Flattening Yield Curve Signals Looming Recession, Some Say

Recently, investors and economists have focused increased attention on bond market yield curves, which have proven to be a compelling predictor of an upcoming economic recession.

The yield curve is the measure of the difference between short-term and long-term interest rates on government bonds.  In a healthy economy, interest rates on long-term (typically, ten-year) bonds are generally higher than rates on short-term (often, two-year) bonds.  This rate increase from short-term to long-term bonds creates a positively sloping yield curve (see Figure 1) which reflects investors’ expectations that economic growth will, among other things, ultimately inflate prices.

Currently, however, the yield curve is flattening, meaning that the disparity between short-term and long-term interest rates is diminishing (see Figure 2).  As a recent New York Times article explained it, the yield curve has been flattening lately because “long-term bond yields have been stubbornly slow to rise – which suggests traders are concerned about long-term growth – even as the economy shows plenty of vitality.”  Additionally, the Federal Reserve has been raising short-term interest rates, and as a result, the short-term and long-term rates threaten to collide.

The growing concern is that if this trend continues, and the short-term rates meet with, and eventually rise above, long-term rates, then the yield curve becomes inverted, meaning that it reflects a downward slope (see Figure 3).  Such a yield curve inversion has occurred in the two years preceding each of the nine officially designated recessions since January 1955, according to research by the San Francisco Federal Reserve Bank.  It is worth noting that the current gap between two-year and 10-year United States Treasury notes fluctuates between thirty and forty basis points.  The last time the yield curve came this close to inverting was in 2007, just before that financial crisis erupted.  For reference, a yield curve in a healthy economy can exceed 280 basis points.

Yet, the yield curve’s prophetic function might be overstated.  The fear that the yield curve indicates a recession may create a self-fulfilling prophecy.  Investors’ pessimism about market growth rates is what causes the yield curve to flatten in the first place.  Therefore, under some views, mounting concerns about yield curve trends, alone, may be sufficient to drive investors to make additional purchases in long-term government bonds, which only further flattens the curve.

Moreover, there has been at least one false positive, in 1966, in which the yield curve inverted but was not followed by an official recession.  At least one study, published by an economic think tank, has concluded that inverted yield curves are actually “not rare,” and that “inverted yield curves per se have not been a serious problem for savings and loans . . . except when they were clustered in a few consecutive years with large negative spreads.”

Publications from 2007 discussing yield curves reveal some skepticism as to whether the inverted yield curve is indeed guaranteed to signal a recession.  The above study, which was published in March 2007, ironically concluded: “[D]epository institutions are in overall good financial condition and . . . regulation has been significantly improved.  Despite concerns over yield curve inversions and weaknesses in the real estate market, the problems emerging today are not of sufficient magnitude or sufficiently widespread to be comparable to those that arose two decades ago and we are unlikely to face a recurrence of the savings and loan crisis of the 1980s.  The developing real estate problems . . . are unlikely at the moment to lead to any significant and costly failures.”  Though not an oracle, a flattening yield curve still deserves to be considered seriously today, particularly if it becomes inverted.

Figure 1:  A “normal” yield curve for U.S. Treasuries from February 29, 1996, reflecting a yield spread between two- and ten-year bonds that was approximately 68 basis points (bps), and rates that were substantially higher than today, with the two-year yielding more than 5.42 percent.

Figure 2:  The current yield curve (June 30, 2018) is in blue and is compared against the yield curve from January 1, 2018, which is in red.  Although yields have risen for every maturity, short-term yields have risen faster, with the two-year adding nearly 65 bps while the 10-year has increased by only 46 bps.  The longest-dated U.S. Treasuries, the 30-year bonds, have seen their yields rise by even less – barely 25 bps.

Figure 3:  The U.S. Treasuries yield curve was inverted on November 30, 2006, after the Federal Reserve had undertaken a two-year effort to “normalize” short-term rates.  The yield spread between the two- and ten-year bonds was negative by more than 15 bps, a factor that contributed to the downfall of Bear Stearns and Lehman Brothers in 2008.

