Opinion
No. 654033/2012.
10-16-2015
BASIS PAC–RIM OPPORTUNITY FUND (Master) and Basis Yield Alpha Fund (Master) Plaintiffs, v. TCW ASSET MANAGEMENT COMPANY, Defendant.
Lewis Baach PLLC, for plaintiffs. Gibson, Dunn & Crutcher, LLP, for defendant.
Lewis Baach PLLC, for plaintiffs.
Gibson, Dunn & Crutcher, LLP, for defendant.
SHIRLEY WERNER KORNREICH, J.
Defendant TCW Asset Management Company (TCW) moves, pursuant to CPLR 3212, for summary judgment against plaintiffs Basis Pac–Rim Opportunity Fund (Master) (Pac–Rim) and Basis Yield Alpha Fund (Master) (BYAFM) (collectively, Basis). Basis opposes the motion. For the reasons that follow, TCW's motion is denied.
I.Factual Background & Procedural History
Unless otherwise indicated, the following facts are undisputed.
See Dkt. 157 (Joint Statement of Undisputed Facts) & Dkt. 159–172 (exhibits).
A. Introduction
On September 21, 2012, Basis commenced this action against TCW to recover its investment losses in a collateralized debt obligation (CDO) known as Dutch Hill Funding II, Ltd. (Dutch Hill). Basis claims TCW made fraudulent misrepresentations that induced it to invest in the riskiest portions of Dutch Hill.
See Dkt. 157 at 19–25 (discussing the composition and sources of Dutch Hill's CDO and RMBS collateral).
TCW, an investment advisory firm based in California, was Dutch Hill's collateral manager. Non-party Deutsche Bank Securities, Inc. (Deutsche Bank) was the investment banker, structurer, underwriter, and placement agent for Dutch Hill. Basis are Cayman Island hedge funds that were managed by non-party Basis Capital Funds Management Limited (BCFM). BCFM was headquartered is Sydney, Australia. The Basis funds are now bankrupt due to their investments, made as late as the summer of 2007, in CDOs and other investment vehicles tied to the performance of residential mortgage backed securities (RMBS), which are bonds secured by pools of residential mortgages. Simply put, and as explained in greater detail below, in the Summer of 2007, Basis had massive long exposure to the United States housing market. That market suffered a catastrophic crash shortly thereafter. Basis' investments, and indeed, Basis itself, was wiped out in the crash.
"In these roles, Deutsche Bank communicated directly with the rating agencies, marketed [Dutch Hill] to potential investors, updated investors on material changes to the characteristics of [Dutch Hill], and negotiated the price of the notes." See Dkt. 157 at 7.
The types of securities at issue in this case are familiar to the court, the parties, and, presumably, many of the readers of this decision. That being said, for a good summary of the "financial terms and concepts" at issue in this case, see pages 4–11 of TCW's affirmative expert report (Dkt.243), authored by R. Glenn Hubbard, the Dean of the Graduate School of Business at Columbia University and the author of many well-known financial and economic publications. See also id. at 48 ("CDOs are created by re-securitizing RMBS, and RMBS are created by securitizing pools of loans"; "since CDOs are derivative assets of RMBS, which are derivative assets of loan pools, the performance of CDOs is ultimately based on the performance of the underlying loan pools"); see generally Wells Fargo, infra, 797 F.3d at 164–66. The court notes, however, that while Dr. Hubbard is, without a doubt, an expert on the matters contained in his report, the court does not necessarily agree, and passes no judgment on, all matters contained in his report not addressed herein.
See Dkt. 157 at 4–6 ("Between first quarter of 2006 and second quarter of 2007 (i.e., June 30, 2007), the Basis Funds' investments in CDOs, excluding CLOs [collateralized loan obligations], increased approximately 81.5% from approximately $606 million to approximately $1.1 billion. As of April 2007, the Basis Funds had approximately $2.5 billion in credit and structured-credit investments under management, including over 180 CDO equity securities with an aggregate value of over $1 billion, across 80 collateral managers. CDOs include CDOs backed by ABS as well as CLOs backed by corporate credit. BYAFM was a CDO equity fund invested primarily in high-yielding corporate securities, CDOs (equity and mezzanine), and CLOs. As of May 29, 2007, BYAFM's total portfolio of $896 million (by market value) was comprised of 83% structured finance investments, including 31% in mezzanine ABS CDOs, 29% in CLOs, 8% in CDO 2 [pronounced "CDO squared", i.e., a CDO composed of tranches of other CDOs], 5% in other CDOs, and 9% in "high grade" ABS CDOs. As of May 29, 2007, 75% of BYAFM's $156 million total liquid portfolio was invested in below investment grade-rated securities or unrated securities. As of May 29, 2007, 84% of BYAFM's $140 million debt securities portfolio was invested in below investment grade-rated securities or unrated securities. As of February 7, 2007, 96% of BYAFM's $672 million total structured credit portfolio consisted of below investment grade-rated securities or unrated securities. Pac–Rim was an Asia–Pacific multi-strategy hedge fund that invested primarily in non-investment grade high yield debt securities, CDOs, and CLOs. As of May 29, 2007, Pac–Rim's total portfolio of $1.4 billion was comprised of 40% structured finance investments, including 11% in mezzanine ABS CDOs, 19% in CLOs, 4% in other CDOs, and 5% in "high grade" ABS CDOs. All percentages are Approximate. As of May 29, 2007, 57% of Pac–Rim's $765 million total liquid portfolio was invested in below investment grade-rated securities or unrated securities. As of May 29, 2007, 74% of Pac–Rim's $638 million debt securities portfolio was invested in below investment grade-rated securities or unrated securities."). In addition to investing Basis' money in RMBS backed CDOs, BCFM also served as the collateral manager (i.e., the role played by TCW here) for two CDOs collectively worth more than $800 million. See id. at 6–7 ("In 2006 and 2007, BCS served as the collateral manager for Port Jackson CDO 2006–1, Ltd. ["Port Jackson"] and Fort Denison Funding, Ltd. ["Fort Denison"]. Port Jackson was a CDO2 collateralized by CDOs that were themselves collateralized in part by U.S. RMBS. Fort Denison was a CDO collateralized by U.S. RMBS, U.S. ABS, CLOs, CRE repacks and CDOs that were themselves collateralized in part by U.S. RMBS."). Additionally, BYAFM invested in "Timberwolf", a CDO2 transaction at issue in Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc., 115 A.D.3d 128, 980 N.Y.S.2d 21 (1st Dept 2014), aff'd as mod. 37 Misc.3d 1212(A) (Sup Ct, N.Y. County 2012), a case where BYAFM is represented by the same counsel as in this action and which, until recently, was before this court. As with Timberwolf, Basis leveraged its investment in Dutch Hill. See Dkt. 243 at 42–43.
Basis blames banks and collateral managers for its losses. Consequently, Basis commenced numerous lawsuits seeking to recover its losses from the financial professionals that allegedly duped it into investing in what are now worthless securities. Those financial professionals, and here, TCW, counter that Basis was highly sophisticated and knew exactly what it was doing. TCW claims Basis was, as this court and the Appellate Division have referred to them, "contrarians", for the simple reason that when most of the market was running from the perceived toxicity of RMBS, Basis was betting long, and doing so aggressively. Indeed, Basis and TCW admit they both knew the RMBS market was littered with toxic assets. However, Basis did not believe the market would crash as badly as it did, believing it could purchase underpriced long RMBS investments that would ultimately turn a profit. TCW marketed itself as having the know-how to navigate the troubled RMBS market.
Compare Dkt. 157 at 12 ("Throughout the first half of 2007, certain individuals at TCW expressed the view that, on average, portions of the subprime market were experiencing deepening deterioration, including certain types of loans originated in 2006, and that certain RMBS bonds issued in 2006 ("2006 vintage") would incur credit losses. TCW also stated in the Dutch Hill II Investor Presentation that it was TCW's view that on a selective basis the subprime RMBS market remains a fundamentally sound asset class.", with id. at 14–15 ("Basis held similar views and, [p]rior to investing in Dutch Hill II, [BCFM] was aware that the RMBS subprime market was becoming increasingly volatile in the first half of 2007" ').
