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S.D.N.Y. Certifies Class of Mortgage-backed Securities Purchasers

Friday, August 19, 2011

Susan M. Greenwood | Bloomberg LawNew Jersey Carpenters Health Fund v. DLJ Mortgage Capital, Inc., No. 08-CV-05653 (S.D.N.Y. Aug. 16, 2011) The U.S. District Court for the Southern District of New York certified a class of investors who purchased certain mortgage-backed securities in the form of pass-through certificates (Certificates). Although investors purchased Certificates worth $2.39 billion, the class comprises only those investors who purchased Home Equity Mortgage Trust, Series 2006-5 (HEMT 2006-5) Certificates, as the Court previously dismissed on standing grounds, claims on behalf of purchases of additional series.

Even Small Classes May Be Certified

The Court relied on the Second Circuit's holding that the numerosity requirement of Federal Rule of Civil Procedure 23(a) presumptively is satisfied by a proposed class of more than 40 members. Based on limited discovery, plaintiff's expert identified 330 "unique entities" that purchased HEMT 2006-5 Certificates. Defendants disputed the math, but conceded that there are at least 103 potential class members. Nevertheless, defendants argued that the potential class includes sophisticated investors who are capable of litigating individual actions to address their large claims. The Court rejected this argument, reasoning that "[s]ophistication and size of certain class members are not bars to a finding of numerosity."

Different Tranches of Certificates Do Not Impede Certification

As defendants did not dispute commonality, the Court next addressed the typicality requirement. Here, defendants focused on the different tranches of HEMT 2006-5 Certificates purchased by class members. Because different tranches have different payment priorities, defendants claimed that "class members in the higher tranches would likely prefer to establish their injury by showing that the bonds decreased in value, while those in the lower tranches would prefer to argue that there was a shortfall in the principal and interest due to such plaintiffs." The Court characterized conflicts among class members as "speculative" and insufficient to defeat typicality. Moreover, it noted that it is "well established" in the Second Circuit that individual issues of damages are not a bar to class certification.

Antagonistic Interests, Not Ignorance

According to defendants, the proposed class representative displayed ignorance of the litigation during its deposition and relied on its counsel to "draft[] and edit[] all legal documents relating to this case." Unimpressed, the Court explained that "'the Supreme Court has expressly disapproved of attacks on the adequacy of a class representative based on the representatives' ignorance.'" In any event, the Court observed that, although the proposed class representative "might not have known or understood every detail about the instant litigation . . . [it] is not so ignorant of the facts of this case that it is 'unable or unwilling' to protect the interests of the class." Further, the Court agreed with plaintiff that complex actions, such as plaintiff's claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933, require reliance on expert counsel. Finding no conflict between the proposed class representative and the class, and that proposed class counsel "is qualified to represent the proposed class," the Court held that plaintiff met the adequacy requirement.

Common Issues Predominate

Next, the Court addressed whether knowledge, reliance, or loss causation defeated the requirement under Federal Rule of Civil Procedure 23(b)(3) that common issues predominate over individual issues. First, the Court held that there were insufficient "'revelatory disclosures'" to require that each class member's knowledge be tested individually. Defendants relied on "rising delinquency and default rates, three trustee reports which discussed the delinquency rates of the collateral pool, and news reports regarding . . . underwriting practices." Plaintiff, however, contended that this information did not specifically address HEMT 2006-5 Certificates or defendants' alleged "systematic disregard of underwriting guidelines." Plaintiff also noted that the HEMT 2006-5 Certificates were not downgraded below investment grade until well after defendants' alleged revelatory disclosures began. Using decisions in In re Initial Public Offering Securities Litigation, 471 F.3d 24 (2d Cir. 2006) and In re Superior Offshore International Securities Litigation, No. 08-CV-00687, 2010 BL 128022 (S.D. Tex. June 8, 2010) as a base-line, the Court held that "the potentially individual issue of knowledge does not predominate over the issues common to the potential class members." Second, individual issues of reliance do not predominate, the Court held. A purchaser must prove reliance, the Court explained, if the issuer made available to investors an earnings statement covering a period of at least 12 months beginning after the registration statement's effective date. Earnings statements are defined under Securities and Exchange Commission Rule 158 and must include certain information. Defendants' offer of trustee reports as earnings statements, the Court held, did not meet Rule 158's requirements. Lastly, the Court held that the affirmative defense of loss causation does not impede class certification. While "[d]efendants may limit their damages by establishing negative causation later," at the class certification stage, the common nucleus of facts forming the basis of the claims predominates over individual issues of damages that will not be calculated until after a finding of liability.

Class Actions Are Superior for Small Classes

Finally, reprising their numerosity argument, defendants challenged superiority on the grounds that the 103 potential class members have a mean investment of $4 million and can protect their interests through individual actions. Plaintiff responded that the median investment is only $60,000, "'far below the millions of dollars in fees and expenses necessary to litigate a complex securities action, thus making a lawsuit economically irrational for the majority of purchasers included in the putative class.'" The Court did not need to weigh competing statistical evidence because, it said, "[t]he amounts at stake for some potential class members is not enough to justify an individual action." It concluded that "securities actions such as this are commonly brought as class actions[] [and] there does not seem to be any particular difficulty in administering such an action."
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