Capital Markets Litigation Team Defeats Jurisdictional Challenge to Ponzi Scheme Dispute

Lowenstein Sandler’s Capital Markets Litigation team recently defeated a fund administrator’s renewed motion to dismiss on jurisdictional grounds, a second key victory in an action for common law fraud, securities fraud, and Racketeer Influenced and Corrupt Organizations Act violations, among other claims. The plaintiffs, investors in a tax lien fund, seek to recoup millions of dollars in losses resulting from the fund’s operation as a Ponzi scheme. The defendants include the fund’s now-dissolved New Jersey-based administrator, Apex Fund Services (US), Inc., as well as its Bermuda-based parent and several other affiliated entities (collectively, the “Apex Defendants”).

New Jersey Superior Court Judge Peter Bogaard of the Law Division, Morris County, denied the Apex Defendants’ entire renewed motion to dismiss on jurisdictional grounds. In their motion, the Apex Defendants claimed that the Court lacked personal jurisdiction over the Apex Defendant entities based outside of New Jersey.

The Lowenstein team persuaded the Court to deny the motion based on theories of agency, alter ego, and successor liability. “Apex is playing a shell game, trying to hide behind layers of phantom entities to evade liability for the fraud it actively committed in New Jersey,” the team argued.

Following jurisdictional discovery, the Lowenstein team submitted extensive evidence convincing the Court to look beyond–or pierce the veil of–the corporate form of the now-dissolved Apex New Jersey entity in order to exercise jurisdiction over its parent. The team successfully argued that the New Jersey Apex subsidiary was the alter ego of its parent entity, functioning as a mere conduit in New Jersey for the Apex parent’s self-described “global” fund administration business. The evidence demonstrated that the Apex subsidiary was not capitalized at inception, that it was financially dependent on its parent, and that it disregarded corporate formalities with respect to intercompany transactions, as well as transfers of employees and clients among the various Apex entities, without compensation. In addition, and consistent with similar Ponzi scheme cases, the team showed that the Apex New Jersey entity acted as its parent’s New Jersey-based agent, providing another basis for the court to exercise personal jurisdiction over the parent. See Anwar v. Fairfield Greenwich Ltd., 728 F. Supp. 2d 372 (S.D.N.Y. 2010).

Additionally, the team showed that the evidence supported a finding of successor liability as to Apex Charlotte because of a de facto merger that occurred between it and Apex New Jersey, and because Apex Charlotte thereafter continued the business of Apex New Jersey, simply “becoming a ‘new hat’ for the predecessor.” Woodrick v. Jack J. Burke Real Estate, Inc., 306 N.J. Super. 73, 74 (App. Div. 1997). The evidence demonstrated that, just as the fraudulent scheme was being revealed, the Apex parent stripped the New Jersey entity of its assets and transferred its ongoing business to a Charlotte, North Carolina-based entity also bearing the Apex name, again for no consideration, ultimately dissolving the New Jersey entity.

Having defeated the jurisdictional challenge, the Lowenstein team will continue to pursue claims on behalf of the investors, who seek more than $40 million in damages based on the defendants’ false representations to them concerning Apex’s control of the money invested in the fund, as well as its active concealment of the theft by providing investors with false monthly net asset value statements. Rather, and remarkably, Apex had been permitting the fund’s manager, Vincent Falci, to access the accounts and embezzle millions of dollars; Falci has since been sentenced to 15 years in federal prison for securities and wire fraud.[1]

As reported by Law360, Judge Bogaard stated at the motion to dismiss hearing: “Justice, while to be blind, is not to be blissfully ignorant of things, and I certainly find based on the materials submitted that plaintiffs have established on a prima facie basis that exercising jurisdiction over the named defendants is appropriate at this time.”[2]

This decision marks the second time the team defeated a motion to dismiss in this action.[3]

The case is Maffei et al. v. Apex Fund Services (US) Inc. et al., case number L-63-18, pending in the Superior Court of New Jersey, Morris County.


