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New Jersey Carpenters Health Fund v. Residential Capital

March 31, 2010

NEW JERSEY CARPENTERS HEALTH FUND, NEW JERSEY CARPENTERS VACATION FUND AND BOILERMAKER BLACKSMITH NATIONAL PENSION TRUST, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFFS,
v.
RESIDENTIAL CAPITAL, LLC, RESIDENTIAL FUNDING, LLC, RESIDENTIAL ACCREDITED LOANS, INC., BRUCE J. PARADIS, KENNETH M. DUNCAN, DAVEE L. OLSON, RALPH T. FLEES, LISA R. LUNDSTEN, JAMES G. JONES, DAVID M. BRICKER, JAMES N. YOUNG, RESIDENTIAL FUNDING SECURITIES CORPORATION D/B/A GMAC RFC SECURITIES, GOLDMAN, SACHS & CO., RBS SECURITIES, INC., D/B/A RBS GREENWICH CAPITAL, DEUTSCHE BANK SECURITIES, INC., CITIGROUP GLOBAL MARKETS, INC., CREDIT SUISSE SECURITIES : (USA) LLC, BANK OF AMERICA CORPORATION AS SUCCESSOR-IN-INTEREST TO MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., UBS SECURITIES, LLC, JPMORGAN CHASE, INC. AS SUCCESSOR-IN-INTEREST TO BEAR, STEARNS & CO., INC., AND MORGAN STANLEY & CO., 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 Vacation Fund"), New Jersey Carpenters Health Fund ("Carpenters Health Fund") and Boilermaker Blacksmith National Pension Trust ("Boilermaker Trust") (collectively "Lead Plaintiffs" or "Plaintiffs") bring claims under sections 11, 12(a)(2), and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k(a), 77l(a)(2) (2010), for alleged omissions and misstatements in publicly-filed registration statements and prospectuses of mortgage-backed securities known as the RALI Certificates. The RALI Certificates were issued in a series of fifty-nine different offerings from March 2006 to October 2007, each with its own prospectus supplement but traceable to two primary "shelf" registration statements. Plaintiffs bring suit against essentially two groups of defendants, the "RALI Defendants," who were the primary issuers, sponsors and sellers of the RALI Securities, and the "Underwriter Defendants," corporate entities who underwrote the RALI offerings. For the reasons that follow, Plaintiffs' claims related to the offerings they did not purchased are dismissed for lack of standing. Claims related to alleged conflicts of interest with rating agencies and allegedly outdated credit ratings and inadequate credit enhancement are dismissed for failure to state an actionable claim under the Securities Act. Claims related to the alleged disregard of underwriting guidelines may proceed.

I.FACTUAL BACKGROUND*fn1

Plaintiffs are three pension funds, who purport to represent a class who purchased or acquired interests in mortgage-backed securities known as the RALI Mortgage Asset-Backed Pass-Through Certificates ("RALI Certificates" or "RALI Securities"), which were registered pursuant or traceable to two registration statements and accompanying prospectuses filed with the SEC on March 3, 2006, and on April 3, 2007. Consol. First. Am. Secs. Class Action Compl. ("Consolidated Amended Complaint" or "CAC") ¶¶ 1, 19-20. There are essentially two sets of defendants (collectively "Defendants"). The "RALI Defendants" are made up of the corporate entities that issued, sponsored and sold the RALI Certificates*fn2 , as well as various individual defendants ("Individual Defendants") who signed the two registration statements filed with the SEC for the RALI Certificates.*fn3 See CAC ¶¶ 2, 4, 21-37. Plaintiffs also bring claims against the "Underwriter Defendants," made up of the corporate entities who underwrote the fifty-nine RALI Securities offerings.*fn4 See CAC ¶¶ 2, 4, 40-52.

Mortgage-backed securities ("MBS") are defined as "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 ¶ 56. 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. See CAC ¶ 57. Due to the varying levels of risk associated with the loans and the potential that a borrower may default or be delinquent, a MBS may be created with a degree of "credit enhancement" built into its structure to protect from that risk. See CAC ¶ 93-94. The issuance of these securities can be done 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).*fn5

According to Plaintiffs, the RALI Defendants derived their profit through the sale of the RALI Certificates at an excess of the purchase price they paid for the underlying mortgages used to create the MBS. CAC ¶ 63. The RALI Defendants would purchase the underlying loans in bulk "directly from its loan origination affiliate," Homecomings Financial LLC f/k/a Homecomings Financial Network, Inc. ("HFN"). CAC ¶¶ 6, 64. The loan collateral was then securitized and sold to investors in the form of certificates, whose value was dependent on the payment of the underlying loans. See CAC ¶ 6. The Underwriter Defendants helped craft the securitization structure, draft and disseminate the related registration statements and prospectuses, and sell the RALI Securities to investors. See, e.g., CAC ¶ 41. Rating agencies provided the credit rating for each certificate based on the value and risks of the loan collateral, and according to Plaintiffs, played a significant role in the structuring of the RALI Securities, "from reviewing the loan tape before the loans were acquired to determining the loans to be included in the underlying Certificate collateral pools." CAC ¶ 65. As part of this process, the Defendants would engage in "ratings shopping," where they would seek a preliminary quote on the rating and necessary credit enhancement of a securitization, negotiate the details of the deal structure with the agencies, and ultimately select the agency that provided the highest rating for the most certificates in the securitization with the least amount of costly credit enhancement. See,e.g.,CAC ¶¶ 14, 65.

