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IN THE CIRCUIT COURT OF COOK COUNTY, ILLINOIS COUNTY DEPARTMENT, CHANCERY DIVISION
FEDERAL HOME LOAN )
BANK OF CHICAGO, ) )
Plaintiff, ) ) ) No. 10 CH 45033 v. ) ) Hon. Kathleen M. Pantle ) BANC OF AMERICA )
FUNDINGCORPORATION, ) et al., )
) Defendants. )
ORDER
Defendants move to dismiss Plaintiff Federal Home Loan Bank of Chicago’s Corrected
Amended Complaint for Rescission and Damages. The various motions are brought pursuant to
section 2619.1, 2615, and 2619 of the Illinois Code of Civil Procedure. 735 ILCS 5/2619.1,
5/2615, and 5/2619.
On October 15, 2010, Plaintiff, The Federal Home Loan Bank of Chicago (“the Bank”)
filed a fivecount Complaint for rescission and damages under: (a) Illinois State Securities Law,
815 ILCS § 5, et seq.; (b) North Carolina State Securities Law, N.C.G.S.A. § 78A1, et seq.; (c)
New Jersey Uniform Securities Law, N.J.S.A. § 49:347 et seq.; and (d) applicable common law
(collectively the “Complaint”). Count I alleges untrue or misleading statements in the sale of
securities and is brought pursuant to 815 ILCS § 5/12(F) & (G); Count II alleges signing or
circulating securities documents that contained material misrepresentations and is brought
pursuant to 815 ILCS § 5/12(H); Count III alleges untrue or misleading statements in the sales of
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securities and is brought pursuant to North Caroline Securities Law, N.C.G.S.A. § 78A8(2) and
78A56(a); Count IV alleges untrue or misleading statements in the sale of securities and is
brought pursuant to New Jersey Securities Law, N.J.S.A. 49:352(b) & (c); and Count V is for
common law misrepresentation.
Federal Home Loan Bank of Chicago is a bank created by the Federal Home Loan Bank
Act and it is headquartered in Chicago, Illinois. The public policy mission of the Federal Home
Loan Bank system is to support residential mortgage lending and related community investment.
(Compl. ¶27.) The individual Federal Home Loan Banks fulfill this role in housing finance by
providing their member financial institutions with access to reliable, economical funding,
technical assistance, and special affordable housing programs so that they can provide affordable
housing and economic development in their communities. (Id.) The Bank is capitalized solely by
the capitalstock investments of its members and its retained earnings. (Compl. ¶29.) The
Defendants, which include depositors/issuers, underwriters/dealers, and certain entities
controlling these parties, sold the Bank certificates that are “securities” within the meaning of
815 ILCS § 5/2.1, N.C.G.S.A. § 78A2(11) and N.J.S.A. § 49:349(m).
This dispute involves Private Label Mortgage Backed Securities (“PLMBS”), a type of
Residential Mortgage Backed Security (“RMBS”), which Defendants sold the Bank. The
PLMBS were accompanied by registration statements, prospectuses, supplemental prospectuses,
and other written offering materials (collectively, “Offering Documents”) that allegedly
contained untrue statements of material facts and omitted to state material facts necessary in
order to make the Offering Documents not misleading. (Compl. ¶¶3, 4.)
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As stated above, the Complaint contains five counts. First, Defendants made untrue or
misleading statements in the sale of securities, under Illinois Securities Law, 815 ILCS § 5/12
(F) & (G). The Bank alleges that Underwriter and Depositor/Issuer Defendants violated the law
by:
(i) engaging in transactions, practices, or courses of business which worked or tended to work a fraud or deceit upon the Bank as the purchaser of these securities; and (ii) obtaining money or property through the sale of securities by means of untrue statements of material fact or by omitting to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading. (Compl. ¶672.)
Second, Defendants violated the law when they signed or circulated securities documents
that contained material misrepresentations and knew, or reasonably should have known, that the
documents contained those material misrepresentations, under Illinois Securities Law, 815 ILCS
§ 5/12 (H). (Compl. ¶687.) Third, Defendants made untrue or misleading statements in the sale
of securities under North Carolina Securities Law, N.C.G.S.A. § 78A8(2) & § 78A56(a).
(Compl. ¶702.) Fourth, Defendants made untrue or misleading statements in the sale of
securities under New Jersey Securities Law N.J.S.A. 49:352(b) & (c). (Compl. ¶717.)
Fifth, Defendants are guilty of negligent misrepresentation under common law because
the defendants’ Offering Documents negligently misrepresented material facts about the
Certificates they offered and sold to the Bank. The Bank alleges that the Defendants had a duty
to make accurate and truthful statements in the information they provided to the Bank. (Compl.
¶733.) The Bank claims that the defendants’ Offering Documents misrepresented:
(a) adherence to the originators’ stated underwriting guidelines and related matters; (b) the LTV ratios of the mortgage loans in the collateral pools of these securitizations; (c) the occupancy status
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rates of properties that secured the mortgage loans in these securitizations; (d) the rating process by which AAAratings were assigned; (e) compliance with predatory lending restrictions; and (f) purported due diligence on the loan pools that backed the PLMBS. (Compl. ¶734.)
A motion to dismiss brought pursuant to section 2615 “admits the truth of the facts
alleged in support of the claim but denies the legal sufficiency of those facts.” BarberColman
Co. v. A & K Midwest Insulation Co., 236 Ill. App. 3d 1065, 1075 (5th Dist. 1992). The critical
inquiry is whether the allegations of the Complaint, when considered in the light most favorable
to the plaintiff, are sufficient to state a cause of action upon which relief may be granted. Jarvis
v. S. Oak Dodge, Inc., 201 Ill.2d 81, 8586 (2002). A motion to dismiss admits for purposes of
review such facts that are wellpleaded, but it does not admit conclusions of law, the pleader’s
construction of a statute, or conclusions of fact unsupported by allegations of specific facts upon
which such conclusions rest. Cain v. American Nat’l Bank & Trust Co., 26 Ill. App. 3d 574, 578
(1st Dist. 1975). A plaintiff is not required to prove his case in the pleading stage, but rather,
must allege sufficient facts to state the elements necessary to constitute a cause of action, so as to
inform the defendant of the claim against which he must defend. Claire Associates v. Pontikes,
151 Ill. App. 3d 116, 123 (1st Dist. 1986).
In ruling on a 2615 motion to dismiss, only those facts apparent from the face of the
pleadings, matters of which the court can take judicial notice and judicial admissions in the
record, may be considered. PoohBah Enterprises, Inv. v. County of Cook, 232 Ill. 2d 463, 473
(2009).
While a Section 2615 motion to dismiss attacks the legal sufficiency of the complaint, a
motion to dismiss under 2619 raises defects or defenses which negate a plaintiff’s cause of
action or refute crucial conclusions of law or fact. Lawson v. City of Chicago, 278 Ill. App. 3d
5
628, 634 (1st Dist. 1996). For a motion to dismiss under 735 ILCS 5/2619, all wellpleaded
facts and reasonable inferences are accepted as true for the purpose of the motion and the motion
should be granted only if the plaintiff can prove no set of facts that would support a cause of
action. Feltmeier v. Feltmeier, 207 Ill.2d 263, 27778 (2003).