Private Cryptocurrency Firm Hit With Class Action Lawsuit Over Initial Offering

Investors in a private cryptocurrency firm brought a class action securities lawsuit against the firm itself, Latium Network, Inc. (Latium) and individually against Latium’s founder and CEO David Johnson and co-founder and chief commercial officer Matthew Carden. The lawsuit alleges that the defendants are subject to strict liability for violating Section 5 of the Securities Act of 1933 by offering and selling unregistered securities in the form of LatiumX tokens. According to the complaint, filed in federal court in Newark last week, the defendants attempted to represent the $17 million Latium initial coin offering (ICO) as a sale of “utility-based tokens,” while in fact the ICO was an offer and sale of securities subject to registration requirements of the federal securities laws because the defendants claimed that the value of the LatiumX tokens would increase after the launch of the new cryptocurrency platform.[1]

Lead plaintiff Joevannie Solis invested $25,000 to buy 208,333 LatiumX tokens during the ICO, relying on the defendants’ representations regarding the cryptocurrency’s platform. According to worldcoinindex.com, the tokens were worth about 5 cents each last week, making Solis’ $25,000 investment now worth around $10,000. Solis, on behalf of himself and similarly situated investors in the class, seeks a judicial declaration that the LatiumX tokens are indeed securities subject to the federal registration requirements, as well as injunctive relief preventing the defendants from transferring or using any investment funds and providing rescission and repayment of all investments in the Latium ICO.

This lawsuit is another in a string of litigations concerning whether virtual currencies constitute securities subject to the federal securities laws and registration requirements. Chairman of the SEC Jay Clayton has said that certain types of cryptocurrencies could qualify as securities, while others do not.[2]  The Commodity Futures Trading Commission (“CFTC”) has classified Bitcoin as a “commodity,” while it’s former Chairman has stated that Ether and Ripple, two other cryptocurrencies, likely are securities subject to the federal registration requirements.[3] In contrast, the director of corporate finance for the SEC recently opined that Bitcoin and Ether are not securities.[4] As Clayton’s SEC statement warns, whether cryptocurrencies are ultimately determined by a court to be securities “will depend on the characteristics and use of that particular asset.” Potential investors in cryptocurrencies should proceed with caution in this legally uncertain territory, as their rights and remedies will vary greatly depending on the ultimate classification of the virtual currency.

[1] Paragraphs 2, 3, 18, and 19 of the complaint, available at https://images.law.com/contrib/content/uploads/documents/1/latium.pdf.

[2] December 11, 2017. “Statement on Cryptocurrencies and Initial Coin Offerings” by SEC Chairman Jay Clayton, available at https://www.law.com/njlawjournal/2018/06/07/investors-sue-private-cryptocurrency-over-17m-initial-offering/?kw=Investors%20Sue%20Private%20Cryptocurrency%20Over%20%2417M%20Initial%20Offering&et=editorial&bu=New%20Jersey%20Law%20Journal&cn=20180608&src=EMC-Email&pt=Daily%20News%20Alert&slreturn=20180511105420.

[3] Gary Gensler, former CFTC Chairman, April 23, 2018, remarks at the MIT Business of Blockchain conference.

[4] William Hinman, director of corporate finance for the SEC, June 14, 2018 remarks at the Yahoo! All Markets Summit: Crypto event.

DOJ Settles RMBS Action Under FIRREA with Barclays for $2 Billion

On Thursday, March 29, Barclays Capital Inc. and several of its affiliates (together, Barclays)–as well as two former Barclays executives–agreed to settle a three-year Department of Justice (DOJ) investigation concerning Barclays’ marketing and sale of residential mortgage-backed securities (RMBS) between 2005 and 2007.

The lawsuit was commenced by the United States Attorney’s Office for the Eastern District of New York in December 2016. The action, filed in the United States District Court for the Eastern District of New York in Brooklyn, alleged that Barclays caused billions of dollars in investor losses by engaging in a fraudulent scheme to sell $31 billion in subprime and Alt-A mortgage loans across 36 different RMBS securitizations, misleading investors about the quality of the mortgage loans backing those securitizations. More than half of the mortgage loans serving as collateral for those 36 RMBS securitizations had defaulted, and these deals helped fuel the 2008 financial crisis. The DOJ complaint alleged violations of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) based on mail fraud, wire fraud, bank fraud, and other predicate offenses.

