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Media Alerts - New Jersey Carpenters v. Royal Bank of Scotland - Second Circuit
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March 2, 2013
  New Jersey Carpenters v. Royal Bank of Scotland - Second Circuit
Headline: Second Circuit Reverses Dismissal of Securities Fraud Action Alleging Material Misrepresentations in Underwriting Standards in Offering Materials of Mortgage-Backed Securities

Area of Law: Securities Law, Civil Procedure

Issue(s) Presented: Whether Plaintiff asserted plausible claims of material misrepresentations or omission sin the offering materials of mortgage-backed securities in violation of the Securities Act of 1933.

Brief Summary: Plaintiff-Appellant New Jersey Carpenters Health Fund (the "Fund") filed a class action complaint alleging that the Defendant-Appellee securities companies, advisors and underwriters violated the Securities Act of 1933 as a result of material misrepresentations contained in the registration statement and prospectus of mortgage-backed securities sold by defendants. Specifically, the Fund alleged that the underwriting standards reported in the offering materials for the securities had, in fact, been effectively abandoned. In support of their allegations, the Fund alleged that that a disproportionately high number of the mortgages defaulted, that rating agencies downgraded the security's ratings after changing their methodologies to account for lax underwriting, and claimed numerous employees of the underwriter had attested to systematic disregard of underwriting standard. The United States District Court for the Southern District of New York dismissed the complaint in its entirety, concluding that these allegations failed to adequately allege securities fraud claims and that the Fund lacked standing to pursue claims, even as the class representative, related to five securities included in the offering that the Fund had not invested in.

The Second Circuit reversed the dismissal, holding that pleading was sufficient to permit the court to draw a reasonable inference that Defendants abandoned underwriting guidelines, making the offering materials misleading and incomplete, and that the alleged misstatements and omissions were not immaterial as a matter of law. The Court also vacated and remanded the question of the Fund's standing for reconsideration pursuant to a recent Second Circuit decision issued subsequent to the district court's ruling.

To read the full opinion, please go to: ">http://www.ca2.uscourt.../de.....f/2/hilite/


Extended Summary: Plaintiff-Appellant, New Jersey Carpenters Health Fund ("the Fund") filed a securities class action complaint alleging that the Defendant-Appellee securities companies, advisors and underwriters violated ยงยง 11, 12(a)(2), & 15 the Securities Act of 1933 as a result of material misrepresentations and omissions in reporting of the underwriting standards in the registration statement and the prospectus for certain mortgage-backed securities.
The Fund's alleges securities violations based on misstatements and omissions contained in the 2005 initial and 2006 amended registration statements and prospectuses (together the "offering materials") filings for interests in trusts that principally contained residential mortgages. The offering materials for six mortgage-backed securities issued by certain of the defendants indicated that supplemental prospectuses accompanying each offering would describe the standards used to underwrite the mortgage loans, and that these standards were described at length in the prospectuses. The offering documents also warned potential investors about certain risks and included a bolded sentence telling investors to read the risk factors before deciding whether to invest. On May 25, 2007, the Fund invested $100,000 in one of the six offered securities and, on March 26, 2010, the Fund sold its interest in for $350.

After amending its initial complaint, on May 18, 2011 the Fund filed a Second Amended Class Action Complaint ("SAC") alleging that the initial prospectus and each of the supplemental prospectuses all misstated and omitted material facts, in essence, by failing to disclose that the underwriting guidelines had been abandoned. In support of their claims, the Fund alleged that that a disproportionately high number of the mortgages in the security at issue defaulted, that rating agencies downgraded the securities' ratings after changing their methodologies to account for lax underwriting, and cited that former employees of the underwriter had attested to systematic disregard of underwriting standards. The United States District Court for the Southern District of New York dismissed the complaint in its entirety, concluding that these allegations failed to state a claim and that the Fund lacked standing, even as a class representative, to pursue claims based upon five securities the Fund had not invested in.

