Opinion ID: 822874
Heading Depth: 2
Heading Rank: 3

Heading: The District Court’s 2011 Decision

Text: On August 31, 2009, the Defendants-Appellees moved to dismiss the FAC in its entirety. On March 31, 2011, the district court granted the motion in principal part, but permitted the Fund to amend the claims based on the Series 2007-2 Trust. N.J. Carpenters Health Fund v. NovaStar Mortg., Inc., No. 08 Civ. 5310(DAB), 2011 WL 1338195, at  (S.D.N.Y. Mar. 31, 2011). First, the district court held that, because the Fund had not invested in any of the first five trusts that NMFC had issued under the June 16, 2006 registration statement, it lacked standing, even as the representative of a proposed class, to assert any claim based on those trusts. Id. at . Turning to the Series 2007-2 Trust, the district court concluded that the Fund had not plausibly alleged that the registration statement, as amended by the 2007-2 Prospectus, contained any material misstatement or omission. Id. at -. In the view of the district court, rather than making “allegations specific to the . . . origination practices that relate to the” Series 2007-2 Trust, the FAC offered “102 pages of ‘the subprime market melted down and Defendants were market participants, so they must be liable for my losses in my risky investment.’” Id. at . 10 D. The Second Amended Class Action Complaint (the “SAC”) On May 18, 2011, the Fund filed the SAC, which asserted claims under §§ 11, 12(a)(2), & 15 of the ’33 Act based solely on the Series 2007-2 Trust. The SAC again alleged that the June 16, 2006 registration statement and prospectus, as supplemented by the 2007-2 Prospectus, misstated NMI’s underwriting guidelines and failed to disclose that NMI had, in fact, abandoned its published guidelines. In support of its allegation that NMI had abandoned its guidelines, the SAC again relied on the two factual allegations presented in the FAC, but it also alleged that several unnamed prior employees of NMI and NMFC had attested to NMI’s systematic disregard of its underwriting standards. First, the SAC repeated its allegation that the rating agencies had severely downgraded the Series 2007-2 Trust’s ratings. Unlike the FAC, however, the SAC attributed these downgrades to the rating agencies’ increased awareness of underwriting practices. Specifically, the SAC alleged that, in June of 2007, approximately one month after NMFC had issued the Series 2007-2 Trust, S & P revised its rating methodology in response to “the level of loosened underwriting at the time of loan origination, misrepresentation and speculative borrower behavior reported for the 2006 ratings.” J. App’x at 1786-87. Moody’s allegedly also revised its methodology to account for previously undisclosed “aggressive underwriting.” Id. According to the SAC, the application of these new methodologies to the Series 2007-2 Trust caused the rating agencies to downgrade the majority of the trust’s ratings by “as many as 20 levels.” Id. at 1787. Next, the SAC again alleged that the Series 2007-2 Trust experienced unusually high default rates. According to the SAC, 18% of the loans in the Series 2007-2 Trust defaulted within six months of the offering, 32% defaulted within one year, 47% defaulted before June 16, 2009, and 68.6% defaulted before June 30, 2011. Like the FAC, the SAC referenced the FBI’s 11 2007 Mortgage Fraud Report. According to that report, between thirty and seventy percent of “early payment defaults” resulted at least in part from “significant misrepresentations in the original loan applications,” and loans containing “egregious misrepresentations were five times more likely to default in the first six months than loans that did not.” Id. at 1790-91. Finally, the SAC relayed statements from no fewer than eight unnamed former employees of NMI and NMFC. According to the SAC, seven of the eight employees the Fund interviewed had worked at NMI or NMFC during the six months preceding May 1, 2007, when over ninety percent of the mortgages in the Series 2007-2 Trust had been originated. Specifically, the Fund had interviewed: (1) a former Vice President of Operations, who worked in Kansas City from 2005 until March 2007; (2) a former Quality Control Auditor/Supervisor, who worked in Kansas City from August 2005 until September 2007; (3) a former Closing Supervisor, who worked in Ohio from 2002 through May 2007; (4) a former Quality Control Auditor, who worked in Ohio from 2004 until 2007; (5) a former Senior Underwriter, who worked in Lake Forest, California from 2005 through 2007; (6) a former Account