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.
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.