In the instant case, Defendants jointly argue that Counts IV should be dismissed with
prejudice pursuant to 735 Ill. Comp. Stat. 5/2615 of the Code of Civil Procedure (the “Code”),
because the Complaint suffers from facial defects, and the wellpleaded facts it contains, even
when taken as true, are not “sufficient to establish a cause of action upon which relief may be
granted.” Vitro v. Mihelcic, 209 Ill. 2d 76, 81 (2004).
Defendants allege that the Bank’s Complaint lacks specificity because it fails to attach
their claims to specific certificates. The Bank, however, does list throughout its Complaint
specific certificates and their ailments. (See e.g., Compl. ¶¶591, 592 (underwriting guidelines),
62326 (appraisals and LTV ratios), 629 (occupancy status).) Moreover, Defendants have
secured a stay of discovery in order to prevent the Bank from gaining access to the loan files,
without which it is nearly impossible to make claims about specific certificates. In any event,
plaintiffs in Illinois are not required to plead evidence, but need only plead the ultimate facts to
be proved. Borgsmiller v. Burroughs, 187 Ill. App.3d 1, 7 (5th Dist. 1989). The Bank has
alleged sufficient facts to allow the Defendants to be able to admit or deny the allegations.
Defendants allege that because Illinois is a factpleading jurisdiction the Bank must
allege specific facts supporting each essential element of its claims. Kaczka v. Ret. Bd. Of the
Policemen’s Annuity & Benefit Fund of Chi., 398 Ill. App. 3d 702, 707 (1st Dist. 2010).
Defendants contend that, given that standard, this claim should be dismissed like other cases that
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have been dismissed for relying on generalized, industrywide allegations. (Mot. to Dismiss at
10).
The Bank argues that there is a “well developed” and “practically unanimous” body of
law that upholds similar claims. (Mem. in Opp. at 6.) Additionally, the Bank asserts that
precedent allows its claim to overcome a motion to dismiss, because: (1) Defendants’
underwriting “disclosures” regarding leniency do not defeat a claim for abandonment of
underwriting guidelines, (2) inflated appraisals and LTV ratio claims have been upheld if they
allege that the appraisers did not believe their own appraisals or that they deviated from appraisal
standards in concrete ways, (3) claims alleging that credit rating agencies did not sincerely
believe the truth of their ratings have been upheld, even when classified as opinions, and (4)
Lone Star Fund V (US) v. Barclay’s Bank PLC, 594 F.3d 383 (5th Cir. 2010) which held that
misrepresentations are not actionable when not “definitive or absolute,” has been heavily
criticized and rejected in analogous circumstances. See e.g. Mass. Mut. Life Ins. Co. v.
Residential Funding Co., LLC, 843 F. Supp.2d 191, 202, fn. 7 (U.S. Dist. Mass.) wherein the
district court found that Lone Star was limited to cases involving a small number of correctable
mistakes rather than claims of widespread misrepresentation. Moreover, there is nothing in Lone
Star to suggest that the result would have been the same if the plaintiffs had shown a
misrepresentation rather than an implicit acknowledgment that some amount of delinquency was
unavoidable. This Court agrees with the arguments made by the Bank and with the cases
criticizing Lone Star and finds that the Bank has pleaded sufficient facts to defeat the
Defendants’ 2615 motion to dismiss.
Defendants also argue that the Illinois pleading standard is more stringent than federal
law. In response, the Bank cites to Illinois Code, which provides, “[p]leadings shall be liberally
7
construed with a view to doing substantial justice between the parties,” and that “[n]o pleading is
bad in substance which constrains such information as reasonably informs the opposite party of
the nature of the claim or defense which he or she is called upon to meet.” 735 ILCS 5/2603(c).
This Court is concerned only with whether the Bank can meet Illinois standards which
the Court finds that it does. In any event, the Defendants’ argument that the Illinois pleading
standard is higher than federal law is primarily based on one case, Madigan v. Tang, 346 Ill.
App. 3d 277 (1st Dist. 2004) that was decided three years before Bell Atlantic Corp. v. Twombly,
550 U.S. 544 (2007) which established the “plausibility” standard in federal cases. No Illinois
case has adopted that heightened standard, nor suggested that Illinois pleading standard is more
stringent than it.
Moreover, as stated above, a plaintiff need only plead ultimate facts, rather than
evidentiary facts. Borgsmiller, 187 Ill. App.3d at 7. The Bank has pleaded both ultimate and
evidentiary facts (though not required to plead evidentiary facts).
The ultimate facts that must be proved are the reasons why the affirmative
misrepresentations are false. The Bank has enumerated in its Complaint (i.e. abandonment of
underwriting guidelines, coerced appraisals, inaccurate occupancy statistics, etc.) these ultimate
facts. Additionally, the Bank has provided evidentiary facts, such as testimony, AVM analysis of
appraisal values, delinquency and foreclosure rates, and pleadings from other civil actions
involving the defendants, which demonstrate the strength of the Bank’s case. At pleading stage,
all reasonable inferences from the Bank’s facts must be drawn in its favor. Brogan v. Mitchell
International, Inc., 181 Ill.2d 178, 813 (1998). As the Complaint contains sufficient specific
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ultimate facts to apprise Defendants what they will be called upon to defend, the Complaint is
sufficiently pleaded.
Moreover, Illinois Securities Law is also liberally construed to protect the public from
irresponsible securities salespeople. Martin v. Orvis Bros. & Co., 25 Ill. App.3d 238, 245 (1st
Dist. 1974). This policy exists for the protection of all investors, regardless of their
“sophistication,” because all investors should be able to rely on material representations made in
the Offering Documents. Ronnett v. Am. Breeding herds, Inc., 124 Ill. App.3d 842, 851 (1st Dist.
1984).
Though Defendants argue that the Bank fails to satisfy the Illinois fact pleading
requirement because in Illinois a plaintiff “cannot rely simply on mere conclusions of law or fact
unsupported by specific factual allegations . . .” ( Weidner v. Midcon Corp., 328 Ill. App. 3d
1056, 1059 (5th Dist. 2002)), the Bank has not merely pleaded mere conclusions of law or fact
unsupported by specific factual allegations. Defendants further contend that the Bank’s
allegations that “originators abandoned their underwriting guidelines” and “originators engaged
in predatory lending” are allegations of law or conclusions and are insufficient without
supporting facts. Chandler v. Illinois Central Railroad Co., 207 Ill. 2d 331 (2003). However, as
stated above and as set out in more detail below, the Bank has alleged specific facts in support of
its causes of action.
A. The SixMonth Notice Requirement.
Defendants allege that Counts I and II should be dismissed because the Bank filed to
plead affirmative facts demonstrating that it served notices of rescission on defendants within six
months of acquiring constructive knowledge that each certificate was voidable, as required by
815 Ill. Comp Stat. § 5/13B. Section 5/13B states:
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Notice of any election provided for in subsection A of this Section shall be given by the purchaser within 6 months after the purchaser shall have knowledge that the sale of the securities to him or her is voidable, to each person from whom recovery will be sought, by registered mail or certified mail, return receipt requested, addressed to the person to be notified at his or her last known address with proper postage affixed, or by personal service.
