Federal Housing Finance Agency v. Nomura Holding America, Inc.
U.S. Court of Appeals9/28/2017
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15‐1872‐cv(L)
Fed. Hous. Fin. Agency v. Nomura Holding Am., Inc.
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
______________
August Term 2016
(Argued: November 18, 2016 Decided: September 28, 2017)
Docket Nos. 15‐1872‐cv(L), 15‐1874‐cv(CON)
FEDERAL HOUSING FINANCE AGENCY, as Conservator
for the Federal National Mortgage Association and the
Federal Home Loan Mortgage Corporation,
Plaintiff‐Appellee,
v.
NOMURA HOLDING AMERICA, INC., NOMURA ASSET
ACCEPTANCE CORPORATION, NOMURA HOME
EQUITY LOAN, INC., NOMURA CREDIT & CAPITAL,
INC., NOMURA SECURITIES INTERNATIONAL, INC.,
RBS SECURITIES, INC., f/k/a GREENWICH CAPITAL
MARKETS, INC., DAVID FINDLAY, JOHN MCCARTHY,
JOHN P. GRAHAM, NATHAN GORIN, N. DANTE
LAROCCA,
Defendants‐Appellants.*
______________
* The Clerk of the Court is respectfully directed to amend the
caption.
Before:
WESLEY, LIVINGSTON, and DRONEY, Circuit Judges.
Appeal from a May 15, 2015 final judgment and
earlier orders of the United States District Court for the
Southern District of New York (Cote, J.).
From 2005 to 2007, in the midst of the housing
bubble, defendants‐appellants, principals, and entities
associated with investment banks Nomura Holding
America, Inc. and RBS Securities, Inc. (collectively,
“Defendants”), sold to two government‐sponsored
enterprises, the Federal Home Loan Mortgage Corporation
(“Freddie Mac”) and the Federal National Mortgage
Association (“Fannie Mae”) (collectively, the “GSEs”),
seven certificates tied to private‐label securitizations
(“PLLs”), a subset of residential mortgage‐backed
securities. The prospectus supplements used in those
transactions represented that the loans supporting the
securitizations were “originated generally in accordance
with the underwriting criteria,” an important indication of
credit risk.
After the housing bubble burst in 2007, plaintiff‐
appellee the Federal Housing Finance Agency (the
“FHFA”), the conservator for the GSEs, sued Defendants in
the U.S. District Court for the Southern District of New
York for violations of the Securities Act of 1933 (the
“Securities Act”) and analogous state “Blue Sky laws,” the
Virginia Securities Act and the D.C. Securities Act. The
2
FHFA alleged, inter alia, that the above representation
regarding underwriting criteria was a material
misstatement. The FHFA also brought fifteen similar
actions against other financial institutions that also sold the
GSEs private‐label securitizations, and all of the actions
were consolidated before Judge Denise Cote. Fifteen of
these actions settled, resulting in more than $20 billion of
recovery for the FHFA. Only the case presently on appeal
went to trial. After conducting a bench trial, the District
Court issued a 361‐page opinion rendering judgment in
favor of the FHFA under Sections 12(a)(2) and 15 of the
Securities Act, and analogous provisions of the Virginia and
D.C. Blue Sky laws. The court awarded rescission and
ordered Defendants to refund the FHFA a total adjusted
purchase price of approximately $806 million in exchange
for the certificates.
Defendants appeal that final judgment, as well as
numerous pretrial decisions. Finding no merit in any of
their arguments, we conclude that Defendants failed to
discharge their duty under the Securities Act to disclose
fully and fairly all of the information necessary for
investors to make an informed decision whether to
purchase the certificates at issue. AFFIRMED.
______________
KATHLEEN M. SULLIVAN (Philippe Z. Selendy, Adam
M. Abensohn, William B. Adams, Andrew R.
Dunlap, Yelena Konanova, on the brief), Quinn
Emanuel Urquhart & Sullivan LLP, New York,
NY, for plaintiff‐appellee.
3
DAVID B. TULCHIN, Sullivan & Cromwell LLP, New
York, NY (Amanda F. Davidoff, Sullivan &
Cromwell LLP, Washington, D.C.; Bruce E. Clark,
Steven L. Holley, Adam R. Brebner, Owen R.
Wolfe, Sullivan & Cromwell LLP, New York, NY,
on the brief), for defendants‐appellants Nomura
Holding America, Inc., Nomura Asset Acceptance
Corporation, Nomura Home Equity Loan, Inc.,
Nomura Credit & Capital, Inc., Nomura Securities
International, Inc., David Findlay, John McCarthy,
John P. Graham, Nathan Gorin, and N. Dante
LaRocca.
E. JOSHUA ROSENKRANZ, Orrick, Herrington &
Sutcliffe LLP, New York, NY (Thomas C. Rice,
Andrew T. Frankel, Alan C. Turner, Craig S.
Waldman, Simpson Thacher & Bartlett LLP, New
York, NY; Paul F. Rugani, Orrick, Herrington &
Sutcliffe LLP, Seattle, WA; Daniel A. Rubens,
Orrick, Herrington & Sutcliffe LLP, New York,
NY; Kelsi Brown Corkran, Orrick, Herrington &
Sutcliffe LLP, Washington, D.C., on the brief), for
defendant‐appellant RBS Securities, Inc.
Michael J. Dell, Kramer Levin Naftalis & Frankel
LLP, New York, NY, for amici curiae Securities
Industry and Financial Markets Association and The
Clearing House Association LLC, in support of
defendants‐appellants.
______________
4
WESLEY, Circuit Judge:
In the wake of the Great Depression, Congress took
measures to protect the U.S economy from suffering
another catastrophic collapse. Congress’s first step in that
endeavor was the Securities Act of 1933 (the “Securities
Act” or “Act”), ch. 38, 48 Stat. 74 (codified as amended at 15
U.S.C. § 77a et seq.). The Act’s chief innovation was to
replace the traditional buyer‐beware or caveat emptor rule of
contract with an affirmative duty on sellers to disclose all
material information fully and fairly prior to public
offerings of securities. That change marked a paradigm
shift in the securities markets. See Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 194–95 (1976).
This case demonstrates the persistent power of the
Securities Act’s full‐disclosure requirement in the context of
the Great Recession. The height of the housing bubble in the
mid‐2000s saw an explosion in the market for residential
mortgage‐backed securities (“RMBS”). See Adam J. Levitin
& Susan M. Wachter, Explaining the Housing Bubble, 100
GEO. L.J. 1177, 1192–202 (2012). In the midst of that market
frenzy, two government‐sponsored enterprises, the Federal
Home Loan Mortgage Corporation (“Freddie Mac” or
“Freddie)” and Federal National Mortgage Association
(“Fannie Mae” or “Fannie”) (collectively, the “GSEs”),
purchased a subset of RMBS known as private‐label
securitizations (“PLS”) from a host of private banks.
Defendants‐appellants Nomura1 and RBS2 (collectively,
1 “Nomura” refers to the following individuals and entities
collectively: defendants‐appellants David Findlay, John
5
“Defendants”)3 sold the GSEs seven of these certificates (the
“Certificates”) in senior tranches of PLS (the
“Securitizations”) using prospectus supplements (the
“ProSupps”). Each ProSupp described the creditworthiness
of the loans supporting the Securitization, including an
affirmation that the loans “were originated generally in
accordance with the underwriting criteria.”
The housing market began to collapse in 2007 and the
value of PLS declined rapidly. Shortly thereafter, plaintiff‐
appellee the Federal Housing Finance Agency (the
“FHFA”), the statutory conservator of Freddie and Fannie,4
McCarthy, John P. Graham, Nathan Gorin, and N. Dante
LaRocca (collectively, the “Individual Defendants”); and
defendants‐appellants Nomura Holding America, Inc., (“NHA”)
Nomura Asset Acceptance Corporation (“NAAC”), Nomura
Home Equity Loan, Inc. (“NHELI”), Nomura Credit & Capital,
Inc. (“NCCI”), and Nomura Securities International, Inc.
(“Nomura Securities”).
2 “RBS” refers to RBS Securities, Inc. in its capacity as successor
to Greenwich Capital Markets, Inc.
3 We refer to Defendants collectively and attribute each
argument to all Defendants, citing their individual briefs when
necessary. See Nomura’s Br. 2 (incorporating RBS’s arguments
by reference); RBS’s Br. 4 (incorporating Nomura’s arguments by
reference).
4 The FHFA was created by Congress out of concern for “the
financial condition of Fannie Mae, Freddie Mac, and other
[GSEs]” and is authorized to take any action necessary to restore
the GSEs to solvency. FHFA v. UBS Ams. Inc. (UBS II), 712 F.3d
6
brought sixteen actions in the U.S. District Court for the
Southern District of New York against financial institutions
that sold PLS certificates to the GSEs, alleging that the
offering documents used in those transactions overstated
the reliability of the loans backing the securitizations, in
violation of the Securities Act and analogous provisions of
certain “Blue Sky laws,”5 the Virginia Securities Act, as
amended, VA. CODE ANN. § 13.1–522, and the District of
Columbia Securities Act, D.C. CODE § 31–5606.05.6 Sixteen
of the FHFA’s actions were coordinated before District
Judge Denise Cote. Fifteen of those cases settled, resulting
in more than $20 billion in recovery for the FHFA. The case
on appeal was the only one to go to trial.
After issuing multiple pre‐trial decisions and
conducting a bench trial, the District Court filed a 361‐page
trial opinion rendering judgment in favor of the FHFA. The
court found that Defendants violated Sections 12(a)(2) and
15 of the Securities Act, see 15 U.S.C. §§ 77l(a)(2), 77o, and
136, 138 (2d Cir. 2013). The FHFA’s statutory purposes and
powers are discussed further below.
5 For a discussion of the origin of the term “Blue Sky laws”—
commonly used to describe state laws regulating the sale of
securities—see Jonathan R. Macey & Geoffrey P. Miller, Origin of
the Blue Sky Laws, 70 TEX. L. REV. 347, 359 n.59 (1991).
6 The FHFA filed a similar action in the District of Connecticut,
FHFA v. Royal Bank of Scot. Grp., PLC, No. 11 Civ. 1383; another,
originally filed in New York, was transferred to the Central
District of California, FHFA v. Countrywide Fin. Corp., No. 12 Civ.
1059. Both have settled.
7
analogous provisions of the Virginia and D.C. Blue Sky
laws, see VA. CODE ANN. § 13.1–522(A)(ii); D.C. CODE § 31–
5606.05(a)(1)(B), (c), by falsely stating in the ProSupps that,
inter alia, the loans supporting the Securitizations were
originated generally in accordance with the pertinent
underwriting guidelines. As a result, the court awarded the
FHFA more than $806 million in recession‐like relief.
Special App. 362–68.
Defendants appeal multiple aspects of the District
Court’s trial opinion, as well as many of the court’s pretrial
decisions. We find no merit in any of Defendants’
arguments and AFFIRM the judgment. The ProSupps
Defendants used to sell the Certificates to the GSEs
contained untrue statements of material fact—that the
mortgage loans supporting the PLS were originated
generally in accordance with the underwriting criteria—
that the GSEs did not know and that Defendants knew or
should have known were false. Moreover, the FHFA’s
claims were timely, the District Court properly conducted a
bench trial, Defendants are not entitled to a reduction in the
FHFA’s award for loss attributable to factors other than the
untrue statements at issue, Defendants NAAC and NHELI
were statutory sellers, and the FHFA exercised jurisdiction
over Blue Sky claims.
8
BACKGROUND
I. Legal Framework
A. The Securities Act
“Federal regulation of transactions in securities
emerged as part of the aftermath of the market crash in
1929.” Ernst & Ernst, 425 U.S. at 194–95. The first set of
regulations came in the Securities Act, which was
“designed to provide investors with full disclosure of
material information concerning public offerings of
securities in commerce, to protect investors against fraud
and, through the imposition of specified civil liabilities, to
promote ethical standards of honesty and fair dealing.” Id.
at 195 (citing H.R. REP. NO. 85, at 1–5 (1933)). Shortly
thereafter, Congress passed a series of companion statutes,
including the Securities Exchange Act of 1934 (the
“Exchange Act”), ch. 404, 48 Stat. 881 (codified as amended
at 15 U.S.C. § 78a et seq.), which was intended “to protect
investors against manipulation of stock prices through
regulation of transactions upon securities exchanges and in
over‐the‐counter markets, and to impose regular reporting
requirements on companies whose stock is listed on
national securities exchanges.” Ernst & Ernst, 425 U.S. at 195
(citing S. REP. NO. 792, at 1–5 (1934)). Congress’s purpose
for this regulatory scheme “‘was to substitute a philosophy
of full disclosure for the philosophy of caveat emptor . . . in
the securities industry.’” Basic Inc. v. Levinson, 485 U.S. 224,
234 (1988) (quoting SEC v. Capital Gains Research Bureau,
Inc., 375 U.S. 180, 186 (1963)).
9
The Securities Act regulates the use of prospectuses
in securities offerings. A prospectus is “any prospectus,
notice, circular, advertisement, letter, or communication,
written or by radio or television, which offers any security
for sale or confirms the sale of any security,” with certain
exceptions not applicable here. 15 U.S.C. § 77b(a)(10).
Section 5(b)(1) of the Securities Act provides that it is
unlawful “to make use of any means or instruments of
transportation or communication in interstate commerce or
of the mails to carry or transmit any prospectus relating to
any security” unless the prospectus meets certain disclosure
requirements. 15 U.S.C. § 77e(b)(1); see 17 C.F.R. § 230.164.
Section 5(b)(2) provides that it is unlawful “to carry or
cause to be carried through the mails or in interstate
commerce any such security for the purpose of sale or for
delivery after sale, unless accompanied or preceded by a
prospectus” that meets additional disclosure requirements.
15 U.S.C. § 77e(b)(2).
Section 12(a)(2) of the Act, as amended, 15 U.S.C.
§ 77l, accords relief to any person (1) who was offered or
purchased a security “by means of a prospectus or oral
communication”; (2) from a statutory seller; (3) when the
prospectus or oral communication “includes an untrue
statement of a material fact or omits to state a material fact
necessary in order to make the statements, in the light of the
circumstances under which they were made, not
misleading”; and (4) the plaintiff did not “know[] of such
untruth or omission” at the time of sale (the “absence‐of‐
knowledge element”). 15 U.S.C. § 77l(a)(2); see In re Morgan
Stanley Info. Fund Sec. Litig. (Morgan Stanley), 592 F.3d 347,
10
359 (2d Cir. 2010). Scienter, reliance, and loss causation are
not prima facie elements of a Section 12(a)(2) claim. Morgan
Stanley, 592 F.3d at 359.
Section 12 authorizes two types of mutually‐exclusive
recovery. See 15 U.S.C. § 77l(a); Wigand v. Flo‐Tek, Inc., 609
F.2d 1028, 1035 (2d Cir. 1979). If the plaintiff owned the
security when the complaint was filed, Section 12
authorizes rescission—the plaintiff returns the security to
the defendant and the defendant refunds the plaintiff the
purchase price with adjustments for interest and income.
See 15 U.S.C. § 77l(a); Wigand, 609 F.2d at 1035. If the
plaintiff no longer owned the security when the complaint
was filed, Section 12(a)(2) permits the plaintiff to recover
“damages.” 15 U.S.C. § 77l(a); see Wigand, 609 F.2d at 1035.
Section 12 contains two affirmative defenses. First, a
plaintiff will not be entitled to relief if the defendant “did
not know, and in the exercise of reasonable care could not
have known, of [the] untruth or omission” at issue. 15
U.S.C. § 77l(a)(2). This is known as the “reasonable care”
defense. Morgan Stanley, 592 F.3d at 359 n.7.
Second, a defendant may seek a reduction in the
amount recoverable under Section 12 equal to
any portion . . . [that] represents [an amount]
other than the depreciation in value of the
subject security resulting from such part of the
prospectus or oral communication, with
respect to which the liability of that person is
asserted, not being true or omitting to state a
material fact required to be stated therein or
11
necessary to make the statement not
misleading, then such portion or amount, as
the case may be.
15 U.S.C. § 77l(b). This is known as the “loss causation”
defense, Iowa Pub. Emps.’ Ret. Sys. v. MF Glob., Ltd., 620 F.3d
137, 145 (2d Cir. 2010), or “negative loss causation,” In re
Smart Techs., Inc. S’holder Litig., 295 F.R.D. 50, 59 (S.D.N.Y.
2013). Unlike the Exchange Act, which generally requires
plaintiffs to prove loss causation as a prima facie element, see
15 U.S.C. § 78u–4(b)(4), the Securities Act places the burden
on defendants to prove negative loss causation as an
affirmative defense, see McMahan & Co. v. Wherehouse
Entm’t, Inc., 65 F.3d 1044, 1048 (2d Cir. 1995).
Section 12 is closely related to Section 11 of the
Securities Act, as amended, 15 U.S.C. § 77k, which “imposes
strict liability on issuers and signatories, and negligence
liability on underwriters,” for material misstatements or
omissions in a registration statement. NECA‐IBEW Health &
Welfare Fund v. Goldman Sachs & Co. (NECA), 693 F.3d 145,
156 (2d Cir. 2012). Both provisions are limited in scope and
create in terrorem7 liability. See id.; William O. Douglas &
George E. Bates, The Federal Securities Act of 1933, 43 YALE
L.J. 171, 173 (1933). The loss causation defense in Section 12
was adapted from the loss causation defense in Section
11(e) of the Securities Act. See S. REP. NO. 104–98, at 23
(1995).
7 “By way of threat; as a warning.” BLACK’S LAW DICTIONARY
(10th ed. 2014).
12
Finally, Section 15 of the Act, as amended 15 U.S.C.
§ 77o, provides that “[e]very person who . . . controls any
person liable under . . . [Section 12(a)(2)] shall also be liable
jointly and severally with and to the same extent as such
controlled person.” 15 U.S.C. § 77o(a). “To establish
[Section] 15 liability, a plaintiff must show a ‘primary
violation’ of [Section 12] and control of the primary violator
by defendants.” See In re Lehman Bros. Mortg.‐Backed Sec.
Litig., 650 F.3d 167, 185 (2d Cir. 2011) (quoting ECA, Local
134 IBEW Joint Pension Tr. of Chi. v. JP Morgan Chase Co., 553
F.3d 187, 206–07 (2d Cir. 2009)).
In this case, the District Court awarded the FHFA
rescission‐like relief against all Defendants under Section
12(a)(2) and found NHA, NCCI, and the Individual
Defendants control persons under Section 15 for the seven
PLS transactions at issue. FHFA v. Nomura Holding Am., Inc.
(Nomura VII), 104 F. Supp. 3d 441, 598 (S.D.N.Y. 2015).
Defendants appeal the District Court’s decisions as to each
prima facie element of the Section 12(a)(2) claims (except that
the sales were made by means of a prospectus) and as to
both affirmative defenses.8
B. The Blue Sky Laws
The Commonwealth of Virginia and District of
Columbia have enacted Blue Sky laws modeled on the
Securities Act as originally enacted in 1933. Andrews v.
Browne, 662 S.E.2d 58, 62 (Va. 2008); see Forrestal Vill., Inc. v.
8 Defendants appeal the court’s Section 15 award only inasmuch
as they contest the primary violations of Section 12(a)(2).
13
Graham, 551 F.2d 411, 414 & n.4 (D.C. Cir. 1977) (observing
that the D.C. Blue Sky law was based on the Uniform
Securities Act); see also Gustafson v. Alloyd Co., Inc., 513 U.S.
561, 602–03 (1995) (Ginsburg, J., dissenting) (observing that
the Uniform Securities Act was based on the Securities Act
of 1933). These Blue Sky laws contain provisions that are
“substantially identical” to Sections 12(a)(2) and 15. Dunn v.
Borta, 369 F.3d 421, 428 (4th Cir. 2004); see Hite v. Leeds Weld
Equity Partners, IV, LP, 429 F. Supp. 2d 110, 114 (D.D.C.
2006).9 As relevant to this appeal, the Blue Sky laws are
distinct only in that each requires as a jurisdictional element
that some portion of the securities transaction at issue
occurred in the State. D.C. CODE § 31–5608.01(a); see Lintz v.
Carey Manor Ltd., 613 F. Supp. 543, 550 (W.D. Va. 1985)
(citing Travelers Health Ass’n v. Commonwealth, 51 S.E.2d 263
(Va. 1949)).
The District Court awarded the FHFA relief under
the D.C. Blue Sky law for the sale of one Certificate and
relief under the Virginia Blue Sky law for the sales of three
other Certificates. Nomura VII, 104 F. Supp. 3d at 598.
9 It is not settled whether the Virginia or D.C. Blue Sky analogs
to Section 12(a)(2) contain loss causation defenses. See FHFA v.
HSBC N. Am. Holdings Inc. (HSBC I), 988 F. Supp. 2d 363, 367–70
(S.D.N.Y. 2013). Because we affirm the District Court’s finding
that Defendants failed to make out a loss causation defense, we
need not address this issue on this appeal.
14
II. Factual Background10
This case centers on the RMBS industry of the late
2000s. RMBS are asset‐backed financial instruments
supported by residential mortgage loans. A buyer of an
RMBS certificate pays a lump sum in exchange for a
certificate representing the right to a future stream of
income from the mortgage loans’ principal and income
payments. PLS are RMBS sold by private financial
institutions. See Pension Benefit Guar. Corp. ex rel. St. Vincent
Catholic Med. Ctrs. Ret. Plan v. Morgan Stanley Inv. Mgmt. Inc.
(Pension Benefit Guar.), 712 F.3d 705, 713–14 (2d Cir. 2013).
This case touches on nearly every aspect of the PLS
securitization process—from the issuance of mortgage loans
through the purchase of a securitization. Because of the size
and complexity of this case, in addition to the fact that the
final order rule requires us to review a number of the
District Court’s pre‐trial rulings, see 28 U.S.C. § 1291, there
is much to consider. We think it best to begin with a
summary of the securitization process from 2005 to 2007,
the time period relevant to this case, and then to introduce
the parties and the transactions at issue. Issue‐specific facts
10 Except where otherwise noted, these facts are drawn from the
District Court’s post‐trial decision and from additional record
evidence. See id. at 458–69; see also Beck Chevrolet Co., Inc. v. Gen.
Motors LLC, 787 F.3d 663, 672 (2d Cir. 2015) (stating that factual
findings after a bench trial are reviewed for clear error). To the
extent portions of the record are quoted in this opinion, the
Court orders the record unsealed solely with regard to those
quoted portions of the record.
15
are addressed in more detail in the discussion sections
below.
A. The PLS Securitization Process
1. Originating a Mortgage Loan Using
Underwriting Guidelines
The first step in the PLS process was the issuance of
residential mortgage loans. Mortgage loans were issued to
borrowers by entities known as originators. Originators
issued loans according to their loan underwriting
guidelines, which listed the criteria used to approve a loan.
See United States ex rel. O’Donnell v. Countrywide Home Loans,
Inc. (O’Donnell), 822 F.3d 650, 653 n.2 (2d Cir. 2016). These
guidelines helped each originator assess the borrower’s
ability to repay the loan and the value of the collateral.
Originators balanced those two criteria to determine a
potential loan’s credit risk.
Following the underwriting guidelines, originators
required each prospective borrower to complete a loan
application, usually on the Uniform Residential Loan
Application (the “URLA”). The URLA required borrowers
to disclose, under penalty of civil liability or criminal
prosecution, their income, employment, housing history,
assets, liabilities, intended occupancy status for the
property, and the sources of the funds they intended to use
in paying the costs of closing the loan. Originators used this
information to determine objective factors relevant to the
borrower’s credit risk, such as a credit score according to
the Fair Isaac Corporation’s model (a “FICO score”), credit
history, and debt‐to‐income ratio. Once each borrower
16
submitted the URLA, the originator kept it and other
related documentation in the borrower’s loan file.
The underwriting guidelines required originators to
assess the reasonableness of the borrower’s assertions on
the URLA. This was easiest when borrowers supported
their URLA applications with corroborating
documentation. Some applications required verification of
both the borrower’s assets and income, while some
required verification only of the borrower’s assets. Other
borrowers submitted stated‐income‐stated‐assets (“SISA”)
applications, which did not require verification of income
or assets, or no‐income‐no‐assets (“NINA”) applications,
which were complete without the borrower even stating his
or her income or assets. SISA and NINA applications were
more difficult to assess, but not categorically ineligible to
receive loans.
The underwriting guidelines generally permitted
originators to accept SISA and NINA applications and to
make other exceptions to the underwriting criteria if there
were compensating factors that indicated the borrower’s
ability and willingness to repay the loan. The guidelines set
forth the specific conditions under which exceptions would
be permitted. Originators were required to mark the
borrower’s loan file whenever an exception to the
underwriting criteria had been granted and to explain the
basis for that decision.
After forming an opinion about a borrower’s
creditworthiness based on the URLA and related
documentation, originators assigned the transaction a credit
17
risk designation, which affected the interest rate for the
loan. When an applicant had good credit, the transaction
was labeled “prime.” When an applicant had materially
impaired credit, the transaction was labeled “subprime.”
And when an applicant’s credit fell between good and
materially impaired, the transaction was labeled “Alt‐A.”
See Pension Benefit Guar., 712 F.3d at 715.
Once they had assessed the borrower’s credit,
originators balanced that assessment against the value of
the collateral (i.e., the present market value of the residence
the borrower wanted to purchase or refinance), as
determined by an appraiser, to measure the overall credit
risk of the loan. Originators compared the amount of the
loan against the value of the collateral to develop a loan‐to‐
value ratio, a key indicator of credit risk. It was common in
the RMBS industry to use a loan‐to‐value ratio of 80% as a
benchmark. Relative to loans at that ratio, a loan worth
between 80% and 90% of the collateral value was 1.5 times
more likely to default and a loan worth between 95% and
100% of the collateral value was 4.5 times more likely to
default. A loan‐to‐value ratio of more than 100% meant that
the loan exceeded the value of the residence and the
borrower was “underwater.”
If the originator was comfortable with the overall
credit risk after reviewing the buyer’s creditworthiness, the
value of the collateral, and the loan‐to‐value ratio, the loan
would be approved.
The underwriting guidelines and loan files were
crucial throughout and beyond the origination process.
18
Supervisors employed by the originators could check loan
files against the underwriting guidelines to ensure that loan
issuance decisions met important criteria. For example, the
District Court found that “[c]ompliance with underwriting
guidelines ensure[d] . . . an accurate calculation of the
borrower’s [debt‐to‐income] ratio, which is a critical data
point in the evaluation of a loan’s risk profile.” Nomura VII,
104 F. Supp. 3d at 536. After the loan issued, originators
used the information in the loan file to describe the loan
characteristics for financial institutions interested in
purchasing it.
