Opinion

Alison Frankel

Repercussions from Rakoff ruling in Dexia MBS case vs JPMorgan?

By Alison Frankel
April 4, 2013

Amid the fusillade of securities suits against the banks that sponsored and underwrote mortgage-backed notes, there have been a couple of reasons to pay particular attention to the Franco-Belgian bank Dexia’s case against JPMorgan Chase and its predecessors Bear Stearns and WaMu Mortgage. For starters, it was a big case: $1.6 billion in MBS and supposed damages of about $800 million. Moreover, Dexia’s lawyers at Bernstein Litowitz Berger & Grossmann had piled allegations into an amended complaint so apparently damning that it was the basis of a splashy story in The New York Times. And finally, the case was shaping up as a bellwether for MBS claims by individual investors. The litigation was on the rocket docket of U.S. Senior District Judge Jed Rakoff of Manhattan, who denied the bank’s motion to dismiss last September and talked in a recent hearing about a July trial date on Dexia’s claims. Given the resounding victory Rakoff delivered in February to the bond insurer Assured Guaranty in Assured’s MBS case against Flagstar Bank, the Dexia case seemed like it could be a perfect storm for defendants: a strong plaintiffs’ firm trying a high-profile case before a judge with demonstrated skepticism for bank defenses.

There may still be a Dexia trial in July, but it will be of considerably less interest after a ruling Wednesday in which Rakoff granted summary judgment to JPMorgan on claims stemming from 60 of the 65 MBS certificates in Dexia’s case. According to a statement by JPMorgan’s lawyers at Cravath, Swaine & Moore, Dexia’s potential losses are now only about $5.7 million, down $769 million from Dexia’s original claims. In a case that had the potential to set settlement standards for individual MBS suits, $6 million in exposure isn’t the kind of leverage MBS investors were hoping for.

What’s worse, Rakoff’s ruling could put new obstacles in the way of MBS plaintiffs who didn’t purchase their notes directly from sponsors. Lots of individual investor claims are based on certificates that have changed hands over the years. Rakoff’s reasoning could complicate those cases.

Of course, we don’t yet know exactly what Rakoff’s reasoning is. In his customary fashion, he issued the bottom-line order without an accompanying opinion, which will follow “in due course.” So we have to engage in a bit of inference, based on JPMorgan’s summary judgment brief and Dexia’s response, to figure out why the judge entirely eliminated claims on 60 of Dexia’s certificates. But as Cravath indicated in its statement on the summary judgment order, it’s pretty clear that Rakoff concluded Dexia does not have standing to sue JPMorgan based on certificates originally purchased by its corporate affiliate FSA Asset Management, and that FSAM (as the affiliate is known) may only sue over certificates Dexia bought for less than FSAM’s purchase price.

There are two different pieces of that holding, so let’s break it down. FSAM was the Dexia entity that originally purchased mortgage-backed notes from JPMorgan and other MBS sponsors in the peak years of the economic boom. When the bank underwent a restructuring in 2009, the parent company acquired FSAM’s notes through some complicated vehicles. Dexia paid its affiliate full purchase price for 60 of the certificates and somewhat less than full price on the other five.

Since the beginning of the litigation, JPMorgan and Cravath have argued that because the purchase agreements between Dexia and FSAM did not specifically mention the assignment of tort rights, the right to sue over securities violations did not move to Dexia along with ownership of the notes. (I’m simplifying but you get the drift.) When Rakoff denied JPMorgan’s motion to dismiss, he credited Dexia’s assertion that it did have standing because FSAM assigned its parent the right to sue, although the judge warned that he might revisit the issue when the record was more developed. In its summary judgment brief, JPMorgan once again cited missing language in the purchase agreements and also added a hairsplitting argument about whether FSAM actually “delivered” the notes to Dexia as the agreements required.

Dexia and Bernstein Litowitz said both arguments were ridiculous. The second was a semantic contortion, Dexia said, and the first was “empty formalism” that would lead to an “absurd” result: “Why, in the context of a transaction within the same corporate family, would a subsidiary and its parents transfer assets among them in a manner that would result in neither entity having the ability to pursue pre-existing legal claims against third parties?”

Nevertheless, Rakoff ruled that Dexia has no claims. (Again, we’ll have to wait and see whether that’s because FSAM didn’t actually assign tort claims to Dexia or because the delivery of the notes was somehow deficient.) He also found that FSAM has no claims based on the 60 certificates for which Dexia repaid the full purchase price. The only remaining certificates that remain in the case are those Dexia acquired from FSAM for less than FSAM paid for them.

At a minimum, the judge’s holding is going to affect Dexia’s suit against Deutsche Bank, in which a motion to dismiss Dexia’s amended complaint is pending before Rakoff. (Bernstein Litowitz also represents Dexia in that case; Deutsche Bank has Paul, Weiss, Rifkind, Wharton & Garrison.) In the worst-case scenario for MBS investors, every indirect MBS purchaser will have to show that tort rights were specifically assigned in order to proceed with securities litigation, even if notes just transferred from one part of a corporation to another.

A Bernstein Litowitz partner declined to comment.

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