The Bank sent out its notices of rescission in July 2010 which Defendants claim is
beyond the sixmonth time period. Defendants argue that, since sister institutions to the Bank
filed RMBS complaints against many of the same defendants named in this case, the Bank had
knowledge of its claims, but failed to timely file its notice of rescission.
Under the plain language of the statute, however, the sixmonth period begins when a
party gains actual or constructive knowledge that the purchase is legally voidable under the
Illinois Securities Law, rather than constructive or actual knowledge of the facts underlying the
claim. A purchaser of a security must give notice that it seeks rescission of the sale “within 6
months after the purchaser shall have knowledge that the sale of the securities to him or her is
voidable.” 815 ILCS 5/13(B) (emphasis added). This provision is not a statute of limitations.
Gowdy v. Richter, 20 Ill. App.3d 514, 523 (1st Dist. 1974); it is an equitable feature built into the
statute to protect against stale claims. Martin, 25 Ill. App.3d at 246. This provision is therefore
not triggered by constructive or actual knowledge of the facts underlying a claim, but rather it
begins when the purchaser gains actual or constructive knowledge that the purchase is legally
voidable under Illinois Securities Law. Norville v. Alton Bigtop Rest. Inc., 22 Ill. App.3d 273,
285 (5th Dist. 1974).
Defendants bear the burden of showing that the Bank has failed to comply with the six
month notice provision. Witter v. Buchanan, 132 Ill. App.3d 273, 28889 (1st Dist. 1985).
Defendants have not shown that there is any overlap between the bonds at issue in the cases filed
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by FHLB of Pittsburgh and FHLB of Seattle and the bonds at issue in this case. Additionally,
these sister institutions are filing their complaints under other State laws. In any event, the mere
commencement of judicial proceedings does not give a purchaser actual or constructive
knowledge of voidability, especially when the defendants in those proceedings deny the claims.
Frendreis v. Financial Concepts, Ltd., 106 Ill. App.3d 438, 44243 (1st Dist. 1982).
The HSBC Defendants contend that certain public information gave the Bank
constructive knowledge of voidability “well before 2010”. The public information upon which
HSBC relies, however, is generalized and did not relate specifically to any of the PLMBS in this
action. Having knowledge of facts concerning another’s claim is insufficient to trigger the six
month period. Fisher v. Samuels, 691 F. Supp. 63, 73 (N.D. Ill. 1988).
B. Statute of Limitations.
Defendants argue that Counts IV of the Complaint are each barred by the applicable
statutes of limitations because the face of the Complaint demonstrates that each of the Bank’s
claims is untimely. Defendants cite to both section 2615 and 2619(a)(5). Section 2619(a)(5)
provides that a defendant may move to dismiss a case when the action was not commenced
within the time limited by law. 735 ILCS 5/2619(a)(5).
The Bank filed this action on October 15, 2010, three years after the Bank purchased the
last of its certificates, by which time the applicable statute of limitations had elapsed.
Defendants contend that Counts III, asserting violations of the Illinois Securities Law,
must be dismissed because the Bank fails to plead affirmative facts to show that it filed this
action within the three year statute of limitations, as required by 815 Ill. Comp. Stat. § 5/13D,
which began to toll on October 15, 2007.
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Defendants argue that Count V, asserting negligent misrepresentation, should be
dismissed because the factual basis for the Bank’s negligent misrepresentation claim and its
Illinois Securities Law claim under section 13D are the same and the Bank’s failure to meet
13D’s limitations period is fatal to the its negligent misrepresentation claim.
Defendants argue that Count IV, asserting violations of the New Jersey Uniform
Securities Law, must be dismissed because the Bank did not file within two years of the contract
of sale for the certificates, as required by N.J. State. Ann. § 49:371(g).
Defendants list news articles and official documents that the Bank included in its
Complaint as facts supporting its claim for negligent misrepresentation. Defendants argue that
the facts contained in these documents are sufficient to have put any reasonably diligent investor
on notice, before October 2007, of the generalized facts upon which the Bank bases its claims.
(Mem. in Supp. at 18.) For example, in March 2007, the Federal Deposit Insurance Corporation
(“FDIC”) issued a cease and desist order against defendant company Fremont Investment &
Loan for “operating without adequate subprime mortgage loan underwriting criteria.” (Compl.
¶289.) The same month Reuters and the New York Times reported that a defendant corporation
was “responsible for some of the worst performing loans.” (Compl. ¶¶289, 417.) In May, 2007,
the FBI published its 2006 Mortgage Fraud Report, which reported that between thirty to seventy
percent of early payment defaults were linked to significant misrepresentations in the original
loan applications. (Compl. ¶151.) The same month the Washington Post ran a story about
concerns with underwriting criteria of a defendant company. (Compl. ¶¶271, 260.) Then, in
August 2007, the New York Times published another article with similar information. (Compl.
¶¶22829.) Defendants contend that these facts taken together should have put the Bank on
notice and if any claim existed, it has been rendered untimely.
12
Additionally, Defendants allege that the Bank failed to plead specific facts to invoke
Illinois’ “discovery rule,” which would toll the applicable statute of limitations. Given that the
Bank has filed in an Illinois court, Illinois law is appropriate under choice of law rules, thus
Counts IV must be dismissed if it is found that the Bank did not plead affirmative facts to
establish that it “neither knew nor in the exercise of reasonable diligence should have known of
all alleged violation of . . . Section 12 of this Act.” 815 Ill. Comp. Stat. § 5/13D. Defendants
assert that the Bank should not benefit from the Illinois tolling statutes because it failed to
specifically allege facts establishing when and how it discovered the facts upon which it bases its
Complaint and why it could not have discovered those facts earlier. See e.g., Hermitage Corp.,
166 Ill. 2d 72, 8485 (1995), (citing Ruklick v. Julius Schmid, Inc., 169 Ill. App. 3d 1098, 1108
(1st Dist. 1988)).
In Hermitage Corp., the Illinois Supreme Court noted that the discovery rule delays the
commencement of the relevant statute of limitations until a plaintiff knows or reasonably should
know that he has been injured and that his injury was wrongfully caused. Id. at 81. The effect of
the discovery rule is to postpone the starting of the period of limitations. Id. When a defendant
raises a statute of limitations issue in a motion to dismiss, the plaintiff must provide enough facts
to avoid application of the statute of limitations. Id. at 84. If a plaintiff uses the discovery rule to
delay commencement of the statute of limitations, the plaintiff has the burden of proving the date
of discovery. Id. at 85. Defendants contend that the Bank has not proved the date of discovery.
Whether a plaintiff has satisfied the discovery rule “is ordinarily a question of fact”,
DuPage County v. Graham, Anderson, Probst, & White, Inc., 109 Ill.2d 143, 154 (1985), unless
only one conclusion can be drawn at some particular point from undisputed facts. LaManna v.
G.D. Searle and Co., 204 Ill. App.3d 211, 218 (1st Dist. 1990).