2. Creating a PLS
The next step in the PLS process was the aggregation
and securitization of the residential mortgage loans into an
RMBS. Originators compiled their issued loans into “trade
pools” and then solicited bids from PLS “sponsors” or
“aggregators” to purchase them. The originators provided
prospective bidders with a “loan tape” for each pool—“a
spreadsheet that provided data about the characteristics of
each loan in the trade pool” including “loan type (fixed or
adjustable rate), . . . original and unpaid principal balance,
amortization term, borrower’s FICO score, the mortgaged
property’s purchase price and/or appraised value,
occupancy status, documentation type and any prepayment
penalty‐related information.” J.A. 4385.
The sponsor that prevailed in the bidding process
was given access to a limited number of loan files to
conduct a due diligence review of the originators’
underwriting and valuation processes before final
19
settlement.11 The sponsor was entitled prior to closing to
remove from the trade pool any loans that did not meet its
purchasing requirements, such as those below a minimum
FICO score or exceeding a maximum debt‐to‐income ratio.
Upon closing, the prevailing sponsor acquired title to the
loans in the trade pools and gained access to the complete
set of loan files. The prevailing sponsor was also given a
copy of the underwriting guidelines the originators used to
issue the loans.
The sponsor then sold the loans to a “depositor,” a
special purpose vehicle created solely to facilitate PLS
transactions. The true sale from sponsor to depositor was
intended to protect the future PLS certificate‐holders’
interests in the loans in the event that the sponsor declared
bankruptcy. It was common in the RMBS industry for the
depositor and sponsor entities to act at the direction of the
same corporate parent.
The depositor then grouped the loans into supporting
loan groups (“SLGs”) and transferred each group of loans
to a trust. In exchange, the trust issued the depositor
certificates that represented the right to receive principal
and interest payments from the SLGs. The trustee managed
the loans for the benefit of the certificate holders, often
hiring a mortgage loan servicing vendor to manage the
loans on a day‐to‐day basis. The depositor then sold most of
the certificates to a lead underwriter, who would shepherd
them to the public securities markets; a few certificates
Defendants’ due diligence processes are discussed in further
11
detail in the discussion sections below.
20
remained under the ownership of the depositor. It was also
common in the industry for the lead underwriter to be
controlled by the same corporate parent that controlled the
sponsor and depositor.
3. Preparing a PLS for Public Sale
The final steps in the PLS process were the
preparation and sale to the public of the certificates. The
lead underwriter, sponsor, and depositor (collectively, “PLS
sellers”) worked together to structure the securitization, to
solicit credit ratings for the certificates principally from
three major credit‐rating agencies, Moody’s Investors
Service, Inc. (“Moody’s”), Standard & Poor’s (“S&P”), and
Fitch Ratings (“Fitch”) (collectively, the “Credit‐Rating
Agencies” or “Rating Agencies”), and to draft and confirm
the accuracy of the offering documents. Once those tasks
were completed, the lead underwriter would market the
certificates to potential buyers.
The PLS sellers structured securitizations with two
credit enhancements that distributed the risk of the loans
unequally among the certificate holders. The first was
subordination. The PLS certificates were organized into
tranches, ranked by seniority. Each SLG supported one or
more tranches of certificates and distributed payments in a
“waterfall” arrangement. This arrangement guaranteed
senior certificate‐holders first claim to all principal and
interest payments. Once all the senior certificate‐holders
were satisfied, the SLGs’ payments spilled over to junior
certificate‐holders, who would receive the remaining
balance of the payments.
21
The second of these credit enhancements was
overcollateralization. The total outstanding balance of all of
the mortgage loans supporting an entire PLS often
exceeded the outstanding balance of the loans supporting
the publicly available PLS certificates. As a result, some
loans in the PLS were tethered to certificates owned by the
depositor or sponsor and were not available for public
purchase. These non‐public loans served as a loss‐saving
measure by making payments to the public certificate‐
holders (in order of seniority) in the event that the loans
supporting their public certificates defaulted.
After structuring the PLS, the PLS sellers would
solicit a credit rating for each tranche. Because, as the
District Court explained, PLS “were only as good as their
underlying mortgage loans,” Nomura VII, 104 F. Supp. 3d at
465, the Credit‐Rating Agencies based their determinations
primarily on the quality of the certificates’ supporting
loans. They did this by modeling the credit risk of the SLGs
using information from the loan tape, provided by the PLS
sellers. The Rating Agencies also evaluated the certificates’
credit enhancements.
The Rating Agencies’ review included examining
draft offering documents for representations that the
supporting loans were originated in accordance with
originators’ underwriting criteria. This was standard in the
industry, as the Rating Agencies agreed that compliance
with the underwriting guidelines was an important
indicator of a loan’s credit risk. More credit enhancements
were required to secure an investment‐grade rating for any
certificate backed by loans that either did not comply with
22
the underwriting guidelines or were missing
documentation from their loan files.
The PLS sellers explained these credit enhancements,
credit ratings, and other important features of the PLS to
the public primarily in three offering documents—a shelf
registration, a free writing prospectus, and a prospectus
supplement. The shelf registration was a pre‐approved
registration statement filed with the Securities and
Exchange Commission (the “SEC”) that contained generally
applicable information about PLS. See 17 C.F.R. §§ 230.409,
230.415. The shelf registration enabled the lead PLS
underwriter to make written offers to potential buyers
using a free writing prospectus. See id. § 230.433(b)(1). The
free writing prospectus broadly described the
characteristics of the certificate and the supporting SLGs. If
an offeree was interested after reading the description, it
could commit to purchasing the certificate. Title in the
certificate and payment were exchanged within
approximately a month of that commitment. The PLS
sellers sent the buyer a prospectus supplement and filed the
same with the SEC near the date of that exchange.12
The prospectus supplement contained the most
detailed disclosures of any of the offering documents. This
document provided specific information regarding the
certificate, the SLGs, and the credit quality of the
underlying loans. It warranted the accuracy of its
representations regarding loan characteristics. And,
This selling process is described in further detail in the
12
discussion sections below.
23
crucially, it affirmed that the loans in the SLGs were
originated in accordance with the applicable underwriting
guidelines. As the District Court noted, “whether loans
were actually underwritten in compliance with guidelines
was extremely significant to investors.” Nomura VII, 104 F.
Supp. 3d at 536. The prospectus supplement ordinarily
disclosed that some number of loans in the SLG may
deviate substantially from, or violate, the applicable
underwriting guidelines.13
B. The PLS Transactions at Issue
1. The Parties
a. The Sellers
Defendants sold the Certificates to the GSEs.
Subsidiaries of Defendant NHA were the Certificates’
primary sellers. Defendant NCCI served as the sponsor for
all seven of the transactions at issue. Defendant NAAC
served as the depositor for one Securitization, and
Defendant NHELI served as the depositor for the
remaining six. And Defendant Nomura Securities, served as
the lead or co‐lead underwriter for three of the
Securitizations.
Defendant RBS served as the lead or co‐lead
underwriter for four of the Securitizations.14
For a chart from one of Defendants’ ProSupps displaying the
13
PLS transaction structure, as modified, see Appendix A.
One Securitization was also underwritten by Lehman Brothers
14
Inc., which is not a party to this action.
24
b. The Buyers15
Fannie and Freddie purchased the Certificates. Both
GSEs are privately‐owned corporations chartered by
Congress to provide stability and liquidity in the mortgage
loan market. Fannie was established in 1938. See National
Housing Act Amendments of 1938, ch. 13, 52 Stat. 8.
Freddie was established in 1970. See Emergency Home
Finance Act of 1970, Pub. L. No. 91–351, 84 Stat. 450. They
were at the time of the transactions at issue, and remain
today, “the dominant force[s]” in the mortgage loan
market. See Town of Babylon v. FHFA, 699 F.3d 221, 225 (2d
Cir. 2012).
The primary way the GSEs injected liquidity into the
mortgage market was by purchasing mortgage loans from
private loan originators. See O’Donnell, 822 F.3d at 653. This
side of the GSEs’ operations was known as the “Single
Family Businesses.” By purchasing loans from originators,
the Single Family Businesses replenished originators’
capital, allowing originators to issue new loans. The Single
Family Businesses held the loans purchased from
originators on their books and sometimes securitized them
into agency RMBS, similar to a PLS, to be offered for public
sale. See Pension Benefit Guar., 712 F.3d at 714–15; Levitin &
Wachter, supra, at 1187–89.
These undisputed facts are drawn from one of the District
15
Court’s summary judgment opinions and from additional record
evidence. See FHFA v. Nomura Holding Am., Inc. (Nomura I), 60 F.
Supp. 3d 479, 489–91 (S.D.N.Y. 2014).
25
The Single Family Businesses contained due diligence
departments. These departments conducted due diligence
of specific loans prior to purchase. They also periodically
reviewed their originator counterparties’ general
underwriting practices, and PLS sellers’ due diligence
practices, including Defendants’.16
As a secondary element of their businesses, the GSEs
operated securities trading desks that purchased PLS. PLS
purchases created liquidity in the mortgage market by
funneling cash back through PLS sponsors and
underwriters to loan originators for use in future loans. The
GSEs’ PLS traders generally operated out of Fannie’s
headquarters in Washington, D.C. and Freddie’s
headquarters in McLean, Virginia.
The GSEs played a significant role in the PLS market
despite the relatively minor role it occupied in their
businesses. The GSEs’ PLS portfolios reached their heights
in 2005, when they owned approximately $350 billion
worth of PLS, with $145 billion backed by subprime loans
and $40 billion backed by Alt‐A loans (loans that were rated
lower than prime loans but higher than subprime loans).
The GSEs bought approximated 8% of the $3 trillion
dollars’ worth of PLS sold from 2005 to 2007. PLS traders
working for the GSEs purchased the Certificates at issue.
The GSEs’ Single Family Businesses’ due diligence practices
16
are discussed in further detail in the discussion sections below.
26
2. The Transactions
Between 2005 and 2007, the GSEs purchased
Certificates from Defendants in seven PLS Securitizations—
NAA 2005‐AR6, NHELI 2006‐FM1, NHELI 2006‐HE3,
NHELI 2006‐FM2, NHELI 2007‐1, NHELI 2007‐2, and
NHELI 2007‐3. These transactions were executed generally
in accordance with the standard practices at the time, as
described in the previous sections. The supporting loans are
predominantly Alt‐A or subprime. Each Certificate is in a
senior tranche of its respective Securitization. Combined,
the Certificates cost approximately $2.05 billion and, at
times of sale, had expected value of $2.45 billion.17
Defendants sold the Certificates by means of shelf
registrations, free writing prospectuses, and the ProSupps.18
The ProSupps provided detailed information regarding the
loans in the SLGs. They described the risks inherent in
subprime and Alt‐A loan transactions and provided the
credit ratings for each tranche. They included charts
displaying the objective characteristics for loans in each
SLG, such as aggregate remaining principal balances, FICO
scores, and loan‐to‐value ratios. Five ProSupps promised
that “[i]f . . . any material pool characteristic differs by 5%
or more from the description in this [ProSupp], revised
For a table listing the distributors and buyer for each
17
Securitization, see Appendix B. For a table listing the purchase
price and actual principal and interest payments made on each
Securitization as of February 2015, see Appendix C.
For a table listing the ProSupps’ listed dates, settlement dates,
18
and filing dates, see Appendix D.
27
disclosure will be provided either in a supplement or in a
Current Report on Form 8‐K.” E.g., J.A. 9120.
Most importantly for purposes of this appeal, every
ProSupp stated that “the Mortgage Loans . . . were
originated generally in accordance with the underwriting
criteria described in this section,” (the “underwriting
guidelines statement”). J.A. 9117; see J.A. 6884, 7174, 7527,
7895, 8296, 8718.19 The ProSupps then described the
underwriting criteria used by originators that contributed
loans to the SLGs and stated that the originators may have
made “certain exceptions to the underwriting standards . . .
in the event that compensating factors are demonstrated by
a prospective borrower.” E.g., J.A. 9117. Six of the ProSupps
described the specific underwriting guidelines for each
originator that alone contributed more than 20% of the
loans in the SLGs. For these originators, the ProSupps
typically also stated that the loans were issued “generally”
in accordance with the underwriting guidelines. E.g., J.A.
7520.
Six of the ProSupps stated that some loans were
issued under “Modified [Underwriting] Standards.” E.g.,
J.A. 9118. The ProSupps stated that these modified
standards permitted originators, for example, to issue loans
to foreign nationals, who might lack reliable sources to
verify their credit score or lack a score altogether, or use
“less restrictive parameters” in issuing loans, such as
Although the FHFA brings an individual claim as to each
19
ProSupp, the parties agree that all of the ProSupps contained
substantially similar language for purposes of this appeal.
28
“higher loan amounts, higher maximum loan‐to‐value
ratios, . . . the ability to originate mortgage loans with loan‐
to‐value ratios in excess of 80% without the requirement to
obtain mortgage insurance if such loans are secured by
investment properties.” E.g., J.A. 9119. The ProSupps
disclosed the number of loans issued under the modified
standards.20
C. The Housing and Financial Crisis21
The GSEs purchased the Certificates from Defendants
during a period when the markets for mortgage loans and
associated securities were exploding. A combination of
factors including low interest and unemployment rates, an
increased use of adjustable‐rate mortgages and other
innovative loan products, and government policies
encouraging home ownership heated the housing market.
Home prices increased, and aggregate mortgage debt in the
U.S. more than doubled between 2000 and 2008.
The ProSupp language relevant on this appeal is discussed in
20
further detail in the discussion sections below.
21 This account of the collapse of the housing market is derived
from the District Court’s post‐trial findings and additional
record evidence. Nomura VII, 104 F. Supp. 3d at 537–40; see also
Ryan Bubb & Prasad Krishnamurthy, Regulating Against Bubbles:
How Mortgage Regulation Can Keep Main Street and Wall Street
Safe—From Themselves, 163 U. PA. L. REV. 1539, 1550–66 (2015)
(describing the housing boom and bust); John C. Coffee, Jr. &
Hillary A. Sale, Redesigning the SEC: Does the Treasury Have A
Better Idea?, 95 VA. L. REV. 707, 732–34 & nn.64–71 (2009) (same).
29
During this period, originators also relaxed
underwriting standards. Subprime lending jumped from
9.5% of all new mortgage loans in 2000 to 20% of all new
mortgage loans in 2005; Alt‐A lending also grew
substantially. Originators also began to approve loans that
failed to meet the underwriting guidelines with an eye
towards securitizing these loans quickly, thus transferring
the credit risk of the loans from originators to PLS
certificate‐holders. See Levitin & Wachter, supra, at 1190.
Securitization fueled the credit bubble. As described
above, securitization enabled originators to shift credit risk
to the financial markets and turn the prospect of future loan
repayment into instant cash for new loans. In 2000, the PLS
market was worth less than $150 billion. By 2005–2006, the
PLS market was worth more than $1.1 trillion. Once it
began, the securitization frenzy built on itself—
securitizations of subprime mortgages increased the
quantity of new subprime mortgage originations. Those
new mortgages were in turn securitized, and the cycle
started over.
The housing market began its decline in 2006.
Increased mortgage interest rates led to a spike in prices
that made many homes too expensive for potential buyers,
decreasing demand. An oversupply of housing also put
downward pressure on home prices. U.S. housing prices
started to fall in April 2006. From April 2007 through May
2009, they fell almost 33%.
Default and delinquency rates increased with the
decline in housing prices. By 2009, 24% of homeowners,
30
many of whom had purchased homes during the mid‐2000s
boom, were left with negative equity: mortgages with
outstanding principal balances greater than the homes’
current valuations. Shoddy underwriting practices, which
approved loans for borrowers who could not afford to
repay, and spikes in adjustable mortgage rates also
contributed to an increase in defaults. With rising interest
rates, refinancing was difficult. Defaulting on mortgage
loans became an attractive option for homeowners. Each
default and resulting foreclosure sale depressed the prices
of surrounding homes further, sending the housing market
into a vicious downward cycle.
Increased default rates had an adverse impact on
investment products tied to mortgage loans, and on the
entire financial system as a result. As principal and interest
payments slowed over the course of 2007, the value of these
securities declined. One bank in August 2007 reported that
the decrease in mortgage securitization markets’ liquidity
made it “impossible” to value certain RMBS instruments.
J.A. 5419. Banks that had invested heavily in RMBS sold off
their positions (driving down the value of those assets
further) and closed related hedge fund divisions. Credit
tightened, interbank lending ceased, and concerns about
financial institutions’ liquidity and solvency led to runs on
financial institutions. Several major financial institutions,
including Lehman Brothers, Bear Sterns, and Merrill Lynch,
experienced significant financial stress.
In December 2007, the U.S. entered a one‐and‐a‐half‐
year recession, the longest since the Great Depression. U.S.
real gross domestic product contracted by about 4.3%
31
during that time. Unemployment rose to 10% in 2009, more
than double the 2007 rate.
III. Procedural History
In the aftermath of the financial crisis, Congress
passed the Housing and Economic Recovery Act of 2008
(the “HERA”), Pub. L. No. 110–289, 122 Stat. 2654, out of
concern for the GSEs’ financial condition. See UBS II, 712
F.3d at 138. The HERA created the FHFA, an “independent
agency of the Federal Government,” 12 U.S.C. § 4511(a), to
serve as a conservator for Fannie, Freddie, and other GSEs
in financial straits, see id. § 4617(a). The HERA empowered
the FHFA to “collect all obligations and money due the
[GSEs],” id. §4617(b)(2)(B)(ii), and take other actions
necessary to return them to solvency. Id. § 4617(b)(2)(B)(i).
On September 2, 2011, the FHFA initiated sixteen
actions that were eventually litigated together in the
Southern District of New York, including the instant
“Nomura action,” against financial institutions that sold
PLS certificates to Fannie Mae and Freddie Mac. These
cases were consolidated before Judge Cote. They all settled
before trial, with the exception of this case.
The FHFA began the Nomura action by bringing
claims under Sections 11, 12(a)(2), and 15 of the Securities
Act and Virginia and D.C. Blue Sky analogs based on
alleged misstatements in the PLS offering documents. The
FHFA alleged that Defendants’ offering documents falsely
stated (1) the underwriting guidelines statement, (2) the
supporting loans’ loan‐to‐value ratios, (3) whether
mortgaged properties were occupied by the mortgagors,
32
and (4) that the Credit‐Rating Agencies were provided with
accurate information regarding loan characteristics before
issuing ratings decisions. The FHFA initially demanded a
jury trial for “all issues triable by jury.” J.A. 409.
The District Court issued numerous pre‐trial
decisions. Defendants appeal from the following:
An opinion holding that the Virginia and D.C. Blue
Sky laws do not provide a loss causation defense,
HSBC I, 988 F. Supp. 2d 363;
An opinion granting the FHFA’s motion for
summary judgment on the absence‐of‐knowledge
element of a Section 12(a)(2) claim, FHFA v. HSBC N.
Am. Holdings Inc. (HSBC II), 33 F. Supp. 3d 455
(S.D.N.Y. 2014);
Two opinions denying Defendants’ motion for
summary judgment on the ground that the FHFA’s
claims are time‐barred, FHFA v. HSBC N. Am.
Holdings Inc. (HSBC III), Nos. 11cv6189, 11cv6201,
2014 WL 4276420 (S.D.N.Y. August 28, 2014) (statutes
of repose); FHFA v. Nomura Holding Am., Inc. (Nomura
I), 60 F. Supp. 3d 479 (S.D.N.Y. 2014) (statutes of
limitations);
An opinion granting the FHFA’s motion for
summary judgment on Defendants’ reasonable care
defense, FHFA v. Nomura Holding Am. Inc. (Nomura
II), 68 F. Supp. 3d 439 (S.D.N.Y. 2014);
An opinion granting the FHFA’s motion in limine to
exclude evidence related to the GSEs’ housing goals,
33
FHFA v. Nomura Holding Am., Inc. (Nomura III), No.
11cv6201, 2014 WL 7229361 (S.D.N.Y. Dec. 18, 2014);
An opinion, FHFA v. Nomura Holding Am., Inc.
(Nomura IV), 68 F. Supp. 3d 486 (S.D.N.Y. 2014), and a
related bench decision, Special App. 544–49, denying
Defendants’ motion for a jury trial on the FHFA’s
Section 12(a)(2) claims;
An opinion granting the FHFA’s motion in limine to
exclude evidence related to the timing of the
purchases of the Certificates, FHFA v. Nomura Holding
Am., Inc. (Nomura V), 68 F. Supp. 3d 499 (S.D.N.Y.
2014);
An opinion denying in relevant part Defendants’
Daubert challenge to an FHFA expert’s testimony,
FHFA v. Nomura Holding Am., Inc. (Nomura VI), No.
11cv6201, 2015 WL 353929 (S.D.N.Y. Jan. 28, 2015);
Several decisions excluding evidence related to the
GSEs’ Single Family Businesses, e.g., J.A. 11619–21.
Trial was originally slated to be held before a jury to
decide the Section 11 claims, while the District Court would
decide the Section 12 claims, with the jury’s determination
controlling overlapping factual issues. Roughly a month
before pretrial memoranda were due, the FHFA voluntarily
withdrew its Section 11 claim. As a result, the District
Court, over Defendants’ objection, conducted a four‐week
34
bench trial on the Section 12, Section 15, and Blue Sky
claims.22
One month after trial concluded, the District Court
issued a detailed 361‐page opinion systematically finding
for the FHFA on each claim. See generally Nomura VII, 104 F.
Supp. 3d 441. The court held that Defendants violated
Section 12(a)(2) because each ProSupp contained three
categories of false statements of material information: (1)
the underwriting guidelines statements, (2) the loan‐to‐
value ratio statements, and (3) the credit ratings statements.
See id. at 559–73. Our focus on appeal, on this point, is
devoted solely to the statements regarding underwriting
guidelines, which are sufficient to affirm the court’s
judgment. See 15 U.S.C. § 77l(a)(2) (authorizing relief if the
offering documents contain just one untrue statement of
material fact); N.J. Carpenters Health Fund v. Royal Bank of
Scot. Grp., PLC (N.J. Carpenters Health Fund II), 709 F.3d 109,
116, 123 (2d Cir. 2013) (allowing a Section 11 lawsuit to
proceed on the allegation that RMBS offering documents
falsely stated that the loans adhered to the underwriting
guidelines).
The court also rejected Defendants’ loss causation
defense, see Nomura VII, 104 F. Supp. 3d at 585–93, found
that Defendants violated the analogous provisions of the
Virginia and D.C. Blue Sky laws, see id. at 593–98, and held
Forty‐eight witnesses testified at trial. The parties consented to
22
the court receiving most of the direct testimony by affidavit and
hearing oral cross‐examinations and re‐direct examinations in
open court.
35
that NHA, NCCI, and the Individual Defendants were
control persons under Section 15, see id. at 573–83. The court
awarded the FHFA $806,023,457, comprised of roughly
$555 million for violations of the Blue Sky laws and roughly
$250 million for violations of the Securities Act. See id. at
598.23
This appeal followed.
DISCUSSION
Our discussion proceeds in two parts. The first
addresses issues the District Court resolved before trial: (A)
whether the FHFA’s claims were timely under the statutes
of repose; (B) whether in light of the GSEs’ generalized
knowledge and experience in the mortgage loan market (1)
the FHFA’s claims were timely under the statutes of
limitations and (2) the FHFA was entitled to summary
judgment holding that the GSEs did not know the
ProSupps’ underwriting guidelines statements were false;
(C) whether the FHFA was entitled to summary judgment
holding that Defendants failed to exercise reasonable care;
and (D) whether the Seventh Amendment entitled
Defendants to a jury trial. The second addresses issues
resolved after trial: (A) whether the FHFA is entitled to
relief under Section 12(a)(2) because (1) each Defendant is a
statutory seller, (2) the underwriting guidelines statements
were false, (3) those statements were material, and (4)
Defendants failed to make out an affirmative defense of loss
The District Court’s opinions are discussed in more detail in
23
the discussion sections below.
36
causation; as well as (B) whether the FHFA is entitled to
relief under the analogous Virginia and D.C. Blue Sky
provisions.
I. Pretrial Decisions24
A. Statutes of Repose
Defendants appeal the District Court’s denial of their
motion for summary judgment on the ground that the
FHFA’s claims, which were filed on September 2, 2011
(more than three years after the Securitizations were sold),
were time‐barred by the Securities Act, Virginia Blue Sky,
and D.C. Blue Sky statutes of repose. See 15 U.S.C. § 77m
(three‐year period of repose); VA. CODE ANN. § 13.1–522(D)
(two‐year period of repose); D.C. CODE § 31–5606.05(f)(1)
(three‐year period of repose).25 The District Court held that
Because these pretrial rulings addressed matters of law, our
24
review of these decisions is de novo. See Noll v. Int’l Bus. Machs.
Corp., 787 F.3d 89, 93–94 (2d Cir. 2015); UBS II, 712 F.3d at 140;
Eberhard v. Marcu, 530 F.3d 122, 135 n.13 (2d Cir. 2008).
25 Statutes of repose and statutes of limitations are “often
confused” but “nonetheless distinct.” Police & Fire Ret. Sys. of
Detroit v. IndyMac MBS, Inc., 721 F.3d 95, 106 (2d Cir. 2013)
(internal quotation mark omitted; brackets omitted) (quoting Ma
v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 597 F.3d 84, 88 n.4
(2d Cir. 2010)). A statute of repose creates “a substantive right in
those protected to be free from liability after a legislatively‐
determined period of time,” regardless of the plaintiff’s actions
and equitable considerations. Id. (emphasis omitted; internal
quotation mark omitted) (quoting Amoco Prod. Co. v. Newton
Sheep Co., 85 F.3d 1464, 1472 (10th Cir. 1996)). A statute of
37
the statutes of repose were displaced by an extender
provision in the HERA, codified at 12 U.S.C. § 4617(b)(12),
which permits the FHFA to bring any “tort claim” within
three years and any “contract claim” within six years of its
appointment as the GSEs’ conservator on September 6,
2008.26 See FHFA v. UBS Ams., Inc. (UBS I), 858 F. Supp. 2d
limitations “is intended to prevent plaintiffs from unfairly
surprising defendants” by sleeping on and then later
“resurrecting stale claims.” City of Pontiac Gen. Emps.’ Ret. Sys. v.
MBIA, Inc. (MBIA), 637 F.3d 169, 175 (2d Cir. 2011).
