United States District Court, D. New Jersey
THE PRUDENTIAL INSURANCE COMPANY OF AMERICA et al., Plaintiffs,
BANK OF AMERICA, NATIONAL ASSOCIATION et al., Defendants
[Copyrighted Material Omitted]
For THE PRUDENTIAL INSURANCE COMPANY OF AMERICA, THE PRUDENTIAL LIFE INSURANCE COMPANY, LTD., THE PRUDENTIAL SERIES FUND, THE GIBRALTAR LIFE INSURANCE COMPANY, LTD., PRUDENTIAL TRUST COMPANY, PRUDENTIAL TOTAL RETURN BOND FUND, INC., PRUDENTIAL RETIREMENT INSURANCE & ANNUITY COMPANY, PRUDENTIAL ASSET ALLOCATION FUND, THE PRUDENTIAL INVESTMENT PORTFOLIOS, INC., PRUDENTIAL INVESTMENT PORTFOLIOS 2, PRUDENTIAL ANNUITIES LIFE ASSURANCE CORPORATION, PRUCO LIFE INSURANCE COMPANY OF NEW JERSEY, PRUCO LIFE INSURANCE COMPANY, PRU ALPHA FIXED INCOME OPPORTUNITY MASTER FUND I, L.P., PARK PLACE COMMERCE INVESTMENTS, LLC, COMMERCE STREET INVESTMENTS, LLC, Plaintiffs: DAVID W. FIELD, LEAD ATTORNEY, LOWENSTEIN, SANDLER LLP, ROSELAND, NJ; ZACHARY D. ROSENBAUM, LEAD ATTORNEY, LOWENSTEIN SANDLER PC, ROSELAND, NJ.
For BANK OF AMERICA, NATIONAL ASSOCIATION, FIRST FRANKLIN FINANCIAL CORPORATION, MERRILL LYNCH MORTGAGE LENDING, INC., MERRILL LYNCH MORTGAGE CAPITAL, INC., MERRILL LYNCH MORTGAGE INVESTORS, INC., MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., MERRILL LYNCH & CO., INC., BANC OF AMERICA FUNDING CORPORATION, BANK OF AMERICA MORTGAGE SECURITIES INC., ASSET BACKED FUNDING CORPORATION, Defendants: WILLIAM E. GOYDAN, LEAD ATTORNEY, WOLFF & SAMSON, PC, WEST ORANGE, NJ; XAVIER MARC BAILLIARD, LEAD ATTORNEY, WOLFF & SAMSON PC, WEST ORANGE, NJ.
Stanley R. Chesler, United States District Judge.
This matter comes before the Court on the motion to dismiss the Complaint for failure to state a valid claim for relief, pursuant to Federal Rule of Civil Procedure 12(b)(6), by Defendants Asset Backed Funding Corporation, Banc of America Funding Corporation, Bank of America Mortgage Securities Inc., Bank of America, National Association, First Franklin Financial Corporation, Merrill Lynch & Co., Inc., Merrill Lynch Mortgage Capital, Inc., Merrill Lynch Mortgage Investors, Inc., Merrill Lynch Mortgage Lending, Inc., and Merrill Lynch, Pierce, Fenner & Smith, Inc. (collectively, " Defendants." ). For the reasons stated below, the motion will be granted in part and denied in part.
In a nutshell, this case arises from a dispute over the sale of certain residential mortgage-backed securities (" RMBS" ) by Defendants to Plaintiffs the Prudential Life Insurance Company, Ltd., Pruco Life Insurance Company of New Jersey, Prudential Asset Allocation Fund, Pru Alpha Fixed Income Opportunity Master Fund I, L.P., the Prudential Investment Portfolios, Inc., the Prudential Insurance Company of America, Prudential Retirement Insurance & Annuity Company, Prudential Annuities Life Assurance Corporation, the Gibraltar Life Insurance Company, Ltd., Prudential Total Return Bond Fund, Inc., Prudential Trust Company, Commerce Street Investments, LLC, Pruco Life Insurance Company, Prudential Investment Portfolios 2, the Prudential Series Fund, and Park Place Commerce Investments, LLC. (collectively,
" Plaintiffs" ). The Complaint alleges that Defendants obtained the underlying mortgages, created the securitizations based on them, issued " Offering Materials" for their sale, and sold them to Plaintiffs. The Complaint asserts eight causes of action: 1) common law fraud; 2) aiding and abetting common law fraud; 3) equitable fraud; 4) negligent misrepresentation; 5) violation of New Jersey Civil RICO (" NJRICO" ); 6) violation of § 11 of the Securities Act of 1933 (the " 1933 Act" ); 7) violation of § 12(a)(2) of the 1933 Act; and 8) violation of § 15 of the 1933 Act. Defendants have now moved to dismiss the Complaint.
