Fed. Hous. Fin. Agency v. Nomura Holding Am., Inc.

68 F.Supp.3d 486

FEDERAL HOUSING FINANCE AGENCY, Plaintiff

v.NOMURA HOLDING AMERICA, INC., et al., Defendants.

No. 11cv6201 DLC.

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

Signed Dec. 18, 2014.

Philippe Z. Selendy, Quinn Emanuel Urquhart & Sullivan, LLP, New York, NY, for plaintiff Federal Housing Finance Agency.

David B. Tulchin, Sullivan & Cromwell LLP, New York, NY, for defendants Nomura Holding America, Inc., Nomura Asset Acceptance Corp., 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.

Thomas C. Rice, Simpson Thacher & Bartlett LLP, New York, NY, for defendant RBS Securities Inc.

OPINION & ORDER

DENISE COTE, District Judge:

This Opinion addresses a motion in limine brought by plaintiff Federal Housing Finance Agency (“FHFA”) to prohibit defendants¹ from presenting, in connection with its Section 11 claims, evidence to the jury of principal and interest payments made on the certificates at issue in this action (the “Certificates”) after September 2, 2011, which is the date on which this lawsuit was filed (the “Post–Filing Payments”).² For the following reasons, the motion is granted.

BACKGROUND

FHFA, acting as conservator for Fannie Mae and Freddie Mac (together, the “Government Sponsored Enterprises” or “GSEs”), filed suit on September 2, 2011 against defendants alleging that the offering documents (“Offering Documents”) used to market and sell seven Certificates to the GSEs associated with residential mortgage-backed securities (“RMBS”) contained material misstatements or omissions. RMBS are securities entitling the holder to income payments from pools of residential mortgage loans (“Supporting Loan Groups” or “SLGs”) held by a trust.

FHFA brought these claims pursuant to Sections 11 and 12(a)(2) of the Securities Act of 1933 (the “Securities Act”), as well as Virginia's and the District of Columbia's Blue Sky laws. This lawsuit is the sole remaining action in a series of similar, coordinated actions litigated in this district by FHFA against banks and related individuals and entities to recover losses experienced by the GSEs from their purchases of RMBS. A description of the litigation and the types of misrepresentations at issue in each of these coordinated actions, including the instant case, can be found in FHFA v. Nomura Holding Am., Inc., 60 F.Supp.3d 479, 484–88, 498–500, 11cv6201 (DLC), 2014 WL 6462239, at *3–6, *16–17 (S.D.N.Y. Nov. 18, 2014) (“Nomura ”).

The GSEs purchased the seven Certificates between November 30, 2005 and April 30, 2007. The Certificates had an original unpaid principal balance of approximately $2.05 billion, and the GSEs paid slightly more than the amount of the unpaid principal balance when purchasing them. Six were purchased by Freddie Mac; one was purchased by Fannie Mae. The GSEs have retained the Certificates.

Nomura acted as sponsor and depositor for all seven of the Certificates, and as the sole lead underwriter and seller for two of them. RBS was the sole lead underwriter for three of the Certificates and a co-lead underwriter for a fourth. For an explanation of the RMBS securitization process, including the roles of mortgage loan originators, sponsors, and underwriters, see Nomura, 60 F.Supp.3d at 485–89, 2014 WL 6462239, at *4–6.

Section 11 and Section 12(a)(2), as described below, use different measures of damages. The Blue Sky laws adopt the Section 12(a)(2) measurement of damages. As a result, FHFA's expert Dr. James K. Finkel (“Finkel”) has used two different methodologies in calculating damages, and has also applied three different interest rates to his calculations. Finkel has calculated damages as high as roughly $1 billion for the claims against Nomura, and roughly $750 million against RBS.

Dr. Timothy Riddiough (“Riddiough”), one of defendants' experts, submitted a report on November 10, 2014 (the “Riddiough Report”) in which he critiqued Finkel's valuation of the Certificates at the time of suit and offered his own valuation model. As explained below, where a plaintiff holds a security through judgment, Section 11 damages are equal to the difference between the purchase price (or the offering price, if lower) and the security's value at the time the suit is filed.

Each Certificate entitled its holder to the receipt of certain monthly payments, which were based on the principal balance for that Certificate.³ The monthly payments to the Certificate holder were equal to a coupon payment—effectively interest, at a predetermined rate, on the remaining principal balance—plus some additional amount that paid down the principal balance.

