FOOTBRIDGE LIMITED TRUST v. COUNTRYWIDE HOME LOANS

S-15 ("You should fully consider the risks of investing in a subordinated certificate, including the risk that you may not fully recover your initial investment as a result of realized losses.").)

Defendants also disclosed that there were risks associated with an investment in the Securitizations, but plaintiffs assert that they were "reassured [that] the credit enhancement mechanisms, including subordination, overcollateralization, and excess cash flow" would "protect them against the risk of loss." (Id. ¶ 111.) Plaintiffs argue that they believed that the subordination structure would protect them from losses, but that this was an incorrect perception because "the collateral underlying the Securitizations was extremely risky and low quality." (Id. ¶ 112.) Plaintiffs do not allege that defendants made inaccurate representations about the structure of the Securitizations.

Plaintiffs also acknowledge that the Prospectuses and Prospectus Supplements state that Countrywide would use "more flexible" loan-origination standards for loans underlying the Securitizations. (Id. ¶ 86.) Plaintiffs claim that, despite this disclosure, the statements regarding Countrywide's underwriting guidelines were false and misleading because Countrywide also represented that "Countrywide Home Loans' underwriting guidelines still place primary reliance on a borrower's ability to repay." (Id. ¶ 93.) The SAC alleges that "Countrywide's underwriting standards actually ignored a borrower's ability to repay. Countrywide's focus, instead, was on profit and market share gained from the origination of large volumes of risky loans, regardless of a borrower's ability to repay." (Id. (emphasis in original).) The SAC does not allege particular facts in support of this allegation.

The SAC also alleges that "Countrywide deviated from the loan-origination practices that it represented in the offering documents, effectively abandoning rather than loosening its loan-origination standards." (Id. ¶ 57.) The SAC does not allege which "practices" Countrywide represented that it would use or which practices were "effectively abandoned," nor does it describe the extent to which such practices were "effectively abandoned." (Id.)

The SAC also fails to allege which statements were made about the "more flexible" underwriting guidelines or the standards that were supposed to be used, who made the statements, that any specific standards under the "more flexible" guidelines were violated, the frequency of departures from the flexible guidelines, or that any loan not conforming with the "more flexible" guidelines was actually included in the Securitizations.

In essence, plaintiffs allege that they were told that the loans would be issued under a "more flexible" set of underwriting guidelines, but that defendants were too flexible in the underwriting decisions. Without more, such allegations are insufficient to set forth a plausible claim of fraud based on the heightened pleading requirements of Rule 9(b) and the PSLRA. The plausibility standard requires "more than a sheer possibility that [a] defendant has acted unlawfully." Iqbal, 129 S. Ct. at 1949. The SAC, read in the light most favorable to plaintiffs, fails to allege facts sufficient to support plaintiffs' claims that Countrywide did not use the underwriting guidelines that it represented it would use in originating the Mortgage Loans.

b. Verification of Application Information and Underwriting Exceptions.

The SAC alleges that the Prospectus Supplements contain a misrepresentation regarding the procedures that Countrywide used to verify applicants' information:

Countrywide Home Loans verifies the loan applicant's sources and amounts of income (except under the Stated Income Program where the amount of income is not verified), calculates the amount of income from all sources indicated on the loan application, reviews the credit history of the applicant, calculates the debt-to-income ratio to determine the applicant's ability to repay the loan, and reviews the appraisal of the mortgaged property for compliance with Countrywide Home Loans' underwriting standards.

(Id. ¶ 105.) Plaintiffs allege that this statement was false and misleading because "[i]n reality, Countrywide abandoned those guidelines and issued the Mortgage Loans with little or no consideration for borrowers' ability to repay." (Id. ¶ 106.) Plaintiffs do not allege that Countrywide did not collect information about borrowers' assets, liabilities, income, and employment history. The SAC alleges that this statement is false and misleading because "Countrywide abandoned those guidelines and issued Mortgage Loans with little or no consideration for borrowers' ability to repay." (Id. ¶ 106.) This allegation is insufficient to plead a fraud claim under Rule 9(b) and the PSLRA.

Plaintiffs acknowledge that the Prospectus Supplements explained that CHL would grant underwriting exceptions on a "case by case basis" to "prospective borrower[s] not strictly qualifying under the underwriting risk category guidelines" outlined therein. (Id. ¶ 96.) Plaintiffs allege that this statement was false and misleading because it "incorrectly implied" that the exceptions would be made on a "limited (`case by case') basis, and with careful consideration of the `compensating factors' of each case" when "[i]n reality" the "exceptions were granted abundantly and without restraint." (Id. ¶¶ 96-97.) Again, plaintiffs do not tie the general allegations that Countrywide granted "abundant" exceptions under its underwriting guidelines to the Securitizations, nor do they allege the misstatement with requisite particularity under the PSLRA because they do not allege facts to explain the extent to which exceptions could be granted, other than to generally allege that they understood the documents to say that exceptions would be granted on a "limited basis." (Id.)

