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Federal Housing Finance Agency v. JPMorgan Chase & Co.

United States District Court, S.D. New York

November 5, 2012

JPMORGAN CHASE & CO., et al., Defendants.

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Philippe Z. Selendy, Kathleen M. Sullivan, Manisha M. Sheth, William B. Adams, Quinn Emanuel Urquhart & Sullivan, LLP, 51 New York, NY, for Plaintiff Federal Housing Finance Agency.

Penny Shane, Sharon L. Nelles, Jonathan M. Sedlak, Yavar Bathaee, Sullivan & Cromwell LLP, New York, NY, for Defendants JPMorgan Chase & Co., JPMorgan Chase Bank, N.A., J.P. Morgan Mortgage Acquisition Corporation, J.P. Morgan Securities LLC, J.P. Morgan Acceptance Corporation I, EMC Mortgage LLC, Bear Stearns & Co., Inc., Structured Asset Mortgage Investments II Inc., Bear Stearns Asset Backed Securities I LLC, WaMu Asset Acceptance Corporation, WaMu Capital Corporation, Washington Mutual Mortgage Securities Corporation, Long Beach Securities Corporation, David M. Duzyk, Louis Schioppo, Jr., Christine E. Cole, Edwin F. McMichael, William A. King, Brian Bernard, Joseph T. Jurkowski, Jr., Kim Lutthans, Katherine Garniewski, Richard Careaga, David Beck, Diane Novak,

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Rolland Jurgens, Thomas G. Lehmann, Stephen Fortunato, Donald Wilhelm, Marc K. Malone, Michael L. Parker, David H. Zielke, Thomas W. Casey, John F. Robinson, D. Keith Johnson, Suzanne Krahling, Larry Breitbarth, Art Den Heyer and Stephen Lobo.

Richard W. Clary, Michael T. Reynolds, Cravath, Swaine & Moore LLP, New York, NY, for Defendant Credit Suisse Securities (USA) LLC.

Thomas C. Rice, David J. Woll, Alan Turner, Simpson Thacher & Bartlett LLP, New York, NY, for Defendant RBS Securities Inc.

Richard H. Klapper, Theodore Edelman, Michael T. Tomaino, Jr., Jordan T. Razza, Sullivan & Cromwell LLP, New York, NY, for Defendant Goldman, Sachs & Co.

Brad S. Karp, Susanna M. Buergel, Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, NY, for Defendant Citigroup Global Markets Inc.

Dani R. James, Jade A. Burns, Kramer Levin Naftalis & Frankel LLP, New York, NY, for Defendant Jeffrey L. Verschleiser.

Sandra Hauser, Patrick E. Fitzmaurice, SNR Denton, New York, NY, for Defendant Matthew Perkins.

Richard A. Edlin, Ronald D. Lefton, Candace Camarata, Greenberg Traurig, LLP, New York, NY, for Defendant Jeffrey Mayer.

Joel C. Haims, LaShann M. DeArcy, Morrison & Foerster LLP, New York, NY, for Defendants Tom Marano and Michael Nierenberg.

Pamela Rogers Chepiga, Josephine A. Cheatham, Allen & Overy LLP, New York, NY, for Defendant Samuel L. Molinaro, Jr.


DENISE COTE, District Judge:

This is one of sixteen actions currently before this Court in which the Federal Housing Finance Agency (" FHFA" or " the Agency" ), as conservator for Fannie Mae and Freddie Mac (together, the " Government Sponsored Enterprises" or " GSEs" ), alleges misconduct on the part of the nation's largest financial institutions in connection with the offer and sale of mortgage-backed securities purchased by the GSEs in the period between 2005 and 2007.[1] As amended, the complaints in each of the actions assert claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933, 15 U.S.C. §§ 77k, l (a)(2), o; the Virginia Securities Act, VA Code Ann. § 13.1-522(A)(ii), (C); and the District of Columbia Securities Act, D.C. Code § 31-5606.05(a)(1)(B), (c).[2] In six of the

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cases, including this one, the Agency has also asserted claims of fraud and aiding and abetting fraud under the common law of New York State (the " Fraud Claim Cases" ).[3]

