The D & O Diary : Directors and Officers Liability and Insurance : The D & O Diary : Kevin LaCroix : Securities Laws, Corporate Fraud, D & O Litigation

In the latest of the subprime and credit crisis cases to be dismissed, on September 30, 2009, District of Massachusetts Judge Richard G. Stearns dismissed the securities class action lawsuit that had been filed by purchasers of mortgage pass-through certificates against Nomura Asset Acceptance Corporation, certain of its directors and officers, the eight mortgage trusts that had issued the certificates, and the offering underwriters who had supported the 2005 and 2006 public offerings of the certificates. A copy of Judge Stearns’s opinion can be found here.

As discussed in my prior post about this case (here), the plaintiffs initially filed their complaint against Nomura in Massachusetts state court, but the defendants removed the case to federal court. After plaintiffs had amended their complaint, the defendants moved to dismiss. More detailed background regarding the case can be found here.

In their amended complaint (here), the plaintiffs alleged that in connection with each of the eight separate certificate offerings, the defendants had misled investors with respect to the loan underwriting by the originators of the mortgages in the trusts; with respect to the originators’ appraisal practices; with respect to level of delinquencies for the mortgages in the trusts; and with respect to the certificates’ investment ratings.

The court first addressed the standing of the plaintiffs to assert claims against the eight trusts, which, Judge Stearns noted, "are separate legal entities" that "each issued its own securities backed by different pools of mortgages." Judge Stearns found that because the named plaintiffs had only bought certificates from three of the eight defendant trusts, "the named plaintiffs are incompetent to allege an injury caused by purchase of Certificates that they themselves never purchased."

Judge Stearns held, based on the "overwhelming weight of authority," that the named plaintiffs lacked constitutional standing to assert claims against the five trusts from which they had not purchased certificates. Judge Stearns also held that the named plaintiffs lacked standing to assert claims against the offering underwriter defendants that had supported offerings only with respect to the five trusts from which the plaintiffs had not purchased securities. Judge Stearns dismissed the claims against the five trusts and the associated offering underwriter defendants.

Judge Stearns also granted the remaining defendants motions to dismiss the plaintiffs Section 12(a)(2) claims. He held that in order to state a claim under Section 12(a)(2), the plaintiffs must allege that they purchased securities from the defendants. However, the plaintiffs alleged only that they "acquired" the securities "pursuant and/or traceable to" the offerings. In granting the motion to dismiss the Section 12(a)(2) claims, Judge Stearns noted that "if plaintiffs did in fact purchase the Certificates directly from the defendants, they should have said so. An evasive circumlocution does not suffice as a substitute."

Finally, Judge Stearns granted the motion of the remaining defendants to dismiss the remaining claims under Sections 11 and 15 of the ’33 Act. He found with respect to the plaintiffs’ allegations concerning the mortgage originators’ underwriting standards that the offering documents contain a "fusillade of cautionary statements" that "abound with warnings about the potential perils." Judge Stearns noted that plaintiffs’ contention that they were not "on notice" of those perils "begs credulity."

With respect to the alleged misrepresentations regarding loan delinquency, Judge Stearns, noting that the allegedly delinquent loans represent 0.1 percent of the mortgages in the pool, stated that "there is no plausible question regarding materiality."

Finally, with respect to the allegations concerning the certificates’ ratings, Judge Stearns noted that while questions regarding the process by which mortgage-backed securities received ratings have arisen in recent months, none of those questions pertain specifically to the ratings of these certificates. Moreover, none of the later developments "support the inference that the ratings were compromised as of the dates" on which the offering documents became effective.

Because Judge Stearns found that the plaintiffs "have failed to allege a sufficient factual basis to support their claims for Securities Act violations," he granted the defendants’ motions to dismiss with prejudice.

The Nomura action is only one of many securities lawsuits that investors have brought against the securitizers that aggregated mortgages into pools that issued mortgage-backed securities. In many of these cases, as in the Nomura case, the plaintiffs have lumped together many different issuing trusts and many different offerings. In some of these cases, the plaintiffs will face the same "standing" hurdles that confounded the plaintiffs in the Nomura case.