Plaintiffs point to no language in the offering documents that limits defendants' ability to grant the underwriting exceptions, so long as each was considered on a "case by case" basis. Indeed, the Prospectus Supplements disclosed that "[i]t is expected that a significant number of mortgage loans will have been originated based on underwriting exceptions of these types." (SPS1 PS at S-14; SPS2 PS at S-14.) Plaintiffs do not point to any language in the offering documents in support of their contention that "asignificant number" of exceptions granted on a "case by case basis" "incorrectly implied" that the underwriting exceptions would be granted "on a limited basis."

The offering documents stated that Countrywide required a credit history for each applicant to be undertaken by an independent credit bureau and that Countrywide would gather information about an applicant's "assets, liabilities, income, and employment history" in order to calculate the debt-to-income ratio which would be used to determine whether the prospective borrower would be able to afford the required payments of principal and interest on the Mortgage Loan. (Id. ¶ 104.)

c. Independent Appraisals.

Countrywide also represented that "it required independent appraisals of the properties on which the Mortgage Loans were issued." (Id. ¶ 89.) Plaintiffs allege that this statement was false and misleading because "Countrywide regularly pressured appraisers to give inflated assessments of property values, threatening to blacklist them if they did not do so." (Id. ¶ 90.) Again, the SAC does not link this allegation to the Securitizations at issue here. The SAC also does not allege that Countrywide pressured appraisers to give inflated assessments of property underlying any Mortgage Loans in the Securizations or that any appraiser actually inflated an assessment of property underlying the Mortgage Loans. The SAC contains no facts in support of the conclusion that Countrywide "regularly" pressured appraisers and it does not identify the source of the information for this allegation. Rule 9(b) and the PSLRA require that the plaintiffs do more than make a conclusory allegation of this nature.

d. "In Accordance with Law."

Finally, plaintiffs allege that Countrywide's statement in the offering documents that its underwriting standards would be "applied in accordance with applicable federal and state laws and regulations" was false because Countrywide "regularly engaged in predatory lending practices in violation of federal or state laws and regulations." (Id. ¶ 91.) Plaintiffs allege that Countrywide "regularly steered borrowers to more expensive mortgage products in order to increase its profits." (Id. ¶ 92.) The SAC does not contain allegations that the loans included in the Securitizations suffered from this problem; rather, it makes general allegations about Countrywide's overall commercial practices. As explained above, such allegations are insufficient to plead a claim under the heightened pleading requirements of Rule 9(b) and the PSLRA.

3. Omissions of Material Facts Regarding Reduced-Documentation Application Programs.

Some of the Mortgage Loans were originated pursuant to Reduced-Documentation Programs. The offering documents explain that, for those loans originated pursuant to the Stated Income loan program, "the borrower's income as stated on the application [i]s not independently verified." (See SPS1 PS at S-34; SPS2 PS at S-34.) Plaintiffs allege that, elsewhere, the Prospectuses state that "employment verification is obtained from an independent source (typically the borrower's employer) which verification reports, among other things, the length of employment with that organization and the borrower's current salary." (Id. ¶ 118.). The SAC alleges that Countrywide represented in the Prospectuses that this was true for "most cases" but that, "[o]n information and belief, Countrywide failed to obtain independent verification of borrowers' income at a far greater rate than it represented." (Id.)

The SAC does not allege facts to support this allegation, such as the "rate" Countrywide represented exceptions would be granted or the "rate" at which exceptions were actually granted. Under the heightened pleading requirements of the PSLRA, plaintiffs must "do more" than allege that, on information and belief that exceptions were granted "at a greater rate than it represented." (See id.)

The SAC also alleges that the Prospectus Supplements falsely state that "[t]he borrower's income as stated [in the applications under the Stated Income Program] must be reasonable for the related occupation and the determination as to reasonableness is subject to the loan underwriter's discretion." (Id. ¶ 119.) The SAC alleges that the "underwriters abused their discretion by abandoning [the] loan-origination standards. . . ." (Id.) While the SAC alleges that underwriters "failed to exercise proper discretion in judging borrower's statements," it does not allege that the representation that the underwriters would use their discretion in reviewing loan applications was a false statement. Nor does it allege particularized facts in support of its conclusion that loan underwriters failed to exercise proper discretion.

Finally, the SAC alleges that "Countrywide failed to take sufficient, if any, action to correct borrowers' suspicious statements [regarding reported employment income]," (id. ¶ 120), and failed to disclose the results of "studies which showed that loans with lower documentation were more likely to default." (Id. ¶ 52.) Again, the SAC does not allege that any borrower who received a loan that was included in the Securitizations falsely reported his income. Plaintiffs acknowledge that the offering documents disclosed that loan officers did not independently verify certain information and that borrowers qualified under the program were "excused" from the "general requirement of submitting documentation to confirm their income and assets." (SAC ¶ 116; see also SPS1 PS at S-34.)

Furthermore, the SAC fails to allege a fiduciary duty that would obligate defendants to disclose that borrowers who received loans originated pursuant to lower documentation programs had an increased likelihood of default. Although not specific to the Mortgage Loans originated in the reduced documentation programs, the offering documents contained a general disclosure that "THE CERTIFICATES ARE BACKED BY MORTGAGE LOANS THAT WILL EXPERIENCE HIGHER RATES OF DELINQUENCY AND LOSS THAN MORTGAGE LOANS UNDERWRITTEN TO MORE TRADITIONAL STANDARDS." (SPS1 Prospectus Supplement at S-14; SPS2 Prospectus Supplement at S-14.) As the Third Circuit noted, "the federal securities laws . . . do not compel [defendants] to state the obvious." In re Donald Trump Casino Sec. Litig., 7 F.3d 357, 377 (3d Cir. 1993).