13
The three year statute of limitations under the Illinois Securities Law begins to run when
the plaintiff “has actual knowledge of the alleged violation” or when the plaintiff “has notice of
facts which in the exercise of reasonable diligence would lead to actual knowledge of the alleged
violation.” 815 ILCS 5/13(D)(1)(2). An investor must be able to learn the facts underlying the
claim with the exercise of reasonable diligence before the statute of limitations begins to run.
Marks v. CDW Computer Centers Inc., 122 F.3d 363, 367 (7th Cir. 1997).
The Bank has pled facts demonstrating that its claims were brought within two years of
discovery of the defendants’ wrongs, which means that the claims are timely under Illinois, New
Jersey, and North Carolina law.
The Bank does not have, and has never had, access to the loan files for the loans that
secured its PLMBS. (Compl. ¶¶ 9192). The Bank had no independent way to verify the
Offering Documents’ extensive representations “about the credit quality and character of the
loans”. (Compl. ¶ 92). It did not have any way of testing the rating agencies’ tripleA ratings.
(Compl. ¶ 555). The tripleA ratings began to be downgraded only in 2008. (Compl. ¶ 557).
The Bank has detailed (in numerous paragraphs) the sources of information from whom it
learned of Defendants’ violations and these sources came to light after October 15, 2007.
Defendants’ exhibits fail to show that the Bank had “actual knowledge”. The arguments
raised by Defendants are insufficient to prevail at this stage: (1) Defendants rely on downgrades
of that took place before October 15, 2007, but those downgrades did not affect any of the
Bank’s investments and holdings; (2) there is no evidence that the Bank failed to review the
characteristics of the underlying mortgages in each PLMBS or that its scrutiny brought any
evidence of its claim to light until after October 15, 2007, despite Defendants’ claims to the
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contrary; (3) Defendants cite to New York Times’ article reporting that agencies intended to
“tighten” ratings and downgrade 322 PLMBS, but all of the Bank’s investments retained their
investmentgrade ratings; and (4) the Bank’s preOctober, 2007 internal reports mention
residential mortgages delinquencies and loss trends, but the reports do not indicate that the
Bank’s assets were experiencing increased delinquencies and losses. The Bank has pled enough
facts to show it was not on inquiry notice prior to October 2007; additionally, even inquiry
would not have led “to actual knowledge” because the Bank has sufficiently pleaded that it took
formal discovery and other judicial processes to expose Defendants’ alleged violations.
Moreover, Defendants have pointed to only generalized information about the mortgage
market to support their argument, and, because generalized information is the most that
Defendants have provided, the action is not untimely as a matter of law because generalized
information about the mortgage market or about certain mortgage originators cannot trigger the
statute of limitations. Pub. Emps.’ Ret. Sys. Of Miss. v. Goldman Sachs Grp., Inc., No. 091110,
2011 WL 135821 (S.D.N.Y. Jan. 12, 2011); . Pub. Emps.’ Ret. Sys. Of Miss. v. Merrill Lynch &
Co.,714 F. Supp. 2d 475 (S.D.N.Y. 2010); In re Wells Fargo Mortg.Backed Certificates Litig.,
712 F. Supp. 2d 958 (N.D. Cal. 2010); N.J. Carpenters Vacation Fund v. Royal Bank of Scotland
Grp., PLC, 720 F. Supp. 2d 254 (S.D.N.Y. 2010).
The HSBC Defendants also move to dismiss the Bank’s Illinois Securities Law claims
under section 2619 on the grounds that “HSBC Securities has no record of receiving…notices
on the OOMLT Certificates.” HSBC contends that the notices were received by HSBC Bank
USA, a nonparty. The Bank responds by pointing out that the certified mail receipts for the two
rescission notices both reflect “HSBC Securities (USA) Inc.” as the addressee. As HSBC
15
correctly acknowledges in its Reply, the Court should not resolve a factual dispute such as this
on a section 2619 motion.
II. THE BANK HAS ALLEGED ACTIONABLE CLAIMS
HSBC seeks dismissal on the grounds that the Bank has failed to plead a physical nexus
with North Carolina sufficient to invoke the North Carolina Securities Act. HSBC argues that
the Bank has not alleged specific, concrete facts that connect North Carolina to the Bank’s
purchase of the OOMLT Certificates. HSBC further contends that the Bank’s allegations that
“an offer of sale for [the OOMLT Certificates] took place in North Carolina” and that the offer,
along with “numerous offering documents” “originated” in North Carolina (Compl. ¶¶ 21, 703,
704) are “conclusory rehearsals of the elements of the North Carolina Securities Law”. (Mem. in
Supp. at 6). HSBC argues that, because the allegations are conclusory, they are insufficient
under Illinois law to survive a 2615 motion to dismiss. (Id. at 7).
Contrary to HSBC’s arguments, however, the Bank has pleaded ultimate facts, rather
than conclusions. A statement concerning the location where something was offered for sale is
an ultimate fact. A statement concerning the location of where an acceptance was made is an
ultimate fact. A statement that an entity made false or untrue statements of material fact is an
ultimate fact. See e.g. Manuel v. red Hill Community Unit School Dist., 324 Ill. App.3d 279, 290
(5th Dist. 2001) (“A statement of a defendant’s knowledge is an allegation of ultimate fact and
not a conclusion.”)
The Court will not address HSBC’s argument that the Bank’s allegations are “frankly
implausible” because addressing that argument would require the Court to weigh the evidence, a
practice which is prohibited at the motion to dismiss stage.
16
The Barclays’ Defendants argue for dismissal on the grounds that the Illinois Security
Law is not a strict liability statute, but requires a showing of negligence. Even if that is true, the
Bank has alleged negligence in that negligence allegations are incorporated throughout the
Complaint and Count V is for negligent misrepresentation. Given the state of the Complaint,
Court will not address whether the Illinois Securities Law is a strict liability statute because a
court is not to render advisory opinions.
The Barclays’ Defendants also argue that the Complaint is insufficiently pled. Contrary
to the Barclays’ Defendants’ assertions, the Complaint, however, does not merely lump the
Barclays’ Defendants in together with the other Defendants under a banner of “industrywide”
allegations. The Complaint identifies them by name and identifies the certificates at issue.
First Horizon takes issue with the Bank’s reliance on a confidential witness. Weighing
evidence, however, is inappropriate at this stage of the proceedings.
Defendants jointly allege that all five Counts should be dismissed because the Bank
failed to plead the requisite facts to establish any misstatement or omission of material fact.
(Motion to Dismiss ¶7.) Each State statute requires that the Bank allege facts establishing a
misrepresentation or omission that is both material and misleading. See Tirapelli v. Advanced
Equities, Inc., 351 Ill. App. 3d 450, 455 (1st Dist. 2004); Latta v. Rainey, 689 S.E.2d 898, 908
(N.C. Ct. App. 2010); Granat v. Puglisi, No. 08cv05204 (D. N.J. Feb. 16, 2010)(quoting N.J.
Stat. Ann. § 49:352); First Midwest Bank, N.A. v. Stewart Title Guaranty Co., 218 Ill.2d 326
(2006).
