New Jersey Carpenters Health Fund v. Royal Bank of Scotland Group, PLC , 709 F.3d 109 ( 2013 )

12-1707
New Jersey Carpenters v. Royal Bank of Scotland
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
_______________
August Term, 2012
(Argued: December 12, 2012 Decided: March 1, 2013)
Docket No. 12-1707-cv
_______________
NEW JERSEY CARPENTERS HEALTH FUND, on behalf of itself and all others similarly situated,
Plaintiff-Appellant,
—v.—
THE ROYAL BANK OF SCOTLAND GROUP, PLC, GREENWICH CAPITAL HOLDINGS, INC.,
GREENWICH CAPITAL MARKETS, INC., dba RBS Greenwich Capital, WACHOVIA CAPITAL
MARKETS, LLC, sued herein as Wachovia Securities, LLC, DEUTSCHE BANK SECURITIES, INC.,
NOVASTAR MORTGAGE FUNDING TRUST, SERIES 2006-3, NOVASTAR MORTGAGE FUNDING
TRUST, SERIES 2006-4, NOVASTAR MORTGAGE FUNDING TRUST, SERIES 2006-5, NOVASTAR
MORTGAGE FUNDING TRUST, SERIES 2006-6, NOVASTAR MORTGAGE FUNDING TRUST, SERIES
2007-1, NOVASTAR MORTGAGE FUNDING TRUST, SERIES 2007-2, NOVASTAR MORTGAGE
FUNDING CORPORATION, SCOTT F. HARTMAN, GREGORY S. METZ, W. LANCE ANDERSON, MARK
A. HERPICH, NOVASTAR MORTGAGE INC., RBS SECURITIES, INC., WELLS FARGO ADVISORS,
LLC, fka Wachovia Securities LLC,
Defendants-Appellees,
MOODYS INVESTORS SERVICE, INC., THE MCGRAW-HILL COMPANIES, INC.,
Defendants.
_______________
Before:
KATZMANN, PARKER, and WESLEY, Circuit Judges.
_______________
Appeal from a judgment of the United States District Court for the Southern District of
New York (Batts, J.), which dismissed the Plaintiff-Appellant’s complaint for failure to state a
claim. 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—state a plausible claim that the offering documents for the security misstated the
applicable underwriting standards in violation of §§ 11, 12(a)(2), & 15 of the Securities Act of
1933. We further hold that the alleged misstatements were not immaterial as a matter of law.
Finally, we vacate the district court’s holding that the Plaintiff-Appellant, even as the
representative of a proposed class, lacked standing to pursue claims based on securities in which
it had not invested. Rather than addressing this issue, we instruct the district court to reconsider
it in light of our intervening opinion in NECA-IBEW Health & Welfare Fund v. Goldman Sachs
& Co., 693 F.3d 145 (2d Cir. 2012). For the reasons stated below, the judgment of the district
court is REVERSED in part, VACATED in part, and REMANDED for further proceedings
consistent with this Opinion.
_______________
JOEL P. LAITMAN (Michael Eisenkraft, Christopher Lometti, on the brief),
Cohen Milstein Sellers & Toll, New York, N.Y., for Plaintiff-Appellant.
2
THOMAS C. RICE (Alan C. Turner, on the brief), Simpson Thacher & Bartlett
LLP, New York, N.Y., for Defendants-Appellees The Royal Bank of
Scotland Group, PLC, Greenwich Capital Holdings, Inc., Greenwich
Capital Markets, Inc., Wachovia Capital Markets, LLC, Deutsche Bank
Securities, Inc., RBS Securities, Inc., Wells Fargo Advisors, LLC.
WILLIAM F. ALDERMAN (Steven J. Fink, on the brief), Orrick, Herrington &
Sutcliffe LLP, San Francisco, Cal., for Defendants-Appellees Novastar
Mortgage Funding Trust, Series 2006-3, Novastar Mortgage Funding
Trust, Series 2006-4, Novastar Mortgage Funding Trust, Series 2006-5,
Novastar Mortgage Funding Trust, Series 2006-6, Novastar Mortgage
Funding Trust, Series 2007-1, Novastar Mortgage Funding Trust, Series
2007-2, Novastar Mortgage Funding Corporation, Scott F. Hartman,
Gregory S. Metz, W. Lance Anderson, Mark A. Herpich, Novastar
Mortgage Inc.
David R. Stickney, Ann M. Lipton, Bernstein Litowitz Berger & Grossman
LLP, San Diego, Cal., for Amicus Curiae National Association of
Shareholder and Consumer Attorneys, in support of Plaintiff-Appellant.
David C. Frederick, Wan J. Kim, Gregory G. Rapawy, Kellogg Huber,
Hansen, Todd, Evans & Figel, P.L.L.C., Washington, D.C., for Amicus
Curiae National Credit Union Administration Board, in support of
Plaintiff-Appellant.
Steven R. Paradise, Michael V. Rella, Lauren E. Leahy, Vinson & Elkins
L.L.P., New York, N.Y., for Amicus Curiae Securities Industry and
Financial Markets Association, in support of Defendants-Appellees.
_______________
KATZMANN, Circuit Judge:
This case requires us to determine whether the Plaintiff-Appellant, New Jersey
Carpenters Health Fund (“the Fund”), has stated plausible claims under §§ 11 & 12(a)(2) of the
Securities Act of 1933 (“the ’33 Act”), 15 U.S.C. §§ 77a et seq. Subject to certain enumerated
exceptions, §§ 11 & 12(a)(2) of the ’33 Act impose liability whenever a security’s registration
statement or prospectus contains a material misrepresentation or omission. Id. §§ 77k &
77l(a)(2). Here, the Fund claims that the registration statement and the prospectus (collectively,
3
the “offering documents”) for a mortgage-backed security contained material misstatements and
omissions because those documents reported standards for underwriting mortgages that the
relevant underwriter had supposedly abandoned. The Fund bases its conclusion about
abandonment on three factual allegations: (1) that a disproportionately high number of the
mortgages included in the security defaulted; (2) that rating agencies downgraded the security’s
ratings after changing their methodologies to account for lax underwriting; and (3) that prior
employees of the relevant underwriter have attested to systematic disregard of the reported
underwriting standards during the relevant time periods.
The United States District Court for the Southern District of New York (Batts, J.)
concluded that these allegations failed to state a claim under §§ 11 & 12(a)(2) of the ’33 Act. It
also held that, even as the representative for a putative class, the Fund lacked standing to pursue
claims based on securities in which it had not invested. Thus, the district court dismissed the
Fund’s complaint in its entirety, entering judgment in favor of the Defendants-Appellees. The
Fund now appeals from that judgment. For the reasons set forth below, we hold that the Fund’s
factual allegations permit us to draw the reasonable inference that the Defendants-Appellees are
liable under §§ 11 & 12(a)(2) of the ’33 Act. Furthermore, we vacate the district court’s holding
that the Fund, as the representative of a proposed class, lacked standing to assert claims based on
securities in which it had not invested. After the district court entered its judgment, this Court
issued an opinion that addressed the issue of class-standing. See NECA-IBEW Health & Welfare
Fund v. Goldman Sachs & Co., 693 F.3d 145 (2d Cir. 2012). Thus, we instruct the district court
to reconsider the issue of standing presented here in light of that recent opinion. In sum, we
reverse the district court’s judgment in part, vacate it in part, and remand the case for further
proceedings consistent with this Opinion.