Certificates were linked to tranches of varying seniority. Generally, holders of the most senior certificates for a given Supporting Loan Group were paid first, after which holders of the next-most-senior certificates received payment, and so on. Thus, should some borrowers in an SLG default on their loans, certificates in the junior-most tranche would absorb all or most of the shortfall before payments to more senior certificates were affected. Accordingly, the most senior certificates were subject to less risk than were more junior certificates. By apportioning risk in this way, defendants were able to create AAA-rated securities from Alt-A and subprime loans. The GSEs purchased senior certificates—often only the most senior—with the highest credit ratings.

For instance, in Nomura Securitization 2006–FM1, Freddie Mac purchased a Certificate linked to the senior-most tranche, class I–A–1, which was supported by Group I loans. That tranche had an initial principal balance of approximately $525 million; the nine subordinated (“mezzanine”) tranches below had a total principal balance of approximately $223 million. All realized losses on Group I loans were to be allocated to the nine mezzanine tranches, until their $223 million principal balance was reduced to zero.⁴ This subordination, in addition to certain other credit enhancements,⁵ protected Freddie Mac's senior Certificate from loss, even in the face of substantial defaults (and limited recovery through foreclosure).

A certificate's value in the market is determined, in large part, by the expected future flow of payments to the certificate holder. Because payments to the certificate holder depend upon borrowers' payments pursuant to the underlying mortgage loans, the expected rate of borrower defaults is a key determinant of the certificate's value. The average expected loss severity—which measures the shortfall between the unpaid principal balance of a loan and the amount recovered through foreclosure (less costs incurred in foreclosure)—is another key factor. In the years following September 2, 2011, all but one of the Certificates never missed a payment.

In his valuation analysis, Riddiough considered the performance of the Certificates after the date this suit was filed, September 2, 2011, for two purposes. First, Riddiough compared actual post-filing rates of default within the relevant Supporting Loan Groups against his and Finkel's predicted default rates, finding that his “forecasts ... are much closer to what actually happened.” Second, Riddiough looked at actual post-filing market prices for the Certificates as “an ex-post check” of his conclusion, based on trading volume, that the RMBS market was illiquid at the time of filing. Riddiough noted that, by one measure, the Certificates' prices in the market have increased by 28 to 81 percent.

Riddiough relies on the conclusions of Dr. Kerry D. Vandell (“Vandell”), a second expert for defendants, as to loss causation. Vandell's analysis considers the performance of loans, including the loans underlying the Certificates, through December 2013. According to FHFA, Vandell notes (in an exhibit to his report that no party has submitted to the Court in connection with this motion) the “expected dollar losses” to one of the Certificates as of December 2013.

FHFA filed the instant motion in limine on October 6, 2014 to prohibit defendants from presenting evidence to the jury of the Post–Filing Payments in connection with the Section 11 claims. This motion was fully submitted on October 24.

DISCUSSION

This motion in limine requires application of the damages provisions for Section 11 of the Securities Act, 15 U.S.C. § 77k, as well as the affirmative defense of negative causation available under that section. Those provisions are set forth below, following the governing Federal Rule of Evidence. Application of this law is followed by a discussion of Section 12(a)(2) of the Securities Act.

I. Legal Standards

A. Rule 403

Pursuant to Rule 403, Fed.R.Evid., “[t]he court may exclude relevant evidence if its probative value is substantially outweighed by a danger of ... unfair prejudice, confusing the issues, misleading the jury, undue delay, wasting time, or needlessly presenting cumulative evidence.” Accord United States v. Dupree, 706 F.3d 131, 138 (2d Cir.2013). A court must “conscientiously balance[ ] the proffered evidence's probative value with the risk for prejudice.” United States v. Massino, 546 F.3d 123, 132 (2d Cir.2008) (citation omitted). “ ‘[U]nfair prejudice’ speaks to the capacity of some concededly relevant evidence to lure the factfinder into [rendering its verdict] on a ground different from proof specific to the [claims brought].” Id. (citation omitted). For instance, the proffered evidence may have a “tendency ... to prove some adverse fact not properly in issue or unfairly excite emotions against the [opposing party].” Id. at 133 (citation omitted). When conducting this balancing, a court “should consider the possible effectiveness of a jury instruction and the availability of other means of proof in making a Rule 403 determination.” Dupree, 706 F.3d at 138.

B. Section 11 Damages

A Section 11 claimant is entitled to recover, pursuant to Section 11(e),

such damages as shall represent the difference

...