In ruling against Barclays, NY judge rejects 2nd Circuit holding

By Alison Frankel
November 5, 2012

Last March, U.S. District Judge Louis Stanton of Manhattan refused to dismiss a case against Barclays by a Florida credit union that claimed it had been defrauded by the bank’s misrepresentations about the collateral underlying a CDO called Markov. According to the credit union’s all-too-familiar allegations, Barclays stuffed the CDO with doomed-to-fail mortgage-backed securities, then shorted the vehicle even as it flogged the CDO to investors. Stanton said that the credit union had shown enough evidence in its complaint to proceed with discovery on its claims.

You might think, based on Stanton’s ruling in that case, that Bayerische Landesbank, a fellow Markov investor, had a slam-dunk case against Barclays, at least as far as surviving the bank’s motion to dismiss. But Barclays and its lawyers at Cleary Gottlieb Steen & Hamilton thought they had a game changer in the case: a ruling last April by the 2nd Circuit Court of Appeals. The appeals court upheld U.S. District Judge William Pauley‘s dismissal of claims by the investor Landesbank Baden-Wuerttemberg that Goldman Sachs rigged an MBS-stuffed CDO to fail.

Even though the 2nd Circuit’s ruling was a summary order that involved a CDO sponsored by a different bank, Barclays argued in its motion to dismiss the Bayerische case last August that the appellate decision was directly on point. “The circuit held that dismissal under (the pleading standard for fraud) was required because the plaintiff failed to identify specifically any reports or statements that allegedly provided the defendants with such contrary information at the time the CDO was issued,” Cleary wrote. “The same is true here. Indeed, plaintiff relies on the very same generalized allegations as in Landesbank when insisting that Barclays ‘knew’ Markov’s collateral would fail.”

Barclays also raised the familiar defense that Bayerische Landesbank was a sophisticated investor, and added, to boot, that the German bank’s claims couldn’t be litigated in U.S. courts under Morrison v. National Australia Bank.

Stanton didn’t buy any of Cleary’s arguments. In a terse 11-page ruling entered last week but issued Monday when federal courts in Manhattan reopened after Sandy, the judge said that none of Barclays’ new arguments in the Bayerische case overcame his reasoning in the Florida credit union decision.

In the Goldman CDO case before Pauley, Stanton wrote, Landesbank Baden-Wuerttemberg failed to identify the specific due diligence reports that allegedly revealed Goldman Sachs’s knowledge of the toxic securities underlying the CDO. By contrast, in the Bayerische case against Barclays, plaintiffs’ lawyers from Bernstein Litowitz Berger & Grossmann offered sufficient allegations, not confined to documentary evidence, that Barclays and the collateral manager State Street misrepresented the underlying collateral. Besides, Stanton said, the 2nd Circuit’s decision affirming Pauley in the Goldman case was a summary order, not intended to have precedential effect.

“It is clear that the 2nd Circuit did not intend its decision in Landesbank to work a sweeping change in the law of this district,” Stanton wrote.

He also rejected Barclays’ Morrison defense, finding that even though the Markov CDO wasn’t traded on a U.S. exchange, investment decision-making and transfer of the securities took place in New York. Stanton offered surprisingly little analysis of Barclays’ argument that the German bank was a sophisticated investor that did not justifiably rely on statements in the CDO offering materials; the judge ruled that the sophisticated investor question was too fact-specific to be decided on a preliminary motion.

I’ve previously noted that Pauley’s Landesbank ruling, despite affirmation by the 2nd Circuit, is looking more and more like an outlier as investors in doomed-to-fail CDOs proceed with their cases. It’s still early, and we’ll have to see how subsequent appeals courts look at sophisticated investor defenses. But for now, leverage seems to favor investors.

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