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In re MBIA

March 31, 2010


The opinion of the court was delivered by: Kenneth M. Karas, District Judge


This case arises out of the continuing fall-out from the collapse of the mortgage-backed securities market. Lead Plaintiff, the Teachers' Retirement System of Oklahoma ("Lead Plaintiff" or "TRSO"), filed this putative class action on behalf of itself and other similarly situated individuals who purchased shares of Defendant MBIA, Inc., from July 2, 2007 to January 9, 2008 (the "Class Period"). Lead Plaintiff brings this action pursuant to § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) ("§ 10(b)"), and Rule 10b-5, 17 C.F.R. § 240.10b-5 ("Rule 10b-5 "), promulgated thereunder. Specifically, Lead Plaintiff alleges that MBIA, and its subsidiary, MBIA Insurance Corporation (collectively "MBIA"), along with MBIA's then-Chairman and Chief Executive Officer, Gary C. Dunton ("Dunton"), and current Chief Financial Officer and Vice President, C. Edward Chaplin ("Chaplin"), violated § 10(b) and Rule 10b-5 when they misrepresented MBIA's risk exposure to certain collateralized debt obligations ("CDOs") containing residential mortgage-backed securities ("RMBS").

Defendants MBIA, Dunton, and Chaplin (collectively "Defendants") move to dismiss Lead Plaintiff's Consolidated Amended Class Action Complaint ("CAC") pursuant to Fed. R. Civ. P. 12(b)(6). For the reasons stated herein, Defendants' Motion to Dismiss is granted in part and denied in part.

I. Background

A. Factual Background

Except as otherwise noted, the following facts are taken from the CAC, and are presumed true for the purposes of this motion.*fn1

1. RMBS, CDOs, and CDOs-Squared

RMBS, CDOs, and CDOs-squared are three types of structured finance securities that are backed by an underlying pool of assets. (CAC ¶ 29.) CDOs are created by pooling a variety of asset-backed securities ("ABS"), such as RMBS or commercial mortgage-backed securities ("CMBS").*fn2 (Id. ¶ 31.) CDOs-squared are created by pooling CDOs (called "inner- CDOs") and other types of ABS, such as RMBS or other kinds of structured finance securities, as the underlying assets. (Id. ¶ 32.) Prior to the Class Period, investors and credit agencies were increasingly concerned with the potential effects of residential mortgage defaults on RMBS and CDOs backed by RMBS. (Id. ¶¶ 36-37.)

2. The Parties

Lead Plaintiff provides retirement and disability benefits to public school teachers and other staff in Oklahoma. (Id. ¶ 9.) MBIA is a publicly-traded company that provides insurance to traditional bond or structured finance issuers in exchange for premium payments, which means that MBIA "wraps" the bonds with its own credit rating by guaranteeing to pay "all principal and interest payments in the event the issuer cannot meet its obligations." (Id. ¶¶ 20-21.) In many such transactions, MBIA possesses "control rights," or the ability to liquidate underlying collateral to pay its obligations. (Id. ¶¶ 72, 79.) In an event of default, MBIA is often responsible for paying timely interest and principal over a large period of time. (Id. ¶ 79.) Essentially, the "'product' that MBIA sells is the lower interest expense it can offer by virtue of its credit rating" (id. ¶ 23), and any reduction in MBIA's credit rating would have adverse effects on MBIA's business, (id. ¶ 24). Rating agencies considered MBIA's "capital adequacy," or its capacity to pay claims when they came due, a primary factor in determining MBIA's credit rating. (Id. ¶ 25.) As a result, even losses in smaller portions of MBIA's portfolio could affect MBIA's capital adequacy if MBIA was unable to pay the losses as they came due. (Id. ¶¶ 25-26.)

Defendant Dunton was MBIA's Chairman, CEO, and President during the Class Period and until his resignation in February 2008. (Id. ¶ 11.) According to MBIA's 10-K for 2006, Dunton was a member of the "Executive Credit Committee," which reviewed "larger, complex, or unique transactions." (Id. ¶ 38; Decl. of Tatyana Trakht ("Trakht Decl.") Ex. 2, at 7).*fn3 A confidential witness ("CW"), who worked in MBIA's structured finance business from 1998 until March 2007, reported that the Executive Credit Committee received memoranda on all transactions over $250 million, which included all the transactions relevant to this case. (Id. ¶¶ 39-41.) According to the CW, these memoranda "detailed delinquency rates, loss rates, [and] shifts in underwriting standards," and "'definitely' provided sufficient information for Dunton to see the deteriorating quality" of the insured CDO transactions backed by RMBS. (Id. ¶ 41.) Defendant Chaplin was MBIA's CFO, Vice President, and a member of its Executive Policy Committee during the Class Period. (Id. ¶ 13.) During the Class Period, Dunton and Chaplin signed MBIA's SEC filings and participated in creating or reviewing MBIA's press releases and web disclosures. (Id. ¶¶ 12, 14.) Both Dunton and Chaplin were members of MBIA's "Loss Reserve Committee," which reviewed transactions for impairments, and of the "Risk Oversight Committee," which reviewed risky or troubled transactions. (Id. ¶ 38.)