The Second Circuit reversed, however, holding that the Fund's pleading was sufficient to permit a reasonable inference that Defendants had abandoned the underwriting guidelines set out in the offering materials. The Second Circuit reasoned that its ruling was consistent with Supreme Court and First Circuit decisions indicating that "courts may draw a reasonable inference of liability when the facts alleged are suggestive of, rather than merely consistent with, a finding of misconduct." The Second Circuit further noted majority of district courts in the Second Circuit have agreed with the First Circuit, by "permitting claims...to proceed where the plaintiff has provided a fairly specific account of how the relevant underwriters had systematically disregarded the guidelines disclosed in a security's registration statement." The Court rejected Defendants' arguments that the Court should distrust the unnamed prior employees' statements, that the inferences drawn by the Fund were unreasonable, and that the rating agencies reduced the ratings, not because of underwriting practices, but because market changes resulted in their credit quality declining.

The Court further concluded that the alleged misstatements and omissions were not immaterial as a matter of law, rejecting Defendants' argument that the risk disclosures made it clear that the Fund invested in an uncertain security at a particularly risky time, that two newspaper articles would have informed the Fund of the very information it claims was withheld, and that no reasonable investor could have cared about the procedures by which Defendants originated the loan. The Court also vacated the district court's decision that the Fund lacked standing and remanded it for reconsideration under the Second Circuit's recent decision in NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145 (2d Cir. 2012).

To read the full opinion, please go to: ">http://www.ca2.uscourt.../de.....f/2/hilite/


Panel: Judges Katzmann, Parker, and Wesley.

Argument (if known): 12/12/2012

Date of Issued Opinion: 03/01/2013
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Docket Number: 12-1707-cv

Decided: Reversed in Part, Vacated in Part, and Remanded for Further Proceedings

Case Alert Author: Jesse Glickstein

Counsel: JOEL P. LAITMAN (Michael Eisenkraft, Christopher Lometti, on the brief), Cohen Milstein Sellers & Toll, New York, N.Y., for Plaintiff-Appellant. THOMAS C. RICE (Alan C. Turner, on the brief), Simpson Thacher & Bartlett LLP, New York, N.Y., for Defendants-Appellees The Royal Bank of Scotland Group, PLC, Greenwich Capital Holdings, Inc., Greenwich Capital Markets, Inc., Wachovia Capital Markets, LLC, Deutsche Bank Securities, Inc., RBS Securities, Inc., Wells Fargo Advisors, LLC. WILLIAM F. ALDERMAN (Steven J. Fink, on the brief), Orrick, Herrington & Sutcliffe LLP, San Francisco, Cal., for Defendants-Appellees Novastar Mortgage Funding Trust, Series 2006-3, Novastar Mortgage Funding Trust, Series 2006-4, Novastar Mortgage Funding Trust, Series 2006-5, Novastar Mortgage Funding Trust, Series 2006-6, Novastar Mortgage Funding Trust, Series 2007-1, Novastar Mortgage Funding Trust, Series 2007-2, Novastar Mortgage Funding Corporation, Scott F. Hartman, Gregory S. Metz, W. Lance Anderson, Mark A. Herpich, Novastar Mortgage Inc. David R. Stickney, Ann M. Lipton, Bernstein Litowitz Berger & Grossman LLP, San Diego, Cal., for Amicus Curiae National Association of Shareholder and Consumer Attorneys, in support of Plaintiff-Appellant.

David C. Frederick, Wan J. Kim, Gregory G. Rapawy, Kellogg Huber, Hansen, Todd, Evans & Figel, P.L.L.C., Washington, D.C., for Amicus Curiae National Credit Union Administration Board, in support of Plaintiff-Appellant. Steven R. Paradise, Michael V. Rella, Lauren E. Leahy, Vinson & Elkins L.L.P., New York, N.Y., for Amicus Curiae Securities Industry and Financial Markets Association, in support of Defendants-Appellees.

Author of Opinion: Judge Katzmann

Supervisor: Professor Elyse Diamond Moskowitz

    Posted By: Elyse Diamond @ 03/02/2013 11:59 AM     2nd Circuit  

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