Opinion ID: 822874
Heading Depth: 2
Heading Rank: 1

Heading: The Underlying Securities

Text: According to the Fund’s Consolidated First Amended Securities Class Action Complaint (“FAC”), on May 25, 2006, Defendant-Appellee NovaStar Mortgage Funding Corporation (“NMFC”) filed a registration statement and prospectus with the Securities and Exchange Commission (“SEC”) on Form S-3. On June 16, 2006, NMFC amended the registration statement and prospectus, using Form S-3/A. Issuers like NMFC may register and offer securities on “a continuous or delayed basis in the future” for up to “three years” after the “initial effective date of the registration statement.” 17 C.F.R. § 230.415(a)(1) & (a)(5).1 Typically, an issuer commences a “continuous or delayed” offering by filing an initial “shelf” registration statement, which “includes a ‘base’ or ‘core’ prospectus that . . . contains general information, including the types of securities to be offered and a description of the risk factors of the offering.” NECA-IBEW, 693 F.3d at 150. The core prospectus may omit otherwise required information if, because the issuer will offer the securities in the future, such information is “unknown or not reasonably available.” 17 C.F.R. § 230.430B(a). In the amended prospectus filed on June 16, 2006, NMFC indicated that it would offer interests in trusts that principally contained residential mortgages. After an issuer files its shelf registration statement, it may issue securities under that statement by filing a supplemental prospectus that discloses “information previously omitted from the prospectus filed as part of [the] effective registration statement.” Id. § 230.424(b)(2); 1 NMFC qualifies as an issuer under the ’33 Act because it acted as a depositor for the relevant offerings. See 15 U.S.C. § 77b(a)(4) (defining issuer to include “the person or persons performing the acts and assuming the duties of depositor or manager” of “collateral-trust certificates”). 5 see also id. § 229.512(a)(1)(ii) (requiring a supplemental prospectus to disclose “any facts or events arising after the effective date of the registration statement . . . which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement”). Information disclosed in a supplemental prospectus “shall be deemed to be part of and included in the registration statement.” Id. § 230.430B(f)(1); see also id. § 229.512(a)(2) (deeming each supplemental prospectus to be “a new registration statement” for the “purpose of determining any liability” under the ’33 Act.).2 According to the FAC, NMFC issued six securities under the June 16, 2006 shelf registration statement: (1) the NovaStar Mortgage Funding Trust, Series 2006-3, which had assets worth approximately $1,089,000,000, and which NMFC offered on June 22, 2006; (2) the NovaStar Mortgage Funding Trust, Series 2006-4, which had approximately $1,004,851,000 in assets, and which NMFC offered on August 18, 2006; (3) the NovaStar Mortgage Funding Trust, Series 2006-5, which had approximately $1,279,850,000 in assets, and which NMFC offered on September 22, 2006; (4) the NovaStar Mortgage Funding Trust, Series 2006-6, which had approximately $1,233,750,000 in assets, and which NMFC offered on November 20, 2006; (5) the NovaStar Mortgage Funding Trust, Series 2007-1, which had approximately $1,813,274,000 in assets, and which NMFC offered on February 23, 2007; and (6) the NovaStar Mortgage Funding Trust, Series 2007-2 (the “Series 2007-2 Trust”), which had approximately $1,324,400,000 in assets, and which NMFC offered on May 25, 2007. Defendant-Appellee NovaStar Mortgage Inc. (“NMI”), NMFC’s parent company, originated or purchased all of the 2 Because § 230.430B(f)(1) deems newly disclosed information to be included in the registration statement, plaintiffs may base claims under § 11 of the ’33 Act on a supplemental prospectus’s material misstatements or omissions. 15 U.S.C. § 77k. 6 mortgages contained in each of the six trusts.3 After NMI originated or purchased the relevant loans, it sold them to NMFC, which assigned them, in turn, to the trusts described above. Defendants-Appellees Greenwich Capital Markets, Inc., Deutsche Bank Securities, Inc., and Wachovia Capital Markets, LLC (collectively, the “Underwriter Defendants”) underwrote and sold each of the six trusts that NMFC offered. The amended prospectus filed on June 16, 2006 indicated that the supplemental prospectuses accompanying each offering would describe “the underwriting standards used to underwrite the mortgage loans.” J. App’x at 202. The supplemental prospectus filed in conjunction with