The sixteen actions are congregated before this Court for coordinated pretrial proceedings. An initial conference was held with counsel for all parties in the coordinated actions on December 2, 2011. At that time, it was agreed that a motion to dismiss filed in FHFA v. UBS, 11 Civ. 5201(DLC) (the " UBS Matter" ), would serve as the vehicle for litigating certain legal issues common to all sixteen cases, including certain timeliness issues and whether the FHFA has standing to bring these cases. On May 4, 2012, the Court denied a motion by the defendants in the UBS Matter to dismiss the plaintiff's securities law claims. See Federal Housing Finance Agency v. UBS Americas, Inc., et al., 858 F.Supp.2d 306 (S.D.N.Y.2012) (" UBS I " ). An Opinion of June 26 decided certain additional legal issues left open by the May 4 Opinion. See Federal Housing Finance Agency v. UBS Americas, Inc., et al., 2012 WL 2400263 (S.D.N.Y. June 26, 2012) (" UBS II " ).[4]

Pursuant to a June 14 Pretrial Scheduling Order, depositions are to begin in all cases in January 2013, and all fact and expert discovery in this matter, 11 Civ. 6188(DLC), must be concluded by December 6, 2013. Trial in this matter is scheduled to begin on June 4, 2014. The June 14 Order also set a schedule for the briefing of defendants' motions to dismiss in the remaining fifteen cases. Briefing has occurred two phases, with the motions in this case and the remaining Fraud Claim Cases becoming fully submitted on October 11, 2012. The motions in the remaining nine cases are scheduled to be fully submitted November 9, 2012.

The primary defendant in this case is JPMorgan Chase & Co. (" JPMorgan" ), in its own right and as successor to Bear Stearns & Co. Inc. (" Bear Stearns" ), Washington Mutual Bank (" WaMu" ), and Long Beach Securities (a subsidiary of WaMu). Various corporate and individual affiliates of JPMorgan, Bear Stearns, WaMu, and Long Beach that were involved in the securitization process are also defendants, as are four banks that acted as underwriters for certain of the securitizations but are not otherwise affiliated with JPMorgan: Citigroup Global Markets, Inc. (" Citigroup" ), Credit Suisse Securities (USA) LLC (" Credit Suisse" ), Goldman Sachs & Co. (" Goldman Sachs" ), and RBS Securities (" RBS Greenwich" ) (collectively, the " Other Underwriter Defendants" ).

Except for the inclusion of substantive and aiding-and-abetting fraud claims, the structure of the Amended Complaint in this case parallels that of the Second Amended Complaint in the UBS Matter. The following discussion, therefore, borrows liberally from UBS I. Briefly stated, FHFA contends that Fannie Mae and Freddie Mac purchased over $33 billion in residential mortgage-backed securities (" RMBS" ) sponsored or underwritten by JPMorgan, Bear Stearns, or WaMu entities during the period between September 2005 and September 2007. RMBS are securities

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entitling the holder to income payments from pools of residential mortgage loans that are held by a trust. For each of the securities at issue here, the offering process began with a " sponsor," which acquired or originated the mortgage loans that were to be included in the offering.[5] The sponsor transferred a portfolio of loans to a trust that was created specifically for that securitization; this task was accomplished through the involvement of an intermediary known as a " depositor." The trust then issued certificates to an underwriter, which, in turn, sold them to the GSEs. The certificates were backed by the underlying mortgages. Thus, their value depended on the ability of mortgagors to repay the loan principal and interest and the adequacy of the collateral in the event of default. In several instances, the GSEs purchased multiple Certificates representing different tranches of a single securitization. Consequently, although this case concerns 103 securitizations, the GSEs purchased 127 distinct certificates (the " GSE Certificates" ), each backed by a different supporting loan group.

Each of the GSE Certificates was offered pursuant to one of nineteen shelf registration statements filed with the Securities and Exchange Commission (" SEC" ). For each of the GSE Certificates, the pertinent shelf registration statement, along with the prospectus and a prospectus supplement filed at the time of securitization together constitute the " Offering Documents" (or " Offering Materials" ). The Securities Act makes the sponsor, depositor, underwriters and any individual signatories jointly and severally liable for any material misstatements in these documents. See 15 U.S.C. § 77k(a). The District of Columbia and Virginia Blue Sky provisions impose liability on similar terms.

JPMorgan served as the lead underwriter for 30 out of the 103 securitizations at issue in this case, and for 27 of those also served as sponsor and depositor. Bear Stearns served as lead underwriter for 38 of the securitizations, depositor for 35 of those, and sponsor for 32 of that subset. WaMu or Long Beach served as sponsor and depositor for 35 of the securitizations, for 31 of which it was also one of the lead underwriters. Citigroup and RBS Greenwich each served as co-lead underwriter (with JPMorgan and WaMu, respectively) for a single securitization. Lehman Brothers served as co-lead underwriter with WaMu for two securitizations and was the sole lead underwriter for two additional securitizations that WaMu entities sponsored. Goldman Sachs was the lead underwriter for two securitizations sponsored by WaMu entities. Each individual defendant signed one or more of the Offering Documents at issue here.