The RALI Certificates are made up of mortgage collateral purchased principally from HFN. CAC ¶ 73. Many, if not most, of the underlying loans were some form of sub-prime or otherwise risky "low documentation" or "no documentation" loans where there was a higher risk of default based on weak credit history and personal finances, or fraud because the borrower either self-reported or was not required to disclose as much information as in a typical loan. See, CAC ¶¶ 5, 64. The certificates were sold in fifty-nine separate offerings between March 28, 2006 and October 9, 2007. CAC ¶ 2. Collectively, $37.66 billion of RALI mortgage backed securities were sold to Plaintiffs and the purported class. Id. The Certificates were filed pursuant to two registration statements, each of which contained a base prospectus, along with subsequently filed prospectus supplements (collectively the "Offering Documents") for each particular RALI offering. CAC ¶¶ 1, 2. The registration statements and prospectus supplements contained detailed information about the securitization and the underlying loan pools.

When they were issued, most of the RALI Certificates received high credit ratings -- Moody's assigned its highest investment grade rating of "Aaa" to 95.80% of the certificates that it rated, while Standard & Poor's assigned its highest investment grade rating of "AAA" to 95.60% of the certificates it reviewed. CAC ¶ 8. "None of the Certificates were initially rated below investment grade." Id. Shortly thereafter, however, defaults and delinquencies on the underlying mortgage collateral rapidly developed. CAC ¶ 67-68. As a result, the RALI Certificates have lost "on average 42% of their value." CAC ¶ 9. Over 38% of the underlying loans of the RALI offerings are delinquent, or in default, foreclosure or bankruptcy. Id. In mid-2007, the rating agencies revised their rating models, re-analyzed the Certificates, and downgraded almost all of them. CAC ¶ 72. More than 98% of the RALI Certificates have been downgraded to "junk" quality. Id. One can't help but wonder what if any due diligence the rating agencies practiced.Plaintiffs allege that the Defendants*fn6 violated section 11 of the Securities Act based on omissions and misstatements of material information from the two registration statements and various prospectus supplements for the RALI Securities offerings. CAC ¶¶ 262-76. They further allege that the Underwriter Defendants violated Section 12(a)(2) of the Securities Act based on material misstatements and omissions in the prospectus supplements. CAC ¶¶ 277-85. Finally, Plaintiffs bring a cause of action under Section 15 of the Securities Act against the Individual Defendants and Underwriter Defendants for "control person liability." CAC ¶¶ 286-94. Plaintiffs' group their allegations of omitted and misstated information into three basic categories: (1) the underwriting guidelines used to originate the underlying loans were "systematically disregarded" by the originator, see, e.g., CAC ¶¶ 205-32 (2) the credit enhancements built into the RALI Certificates were "inadequate" and the model for credit rating was "outdated," see, e.g., CAC ¶¶ 113-21 and (3) there were undisclosed conflicts of interests between the Defendants and rating agencies, see, e.g., CAC ¶¶ 117-27;see also Pls.' Mem. of Law in Opp. to the RALI Defs.' Mot. to Dismiss ("Pls.' RALI Mem.") at 4. The allegations and arguments raised in this case are very similar to those raised in a previous case before me brought by some of the same plaintiffs, New Jersey Carpenters Vacation Fund v. Royal Bank of Scotland Group, PLC, No. 08 CV 5093(HB), 2010 WL 1172694 (S.D.N.Y. Mar. 26, 2010). Although this case is considered on its own merits, many of the legal issues are explored in greater detail in the Royal Bank of Scotland opinion.

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 which it relied in bringing the suit." ATSI Commc'ns v. Shaar Fund, Ltd., 493 F.3d 87, 98 (2d Cir. 2007); In re Morgan Stanley Tech. Fund Secs. Litig., Nos. 02 Civ. 6153, 02 Civ. 8579 (BSJ), 2009 WL 256005 (S.D.N.Y. Feb. 2, 2009)(applying ATSI to Securities Act claims), aff'd, 592 F.3d 347 (2d Cir. 2010).

Claims premised on fraud, including claims brought under the Securities Act, must satisfy the heightened particularity requirements of Rule 9(b) of the Federal Rules of Civil Procedure, whereas Securities Act claims that "sound in negligence" are governed by the standard notice pleading requirements of Rule 8. See In re Morgan Stanley Info. Fund Secs. Litig., 592 F.3d 347, 358 (2d Cir. 2010). Defendants argue that Plaintiffs' claims sound in fraud, but Plaintiffs expressly disclaim any allegations of fraud, and their allegations focus on the alleged negligent omission of information. See Landmen Partners, 659 F.Supp.2d at 539, n.5 ("Plaintiff's allegations in this case clearly sound in negligence and not fraud.").

B. Standing

Named plaintiffs allegedly purchased RALI Certificates in four offerings, each traceable to the 2006 and 2007 registration statements. CAC ¶¶ 19-20. Defendants argue that Plaintiffs lack standing for the other fifty-five offerings because they did not purchase those securities, and therefore could not be harmed by any misleading statement or omission in the related documents. Standing is challenged on the basis of the pleadings, and a district court must "accept as true all material allegations of the complaint, and must construe the complaint in favor of the complaining party." W.R. Huff Asset Mgmt Co. v. Deloitte & Touche LLP, 549 F.3d 100, 106 (2d Cir. 2008). In a putative class action, "named plaintiffs.must allege and show that they personally have been injured, not that injury has been suffered by other, unidentified members of the class to which they belong and which they purport to represent." Id. at 106 n.5 (internal quotations omitted, emphasis in original). To demonstrate Article III standing, Plaintiffs must allege (1) injury in fact, a "concrete and particularized harm to a legally protected interest;" (2) causation, a "fairly traceable connection between the asserted injury-in-fact and the alleged actions of the defendants," and; (3) redressability -- "a nonspeculative likelihood that the injury can be remedied by the requested relief." Id. at 106-07 (quoting Lujan v. Defenders of Wildlife, 504 U.S. 555, 560-61 (1992)). ...


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