The subprime meltdown has already provoked a wave of shareholder lawsuits (as detailed here), in which public company shareholders have alleged subprime-related misrepresentations or omissions that shareholders contend inflated the companies’ share price. But the plaintiffs in an unusual class action securities lawsuit recently filed in Massachusetts state court are not public company shareholders but rather mortgage-backed securities investors who have sued the securitizers who created, issued and underwrote the securities.
In a complaint filed on January 31, 2008 in Suffolk County Mass. Superior Court (here), the Plumbers’ Union Local No. 12 Pension Fund has brought a lawsuit under Section 11, Section 12 and Section 15 of the Securities Act of 1933. The Fund has brought the lawsuit on behalf of itself and the class of investors who purchased mortgage-pass through certificates in connection with Nomura Asset Acceptance Corporation’s July 29, 2005 and April 24, 2006 issuance of hundreds of millions of dollars of the certificates. The defendants in the lawsuit include Nomura Asset and certain of its directors and officers; the eight Delaware trusts in which the underlying mortgage assets were held; and the six investment banks that underwrite the offerings, including Nomura Securities, Goldman Sachs, Merrill Lynch and Citigroup.
The plaintiff alleges that the Registration Statements and Prospectuses issued in connection with the offerings contain false and misleading statements concerning the underwriting standards that would apply to the mortgages to be included; the borrower qualifications to be applied; and the collateral requirements and appraisal standards. The complaint alleges that the actual lending and other practices fell far below the standards described in the Registration Statement, and as a result the assets in the pool “had a much greater risk profile than represented in the Registration Statement.”
The complaint alleges that beginning in the summer of 2007, “the truth about the performance of the mortgage loans that secured the certificates began to be revealed.” The delinquency rates of the underlying mortgages “have skyrocketed.” Several classes of the certificates were downgraded in July 2007 and again in December 2007. The complaint alleges that as a result of the underlying assets’ deteriorating performance, the certificate investors “should receive less absolute cash flow in the future and will not receive it on a timely basis.” In addition, the complaint alleges that the certificates “are no longer marketable at prices anywhere near the price paid” and the investors are “exposed to much more risk with respect to both the timing and absolute cash flow to be received than the Registration Statement …represented.”
There have been prior subprime-related cases brought by mortgage-backed securities investors against the financial institutions that packaged and sold the mortgage instruments. Probably the most prominent example is the case of Bankers Life Insurance Company v. Credit Suisse First Boston, et al., pending in the United States District Court for the Middle District of Florida (amended complaint here). In that case, Bankers Life also alleges misrepresentations in connection with the issuance of certain mortgage-backed pass through certificates. But the Bankers Life case is an individual action, not a class action. In addition, the Bankers Life case does not allege violations of the federal securities laws. Bankers Life alleges negligent misrepresentation, common law fraud, breach of contract, and breach of fiduciary duty, among other things.
UPDATE: An alert reader who prefers anonymity points out another action by a mortgage-backed asset investor against securitizers is the Luminent Mortgage Capital v. Merrll Lynch case pending in the Eastern District of Pennsylvania (complaint here). Luminent alleges that the defendants misled investors concerning certain mortgage loan asset-backed certificates they offered and sold to Luminent. Luminent asserts claims under Section 10(b) of the ’34 Act, Section 12 of the ’33 Act and state law claims of fraud, misrepresentation, negligence, breach of contract and rescission.
So far as I know, the Nomura Asset case is the first class action and the first federal securities case in connection with the current subprime meltdown where mortgage-backed asset investors have sued the mortgage securitizers. (There may well be other federal securities class actions, about which readers are encouraged to let me know .)
UPDATE: Obviously, the Luminent case refered to in the update above asserts claims under the federal securities laws. In addition, an alert reader has brought to my attention another federal securities law class action, captioned as Luther v. Countrywide Home Loans Servicing, originally filed in Los Angeles Ca. County Superior Court, later removed to federal court. The federal court case is now pending in the Central District of California under Civil No. 07-8165. The removal issues are discussed further below. In the Luther case, as in the Nomura Assets case, the plaintiff asserts claims that the defendants omitted material information about the mortgage pass through certificates they sold. The plaintiffs assert claims on behalf of themselves and the class of other certificate purchasers under Sections 11, 12 and 15 of the ’33 Act. Because of the similarities between the Luther case and the Nomura case, the issues surrounding the Luther case are highly relevant to the issues discussed below regarding the Nomura caqse.
The lawsuit is unusual in another respect, which is that it is a federal securities class action lawsuit brought in state court.
The filing of the federal class action lawsuit in state court cannot be written off as the misguided action of some backwater law firm. The plaintiffs’ firms on the complaint include the Coughlin Stoia firm and the Shapiro Haber & Umry firm. I think the only fair assumption is that these lawyers made a deliberate and informed decision to file this case in state court. Which of course begs the question: why?