26 12 U.S.C. § 4617(b)(12) provides:
Statute of limitations for actions brought by conservator
or receiver
(A) In general
Notwithstanding any provision of any contract, the
applicable statute of limitations with regard to any
action brought by the [FHFA] as conservator or
receiver shall be—
(i) in the case of any contract claim, the longer of—
(I) the 6‐year period beginning on the date on
which the claim accrues; or
(II) the period applicable under State law; and
(ii) in the case of any tort claim, the longer of—
(I) the 3‐year period beginning on the date on
which the claim accrues; or
(II) the period applicable under State law.
(B) Determination of the date on which a claim accrues
For purposes of subparagraph (A), the date on which
the statute of limitations begins to run on any claim
described in such subparagraph shall be the later
of—
38
306, 313–17 (S.D.N.Y. 2012) (holding all coordinate cases
brought by the FHFA before September 6, 2011 timely
under the HERA), aff’d, UBS II, 712 F.3d 136 (2d Cir. 2013);
see also HSBC III, 2014 WL 4276420, at *1. On appeal,
Defendants argue that while the HERA displaces otherwise
applicable statutes of limitations, it does not affect statutes of
repose.
In UBS II, a 2013 decision in an interlocutory appeal
in one of the FHFA’s parallel coordinated actions, a panel of
this Court held that § 4617(b)(12) “supplants any other
[federal or state] time limitations that otherwise might have
applied” to the FHFA’s actions, including the Securities Act
and Blue Sky statutes of repose. 712 F.3d at 143–44. This
conclusion was compelled by the definitive language in
§ 4617(b)(12), which makes clear that “the applicable statute
of limitations with regard to any action brought by the
[FHFA] . . . shall be” time periods provided in the HERA, see
UBS II, 712 F.3d at 141–42 (internal quotation marks
omitted) (quoting 12 U.S.C. § 4617(b)(12)), and was
corroborated by the purpose of the HERA to permit the
FHFA to “‘collect all obligations and money due’ to the
GSEs[] to restore them to a ‘sound and solvent condition,’”
id. at 142 (quoting 12 U.S.C. §§ 4617(b)(2)(B)(ii), (D)). We
considered that reading § 4617(b)(12) to preclude and pre‐
empt all types of time‐limitation statutes, including statutes
of repose, was consistent with Congress’s intent because it
(i) the date of the appointment of the [FHFA] as
conservator or receiver; or
(ii) the date on which the cause of action accrues.
39
allowed the FHFA more “time to investigate and develop
potential claims on behalf of the GSEs.” Id.
Ordinarily, UBS II would end our inquiry. See Lotes
Co., Ltd. v. Hon Hai Precision Indus. Co., 753 F.3d 395, 405 (2d
Cir. 2014) (“[A] panel of this Court is ‘bound by the
decisions of prior panels until such time as they are
overruled either by an en banc panel of our Court or by the
Supreme Court.’” (quoting In re Zarnel, 619 F.3d 156, 168
(2d Cir. 2010))). But one year after UBS II was decided, the
Supreme Court handed down CTS Corp. v. Waldburger, 134
S. Ct. 2175 (2014), which held that 42 U.S.C. § 9658,27 a
27 42 U.S.C. § 9658 provides in relevant part:
(a) State statutes of limitations for hazardous substance
cases
(1) Exception to State statutes
In the case of any action brought under State law for
personal injury, or property damages, which are
caused or contributed to by exposure to any
hazardous substance, or pollutant or contaminant,
released into the environment from a facility, if the
applicable limitations period for such action (as
specified in the State statute of limitations or under
common law) provides a commencement date which
is earlier than the federally required commencement
date, such period shall commence at the federally
required commencement date in lieu of the date
specified in such State statute.
(2) State law generally applicable
Except as provided in paragraph (1), the statute of
limitations established under State law shall apply in
40
provision in the Comprehensive Environmental Response,
Compensation, and Liability Act of 1980 (the “CERCLA”)
that imposes a federal commencement date for state
statutes of limitations, does not pre‐empt state statutes of
repose. See 134 S. Ct. at 2188. Defendants’ sole argument in
the present appeal is that CTS abrogated UBS II.
all actions brought under State law for personal
injury, or property damages, which are caused or
contributed to by exposure to any hazardous
substance, or pollutant or contaminant, released into
the environment from a facility.
(b) Definitions
As used in this section—
. . .
(2) Applicable limitations period
The term “applicable limitations period” means the
period specified in a statute of limitations during
which a civil action referred to in subsection (a)(1) of
this section may be brought.
(3) Commencement date
The term “commencement date” means the date
specified in a statute of limitations as the beginning
of the applicable limitations period.
(4) Federally required commencement date
(A) In general
Except as provided . . . , the term “federally
required commencement date” means the date the
plaintiff knew (or reasonably should have known)
that the personal injury or property damages
referred to in subsection (a)(1) of this section were
caused or contributed to by the hazardous
substance or pollutant or contaminant concerned.
41
This is not the first case in this Circuit to consider the
impact of CTS on UBS II. In FDIC v. First Horizon Asset Sec.,
Inc. (First Horizon), 821 F.3d 372 (2d Cir. 2016), cert. denied,
137 S. Ct. 628 (2017), we held that CTS did not disturb the
portion of UBS II’s holding that held § 4617(b)(12)
precludes the federal Securities Act’s statute of repose. Id. at
380–81. That forecloses Defendants’ argument insofar as it
applies to the FHFA’s claims under the Securities Act. 28 See
Lotes, 753 F.3d at 405.
It remains an open question in this Circuit whether
CTS undermined the portion of UBS II’s holding that held
§ 4617(b)(12) pre‐empts the Virginia and D.C. Blue Sky
laws’ statutes of repose. Cf. Church & Dwight Co., Inc. v. SPD
Swiss Precision Diagnostics, GmBH, 843 F.3d 48, 64–65 (2d
Cir. 2016) (observing that pre‐emption analysis does not
control preclusion analysis).29 “[C]oncerns about the
First Horizon is controlling with regard to the FHFA’s federal
28
claims even though it dealt with a different extender provision,
12 U.S.C. § 1821(d)(14)(A), which was designed for suits brought
by the Federal Deposit Insurance Corporation (the “FDIC”). The
FDIC extender provision is “materially identical” to the HERA
extender provision. First Horizon, 821 F.3d at 375.
This is not an open question in two other Circuits. FDIC v. RBS
29
Sec. Inc., 798 F.3d 244, 254 (5th Cir. 2015) (holding FDIC extender
provision pre‐empts state statutes of repose notwithstanding
CTS); Nat’l Credit Union Admin. Bd. v. Nomura Home Equity Loan,
Inc., 764 F.3d 1199, 1217 (10th Cir. 2014) (holding an extender
provision for claims brought by the National Credit Union
Administration Board (the “NCUA”) pre‐empts state statutes of
repose notwithstanding CTS); see also Nat’l Credit Union Admin.
42
primacy of federal law and the state‐federal balance” that
are unique to the pre‐emption context presented here
distinguish it from preclusion context in First Horizon.
Church & Dwight Co., 843 F.3d at 64 (internal quotation
mark omitted) (quoting POM Wonderful LLC v. Coca‐Cola
Co., 134 S. Ct. 2228, 2236 (2014)). Still, some aspects of our
earlier preclusion analysis aid in deciding the pre‐emption
issue on this appeal. Cf. id. (“[P]re[‐]emption principles can
be ‘instructive’ in the . . . preclusion context . . . .” (quoting
POM Wonderful, 134 S. Ct. at 2236)).30
Bd. v. RBS Sec., Inc., 833 F.3d 1125, 1135 (9th Cir. 2016) (holding
NCUA extender provision pre‐empts Securities Act statute of
repose notwithstanding CTS).
30 Defendants urge us to begin our pre‐emption analysis with a
presumption that Congress did not intend to displace the Blue
Sky statutes of repose. It is well‐established that courts presume
Congress does not intend to supersede “the historic police
powers of the States” absent clear intent, CTS, 134 S. Ct. at 2188
(Kennedy, J., concurring) (quoting Medtronic, Inc. v. Lohr, 518
U.S. 470, 485 (1996)), and that Blue Sky laws are considered
“‘traditional’ state regulation[s]” for pre‐emption purposes,
Oneok, Inc. v. Learjet, Inc., 135 S. Ct. 1591, 1600 (2015) (quoting
Schneidewind v. ANR Pipeline Co., 485 U.S. 293, 308 n.11 (1988)).
The presumption favoring traditional state regulations is
irrelevant, however, to the discrete question before us—whether
CTS abrogated UBS II’s pre‐emption holding. The presumption
is no novel invention of CTS; it existed well before CTS and UBS
II were decided. See Medtronic, 518 U.S. at 485. Further, the
presumption is rebuttable upon a showing of clear congressional
intent. See id. UBS II concluded that Congress clearly intended
§ 4617(b)(12) to eliminate all time limitations that might hinder
43
Nothing about CTS seriously undermines UBS II. The
Supreme Court’s analysis in CTS focused primarily on four
considerations. First, § 9658 provides that state law will be
the default rule for time limitations and that a federal
commencement date will operate as a limited “exception”
to that rule. This suggested to the Court that Congress
intended § 9658 to leave many of the state time‐limitation
rules in place. See CTS, 134 S. Ct. at 2185 (majority opinion).
Second, § 9658 refers explicitly to a “statute of limitations”
but does not mention a “statute of repose.” Although this
was not dispositive of the ultimate issue, the Court took this
as an indication that Congress did not intend § 9658 to
reach statutes of repose. Id. at 2185–86. Third, Congress, in
debating the CERCLA, considered a report that
recommended language providing for explicit pre‐emption
of state statutes of repose, but chose not to include the
proposed language in the final statute. Id. at 2186. Fourth,
§ 9658 defines the state provisions it preempts as the
“applicable limitations period[s]” during “which a civil
action may be brought” and provides for equitable tolling
in certain circumstances, two concepts inapplicable to
repose analyses. Id. at 2187–88 (internal quotation marks
omitted). For these reasons, the Supreme Court held § 9658
did not reflect clear congressional intent to pre‐empt
overlapping state statutes of repose. Id. at 2188.
the FHFA’s charge “to ‘collect all obligations and money due’ to
the GSEs[] to restore them to a ‘sound and solvent condition.’”
712 F.3d at 142 (quoting 12 U.S.C. §§ 4617(b)(2)(B)(ii), (D)).
44
One similarity between § 4617(b)(12) and § 9658 is
that both refer to statutes of limitations but neither
references statutes of repose. See First Horizon, 821 F.3d at
376, 379. While this might suggest on first glance that
neither statute reaches repose statutes, we reasoned in UBS
II that an explicit statutory reference to repose statutes is
not a sine qua non of congressional intent to pre‐empt such
statutes. See 712 F.3d at 142–43. CTS confirmed—rather than
undermined—that reasoning. See 134 S Ct. at 2185. CTS
observed that usage of the terms “limitations” and “repose”
“has not always been precise.” Id. at 2186; accord UBS II, 712
F.3d at 142–43 (“Although statutes of limitations and
statutes of repose are distinct in theory, the courts . . . have
long used the term ‘statute of limitations’ to refer to statutes
of repose . . . .”). Indeed, although Congress has
indisputably created statutes of repose in the past, it “has
never used the expression ‘statute of repose’ in a statute
codified in the United States Code.” First Horizon, 821 F.3d
at 379 (observing that 15 U.S.C. § 77m, titled “Limitation of
actions,” creates a three‐year repose period); see also Cal.
Pub. Emps.’ Ret. Sys. v. ANZ Sec., Inc. (CalPERS), 137 S. Ct.
2042, 2049 (2017) (analyzing federal statute to determine
whether it included a statute of limitation or statute of
repose). As a result, CTS cautioned, while the presence of
the term “statute of limitations” in a federal statute may be
“instructive” of Congress’s intended pre‐emptive scope, it
is not “dispositive.” See 134 S. Ct. at 2185. That reinforces
UBS II’s refusal to resolve its pre‐emption inquiry based
45
solely on the bare text of § 4617(b)(12). See First Horizon, 821
F.3d at 376.31
Defendants also argue that, under CTS,
§ 4617(b)(12)’s repeated use of the words “claim accrues”
indicates that it was meant only to pre‐empt statutes of
limitations. In CTS, the Supreme Court noted that § 9658
pre‐empts the “commencement date” for any “applicable
limitations period” under state law, 42 U.S.C. § 9658(a)(1),
and defines the “applicable limitations period” as the
period when “a civil action [alleging injury or damage
caused by exposure to a hazardous substance] may be
brought,” id. § 9658(b)(2). See 134 S. Ct. at 2187. That
indicated to the Court that Congress intended to displace
only the commencement date for statutes of limitations
because a “statute of repose . . . ‘is not related to the accrual
of any cause of action.’” Id. (quoting 54 C.J.S., LIMITATIONS
OF ACTIONS § 7, p. 24 (2010)).
Section 4617 uses some similar language. It provides
that the new filing period for claims brought by the FHFA
is at least six years for any “contract” claim and three years
for any “tort” claim, “beginning on the date on which the
claim accrues.” 12 U.S.C. §§ 4617(b)(12)(A)(i)(I), (ii)(I). It
also describes how to determine “the date on which a claim
accrues” for purposes of the HERA. Id. § 4617(b)(12)(B).
Defendants argue that this language—specifically the
31 That § 4617(b)(12) refers to “statute of limitations” in the
singular while § 9658 refers to “statutes of limitations” in the
plural is also unimportant in determining whether Congress
intended to displace statutes of repose. See id. at 379.
46
words “claim accrues”—carries the same indication of
congressional intent as § 9658’s definition of the “applicable
limitations period.”
We disagree. CTS does not stand for the proposition
that whenever “accrue” appears in a federal statute it is a
talismanic indication of congressional intent to pre‐empt
only statutes of limitations. Context is crucial. Congress
used the phrase “a civil action . . . may be brought” in
§ 9658 in defining the class of state statutes it intended to
pre‐empt. In contrast, Congress used the words “claim
accrues” in § 4617(b)(12) in defining the time limitation the
HERA newly created for claims brought by the FHFA. Put
another way, the HERA’s use of the word “accrues” “tells
us . . . that [§ 4617(b)(12)] is itself a statute of limitations” but
does not “provide[] . . . guidance on the question whether
[§ 4617(b)(12)] displaces otherwise applicable statutes of
repose . . . .” First Horizon, 821 F.3d at 379.
The only remaining argument against pre‐emption of
the state statutes of repose is that both § 9658 and
§ 4617(b)(12) pre‐empt certain time limitations for state
claims while leaving untouched “other important rules
governing civil actions.” CTS, 134 S. Ct. at 2188. “‘The case
for federal pre‐emption is particularly weak where
Congress has indicated its awareness of the operation of
state law in a field of federal interest, and has nonetheless
decided to stand by both concepts and to tolerate whatever
tension there is between them.’” Id. (brackets omitted)
(quoting Wyeth v. Levine, 555 U.S. 555, 575 (2009)). But
§ 9658 leaves in place far more of state law than
§ 4617(b)(12). Section 9658 provides only a federally
47
mandated accrual date for state limitations periods and
leaves unchanged “States’ judgments about causes of
action, the scope of liability, the duration of the period
provided by statutes of limitations, burdens of proof, [and]
rules of evidence.” CTS, 134 S. Ct. at 2188. Section
4617(b)(12), by contrast, provides a comprehensive,
singular time limitation for all actions brought by the
FHFA. See UBS II, 712 F.3d at 141–42. It governs entirely the
rules regarding when the FHFA may bring its claims—from
the moment the filing period commences, see 12 U.S.C.
§ 4617(b)(12)(B), through the length of the period for each
type of the claim, see id. § 4617(b)(12)(A). Congress has not
stood by any state time‐limitation rules when it comes to
claims brought by the FHFA as the GSEs’ conservator.
In all other respects, CTS and UBS II arose in
substantially different contexts. Section 9658’s legislative
history reveals that Congress specifically considered and
decided against using language that would explicitly pre‐
empt statutes of repose. See CTS, 134 S. Ct. at 2186. There is
no similar legislative history for Section 4617(b)(12). See
UBS II, 712 F.3d at 143. Section 9658 “describ[es] the [pre‐
empted] period in the singular,” which “would be an
awkward way to mandate the pre‐emption of two different
time periods.” CTS, 134 S. Ct. at 2186–87. Section
4617(b)(12) applies “to any action brought by the [FHFA],”
12 U.S.C. § 4617(b)(12)(A) (emphasis added), “‘including
claims to which a statute of repose generally attaches.’”
UBS II, 712 F.3d at 143 (quoting UBS I, 858 F. Supp. 2d at
316–17). Section 9658 contains a provision for equitable
tolling, an important characteristic of statutes of limitations
48
that distinguishes them from statutes of repose. See CTS,
134 S. Ct. at 2187–88. There is no similar provision in
§ 4617(b)(12).
In sum, “CTS’s holding is firmly rooted in a close
analysis of § 9658’s text, structure, and legislative history.”
First Horizon, 821 F.3d at 377. None of those statute‐specific
considerations undermines UBS II’s close analysis of
§ 4617(b)(12), which differs significantly from § 9658. We
reaffirm our prior holding that Congress designed
§ 4617(b)(12) to pre‐empt state statutes of repose.32
B. Knowledge Issues — Statutes of Limitations and
Knowledge of the ProSupps’ Underwriting
Guidelines Misrepresentations
Defendants next raise two pre‐trial issues that turn on
the extent to which the GSEs were or should have been
aware that the ProSupps’ underwriting guidelines
statements were false. The first is the statute of limitations.
In addition to the statute of repose discussed above, Section
13 of the Securities Act contains a statute of limitations that
bars any action not brought within one year after the
plaintiff learned or should have learned of the material
misstatement or omission giving rise to the claim. 15 U.S.C.
32 We reject Defendants’ arguments that § 4617(b)(12) does not
pre‐empt statutes of repose because it refers only to “contract”
and “tort” claims, rather than securities claims, and because the
statute’s initial language is not as sharp as other pre‐emption
clauses in the HERA. In addition to lacking in merit, these
arguments are not grounded in any unique feature of CTS that
might have undermined UBS II. See Lotes, 753 F.3d at 405.
49
§ 77m; see CalPERS, 137 S. Ct. at 2049 (2017) (discussing
three‐year time bar).33 The HERA extended the filing period
only for contract claims that were valid on (or became valid
after) September 6, 2008, the date when the FHFA assumed
conservatorship. See 12 U.S.C. §§ 4617(b)(12)(A), (12)(B); J.A.
341–42. Thus, any FHFA claim that was time‐barred by
Section 13 on that date remained time‐barred under the
HERA. On the FHFA’s motion for summary judgment, the
District Court held that the FHFA’s claims were timely as a
matter of law. The court concluded that no reasonable jury
could find the GSEs knew or should have known as of
September 6, 2007, one year before the HERA extender
became effective, that ProSupps’ underwriting guidelines
statements were false, despite widespread PLS credit
downgrades in the summer of 2007 and the Single Family
Businesses’ generalized experience with mortgage loan
originators and PLS aggregators. Nomura I, 60 F. Supp. 3d at
502–09; see also UBS I, 858 F. Supp. 2d at 321–22. Defendants
contest that decision on appeal.
The second, related issue is whether the FHFA was
entitled to summary judgment on the purchaser’s absence‐
of‐knowledge element of a Section 12(a)(2) claim. See 15
U.S.C. § 77l(a)(2).34 The District Court granted the FHFA
33 The D.C. Blue Sky statute of limitations is the same as the
statute of limitations under the Securities Act. D.C. CODE § 31–
5606.05(f)(2)(B).
34 The standard for purchaser knowledge under the Blue Sky
laws is the same as it is under the Securities Act. See VA. CODE
ANN. § 13.1–522(A)(ii); D.C. CODE § 31–5606.05(a)(1)(B).
50
summary judgment on this element, holding again that the
Single Family Businesses’ expertise in the general mortgage
loan market did not provide adequate knowledge of the
specific untruths in the ProSupps. See HSBC II, 33 F. Supp.
3d at 480–93. Defendants also contest this decision on
appeal.
We address these issues in tandem, as the relevant
facts and legal questions overlap in large part.
1. Factual Summary35
a. The Single Family Businesses’ Due Diligence
The GSEs’ Single Family Businesses, in their
capacities as aggregators and sponsors of RMBS
instruments, gathered a significant amount of information
about the mortgage loan market and mortgage loan
originators. Fannie’s Single Family due diligence division
was the Single Family Counterparty Risk Management
Group (the “SFCPRM”); Freddie’s Single Family due
diligence division was the Alternative Market Operations
Group (the “AMO”). Through the work of the SFCPRM and
AMO, the GSEs amassed “more knowledge about the
mortgage market than probably anybody else.” J.A. 1317.
35 The following summary draws on the District Court’s
discussions of the relevant facts, which we view in the light most
favorable to Defendants and which Defendants do not dispute.
See Nomura I, 60 F. Supp. 3d at 489–92 (Single Family
Businesses), 498–99 (credit downgrades); HSBC II, 33 F. Supp. 3d
at 463–74 (Single Family Businesses).
51
The SFCPRM and AMO conducted counterparty
reviews of originators with whom the GSEs regularly did
business. These reviews involved desk audits and on‐site
visits to originators’ offices. Often the GSEs hired Clayton
Advisory Services, Ltd. (“Clayton”), a third‐party mortgage
diligence vendor, to re‐underwrite a sample of the
originators’ issued loans and assess the originators’
compliance with their underwriting guidelines. The GSEs
also analyzed originators’ adherence to appraisal protocols,
capability to detect fraud, and ability to meet repurchase
obligations. If an originator received a positive result from
this review, the GSE placed, or maintained, it on a list of
approved originators.
The SFCPRM and AMO conducted counterparty
reviews for at least five originators that issued loans
backing the Certificates in this case; we note some pertinent
results of those reviews below:
First NLC Mortgage Corporation, which issued
~14.5% of the loans backing NHELI 2006‐HE3 and
~11.5% of the loan backing NHELI 2007‐2: The AMO
issued a “Poor” rating (the worst possible) in January
2005, reporting “poor command of its credit,
appraisal and quality control units,” and a
“Marginal” rating in April 2005, J.A. 10409;
Mandalay Mortgage, which issued ~5.7% of the loans
backing NHELI 2006‐HE3: The AMO issued a “Poor”
rating in November 2004 based on its “aggressive”
participation in risky loan product categories, id. at
10410;
52
ResMAE, which issued ~77.6% of the loans backing
NHELI 2007‐3: The AMO issued a “Marginal” rating
in April 2004 and recommended that Freddie Mac
components dealing with ResMAE “Proceed with
Caution” given ResMAE’s lack of an internal quality
program and relaxed underwriting procedures, id. at
10411; the AMO placed ResMAE on a watch list in
April 2007 due to a liquidity crisis; ResMAE later
went bankrupt;
Ownit, which issued ~42.4% of the loans backing
NHELI 2007‐2: The AMO, in August 2004, found
controls “marginal” due to the originator’s
instability, and noted its practice of keeping “very
inaccurate” loan data, id. at 10410; and
Fremont, which backed entirely NHELI 2006‐FM1
and NHELI 2006‐FM2: After reviews in February
2004 and August 2005, the AMO found wide LTV
variances, “data integrity issues,” and a large number
of exceptions to the underwriting guidelines, id. at
10314 (brackets omitted).
The GSEs’ knowledge about the mortgage loan
industry required a delicate information sharing
arrangement between their Single Family Businesses and
their PLS traders.
On the one hand, the GSEs did not want to purchase
loans or securitizations supported by loans that they knew
were originated or aggregated by companies they did not
trust. The Single Family Businesses’ research proved
helpful to the PLS traders in that regard; and indeed each
53
GSE required that any originator that individually
contributed more than a certain percentage (10% for Fannie,
1% for Freddie) of the total unpaid principal balance of a
PLS be on its list of approved originators.
On the other hand, the GSEs were concerned that its
PLS traders would violate federal insider‐trading laws if,
before purchasing PLS, they reviewed the certain loan‐
specific information the Single Family Businesses
considered in making purchases for their own aggregation
practices. The GSEs accordingly limited their PLS traders’
access to only the Single Family Businesses’ reviews of
originators’ general practices. Fannie’s PLS traders were
given the final lists of approved originators; Freddie’s were
given the full counterparty review paperwork. PLS traders
were not given access to any specific loan‐level information
for the transactions at issue.
The SFCPRM and AMO also evaluated PLS sellers
and maintained a list of approved PLS counterparties. Both
Nomura and RBS were placed on the GSEs’ lists of
approved PLS sellers. In August 2004, the AMO rated
Nomura’s due diligence program “Satisfactory” based on
Nomura’s “good due diligence methodologies, reasonable
valuation processes and sound controls.” Id. at 3170. In a
November 2006 review, the SFCPRM noted it had access to
somewhat limited information to review RBS’s diligence,
but apparently accepted RBS’s characterization of its
practices as robust. Nomura I, 60 F. Supp. 3d at 491.
Despite ensuring that they purchased loans from
approved originators and PLS sellers, the GSEs knew that
54
there was still a risk that some defective loans could creep
into SLGs for PLS certificates they purchased. The heads of
the GSEs’ PLS portfolios acknowledged in deposition
testimony that they believed that loans in an SLG “would
reflect the general underwriting practices of the originators
responsible for those loans.” J.A. 10323. That meant that “if
an originator was not following its own guidelines and was
contributing loans to the collateral for the pool,” the GSEs
“would have expected that loans not underwritten to the
originator’s guidelines would then end up in the” SLGs. Id.
at 10325 (emphasis added; internal quotation marks
omitted). To limit that possibility, the GSEs required
“rep[resentation]s and warrant[ie]s” from the approved
PLS sellers for each certificate they purchased, believing
that they could rely on those institutions to limit the
number of the defective loans to an immaterial level. Id. at
1063; see also HSBC II, 33 F. Supp. 3d at 471 (“[A Fannie
employee] testified that Fannie Mae’s ‘process basically
relied on the dealers and originators providing it with reps
and warranties as to the validity of how these loans were
underwritten.’” (brackets omitted)).
b. The GSEs’ Awareness of PLS Market Trends
GSEs were also familiar with public information
about the overall RMBS market in 2006 and 2007. This
information included a growing number of reports of
borrower fraud and lower underwriting standards among
mortgage loan originators. Beginning in July and August of
2007, it also included reports that the three primary credit‐
rating agencies, Moody’s, S&P, and Fitch, began to
accelerate their negative views of RMBS.
55
On July 10, 2007, Moody’s downgraded the junior
tranches of many RMBS—including Securitizations NHELI
2006‐FM1 and NHELI 2006‐FM2. The credit ratings for the
senior tranches in these Securitizations did not change.