B. Basis' Investment In Dutch Hill
Dutch Hill was structured as "a paired hedging strategy' involving long' positions in [RMBS] (rated BB+ and BB) paired with short' positions in higher-rated tranches of the same bonds (BBB-, BBB and BBB+)." See Dkt. 157 at 2. "This feature was intended to utilize gains in short' positions held by [Dutch Hill] to offset declines in the value of corresponding long' RMBS investments." Id. "Dutch Hill II also held investments in CDOs, commercial mortgage-backed securities [ ], two money markets and an asset-backed security [ ] backed by small business loans." Id. That being said, Dutch Hill, particularly the lowest rated and equity tranches purchased by Basis, was fundamentally an investment vehicle for taking a net long position on extremely risky RMBS.
Dutch Hill was not a pure volatility bet, that is, it was not an investment that paid off in an amount correlated with volatility, as opposed to price. Rather, Dutch Hill's "investment strategy was to partially hedge against losses" and to arbitrage the perceived mispricing of RMBS assets. See Dkt. 243 at 37.
"[Dutch Hill's] capital structure included seven tranches referred to as Notes' (i.e., A–1, A–2, B, C, D–1, D–2, D–3), and an equity tranche, referred to as the Subordinated Notes." ' See Dkt. 157 at 2. The tranches carried ratings from Standard & Poor's, Fitch, and Moody's raging from AAA (the Class A–1 tranche) to BB+ (the Class D–3 tranche). See id. at 3 (table listing rating of each tranche). "The Subordinated Notes [a/k/a the] equity tranche of [Dutch Hill] was not rated." Id.
The events leading up to Basis' investment in Dutch Hill are set forth in the court's decision on the motion to dismiss, and discovery has revealed such facts to be largely undisputed:
On January 16, 2007, Paul Brownsey, an employee of [ ] Deutcshe Bank, sent plaintiffs an email solicitation to invest in Dutch Hill. On January 26, 2007, representatives of [Basis] and TCW attended a Deutcshe Bank conference in Portugal. At that conference, TCW predicted that there would be losses on RMBS issued in 2006. However, TCW claimed to have developed a system for "navigating" the RMBS market that could identify which RMBS were likely to fail and which RMBS were still good investments. This methodology was supposedly applied to the selection of Dutch Hill's RMBS investments. [Basis was] told that TCW had so much confidence in Dutch Hill that TCW's senior managers would personally invest in Dutch Hill's equity.
On February 12, 2007, [ ] Brownsey sent [Basis] a "preliminary investor presentation" for Dutch Hill (the Presentation). The Presentation expanded on TCW's supposed ability to continue to identify good RMBS investments. Specifically, TCW represented that it "designed [Dutch Hill] to capitalize on opportunities in the below investment grade RMBS market" [emphasis added] by "exploiting market inefficiencies" as "the most reliable way to enhance returns." The supposed "inefficiencies" were "the market being relatively young' and still developing,' " "the perceived complexity of security valuation," and "lack of skill or experience' leading investors to avoid these offerings." The Presentation expressed TCW's view that "on a selective basis the subprime RMBS market remains a fundamentally sound asset class." TCW also confirmed that, as originally indicated at the conference, three of its senior staff would personally invest in the equity of Dutch Hill.
On March 14, 2007, TCW sent [Basis] a "U.S. Housing Market Update" (the Market Update) along with a letter by TCW's Managing Director (who supposedly intended to purchase Dutch Hill equity), which stated that "we are confident that our investment process has mitigated the impact on [RMBS] portfolios." The Market Update again remarked on problems in the RMBS market, such as originators easing mortgage underwriting standards and home price depreciation, but reemphasized that TCW has "minimized and often avoided" poor quality loans in TCW transactions.
On April 30, 2007, Brownsey forwarded [Basis] an email from TCW which stated that the three senior TCW employees who were going to invest in Dutch Hill had decided not to invest. The explanation provided was that they were relying on a loan from TCW to make the investment, but TCW recently changed company policy to prohibit such loans. [Basis was] assured, however, that the TCW employees' decision not to invest was based solely on the unavailability of TCW financing and "in no way reflects on their confidence in [Dutch Hill], which remains very high."
In reliance on all of TCW's above mentioned representations—most importantly its ability to figure out which RMBS were still good, long bets—[Basis] decided to invest in the riskiest portions of Dutch Hill. On May 2, 2007, Pac–Rim purchased $11.8 million of BBB minus rated Dutch Hill notes and BYAFM purchased over $16.3 million in unrated Dutch Hill subordinated notes (including the notes that were originally going to be purchased by TCW employees).
The very next day, May 3, 2007, Jeffrey E. Gundlach, TCW's Chief Investment Officer (the lead executive on Dutch Hill), published a letter in which he expressed negative views on the RMBS market and indicated that "the lowest-rated investment grade bonds [such as the notes purchased by Basis] would experience losses." Over the next few months, as the RMBS market continued to deteriorate and eventually crash, Gundlach made further negative remarks about the RMBS market. He later referred to his May 3, 2007 letter as a "public sell recommendation on subprime bonds and CDOs." By the end of July 2007, after ratings agency downgrades and margin calls, [Basis'] Dutch Hill notes had lost most of their value. [Basis'] Dutch Hill notes, now, are virtually worthless.
As discussed below, discovery has revealed what types of RMBS and loans TCW considered to be "poor quality", namely, 2006 vintage RMBS, and particularly those backed by certain shoddy originators.
Discovery has revealed this explanation was proffered as pretext for assuaging Basis' concern that TCW's employees no longer believed in Dutch Hill. TCW, however, produced evidence suggesting that Basis considered the significance of the TCW employees not investing to be immaterial to its decision to invest in Dutch Hill.
On May 18, 2007, approximately two weeks after Gundlach published his letter, BYAFM purchased the reminder of the equity tranche for approximately $528,000. This, as explained further below, undercuts Basis' argument that Gundlach's opinions were material to Basis' decision to invest. Basis may simply have disagreed with Gundlach. This, however, is a question of fact that cannot be resolved by the court.
Basis Pac–Rim Opportunity Fund (Master) v. TCW Asset Mgmt. Co., 40 Misc.3d 1240(A), at *2–3 (Sup Ct, N.Y. County 2013) (MTD Decision) (bold added), aff'd 124 AD3d 538 (1st Dept 2015).
The Appellate Division affirmed this court's dismissal of Basis' negligent misrepresentation cause of action and also this court's subsequent denial of Basis' motion to renew. TCW did not appeal this court's denial of its motion to dismiss Basis' fraud cause of action. Nor did Basis appeal this court's dismissal of its cause of action for unjust enrichment and third-party beneficiary breach of contract claim under the Investment Advisory Agreement. See MTD Decision at *9–10.
The court further explained that:
[Basis'] fraud claims, as alleged, can be summarized as follows[:] First, TCW—which supposedly was an independent collateral manager tasked with picking Dutch Hill's RMBS investments based on some proprietary method of separating the wheat from the chaff—was neither independent nor that insightful. Rather, TCW, whose business of managing CDOs worth approximately $28 billion was in peril due to the impending collapse of the housing market, needed to find a way to convince investors to keep making long RMBS bets in an environment where the appetite for such bets was justifiably waning. Thus, TCW fabricated an ability for finding "good" RMBS and touted such ability to investors, such as plaintiffs, to assure them that, with TCW's expertise, there was still good money to be made on RMBS even as the market continued to destabilize. This [allegedly] was a lie.
