¶¶ 260-75. They further allege that GCM violated Section 12(a)(2) of the Securities Act based on "untrue statements of material fact" and "omitted facts necessary to make statements not misleading" in the prospectus supplements. CAC ¶¶ 276-83. Finally, Plaintiffs bring a cause of action under Section 15 of the Securities Act against RBSG, GCH, GCM, the Individual Defendants, and the Rating Agency Defendants for "control person liability." CAC ¶¶ 284-93. Plaintiffs' group their allegations into three basic categories of omitted and misstated information: (1) the underwriting guidelines were "systematically disregarded;" (2) the credit enhancements built into the Certificates were "inadequate" and the model for credit rating was "outdated" and (3) there were material conflicts of interest with regard to the Rating Agency Defendants' activities.

II. DISCUSSION

A. Legal Standard

A complaint will be dismissed under Rule 12(b)(6) if there is a "failure to state a claim upon which relief can be granted." Fed.R.Civ.P. 12(b)(6). To survive a motion to dismiss under Rule 12(b)(6), a plaintiff must "plead enough facts to state a claim to relief that is plausible on its face." Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007); see also Landmen Partners Inc. v. Blackstone Group, L.P., 659 F.Supp.2d 532, 538 (S.D.N.Y. 2009). A facially plausible claim is one where "the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Ashcroft v. Iqbal, 129 S.Ct. 1937, 1949 (2009). Where the court finds well-pleaded factual allegations, it should assume their veracity and determine whether they "plausibly give rise to an entitlement to relief." Id. at 1950. "Bald contentions, unsupported characterizations, and legal conclusions are not well-pleaded allegations and will not defeat the motion." Garber, 537 F.Supp.2d 597, 610 (S.D.N.Y. 2008). In addition to well-pleaded factual allegations in the complaint, a court "may consider any written instrument attached to the complaint, statements or documents incorporated into the complaint by reference, legally required public disclosure documents filed with the SEC, and documents possessed by or known to the plaintiff and upon ...


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