On May 17, Judge Jed S. Rakoff of the United States District Court for the Southern District of New York vacated his earlier “bottom line” summary judgment decision dismissing Dexia NV/SA’s (Dexia) suit against J.P. Morgan Chase Bank (J.P. Morgan) and its various affiliates. Dexia alleged fraud, negligent misrepresentation and successor liability claims related to the sale of $774 million in residential mortgage-backed securities. J.P. Morgan had removed the action from state court claiming federal jurisdiction primarily under the Edge Act as well as under the Court’s bankruptcy jurisdiction. The Edge Act, a statute enacted in 1919, provides for federal jurisdiction if two conditions are met: (i) an international banking and financial corporation organized under the laws of the United States (an Edge Act corporation) must be a party and (ii) the lawsuit must involve an offshore banking transaction. Although the Court initially denied plaintiffs’ motion to remand based on the Edge Act, Judge Rakoff vacated that decision based on a recent Second Circuit decision requiring the offshore banking transaction to be engaged in by the Edge Act corporation. Because J.P. Morgan did not originate the securitized loans or otherwise engage in the foreign banking transactions, the court concluded the Edge Act did not apply, and it could not exercise jurisdiction. Opinion.
Judge Jed S. Rakoff
S.D.N.Y Denies Motion to Dismiss RMBS Claims Against JPMorgan Chase
On February 26, Judge Jed S. Rakoff of the federal district court for the Southern District of New York issued a memorandum explaining the reasoning for his September 2012 order denying JP Morgan’s motion to dismiss a lawsuit against it in connection with the sale of $1.6 billion in RMBS. The suit, brought by FSA Asset Management and Dexia, alleges claims under New York law for fraud, fraudulent inducement, aiding and abetting fraud, negligent misrepresentation and successor liability. Plaintiffs claimed that JPMorgan and affiliated entities made fraudulent misrepresentations concerning the riskiness of the securitizations at issue and the underlying loans. The court found that plaintiffs: (a) pleaded the elements of their fraud and fraudulent inducement claims with sufficient detail, (b) provided enough facts to sustain a claim for aiding and abetting fraud, based on allegations that Bear Stearns Co. and JPMorgan Chase & Co. directed the purported fraudulent activity of subsidiary companies and received profits in return, and (c) stated claims for negligent representation based on allegations that the defendants induced the plaintiffs into a relationship of trust, convinced them to forego their own diligence and provided them with deceptive information. Decision.
Southern District of New York Dismisses Investors’ Claims Against Deutsche Bank
On January 4, Judge Jed S. Rakoff of the Southern District of New York issued a memorandum order explaining the bases for his February 6, 2012 decision that RMBS claims brought by several investor plaintiffs against several Deutsche Bank affiliates would be dismissed, with prejudice in part and without prejudice in part. Plaintiffs allege that Deutsche Bank made misrepresentations concerning the quality of the loans underlying 43 RMBS that they purchased. Plaintiffs also allege that Deutsche Bank concealed from plaintiffs that it had taken a short position against its own RMBS, including some of the securities it sold to plaintiffs. Plaintiffs asserted claims for common law fraud, fraudulent inducement, aiding and abetting fraud, and negligent misrepresentation. Judge Rakoff held that plaintiffs failed to plead their claims with particularity, as required by Rule 9(b), in a number of ways. For instance, they failed to state with particularity the alleged misstatements in the offering documents for each of the 43 securities or who made each of those statemens. Plaintiffs also failed to allege the dates on which they purchased the securities and whether they relied on draft or final versions of the offering documents at the time of purchase. Judge Rakoff granted plaintiffs leave to amend their claims involving RMBS sponsored by Deutsche Bank. The claims related to RMBS not sponsored by Deutsche Bank, however, were dismissed with prejudice because Deutsche Bank had only a limited and attenuated role in the offerings. Order.
Federal Court Rules that Insurer May Prevail on its Representation and Warranty Claims Without Proving that the Breaches Caused Loans to Default
On September 25, Judge Jed S. Rakoff of the Southern District of New York issued a written opinion denying summary judgment in Assured Guaranty Municipal Corp.’s contract dispute with Flagstar Bank FSB over its insurance policies on nearly $1 billion in mortgage-backed securities backed by home equity loans. Assured initiated this action in April 2011, alleging that Flagstar breached representations and warranties concerning the underwriting guidelines used to originate the mortgages, the credit characteristics of the loans, and the absence of negligence or fraud in the origination process. Assured alleges that many of the loans have defaulted, resulting in $82.4 million in claims paid to date. In denying Flagstar’s summary judgment motion, Judge Rakoff found that Assured need not demonstrate loss causation – that is, that the representation and warranty breach caused the loan to default and caused Assured to suffer damages – but rather that Assured could prevail if it proves that the representation and warranty breach materially increased the risk of loss to Assured. Trial in this matter is scheduled for October 9. Judge Rakoff’s ruling is similar to that of Judge Paul Crotty in Syncora Guarantee Inc. v. EMC Mortgage Corp., a decision covered in the June 25 issue of the Week in Review. Order.
SDNY Judge Rejects Proposed SEC-Citigroup Settlement
On November 28, 2011, U.S. District Judge Jed S. Rakoff of the Southern District of New York refused to approve a proposed settlement between the SEC and Citigroup Inc. in connection with Citigroup’s alleged shorting of RMBS that it marketed and sold to the public on the grounds that the settlement was “neither fair, nor reasonable, nor adequate, nor in the public interest.” The settlement involved the payment of a total of $285 million by Citigroup, as well as the imposition of certain injunctive measures against Citigroup. In rejecting the settlement, Judge Rakoff stringently criticized the SEC’s policy – “hallowed by history, but not by reason” – of allowing settling defendants to neither admit nor deny wrongdoing because it “deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact.” He stressed that the exercise of judicial power and authority that does not rest on facts cannot serve the public interest because it “is worse than mindless, it is inherently dangerous.” Judge Rakoff consolidated the action with a related matter filed by the SEC against a Citigroup employee and directed the parties to be ready to try the case beginning on July 16, 2012. Order.
Citigroup and SEC Defend Proposed Settlement
On November 7, 2011, Citigroup Global Markets Inc. and the Securities and Exchange Commission filed separate memorandums in support of their proposed settlement agreement in the United Stated District Court for the Southern District of New York. Citigroup and the SEC agreed to a settlement over allegations of wrongdoing by Citigroup’s mortgage-backed securities group wherein Citigroup agreed to pay $285 million in exchange for a “no admit, no deny” settlement. Judge Jed S. Rakoff ordered both parties to defend the proposed settlement after questioning the SEC’s decision to accept a non-admission of wrongdoing despite “alleg[ing] a serious securities fraud.” Citigroup defended the settlement in part by arguing that the public interest is better served by allowing sophisticated parties to compromise complicated matters in a manner that avoids wasteful litigation and exposing both parties to extreme results. It also argued that current market conditions penalize corporate stock prices simply because of a company’s involvement in litigation with a regulatory agency, and that a “no admit, no deny” result was necessary to minimize potential collateral consequences in the civil class actions and other litigations pending against Citigroup related to mortgage-backed securities and subprime mortgages. The SEC defended the settlement by stating that the outcome allowed for a quick resolution to the case while still “clearly conveying” that the alleged conduct by Citigroup occurred. Citigroup Submission. SEC Submission.