4
BACKGROUND
A. The Underlying Securities
According to the Fund’s Consolidated First Amended Securities Class Action Complaint
(“FAC”), on May 25, 2006, Defendant-Appellee NovaStar Mortgage Funding Corporation
(“NMFC”) filed a registration statement and prospectus with the Securities and Exchange
Commission (“SEC”) on Form S-3. On June 16, 2006, NMFC amended the registration
statement and prospectus, using Form S-3/A. Issuers like NMFC may register and offer
securities on “a continuous or delayed basis in the future” for up to “three years” after the “initial
effective date of the registration statement.” 17 C.F.R. § 230.415(a)(1) & (a)(5).1 Typically, an
issuer commences a “continuous or delayed” offering by filing an initial “shelf” registration
statement, which “includes a ‘base’ or ‘core’ prospectus that . . . contains general information,
including the types of securities to be offered and a description of the risk factors of the
offering.” NECA-IBEW, 693 F.3d at 150. The core prospectus may omit otherwise required
information if, because the issuer will offer the securities in the future, such information is
“unknown or not reasonably available.” 17 C.F.R. § 230.430B(a). In the amended prospectus
filed on June 16, 2006, NMFC indicated that it would offer interests in trusts that principally
contained residential mortgages.
After an issuer files its shelf registration statement, it may issue securities under that
statement by filing a supplemental prospectus that discloses “information previously omitted
from the prospectus filed as part of [the] effective registration statement.” Id. § 230.424(b)(2);
1
NMFC qualifies as an issuer under the ’33 Act because it acted as a depositor for the relevant
offerings. See 15 U.S.C. § 77b(a)(4) (defining issuer to include “the person or persons performing the acts
and assuming the duties of depositor or manager” of “collateral-trust certificates”).
5
see also id. § 229.512(a)(1)(ii) (requiring a supplemental prospectus to disclose “any facts or
events arising after the effective date of the registration statement . . . which, individually or in
the aggregate, represent a fundamental change in the information set forth in the registration
statement”). Information disclosed in a supplemental prospectus “shall be deemed to be part of
and included in the registration statement.” Id. § 230.430B(f)(1); see also id. § 229.512(a)(2)
(deeming each supplemental prospectus to be “a new registration statement” for the “purpose of
determining any liability” under the ’33 Act.).2
According to the FAC, NMFC issued six securities under the June 16, 2006 shelf
registration statement: (1) the NovaStar Mortgage Funding Trust, Series 2006-3, which had
assets worth approximately $1,089,000,000, and which NMFC offered on June 22, 2006; (2) the
NovaStar Mortgage Funding Trust, Series 2006-4, which had approximately $1,004,851,000 in
assets, and which NMFC offered on August 18, 2006; (3) the NovaStar Mortgage Funding Trust,
Series 2006-5, which had approximately $1,279,850,000 in assets, and which NMFC offered on
September 22, 2006; (4) the NovaStar Mortgage Funding Trust, Series 2006-6, which had
approximately $1,233,750,000 in assets, and which NMFC offered on November 20, 2006; (5)
the NovaStar Mortgage Funding Trust, Series 2007-1, which had approximately $1,813,274,000
in assets, and which NMFC offered on February 23, 2007; and (6) the NovaStar Mortgage
Funding Trust, Series 2007-2 (the “Series 2007-2 Trust”), which had approximately
$1,324,400,000 in assets, and which NMFC offered on May 25, 2007. Defendant-Appellee
NovaStar Mortgage Inc. (“NMI”), NMFC’s parent company, originated or purchased all of the
2
Because § 230.430B(f)(1) deems newly disclosed information to be included in the registration
statement, plaintiffs may base claims under § 11 of the ’33 Act on a supplemental prospectus’s material
misstatements or omissions. 15 U.S.C. § 77k.
6
mortgages contained in each of the six trusts.3 After NMI originated or purchased the relevant
loans, it sold them to NMFC, which assigned them, in turn, to the trusts described above.
Defendants-Appellees Greenwich Capital Markets, Inc., Deutsche Bank Securities, Inc., and
Wachovia Capital Markets, LLC (collectively, the “Underwriter Defendants”) underwrote and
sold each of the six trusts that NMFC offered.
The amended prospectus filed on June 16, 2006 indicated that the supplemental
prospectuses accompanying each offering would describe “the underwriting standards used to
underwrite the mortgage loans.” J. App’x at 202. The supplemental prospectus filed in
conjunction with the Series 2007-2 Trust (the “2007-2 Prospectus”) described NMI’s
underwriting guidelines at length. According to the 2007-2 Prospectus, NMI adopted its
underwriting guidelines in order to “evaluate the credit history of the potential borrower, the
capacity and willingness of the borrower to repay the loan[,] and the adequacy of the collateral
securing the loan.” Id. at 370. To this end, NMI required each potential borrower to file an
application and to provide documentation according to one of “six levels of applicant
documentation,” which ranged from “Full Documentation” to “Stated Income” to “No
Documentation.” Id. at 370-71. Under the Full Documentation program, applicants would
“generally . . . submit verification of employment and most recent pay stub or up to prior two
years W-2 forms and most recent pay stub.” Id. at 371. The Stated Income program, in contrast,
permitted an applicant to “qualif[y] based on monthly income as stated in the loan application.”
Id. According to the 2007-2 Prospectus, NMI originated 56.96% of the loans in the Series 2007-
3
The supplemental prospectus that accompanied the Series 2007-2 Trust identified only NMI as
an originator of the mortgages contained in the trust. If any other originator or group of affiliated
originators had originated ten percent or more of the Series 2007-2 Trust’s assets, then 17 C.F.R.
§ 229.1110(a) would have required NMFC to identify that originator in the supplemental prospectus.
7
2 Trust under the Full Documentation program, 36.07% under the Stated Income program, and
6.38% under the No Documentation program.
The 2007-2 Prospectus also notified investors that, “[o]n a case-by-case basis, exceptions
to the underwriting guidelines are made where [NMI] believes compensating factors exist.” Id.Compensating factors could include the “length of time in residence, lowering of the borrower’s
monthly debt service payments, the loan-to-value ratio on the loan, as applicable, or other
criteria that in the judgment of the loan underwriter warrant an exception.” Id. Finally, the 2007-
2 Prospectus assured investors that “[q]uality control reviews [were] conducted to ensure that all
mortgage loans [met] quality standards.” Id. at 374.
In addition to describing NMI’s underwriting guidelines, the Series 2007-2 Trust’s
offering documents warned potential investors about certain risks. The amended prospectus filed
on June 16, 2006 advised readers in bold to “read the section entitled ‘Risk Factors’ starting
on page 5 of this prospectus before making a decision to invest.” Id. at 183. Certain risks
resulted from the characteristics of the loans composing the Series 2007-2 Trust, and others were
caused by changes that might occur in the housing market.
