In the latest bit of welcome news for mortgage-backed securities plaintiffs, the U.S. Court of Appeals for the Second Circuit has reinstated a class action brought on behalf of investors in a $1.32 billion MBS offering underwritten and sold by Royal Bank of Scotland Group PLC, Wells Fargo & Co, and several other big banks. The decision gives the plaintiffs hope that they can revive claims related to five other offerings in the case that once had a combined value of about $6 billion.
Reversing a March 2012 ruling by U.S. District Judge Deborah Batts in Manhattan, the appeals court on Friday allowed investors to go forward with claims that the banks misrepresented the underwriting standards they used in connection with a security called NovaStar Funding Trust, Series 2007-2. The court ruled that the allegations in the complaint are "suggestive of, rather than merely consistent with, a finding of liability."
Friday's decision, penned by Circuit Judge Robert Katzmann, also instructs Batts to reconsider a 2011 decision in which she trimmed the case on standing grounds. Katzmann wrote that Batts's prior ruling is at odds with NECA-IBEW Health & Welfare Fund v. Goldman Sachs, a September 2012 ruling by the Second Circuit that reversed a win for Goldman. In NECA, as we reported, the court ruled that investors can have standing to sue over mortgage-backed securities that share common loan originators even if the plaintiffs didn't directly invest in each security.
Joel Laitman and Christopher Lometti of Cohen Milstein Sellers & Toll brought the case in 2008 on behalf of New Jersey Carpenters Health Fund. They allege that three banks--RBS, Wells Fargo, and Deutsche Bank AG--misrepresented in offering documents the underwriting standards they used for six trusts backed by subprime mortgages originated by NovaStar Mortgage Inc. The trusts, marketed between June 2006 and May 2007, were each valued at more than $1 billion. According to Cohen Milstein, half of the underlying mortgages eventually defaulted, and ratings agencies downgraded the securities because of allegedly lax underwriting.
Batts gutted the case in March 2011, ruling that NJ Carpenters Health Fund could not assert claims relating to trusts it didn't actually invest in. Since the fund only invested in one of the trusts at issue, NovaStar Funding Trust, Series 2007-2, Batts' ruling shrunk the case dramatically. Then, in March 2012, Batts dismissed the case entirely, ruling that Cohen Milstein presented insufficient evidence that investors were misled about the remaining trust.
With Friday's ruling, the Second Circuit may have undone two years of damage to Cohen Milstein's case. The court reversed Batts's March 2012 ruling, finding that the plaintiffs had alleged enough evidence to survive a motion to dismiss as to NovaStar Funding Trust, Series 2007-2. And, based on NECA, the court urged Batts to consider reinstating all the original claims. That part of the opinion didn't come as a surprise, since the Second Circuit's ruling against Goldman in NECA has already proven very useful to plaintiffs in MBS class actions, as we reported here and here.
Laitman told us Monday that he expects the defendants to argue on remand that NECA is distinguishable from this case. But he said he's optimistic that Batts will find NECA on point and will reinstate the claims relating to the five other trusts.
Thomas Rice of Simpson Thacher & Bartlett, who represents the bank defendants, declined to comment. Novastar is represented by William Alderman of Orrick, Herrington & Sutcliffe.