FHFA's Amended Complaint asserts, inter alia, that the Offering Documents for the 127 GSE Certificates " contained materially false or misleading statements and omissions." More particularly, the Amended Complaint alleges that " [d]efendants falsely represented that the underlying mortgage loans complied with certain underwriting guidelines and standards, including representations that significantly overstated the ability of borrowers to repay their mortgage loans." The Offering Documents are also alleged to have contained representations regarding " the percentage of loans secured by owner-occupied

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properties and the percentage of the loan group's aggregate principal balance with loan-to-value ratios within specified ranges" that were both false and materially incomplete. FHFA asserts that " the false statements of material facts and omissions of material facts in the Registration Statements, including the Prospectuses and Prospectus Supplements, directly caused Fannie Mae and Freddie Mac to suffer billions of dollars in damages," because " [t]he mortgage loans underlying the GSE Certificates experienced defaults and delinquencies at a much higher rate than they would have had the loan originators adhered to the underwriting guidelines set forth in the Registration Statement." FHFA's claims of substantive fraud and aiding and abetting fraud are predicated on each of these three categories of misstatement.[6] With regard to these claims only, FHFA further alleges: (1) that JPMorgan, Bear Stearns, WaMu, Long Beach and their affiliates knew that the Offering Documents' representations were false; and (2) that the GSEs justifiably relied on those representations.

In moving to dismiss the plaintiff's complaint in this case the defendants raise four principal arguments, most of which focus on the adequacy of the fraud claims.[7] First, the defendants argue that the Amended Complaint does not contain sufficient factual support for the allegation that the loans underlying the securitizations were not underwritten in accordance with the guidelines set out in the Offering Documents. They do not argue that the remaining two categories of misrepresentation— regarding owner-occupancy rates and loan-to-value ratios— are inadequately pleaded. Second, JPMorgan argues that the Amended Complaint fails to plead the remaining elements necessary to sustain the plaintiff's fraud claims, including scienter, justifiable reliance, and loss causation. Third, JPMorgan maintains that downgrades in the credit ratings of certain certificates related to those at issue here (though, importantly, none of the GSE Certificates themselves) should have put the GSEs on notice of their claims at least as early as September 2007, making this action untimely when filed. Fourth, JPMorgan asserts that FHFA's claims against it as successor-in-interest to WaMu are barred by the Financial Institutions Reform, Recover, and Enforcement Act of 1989 (" FIRREA" ). For their part, the Other Underwriter Defendants assert that the Amended Complaint's allegations as to them are inadequate to state a claim, as the Agency does not purport to have reviewed the files of any of the loans included in the securitizations for which they acted as underwriters.[8] For the reasons that follow, defendants' motion is granted in part.

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I. Falsity With Regard to Underwriting Standards

JPMorgan and the Other Underwriter Defendants contend that the Amended Complaint " sets out no basis to assert" that Offering Documents' representations regarding adherence to loan underwriting guidelines were false " with respect to the specific securitizations, certificates or loans at issue here." This failure, they argue, renders the pleading inadequate pursuant to Rule 12(b)(6), Fed.R.Civ.P. As defendants note, the Agency's fraud, Securities Act, and Blue Sky claims all require that the plaintiff plead, inter alia, that the defendants made a materially false or misleading statement. See 15 U.S.C. §§ 77k(a), 77 l (a)(2); D.C. Code § 31-5606.05(a)(1)(B); Va.Code § 13.1-522; City of New York v., Inc., 541 F.3d 425, 454 (2d Cir.2008)(reciting the elements of fraud under New York common law), rev'd on other grounds sub nom. Hemi Group, LLC v. City of New York, 559 U.S. 1, 130 S.Ct. 983, 175 L.Ed.2d 943 (2010).[9]