In an unusual move by the government, the DOJ suit also targeted two former executives at the bank as individual defendants: Paul K. Menefee, of Austin, Texas, who served as Barclays’ head banker for subprime RMBS securitizations, and John T. Carroll, of Port Washington, New York, who served as Barclays’ head trader for subprime loan acquisitions. Menefee and Carroll were charged with violations of predicate offenses under FIRREA with respect to seven of the 36 RMBS securitizations at issue.

Under the terms of the settlement agreement, Barclays will pay $2 billion in civil penalties–with no admission of wrongdoing–to settle the action. Carroll and Menefee have agreed to pay a combined $2 million in civil penalties–also without admissions of wrongdoing–for dismissal of the claims against them. The settlement agreement has been called final by both sides and is currently pending execution.

Prior to the DOJ’s commencement of litigation, the two sides had attempted to reach settlement in 2016, but those negotiations stalled when Barclays refused to pay more than $2 billion in penalties to settle the dispute, while the DOJ sought higher penalties–a move that appears to have paid off for the London-based bank.

According to Ian Gordon, an analyst at Investec Plc, “[t]he settlement came at the bottom end of expectations and much sooner than expected,” and Gordon called the result a “clear positive” for Barclays. The $2 billion penalty is also notably less than settlements reached by Goldman Sachs, JPMorgan Chase, and other Wall Street banks over their pre-financial–crisis mortgage deals.

While analysts have clearly chalked up the deal as a win for Barclays, both sides publicly endorsed the settlement as a vindication of their efforts.

“The actions of Barclays and the two individual defendants resulted in enormous losses to the investors who purchased the Residential Mortgage-Backed Securities backed by defective loans,” Laura Wertheimer, the inspector general for the Federal Housing Finance Agency, said in a statement Thursday. “Today’s settlement holds accountable those who waste, steal or abuse funds in connection with FHFA or any of the entities it regulates.”

Barclays CEO Jes Stasley called the deal “a fair and proportionate settlement.” Menefee and Carroll appeared equally pleased. Menefee “has always maintained that the government’s FIRREA lawsuit against him was baseless. … Solely to put this matter behind him, Mr. Menefee has agreed to a settlement in which he has not admitted any wrongdoing,” his lawyers said in a statement. Carroll’s lawyers stated that Carroll was gratified the DOJ “relented in its efforts to prove wrongdoing where none exists.”


CLO Litigation Update

In December 2014, the credit risk retention rule, 79 Fed. Reg. 77,601 (the credit risk retention rule), was adopted pursuant to Section 941 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The credit risk retention rule requires any “securitizer” of asset-backed securities (or other related parties) to acquire and retain either (i) 5 percent of the face amount of each class of notes issued by the collateralized loan obligation (CLO), (ii) notes of the most subordinated class issued by the CLO representing 5 percent of the fair value of all CLO notes, or (iii) a combination of (i) and (ii) representing 5 percent of the fair value of all CLO notes. The rule was designed to align the interests of the managers and investors in a CLO deal.

CLOs, the largest purchasers of leveraged loans, are generally classified into one of two types: open-market CLOs or middle-market CLOs. Open-market CLOs acquire their assets from third parties on the open market. Middle-market, or balance sheet, CLOs are created by a CLO manager or a related party transfering the loans off its balance sheet and into the securitization vehicle. Until a recent D.C. Circuit Court decision, the credit risk retention rule applied to managers of both open-market and middle-market CLOs.

In 2014, the Loan Syndications and Trading Association – the trade group representing the CLO and leveraged loan markets – filed a lawsuit against the Federal Reserve and the SEC, arguing that the credit risk retention rule was arbitrary, capricious, and an abuse of discretion. In December 2016, a D.C. District Court held that collateral managers of open-market CLOs were considered securitizers for purposes of the credit risk retention rule. Loan Syndications & Trading Ass’n v. SEC, 223 F. Supp. 3d 37 (D.D.C. Dec. 22, 2016).