First, the 2007-2 Prospectus warned that the loans composing the Series 2007-2 Trust
“would be ineligible for direct purchase by Fannie Mae due to credit characteristics that do not
meet the Fannie Mae underwriting guidelines.” Id. at 297. As a result, the loans were “likely to
experience rates of delinquency, foreclosure and loss that are higher, and may be substantially
higher, than mortgage loans originated in accordance with the Fannie Mae underwriting
guidelines.” Id. The 2007-2 Prospectus also identified other characteristics of the loans that
might increase the likelihood of default. Specifically, it disclosed that a small percentage of the
loans were “secured by second-liens on the related mortgaged properties,” id. at 299, and that
8
another portion of the loans did “not provide for any required payments of principal during the
first five or ten years of their term,” which significantly increased the amount of later monthly
payments, id. at 299-300.
The 2007-2 Prospectus also warned investors about systemic risks. According to the
2007-2 Prospectus, “[i]f the residential real estate market should experience an overall decline in
property values such that the outstanding balances of the mortgage loans . . . become equal to or
greater than the value of the mortgaged properties [serving as collateral for the loans], the actual
rates of delinquencies, foreclosures and losses could be higher than those now generally
experienced.” Id. at 297. Nine pages later, the 2007-2 Prospectus disclosed that, “in recent
months[,] residential property values in many states have declined or remained stable, after
extended periods during which those values appreciated.” Id. at 306.
On May 25, 2007, the Fund invested $100,000 in the Series 2007-2 Trust. Nearly three
years later, on March 26, 2010, the Fund sold its interest in the trust for $350.
B. The FAC
On June 16, 2009, the Fund filed the FAC, which brought claims under §§ 11, 12(a)(2),
& 15 of the ’33 Act based on all six of the trusts that NMFC issued in connection with the June
16, 2006 registration statement. In the FAC, the Fund alleged that the initial prospectus and each
of the supplemental prospectuses all misstated and omitted material facts, most notably, the fact
that NMI, in an effort to increase the number of mortgages it originated, had abandoned its
disclosed underwriting guidelines.
The FAC based its assertion that NMI had abandoned its underwriting guidelines on two
factual allegations. First, the Fund alleged that, although Moody’s and S & P, the two rating
agencies who had evaluated the six trusts, had initially given the trusts some of their highest
9
ratings, they had later dramatically downgraded the trusts, categorizing them as either
“speculative” or at “substantial risk of default.” Second, the Fund alleged that an unusually large
percentage of the mortgages in each trust had entered default. According to the FAC, 8.5% of the
mortgages had defaulted within four months of their trust’s offering, 12.6% had defaulted within
six months, and over 51% had defaulted by June 16, 2009. The FAC then referenced the 2007
Mortgage Fraud Report by the Federal Bureau of Investigation (“FBI”), which was based on a
study of three million residential mortgages and which indicated that between thirty and seventy
percent of “early payment defaults” resulted at least in part from “significant misrepresentations
in the original loan applications.” J. App’x at 75.
C. The District Court’s 2011 Decision
On August 31, 2009, the Defendants-Appellees moved to dismiss the FAC in its entirety.
On March 31, 2011, the district court granted the motion in principal part, but permitted the
Fund to amend the claims based on the Series 2007-2 Trust. N.J. Carpenters Health Fund v.
NovaStar Mortg., Inc., No. 08 Civ. 5310(DAB), 2011 WL 1338195, at *1 (S.D.N.Y. Mar. 31,
2011). First, the district court held that, because the Fund had not invested in any of the first five
trusts that NMFC had issued under the June 16, 2006 registration statement, it lacked standing,
even as the representative of a proposed class, to assert any claim based on those trusts. Id. at *6.
Turning to the Series 2007-2 Trust, the district court concluded that the Fund had not plausibly
alleged that the registration statement, as amended by the 2007-2 Prospectus, contained any
material misstatement or omission. Id. at *10-*11. In the view of the district court, rather than
making “allegations specific to the . . . origination practices that relate to the” Series 2007-2
Trust, the FAC offered “102 pages of ‘the subprime market melted down and Defendants were
market participants, so they must be liable for my losses in my risky investment.’” Id. at *11.
10
D. The Second Amended Class Action Complaint (the “SAC”)
On May 18, 2011, the Fund filed the SAC, which asserted claims under §§ 11, 12(a)(2),
& 15 of the ’33 Act based solely on the Series 2007-2 Trust. The SAC again alleged that the
June 16, 2006 registration statement and prospectus, as supplemented by the 2007-2 Prospectus,
misstated NMI’s underwriting guidelines and failed to disclose that NMI had, in fact, abandoned
its published guidelines. In support of its allegation that NMI had abandoned its guidelines, the
SAC again relied on the two factual allegations presented in the FAC, but it also alleged that
several unnamed prior employees of NMI and NMFC had attested to NMI’s systematic disregard
of its underwriting standards.
First, the SAC repeated its allegation that the rating agencies had severely downgraded
the Series 2007-2 Trust’s ratings. Unlike the FAC, however, the SAC attributed these
downgrades to the rating agencies’ increased awareness of underwriting practices. Specifically,
the SAC alleged that, in June of 2007, approximately one month after NMFC had issued the
Series 2007-2 Trust, S & P revised its rating methodology in response to “the level of loosened
underwriting at the time of loan origination, misrepresentation and speculative borrower
behavior reported for the 2006 ratings.” J. App’x at 1786-87. Moody’s allegedly also revised its
methodology to account for previously undisclosed “aggressive underwriting.” Id. According to
the SAC, the application of these new methodologies to the Series 2007-2 Trust caused the rating
agencies to downgrade the majority of the trust’s ratings by “as many as 20 levels.” Id. at 1787.
Next, the SAC again alleged that the Series 2007-2 Trust experienced unusually high
default rates. According to the SAC, 18% of the loans in the Series 2007-2 Trust defaulted
within six months of the offering, 32% defaulted within one year, 47% defaulted before June 16,
2009, and 68.6% defaulted before June 30, 2011. Like the FAC, the SAC referenced the FBI’s
11
2007 Mortgage Fraud Report. According to that report, between thirty and seventy percent of
“early payment defaults” resulted at least in part from “significant misrepresentations in the
original loan applications,” and loans containing “egregious misrepresentations were five times
more likely to default in the first six months than loans that did not.” Id. at 1790-91.
Finally, the SAC relayed statements from no fewer than eight unnamed former
employees of NMI and NMFC. According to the SAC, seven of the eight employees the Fund
interviewed had worked at NMI or NMFC during the six months preceding May 1, 2007, when
over ninety percent of the mortgages in the Series 2007-2 Trust had been originated.
