HSH Nordbank AG v Goldman Sachs Group, Inc. | NYSC - Number of loan originators, including MILA, Inc., Fremont Investment and Loan, New Century Financial Corporation, Meritage Mortgage Corporation,. Aames Investment Corporation, ResMAE

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HSH Nordbank AG v Goldman Sachs Group, Inc. | NYSC – Number of loan originators, including MILA, Inc., Fremont Investment and Loan, New Century Financial Corporation, Meritage Mortgage Corporation,. Aames Investment Corporation, ResMAE

HSH Nordbank AG v Goldman Sachs Group, Inc. | NYSC – Number of loan originators, including MILA, Inc., Fremont Investment and Loan, New Century Financial Corporation, Meritage Mortgage Corporation,. Aames Investment Corporation, ResMAE

SUPREME COURT OF THE ST A TE OF NEW YORK
COUNTY OF NEW YORK: PART 45

————————————————————————x
HSH NORDBANK AG, et al.,
Plaintiffs,

-against-

THE GOLDMAN SACHS GROUP, INC., et al.,
Defendants.

Excerpt:

Nordbank has Adequately Pleaded Scienter.

Goldman Sachs disputes the adequacy of Nordbank’s allegations of scienter. To state a
claim for fraud, a plaintiff must allege some “rational basis for inferring that the alleged
misrepresentations were knowingly made.” .Houbigant, Inc v. Deloitte & Touche LLP, 303 AD2d
92, 93 (I st Dept 2003 ). These allegations must meet the heightened pleading standard of CPLR
3 0 l 6(b ), but this “requirement should not be confused with unassailable proof of fraud.”
Pludeman v N Leasing Sys Inc, 10 NY3d 486, 492 (2008). This is a more lenient test than the
Second Circuit’s “strong inference of fraud” test, and requires only that the complaint include
“facts from which it is possible to infer defendant’s knowledge of the falsity of its statements.”
Houbigant, 303 AD2d at 99; Stichting, 2012 WL 6929336, *9.

“In a case involving RMBS’, ‘the allegations of the mortgage loans material and pervasive
non-compliance with the Seller’s underwriting Guide and the mortgage loan representations are
sufficient non-compliance from which Defendant’s scienter can be inferred.”‘ Allstate v Morgan
Stanley, 2013 WL 2369953, at *IO (quoting MBIA Ins Co v Morgan Stanley, 2011WL2118336,
at *4-5 (NY Sup Ct May 26, 2011)). The complaint alleges widespread abandonment of
underwriting guidelines by a number of loan originators, including MILA, Inc., Fremont
Investment and Loan, New Century Financial Corporation, Meritage Mortgage Corporation,.
Aames Investment Corporation, ResMAE.

To further establish that Goldman Sachs knowingly misrepresented that loan originators
complied with underwriting standards, the complaint includes allegations regarding Goldman
Sachs’s use of a third-party due diligence provider to review the quality of underlying loans.
Nordbank alleges that this diligence provider furnished Goldman Sachs with “detailed reports”
regarding the qua.lity of the underlying mortgages “prior to and during the preparation of the
Offering Materials.” In 2007, the diligence provider informed Goldman Sachs that a significant
portion of the soon-to-be-securitized loans did not meet underwriting standards.6 Nord bank
alleges that the due diligence provider provided Goldman Sachs with knowledge that CL TV
ratios, owner-occupancy rates, and appraisal values represented in the Offering Materials for
each of the securities were false. But instead of informing its investors of these deficiencies or
asking the originators to repurchase the loans, Nordbank alleges that Goldman Sachs instead
negotiated discounts of the purchase price and waived these loans into the pool.

These allegations allow a reasonable inference that Goldman Sachs acted with fraudulent
intent when it represented that loan originators complied with underwriting guidelines. Goldman
Sachs not only allegedly had access to information indicating a “wholesale abandonment of
underwriting standards,” see Plumbers Union Local No 12 Pension Fund v Nomura Asset
Acceptance Corp, 632 F3d 762, 773 (1st Cir 2011 ), but it also had both the motive and a clear
opportunity to realize greater profits by negotiating discounts for lons that did not meet
underwriting standards. See also Stichting, 2012 WL 929336, at *I 0 (finding reasonable
inference of scienter based on, inter alia, defendant’s demand for extra compensation from
originators for poor quality loans); Phoenix Light SF Ltd v Ace Secs Corp., 201TWL 1788007,
at *2 (NY Sup Ct Apr 24, 2013) (denying motion to dismiss fraud claims where defendant
negotiated a lower purchase price because underlying loans did not comply with stated
underwriting guidelines).