4. Misrepresentations Regarding Adverse Effects on Investors' Interests.

The SAC alleges that "Countrywide represented in the PSAs and Prospectus Supplements that the Mortgage Loans in the Securitizations were not selected `in a manner that would adversely affect the interests of Certificateholders.'" (Id. ¶ 123.) Plaintiffs assert that this statement was fraudulent because "Countywide knew that by issuing unnecessarily risky and expensive loans to borrowers with poor credit histories and low incomes, the Company increased the likelihood that borrowers would default on their loans, thereby creating an adverse effect on Plaintiffs." (Id.) Again, plaintiffs acknowledge that they knew that the Securitizations were comprised of only "credit-blemished, closed-end, fixed-rate loans that were secured by second liens on one- to four-family residential properties." (Id. ¶ 2.)

The SAC alleges that Countrywide failed to disclose that it had attempted to "sell the Mortgage Loans as whole loans," but was unable to do so successfully. (Id. ¶ 124.) Countrywide was able to sell the loans in the form of mortgage-backed securities "because the securitization process made the loans more attractive investments." (Id. ¶ 125.) Plaintiffs do not allege that defendants had any duty to inform plaintiffs that the loans had originally been marketed as whole loans.

Plaintiffs also allege that Countrywide knew that some of the Mortgage Loans were already experiencing defaults when the Securitizations were created. (Id. ¶ 129.) Defendants argue that plaintiffs do not "identify a material number (or any number of loans for that matter) that were allegedly in default or at a special risk of default." (Def. Mem. In Support at 17 n. 27.) Defendants also argue that, in any event, when read as a whole, the offering documents actually represent that "[n]o Mortgage Loan is one payment or more delinquent as of the applicable Cut-off Date," but in the event that Mortgage Loans are delinquent as of that date, Countrywide promised to "cure" or "remove . . . and substitute" or "repurchase" the delinquent loans. (See SPS1 and SPS2 PSAs at § 2.03(b)(9), (f).) Defendants argue that plaintiffs' failure to allege that Countrywide refused to cure any deficiency or that Countrywide never intended to fulfill this promise is fatal to their fraud claims.

When read in context, the offering documents covenant that there ought not be any Mortgage Loans in default at the time of the Securitizations, but acknowledge the possibility that there could be delinquent loans and, in that event, Countrywide would cure the delinquent loan in one manner or another. "[T]he prospectuses must be read `as a whole.'" Olkey v. Hyperion 1999 Term Trust, Inc., 98 F.3d 2, 5 (2d Cir. 1996). As the Fifth Circuit recently noted, such provisions

are sensible given the difficulties of investigating the underlying residential mortgages. Even the best due diligence may overlook problems. A mortgage may become delinquent from a single missed payment. Some of the loans might fall into delinquency during the pendency of the transactions leading to an investor's purchases. Because mistakes are inevitable, both seller and purchaser are protected by a promise that the mortgage pools will be free from later-discovered delinquent mortgages.

Lone Star Fund V (U.S.) L.P. v. Barclays Bank PLC, 594 F.3d 383, 389 (5th Cir. 2010).

In opposition to defendants' motion, plaintiffs argue that such a result would violate the anti-waiver provisions of the Securities Exchange Act of 1934 because it would effectively allow a defendant to contract around federal securities laws. See 15 U.S.C. § 78cc(a) ("Any condition, stipulation, or provision binding any person to waive compliance with any provision of [the Act] . . . shall be void."). As the Fifth Circuit held,

[r]ather than waive [plaintiffs'] right to pursue claims of fraud, the `repurchase or substitute' clauses change the nature of [Countrywide's] representation. If [plaintiffs] had alleged that [Countrywide] falsely represented to prospective investors that it would repurchase or substitute delinquent mortgages, they might have stated a case of fraud under the pertinent agreements. This is not their claim.

Lone Star Fund, 594 F.3d at 390.

Furthermore, as discussed below, even if the statement in the offering documents were a misstatement, the SAC does not allege any facts which support plaintiffs' conclusory allegation that defendants had knowledge that some of the loans were defaulting when the Securitization pools were created. (See SAC ¶ 129.)

5. Misrepresentations Regarding Countrywide's Loan Servicing.

The SAC alleges that "Countrywide's servicing of its mortgage loans lagged behind the standards of the industry, contrary to its representations" that it would "service and administer the Mortgage Loans in accordance with customary and usual standards of practice of prudent mortgage loan lenders. . . ." (Id. ¶¶ 133-34.) The SAC does not tie this allegation to any of the Mortgage Loans included in the Securitizations, but complains that Countrywide was generally "unhelpful in resolving customers' problems." (Id. ¶ 135.) Plaintiffs point to "[d]ozens of Countrywide customers" who "posted stories on the internet regarding their dealings with the Company's unhelpful, unprofessional, and harassing bureaucracy." (Id.)