And more to the point, the offering documents provided in connection with many of these mortgage-backed securities offerings, like the documents relating to the offerings at issue in the Nomura case, also contained a "fusillade of cautionary statements" that abound with warnings" about the perils.

During most of 2008 and into early 2009, Plaintiffs aggressively filed these types of Securities Act cases against the securitizers, perhaps on the theory that a Securities Act case (for which there are no scienter pleading requirements) might more easily survive a dismissal motion. However, Judge Stearns opinion in the Nomura suit suggests that these cases could face rigorous scrutiny and may also face substantial difficulty getting over the initial pleading hurdles.

I have in any event added the opinion in the Nomura case to my register of subprime and credit crisis-related lawsuit dismissal motion rulings, which can be accessed here.

Special thanks to a loyal reader for providing a copy of Judge Stearns’s opinion.

Full Disclosure: On October 5, 2009, the Federal Trade Commission announced (here) that it had approved final revisions to the guidance it gives advertisers on how to keep their endorsements and testimonials in compliance with FTC requirements. The FTC’s formal Notice of Adoption of the guidelines can be found here.

These new guidelines have received a great deal of attention for the requirements they purport to impose on bloggers. For example, the Wall Street Journal seemed to think that the FTC’s requirements regarding bloggers is front page news (refer here). The guidelines do seek to impose certain requirements on bloggers. For example, in its press release, the FTC stated that "bloggers who made an endorsement must disclose material connections they share with the seller of a product or service."

Everyone here at The D&O Diary wants to reassure our readers that we have accepted no promotional considerations of any kind in connection with matters discussed on this blog. Of course, it is probably fair to note that no one has ever offered us any promotional considerations, darn it. But readers can be assured that if we ever did have the opportunity to accept any promotional consideration, we would fully disclose the consideration in compliance with FTC requirements.

Our "promotional consideration intake operators" are standing by …

Speakers’ Corner: On October 16, 2009, at 11 am EDT, I will be participating in a one hour webinar sponsored by Advisen, about securities litigation during the third quarter of 2009. Joining me on the panel will be Arthur J. Gallagher’s Phil Norton, Zurich’s Paul Schiavone, and Advisen’s David Bradford. The session will be moderated by Advisen’s Jim Blinn.

This webinar will review securities cases filed and settled during the third quarter, include shareholder derivative suits, securities fraud suits, and other categories of securities-related litigation. The registration materials for the webinar can be found here.

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Among the many lawsuits that have flooded in as part of the subprime and credit crisis litigation wave has been a profusion of lawsuits against the mortgage-backed securities issuers and their securities offering underwriters. These lawsuits, typically filed under the ’33 Act and alleging misrepresentations in the offering documents, claim that investors who purchased securities in the offering have been harmed due to the deterioration in the performance of the underlying mortgages.

As discussed below, questions about the damages claimed in these lawsuits could present serious hurdles as the cases go forward.

Background

A recent example of the class action securities litigation filed on behalf on investors in these mortgage-backed securities investments may be found in the January 26, 2009 press release (here) in which the plaintiffs’ lawyers described the lawsuit they filed in the Eastern District of New York against Deutsche Alt-A, Inc., and certain other defendants in connection with the offering of mortgage-backed pass-through securities by 32 mortgage loan trusts.

As described in the press release, the complaint (here) alleges that the offering documents failed to disclose that:

sellers of the underlying mortgages to Deutsche Alt-A were issuing many of the mortgage loans to borrowers who: (i) did not meet the prudent or maximum debt-to-income ratio purportedly required by the lender; (ii) did not provide adequate documentation to support the income and assets required to issue the loans pursuant to the lenders’ own guidelines; (iii) were steered to stated income/asset and low documentation mortgage loans by lenders, lenders’ correspondents or lenders’ agents, such as mortgage brokers, because the borrowers could not qualify for mortgage loans that required full documentation; and (iv) did not have the income or assets required by the lenders’ own guidelines necessary to afford the required mortgage loan payments, which resulted in loans that borrowers could not afford to pay.

