The Second Circuit Court of Appeals Hands Plaintiffs a Significant Victory in Goldman Sachs

September 6, 2012

On September 6, 2012, the Second Circuit Court of Appeals in New York City issued a precedent-setting ruling when it revived a lawsuit accusing Goldman Sachs of misleading investors in connection with billions of dollars in mortgage-backed securities offerings. The court’s decision overturned key parts of a dismissal by U.S. District Judge Miriam Goldman Cedarbaum that had shut down the entire lawsuit in 2010. The appellate decision allows institutional investor lead plaintiff NECA-IBEW Welfare Trust Fund (the “Fund”) to resume prosecuting a class action against several Goldman Sachs entities on behalf of investors in various mortgage-backed securities.

The lawsuit had its genesis in a series of securities offerings during 2007, when a Goldman Sachs unit sold investors billions of dollars in mortgage-backed certificates in 17 separate offerings using the same common shelf registration statement and supplemental prospectuses for each offering (the “Certificates”). In addition, each of the offerings’ securities were further divided into various tranches, or levels of seniority. Plaintiffs alleged that the shelf registration statement and prospectuses contained false and misleading statements and omissions as to the Certificates’ true nature, risk, and overall quality, and sued several Goldman Sachs units under the Securities Act of 1933. While the Fund had purchased Certificates in just two of the offerings, it sought to represent a class composed of purchasers in all 17 offerings based upon the common misstatements and omissions in the offering materials.

In a series of rulings – some made orally from the bench – Judge Cedarbaum whittled away at the lawsuit before ultimately dismissing it with prejudice. Although §11 of the Securities Act requires only diminished value to establish a redressable injury, Judge Cedarbaum held that the Fund had not been injured because (i) it was still receiving monthly payments from its Certificates, and (ii) it had not yet sold the Certificates at a loss. In addition, Judge Cedarbaum held that the Fund did not have standing to represent the other members of the as-yet-uncertified class of purchasers in all 17 offerings; she believed that the Fund could represent only those putative class members who had purchased Certificates from (i) the same two offerings that the Fund had, and (ii) in the same tranches.

Following briefing and argument in February 2012, on September 6, 2012, the Second Circuit vacated key parts of the lower-court dismissal in a landmark published opinion. The Second Circuit held that the Fund had class standing to assert claims on behalf of purchasers of securities that were backed by pools of mortgages originated by the same lenders who had originated mortgages backing the Fund’s securities. The court noted that, given those common lenders, the Fund’s claims as to its purchases implicated “the same set of concerns” that purchasers in several of the other offerings possessed. The court also rejected the notion that the Fund lacked standing to represent investors in different tranches. It held that the varying payment-priority levels across the tranches did not raise a “fundamentally different set of concerns” so as to defeat class standing, and noted the well-established rule that individual damages are not enough to defeat class standing.

The Second Circuit also made short work of Judge Cedarbaum’s damages holding. The key to §11 injury under that statute, the panel said, was not the securities’ “market price,” but rather whether the Fund had “plausibly” alleged a decline in their value. In this case, the Fund had done just that with “well-pleaded facts” showing that rating agencies had downgraded the Certificates, and allegations that purchasers were now exposed to more risk concerning both the timing and amount of absolute cash flow to be received. Whether the Certificate holders still received monthly payments was not determinative.

By vacating and remanding key parts of the putative class action lawsuit, the Second Circuit has issued a watershed ruling in these types of cases. Many district courts around the country have been dismissing mortgage-backed securities actions based upon the same purported lack of standing by lead plaintiffs, and defendants are insisting that the securities purchasers in these actions have not incurred a requisite injury redressable under the federal securities laws. This latest decision rejects those arguments. And, while the Second Circuit’s contrary decision is not binding on courts outside of its jurisdiction, the court’s reputation for considered analysis in securities cases may prove to be influential. Legal and financial media have reported that the decision represents a “substantial victory” for plaintiffs in these types of suits, and that the Second Circuit has provided a “potent tool” for fighting defendants’ class-standing arguments.

Robbins Geller appellate partner Joseph D. Daley, who argued the appeal (with the briefing aided by litigation partner Arthur C. Leahy and litigation associate Nathan R. Lindell), applauded the Second Circuit’s rulings. “We knew all along that the district court had erred in several significant respects. The ‘damages’ ruling was patently wrong, and we thought that the ‘class standing’ ruling, both on a certificate and tranche level, required a more-nuanced analysis than had been given by the district court. It was gratifying to see the Second Circuit undertake that analysis and revive the suit for the class members.”

NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145 (2d Cir. 2012).

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