The SAC does not allege that any of the Mortgage Loans in the Securitizations were inadequately serviced. Plaintiffs' broad allegations of poor customer service on the part of the Company as a whole are not supported by particularized facts and are insufficient to support a fraud claim. Plaintiffs do not address these deficiencies in their opposition to the motion to dismiss.

b. The Complaint Fails to Raise a Strong Inference of Scienter.

As explained above, the SAC fails to allege that defendants made any material misstatements or omissions with sufficient particularity to survive the heightened pleading requirements of Rule 9(b) and the PSLRA. This deficiency alone is sufficient to compel dismissal; however, even if the allegations in the SAC alleged a material misrepresentation or omission, the SAC fails to allege that the defendants made the statements with the requisite scienter.

The PSLRA requires a plaintiff to "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind." 15 U.S.C. § 78u-4(b)(2). The statute "unequivocally raise[d] the bar for pleading scienter."Tellabs, 551 U.S. at 321 (alteration in original; quotation marks omitted). In scrutinizing a complaint's allegations of scienter, a court is to consider "whether all of the facts alleged, taken collectively, give rise to a strong inference of scienter, not whether any individual allegation, scrutinized in isolation, meets that standard." Id. at 323 (emphasis in original). A court also "must take into account plausible opposing inferences." Id. at 323. This requires close scrutiny of the factual allegations:

The strength of an inference cannot be decided in a vacuum. The inquiry is inherently comparative: How likely is it that one conclusion, as compared to others, follows from the underlying facts? To determine whether the plaintiff has alleged facts that give rise to the requisite "strong inference" of scienter, a court must consider plausible nonculpable explanations for the defendant's conduct, as well as inferences favoring the plaintiff. The inference that the defendant acted with scienter need not be irrefutable, i.e., of the "smoking-gun" genre, or even the "most plausible of competing inferences[.] . . . Yet the inference of scienter must be more than merely "reasonable" or "permissible" — it must be cogent and compelling, thus strong in light of other explanations. A complaint will survive, we hold, only if a reasonable person would deem the inference of scienter cogent and at least as compelling as any opposing inference one could draw from the facts alleged.

Id. at 323-24. Defendants' pecuniary motive is a relevant consideration, although an absence of motive is not alone dispositive. Id. at 325. Personal financial gain on the part of a defendant weighs in favor of a scienter inference. Id. If a complaint contains ambiguities or omissions, those weigh against inferring scienter. Id. at 326.

In the Second Circuit, scienter may be pleaded by "alleging facts (1) showing that the defendants had both motive and opportunity to commit the fraud or (2) constituting strong circumstantial evidence of conscious misbehavior or recklessness." ATSI, 493 F.3d at 99. Circumstantial evidence may go toward showing "deliberate illegal behavior," or "conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care." Novak, 216 F.3d at 308 (quotation marks omitted). "Intentional misconduct is easily identified since it encompasses deliberate illegal behavior, such as securities trading by insiders privy to undisclosed and material information, or knowing sale of a company's stock at an unwarranted discount." Id. at 308 (internal citation omitted). As to recklessness, "allegations that defendants should have anticipated future events and made certain disclosures earlier than they actually did do not suffice to make out a claim of securities fraud." Id. at 309.

Here, the SAC's allegations do not support a strong inference of scienter. The SAC does not raise an inference that the defendants intended to defraud the plaintiffs. The plaintiffs have set forth only a conclusory allegation that defendants intended to deceive the plaintiffs in order to "maximize [their] own profits and market share." (See, e.g., SAC ¶ 2.) "Motives that are common to most corporate officers, such as the desire for the corporation to appear profitable and the desire to keep the stock prices high to increase officer compensation, do not constitute `motive' for purposes of [a scienter] inquiry." ECA, 553 F.3d at 198.

The Complaint elsewhere asserts that defendants engaged in recklessness and conscious "misbehavior" for inadequately disclosing the extent that Countywide relaxed its underwriting guidelines and the potential that borrower fraud was occurring in the reduced documentation programs. (See id. ¶¶ 84-122.)

In opposition to the defendants' motion, plaintiffs have cited the following allegations which are discussed below as indicative of scienter. I address each of them in turn, and note at the outset that, neither individually nor collectively do they raise a strong inference of scienter. Tellabs, 551 U.S. at 322.

i. Scienter with Respect to Statements Regarding Owner Occupancy.

The SAC alleges that, during a conference call in May 2007, Countrywide "`admitted' that the Mortgage Loans were defaulting at an `incredibly high' rate" and "sought to blame the high default rates on real-estate speculators, alleging that the `biggest driver' of losses had been a large number of borrowers who `are participating in the real estate flipping market.'" (Id. ¶ 75.) The SAC asserts that "Countrywide claimed that these speculators had represented to the Company that they would occupy the mortgaged properties, when in reality [the borrowers] hoped to quickly resell the properties for a profit without ever living in them." (Id.) Plaintiffs allege that, because "Countrywide is a sophisticated loan originator, . . . [i]t was not blindsided and misled by speculators who allegedly lied on their loan applications." (Id. ¶ 76.)

The SAC contains no facts which, when read in the light most favorable to plaintiffs, plausibly allege that Countrywide was aware, at the time that it made the statements in the offering documents, that the borrowers' statements about owner-occupancy were false. Instead, the SAC contains conclusory assertions regarding a "corrupt culture" at Countrywide where "Countrywide facilitated and furthered borrowers' fraud by turning a blind eye to it, failing to enforce its underwriting standards, failing to exercise proper oversight or loan origination, and/or by other means." (Id.)