Moody’s attributed its downgrades to “a persistent
negative trend in severe delinquencies for first lien
subprime mortgage loans securitized in 2006.” Nomura I, 60
F. Supp. 3d at 498 (internal quotation marks omitted).
Moody’s noted that the supporting loans “were originated
in an environment of aggressive underwriting” and that
increased default rates were caused in part by “certain
misrepresentations . . . like occupancy or stated income and
appraisal inflation.” Id. (internal quotation marks omitted;
brackets omitted).
That same day, S&P placed on negative rating watch
a host of RMBS—but none of the Securitizations—citing
“lower underwriting standards and misrepresentations in
the mortgage market.” Id. (internal quotation mark
omitted). S&P questioned the quality of the data
“concerning some of the borrower and loan characteristics
provided during the rating process.” Id. S&P made clear
that, going forward, its ratings for RMBS certificates would
hew more closely to their seniority within the
securitization.
After expressing doubt on July 12, beginning in
August of 2007 Fitch downgraded hundreds of RMBS. On
August 3, 2007, Fitch downgraded junior tranches in
Securitizations NHELI 2006‐FM2 and NHELI 2006‐HE3, but
Fitch did not downgrade the senior tranches in those
Securitizations at that time.
56
On August 17, 2007, S&P downgraded junior
tranches in Securitization NAA 2005‐AR6. As with Moody’s
and Fitch’s downgrades, S&P did not change its rating for
the senior tranches in the Securitization at that time.
The Rating Agencies took no further action on the
Securitizations through September 6, 2007. As of that date,
none of the GSEs’ senior‐tranche Certificates had been
downgraded, but junior tranches in NHELI 2006‐FM2 had
been downgraded by two Rating Agencies, and junior
tranches in NAA 2005‐AR6, NHELI 2006‐FM1, and NHELI
2006‐HE3 had each been downgraded by one Rating
Agency.
The GSEs monitored these junior tranche
downgrades. The GSEs understood that the credit risks of
the all of the tranches in a Securitization were connected. At
least one Fannie employee during the summer of 2007
attempted to ascertain whether the GSE owned any
Certificates in Securitizations that had been downgraded.
On August 17, 2007, a Fannie employee circulated
internally “a short eulogy for the subprime RMBS market.”
Id. at 499.
2. Analysis
a. Statutes of Limitations
Section 13’s statute of limitations extinguishes any
action not “brought within one year after the discovery of
the untrue statement or the omission, or after such
discovery should have been made by the exercise of
reasonable diligence.” 15 U.S.C. § 77m. The filing period
commences “when the plaintiff discovers (or should have
57
discovered) the securities‐law violation.” CalPERS, 137 S.
Ct. at 2049. A securities‐law violation is discovered when
the plaintiff learns “sufficient information about [the
violation] to . . . plead it in a complaint” with enough
“detail and particularity to survive a [Federal Rule of Civil
Procedure] 12(b)(6) motion to dismiss.” MBIA, 637 F.3d at
175. A plaintiff is charged with knowledge of any fact that
“a reasonably diligent plaintiff would have discovered.” Id.
at 174 (internal quotation mark omitted) (quoting Merck &
Co., Inc. v. Reynolds, 559 U.S. 633, 653 (2010)).
“[W]hen the circumstances would suggest . . . the
probability that” a violation of the securities laws has
occurred—a situation sometimes called “storm
warnings”—we deem the plaintiff on inquiry notice and
assume that a reasonable person in his or her shoes would
conduct further investigation into the potential violation.
Lentell v. Merrill Lynch & Co., Inc., 396 F.3d 161, 168 (2d Cir.
2005) (internal quotation marks omitted) (quoting Levitt v.
Bear Stearns & Co., Inc., 340 F.3d 94, 101 (2d Cir. 2003)).
Under prior Circuit law, the Section 13 limitations period
could begin to run as early as the moment a plaintiff knew
or should have known of storm warnings that placed it on
inquiry notice. See Staehr v. Hartford Fin. Servs. Grp., 547
F.3d 406, 426 (2d Cir. 2008).36 The Supreme Court’s decision
in Merck changed that rule. See 559 U.S. at 650–53. After
36 If the plaintiff took some action on the information, however,
the limitations period began to run only when an investor
exercising reasonable diligence should have discovered the
fraud. Id.
58
Merck, we still assume a reasonable plaintiff on inquiry
notice would conduct further investigation, but the
limitations period begins to run only when, in the course of
that investigation, the reasonable plaintiff would have
discovered sufficient information to plead a securities‐law
violation adequately. See id. at 651; MBIA, 637 F.3d at 174.37
A storm warning “need not detail every aspect of the
alleged” securities‐law violation. Staehr, 547 F.3d at 427.
Information triggers the duty to inquire if it “‘relates
directly to the misrepresentations and omissions the
[p]laintiff[] . . .allege[s] in [its] action against the
defendants,’” id. (alteration omitted) (quoting Newman v.
Warnaco Grp., Inc., 335 F.3d 187, 193 (2d Cir. 2003)), and is,
in the totality of the circumstances, “specific enough to
provide an ordinary investor with indications of the
probability (not just the possibility) of” a violation. Id. at 430
(emphases added; citations omitted). For example, we have
found that an insurance company taking three substantial
“reserve charges” followed by a national periodical
publishing an article about the company’s issues with
reserves triggered a duty to inquire about the company’s
Following the parties’ lead, we assume arguendo that Merck,
37
which involved the statute of limitations for claims under
Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b), applies with
equal force to the statute of limitations in Section 13 of the
Securities Act. See Pension Tr. Fund for Operating Eng’rs v. Mortg.
Asset Securitization Transactions, Inc. (Pension Tr. Fund), 730 F.3d
263, 273 (3d Cir. 2013) (holding Merck applies to both the
Exchange Act and Securities Act); UBS I, 858 F. Supp. 2d at 318–
20 (same).
59
concealment of a negligent practice to under‐reserve for
insurance claims. See LC Capital Partners, LP v. Frontier Ins.
Grp., Inc., 318 F.3d 148, 155 (2d Cir. 2003). We have also
found a plaintiff on inquiry notice regarding a bank’s
concealment of conflicts of interest when a magazine article
described one of an affiliated financial research analyst’s
conflicts. See Shah v. Meeker, 435 F.3d 244, 249–51 (2d Cir.
2006). But we have found “generic articles” regarding
structural conflicts of interest in the financial services
industry insufficient to trigger a duty to inquire about
specific instances of knowing and intentional fraud in that
industry. See Lentell, 396 F.3d at 170.
In this case, Defendants argue the GSEs became
aware of two categories of storm warnings before
September 6, 2007, one year prior to the effective date of the
HERA’s extender provision. First, Defendants argue that
the GSEs, through their Single Family Businesses, knew
first‐hand that originators that issued loans supporting the
Securitizations had subpar underwriting practices. That
knowledge, the argument goes, would have caused a
reasonable investor in the GSEs’ shoes to conduct an
investigation into whether the loans in the SLGs supporting
the Securitizations were poorly underwritten. Second,
Defendants contend that the credit downgrades of junior
tranches in the Securitizations in the summer of 2007 put
the GSEs on notice that the supporting loans were not as
trustworthy as the ProSupps portrayed.
We are not persuaded. The Single Family Businesses’
generalized experience with originators in the mortgage
loan market did not trigger inquiry notice to investigate the
60
specific representations in the ProSupps. The Single Family
Businesses clearly knew or should have known that some
originators who issued loans backing the Certificates were,
as a general matter, less‐than‐rigorous in adhering to
underwriting guidelines. But they reasonably believed that
not every loan issued by those originators was defective,
that the SLGs backing the Certificates did not contain all of
the originators’ loans, and that the SLGs were not
representative samples of the originators’ entire loan pools.
The SLGs contained specific loans that Defendants
specifically selected from a larger population of loans
issued by the originators.
Generalized knowledge that originators issued some
defective loans alone would not cause a reasonable investor
to believe necessarily that his or her particular PLS
certificates were backed by such loans. A reasonable
investor’s suspicions would be raised only if Defendants’
loan‐selection processes were also defective such that the
shoddily underwritten loans would slip past their screens
and into the SLGs. In this case, there was little indication of
that, as both Nomura and RBS were approved by the GSEs
as PLS counterparties.
Neither do the acknowledgments by leaders in the
GSEs’ PLS trading departments that they expected the SLGs
to contain some defective loans indicate that a reasonable
investor in their shoes would have investigated whether the
ProSupps contained false statements. See HSBC II, 33 F.
Supp. 3d at 471. Those statements reflect an understanding
that due diligence processes are never perfect and a
reasonable expectation that those processes may fail to
61
excise an immaterial number of defects from the SLGs.
Knowledge of a risk of immaterial deviations is quite
different from knowledge of a risk of material deviations.
For a material portion of the SLGs, a reasonable investor
would do exactly as the GSEs’ did—“rel[y] on the dealers
and originators providing . . . reps and warranties as to the
validity of how these loans were underwritten.” Id.
(internal quotation mark omitted; brackets omitted).
Defendants argue that the GSEs were not entitled to
rely on Defendants’ diligence and should have assumed
that the loans in the SLGs were representative of the
originators’ entire loan pools because the ProSupps did not
represent that the loans in the SLGs would be “the cream of
the crop.” RBS’s Br. 35. While it is true that the ProSupps
made no representations about the loans in the SLGs
relative to other loans the originators issued, the ProSupps
did represent that the loans in the SLGs “were originated
generally in accordance with the underwriting criteria.”
E.g., J.A. 6884. A reasonable investor in the GSEs’ shoes
would take that statement for all that it was worth: an
affirmation that, regardless of the quality of the median
loan in the residential mortgage market, these specific loans
in these specific SLGs met the underwriting criteria.
Neither would the credit downgrades of junior
tranches cause a reasonable investor in the GSEs’ shoes to
investigate whether the ProSupps contained material
misstatements or omissions. To be sure, the Credit‐Rating
Agencies’ bearish turn on RMBS expectations revealed that
they had begun to doubt the strength of the loans in the
downgraded securitizations’ SLGs, and those doubts would
62
cause some concern for every reasonable certificate‐holder
regardless of seniority. As a product of the subordination
for senior PLS certificates, a single SLG supported junior
and senior‐tranche certificates simultaneously. Thus,
concerns about the SLGs’ creditworthiness could reach the
senior tranches of any Securitization that had downgraded
junior tranches. See Nomura I, 60 F. Supp. 3d at 499 (“The
GSEs recognized that, generally, downgrades to junior
tranches increased the risk of a future downgrade to the
GSEs’ senior tranches.”).
It does not follow, however, that the summer 2007
credit downgrades would cause a reasonable senior‐
certificate holder to believe the PLS offering documents
contained false statements that were material. See Staehr,
547 F.3d at 430 (observing that a storm warning triggers
inquiry notice only when it indicates a probability of a full
securities violation). The senior and junior certificate‐
holders did not have the same risk exposure. Certificate‐
holders were entitled to distributions of principal, interest,
and collateral in the supporting loans in descending order
of seniority. A reasonable senior certificate‐holder might
understand the Rating Agencies’ decisions to downgrade
junior tranches while maintaining the senior‐tranche ratings
to mean that any misrepresentation in the offering
documents was mild enough that the subordination and
over‐collateralization still insulated them from loss. On that
understanding, tranche‐specific downgrades might seem
material to a reasonable investor in a junior certificate but
not to a reasonable investor in a senior certificate.
63
Finally, under Merck, it was Defendants’ burden to
prove that a reasonable investor in the GSEs’ shoes would
have conducted a fulsome investigation and uncovered
information sufficient to make out a plausible claim for
relief by September 6, 2007—just weeks after the credit
downgrades. See MBIA, 637 F.3d at 174. Defendants
adduced “no evidence of . . . how long it would take a
reasonably diligent investor in the GSEs’ position to
investigate the [instant Section 12(a)(2)] claims such that it
could adequately plead them.” Nomura I, 60 F. Supp. 3d at
509; see also Pension Tr. Fund, 730 F.3d at 279 (concluding
that it would have taken a reasonable institutional investor
in RMBS using a “proprietary process” that involved
analyzing “court filings” two months to uncover loan‐
quality misrepresentations in offering documents). Their
failure to establish this indispensable piece of the statute of
limitations defense dooms their argument on appeal.
b. Absence‐of‐Knowledge Element
Section 12(a)(2) requires the plaintiff to prove that it
did not “know[]” of the material misstatement in the
prospectus. 15 U.S.C. § 77l(a)(2); see Healey v. Chelsea Res.,
Ltd., 947 F.2d 611, 617 (2d Cir. 1991). This is an actual
knowledge standard. See Casella v. Webb, 883 F.2d 805, 809
(9th Cir. 1989). In contrast to the reasonable care affirmative
defense (discussed below), Section 12 does not require the
plaintiff to undertake any investigation or prove that it
could not have known the falsity of the misstatement at
issue. See 15 U.S.C. § 77l(a)(2) (precluding recovery if the
defendant “did not know, and in the exercise of reasonable
care could not have known, of such untruth or omission”).
64
Section 12 requires plaintiffs to prove only that they in fact
lacked knowledge of the falsity. See N.J. Carpenters Health
Fund v. Rali Series 2006‐QO1 Tr., 477 F. App’x 809, 813 n.1
(2d Cir. 2012) (summary order); cf. N.J. Carpenters Health
Fund II, 709 F.3d at 127 n.12 (observing that Section 11
creates an analogous “affirmative defense where a
defendant can prove that ‘at the time of . . . acquisition,’ the
purchaser ‘knew’ of the alleged ‘untruth or omission’”
(quoting 15 U.S.C. § 77k(a))).
Actual knowledge may be proven or disproven by
direct evidence, circumstantial evidence, or a combination
of the two. See Desert Palace, Inc. v. Costa, 539 U.S. 90, 100
(2003). Publicly available information may provide relevant
circumstantial evidence of actual knowledge. See id.
However, Section 12’s amenability to circumstantial
evidence of actual knowledge should not be viewed as
creating a constructive knowledge standard. The mere
“[a]vailability elsewhere of truthful information cannot
excuse untruths or misleading omissions in the
prospectus.” Dale v. Rosenfeld, 229 F.2d 855, 858 (2d Cir.
1956) (emphasis added). A plaintiff is entitled to recover
under Section 12 if it was genuinely unaware of the falsity
no matter how easily accessible the truth may have been.
Furthermore, Section 12 requires the plaintiff to
prove only that it did not know that the specific statement at
issue in the prospectus or oral communication was false. See
15 U.S.C. § 77l(a)(2) (“[T]he purchaser not knowing of such
untruth or omission . . . .” (emphasis added)). This is to be
distinguished from knowing that there was a risk that the
statement was false and from knowing that other similar
65
statements in the same prospectus or other prospectuses
were false. Section 12(a)(2)’s absence‐of‐knowledge element
focuses on the buyer’s actual knowledge of the truth‐in‐fact
of the particular statement at issue.
For substantially the same reasons that undergird our
statute of limitations ruling above, we conclude that the
GSEs lacked actual knowledge of the falsity of the specific
underwriting guidelines statements in the ProSupps.
Defendants failed to link the GSEs’ generalized knowledge
about the mortgage loan origination industry to the
ProSupps’ specific statements regarding the quality of the
loans in the SLGs. Section 12 permitted the GSEs to rely on
the ProSupps’ representations that the specific loans
backing the Securitizations were originated generally in
accordance with the underwriting criteria, regardless of the
existence of other poorly issued loans in the market at the
time. The Securities Act placed the sole burden on
Defendants to ensure that representation was correct. See
Basic, 485 U.S. at 234 (observing that the Securities Act
replaces caveat emptor with “a philosophy of full disclosure”
(quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S.
180, 186 (1963))).
Two cases that bear directly on the absence‐of‐
knowledge issue warrant further discussion.
Defendants’ absence‐of‐knowledge argument relies
on an analogy to In re Initial Public Offerings Securities
Litigation (IPO), 471 F.3d 24 (2d Cir. 2006). IPO was an
appeal under Federal Rule of Civil Procedure 23(f) to
review the certification of a class of investors in an action
66
against underwriters of initial public offerings (“IPOs”). Id.
at 27, 31. The class alleged that the underwriters violated
Section 10(b) of the Exchange Act and Section 11 of the
Securities Act by “condition[ing] allocations of shares at the
[IPO] price on agreements to purchase shares in the
aftermarket.” Id. at 27. This scheme allegedly inflated
secondary share prices and, consequently, the
underwriters’ compensation. See id. Part of the class’s
burden was to establish that it could provide common
proof that each plaintiff lacked actual knowledge of the
underwriters’ aftermarket‐purchase scheme. Id. at 43.
We held that the class failed to meet its burden. Id. at
43–44. The class initially based its allegations of the
aftermarket‐purchase scheme on an “industry‐wide
understanding” that IPO underwriters secured agreements
to make such purchases, gleaned from customer
interactions with those underwriters and from publicly
available information in an SEC bulletin and news reports.
Id. at 43. Those allegations of widespread knowledge led us
to require individual inquiries into which members of the
class had been exposed to that information before
participating in an IPO. Id. at 43–44. We also concluded in a
footnote that knowing about the aftermarket‐purchase
agreements was the functional equivalent of knowing about
the scheme to inflate secondary securities prices because
one could reasonably infer knowledge of the latter from
knowledge of the former. Id. at 44 n.14.
Drawing on IPO, Defendants argue that the GSEs
could have reasonably inferred that the ProSupps contained
false statements from their Single Family Businesses’
67
experience with the mortgage loan originators. That
argument reads IPO too broadly. IPO—in the course of de‐
certifying the class—held that the widespread public
information in that case made it too difficult to determine as
a common question whether the plaintiffs had actual
knowledge of the material misstatements at issue. We did
not rule that public information alone can prove actual
knowledge for all plaintiffs. See id. at 43–44. The district
court on remand still had to examine whether each plaintiff
had actual specific knowledge notwithstanding the public
information.
We did not suggest in IPO that generalized public
information plus a “reasonable inference” establishes
specific knowledge. We stated that if a plaintiff actually
knew about the aftermarket‐purchase agreements, it was
reasonable to infer that the plaintiff knew those agreements
would result in inflated secondary market prices. Id. at 44
n.14. In other words, once a plaintiff had actual knowledge
of a specific fact, a fact‐finder could reasonably infer that
the plaintiff knew of the natural specific consequences of
that fact. For example, if the GSEs actually knew that the
loans in the SLGs were not originated generally in
accordance with the underwriting criteria, then under IPO,
it would be reasonable to infer that the GSEs knew those
loans were more likely to default and the value of the
Certificates would likely fall. Defendants, however, attempt
to establish actual knowledge of a specific fact (that the
loans in the SLGs were defective) by drawing a “reasonable
inference” from generalized knowledge about the mortgage
loan industry. IPO cannot bear that weight.
68
Viacom International, Inc. v. YouTube, Inc. (Viacom), 676
F.3d 19 (2d Cir. 2012), is more on point. There, Viacom and
other content‐providers alleged that YouTube committed
direct and secondary copyright infringement by hosting
vast amounts of unlicensed copyrighted material on its
website. Id. at 28–29. One issue was whether YouTube had
actual and specific knowledge of the copyrighted material
Viacom accused it of hosting. Id. at 32–34. Record evidence
revealed that YouTube knew, based on internal surveys of
its website, that between 75% and 80% of its content
contained copyrighted material. Id. at 32–33. We concluded
that those surveys were “insufficient, standing alone, to
create a triable issue of fact as to whether YouTube actually
knew, or was aware of facts or circumstances that would
indicate, the existence of particular instances of
infringement.” Id. at 33. More evidence was required to
establish that YouTube had actual knowledge of the
copyrighted material specified in Viacom’s complaint. See
id. at 33–34.
The best case scenario for Defendants is no better
than the survey evidence in Viacom. At most, the GSEs were
aware that many PLS were supported by loans that were
not originated in accordance with the underwriting
guidelines. There is no evidence that the GSEs knew
whether the specific PLS at issue were within or without
the class of infected PLS. Without that crucial piece of
information, Viacom precludes a reasonable jury from
69
holding that the GSEs actually knew of the specific
misstatements in the ProSupps.38
C. Reasonable Care Defense
Defendants appeal the District Court’s grant of the
FHFA’s motion for summary judgment seeking to preclude
Defendants from asserting a reasonable care defense at trial.
Nomura II, 68 F. Supp. 3d at 444–46.
Section 12(a)(2) provides a complete defense to any
defendant who “did not know, and in the exercise of
reasonable care could not have known,” that the
misstatement at issue was false. 15 U.S.C. § 77l(a)(2); see
Morgan Stanley, 592 F.3d at 359 n.7.39 This raises a classic,
mixed‐law‐and‐fact question of reasonableness, usually
committed to a jury. For that reason, only in the rare case
can a court, viewing the facts in light most favorable to
defendants, resolve the reasonable care defense as a matter
of law. We are aware of only two other federal decisions,
one of which was recently decided in a similar RMBS case,
holding on summary judgment that a Section 12 defendant
cannot pursue this defense. See Nat’l Credit Union Admin.
Bd. v. UBS Sec., LLC, Nos. 12‐2591, 12‐2648, 2017 WL 411338,
at *4–6 (D. Kan. Jan. 31, 2017) (granting partial summary
38 Affirming the award of summary judgment in the FHFA’s
favor, we do not reach Defendants’ related requests to reopen
and expand discovery.
Both Blue Sky laws provide a substantially similar reasonable
39
care defense. See VA. CODE ANN. § 13.1–522(a)(ii); D.C. CODE
§ 31–5606.05(a)(1)(B).
70
judgment where “defendants essentially offered no
evidence of due diligence,” id. at *5); see also Plunkett v.
Francisco, 430 F. Supp. 235, 241 (N.D. Ga. 1977).40
Nevertheless, the District Court held this was an
“exceptional” case “where no reasonable, properly
instructed jury could find” that Defendants should not have
known that the ProSupps’ statements affirming that the
loans in the SLGs adhered to the underwriting guidelines
were false. Nomura II, 68 F. Supp. 3d at 445.41 Defendants
argue on appeal that a reasonable jury could find that
Defendants met the reasonable care standard because their
due diligence complied with PLS industry practices at the
time.
We are aware of another federal decision, Massachusetts Mutual
40
Life Insurance Company v. DB Structured Products, Inc., in which
the court found that the due diligence defense failed as a matter
of law and granted partial summary judgment with respect to
one defendant, but also denied summary judgment regarding
the due diligence defense with respect to other defendants. 110
F. Supp. 3d 288, 301 (D. Mass. 2015).
The District Court also held as a matter of law that Defendants
41
knew or should have known that the ProSupps’ statements
regarding loan‐to‐value ratios were false. See id. at 445–46. We
need not review that decision because we affirm the court’s
alternative holding that Defendants’ credit and compliance
diligence processes were inadequate.
71
1. Factual Summary42
a. Nomura
Nomura’s Transaction Management Group oversaw
the process of purchasing and conducting due diligence of
loans intended for securitization. Individual Defendants
John P. Graham and N. Dante LaRocca both served, at
different times, as the head of this group; Individual
Defendant David Findlay, Nomura’s Chief Legal Officer,
also played a role in supervising this group. Nomura’s
Trading Desk purchased loans from originators, and
Nomura’s Due Diligence Group reviewed those loans. The
Diligence Group consisted of between three and five
employees, including its group leader, initially Joseph
Kohout and later Neil Spagna.
The Trading Desk purchased a few loans
individually, but a vast majority of the loans it securitized
were purchased in trade pools. A trade pool with an
aggregate principal balance greater than $25 million was
known as a “bulk pool.” All other trade pools were “mini‐
bulk pools.” The SLGs at issue here were comprised of
15,806 loans, 14,123 (~89%) of which came from 54 bulk
pools and 1,561 (~10%) of which came from 140 mini‐bulk
pools. The remaining 122 (~1%) loans in the SLGs were
purchased individually. When an originator solicited bids
for a trade pool, it made only the loan tape available to
The following summary draws on the District Court’s
42
discussion of the relevant facts and additional record evidence,
which we view in the light most favorable to Defendants and
which Defendants do not dispute. See id. at 448–65.
72
Nomura and other PLS aggregators. Traders did not review
individual loan files before bidding on a pool.
After Nomura won a bid to purchase loans but before
final settlement, the originators made available some
number of loan files for Nomura’s Diligence Group to
review. Consistent with industry practices at the time, this
pre‐acquisition review was the only round of diligence
Nomura conducted prior to offering the Securitizations to
the public. The Diligence Group directed, inter alia, a credit
review and a compliance review of the loans. The credit
review examined whether the loans were originated in
accordance with the originators’ underwriting guidelines.
The compliance review examined whether the loans
complied with the relevant federal, state, and municipal
regulations.
The Diligence Group conducted credit and
compliance reviews for approximately 40% of the loans in
the SLGs at issue. Nomura reviewed each loan purchased
individually, virtually every loan purchased in a mini‐bulk
pool, and virtually all of the loans in 24 of the bulk pools.
For the remaining 30 bulk pools (which contributed 82.1%
of the total loans in the SLGs), the Diligence Group
reviewed only a sample. Nomura’s Trading Desk—not the
Diligence Group—sometimes entered into agreements with
counterparty originators limiting the size of the samples,
which ranged from about 20% to 50% of the pool. Some of
those agreements placed a hard cap on the size of the
sample, while others affixed the size of the sample but
entitled Nomura to request additional loans, a process
73
known as “upsizing” the sample. Nomura did not upsize
any of the samples at issue in this case.
Nomura used a non‐random process to compile their
samples. The Diligence Group selected 90% of the sample
using a proprietary computer program created by S&P
known as LEVELS. LEVELS employed adverse sampling, a
process which involves combing through the loan tape to
select for review the loans with the highest credit risk in a
trade pool based on debt‐to‐income ratio, FICO score, loan‐
to‐value ratio, and outstanding principal balance. The
remaining 10% of the sample was selected “in an ad hoc
fashion” based on similar risk factors. Id. at 451.
Kohout warned Nomura employees in an internal
email that Nomura’s use of LEVELS “is a non industry
standard approach,” J.A. 2631, and “does not conform to
what is generally deemed to be effective by industry
standards,” id. at 2632. He stated that “when presenting our
process to both internal and external parties, it will have to
be made clear that [the Diligence Group’s] role in both the
sample selection and management of risk on bulk
transactions has been diminished to the point of that of a
non effective entity pursuant to our limited role in the
process.” Id. at 2631–32. The Single Family Businesses’
counterparty reviews of PLS sponsors revealed that several
other sponsors also used LEVELS to compose portions of
their due diligence samples.
