Judge Batts has had an interesting month, moving from the Madoff Ponzi scheme (see my May 31 post) to the role of the ratings agencies in the subprime meltdown. In New Jersey Carpenters Health Fund v. Nova Star Mortgage, plaintiffs sought recovery for $7 billion in losses arising from their investment in Nova Star’s supposedly triple A rated mortgage backed securities. Since the triple A rating evaporated soon after the securities were issued in Spring of 2007 (most were downgraded to junk), plaintiffs also sued Nova Star’s ratings agencies (Moody’s/McGraw-Hill). The claims were brought as strict liability claims under Section 11 based on misstatements in the offering documents for Nova Star’s securities, not as fraud claims.
Nova Star itself got at least a temporary pass when the claims against it were dismissed without prejudice because they were based on a recitation of facts regarding the mortgage market, not on any specific misleading statements in the relevant offering documents: “While the Court is aware that Plaintiff is not required to meet the heightened pleading requirement under Rule 9(b) [for fraud claims], more is required than what Plaintiff has done here: 102 pages of “the subprime market melted down and Defendants were market participants, so they must be liable for my losses in my risky investment.”
Plaintiffs alleged that the ratings agencies should be liable as “underwriters” because they used their models to advise Nova Star on the potential value of Nova Star’s mortgage loans, helped structure the Nova Star securities, and participated in the drafting and dissemination of the offering documents. According to Judge Batts, “Plaintiff rests its claim [against the rating agencies] on the assertion that the term “underwriter” includes not only those who have purchased securities from an issuer for resale, but also those who “perform some act (or acts) that facilitates the issuer’s distribution.”
But, the rating agencies also dodged the bullet as Judge Batts held that even if their advice had some overlap with underwriting, they did not fit the definition of “underwriter” in the securities laws. “The Rating Agency Defendants’ alleged participation may have been in loan valuing, Certificate structuring to secure particular ratings, and drafting and disseminating the Offering Documents. However, the [complaint] is devoid of the activity necessary to show that the Rating Agency Defendants participated in the relevant ‘undertaking’—that of purchasing the securities here at issue, the Certificates—from the issuer with a view to their resale.”
Further, the rating agencies’ role did not support a claim that they “controlled” Nova Star’s issuance of securities for purposes of the securities laws. Although “the Rating Agency Defendants had considerable ability to advise, influence and work with the NovaStar and Underwriting Defendants with respect to virtually all stages of the securitization process… these allegations do not rise to the level of demonstrating that the Rating Agency Defendants had … control.”
As I said, Judge Batts has been busy with interesting cases. If you also want her take on pleading derivative claims against Morgan Stanley’s directors for failing to disclose the company’s actual financial conditon during the mortgage crisis (dismissed because a pre-suit demand alerting them to the problems would not have been futile), and pleading fraud claims against its officers (dismissed without prejudice as to loss causation, but with plenty of room to amend) take a look at her recent opinons in Staehr v. Morgan Stanley, and Stratte–McClure v. Morgan Stanley.
Finally, we updated the design of the blog last month – any comments or reactions on that are welcome, too.