The securitization of mortgage-related assets into private-label residential-mortgage-backed securities (RMBS) during late 2005 through 2007 has been a root cause of the financial crisis in the United States. And the tremendous decline in value of many of those RMBS has spawned many putative class-action lawsuits against investment banks and the rating agencies. Many investors in those RMBS appear to have decided that the best course for potential recovery of their losses is to allow class-action lawsuits involving their RMBS to run their course. But several recent rulings in RMBS-related lawsuits have resulted in the named plaintiffs having standing to sue only on behalf of themselves and members of a class that hold the same bonds held by the named plaintiffs. The interests of RMBS investors who did not purchase the same bonds are being excluded from suit. Investors who thought that their interests were represented in class-action lawsuits might find themselves still trapped with their toxic assets, with no pending means for recovery of their losses.
Background
As problems with mortgage-underwriting standards and other RMBS issues started to surface, a number of class-action lawsuits were filed against the banks that issued the securities and, in some instances, the rating agencies who gave the securities high ratings. The plaintiffs in many of those lawsuits alleged violations of Sections 11, 12, and 15 of the Securities Act of 1933, based on alleged misstatements and omissions in the offering documents. Over time, these cases were consolidated into at least twenty-five class-action lawsuits that are venued in federal courts across the country. These cases potentially encompassed the vast majority of the RMBS issued in late 2005 through 2007-a time period during which mortgage-underwriting standards deteriorated, resulting in skyrocketing defaults.
Typically, the plaintiffs in these cases hold only a few bonds, at most, related to an SEC shelf-registration statement (each offering under a shelf-registration statement has its own prospectus supplement). The number of RMBS related to any given registration statement can range from as few as 10 or 12 to more than 100. The class-action structure of the plaintiffs' complaints typically seek to include, as part of the alleged class, all other bonds sold under the same registration statement affecting the named plaintiff. The collective, ambitious scope of these class-action complaints would include, as potential class members, many of the investors in RMBS in late 2005 through 2007. But a series of recent decisions resulting from defendants' motions to dismiss have limited the scope of these actions to the named plaintiffs' interests alone.
Motions to Dismiss
In at least nine of the consolidated class-action cases pending across the country, courts have issued decisions in response to defendants' motion to dismiss that are remarkably consistent in that the courts have universally rejected the notion that the named plaintiffs have standing to sue on behalf of RMBS bondholders who do not hold the same bonds as the named plaintiffs. These courts have held that only bonds held by the named plaintiffs can remain in the case; claims regarding other bonds are dismissed.
Judge Kaplan, in the United States District Court for the Southern District of New York-in granting in part a defendants' motion to dismiss the class-action complaint in In Re Lehman Brothers Securities and ERISA Litigation-decided that the named plaintiffs had no standing to sue on behalf of other bondholders. Because the named plaintiffs in that case had only purchased bonds in six of the ninety-four offerings under the registration statements, all of the claims arising from the other eighty-eight offerings were dismissed:
- Standing is a threshold constitutional requirement that mandates an allegation of injury traceable to the conduct of which Plaintiffs complain. It can not be dispensed with by styling the complaint as a class action. In a class action, as in any other lawsuit, the named plaintiffs must "show that they personally have been injured, not that injury has been suffered by other, unidentified members of the class . . . they purport to represent." . . .
- Named plaintiffs have purchased in six of the ninety-four offerings. They have not alleged any personal injury stemming from the other eighty-eight. They therefore have no standing to assert those claims. . . . In consequence, all claims arising from the eighty-eight offerings in which none of the plaintiffs purchased any securities are dismissed.