[1] https://www.law360.com/articles/1162422/former-nj-fire-chief-gets-15-years-for-10m-ponzi-scheme

[2] https://www.law360.com/articles/1215974/fund-admin-s-parent-can-t-escape-40m-ponzi-scheme-suit

[3] https://www.law360.com/articles/1076984/investors-beat-bid-to-toss-40m-nj-ponzi-scheme-row

Government Preparing to Rest Its Case in $2 Billion Mozambican Loan Fraud Trial

Prosecutors are nearing the end of their case after over three weeks of trial for Privinvest Group executive Jean Boustani, who is accused of conspiring to defraud investors in loans made by Credit Suisse and Russian bank VTB to Mozambican state-backed special-purpose vehicles (SPVs).

The government alleges that Boustani structured the deals so that the $2 billion in loans to fund maritime projects for Mozambique were instead funneled directly to the bank accounts of Privinvest, the projects’ main contractor. Prosecutors claim that the three Mozambican SPVs were created as shams to divert over $200 million in bribes and kickbacks to Mozambican government officials and investment bankers. The superseding indictment alleges that after conducting little or no business activity, each of the three SPVs defaulted on its loan.

Credit Suisse employees have admitted to their role in facilitating the fraud and kickback scheme. Andrew Pearse, the former head of Credit Suisse’s Global Financing Group, testified that he received $45 million in kickbacks from Privinvest for ensuring loan approval. Surjan Singh, a former Credit Suisse banker, also testified that he took $5.7 million in kickbacks for promoting two of the SPV deals. The bankers also allegedly intentionally withheld red flags about the likelihood of corruption connected to the deals from Credit Suisse’s compliance department. Pearse and Singh, along with another former Credit Suisse investment banker, Detelina Subeva, have pled guilty to conspiracy charges.

A former AllianceBernstein portfolio manager testified that the hedge fund lost millions of dollars from its approximately $75 million stake in one of the impacted SPVs. AllianceBernstein was offered and accepted Eurobonds in exchange for its debt securities, and ultimately liquidated its position at a loss.

The case is U.S. v. Boustani et al., case number 1:18-cr-00681, in the U.S. District Court for the Eastern District of New York.

Capital One Affiliates Seek Dismissal of Usury Putative Class Action

In the latest development in one of two federal cases examining whether New York usury laws can limit the interest rates charged on credit card debts that are securitized, the Capital One affiliate defendants have moved to dismiss the action brought by plaintiff credit card holders. The plaintiffs alleged that their interest rates, ranging from 22.5 to 27.74 percent, exceed New York’s statutory interest rate limit of 16 percent for civil usury, and even, in some cases, the 25 percent limit for criminal usury. The case is Cohen et al. v. Capital One Funding LLC et al., docket number 19-cv-03479, pending in the U.S. District Court for the Eastern District of New York.

As previously covered on this blog, the U.S. Supreme Court has held that the National Banking Act of 1864 preempts state laws that “significantly interfere” with national bank activities. Marquette Nat. Bank v. First of Omaha Svc. Corp., 439 U.S. 299, 313 (1978). Accordingly, while national banks must comply with the usury laws of the state in which they are located, if a borrower moves to a state with a lower maximum interest rate, the bank need not comply with that state’s lower rate. Barnett Bank of Marion County, N.A. v. Nelson, 517 U.S. 25, 33 (1996).

In 2015, the U.S. Court of Appeals for the Second Circuit examined this National Banking Act preemption when a Delaware bank lent to a New York borrower. Although the loan complied with Delaware usury law, the Delaware bank then sold the loan to an entity that was not a national bank. Because the loan purchaser was not a national bank or acting on behalf of a national bank, the appellate court concluded that New York usury law did not “significantly interfere” with the purchaser and that New York’s maximum interest rate cap applied to the loan. Madden v. Midland Funding, LLC, 786 F.3d 246 (2d Cir. 2015).

In moving to dismiss the Cohen claims, the Capital One defendants argued that the Second Circuit recognized in Madden that usury claims are still federally preempted when there is still substantial connection between a national bank and the debt after it is sold, so that state usury laws would still “significantly interfere” with national banking activities. Because Capital One, N.A. – the ultimate parent entity of the defendants – still retained ownership of the plaintiff’s credit card accounts after selling the credit card receivables to its affiliates to be securitized, the defendants argued that New York’s usury limit would “significantly interfere” with Capital One’s ability to run its credit card business nationwide.

Capital One received support from the Bank Policy Institute and the Structured Finance Association in an amicus brief, urging the court to adopt the defendants’ reading of Madden. Plaintiffs argued in their opposition brief that because defendants are not national banks and do not exercise national banking authority, Madden is dispositive and New York’s usury limits apply to their debts.