The complaint alleges as the underlying mortgages have deteriorated, "the Certificates are no longer marketable at prices anywhere near the price paid by plaintiff and the Class and the holders of the Certificates are exposed to much more risk with respect to both the timing and absolute cash flow to be received than the Registration Statement/Prospectus Supplements represented."

This case is only one of several recent lawsuits in which the same or similar allegations have been raised. Plaintiffs’ lawyers have raised similar allegations against, for example, mortgage-backed pass through certificates sponsored by JP Morgan Acceptance Corporation (refer here); mortgage backed securities sponsored by GS Mortgage Securities Corp. (refer here); mortgage pass-through certificates sponsored by Washington Mutual (refer here); and mortgage-pass through certificates sponsored by Residential Asset Securitzation Trust (refer here). By my count, there have been more than a dozen of these types of lawsuits filed in connection with the current subprime and credit crisis-related litigation wave.

Like many of these cases, the Deutsche Alt-A case was originally filed in state court, and removed by defendants to federal court. (The removal petition, which accompanies the complaint, can be found here.) The federal court subsequently denied the plaintiffs' motion to have the case remanded to state court, in this case on the relatively narrow and specific ground that that one of the entities that originated the underlying mortgages, American Home Mortgage Corporation, is in bankruptcy in the federal court in Delaware, and the securities case is related to the bankruptcy proceeding. A copy of the January 8, 2009 opinion denying the remand motion can be found here.

Special thanks to Adam Savett of the Securities Litigation Watch blog (here) for providing a copy of the removal petition and complaint in the Deutsche Alt-A case.

Damages Analysis

In each of these cases, the harm claimed is similar to that alleged in the Deutsche Alt-A case; that is, that as a result of problems associated with the underlying mortgages, the securities are "no longer marketable at prices near the price paid" and the holders are exposed to much more risk with respect to the timing and absolute cash flow."

These allegations raise some interesting and perhaps novel questions, as discussed in a January 2009 article from the Milbank Tweed law firm entitled "Subprime Litigation Against Issuers and Underwriters of Mortgage-Backed Securities—Where are the Actual Losses?" (here).

As the memo notes, these lawsuits embody "the relatively untested assumption" that the current paper value of these securities is "the appropriate reference point" for determining whether the investors have "suffered a loss that is ripe for litigation (and the extent of any such loss)."

The authors note that these securities are not listed on any public exchanges, but rather all trades are privately negotiated. The securities themselves are essentially contracts that entitle the owner to certain portions of principal and interest from the pools of mortgages that serve as collateral for the securities. The securities also have various forms of credit enhancement, such as overcollateralization, subordination and excess spreads, so that defaults on the underlying mortgages will not necessarily trigger a default on the payment obligations on the securities themselves.

As a result, an investor could continue to receive payments under the securities as scheduled, even if GAAP accounting might require the carrying value of the securities to be reduced.

These circumstances lead the authors to ask

Is the fear that certain tranches of the [mortgage backed securites] might not be paid in full a sufficient basis for brining a claim under the ’33 Act? Is such a claim a ripe case or controversy for the courts? And is the fact that some "paper measure of price" for the [mortgage backed securities] tranche has declined since the time of purchase enough to overcome these hurdles?

In considering these questions, the authors note that the typical offering documents for these kinds of securities expressly warn that a secondary market for the securities may not exist and that investors may not be able to sell the securities at the price they hope to obtain. For most investors in these types of securities, this consideration is generally of less concern, because the investors "expect to make money by holding the bond through maturity and receiving the income stream they bargained for, not by trading on a secondary market."

Nevertheless, the lawsuits relating to these securities claim damages based on the decline in their valuation and the fears that payments may be at "risk" in the future. The memo reviews the well-publicized difficulties associated with valuing these securities, and notes the probable lack of valuation uniformity among holders of these securities, given the flexibility of the relevant accounting standards. As a result, the securities holders may face challenges in establishing with sufficient certainty that they have suffered an "economic loss," as the securities laws arguably require. These difficulties are particularly where, as is the case with many of these securities, the investors continue to receive all payments due to them.

