Securities and Financial Sector Legal Review

Deutsche Bank Settles False Claims Act Mortgage Fraud Lawsuit

By Lystra Batchoo on Posted in False Claims Act and Whistleblower Litigation, Mortgage Lending and Foreclosure

We previously posted about the mortgage fraud lawsuit filed by the United States Attorney’s Office for the Southern District of New York against Deutsche Bank and its subsidiary, MortgageIT, and subsequent developments regarding the defendants’ attempts to get the case dismissed.  The lawsuit alleged violations of the False Claims Act based on two types of repeated false certifications defendants made to the Department of Housing and Urban Development and which led to the Government having to pay mortgage insurance on defaulted mortgages.

Yesterday, Deutsche Bank agreed to pay $202 million to settle the lawsuit.  According to a press release from the U.S. Attorney’s Office, as part of the agreement, Deutsche Bank also admitted that it was “in a position to know that the operations of MortgageIT did not conform fully to all of HUD-FHA’s regulations, policies, and handbooks.”

For further commentary, visit Bank to Pay $202 Million to Settle Suit on Mortgages, Deutsche Bank to Pay $202 Million to Settle Suit, and Deutsche Bank to Pay $202 Million Over Mortgage Fraud.

One Court Takes A Narrow Reading of HSH Nordbank in Connection With Fraud Claims

By Nicholas Panarella on Posted in Mortgage-Backed Securities, Notable Decisions

We posted recently about the HSH Nordbank decision concerning the justifiable reliance element in fraud claims.  A recent decision from Justice Kapnick in the New York State Supreme Court Commercial Division suggests a limited application of HSH Nordbank that would not cover the situation where the fraud was not “discoverable through any publically available source of information.”  In ACA Finanacial Guaranty v. Goldman Sachs & Co., ACA alleged that Goldman Sachs induced it to provide financial guaranty insurance for a CDO transaction called ABACUS that consisted in part of a portfolio of investment securities chosen by Goldman’s hedge fund client Paulson & Co., Inc. (“Paulson”).   ACA alleged that Goldman falsely represented  that Paulson would be an equity investor in the CDO (and thereby have an economic interest in selecting securities that would perform well). In fact, according to ACA’s Complaint, Goldman and Paulson has entered into a separate credit default transaction — which they concealed from ACA — whereby Paulson was a “protection buyer” in ABACUS — meaning that Paulson had an economic incentive to have the investment securities in ABACUS default.

Goldman moved to dismiss ACA’s fraud claims arguing in part that ACA could not, as a matter of law, demonstrate justifiable reliance since ACA signed a contract with Goldman that disclaimed reliance and also – as a sophisticated party — should have investigated Paulson’s investment role in the transaction.  The court disagreed, and distinguished ACA’s claims from those in HSH Nordbank:

 In this case, however, plaintiff’s fraud claims do not allege that plaintiff was relying on defendant’s advice as to the risk of the transaction or the level of risk or reliability of the securities involved.  Rather, ACA’s Complaint specifically alleges that Goldman Sachs concealed from it that through the Goldman Sachs–Paulson CDS, Paulson had purchased from Goldman Sachs the protection on the reference portfolio that Goldman Sachs had purchased from the SPV, making Paulson the undisclosed protection buyer and short investor in ABACUS.  AC, ¶ 5.  ACA further alleges that the Goldman Sachs-Paulson CD was not discoverable through any publically available source of information.  Id.

This decision, however, may have limited utility for sophisticated plaintiffs alleging fraud claims since it arose from a unique set of facts.  As Justice Kapnick also noted, there had been a prior SEC investigation into this very same ABACUS transaction in which the SEC concluded that Goldman had “hidden” Paulson’s true investment role.  As a result, Goldman had signed a Consent Decree with the SEC in which:

 Goldman Sachs specifically acknowledged that it had made a mistake in failing to disclose Paulson’s role in the portfolio selection process and the fact that Paulson’s economic interests in the transaction were adverse to the CDO investors (as well as the financial guarantor).

