Opinion ID: 1033271
Heading Depth: 3
Heading Rank: 1

Heading: Misstatement in May/June Offering

Text: The Plaintiffs first argue that Thornburg made a material misstatement in its May and June offering documents when it failed to disclose its exposure to Alt-A assets while at the same time commenting about the subprime and Alt-A markets. The alleged misstatement was part of an 8-K statement, filed with the SEC on April 19, 2007, and incorporated by reference in the May and June offering documents. In the 8-K form, Thornburg’s CEO, Larry Goldstone, stated that Thornburg had “benefited from wider spreads on new prime quality mortgage assets caused by credit concerns in the subprime and Alt-A segments of the mortgage market.” App. 115. The Plaintiffs contend this statement was misleading because Thornburg failed to disclose that it was exposed to risk from its own Alt-A assets. That is, Thornburg misled investors when it said it benefitted from the decline in the subprime market without also disclosing its own exposure to the subprime market. Yet the complaint and relevant documents filed with the SEC do not support the claim that these statements were misleading. First, the focus of Thornburg’s business was originating prime mortgages and acquiring investment- -15- grade mortgage assets. Its asset holdings reflected this fact. In its 2006 10-K statement, for example, Thornburg disclosed that it had around $51.5 billion in total ARM assets (about $28.3 billion in purchased ARM assets and $23.2 billion in ARM loans). 6 Supp. App. 257. Of its $23.2 billion in ARM loans, 21.2 percent were “stated income/no ratio,” id. at 259, a synonym for Alt-A or subprime loans, while 78.8 percent were “full/alternative,” or prime loans. And of its $28.3 billion in purchased ARM assets, 88 percent were rated AAA, and 98.4 percent were “High Quality.” Id. at 257. These disclosures give context to Thornburg’s 8-K statement. Given its investment-grade mortgage assets primarily backed by prime loans, Thornburg’s backward-looking comment that it had benefitted from a decline in the subprime market was not misleading even though Thornburg also held $2.9 billion in purchased MBSs backed by Alt-A loans. The $2.9 billion would comprise, as of December 31, 2006, only 5.6 percent of Thornburg’s total assets. Even after factoring in Thornburg’s portfolio of “stated income/no ratio” loans, about $4.9 billion, Thornburg’s total Alt-A holdings would be less than 15 percent of its assets. With this relatively small exposure to the Alt-A mortgage market and 6 In its SEC filings, Thornburg divided its ARM assets into two general categories: “purchased ARM assets” and “ARM loans.” The ARM loan category consisted of loans held for securitization, loans held as collateral for debt, and loans securitized for its own portfolio. The purchased ARM assets category consisted of MBSs that Thornburg itself had not securitized but only purchased afterwards. -16- Thornburg’s focus on originating prime mortgages, the 8-K did not paint a misleading picture of Thornburg’s financial performance. All the allegations presented do not contradict Thornburg’s statement that in the first quarter of 2007 Thornburg had “benefitted from the spread on new prime quality mortgage assets.” App. 115. Next, and importantly, the Plaintiffs have not alleged that in April 2007 the decline in Alt-A mortgages was severe enough to harm the then-market value of Thornburg’s purchased MBS assets backed by Alt-A loans. One of the underpinnings of securitization, which drove the subprime market, was that subprime loans from different parts of the country could be pooled together and sold—on the assumption that the housing markets across the country were not linked. See Bruce I. Jacobs, Tumbling Tower of Babel: Subprime Securitization and the Credit Crisis, Fin. Analysts J., Mar. 2009, at 18 (“Rather than taking on the risk of default by one or a few borrowers in a given locality, a single []MBS diversifies risk exposures among numerous individual mortgages spread over a large area.”). This served to reduce investors’ exposure to an otherwise risky asset because while one part of the country could face a declining market, other parts of the country would be fine, thus diversifying the risk in any particular instrument. As a result, the market for new Alt-A mortgages could be shaky in many locales while the value of already-issued MBSs and CDOs backed by Alt-A mortgages could remain steady. Cf. Kathryn Judge, Fragmentation Nodes: A -17- Study in Financial Innovation, Complexity, and Systemic Risk, 64 Stan. L. Rev. 657, 685 (2012) (noting that with CDOs “the nonperformance of an underlying asset, be it a mortgage or MBS, may have no effect on the cash flows paid to holders of a senior tranche issued in a securitization”). This assumption seemed particularly true for Thornburg, as almost all of its purchased mortgage assets were AAA-rated, meaning, in the case of a CDO, it owned the senior tranche. Without a contemporaneous collapse in the value of its MBSs, or at least some sign that their value would collapse shortly after the statement was made, Thornburg’s portfolio of purchased MBS holdings does not darken the marginally optimistic picture painted by the 8-K. See id. at 698 (“[E]arly indications that housing values may have been weakening or in decline were not immediately reflected in the prices of subprime MBSs, CDOs, and other financial instruments with linked values, even though the expected future cash flows from these financial instruments could be significantly affected by the performance of the housing market.”). Economic historians will long study the havoc wreaked by securitized financial instruments in the 2007-2009 crisis. At the time, few economists or investment professionals foresaw the timing and breadth of the downturn. See generally Michael Lewis, The Big Short (2010) (detailing the handful of investors who did foresee the collapse and profited handsomely from their uncommon insight). But for the securities claims here, no further -18- disclosures were necessary to make Thornburg’s statement truthful and accurate. As a result, the statement cannot be considered misleading. Given our conclusion that Goldstone’s statement was not misleading, we need not consider whether the omission of the $2.9 billion in Alt-A MBSs was material.