Plaintiffs also cite to internal email communications between Countrywide officers regarding concerns about borrower fraud with respect to other types of loans, such as Pay-Option ARMs, and other borrower information, such as the accuracy of stated-income amounts reported by borrowers. (Id. ¶ 77.) As explained above, plaintiffs do not tie the allegations about officers' concerns with other types of loan products or other transactions to the statements made with respect to the Securitizations at issue here.

The SAC does not allege that defendants knew that loans included in the Securitizations were related to properties that were not actually owner-occupied at the time that the statements were made. The SAC, read in the light most favorable to plaintiffs, alleges generally that defendants knew that borrowers, at times, lied on loan applications. However, the SAC does not allege that defendants knew that borrowers lied about their owner-occupied status, or that any of the loans contained in the Securitizations were related to fraudulent applications.

Also, the SAC's allegations regarding Countrywide's "admissions" during an investor call in May 2007 do not support plaintiffs' allegation that the statements amounted to fraud because plaintiffs do not allege facts to plausibly support their allegation that Countrywide knew that the statements were false at the time they were made, i.e. June and August of 2006. (See SAC ¶ 67 (alleging that "Countrywide's subsequent admission underscores the fact that it knew or should have known at the time it made the representations about owner occupancy . . . that such representations were incorrect").) Allegations of fraud by hindsight are insufficient as a matter of law. See Jackson Nat'l Life Ins. Co. v. Merrill Lynch Co., 32 F.3d 697, 703 (2d Cir. 1994).

The SAC's allegation that Countrywide later estimated that approximately 15 percent of the Mortgage Loans in the Securitizations were applied to investment properties is likewise deficient because plaintiffs do not allege facts to plausibly support their conclusory allegation that Countrywide knew or should have known this information at the time the statements about owner-occupancy were made. (See SAC ¶ 79-80.)

ii. Scienter with Respect to Statements Relating to Underwriting Guidelines.

The SAC also fails to allege scienter with respect to the alleged misstatements regarding the underwriting standards used for the loans included in the Securitizations. The SAC generally alleges that Countrywide's "senior management" was aware that borrowers were submitting fraudulent loan applications, but there is no allegation that loans relating to fraudulent applications were packaged as part of the Securitizations, nor that Countrywide knew that any fraudulent loan applications related to loans in the Securitizations.

There is also no allegation that Countrrywide officials acted with scienter when they made the statement that the loans in the Securitizations would be subject to "more flexible" underwriting standards. General allegations that loan officers — who are not alleged to be senior corporate officials — were "participating in submitting fraudulent loan applications" for approval or that loan officers engaged in "flipping" a loan application from full documentation to reduced documentation in order to increase the chance for approval, are insufficient under the PSLRA. (See id. ¶¶ 121-22.) The SAC fails to allege any facts which tie this allegation about loan officer practices to the Securitizations at issue here and does not allege with particularity facts that support the allegation.

The SAC also includes blanket statements about Countrywide's motives for lowering its underwriting standards as a general matter. For example, the SAC alleges that "[t]he inevitable result of Countywide's quest for increased market share, and specifically its hunger for increased production of risky loans, was a steep decline in the creditworthiness of its borrowers and its own underwriting standards." (Id. ¶ 53.) Plaintiffs do not tie the allegations about a general "corrupt corporate culture" to the Securitizations at issue in this case or the misrepresentations that plaintiffs assert constituted the fraud they claim here. As explained above, alone, a general allegation that defendants wanted to originate as many loans as possible in order to increase profits and market share, without more, is insufficient to set forth a strong inference of scienter.

The SAC also alleges that Countrywide "made representations about its rigorous underwriting standards directly to plaintiffs" during a May 2007 conference call. (Id. ¶ 99.) Because plaintiffs purchased the Securities during the period between June and August 2006, plaintiffs could not have relied on the statements made during the May 2007 conference call with respect to those purchases. Plaintiffs do not identify how such statements would demonstrate intent relating to statements made more than a year earlier.

The SAC fails to allege facts demonstrating that at the time the plaintiffs purchased the Certificates, defendants acted with scienter in making misstatements about the underwriting guidelines used in the origination of the Mortgage Loans. Indeed, the offering documents contained explicit warnings which disclosed that "[i]t is expected that a significant number of the mortgage loans will have been originated based on underwriting exceptions. . . ." (SPS1 PS at S-14; SPS2 PS at S-14.) The offering documents also contained a warning that the Certificates were backed by mortgage loans that "WILL EXPERIENCE HIGHER RATES OF DELINQUENCY AND LOSS THAN MORTGAGE LOANS UNDERWRITTEN BY MORE TRADITIONAL STANDARDS." (SPS1 PS at S-14; SPS2 PS at S-14) (all capitals in originals). Defendants' disclosures about the risk inherent in the investment in the "credit-blemished, closed-end, fixed-rate loans that were secured by second liens on one- to four-family residential properties," SAC ¶ 2, and the flexibility of the underwriting guidelines employed for originations of the Mortgage Loans are inconsistent with a state of mind going toward "deliberate illegal behavior" or "conduct which is highly unreasonable and which represents an extreme departure from the standards of ordinary care." Novak, 216 F.3d at 308.