3. Defendants' Disclosures and Alleged Misrepresentations and Omissions

The CAC alleges three categories of material misstatements and omissions: (1) statements and charts regarding MBIA's total exposure to RMBS-backed CDOs that omitted CDOs-squared containing RMBS; (2) statements regarding MBIA's control rights that failed to disclose MBIA's lack of control rights over the inner-CDOs of the CDOs-squared; and (3) statements regarding MBIA's payment obligations that did not disclose MBIA's obligation to pay for events of default as they occurred for the CDOs-squared.

In the first category of statements and omissions, Lead Plaintiff alleges that MBIA published a materially misleading quarterly disclosure document on its website. On July 2, 2007, the first day of the Class Period, MBIA issued a document entitled "MBIA's CDO Strategy, Portfolio Analysis and Subprime Exposure" ("First Quarter CDO Primer"). The document stated that MBIA's "Multi-Sector CDO Portfolio" consisted of $22.7 billion in net par exposure. (Trakht Decl. Ex. 4, at 5.) Multi-Sector CDOs were defined as "transactions that include a variety of structured finance asset classes . . . includ[ing] asset-backed securities (e.g. securitizations of auto receivables, credit cards, etc.), commercial mortgage-backed securities, CDOs, and various types of residential mortgage-backed securities including prime and subprime RMBS." (Id.) It stated that the range of asset classes listed was "found throughout the entire Multi-Sector CDO portfolio." (Id.) The document contained a chart listing MBIA's "Multi-Sector CDOs with U.S. RMBS" as $14.7 billion, compared to "Other CDOs." (CAC ¶ 75.) The $14.7 billion figure allegedly did not include approximately $6 billion in CDOs-squared containing RMBS. (Id. ¶ 77.) Another chart within the First Quarter CDO Primer, described as a "summary of MBIA-guaranteed Multi-Sector CDOs that include U.S. RMBS collateral originated from 2004 through the first quarter 2007," listed fifteen CDO transactions with a "total" of about $12 billion. (Id. ¶ 76.) MBIA separately listed the $12 billion in RMBS-backed CDOs from after 2004 because CDOs originated after 2004 were considered riskier. (Id. ¶ 47.) The summary chart allegedly did not include approximately $5 billion in CDOs-squared containing RMBS.*fn4 (Id. ¶ 77.)

Subsequently, MBIA published two updated CDO Primers on July 26, 2007 and October 25, 2007 ("Second Quarter CDO Primer" and "Third Quarter CDO Primer," respectively). (Id. ¶¶ 81, 94.) The Second Quarter CDO Primer listed the aggregate multi-sector CDO portfolio exposure as $24.2 billion. (Trakht Decl. Ex. 6, at 5.) According to Lead Plaintiff, the Second and Third Quarter CDO Primers contained statements and charts, similar to those in the First Quarter CDO Primer, listing the "total" of MBIA's multi-sector CDOs containing RMBS without including the RMBS-backed CDOs-squared. (CAC ¶¶ 81-82 (alleging that figures and charts in the Second Quarter CDO Primer omitted approximately $5-6 billion in CDOs-squared); id. ¶ 94 (alleging that figures and charts in Third Quarter CDO Primer omitted approximately $8-9 billion in CDOs-squared).)

Lead Plaintiff also alleges that Defendants made material misstatements and omissions regarding the total RMBS-backed CDO portfolio during a series of conference calls and presentations with investors and analysts. On August 2, 2007, MBIA organized an investor conference call, during which MBIA's Head of Structured Finance Insurance Portfolio Management, Anthony McKiernan, stated that MBIA's "multi-sector CDO net par out standings [sic] was [$]24.2 billion" and that out "[o]f the $24.2 [b]illion multisector total, approximately $15.9 billion of net par contains RMBS collateral." (CAC ¶ 85; Trakht Decl. Ex. 7, at 14.) In response to a question asking for "more detail on the CDO collateral within [MBIA's] multisector CDOs and the general composition of [MBIA's] CDOs squared" (CAC ¶ 109; Trakht Decl. Ex. 7, at 19), McKeirnan stated that MBIA had approximately $6.1 billion of net exposure to CDOs-squared and that "22% of the collateral supporting [the CDO-squared] deals [was] comprised [of] CDOs of ABS," (Trakht Decl. Ex. 7, at 20). McKiernan did not specifically state whether or not the outer- or inner-CDOs contained RMBS. (CAC ¶ 109.) On August 16, 2007, a few weeks after the investor call, Morgan Stanley published a report stating that MBIA's RMBS-related exposure was $15.9 billion, a figure that omitted the CDOs-squared, and that Morgan Stanley thought was "more modest" than the RMBS exposure of Ambac, one of MBIA's main competitors. (Id. ¶ 52; Trakht Decl. Ex. 9, at 8.) The report also stated that "[t]he reason for MBIA's lower losses . . . is due almost entirely to the lack of mezzanine CDO-squared transactions." (Trakht Decl. Ex. 9, at 8.)