Nordbank alleges that the relationship between Goldman Sachs and the loan originators
was such that Goldman knew or should have known that the representations in the Offering
Materials regarding the quality of the pooled mortgages were false. Courts have found that
scienter can be adequately pleaded by alleging that the issuer of securities was also a loan
originator with “knowledge of the true characteristics and credit quality of the mortgage loans.”
Fed Haus Fin Agency (“FHFA “) v JP Morgan, 902 F Supp2d at 492; see also Stichting, 2012
WL 929336, at *10.

Here, although Goldman Sachs was not technically a loan originator, Goldman’s role as a
warehouse lender strongly suggests it had access to information regarding the “true
characteristics and credit quality of the mortgage loans.” FHFA v JP Morgan, 902 F Supp 2d at
492. For example, Goldman Sachs served as a major warehouse lender for MILA, Inc., an
originator of residential loans that were ultimately securitized by Goldman Sachs and sold to
Nordbank. Goldman Sachs’s close relationship with originators like MILA, Inc. put Goldman
Sachs in the unique position to observe originators’ lax lending practices before the mortgages
were pooled and securitized.

Goldman Sachs’s role as a warehouse lender would have provided a strong incentive to
quickly securitize fraudulent loans and not reveal their dismal quality. If the originators that
Goldman Sachs financed had ever defaulted, Goldman Sachs would presumably be saddled with
the bad loans that secured the warehouse loans. By securitizing the loans and selling the
resulting securities as fast as possible, Goldman Sachs could instead unload the risk that the
loans would default while they were still on its books. See China Dev Indus Bank v Morgan
Stanley & Co, 86 AD2d 435, 436 (1st Dept 2011) (“The element of scienter can be reasonably
inferred from the facts alleged including e-mails, which support a motive by Morgan, at the time
of the subject transaction, to quickly dispose of troubled collateral (i.e., predominantly
residential mortgage-backed securities) which it owned at the time.” (citation omitted)).
Accordingly, Goldman Sachs’s role as a warehouse lender reasonably supports an inference of
scienter.

Finally, the complaint alleges that two separate Congressional investigations concluded
that at the time it was marketing two of the securities presently at issue, Goldman Sachs had
knowledge that the underlying loans did not meet the underwriting guidelines included in the
Offering Materials.7 The United States Senate’s Permanent Subcommittee on Investigations (the
“PSI Report”) found that “Goldman was aware of the poor quality of at last some of Fremont’s
loans,” and that “Goldman initiated a detailed review of its Fremont loan inventory … and
found that on average about 50% of about 200 files” did not meet loan quality standards.
Nordbank also alleges that a different government investigation report revealed that “Goldman
Sachs employees routinely used terms such as ‘monstrosities,’ ‘dogs,’ ‘junk’ and other such
disparaging descriptors when discussing their own mortgage-backed products internally.”

Taken together, these allegations state with sufficient particularity that Goldman Sachs
intended to deceive Nordbank by falsely indicating that the residential loans met underwriting
guidelines. Based on information allegedly gleaned from it~ third-party due diligence provider
and its role as a warehouse lender, Goldman Sachs had both knowledge of and a motive to
disregard the loan originators’ substantial noncompliance with underwriting guidelines.
Goldman Sachs’s alleged knowledge concerning the abandonment of underwriting guidelines is
further supported by the fact that Goldman actually benefitted from securitizing substandard
loans by negotiating a lower purchase price. Finally, the allegations regarding the results of the
various government investigations serve as further support of Goldman Sachs’s fraudulent
intent.

At this stage, the court must reject Goldman Sachs’s argument that Nordbank’s scienter
allegations “defy economic reason.” Goldman Sachs contends that because it exposed itself to
greater financial risk by purchasing the same securities, Nordbank’s scienter theory is
economically irrational and must be rejected as a matter of law. Not only is this is a factual
dispute inappropriate for resolution at this stage, see FHF A v Morgan Stanley, 2012 WL
5868300, at *2 (SONY 2012), but the court is skeptical of this line of reasoning. See Phoenix
Light, 2013 WL 1788007, at *6 (“for a bank to contend that it did not act with sci enter with
respect to touting the safety of RMBS because the bank stood to sustain a net loss if the RMBS
were bad investments[] defies the reality of the situation”).

[…]

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