Plaintiffs have failed to raise a "strong inference" of scienter with respect to statements regarding the "more flexible" set of underwriting guidelines that defendants represented they used during the origination process for the Mortgage Loans underlying the Securitizations.

iii. Scienter with Respect to Statements Regarding Reduced Documentation Programs.

The SAC alleges that "Countrywide's senior management was aware that Countrywide loan officers were participating in submitting fraudulent applications through the Company's reduced documentation application programs, as evidence by internal Countrywide emails." (SAC ¶ 121.) The emails cited, however, are not alleged to be related to the Securitizations.

Plaintiffs quote from an email from defendant Mozilo regarding his perception that a deal with HSBC raised concerns about "a serious lack of compliance within our origination system as it relates to documentation and generally, a deterioration in the quality of loans originated versus the pricing of those loan[s]." (Id.; Supplemental Decl. of Victor Hou, Ex. A.) Plaintiffs do not link the allegations regarding Mozilo's concern with the origination of loans originated in the HSBC transaction to the Securitizations here. Indeed, there is no allegation that Mozilo had any role in plaintiffs' purchase or that the "more flexible" guidelines at issue here were involved in other transactions.

The SAC also alleges that a former Countrywide executive, Mark Zachary "complained to Countrywide's regional management" about "a practice known within Countrywide as `flipping' an application" in which applications that were unable to get approval via the full-documentation program were "flipped" for consideration under a reduced-documentation program. (SAC ¶ 122.) Plaintiffs do not allege that any of the Mortgage Loans in the Securitizations were "flipped" or that applications that were submitted for approval in the reduced-documentation program did not meet the underwriting guidelines required for that program, the risks of which were disclosed to plaintiffs in the offering materials. Such allegations do not raise an inference of scienter with respect to the alleged misrepresentations regarding the reduced-documentation program because any alleged knowledge about the "flipping" of applications is not tied to any allegations about the Mortgage Loans here.

iv. Scienter with Respect to Statements Regarding Avoidance of Adverse Effects on Investors' Interests.

Plaintiffs assert that Countrywide knew "that the loans were likely to perform poorly" because it "had payment histories onsome of the Mortgage Loans that it added to the Securitizations' pools, in its role as servicer of the Loans, so it knew that certain Loans were already defaulting when the pools were created." (SAC ¶ 129 (emphasis added).)

The SAC does not allege facts that support the conclusory allegation that Countrywide knew that some of the Mortgage Loans were defaulting at the time when the Securitization pools were created. Plaintiffs do not identify which persons or entities had access to such information. Furthermore, the SAC does not allege facts that demonstrate that Countrywide had the motive and opportunity necessary for scienter with respect to this alleged misrepresentation. Pursuant to the PSAs, Countrywide was required to "cure," "remove . . . and substitute" or "repurchase" any noncompliant loans. (SPS1 PSA § 2.03(f); SPS2 PSA § 203(f).) The SAC does not allege that defendants did not intend to fulfill this obligation. Plaintiffs do not identify a motive that leads to an inference of scienter that is compelling in light of defendants' obligation to cure any noncompliant loan. Collectively, these allegations fail to raise a strong inference of scienter. See Tellabs, 551 U.S. at 322.

Plaintiffs also complain that based on information about other, similar mortgage loans' payment histories, Countrywide should have known that the SPS1 and SPS2 Mortgage Loans "were likely to experience high rates of default." (Id. ¶ 130.) As explained above, the offering documents disclosed this precise risk. (See SPS1 Prospectus Supplement at S-14; SPS2 Prospectus Supplement at S-14.) Again, such a disclosure is inconsistent with the state of mind required to state a claim for securities fraud. See Novak, 216 F.3d at 308.

c. Loss Causation

I need not reach the issue of whether the SAC alleges loss causation because the SAC fails to allege a misstatement or that defendants acted with scienter. I note, however, that there is a serious issue as to whether plaintiffs have plead loss causation because the SAC does not allege when, how, and to what extent the losses plaintiffs suffered were attributable to the alleged misstatements. As the Second Circuit explained in Lentell v. Merrill Lynch Co., where a "plaintiff's loss coincides with a marketwide phenomenon causing comparable losses to other investors . . . a plaintiff's claim fails when it has not adequately pled facts which, if proven, would show that its loss was caused by the alleged misstatements as opposed to intervening events." 396 F.3d 161, 174 (2d Cir. 2005) (internal quotation marks and citation omitted).

The SAC alleges in conclusory fashion that "[t]he loss in value was not due to the recent decline in the American housing market and the mortgage-backed securities markets. . . ." (SAC ¶ 223 (emphasis in original).) The SAC goes on to allege that "[t]hose broader market declines occurred long after the Securities began to experience high rates of delinquency and default." (Id.) The SAC does not, however, identify when the Securities began to experience "high rates of delinquency and default," when the "broader market declines" began, or the extent that plaintiffs' investments were affected by the delinquency and default. The SAC does not include facts which, if proven, would show that the loss in value of plaintiffs' Securities was caused by the alleged misstatements as opposed to the "broader market declines."

