Many of the toxic mortgage-backed securities that were a key part of the subprime mortgage meltdown were sold in multiple separate offerings based on the same shelf registration statement but separate prospectuses. Each separate offering included multiple securities at varying tranches of seniority and subordination. In the litigation following the subprime meltdown, defendants in suits bought by mortgage-backed securities investors have had considerable success in arguing that the claimants have standing only to assert claims only with respect to the specific offerings and tranches in which the claimant had invested, and lacked standing to assert class claims on behalf of investors who purchased securities in other offerings and tranches.
The plaintiffs may now have a potent tool to try to fight these standing arguments. In a September 6, 2012 opinion (here), the Second Circuit ruled -- in a case involving mortgage-backed securities issued by a unit of Goldman Sachs -- that the investor plaintiff had standing to assert claims relating not only to the specific offerings in which the plaintiff invested but also the claims of investors in other related offerings, to the extent that the securities in the other offerings were backed by mortgages originated by the same lenders that originated the mortgages backing the plaintiff’s securities. The Second Circuit also rejected the argument that the plaintiff lacked standing to assert claims on behalf of investors in the different tranches. Finally, the Second Circuit also held the plaintiff need not plead an out-of-pocket loss in order to allege a cognizable diminution in the value of an illiquid security under Section 11.
During the period of 2006 to 2007, a unit of Goldman Sachs sold mortgage-backed certificates in 17 separate offerings, using a single shelf registration statement and a separate prospectus for each of the offerings. Each offering included securities at varying tranches of seniority or subordination. The mortgages backing the offerings had been originated by different mortgage originators. For example, mortgage issued by National City Mortgage Corp. backed six of the seventeen offerings, and Countrywide originated mortgages backed five of the offerings and so on.
The plaintiff had purchased securities in two of the offerings. As the mortgage meltdown unfolded all of the securities were downgraded. Believing that the securities were now worth substantially less than their cost, and believing that they had been misled about the mortgage origination practices of the mortgage originators, the plaintiff filed an action against the Goldman Sachs entities asserting claims on behalf of investors who purchased securities in all 17 offerings.
The district court ruled that the plaintiff had standing to assert claims only on behalf of investors i n the offerings and tranches in which the plaintiff had invested, but lacked standing to represent investors who purchased shares in the other offerings and tranches. As discussed here, the district court also held that because the plaintiff had not alleged that they had failed to receive payments due under the certificates, they had failed to allege injuries cognizable under the federal securities laws. The district court dismissed the plaintiff’s case. The plaintiff appealed to the Second Circuit.
The September 6 Opinion
In an opinion written by Judge Barrington Parker on behalf of a three-judge panel, the Second Circuit held that the plaintiff has class standing to assert claims of purchasers of securities backed by mortgages originated by the same lenders that originated the mortgages backing the plaintiff’s securities.
In reaching this conclusion, the Second Circuit relied on the U.S. Supreme Court’s opinion in Gratz v. Bollingerin whcih the Supreme Court held in a case involving the University of Michigan's admission practices that a claimant could represent a class of plaintiffs where the claimant's claims implicate "the same set of concerns" rather than a "significantly different set of concerns." ,
The Second Circuit said that in a securities case where the alleged misrepresentation involved the mortgage lenders’ origination practices, the plaintiff had standing to represent a class of investors in the offerings in which the same mortgage lenders were involved, because the plaintiffs’ claims and the other investors’ claims implicate the “same set of concerns.” The purchasers of securities backed by mortgages originated by different mortgage originators were “different in character and origin” and so the plaintiff did not have class standing to represent those investors. As a result the Court concluded that the plaintiff had standing to represent investors in seven out of the 17 offerings.
The Second Circuit also rejected the defendants’ argument that the plaintiff lacked class standing to represent investors in different tranches. The Court said that it did not believe that the “varying levels of payment priority raise such a ‘fundamentally different set of concerns’ as to defeat class standing.”
Finally, the Second Circuit concluded that the plaintiffs had “plausibly pled a cognizable injury – a decline in value” as a result of the securities credit downgrade, which exposed the plaintiff to much more risk concerning future payments of interest and principle. The Court specifically rejected the defendants arguments that the plaintiff had suffered no loss because it had not alleged that there had been any missed payments under the securities, and also rejected the defendants argument that the plaintiff had not sufficiently alleged injury because the plaintiff had not sufficiently alleged the existence of secondary market for the securities. The Court said that the district court had “conflated the price of a security and its ‘value,” adding that the absence of an actual market price for a security at the time of the suit “does not defeat an investor’s plausible claim of injury.”
The Second Circuit’s decision in this case not only represents a substantial victory for this plaintiff, but also for the plaintiffs in all of the cases involving mortgage-backed securities where the plaintiffs seek to represent a class of investors who purchased securities in multiple offerings. The Second Circuit made it clear that the mere fact that the plaintiff did not purchase securities in another related offering is not determinative of whether or not the plaintiff has class standing to represent investors in the other offerings. The Second Circuit also made it clear that the plaintiff has class standing to represent investors in other tranches as well.
Plaintiffs in the other cases will undoubtedly be studying this opinion closely and will try to use it to support their claims to represent a larger class of investors. However, this opinion is not going to help all plaintiffs, at least not in the same way. The Second Circuit did not conclude that the plaintiff here had standing to represent investors in all of the 17 offerings, but only in those offerings that involve “the same set of concerns.” The plaintiff lacked class standing to represent investors whose claims represent a fundamentally different set of concerns
In other works, the extent of a plaintiff’s standing to represent investors who purchased securities in multiple mortgage-backed securities offerings will depend on a complex interaction between the specifics of the misrepresentation that plaintiff is alleging and the relation of the misrepresentation to the various offerings.
This requirement to determine whether or not the other offerings implicate the “same set of concerns” as presented in the plaintiff’s claim will be more helpful to some plaintiffs than others. But at least they will not categorically barred from representing investors who purchased securities in other offerings. And they will not be barred from representing investors who purchased securities in other tranches as well.
The Second Circuit’s holding on the cognizable injury issue is also significant. From the early stages of the subprime litigation wave, commentators had been suggesting that the “paper losses” of the plaintiffs in the mortgage-backed securities cases did not represent the type of injury for which the protections of the federal securities laws were designed. The district court’s dismissal of the plaintiffs’ case for failure to plead a sufficiently cognizable injury seemed to be a significant affirmation of this argument. However, the Second Circuit seems to have clearly rejected this approach, and may in fact remove a significant potential pleading obstacle for the plaintiffs in these mortgage-backed securities cases.
I have updated my running tally of subprime and credit crisis securities lawsuit dismissal motion ruling to reflect the Second Circuit’s ruling. The tally can be accessed here.
David Bario's September 6, 2012 Am Law Litigation Daily Article about the Second Circuit's opinion can be found here.
Very special thanks to a loyal reader for sending me a copy of the Second Circuit’s opinion.