Manager, who worked in Ohio from 2004 until 2007; and (7) a former Account Executive, who worked in Ocala, Florida from February 2006 until May 2007. Many of the former employees’ alleged statements contradicted the 2007-2 Prospectus’s description of NMI’s underwriting standards. According to several former employees, although the underwriting guidelines prioritized “evaluat[ing] 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, the “pressure” NMI employees allegedly felt to “achieve loan production” and hit “volume-based performance targets” overshadowed the need for such evaluations, resulting in the guidelines’ “systematic loosening,” id. at 1775-76. The former Vice 12 President allegedly said that, as a result of the emphasis on volume, the guidelines were “tossed out the window.” Id. at 1776. According to that Vice President, employees did not worry about the consequences of disregarding the underwriting guidelines because NMI and NMFC were “not keeping the crap,” but instead “selling it for securitization.” Id. at 1777. The alleged “systematic loosening” of the underwriting standards took many forms. For example, although the underwriting guidelines disclosed that NMI might make “exceptions” where “compensating factors exist[ed],” id. at 371, former employees allegedly told the Fund that vice presidents and supervisors at NMI and NMFC would routinely grant exceptions, even where underwriters had rejected an application because they regarded the accompanying documentation as suspicious or fraudulent. As a result of NMI’s alleged willingness to overlook questionable or insufficient documentation, NMI purportedly originated many loans under its Full Documentation program even though it had not actually obtained the documentation its underwriting guidelines required. For example, according to a former Quality Control Auditor, one borrower had verified her employment by submitting a post-it note that said, “Mrs. X cleans my house and I pay her three thousand a week.” Id. at 1778. NMI also allegedly disregarded the requirements described in its Stated Income program. According to the SAC, prior to late 2006, statements of income helped NMI determine a borrower’s “capacity . . . to repay,” id. at 370, and applicants were rejected where their stated “incomes were too low to sustain the payments” that a mortgage required, id. at 1779-80. In late 2006 and 2007, however, as NMI employees sought to increase the number of mortgages they originated, they allegedly began to make exceptions to the income guidelines and to accept apparently unreasonable statements of income at face value. For example, one former Senior Underwriter stated that, although she had denied an application from a department store 13 employee who claimed to make $10,000 per month, she later discovered that others at NMI had overridden her denial. Based on these accounts, the Fund alleges that, during the relevant time periods, NMI “systematically disregarded” its underwriting guidelines. J. App’x at 1786. E. The District Court’s 2012 Decision The Defendants-Appellees moved to dismiss the SAC on July 8, 2011. On March 29, 2012, the district court held that the SAC failed to state a plausible claim under §§ 11 & 12(a)(2) of the ’33 Act. N.J. Carpenters Health Fund v. NovaStar Mortg., Inc., No. 08 Civ. 5310(DAB), 2012 WL 1076143, at  (S.D.N.Y. Mar. 29, 2012). The district court identified two bases for its holding. First, quoting its 2011 decision, it again found that the Fund had failed “to make allegations specific to the . . . origination practices that relate to the only offer that is relevant here,” the Series 2007-2 Trust. Id. at . According to the district court, to state a plausible claim under the ’33 Act, the Fund needed either to “cite an[] example of a loan that failed to meet the underwriting guidelines and ended up in the 2007-2 loan pool” or to otherwise “provide details that would tie its claim of loosened underwriting guidelines to the specific loans” at issue. Id. at -. Second, the district court found that the SAC had failed to allege that any “misstatements and omissions would have been material in light of the extensive risk disclosures and information [the Fund] received, as well as events generally known about [NMI, NMFC,] and the subprime market in the months preceding” the offering of the Series 2007-2 Trust. Id. at - . Because the district court had dismissed all of the Fund’s claims in its 2011 and 2012 decisions, it entered final judgment in favor of the Defendants-Appellees. The Fund now appeals from that judgment. 14