III. Plaintiffs' Section 10(b) and Rule 10b-5 Claims Against Mozilo and Sambol are Dismissed.

Because they are based on a slightly different theory of liability, I separately address the securities fraud claims against Mozilo and Sambol. As explained more fully below, the claims against Mozilo and Sambol are dismissed because the SAC fails to plausibly state a claim against them under the heightened pleading requirements of Rule 9(b) and the PSLRA.

a. Mozilo.

i. The SAC Fails to Allege That Mozilo Made a Material Misstatement or Omission.

The SAC does not allege that Mozilo had any personal involvement with plaintiffs' investment in the Securitizations. The SAC also does not allege any statement made by Mozilo in connection with plaintiffs' purchase of securities. Instead, the SAC alleges that Mozilo is liable for misrepresentations in the offering documents as well as general statements that he made about Countrywide's business.

1. The Group Pleading Doctrine.

First, plaintiffs argue that Mozilo is liable for statements in the offering documents under the group pleading doctrine. The group pleading doctrine allows plaintiffs, "for pleading purposes only, to `rely on a presumption that . . . press releases, or other group-published information, are the collective work of those individuals with direct involvement in the everyday business of the company. This allows plaintiffs, to a limited extent, to circumvent the general pleading rule that fraudulent statements must be linked directly to the party accused of the fraudulent intent.'" In re BISYS Sec. Litig., 397 F. Supp. 2d 430, 438 (S.D.N.Y. 2005) (quoting In re NTL, Inc. Sec. Litig., 347 F. Supp. 2d 15, 22 n. 26 (S.D.N.Y. 2004)). The group pleading doctrine is only available against a defendant if the plaintiff has "alleged facts indicating that the defendant was a corporate insider or affiliate with direct involvement in the daily affairs of the company." Id. at 440-41.

I recognize that whether the PSLRA has abrogated the group pleading doctrine is an open question in this Circuit, and that some courts, including the Fifth Circuit, have held that it has.Southland Sec. Corp. v. INSpire Ins. Solutions Inc., 365 F.3d 353 (5th Cir. 2004). The majority of judges in this district who have addressed the issue have concluded that the group pleading doctrine has survived the PSLRA. In re BISYS Sec. Litig., 397 F. Supp. 2d at 439 n. 42 (collecting cases). For the purposes of this motion, I accept the conclusion that the group pleading doctrine has some continued viability. See, e.g., In re Refco, Inc. Sec. Litig., 503 F. Supp. 2d 611, 641-42 (S.D.N.Y. 2007) (stating that there is no "apparent contradiction between the idea that each defendant's role must be pled with particularity and the fact that corporate officers may work as a group to produce particular document[s]").

As explained above, the SAC fails to plausibly allege that the offering documents contained material misrepresentations. Furthermore, plaintiffs fail to plausibly allege that Mozilo's position as a "corporate insider" at the parent corporation, CFC, made him a "corporate insider or affiliate with direct involvement" in the various subsidiaries' actions related to the Securitizations. As other courts in this district have noted, "even if the group pleading doctrine applied to the statements at issue, it would not link . . . the corporate parent . . . to statements attributable to [its subsidiary]. The defendants must be directly involved in the daily business of the company responsible for the statements for the exception to apply." See,e.g., Defer L.P. v. Raymond James Fin., Inc., 654 F. Supp. 2d 204, 214 (S.D.N.Y. 2009); Yung v. Lee, 2002 WL 31008970, at *3 (S.D.N.Y. Sept. 5, 2002), aff'd, 160 Fed. App'x 37, 42 (2d Cir. 2005) (allegation that defendant "owns and controls [subsidiaries] . . . is insufficient to plead [defendant's] participation in the securities offer at issue, even under the group pleading doctrine").

Therefore, plaintiffs' claim against Mozilo based on alleged misrepresentations in the offering documents is dismissed.

ii. Mozilo's Statements.

In opposition to the motion to dismiss, plaintiffs' also argue that the SAC identifies six misrepresentations that Mozilo "made directly." (Pl. Opp. Mem. at 51.) The SAC alleges that Mozilo represented that Countrywide

(i) "manage[d] credit risk through credit policy, underwriting, quality control and surveillance activities;" (ii) engaged in "prudent underwriting guidelines;" (iii) would not "compromise [its underwriting standards] as we grow market share;" (iv) under "no circumstances will . . . ever sacrifice sound lending and margins for the sake of getting to that 30 percent market share;" (v) had not experienced any loosening of underwriting standards that create[d] less of a quality of loan than [Countrywide] did in the past;" and (vi) kept "loan quality . . . extremely high."

(Id. (alterations in original)); SAC ¶¶ 33, 35, 38, 44, 169, 186.)

As explained above, the SAC does not allege facts that link these statements to the Securitizations at issue here. The statements include comments on Countrywide's business as a whole; they do not relate to the Certificates plaintiffs purchased. As explained more fully above, plaintiffs "must do more than say that the statements . . . were false and misleading; they must demonstrate with specificity why and how that is so." Rombach v. Chang, 355 F.3d 164, 174 (2d Cir. 2004). Plaintiffs' failure to allege how and why the statements above were misleading with respect to the Securitizations they purchased is fatal to their claim.

b. Sambol.

i. The SAC Fails to Allege that Sambol Made a Material Misstatement or Omission.