Specifically, the Fund had interviewed: (1) a former Vice President of Operations, who worked
in Kansas City from 2005 until March 2007; (2) a former Quality Control Auditor/Supervisor,
who worked in Kansas City from August 2005 until September 2007; (3) a former Closing
Supervisor, who worked in Ohio from 2002 through May 2007; (4) a former Quality Control
Auditor, who worked in Ohio from 2004 until 2007; (5) a former Senior Underwriter, who
worked in Lake Forest, California from 2005 through 2007; (6) a former Account Manager, who
worked in Ohio from 2004 until 2007; and (7) a former Account Executive, who worked in
Ocala, Florida from February 2006 until May 2007.
Many of the former employees’ alleged statements contradicted the 2007-2 Prospectus’s
description of NMI’s underwriting standards. According to several former employees, although
the underwriting guidelines prioritized “evaluat[ing] the credit history of the potential borrower,
the capacity and willingness of the borrower to repay the loan[,] and the adequacy of the
collateral securing the loan,” id. at 370, the “pressure” NMI employees allegedly felt to “achieve
loan production” and hit “volume-based performance targets” overshadowed the need for such
evaluations, resulting in the guidelines’ “systematic loosening,” id. at 1775-76. The former Vice
12
President allegedly said that, as a result of the emphasis on volume, the guidelines were “tossed
out the window.” Id. at 1776. According to that Vice President, employees did not worry about
the consequences of disregarding the underwriting guidelines because NMI and NMFC were
“not keeping the crap,” but instead “selling it for securitization.” Id. at 1777.
The alleged “systematic loosening” of the underwriting standards took many forms. For
example, although the underwriting guidelines disclosed that NMI might make “exceptions”
where “compensating factors exist[ed],” id. at 371, former employees allegedly told the Fund
that vice presidents and supervisors at NMI and NMFC would routinely grant exceptions, even
where underwriters had rejected an application because they regarded the accompanying
documentation as suspicious or fraudulent. As a result of NMI’s alleged willingness to overlook
questionable or insufficient documentation, NMI purportedly originated many loans under its
Full Documentation program even though it had not actually obtained the documentation its
underwriting guidelines required. For example, according to a former Quality Control Auditor,
one borrower had verified her employment by submitting a post-it note that said, “Mrs. X cleans
my house and I pay her three thousand a week.” Id. at 1778.
NMI also allegedly disregarded the requirements described in its Stated Income program.
According to the SAC, prior to late 2006, statements of income helped NMI determine a
borrower’s “capacity . . . to repay,” id. at 370, and applicants were rejected where their stated
“incomes were too low to sustain the payments” that a mortgage required, id. at 1779-80. In late
2006 and 2007, however, as NMI employees sought to increase the number of mortgages they
originated, they allegedly began to make exceptions to the income guidelines and to accept
apparently unreasonable statements of income at face value. For example, one former Senior
Underwriter stated that, although she had denied an application from a department store
13
employee who claimed to make $10,000 per month, she later discovered that others at NMI had
overridden her denial. Based on these accounts, the Fund alleges that, during the relevant time
periods, NMI “systematically disregarded” its underwriting guidelines. J. App’x at 1786.
E. The District Court’s 2012 Decision
The Defendants-Appellees moved to dismiss the SAC on July 8, 2011. On March 29,
2012, the district court held that the SAC failed to state a plausible claim under §§ 11 & 12(a)(2)
of the ’33 Act. N.J. Carpenters Health Fund v. NovaStar Mortg., Inc., No. 08 Civ. 5310(DAB),
2012 WL 1076143, at *1 (S.D.N.Y. Mar. 29, 2012). The district court identified two bases for its
holding. First, quoting its 2011 decision, it again found that the Fund had failed “to make
allegations specific to the . . . origination practices that relate to the only offer that is relevant
here,” the Series 2007-2 Trust. Id. at *5. According to the district court, to state a plausible claim
under the ’33 Act, the Fund needed either to “cite an[] example of a loan that failed to meet the
underwriting guidelines and ended up in the 2007-2 loan pool” or to otherwise “provide details
that would tie its claim of loosened underwriting guidelines to the specific loans” at issue. Id. at
*4-*5. Second, the district court found that the SAC had failed to allege that any “misstatements
and omissions would have been material in light of the extensive risk disclosures and
information [the Fund] received, as well as events generally known about [NMI, NMFC,] and
the subprime market in the months preceding” the offering of the Series 2007-2 Trust. Id. at *5-
*6. Because the district court had dismissed all of the Fund’s claims in its 2011 and 2012
decisions, it entered final judgment in favor of the Defendants-Appellees.
The Fund now appeals from that judgment.
14
DISCUSSION
“We review de novo the dismissal of a complaint under [Federal] Rule [of Civil
Procedure] 12(b)(6), accepting all factual allegations as true and drawing all reasonable
inferences in favor of the plaintiff.” Litwin v. Blackstone Grp., L.P., 634 F.3d 706, 715 (2d Cir.
2011) (internal quotation marks omitted). On a motion to dismiss under Rule 12(b)(6), a court
must assess whether the complaint “contain[s] sufficient factual matter, accepted as true, to ‘state
a claim to relief that is plausible on its face.’” Ashcroft v. Iqbal, 556 U.S. 662, 678 (2009)
(quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007)). Although a court must accept
the truth of factual allegations, it need not credit “a legal conclusion couched as a factual
allegation.” Id. (quoting Twombly, 550 U.S. at 555). Thus, a “pleading that offers ‘labels and
conclusions’ or ‘a formulaic recitation of the elements of a cause of action will not do.’” Id.(quoting Twombly, 550 U.S. at 555). “A claim has facial plausibility when the plaintiff pleads
factual content that allows the court to draw the reasonable inference that the defendant is liable
for the misconduct alleged.” Id.A. Misstatements or Omissions
Section 11 of the ’33 Act provides:
In case any part of [a] registration statement . . . contained an untrue statement of
a material fact or omitted to state a material fact required to be stated therein or
necessary to make the statements therein not misleading, any person acquiring
such security (unless it is proved that at the time of such acquisition he knew of
such untruth or omission) may . . . sue—(1) every person who signed the
registration statement; (2) every person who was a director of . . . or partner in the
issuer at the time of the filing[;] . . . [and] (5) every underwriter with respect to
such security.
15 U.S.C. § 77k(a). Section 12(a)(2), in turn, permits a plaintiff to sue “[a]ny person” who
“offers or sells a security . . . by means of a prospectus . . . which includes an untrue statement of
15
a material fact or omits to state a material fact necessary in order to make the statements, in the
light of the circumstances under which they were made, not misleading.” 15 U.S.C. § 77l(a)(2).
“Claims under sections 11 and 12(a)(2) are . . . Securities Act siblings with roughly
parallel elements.” In re Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 359 (2d Cir.