The authors suggest that generally there is no basis in law for seeking damages where the damages cannot be quantified and may never come to pass. They suggest that defendants in these cases will attempt to argue based on these principles that investors "who continue to be paid the full amount of any principal and interest payments due to them may have little choice but to ‘wait and see’ whether feared, modeled, or projected losses…come to fruition (i.e., become ‘clear and definite’) before being able to state claims under the securities laws."

The authors add that this argument may be particularly compelling where "intervening events such as legislative or executive action….could drastically alter the future payment outlook for many mortgage-backed securities."

These lawsuits against the issuers of mortgage-backed securities represent a significant number of the subprime securities lawsuits. Plaintiffs’ lawyers seem inclined to file these lawsuits, undoubtedly in part due to the degree of investor concern about their investments. Whether and to what extent these cases ultimately will succeed remains to be seen. As the law firm memo demonstrates there may be a host of questions surrounding these lawsuits. At a minimum it will be interesting to see what the courts make of these cases, and in particular the alleged damages, as the lawsuits proceed.

A more academic overview of many of these issues may be found in the paper Harvard Law School professor Allen Ferrell and Babson Business School Professors Jennifer Bethel and Gang Hu entitled "Legal and Economic Issues in Litigation Arising from the 2007-2008 Credit Crisis" (here).

Largest FCPA Penalty Ever Against U.S. Company: Fast on the heels of Siemens recent agreement to pay $800 million to settle bribery allegations (about which refer here), Halliburton has now agreed to pay $559 million to settle charges that one of its former units bribed Nigerian officials during the construction of a gas plant.

According to Halliburton’s January 26, 2009 press release (here), Halliburton has agreed to pay $382 million to the U.S. Department of Justice in eight installments over the next two years. In addition, Halliburton agreed to pay the SEC $177 million in disgorgement. Both settlements are subject to final approval by the relevant authorities.

As reported on the WSJ.com Law Blog (here), the Halliburton penalty is by far the largest ever for a U.S. company, far surpassing the prior record of $44 million by Baker Hughes in 2007. More detail about the Halliburton agreement can be found on The FCPA Blog (here).

The Halliburton settlement is further evidence of a point I have made numerous times on this blog, that FCPA enforcement activity represents a growing area of concern. As I discussed most recently here, an important part of this exposure is the threat of civil litigation that frequently follows on after the enforcement proceeding. The sheer magnitude of the Siemens and Halliburton settlements suggest that potential FCPA liability could represent a significant exposure for corporations and their directors and offices.

Blast from the Past: Another Options Backdating Settlement: The options backdating cases are a vestige from another time and place, yet they remain, like so much cosmic dust, reminders of a distant catastrophe. In a recent development in one prominent case, the Delaware Chancery Court has approved a settlement that is noteworthy in at least a couple of respects.

As reflected in a January 2, 2009 opinion by Chancellor William Chandler in the Ryan v. Gifford case (here), the court has approved the settlement of the options backdating case involving Maxim Integrated Products, over shareholder objections. Under the settlement, which is detailed in the opinion, the defendants agreed to pay a total of $28,505,473 in cash. In addition, the defendants agreed to cancel, reprice or surrender claims with respect to certain options they continued to hold. The company also agreed to certain corporate governance reforms.

The settlement is noteworthy in a couple of respects. The first is simply that it involves the Ryan v. Gifford case, in which Chandler had written an influential and important February 2007 opinion denying the defendants’ motion to dismiss (as discussed here). Because of this opinion, the case is among the more prominent of the options backdating cases.

The other noteworthy aspect of the settlement is the individual defendants’ significant contribution toward settlement. Of the $28.5 million settlement amount, $21 million was paid by insurance. The balance of the cash was paid by the individual defendants. John Gifford, the company’s former CEO, agreed to make his own cash payment of $6 million to Maxim, even though, as the Court noted, he was "covered by insurance." The court’s statement in this respect seems to suggest that there were additional insurance funds available to fund this amount, but that as part of the settlement Gifford nevertheless agreed to pay this amount out of his own assets. Other individuals agreed to pay lesser amounts.

