In re Bear Stearns Mortg. Pass–Through Certificates Litig.

• Decision Date: 30 March 2012
• Docket Number: No. 08 CIV. 8093(LTS)(KNF).,08 CIV. 8093(LTS)(KNF).
• Citation: 851 F.Supp.2d 746
• Parties: In re BEAR STEARNS MORTGAGE PASS–THROUGH CERTIFICATES LITIGATION. This Document Relates to All Actions.
• Court: U.S. District Court — Southern District of New York

851 F.Supp.2d 746

In re BEAR STEARNS MORTGAGE PASS–THROUGH CERTIFICATES LITIGATION. This Document Relates to All Actions.

No. 08 CIV. 8093(LTS)(KNF).

United States District Court, S.D. New York.

March 30, 2012.

Cohen Milstein Sellers & Toll PLLC by Joel P. Laitman, New York, NY, Bernstein Litowitz Berger & Grossman LLP by David R. Stickney, San Diego, CA, Kohn, Swift & Graf, P.C. by Joseph C. Kohn Philadelphia, PA, for Plaintiffs and the Proposed Class, Police and Fire Retirement System of the City of Detroit.

Bingham McCutchen LLP by Kenneth I. Schacter, Esq., Theo J. Robins, Esq., Simpson Thacher & Bartlett LLP by Michael J. Chepiga, William T. Russell, Jr., Morrison & Foerster LLP by Joel C. HaimsRuti Smithline, Kramer Levin Naftalis & Frankel LLP by Dani R. James, Greenberg Traurig, LLP by Richard A. Edlin, Ronald D. Lefton, Candace Camarata, New York, NY, for Defendants Bear, Stearns & Co. Inc., J.P. Morgan Securities, Inc., EMC Mortgage Corporation, Structured Asset Mortgage Investments II Inc., Bear Stearns Asset Backed Securities I, LLC and Josepth T. Jurkowski, Samuel L. Molinaro, Jr., Jeffrey Mayer.

Opinion and Order

LAURA TAYLOR SWAIN, District Judge.

Plaintiffs have filed a Third Amended Complaint (“TAC”) asserting claims on behalf of a putative class of investors against various Bear Stearns entities, Structured Asset Mortgage Investments II, Inc., (“SAMI”), and several individuals for violations of Sections 11, 12(a)(2), and 15 of the Securities Act of 1933 (the “33 Act”), 15 U.S.C. §§ 77k, 77 l(a)(2), 77 o, in connection with the sale of mortgage-backed security (“MBS”) pass-through certificates (“Certificates”)that were offered for sale by means of documents that allegedly contained untrue statements and material omissions. ¹ Defendants have moved to dismiss the TAC pursuant to Federal Rule of Civil Procedure 12(b)(6) for failure to state a claim. The Court has jurisdiction of this matter under 28 U.S.C. § 1331. For the reasons stated below, Defendants' motion is granted in part and denied in part.

Background

I. Mortgage–Backed Security Allegations

The following facts are taken from the TAC, the documents incorporated by reference therein, and other documents of which the Court may properly take judicial notice. Plaintiffs' factual allegations are taken as true for purposes of this motion practice.

On March 10, 2006, and March 31, 2006, SAMI Depositor and Bear Stearns Depositor, respectively, filed Registration Statements with the Securities and Exchange Commission (“SEC”) indicating their intention to sell $50 billion in MBS Certificates. (TAC ¶ 4.) ² The Registration Statements and the accompanying Prospectus and Prospectus Supplements (collectively referred to as “Offering Documents”) contained untrue statements and omissions of material fact regarding the underwriting and appraising standards, the value of the collateral, the amount of credit support for each offering, and the credit ratings of the Certificates. ( Id. ¶ 9.) These omissions and misstatements are alleged to have caused the Offering Documents to be materially false and misleading. ( Id.)

In brief, an MBS is created when a “depositor” buys an inventory of mortgages (or “loan pool”) from a primary lender (or “originator”).³ After the depositor obtainsthe loan pools, it places them in issuing trusts, securitizes them by organizing the loans into “tranches,” and issues securities backed by the loan pools. The depositor uses the borrowers' monthly payments as the revenue stream to pay investors who have bought the securities. Each tranche has a different risk profile and is assigned a credit rating—here, by the rating agencies S & P and Moody's (“Rating Agencies”).⁴ All of the tranches from which named Plaintiffs purchased Certificates were initially rated AAA, which ostensibly indicated the lowest likelihood of default. ⁵ (TAC ¶¶ 40–41.)

Because the value of an MBS depends on the ability of the borrowers to repay the principal and interest on the underlying loans as well as the adequacy of the collateral in the event of default, thorough assessments of the borrowers' creditworthiness and the homes' values are paramount. ( Id. ¶ 3.) To this end, the MBS packaging process has three principal levels of quality control. First, underwriting and appraisal standards are crafted to assist the originator in weeding out excessively risky loan applications; second, the depositor reviews the loan pools to ensure that they meet the originator's stated underwriting standards ( id. ¶¶ 55–58); and third, the Rating Agencies review the securities' risk profiles and assign ratings. ( Id. ¶¶ 6, 184–85.)

