A while back Bear Stearns sold some mortgage-backed securities to a thing called FSAM, which was basically a subsidiary of Franco-Belgian monstrosité Dexia, and FSAM sold the RMBS on to Dexia, and the mortgages were all terrible, and their value dropped, and Dexia sued JPMorgan, currently the proud owner of Bear Stearns, and today JPMorgan won:
JPMorgan Chase & Co has won the dismissal of the vast majority of a lawsuit accusing it of misleading the Belgian-French bank Dexia SA into buying more than $1.6 billion of troubled mortgage debt.
The decision, made public Wednesday by U.S. District Judge Jed Rakoff in Manhattan, is a victory for the largest U.S. bank, in a case that gained notoriety after emails and other materials were disclosed that suggested the bank and its affiliates knew the debt was toxic, but sold it anyway.
Despite the notoriety this is kind of a boring case: it's a garden-variety RMBS fraud case; Bear said various things in the offering documents that maybe weren't so true, and the market crashed and the investors lost a lot of money, and now they're mad. There's like a zillion of those cases; actually there's like a zillion of those cases just against Bear Stearns (here are two).
But the fact that the bank won is pretty interesting? Like, if JPMorgan can win a garden-variety RMBS case then so can anyone? I guess? So I suppose it's worth spending a minute figuring out what this means for other banks.
We run into immediate problems because it's hard to know exactly why JPMorgan won; the judge's order is two pages of "opinion to follow." But reading JPMorgan's submissions you can get behind CNBC's interpretation:
Rakoff's decision was based on an arcane point of law that says fraud claims don't transfer to secondary buyers unless they are specifically assigned. ... Rakoff's decision could drastically cut future liabilities related to mortgage-backed securities suits for JPMorgan and other banks.
I don't know that it's that arcane but here is how JPMorgan's lawyers put it:
It is undisputed that the Dexia Entities did not purchase the [RMBS] Certificates at issue. Instead, the Complaint alleges those entities have standing because FSAM, the entity that did purchase the Certificates, assigned the Certificates, “including all ‘right, title and interest’ in the RMBS assets (including all rights and remedies sought in this action), to [them] pursuant to certain intercompany agreements”. ...
Under New York law, an assignment of fraud and other tort claims must be explicit. ... New York state and federal courts have interpreted the requirement that an assignment of tort claims be “explicit” to mean that, while assignment of all right, title and interest in a transaction may suffice to transfer tort claims, the assignment of all right, title and interest in an asset—like the “Delivery” at issue here—does not.
There's a lot more dithering around about mechanics but that's the gist: Bear (fraudulently?) sold the newly-issed RMBS to FSAM; FSAM "transferred all right, title and interest" in those RMBSes to Dexia, and Dexia sued for the original fraud. But that doesn't work, because FSAM didn't explicitly transfer the right to sue for original fraud to Dexia, and "all right, title and interest" doesn't cover that. So Dexia can't sue.
CNBC's conclusion that this ruling "could drastically cut future liabilities related to mortgage-backed securities suits" seems right: if you bought RMBS directly from underwriters, and got out before the market tanked, then you don't have a fraud claim (you didn't lose money) and perhaps neither does anyone else, since they weren't defrauded by the underwriter.
For one bank, though, the result might be more liability. You know where we've seen the "right, title and interest" thing before? Once upon a time AIG sold a ton of Countrywide RMBSes to the Federal Reserve's Maiden Lane vehicles, at a steep loss, transferring "all right, title and interest" in those RMBSes to Maiden Lane. The Fed then settled original-underwriting-fraud claims over those RMBSes with BofA/Countrywide, for a fraction of a penny on the dollar. AIG has been banging around in court saying that the Fed couldn't do that, because those claims belonged to AIG, not the Fed.
Doesn't this case suggests that AIG might be right? I kind of hope so, one because that Fed settlement was pretty shady, and two because it fills me with inexplicable joy to think that a strongly pro-bank ruling that generally cuts off a lot of mortgage-fraud liability could nonetheless create more mortgage fraud liability for BofA/Countrywide. It just seems right.
But what do I know, the reasoning for this ruling might be different. JPMorgan's motion for summary judgment contained other theories. Here's a good one: even if the prospectuses for these RMBSes were packed full of lies, that wouldn't be fraud, because no one read them:1
Plaintiffs did not review prospectuses or prospectus supplements in connection with their decision to purchase the Certificates. In fact, Jake Hendrickson, the Portfolio Manager ..., testified unequivocally that FSAM’s investment personnel did not review such documents:
Q. In the process of reviewing a new issue deal, what, if any, role would reviewing the prospectus supplement or other offering documents play, if any, in your investment decision?
A. It would -- they were not available.
Q. Okay. You were making your investment decisions before the pro supps were available, correct?
Q. And that’s the case in general and also with respect to the deals at issue in this case, right?
Q. So you didn’t read or review the prospectus supplements, right? …
A. Not prior to purchase.
Q. Okay. And the analysts who worked for you, Mr. Albus and the others, they didn’t do it either prior to purchase, right?
A. Correct. …
Q. Okay. And with respect to the specific deals at issue in this case, you don’t recall anything different, in general, nobody would review the prospectus supplements for secondary market purchases, correct?
A. In general, no.
A little while back I expressed some doubt about that theory in a different RMBS-fraud case, saying that "the securities laws maintain the polite fiction that people read offering documents, if for nothing else to keep the lawyers who write those documents from confronting too directly the meaninglessness of their existence." Asking them the question directly seems almost like cheating. If no one reads the offering documents, why bother writing them?2 And, really, why bother lying in them?
JPMorgan wins dismissal of most Dexia mortgage claims [Reuters]
JPMorgan Court Win Changes Banks' Liability Picture [CNBC]
Dexia SA v. Bear, Stearns & Co.: Motion for Summary Judgment, Opposition, Reply, Decision [SDNY via Bloomberg Law]
1.JPMorgan quotes another, even more succinct Q&A: "I just want to make sure, you’ve never read a prospectus in connection with the purchase of a residential mortgage-backed security? A. No." I imagine the next question was "are you really sure?" Raise your hand if you're in charge of investing in structured credit securities and have never read a prospectus.
2.I think the rough answer is that the SEC's idea of when the investment decision is made involves closing of an offering (T+3 or whatever), while the market's idea involves pricing of the offering (T+0). So if you put out a prosupp after pricing but before closing then you've satisfied the SEC but obviously no one's read it before making their investment decision, and why would they read it after?