Moreover, TCW, according to [Basis], worked closely with major financial institutions, such as Deutsche Bank, who TCW relied on to structure RMBS deals. To maintain this relationship and ensure that Deutsche Bank continued to send TCW highly lucrative deals, TCW betrayed its obligation of independence to CDO investors by allowing Deutsche Bank to offload toxic RMBS from its balance sheet and dump them into CDOs managed by TCW. In this case, [Basis] identified a notorious CDO called Gemstone 7, that they claimed Deutsche Bank knew to be toxic (its underlying RMBS were called "crap" by Deutsche Bank's employee Greg Lippman) and could not sell to anyone. Despite TCW's assurances that it would only allow Dutch Hill to acquire RMBS investments it knew to be good, TCW caused Dutch Hill to acquire Gemstone 7. [Basis] allege[s] that TCW engaged in similar improper methods of building Dutch Hill's portfolio.
A Deutsche Bank prop trader who heavily shorted the RMBS market before the crash.
MTD Decision, at *3.
That being said, the court noted that this case was somewhat different than many of the typical RMBS fraud cases, since the allegation was not that the defendant bank duped the plaintiff investor into thinking that RMBS were generally a sound asset class. Instead:
[T]his is a case where all parties recognized the problems in the housing market prior to [Basis'] investment. However, unlike other investors who may have disagreed with the general consensus about the housing market and still made large, long RMBS investments as late as May 2007, [Basis], sophisticated investors, relied upon TCW's representations championing a unique investment strategy. Here, TCW marketed and [Basis] invested in a purported ability to target specific RMBS that were immune from the general toxicity of the housing market. Though most investors were wary of all RMBS given the known problems in the market, [Basis] bought into TCW's alleged ability to identify non-toxic RMBS. If this really was the basis for [Basis'] investment, TCW cannot rely on the common defense that "plaintiffs are sophisticated" and that "they should have known better" because "problems in the housing market were well known at the time of their investment." This argument is useless because the very point of investing with TCW was to alleviate these concerns. Hence, the issue in this case is not whether it was objectively reasonable for a sophisticated investor to make long RMBS bets in May 2007. Rather, the question is whether a sophisticated investor such as [Basis] could have reasonably believed in TCW's purported unique abilities.
MTD Decision, at *4.
This argument has now been presented to the court in a more nuanced manner. Specifically, Basis not only alleges that TCW failed to select Dutch Hill's RMBS collateral in the manner represented, but that TCW's particular long-short investment strategy was impossible to execute under 2007 market conditions. Dutch Hill had been marketed by TCW since 2005. Basis contends that when it was being solicited by TCW in 2007, the market conditions TCW was relying on to profitably execute its long-short strategy had abated. Simply put, TCW was allegedly marketing an investment strategy in 2007 it did not believe it could profitably execute.
The truth of this allegation is not at issue on this motion, as such truth (or lack thereof) is not a ground on which TCW seeks summary judgment. Nonetheless, framing the allegation in this way is useful to ascertaining the viability of TCW's summary judgment arguments—namely: (1) whether TCW actually made such misrepresentations; (2) whether, if false, they were knowingly false; (3) whether Basis reasonably relied on these representations in deciding to invest in Dutch Hill; and (4) whether these representations being false was the cause of Basis' loss. As set forth below, questions of fact regarding all of these issues preclude summary judgment.
II.Legal Standard
Summary judgment may be granted only when it is clear that no triable issue of fact exists. Alvarez v. Prospect Hosp., 68 N.Y.2d 320, 325, 508 N.Y.S.2d 923, 501 N.E.2d 572 (1986). The burden is upon the moving party to make a prima facie showing of entitlement to summary judgment as a matter of law. Zuckerman v. City of New York, 49 N.Y.2d 557, 562, 427 N.Y.S.2d 595, 404 N.E.2d 718 (1980) ; Friends of Animals, Inc. v. Associated Fur Mfrs., Inc., 46 N.Y.2d 1065, 1067, 416 N.Y.S.2d 790, 390 N.E.2d 298 (1979). A failure to make such a prima facie showing requires a denial of the motion, regardless of the sufficiency of the opposing papers. Ayotte v. Gervasio, 81 N.Y.2d 1062, 1063, 601 N.Y.S.2d 463, 619 N.E.2d 400 (1993). If a prima facie showing has been made, the burden shifts to the opposing party to produce evidence sufficient to establish the existence of material issues of fact. Alvarez, 68 N.Y.2d at 324, 508 N.Y.S.2d 923, 501 N.E.2d 572 ; Zuckerman, 49 N.Y.2d at 562, 427 N.Y.S.2d 595, 404 N.E.2d 718. The papers submitted in support of and in opposition to a summary judgment motion are examined in the light most favorable to the party opposing the motion. Martin v. Briggs, 235 A.D.2d 192, 196, 663 N.Y.S.2d 184 (1st Dept 1997). Mere conclusions, unsubstantiated allegations, or expressions of hope are insufficient to defeat a summary judgment motion. Zuckerman, 49 N.Y.2d at 562, 427 N.Y.S.2d 595, 404 N.E.2d 718. Upon the completion of the court's examination of all the documents submitted in connection with a summary judgment motion, the motion must be denied if there is any doubt as to the existence of a triable issue of fact. Rotuba Extruders, Inc. v. Ceppos, 46 N.Y.2d 223, 231, 413 N.Y.S.2d 141, 385 N.E.2d 1068 (1978).
III.Discussion
By virtue of the MTD Decision, issued on September 10, 2013, all that remains is Basis' cause of action against TCW for fraudulently inducing its investment in Dutch Hill. Both fact and expert discovery were completed 13 months thereafter, and Basis filed a Note of Issue on October 3, 2014.
Counsel are commended for the exemplary and expeditious manner in which they conducted discovery. This is a highly complex RMBS fraud case, yet counsel have demonstrated that it is possible for cases such as this to be resolved on the merits without discovery dragging on for more than half a decade.
On February 6, 2015, TCW filed the instant motion for summary judgment, seeking dismissal of Basis' fraud claim on four independent grounds, each of which is a predicate element for fraud. See Eurycleia Partners, LP v. Seward & Kissel, LLP, 12 N.Y.3d 553, 559, 883 N.Y.S.2d 147, 910 N.E.2d 976 (2009) ("The elements of a cause of action for fraud [are] a material misrepresentation of a fact, knowledge of its falsity, an intent to induce reliance, justifiable reliance by the plaintiff and damages."); Basis Yield Alpha Fund (Master) v. Goldman Sachs Group, Inc., 115 A.D.3d 128, 135, 980 N.Y.S.2d 21 (1st Dept 2014) ; see also Gaidon v. Guardian Life Ins. Co. of Am., 94 N.Y.2d 330, 349–50, 704 N.Y.S.2d 177, 725 N.E.2d 598 (1999) (plaintiff must prove each element by clear and convincing evidence.)
First, TCW argues that it did not make any material misrepresentation. Second, it argues that it did not have fraudulent intent. Third, TCW argues that Basis did not actually rely on its representations and, even if Basis did, its reliance was unreasonable. Last, TCW argues that it did not cause Basis' investment losses. Specifically, as discussed below, TCW argues that Basis has no proof of loss causation. TCW does not seek summary judgment on transaction causation.
Basis opposes all four arguments. In reply, TCW avers that Basis' opposition reveals that it cannot prove the elements of loss causation or reliance. The court reserved on the motion after oral argument. See Dkt. 257 (7/30/15 Tr.).