The TAC details a systemic breakdown at each level, one that resulted largely from the misalignment of incentives in the MBS industry. Under the traditional mortgage investment model, the loan originator held the mortgage to maturity and made its profits from the borrower's payment of interest and repayment of principal-an arrangement that gave the originator an economic interest in ensuring that (1) the borrower had the financial wherewithal to repay the promissory note, and (2) the underlying property had sufficient value to cover the lender's losses in the event of default. ( Id. ¶¶ 44–47, 168.) With the advent of securitization, originators quickly parted with the mortgages—and the attendant risk of default—by selling them to investors. ( Id. ¶ 169). The primary source of profit shifted from borrowers' interest payments to loan fees and sales revenue. Largely free from the risk of defaults, originators began pushing high-risk loan products and deviating from underwriting and appraisal standards in an attempt to maximize loan volume. ( Id. ¶¶ 169–70). Wall Street banks like Bear Stearns, which profited enormously from the packaging and sale of MBS, were content to overlook the widespread degradation of underwriting and appraisal practices. ( Id. ¶¶ 56–67, 171.) The final guarantors of the securities' quality, the Rating Agencies, were equally compromised. The Rating Agencies' models were outdated and failed to properly account for the increased riskiness of new loan products. ( Id. ¶ 196.) Compounding the problem, banks such as Bear Stearns shopped for Rating Agencies willing to assign their securities top credit ratings, pitting the Agencies against each other and provoking a race to the bottom in rating quality. ( Id. ¶¶ 195.)

A. Misrepresentations and Omissions Regarding Underwriting Standards and Appraisals

Plaintiffs allege that the Offering Documents misrepresented and omitted material facts regarding the underwriting standards applied by the loan originators. EMC Mortgage Corp. (“EMC”),⁶ Bear Stearns Residential Mortgage Corp. (“BSRM”), Countrywide Home Loans (“Countrywide”), American Home Mortgage (“AHM”), Wells Fargo Mortgage Corp. (“Wells Fargo”), Fieldstone Mortgage Corp. (“FMC”), as well as six additional corporations listed in the Prospectus Supplement, originated loans held by the trusts in which Plaintiffs invested.⁷ ( Id. ¶¶ 82, 94, 100, 126, 141, 157, 166.)

EMC was an originator of loans for the BSABS 2007–HE4, BSMF 2006–AR1, BSMF 2006–AR4, BSMF 2006–AR5, BALTA 2006–6, BALTA 2006–8, and BALTA 2007–1 trusts. ( Id. ¶ 82.) The Offering Documents represented that: “Each mortgaged property relating to an EMC mortgage loan has been appraised by a qualified independent appraiser” in accordance with the “Uniform Standards of Professional Appraisal Practice.” ( Id. ¶ 84.) The Offering Documents further represented that “underwriting standards are applied to evaluate the prospective borrower's credit standing and repayment ability and the value and adequacy of the mortgaged property as collateral” and elaborated that:

In determining whether a prospective borrower has sufficient monthly income available (i) to meet the borrower's monthly obligation on their proposed mortgage loan and (ii) to meet the monthly housing expenses and other financial obligations on the proposed mortgage loan, each lender generally considers, when required by the applicable documentation program, the ratio of such amounts to the proposed borrower's acceptable stable monthly gross income.

( Id. ¶ 83.) The Prospectus Supplement also stated that, while certain loans did not require income verification, the originators would “obtain a telephonic verification of the borrowers' employment without reference to income” and that “[b]orrower's assets are verified.” ( Id. ¶ 85.)

EMC systematically disregarded its own underwriting and appraisal standards and prioritized the pursuit of loan volume over loan quality. ( Id. ¶ 86.) According to one study, EMC breached its representations and warranties with respect to 89% of its loans by providing misrepresentations about borrower income, employment, and assets, and by failing to adhere to its own mortgage lending guidelines. ( Id. ¶ 88.) According to Matt Van Leeuwen, a former mortgage analyst with EMC, Bear Stearns forced EMC analysts to rush their loan analyses so that Bear Stearns would not have to hold the loans on its books. ( Id. ¶ 92.) Mr. Van Leeuwen further revealed that EMC analysts were allowed to falsify missing loan data, that the documentation level of the loans was often incorrectly identified, and that Bear Stearns would declare the loan “fit” rather than investigating to fill in the missing information. ( Id.) As of the date of the TAC, 98% ($7.3 billion) of the $7.45 billion of the initially AAA-rated Certificates from the seven trusts had been downgraded to or below speculative “junk” status. ( Id. ¶ 93.)

BSRM was an originator of loans for the BSMF 2006–AR1, BSMF 2006–AR4, BSMF 2006–AR5, and BSABS 2007–HE4 trusts. ( Id. ¶ 94.) The Prospectus Supplements described stringent underwriting standards. For example, the Prospectus Supplement for the BSMF Series 2006–AR1 Certificate Offering stated:

The BSRM Alt–A Underwriting Guidelines are intended to ensure that (i) the loan terms relate to the...