After selecting the sample, the Diligence Group
deputized a third‐party vendor, often Clayton or American
Mortgage Consultants Inc. (“AMC”), to perform the credit
74
and compliance reviews, with occasional oversight and
assistance from Nomura employees. This was consistent
with industry practices. The vendor used the sample loan
files to re‐underwrite the loans according to the originators’
underwriting guidelines, additional criteria provided by
Nomura, and applicable laws. The vendor gave each loan
an “Event Level” (“EV”) grade on a scale from 1 to 3, 1
indicating that the loan met all of the review criteria and 3
indicating that the loan materially deviated from the criteria
or lacked critical documentation. The vendor then
transmitted those grades to Nomura’s Diligence Group on a
document titled “Individual Asset Summaries.”
The Diligence Group reviewed all of the vendor’s
EV2 and EV3 grades and as many as half of its EV1 grades.
This review was limited to examining the “Individual Asset
Summaries”; Nomura did not examine any loan files. The
Diligence Group possessed the authority to issue client
overrides that vacated the vendor’s grade and to direct the
vendor to re‐grade the loan. With respect to the loans
drawn from the 54 bulk pools that contributed to the SLGs
here, the Diligence Group directed the vendor to change
roughly 40% of the EV3 grades to EV2 grades.
The record contains one audit of Nomura’s pre‐
acquisition review vendors, which LaRocca, then‐head of
Nomura’s Transaction Management Group, reviewed. The
audit report is dated August 24, 2006 (before four of the
Securitizations settled). It finds that in a sample of 109 loans
previously graded EV1 or EV2, seven of these should have
received an EV3 grade and another 29 should have received
no grade at all given the lack of supporting documentation.
75
There is no evidence that Nomura changed its credit and
compliance review processes after this audit.
After it received the final results of the third‐party
review, Nomura purchased all of the EV1 and EV2 loans—
and acquired their loan files. Nomura intended to “kick
out” (i.e., remove from the trade pool) all of the EV3 loans,
although approximately 2.6% of the loans backing the
Securitizations had been sampled and received an EV3
grade. In an internal email, Spagna stated that “typical”
kick‐out rate ranged from 7% to 8% of the sample and a rate
of 12.12% was “much higher” than average. Id. at 2639. The
average kick‐out rates for the trade pools at issue was
15.2%.
Nomura held most of the purchased loans for
between two and five months. During that time, the
Trading Desk grouped the purchased loans into SLGs.
Nomura’s traders made loan‐by‐loan selections using a
non‐random process designed to create SLGs that would
meet market demands. The traders based their evaluations
of the loans on factors such as credit scores, geographic
concentrations, and loan‐to‐value ratios. Nomura
conducted no review of the SLGs’ creditworthiness as a
whole.
Nomura’s Transaction Management Group wrote the
ProSupps after the SLGs were formed. The ProSupps made
representations about the characteristics of the SLGs. For
three of the Securitizations, there is no specific evidence
that Nomura verified the accuracy of these representations.
For four of the Securitizations, Nomura’s verification
76
process consisted of the Transaction Management Group
reviewing a “Due Diligence Summary”—a single page
created by the Diligence Group listing the percentage of
loans to be securitized that had been reviewed and the kick‐
out rates for the trade pools. Each summary included a
disclaimer: “The material contained herein is preliminary
and based on sources which we believe to be reliable, but it
is not complete, and we do not represent that it is accurate.”
J.A. 2876.
b. RBS
RBS, the lead or co‐lead underwriter for four of the
Securitizations, also reviewed the loans in the SLGs. RBS’s
due diligence was led by Brian Farrell, the Vice President of
RBS’s credit risk department.
For two of the Securitizations it underwrote, RBS
conducted no independent review. This practice was
common among underwriters in the PLS industry. RBS’s
review of NHELI 2006‐HE3 diligence consisted of
reviewing three documents created by Nomura—an
aforementioned Due Diligence Summary, an additional
summary of collateral characteristics, and a list of the
names of the originators that contributed more than 5% of
the loans in the SLGs. RBS also relied on Nomura‐provided
data integrity studies that affirmed the ProSupps contained
no input errors or mathematical miscalculations, as well as
a “negative assurance letter” from Nomura’s counsel that
stated counsel was unaware of any facts that would render
the ProSupps misleading.
77
RBS’s review of NHELI 2006‐FM2 consisted primarily
of reviewing reports from AMC that described the loans.
Before transmitting it to RBS, Nomura reviewed these
reports and discovered that the SLGs contained 19 EV3
loans, despite Nomura’s policy against purchasing such
loans. Spagna, who took over Nomura’s Diligence Group
after Kohout, emailed AMC and requested that it “mark
these loans as client overrides Credit Event 2s for all 19
loans in question” and then “forward to me the updated set
of reports for these two deals.” J.A. 2878. The vendor
complied and Nomura sent RBS the reports as revised.
After noting one issue based on experience with a
particular originator, RBS approved the vendor’s reports.
RBS also participated in a teleconference with RBS’s
counsel, Nomura (represented in part by Spagna),
Nomura’s counsel, and other underwriters to discuss
diligence on NHELI 2006‐FM2. Spagna recalled to a fellow
Nomura employee that RBS asked two questions about
Nomura’s diligence processes, that he “took the liberty to
bullshit them,” and that he thought “it worked.” Id at 2881.
After NHELI 2006‐FM2 had closed, an RBS employee
emailed Farrell to discuss RBS’s diligence for this deal.
Farrell wrote: “We did not perform actual diligence on this.
Diligence was performed by another company for Nomura.
We signed off on their results.” Nomura II, 68 F. Supp. 3d at
460. The RBS employee responded: “How frequently is this
done?” Id. Farrell replied: “Since being employed, this is the
only review type I was involved in where due diligence
results were reviewed and a new diligence was not
ordered.” Id. (brackets omitted).
78
RBS did conduct independent reviews of sample
loans from NHELI 2007‐1 and NHELI 2007‐2. RBS selected
samples using adverse sampling in part and “semi‐
random” sampling in remaining part. J.A. 2606. The semi‐
random technique grouped the remaining loans by unpaid
principal balance and selected randomly from within those
groups. For NHELI 2007‐1, RBS’s sample contained 5.8% of
the adjustable‐rate loans in a group, part of which
eventually composed the relevant SLG. For NHELI 2007‐2,
Farrell requested RBS employees to form a larger sample,
preferably 25% of the loan pool, because he thought the
loans were “crap.” Id. at 2886. In the end, RBS sampled 6%
of the loans from the NHELI 2007‐2 SLG.
RBS’s diligence as an underwriter was similar to
Nomura’s as a PLS sponsor.43 RBS outsourced its credit and
compliance reviews to Clayton, which used loan files to re‐
underwrite the loans in each sample subject to client
overrides. The re‐underwriting analyses for NHELI 2007‐1
yielded 33 loans (~32% of the sample) graded “3,” the
equivalent of EV3. Within an hour and six minutes after
Clayton transmitted that information to RBS, RBS issued
overrides for 30 of those grades and ordered that the loans
be reclassified as acceptable for purchase. The re‐
underwriting analysis for NHELI 2007‐2 yielded 50 grade‐3
loans (~16.2% of the sample), all of which RBS overrode.
The District Court identified some evidence suggesting that
43
RBS’s diligence standards were less strict when it acted as an
underwriter than when it acted as a PLS sponsor. See Nomura II,
68 F. Supp. 3d at 462; see also J.A. 2832.
79
RBS provided no objective record evidence to
support these overrides. An RBS employee testified that the
decision‐making process for issuing a client override
consisted of “review[ing] a loan file to see if there were
compensating factors for exceptions” by “flip[ping] through
the pages” for between “20 minutes” and “three hours”
depending on whether he “thought it was important.”
Nomura II, 68 F. Supp. 3d at 462. Farrell testified that he
reviewed six of the overridden loans in NHELI 2007‐1 and
found them to have “sufficient compensating factors.” Id.
He justified the rest of the overrides in NHELI 2007‐1 with
similar reasoning.
2. Analysis
Section 12’s reasonable care defense is available to
any defendant who did not know and in the exercise of
reasonable care could not have known of the material
misstatement in the prospectus. See 15 U.S.C. § 77l(a)(2).
Congress did not explicitly define the duty of reasonable
care under Section 12. But one can discern the term’s
meaning by reference to related administrative guidance,
non‐statutory indicators of congressional intent, such as the
section’s legislative history and statutory context, and
common‐law principles. See Mohamad v. Palestinian Auth.,
132 S. Ct. 1702, 1709 (2012) (“Congress is understood to
legislate against a background of common‐law adjudicatory
principles.” (quoting Astoria Fed. Sav. & Loan Ass’n v.
Solimino, 501 U.S. 104, 108 (1991)); Demarco v. Edens, 390
F.2d 836, 842 (2d Cir. 1968) (looking to common‐law
principles to define reasonable care under Section 12).
80
Section 12 imposes negligence liability. See NECA,
693 F.3d at 156. “Negligence, broadly speaking, is conduct
that falls below the standard of what a reasonably prudent
person would do under similar circumstances . . . .” Fane v.
Zimmer, Inc., 927 F.2d 124, 130 n.3 (2d Cir. 1991). “[I]t is
usually very difficult, and often simply not possible, to
reduce negligence to any definite rules; it is ‘relative to the
need and the occasion,’ and conduct which would be
proper under some circumstances becomes negligence
under others.” W. Page Keeton et al., Prosser and Keeton on
Torts § 31 at 173 (5th ed. 1984) (quoting Babington v. Yellow
Taxi Corp., 250 N.Y. 14, 18 (1928) (Cardozo, C.J.)).
Courts have explored negligence liability for
securities offerors in the analogous context of Section 11. See
In re Software Toolworks Inc. (Software Toolworks), 50 F.3d 615,
621 (9th Cir. 1994); In re WorldCom, Inc. Sec. Litig.
(WorldCom), 346 F. Supp. 2d 628, 663 (S.D.N.Y. 2004) (Cote,
J.). But see Glassman v. Computervision Corp., 90 F.3d 617, 628
(1st Cir. 1996) (“The law on due diligence is sparse . . . .”).
SEC guidance advises that “the standard of care under
Section 12(a)(2) is less demanding than that prescribed by
Section 11.” Securities Offering Reform, SEC Release No. 75,
85 SEC Docket 2871, available at 2005 WL 1692642, at *79
(Aug. 3, 2005).44 Still, Section 11 law is persuasive in
44 Some courts have agreed. See Associated Randall Bank v. Griffin,
Kubik, Stephens & Thompson, Inc., 3 F.3d 208, 213 (7th Cir. 1993)
(describing the Section 12 duty to exercise “‘reasonable care’” as
“significantly lesser” than the duty to conduct a “‘reasonable
investigation’”); Mass. Mut. Ins., 110 F. Supp. 3d at 298–99
(concluding that Section 12 is less demanding than Section 11);
81
defining reasonable care under Section 12.45 See SEC Release
No. 75, 2005 WL 1692642, at *79 (“[W]e believe that any
practices or factors that would be considered favorably
under Section 11, including pursuant to Rule 176, also
would be considered as favorably under the reasonable care
standard of Section 12(a)(2).”); H.R. REP. NO. 73–85, at 9
(1933) (discussing jointly the duties of care under Sections
11 and 12).
Section 11, like Section 12, imposes a negligence
standard. See Herman & MacLean v. Huddleston, 459 U.S. 375,
383–84 (1983); NECA, 693 F.3d at 156. Section 11 achieves
this by providing a defense to any underwriter defendant
who “had, after reasonable investigation, reasonable
ground to believe and did believe . . . that the statements [at
issue] were true and that there was no omission to state a
material fact required to be stated therein or necessary to
make the statements therein not misleading.” 15 U.S.C.
see also John Nuveen & Co., Inc. v. Sanders, 450 U.S. 1005, 1008–09
(1981) (Powell, J., dissenting from denial of petition for
certiorari) (“‘Investigation’ commands a greater undertaking
than ‘care.’” Id. at 1009.). Others have not. See Software Toolworks,
50 F.3d at 621 (“[T]he analysis of [the Section 11 and Section 12
defenses] on summary judgment is the same.”); Glassman, 90
F.3d at 628.
Because the FHFA withdrew its Section 11 claim and
45
Defendants argue that they conducted reasonable due diligence,
we need not consider today whether there are any differences in
proof demands between Section 12 and Section 11 or whether
the Section 12 defense is available absent an actual investigation.
See Nomura II, 68 F. Supp. 3d at 475 & n.48.
82
§ 77k(b)(3)(A). For a defendant’s investigation to be
reasonable, its actions must conform to those of “a prudent
man in the management of his own property.” 15 U.S.C.
§ 77k(c); see WorldCom, 346 F. Supp. 2d at 663.
The measures a reasonably prudent person would
take in the management of his property are context
dependent. Under Section 12, they are a function of, inter
alia, (1) the nature of the securities transaction, (2) the
defendant’s role in that transaction, (3) the defendant’s
awareness of information that might suggest a securities
violation and its response(s) upon learning of such
information, and (4) industry practices. See WorldCom, 346
F. Supp. 2d at 674–77; 17 C.F.R. § 230.176 (listing relevant
considerations in deciding whether an investigation was
reasonable under Section 11).
The reasonable care standard adapts to the context of
each transaction. The SEC has issued a rule regarding the
due diligence review that issuers of asset‐backed securities
should conduct before making public offerings. See 17
C.F.R. § 230.193; Issuer Review of Assets in Offerings of
Asset‐Backed Securities, SEC Release No. 9176, 100 SEC
Docket 706, available at 2011 WL 194494 (Jan. 20, 2011).46 The
Although this rule issued after the transactions in this case and
46
was “not intended to change” the standards of care under
Sections 11 and 12, it is instructive for our analysis. SEC Release
No. 9176, 2011 WL 194494, at *2 n.9; see In re City of New York, 522
F.3d 279, 286 (2d Cir. 2008) (“[F]ederal agencies are often better
positioned to set standards of care than are common‐law
courts.”).
83
SEC requires issuers to adopt due diligence policies that
provide reasonable assurance that the offering documents’
descriptions of the assets are accurate in all material
respects. See SEC Release No. 9176, 2011 WL 194494, at *6.
Specific review standards depend on the type of product
offered. See id. For RMBS, the SEC requires issuers to
provide reasonable assurance of the truth of all information
related to the supporting loans that is required to be in a
prospectus or prospectus supplement, including
representations of the loans’ “credit quality and
underwriting.” Id. at *7. Sometimes that may require
reviewing all of the supporting loans. But an RMBS issuer
also may review a sample of the loans if the loan pool is so
large that reviewing all of the loans is prohibitive and the
sample is “representative of the pool.” Id. at *6.
The nature of the defendant’s position within a given
transaction also affects the standard of care. See 2 THOMAS
LEE HAZEN, THE LAW OF SECURITIES REGULATION § 7:45 (7th
ed., 2016) (“Reasonable care imparts a sliding scale of
standards of conduct . . . .”). As Congress explained when it
initially passed the Securities Act, “[t]he duty of care to
discover varies in its demands upon participants in security
distribution with the importance of their place in the
scheme of distribution and with the degree of protection
that the public has a right to expect.” H.R. REP. NO. 73–85,
at 9. Those closest to the offered securities—issuers, for
example—are more likely to come into contact with
material information, and thus may be required to exercise
more care to assure that disclosures are accurate. See Feit v.
Leasco Data Processing Equip. Corp., 332 F. Supp. 544, 577–78
84
(E.D.N.Y. 1971). In an RMBS distribution, the depositor as
the formal issuer, and the affiliated entities that control it,
such as the sponsor and affiliated underwriters, occupy this
position of closeness to the offered products. See H.R. REP.
NO. 73–85, at 12.
Unaffiliated underwriters are often the sole
adversarial entities in a securities distribution. As a result,
they assume a unique role. See Feit, 332 F. Supp. at 581–82.
The Securities Act places upon underwriters “the primary
responsibility for verifying the accuracy and completeness
of information provided to potential investors.” Chris‐Craft
Indus., Inc. v. Piper Aircraft Corp., 480 F.2d 341, 369–70 (2d
Cir. 1973). That special responsibility guides the standard of
care for underwriters under Section 12 mandates. See
Sanders, 619 F.2d at 1228 n.12 (“The fact that [Section 12]
does not expressly single out underwriters . . . for a higher
standard of liability does not mean that this status is
irrelevant to determining what specific actions [an
underwriter must] show to prove its exercise of reasonable
care.”).
Whether a defendant learns or should learn of
alarming information that suggests a violation of the
securities laws—so‐called “red flags”—and how the
defendant responds are perhaps the most important
considerations in assessing reasonable care. See WorldCom,
346 F. Supp. 2d at 679. Reasonable care requires a context‐
appropriate effort to assure oneself that no such red flags
exist. If a defendant encounters red flags, reasonable care
mandates that it examine them to determine whether the
offering documents contain a material falsehood and, if so,
85
to correct it. Cf. Lentell, 396 F.3d at 168 (“Inquiry notice . . .
gives rise to a duty of inquiry when the circumstances
would suggest to an investor of ordinary intelligence the
probability that [there has been a violation of the securities
laws].” (internal quotation marks omitted) (quoting Levitt,
340 F.3d at 101)). An RMBS seller must conduct “further
review” when “warranted in order to provide reasonable
assurance that [the offering documents are] accurate in all
material respects.” SEC Release No. 9176, 2011 WL 194494,
at *6.
Finally, industry standards and customs are highly
persuasive in setting the standard of care, but they are not
controlling. See In re City of New York, 522 F.3d at 285. As
Judge Hand famously explained in The T.J. Hooper, in
exceptional cases “a whole calling [or industry] may have
unduly lagged in the adoption of new and available
devices. It never may set its own tests, however persuasive
be its usages. Courts must in the end say what is required.”
60 F.2d 737, 740 (2d Cir. 1932). The reasonable care standard
will not countenance an industry‐wide “‘race to the bottom’
to set the least demanding standard to assess [its] conduct.”
SEC v. Dain Rauscher, Inc., 254 F.3d 852, 857 (9th Cir. 2001).
Thus, particularly where “the industry was comprised of
only a few participants who controlled the practice,” id.,
and where industry practices have not previously survived
judicial scrutiny, see Chasins v. Smith, Barney & Co., 438 F.2d
1167, 1171 (2d Cir. 1970), custom is less persuasive evidence
of reasonable prudence. But see In re City of New York, 522
F.3d at 285 (“Courts will not lightly presume an entire
industry negligent.”).
86
In this case, no reasonable jury could find that
Defendants exercised reasonable care. Nomura, as the
sponsor, depositor, and occasional underwriter, was given
access to the loans—and the loan files—prior to purchase
and later owned the loans themselves. That uniquely
positioned Nomura to know more than anyone else about
the creditworthiness and underwriting quality of the loans.
As a result, investors relied on Nomura’s review of the
loans and representations about the loans’ likelihood to
default. In making those representations, Nomura fell
below the standard of conduct Section 12 requires.
Nomura could not be reasonably sure of the truth of
any statements in the ProSupps regarding the loans’
adherence to the underwriting guidelines. The single round
of diligence Nomura conducted involved credit reviews for
only a sample of the loans. At the direction of its Trading
Desk, Nomura limited that sample to about 40% of the
trade pool. Nomura then used a combination of ad hoc
selections and LEVELS, the adverse sampling program, to
compile its samples. These selection procedures chose a
sample of the “riskiest” loans rather than a sample that was
representative of the entire loan pool.
The criteria LEVELS used to identify “risky” loans
was not tied to the loans’ adherence to the underwriting
guidelines. LEVELS relied solely on loan‐tape information,
such as loan‐to‐value and debt‐to‐income ratios, to form its
adverse samples. These characteristics may be indicators of
general credit risk, but Nomura provided no evidence
whatever to suggest that they are indicators of the
likelihood that a loan met the underwriting criteria. “As
87
Kohout [later] explained at trial,” LEVELS’s singular
reliance on the loan tape “made it impossible to select a
sample based on a prediction of which loans were more
likely to have ‘adverse’ characteristics, such as a misstated
LTV ratio or DTI ratio, an unreasonable ‘stated’ income, or
to find loans that deviated from the originatorʹs
underwriting guidelines.” Nomura VII, 104 F. Supp. 3d at
473.
The problems with Nomura’s sample selection were
compounded by its failure to conduct reliable credit and
compliance reviews. The audit Nomura commissioned of
its credit and compliance reviews, however, raised serious
red flags about the efficacy of its due diligence procedures.
Nomura learned that approximately 30% of a sample of 109
loans receiving a final grade of EV1 or EV2 after the loan‐
level reviews should have received an unacceptable grade
of EV3 or no grade at all. There is no evidence that Nomura
took any action to correct that deficiency in its procedures.
Similarly, the high kick‐out rates for the trade pool
samples observed by Nomura should have raised
suspicions about whether its due diligence was reliable.
Spagna considered a 7% to 8% kick‐out rate to be standard
and a 12% kick‐out rate to be higher than normal, yet
Nomura observed a 15.2% kick out rate for the trade pools
at issue. In other words, Nomura’s samples contained
nearly double the normal amount of loans that failed credit
or compliance review. A reasonable investor in that
scenario would have upsized the sample to determine if
this problem pervaded the entire trade pool. Nomura did
not.
88
Nomura’s SLG compilation procedures were also
problematic. The Trading Desk grouped the loans into
SLGs without any assistance from the Diligence Group.
Nomura performed no review of the SLGs after they were
compiled. The only due diligence the Trading Desk
reviewed was a single‐page summary describing diligence
for the loan pool, attached to which was an express
disclaimer that the information contained therein should
not be taken as complete and accurate. Moreover, the
Trading Desk’s methodology for selecting loans broke the
inferential chain between the results of its sample testing
and the representations in the ProSupps. The ProSupps
described the loans as SLGs, yet Nomura compiled SLGs
using non‐random and ad hoc selection procedures that
turned on the trader’s instincts about market demand.
Despite its representations in PLS offering documents, in
reality Nomura had no way to know the credit risk of any
given SLG.47
RBS’s conduct was no better. For NHELI 2006‐HE3
and NHELI 2006‐FM2, RBS relied entirely on Nomura’s
diligence. That did not adequately discharge RBS’s
responsibility as an underwriter to verify independently the
representations in the offering documents. Spagna’s
conduct with regard to NHELI 2006‐FM2 is a revealing
That the AMO found Nomura’s diligence “Satisfactory” in
47
August 2004 (and again in March 2006) after an on‐site review
and a re‐underwriting of 50 sampled loans does not change our
analysis of Nomura’s diligence practice during the pertinent
period. J.A. 3170, 3177.
89
example. Without RBS’s knowledge, Spagna retroactively
changed the pre‐acquisition grades for 19 purchased loans
from EV3 to EV2 before sending the due diligence reports
to RBS. And when RBS asked Spagna about Nomura’s due
diligence, he “bullshit[ted]” them. Nomura II, 68 F. Supp. 3d
at 460. RBS was blind to these acts of malfeasance. See Nat’l
Credit Union Admin. Bd., 2017 WL 411338, at *4–6; Mass.
Mut. Life Ins., 110 F. Supp. 3d at 301.
For NHELI 2007‐1 and NHELI 2007‐2, RBS conducted
some diligence but not enough to meet the standard of
reasonable care. RBS sampled just 5.8% of a group of loans
from which Defendants composed the SLG backing the
NHELI 2007‐1 Certificate and just 6% of the loans in NHELI
2007‐2 even though it believed the loans in the latter
Securitization were “crap.” Nomura II, 68 F. Supp. 3d at 461
(internal quotation marks omitted). RBS compiled those
samples in part using non‐representative adverse selection.
Its re‐underwriting analyses revealed that ~32% of the loans
in NHELI 2007‐1 and ~16.2% of the loans in NHELI 2007‐2
deserved a failing grade for credit or compliance review
even after Nomura’s pre‐acquisition screening. But instead
of requesting a larger sample to determine if this problem
was consistent for the entire trade pool or further
questioning Nomura about this issue, RBS overrode all, or
nearly all, of those failing grades in short time periods—in
the case of NHELI 2007‐1 just over an hour. RBS provided
no objective justification for any of those override decisions
90
and only specific subjective justification for six. That
conduct fell well below the standard of reasonable care.48
Defendants’ primary contention on appeal is that
their conduct could not be unreasonable as a matter of law
because it conformed to industry practices at the time. They
argue that LEVELS was an industry standard adverse
selection software,49 most PLS sellers conducted only one
round of pre‐acquisition diligence, it was standard for PLS
sellers to outsource loan‐level diligence to third parties such
as Clayton, and many PLS underwriters relied on the
aggregator’s diligence representations.
We are not persuaded a properly instructed jury
could find Defendants’ conduct reasonable based on these
standards. This argument is tellingly limited. Defendants
do not contend that every choice they made was in keeping
with best practices in the PLS industry, nor do they suggest
that their actions, on the whole, were consistent with
industry customs. They pick and choose instances of
conduct that they claim met the standards of the industry.
A seller’s scattershot compliance with industry custom does
not deprive a plaintiff of a Section 12 remedy. That
Defendants’ use of sampling or LEVELS or a third‐party
48 As above, that the SFCPRM, after reviewing limited
information, apparently accepted RBS’s characterization of its
diligence as “robust” does not change our analysis here. Nomura
I, 60 F. Supp. 3d at 491 (internal quotation mark omitted).
49 But see J.A. 2631–32 (Kohout warning Nomura employees that
Nomura’s use of LEVELS did not comport with industry
standards).
91
vendor complied with industry customs does not mean
their conduct taken as a whole was reasonable under the
circumstances.
Moreover, our analysis is only informed by industry
standards, not governed by them. See In re City of New York,
522 F.3d at 285. The RMBS industry in the lead up to the
financial crisis was a textbook example of a small set of
market participants racing to the bottom to set the lowest
possible standards for themselves. See Dain Rauscher, 254
F.3d at 857. Accordingly, even if Defendants’ actions on the
whole complied with that industry’s customs, they yielded
an unreasonable result in this case.
Defendants also argue that use of adverse sampling
cannot be unreasonable because the SEC has advised that
asset due diligence may vary depending on the
circumstances, in lieu of adopting a proposed rule that
would require RMBS sellers to use representative samples
in all cases. See SEC Release No. 9176, 2011 WL 194494, at
*4, *6. This argument is not persuasive either. SEC’s refusal
to ban adverse sampling in all cases is not inconsistent with
our holding that, in this particular case, Defendants’ use of
non‐representative sampling contributed in part to a course
of unreasonable conduct.