A. Material Misrepresentation
"In a securities fraud case, there are two ways to establish a material misrepresentation. The first, as in all fraud cases, is to identify a specific false statement. The second is to establish that defendants' representations, taken together and in context, would have [misled] a reasonable investor' about the nature of the investment." MTD Decision, at *4 (collecting cases), quoting Acacia Nat'l Life Ins. Co. v. Kay Jewelers, Inc., 203 A.D.2d 40, 44, 610 N.Y.S.2d 209 (1st Dept 1994). With respect to the former, an expression of opinion may "be actionable if the speaker does not genuinely and reasonably believe it or if it is without a basis in fact." Basis Yield, 37 Misc.3d 1212(A), at *7, quoting Abu Dhabi Comm. Bank v. Morgan Stanley & Co., 651 FSupp2d 155, 176 (S.D.N.Y.2009), quoting In re IBM Corp. Sec. Lit., 163 F.3d 102, 109 (2d Cir.1998) ; see generally FHFA v. Nomura Holding Am., Inc., 2015 WL 2183875, at *94 (S.D.N.Y.2015) (Cote, J.), accord Omnicare, Inc. v. Laborers Dist. Council Const. Indus. Pension Fund, ––– U.S. ––––, –––– – ––––, 135 S.Ct. 1318, 1326–30, 191 L.Ed.2d 253 (2015) :
[A] reasonable investor may, depending on the circumstances, understand an opinion statement to convey facts about how the speaker has formed the opinion—or, otherwise put, about the speaker's basis for holding that view. And if the real facts are otherwise, but not provided, the opinion statement will mislead its audience.... Thus, if a [Prospectus Supplement] omits material facts about the issuer's inquiry into or knowledge concerning a statement of opinion, and if those facts conflict with what a reasonable investor would take from the statement itself, then [there is] liability.
Omnicare, 135 S.Ct. at 1328–29.
There are questions of fact about whether the representations TCW made to Basis about Dutch Hill were material to Basis' investment decision. As the court previously discussed on the motion to dismiss, materiality and the related element of actual reliance are inherently fact intensive inquiries, and are likewise not ordinarily amenable to summary judgment. That being said, TCW argues that Basis has not identified a single, actionable misstatement that could possibly be material to Basis. TCW is wrong.
Basis' core theory is that TCW's expressed views about the RMBS market and the collateral it was selecting for Dutch Hill were not, in fact, the views held by TCW internally. The record on this motion is certainly not dispositive of this question, nor does Basis think otherwise, as Basis does not seek summary judgment. Nonetheless, Basis has met its burden of proffering evidence from which a reasonable juror could conclude that TCW's internal views of the subject RMBS collateral differed from the representations made to Basis.
As discussed herein, whether Basis could reasonably rely on TCW's statements given the information about the market at Basis' disposal is a question of fact. There is nothing in the record that definitively resolves this question. The court may not, for the purpose of summary judgment, decide that TCW's reliance evidence is more persuasive. On the contrary, all reasonable inferences must be drawn in favor of Basis, the non-moving party. See Rollins v. Fencers Club, Inc., 128 A.D.3d 401, 402 (1st Dept 2015) ("all of the evidence must be viewed in the light most favorable to the party opposing the motion, and all reasonable inferences must be resolved in that party's favor") (citation omitted).
Insight into TCW's views on the RMBS market can be gleaned by reviewing its employees' internal emails from early 2007. For instance, Roland Ho, Dutch Hill's portfolio manager, sent the following email to his team on February 11, 2007:
I am very excited as great opportunities could be just ahead of us. And of course, as always, opportunities would only be captured by those who have well prepared to capture them. The problems with Ameriquest & New Century, the free-fall of ABX, the jumps in delinquency of the 06 vintage and the speed of widening of spreads tell us that there are,
a. extreme high perceived risk in the market
b. high real risk in ABS
c. fear in the market, and the level of fear could race to an even higher level
These would likely [ ] continue to cause:
a.volatilities in both prices and basis
b.non-differentiation of credit
c.very high liquidity premium
And this would give rise to great opportunities:
a.cheap ok/good performing assets (e.g.> 07.Feb origination )
b.chance to risk mitigate our existing portfolios
c.earn high liquidity premium at low risk from stressed/distressed assets
Frozen by the fear of risk, many of our competitors might not know what to do, many would choose to retreat from the market and stay on the sideline, and some might have already started their panic selling. We, on the other hand, shall find ourselves very busy in working to protect our current business, expanding into new businesses and capture all kinds of market opportunities in the next 6 to 18 months.
It is imperative to make sure that we do not fall victim to fear even if the market might seemed crumbling around us in the next few months. It is also very important that we make sure everyone working for each of us would not succumb to such fear. We shall show leadership and hold our team together strong. We shall prevail.
Here is my summary of what many of us know and have been talking about (in particular from Lou):
Our closed CDOs
1. chance to buy cheap discount bonds
2. might be able to recoup losses incurred before
3. Find out how much flexibility for each CDO portfolio (WARF, correlation, WAC/WAS etc ... ), and how much subprime BBB & BBBwe could use
4. buy discount subprime BBB & BBB-. Buy high coupon premium higher grade assets
5. sell weak BBB and buy strong BBB-.
6. Sajjad needs to re-establish approval names: AM, AR?, CW, and a few more names
New Business
1. Contrary to common reaction to fear of market, we should want to do as much new business as possible. In fact, we should be willing to stretch (but not overly-stretched) ourselves a little to maximize our capacity of doing new business. The business reasons are:
a. We can do business while others stop. This enables us to build further lead from our competitors even faster.
b. At the minimum we will be producing portfolios that would perform much better than say 06 vintage. We are likely producing great performing portfolios as underwriting is improved and prices are cheap.
c. We might be able to expand into business areas that was tough to get into because competitors in those areas might be sitting on the sideline.
d. We could get in position to take advantage of stressed/distressed market.
2. This means that in addition to maximizing our capacity for the existing CDO business, we shall work very hard to explore all new business potential
3. However, while we do want to do as much business as we could, execution is the key. We need to execute very well. In fact, we need to execute better than before. We cannot afford to trip because of poor execution.
4. There is not [sic] shortage of demand from banks for doing TCW mezz deals. This will of course give us great buying power of subprime BBB & BBB-. We shall use this to:
a. Get friendly bank to manufacture good subprime pools, thus good BBB & BBBfor new deals as well as for risk mitigation of existing deals
b. We might get banks to make cheap AA & A for high grade deals too. For example, Lehman CP deal.
5. We should work hard to set up Jolero, closed end fund and/or other opportunistic fund & separate accounts.
See Dkt. 195 (underline in original; bold added); see also Dkt. 194 (email and attached supporting data, concerning Dutch Hill, discussing 2006 vintage RMBS delinquency rates); see generally Dkt. 166 at 2–16 (March 2007 confidential internal memoranda and market update concerning TCW's view of the U.S. housing market.).
The "Closing Remarks" note that between "December 1[, 2006] to March 3, [2007,] the Wall Street Journal printed 128 articles that mentioned the subprime mortgage industry." See Dkt. 166 at 16. That being said, the next two lines stated: "Our credit research, asset-selection and surveillance processes were developed to help mitigate these risks. We view continued announcements of acquisitions and consolidations among mortgage originators as an indication that some investors think a rapid recovery is probable. " See id. (emphasis added).
These emails and internal documents, among others, indicate that TCW recognized that there were problems in the RMBS market, but nonetheless thought there were still opportunities to buy underpriced RMBS assets. Specifically, TCW noted that there were serious problems with 2006 vintage RMBS, but that RMBS from other years backed with collateral from decent originators could be good investments. However, as Basis correctly observes, Dutch Hill was heavily composed of CDOs backed by 2006 vintage RMBS, including RMBS backed by loans from some of the worst originators. Basis, therefore, complains that even if TCW may have believed that there were opportunities to find "good" RMBS to include in Dutch Hill, it simply did not, nor did it intend to do so. Indeed, on March 16, 2007, approximately a month and a half before Basis invested in Dutch Hill, Joe Burschinger, TCW's Chief Risk Officer, thought there was only a 50% chance that there would be sufficient cash flow to pay the eventual equity investor (BYAFM).See Dkt. 165 at 121.