2010). “So long as a plaintiff establishes one of the three bases for liability under these
provisions—(1) a material misrepresentation; (2) a material omission in contravention of an
affirmative legal disclosure obligation; or (3) a material omission of information that is
necessary to prevent existing disclosures from being misleading—then, in a Section 11 case, the
general rule is that an issuer’s liability . . . is absolute.” Litwin, 634 F.3d at 715-16 (citation and
internal quotation marks omitted). “[U]nlike securities fraud claims pursuant to section 10(b) of
the Securities Exchange Act of 1934, plaintiffs bringing claims under sections 11 and 12(a)(2)
need not allege scienter, reliance, or loss causation.” Morgan Stanley Info. Fund, 592 F.3d at 359(citation omitted).4
Because claims under §§ 11 & 12(a)(2) of the ’33 Act need not include allegations of
fraud, “this is an ordinary notice pleading case, subject only to the ‘short and plain statement’
requirements of Federal Rule of Civil Procedure 8(a).” Litwin, 634 F.3d at 715. Thus, as
described above, to prevail on appeal, the Fund must have alleged “factual content that allows
the court to draw the reasonable inference that the [Defendants-Appellees are] liable for the
misconduct alleged.” Iqbal, 556 U.S. at 678. Here, the Fund’s general claim that NMI abandoned
4
The Fund also asserted a claim based on § 15 of the ’33 Act. That sections imposes liability on
anyone who “controls any person liable under” §§ 11 & 12(a)(2). See 15 U.S.C. § 77o(a). Because the
district court held that the Fund had failed to state a claim under §§ 11 & 12(a)(2), it further dismissed the
Fund’s claim under § 15. N.J. Carpenters, 2012 WL 1076143, at *7. As described below, we reverse the
district court’s decision with respect to the claims under §§ 11 & 12(a)(2). Accordingly, we also vacate its
decision to dismiss the claims under § 15.
16
its underwriting guidelines is the functional equivalent of an allegation that the 2007-2
Prospectus contained material misstatements and omissions. We need not accept such a “legal
conclusion” merely because the Fund has “couched” it as a “factual allegation.” Id. (quoting
Twombly, 550 U.S. at 555). In contrast, however, the Fund’s allegations concerning default rates,
credit ratings, and NMI’s specific practices—as described by its former employees—all contain
“factual content,” which we must accept as true. Id. The question, then, is whether this factual
content permits us to draw the “reasonable inference” that NMI abandoned its underwriting
guidelines, rendering the statements in the 2007-2 Prospectus misleading and incomplete. Id.The Supreme Court has offered considerable guidance on what qualifies as a “reasonable
inference.” For example, in Twombly, the Supreme Court clarified that factual content that is
“merely consistent with,” rather than suggestive of, a finding of liability will not support a
reasonable inference. 550 U.S. at 556. Thus, where the antitrust laws required a plaintiff to plead
that the defendants had agreed not to compete, the plaintiff could not simply rely on allegations
that the defendants had acted as if they had agreed. Id. at 566-68. As the Supreme Court
explained, the conditions of the relevant market provided an “obvious alternative explanation”
for the conduct alleged, specifically, that the defendants had more to lose by competing with one
another than they had to gain. Id. The factual content at issue, then, would not support a
reasonable inference of liability because it was “just as much in line with a wide swath of
rational and competitive business strategy.” Id. at 554.
The Supreme Court has also implicitly contrasted the reasonable inference standard with
the higher standard that applies under the Private Securities Litigation Reform Act (“PSLRA”),
15 U.S.C. § 78u-4. When construing the PSLRA’s requirement that plaintiffs in securities fraud
cases allege facts that support a “strong inference” of scienter, id. § 78u-4(b)(2)(A), the Supreme
17
Court emphasized that a strong inference “must be more than merely ‘reasonable’ or
‘permissible’—it must be cogent and compelling, thus strong in light of other explanations.”
Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 324 (2007). The Supreme Court
further held that an inference qualifies as strong “only if a reasonable person would deem [it] . . .
at least as compelling as any opposing inference one could draw from the facts alleged.” Id. By
implication, then, a reasonable inference need not be “as compelling as any opposing inference”
one might draw from the same factual allegations.
Thus, courts may draw a reasonable inference of liability when the facts alleged are
suggestive of, rather than merely consistent with, a finding of misconduct. Moreover, the
existence of other, competing inferences does not prevent the plaintiff’s desired inference from
qualifying as reasonable unless at least one of those competing inference rises to the level of an
“obvious alternative explanation.”5
The United States Court of Appeals for the First Circuit has applied this standard to a
similar set of allegations. See Plumbers’ Union Local No. 12 Pension Fund v. Nomura Asset
Acceptance Corp., 632 F.3d 762 (1st Cir. 2011). In Nomura, as here, the plaintiff brought claims
under §§ 11, 12(a)(2), & 15 of the ’33 Act, alleging that the offering documents of certain
mortgage-backed securities misstated the relevant underwriter’s guidelines. Id. at 766, 772.
Specifically, the plaintiff alleged that “First National Bank of Nevada (‘FNBN’), one of the ‘key’
5
The Supreme Court has not defined the phrase “obvious alternative explanation.” See generally
Iqbal, 556 U.S. at 682; Twombly, 550 U.S. at 567. Whatever the phrase means, the standard under Rule
8(a) undoubtedly remains less stringent than the “heightened” pleading standard imposed by the PSLRA.
See Tellabs, 551 U.S. at 321. The resolution of this appeal, however, does not depend on a precise
definition of “obvious alternative explanation” because no argument advanced by the Defendants-
Appellants even comes close to identifying such an explanation. As described below, the Defendants-
Appellants’ explanations for the SAC’s factual content do not impugn the inference of liability that the
Fund asks us to draw. In other words, even crediting the Defendants-Appellants’ explanations, the Fund’s
inference of liability remains reasonable.
18
loan originators” for the relevant securities, had “‘routinely violated’ its lending guidelines,”
approving “as many loans as possible” and “even ‘scrub[bing]’ loan applications of potentially
disqualifying material.” Id. at 772 (alteration in original). These practices allegedly contradicted
the registration statement’s claim that borrowers had “demonstrate[d] an established ability to
repay” and that FNBN had “verified” their employment history. Id. at 772-73. Finally, the
complaint asserted that, in 2007, Moody’s had “downgraded the rating of all of the” securities.
Id. at 766. Considering “whether enough ha[d] been said in the complaint . . . to link [FNBN’s]
practices with . . . the mortgages that underpinned” the securities at issue, the First Circuit, with
Judge Michael Boudin writing for the Court, held that, although a “judgment call, the sharp drop
in the credit ratings after the sales and the specific allegations as to FNBN offer enough basis to
warrant some initial discovery aimed at these precise allegations.” Id. at 773-74. In passing, the
First Circuit commented that “[s]imilar complaints in other cases have cited to more substantial
sources, including statements from confidential witnesses, former employees and internal
emails.” Id. at 773.
A majority of district courts in this Circuit have agreed with the First Circuit, permitting
claims under §§ 11 & 12(a)(2) of the ’33 Act to proceed where the plaintiff has provided a
“fairly specific” account of how the relevant underwriters had systematically disregarded the
guidelines disclosed in a security’s registration statement. Id.; see In re Morgan Stanley Mortg.