The Bank contests Defendants’ statements that the Offering Documents disclosed the
alleged misstatements underlying the Bank’s claims. Additionally, the Bank takes issue with
17
Defendants’ attempt to extend the “bespeaks caution” doctrine, which holds that forwardlooking
statements paired with cautionary language are not actionable. The Bank alleges that
underwriting and appraisals are current or historical facts, rather than “forwardlooking
statements.” Also, for cautionary language to be effective, it must warn of specific, rather than
general, risks and include “hard facts,” which the Bank claims the Offering Documents failed to
do so on both accounts. (Mem. in Opp. at 3839.)
In Defendants’ Reply they again allege that FHLBC does not plead any actionable
misstatements or omissions by defendants. Defendants contend that the Bank’s “bespeaks
doctrine” argument is irrelevant because the defendants’ argument is that the challenged
statements in the Offering Documents are correct, and neither misrepresents nor omits any
essential facts.
1. Dispute regarding underwriting guidelines
Defendants allege that the express language of the Offering Documents disclosed that
originators would make departures from their already lenient underwriting criteria. Defendants
claim there is no liability for omissions in the absence of a duty to disclose, especially not for
unknown deviations by mortgage originators. See Connick v. Suzuki Motor Co., 174 Ill. 2d 482,
500 (1996). In the instant case, the Bank has not alleged that Defendants knew at the time of
offerings about specific, undisclosed departures or even that Defendants had to duty to disclose
any such departures. (Mem. in Supp. at 23, 24.)
Further, Defendants cite to case law holding that issuers and underwriters cannot be liable
under the securities laws if they warn of the specific risks. See Adler v. William Blair & Co., 271
Ill. App. 3d 117, 12122, 126 (1st Dist. 1995). Defendants allege that the offering materials
18
sufficiently disclosed information regarding underwriting guidelines, noting that some
documents disclosed that a “substantial portion” or “substantial number” of mortgage loans
backing the certificates were originated as exceptions to those guidelines. (Mem. in Supp. at 25.)
Instead of pleading with some specificity that Defendants had actual knowledge of the
deviations, as is required, the Bank is substituting posthoc allegations, supported by December,
2010 delinquency and foreclosure data. (Compl. ¶¶590592; Mem. in Supp. at 2933.)
The Bank’s primary contention, however, is that originators “abandoned” their
underwriting guidelines. (Compl. ¶¶12, 14(a), 11518, 58588.) Defendants do not identify any
language in the Offering Documents stating that underwriting guidelines were abandoned; rather
Defendants rely on more generalized disclosures, e.g. though the Offering Documents did
disclose that that there were a substantial amount of exceptions to underwriting guidelines when
there were “compensating circumstances”, Defendants routinely granted exceptions without any
justification. (Mem. in Opp. at 40.)
Courts have held that disclosure of exceptions does not disclose the abandonment of
underwriting guidelines. Plumbers’ Union Local No. 12 Pension Fund v. Nomura Asset
Acceptance Corp., 632 F.3d 762, 773 (1st Cir. 2011); Boilermakers’ Nat’l Annuity Trust Fund v.
Wamu Mortg. Pass Through Certificates, Series AR1, 748 F.Supp.2d 1246, 1255 (W.D. Wash.
2010) (Statements may be misleading if they mask the extent to which the sponsor’s
underwriting guidelines were disregarded.); In re IndyMac MortgageBacked Sec. Lit., 718 F.
Supp.2d 495, 509 (S.D.N.Y. 2010).
Defendants’ Offering Documents disclosed that guidelines were “generally” applied,
there was a portion of “no documentation” loans, and there were some “alternative programs.”
19
The Bank alleges that Defendants were misleading in the extent of the disregarded verification
requirements and omitted necessary explanations so that these vague disclosures were
misleading. 815 ILCS 5/12(G). For example, Defendants did not explain that “alternative
programs” meant that borrowers were able to purchase loans that they could not, realistically,
afford to repay, resulting in a much riskier investment for the Bank because delinquencies and
foreclosures were virtually certain to increase. The allegations in the Complaint are enough to
defeat dismissal.
Moreover, Regulation AB is not a protection for defendants. Defendants claim that
Section 1111 of Regulation AB required them only to disclose deviations from underwriting
guidelines “to the extent known” by them. But Defendants themselves acknowledge, Regulation
AB applies to omissions, not affirmative misstatements, which the Defendants are alleged to
have made in the Offering Documents.
Additionally, the Bank alleges that delinquency and foreclosure data, coupled with
originator specific allegations, including internal documents, confidential witnesses, and
government investigations, provides specific support for the claim that underwriting guidelines
were abandoned. Defendants take issue with the Bank’s reliance on post hoc foreclosure and
delinquency data. They allege that, unlike the Bank claims, it is not reasonable to infer that
increases in delinquencies and foreclosures resulted from the abandonment of underwriting
guidelines, which would have occurred five years earlier, before the crash of the entire real estate
market. (Reply at 17, 18.)
The cause of increases in delinquencies and foreclosures is a factual debate that should
not be decided at the motion to dismiss stage, but the Bank’s argument that is reasonable to infer
20
that the increases resulted from the abandonment of underwriting guidelines, which, if proved
true, would entitle it to recovery, is welltaken at this stage of the proceedings. At the motion to
dismiss stage, the Court should construe all wellpleaded facts and reasonable inferences from
those facts in favor of the Bank.
The Bank contends that disclosures regarding “no doc” loans should have been
accompanied by disclosures regarding misconduct by loan officers. But, Defendants contend
there is no requirement that the Offering Documents disclose purported loan officer misconduct
simply because that misconduct might have some connection with underwriting. They add that
all supplements disclosed that for “stated document” or “stated income” loans in the pool,
originators undertook no verification of borrower income beyond what the borrower had listed
on the loan application, and no further disclosure was required. (Mem. in Supp. at 2728; Reply
at 1617.)
Additionally, Defendants allege “alternative programs,” such as interestonly loans, did
clearly disclose the extent to which borrowers might be unable to meet their obligations, unlike
the Bank’s claim alleges. The documents stated that these loan products: (i) allowed borrowers
to finance homes “they might otherwise have been unable to afford;” (ii) were new and had no
performance history; and (iii) could “result in increased delinquencies by the related
mortgagors.” (Reply at 17.)
As stated above, all wellpleaded facts and reasonable inferences from those facts should
be construed in favor of the Bank at this stage of the proceedings. The Complaint is factually
sufficient.
21
2. Dispute regarding LTV Ratios or Appraisals
An LTV ratio or appraisal is the ratio of amount of mortgage loan to the value of
collateral, determined by the lower of the appraised value or sale price of mortgaged property
when the loan is made. (Compl. ¶ 119.) The LTV ration partially reflects the extent to which a
loan is actually secured by the mortgaged property, as well as the borrower’s equity in the
property, which can be used to assess the borrower’s incentive to continue making payments on
the loan. (Id.)
Defendants allege that the LTV ratios were not misstated and that the Bank’s LTV ratios
claim is unsuccessful because it uses an “automated valuation model” (AVM) to compute higher
LTV ratios. The AVM ratios are different because LTV ratios are calculations based on
appraisals, which is a method that is compliant with the Offering Documents. (Mem. in Supp. at
3436.)