It is not entirely clear whether the insurance would in fact have covered the amounts of these individual payments. For example, in connection with the payments by the individuals other than Gifford, the court noted that the amounts paid "represent the entire amount that they were alleged to have benefitted from the exercise of backdated stock options." To the extent these amounts represent disgorgement or return of ill-gotten gains, the policy’s coverage would not apply. The court’s opinion is not as specific with respect to Gifford’s payment, but to the extent his contribution also represents his return of benefits from the exercise of backdated options, the insurance coverage similarly would not likely apply.

In any event, the size of the settlement, the prominence of the case and the significance of the individuals’ contributions make this a noteworthy settlement. I have added the settlement to my list of options backdating lawsuit settlements, dismissals and dismissal motion denials, which can be accessed here.

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As I have previously noted (here), one of the significant procedural developments in the subprime securities litigation wave has been the plaintiffs’ apparent interest in pursuing ’33 Act subprime-related lawsuits in state court. Section 22(a) of the ’33 Act expressly provides that the federal court’s jurisdiction for ’33 Act lawsuits is "concurrent with State and Territorial courts," which presents an immediate forum selection issue for any prospective ’33 Act plaintiff.

A recent ’33 Act lawsuit filing suggests that the forum selection issue involves not only electing between federal and state courts, but also deciding in which state to file, if a state court forum is to be preferred. The case also suggests that the forum selection may also entail forum shopping.

The Lawsuit

On December 2, 2008, the Public Employees’ Retirement System of Mississippi filed a ’33 Act class action complaint in Orange County (California) Superior Court against Morgan Stanley and several Morgan Stanley affiliates, several individuals associated with the Morgan Stanley affiliates and fourteen issuing trusts that sold certain mortgage pass-through certificates. The complaint also names as defendants McGraw Hill Companies, the corporate parent of S&P, and Moody’s. A copy of the complaint can be found here.

The complaint alleges that the offering documents associated with the securities "misstated and omitted material information regarding the quality of the loans underlying the Certificates," and failed to disclose" that the loan originators had "systematically ignored their stated and pre-established underwriting and appraisal standards." The complaint also alleges that Morgan Stanley entities "overpaid for underlying mortgages without regard to the quality of the loans for the sole purpose of increasing its position in the mortgage lending and securitization industry."

The complaint further alleges that the rating agency defendants "directly participated in structuring the securitization transaction" and that the rating agencies’ ratings "did not represent the true risk of the Certificates."

The complaint asserts claims under Sections 11, 12 and 15 of the ’33 Act and seeks relief on behalf of the class of investors who purchased securities pursuant to or traceable to the March 16, 2006 Registration Statement and accompanying prospectus.

Jurisdiction and Venue

The plaintiff is a Mississippi public employee pension fund. Morgan Stanley has its headquarters in midtown Manhattan. The complaint does not allege that any of the other defendants are domiciled in California. Apparently none of the parties are from California. So what exactly is this case doing in California?

As to why it is in state court rather than federal court, the state court has concurrent jurisdiction as I noted at the outset. But the mere availability of a state court forum does not explain why a state court was chosen in preference to a federal court. In my earlier posts (here), I have speculated that the plaintiffs are hoping to make an end run around the PSLRA’s procedural requirements, although no one has ever confirmed that.

But even if the preference of state court over federal court can be explained, why a state court in California?

The complaint itself purports to allege a variety of California connections: a "substantial portion of the wrongs complained of" are alleged to have occurred in Orange County. The defendants are alleged to have "availed themselves of the benefits of conducting business" in Orange County. Moreover, the complaint alleges that "a great percentage of the underlying mortgages pooled in the Certificates…were securitized by properties located in California."

All of these supposed connections to California are superficially plausible. But the fact is that all the parties are from outside California. The transaction that is at the heart of the lawsuit took place outside California. The supposedly misleading documents were created outside California.

I have my own theory why the case has been filed in California. That is, the plaintiffs really want the case to be in state rather than federal court. They anticipate that the defendants will seek to remove the case to federal court. The case law on which the plaintiffs would seek to rely in trying to have the case remanded back to state court is more favorable in California and less favorable in New York.