Pass-Through Certificates Litig., 810 F. Supp. 2d 650, 672 (S.D.N.Y. 2011); Emps.’ Ret. Sys. of
the Gov't of the V.I. v. J.P. Morgan Chase & Co., 804 F. Supp. 2d 141, 152-53 (S.D.N.Y. 2011);
In re IndyMac Mortg.-Backed Sec. Litig., 718 F. Supp. 2d 495, 509-10 (S.D.N.Y. 2010); Pub.
Emps.’ Ret. Sys. of Miss. v. Merrill Lynch & Co., 714 F. Supp. 2d 475, 483 (S.D.N.Y. 2010);
N.J. Carpenters Health Fund v. Residential Capital LLC, No. 08 Civ 8781(HB), 2010 WL
191257528, at *6 (S.D.N.Y. Mar. 31, 2010); N.J. Carpenters Health Fund v. DLJ Mortg. Capital,
Inc., No. 08 Civ 5653(PAC), 2010 WL 1473288, at *6-*7 (S.D.N.Y. Mar. 29, 2010).6
We also agree. Here, the SAC incorporates one of the “more substantial sources”
identified by the First Circuit. Nomura, 632 F.3d at 773. The statements from prior NMFC and
NMI employees suggest that NMI—throughout the relevant time period and at different
locations across the country—disregarded its underwriting guidelines, approving loan
applications despite deficiencies in an effort to generate a large volume of mortgages that it
could sell to third parties. These allegations are suggestive of, rather than merely consistent with,
a finding of liability. To connect its specific description of NMI’s conduct with the Series 2007-2
Trust, the Fund has alleged that the loans in the trust had exceedingly high rates of early payment
default. Had NMI in fact disregarded its underwriting guidelines, which helped it to “evaluate”
each borrower’s “capacity and willingness . . . to repay,” J. App’x at 370, it would have become
more vulnerable to mortgage fraud. Thus, according to the FBI’s 2007 Mortgage Fraud Report,
which the SAC referenced, one would reasonably expect higher rates of early payment default,
like those allegedly experienced by the Series 2007-2 Trust, to be a consequence of loosened
underwriting. Finally, the Fund has alleged that the credit rating agencies, after becoming
6
In support of its contrary holding, the district court cited two cases. First, it relied on a case in
which a court concluded that allegations that a mortgage originator had “abandoned” its “guidelines and
issued Mortgage Loans with little or no consideration for borrowers’ ability to repay” failed to state a
securities fraud claim under the heightened standard set forth in the PSLRA. Footbridge Ltd. v.
Countrywide Home Loans, Inc., No. 09 Civ. 4050(PKC), 2010 WL 3790810, at *12-*13 (S.D.N.Y. Sept.
28, 2010). The district court also cited a case that held that, although the “strong nature of the cautionary
language contained in . . . disclosure materials brings this case very close to the dismissal line,” plaintiffs
were nonetheless entitled to replead in order to “put the court in a better position from which to evaluate
the merits of the claims alleged.” City of Ann Arbor Emps.’ Ret. Sys. v. Citigroup Mortg. Loan Trust Inc.,
703 F. Supp. 2d 253, 263-64 (E.D.N.Y. 2010). To support its claim that the complaint was “very close to
the dismissal line,” the court in City of Ann Arbor cited Plumbers’ Union Local No. 12 Pension Fund v.
Nomura Asset Acceptance Corp., 658 F. Supp. 2d 299 (D. Mass. 2009), the district court decision that the
First Circuit later reversed on this issue.
20
concerned about “loose” and “aggressive” underwriting, expressed greater and greater
skepticism about the Series 2007-2 Trust. J. App’x at 1786-88. In sum, the Fund has alleged that
NMI disregarded its underwriting guidelines in specific ways, that the signs of disregard
materialized for the Series 2007-2 Trust, and that those charged with evaluating the security
looked for disregard and apparently found it. These allegations, taken together, permit us to draw
the reasonable inference that the 2007-2 Prospectus’s description of NMI’s underwriting
standards misstated NMI’s actual practices, and the district court erred in concluding that
something more was required.7
The Defendants-Appellees resist this conclusion, challenging the capacity of the Fund’s
allegations to support any inference of liability. First, the Defendants-Appellees argue that we
should distrust the unnamed prior employees’ purported statements and that, in any event, those
few employees could have conceivably described NMI’s practices at only a tiny fraction of its
432 offices. Even under the higher standard imposed by the PSLRA, however, we have
permitted plaintiffs to rely on unnamed sources so long as “they are described in the complaint
with sufficient particularity to support the probability that a person in the position occupied by
the source would possess the information alleged.” Novak v. Kasaks, 216 F.3d 300, 314 (2d Cir.
2000). Here, the SAC describes its sources as employees who would have participated in
different aspects of NMI’s origination process during part or all of the relevant time period.
These descriptions easily “support the probability” that the unnamed prior employees would
7
We do not attempt to identify any “minimum” that a plaintiff must plead in order to state a claim
under §§ 11 & 12(a)(2) of the ’33 Act based on offering documents’ description of an underwriter’s
guidelines. As the Supreme Court has observed, “[d]etermining whether a complaint states a plausible
claim for relief will . . . be a context-specific task that requires the reviewing court to draw on its judicial
experience and common sense.” Iqbal, 556 U.S. at 679. Nonetheless, we note that, both here and in
Nomura, the plaintiff gave a “fairly specific” account of a “key” underwriter’s practices and alleged facts
that tied the purported practices to the specific securities at issue. 632 F.3d at 772-74.
21
have the alleged knowledge of NMI’s underwriting practices. Id.; see also New Orleans Emps.’
Ret. Sys. v. Celestica, Inc., 455 F. App’x 10, 13-14 (2d Cir. 2011) (summary order). Moreover,
although the unnamed employees apparently worked at only a few of NMI’s many offices, the
SAC alleges that those offices were “regional operations offices” and that they were spread
across the country. J. App’x at 1771-72. Finally, the statements relayed in the SAC provide no
basis for believing that factors unique to the relevant offices, rather than company-wide
practices, resulted in the “pressure to achieve loan production” that these employees allegedly
experienced. Id. at 1775. Thus, we must draw the reasonable inference that these factual
allegations support, namely, that the unnamed employees described widespread practices at
NMI. Litwin, 634 F.3d at 715.
Second, the Defendants-Appellees argue that the 2007-2 Prospectus disclosed that the
loans in the Series 2007-2 Trust might default at rates “higher,” and perhaps even “substantially
higher,” than those experienced by loans that conformed to different standards. J. App’x at 297.
According to the Defendants-Appellees, the materialization of the very risks described in the
2007-2 Prospectus, including the risk that the housing market would collapse, explains the
default rates alleged by the SAC, rendering the inferences the Fund attempts to draw
unreasonable. But this argument does not provide an “obvious alternative explanation.”