The Complaint alleges a variety of statistics in support of its claims. It is often not clear, however, what the basis for a particular statistic is. The Complaint highlights one particular research study and appears to use the phrases " forensic analysis" and " loan-level analysis" to refer to it interchangeably. The forensic analysis was performed on 20,906 mortgages across 29 or 30 securitizations, but it is not always clear which statistics came from it. (Compl. ¶ ¶ 20, 148, 153.) For each securitization examined, this analysis looked at 400 defaulted loans and 400 randomly selected loans. (Compl. ¶ 149.) The Complaint clearly states that this forensic analysis yielded the " Occupancy Analysis." The Occupancy Analysis aimed to test Defendants' representations about owner-occupancy, based on tax and property records. (Compl. ¶ 6.) There are four other subjects for which statistics are given, and it is not clear whether the loans examined were the same as those used in the forensic analysis: 1) chain of title; 2) material defects; 3) default and delinquency rates; and 4) the AVM Study. The AVM Study aimed " to test the reasonableness of Defendants' appraisal values." (Compl. ¶ 8.) The Complaint also alleges a " loan-level analysis" which looked for loans with at least one " material defect" and found over 62,000 such loans. (Compl. ¶ 21.) This suggests that at least the material defect analysis was performed on a different loan sample from the 20,906 mortgage forensic analysis.
STANDARD OF REVIEW
I. Motion To Dismiss Under Rule 12(b)(6)
In deciding a motion to dismiss pursuant to Rule 12(b)(6), courts must " accept all factual allegations as true, construe the complaint in the light most favorable to the plaintiff, and determine whether, under any reasonable reading of the complaint, the plaintiff may be entitled to relief." Phillips v. County of Allegheny, 515 F.3d 224, 233 (3d Cir. 2008) (quoting Pinker v. Roche Holdings, Ltd., 292 F.3d 361, 374 n.7 (3d Cir. 2002)). A Rule 12(b)(6) motion to dismiss should be granted only if the plaintiff is unable to articulate " enough facts to state a claim to relief that is plausible on its face."
Bell A. Corp. v. Twombly, 550 U.S. 544, 127 S.Ct. 1955, 1974, 167 L.Ed.2d 929 (2007). " The defendant bears the burden of showing that no claim has been presented." Hedges v. United States, 404 F.3d 744, 750 (3d Cir. 2005).
" Federal Rule of Civil Procedure 8(a)(2) requires only 'a short and plain statement of the claim showing that the pleader is entitled to relief,' in order to 'give the defendant fair notice of what the . . . claim is and the grounds upon which it rests.'"
Twombly, 127 S.Ct. at 1964 (quoting Conley v. Gibson, 355 U.S. 41, 47, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957)). " While a complaint attacked by a Rule 12(b)(6) motion to dismiss does not need detailed factual allegations, a plaintiff's obligation to provide the 'grounds' of his 'entitle[ment] to relief' requires more than labels and conclusions, and a formulaic recitation of the elements
of a cause of action will not do."
Twombly, 127 S.Ct. at 1964-65 (internal citations omitted); see also Fed.R.Civ.P. 8(a)(2). " Factual allegations must be enough to raise a right to relief above the speculative level on the assumption that all the allegations in the complaint are true (even if doubtful in fact)." Id. at 1965 (internal citations omitted).
Factual allegations must be well-pleaded to give rise to an entitlement to relief:
[A] court considering a motion to dismiss can choose to begin by identifying pleadings that, because they are no more than conclusions, are not entitled to the assumption of truth. While legal conclusions can provide the framework of a complaint, they must be supported by factual allegations. When there are well-pleaded factual allegations, a court should assume their veracity and then determine whether they plausibly give rise to an entitlement to relief.