See Dkt. 186 at 9 (explaining that Burschinger "ascribed a 50/50 probability to the likelihood that TCW would not earn its subordinate management fee for [Dutch Hill]. That fee is paid only if all coverage tests are satisfied and has priority over distributions to the equity. If so, there was a greater than 50/50 chance that cash flow that would otherwise go to the equity investor (here, BYAFM) would be diverted to higher tranches of notes.").
One month later, on April 16, 2007, Gundlach and others at TCW gave a presentation to board members that also painted a bleak picture about 2006 vintage RMBS. The presentation is summarized in the board minutes:
Mr. Gundlach provided an overview of the sub-prime market as a driver of borrowing in recent times. He noted that 20% of 2006 home loan origination was in the sub-prime market. He noted that sub-prime is not a universal definition but that approximately $1.3 trillion is considered to be in the sub-prime market and $1 trillion in the Alt A space (a level above sub-prime, with higher origination standards). He stated that 2006 was a late-stage boom and that some lenders had shaky practices or were more lax in their underwriting standards. He also noted that in addition to predatory lending practices there were also predatory borrowing practices. He noted that delinquencies in the sub-prime market were reported at 13.3% but that this was off of a nominalized base of 10%. His view is that the problems in the sub-prime market are probably overstated today but are understated for the future as defaults come in, which will happen over time. He explained the "put" feature associated with bad loans, the exercise of which has resulted in several marginal lenders going out of business, including, eventually, a significant lender, New Century.
Mr. Gundlach reviewed for the Board the compensation of the ABX index, which has been used as a proxy for the sub-prime market. He noted the composition is not reflective of the sub-prime market. He stated that the index drop from 100 to 62 over a short period of time has elevated the matter to a matter of concern. He noted that the mortgage-backed market generally moves in slow motion and that the Company nominally has one data point per month when resets take place. He noted that TCW portfolios have approximately $16 billion in sub-prime in its portfolio. However, the below investment grade tranches issued in 2006 reflect the largest exposures; our exposure in this area is approximately $200 million.
He noted that the $200 million exposure we have to the sub-prime market is part of our long-short strategy. He stated that only 20% of issuances in 2006 satisfied TCW's tests of credit and structure.
[Louis] Lucido [Dutch Hill's Group Manager] discussed various market aspects involving the loans, involving reset issues and refinancing. He stated that TCW's emphasis on fundamental research capabilities services could help us stand out in this market. Mr. Day believed that TCW thrives in changing markets and our emphasis in research will result in a flight to quality.
Mr. Gundlach concluded that volatility will not likely slow down business opportunities in the near term but may affect it in the mid term. He believes that there will be downgrades that will be taken by the rating agencies that will provide opportunities for the Firm.
See Dkt. 165 at 36–37 (emphasis added).
Basis, moreover, does not merely rest its fraud claim on TCW's alleged false expressions of opinions about the market. Rather, Basis also alleges actual malfeasance on the part of TCW with respect to how Dutch Hill's collateral, such as Gemstone VII, was selected. In support of its summary judgment motion, TCW argues that Basis has no evidence of any such malfeasance. TCW is certainly correct that its employees' correspondence with Deutsche Bank does not prove, without a doubt, that TCW included Gemstone VII in Dutch Hill as part of a quid pro quo with Deutsche Bank. However, the emails raise questions about why Gemstone VII was included in Dutch Hill, particularly given the composition of Gemstone VII's collateral. For instance, Gemstone VII, a CDO, was primarily composed of 2006 vintage RMBS rated BBB or lower, precisely the sort of RMBS investment that TCW stated was terrible. Its inclusion in Dutch Hill, even in the absence of any improper agreement with Deutsche Bank, raises a question of fact about whether TCW intended to compose Dutch Hill in the manner advertised. Likewise, TCW caused Dutch Hill to acquire other collateral of the sort TCW appeared to believe would not perform, such as Tourmaline III, again mostly backed by 2006 vintage RMBS composed of mortgages originated by the very originators, such as Fremont and New Century, which TCW knew to be engaged in some of the worst origination practices. TCW, nonetheless, avers that summary judgment in its favor is still warranted because all of the TCW and Deutsche Bank witnesses testified at their depositions that Basis' quid pro quo allegations are false. Basis correctly responds that such self-serving testimony cannot justify summary judgment, as those witnesses' credibility is a question of fact for the jury to assess. Consequently, TCW is not entitled to summary judgment on the element of material misrepresentation.
B. Scienter
There also are questions of fact about whether TCW acted with scienter, the requisite intent to defraud. Whether a defendant had fraudulent intent "is ordinarily a question of fact which cannot be resolved on a motion for summary judgment." Shisgal v. Brown, 21 A.D.3d 845, 847, 801 N.Y.S.2d 581 (1st Dept 2005). Direct proof of fraudulent intent does not always exist, nor does lack of such proof preclude a fraud claim because "[p]articipants in a fraud do not affirmatively declare to the world that they are engaged in the perpetration of a fraud." Oster v. Kirschner, 77 A.D.3d 51, 55–56–57, 905 N.Y.S.2d 69 (1st Dept 2010). For this reason, "intent to commit fraud [may] be divined from surrounding circumstances." Id. at 57, 905 N.Y.S.2d 69, citing Eurycleia, 12 N.Y.3d at 559, 883 N.Y.S.2d 147, 910 N.E.2d 976.
That said, TCW correctly avers that "the motive to earn fees alone is, without more, insufficient for the court to infer scienter." MTD Decision, at *5 (emphasis added; collecting cases). As discussed on the motion to dismiss, Basis has proffered a reasonable inference about why TCW would have been motivated to make material misrepresentations to induce Basis to invest in Dutch Hill. See id. Furthermore, on this record, Basis does more than merely make a plausible showing of scienter based on proof of motive. For instance, as discussed earlier, Basis has submitted evidence suggesting that TCW's own internal views about Dutch Hill's collateral did not align with the views TCW publicly expressed to investors. This is enough to raise a question of fact as to TCW's fraudulent intent, as a reasonable finder of fact could conclude that this proves TCW's misrepresentations were made with the intent to deceive. Whether a jury will ultimately find that TCW acted with fraudulent intent is of no moment at this juncture. Basis' burden is to raise questions as to whether TCW's expressed opinions were genuinely felt, and it has met that burden. TCW has not submitted any evidence conclusively resolving these questions. Summary judgment on scienter, therefore, is denied.
C. Reliance
Additionally, the questions of whether Basis actually and reasonably relied on TCW's representations cannot be resolved on this motion. The reasonableness of Basis' reliance is a question of fact for the jury. It requires a specific determination of what an investor in Basis' position could be expected to know about the RMBS market. See Mountain Creek Acquisition LLC v. Intrawest U.S. Holdings, Inc., 96 A.D.3d 633, 634, 947 N.Y.S.2d 470 (1st Dept 2012), citing UST Private Equity Invs. Fund v. Salomon Smith Barney, 288 A.D.2d 87, 88, 733 N.Y.S.2d 385 (1st Dept 2001) ("a sophisticated plaintiff cannot establish that it entered into an arm's length transaction in justifiable reliance on alleged misrepresentations if that plaintiff failed to make use of the means of verification that were available to it"); Stuart Silver Assoc. v. Baco Dev. Corp., 245 A.D.2d 96, 98–99, 665 N.Y.S.2d 415 (1st Dept 1997) ("Where a party has the means to discover the true nature of the transaction by the exercise of ordinary intelligence, and fails to make use of those means, he cannot claim justifiable reliance on defendant's misrepresentations"). Based on the evidence submitted, it does not appear that Basis had the level of knowledge of those that aggressively shorted the market. Basis, after all, was an Australian hedge fund, not an American bank that originated bad loans that caused RMBS to fail. On the other hand, Basis was a collateral manager in other deals, and, therefore, must be charged with a heightened level of diligence given its relative sophistication, even if Greg Lippman and Goldman did not think Basis should be considered "smart money". Nonetheless, it is for the jury, not the court, to decide what was reasonable for Basis to rely on.