A Warning to Sophisticated Parties in Fraud Cases: Do Your Homework

By Alison MacGregor on Posted in Mortgage-Backed Securities, Notable Decisions

On March 27, 2012, the Appellate Division, First Department issued its opinion in HSH Nordbank AG v. UBS AG, which reversed the lower court’s denial of a motion to dismiss the fraud claim. HSH Nordbank alleged that UBS induced it to enter a credit default swap transaction by misrepresenting the risk HSH Nordbank would assume – the risk of default in a $3 billion securities portfolio “comprised predominantly of assets linked to the United States real estate market (for example, mortgage-backed securities and instruments issued by real estate investment trusts).”   The Appellate Division found that HSH Nordbank, as a sophisticated party, could not plead justifiable reliance because it had failed to “exercise ordinary diligence” and “conduct an independent appraisal of the risk [it was] assuming.”  The court wrote:

By no means do we suggest that UBS, if it engaged in the sharp dealing alleged by HSH, is to be commended; such practices are indeed troubling. Still, however much UBS’s alleged conduct leaves to be desired as a matter of business ethics, the undisputed documentary evidence and HSH’s own allegations eliminate, as a matter of law, any reasonable inference that HSH justifiably relied on the representations of which it now complains. To sustain HSH’s fraud cause of action, we would have to ignore the fact that the amended complaint—assuming the truth of its allegations—does not allege that UBS misrepresented any material existing fact as to which HSH could not have learned the truth had it conducted (or hired a consultant to conduct on its behalf) an independent appraisal of the risks of the NS4 transaction. We would also have to close our eyes to HSH’s sophistication; to HSH’s disclaimer of reliance on UBS for advice or on any extracontractual representations; to the detailed and specific disclosures of risk and conflict of interest in the transactional documents; to HSH’s ability to protect itself through the exercise of due diligence; and to the availability to HSH of appropriate relief (if any) under the rubric of its claim for breach of contract. Indeed, if we were to affirm the denial of the motion to dismiss this fraud claim, we would be judging the sufficiency of a claim asserted by a € 140 billion commercial bank by a standard more lenient than the one by which this Court has judged similar claims made by individual investors against their retail brokers (see e.g. Matter of Dean Witter Managed Futures Ltd. Partnership Litig., 282 A.D.2d 271 [2001] ). Such a result would put in question whether any set of disclaimers and disclosures, no matter how detailed and specific, affords protection against a fraud claim—even a claim by a commercial entity of a high degree of sophistication, and with the resources to hire any outside help it needs—concerning matters subject to discovery through due diligence, and as to which the claimant agreed that it was not relying on the party sitting across the table.

This decision is an important one for fraud jurisprudence in the post-financial crisis world.  Many of the cases winding their way through the courts involve claims by sophisticated parties, such as monoline insurers, that they were duped into investing in or insuring risky mortgage-backed securities.  Many of these complaints rely on sampling to illustrate the poor performance of the mortgages in the pools.  The HSH Nordbank decision suggests that sampling and other diligence should take place before entering into the deal.  On May 1, 2012,  a decision from Justice O. Peter Sherwood held that a monoline insurer wishing to plead fraud must do just that.

In CIFG Assurance North America v. Goldman Sachs & Co., plaintiff CIFG alleged that Goldman Sachs induced it to insure a securitization created by Goldman.  Defendant M&T Bank was the underwriter for the mortgages backing the securitization.   The court dismissed fraud claims against both defendants on the ground that plaintiff CIFG failed to show justifiable reliance.  The court held, as to M&T, that

Because CIFG cannot show detrimental reliance, its fraud-related claim against M&T Bank must fail. CIFG acknowledges in its complaint that while it conducted due diligence as to certain aspects of the transaction, it made a decision not to conduct a review of the underlying loans as a cost avoidance measure. However, as M&T Bank notes, if the misrepresentations in such loans was as pervasive as CIFG asserts, then CIFG would have discovered the misrepresentations had it conducted a review of sample loans, similar to what CIFG later hired Opus to do.

***

As a sophisticated party involved in an arms length transaction, CIFG had a duty to undertake an independent due diligence review of the risks associated with the guaranty it sold, including, at the very least, a review of a sample of the underlying mortgage loans which would have revealed the problems in such loans. Having failed to do so, CIFG cannot now be heard to claim that it justifiably relied to its detriment on M&T Bank’s representations.

The court dismissed the fraud claim against Goldman Sachs under the same theory, holding that”[h]ad CIFG conducted proper due diligence prior to writing the insurance, it would have uncovered the alleged misrepresentations about which it now complains.”