Ashcroft v. Iqbal, 556 U.S. 662, 129 S.Ct. 1937, 1950, 173 L.Ed.2d 868 (2009).
In reviewing a motion to dismiss, pursuant to Rule 12(b)(6), a court may consider the allegations of the complaint, as well as documents attached to or specifically referenced in the complaint, and matters of public record. Pittsburgh v. W. Penn Power Co., 147 F.3d 256, 259 (3d Cir. 1998); see also 5B Charles Alan Wright & Arthur R. Miller, Federal Practice & Procedure: Civil 3d § 1357 (3d ed. 2007). " Plaintiffs cannot prevent a court from looking at the texts of the documents on which its claim is based by failing to attach or explicitly cite them." In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1426 (3d Cir. 1997).
The Supreme Court has characterized dismissal with prejudice as a " harsh remedy." New York v. Hill, 528 U.S. 110, 118, 120 S.Ct. 659, 145 L.Ed.2d 560 (2000). Dismissal of a count in a complaint with prejudice is appropriate if amendment would be inequitable or futile.
Alston v. Parker, 363 F.3d 229, 235 (3d Cir. 2004). " When a plaintiff does not seek leave to amend a deficient complaint after a defendant moves to dismiss it, the court must inform the plaintiff that he has leave to amend within a set period of time, unless amendment would be inequitable or futile." Grayson v. Mayview State Hosp., 293 F.3d 103, 108 (3d Cir. 2002).
I. First Count: common law fraud
There is no dispute that Plaintiff's claims for common law fraud are governed by the law of the State of New Jersey. Under New Jersey law:
The five elements of common-law fraud are: (1) a material misrepresentation of a presently existing or past fact; (2) knowledge or belief by the defendant of its falsity; (3) an intention that the other person rely on it; (4) reasonable reliance thereon by the other person; and (5) resulting damages.
Gennari v. Weichert Co. Realtors, 148 N.J. 582, 610, 691 A.2d 350 (1997). Federal Rule of Civil Procedure 9(b) requires that " fraud must be pled with particularity in all claims based on fraud." Lum v. Bank of Am., 361 F.3d 217, 220 (3d Cir. 2004). Defendants move to dismiss the common law fraud claims on multiple grounds.
A. Are the forensic analysis allegations sufficient?
Defendants first attack the claim for common law fraud on the ground that the forensic analysis (the " Analysis" ) " is so flawed as to be utterly useless at the pleading stage." (Defs.' Br. 10.) At the outset, the Court notes that this kind of argument presents an uphill climb for Defendants: methodological critiques of research
evidence may be effective at trial, but, on a motion to dismiss, well-pleaded  factual allegations are taken as true. Defendants' methodological attacks on the Analysis confuse the process of weighing evidence as proof with the process of examining whether allegations suffice to make a claim plausible. The two are very different and, on a Rule 12(b)(6) motion, this Court does only the latter. Arguments that go to the proof value of evidence miss the mark at this stage.
Defendants first contend that, since the Analysis was not performed on 24 of the 54 offerings at issue, this leaves any claims about those 24 offerings unsupported by factual allegations of misrepresentation. This argument is unpersuasive, as it overlooks the relevant legal standard at this stage: factual allegations must be sufficient merely to make a claim plausible. Proof is not required. Twombly teaches that, to survive a Rule 12(b)(6) motion, a complaint does not need " detailed factual allegations."
Twombly, 127 S.Ct. at 1964-65. Rather, the complaint " needs more than 'labels and conclusions.'" Id. Sampling is a well-known method for generating inferences about a population based on assessment of a subset of its members. Allegations based on sampling easily satisfy the requirement that the factual basis be more than labels and conclusions. At this stage, sampling provides a sufficient factual basis for the Court to find it plausible that a sample of 29 out of 54 offerings adequately represents all 54. Defendants will have the opportunity at trial to persuade the finder of fact of the flaws of sampling as evidence.
Defendants next attack the sampling methodology used in the Analysis: " Because Plaintiffs used a non-random and intentionally biased sample, their 'analysis' is inherently incapable of saying anything statistically significant about the loan pools." (Defs.' Br. 11.) The Complaint alleges that, for each offering, the forensic analysis examined 400 defaulted loans and 400 randomly sampled loans. (Compl. ¶ 149.) Defendants argue that, in such a sample, bad loans are overrepresented.