On February 9, 2018, the D.C. Circuit Court reversed the district court’s 2016 ruling, and found that open-market CLO managers are no longer obligated to abide by Dodd-Frank’s risk retention requirements because CLO managers do not originate or hold assets and therefore do not qualify as “transferors” of assets or securitizers under Section 941 of Dodd-Frank. The case is Loan Syndications and Trading Association v. SEC, No. 17-5004, and the decision is available at https://www.cadc.uscourts.gov/internet/opinions.nsf/871D769D4527442A8525822F0052E1E9/$file/17-5004-1717230.pdf

The Circuit Court focused on Dodd-Frank’s definition of a securitizer as being an entity that transfers assets to an issuer of securities, and it noted that open-market CLO managers typically do not own the assets underlying the CLO and therefore do not transfer them to the issuer. Decision at 8-9. Rather, these managers select assets to be purchased by the issuer from third parties on the open market. Id. at 16. Therefore, because open-market CLO managers are not securitizers, they are not obligated to retain any credit risk in the CLOs they manage. Id. at 17.

The D.C. Circuit Court’s decision effectively groups open-market CLO managers with other asset managers rather than with securitizers of asset-backed securities. Wall Street’s reaction to this recent ruling has been positive, as this exemption is expected to grow the market, especially benefiting smaller managers who were most challenged by coming up with the capital to buy the required retention when issuing new deals.

However, the D.C. Circuit Court’s decision applies only to open-market CLOs. Middle-market CLOs will remain subject to the credit risk retention rule. The Federal Reserve and SEC have 45 days to seek en banc review of the decision before the D.C. Circuit Court and 90 days to seek certiorari from the U.S. Supreme Court. If regulators do not appeal the decision, open-market CLO managers can then begin structuring new deals without holding the credit risk.

Third-Party Litigation Funding Fuels Foreign Securities Class Actions

Foreign securities class actions have been on the rise since the U.S. Supreme Court’s 2010 decision in Morrison v. National Australia Bank, Ltd., which held that federal securities laws apply only to securities purchased on domestic exchanges. 561 U.S. 247 (2010). Investors are increasingly turning to foreign forums to recoup losses associated with securities purchased or sold outside of the U.S. In addition to differences in substantive and procedural law, certain foreign jurisdictions have laws on how litigation is funded, which make for significant practical distinctions as compared with U.S. class action participation.

In contrast to the typical U.S. securities class action contingency fee arrangement, several countries–including Australia, the UK, France, and Canada–prohibit the use of contingent fee agreements. The U.S. system also generally does not require the losing party to pay costs or legal fees, whereas several foreign jurisdictions, including those listed above, obligate the loser to cover the prevailing party’s costs and expenses. These legal prohibitions on contingency fee arrangements and “loser pays” systems have fueled the surge of third-party litigation funders for foreign securities class actions.

Not only do litigation funders finance the cost of proceedings in exchange for a portion of the recovery, but they also often function as coordinators amongst investor-plaintiffs, provide access to legal resources, and are even beginning to influence the legal systems themselves. In Australia, funders require each class member to contract directly with them, which has essentially morphed the country’s opt-out class action procedure into a de facto opt-in system. Recently, Australian regulators have started investigating certain aspects of the class action funding regime. The Australian Law Reform Commission is looking into potential conflicts of interest with third-party litigation funding, and the Victorian Law Reform Commission is considering whether law firms should be allowed to receive contingency fees in class actions.

The growth in third-party litigation funding in recent years has also created a competitive environment among funders, resulting in better and less expensive options for investors. While major recoveries are possible, investors should be aware of the fundamental distinctions between U.S. and international securities litigation, particularly with respect to the challenges raised by funding arrangements. Lawyers with experience in international securities class actions are a helpful resource for potential plaintiff investors when considering different foreign jurisdictions, reviewing funding agreements, and ultimately deciding whether to participate in a foreign securities class action.

For more information (sources):





Supreme Court Gives Some Defrauded Investors More Time To Seek Recovery

In the past few years, institutional investors and others seeking to enforce their rights in court have been hit with several negative legal decisions concerning statutes of limitation issues. In 2015, the New York Court of Appeals held in ACE Securities that a claim for breaches of representations and warranties in an RMBS contract accrues when the representations are made, not when a sponsor refuses to cure or repurchase the breaching mortgage loans, rendering certain contractual put-back claims in connection with early-vintage RMBS time-barred under New York’s six-year statute of limitations. Then, last year, the Supreme Court ruled in CalPERS v. ANZ Securities, Inc. that the filing of a securities class action did not toll the three-year statute of repose (the law’s absolute bar to bringing suit) set forth in the Securities Act with respect to direct claims brought by investors “opting-out” of the related class.