Twombly, 550 U.S. at 556. The fact that the risks described in the 2007-2 Prospectus may have
caused many of the defaults that occurred does not impugn the Fund’s central allegation, namely,
that unconstrained underwriting increased the number of defaults, causing the ultimate rate of
default to “skyrocket[]” to 68.6%. J. App’x at 1790.8 Moreover, the SAC relies not only on the
8
If, after discovery, the Fund successfully proves that the 2007-2 Prospectus in fact misstated
NMI’s underwriting practices, then evidence that other risks caused the defaults that occurred would
22
number of defaults that occurred, but also on the timing of those defaults. Given the findings set
forth in the FBI’s 2007 Mortgage Fraud Report, the frequency of early defaults suggests that
mortgage fraud contaminated a significant portion of the loans in the Series 2007-2 Trust.9
Because anyone evaluating a borrower’s “capacity and willingness” to repay a loan would want
to detect fraud, J. App’x at 370, the apparent portion of the Series 2007-2 Trust that was affected
by fraud provides additional support for the Fund’s conclusion that NMI employees did not
conduct the evaluations that the company’s disclosed underwriting guidelines required.
Third, the Defendants-Appellees argue that the rating agencies reduced the Series 2007-2
Trust’s ratings not because they had discovered NMI’s underwriting practices, but instead
because the trust’s credit quality had deteriorated. Once again, however, the deterioration of the
trust’s credit quality is wholly consistent with the Fund’s allegation that NMI had abandoned its
underwriting guidelines. Indeed, the rating agencies’ decisions to amend their methodologies to
account for instances of loosened or aggressive underwriting indicates that adherence to
published underwriting guidelines constituted one component of the credit quality that the
agencies sought to assess. Thus, the SAC’s claim that the rating agencies significantly reduced
the Series 2007-2 Trust’s ratings after amending their methodologies to account for aggressive
underwriting again provides further support for the inference that the Fund asks us to draw.
pertain only to the calculation of damages. Under § 11(e), for example, the Defendants-Appellees may
prove “that any portion or all of [the Fund’s] damages represents other than the depreciation in value of
such security resulting from such part of the registration statement, with respect to which . . . liability is
asserted, not being true or omitting to state a material fact.” 15 U.S.C. § 77k(e).
9
The SAC alleges that 18% of the loans defaulted within six months of the Series 2007-2 Trust’s
offering. The 2007-2 Prospectus disclosed that 91.9% of the loans in the Series 2007-2 Trust had been
originated within six months of the offering. While we cannot know exactly what percentage of the loans
that defaulted no later than six months after the offering had been originated more than six months before
the offering, at least 9.9% of the loans in the trust defaulted within a year of their origination.
23
Finally, the Defendants-Appellees argue that the 2007-2 Prospectus did not misstate
NMI’s origination practices because it disclosed that NMI could make “exceptions to [its]
underwriting guidelines” based on any “criteria” that “the loan underwriter” found persuasive. J.
App’x at 371. As the First Circuit has explained, however, “saying that exceptions occur” does
not reveal what the Fund alleges, “namely, a wholesale abandonment of underwriting standards.”
Nomura, 632 F.3d at 773. Thus, because the factual content set forth in the SAC allows us to
draw the reasonable inference that NMI disregarded the underwriting standards described in the
2007-2 Prospectus, the acknowledgment that those standards permitted exceptions does not cure
the misstatements and omissions that the Fund alleges.10
Discovery may reveal that the actual facts support the inferences drawn by the
Defendants-Appellees, rather than those drawn by the Fund. But that has no bearing on the
question before us. As the Supreme Court explained in Twombly, “a well-pleaded complaint may
proceed even if it strikes a savvy judge that actual proof of those facts is improbable, and that
recovery is very remote and unlikely.” 550 U.S. at 556 (internal quotation marks omitted). Thus,
we ask only whether the facts alleged in the SAC, taken as true, allow us to draw the “reasonable
inference” that the Series 2007-2 Trust’s offering documents contained misstatements and
omissions. Iqbal, 556 U.S. at 678. For the reasons set forth above, we find the SAC’s factual
allegations support such an inference.
10
We do not consider the SAC’s allegations that the underwriters of the Series 2007-2 Trust
failed to reasonably investigate the 2007-2 Prospectus’s description of NMI’s underwriting standards.
Whether the underwriters conducted a reasonable investigation pertains only to an affirmative defense
that the Defendants-Appellees may raise in future proceedings. See 15 U.S.C. § 77k(b)(3); cf. Pani v.
Empire Blue Cross Blue Shield, 152 F.3d 67, 74 (2d Cir. 1998) (“An affirmative defense may be raised by
a pre-answer motion to dismiss under Rule 12(b)(6), without resort to summary judgment procedure, if
the defense appears on the face of the complaint.”).
24
B. Materiality
Even though the Fund has plausibly alleged that the 2007-2 Prospectus contained
misstatements and omissions, its claims under §§ 11 & 12(a)(2) of the ’33 Act may nonetheless
fail if the alleged misstatements and omissions are not material. For a misstatement or omission
to qualify as material, “there must be a substantial likelihood that” a complete and truthful
disclosure “would have been viewed by [a] reasonable investor as having significantly altered
the ‘total mix’ of information made available.” Basic Inc. v. Levinson, 485 U.S. 224, 231-32
(1988) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). Because
questions of materiality are “inherently fact-specific,” id. at 236, we have previously held that “a
complaint may not properly be dismissed . . . on the ground that the alleged misstatements or
omissions are not material unless they are so obviously unimportant to a reasonable investor that
reasonable minds could not differ on the question of their importance.” Ganino v. Citizen Utils.
Co., 228 F.3d 154, 162 (2d Cir. 2000) (quoting Goldman v. Belden, 754 F.2d 1059, 1067 (2d Cir.
1985)) (internal quotation marks omitted).
Applying these standards, numerous courts, including the First Circuit in Nomura, have
concluded that misstatements of an underwriter’s guidelines are not “so obviously unimportant”
that they are immaterial as a matter of law. Id. at 162; see Nomura, 632 F.3d at 773; J.P.
Morgan, 804 F. Supp. 2d at 154; IndyMac, 718 F. Supp. 2d at 510; Tsereteli v. Residential Asset
Securitization Trust 2006-A8, 692 F. Supp. 2d 387, 392-93 (S.D.N.Y. 2010). We agree. The
Series 2007-2 Trust consisted primarily of a pool of mortgage loans and interests in the
properties that secured those loans. Investors would profit from their interests in the Series 2007-
2 Trust only if the trust could recoup a sufficient portion of the balance of those loans. Thus, a
“substantial likelihood” exists that a reasonable investor would want to know whether those
25
underwriting the loans had adhered to the procedures in place for evaluating “the capacity and
willingness of the borrower[s] to repay the loan[s] and the adequacy of the collateral securing the
loan[s].” J. App’x at 370. Given the apparent importance of this information, we conclude that,
at this stage of the proceedings, the alleged misstatements and omissions are not immaterial as a
matter of law.
