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The Second Circuit Court of Appeals overturned a lower court's dismissal of a major residential mortgage-backed securities lawsuit filed against U.S. mortgage bond issuers.
The court's ruling revived claims from an investor group that alleged several securities law violations stemming from the defendants' packaging and sale of mortgage securities supported by alleged risky loans.
The defendants include Novastar Mortgage, Royal Bank of Scotland Group ($10.01 -0.21%), Wachovia Capital — now Wells Fargo ($40.24 0.23%) — Greenwich Capital Markets and Deutsche Bank Securities ($37.86 -0.127%).
The reversal revives a dispute between the defendants and investors who claim they were sold $7.75 billion in MBS during six separate offerings in 2006 and 2007. The underlying loans were originated by NovaStar and sold off by the investmetn banks. The deals ended up costing MBS investors money later on due to an uptick in borrower delinquencies, foreclosures, repossessions and bankruptcies.
Though a lower court dismissed the complaint, the Second Circuit revived it holding that the parties stated "a plausible claim that the offering documents for the security misstated the applicable underwriting standards ... violating the Securities Act of 1933."
"We hold that the allegations in the complaint—principally, that a disproportionately high number of the mortgages in a security defaulted, that rating agencies downgraded the security’s ratings after changing their methodologies to account for lax underwriting, and that prior employees of the relevant underwriter had attested to systematic disregard of underwriting standards," the Second Circuit judges wrote.
The ruling also paves the way for potential prosecution of claims arising from five other MBS offerings sold by the same investment banks totaling an additional $6.4 billion, according to attorneys for the plaintiff.
"We are gratified that the Second Circuit agreed with us that the dismissal of the case against the investment bank and other defendants should be reversed and that the case should be allowed to proceed on behalf of the investors," said plaintiffs' lead counsel Joel Laitman, of Cohen Milstein Sellers & Toll.
Click here to read the full court case.
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