On September 4, 2007, Defendant Dunton gave a presentation at a Keefe, Bruyette & Woods, Inc. ("KBW") conference. The CAC alleges that Dunton stated that MBIA "had '$15.9 billion' of exposure to 'CDOs that contain some level of RMBS.'" (CAC ¶ 53 (emphasis omitted).) However, the transcript of the conference shows that Dunton actually stated that MBIA had "written about $24.2 billion of multi-sector CDOs that contain some level of RMBS. That level of RMBS is indicated by the $15.9 billion" figure. (Trakht Decl. Ex. 11, at 4.) Dunton referred to presentation slides, showing that MBIA had $24.2 billion net par outstanding in multi-sector CDOs (id. Ex. 10, at 12), and that the net par outstanding for "CDOs with some subprime exposures" was $15.9 billion, (id. at 15; CAC ¶ 90.) No mention was made of CDOs-squared collateralized, at least in part, by RMBS.

On October 25, 2007, Defendant Chaplin participated in a conference call during which, in response to a question about the portfolio referenced in a sensitivity analysis, he responded that "[i]t was all of our CDOs that contain sub prime mortgage collateral . . . I think it's all the CDOs that contain RMBS and as of the second quarter, the size of that portfolio is about $17 billion" and that for the "third quarter . . . the size of that portfolio was, I believe, $22 million. I'm sorry, $19 billion." (CAC ¶ 54; Trakht Decl. Ex. 14, at 11.) Again, this figure did not include the CDO-squared holdings of MBIA, which by then totaled between $8 and $9 billion. (CAC ¶ 93.) After this call, Morgan Stanley issued a report noting that MBIA had "$17.2 billion" in exposure to "CDOs with RMBS collateral." (CAC ¶ 55.) On November 27, 2007, Chaplin stated at a Bank of America conference that MBIA's exposure to CDOs with RMBS was "[a]bout $19 billion." (Id. ¶ 98.)

Regarding the second and third categories of misstatements, Lead Plaintiff alleges that MBIA's 2006 10-K was misleading because it failed to disclose the risks from the lack of structural protections in some of the CDOs-squared. (Id. ¶ 120.) Lead Plaintiff also alleges that the First Quarter CDO Primer did not state that MBIA lacked "control rights" over the innerCDOs or that MBIA was subject to onerous payment obligations, despite stating that the CDOs-squared were "consistent with [MBIA's] zero-loss standard" and "did not represent a material risk." (Id. ¶¶ 78-79.) Lead Plaintiff further alleges that MBIA representatives on the August 2, 2007 conference call repeatedly emphasized that MBIA had "control rights" over its entire RMBS-backed CDO portfolio and that MBIA was "only covering" timely interest and ultimate principal for the RMBS-backed CDOs. (Id. ¶ 87.)

4. Rating Agency Evaluations and Alleged Corrective Disclosures

On December 10, 2007, Fitch Ratings stated that in providing additional commentary on MBIA's exposure, it would include views on "MBIA's exposure to structured finance collateralized obligations (SF CDOs) backed by subprime RMBS and CDO-squared securities, which totaled $29.9 billion at September 30, 2007." (Trakht Decl. Ex. 18, at 1.) On December 19, 2007, Standard & Poor's ("S&P") issued a report assigning MBIA a negative outlook. (CAC ¶ 58.) S&P was aware of MBIA's CDOs-squared based on information MBIA made available to it, but allegedly did not provide to investors. (Id. ¶¶ 58, 104.) The report explained that CDOs-squared could pose problems for insurers because insurers may not have control rights over the inner-CDO. (Id. ¶ 58; Trakht Decl. Ex. 20, at 8.) A chart entitled "RMBS Exposure Information and Stress Test Results" stated that MBIA's total par outstanding at the end of the third quarter of 2007 was approximately $29.7 billion. (Trakht Decl. Ex. 20, at 10.) After the S&P report, MBIA's stock fell from $28.04 to $27.02 per share. (CAC ¶ 58.)