Again, this is an argument for trial, as it attacks the inference that the evidence is probative. At this stage, statistically significant evidence is not required; only allegations giving rise to plausibility are needed. Plaintiffs allege that the Analysis reviewed roughly 21,000 mortgage loans underlying 30  offerings and found evidence both of " systemic misrepresentation" and that certain statements in the Offering Materials were false. (Compl. ¶ ¶ 153, 155.) As explained more fully in the discussion that follows, considering these allegations under the plausibility standard, this Court finds that they can make plausible some claims that certain statements in the Offering Materials were false. Assuming, arguendo, that, as Defendants contend, this sample was " biased" and that defaulted loans were overrepresented, a study of 21,000 mortgage loans nonetheless provides a sufficient factual basis to make certain of these claims plausible. For example, the Analysis found evidence that, in samples drawn from 30 securitizations, the percentage of loans with a material defect ranged from a low of 13% to a high of 96%. (Compl. ¶ 21.) Eighteen of the 30 showed material defect rates higher than 50%. (Id.) This is not proof of the claim that underwriting standards were abandoned and misrepresented, but it does offer substantial support to make the claim of systematic abandonment of underwriting standards and misrepresentation plausible. Sampling bias is an argument for trial.
Furthermore, the cases Defendants cite in support do not make their case. Utah v. Evans, 536 U.S. 452, 467, 122 S.Ct. 2191, 153 L.Ed.2d 453 (2002), deals with the construction of " sampling" as a statutory term and has no relevance. First Nationwide Bank v. Gelt Funding Corp., 27 F.3d 763, 772 (2d Cir. 1994), is at least more in the ballpark, since the Second Circuit did indeed hold that the research methodology in the complaint was so flawed that it did not adequately plead RICO proximate cause. The problem is that the proposition that the research methodology described in a complaint could be so manifestly flawed that a court might find that it fails to provide sufficient factual support for an element of a claim is unremarkable. First Nationwide offers nothing close to a bright line rule; the analysis is highly fact-specific. As the discussion above makes clear, this Court does not find that the Analysis, as described in the Complaint, is such obvious junk research that it fails to constitute relevant factual allegations which, considered along with the other factual allegations in the Complaint, make plausible certain of the assertions of misrepresentation.
Furthermore, courts in similar cases have rejected such arguments on a motion to dismiss.
See, e.g., CMFG Life Ins. Co. v. RBS Secs., *20 (W.D. Wis. Aug. 19, 2013) (denying a motion to dismiss based on critique of similar forensic analysis allegations).
B. Do Plaintiffs fail to adequately plead a misrepresentation relating to occupancy?
The Complaint alleges that the forensic analysis shows: " Across every Offering, Defendants significantly overstated the number of owner-occupied properties, thus understating the true riskiness of the loans." (Compl. ¶ 155.) The Complaint alleges that Plaintiffs performed a number of tests on the sampled loans and that " [f]ailing more than one of the above tests is strong evidence that the borrower did
not in fact reside at the mortgaged properties." (Id. at ¶ 160.) The Complaint then asserts:
The consistency of these results shows that the divergence between Defendants' representations and reality was not due to phenomena such as borrowers changing their mind about where to live. Instead, these results reflect the fact that Defendants and their Originators knew borrowers were misrepresenting their intent to live at the property.
(Id. at ¶ 161.) This Court finds the reasoning here unpersuasive. The Complaint has failed to allege sufficient facts to make plausible the claim that the Defendants had knowledge at any relevant time during the processes of underwriting, securitization, or sale of the securities that borrowers misrepresented their intent to live on the property.
Crucially, the Complaint confuses two distinct issues: 1) the borrowers knew that the properties would not be owner-occupied and misrepresented this to Defendants; and 2) the Defendants knew that the borrowers would not be occupying the property and misrepresented this to the Plaintiffs. These are very different. The fraud claim here requires factual support for the second of these propositions, but the facts alleged are insufficient. In the absence of facts supporting the second proposition, allegations supporting the first are irrelevant.
