There was a flurry of subprime related securities lawsuit dismissal motion activity at the end of last week, and although in some cases the motions were granted and in other instances large parts of the cases were dismissed, in several instances enough of the cases survived for the plaintiffs to tally the rulings in the win column. Among the cases where the plaintiffs retained enough to live for another day were at least one high profile case and another interesting auction rate investor case.
Fannie Mae: In a September 30, 2010 order (here), Southern District of New York Judge Paul A. Crotty granted in part and denied in part the defendants’ motions to dismiss the plaintiffs’ ’34 Act claims in the Fannie Mae subprime-related securities class action lawsuit. (In a November 29, 2009 order, here, Judge Crotty had previously granted the defendants’ motions to dismiss the plaintiffs’ claims under the ’33 Act).
The plaintiffs’ ’34 Act claims involved three principal allegations: (1) that the defendants had misrepresented Fannie’s exposure to subprime and Alt-A mortgage markets and related risks; (2) that the defendants had misrepresented the quality of Fannie’s internal risk controls (3) that Fannie had filed materially inaccurate financial statements.
Judge Crotty granted the defendants’ motions to dismiss both as to the allegations that Fannie had misrepresented its subprime and Alt-A exposure and as to the allegations that Fannie has filed inaccurate financial statements. However, Judge Crotty denied the dismissal motions of the company itself, its CEO and its Chief Risk Officer, with respect to the allegations that the defendants had misrepresented the quality of Fannie’s internal controls.
In granting the motions to dismiss as to allegations concerning Fannie’s exposure to subprime and Alt-A mortgages, Judge Crotty ruled that Fannie’s public filings contained cautionary language that warned investors about the risks of Fannie’s subprime and Alt-A investments. He also held that the plaintiffs had failed to explain why the defendants’ statements regarding Fannie’s subprime and Alt-A investments were false. Finally, he held that the plaintiffs had failed to allege that the defendants had acted with scienter in making statements about Fannie’s subprime and Alt-A exposure.
In granting the motions to dismiss as to the allegations that Fannie filed inaccurate financial statements, Judge Crotty held that the plaintiffs had not alleged sufficient facts to establish that Fannie’s financial statements were false at the time they were issued. Judge Crotty also noted that Fannie’s regulators had never claimed that Fannie had committed any GAAP violations and had never asked for restatements of any of Fannie’s financial statements for the class period, but at the same time reported repeatedly that Fannie was adequately capitalized.
In denying the motions to dismiss as to the plaintiffs’ allegations that the defendants had misrepresented the quality of Fannie’s internal risk controls, Judge Crotty relied heavily upon three emails that had gone between the company’s Chief Risk Officer and its CEO. In these emails, the Chief Risk Officer complained, among other things, that the company "was not even close to having the proper control processes for credit, market and operational risk."
Judge Crotty said that these statements "show that Fannie may have been saying one thing while believing another" and are sufficient to survive a motion to dismiss. However, because the plaintiffs had not shown that two of the other individual defendants were aware of the emails, Judge Crotty granted these two defendants’ motions to dismiss, while denying the dismissal motions of the company, its CEO and the Chief Risk Officer.
Perrigo Company: As discussed here, the auction rate securities lawsuit filed against Perrrigo and certain of its directors and offices did not involve the usual allegations that an auction rate securities seller had misrepresented the securities in connection with the securities’ sale; rather, Perrigo was an auction rate securities investor, and the plaintiffs, Perrigo shareholders, alleged that the defendants had misrepresented the company’s own investment exposure to auction rate securities.
Essentially, the plaintiffs alleged that during a period in 2008 and early 2009, the company failed to write down the value of its auction rate securities investments, and also failed to acknowledge publicly that it has purchased its auction rate securities from Lehman Brothers, and was therefore not going to benefit from the same kind of redemption as had other auction rate securities investors who had purchased their securities from, for example, Merrill Lynch, Citigroup and UBS. On February 3, 2009, the company reported that it had incurred a significant charge related to the write down of the auction rate securities and also revealed the Lehman connection.
In his September 30, 2010 order (here) denying the defendants’ motions to dismiss, Southern District of New York Judge Thomas Griesa had that the "plaintiffs argue persuasively that the identical factors that caused Perrigo to drastically write down the value of the ARS on February 3, 2009 – increased credit and liquidity risks – were operative and evident to defendants at the time they issued the November 6, 2008 statements." Judge Griesa also found that the plaintiffs had sufficiently alleged materiality, scienter and loss causation.
WaMu Mortgage Pass-Through Certificates: In a September 28, 2010 order (here), Western District of Washington Judge Marsha Pechman granted in part and denied in part the dismissal motions in the securities class action lawsuit that had been brought by investors who had purchased interests in certain Washington Mutual Mortgage Pass-Through Trusts. The defendants in the case included Washington Mutual and certain of its subsidiaries, as well as certain officers of the subsidiaries who had signed the offering documents, and the rating agencies which had provided credit ratings for the investments.
Judge Pechman first ruled that the named plaintiffs lacked standing to assert claims with respect to 25 of the 36 offerings at issue because the plaintiffs had not purchased securities in connection with those 25 offerings. In addition, Judge Pechman also dismissed allegations as to three other offerings as time-barred.
With respect to the remaining offerings, Judge Pechman found that the plaintiffs had adequately alleged misrepresentation in connection with the offering documents’ statements about the underwriting guidelines used in connection with the origination of the underlying mortgages. She observed that "in essence, Plaintiffs allege the underwriting guidelines ceased to exist," adding that "the absence of underwriting standards could make the identified statements misleading."