Last week, however, plaintiffs scored a small but meaningful victory when the Supreme Court held that the statute of limitations clock stops running on state law claims (like fraud and other misrepresentation claims) when the plaintiff files those claims in federal court. This has the practical effect of extending, in some cases significantly, the amount of time in which some plaintiffs can file suit to enforce their rights.

The case is Artis v. District of Columbia. The issue was simple. The so-called “supplemental jurisdiction statute,” which gives investors the ability to bring state law claims along with federal claims in one federal lawsuit, says that any state claim included in a federal suit “shall be tolled while the claim is pending (in federal court) and for a period of 30 days after it is dismissed.” Relaying on this language, investors and other plaintiffs often bring state claims in connection with their federal claims with the belief that if the federal claims are dismissed and the federal court does not reach the merits of the state claims, those claims can be refiled in a timely manner in state court.

Analyzing the language, the Supreme Court was faced with two competing readings – the first approach would hold the state law statute of limitations in abeyance (or “stop the clock”) until 30 days after the federal court dismissed the case, at which point the statute would begin to run again; the second approach treated the 30 days set forth in the statute as a “grace period” within which the effects of an expired statute of limitations would be defeated and the plaintiff could refile its suit. In other words, under the second, “grace period” approach, any state lawsuit commenced more than 30 days after dismissal from federal court would fail on timeliness grounds and could never be heard on the merits. In a victory for plaintiffs, the Supreme Court adopted the “stop the clock” interpretation, rejecting the notion that Congress intended to give plaintiffs only an arbitrary 30-day period within which to refile. This has the practical effect (in the words of Justice Ruth Bader Ginsburg, who wrote for the majority) of giving plaintiffs “breathing space” beyond 30 days to commence potentially meritorious claims.

The decision, while narrow, can have significant impact on aggrieved investors. For instance, many investors bring common law negligence claims in addition to their federal fraud claims, like securities fraud and RICO. If those federal, fraud-based claims fail, Artis ensures that investors can preserve their negligence-based, state law claims without fear of dismissal for a technicality like a statute of limitations. Of course, even before yesterday’s decision, diligent counsel were well-advised to refile within the 30-day grace period to avoid the risk of an adverse ruling on timeliness grounds. But now, investors and other plaintiffs who do not refile their state law claims within 30 days can rest assured that those claims will be heard on the merits.

Federal Court Reinstates Trustee’s Failure to Notify Claim in $306 Million RMBS Suit

Last week, U.S. District Judge Katherine B. Forrest of the Southern District of New York reinstated a failure-to-notify claim brought by plaintiff Deutsche Bank National Trust Company (the trustee) against defendant Morgan Stanley Mortgage Capital Holdings LLC (“Morgan Stanley”). This notification claim is distinct from the trustee’s claim for breach of contract—based on Morgan Stanley’s alleged breaches of the agreements governing the residential mortgage-backed security (“RMBS”) transaction—and concerns Morgan Stanley’s failure to inform the trustee about alleged misrepresentations made by Morgan Stanley about the mortgage loans which served as the underlying collateral for the securities issued by the Morgan Stanley Structured Trust I 2007-1 (“the trust”).

The trustee’s suit, initially brought in April 2014, claims that Morgan Stanley, as sponsor of the trust, misrepresented the quality of the mortgage loans it sold into the trust, inducing investors to purchase approximately $735 million in RMBS. Because of the resulting borrower defaults that occurred in the wake of the 2007-2008 financial crisis, the trustee alleges investors suffered more than $306 million in losses and Morgan Stanley breached the representations and warranties it made on the underlying mortgage loans and failed to cure or repurchase the loans as contractually required.

In a 2015 decision, U.S. District Judge Laura Taylor Swain dismissed the trustee’s failure-to-notify claim based on a series of prior New York decisions holding that contractual remedy provisions—including notification provisions in the RMBS context—are not bases for independent causes of action but rather are intended to be solely remedial in nature and exercised prior to bringing suit. That is, only the underlying breaches of representations and warranties could provide a basis for suit. The case was subsequently transferred to Judge Forrest in September 2017.