The motion was fully briefed on Nov. 1, 2019, and the parties await a decision from Judge Kiyo A. Matsumoto. We will cover the decision when it is published.

Second Circuit Gives Green Light to Foreign Litigants Seeking Discovery in the U.S.

As cross-border business continues to grow, litigation too is increasingly crossing borders. In a recent decision addressing several issues of first impression, the U.S. Court of Appeals for the Second Circuit opted to aid international litigants, interpreting Section 1782 of Chapter 28 of the United States Code to allow discovery in aid of foreign proceedings to be taken in the U.S. from entities that are subject to personal jurisdiction in the U.S. In re del Valle Ruiz, 939 F.3d 520 (2d Cir. 2019). The appellate court held that “there is no per se bar to extraterritorial discovery” in the United States, and that district courts may exercise personal jurisdiction in their discretion, consistent with the mandates of due process, in ruling on an application for discovery under Section 1782. Id. at 524, 533-34. The Second Circuit noted “that a court may properly, and in fact should, consider the location of documents and other evidence when deciding whether to exercise its discretion to authorize such discovery.” Id. at 533.

Armed with this ruling, parties litigating abroad can file a petition in a U.S. district court seeking documents and information, thereby taking advantage of the breadth afforded by American-style discovery. However, the Second Circuit preserved constitutional limitations on this extraterritorial reach by mandating that the target individual or entity from which discovery is sought be subject to personal jurisdiction in the district where the petitioned court sits–holding that Section 1782’s “resides or is found” language extends only to the limits of personal jurisdiction consistent with due process. Id. at 528.

The decision was a victory for Pacific Investment Management Company LLC and Anchorage Capital Group, LLC (the PIMCO petitioners)–investment and asset-management firms–which filed petitions under Section 1782 in the U.S. District Court for the Southern District of New York. The PIMCO petitioners sought to obtain discovery from Banco Santander S.A. (Santander) and its New York-based affiliate, Santander Investment Securities Inc. (SIS) concerning a 2017 transaction in Spain.

In June 2017, Santander purchased Banco Popular Espanol, S.A. (BPE), which was then Spain’s sixth-largest bank, with assets approximating $150 billion. The 2008 financial crisis had filled BPE’s balance sheet with toxic assets, putting the bank at risk of failure and on the brink of bankruptcy after large withdrawals from Spanish government entities in 2016. In lieu of a bankruptcy filing, the Spanish government forced a sale of BPE in June 2017; Spain’s national banking supervisory authority invited several banks to submit bids for the purchase of 100% of BPE’s equity. A single bid–Santander’s, for a total of one euro (€ 1)–was received on June 6, 2017 and accepted the next day.

The forced sale to Santander caused many investors–including the PIMCO petitioners–significant losses, causing a myriad of foreign proceedings challenging the BPE transaction. Among them, the PIMCO petitioners and certain individual investor petitioners led by Antonio del Valle Ruiz filed Section 1782 applications against Santander, seeking documents and communications relating to BPE’s liquidity and the sale. The PIMCO petitioners also sought discovery from SIS. Before the trial court, Santander challenged the extraterritorial reach of the statute–protesting that Santander does not reside in the Southern District of New York, and while its U.S. affiliate SIS resides or is found in the district, SIS was not involved in the BPE acquisition. The district court held that “at a minimum § 1782 must comport with constitutional due process, i.e., the court must have personal jurisdiction” and “none of the Santander entities except SIS met the requirement for general jurisdiction.” In re del Valle Ruiz, 342 F. Supp. 3d 448, 453-57, 459 (S.D.N.Y. 2018) (Ramos, J.).

Accordingly, the trial court denied both petitioners’ discovery requests to Santander but granted the PIMCO petitioners’ discovery requests to SIS. The petitioners appealed, arguing that they were entitled to discovery from Santander, and Santander cross-appealed, arguing that the PIMCO petitioners were not entitled to discovery from SIS.