As for actual reliance, nothing in the record is dispositive of whether Basis actually based its investment decisions upon TCW's representations. There is evidence that suggests otherwise, such as Basis' apparent apathy toward the revelation that TCW employees would not be investing in Dutch Hill [see Dkt. 168 at 6] and Basis' investments in other risky RMBS after Gundlach published his May 3, 2007 letter. Nevertheless, while these are facts a jury can consider in deciding whether Basis relied on TCW's representations, they do not conclusively prove that Basis did not justifiably rely on TCW's opinions or how Dutch Hill was structured. Based on the evidence submitted, a reasonable finder of fact could conclude that Basis believed TCW had a technique by which it could select RMBS that did not suffer from the fraud that permeated the 2006 mortgage origination market and that Basis invested in Dutch Hill in reliance on TCW's representations. Alternatively, a reasonable finder of fact might conclude that Basis did not care about TCW's purported system and was merely a contrarian that thought the RMBS market presented opportunities for those who believed there was merely a short term panic that would quickly abate. It is for the jury to decide which story to believe. And while there is no question of fact that Basis' views of the RMBS market were woefully misguided-views which put Basis out of business-if Basis' views about the opportunities presented by Dutch Hill were reasonably based on representations about Dutch Hill that were false and which TCW did not itself believe, Basis may be entitled to recover its investment.
D. Loss Causation
Of the four issues addressed in the parties' briefs, loss causation is the least discussed. Nevertheless, it was the focus of oral argument. It, likewise, is the focus of this decision. In making its determination, the court relies on the comprehensive decision of Judge Guido Calabresi, who eloquently explains the concept of loss causation in a recent, highly persuasive Second Circuit opinion. See Loreley Fin. No. 3 Ltd. v. Wells Fargo Secs., LLC, 797 F.3d 160, 183 (2d Cir.2015) (Wells Fargo ).
The substantive loss causation discussion in Wells Fargo pertains to New York common law, not federal securities law. It should be noted, however, that Wells Fargo was a decision on a motion to dismiss, and hence focused on what must be pleaded to survive such a motion, as opposed to proven at summary judgment and trial. As Judge Calabresi noted, there appears to be conflicting precedent in the First Department on whether loss causation must be pleaded and what that standard actually entails. See Wells Fargo, 797 F.3d at 182 n. 14 (collecting cases). The standard proffered by plaintiffs—that the plaintiff's "allegations are sufficient to show loss causation since it was foreseeable that [plaintiff] would suffer losses as a result of relying on [defendant's] alleged misrepresentations" [MBIA Ins. Corp. v. Countrywide Home Loans, Inc., 87 A.D.3d 287, 296, 928 N.Y.S.2d 229 (1st Dept 2011) ]—is too general to be useful. Judge Calabresi further noted that the First Department held that the Loreley Cases (the UBS case before this Justice and the Citigroup and Merrill cases before Justice Oing) were sufficiently pleaded "with nary a mention of loss causation." See Wells Fargo, 797 F.3d at 182 n. 14. That being said, this court relies on Wells Fargo only to the extent it clearly sets forth the nature of loss causation and distinguishes that concept from transaction causation. Wells Fargo's holdings regarding pleading standards are inapposite because a plaintiff's burden for surviving a motion to dismiss differs from the burden on a summary judgment motion.
The parties both recognize that loss causation is an element a plaintiff must prove to prevail on a common law fraud claim, a requirement long recognized in securities and other fraud cases. See Wells Fargo, 797 F.3d at 183, citing Schlick v. Penn–Dixie Cement Corp., 507 F.2d 374, 380 (2d Cir.1974), Bastian v. Petren Res. Corp., 892 F.2d 680, 683 (7th Cir.1990) (Posner, J.) ("what securities lawyers call loss causation' is the standard common law fraud rule, merely borrowed for use in federal securities fraud cases."), and Moore v. PaineWebber, Inc., 189 F.3d 165, 174 (2d Cir.1999) (Calabresi, J., concurring) (RICO fraud). The parties further agree that under New York common law, the causation element of a fraud claim has two distinct prongs: (1) transaction causation; and (2) loss causation. See Laub v. Faessel, 297 A.D.2d 28, 31, 745 N.Y.S.2d 534 (1st Dept 2002) ("To establish causation, plaintiff must show both that defendant's misrepresentation induced plaintiff to engage in the transaction in question (transaction causation) and that the misrepresentations directly caused the loss about which plaintiff complains (loss causation)") (collecting cases; emphasis added); see also Mosaic Caribe, Ltd. v. AllSettled Group, Inc., 117 A.D.3d 421, 422, 985 N.Y.S.2d 33 (1st Dept 2014) (holding loss causation is not only mandatory element of fraud claim, but also must be pleaded with particularity to survive motion to dismiss); Greentech Research LLC v. Wissman, 104 A.D.3d 540, 961 N.Y.S.2d 406 (1st Dept 2013) (same).
TCW does not seek summary judgment on transaction causation. For the purposes of this motion, the parties and the court assume that if Basis knew TCW's representations were false, Basis would not have invested in Dutch Hill.
Superficially, the difference between transaction causation and loss causation appears straightforward. Transaction causation is "but-for" causation, and merely requires proof that but for "[defendant's] fraudulent misrepresentations, [plaintiff] would not have entered into the transaction." See Fin. Guar. Ins. Co. v. Putnam Advisory Co., 783 F.3d 395, 402 (2d Cir.2015). "Loss causation, on the other hand, is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff." ' Id., quoting Lentell v. Merrill Lynch & Co., 396 F.3d 161, 172 (2d Cir.2005). "In the securities fraud context in general, an investor may buy shares of a certain stock because her broker falsified—or neglected to mention—some detail but then suffer a loss due to a nationwide recession. Loss causation is lacking unless the fraudulent statement that induced her to invest can also be shown to have made her investment, in fact, more disposed to suffer the alleged harm—a catastrophic market collapse—than honestly described alternative investments. " Wells Fargo, 797 F.3d at 186 (emphasis added). This sounds simple enough. It is not.
See also Loreley Fin. (Jersey) No. 4 Ltd. v. UBS Ltd., 42 Misc.3d 858, 864, 978 N.Y.S.2d 615 (Sup Ct, N.Y. County 2013) ("though an investor may be able to prove that he would not have invested but for the misrepresentation, if the investor lost his money for wholly unrelated reasons (say, the market crashing), the investor cannot get his money back via rescission. This makes perfect sense and is the law in this state. If this were not the law, for instance, one could sue for a stock's depreciation on the grounds that the company represented an earnings expectation that proved to have no basis in fact when the stock's depreciation occurred during a massive economic downturn, when all stocks in a particular asset class declined, regardless of their individual forecasted earnings. There is a litany of precedent firmly establishing that the loss causation element exists precisely to prevent opportunistic investors from getting their money back when their losses had nothing to do with the subject representations. (See Dexia, 929 F Supp 2d at 243 ["when a plaintiff's loss coincides with a marketwide phenomenon causing comparable losses to other investors,' a plaintiff must allege specific facts which, if proven, would show that its loss was caused by the alleged misstatements as opposed to intervening events"], quoting Lentell, 396 F.3d at 174 ["our precedents make clear that loss causation has to do with the relationship between the plaintiff's investment loss and the information misstated or concealed by the defendant"].) Indeed, if loss causation was not a required element, every market downturn would subject every investment to a fraud claim."), mod. on other grounds, 123 A.D.3d 413, 998 N.Y.S.2d 172 (1st Dept 2014).