Once again, the Defendants-Appellees resist this conclusion. First, they argue that the
2007-2 Prospectus’s risk disclosures made it clear that the Fund invested in an uncertain security
at a particularly precarious time. Nonetheless, such risk disclosures do not rectify the defect that
the Fund purports to identify. As the First Circuit explained, “[n]either being ‘less stringent’ than
Fannie Mae” nor “warning that less verification may be employed for ‘certain limited
documentation programs’” alerts investors to an alleged “wholesale abandonment of
underwriting standards.” Nomura, 632 F.3d at 773. In general, disclosures about why a security,
as described, might perform poorly cannot overcome an allegation that the registration
statement’s description of that security was materially inaccurate. A reasonable investor can
independently analyze how a security will perform in the market, but she cannot compensate for
the fact that she has not received what she was told to expect. Accordingly, the 2007-2
Prospectus’s disclosure of other, distinct risks cannot render the alleged misstatement of NMI’s
underwriting standards immaterial as a matter of law.
Second, the Defendants-Appellees argue that two newspaper articles would have
informed the Fund of the very information it claims that the 2007-2 Prospectus withheld.11 While
11
Generally, courts considering a motion to dismiss may “take judicial notice of the fact that
press coverage . . . contained certain information” so long as they do not rely on the “truth” of that
information. Staehr v. Hartford Fin. Servs. Grp., Inc. 547 F.3d 406, 425 (2d Cir. 2008).
26
the “total mix” of information relevant to the question of materiality can include publicly
available information, “case law does not support the sweeping proposition that an issuer of
securities is never required to disclose publicly available information.” Litwin, 634 F.3d at 718.
Indeed, we have previously stated that “[t]here are serious limitations on a corporation’s ability
to charge its stockholders with knowledge of information omitted from a document such as a . . .
prospectus on the basis that the information is public knowledge and otherwise available to
them.” Kronfeld v. Trans World Airlines, Inc., 832 F.2d 726, 736 (2d Cir. 1987).12 Thus, in the
context of allegedly false or incomplete proxy solicitations, we have held that “sporadic news
reports . . . should not be considered part of the total mix of information that would clarify or
place in proper context . . . representations” that were contained in materials that the company
provided “directly.” United Paperworkers Int’l Union v. Int’l Paper Co., 985 F.2d 1190, 1199
(2d Cir. 1993).13
Here, the Defendants-Appellees cite an April 1, 2007 New York Times article that stated
that NMI had “eased up on the required documentation of a borrower’s income,” J. App’x at
591, and an April 23, 2007 article in Forbes that imputed “loose underwriting standards” to
NMI, among other “subprime lenders,” id. at 596. These articles, however, are only “sporadic
12
The ’33 Act itself implicitly limits the impact of public information on materiality
determinations. Section 11 creates an affirmative defense where a defendant can prove that “at the time of
. . . acquisition,” the purchaser “knew” of the alleged “untruth or omission.” 15 U.S.C. § 77k(a); see also
N.J. Carpenters Health Fund v. Rali Series 2006-QO1 Trust, 477 F. App’x 809, 813 (2d Cir. 2012)
(summary order). If courts held that merely available, as opposed to widely known, public information
exposed an untruth or omission, thereby rendering it immaterial, they would effectively shift the burden
of proof on § 11’s affirmative defense, presuming that the plaintiff should have known the relevant
information rather than requiring the defendant to prove actual knowledge.
13
NMFC had an obligation to provide the 2007-2 Prospectus directly to investors. Section 5(b)(2)
of the ’33 Act requires a prospectus to “accompan[y] or precede[]” the sale of any security. 15 U.S.C.
§ 77e(b)(2); see also SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1098 (2d Cir. 1972).
27
news reports,” which do not alone clarify or contextualize the alleged misstatements in the 2007-
2 Prospectus. Paperworkers Int’l, 985 F.2d at 1199. Moreover, neither article discloses what the
fund alleges, namely, that NMI had abandoned its published underwriting guidelines. Instead,
the claim that NMI had “eased up on the required documentation” might only have referred to
the number of loans it issued under its “No Documentation” and “Stated Income” programs.
Similarly, the Forbes article might plausibly have characterized NMI’s standards as “loose”
simply because they did not conform to “the Fannie Mae underwriting guidelines.” J. App’x at
297. Thus, rather than revealing what the Series 2007-2 Prospectus omitted, these articles could
be interpreted as criticisms of NMI for what that prospectus disclosed. Such vague criticisms of
NMI did not render the alleged abandonment of its underwriting guidelines “public knowledge.”
See Litwin, 634 F.3d at 718-19.
Finally, the Defendants-Appellees argue that, because the 2007-2 Prospectus disclosed an
extensive amount of information about the loans contained in the Series 2007-2 Trust, including
the borrowers’ credit scores and the loan-to-value ratios, no reasonable investor could have cared
about the procedures by which NMI originated the loans. We think, however, that knowledge
that the borrowers had low credit scores and that many of the mortgages had high loan-to-value
ratios would make a reasonable investor more, rather than less, interested in whether NMI had
adhered to its processes for evaluating “the capacity and willingness of the borrower[s] to
repay.” J. App’x at 370. Accordingly, for the reasons described above, we conclude that
the alleged misstatements and omissions are not immaterial as a matter of law.
C. Standing
Finally, the Fund appeals from the district court’s dismissal of its claims based on the
other five trusts that NMFC issued in connection with the June 16, 2006 registration statement.
28
See N.J. Carpenters, 2011 WL 1338195, at *6. After the district court entered judgment, this
Court issued an opinion that addressed the issue of whether the representative for a proposed
class could bring claims under the ’33 Act based on securities in which it had not invested. See
NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co., 693 F.3d 145 (2d Cir. 2012).
Specifically, the Court held that, where an issuer had issued multiple securities under the same
shelf registration statement, a plaintiff who had invested in at least some of those securities
could, as the representative of a putative class, bring claims based on securities in which it had
not invested so long as all of the relevant claims implicated “the same set of concerns.” Id. at
162-64. Because the claims at issue in NECA-IBEW alleged that the securities’ offering
documents contained “nearly identical misrepresentations” concerning “origination guidelines,”
the Court clarified that those claims would raise “the same set of concerns” to the extent that the
securities “were backed by loans originated by [common] originators.” Id. (emphasis removed).
Here, we vacate the district court’s decision and remand for reconsideration under the
standard set forth in NECA-IBEW. Because the district court may, in its sound discretion,
conduct evidentiary proceedings on the issue of standing, Alliance for Envtl. Renewal, Inc. v.
Pyramid Crossgates Co., 436 F.3d 82, 87-88 (2d Cir. 2006), we think that it is better positioned
to resolve the factual issues that pertain to the analysis required by NECA-IBEW. Such factual
questions may include whether the relevant prospectuses contained “similar if not identical”
descriptions of the underwriting standards, whether the trusts “were backed by loans originated
by [common] originators,” and whether any differences among the originators of the mortgages
in each trust prevent the Fund’s claims based on the different securities from raising “the same
set of concerns.” NECA-IBEW, 693 F.3d at 162-64. Nonetheless, we list these issues only by
way of example, leaving it to the district court to undertake the full analysis required by NECA-
IBEW in the first instance.
29
CONCLUSION
For the reasons stated above, the district court’s judgment is REVERSED in part,
VACATED in part, and REMANDED for further proceedings consistent with this Opinion.
30