Opinion ID: 2820087
Heading Depth: 2
Heading Rank: 2

Heading: Plaintiffs’ Fraud Allegations

Text: Plaintiffs invested millions in three CDOs created and offered by Wachovia: Octans, Sagittarius, and Longshore. Wachovia marketed these CDOs to Plaintiffs and also sold CDSs on each CDO. Structured Asset Investors, LLC (“SAI”), a Wachovia subsidiary, and Harding Advisory LLC (“Harding”), an independent company, served as collateral managers—Harding for Octans, SAI for Sagittarius and Longshore. All three CDOs held MBS notes as well as the long side of CDS contracts. With respect to Octans and Sagittarius, Plaintiffs allege that, contrary to representations made to investors, Harding and SAI selected shoddy, high-risk assets at the urging of Magnetar Capital LLC (“Magnetar”), a hedge fund that stood to profit massively if the CDOs failed. As to Longshore, Plaintiffs allege that, without telling 8 13‐1476‐cv Loreley Financing (Jersey) No. 3 v. Wells Fargo Securities, LLC investors, Wachovia used it to dump, at above-market prices, riskier MBS notes that had been on Wachovia’s own balance sheets. Each alleged scheme is recounted more fully below. 1. The Constellation CDOs: Octans and Sagittarius According to the complaint, Magnetar colluded with several banks and collateral managers to “orchestrate” at least 27 CDOs named after constellations, including Octans and Sagittarius. J.A. at 112. Magnetar would purchase the equity tranches in exchange for clandestine influence over the selection of assets. Although, as an equity holder, Magnetar thus stood to benefit from the CDOs’ success, it used its position and influence to advance a contrarian investment strategy. In reality, Magnetar was betting heavily against the CDOs and the underlying MBSs by buying the short side of CDS contracts, which it had the ability to purchase at below-market prices from banks like Wachovia as a condition of its equity investment in the CDOs. Magnetar was simultaneously able to fund these short positions with payments from its equity stake for a longer period of time, until the CDOs actually went into default, because the CDOs had been structured—at Magnetar’s insistence—so that they would not divert cash from the equity holders to senior tranches in the face of early warning signs that the value of the portfolio collateral was deteriorating. Plaintiffs, however, did not bring this suit against Magnetar. The instant litigation concerns Magnetar’s helpmeets, Defendants, who are alleged to have conspired in structuring the deals and attracting long investors like Plaintiffs by masking Magnetar’s central and adverse role. 9 13‐1476‐cv Loreley Financing (Jersey) No. 3 v. Wells Fargo Securities, LLC As to Octans, the offering documents touted Harding’s experience and skill as a collateral manager, stating that Harding would “[i]nvest in high quality assets with stable returns” and “minimize losses through rigorous upfront credit and structural analysis, as well as ongoing monitoring of asset quality and performance.” Id. at 121. The documents also specified numerous procedures to be used by Harding in asset selection, including “detailed loan-level analysis.” Id. at 121-22. Harding, however, allegedly acted entirely contrary to these representations. It acceded to Magnetar’s requests, knowing that Magnetar’s interests were directly at odds with the CDOs’ success. In support of this claim, Plaintiffs assert several facts regarding particular email exchanges between Magnetar and Harding in August and September 2006, as assets were being selected. In one such exchange—between James Prusko, Magnetar’s Senior Vice President, and Wing Chau, Harding’s founder and president—Prusko requests to be copied on the trade approval process and updated daily if any trading activity occurred, adding, “We should also discuss CDO exposure as I will source the CDO CDS.” Id. at 124. Chau responds, “Sounds good.” Id. In another such exchange, a Harding employee asks Prusko “to let [them] know if [Magnetar] plan[s] on shorting any names into any of the [Octans] transactions.” Id. at 125. An email to Prusko three days later from the same employee lists shorting opportunities that Harding was “able to source for [Magnetar].” Id. Based on these and other such exchanges, Harding is alleged not only to have known of Magnetar’s shorting activities but also to have facilitated and concealed them. 10 13‐1476‐cv Loreley Financing (Jersey) No. 3 v. Wells Fargo Securities, LLC Ignorant of Magnetar’s role, Plaintiffs invested $94 million in October 2006 in the notes of various Octans tranches. All of these notes became virtually worthless when the respective tranches went into default in May 2008. Plaintiffs’ factual allegations regarding Sagittarius are similar. The Sagittarius term sheets outlined the same type of goals as the Octans term sheets, detailing similarly rigorous procedures for managing the CDO. The “conservative approach” of the chosen collateral manager, SAI, was a key selling point, as Defendants knew. Id. at 128. With respect to both CDOs, Defendants stressed the collateral manager’s expertise and its approach to asset selection because, as acknowledged in the offering documents, each CDO’s performance ultimately turned on these two variables. Plaintiffs allege that, despite these representations, Magnetar exerted control over SAI’s asset selection, as it did over Harding’s, and that Magnetar’s strategy of betting against Sagittarius was known to SAI. For example, Prusko assertedly emailed Wachovia’s managing director early on, stating that while he “didn’t mean to kill [SAI] off,” he did want it to be “more user friendly.” Id. at 131. A few months later, a Wachovia trader allegedly emailed Prusko with a list of especially weak MBSs that were proposed for inclusion in the CDO, inviting him to express “any thoughts or concerns.” Id. at 132. Prusko responded, “Let[’]s test the waters!” Id. Finally, in March 2007 Prusko sent Wachovia an email to which he attached a document that graphed Magnetar’s returns for different projected loss scenarios. The graph showed that the worse the CDO performed, the larger Magnetar’s profit. In the body of the email Prusko himself described Sagittarius as “not a pretty bond.” Id. at 134. 11 13‐1476‐cv Loreley Financing (Jersey) No. 3 v. Wells Fargo Securities, LLC In March 2007 Plaintiffs invested $5 million in Sagittarius Class A and B notes each. Both tranches defaulted in October of that year. 2. Longshore The third CDO at issue, Longshore, was not among the constellation CDOs created as part of Magnetar’s so-called “long-short” strategy. As with the other two CDOs, however, the Longshore offering documents highlighted the high quality of the asset selection and due diligence procedures that would be used by the collateral manager—here SAI. Contrary to these representations, Wachovia allegedly used Longshore as a dumping ground for MBS assets that it knew faced an imminent and steep decline in value, including assets on Wachovia’s own books that were being transferred into Longshore from the warehouse of another, canceled CDO deal. As detailed in the complaint, these allegations were the subject of a fraud investigation by the SEC. In an order issued as part of the settlement of that investigation, the SEC found that while Wachovia represented in its offering documents that Longshore assets would be acquired in deals resembling arm’s-length transactions, the assets from the collapsed CDO were transferred at their original cost basis despite, according to Wachovia’s own internal valuations, a significant decline in their fair market value. In April 2007 Plaintiffs bought notes of various Longshore tranches with a total face value of $59.1 million. In February 2008 these notes went into default. 12 13‐1476‐cv Loreley Financing (Jersey) No. 3 v. Wells Fargo Securities, LLC