On November 12, the liquidators for two Bear Stearns overseas hedge funds filed their complaint against McGraw Hill, Standard & Poor’s, Moody’s, and Fitch (collectively the rating agencies) in an action in New York Supreme Court alleging that fraudulent ratings led to over $1 billion in losses for the funds’ investors. According to the complaint, the funds invested in a portfolio of high-grade structured finance products, including CDOs and RMBS, where “at least 90% had the highest rating available,” and therefore depended heavily on ratings in making investment decisions. The complaint alleges that the rating agencies knew that the ratings assigned to the securities in which the funds invested were false. Plaintiffs claim that the rating agencies lacked independence from the issuers of the securities and that their ratings were tainted by a desire to maintain market share in a profitable industry. The funds also allege that the rating agencies used relaxed standards in their initial ratings and subsequently failed to conduct proper ongoing surveillance of rated securities, leading to delays in downgrading ratings for allegedly faulty securities. The liquidators initially commenced the action in July through New York’s summons with notice procedure. Complaint.
Several Bear Stearns defendants agreed to undisclosed terms with the joint official liquidators of two Bear Stearns hedge funds, resolving the liquidators’ claims for breach of fiduciary duty, breach of contract and negligence. The terms of the settlement are undisclosed. The lawsuit arose out of the failure of the Bear Stearns High Grade Structured Credit Strategies and Bear Stearns High Grade Structured Credit Strategies Enhanced Leverage hedge funds that had allegedly invested heavily in Collateralized Debt Obligations (CDOs) and “CDO-squareds” (CDOs comprised of slices of other CDOs). The liquidators alleged that the defendants failed to provide adequate oversight and risk management to the funds and placed their own interests ahead of those of the funds. Complaint. By virtue of the settlement, the lawsuit was dismissed with prejudice on August 16. Stipulation.
On August 21, a collection of investors including Phoenix Light SF Limited, Blue Heron Funding II Ltd. and Kleros Preferred Funding V PLC (the Investors) brought suit against a number of JP Morgan and Bear Stearns entities in New York State Supreme Court. The Investors allege that JP Morgan and Bear Stearns made misrepresentations in the offering documents for 47 RMBS concerning the underwriting guidelines used to originate the mortgage loans backing the RMBS, loan-to-value ratios, owner occupancy rates, the credit ratings assigned to the RMBS and the transfer of title of the underlying mortgage loans. The Investors allege that the defendants knew their representations were false by virtue of due diligence performed prior to the securitizations and by virtue of their decision to dispose of substantial subprime assets while simultaneously marketing the RMBS to the Investors as sound investments. The Investors assert causes of action for common law fraud, fraudulent inducement, aiding and abetting fraud, negligent misrepresentation and rescission based upon mutual mistake. Complaint.
On August 13, the First Department of the Appellate Division of the Supreme Court of New York reversed a trial court decision denying Syncora Guarantee Inc.’s motion for summary judgment in an action against J.P. Morgan Securities LLC. Syncora’s suit alleged $320 million in losses resulting from its insurance of an RMBS transaction underwritten by Bear Stearns and sponsored by EMC Mortgage, entities that J.P. Morgan acquired in 2008. In this action, Syncora asserted claims for fraudulent inducement and tortious interference against J.P. Morgan, similar to the claims that it had been denied leave to assert against Bear Sterns in an earlier-filed federal court action. J.P. Morgan moved for summary judgment and dismissal on the basis of res judicata, but the trial court denied the motion, finding that J.P. Morgan and EMC had no pre-existing substantive legal relationship, and therefore no privity existed between them. The First Department reversed, finding sufficient privity existed between J.P. Morgan and EMC based on Syncora’s own allegations that the companies acted in concert in the alleged scheme. Decision.