The forensic analysis was performed after the purchase of the securities by Defendants. Even accepting the assertion as true that, on the whole, the prospectuses overstate the number of owner-occupied properties, and thus understate the true riskiness of the loans, this says nothing about how this happened or what Defendants knew at what time. The Complaint fails to present even the barest theory explaining how Defendants were involved in any fraud. What employees of Defendants knew that the borrowers would not be occupying the property during the underwriting process, and how would they have known it? The Complaint relies on information that could not have been available during the underwriting process -- as alleged, it was obtained after the borrowers already owned the property.
Instead of allegations supporting the second proposition, the Complaint alleges facts that support the inference that, on the whole, some borrowers may have misrepresented their intent to live at the property and third-party due diligence reviewers should have flagged such misrepresentations. There is nothing here to suggest that Defendants knew that the borrowers would not be occupying the properties at any relevant time. Nor, as Defendants observe, does the Complaint allege facts to support the inference that the Offering Materials even misreported what the borrowers said about their intent to occupy the properties. Rather, the Complaint acknowledges that the owner occupancy representations were based on the self-reports of borrowers -- and there is no allegation here that Defendants misrepresented what borrowers reported.
The Complaint fails to adequately plead scienter with regard to the owner occupancy statements. The parties dispute the proper standard for pleading scienter in the Third Circuit under Rule 9(b). Defendants cite In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1418 (3d Cir. 1997), as authority for the proposition that " a plaintiff alleging securities fraud must still allege specific facts that give rise to a 'strong inference' that the defendant possessed the requisite intent." To meet this standard, " Plaintiffs must either (1) identify circumstances indicating conscious or reckless behavior by defendants or (2) allege facts showing both a motive and a
clear opportunity for committing the fraud." Id. at 1422. Plaintiffs, in opposition, contend that the holding of Burlington is limited to claims under the Securities Exchange Act of 1934, and that it does not apply to common law fraud claims. Plaintiffs do not, however, persuade this Court that Burlington should be read so narrowly. In Burlington, in short, the Third Circuit adopted the Second Circuit's position that Rule 9(b) requires a complaint alleging securities fraud to meet the " strong inference of scienter" standard. Id. Plaintiffs have pointed to nothing in Burlington to support limiting this to a particular subset of securities fraud cases. Rather, the language of Burlington supports the understanding that Rule 9(b) applies to all securities fraud claims, and that it requires the plaintiff asserting such claims to allege specific facts that give rise to a strong inference of scienter.
In three pages, the Complaint states the basis for the inference that Defendants knew that the owner occupancy representations were false. The Complaint relies entirely on information provided by three confidential witnesses. In brief, the Complaint first alleges that CCW10 said that a due diligence underwriter " worth his salt" would have verified owner occupancy, and that the due diligence underwriters reviewed owner occupancy. (Compl. ¶ 631.) In the following paragraph, however, the Complaint alleges that the due diligence underwriters " were instructed to spot occupancy problems in a variety of ways," and lists eight signs of potential owner occupancy problems that could be found from a file review. (Compl. ¶ 632). Also, due diligence reviewer Clayton's " Loan Analysis System" allowed the entry of notes about " unreasonable occupancy claims" and generated reports for Defendants. This provides very close to no factual support for an inference that Defendants actually knew that borrowers had misrepresented their intent to occupy the property. Rather, it suggests at most that, as a matter of best practices, third-party due diligence reviewers should check for eight indicators that owner occupancy may have been misrepresented. The occurrence of an indicator, it would seem, would mean at most that there was a basis to consider the owner occupancy representation to be suspect. It does not support inferences that, for the securitizations at issue, the due diligence reviewers actually did check for these indicators, did find signs of misrepresentation of owner occupancy status, and did report such findings to the Defendants, who willfully disregarded these reports. Instead, at most, the cited confidential witness statements suggest that, as a best practice, third-party due diligence reviewers ought to have found information in the file that ought to have raised suspicions of misrepresentation, that ought to have been reported to Defendants, who ought to have then investigated the facts of owner occupancy and found out the truth. That is very far from supporting the inference that Defendants knew at the time of issuance of the Offering Materials that a substantial number of owner occupancy representations were false.
Applying the Third Circuit's standard for pleading scienter in ...