In her opinion reviving the notification claim, Judge Forrest noted that since 2015, “multiple New York appellate courts have held that notice provisions, unlike cure/repurchase obligations, do provide a basis for separate breach of contract claims.” Judge Forrest noted three First Department Appellate Division cases providing unequivocal support for this holding. See Nomura Home Equity Loan, Inc. v. Nomura Credit & Capital, Inc., 143. A.D.3d 1 (1st Dep’t 2015) (docket number 650337/13); Morgan Stanley Mortg. Loan Tr. 2006-13ARX v. Morgan Stanley Mortg. Capital Holdings LLC, 151 A.D.3d 72 (1st Dep’t 2016) (docket number 653429/12); and Bank of New York Mellon v. WMC Mortg., LLC, 151 A.D.3d 72 (1st Dep’t 2017) (docket number 653831/13).

Accordingly, Judge Forrest held “this Court is convinced that subsequent developments in the law have rendered Judge Swain’s decision to dismiss the Notice Claim incorrect.”

Morgan Stanley has moved for reconsideration of the court’s decision. Morgan Stanley previously moved for summary judgment in May 2017, challenging the sufficiency of the trustee’s decision to use a sample of loans to prove breaches throughout the entire trust. The summary judgment motion, also pending before the court, is unaffected by the reinstatement of the failure-to-notify claim.

The case is Deutsche Bank National Trust Co. v. Morgan Stanley Mortgage Capital Holdings LLC, case number 1:14-cv-03020, in the U.S. District Court for the Southern District of New York.

Second Circuit Affirms $806 million Judgment Against Nomura and RBS

Last month, the U.S. Court of Appeals for the Second Circuit upheld a 2014 ruling holding issuers of residential mortgage-backed securities (RMBS) liable for securities fraud. In the opinion by U.S. Circuit Judge Richard C. Wesley, the court emphasized the policies underlying the passage of the Securities Act of 1933 and related state laws, which aim to protect securities purchasers by imposing a duty on sellers of securities to disclose all material information before such public offerings.

The plaintiff-appellee Federal Housing Finance Agency (FHFA) brought suit in the Southern District of New York on behalf of government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac against Nomura Holding America Inc. (Nomura) and Royal Bank of Scotland Securities Inc. (RBS, and together, Defendants). From 2005 to 2007, Defendants sold RMBS certificates to the GSEs while knowingly making false representations in the accompanying offering materials that the mortgage loans underlying the RMBS were originated in accordance with the applicable underwriting guidelines.

The FHFA initially brought 15 similar actions against other financial institutions, but these all settled, allowing the FHFA to recover more than $20 billion in total. The case against Nomura and RBS proceeded to trial before Judge Denise Cote, who held that Defendants made material misstatements to the GSEs and thus awarded the agency rescission.

Affirming Judge Cote’s decision, the Second Circuit saw “no merit in any of [Defendants’] arguments” and held that Defendants violated the Securities Act. Dismissing Defendants’ assertions that the FHFA should have been aware of the misstatements, the court found that because Nomura had access to the mortgage loan files before the securitization, it was uniquely positioned to have the most knowledge about the loans. The court also agreed that Defendants’ partial compliance with widespread industry custom was no defense, because RMBS industry standards prior to the financial crisis generally fell far short of satisfying the duty of reasonable care.

The Second Circuit further held that neither the GSEs’ general knowledge about the mortgage loan industry nor their awareness that the market contained numerous poorly underwritten loans constituted actual knowledge of any specific problems with the loans underlying the RMBS they purchased. The court agreed that the GSEs were not required to investigate the truth of Defendants’ representations; rather, it was reasonable for the GSEs to rely on Defendants’ diligence in selecting and reviewing these loans.

The appellate court also affirmed that the statement in Defendants’ offering materials that the loans underlying the RMBS “were originated generally in accordance with the underwriting criteria,” was both false and material. Expert evidence revealed that vast numbers of these loans materially deviated from the mortgage originators’ underwriting criteria to an extent that negatively affected the value of the loans. The court recognized that such defects greatly affect credit risk and that these underwriting guidelines statements are crucial to a reasonable investor’s decision to move forward in making that investment.