The Second Circuit resolved the issue of the meaning of “resides or is found” under Section 1782, finding that the statute reaches as far as the constitutional limits of personal jurisdiction, affirming the district court’s holding that SIS had sufficient contacts with the Southern District of New York such that allowing discovery would not violate “traditional notions of fair play and justice.” In doing so, the Second Circuit declined to adopt “a categorically lower showing of due process needed to obtain discovery from a nonparty,” holding that it is “enough for purposes of due process in these circumstances that the nonparty’s contacts with the forum go to the actual discovery sought rather than the underlying cause of action.” In re del Valle Ruiz, 939 F.3d at 530. The Second Circuit also affirmed the district court’s ruling that investor plaintiffs could not seek discovery from Santander in the United States because Santander did not have sufficient minimum contacts in the district prior to the nominal purchase of BPE–the underlying impetus of the case.

This decision will have far-reaching impact on other foreign litigants who seek to enforce Section 1782 petitions in the U.S. to obtain expansive discovery unavailable in foreign courts.

Mutual Funds and Shareholder Litigation: Funds Should Lean In

Should mutual funds take a more active role in securities litigation? Data appears to suggest that they should.

According to Sean J. Griffith[1] and Dorothy S. Lund[2], authors of “Toward a Mission Statement for Mutual Funds in Shareholder Litigation”[3], mutual funds can improve returns for investors by taking on a greater role in enforcing shareholder and investor rights in court. Griffith and Lund survey participation in derivative suits, direct and class claims under state law, appraisal claims, and private securities litigation, and develop a recommendation for “a few simple changes [by which] mutual funds will be able to reap litigation benefits without substantially increasing their costs.”[4]

Amy Roy and Robert Skinner[5] offered a counterpoint in their piece “Mutual Funds Should Stay Out Of Shareholder Litigation,” asserting that “[l]itigation opportunities–like investment opportunities–come with opportunity costs, which the authors fail to acknowledge.” Focusing primarily on burdens of private securities litigation, such as serving as a lead plaintiff and what they view as the “myth” of improved opt-out recovery, Roy and Skinner concluded, “Notable exceptions aside, fund shareholders are generally better served by allowing their advisers to remain focused on what it is they were hired to do–investing their money and outperforming the market.”

Griffith and Lund responded to this critique in “Mutual Funds Should Use Litigation For Shareholders’ Benefit.” They wrote that the “notable exceptions” that Roy and Skinner brush aside are, in fact, “specific evidence . . . showing that shareholder litigation can benefit mutual funds and their investors–directly, by securing compensation, or indirectly, by deterring misconduct, among other things.” Looking at securities class actions and finding an active participation rate of only 0.6 percent–i.e., 10 cases out of 1,500 over a 10-year period–Griffith and Lund wonder (and rightly so) whether the true “rate of good cases to bad ones” could be so low.

Griffith and Lund’s conclusion that mutual funds’ “dismal litigation record . . . raises serious questions of whether mutual funds are acting as faithful governance intermediaries for their investors” presents an issue that both mutual fund managers and investors need to address, due in part to the rising prevalence of mutual funds.

By one recent measure, if mutual funds chose to functionally self-exclude from securities litigation, this would sideline nearly a quarter of all equity ownership:

Source: https://awealthofcommonsense.com/2019/01/who-owns-all-the-stocks-bonds/

As Congress noted when drafting the Private Securities Litigation Reform Act of 1995:

Private securities litigation is an indispensable tool with which defrauded investors can recover their losses without having to rely upon government action. Such private lawsuits promote public and global confidence in our capital markets and help deter wrongdoing and to guarantee that corporate officers, auditors, directors, lawyers, and others properly perform their jobs.[6]

This sentiment was echoed more recently by then-SEC Commissioner Luis Aguilar in his 2012 statement in the wake of the Supreme Court’s decision in Morrison v. National Australia Bank, Ltd.:

It is unrealistic to expect that the Commission will have the resources to police all securities frauds on its own, and as a result, it is essential that investors be given private rights of action to complement and complete the Commission’s efforts.[7]

Relegating the largest single group of institutional investors to the role of onlookers in the face of securities fraud is not the path to maintaining a robust and trustworthy capital market. Mutual funds would often do well to adopt a more active role in protecting their investors.

____________________________________________________________

[1] T.J. Maloney Chair and Professor of Law at Fordham University School of Law.

[2] Assistant Professor of Law, University of Southern California Gould School of Law.