Additionally, Defendants contend that Offering Documents warned that LTV ratios might
not represent a property’s true value and might be influenced by appraisal pressures. (Mem. in
Supp. at 38.) Further, Defendants allege that LTV ratios are nonactionable statements of
opinion because they are based on real estate appraisals. (Mem. in Supp. at 4041.)
The Bank has pleaded that the appraisals were coerced and that the LTVs were inflated.
The Bank alleges that defendants’ LTV representations failed to meet the federally required
definition of “appraisal” because they were biased and coerced valuations, and thus the
statements in the Offering Documents regarding the LTV ratios of the mortgage pools were false
and misleading. Moreover, the Bank alleges that the Offering Documents did not disclose that
the appraisals, and thus the LTVs, were inflated because they were not independent valuations
conducted in conformance with applicable appraisal standards.
22
Coerced appraisals and inflated LTVs are actionable because the appraisers did not in
fact believe their appraisals at the time they gave them and that the ratios deviated from USPAP
representations in concrete ways, including whether employees used the appropriate appraisal
standards. Oltmer v. Zamora, 94 Ill. App. 3d 651, 654 (4th Dist. 1981); Sampen v. Dabrowski,
222 Ill. App. 3d 918 (1st Dist. 1991).
Additionally, the reliability of the Bank’s AVM model is a factual issue that is not
appropriate for resolution on a motion to dismiss.
3. Dispute regarding Occupancy Status
The Bank alleges that twentynine certificates misrepresented the occupancy status of a
number of loans that were supposed to be secured by primary residences, as opposed to second
homes or investment properties. Defendants argue that accurate reports of information expressly
attributed to third parties are not actionable. Most of the Offering Documents disclosed that
statements regarding occupancy status were based either solely on borrower representations or
by loan originators at the time of loan origination. Also, the “vast majority” of disclosures
warned of potential losses arising from fraud in loan origination, including fraudulent
misrepresentations by borrowers misstating their intended occupancy status. (Mem. in Supp. at
43.)
Defendants are skeptical of the Bank’s alleged discovery that owners of some properties
that were represented at primary residences received bills at other addresses and did not claim
the property as a homestead for tax purposes. Despite that information, Defendants allege that
the Bank’s claim is insufficient because it provides no facts demonstrating Defendants should
have known that the occupancy status was materially misstated at the time of origination. (Mem.
23
in Supp. at 44.) Defendants argue that they are not liable for any misstatements because they
accurately reported third parties’ information.
In the Bank’s Response, it argues that the Offering Documents misstated the percentage
of “nonprimary” mortgages in the loan pools, which is material to investors because non
primary mortgages default at higher rates than do primary mortgages. The Bank also takes issue
with Defendants’ argument that they had no obligation to ensure the accuracy of the information
that they put in their Offering Documents. The Bank argues that the latter argument is an
attempt to avoid liability by hiding behind third parties.
Underwriters owe a duty of care to ensure the truthfulness of the statements they make. In
re Worldcom, Inc. Sec. Litig., 346 F. Supp.2d 628, 662 (S.D.N.Y. 2004). Issuers and
underwriters cannot succeed on a motion to dismiss by merely contending that information was
gathered by third parties. One of the purposes of Illinois Securities Law is to protect the public
“from incompetency, ignorance, and irresponsibility of persons engaging in the business of
disposing of securities to the public”, Martin, 25 Ill. App.3d at 245. Scienter is not a required
element under Sections 12(F) and (G). Foster v. Alex, 213 Ill. App.3d 1001, 1006 (5th Dist.
1991). Additionally, as the Bank has specifically pleaded that Defendants made specific and
detailed misrepresentations about occupancy status rates, these factual allegations suffice to
defeat the Defendants’ motion to dismiss.
4. Dispute regarding Credit Ratings
The Bank’s alleges that Defendants should have known that the certificates did not
possess the characteristics necessary to qualify for AAA ratings and that the Offering Documents
did not disclose the industry pressures and flawed calculation models that distorted the accuracy
24
of the ratings. (Compl. ¶¶632, 52535.) Defendants allege that the Bank’s claims are
unsuccessful because credit ratings are the subject of express disclaimers, are nonactionable
opinions and the Bank did not allege any facts to show that the ratings were not an accurate
reflection of the rating agencies’ views at the time. (Mem. in Supp. at 45, 47.) The Bank
proffered evidence that ratings were downgraded during the financial crisis is similarly generic
to industrywide allegations regarding rating agencies that courts have rejected. (Mem. in Supp.
at 48, 49.)
The Bank responds that the credit ratings purported to be based on facts and are therefore
actionable. (Mem. in Opp. at 62.)
Under Illinois law, credit ratings can be actionable statements of fact. “Wherever a party
states a matter which might otherwise be only an opinion but does not state it as the expression
of the opinion of his own but as an affirmative fact material to the transaction,*** the statement
clearly becomes an affirmation of the fact within the meaning of the rule against fraudulent
misrepresentation.” Schrager v. North Community Bank, 328 Ill. App.3d 696, 704 (1st Dist.
2002), quoting Heider v. Leewards Creative Crafts, Inc., 245 Ill. App.3d 258, 266 (1993). It is
not the form of the statement which is important or controlling, but the sense in which it is
reasonably understood. Id. Moreover, whether a statement is one of fact or of opinion depends on
all the facts and circumstances of the case. Id.
The Bank has alleged that the credit ratings were based on “the credit quality of the
related mortgage pool, including any credit support providers, structural and legal aspects
associated with [the] certificates, and the extent to which the payment stream on the mortgage
pool is adequate to make the payments required by [the] certificates.” (Compl. ¶634) The
Offering Documents did not portray the ratings as subjective opinions. The Bank has alleged
25
that agencies did not believe them. The Bank alleges that the falsity of agencies’ reports is
evidenced by the fact that though the credit rating agencies were aware that underwriting
standards had been abandoned, they did not factor that into their ratings evaluations. (Compl. ¶¶
51924, 538, 548, 559, 632.) These allegations are sufficient to withstand a motion to dismiss.
5. Dispute regarding Predatory Lending Restrictions
Defendants allege that the Bank’s Complaint does not identify any federal or state
predatory lending law that any defendants violated. The Bank’s Complaint contains “generic
allegations” based on purportedly high delinquency and foreclosure rates that may or may not
have resulted from predatory lending. (Compl. ¶647; Mem. in Supp. at 50.) Additionally,
Offering Documents disclosed the possibility that that the loans might violate federal and state
lending laws to investors’ detriment. (Mem. in Supp. at 50.)
The Bank responds that it did not base its predatory lending claim upon increases in
delinquency and foreclosures rates, as Defendants assert. Rather, the Bank coupled that data
with statements from government authorities, including the Chairman of the Federal Reserve,
supported by examples of specific originators’ predatory behavior, such as providing mortgages
to borrowers regardless of their ability to repay the loans. (Mem. in Opp. at 6667.)
The Bank alleges systematic disregard of underwriting guidelines, including the
requirement that the borrower be able to repay the loan. (Compl. ¶¶ 12, 148149). The Bank also
alleges that this type of behavior is one of the hallmarks of predatory lending. (Compl. ¶ 136).