the Series 2007-2 Trust (the “2007-2 Prospectus”) described NMI’s underwriting guidelines at length. According to the 2007-2 Prospectus, NMI adopted its underwriting guidelines in order to “evaluate the credit history of the potential borrower, the capacity and willingness of the borrower to repay the loan[,] and the adequacy of the collateral securing the loan.” Id. at 370. To this end, NMI required each potential borrower to file an application and to provide documentation according to one of “six levels of applicant documentation,” which ranged from “Full Documentation” to “Stated Income” to “No Documentation.” Id. at 370-71. Under the Full Documentation program, applicants would “generally . . . submit verification of employment and most recent pay stub or up to prior two years W-2 forms and most recent pay stub.” Id. at 371. The Stated Income program, in contrast, permitted an applicant to “qualif[y] based on monthly income as stated in the loan application.” Id. According to the 2007-2 Prospectus, NMI originated 56.96% of the loans in the Series 2007- 3 The supplemental prospectus that accompanied the Series 2007-2 Trust identified only NMI as an originator of the mortgages contained in the trust. If any other originator or group of affiliated originators had originated ten percent or more of the Series 2007-2 Trust’s assets, then 17 C.F.R. § 229.1110(a) would have required NMFC to identify that originator in the supplemental prospectus. 7 2 Trust under the Full Documentation program, 36.07% under the Stated Income program, and 6.38% under the No Documentation program. The 2007-2 Prospectus also notified investors that, “[o]n a case-by-case basis, exceptions to the underwriting guidelines are made where [NMI] believes compensating factors exist.” Id. Compensating factors could include the “length of time in residence, lowering of the borrower’s monthly debt service payments, the loan-to-value ratio on the loan, as applicable, or other criteria that in the judgment of the loan underwriter warrant an exception.” Id. Finally, the 2007- 2 Prospectus assured investors that “[q]uality control reviews [were] conducted to ensure that all mortgage loans [met] quality standards.” Id. at 374. In addition to describing NMI’s underwriting guidelines, the Series 2007-2 Trust’s offering documents warned potential investors about certain risks. The amended prospectus filed on June 16, 2006 advised readers in bold to “read the section entitled ‘Risk Factors’ starting on page 5 of this prospectus before making a decision to invest.” Id. at 183. Certain risks resulted from the characteristics of the loans composing the Series 2007-2 Trust, and others were caused by changes that might occur in the housing market. First, the 2007-2 Prospectus warned that the loans composing the Series 2007-2 Trust “would be ineligible for direct purchase by Fannie Mae due to credit characteristics that do not meet the Fannie Mae underwriting guidelines.” Id. at 297. As a result, the loans were “likely to experience rates of delinquency, foreclosure and loss that are higher, and may be substantially higher, than mortgage loans originated in accordance with the Fannie Mae underwriting guidelines.” Id. The 2007-2 Prospectus also identified other characteristics of the loans that might increase the likelihood of default. Specifically, it disclosed that a small percentage of the loans were “secured by second-liens on the related mortgaged properties,” id. at 299, and that 8 another portion of the loans did “not provide for any required payments of principal during the first five or ten years of their term,” which significantly increased the amount of later monthly payments, id. at 299-300. The 2007-2 Prospectus also warned investors about systemic risks. According to the 2007-2 Prospectus, “[i]f the residential real estate market should experience an overall decline in property values such that the outstanding balances of the mortgage loans . . . become equal to or greater than the value of the mortgaged properties [serving as collateral for the loans], the actual rates of delinquencies, foreclosures and losses could be higher than those now generally experienced.” Id. at 297. Nine pages later, the 2007-2 Prospectus disclosed that, “in recent months[,] residential property values in many states have declined or remained stable, after extended periods during which those values appreciated.” Id. at 306. On May 25, 2007, the Fund invested $100,000 in the Series 2007-2 Trust. Nearly three years later, on March 26, 2010, the Fund sold its interest in the trust for $350.