Finally, we have no doubt that, had they exercised
reasonable care, Defendants could have learned that a
material number of the loans were not originated in
accordance with the underwriting guidelines. This is not a
case where Defendants incorrectly forecasted a future
occurrence or inaccurately assessed the future impact of a
92
past event. The relevant information in this case was static
and knowable when Defendants securitized the loans and
wrote the ProSupps. At that time, the manner in which the
loans were originated had already occurred—they had been
issued either in accordance with the underwriting criteria
or not. And it was possible for Defendants, who owned the
loans and regularly conducted business with third‐party
vendors that perform re‐underwriting analyses, to learn
whether they were.
D. Jury Trial
After the FHFA withdrew its Section 11 claim, the
District Court conducted a bench trial on the remaining
Section 12(a)(2), Section 15, and analogous Blue Sky claims.
See Nomura IV, 68 F. Supp. 3d at 496–98.50 Defendants
contend that the bench trial violated their right to a jury
trial under the Seventh Amendment.
The Seventh Amendment to the United States
Constitution preserves the right of any party to a civil
action to compel a jury trial in “Suits at common law.” “The
phrase ‘Suits at common law’ refers to ‘suits in which legal
rights were to be ascertained and determined, in
contradistinction to those where equitable rights alone were
recognized, and equitable remedies were administered.’”
Eberhard v. Marcu, 530 F.3d 122, 135 (2d Cir. 2008) (emphasis
in original) (quoting Granfinanciera, S.A. v. Nordberg, 492
For the sake of clarity, we confine our discussion to whether
50
the Seventh Amendment applies to Section 12(a)(2) claims. Our
analysis applies equally to the FHFA’s remaining Section 15 and
Blue Sky claims.
93
U.S. 33, 41 (1989)). Determining whether an action is a
“Suit[] at common law” requires two steps. Id. The first
assesses “whether the action would have been deemed
legal or equitable in 18th century England.” Id. (internal
quotation marks omitted) (quoting Germain v. Conn. Nat’l
Bank, 988 F.2d 1323, 1328 (2d Cir. 1993)). The second and
“more important” step asks “whether ‘the remedy sought
. . . is legal or equitable in nature.’” Id. (alteration in
original) (quoting Granfinanciera, 492 U.S. at 42).
For years, there was little doubt that an action under
Section 12(a)(2) was not a “Suit[] at common law,” id.,
within the meaning of the Seventh Amendment. A Section
12 action operates much like an 18th century action at
equity for rescission, which extinguished a legally valid
contract that had to “be set aside due to fraud, mistake, or
for some other reason.” 12A C.J.S. CANCELLATION OF
INSTRUMENTS § 1 (2017); see Randall v. Loftsgaarden, 478 U.S.
647, 655 (1986) (describing Section 12’s remedy of
“rescission” upon “prospectus fraud”).51 The Supreme
Defendants argue that Section 12(a)(2) is unlike common‐law
51
equitable rescission because the latter required proof of scienter
and justifiable reliance whereas the former does not. Scienter
was not required to make out an equitable rescission claim at
common law. See BLACK, RESCISSION OF CONTRACTS AND
CANCELLATION OF INSTRUMENTS § 106 (1916). And Section
12(a)(2) does not omit justifiable reliance from a rescission claim
as much as it presumes conclusively that the buyer relied on the
prospectus, which “although [it] may never actually have been
seen by the prospective purchaser, because of [its] wide
94
Court and this Court have recognized that a Section 12(a)(2)
action is the Securities Act‐equivalent of equitable
rescission. See Gustafson, 513 U.S. at 576 (“[Section] 12(2) . . .
grant[s] buyers a right to rescind . . . .”); Pinter v. Dahl, 486
U.S. 622, 641 n.18 (1988) (“Section 12 was adapted from
common‐law (or equitable) rescission . . . .”); Deckert v.
Indep. Shares Corp., 311 U.S. 282, 288 (1940) (concluding that
a Section 12(a)(2) claim “states a cause for equitable relief”);
Royal Am. Managers, Inc. v. IRC Holding Corp., 885 F.2d 1011,
1019 n.4 (2d Cir. 1989) (“An equitable claim such as
rescission [under Section 12(a)(2)] is for the court, not the
jury, to decide.”). Commentators have also consistently
analogized an action under Section 12(a)(2) to equitable
rescission. See, e.g., 69A AM. JUR. 2D Securities Regulation—
Federal § 982 (2016); 2 HAZEN, THE LAW OF SECURITIES
REGULATION § 7:56; Harry Shulman, Civil Liability and the
Securities Act, 43 YALE L.J. 227, 243–44 (1933).
In 1995, Congress added the loss causation
affirmative defense to Section 12(a)(2). Private Securities
Litigation Reform Act of 1995, Pub. L. No. 104–67, § 105(3),
109 Stat. 737, 757 (codified at 15 U.S.C. § 77l(b)).
Defendants’ primary argument is that the amendment
altered the nature of the Section 12(a)(2) remedy to that of
damages for the injury arising from the false statement—a
decidedly legal remedy—and therefore a Section 12 action
now triggers the Seventh Amendment jury trial right.
dissemination, determine[s] the market price of the security.”
Gustafson, 513 U.S. at 576 (quoting H.R. REP. NO. 85, at 10).
95
There is some credence to Defendants’ position. At
18th century common law, equitable rescission required the
seller to refund the buyer the full original purchase price in
exchange for the purchased item, regardless of its present
value. See Pinter, 486 U.S. at 641 n.18; Lyon v. Bertram, 61
U.S. 149, 154–55 (1857) (“‘Where a contract is to be
rescinded at all, it must be rescinded in toto, and the parties
put in statu quo.’” (quoting Hunt v. Silk (1804) 5 East 449, 452
(Lord Ellenborough, C.J.))). In other words, the seller bore
the risk of depreciation unrelated to the misrepresentation.
Section 12(a)(2) with a loss causation defense shifts the risk
burden to the buyer by authorizing the seller to refund the
original purchase price less any reduction in the item’s
present value not attributable to a material misstatement.
See Iowa Pub. Emps’. Ret. Sys., 620 F.3d at 145.
Furthermore, in the Section 10(b) context, this Court
has “described loss causation in terms of the tort‐law
concept of proximate cause.” Lentell, 396 F.3d at 172; see also
Nomura VII, 104 F. Supp. 3d at 585 (“‘Loss causation is the
causal link between the alleged misconduct and the
economic harm ultimately suffered by the plaintiff . . . [and]
is related to the tort law concept of proximate cause.’”
(alterations in original) (quoting Lattanzio v. Deloitte &
Touche LLP, 476 F.3d 147, 157 (2d Cir. 2007))). Proximate
cause generally defines the scope of a defendant’s legal
liability. CSX Transp., Inc. v. McBride, 564 U.S. 685, 692–93
(2011); Lattanzio, 476 F.3d at 157. When a judgment imposes
personal legal liability on a defendant, even occasionally in
the context of a restitution claim, it can create a legal
96
remedy. See Great‐West Life & Annuity Ins. Co. v. Knudson
(Knudson), 534 U.S. 204, 213–14 (2002).
Nevertheless, the addition of the loss causation
defense did not transform Section 12(a)(2)’s equitable
remedy into a legal one. The limited degree to which the
modern Section 12(a)(2) remedy differs from common‐law
rescission does not change the fact that, fundamentally, it is
equitable relief. Section 12(a)(2) has never provided exactly
the same relief as 18th century equitable rescission. Section
12(a)(2) has traditionally been more buyer‐friendly than its
common‐law counterpart because it authorizes recovery
even after the buyer no longer owns the security at issue.
See Pinter, 486 U.S. at 641 n.18; Shulman, supra, at 244. The
availability of an alternative damages remedy never stood
as a barrier to considering Section 12(a)(2)’s rescission‐like
remedy equitable for purposes of the Seventh Amendment.
Nor does the loss causation defense, which merely tilts the
balance of equities in the modern Section 12(a)(2) remedy
slightly back toward sellers.
Likewise, our suggestion in the Section 10(b) context
that loss causation is akin to proximate cause does not
mean that Section 12(a)(2) with a loss causation defense
necessarily provides a legal claim. Equitable rescission
permits a court to order “the nullification of a transfer of
property between the claimant and the defendant . . . and
. . . a mutual accounting in which each party pays for
benefits received from the other in consequence of the
underlying exchange and its subsequent reversal.”
RESTATEMENT (THIRD) OF RESTITUTION AND UNJUST
ENRICHMENT § 54 cmt. a. Loss causation in Section 12(a)(2)
97
serves the latter function—it is a mutual accounting that
prevents the buyer from reaping an unjust benefit at the
expense of the seller. This restores the parties to the status
quo ante the securities transaction at issue while ensuring
that the terms of the rescission are just (in Congress’s view),
a hallmark of equitable recessionary relief. See Marr v.
Tumulty, 256 N.Y. 15, 22 (1931) (Cardozo, C.J.).
Defendants’ further arguments come up short. As an
initial matter, none of the Defendants’ remaining
arguments rely on changes in the law that would upset the
long‐established consensus that Section 12(a)(2) is an
equitable claim that authorizes equitable relief. See Pinter,
486 U.S. at 641 n.18. Moreover, Defendants’ arguments are
unpersuasive on the merits.
Defendants contend that because Section 11 and
Section 12 claims are similar and Section 11 claims are
considered legal for purposes of the Seventh Amendment,
Section 12 claims ought to be considered legal too. While
Sections 11 and 12(a)(2) are “Securities Act siblings with
roughly parallel elements,” Morgan Stanley, 592 F.3d at 359,
they are not identical twins when it comes to the nature of
relief each authorizes; indeed, sometimes they are quite
different. See id. (“Section 12(a)(2) [and Section 11] provide[]
similar redress . . . .” (emphasis added)). Section 12
authorizes two forms of relief: A buyer who retains
ownership over the security may sue under Section 12 for
equitable rescission, which limits recovery to “the
consideration paid for such security.” 15 U.S.C. § 77l(a). A
buyer who no longer owns the security may sue under
Section 12 for “damages,” id., “the classic form of legal
98
relief,” Knudson, 534 U.S. at 210 (internal quotation mark
omitted) (quoting Mertens v. Hewitt Assocs., 508 U.S. 248,
255 (1993)). See also Wigand, 609 F.2d at 1035 (“If [a Section
12(a)(2)] plaintiff owns the stock, he is entitled to rescission
. . . .”). Section 11 authorizes only legal “damages.” 15
U.S.C. § 77k(e).
Defendants argue further that since a plaintiff who
no longer owns the security at issue is entitled to a legal
remedy under Section 12(a)(2), the remedy for a plaintiff
who still owns the security must be of the same nature. In
Defendants’ view, a plaintiff should not have the power to
manipulate a seller’s constitutional right to a jury trial by
choosing, through the act of selling or retaining the
security, whether the suit will sound in law or in equity.
Assuming Defendants are correct that an action for money
damages under Section 12(a)(2) is a “Suit[] at common
law,”52 Eberhard, 530 F.3d at 135, this case does not involve
that situation. Here, the FHFA still owns and can physically
return the Certificates as it would be required to do on an
equitable rescission claim. Indeed, in issuing its final
52 We express no view on the merits of this position. When a
buyer who no longer owns the security successfully sues for
damages under Section 12(a)(2), the monetary award “is the
substantial equivalent of rescission.” Pinter, 486 U.S. at 641 n.18.
Although, as a “general rule,” a money judgment is considered a
legal remedy for Seventh Amendment purposes, a restitutionary
damages award is sometimes considered equitable relief.
Chauffeurs, Teamsters & Helpers, Local No. 391 v. Terry, 494 U.S.
558, 570 (1990). But see Knudson, 534 U.S. at 213 (explaining that
some restitution remedies are legal in nature).
99
judgment, the District Court ordered the FHFA to “deliver”
the Certificates to Defendants in exchange for the amounts
recoverable. Special App. 365–67. Moreover, Defendants’
contention that a buyer should not have the power to
decide the form of relief sought overlooks the express
language of Section 12(a)(2), which authorizes the buyer to
sue “either at law or in equity.” 15 U.S.C. § 77l(a).
Finally, Defendants urge that, at common law, a
court of equity could issue an order only against persons
who actually “possessed the funds in question and thus
were . . . unjustly enriched.” Pereira v. Farace, 413 F.3d 330,
339 (2d Cir. 2005). Defendants argue that the non‐
underwriter Defendants cannot be subject to equitable
rescission because they did not in fact sell the Certificates
nor did they receive funds from the GSEs in exchange for
the Certificates. The Supreme Court has made clear that
“there is no reason to think that Congress wanted to bind
itself to the common‐law notion of the circumstances in
which rescission [under Section 12(a)(2)] is an appropriate
remedy.” Pinter, 486 U.S. at 647 n.23. “Congress, in order to
effectuate its goals, chose to impose [rescission‐like] relief
on any defendant it classified as a statutory seller,
regardless of the fact that such imposition was somewhat
inconsistent with the use of rescission at common law.” Id.
As discussed further below, all of the Defendants were
statutory sellers.
Accordingly, we reaffirm that, even after the addition
of the loss causation defense, a Section 12(a)(2) action
allows for equitable relief where the plaintiff still owns the
securities and the remedy sought is literal rescission. Such
100
an action is not a “Suit[] at common law,” Eberhard, 530 F.3d
at 135, for purposes of the Seventh Amendment.53
53 The analysis here reflects the difficulty of trying to fit modern
legal policy choices onto a grid of legal principles that originated
in an agrarian economy reliant on custom to regulate
transactional conduct. How many law schools teach remedies
today? How many law students have a basic understanding of
the genesis and nature of courts of equity?
101
II. Trial Decision54
A. Section 12(a)(2) Claims
1. Statutory Sellers
Defendants contest the District Court’s finding that
NAAC and NHELI, the PLS depositors for the transactions
at issue, were statutory sellers for purposes of Section
12(a)(2). See Nomura VII, 104 F. Supp. 3d at 554–55; UBS I,
858 F. Supp. 2d at 333–34. Defendants argue that PLS
depositors cannot be statutory sellers because they have no
direct involvement in passing title in PLS to buyers.55
54 On appeal from a bench trial, we review findings of fact for
clear error and conclusions of law de novo. Beck Chevrolet Co., Inc.
v. Gen. Motors LLC, 787 F.3d 663, 672 (2d Cir. 2015). “Under [the
clear error] standard, factual findings by the district court will
not be upset unless we are left with the definite and firm
conviction that a mistake has been committed.” Henry v.
Champlain Enters., Inc., 445 F.3d 610, 617 (2d Cir. 2006) (internal
quotation marks omitted) (quoting FDIC v. Providence Coll., 115
F.3d 136, 140 (2d Cir. 1997)). Mixed questions of law and fact
following a bench trial “are reviewed either de novo or under the
clearly erroneous standard, depending on whether the question
is predominantly legal or predominantly factual.” Krist v.
Kolombos Rest. Inc., 688 F.3d 89, 95 (2d Cir. 2012) (internal
quotation mark omitted; brackets omitted) (quoting United States
v. Skys, 637 F.3d 146, 152 (2d Cir. 2011)). We review evidentiary
rulings for abuse of discretion. Boyce v. Soundview Tech. Grp., Inc.,
464 F.3d 376, 385 (2d Cir. 2006).
We review de novo this predominantly legal issue. See Krist, 688
55
F.3d at 95.
102
Section 12(a)(2) requires proof that the defendant is a
“statutory seller” within the meaning of the Securities Act.
Pinter, 486 U.S. at 641–42; see 15 U.S.C. § 77l(a)(2).56 The
Securities Act does not define “statutory seller,” however.
See Pinter, 486 U.S. at 642. Judicial precedent has settled that
an entity is a statutory seller if it “(1) ‘passed title, or other
interest in the security, to the buyer for value,’ or
(2) ‘successfully solicited the purchase of a security,
motivated at least in part by a desire to serve [its] own
financial interests or those of the securities’ owner.’”
Morgan Stanley, 592 F.3d at 359 (brackets omitted) (quoting
Pinter, 486 U.S. at 642, 647). SEC Rule 159A provides that,
for purposes of Section 12(a)(2), an “issuer” in “a primary
offering of securities” shall be considered a statutory seller.
17 C.F.R. § 230.159A(a). The Securities Act in turn defines
“issuer” to include “the person or persons performing the
acts and assuming the duties of depositor.” 15 U.S.C.
§ 77b(a)(4). SEC Rule 191 further clarifies that “[t]he
depositor for . . . asset‐backed securities acting solely in its
capacity as depositor to the issuing entity is the ‘issuer’ for
purposes of the asset‐backed securities of that issuing
entity.” 17 C.F.R. § 230.191(a).
The combination of this statutory provision and
administrative direction makes clear that PLS depositors,
such as NAAC and NHELI, are statutory sellers for
purposes of Section 12(a)(2). Each is a “depositor for . . .
The D.C. Blue Sky law’s definition of statutory seller is the
56
same as the Securities Act’s definition. See Hite, 429 F. Supp. 2d
at 115.
103
asset‐backed securities,” specifically RMBS. See 17 C.F.R.
§ 230.191. PLS depositors are thus “issuers.” See 15 U.S.C.
§ 77b(a)(4). And, as “issuers,” PLS depositors fall within the
definition of statutory seller. See 17 C.F.R. § 230.159A.
Defendants’ only avenue of attack on appeal is to
contest the validity of Rules 159A and 191. “[A]mbiguities
in statutes within an agency’s jurisdiction to administer are
delegations of authority to the agency to fill the statutory
gap in reasonable fashion.” Nat’l Cable & Telecomms. Ass’n v.
Brand X Internet Servs. (Brand X), 545 U.S. 967, 980 (2005).
“Chevron requires a federal court to accept [a federal]
agency’s construction of [a] statute” so long as the statute is
ambiguous and the agency’s interpretation is reasonable. Id.
(citing Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, 467 U.S.
837, 843–844 & n.11 (1984)). “Only a judicial precedent
holding that [a] statute unambiguously forecloses [an]
agency’s interpretation . . . displaces a conflicting agency
construction.” Id. at 982–83.
Defendants do not and cannot argue that SEC Rules
159A and 191 are unreasonable. Instead, they cite Pinter v.
Dahl as “a judicial precedent holding that” the Securities
Act “unambiguously forecloses” SEC Rules 159A and 191.
See Brand X, 545 U.S. at 982–83. We disagree. Pinter actually
stands for the proposition that the Securities Act is
ambiguous as to the definition of statutory seller. See 486 U.S.
at 642–47. Pinter acknowledged that, given the lack of clear
guidance from Congress, statutory seller must include “[a]t
the very least . . . the owner who passed title, or other
interest in the security, to the buyer for value.” Id. at 642.
But it also observed that Section 12 “is not limited to
104
persons who pass title” for value and that related statutory
terms “are expansive enough” for Section 12 “to encompass
the entire selling process.” Id. at 643 (quoting United States
v. Naftalin, 441 U.S. 768, 773 (1979)). The only element of the
statutory seller provision Pinter found unambiguous is that
“Congress did not intend to impose [Section 12] rescission
. . . on a person who urges the purchase but whose
motivation is solely to benefit the buyer.” Id. at 647.
SEC Rules 159A and 191 locate depositors within the
selling process for PLS. As the District Court explained,
depositors play an essential role in PLS distribution
schemes—at the direction of the PLS sponsor, they
“purchase the loans . . . and deposit them in a trust,” which
“creates a true sale of the assets, thereby protecting
certificate‐holders against the risk of a subsequent
bankruptcy by the sponsor.” Nomura VII, 104 F. Supp. 3d at
463. Rules 159A and 191 therefore accord with Pinter’s
understanding of the expansive definition of statutory
seller. See 486 U.S. at 643.
2. Falsity
Defendants contest the District Court’s finding that
the underwriting guidelines statements were false.
Section 12(a)(2) requires proof that the prospectus at
issue contains at least one “untrue statement of a . . . fact or
omit[ted] to state a . . . fact necessary in order to make the
statements, in the light of the circumstances under which
they were made, not misleading.” 15 U.S.C. § 77l(a)(2); see
105
Morgan Stanley, 592 F.3d at 359.57 “[W]hether a statement is
‘misleading’ depends on the perspective of a reasonable
investor: The inquiry . . . is objective.” Omnicare, Inc. v.
Laborers Dist. Council Constr. Indus. Pension Fund, 135 S. Ct.
1318, 1327 (2015) (discussing misleading omissions in the
context of Section 11). The falsity inquiry “requires an
examination of ‘defendants’ representations, taken together
and in context.’” Morgan Stanley, 592 F.3d at 366 (quoting
DeMaria v. Andersen, 318 F.3d 170, 180 (2d Cir. 2003)). “The
literal truth of an isolated statement is insufficient.” Id.
“[W]hen an offering participant makes a disclosure about a
particular topic, whether voluntary or required, the
representation must be ‘complete and accurate.’” Id.
(quoting Glazer v. Formica Corp., 964 F.2d 149, 157 (2d Cir.
1992)). Both false statements of fact and false statements of
opinion are actionable under Section 12(a)(2). See Omnicare,
135 S. Ct. at 1325‐27.
a. Factual Summary
This case turns on the following statement, which
appeared in each of the ProSupps: “The Mortgage Loans [in
the SLGs] have been purchased by the seller from various
banks, savings and loan associations, mortgage bankers and
other mortgage loan originators and purchasers of
57 The standards for falsity under the Virginia and D.C. Blue Sky
laws are the same as the federal standards. See Dunn, 369 F.3d at
428–29 (applying Section 12(a)(2) case law to the analogous
Virginia Blue Sky law provision); Hite, 429 F. Supp. 2d at 114
(noting that Section 12(a)(2) case law should be applied in
interpreting the analogous D.C. Blue Sky law provision).
106
mortgage loans in the secondary market, and were originated
generally in accordance with the underwriting criteria described
in this section.” J.A. 6884 (emphasis added).58
Each ProSupp described that underwriting process:
Generally, each borrower will have been
required to complete an application designed
to provide to the original lender pertinent
credit information concerning the borrower. As
part of the description of the borrower’s
financial condition, the borrower generally will
have furnished certain information with
respect to its assets, liabilities, income . . . ,
credit history, employment history and
personal information, and furnished an
authorization to apply for a credit report which
summarizes the borrower’s credit history with
local merchants and lenders and any record of
bankruptcy. The borrower may also have been
required to authorize verifications of deposits
at financial institutions where the borrower
had demand or savings accounts. In the case of
investment properties and two‐ to four‐unit
dwellings, income derived from the mortgaged
property may have been considered for
underwriting purposes, in addition to the
58 Throughout this section we use language from the ProSupp for
NAA 2005‐AR6 as a representative example unless otherwise
noted. All of the ProSupps contained substantially similar
language. See J.A. 7174, 7527, 7895, 8296, 8718, 9117.
107
income of the borrower from other sources.
With respect to mortgaged properties
consisting of vacation or second homes, no
income derived from the property generally
will have been considered for underwriting
purposes. In the case of certain borrowers with
acceptable compensating factors, income
and/or assets may not be required to be stated
(or verified) in connection with the loan
application.
Based on the data provided in the
application and certain verifications (if
required), a determination is made by the
original lender that the borrower’s monthly
income (if required to be stated) will be
sufficient to enable the borrower to meet their
monthly obligations on the mortgage loan and
other expenses related to the property such as
property taxes, utility costs, standard hazard
insurance and other fixed obligations other
than housing expenses. Generally, scheduled
payments on a mortgage loan during the first
year of its term plus taxes and insurance and all
scheduled payments on obligations that extend
beyond ten months equal no more than a
specified percentage not in excess of 60% of the
prospective borrower’s gross income. The
percentage applied varies on a case‐by‐case
basis depending on a number of underwriting
criteria, including, without limitation, the loan‐
108
to‐value ratio of the mortgage loan. The
originator may also consider the amount of
liquid assets available to the borrower after
origination.
Id. at 6884–85.
Each ProSupp also included a warning regarding
possible deviations from the underwriting guidelines:
Certain of the Mortgage Loans have been
originated under reduced documentation, no‐
documentation or no‐ratio programs, which
require less documentation and verification
than do traditional full documentation
programs. Generally, under a reduced
documentation program, verification of either a
borrowerʹs income or assets, but not both, is
undertaken by the originator. Under a no‐ratio
program, certain borrowers with acceptable
compensating factors will not be required to
provide any information regarding income and
no other investigation regarding the borrower’s
income will be undertaken. Under a no‐
documentation program, no verification of a
borrower’s income or assets is undertaken by
the originator. The underwriting for such
Mortgage Loans may be based primarily or
entirely on an appraisal of the Mortgaged
Property, the loan‐to‐value ratio at origination
and/or the borrower’s credit score.
Id. at 6886.
109
NHELI 2007‐3 contained an additional warning
regarding originator ResMAE:
The Depositor is aware that the originators
of approximately 79.04% of the Mortgage
Loans, by aggregate principal balance as of the
Cut‐off Date, have filed for bankruptcy
protection under the United States Bankruptcy
Code. These originators include ResMAE
Mortgage Corporation, which originated
approximately 77.61% of the Mortgage Loans,
by aggregate principal balance as of the Cut‐off
Date. Any originator whose financial condition was
weak or deteriorating at the time of origination may
have experienced personnel changes that adversely
affected its ability to originate mortgage loans in
accordance with its customary standards. It may
also have experienced reduced management
oversight or controls with respect to its
underwriting standards. Accordingly, the rate
of delinquencies and defaults on these
Mortgage Loans may be higher than would
otherwise be the case.
Id. at 9069 (emphasis added).
b. Procedural Summary
The District Court examined the above language in
detail. The court interpreted the underwriting guidelines
59
The District Court also reviewed statements in the ProSupps
59
regarding loan‐to‐value ratios and credit ratings and found them
110
statements as asserting that the supporting loans, with a
few immaterial exceptions, were originated in accordance
with the underwriting guidelines the originators used to
issue the loans.
The court then set out to determine whether in fact
the loans in the SLGs were originated generally in
accordance with the underwriting guidelines. (As the
underwriting guidelines statement is unquestionably one of
provable fact, the District Court did not need to consider
Defendants’ subjective belief in, inquiry into, or knowledge
of the truthfulness of the statement. See Omnicare, 135 S. Ct.
at 1325–26.) The court relied on the testimony of one of the
FHFA’s experts, Robert Hunter, a consultant with
“expertise in residential loan credit issues.” Nomura VII, 104
F. Supp. 3d at 456. Hunter conducted a forensic re‐
underwriting of 723 sample loans including “100 or close to
100 . . . loans for six of the seven SLGs, and 131 . . . loans for
the relevant SLG in NAA 2005‐AR6.” Id. at 522.60
Hunter’s review entailed comparing “the loan file for
each loan to the originator’s guidelines.” Id. at 522. The
parties stipulated for the most part to an applicable set of
to be false. As stated above, we need not address those findings
here.
