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LBBW Luxemburg S.A. v. Wells Fargo Securities LLC

United States District Court, S.D. New York

March 30, 2017



          J. PAUL OETKEN, United States District Judge.

         Plaintiff LBBW Luxemburg S.A. (“LBBW”) brought suit against Defendants Wells Fargo Securities LLC (“Wells Fargo”), the successor to Wachovia Capital Markets (“Wachovia”), and Fortis Securities LLC (“Fortis”; collectively with Wells Fargo, “Defendants”). On March 31, 2014, this Court granted in part and denied in part Defendants' motions to dismiss, keeping alive one theory of liability advanced by LBBW. (Dkt. No. 56.) Following discovery, Defendants moved for summary judgment on LBBW's remaining claims, additionally challenging LBBW's standing to maintain the suit. (Dkt. No. 213; Dkt. No. 214.) This Court heard oral argument on February 10, 2017. For the reasons that follow, Defendants' motions for summary judgment are granted.

         I .Background

         Familiarity with the background of this case is presumed and detail is provided in this Court's earlier Opinion and Order, granting in part and denying in part Defendants' motion to dismiss. See LBBW Luxemburg S.A. v. Wells Fargo Secs. LLC, 10 F.Supp.3d 504 (S.D.N.Y. 2014). The facts, as recounted here, are taken from the parties' 56.1 Statements and responses (citations are to the last such Statement filed, Docket Number 226 (“SOF”)), and are undisputed unless otherwise indicated.

         As relevant to the pending motions for summary judgment, the Grand Avenue II (“GA II”) CDO-for which Wachovia and Fortis served as “Initial Purchasers, ” purchasing and then re-selling the issued securities to sophisticated parties, including LRI (an investment arm of LBBW, or one of its related entities)-issued several tranches of Notes, with varying degrees of seniority, that had recourse to the income generated by the CDO's underlying portfolio of assets. (SOF ¶¶ 21-23, 30, 42, 65-66.)[1]

         In denying in part Defendants' earlier motions to dismiss, this Court held open a single theory of the case: that Wachovia's internal markdown on GAII's Preference Shares supported a misrepresentation, and thus a fraud or negligence claim, against Defendants or a breach of contract claim against Wachovia.[2]

         The unrated Preference Shares represented the bottom one percent (in terms of payment priority) of GAII's issued securities; these shares were equity stakes and thus were not secured by income on the CDO assets and did not enjoy a fixed coupon payment (though they received dividends). (SOF ¶¶ 24-27.) According to the Offering Circular (“OC”), issued in October 2006, [3] the 16, 500 Preference Shares each had a “technical par value” of $0.01 and an aggregate liquidation preference of $1, 000 per share; but, because of the waterfall of payments, in the event of CDO liquidation, the actual amount a holder of the Preference Shares would receive would depend on the amount of cash remaining after the senior Notes had been paid in full. (SOF ¶¶ 28-29.) As such, the Offering Circular was explicit that the market for and price of the Preference Shares were separate from the market for and price of GAII's rated notes: The Preference Shares would not necessarily find a market with investors; and they could be sold at different prices. (SOF ¶ 49; see also Dkt. No. 217 Exs. FF, PP (illustrating the difference between Wachovia's representations as to the notional size of the Preference Shares and the price of the senior Notes).)[4] (LBBW contests this point, arguing that Wachovia advertised the Preference Shares as having a fixed value, but the evidence to which LBBW points circles back to the liquidation preference of $1, 000 per share, does not indicate the price or market value of the Preference Shares, and ignores the $0.01 “par value.” (See Dkt. No. 217 Exs. FF, OO, and PP.))

         Beyond making representations as to the price of Notes and notional size of the Preference Shares, the Offering Circular provided that, among its underlying assets, GAII would include “Synthetic Securities” (including, for example, credit default swaps on asset-backed securities), for which Defendants, as Initial Purchasers, could act as a counter-party. (SOF ¶ 113.) The OC also made clear that Wachovia would enter “short” positions, through credit default swaps, which it did at closing, for eight bonds that made up the CDO's Synthetic Securities.[5] (SOF ¶¶ 117-18.) LBBW contests this point, insofar as it maintains that the OC did not reflect the possibility that Wachovia would be net short. (SOF ¶¶ 117-18.) But, in 2006 and 2007, Wachovia entered additional long positions referencing the same eight bonds, and, according to documents produced in discovery, by February 2007, it was net neutral-that is, completely hedged-with respect to these assets. (SOF ¶¶ 119-20).[6]

         While the Offering Circular made clear that prospective investors would be “notified” if the securities' “characteristics” (such as its structure or composition) changed between commitment date and closing, it disclaimed any obligation to “update or otherwise revise any projections, including any revisions to reflect changes in the economic conditions or other circumstances.” (SOF ¶¶ 52, 90 (emphasis added).)

