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.

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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.

RMBS Cases Seeking $3.7 Billion Dismissed for Lack of Standing

On Wednesday, April 12, Justice Ramos of the Commercial Division of the New York Supreme Court dismissed with prejudice four lawsuits filed by Royal Park Investments SA/NV (“Royal Park”).  The lawsuits alleged fraud and negligent misrepresentation with respect to residential mortgage-backed securities (“RMBS”) sold to Fortis NV/SA (“Fortis”) – formerly an independent Belgian bank that was sold off to BNP Paribas during the financial crisis – between 2005 and 2007.  The claims sought damages totaling $3.7 billion from four of the world’s largest banks: Morgan Stanley, Credit Suisse, Deutsche Bank, and UBS.

In 2009, Fortis and its affiliates transferred “all right, title and interest in and to” their RMBS holdings to Royal Park through the use of a portfolio transfer agreement (“PTA”), which did not expressly address the right to assert legal causes of action.  The four defendant banks moved to dismiss the complaints, contending that the representations made in the RMBS transaction documents were only made to the original purchaser (Fortis) and, under both New York and Belgian law, no transfer of the rights to sue for breaches of such representations had been made in the PTA, as the transfer of such rights must be explicit.

Justice Ramos agreed and – after determining New York law should be applied to the dispute – found that the only rights that had been explicitly transferred under the PTA were contractual rights unrelated to the right to assert legal causes of action, with no express assignment of the right to bring the common law misrepresentation claims.

Royal Park attempted to introduce a 2013 letter as extrinsic evidence purporting to show the intent to transfer all rights at law to sue over the RMBS holdings, but Justice Ramos found any such evidence was barred, holding that “[Royal Park] has failed to persuade this court that the plain terms of the [PTA] are ambiguous . . . [t]here is simply no language in the documents evidencing an outward expression of intent to assign the tort claims at issue.”

The cases are Royal Park Investments SA/NV v. Morgan Stanley et al., index number 653695/2013, Royal Park Investments SA/NV v. Deutsche Bank AG et al., index number 652732/2013, Royal Park Investments SA/NV v. Credit Suisse AG et al., index number 653335/2013, and Royal Park Investments SA/NV v. UBS AG et al., index number 653901/2013, in the Supreme Court of the State of New York, County of New York.

Appellate Decision on Loss Causation Is a Warning to RMBS Fraud Plaintiffs

Investment advisor TCW Asset Management Company (“TCW”) scored a major victory last week when an appellate court dismissed a $128 million RMBS fraud suit that was filed against it by two Australian-based Cayman Island hedge funds: Basis Pac-Rim Opportunity Fund (Master) and Basis Yield Alpha Fund (Master) (together, “Basis”).  Basis sued TCW for alleged fraud in selecting RMBS assets for, and recommending an investment in, a $400 million investment vehicle called Dutch Hill II.

On March 2, a five-judge panel of the First Department Appellate Division in New York reversed Justice Kornreich’s October 19, 2015, denial of TCW’s motion for summary judgment.  The panel found that Basis failed to present evidence of loss causation, i.e., that TCW’s alleged fraud caused Basis’ loss.  Once TCW made a showing that Basis’ loss was not due to any misrepresentations or omissions by TCW and that Dutch Hill II would have collapsed regardless as a result of the market crash, the burden shifted back to Basis to raise an issue of fact on loss causation.  The appellate panel’s decision turned on Basis’ “complete failure” to show that its loss was caused directly by TCW’s alleged fraud, and not by intervening economic forces such as the housing market crash.

RMBS fraud plaintiffs should heed the warning of the appeals court: in the event of a market collapse coincident with loss, investors must demonstrate loss causation by showing that misstatements rather than macroeconomic forces ultimately caused the loss.

The case is Basis Pac-Rim Opportunity Fund (Master) v. TCW Asset Management Co., docket number 654033/12, in the Supreme Court of the state of New York, Appellate Division, First Department.

Trustee Seeks Revival of Morgan Stanley Putback Claims

Attorneys for Deutsche Bank National Trust Co. argued recently to a First Department panel that several of the RMBS putback claims that it was pursuing as trustee against Morgan Stanley should be revived after they were dismissed in April for being untimely.  The claims were originally commenced when the Federal Housing Finance Agency filed summonses with notice on the final day before the expiration of the statute of limitations.  However, Deutsche Bank, as trustee, subsequently filed the complaints for the claims.  The trial court threw out the claims, finding that certificate holders lacked standing to sue and that the trustee could not benefit from tolling agreements entered into by Morgan Stanley and certain other certificate holders.

At the recent argument, Deutsche Bank’s attorney argued that the certificate holders were not barred from filing the summonses with notice and that the trustee could benefit from them, because they were filed derivatively.  In addition, he argued that Deutsche Bank was a third-party beneficiary of the tolling agreements at issue because the agreements applied to representatives of the certificate holders and that Deutsche Bank, as trustee, was a representative.  Morgan Stanley’s attorney argued that “merely purporting” to file derivatively did not allow the certificate holders to sidestep contractual provisions that deprived them of standing to sue.  He also argued that Deutsche Bank’s reliance on the word “representative” in the tolling agreements was misplaced because, read in its entirety, the provision at issue did not apply to the trustee, and the trustee represents the whole group of certificate holders, not any individual one.

The panel did not render a decision at the hearing.

$500 Million Suit Against UBS Dismissed on Jurisdictional Grounds

On December 7, New York Supreme Court Justice Eileen Bransten dismissed a $500 million lawsuit against UBS AG (“UBS”) brought by Ace Decade Holdings Limited (“Ace Decade”), a British Virgin Islands company, for lack of personal jurisdiction and forum non conveniens.  Ace Decade alleged that UBS fraudulently induced it to invest in shares of a company publicly traded in Hong Kong through a UBS-affiliated intermediary in Hong Kong, an affiliation that UBS concealed.  Ace Decade’s investment allegedly resulted in a loss of more than $500 million.

Ace Decade pled that both general and specific jurisdiction existed because UBS had systematic contact with New York and transacted business in New York that gave rise to the claims: the “cause of action [arose] from a transaction that UBS induced Ace Decade to make…months after Ace Decade moved to New York,” “UBS made misrepresentations to Ace Decade over several months while they were in New York,” and “UBS’s tortious acts injured Ace Decade in New York.”

In its motion to dismiss, UBS argued that under Daimler AG v. Bauman, 134 S. Ct. 746, 754 (2014), UBS is not subject to general jurisdiction in New York because UBS is incorporated in and has its principal place of business in Switzerland.  Furthermore, UBS argued that New York lacked specific jurisdiction because the transactions giving rise to Ace Decade’s claims occurred in Hong Kong, not New York.  Lastly, UBS argued that New York was not a convenient forum for several reasons, including the fact that trying the case in New York would impose undue hardship on UBS because almost all relevant witnesses and documents were abroad.

Justice Bransten agreed with UBS and held that the Court lacked personal jurisdiction.  She stated that “the record makes clear that the ‘original critical events’ associated with the [i]nvestment occurred in Hong Kong.”  The fact that Ace Decade moved to New York after entering into all relevant agreements and committing to make an investment was not a sufficient basis for jurisdiction.  The Court also concluded that even if it could properly exercise jurisdiction, the action would be dismissed based on forum non conveniens because all relevant documents and witnesses are located in Hong Kong.