[3] Griffith, Sean J., and Lund, Dorothy S., Toward a Mission Statement for Mutual Funds in Shareholder Litigation (July 19, 2019), Univ. of Chicago L. Rev., Forthcoming; European Corporate Governance Institute–Law Working Paper No. 468/2019; USC CLASS Research Paper No. CLASS19-23; USC Law Legal Studies Paper No. 19-23. Available at SSRN: https://ssrn.com/abstract=3422910.

[4] Id. at 48.

[5] Roy and Skinner are partners at Ropes & Gray LLP.

[6] H.R. Rep No. 104-369, at 31 (1995).

[7] Aguilar, Luis A., Statement by Commissioner: Defrauded Investors Deserve Their Day in Court, Secs. & Exchange Comm., Apr. 11, 2012, available at https://www.sec.gov/news/public-statement/2012-spch041112laahtm.

Credit Card ABS: Securitization and State Usury Laws

Consumer lending as we know it today – and credit card lending in particular – depend on securitization for significant access to capital. However, the ability of banks to bundle and sell credit card debt-backed securities may be thrown into disarray depending on the outcomes of a pair of pending cases: Cohen v. Capital One Funding, LLC[1] and Cohen v. Chase Card Funding, LLC.[2]

The outcomes of these matters will likely turn on the application of a 2015 decision by the 2nd Circuit Court of Appeals regarding a statute that is more than 150 years old: the National Bank Act of 1864 (“NBA”).

The Supreme Court has stated that the NBA preempts state laws that “significantly interfere” with a “national bank’s exercise of its powers,”[3] a ruling that has been applied to cover state usury laws that set maximum rates of interest. As a result, a bank must comply with the usury law of the state “in which the bank [is] located”[4] – if the borrower moves to a state with a lower rate cap, the interest rate remains valid.

In 2015, the 2nd Circuit decided Madden v. Midland Funding, LLC.[5] In Madden, a Delaware-based bank had issued a loan to a New York borrower with an interest rate that complied with Delaware law.[6] The bank, however, then sold the loan to a debt purchaser. But because the purchaser was neither a national bank itself nor acting “on behalf of” a national bank, the 2nd Circuit found that New York’s usury law[7] did not “significantly interfere” with the bank and held that New York’s maximum interest rate cap applied.

Now, plaintiffs in Capital One and Chase Card seek to extend this reasoning to ABS that hold credit card debts. Because the debts are now owned by an independent trust, plaintiffs allege the credit card ABS entity has no right to assert that state usury laws preempt the interest rates being charged on the underlying debts.

Data: SIFMA https://www.sifma.org/resources/research/us-abs-issuance-and-outstanding/

Should plaintiffs prevail, banks’ ability to free up capital and spread risk across nonbank institutional investors would be severely hampered – and would likely face a period of upheaval as the effects on the billions of dollars of outstanding CCABS are sorted out.

The 2nd Circuit’s decision in Madden has sparked criticism from regulators[8] and at least two efforts in Congress to legislate a change to the ruling.[9] However, until such a change is enacted, market participants will have to watch the courses of Capital One and Chase Card.

________________

[1] No. 19-cv-03479 (E.D.N.Y.).

[2] No. 19-cv-00741 (W.D.N.Y.).

[3] Marquette Nat. Bank v. First of Omaha Svc. Corp., 439 U.S. 299, 313 (1978).

[4] Barnett Bank of Marion County, N.A. v. Nelson, 517 U.S. 25, 33 (1996).

[5] 786 F.3d 246 (2d Cir. 2015).

[6] 6 Del. C. § 2301 et seq.

[7] NY CLS Gen Oblig § 5-501 et seq.

[8] See, e.g., amicus brief of the F.D.I.C. and Office of Comptroller of the Currency, In re: Rent-Rite Super Kegs West Ltd., No. 19-cv-01552 (D. Colo.), dkt. no. 11.

[9] See, e.g., Sykes, J., Banking Law: An Overview of Federal Preemption in the Dual Banking System (Jan. 23, 2018), available at http://fas.org/sgp/crs/misc/R45081.pdf.

Capital Markets Litigation Team Achieves Key Victory in Pro Bono Transgender Rights Case

We are proud to announce that our team achieved a key victory as plaintiffs’ pro bono counsel in Doe v. Esper, a constitutional challenge to the Pentagon’s transgender service policy. The government’s policy is to discharge or deny enlistment to anyone who will not serve in the gender to which they were assigned at birth, or who is undergoing hormone therapy or other gender-confirmation procedures.