         Any investor hearing Defendants' pitch for GAII was a “sophisticated” one-and LRI was no exception. (SOF ¶ 58.) LRI's parent company was an international commercial bank, and LRI, as its investment arm, entered CDS positions regularly. (SOF ¶¶ 7, 65-66.) But just how much it could or did rely on Defendants' representations was left open by this Court following the 12(b)(6) motions in this matter as an element of LBBW's fraud, constructive fraud, and misrepresentation claims that could be borne out by discovery. See LBBW Luxemburg S.A., 10 F.Supp.3d at 517-19. As far as questions that LRI wanted answered, the firm was particularly interested in a security that would be low-risk, which Defendants represented was true of the tranches of senior Notes that LRI expressed interested in. (SOF ¶¶ 144-81.) To that end, LRI engaged in some modeling of its own, including stress tests that, together with other “standard” scenarios, modeled a 30% principal loss in the CDO's portfolio of assets, which would completely wipe out of the Preference Shares, and even the AA-rated Aa2 Notes. (SOF ¶¶ 83-86.) At the same time, LRI expressed that it was relying on Defendants for some analytics and information on GAII because of their expertise and the tight time frame of the GAII placement. (SOF ¶¶ 45-46, 57-60.) (LBBW admits that Defendants never refused to provide the requested models or analysis. (SOF ¶ 89.))

         Ultimately, on or around September 28, 2006, LRI committed to purchase $25 million of Class A-1A Notes, $10 million of Class A-1B Notes, and $5 million of Class A-2 Notes. (SOF ¶ 102.) LRI did not purchase-and there is no representation that it ever considered purchasing-the GAII Preference Shares. (SOF ¶ 105.)

         At closing, the Initial Purchasers bought the GAII Preference Shares as planned. Wachovia sold about two-thirds of the Shares to various purchasers at various prices, [7] and retained about one-third of the Preference Shares on its own books. (SOF ¶¶ 37, 123.) Central to LBBW's surviving theory of the case, Wachovia marked those shares internally at about 40.9% before closing and then at about 52.7% at closing. (SOF ¶¶ 126-38.) The reason for the markdown is the main contest between the parties.

         On one hand, LBBW insists that the markdown was a required “mark-to-market” that reflected Wachovia's true view of the value of the Preference Shares and, by extrapolation, GAII's underlying assets generally. As an extension of this theory, LBBW argues that the markdown of the Preference Shares was a “red flag, ” not only regarding the market price of the Preference Shares, but also regarding the fundamentals of GAII's portfolio of assets. (See SOF ¶ 224.) In short, LBBW argues that Wachovia marked down the Preference Shares because it believed GAII was in trouble.

         Defendants, on the other hand, offer a different explanation. Wachovia's internal models (which were used to justify the markdowns) indicate that the markdown of the Preference Shares, in fact, anticipated “no defaults on the underlying portfolio, ” and thus did not reflect a dim view of the underlying assets. (SOF ¶¶ 128-29, 131-34 (emphasis added).)

         As documents unearthed during discovery demonstrate, unrelated to any view of the general health of GAII's portfolio of assets, the precise markdowns were calculated to offset the fees that Wachovia anticipated taking in as a result of its placement of GAII. Initially, Wachovia anticipated approximately $3.25 million in fees, and marked the Preference Shares it was holding on its books at about 41% of the aggregate liquidation preference, an estimated loss that perfectly offset the recouped fees. (SOF ¶¶ 123-25.) Wachovia's internal emails reveal that tethering the markdown to the fees amounted to a conservative accounting strategy to appropriately manage the risk of carrying the relatively illiquid GAII Preference Shares on its books-that is, to prevent a potential loss on its books when, in the future, it ultimately sold the Preference Shares. (SOF ¶ 125; Dkt. No. 217 Exs. U-Z.) This theory finds further backing in Wachovia's second markdown on the Preference Shares. When Wachovia's fee calculation from the GAII placement was later reduced to $2.6 million, the markdown on the Preference Shares increased, to “just north of 50%” at closing; this new markdown, multiplied by the value of the Preference Shares Wachovia was holding, constituted an estimated loss that exactly offset the new fee calculation. (SOF ¶¶ 132-34.) While the markdown on the Preference Shares was apparently driven by the GAII placement fees, the internal mark was lent support-reverse engineered, within the metes and bounds of generally accepted accounting principles-by internal modeling that drew, in part, from other comparable transactions (such as the Preference Shares of a different CDO on which Wachovia had bid the month before). (SOF ¶ 129.)

         The rest, as they say, is history. In 2008, the financial crisis hit. Mortgage-backed securities tanked. And CDOs composed of those assets similarly suffered. GAII went into default, and LRI lost its investment. (SOF ¶¶ 139-40, 149.)

