Wednesday, February 18, 2015

FHFA 3 for 3 on Challenges to RMBS Defendants’ Experts

[This story previously appeared in Securities Regulation Daily.]

By Anne Sherry, J.D.

The Federal Housing Finance Agency has prevailed on a series of procedural motions in its remaining case against financial institutions over residential mortgage-backed securities (RMBS) sales. In a trio of opinions, the court agreed with the conservator that portions of the defendants’ experts’ reports and testimony had to be stricken or excluded (FHFA v. Nomura Holding America, Inc., February 13, 2015, Cote, D.).

Background. The lawsuit represents the sole remaining action in a series of similar, coordinated actions brought in the Southern District of New York by FHFA against banks and related persons to recover losses experienced by government-sponsored enterprises Fannie Mae and Freddie Mac (collectively, the GSEs) from their purchases of RMBS. Among other things, FHFA alleged that the defendants misstated the extent to which the loan groups supporting the RMBS complied with relevant underwriting guidelines. FHFA also alleged that credit rating agencies gave inflated ratings to the mortgage pass-through certificates as a result of the defendants providing these agencies with incorrect data concerning the attributes of the loans.

Reliance and materiality. FHFA has filed a number of procedural motions challenging the defendants’ experts’ testimony and reports. In one, the conservator sought to exclude the testimony of John J. Richard, a professional investor, who was offered as an expert on the RMBS industry. In the opinion granting this motion in part, the court distinguished between the elements of reliance and materiality. Reliance is not an element of claims brought under Sec.12 of the Securities Act, which is a strict liability statute. Accordingly, the parties could offer evidence at trial going to the materiality of the type of information at issue, but not evidence or argument for the purpose of proving that the GSEs did not rely on any specific misrepresentations.

The court concluded that Richard was qualified to provide expert testimony regarding the private-label securities market generally and the practices of RMBS investors. However, FHFA succeeded in showing that Richard’s proposed testimony regarding the GSEs was not admissible because he had no experience qualifying him to testify as an expert regarding the GSEs. Most of his report regarding the GSEs simply recited passages from their own documents and depositions and much of that was irrelevant. Nevertheless, Richard would be permitted to use the evidence about the GSEs learned through discovery to support his well-founded expert opinions about general industry practices and the materiality of loan characteristics to RMBS investment decisions. Finally, the portions of Richard’s report presenting a critique of the FHFA’s three experts were stricken, because his discussion pertained to the issue of the GSE’s reliance on the alleged misrepresentations.

Damages. The court also granted in part the motion to exclude the testimony of Timothy J. Riddiough, whom the defendants intended to testify regarding damages. Riddiough’s damage calculation incorporated an error by calculating interest on income; because Sec. 12(a)(2) expressly provides that interest may be calculated on “consideration paid” but does not so provide regarding “income received,” principles of statutory interpretation compelled the conclusion that interest should not be calculated on income. Because the defendants’ interpretation of Sec. 12(a)(2) was incorrect as a matter of law and the conclusions drawn from that interpretation could not help the trier of fact to determine a fact in issue, Rule 702 and Daubert required excluding the expert’s testimony.

Accounting issues. Finally, FHFA moved to exclude the testimony of Stephen Ryan, who was retained to give an opinion on issues connected to the GSEs’ accounting for the losses of fair value and their accounting treatments for the certificates. Ultimately, the court determined, the only two issues remaining to be tried in order for FHFA to make out a prima facie strict liability claim under Sec. 12(a)(2) and the Blue Sky laws were falsity and materiality of the alleged misrepresentations. Ryan’s testimony on the GSEs’ accounting practices was wholly irrelevant to the FHFA’s prima facie case. Indeed, the court noted, the falsity and materiality elements could be satisfied even if the GSEs had not incurred losses. While the testimony may address the defendants’ loss causation affirmative defense, it has “such minimal probative value that it is easily substantially outweighed by even the slightest danger of undue delay and wasting time,” the court wrote.

The case is No. 11cv6201.