As explained above, Sambol was President and COO of CHL from 2004 to 2006 and President and COO of CFC from September 2006 until mid-2008. (See SAC ¶ 20.)

1. The Group Pleading Doctrine.

Plaintiffs do not point to any statements that were made by Sambol in connection with the Securitizations. The SAC acknowledges that Sambol was not a signatory to the prospectuses or registration. (Id. ¶ 64.) The SAC does not allege that Sambol had a role in Securitizations by virtue of his work for Countrywide, nor does it allege that Sambol had a role related to the Securitizations at issue here. As with their allegations against Mozilo, plaintiffs rely on the Group Pleading Doctrine in support of their assertion that Sambol is liable for misrepresentations in the offering documents. Because the plaintiffs have failed to allege that the offering documents contained a material misstatement, the group pleading doctrine does not save their claims against Sambol.

2. Sambol's Statements.

The SAC also alleges that Sambol made three direct misrepresentations, but does not allege that the misstatements were made with respect to the Securitizations here. First, plaintiffs allege that Sambol stated that "we have an intense and ongoing focus on share growth while at the same time maintaining a very strong internal control environment and what we believe is a best-of-class governance. . . . [O]ur culture is also characterized by a very high degree of ethics and integrity in everything we do." (SAC ¶ 35.)

Statements about corporate culture and integrity are typically considered to be inactionable puffery. See In re JP Morgan Chase sec. Litig., 2007 WL 950132, at *4, 12 (S.D.N.Y. Mar. 29, 2007),aff'd sub nom. ECA Local 134 IBEW Joint Pension Trust of Chi v. JP Morgan Chase, 553 F.3d 187 (2d Cir. 2009) (holding that statements regarding "integrity," "fiscal discipline" and "risk management" are "precisely the type of puffery that this and other circuits have consistently held to be inactionable"). Furthermore, the SAC does not allege facts that link this general statement about corporate culture to the Securitizations purchased by plaintiffs.

The SAC also alleges that Sambol stated that "Countrywide required `higher credit scores or lower loan to value ratios' as a condition to approving riskier adjustable-rate mortgages, in order to counter the increased risk." (SAC ¶ 172.) As explained above, statements about guidelines and practices relating to adjustable-rate mortgages are immaterial to the claims here because the Securitizations included only "credit-blemished, closed-end, fixed-rate loans that were secured by second liens on one- to four-family residential properties." (Id. ¶ 2 (emphasis added).) The SAC does not contain any factual allegations which explain how Sambol's statement regarding adjustable-rate mortgage originations relates to the "fixed-rate loans" in the Securitizations.

Finally, the SAC alleges that, in September 2006, Sambol stated that Countrywide was "on the sidelines" of the subprime market. (Id. ¶ 172.) The full statement made by Sambol was: "[W]e remain committed to having a subprime presence. But there are no particular plans to accelerate growth. And, I think, that would characterize our current position as remaining on the sidelines. . . ." (Phillips Decl. Ex. D at 19.) Plaintiffs do not allege that this statement was false or how Sambol's characterization of Countrywide's overall business strategy were relevant to their purchase of the Securities. The percentage of Countrywide's business that related to subprime loans is immaterial with respect to the Securitizations because, as plaintiffs acknowledge, all of the loans included in the Securitizations were "credit-blemished, closed-end, fixed-rate loans that were secured by second liens on one- to four-family residential properties." (Id. ¶ 2.) Plaintiffs do not contend that they were unaware of the number of subprime loans included in the Securitizations.

IV. The Plaintiffs' Section 20(a) Claim is Dismissed.

To state a claim of control person liability under Section 20(a), a plaintiff must allege (1) primary violation by the controlled person, (2) control of the primary violator by the defendant, and (3) meaningful culpable participation in the controlled person's acts of fraud. ATSI, 493 F.3d at 108. Because the Complaint fails to state a primary violation, the plaintiffs' section 20(a) claim is dismissed.

The plaintiffs' section 20(a) claims are dismissed.

V. The Plaintiffs' Claims for Successor Liability Against BofA Are Dismissed.

The SAC alleges a claim against BofA and BAC HLS based on a theory of successor liability. (See SAC ¶¶ 257-74.) Because the SAC fails to state a claim against the Countrywide defendants, there is no basis for a claim based on successor liability against BofA and BAC HLS.

VI. The Plaintiffs' Claims of Common-Law Fraud Are Dismissed.

To state a claim for fraud under New York law, a plaintiff must allege "a material, false representation, an intent to defraud thereby, and reasonable reliance on the representation, causing damage to the plaintiff." See May Dep't Stores Co. v. Int'l Leasing Corp., Inc., 1 F.3d 138, 141 (2d Cir. 1993). As explained above, the SAC fails to allege a material, false representation or that defendants made such statements with an intent to defraud the plaintiffs. Therefore, for substantially the same reasons explained above, plaintiffs' claims against the Countrywide defendants for common-law fraud are dismissed. See Rule 9(b).

CONCLUSION

The defendants' motion to dismiss the SAC is GRANTED. (Docket No. 37.)

SO ORDERED.

Dated: New York, New York

September 28, 2010