The Bank alleges facts supporting the Bank’s position that the use of “teaser rates” to entice
borrowers who do not have the ability to repay the entire loan constitutes predatory lending.
(Compl. ¶¶ 141147). These allegations of systematic disregard of underwriting guidelines are
sufficient to withstand Defendants’ motion to dismiss.
26
Wells Fargo moves to dismiss on the additional grounds that (1) the Bank provides no
link between alleged predatory lending and its claims and (2) predatory lending involves pushing
subprime loans while WFMBS 2006AR3 was backed exclusively by prime loans. The
Complaint, however, contains sufficient facts to properly allege the link. Wells Fargo’s second
argument lacks merit at this stage of the proceedings because Wells Fargo raises a factual issue
rather than a legal issue, i.e. whether predatory lending is confined to pushing subprime loans.
6. Dispute regarding Due Diligence on the mortgage pools
Defendants allege that the Bank’s due diligence claim is deficient because the Offering
Documents do not make any definitive statements about the scope of diligence or integrity of the
review process and the statements the documents do make are not alleged to be false. (Mem. in
Supp. at 51.) The Offering Documents disclosed that not every loan would be reviewed and that
loan purchasers generally relied on the representations from the originating lender that the
mortgage loans were underwritten by agreed upon underwriting standards. (Mem. in Supp. at
52.)
The Bank’s Response states that its Complaint specifically addresses the nature of
Defendants’ actions regarding the Offering Documents’ misleading statements about the review
process, including credit compliance and standing, property value, and repayment ability.
(Compl. ¶655; Mem. in Opp. at 69.)
Defendants contend that the Offering Documents contained general statements. The Bank
argues that the representations did not disclose that third party due diligence firms were being
pressured to ignore deviations from underwriting guidelines and that defective loans were sold
for lower prices, rather than waived entirely for their defects. Moreover, the Bank argues that
many of the Offering Documents represented that sponsors reviewed a sample of the loan files
27
and evaluated such factors as credit compliance and standing, property value, and repayment
ability.
The Bank has alleged sufficient facts to defeat the Defendants’ motion to dismiss.
7. Dispute regarding Valid Assignment and Transfer
The Bank alleges that PLMBS have value because they are backed by income streams
from loans and by the collateral that secure the loans. (Compl. ¶ 657.) If mortgage notes and
mortgages are not enforceable by the trust that issues the PLMBS, then the PLMBS have no
value. (Id.) For that reason, the valid assignment and transfer of mortgage notes and mortgages
in accordance with the procedures laid out in the Offering Documents was material to the Bank’s
decision to purchase the PLMBS certificates at issue here. (Id.)
The Bank further alleges that the Offering Documents misrepresented that all promissory
notes had been or would be validly transferred to the trusts that issued the PLMBS certificates.
(Compl. ¶ 658.) Mortgage notes were not properly endorsed by the originators, such that the
depositor could in turn properly endorse the notes; possession of the notes was not transferred to
the trustee, custodian, or agent of the trustee. (Compl. ¶ 660.) Additionally, where the procedure
was not followed, the defective loans have not been repurchased or substituted, as represented in
the Offering Documents. (Compl. ¶661.) The Offering Documents also misrepresented that all
mortgages had been or would be validly assigned to the trusts that issued the PLMBS
certificates. (Compl. ¶ 662.)
Defendants argue that the Offering Documents provided only general guidance regarding
the procedures of valid transfer and assignment, contrary to the Bank’s claims that the Offering
Documents made definitive representations about the mortgage loans. (See Compl. ¶¶65868.)
However, the Offering Documents disclosed that the characteristics of some mortgage loans
28
might not conform to the representations and warranties made by the mortgage sellers and that
mortgage sellers could be required to “cure, repurchase or substitute” such nonconforming loans
upon request.
Defendants argue that courts have held that “nearly identical” “cure, repurchase or
substitute” provisions render statements regarding the characteristics of the underlying loans
nonactionable. See e.g., Lone Star Fund V (US), L.P. v. Barclays Bank PLC, 594 F.3d 383, 389
90 (5th Cir. 2010); (Mem. in Supp. 54). The Bank purchased the certificates and, in doing so,
recognized that the mortgage loan pools might contain nonconforming loans. Thus, because
Defendants created a mechanism to address the presence of such nonconforming loans, the
Bank’s claims are nonactionable. (Mem. in Supp. at 5556.)
The Bank argues in response that it interpreted the Offering Documents to provide that
normally the related original Mortgage Note would be delivered to the trustee, but that if the
original was not available, an authenticated duplicate or other documentation showing that the
original had been had been lost, destroyed or stolen would be delivered in its place. Defendants’
claim that the Offering Documents never said the notes would be validly transferred insinuates
that Defendants wish the court to believe that investors bought securities knowing that the
underlying assets could not be enforced. Also, many of the Offering Documents did not contain
the “generally” language, despite defendants’ claims to the contrary. (Mem. in Opp. at 7172.)
Additionally, the Bank argues that the invalid assignment and transfer allegations in its
Complaint are sufficient to satisfy pleading requirements. Defendants argue that the Bank is
unable to allege which specific notes were not transferred because that would require access to
the loan files.
29
The Bank has made the factual allegations that failure to validly assign and transfer
mortgages and mortgage notes was “systematic in the industry” and occurred often enough to
“materially impair the value of the PLMBS.” (Compl. ¶576.) Additionally, as pointed out by the
Bank, it does not have access to the loan files. Even if the Bank had access to the loan files, no
plaintiff in Illinois is required to plead evidence.
As stated above, Defendants’ reliance on Lone Star is misplaced because Lone Star (594
F. 3d at 389) does not immunize Defendants from liability. The Bank does not allege that
Defendants occasionally made imprudent loans; rather, the Bank asserts that underwriting
guidelines and appraisal standards were abandoned, predatory lending laws were broken and
other statements were entirely false. Lone Star protects companies with agreements that disclose
that trusts are not “absolutely free” from nonconforming loans, as opposed to the allegations in
this case which concern whether the PLMBS trusts are shot through with loans that deviate from
Defendants’ representations. Also, a direct statement that there may be some nonconforming
loans does not disclose wholesale abandonment of underwriting guidelines. Finally, the plaintiff
in that case had the possible remedy of repurchase or substitution of delinquent loans, while the
Bank has no such remedy because it has no contractually guaranteed right to demand repurchase
or substitution.
The Bank has pleaded sufficient facts to defeat Defendants’ motion to dismiss.
III. FHLBC’S MATERIALITY AND RELIANCE CLAIMS ARE ADEQUATELY PLEADED.
Defendants allege that all five Counts should be dismissed because the Bank failed to
plead the requisite facts to establish that the purported misstatements or omissions were material
or that the Bank reasonably relied on them. (Mot. to Dismiss ¶8; Mem. in Supp. At 5759.)