Interestingly, Justice Sherwood reached this result without citation to HSH Nordbank, which had been decided during the briefing of CIFG v. Goldman Sachs. In a footnote, the court acknowledge that counsel had submitted the HSH Nordbank decision to the court via letters, but that under Commercial Division Rule 19, sur-reply papers – including correspondence – require advance permission, which was not sought in this case.  Thus, the court did not consider the submissions on HSH Nordbank.  Otherwise, Justice Sherwood allowed contract claims to proceed against Goldman, and dismissed M&T Bank from the action.

For further discussion regarding these decisions, please see NY appeals court raises bar for sophisticated investors; UBS Wins Dismissal of Fraud Claim in HSH Nordbank Suit; Goldman Sachs Wins Dismissal of Some Claims in CIFG Suit.

New Derivatives Rules Define Swap Dealers

By Lystra Batchoo on Posted in Regulatory Actions

On Wednesday, regulators from the Securities and Exchange Commission and the Commodity Futures Trading Commission jointly issued new rules that define certain terms related to the swaps market and which entities will be subject to oversight.  The rules are the agencies’ latest efforts to implement part of the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

 Under the new rules, an entity is considered a swap dealer if it traded more than $8 billion in swaps over a 12-month period.  That threshold number may be lowered five years later to $3 billion after the SEC and CFTC evaluate whether the threshold should be changed.

 According to the SEC website:

 The new Rule 3a71-1 under the Securities Exchange Act defines the term “security-based swap dealer” consistent with the criteria set forth in the Dodd-Frank Act as someone who:

  • Holds themselves out as a dealer in security-based swaps.
  • Makes a market in security-based swaps.
  • Regularly enters into security-based swaps with counterparties as an ordinary course of business for their own account.
  • Engages in activity causing them to be commonly known in the trade as a dealer or market maker in security-based swaps.

Consistent with the statute, the new rule also specifies that the term “security-based swap dealer” does not include a person who enters into security-based swaps for their own account “not as a part of a regular business.”  The new rule interprets this definition in a manner that builds on the dealer-trader distinction that already is used to identify dealing activity involving other types of securities, while taking into account the special attributes of security-based swap markets. Further, the SEC would clarify the distinction between dealing activity and non-dealing activity such as hedging.  In addition, the new rule excludes from the dealer analysis (as well as the major participant analysis) security-based swaps between counterparties that are majority-owned affiliates.

According to the agencies, less than 200 entities would have to register as a swaps dealer under the new rules.  Some commentators have criticized the $8 billion exemption level as too high and a departure from the 2010 initial proposal that firms would be considered swap dealers at the $100 million trading level, which would have subjected many more entities to oversight.  The SEC unanimously adopted the rules, while the CFTC approved them by a 4 to 1 vote.  The new rules will become effective 60 days after they are published in the Federal Register.

For information on the rules, see http://www.sec.gov/news/press/2012/2012-67.htm.  For additional insights and analysis, visit Regulators Defend Derivatives Rule, Regulators Spare All But Biggest Swap Dealers, Swap-Dealer Bar Set at $8 Billion, and Smaller Companies Getting a Pass From Tougher Swap Regulation.

April Corporate Governance and Regulatory Update – Part Two

By Alison MacGregor on Posted in Corporate Governance, Regulatory Actions

 

We are bringing a new feature to the blog – a monthly update on goings on in the world of corporate governance and the regulatory environment.  Our Kelley Drye Colleagues Patricia Lee and Julia Sitarz compiled the following information.  Part One of the update, focusing on general corporate/securities law developments, can be found here.

 

2.                  SEC and SRO Rules and News

(a)                Submissions to Corp Fin’s Office of Chief Counsel: Use Online Forms, Not E-Mail Address

As of April 1, the Office of Chief Counsel (OCC) at the Division of Corporation Finance of the SEC has shut down its email address used to ask questions, submit no-action letters, etc. – cfletters@sec.gov. Apparently the Staff had been getting too much spam at this email address, rendering it no longer an efficient way for the SEC to receive communications from the public.

Going forward, the forms linked below should be used to ask interpretive questions and to submit no-action requests. In addition, the OCC is still accessible by telephone to ask questions (at 202.551.3500, leaving your name, phone number and a phrase describing the topic on their voicemail) and no-action requests by mail can be submitted by mail.