The Hon. Colleen Kollar-Kotelly of the U.S. District Court for the District of Columbia granted our team’s motion to compel production of documents withheld by the Department of Defense (DOD) and other government defendants.  The court rejected the government’s argument that it should automatically be accorded a high level of deference because the policy resulted from military-decision-making, and ruled that “[a]dditional discovery is needed to determine if the [challenged Mattis] Plan is the product of considered military decision-making that reasonably and evenhandedly regulates the matter at issue.”

The judge further agreed that DOD could not invoke the deliberate process privilege, which protects documents revealing the process behind government decisions, because “[t]hose documents go to the heart of Defendants’ intent and decision-making process … — both key issues in establishing the legitimacy of the disputed transgender policy.” The opinion made clear that “Plaintiffs’ need for the information overcomes Defendants’ privilege.”

As noted in Lowenstein’s press release about the victory, we are pleased to contribute our trial skills to protect the rights of individuals fighting on behalf of our country.

Survey Shows Hedge Funds Are Using More Alternative Data, but Data Cost and Quality Issues Remain

According to survey results published in September, 2019, by Lowenstein Sandler, over 80 percent of hedge funds of all sizes are using alternative data in some capacity, with 75 percent of respondents saying they use it to make better investment predictions.

Completed by C-level executives, data scientists, equity analysts, portfolio managers, and legal/compliance officers in the private funds industry, the survey assessed how funds of all sizes use alternative data. Funds were grouped by size–less than $500 million, $500 million to $5 billion, and greater than $5 billion–to determine how data use, and concerns about it, differ at varying levels of asset value.

The report, entitled Alternative Data = Better Investment Strategies, But Not Without Concerns, is the first survey of its kind from the firm’s Investment Management Group; it was authored by Peter D. Greene, partner and Vice Chair of the group, with contributions from partner Benjamin Kozinn.

“It is not surprising to me that an overwhelming majority of funds are using alternative data,” said Greene. “What is interesting is how funds of various sizes are using it and how they plan to expand their use in the future. In a changing industry, it is more important than ever to learn what alternative data can do, while also acknowledging the limitations and concerns that come with using such data.”

81 percent of respondents’ organizations plan to increase their budgets for alternative data. Of those, the majority plan to increase budgets by 11-25 percent.

The survey results also show an increasing interest in using newer data sources such as web scraping and biometrics to stay competitive. 57 percent of respondents expect to use web scraping as a data source within a year, a jump from the 49 percent who currently use it; and 32 percent said they currently use biometric data now, with 45 percent expecting to use it in the future.

However, concerns do remain over new regulations and privacy laws, cost and time investment, and the ability to distinguish relevant information from large volumes of data.

Most respondents (98%) said they used alternative data in combination with fundamental analysis to make investment decisions.

The release of the report was noted by HedgeweekBusiness WireOpalesque, the Managed Funds Association newsletter, Institutional InvestorAssociated PressYahoo! Finance, StreetInsider.com, and Chief Investment Officer.

Syndicated Loans: Have They Been Securities All Along?

In a case pending in federal court in New York, Kirschner v. JPMorgan Chase Bank, N.A., No. 17-cv-06334-PGG (S.D.N.Y.), a bankruptcy trustee may upend what has long been accepted wisdom on Wall Street: securities laws apply to stocks, bonds, equity options, and the like – but not to syndicated loans.

Kirschner is brought by the bankruptcy trustee on behalf of a group of “approximately 400 mutual funds, pension funds, universities, [CLO]s and other institutional investors,” and alleges that the banks that led Millennium Labs’ 2014 loan syndication violated state securities laws of California, Massachusetts, and Colorado, among other claims.

Syndicated loans, often referred to as “leveraged loans,” are term loans extended to companies by a group of lenders. Like corporate bonds, syndicated loans are debt instruments that entitle the holder to interest and principal.  However, unlike traditional securities, interests in a syndicated loan are not sold like a bond, but assigned to the new holder.  As a result, only current investors have standing to bring claims against the borrower.  Another difference is that syndicated loans are not offered through a risk-warning-laden prospectus, but rather a confidential information memorandum, or “CIM.”  The CIM is not a public document, and is generally only made available to lenders upon approval of the borrower.[1]

Enter privately-held Millennium Laboratories LLC, a San Diego-based company that performed urinalysis drug testing for Medicare, Medicaid programs, and commercial insurance companies.  In 2014, Millennium Labs teamed up with a group of banks to organize a $1.765 billion term loan to refinance older debt and pay out a substantial cash dividend to insiders.

