Deutsche Bank RMBS Fraud Claims Upheld
On April 26, 2013, New York State Supreme Court Justice Shirley Werner Kornreich issued an order upholding common law fraud claims asserted against several affiliated Deutsche Bank entities in connection with the offering and sale of more than $150 million of residential mortgage-backed securities (“RMBS”). The claims at issue in the individual, non-class action arise from 24 separate RMBS purchases made in 14 different offerings, which were structured and sold by defendants. As described by the court, the complaint generally alleges that defendants – who served as the sponsors, depositors and underwriters for the 14 RMBS offerings at issue – “concealed the true risk of the RMBS by engaging in fraudulent conduct in the underwriting of mortgages, packaging these risky mortgages into securities, obtaining an investment grade rating from the credit agencies by providing them with false or misleading data, and, finally, marketing the RMBS to plaintiffs as low-risk investments, knowing full well that the RMBS were toxic.” The plaintiffs are five special purpose investment vehicles – Phoenix Light SF Limited (“Phoenix”), Silver Elms CDO PLC, Silver Elms II CDO PLC, Kleros Preferred Funding V PLC and Blue Heron Funding V Ltd.
As a preliminary matter, the court’s opinion addressed defendants’ argument that Phoenix lacked standing to sue based on supposed deficiencies in the complaint’s allegations that Phoenix had been assigned the right to sue on its asserted fraud claims. The court rejected this argument, finding that “defendants [had] not submitted documentary evidence that refutes Phoenix’s contention that its acquisition of ‘all title, rights and causes of action’ from the Assignors includes fraud claims.”
The court similarly rejected defendants’ argument that plaintiffs’ claims were barred by the applicable statute of limitations, which was premised on the contention “that plaintiffs were on notice of the fraud in 2008 because information concerning the falsity of the underlying loan data was widely reported by numerous major newspapers.” In rejecting defendants’ argument, the court determined that “information reported in newspapers about the possible falsity of loan data is insufficient to put plaintiffs on notice of a defendant’s intent to defraud.” The court further noted that “[d]efendants cannot turn [the] protection [afforded by New York’s requirement that fraud be pled with particularity] on its head by contending that the time to bring a fraud claim begins to run before a viable complaint can be filed.” Accordingly, the court found that the statute of limitations “did not begin to run in 2008,” and that plaintiffs’ claims were timely as a result.
In addressing the merits of plaintiffs’ fraud claims, Justice Kornreich’s opinion focused on the complaint’s allegations that, before acquiring the mortgage loans underlying plaintiffs’ certificates, “Deutsche Bank hired non-party Clayton Holdings, Inc. (Clayton) to conduct due diligence on the loans to determine if they complied with their underwriting guidelines and to ascertain if the property valuations were accurate.” As further alleged in the complaint, “Clayton tested a sample of the loans and determined that approximately 35% of the tested loans did not comply with the stated underwriting guidelines and/or were supported by false or inflated appraisals.” Deutsche Bank, however, “did not inform plaintiffs of these findings and did not disclose them in the offering materials,” choosing instead to “use this information to negotiate a lower purchase price for itself from the originators.” Moreover, “Deutsche Bank profited by obtaining millions of dollars in fees from the sale of these RMBS and also made billions of dollars by shorting other RMBS through credit default swaps,” while plaintiffs “lost virtually their entire $150 million investment in the subject RMBS.”
In upholding plaintiffs’ fraud claims, Justice Kornreich found that “the allegations that Deutsche Bank made false representations in the RMBS offering materials that flatly contradict the reality depicted in [due diligence provider] Clayton’s report to induce plaintiffs to purchase RMBS are sufficient to state a claim for fraud and fraudulent inducement.”
Phoenix Light SF Ltd. v. ACE Sec. Corp., 975 N.Y.S.2d 369, 2013 N.Y. Misc. LEXIS 1723 (Sup. Ct. 2013).