Form for Interpretive Questions

https://tts.sec.gov/cgi-bin/corp_fin_interpretive

Form for No-Action Requests

https://www.sec.gov/forms/corp_fin_noaction

(b)               PCAOB’s Auditor Rotation Roundtable

On March 22, the Public Company Accounting Oversight Board heard testimony from a series of high-profile auditing experts on the advantages and disadvantages of requiring companies to rotate their auditing firms on a regular basis.  The testimony came in response to a concept release that the PCAOB proposed last year on the controversial matter of mandatory audit firm rotation.  The PCAOB heard from former Federal Reserve Chairman Paul Volcker, along with several former chairmen of the Securities and Exchange Commission—Arthur Levitt, Harvey Pitt and Richard Breeden—and the heads of the five largest auditing firms.  For an article describing the events of the first day of the hearing, including former Fed Chair Volcker’s support of auditor rotation, see here.

(c)               Corp Fin to Consider Tweaking Foreign Private Issuer Reporting System

At an early March conference in London, Meredith Cross, the director of the SEC Division of Corporation Finance, announced that the SEC is considering changing the foreign private issuer reporting system under the U.S. Securities Exchange Act of 1934. Depending on its scope and results, this review could have a significant impact upon foreign private issuers that want to list their securities in the United States or conduct U.S. public offerings under the Securities Act of 1933 as well as issuers that are already reporting under the Exchange Act.  For a Jones Day memo recapping the speech, see here.

(d)                Proxy Access: The Staff Weighs In on No-Action Requests

On March 8, the SEC Staff posted responses to a number of no-action requests relating to proxy access shareholder proposals. The requests that the Staff answered deal with several different bases for exclusion, reflecting the different approaches taken by the proponents and the particular issues raised by the wording of their proposals. Below is a summary of how the Staff came out on these letters:

  •   More than one proposal. In responses to Bank of America Corporation, The Goldman Sachs Group, Inc. and Textron, the Staff indicated that there appeared to be some basis that the companies could exclude the proxy access proposals under Rule 14a-8(c), which provides that a proponent may submit no more than one proposal. In particular, the Staff noted that several paragraphs of the proponents’ submissions contained a proposal relating to the inclusion of shareholder director nominations in the companies’ proxy materials, while one paragraph of the submissions included a proposal relating to events that would not be considered a change in control. The Staff concurred with the view that this paragraph constituted a separate and distinct matter from the proposal relating to the inclusion of shareholder nominations for director in the companies’ proxy materials.
  • Vague and indefinite. In responses to Chiquita Brands, Inc., MEMC Electronic Materials, Inc. and Sprint Nextel Corporation, the Staff indicated that there appeared to be some basis for the view that the companies could exclude the proxy access proposals under Rule 14a-8(i)(3) as vague and indefinite. The Staff particularly noted that the proposals provided that the companies’ proxy materials shall include the director nominees of shareholders who satisfy the “SEC Rule 14a-8(b) eligibility requirements,” without describing the specific eligibility requirements. The Staff viewed the specific eligibility requirements as representing a central aspect of the proposals, and that while some shareholders voting on the proposals may be familiar with the eligibility requirements of Rule 14a-8(b), many other shareholders may not be familiar with the requirements and would not be able to determine the requirements based on the language of the proposal. Based on this ambiguity, the Staff believed that neither shareholders nor the companies would be able to determine with any reasonable certainty exactly what actions or measures the proposals required.
  •  Website Reference Cannot be Omitted Under 14-8(i)(3). In responses to The Charles Schwab Corporation, Wells Fargo & Company and The Western Union Company, the Staff indicated that it was unable to concur with the view that the companies could exclude a reference to the proponent’s website in the proposal under Rule 14a-8(i)(3), which permits the exclusion of a proposal or a portion of a proposal if it is materially false or misleading. The Staff particularly noted that the proponent had provided the companies with the information that would be included on the website, the companies had not asserted that the content to be included on the website was false or misleading, and the proponent represented that it intended to include the information on the referenced website when the companies filed their 2012 proxy materials. For these reasons, the Staff was unable to conclude that the companies demonstrated that the portion of the proposal was materially false or misleading and could be omitted.
  •    One Proposal Not Excludable Based on a Substantially Implemented Argument. In a response to KSW, Inc., the Staff addressed a proposal seeking to amend the company’s bylaws to require that the company include in its proxy materials the name, along with certain other disclosures and statements, of any person nominated for election to the board by a shareholder or a group of shareholders who beneficially owned 2% or more of the company’s outstanding common stock and to allow shareholders to vote with respect to such nominee. The company had adopted a bylaw that allows a shareholder who has owned 5% or more of the company’s outstanding common stock to include a nomination for director in the company’s proxy materials. Given the differences between the shareholder proposal and the company’s bylaw, including the difference in ownership levels required for eligibility to include a shareholder-nominated director nominee in the company’s proxy statement, the Staff was unable to concur that the proposal could be omitted as substantially implement under Rule 14a-8(i)(10).