60 This sample was composed by sorting “each SLG’s loan
population into four strata” by FICO score and then drawing “25
loans at random from each stratum.” Id. at 495. The drawn loans
were then “tested . . . against the corresponding SLGs on eleven
separate metrics to ensure that they were adequately
representative of the relevant loan populations.” Id.
111
guidelines that were representative of the originators’
guidelines at the time the loans were issued. When they did
not, Hunter re‐underwrote the sample loans using
“originators’ guidelines that were dated between 30 to 90
days prior to the closing of the loan.” Id. When those were
not available, Hunter analyzed the loans using what he
styled “minimum industry standards.” Id. Hunter’s
“industry standards” were “the most lenient standards
employed for subprime and Alt–A loans between 2002 and
2007” drawn “from the many guidelines he examined and
from his professional experience.” Id. Hunter also used
these industry standards to supplement gaps in the
originators’ guidelines.
Hunter concluded that approximately 66% of the
sample loans contained material deviations from the
originators’ underwriting criteria that negatively affected
the creditworthiness of the loans. Id. at 523. Hunter also
found that “the level of underwriting defects in the
[s]ample was so severe that it was unlikely that any of the
loans in the seven SLGs . . . was actually free of defects,” id.
at 541, although some of the defects in the sample were
immaterial to credit risk.
Defendants called Michael Forester, founder of “a
regulatory compliance, loan review, and internal audit
services firm,” id. at 457, as an expert to contest Hunter’s
findings. After reviewing Forester’s analysis in detail, the
District Court concluded that many of his complaints about
Hunter’s work were “essentially irrelevant.” Id. at 525. The
court also rejected Defendants’ objections to Hunter’s
analysis.
112
The District Court ultimately credited the bulk of
Hunter’s analysis. See id. at 531. The court, acting as a fact‐
finder and guided by the expert testimony, conducted its
own loan‐by‐loan underwriting analysis. The court
confirmed that, as a “conservative” measurement, at least
45% of the loans in each SLG “had underwriting defects
that materially affected credit risk.” Id. at 533. As a result, it
found that the ProSupps’ descriptions of the supporting
loans “as having been ‘originated generally in accordance’
with originators’ guidelines” were false. Id.
c. Analysis
On appeal, Defendants contend that the District
Court misinterpreted the underwriting guidelines
statements. They also argue that the District Court
improperly credited Hunter’s analysis. Neither argument is
persuasive.
113
1. The District Court’s Interpretation of the
Underwriting Guidelines Statements61
Defendants attack the District Court’s interpretation
of the ProSupps on four grounds. First, they contend the
District Court misinterpreted the phrase “the underwriting
criteria described in this section” as referring to the
underwriting criteria the originators used in issuing the
loans. Defendants argue that the ProSupps meant to refer to
the underwriting criteria described in the ProSupps
themselves.62 Because the District Court and Hunter re‐
underwrote the sample loans according to the originators’
guidelines, Defendants conclude, their findings are
fundamentally flawed.
61 Although generally we review factual findings following a
bench trial for clear error, see Krist, 688 F.3d at 95, at Defendants’
urging we assume arguendo that the proper standard of review
for this question of pure textual interpretation is de novo. See
Bellefonte Reins. Co. v. Aetna Cas. & Surety Co., 903 F.2d 910, 912
(2d Cir. 1990) (“The proper standard for appellate review of a
pure textual construction by the district court, whatever the
procedural posture of the case, is de novo.”); United States v. Int’l
Bhd. of Teamsters, Chauffeurs, Warehousemen & Helpers of Am., 899
F.2d 143, 148 n.5 (2d Cir. 1990) (“We review de novo the district
court’s interpretation of the language of a document such as a
contract or a bylaw.”).
We assume for purposes of this argument that the originators’
62
guidelines and the guidelines described in the ProSupps were
materially different.
114
This argument makes no sense. Defendants urge us
to read the ProSupps as stating that the loans in the SLGs
“were originated” in accordance with underwriting
guidelines that the PLS sellers wrote after purchasing and
securitizing the loans—that is, after the loans were originated.
Of course, loans cannot be originated in accordance with
guidelines that do not exist until after their creation. In a
similar vein, the principal reason why the six later‐issued
ProSupps included descriptions of the underwriting
guidelines was that SEC Regulation AB requires RMBS
sponsors in their offering documents to describe “the . . .
underwriting criteria used to originate . . . pool assets.” 17
C.F.R. § 229.1111(a)(3) (emphasis added).63 It would make
little sense to read the ProSupps as stating that guidelines
written after loan origination were “used to originate” the
loans.
Defendants’ own actions belie their argument. When
Nomura hired Clayton and AMC to conduct pre‐
acquisition credit and compliance reviews, Nomura
instructed it to compare the loan files against the
originators’ underwriting guidelines. See Nomura II, 68 F.
Supp. 3d at 451. Furthermore, trial testimony from Nomura
employees and others confirms that Defendants, other
RMBS issuers and underwriters, as well as Moody’s, S&P,
and Fitch all understood the underwriter guidelines
assertion in the ProSupps to refer to originators’ guidelines.
E.g., J.A. 4392, 4491, 5355, 6295–96, 6299–300.
NAA 2005‐AR6 was issued before Regulation AB went into
63
effect on January 1, 2006.
115
Second, Defendants argue that the ProSupps merely
describe the procedures the originators’ used to issue the
underlying loans, rather than promise that the loans met
the originators’ guidelines criteria. It would have been
“meaningless” to promise compliance with that criteria,
Defendants contend, because “investors did not know what
those guidelines said.” Nomura’s Br. 39.
The central flaw in this argument is that it is a‐
textual. The ProSupps affirm that the loans “were
originated . . . in accordance with the underwriting criteria.”
Defendants’ argument reads the word “criteria” out of that
sentence.
Moreover, it would not be meaningless to read the
ProSupps as promising that the loans complied with the
underwriting guidelines, regardless of whether the reader
is familiar with the details of those guidelines. See ACE Sec.
Corp., Home Equity Loan Tr., Series 2006‐SL2 v. DB Structured
Prods., Inc., 25 N.Y.3d 581, 596 (2015) (observing that PLS
sponsors generally “warrant[] certain characteristics of the
loans”). PLS consumers and the Credit‐Rating Agencies—
the primary audience for the ProSupps—considered it
important that a sponsor warrant in offering documents
that loans in the SLGs met the originators’ underwriting
criteria. This affirmed that the loans in the SLGs survived
the gauntlet of the originators’ underwriting reviews for
creditworthiness, which bore directly on the loans’ risk of
default. The statement also assured investors that
Defendants, through their diligence departments,
independently checked that loans satisfied the originators’
116
guidelines criteria. A mere description of the origination
process would not accomplish that effect.
Third, Defendants argue that the word “generally”—
as in, the loans “were originated generally in accordance
with the underwriting criteria”—put readers of the
ProSupps on notice that loans in the SLGs may deviate
materially from the underwriting guidelines. The District
Court, by contrast, interpreted “generally” to warn only
that the SLGs may contain loans with “certain immaterial
exceptions” to the underwriting guidelines. Nomura VII, 104
F. Supp. 3d at 563 (emphasis added; internal quotation
marks omitted) (quoting Nomura II, 68 F. Supp. 3d at 485).
We agree with the District Court. Defendants’
interpretation of “generally” would render the
underwriting guidelines statement essentially meaningless.
As noted above, readers of the ProSupps looked to this
representation for an affirmation that the loans met the
underwriting criteria. They would find cold comfort in a
promise that contained the significant hedge Defendants
urge. Furthermore, Defendants’ interpretation of
“generally” is undermined by the view of their own expert,
Forester, who testified:
Q. You understand the word “generally” to
mean that there may be individual
exceptions but that in most cases the
statement that the loans were originated in
accordance with [underwriting] standards
will be accurate; is that right?
A. I would agree with that, yes.
117
J.A. 6125.64
Fourth, Defendants argue that the District Court
failed to accord proper weight to the explicit warning in the
ProSupp for NHELI 2007‐3 that ResMAE’s weak “financial
condition . . . at the time of origination may have . . .
adversely affected its ability to originate mortgage loans in
accordance with its customary standards.” J.A. 9069. They
argue that this specific hedge superseded the more general
statements about the quality of the supporting loans writ
large. See Omnicare, 135 S. Ct. at 1330 (“[A]n investor reads
each statement . . . in light of all its surrounding text,
including hedges . . . .”).
The problem with this argument is that the warning
was too equivocal to hedge adequately against the
ProSupps’ later statements regarding compliance with
underwriting guidelines. The vague warning that
ResMAE’s bankruptcy “may have . . . adversely affected its
ability to originate mortgage loans in accordance with its
customary standards” was insufficient to put the reader on
notice that a critical mass—nearly 50%—of the loans in the
64 This case is unlike Glassman v. Computervision Corp., where the
court held that an analysis of defendants’ backlog, from a single
one‐week period, indicating that 39% of the backlog balance at
that time would ship in over 30 days did not render false their
representation that “shipments are generally made within thirty
days of receiving an order.” 90 F.3d at 634. Here, Defendants
failed to comply with their affirmations at a rate of nearly 50%
for multiple years, infecting multiple complex financial products
with material defects in the process.
118
pertinent SLG were not originated properly. J.A. 9069.
Furthermore, despite the warning the ProSupp affirmed
that ResMAE “fully reviews each loan to determine
whether [its underwriting] guidelines . . . are met.” Id. at
9113. That watered down any of the marginal ameliorative
effect the ProSupp’s earlier warning might have had.
2. The District Court’s Falsity Findings65
Defendants also challenge the District Court’s
crediting of Hunter’s expert testimony and finding based
thereon that at least 45% of the loans in the SLGs were
originated with underwriting defects.
Their arguments, at best, marginally undercut the
substance of Hunter’s analysis.66 We find in them no basis
to second guess the District Court’s adoption of Hunter’s
findings.
We review this factual finding for clear error. See Krist, 688
65
F.3d at 95.
66 Defendants lodge the following objections to Hunter’s
analysis: Hunter testified that he was “a little stricter” than he
imagined the originators’ underwriters were when making loan
issuance decisions, J.A. 11736; Hunter made a “defect” finding
when he “disagreed” with the originator’s “judgment,” id.;
Hunter found a disproportionately low number of loans that
were originated with “exceptions” based on “compensating
factors,” calling into question the reliability of all of his findings,
id. at 11737–40; and Hunter’s “minimum industry standards”
were marginally stricter than the lowest observed standard in
the RMBS industry at the time, see id. at 11726–29, 11783.
119
Defendants further argue that it was improper for the
District Court, which lacks the expertise of Hunter and
Forester, to conduct its own confirmatory re‐underwriting
analysis. We disagree. The court conducted this analysis in
its capacity as fact‐finder. A fact‐finder is not required to
make a binary choice between adopting an expert’s
conclusion in full or rejecting it entirely. See United States v.
Duncan, 42 F.3d 97, 101 (2d Cir. 1994) (explaining that
expert testimony should not “tell the jury what result to
reach” but “aid the jury in making a decision”) (emphasis in
original). Furthermore, any error the District Court
committed in crediting only a portion of Hunter’s
testimony would be harmless. See 28 U.S.C. § 2111. The
court made clear that “[i]f limited to the stark choice
between Hunter’s expert testimony and Forester’s, [it]
would unhesitatingly accept Hunter’s.” Nomura VII, 104 F.
Supp. 3d at 531.67
For the foregoing reasons, Nomura offers no basis to
reverse the District Court’s finding that the ProSupps’
underwriting guidelines assertion was false.
Defendants also argue that the District Court failed to make
67
detailed findings explaining why it accepted only a portion of
Hunter’s defect findings. Federal Rule of Civil Procedure 52(a)
requires a court following a bench trial to “make sufficiently
detailed findings to inform the appellate court of the basis of the
decision and to permit intelligent appellate review.” T.G.I.
Friday’s Inc. v. Nat’l Rests. Mgmt., Inc., 59 F.3d 368, 373 (2d Cir.
1995) (quoting Krieger v. Gold Bond Bldg. Prods., 863 F.2d 1091,
1097 (2d Cir. 1988)). The District Court’s 361‐page trial opinion
satisfies that requirement.
120
3. Materiality
Defendants contest the District Court’s finding that
the underwriting guidelines statements were material.
Section 12(a)(2) requires proof that each false
statement or omission was material. See 15 U.S.C.
§ 77l(a)(2); Morgan Stanley, 592 F.3d at 359. Whether a
statement or omission is material is an objective, totality‐of‐
the‐circumstances inquiry. TSC Indus., Inc. v. Northway, Inc.,
426 U.S. 438, 445, 449 (1976). A material fact is one that
“assume[s] actual significance” for a reasonable investor
deciding whether to purchase the security at issue, but it
need not be outcome‐determinative. Id. at 449; see Folger
Adam Co. v. PMI Indus., Inc., 938 F.2d 1529, 1533 (2d Cir.
1991). “In the Second Circuit,” a statement or omission is
material “if a reasonable investor would view [it] as
‘significantly altering the “total mix” of information made
available.’” Stadnick v. Vivint Solar, Inc., 861 F.3d 31, 36 (2d
Cir. 2017) (brackets omitted) (quoting TSC Indus., Inc., 426
U.S. at 449); see Basic, 485 U.S. at 231–32.
Here, the District Court easily found that the
ProSupps’ underwriting guidelines statements were
material. Nomura VII, 104 F. Supp. 3d at 557–59, 570–73.68
The court began by presuming materiality for any
description in the ProSupps that deviated by 5% or more
from the loans’ true characteristics. See id. at 558. It drew the
The District Court also found that the ProSupps’ loan‐to‐value
68
ratio and credit ratings statements were material, but as
explained above, we need not review those findings here.
121
5% figure from two sources: First, five of the ProSupps
promised that Defendants would issue supplementary
disclosures in the event that “any material pool
characteristic differs by 5% or more from the description in
this [ProSupp].” Id.; see also Asset‐Backed Securities, SEC
Release No. 8518, 84 SEC Docket 1624, available at 2004 WL
2964659, at *235 (Dec. 22, 2004) (requiring supplemental
disclosure “if any material pool characteristic of the actual
asset pool at the time of issuance of the asset‐backed
securities differs by 5% or more . . . from the description of
the asset pool in the prospectus”). Second, SEC
administrative guidance, which we have repeatedly cited
with approval, counsels that 5% falsity for statements in
offering documents may provide “a preliminary
assumption” of materiality. SEC Staff Accounting Bulletin
No. 99, 64 Fed. Reg. 45,150, 45,151 (Aug. 19, 1999); see Litwin
v. Blackstone Grp., L.P., 634 F.3d 706, 717 (2d Cir. 2011); ECA,
Local 134 IBEW Joint Pension Tr. of Chi. v. JP Morgan Chase
Co., 553 F.3d 187, 197–98 (2d Cir. 2009); Ganino v. Citizens
Utils. Co., 228 F.3d 154, 163–64 (2d Cir. 2000). The court
found that the underwriting guidelines statements far
exceeded that threshold, as at least 45% of the loans in the
SLGs did not adhere to the originators’ underwriting
criteria. Nomura VII, 104 F. Supp. 3d at 571. The court then
confirmed its presumption of materiality by demonstrating
how loans that do not adhere to underwriting criteria have
higher default rates, and as a result, affect a reasonable
investor’s view of the value of PLS supported by such
loans. Id.
122
On appeal, Defendants raise five challenges to the
District Court’s materiality analysis—one procedural, two
substantive, and two evidentiary.69 We address each in
turn.
a. Procedural Challenge: Use of a Numerical
Threshold
Defendants argue that the District Court employed a
legally erroneous process for deciding materiality because it
relied in part on a numerical threshold. See Nomura VII, 104
F. Supp. 3d at 558.
Although “we have consistently rejected a [purely]
formulaic approach to assessing the materiality of an
alleged misrepresentation,” Hutchison v. Deutsche Bank Sec.
Inc., 647 F.3d 479, 485 (2d Cir. 2011) (alteration omitted)
(quoting Ganino, 228 F.3d at 162), we have permitted courts
to conduct materiality analyses that are partially
quantitative, see Litwin, 634 F.3d at 717. A numerical
threshold is no substitute for a fulsome materiality analysis
that also considers qualitative factors, but it can provide “‘a
good starting place for assessing the materiality of [an]
alleged misstatement.’” Hutchison, 647 F.3d at 487 (quoting
ECA, Local 134 IBEW Joint Pension Trust of Chi., 553 F.3d at
204); see also id. at 485. Indeed, an “integrative” materiality
analysis will consider both quantitative factors and
Materiality is a mixed question of law and fact. See TSC Indus.,
69
426 U.S. at 450. We review Defendants’ primarily legal
challenges de novo and primarily factual challenges for clear
error. See Krist, 688 F.3d at 95. We review related evidentiary
challenges for abuse of discretion. See Boyce, 464 F.3d at 385.
123
qualitative factors to determine whether a reasonable
investor would have considered the misstatement or
omission significant in making an investment decision.
Litwin, 634 F.3d at 717.
The District Court in this case did exactly what we
require. The court began with a reasonable quantitative
analysis, using 5% falsity as a threshold for materiality. See
Nomura VII, 104 F. Supp. 3d at 558. The court then turned to
qualitative factors. It found “overwhelming, and essentially
undisputed, evidence that” the ProSupps’ false
underwriting guidelines statements “would be viewed by
the reasonable PLS investor as significantly altering the
total mix of information available.” Id. at 570. Indeed,
Defendants’ own witnesses agreed that, as a general matter,
adherence to underwriting criteria is a reliable indicator of
mortgage loan default rates, and the return for a PLS
certificate is a function of the degree to which such loans
are repaid. The court therefore concluded that a reasonable
investor deciding whether to invest in PLS would consider
the underwriting guidelines statements crucial to his or her
investment decision. See id. at 570–71. The court buttressed
its qualitative materiality conclusion by noting that defense
counsel admitted in summation that the supporting loans’
rate of adherence to the underwriting guidelines “could be
material to an investor.” Id. at 571 n.185.
The District Court’s opinion is a textbook example of
an integrative materiality analysis that considers “both
quantitative and qualitative factors.” See Litwin, 634 F.3d at
717 (internal quotation marks omitted) (quoting SEC Staff
Accounting Bulletin No. 99, 64 Fed. Reg. at 45,151). We find
124
no legal error in the court’s use of a numerical threshold to
inform its decision.
b. Substantive Challenge: The Trade Date
Defendants challenge the substance of the District
Court’s materiality decision first on the ground that none of
the ProSupps’ statements could have been material because
the GSEs did not receive the ProSupps until after the so‐
called “trade dates.”
1. Factual Summary
The Securities Act requires virtually every written
offer of securities to qualify as a prospectus under Section
10. 15 U.S.C. § 77e(b)(1). Section 10 provides for two types
of permissible prospectuses. The default type is a written
offer that meets intensive disclosure requirements listed in
Section 10(a), sometimes called a “Section 10(a)
prospectus.” Id. § 77j(a); see 17 C.F.R. § 229.1100 et seq.
Alternatively, Section 10(b) permits the SEC to promulgate
rules expanding the definition of a Section 10 prospectus to
include offerings that “omit[] in part or summarize[]
information” required by Section 10(a), sometimes called a
“Section 10(b) prospectus.” 15 U.S.C. § 77j(b).70
For years after the passage of the Securities Act, the
SEC did not promulgate any rules pursuant to Section
A Section 10(a) prospectus is not perfectly interchangeable
70
with a Section 10(b) prospectus. For example, Section 5(b)(2)
provides that it is unlawful to sell or deliver a registered security
by means of interstate commerce unless accompanied or
preceded by a Section 10(a) prospectus. See id. § 77e(b)(2).
125
10(b). During that time, every written offer of securities
needed to comply with the detailed requirements of Section
10(a). See FHFA v. Bank of Am. Corp., No. 11cv6195, 2012 WL
6592251, at *3–4 (S.D.N.Y. Dec. 18, 2012).
In 2005, the SEC invoked its Section 10(b) power for
the first time when it promulgated Rule 164 and associated
rules. These rules liberalize the offering process by
permitting certain issuers to make initial written offers of
securities using “free writing prospectuses.” 17 C.F.R.
§§ 230.164, 230.405; see Securities Offering Reform, SEC
Release No. 75, 2005 WL 1692642, at *37–38. Free writing
prospectuses may be used only if, inter alia, (1) the offered
security is subject to a filed registration statement and to a
base prospectus, 17 C.F.R. § 230.433, and (2) the issuer
transmits a Section 10(a) prospectus to the SEC “no later
than the second business day following . . . the date of the
determination of the offering price” of the security, id.
§ 230.424(b)(5). The information in a free writing prospectus
and the information in the final Section 10(a) prospectus
“shall not conflict.” Id. § 230.433(c)(1).
Defendants sold the Certificates at issue here in a
fluid process that relied on the use of free writing
prospectuses. They contacted GSE traders to offer a PLS
certificate sale, and if a trader was interested, transmitted a
free writing prospectus containing some (but not all) of the
information regarding the loans in the SLG. After reviewing
the free writing prospectus, the GSE trader and Defendants
made mutual commitments to purchase and to sell the
Certificate described in it. The date of this commitment is
known as the “trade date.”
126
Within roughly a month following the trade date, the
GSE transferred payment to Defendants, who in turn
transferred title in the Certificate to the GSE, on what is
known as the “settlement date.” Defendants filed a
ProSupp with the SEC within one day of the settlement
date and delivered the ProSupp to the GSE shortly
thereafter. The ProSupp contained the balance of the
detailed information regarding the supporting loans and
served as Defendants’ final Section 10(a) prospectus for
purposes of 17 C.F.R. § 230.424(b)(5).
Each transaction was conditioned on Defendants’
promise that the ProSupp would not reveal a material
difference between the true character of the supporting
loans and those described in the free writing prospectus. Cf.
id. § 230.433(c)(1) (providing that a free writing prospectus
and prospectus supplement “shall not conflict”).
Conditional agreements of this sort were common in the
market for asset‐backed securities at the time. As comments
to the SEC explained, “asset‐backed securities offerings
involved conditional contracts where investors agreed to
purchase securities before they had all the prospectus
information.” Securities Offering Reform, SEC Release No.
75, 2005 WL 1692642, at *75 n.407. If a ProSupp revealed
“new or changed information” that differed materially from
the loan descriptions in the free writing prospectus, the GSE
would be “given the opportunity to reassess [its] purchase
decision[].” See id.
127
2. Analysis
With that context in mind, it is clear that the
ProSupps, although transmitted after the GSEs initially
committed to purchase the Certificates, could be material to
the GSEs’ purchase decisions. See, e.g., N.J. Carpenters Health
Fund II, 709 F.3d at 125–28 (holding statements in RMBS
prospectus supplements could be material); Plumbers’ Union
Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp.,
632 F.3d 762, 773 (1st Cir. 2011) (same). The ProSupps
served dual functions of filling informational gaps left by
the free writing prospectus offerings while also confirming
that the loan quality representations in those initial offering
documents were truthful in all material respects. In so
doing, the ProSupps assumed the material role of
convincing the GSEs to finalize the transactions. Cf. Field v.
Trump, 850 F.2d 938, 948 (2d Cir. 1988) (concluding that
misstatements or omissions that “lull” plaintiffs “into
forgoing” a unilateral right are material).
A contrary result would undermine the Securities
Act’s “philosophy of full disclosure.” See Basic, 485 U.S. at
234 (quoting SEC v. Capital Gains Research Bureau, Inc., 375
U.S. 180, 186 (1963)). It is fundamental to the Act that every
sale of registered securities must be preceded or
accompanied by a Section 10(a) prospectus without any
material misstatements or omissions on pain of civil
liability. See 15 U.S.C. §§ 77e(b)(2), 77l. The ProSupps were
the sole Section 10(a) prospectuses delivered in these
transactions. If they were categorically immaterial because
of their dates of transmission, Defendants could be held to
account only for statements made in free writing
128
prospectuses, which may “omit[] in part or summarize[]
information,” 15 U.S.C. § 77j(b), and would no longer face
the possibility of civil litigation for failing to satisfy the full
disclosure requirements of Section 10(a). The Act does not
permit such an outcome.
c. Substantive Challenge: The Reasonable
Investor Standard
Defendants further attack the substance of the court’s
materiality holding by arguing that the ProSupps’
underwriting guidelines statements would not have
“assumed actual significance” to a reasonable investor in
the GSEs’ shoes. See TSC Indus., 426 U.S. at 449. Defendants
contend that, given the GSEs’ unique power in the RMBS
market, the analysis in this case should have focused on
whether a reasonable investor with the GSEs’ knowledge and
investment purposes, rather than a reasonable generic buyer
of PLS certificates, would have considered the underwriting
guidelines statements material. This more‐specific
reasonable investor, Defendants claim, would have valued
less the credit quality of the loans backing the Certificates
because the GSEs’ driving purpose for purchasing PLS
certificates was to meet a statutorily‐mandated goal of
devoting a percentage of their loan portfolio to low‐ and
moderate‐income housing, not to secure a return on
investment. Defendants further argue that, to the extent the
GSEs valued such a return, the credit enhancements of the
GSEs’ senior tranche Certificates meant that the quality of
the loans would have no more than a de minimis impact on
their returns on these investments.
129
1. Factual Summary
In 1992, Congress imposed on the GSEs “an
affirmative obligation to facilitate the financing of
affordable housing for low‐ and moderate‐income families
in a manner consistent with their overall public purposes,
while maintaining a strong financial condition and a
reasonable economic return.” Federal Housing Enterprises
Financial Safety and Soundness Act, Pub. L. No. 102–550,
§ 1302(7), 106 Stat. 3491 (codified at 12 U.S.C. § 4501(7)).
Congress delegated authority to administer this mandate to
the U.S. Department of Housing and Urban Development
(“HUD”).71
HUD set annual requirements for the percentage of
the GSEs’ loan portfolios that were required to be devoted
to low‐ and moderate‐income housing. See Federal Housing
Enterprises Financial Safety and Soundness Act, § 1331, 106
Stat. at 3956 (codified as amended at 12 U.S.C. § 4561). In
1993, HUD required the GSEs to devote 30% of their
portfolios to low‐ and moderate‐income housing. See 58
Fed. Reg. 53048, 53049 (Oct. 13, 1993). By 2006, HUD’s
requirement grew to 53%. The penalties for failing to meet
HUD’s low‐income housing goals were severe. The GSEs’
executives’ compensation was tied to meeting HUD’s goals.
HUD could also send the GSEs cease‐and‐desist letters and
assess civil monetary penalties against them.
In 2008, after the conduct at issue in this case, Congress
71
repealed this version of the GSEs’ low‐income housing mandate
and replaced it with a new scheme administered by the FHFA.
See HERA, § 1128, 122 Stat. at 2696–703.