Less than a year later, however, lenders found Millennium Labs besieged under a barrage of legal threats from federal regulators and civil litigants that would ultimately lead to the company’s bankruptcy – risks that the trustee in Kirschner asserts were well known to Millennium Labs and its bankers but fraudulently concealed from investors in the 2014 CIM.

As the true depth of these risks was revealed in late 2015 and early 2016, the market value of Millennium Labs’ loan fell sharply:

The secondary market price of Millennium Labs’ syndicated loan during 2016 highlights one of the hazards of this type of investment – as the extent and gravity of the company’s litigation risks were becoming known, Millennium reportedly refused to provide prospective lenders access to the CIM, leading to nearly three months in mid-2016 of no secondary market activity with lenders locked into their stale-priced positions:

As defendants point out in their motion to dismiss, federal courts have for some time agreed that bank loans such as these do not qualify as “securities” for purposes of federal securities laws, citing Banco Espanol de Credito v. Pacific National Bank, 973 F.2d 51 (2d Cir. 1992). Although the Second Circuit did affirm this lower-court determination in Banco Espanol de Credito, the panel cautioned: “We recognize that even if an underlying instrument is not a security, the manner in which participations in that instrument are used, pooled, or marketed might establish that such participations are securities.” Id. at 56.

Further, that ruling was delivered contrary to an amicus brief submitted by the Securities and Exchange Commission, eliciting a vociferous dissent by then-Chief Judge Oakes, who noted:“I fear that the majority opinion misreads the facts, makes bad banking law and bad securities law, and stands on its head the law of this circuit and of the Supreme Court….” Id.

Whether the analysis in Banco Espanol de Credito proves equally availing for purposes of the various state laws that the Trustee in Kirschner relies on remains to be seen.

Defendants’ motions to dismiss the claims in Kirschner have been fully briefed and both sides have requested oral argument.

_________________

[1] A publicly filed exhibit in Kirschner offers a rare look at a CIM.  See Decl. in Sup. of Mot. to Dismiss, Ex. B, Parts 1 & 2, Kirschner, No. 17-cv-06334-PGG, Dkt. Nos. 79-2 & 79-3 (S.D.N.Y. June 28, 2019).

 

Student Loan Debt Called a “Trillion-Dollar Blackhole”

Do student loans bear any similarities to mortgage loans, which lay at the heart of the 2008 economic crisis? The short answer is yes. Student loan asset-backed securities (SLABS), much like residential mortgage-backed securities (RMBS), are loans bundled and packaged into securities available for purchase by investors. Bearing ominous resemblance to the precursors to the 2008 financial crisis, the number of student loan borrowers, as well as the average balance per borrower, continues to rise every year, while most recent college graduates are unable to find jobs allowing them to pay back their loans.

According to members of Congress, the U.S. is already in crisis over growing student loan debt. The House Committee on Financial Services held a hearing on Tuesday, September 10th entitled “A $1.5 Trillion Crisis: Protecting Student Borrowers and Holding Student Loan Servicers Accountable.” A five-person panel warned the Committee that there is currently $1.5 trillion in outstanding student loans, from about 44 million borrowers, with approximately 11% of those loans more than 90 days delinquent.

At the hearing, Ashley Harringston, Senior Policy Counsel for the Center for Responsible Lending, testified that 70 percent of 2016 graduates had student loan debt. The crisis is impacting not only low and middle-class families: even students from high-income families are borrowing to attend college, perhaps choosing to attend higher-ranked and more expensive schools. The executive director of the Student Borrower Protection Center, Seth Frotman, called the student loan crisis a “trillion-dollar blackhole in our financial markets.” But with nine pending pieces of legislation aimed at tackling rising student debt, members of Congress disagree on how to handle this crisis. Time will tell whether Congress – and the American people – have learned from the 2008 financial crisis, or whether history is doomed to repeat itself.

LexBlog