 

April Corporate Governance and Regulatory Update – Part One

By Alison MacGregor on Posted in Corporate Governance, Regulatory Actions

 

We are bringing a new feature to the blog – a monthly update on goings on in the world of corporate governance and the regulatory environment.  Our Kelley Drye Colleagues Patricia Lee and Julia Sitarz compiled the following information.

 

 

1.                  General Corporate/Securities Law Developments

(a)                Congress Passes JOBS Act

We previously posted about how the JOBS Act will allow hedge fund advertising.  Overall, the JOBS Act creates a new category of issues called “emerging growth companies” that would be exempt from, or subjected to reduced, regulatory requirements for a limited period of time in an effort to encourage them to go public in the United States.  The JOBS Act also includes other measures intended to ease significantly private capital formation and reduce public reporting requirements for small and emerging businesses.

A summary of the key measures included in the JOBS Act follows:

Title I, Reopening American Capital Markets to Emerging Growth Companies. This portion of the Act will become effective immediately upon enactment and is what is most commonly referred to as the “IPO On-Ramp” legislation, and it is meant to encourage smaller companies to go public through a process where public company obligations would be phased in over time. This legislation would amend the 1933 Act and 1934 Act to create a new category of issuer referred to as an “emerging growth company,” which is an issuer with total annual gross revenues of less than $1 billion, and would continue to have this status until (i) the last day of the fiscal year in which the issuer had $1 billion in annual gross revenues or more; (ii) the last day of the fiscal year following the fifth anniversary of the issuer’s initial public offerings; and (iii) the date when the issuer is deemed to be a “large accelerated filer” as defined by the SEC. The legislation provides for scaled regulation to be applied to the emerging growth company for up to five years following the IPO, including reduced compliance with provisions such as Section 404(b) of the Sarbanes-Oxley Act, mandatory Say-on-Pay, and the Dodd-Frank CEO pay ratio disclosure rules. On the 1933 Act registration front, the legislation would permit greater pre-filing communications, allow for expanded research at the time of the IPO by offering participants, and would provide for pre-filing confidential review of draft registration statements by the SEC Staff.

Title II, Access to Capital for Job Creators. This portion of the legislation would remove the prohibition against general solicitation and general advertising in private offerings under Regulation D, provided that all of the purchasers of securities are accredited investors. Similarly, general solicitation and general advertising would not be prohibited in secondary sales so long as only QIBs are purchasers in the offering. In addition, the legislation would provide that offline and online forums bringing together companies and investors would not be treated as broker-dealers unless they receive transaction-based fees for their activities.

Title III, Entrepreneur Access to Capital. This part of the bill would provide an exemption for crowdfunding, by permitting offerings up to $1 million, provided that investor contributions are limited to (i) the greater of $2,000 or 5% of the investor’s annual income or net worth (if either the investor’s annual income or net worth is less than $100,000) and (ii) 10% of the investor’s annual income or net worth, up to a maximum amount of $100,000 (if either the investor’s annual income or net worth is equal to or more than $100,000). Requirements targeted at investor protection are imposed on the issuer and/or the intermediary involved in the crowdfunding effort.

Title IV, Small Company Formation. This part of the legislation is commonly referred to as Regulation A reform, raising the limit for Regulation A offerings from $5 million to $50 million. Most importantly, the legislation would exempt Regulation A offerings from state securities laws when the Regulation A securities are (i) offered or sold through a broker-dealer; (ii) offered or sold on a national securities exchange; or (iii) sold to a qualified purchaser as defined by the SEC.

