In a 66-page opinion issued yesterday, Judge Cote allowed the Federal Housing Finance Agency (the conservator of Fannie Mae and Freddie Mac) to proceed with Securities Act claims against UBS and affiliates for false statements in the registration statements of mortgage-backed securities. Judge Cote first rejected the argument that the FHFA’s claims were time-barred because of widespread reports of questionable loan practices by originators as early as 2007:
[T]he relevant question in assessing the timeliness of these claims is not when the GSEs were put “on notice” of the potential that the prospectuses included material misstatements or omissions, but rather when they, or a reasonably diligent plaintiff in their position, could have “discovered” that this was so with sufficient particularity to plead a Securities Act claim that would survive a motion to dismiss. To the extent defendants contend this standard was met as early as September 2007, that claim is significantly undercut by the assertion elsewhere in their motion to dismiss that FHFA has, even now, failed to allege facts sufficient to support a claim under the Securities Act. Recognizing this tension in their argument, defendants attempt to turn the tables on the plaintiff — asserting that “either the information in the SAC is insufficient to plead its claims, or Plaintiff had enough information to plead its claims prior to September 2007.” But defendants pose a false dichotomy. Between 2007 and the filing of this complaint an important event occurred that caused the GSEs to discover that the loans included in the securitizations they bought from defendants were not as advertised: the securities were downgraded from investment grade to near-junk status. The earliest of those downgrades occurred on February 15, 2008 for Freddie Mac, and March 3, 2008, for Fannie Mae — less than a year before September 6, 2008, when the GSEs were placed into conservatorship. The truth of the matter is that when the GSEs learned of the loan originators’ dubious underwriting practices says little about when they discovered the facts that form the basis of this complaint. FHFA’s claim here is not that the originators failed to scrutinize loan applicants adequately in general; it is that defendants failed to act diligently to ensure that, consistent with the representations in the offering materials, the originators’ questionable practices did not lead to the inclusion of non-conforming loans in the particular securitizations sold to the GSEs. The downgrade of the securities’ credit ratings and the results of the loan audit that FHFA undertook in response to that action are crucial to the Agency’s claim in this regard, since they are the only facts that connect the originators’ general practices to particular securities that the GSEs bought from defendants.
Judge Cote also rejected UBS’s claim that loan-to-value ratios in the registration statements were mere opinions and not actionable:
[I]n this case representations regarding LTV ratios — and the property value estimates that underlay them — were material to investors precisely because they believed that these figures represented the sincere judgments of professional appraisers with experience making these sorts of assessments. Without a doubt it is as important to investors that the appraisers truly believed the estimates on which the LTV ratios were built as it is that defendants — who tabulated and reported appraisal values following the completion of their due diligence inquiry — believed that this information was correct.
Finally, Judge Cote found that the FHFA had adequately alleged claims based on statements that the originators followed certain underwriting standards.
The SAC has plausibly alleged that the offering materials contained false statements regarding originators’ compliance with the underwriting standards. In support of this claim, the SAC relies primarily on the results of FHFA’s forensic review of individual loan files, which found, for example, that out of 996 randomly selected loans included in the MABS 2007-WMC1 and MABS 2006-WMC2 securitizations, approximately 78% were not underwritten in accord with the applicable underwriting guidelines. The claim is further supported by: investigations by government and private agencies that revealed underwriting failures by originators that contributed loans to the securitizations at issue here, confidential witness accounts, and, ultimately, the surge in defaults on the underlying mortgages and collapse of the certificates’ credit ratings. Taken together, these allegations are sufficient to render plausible FHFA’s assertion that the mortgage originators serially deviated from their mortgage underwriting standards. This conclusion is unaltered by statements in the offering materials that the standards were only “generally” followed. Such limiting language does not assist a Securities Act defendant faced with a plausible assertion that as few as 1/4 of the mortgages in a given loan pool conformed to the underwriting standards.