Specifically, as discussed here, in New York, in the HarborView mortgage case (about which refer here), the plaintiffs’ motion to remand the subprime-related securities case to state court was denied. However, in the Luther v Countrywide case, a subprime-related Section 11 lawsuit originally filed in California state court but removed by the defendants to federal court, the motion to remand the case to state court was granted, and the remand was specifically affirmed by the Ninth Circuit. For a detailed discussion of the Luther case including the Ninth Circuit’s opinion, refer here.

So did the plaintiffs choose a California state court because of the Ninth Circuit’s opinion in the Luther v. Countrywide case -- that is, because the chances of being able to proceed in state court in California was perceived to be greater than the chances of being able to proceed in state court in New York? If I am right, the plaintiffs selected the forum in order to increase the likelihood of a state court venue. Call it forum shopping to the second power.

Anyone who questions my theory should know that the complaint in the Morgan Stanley case explicitly references the Luther case, complete with case citation to the Ninth Circuit opinion. .

Of course, it may also be fairly observed that Orange County is ground zero for the mortgage meltdown, and as result the plaintiffs may expect a more sympathetic court and jury in that forum . This possible explanation is not inconsistent with my theory. Call it fourm shopping to the third power.

In any event, as I have previously noted, it appears likely that in connection with the subprime litigation wave, a significant amount of high stakes class action securities litigation will be going forward in state court. The plaintiffs’ lawyers ’33 Act forum selection preference is now well-established. Now we must wait and see what it all portends.

Rating Agency Defendants

The Morgan Stanley case is not the first subprime securities lawsuit naming the rating agencies as co-defendants. Indeed, the HarborView case referenced above also named rating agencies as defendants. However, in the HarborView case, the complaint alleged that the rating agency defendants were liable under Section 11 as "appraisers" as defined in Section 11(a)(4) of the ’33 Act. (Refer here for a detailed discussion of the allegations in the HarborView complaint.)

The Morgan Stanley complaint takes a different approach. Because it alleges that the rating agencies were directly involved in the creation of the securitized assets, the Morgan Stanley complaint alleges that the rating agencies are liable under Section 11(a)(5) as "underwriters" of the mortgage pass-through certificates. (The text of Section 11 can be found here.)

It will be interesting to see in any event whether these various liability lawsuits against the rating agencies succeed under any theory. As I have previously noted here, the rating agencies may have constitutional defenses protecting their rating activities. It remains to be seen whether the rating agencies involvement in the securitization process transformed them into "underwriters" sufficiently to subject them to Section 11 underwriter liability.

Run the Numbers

In any event, I have added the Morgan Stanley Pass-Through Certificates lawsuit to my running tally of subprime related securities litigation, which can be accessed here. With the addition of the new Morgan Stanley case, the current tally of subprime and credit crisis-related securities lawsuits now stands at 133, of which 93 have been filed in 2008.

Special thanks to Adam Savett of the Securities Litigation Watch (here) for a copy of Morgan Stanley mortgage pass-through certificates lawsuit complaint.

Subprime Loans, Predatory Lending?: One of the recurring allegations on behalf of subprime borrowers is that the subprime loans in which the borrowers became ensnared represented "predatory lending." A November 20, 2008 article by three NERA Economic Consulting economists – Denise Neumann Martin, Faten Sabry and Stephanie Plancich – reviews "the definition of predatory lending and describe the recent litigation history. The authors then examine alleged discriminatory lending in detail, reviewing key economic theory and evidence, as well as relevant statistical techniques."

The paper also reviews predatory lending allegations and takes a look at recent predatory lending lawsuit filings. The article categorizes the lawsuits according to the specific allegations, and also examines predatory lending lawsuit settlements.

The report contends that proper statistical analysis is required to establish whether or not discriminatory or other improper lending activity has taken place. The report states that:

A proper assessment of alleged predatory lending, then, must control for characteristics including but not limited to the credit history, employment status, income level, and education of the borrower, as well as the borrower’s preference for risk (or discount rate). The competitiveness of the market in which the loan was arranged and other relevant macroeconomic factors may also need to be considered. Such analysis is essential to distinguish behavior that is predatory from that which is explainable by these other factors and would not be evidence of discrimination.

The paper, entitled "The Use of Economic Analysis in Predatory Lending Cases: Application to Subprime Loans," can be found here.

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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

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