Title V, Private Company Flexibility and Growth. This portion of H.R. 3606 increases the 1934 Act registration shareholder of record threshold from 500 to 2,000 (only 500 of which can be non-accredited investors). Employees receiving company securities under employee benefit plans would be excluded from calculating the number of record holders.

Title VI, Capital Expansion. This portion of the Act would increase the shareholder of record threshold from 500 to 2,000 for banks and bank holding companies, and would provide that a bank or bank holding company could terminate 1934 Act registration if the number of holders of record drops to less than 1,200.

Title VII, Outreach on Changes to the Law. This part of the Act requires SEC outreach to certain small and medium-sized businesses informing them of the effect of the law, so that these business are made fully aware of the benefits of the legislation.

For in-depth analysis of the provisions of the JOBS Act, see the law firm memos here and here.

(b)               Credit Ratings: S&P Considering Making Governance a Factor

On March 12, Standards & Poor’s posted a request for comment as it proposes to score companies as “Strong/Fair/Adequate/Weak” in the area of management & governance in an effort to enhance transparency. A few details to note:

  • Stage One would be to evaluate “Management & Governance” and assign a score. Stage Two (likely to come later this year) would be to directly link this score to a credit rating, which commentators have noted has the ultimate objective of taking the most qualitative part of S&P’s analysis and removing any mystery.
  • The Management & Governance analysis would consolidate their currently separate analyses of governance, accounting aggressiveness, operational capabilities, organizational effectiveness, risk management (ERM), and strategy. The proposed criteria do not address financial policy, which commentators note will likely come later.
  • S&P analysts will base their assessments on publicly observable track records of management and boards as well as observations from meetings with management.

Commentators have noted that if S&P adopts this framework, it will be the only rating agency to explicitly assess corporate governance from a credit perspective. While Moody’s used to publish ratings separately on governance, that agency currently uses its trained governance analysts to factor governance into its “normal” ratings as it deems appropriate (i.e., when governance red flags arise) rather than on a separate basis.

See the full request for comment here.

(c)                Insider Trading: Senate Passes STOCK Act

On March 22, the Senate passed the STOCK Act, an ethics bill that bans insider trading by members of Congress, by a vote of 96-3 – accepting the changes that the House passed last month (i.e., proposed regulation of “political intelligence” firms was eliminated). The bill prohibits members of Congress from trading stocks and other securities on the basis of confidential information they receive as lawmakers. It makes clear that the insider trading ban in federal law applies to members of Congress and their aides and to officials in the executive and judicial branches of the federal government.

In addition, the bill requires lawmakers to disclose the purchase or sale of stocks, bonds, commodities futures and other securities within 45 days of transactions, rather than once a year as they now do. The information disclosed will be posted on the Web.

 

Update: $25 Billion Mortgage Servicing Settlement Approved by Court

By Alison MacGregor on Posted in Mortgage Lending and Foreclosure, Regulatory Actions

We previously posted (see here and here) regarding the $25 billion settlement entered into between the Justice Department, 49 state attorneys general and the nation’s five largest mortgage servicers.

Last week, Judge Rosemary Collyer, of the United States District Court for the District of Columbia, approved the settlement, and signed off on five consent orders (JPMorgan, Bank of America, Citi, Wells Fargo and Ally).

According to Reuters, The Association of Mortgage Investors, “a trade group that represents investors with interests in mortgage settlements, had said they planned to ask for changes to the settlement, but did not file a formal challenge in court.” Similarly, the Denver Post reported that “one trade group hint[ed] at a potential legal challenge.”

Supreme Court Holds Equitable Tolling Applies To 1934 Act §16(b) Claims – For Now

By Sarah Reid on Posted in Notable Decisions, Securities Fraud and Class Actions

In Credit Suisse Securities (USA) LLC, et al. v. Simmonds, the Supreme Court held, at least for now, that equitable tolling principles apply to claims asserted under §16(b) of the Securities and Exchange Act of 1934.  In doing so, the Court reversed the Ninth Circuit in an 8-0 decision and remanded the case to the district court to determine if equitable tolling should be found.  Chief Justice Roberts recused himself from the case.  Under §16(b), corporate insiders may be forced to disgorge any profits from the purchase and sale or sale and purchase of the corporation’s securities within any six-month period.  §16(b) provides that such suits must be brought within “two years after the date such profit was realized.”  15 USC §78p(b).  The Ninth Circuit, following its rule in Whittaker v. Whittaker Corp., 639 F.2d 516 (9th Cir. 1981), held that only the filing of the required §16(a) forms disclosing such profit commenced the running of the two-year period even where, as here, the defendants contended they were under no obligation to file such a form.  The Supreme Court unanimously rejected such a rule, noting:

The inequity of the Whittaker rule is especially apparent in a case such as this, where the theory of §16(b) liability of underwriters is so novel that petitioners can plausibly claim that they were not aware they were required to file a §16(a) statement. And where they disclaim the necessity of filing, the Whittaker rule compels them either to file or to face the prospect of §16(b) litigation in perpetuity.

The Court also rejected the Second Circuit’s “actual notice” rule set forth in Litzler v. CC  Investments, L.D.C., 362 F.3d 203 (2d Cir. 2004), and adopted instead the common law equitable tolling test, urged by the United States in its amicus brief, where tolling ceases when a reasonably diligent plaintiff discovers or should have discovered the underlying facts.  Perhaps the most intriguing aspect of the decision is that while all eight justices rejected the Whittaker test, the Court was split 4-4 as to whether there should be any equitable tolling at all under §16(b), and stated that as a result there was no precedential effect to its holding that §16(b) was subject to tolling as opposed to being a statute of repose.  Had Justice Roberts been able to participate in the case, query whether the Court would also have reversed this prong of the Ninth Circuit’s decision and held that §16(b)’s two-year period was indeed a statute of repose not subject to any tolling.

For further analysis and commentary, please see For Whom The Statute Stops Tolling,  and Opinion analysis: Occupying the “reasonable middle ground” on tolling of insider trading claims.

JOBS Act to Allow Hedge Fund Advertising

By Alison MacGregor on Posted in Regulatory Actions

Several media outlets reported last week concerning Congress’s passage of the JOBS Act (the Jump Start Our Business Startups Act).  The JOBS Act, which has passed both the House and Senate (as of March 27, 2012), is expected to be signed into law by the President.  The JOBS Act enjoyed bipartisan support as well as backing from companies such as Google, whose blog applauds, in particular, the “crowdfunding” provisions (“raising small amounts of money from a large crowd”) as “helping to promote innovation and economic growth.”  Others are critical of the Act, claiming that it loosens investor protections (see, for example, this letter from the Consumer Federation of America).

One aspect of the JOBS Act that has received some attention is that it would  relax certain rules on how hedge funds and other investment firms can advertise and market to the public.  As the New York Times’ Dealbook reported:

The bill, called the Jump-start Our Business Start-ups Act, or JOBS Act, would reverse parts of a nearly 80-year-old regulation preventing these funds from discussing even the most basic items, like performance or investment strategy, with outsiders. The rule, part of the Securities Act of 1933, gave an already secretive industry the regulatory cover to remain silent.

***

The bipartisan bill, which President Obama is expected to sign next month, enables hedge funds and private equity firms to solicit investors directly, instead of through third parties, which typically vet the firms before introducing them to clients. While the bill could ease the path to fund-raising, it could also introduce new risks to small investors unaccustomed to the complex and risky strategies the firms deploy.

The Times also reported that the final rules would be written by the Securities and Exchange Commission 90 days after the President signs the bill, and suggested that the impact of the new rules would be felt primarily by smaller funds, as for “bigger players”, the “client base is largely institutional, and therefore less swayed by mass marketing.”

The Term Sheet (Fortune/CNN) raised concerns about the new rules from Wall Street’s perspective, noting that with the ability to advertise comes more disclosure:

Wall Street may be elated now, but the industry may come to regret this fundamental shift in their business. While the change is expected to make it easier to market private placements, it also drops the mystique of exclusivity the industry has used to draw in high net worth clients. The change also raises the bar on disclosures as funds will now be able to talk publicly about their investment returns and strategies, forcing a new level of openness in the industry that many managers may find uncomfortable. And most troubling, the lifting of the veil exposes the industry to fraudsters looking to cash in on the public’s naiveté on alternative investments.

On a related note, our Kelley Drye and Warren LLP colleagues regularly follow and report on advertising issues in their blog, Ad Law Access.