130
The GSEs were entitled to count loans backing PLS
toward HUD’s low‐ and moderate‐income housing goals.
See 24 C.F.R. § 81.16(c)(2). The GSEs negotiated with
Defendants and other PLS sellers for the right to select
certain loans for the SLGs backing the Certificates to ensure
that those loans met HUD’s criteria. The GSEs knew that
mortgage loans issued to borrowers with lower income
came with an increased risk of default. Hence, they secured
credit enhancements to protect their investments in the
Certificates.
2. Analysis
“The question of materiality, it is universally agreed,
is an objective one, involving the significance of an omitted
or misrepresented fact to a reasonable investor.” TSC Indus.,
426 U.S. at 445. For that reason, the GSEs’ HUD‐mandated
investment goals have no role to play in the reasonable
investor test in this case. A court is not required to import
the subjective motives of a particular plaintiff into its
materiality analysis.
The reasonable investor was designed to stand in for
all securities offerees, whose purposes for investing and
experiences with financial products may vary. Limiting the
reasonable investor’s intentions and knowledge to the
plaintiff’s subjective features would undermine that design.
See Basic, 485 U.S. at 234.
Defendants’ definition of the reasonable investor is
not compelled by the rule that a court assessing the
materiality of a statement must consider the offering
documents “taken together and in context.” See Rombach v.
131
Chang, 355 F.3d 164, 172 n.7 (2d Cir. 2004) (quoting I. Meyer
Pincus & Assocs., P.C., v. Oppenheimer & Co., Inc., 936 F.2d
759, 761 (2d Cir. 1991)). A court must, of course, consider
the statement at issue in the context of the objective features
surrounding the sale and the seller. That context includes, for
example, all facts related to the statement or omission, its
surrounding text, the offering documents, the securities, the
structure of the transaction, and the market in which the
transaction occurs. See Omnicare, 135 S. Ct. at 1330 (“[A
reasonable] investor takes into account the customs and
practices of the relevant industry.”); Freidus v. Barclays Bank
PLC, 734 F.3d 132, 140 (2d Cir. 2013) (considering the
materiality of misstatements and omissions in light of the
“deteriorating credit market”). The context Defendants
contend the District Court improperly ignored is different.
They argue that the District Court should have considered
subjective facts about the buyers and their motives for
engaging in the transaction. We find no support for that
position.
In any event, we would affirm even assuming
arguendo that a reasonable investor would have shared the
GSEs’ subjective purpose of purchasing PLS certificates to
meet HUD‐mandated housing targets. Materiality casts a
net sufficiently wide to encompass every fact that would
significantly alter the total mix of information that a
reasonable investor would consider in making an
investment decision. See Basic, 485 U.S. at 231–32. An
interest in whether the loans backing a particular PLS met
HUD’s definition of low‐ and moderate‐income housing
does not exist to the exclusion of a profit motive. Indeed,
132
the fact that the GSEs sought credit protection for their
investments indicates that they cared whether the PLS
certificate would yield a reliable return. And, as explained
above, a reasonable investor in PLS would consider the
creditworthiness of the supporting assets material to his or
her projection of the securities’ total return.
Defendants similarly misplace their reliance on the
GSEs’ interest in credit protections. This argument
erroneously implies a zero‐sum game where, on the one
hand, an investor either has no credit protection and
therefore cares deeply about the credit quality of the loans
or, on the other, has strong credit protection and therefore
considers the credit quality of the loans irrelevant. Credit
enhancement is one important factor that a reasonable
investor would consider when deciding whether to invest
in PLS. But credit enhancement is not so important that,
alone, it would cause an investor to ignore entirely the
quality of the loans in the SLG. As one of Defendants’
witnesses explained, “[i]nvestors balanced the degree of
credit enhancement against the expected losses on the
underlying collateral, which generally depended on . . .
collateral characteristics.” J.A. 5226. In other words, the
riskier the sponsor represents the loans to be, the more
credit protection an investor will seek. It is crucial that a
reasonable investor know the true nature of the collateral to
ensure that her credit protection is appropriately tethered to
the risk of default.
133
d. Evidentiary Challenges
Finally, Defendants argue that the District Court
erred in excluding two categories of evidence related to
materiality. First, Defendants argue the court improperly
excluded evidence that showed the GSEs, through their
Single Family Businesses, knew of the shoddy mortgage
origination processes. Second, Defendants argue the court
improperly excluded evidence of the GSEs’ HUD‐mandated
housing targets, which they contend are relevant for the
reasons described above.
The District Court granted the FHFA’s motion in
limine to exclude the above evidence under Federal Rule of
Evidence 403 because the court found its probative value
substantially outweighed by the prejudicial effect of
injecting the issue of reliance into the trial. Nomura III, 2014
WL 7229361, at *3–4; see also Morgan Stanley, 592 F.3d at 359
(“[P]laintiffs bringing claims under sections 11 and 12(a)(2)
need not allege . . . reliance . . . .”). At the time the court
rendered its initial Rule 403 decision, the FHFA’s Section 11
claims were still in the case, and thus the case was still set
for a jury trial. After the trial was converted into a bench
trial, the court maintained that the evidence violated Rule
403 and held in the alternative that such evidence was
irrelevant. Nomura VII, 104 F. Supp. 3d at 593.
We conclude that the District Court did not abuse its
discretion on the basis that the challenged evidence was
irrelevant to whether the ProSupps’ false statements
regarding underwriting guidelines were material.
134
The GSEs’ general knowledge of the mortgage
market was irrelevant to materiality. As explained above,
the GSEs were entitled to treat Defendants’ loan quality
representations as promises that the loans in these specific
SLGs were not a representative cross‐section of available
mortgage loans but rather a select group of loans with the
qualities described in the ProSupps. That the loans differed
from those qualities would have affected a reasonable
investor’s view of the Certificate regardless of that
investor’s knowledge about mortgage market generally.
The GSEs’ housing mandates were similarly
irrelevant. However important HUD’s housing mandates
were to the GSEs’ PLS investment decisions, they would
not render immaterial to a reasonable investor in the GSEs’
position whether or not the investment would produce a
financial return.
4. Negative Loss Causation
Defendants appeal the District Court’s denial of their
negative loss causation defense.
Section 12(b) permits a defendant to seek a reduction
in the plaintiff’s Section 12 award equal to the depreciation
in value of the security not resulting from the material
misstatement or omission at issue. See 15 U.S.C. § 77l(b);
Morgan Stanley, 592 F.3d at 359 n.7. The text of Section 12(b)
plainly provides that loss causation is an affirmative
defense to be proven by defendants, not a prima facie
element to be proven by plaintiffs. See 15 U.S.C. § 77l(b)
(placing the burden of proof on “the person who offered or
sold [the] security”); McMahan, 65 F.3d at 1048. The burden
135
to prove negative loss causation is “heavy,” given
“Congress’ desire to allocate the risk of uncertainty to the
defendants in [Securities Act] cases.” Akerman v. Oryx
Commc’ns, Inc., 810 F.2d 336, 341 (2d Cir. 1987); see also
NECA, 693 F.3d at 156 (observing that the Securities Act
creates in terrorem liability designed to encourage full
disclosure by offerors).
Defendants relied on the testimony of two experts,
Kerry Vandell and Timothy Riddiough, to meet their
burden. Both experts opined that the entirety of the
Certificates’ losses were attributable to macroeconomic
factors related to the 2008 financial crisis and not
attributable to the ProSupps’ misrepresentations. Faced
with the “all‐or‐nothing proposition” that the Certificates’
losses either were or were not “caused entirely by factors
other than any material misrepresentations,” the court
sided with the FHFA. Nomura VII, 104 F. Supp. 3d at 541.
The court agreed that the financial crisis played a role in the
Certificates’ reductions in value, but concluded that
Defendants failed to disaggregate the crisis from the
ProSupps’ misstatements. As a result, the macroeconomic
financial downturn provided no basis to reduce the FHFA’s
award. See id. at 585–93. On appeal, Defendants reiterate
their arguments that the Certificates lost value as a product
of macroeconomic factors related to the 2008 financial crisis,
and that the ProSupps’ misstatements or omissions are not
causally linked to that crisis.72
We review de novo whether the District Court applied the
72
proper legal standards in assessing Defendants’ loss causation
136
Although Defendants have maintained that,
“through trial, six of the seven Certificates at issue paid . . .
every penny, and on the seventh, realized losses were $25
million,” Nomura’s Br. 72, it is clear that the Certificates
have suffered loss. “[T]he value of a security may not be
equivalent to its market price.” McMahan, 65 F.3d at 1048.
In the context of RMBS,
basic securities valuation principles—
discounting future cash flows to their present
value using a rate of interest reflecting the cash
flows’ risk—belie the proposition that a fixed
income investor must miss an interest payment
before his securities can be said to have
declined in “value.” . . . [B]ecause the loans
backing the Certificates were riskier than
defendants represented, the future cash flows
to which [the Certificate‐holder] was entitled
. . . required a higher discount rate once the
Offering Documents’ falsity was revealed,
resulting in a lower present value. Put
differently, the revelation that borrowers on
loans backing the Certificates were less
creditworthy than the Offering Documents
represented affected the Certificates’ “value”
immediately, because it increased the
Certificatesʹ credit risk profile. In this analysis,
defense, and we review for clear error the court’s application of
those standards to the facts of this case. See Miller v. Thane Int’l,
Inc., 615 F.3d 1095, 1104 (9th Cir. 2010); Krist, 688 F.3d at 95.
137
whether Certificate‐holders actually missed a
scheduled coupon payment is not
determinative.
NECA, 693 F.3d at 166.
The District Court’s task was to determine the cause
of that loss. Given that Defendants bore the burden of proof
on this issue, the court correctly began with the
presumption that “any decline in value” was “caused by
the [ProSupps’] misrepresentation[s].” See McMahan, 65
F.3d at 1048. Defendants could break that causal link only
by proving that “the risk that caused the loss[es] was [not]
within the zone of risk concealed by the misrepresentations
and omissions.” See Lentell, 396 F.3d at 172 (emphasis
omitted). In other words, they were required to prove that
“the subject” of the ProSupps’ misstatements73 and
omissions was not “the cause of the actual loss suffered.”
See Suez Equity Inv’rs, L.P. v. Toronto‐Dominion Bank, 250
F.3d 87, 95 (2d Cir. 2001).
We agree with the District Court that Defendants
failed to break the link between the Certificates’ reduction
in value and the ProSupps’ misstatements. We previously
suggested that “there may be circumstances under which a
marketwide economic collapse is itself caused by the
conduct alleged to have caused a plaintiff’s loss, although
While the District Court stated that Defendants were required
73
to show that the loss in value was caused “by events unrelated to
the phenomena,” Nomura VII, 104 F. Supp. 3d at 589, which is an
arguably higher standard than the standard in Lentell,
Defendants did not meet the lower bar either.
138
the link between any particular defendant’s alleged
misconduct and the downturn may be difficult to
establish.” Fin. Guar. Ins. Co. v. Putnam Advisory Co., LLC
(Putnam Advisory), 783 F.3d 395, 404 n.2 (2d Cir. 2015).74 The
largely uncontested record evidence suggests that this was
such a case. The District Court found that “shoddy
[mortgage‐loan] origination practices” of the sort concealed
by the ProSupps’ misstatements “contributed to the
housing bubble” that created the 2008 financial crisis.
Nomura VII, 104 F. Supp. 3d at 587; id. at 536–40; see also
Bubb & Krishnamurthy, supra, at 1550–55 (arguing that
overinflated expectations of expansions in the housing
market created a bubble, which in turn led to the financial
crash); Levitin & Wachter, supra, at 1202–10 (arguing that
the housing bubble was the product of the PLS market
providing an oversupply of housing finance).75 Defendants
74 This suggestion came in the context of a claim under Section
10(b) of the Exchange Act, which requires the plaintiff to prove
loss causation as a prima facie element. See 15 U.S.C. § 78u–
4(b)(4). We express no opinion about whether the FHFA could
have met that burden in this case. We conclude only that
Defendants failed to disprove that the market‐wide collapse in
2008 was connected to the ProSupps’ misstatements.
The court “confirm[ed]” this finding by relying on similar
75
observations in a 2011 report published by the U.S. Financial
Crisis Inquiry Commission, which we have cited favorably in the
past. Nomura VII, 104 F. Supp. 3d at 586 n.196; see Putnam
Advisory, 783 F.3d at 404 n.2 (citing FIN. CRISIS INQUIRY COMM’N,
THE FINANCIAL CRISIS INQUIRY REPORT 190–95 (2011)). This was
139
agreed “that there is a link between the securitization
frenzy associated with those shoddy practices and the very
macroeconomic factors that they say caused the losses to
the Certificates.” Nomura VII, 104 F. Supp. 3d at 587. They
therefore failed to rupture the causal connection between
“the subject” of the ProSupps’ misstatements and the loss
the GSEs suffered. See Suez Equity Inv’rs, 250 F.3d at 95.
The District Court concluded that the 2008 financial
crisis was, if anything, an impediment to Defendants’
attempt to carry their burden to prove negative loss
causation. See Nomura VII, 104 F. Supp. 3d at 586–87. That
was consistent with our prior statements regarding loss
causation and macroeconomic crises. A financial crisis may
stand as an impediment to proving loss causation because it
can be difficult to identify whether a particular
misstatement or macroeconomic forces caused a security to
lose value in the fog of a coincidental market‐wide
downturn. See Lentell, 396 F.3d at 174. When a plaintiff
alleges a violation of the Exchange Act, defendants benefit
from the opacity of a financial crisis because the burden is
on the plaintiff to prove loss causation as a prima facie
element. See id. at 172. When a plaintiff alleges a violation of
the Securities Act, loss causation is not a prima facie element
but an affirmative defense. McMahan, 65 F.3d at 1048. The
burden is then on defendants to prove loss causation, and
any difficulty separating loss attributable to a specific
not reversible error. The court did not admit this report into
evidence, nor did it rely on this report in reaching any of its
factual findings. See Nomura VII, 104 F. Supp. 3d at 586 n.196.
140
misstatement from loss attributable to macroeconomic
forces benefits the plaintiff. See id. (presuming absent proof
to the contrary that any decline in value is caused by the
misstatement or omission in the Securities Act context).
Defendants argue that the record clearly refutes the
District Court’s findings. They contend that testimony from
Riddiough, Vandell, and FHFA loss‐causation expert James
Barth, as well as the GSEs’ statements in legal briefs in other
cases, SEC filings, and internal documents, all reveal that
market‐wide forces caused the Certificates to lose value.
Even accepting Defendants’ view of the trial evidence, we
find no basis for reversal. It is uncontested that the housing
market and related macroeconomic forces were partial
causes of the Certificates’ losses. The crucial point that
doomed Defendants’ loss causation defense is that those
macroeconomic forces and the ProSupps’ misstatements
were intimately intertwined. The financial crisis may have
been an important step in between the ProSupps’
misstatements and the Certificates’ losses, but all three
events were linked together in the same causal chain. See
Nomura VII, 104 F. Supp. 3d at 592 (“[The financial crisis]
cannot be ‘intervening’ if [D]efendants’ misrepresentations,
and the underlying facts they concealed, were part and
parcel of it.”).76
The District Court did not abuse its discretion in excluding
76
portions of Vandell’s testimony. See FHFA v. Nomura Holding
Am., Inc., No. 11cv6201, 2015 WL 539489, at *6–9 (S.D.N.Y. Feb.
10, 2015); see Boyce, 464 F.3d at 385.
141
Finally, we reject Defendants’ argument that the
ProSupps’ misstatements and the financial crisis were not
connected because any contribution the ProSupps made to
that crisis was “[t]iny.” Nomura’s Br. 85. Rarely, if ever, is it
the case that one can point to a single bad actor or a single
bad act that brought an entire financial system to its knees.
Financial crises result when whole industries take
unsustainable systemic risks. See John C. Coffee, Jr.,
Systemic Risk after Dodd‐Frank: Contingent Capital and the
Need for Regulatory Strategies Beyond Oversight, 111 COLUM.
L. REV. 795, 797 (2011) (“In 2008, . . . a localized economic
shock in [the U.S.] subprime mortgage market . . . nearly
caused the meltdown of worldwide capital markets as that
shock was transmitted through counterparties and global
markets with the speed of a tsunami.”); Kathryn Judge,
Fragmentation Nodes: A Study in Financial Innovation,
Complexity, and Systemic Risk, 64 STAN. L. REV. 657, 670–77
(2012) (explaining the systemic risk in the market for home‐
loan securitizations); see also Steven L. Schwarcz, Systemic
Risk, 97 GEO. L.J. 193, 204 (2008) (defining systemic risk).
The ProSupps’ misstatements contributed to the systemic
risk in the PLS market in the mid‐2000s. Defendants may
not hide behind a market downturn that is in part their own
making simply because their conduct was a relatively small
part of the problem.
B. Blue Sky Claims
Even when a plaintiff prevails under Section 12(a)(2),
the analogous Virginia and D.C. Blue Sky provisions
require proof of an additional element to trigger relief—that
the securities transaction(s) at issue occurred within the
142
regulating jurisdiction. The District Court found that the
FHFA met its burden of proof on this element. Nomura VII,
104 F. Supp. 3d at 595–97. Defendants contest that finding.77
1. Blue Sky Jurisdiction
“[B]lue‐sky laws . . . only regulate[] transactions
occurring within the regulating States.” Edgar v. MITE
Corp., 457 U.S. 624, 641 (1982); see UNIF. SEC. ACT § 414(a)
(1956); D.C. CODE § 31–5608.01(a) (providing that the D.C.
Blue Sky law applies “when an offer to sell is made in
[D.C.] or an offer to purchase is made and accepted in
[D.C.]”); Lintz, 613 F. Supp. at 550 (observing that the
Virginia Blue Sky law applies only to securities transactions
that occurred in Virginia). A securities transaction occurs
where each party “incur[s] irrevocable liability.” Absolute
Activist Value Master Fund Ltd. v. Ficeto (Absolute Activist),
677 F.3d 60, 68 (2d Cir. 2012). That may be more than one
location. For example, if the buyer “incur[s] irrevocable
liability . . . to take and pay for a security” in New York and
the “seller incur[s] irrevocable liability . . . to deliver a
security” in New Jersey, the transaction occurs in both New
York and New Jersey. See id.
It is undisputed that Defendants did not incur
liability to deliver the Certificates in either D.C. or Virginia.
The FHFA triggered Blue Sky liability by proving that
Fannie incurred irrevocable liability to purchase NAA 2005‐
AR6 in D.C. and that Freddie incurred irrevocable liability
We review this predominantly factual issue for clear error. See
77
Krist, 688 F.3d at 95.
143
to purchase NHELI 2006‐FM2, NHELI 2007‐1, and NHELI
2007‐2 in Virginia.
2. The D.C. PLS Transaction
The District Court found that the NAA 2005‐AR6
transaction occurred in D.C. based on the following facts:
Fannie’s principal place of business was D.C.; Fannie’s PLS
traders worked in D.C.; Nomura emailed offering materials
to Fannie’s PLS traders’ work email addresses; and Nomura
sent a physical confirmation of purchase to Fannie’s D.C.
headquarters. Nomura VII, 104 F. Supp. 3d at 597. On
appeal, Defendants do not contest those findings, but argue
they fail to provide a sufficient basis for D.C. Blue Sky
liability.
First, Defendants argue that the mere fact that
Fannie’s principal place of business is in D.C. “does not
affect where the transaction occur[red].” Nomura’s Br. 93
(internal quotation mark omitted) (quoting Absolute Activist,
677 F.3d at 69).78 That is accurate, but is insufficient to
require reversal. The District Court’s finding that Fannie
purchased a Certificate in D.C. did not rely solely on
Fannie’s principal place of business. Rather, the court relied
on the location of Fannie’s principal place of business in
addition to testimonial evidence that Fannie’s PLS traders
78 Nomura slightly misquoted Absolute Activist. See 677 F.3d at 69
(noting that “[a] purchaser’s citizenship or residency does not
affect where a transaction occurs” (alteration in original)
(emphasis added) (quoting Plumbers’ Union Local No. 12 Pension
Fund v. Swiss Reins. Co., 753 F. Supp. 2d 166, 178 (S.D.N.Y.
2010))).
144
worked in the D.C. office. Those two facts taken together
adequately support the court’s inference for purposes of
our review. See Absolute Activist, 677 F.3d at 68 (“[T]he
location of the broker [is] relevant to the extent that the
broker carries out tasks that irrevocably bind the parties to
buy or sell securities . . . .”).
Second, Defendants assert that the email addresses
on which the District Court relied are “non sequitur[s]”
because they “do not reveal anything about the geographic
location of the addressee.” Nomura’s Br. 93 (internal
quotation mark omitted) (quoting Shrader v. Biddinger, 633
F.3d 1235, 1247–48 (10th Cir. 2011)). There is a kernel of
truth to this argument as well, but it misses the mark. An
email address may not reveal much about geographic
location of the addressee on its own, but the fact that an
addressee received an email at his work email address can
support the inference that the addressee opened the email
at work. And that fact in turn, taken together with the
District Court’s finding that Fannie’s PLS traders worked in
D.C., supports the inference that Nomura’s emails were
opened in D.C. These findings are further buttressed by the
fact that Nomura sent a physical copy of an after‐sale
confirmation to Fannie’s D.C. headquarters. Where Nomura
sent an after‐sale confirmation is not irrefutable evidence of
where the antecedent sale occurred. But the destination for
that confirmation supports the inference that the entire
Certificate transaction—including the initial offering, the
sale, and the after‐sale confirmation—occurred between
Nomura’s New York office and Fannie’s D.C. office.
145
Finally, Defendants argue that the District Court
improperly shifted the burden of proof when it observed
that that “Defendants have offered no affirmative evidence
that the offers to sell were not made in and/or accepted in
. . . D.C.” Nomura VII, 104 F. Supp. 3d at 597. Defendants
misunderstand the District Court’s statement. In deciding
whether the evidence showed that the sale occurred in D.C.,
the District Court merely noted that Defendants offered no
evidence to counterbalance the evidence in the FHFA’s
favor. Balancing evidence, a task well within the fact‐
finder’s competence, is not the same as shifting the burden
of proof.
3. The Virginia PLS Transactions
The District Court found that the NHELI 2006‐FM2,
NHELI 2007‐1, and NHELI 2007‐2 transactions occurred in
Virginia based on similar facts: Freddie’s principal place of
business was in Virginia; Freddie’s PLS traders worked in
Freddie’s Virginia office; Defendants sent PLS offering
materials to Freddie’s PLS traders at their work email
addresses; and Defendants sent a physical confirmation of
sale to Freddie’s Virginia headquarters. Id.
Defendants’ arguments regarding Virginia Blue Sky
jurisdiction largely track their D.C. Blue Sky arguments
above and are rejected for the same reasons. Defendants
offer two new arguments with regard to the Virginia PLS
sales. First, Defendants fault the District Court for not
requiring the FHFA to “present[] testimony from someone
who . . . had direct knowledge about how and where
[Freddie’s PLS traders] executed the trades” at issue. RBS’s
146
Br. 59. While perhaps good advice for the FHFA going
forward, that is no argument for clear error. There was
more than one correct way for the FHFA to prove its case.
Second, Defendants make much of the fact that two Freddie
employees stated that Freddie’s PLS traders purchased PLS
certificates “generally”—instead of “always”—from an
office in McLean, Virginia. That testimony may not be the
best evidence that Freddie purchased the Certificates at
issue in Virginia, but clear error requires more than
pointing out that a plaintiff could have, in theory, offered
stronger evidence. See Krist, 688 F.3d at 95.
CONCLUSION
“It requires but little appreciation of the extent of the
[securities industry]’s economic power and of what
happened in this country during the [Great Depression] to
realize how essential it is that the highest ethical standards
prevail” in financial markets. Silver v. N.Y. Stock Exch., 373
U.S. 341, 366 (1963). In passing the Securities Act, Congress
affixed those standards of honesty and fair dealing as a
matter of federal law and authorized federal courts to
impose civil remedies against any person who failed to
honor them. See Ernst & Ernst, 425 U.S. at 195. And now, in
the wake of the Great Recession, the mandate of Congress
weighs heavy on the docket of the Southern District of New
York. The district court’s decisions here bespeak of
exceptional effort in analyzing a huge and complex record
and close attention to detailed legal theories ably assisted
by counsel for all parties.
The judgment is AFFIRMED.
147
APP
PENDIX A
A
148
APPENDIX B
Lead
Securitizatio Sponso Deposito
Buyer Underwriter(
n r r
s)
NAA Nomura
Fannie NCCI NAAC
2005‐AR6 Securities
NHELI Freddi Nomura
NCCI NHELI
2006‐FM1 e Securities
RBS &
NHELI Freddi
NCCI NHELI Nomura
2006‐HE3 e
Securities
NHELI Freddi
NCCI NHELI RBS
2006‐FM2 e
NHELI Freddi
NCCI NHELI RBS
2007‐1 e
NHELI Freddi
NCCI NHELI RBS
2007‐2 e
NHELI Freddi
NCCI NHELI [nonparty]
2007‐3 e
149
APPENDIX C
Purchase Principal Interest
Securitization
Price Payments79 Payments
NAA
$65,979,707 $42,801,327 $17,517,513
2005‐AR6
NHELI
$301,591,187 $282,411,183 $23,756,542
2006‐FM1
NHELI
$441,739,000 $331,937,382 $34,559,137
2006‐HE3
NHELI
$525,197,000 $346,402,921 $42,099,996
2006‐FM2
NHELI
$100,548,000 $53,271,881 $8,701,219
2007‐1
NHELI
$358,847,000 $235,700,674 $29,010,757
2007‐2
NHELI
$245,105,000 $127,924,783 $19,350,587
2007‐3
All principal and interest payments made as of February 28,
79
2015.
150
APPENDIX D
ProSupp Settlement Filing
Securitization
Date80 Date81 Date82
NAA
11/29/2005 11/30/2005 11/30/2005
2005‐AR6
NHELI
1/27/2006 1/31/2006 1/31/2006
2006‐FM1
NHELI
8/29/2006 8/31/2006 8/30/2006
2006‐HE3
NHELI
10/30/2006 10/31/2006 10/31/2006
2006‐FM2
NHELI
1/29/2007 1/31/2007 1/31/2007
2007‐1
NHELI
1/30/2007 1/31/2007 2/1/2007
2007‐2
NHELI
4/27/2007 4/30/2007 5/1/2007
2007‐3
80 This date listed on the cover of each ProSupp.
The date when Defendants transferred title to the GSE and the
81
GSE transferred payment in exchange.
82 The date the ProSupp was filed with the SEC.
151