On February 13, Judge Rya W. Zobel of the District of Massachusetts dismissed in part, but largely sustained, an investor suit brought by Capital Ventures International (CVI) against J.P. Morgan and certain of its subsidiaries in connection with four RMBS offerings underwritten by J.P. Morgan and Bear Stearns. CVI brought the suit under the Massachusetts Uniform Securities Act (MUSA), claiming that the defendants violated MUSA by making material misstatements in the offering materials. The court dismissed one of the claims against the RMBS sponsors, finding an insufficient relationship between the sponsors and CVI to support liability under section 410(a)(2) of MUSA. The court also dismissed one of the claims against the RMBS depositors for lack of control required under 410(b) of MUSA. The court otherwise denied the motion to dismiss with respect to all other parties and claims, finding (1) that there were sufficient allegations of material misstatements against the RMBS underwriters, including allegations concerning underwriting guidelines, appraisals and LTV/CLTV ratios, owner-occupancy status, and credit ratings, (2) the claims were not time-barred, (3) the depositors could be liable as issuers under SEC Rule 159A, and (4) sufficient allegations of control by the RMBS sponsors over the depositors. Decision.
On December 17, 2012, the National Credit Union Administration Board, acting in its capacity as liquidating agent for four failed credit unions, sued several Bear Stearns affiliates in federal court in Kansas in connection with $3.6 billion in RMBS allegedly purchased by the failed credit unions. The NCUA alleges that the originators of the mortgage loans underlying the RMBS systematically disregarded the underwriting guidelines stated in the offering documents. It also alleges that the offering documents contain untrue statements of material fact concerning the evaluation of the borrowers’ capacity and likelihood to repay the mortgage loans, reduced documentation programs, loan-to-value ratios, and credit enhancement. The NCUA asserts 24 separate counts for relief under Sections 11 and 12(a)(2) of the Securities Act of 1933, the California Corporate Securities Law, the Kansas Uniform Securities Act, the Texas Securities Act, and the Illinois Securities Act. Complaint.
On November 26, CIFG sued JP Morgan in Supreme Court for the State of New York for alleged losses stemming from its insurance of credit default swaps on two Bear Stearns RMBS-backed CDOs. CIFG alleges that instead of being selected and managed by independent collateral managers, the CDO portfolios were actually selected by Bear Stearns in order to unload its own risk. CIFG alleges it suffered more than $100 million in losses when the two CDOs defaulted. The complaint’s causes of action are for material misrepresentation in the inducement of an insurance contract and fraud. Complaint.
On October 1, New York Attorney General Eric T. Schneiderman filed suit against Bear Stearns & Company, now a unit of JPMorgan Chase, in New York state court in Manhattan. This is the first suit filed by a member of the joint federal and state Residential Mortgage Backed Securities Fraud Working Group, which was formed in January and is co-chaired by Schneiderman. The complaint asserts two claims under New York law: securities fraud under Article 23-A of the General Business Law (the Martin Act) and persistent fraud or illegality under Section 63(12) of the Executive Law. The complaint alleges that Bear Stearns ignored defects in mortgage loans underlying its RMBS, made material misrepresentations to investors about the quality of due diligence, ignored defects identified by due diligence firms, and failed to perform post-purchase quality review. Losses, according to the complaint, total approximately $22.5 billion across more than 100 subprime and Alt-A securitizations which the defendants sponsored and underwrote in 2006 and 2007. Complaint.
On July 16, Judge Lewis A. Kaplan of U.S. District Court for the Southern District of New York remanded suits brought by Bayerische Landesbank against Bear Stearns and Merrill Lynch to the Supreme Court of the State of New York, where they were originally filed. The lawsuits allege that Defendants knowingly made misrepresentations in RMBS offering materials concerning the underwriting standards used in connection with the underlying mortgage loans. Defendants sought removal to federal court on the ground that the cases were related to bankruptcy proceedings of the originators of some of the underlying mortgages. Judge Kaplan’s remand order indicated that a further written order may be forthcoming. Order. Notice of Removal.
On June 20, 2012, the Sixth Circuit affirmed an order by the Western District of Kentucky granting Bear Stearns’s motion to dismiss claims brought against it by Republic Bank & Trust Co. arising out of Republic Bank’s purchase of $52 million in RMBS. The Sixth Circuit’s ruling largely rested on Republic Bank’s failure to plead its claims with the required particularity. Specifically, the court found that allegations that prudent loan underwriting standards had not been followed and that property valuations were inaccurate were too general and not sufficiently tied to the loans backing the particular securities Republic Bank purchased. The court also found that many of the facts that Republic Bank alleged to have been misrepresented were in fact disclosed in the offering documents for the securities. Republic Bank admitted it had not read the offering documents prior to its purchases, conduct the court criticized as in dereliction of Republic Bank’s duty to exercise ordinary diligence. Opinion.