The FHFA's Securities Act and Blue Sky Claims are governed by the pleading standard set forth in Rule 8(a), Fed. R. Civ. P., which " place[s] a relatively minimal burden on the plaintiff." NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145, 157 (2d Cir.2012) (citation omitted).[10] Under the rule, a pleading need only contain " sufficient factual matter, accepted as true, to state a claim to relief that is plausible on its face." Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009). Applying this plausibility standard is " a context-specific task that requires the reviewing court to draw on its judicial experience and common sense." Id. at 1950. The plaintiff's fraud allegations must satisfy not only Rule 8(a), but also Rule 9(b), Fed.R.Civ.P.,[11] which imposes the additional requirement that a plaintiff " state with particularity the circumstances constituting fraud." But in reviewing the sufficiency of a fraud plaintiff's allegations with regard to falsity, the Court of Appeals has taken care to note that, " [e]ven with the heightened pleading standard under Rule 9(b), ... we do not require the pleading of detailed evidentiary matter in securities litigation." In re Scholastic Corp. Securities Litig., 252 F.3d 63, 72 (2d Cir.2001). When assessing the adequacy of a complaint in the face of a Rule 12(b)(6) motion, the court is obliged— under either pleading standard— to accept as true the facts alleged by the plaintiff. Stevelman v. Alias Research Inc., 174 F.3d 79, 83 (2d Cir.1999).

As in UBS I, the prospectus and prospectus supplement for each of the securitizations at issue in this case described the underwriting guidelines that were said to

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govern the origination of mortgages with whose income the securitization was backed. For example, the prospectus supplement for the JPMAC 2006-CH1 Securitization, for which JPMorgan affiliates acted as sponsor, depositor, and lead underwriter— as well as originator of all the underlying loans— contained the following representations:

• The Mortgage Loans were originated and underwritten in accordance with either the Chase Home Mortgage Call Center Underwriting Guidelines described below (the " CHM Call Center Underwriting Guidelines" ) or the Chase Home Mortgage Wholesale/Retail Underwriting Guidelines described below (the " CHM Wholesale/Retail Underwriting Guidelines" ).

[Regarding CHM Wholesale/Retail Underwriting Guidelines:]

• The Chase Home Mortgage Wholesale/Retail Underwriting Guidelines consider the value and adequacy of the mortgaged property as collateral for the proposed mortgage loan, but also take into consideration the borrower's credit standing and repayment ability.
• In general, for mortgage loans underwritten under the Full Documentation program, Chase Home Mortgage verifies income and assets through alternate documentation or written third party verifications, except that no asset verification is required for borrowers in all credit grades and all documentation types that have an LTV less than, or equal to 80%, or a credit score equal to or greater than 640. For loan amounts in excess of $500,000 asset verification is required regardless of LTV or credit score. The 12-Month Bank Statement program is similar to the Full Documentation program, except that the last 12 months of bank statements are utilized to support income.... Under the Reduced Documentation program the maximum loan-to-value ratio for non-self-employed borrowers is reduced by 10%, and asset verification for the source of the borrower's down payment is not required for all credit grades and all documentation types that meet the following criteria: LTV less than or equal to 80%, or a credit score equal to or greater than 640. For loan amounts in excess of $500,000 asset verification is required regardless of LTV or credit score.
• On a case by case basis, Chase Home Mortgage may determine that, based upon compensating factors, a prospective borrower not strictly qualifying under the underwriting risk category guidelines described below warrants an underwriting exception. Compensating factors may include, without limitation, relatively low loan-to-value ratio, relatively low debt-to-income ratio, stable employment and time in the same residence. It is expected that a significant number of the mortgage loans underwritten in accordance with the Chase Home Mortgage Wholesale/Retail Underwriting Guidelines will have been originated with such underwriting exceptions based on compensating factors.
• [T]he depositor will not include any loan in the trust fund for any series of securities if anything has come to the depositor's attention that would cause it to believe that the representations and warranties of a seller or originator will not be accurate and complete in all material respects in respect of the loan as of the date of initial issuance of the related series of securities.

The prospectus supplements for the other securitizations contained similar representations.

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As noted, FHFA's claims are premised in part on the allegation that the mortgages underlying the 127 GSE Certificates (the " Supporting Loans" or " Supporting Loan Groups" ) deviate so significantly from the underwriting guidelines set out in the Offering Documents as to render those representations false. In an effort to provide the requisite factual support for this allegation, the Amended Complaint cites four categories of evidence.

First, the Amended Complaint reports the results of private and government investigations, which have concluded that, during the relevant period, several of the mortgage originators whose loans support the GSE Certificates disregarded their own underwriting guidelines on a widespread and systematic basis. Among the originators specifically mentioned are: WMC Mortgage Corp.; Fremont Investment & Loan; Countrywide Home Loans, Inc.; GreenPoint Mortgage Funding, Inc.; Argent; New Century; American Home; and Option One. These eight originators are alleged to have underwritten some or all of the loans in at least 31 of the securitizations at issue here, representing 36 ...

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