Here, Basis' investment in Dutch Hill was, even without accounting for the financial crisis, objectively risky. Basis invested in the lowest tranches of Dutch Hill, which suffer the first losses if the collateral does not generate enough revenue to pay off the senior tranches. In fact, much of Dutch Hill's collateral carried below investment grade ratings. That was by design, as riskier investments have a higher rate of return. TCW's strategy, purportedly, was to select collateral that was rated poorly by the ratings agencies but which, in TCW's opinion, was mispriced and was worth more than the market perceived. Consequently, of the available universe of risky RMBS collateral, TCW supposedly could pick good risky RMBS and make money. TCW argues that the loss causation inquiry should focus on whether, had TCW picked the "best" of the riskiest collateral—would that collateral also have gone bust since Basis wanted risky collateral, and all the riskiest collateral lost money. In other words, TCW contends that the manner in which it picked the collateral did not matter since all the risky collateral was wiped out. If that is the case, TCW contends Basis cannot establish loss causation.
Moreover, what about the counterfactual that flows from Basis' transaction causation argument—that is, if Basis knew TCW was lying about its investment methods, then Basis would have invested elsewhere. If that elsewhere was also risky RMBS, the money Basis lost investing with TCW would have still been lost, just in another (allegedly fraudulent) investment such as, for instance, Timberwolf, which Basis invested in mid-June 2007, approximately a month and a half after it invested in Dutch Hill, and a month and a half after Gundlach made negative comments about the RMBS market. Is this relevant to loss causation? Should the loss causation inquiry take into account the general, non-speculative fate of Basis' money possibly being destined to be lost in the RMBS market, or is the only relevant inquiry whether there were RMBS suitable for inclusion in Dutch Hill that would not have lost money had they been properly selected by TCW in accordance with its advertised methodology?
As noted earlier, the fact that Basis invested in risky RMBS deals more than two months after Gundlach published his letter is certainly relevant to the elements of materiality and reliance.
No RMBS case is squarely on point, but Wells Fargo speaks to the issue:
Here, Plaintiffs clearly allege transaction causation, i.e., that they would not have invested in the three CDOs but for Defendants' misrepresentations. They also allege that the CDOs were all in some way designed to fail and did fail. Specifically, Plaintiffs assert that contrary to the picture painted in the offering documents of purportedly independent collateral managers selecting high-quality assets for the benefit of long investors, toxic assets were purposefully chosen for each CDO—in the case of the constellation CDOs, in order to advance Magnetar's long-short strategy; in the case of Longshore, in order to offload these assets from Wachovia's own books. Defendants contend, however, that the subsequent market crash was of such dramatic proportions that Plaintiffs' losses would have occurred at the same time and to the same extent regardless of the alleged fraud. If Defendants are right, and the alleged fraud in no way increased the chance of Plaintiffs' ultimate losses, then loss causation is lacking.
Wells Fargo, 797 F.3d at 186–87 (italics in original; bold added).
To understand the loss causation issue in this case, the court finds it useful to view the matter from a perspective outside of the RMBS context. In this regard, the court finds Judge Calabresi's examples instructive:
Take the classic torts case of [Berry v. Sugar Notch Burrough, 191 Pa. 345, 43 A. 240 (1899) ], in which a negligently speeding trolley car is damaged by a falling tree. The wrongfulness—the speeding—is a but-for cause of the accident and injury: had the trolley car not been speeding, it would have been elsewhere when the tree fell. As a general matter, though, and apart from the chance occurrence in this case, speeding does not make it likelier that trees will fall on trolley cars. Indeed, speeding arguably reduces the likelihood of such accidents by reducing the amount of time that one is under any given tree. But-for cause is present; causal link or tendency is not. (It would, of course, be different if one could demonstrate that speeding trolley cars create vibrations that lead damaged trees to fall with greater frequency. In that case, a causal relation could be said to exist between the speeding and the injury. See Guido Calabresi, Concerning Cause and the Law of Torts, 43 U. Chi. L.Rev. 69, 72 (1975).)
The requirements of transaction and loss causation are exactly analogous to but-for cause and causal tendency in this classic torts case. Suppose a real estate company misrepresents that a certain house belonged to Abraham Lincoln, and a buyer purchases the house because of this. Suppose the buyer can show that, absent the lie, she would not have bought the house and would instead have bought a house in another part of town. Subsequently, a flood destroys her house and others in the neighborhood, while leaving the "other part of town" unscathed. The loss to her would not have occurred but for the fraud. And yet, so long as the neighborhood was not more prone to flooding, the lie in no way increased the chances of the actual damage to her house. Transaction causation is present; loss causation is not. (To be sure, if the buyer paid a premium for Lincoln's house, that premium-i.e., the amount above the fair market value of the house in light of its true, non -presidential provenance-represents a separate harm whose causal linkage to the lie is evident.)
Wells Fargo, 797 F.3d at 183–84 (emphasis in original)
TCW would have the court believe that the crash of the RMBS market is akin to the flood and the falling tree-that is, an unforeseen event that causes a loss, which occurrence was not made more likely by TCW misrepresentations. The court disagrees. Since TCW's investment strategy was premised on navigating an admittedly problematic RMBS market, lying about navigating the market in the manner advertised would surely be causally related to Basis' loss, as Basis having its money invested in knowingly troublesome RMBS was precisely the risk Basis sought to avoid by investing with TCW. This, according to Basis, places its loss within the applicable "zone of risk." See In re Flag Telecom Holdings, Ltd. Sec. Lit., 574 F.3d 29, 36 (2d Cir.2009) ("a misstatement or omission is the proximate cause' of an investment loss if the risk that caused the loss was within the zone of risk concealed by the misrepresentations and omissions alleged by a disappointed investor") (emphasis in original); see also In re Omnicom Grp., Inc. Sec. Lit., 597 F.3d 501, 513 (2d Cir.2010) (same, and noting that "[t]he zone of risk is determined by the purposes of the securities laws, i.e., to make sure that buyers of securities get what they think they are getting" '), quoting Chem. Bank v. Arthur Andersen & Co., 726 F.2d 930, 943 (2d Cir.1984) ; see also In re Lehman Bros. Sec. & Erisa Lit., 2015 WL 5514692, at *16 (S.D.N.Y.2015) (Kaplan, J.) ("zone of risk" doctrine "means that proof of loss causation does not require a perfect connection between the false statements and the precise risk that materialized.") (emphasis added).
Nonetheless, it should be noted that contrary to TCW's argument, summary judgment could not be granted based on Dr. Hubbard's claim that all collateral suitable for inclusion in Dutch Hill was doomed to fail given the severity of the market crash. Dr. Hubbard writes:
As I note above, when examining the performance of CDOs it is difficult to identify comparable CDOs that have similar collateral criteria and structures. Nonetheless, the evidence of widespread downgrades suggests that any CDO—selected by TCW, Basis Capital, or other investors—would likely suffer losses as a result of market-wide credit events that occurred here.
Therefore, even if one assumes, for the sake of argument, that TCW's selection of RMBS or CDOs was somehow inappropriate, this finding would not be sufficient to establish that TCW's actions caused Basis Capital's economic loss. My analyses indicate that all RMBS and CDOs that TCW could have selected consistent with Dutch Hill II's investment criteria during this time period were subject to the economic downturn that caused unprecedented losses in the structured finance market. Accordingly, it is my opinion that Basis Capital's losses were caused by unforeseeable macroeconomic events, and not by TCW's alleged misrepresentations of Dutch Hill II.