Courts in other RMBS class actions have followed Judge Kaplan's reasoning, dismissing claims regarding all of the bonds that are not held by the named plaintiffs. These decisions have resulted in 85% of the claims regarding other bonds being dismissed from the litigation:
|
Case |
Remain |
Dismiss |
Total |
|
New Jersey Carpenters Health Fund et all v. RALI Series 2006-QO1 et al. |
4 |
55 |
59 |
|
New Jersey Carpenters Vacation Fund and Boilermaker National Pension Fund v. The Royal Bank of Scotland Group et al. |
2 |
13 |
15 |
|
City of Ann Arbor Employees Retirement v. Citigroup Mortgage Loan Trust |
2 |
16 |
18 |
|
NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co. et al. |
2 |
15 |
17 |
|
In Re Wells Fargo Mortgage Backed Certificates Litigation |
17 |
37 |
54 |
|
Public Employees' Retirement System of Mississippi v. Merrill Lynch & Co. et al. |
19 |
65 |
84 |
|
In Re Indy-Mac Mortgage-Backed Securities |
15 |
91 |
106 |
|
In Re Morgan Stanley Mortgage Pass-Through Certificates Litigation |
2 |
29 |
31 |
|
Totals |
63 |
321 |
384 |
In the aggregate, these nine class-actions lawsuits (including the Lehman Bros case before Judge Kaplan) represented 478 RMBS offerings. But claims regarding 409 of the RMBS-or 85%-were dismissed for lack of standing, and thus only 69 bonds remain in the lawsuits. Investors holding any of the 409 bonds that were dismissed will not share in any potential recovery. Assuming that courts will continue to issue similar opinions in other RMBS class-action cases, it is reasonable to assume that a substantial number of RMBS in other class-action lawsuits will also be dismissed for lack of standing.
Statute of Limitations
The statute of limitations under Sections 11, 12 and 15 of the Securities Act of 1933 is one year from discovery or three years from either the offering or sales date of the security, depending on the claim. (Statutes of limitation under state laws vary.) While class-action claims regarding a bond are pending, the federal statute of limitations affecting the bond is potentially tolled. But after the claims affecting a bond have been dismissed, defendants will surely argue that the statute has begun to run again. Determining whether the statute has run on any particular bond might require a bond-by-bond and jurisdiction-specific analysis. In some jurisdictions and for some bonds, the federal statute of limitations might have already expired; for others, the statute might be running now (or still tolled).
Alternative Avenues of Potential Recovery
Investors whose bonds were dismissed from would-be class actions might have avenues for potential recovery through individual lawsuits alleging violations under Sections 11, 12 and 15 or violations of various state-law claims such as common-law fraud and negligent misrepresentation or claims under state securities or blue-sky laws. State-law claims would be state specific, of course, both in terms of the elements of the claims and the applicable statutes of limitations, each of which would require an evaluation.
In general, statutes of limitation are longer under common-law claims than they are under Sections 11, 12 and 15 of the Securities Act of 1933. But we are unaware of any individual actions that have been commenced for an RMBS that was affected by a dismissal of claims in one of the class-action lawsuits, although some individual actions have been commenced recently (July 2010) that seem to follow this potential avenue for relief:
- Cambridge Place Investment Management Inc. v Morgan Stanley & Co, et al. (Massachusetts state court)
- The Charles Schwab Corp. v. Merrill Lynch, Pierce, Fenner & Smith Inc. et al. (California state court)
- Maine State Retirement System v. Countrywide Financial Corp, et al. (United States District Court for the Central District of California)
These types of individual actions might provide investors with an alternative means of potential recovery for their RMBS.
Conclusion
Recent court rulings have dismissed claims for 85% of the RMBS that had initially been included under the scope of the claims in those cases. Other court rulings to come might contribute to these numbers, leaving the vast majority of bonds issued in late 2005 through 2007 dismissed from class-action lawsuits. Investors in those RMBS who want to seek recovery through litigation will need to find some avenue for relief other than through participation as a would-be class member. The best means for relief, for some investors, might be through individual actions alleging federal-law claims or state-law claims. If investors do nothing, they might remain trapped with their toxic assets and losses.
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