Finally, the court dismissed Defendants’ loss causation defense, stating that Defendants’ irresponsible practices, in aggregation, were precisely what caused the housing bubble that created the financial crisis. Echoing the trial court, the Second Circuit held that Defendants failed to disprove that their misconduct contributed to the very problem they attempted to hide behind.

The case is Federal Housing Finance Agency v. Nomura Holding America, 15-1872-cv(L).

RBS Settles RMBS Claims in FHFA Settlement

On July 12, 2017, the Royal Bank of Scotland (RBS) and the Federal Housing Finance Agency (“FHFA”) announced an agreement to settle claims arising out of RBS’s sale of allegedly faulty residential mortgage-backed securities (“RMBS”).  RBS will pay $5.5 billion to settle the claims.

The FHFA, as conservator of Fannie Mae and Freddie Mac, filed a lawsuit against RBS in 2011 in the United States District Court for the District of Connecticut, alleging that RBS violated federal and state securities laws in the sale and underwriting of approximately $32 billion in RMBS purchased by Fannie Mae and Freddie Mac from 2005 to 2007.  See Federal Housing Finance Agency v. The Royal Bank of Scotland Group plc, et al. (D. Conn., Case No. 3:11-CV-01383 (AWT)).  The FHFA alleged that in RBS’s offering documents, RBS falsely represented that the underlying mortgage loans complied with certain underwriting guidelines and standards, including representations that significantly overstated the ability of borrowers to repay their mortgage loans.  Fannie Mae and Freddie Mac alleged that they relied upon these false and misleading statements and suffered massive losses because of these misrepresentations.

The lawsuit against RBS is one of eighteen similar lawsuits that the FHFA filed against participants in the mortgage finance sector, including Bank of America, JPMorgan Chase, Deutsche Bank, and HSBC.  The settlement with RBS is the FHFA’s seventeenth settlement in these eighteen cases.  In the eighteenth case, the FHFA prevailed against Nomura at trial; that verdict is currently the subject of an appeal.

RBS is still the subject of a separate U.S. Department of Justice (“DOJ”) investigation and is seeking to enter settlement negotiations with the DOJ.  RBS’s chief financial officer, Ewen Stevenson, commented that there have been “no discussions with the DOJ of any substance so far” but that RBS “would still like to get it resolved, if [it] could, during this calendar year.”

Credit Suisse and UBS Settle RMBS Claims with National Credit Union Administration

On May 1 and 3, UBS Securities LLC and Credit Suisse Securities USA LLC announced settlements of significant claims brought against them by the National Credit Union Administration (“NCUA”), the federal agency serving as liquidation agent for credit unions that folded during the economic crisis. Credit Suisse will pay $400 million and UBS $445 million to settle the NCUA claims.

The NCUA brought RMBS fraud claims against Credit Suisse, alleging that the bank made false and misleading statements about the quality of the mortgage loans underlying the RMBS it sold to three credit unions that later failed. In January, Judge John W. Lungstrum of the District of Kansas denied the NCUA’s motion for summary judgment, holding that there were triable issues of fact concerning whether the bank’s due diligence with respect to the mortgage loans could be a defense to the NCUA’s allegations.

Similar to its claims against Credit Suisse, the NCUA alleged that UBS made false and misleading statements in underwriting and selling RMBS to the U.S. Central Federal Credit Union and the Western Corporate Federal Credit Union. Those two defunct entities were the largest corporate credit unions in the country before being placed under NCUA conservatorship, largely due to losses on mortgage-backed securities. The NCUA alleged, among other things, that the originators of the mortgages underlying the UBS-sponsored RMBS “systematically abandoned” underwriting guidelines, resulting in significantly higher risk for the RMBS than indicated by its AAA ratings.

Including these recoveries, the NCUA has now amassed more than $5 billion in settlements from Wall Street banks stemming from the collapse of corporate credit unions that invested in toxic RMBS. The cases are National Credit Union Administration Board v. Credit Suisse Securities USA LLC et al., number 12-cv-2648, and National Credit Union Administration v. UBS Securities LLC, number 12-cv-02591, both venued in the District of Kansas.