         LBBW initiated this lawsuit in 2013, claiming that Defendants had engaged in fraud, constructive fraud, negligent misrepresentation, breach of fiduciary duty, and breach of contract. The initial complaint advanced multiple theories of wrongdoing, but, as discussed above, only one has survived to summary judgment.

         The remaining issue in the case is whether Wachovia's internal markdowns of the Preference Shares, before and at closing, were motivated by some doubt about the health of GAII's underlying investment portfolio. LBBW argues that Wachovia's taking some short positions vis-à-vis the Synthetic Securities lends additional support to the claim that Defendants privately held a dim view of GAII's portfolio. The Court kept alive the claims against Fortis based on the theory that Fortis shared data and collaborated with Wachovia in issuing GAII, such that discovery might uncover wrongdoing on its part. Defendants now move for summary judgment.

         II. Standing

         As a threshold matter, Defendants contest LBBW's standing to maintain this action on two grounds: first, that LBBW cannot show, per Luxemburg law, that it took the measures required of an S.A. (its corporate form) to authorize this suit in the first instance; and, second, that LBBW cannot show, following its ostensible merger with LRI's parent company, that the new entity actually acquired the interest in this suit necessary to maintain it. As an additional procedural matter, Defendants argue that LBBW's failure to object to an earlier determination by Magistrate Judge Fox that Landesbank Baden-Württemberg could not be substituted for LBBW to maintain the action is the final death knell to its ability to bring this case.

         A plaintiff bears the burden of establishing standing. See Abu Dhabi Commercial Bank v. Morgan Stanley & Co., 888 F.Supp.2d 431, 446 (S.D.N.Y. 2012). Here, it is uncontested that, since 2014, after a merger, LBBW, the named Plaintiff, has “cease[d] to exist” and is no longer listed on the Luxemburg register of companies. (SOF ¶ 8; Dkt. No. 92 at 2.) Where a company ceases to exist following a merger under the governing law, the action should be dismissed for lack of standing, unless it can be shown that the successor entity was assigned the litigation rights to the case at bar. See MPEG LA, L.L.C. v. Toshiba Am. Info. Sys., Inc., No. 15 Civ. 3997, 2015 WL 6685523, at *6 (S.D.N.Y. Oct. 29, 2015) (collecting cases). And, consistent with its obligation to demonstrate standing, a plaintiff bears the responsibility to demonstrate that the successor company was assigned the cause of action at issue. See Abu Dhabi, 888 F.Supp.2d at 447-48.

         Under Federal Rule of Civil Procedure 17(b), the capacity of a corporation to sue or be sued is determined by the law under which it was organized. Fed.R.Civ.P. 17(b). Upon consideration of a second motion to substitute, Magistrate Judge Fox held that LBBW had “failed to show what law governs the transfer of claims at issue here, and its conclusory allegations . . . are insufficient to establish that the instant litigation rights were transferred by the plaintiff to Landesbank Baden-Württemberg. The plaintiff failed to show that, in the circumstance of this case, the merger by absorption included the transfer of litigation rights as part of the transfer of ‘all assets and liabilities, '” including the right to bring and maintain this suit. LBBW Luxemburg S.A. v. Wells Fargo Sec. LLC, No. 12 Civ. 7311, 2016 WL 3080723, at *6 (S.D.N.Y. May 13, 2016). As a result, Magistrate Judge Fox held that Landesbank Baden-Württemberg could not be substituted for LBBW. LBBW failed to object to this ruling in a timely manner. Magistrate Judge Fox's holding-as to the appropriateness of substitution and as to the failure to demonstrate the assignment of litigation rights-is law of the case and cannot now be challenged.

         Rather than directly confront Defendants' arguments under Rule 17(b), LBBW counters with Federal Rule of Civil Procedure 25(c)'s permissive substitution rule and asks that the Court allow this suit to proceed under that Rule instead. LBBW has admitted that, following its delisting from Luxemburg's register of companies, the named Plaintiff is “not an entity with capacity to sue now, ” under the relevant law. (See Dkt. No. 305 at 16:7-8.) But it argues that, under Rule 25, it should be allowed to continue.

         Rule 25(c) provides, in relevant part: “If an interest is transferred, the action may be continued by or against the original party unless the court, on motion, orders the transferee to be substituted in the action or joined with the original party.” Fed.R.Civ.P. 25(c). To support its proposition, LBBW leans on a decision out of the Eastern District of New York, Patsy's Italian Restaurant Inc. v. Banas, No. 06 Civ. 0729, 2008 WL 495568 (E.D.N.Y. Feb. 20, 2008). But there (as in other relevant precedent), unlike here, it was “undisputed that . . . a transfer [of the relevant interest to maintain the suit] in fact occurred.” Id. at *2. The facts thus satisfied an underlying premise of Rule 25(c)-that, as an initial matter, the interest in the litigation was, in fact, transferred. But here, as already discussed, ...

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