30
Materiality and “justifiable” reliance are requirements under Ill. Comp. Stat. §§ 5/12(F), (G), and
(H), for a common law negligent misrepresentation claim, and also for North Carolina securities
claims. Defendants allege that a fact is “material” if “a reasonable and prudent investor would
attach importance to the fact omitted or misrepresented in determining his choice of action in the
transaction in question.” Lucas v. Downtown Greenville Investors Ltd. P’ship, 284 Ill. App. 3d
37, 45 (2d Dist. 1996); Tirapelli v. Advanced Equities, Inc., 351 Ill App. 3d 450, 456 (1st Dist.
2004); (Mem. in Supp. 57). Further, defendants allege that the total mix of information that a
prudent investor must consider includes information already in the public domain and the
defendants were not obligated to alert investors to news articles and reports that publicized the
issues central to FHLBC current claims. (Mem. in Supp. at 58.)
Defendants argue that the Court must determine that the Bank’s reliance was
unreasonable because “the court must consider all the facts that the party knew, as well as those
facts that the party could have discovered through the exercise of ordinary prudence.” Tirapelli,
351 Ill. App. 3d at 456. Additionally, Defendants allege that because the Bank was a
sophisticated investor, given the nature of their specialization in mortgages, it should have been
aware of the risks associated with the underlying mortgages. Thus, the Bank’s reliance was
unreasonable and its losses are its own responsibility. (Mem. in Supp. at 59.)
The Bank did adequately plead reliance and materiality. The reasonableness of a
plaintiff’s reliance is appropriate for resolution upon a motion to dismiss only “where it is
apparent from the undisputed facts that only one conclusion can be drawn.” Copley Group V.,
L.P. v. Sheridan Edgewater Props., Ltd., 376 Ill. App. 3d 1006, 1018 (1st Dist. 2007).
Defendants’ arguments are inconsistent with the facts pleaded and with the information generally
known in 2006 and 2007 (that the Court has been made aware of). The Bank has alleged facts
31
that underwriting guidelines were abandoned and that the Offering Documents do not warn of
this, or other, specific risk. As noted above, the generalized information cited by Defendants was
insufficient to warn the Bank in 2006 and 2007. Public reports that were available prior to
October 2007 did not relate to the securities that are the subject of this litigation, and did not
disclose the specific harms and abuses alleged by the Bank. As noted earlier, the Bank did not
have access to the loan files. Therefore, the resolution of the question of the reasonableness of
the Bank’s reliance cannot be made at this stage of the proceeding because it is not apparent
from undisputed facts that only one conclusion can be drawn.
Defendants’ arguments with respect to materiality are inappropriate for resolution on a
motion to dismiss. The question of materiality “requires delicate assessments of the inferences a
reasonable [investor] would draw from a given set of facts and the significance of those
inferences to him, and these assessments are peculiarly ones for the trier of fact.” TSC Indus.,
Inc. v. Northway, Inc., 426 U.S. 438, 450 (1976). It is only when reasonable minds cannot differ
on the question of materiality because the misrepresentations or omissions are so obviously
unimportant to an investor that even summary judgment is appropriate. Id.
The allegations sufficiently allege that the Offering Documents’ misstatements were
adequately material. As reasonable minds could differ on this question, dismissal is
inappropriate.
IV. THE MOORMAN DOCTRINE DOES NOT BAR FHLBC’S NEGLIGENT MISREPRESENTATION CLAIMS.
The Moorman doctrine states that a buyer cannot recover purely economic damages for
seller’s negligent misrepresentation, except when the seller is in the business of providing
information. The Illinois Supreme Court has ruled, “focus must be on whether the defendant is
32
in the business of supplying information as opposed to providing something tangible.” First
Midwest Bank, N.A. v. Stewart Title Guar. Co., 218 Ill. 2d 326, 339 (2006). Courts have held
that “businesses that provide informational services as well as a product may be considered a
business that supplies information.” Prime Leasing, Inc. v. Kendig, 332 Ill. App. 3d 300, 311
(1st Dist. 2002).
Defendants contend that they are not liable for any of the Bank’s economic losses
because they sold information in connection with the sale of tangible securities. Additionally,
certain defendants, such HSBC, assert that they were not in the business of supplying
information for the guidance of others in their business transactions.” (HSBC Mot. to Dismiss at
10.)
The Bank argues that Defendants breached their “duty . . . to avoid negligently conveying
false information” because they were “in the business of supplying information for the guidance
of other in their business transactions.” First Midwest Bank, N.A. v. Stewart Title Guar. Co., 218
Ill. 2d 326, 335 (2006). (Mem. in Opp. at 84.) The Bank also argues that issuers and
underwriters of securities do not belong on the “pure tangible good” end of the spectrum of
businesses, which is generally occupied by manufacturers and sellers dealing only in tangible
products. (Mem. in Opp. at 86.)
The Bank received a piece of paper evidencing its right to an income stream, the value of
which came from the pools of assets underlying that paper. The value of the security is not the
paper itself, but rather in the pool of assets underlying the paper. The Bank, unlike the buyer of a
tangible product, did not have personal access to the assets and could not verify their value.
Thus, the issuers and underwriters’ sale was dependent upon the information they provided about
33
the quality and value of the underlying asset pools, which places them, at minimum, in the
middle spectrum amongst banks and insurance providers. For such middle spectrum businesses,
“[t]he critical question . . .is whether the information is an important part of the product offered.”
Gen. Elec. Capital Corp. v. Equifax Servs., Inc., 797 F. Supp. 1432, 1443 (N.D. Ill. 1992).
The Bank has pleaded facts supporting its allegations that a finding that Defendants were
in the business of supplying information for the guidance of others. Defendants’ motion is
denied with respect to the Moorman doctrine.
IV. FHLBC ADEQUATELY PLED CONTROL PERSON LIABILITY
Defendants allege that dismissal is appropriate under 735 ILCS 5/2615 because the Bank
did not allege a primary violation of the securities laws, which disqualifies them from recovery
under a controlling person theory of liability. (Mot. to Dismiss ¶9.) The Illinois Securities Law
requires that the “controlling person” has a direct ownership interest in the issuer and owns a
requisite percentage of the “outstanding voting securities of the issuer,” which the Bank does not
allege and indirect ownership does not render defendants “controlling persons.” See 815 ILCS
5/13; N.J. Stat. Ann. § 49:352; N.C. Gen. Stat. § 78A56.
The Bank correctly argues that it has properly stated a claim for “control person” liability
because it has properly stated claims for primary violations of securities laws. Defendants argue
that Illinois law requires a “direct ownership interest”; however in Ansbro v. Southeast Energy
Group, Ltd., 658 F. Supp. 566 (N.D. Ill. 1987), the district court noted that a general partner of
the controlling limited partner of an issuer may be liable as a control person under Illinois
Securities Law. 658 F. Supp. at 575. Additionally, the statute ties control to “beneficial
ownership,” rather than direct ownership, which is relevant because direct ownership does not
necessarily indicate control. Intricate partnership schemes should not shield parties from liability.
34
CONCLUSION
Defendants’ Joint Motion to Dismiss is denied.
Defendant HSBC’s Motion to Dismiss is denied.
Defendant First Horizon’s Motion to Dismiss is denied.
Defendant Wells Fargo’s Motion to Dismiss is denied.
Defendant Barclay’s Motion to Dismiss is denied.
DATE: September 19, 2012
__________________________________
Kathleen M. Pantle