At around 6:30 p.m. on December 19, 2007, MBIA issued a press release stating that it had "supplemented the listing of its exposure to CDOs that include RMBS as of September 30, 2007 to make it consistent with the CDOs that were included in Standard & Poor's analysis." (Id. ¶ 59.) On its website, MBIA updated the summary chart from the CDO Primers that listed specific RMBS-backed CDOs from after 2004 to include an additional section of "CDOs of Multi-Sector High Grade Collateral." (CAC ¶ 60.) The chart listed six such transactions, representing MBIA's CDOs-squared from 2004 or later, totaling $8.1 billion. (Id.) This additional section listing CDO-squared transactions had not appeared on any of the charts included in the First, Second, or Third Quarter CDO Primers. After MBIA's press release, Morgan Stanley issued a report stating that MBIA had "disclosed that it has a massive $8.1 billion of exposure to CDO-squared transactions" and that Morgan Stanley was "shocked that [MBIA] management withheld this information for as long as it did." (Id. ¶ 62.) The Morgan Stanley report also stated that "MBIA simply did not disclose arguably the riskiest parts of its CDO portfolio to investors: $8.1 billion of CDO-squareds." (Id.)

The next day, MBIA's stock dropped from the December 19, 2007 closing price of $27.02 to $19.95 at the end of trading on December 20, 2007, a 26% drop. (Id. ¶ 106.) Dow Jones Newswires reported that the "the $8.1 billion exposure in CDO-squareds was new to investors, causing the stock to plunge." (Id. ¶ 65.) On December 20, 2007, MBIA issued a press release stating that the "information posted on December 19, 2007 disclose[d] no additional Multi-Sector CDO exposure," because the information "provide[d] detail on the composition of MBIA's $30.6 billion Multi-Sector CDO exposure that had previously been provided in its Operating Supplement." (Id. ¶ 107; Trakht Decl. Ex. 23, at 1.) Indeed, MBIA had previously published an "Operating Supplement" on its website for the third quarter of 2007 ("Third Quarter Operating Supplement"), stating that its Multi-Sector CDO exposure was $30.6 billion. (CAC ¶ 108; Trakht Decl. Ex. 12, at 18).*fn5 MBIA also stated that it had previously discussed its CDO- squared exposure during the August 2, 2007 conference call and that "MBIA had not previously detailed these transactions because they contain less than 25 percent direct U.S. RMBS collateral."*fn6 (CAC ¶ 108; Trakht Decl. Ex. 23, at 1.)

After the December 20, 2007 MBIA press release, Citigroup Global Markets issued a report stating that MBIA's CDOs-squared "ha[d] less than 25% RMBS" and that "[t]he standard disclosures established by all [financial guarantors] was to only identify CDOs of ABS with more than 25% RMBS," which Citigroup believed MBIA did during the August 2, 2007 conference call. (Trakht Decl. Ex. 24, at 1-2.) Similarly, Merrill Lynch issued a report stating that "the lack of a previous detailed disclosure on a transaction by transaction basis was the result of a definitional issue . . . as opposed to willful effort by MBIA management to conceal the information." (Id. Ex. 25, at 3.) Bank of America stated that "concerns over MBIA's disclosure and capital plan were overblown." (Id. Ex. 26, at 1.)*fn7

On January 9, 2008, the last day of the Class Period, MBIA filed an SEC Form 8-K in which it stated that its total exposure to CDOs-squared was $9 billion. (CAC ¶¶ 67-68.) MBIA also stated that the CDO-squared portfolio had suffered $200 million in loss impairments. (Id. ¶ 68.) The 8-K further stated that $8.1 billion in CDOs-squared lacked structural protections, such as control rights and a limited payout structure. (Id. ¶ 69.) MBIA also revised the risk factors from the 2006 10-K, adding that the "performance of the securities MBIA insures depends on a wide variety of factors which are outside our control, including . . . the exercise of control or other rights held by other transaction participants." (Id. ¶ 120 (emphasis omitted).) MBIA's share price fell from an opening price of $15.00 per share on January 9, 2008 to a closing price of $13.40. (Id. ¶ 70.) In February 2008, Dunton resigned as CEO. (Id.) In April 2008, Fitch downgraded MBIA, depriving it of its triple-A ratings, and other ratings agencies followed suit. (Id.)

B. Procedural Background

Beginning on January 11, 2008, three Plaintiffs filed complaints on behalf of themselves and others similarly situated against MBIA, Dunton, and Chaplin for violations of §10(b) and Rule 10b-5, asserting claims related to the CDOs-squared and the disclosures discussed above.*fn8

Five additional Parties petitioned the Court for appointment as lead counsel.*fn9 In a Case Management Order dated June 30, 2008, the Court consolidated the three pending cases and appointed TRSO as Lead Plaintiff.*fn10 (Dkt. No. 31.) On October 17, 2008, Lead Plaintiff filed its CAC. (Dkt. No. 37.) Defendants timely moved ...

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