See Dkt. 243 at 49. The analysis referred to by Dr. Hubbard is a regression analysis where he compared the performance of collateral "consistent with Dutch Hill II's investment criteria" with the performance of Dutch Hill's actual collateral. The robust manner in which Dr. Hubbard determined what should be considered comparable collateral makes for a fascinating read. He concluded that all of the collateral suitable for inclusion in Dutch Hill would have failed to a significant enough degree that Basis' investment in the bottom tranches of Dutch Hill would have been wiped out, even if TCW selected the collateral in the manner advertised. The problem, however, with using Dr. Hubbard's report to justify summary judgment in TCW's favor on loss causation is a reasonable finder of fact could disagree with Dr. Hubbard's methodology. If one disagrees with his approach (e.g., how he defined comparable collateral), it would be reasonable to disagree with his conclusion, or at least remain agnostic in the absence of the requisite evidence. While the court does find Dr. Hubbard's analysis (see summary, id. at 98–100, 998 N.Y.S.2d 172 ) persuasive, the court is not the finder of fact. It is for the jury to judge Dr. Hubbard's work, decide if his methodology is persuasive, and determine whether his conclusions support TCW's loss causation arguments.
It also should be noted that there is scant precedent addressing loss causation arguments based on the theory "all the collateral went bust" where such arguments are based on empirical analysis in expert reports. The most analogous summary judgment decision the court could find is Bank of Am., N.A. v. Bear Stearns Asset Mgmt., 969 FSupp2d 339 (S.D.N.Y.2013) (Nathan, J.) There, Judge Nathan held that plaintiffs could not prove loss causation because the methodology of plaintiff's expert was unreliable. In another case, Judge Sweet conducted a similar analysis on a motion to dismiss, but that decision was reversed by the Second Circuit. See Fin. Guar. Ins. Co. v. Putnam Advisory Co., 2014 WL 1678912 (S.D.N.Y.2014), vacated, 783 F.3d 395 (2d Cir.2015).Here, aside from the relevant loss causation inquiry being different, the parties did not adequately brief the issues raised in Dr. Hubbard's report in a robust enough manner to address the types of concerns that Judge Nathan raised. Moreover, as noted above, predicate questions of fact regarding Dr. Hubbard's methodology make resolution of his arguments not amenable to summary judgment.
The conundrum here is that this is not strictly a Magnetar type case. That is, TCW is not merely alleged to have abdicated its role of independently selecting Dutch Hill's collateral for the benefit of a short side investor. To be sure, the allegations regarding the circumstances under which Gemstone VII was selected for inclusion are suspicious and, as discussed earlier, present questions of fact that a jury must resolve. If a jury finds that TCW was pressured into placing Gemstone VII into Dutch Hill to placate Deutsch Bank, as opposed to TCW actually believing Gemstone VII was suitable for Dutch Hill, there should be a finding of liability.
The issue here is not whether TCW should have picked better collateral for Dutch Hill and, if it did, Basis would not have suffered a loss. Rather, the issue is, as plaintiffs allege, that there was no suitable collateral in existence that could be used for the purpose of successfully executing TCW's investing strategy. TCW allegedly knew this to be true, but nonetheless bought inadequate RMBS collateral anyway so Basis would invest and the deal would close. This makes the loss causation question somewhat more straightforward. If a jury finds that this occurred, then Basis' loss would certainly have been caused by TCW's misrepresentations since the loss would have occurred by virtue of the fact that Basis' money was invested in a strategy it was not signing up for, i.e., the zone of risk Basis sought to avoid by investing with TCW. Basis avers it did not simply want to invest in risky RMBS, but that it wanted a certain type of exposure to risky RMBS-that is, exposure to risky RMBS selected by a trusted collateral manager who supposedly believed in its own methods.
With these concerns in mind, the court first finds that it does not matter what else Basis would have done with its money if it did not invest with TCW. That is too speculative to preclude loss causation, even if it is more likely than not that Basis would have invested in other RMBS deals that went bust. It is too speculative because Basis may well prevail in its other litigation, meaning that even if Basis would have taken the money set aside for Dutch Hill and instead invested in Timberwolf, if Basis prevails in its Timberwolf litigation, TCW's loss causation counterfactual falls apart. Ergo, but for TCW's fraud, Basis still would have invested in other fraudulent RMBS deals, but nonetheless may not end up losing money due to its suits against the other banks that allegedly defrauded it. Moreover, TCW's loss causation argument becomes perversely recursive if all banks argue that but for their fraud, Basis would have invested in the other defendant banks' allegedly fraudulent RMBS deals. The court, therefore, holds that the loss causation inquiry may not take into account what Basis would have done with its money had it not invested with TCW.
A likelihood this court will not and cannot handicap.
That leaves the question of whether there existed a hypothetical pool of collateral eligible for inclusion in Dutch Hill-based on the types of investments Dutch Hill was designed to make, taking into account, for instance, risk tolerance, desired rates of return, and diversification-that would not have lost money had TCW selected Dutch Hill's collateral differently. There are also the questions of whether TCW believed in its own abilities to select RMBS assets that were not corrupted by shoddy origination practices, whether it acted acceptably in including Gemstone VII in Dutch Hill, and whether TCW's investment strategies were capable of being successfully executed at the time of Basis' investment in 2007. These questions are fact intensive and difficult to resolve on a summary judgment motion. The record on this motion is simply inadequate for the court to definitely resolve any of these issues without resolving disputed material facts.
That is not to say that TCW has not made a strong showing that Basis' claim should be viewed, as this court did on the motion to dismiss, with a fair degree of skepticism. TCW may still be legally in the right even if one assumes TCW lied to Basis about all of the matters alleged in Basis' complaint. Assume, arguendo, that Basis wanted to invest $30 million in risky RMBS. In the spring of 2007, there was a set universe of possible investments that Basis could have selected. It could have, inter alia, purchased poorly rated subprime RMBS, tranches of CDOs backed by poorly rated subprime RMBS, or written CDS protection on tranches of CDOs backed by poorly rated subprime RMBS. It could have made these investments with any number of banks and collateral managers. Basis had to make the decision of who to invest with and what to invest in. Basis considered TCW's marketing materials, and also the marketing materials of countless other investment advisors. See Dkt. 157 at 10 (listing nine structured finance industry conferences, sponsored by banks, attended by Basis between February 2006 and March 2007). The story Basis tells, which it will surely attempt to convince a jury of, is that it chose to invest with TCW because the manner in which TCW represented itself to manage Dutch Hill was superior, in Basis' mind, to the other collateral managers soliciting it. This may well be true. Alternatively, it may be the case, as TCW avers, that Basis simply did not care about nor genuinely believe in TCW's marketing materials. Basis had to pick someone, so it picked TCW. Basis had to put its $30 million of RMBS fund money somewhere, and so it picked TCW, not because of TCW's advertised abilities, but because someone selling RMBS was going to get Basis' business. It could easily have been Declaration or any of the collateral managers that allegedly permitted Magnetar to select the collateral.
These issues also go to materiality and reliance. That is, if Basis was not making investment decisions based on TCW's marketing materials, but was simply selecting RMBS collateral managers without an actual regard to their purported abilities or methodologies, then the alleged fraudulent misrepresentations would not have been material to Basis' investment decision. This is a question of fact for the jury. But make no mistake, finding TCW's viewpoint to be correct is by no means cynical. The notion that TCW acted badly is not incompatible with the notion that Basis invested recklessly. Basis may not be entitled to recourse for the former if, independently of any wrongdoing on the part of TCW and Deutsche Bank, Basis made a particular bet on the toxicity of the RMBS market and failed to appreciate the severity of the contagion that, frankly, most of the world did not fully appreciate at the time. To wit, if Basis was truly questioning the health of the RMBS market, perhaps it should have been more critical of the manner in which its collateral mangers were selecting RMBS investments. After all, Basis itself was a collateral manager on other RMBS deals, which also did not end well.
That said, in light of the questions of fact discussed herein, summary judgment is denied. Accordingly, it is
ORDERED that the motion by defendant TCW Asset Management Company for summary judgment against plaintiffs Basis Pac–Rim Opportunity Fund (Master) and Basis Yield Alpha Fund (Master) is denied; and it is further
ORDERED that if no interlocutory appeal is taken from this decision, the parties shall contact the court to schedule a pre-trial conference, and, is an appeal is taken, the parties shall contact the court promptly after such appeal is decided.