It is late here at blog central, and there aren’t many people around at this hour with whom I can discuss this question. So I am left to my own meager speculation, which I have set out below. My speculation probably reveals little except my own ignorance of the securities laws. But these are the only reasons I can come up with to explain why this case was filed in state court.
Presumably, the plaintiff intends to rely on the concurrent state court jurisdiction provision in Section 22(a) of the ’33 Act. Whether or not this case is removable to federal court under the Securities Litigation Uniform Standards Act (SLUSA) also seems to be addressed in Section 22(a), which provides that other than with respect to “covered class action” under SLUSA, “no case arising under this title brought in any state court of competent jurisdiction shall be removed to any court of the United States.”
The jurisdictional argument thus turns on whether this is a “covered class action” under SLUSA. The language of SLUSA, codified in Section 16(b) of the ’33 Act, defines a “covered class action” as one “based upon the statutory or common law of any State or subdivision thereof” containing specified allegations in connection with the purchase or sale of a security. The plaintiff will undoubtedly argue that the claims in this case are brought only under federal law, not under the “statutory or common law of any State” and therefore SLUSA does not apply, and the case can therefore remain in state court under the ’33 Act’s concurrent state court jurisdiction.
But even if I am right about this jurisdictional argument (and I will be the first to concede that my jurisdictional analysis could be 100% wrong), that still does not answer the question why the plaintiffs would choose to avail themselves of the state court jurisdiction in the first place, even if it is an available jurisdiction. The best guess I have is that the plaintiffs may intend to argue, under the provisions of the Private Securities Litigation Reform Act (PSLRA) codified into Section 27(a)(1) of the ’33 Act, that the PSLRA applies only to private actions “brought as a plaintiff class action pursuant to the Federal Rules of Civil Procedure.” The plaintiff’s argument may be that because the case was not brought pursuant to the Federal Rules of Civil Procedure, the various provisions of the PSLRA do not apply – for example, the discovery stay or the lead plaintiff provisions. In other words, the plaintiff is proceeding in state court to try to circumvent the hurdles and obstacles of the PSLRA.
An alternative theory is that the plaintiff filed the action in state court to try to circumvent the Supreme Court’s recent holding in the Stoneridge case (about which refer here). But the plaintiff’s claims against the offering underwriters are not based on scheme liability or aiding and abetting theories. The plaintiff is asserting that the various defendants each violated their respective primary duties under the ’33 Act. So it does not appear that the state court filing is an attempt to get around Stoneridge.
My speculative analysis might be completely wrong. But there has to be some reason why these experienced plaintiffs’ attorneys filed this suit in state court. I have tried to come up with the most plausible theory I could thing of. I welcome readers’ thoughts and commentary, particularly any alternative theories as to why this lawsuit was brought in state court.
UPDATE: As mentioned above, the Luther v. Countrywide Homes case is also a federal securities law action that was filed in state court. Defendants removed the case to federal court and the plaintiffs have moved to remand the case back to state court. The memorandum in support of the plaintiffs’ remand motion can be found here. The plaintiffs argue that the sole basis on which defendants sought to remove the case is the Class Action Fairness Act of 2005, not SLUSA as I had speculated. The plaintiffs argue that Section 22(a) affirnatively forbids the removal of state court ’33 Act cases to federal court and that CAFA did not change that and does not apply to ’33 Act cases. The remand petition will be argued on February 25, 2008.
In any event, it has seemed likely it was only a matter of time before mortgage-backed securities investors pursued federal securities class action lawsuits against the financial institutions that were involved in packaging the subprime mortgages into investment securities. The Nomura Asset case, even though brought in state court, may well portend a whole new category of subprime-related securities litigation. UPDATE: With the added reference to the Luther case, the conclusion that there may be a whole new category of securities cases seems even stronger.
This case poses one other problem for me, which is whether or not to include it in my running tally of subprime related securities lawsuits (which can be found here). While I have faced other definitional issues in maintaining the tally, the one issue that all of the cases have in common is that they were all brought against public companies by the public companies’ shareholders. This case obviously represents something different. Nevertheless, because it is a subprime-related securities lawsuit, I have decided to include in the running tally. Even if I did not forsee all of the kinds of securities litigation that would arise in connection with the subprime meltdown, I did undertake to capture all of the subprime-related securities litigation. So I have added it to the list, even though reasonable minds could disagree over whether it belongs there. UPDATE: I have also added the Luther case to the list as well.
The addition of the Nomura lawsuit to the list brings the total of subprime-related securities lawsuits to 45, including eight so far in 2008. To the extent future developments warrant, I may separately tally the subprime-backed securities investor lawsuits from the shareholder lawsuits. UPDATE: The addition of the Luther case brings the total to 46