MBS Updates: Investors’ Suit Tossed; Countrywide’s Repurchase Documents Discoverable

By Alison MacGregor on Posted in Mortgage-Backed Securities

Today, we bring you two updates from the mortgage-backed securities litigation universe. First, on March 28, 2012, Justice Barbara R. Kapnick dismissed the complaint of investor group, Walnut Place (which Law360 calls “a legal moniker for distressed debt-focused hedge fund The Baupost Group LLC”) against various Countrywide entities and Bank of America.  Walnut Place brought the Complaint in February 2011, amending it  in April 2011 (see the Amended Complaint here).  Walnut Place alleges that Countrywide breached representations and warranties set forth in two Pooling and Servicing Agreements (PSAs), and the investors suffered damages as a result of Countrywide’s failure to repurchase the breaching loans.  Walnut Place named trustee Bank of New York Mellon as a “nominal defendant,” claiming that the trustee “unreasonably failed to sue the defendants and enforce their obligations to repurchase the loans.”

Justice Kapnick found that a “no-action clause” in the PSAs barred Walnut Place’s suit. The clause required an Event of Default by the Master Servicer, which Walnut Place did not allege. The court distinguished situations where no-action clauses were not enforced because the trustee’s misconduct was at issue, which was not the case here.  Judge Kapnick also rejected the contention that the trustee was “unreasonable” in refusing to sue, citing the fact that upon Walnut Place’s communication, the trustee “asked for additional time to investigate the matter.” The court also found that the $8.5 million settlement involving Countrywide MBS showed that the trustee “did, in fact, act upon plaintiffs’ complaints.”  (We’ve reported extensively about the settlement, see our posts here, here, here and here). Thus, the action was premature.

For additional reporting, see Mortgage Suit Vs Bank of America, BNY Mellon Is Dismissed and Bank of America’s Countrywide Wins Walnut Place Dismissal.

Second,  in a blow for Countrywide, on March 27, 2012, the First Department upheld two discovery rulings by Justice Bransten in the MBIA v. Countrywide case.  First, the court upheld Justice Bransten’s January 28, 2011 denial of Countrywide’s motion to compel “documents concerning [MBIA's] remediation efforts,” finding that “Plaintiff met its burden of establishing that the documents concerning its remediation efforts were primarily prepared in anticipation of litigation, and are, thus, privileged.” The documents in question related to MBIA’s analysis of loans it insured and its decision-making concerning which loans it would ask Countrywide to repurchase.  MBIA did this analysis through counsel and consultants, a fact which the court highlighted, finding that “[MBIA] submitted evidence, including retainer agreements, showing that its counsel retained consultants to help provide legal advice to [MBIA] with respect to potential legal claims against defendants.” Thus, the material was attorney-client privileged, and the court found with little analysis that the fact that MBIA referred to its repurchase review in the complaint did not constitute a waiver.

The First Department also upheld Justice Bransten’s July 1, 2011 order compelling Countrywide to produce documents concerning its review of MBIA’s requests that it repurchase loans.  The court distinguished this holding from its ruling on the remediation efforts, finding that “Plaintiff proved that its repurchase analysis was not a part of its ordinary business. By contrast, the record shows that processing repurchase requests was an inherent and long-standing part of defendants’ business,” because “defendants were, and always had been, contractually obligated to conduct repurchase reviews and such reviews were, and always had been, conducted by defendants’ own staff of underwriters and auditors.”

Finally, to give some context to the rulings  coming down on the side of monoline insurers, the New York Times published an interesting article on March 8, 2012, An Industry’s Failure to Verify, After Trusting, that considered  MBIA in a different light. Floyd Norris of the Times and Herald Tribune wrote,

Many of the securitizations being fought over now were composed entirely of mortgages that appeared risky on their faces. That is why the investors wanted insurance.

In one securitization for which MBIA is suing Credit Suisse, the vast majority of loans went to borrowers whose income, or assets, or both, had not been verified. About 15 percent of the loans had been made by New Century Mortgage, which by the time MBIA issued its insurance had already gone bankrupt because of its shoddy lending practices.

It would be nice to hear someone — whether the regulators or MBIA — say that in retrospect they were far too trusting and bear some responsibility for what happened.

Don’t hold your breath waiting for that to happen.