However, she held that the plaintiffs had not alleged actionable misrepresentations with respect to the offering documents’ statements about appraisals and loan to value ratio, noting that the "allegations on this issue are simply too conclusory." With respect to the alleged failure to disclose the credit ratings alleged conflict of interest, she concluded that "because reasonable investors knew that the rating agencies were paid by the issuers, the alleged misrepresentation is immaterial.
Judge Pechman also rejected the defendants’ arguments that the plaintiffs had not adequately alleged economic loss, since the plaintiffs have not alleged that they failed to receive an income stream from the certificates. Judge Pechman said that plaintiffs allegations "give rise to the inference that the value of the security is much less that the purchase price," and the "mere fact that Plaintiffs may have difficulty substantiating the exact nature of their loss in an illiquid market does not necessitate dismissal."
Oppenheimer Auction Rate Securities: In a September 29, 2010 order (here), Judge Loretta Preska granted the defendants’ motion to dismiss the auction rate securities lawsuit that had been brought against Oppenheimer Holdings and one of its subsidiaries. The Oppenheimer lawsuit is one of the conventional auction rate securities lawsuits, in that it had been brought by auction rate securities buyers against the firm that sold them the investments.
The plaintiffs contend that in connection with their purchase of the securities they had been misled about the nature and safety of the securities as well as the nature and operation of the market for the securities. The plaintiffs allege that as a result of the failure of the auction rate securities market in February 2008, they are stuck holding illiquid securities for which there is no market.
In granting the motions to dismiss, Judge Preska found that the plaintiffs had not sufficiently alleged scienter. Specifically, she found that the plaintiffs allegations of motive and opportunity were insufficient and that the alleged circumstantial evidence of scienter were also insufficient.
Among other things, Judge Preska found that the inference of scienter that plaintiffs urged "is not at least as strong as the inference that Oppenheimer negligently or carelessly provided insufficient training to its financial advisors and was merely negligent in not detecting and disclosing the imminent market collapse." The "more compelling inference" is that "Oppenheimer did not predict that all broker dealers would withdraw from the ARS market en masse."
Countrywide Asset-Backed Certificates Trust: In a mortgage-backed asset securities case that was not brought as a class action, on September 28, 2009 Judge Kevin Castel granted the motion of defendants Countrywide Home Loans and related entities, as well as certain Countrywide directors and officers, brought by two individual investors who had purchased mortgage backed securities from Countrywide. A copy of the order can be found here.
The plaintiffs, who had purchased over $540 million of the securities in their initial offerings, alleged that the offering documents contained material misrepresentations regarding the underlying loans, regarding the underwriting guidelines used in connection with the origination of the underlying loans; as well as regarding the selection and servicing of the underlying loans.
Judge Castel noted at the outset that this is the unusual case where the plaintiffs acknowledge that they knew that the underlying loans were "risky" and that the borrowers were "credit-blemished," but claim that they were misled because the loans were riskier than they were led to believe.
Judge Castle concluded both that the plaintiffs had insufficiently alleged misrepresentation and that the plaintiffs had insufficiently alleged scienter.
Discussion
In one sense, these dismissal motion rulings described above just represent a random selection of rulings as the courts continue to grind through the mountain of pending subprime and credit crisis related lawsuits. However I have some observations about this group of rulings.
First, though some subprime cases are dismissed outright and there are many other cases where substantial parts of the cases have been knocked out, in a substantial number of these cases the plaintiffs are either prevailing on the dismissal motions or at least managing to scrape out just enough to live to see another day. Thus for example in both the Fannie Mae and WaMu cases discussed above, even though huge parts of the cases were dismissed, enough remains for the plaintiffs to be able to continue to fight and to try to work toward an eventual payday.
Second, among the cases surviving in whole or in part are many of the highest profile cases. The Fannie Mae case is just the latest illustration of this, following close on the heels of the dismissal motion survival of the AIG case (refer here) and the Merrill Lynch/BofA merger case (refer here). This follow along with many of the other high profile cases such as the Countrywide, New Century and Washington Mutual. subprime related securities suits. The point is that while many of the subprime cases may have been dismissed along the way, the biggest, highest-profile cases are generally going forward.
Third, as the cases grind through, some important issues are being worked out. Thus, for example, as suggested in the Oppenheimer case, courts are now working through the merits of the auction rate securities cases. Up to this point, many of the auction rate securities cases that had been dismissed were based on mootness grounds, based on the defendants’ entry into regulatory settlements that more or less made plaintiffs whole. In Oppenheimer, the court addressed the merits of the plaintiffs’ allegations and found the allegations to be insufficient.
The Oppenheimer ruling is not the first auction rate securities lawsuit dismissal on the merits (refer for example here with respect to the Merrill Lynch auction rate securities case) but it does represent another instance suggesting that the plaintiffs in these auction securities cases are not doing particularly well.
By contrast, in the Perrigo case, the court found the plaintiffs’ allegations against Perrigo as an auction rate securities investor to be sufficient. The claimants in other cases against auction rate investors have not been as successful – refer for example here with respect to the dismissal motion grant in the securities suit brought against Mind M.T.I. Even though the plaintiffs’ record in these auction rate investor cases may be mixed, the Perrigo case at least shows that plaintiffs are overcoming initial pleading hurdles in at least some of these cases.
Finally, and notwithstanding the cases where the plaintiffs did manage to overcome the dismissal motion phase at least in part, there are still a number of cases where the defendants are succeeding in getting the cases dismissed, as evidenced in the Countrywide and Oppenheimer cases discussed above.
I have in any event added these decisions to my running tally of subprime and credit crisis-related dismissal motion rulings, which can be accessed here.
Many thanks to the several readers who forwarded copies of these decisions to me.