Sure, we blew up the economy, but not with consumer-oriented conduct

M & T Bank Corp. v. LaSalle Bank Nat. Ass'n, 2012 WL 432890 (W.D.N.Y.)

M&T alleged that the defendants violated the law by failing to make interest payments owed to M&T on a $50 million note.  The court granted defendants’ motion to dismiss.

The Cairn defendants, Cairn Ltd. and Cairn Inc., co-issued $960 million in collateralized debt obligations, CDOs, based on subprime mortgages.  Greenwich, a registered broker-dealer, bought the notes for resale to investors.  It provided M&T with a Preliminary Offering Memorandum summarizing and describing the Cairn notes and the payment stream they (purported to) represent.  There were 13 classes of notes, each with a different level of priority.

M&T bought $50 million in Class A2A notes in 2007.  Only Class A1-VF notes had higher priority.  Greenwich allegedly owns all of those notes.  Cairn made defendant LaSalle the trustee responsible for making principal and interest distributions to note holders.  About a year after M&T bought, LaSalle notified M&T that there’d been a default event—quelle surprise, as Yves Smith might say.  LaSalle then explained that the underlying collateral earned a bit over $8 million in available interest proceeds, a little under $1.6 million of which was distributed to pay fees (because the servicer gets paid first, another charmingly disastrous incentive) and to pay the Class A1-VF notes.  Instead of getting paid out to the second priority noteholders, the remainder went into a Reserve Account for the benefit of Greenwich as Class A1-VF noteholder, as LaSalle interpreted the agreement it had with Cairn to require.  (So basically, the first tranche had to be paid in full before anyone else got paid a penny.  Well, I’m sure that will happen any day now!)

M&T, understandably chafed, brought suit.  The court first ruled that the terms of the CDO comported with LaSalle’s interpretation, thus getting rid of all claims against LaSalle and leaving only claims against Greenwich and the Cairn defendants for material misrepresentations in the offering memorandum, a violation of GBL sec. 349 as well as of the common law.

M&T’s position was that, if LaSalle’s interpretation of the agreement was right, then Greenwich and the Cairn defendants misled it about its priority.  The offering memorandum said that, “Following an Event of Default and acceleration of the maturity of the Secured Notes, payments of interest on the Secured Notes shall continue to be made in accordance with the Priority of Payments. As a result, interest on Subordinate Classes of Secured Notes (as well as other amounts set forth in the Priority of Payments) may continue to be paid prior to the payment in full of the principal amount of the Senior Classes of Notes.”

Bill Clinton ought to be so proud of the defendants’ arguments here, which the court proceeds to accept, except for the argument that the Martin Act (NY’s securities law) preempts common law and GBL claims.  The NY Court of Appeals just rejected that argument, concluding that the purpose of the Martin Act, “combating fraud and deception in securities transactions,” isn’t impaired by other causes of action with independent legal bases because such actions further the same goal of fighting fraud.  (Compare the 9^th Circuit’s analysis in the recent Honda case, which gave more weight to a state’s calibration of just how much fraud it wanted to tolerate.)

However, M&T’s claims failed on the pleadings.  Negligent misrepresentation requires:  (1) awareness by the maker of a statement that the statement is to be used for a particular purpose; (2) reliance by a known party on the statement in furtherance of that purpose; and (3) some conduct by the maker of the statement linking it to the relying party and evincing its understanding of that reliance. There’s only a cause of action if there’s a special relationship of trust or confidence between the parties, closer than in an ordinary business relationship.  In a business relationship, the necessary degree of dominance/reliance must exist prior to the problematic transaction, not as a result of it.

M&T argued that, as a broker-dealer, Greenwich had a duty to provide it with accurate information and disclose all material information relative to the transaction at issue. But M&T didn’t allege that Greenwich acted as its broker.  M&T further pointed to defendants’ expertise and unique and specialized knowledge of the collateral underlying the notes and its risk level, along with the structure of the CDO.  But, the court ruled, even assuming defendants understood the risks of subprime mortgages better than M&T, that didn’t make their expertise unique in the financial industry, as would be required to “engender the requisite high degree of dominance and reliance in a complex transaction among sophisticated parties.”

Furthermore, M&T didn’t allege actual reliance.  Even assuming that it had, defendants argued that reliance was impossible as a matter of law due to the disclaimers in the memo.  The memo said that it described only “certain provisions of the Secured Notes and that the Indenture,” did “not purport to be complete,” and was “subject to, and qualified in its entirety by reference to, the provisions of the Indenture.”  (Though especially those first two seem irrelevant: the statement about who had priority after default was in there, it just didn’t reflect reality.)  Moreover, the memo said that each note purchaser was “deemed to acknowledge, represent to and agree ... [it] has such knowledge and experience in financial and business matters that [it] is capable of evaluating the merits and risks ... of its prospective investment ... is financially able to bear such risk, ... is not relying on the advice or recommendations of [Defendants and specified others] ... and has had acecss [sic] to such financial and other information concerning the ... Notes as it has deemed necessary to make its own independent decision to purchase notes.”

The court was persuaded: when a plaintiff has been told that it has incomplete information, or needs to look elsewhere for more information, then it has willingly assumed the business risk that the facts may be different.  “It is well settled that a plaintiff cannot establish justifiable reliance when ‘by the exercise of ordinary intelligence’ it could have learned of the information it asserts was withheld.”  M&T didn’t allege that it requested a copy of the actual terms before proceeding, nor that it sought to add protective language to the agreement. Thus, its purported reliance on the memo was unreasonable as a matter of law.

Finally, the court also accepted the alternative argument that the alleged misrepresentation was more an opinion about how the CDO would work than a material fact.  The statement was found in a portion of the memo called “Risk Factors,” prefaced by a stated expectation “that prospective investors interested in participating in this offering are willing and able to conduct an independent investigation of the risks posed by an investment in the Notes.”  The fact that the summary of terms was a different section supported the conclusion that the risk factor discussion was opinion.

So did the content.  The use of the statement that subordinate tranches “may” continue to be paid prior to full payment of the senior tranche was indefinite, thus confirming that it was a statement of opinion. 

Except: if the junior tranches could not be paid before the senior was paid off by the explicit terms of the CDO, as the court just concluded, then it’s not indefinite in a way that matters; if you said that I “may” flap my wings and fly to the moon, you’d just be wrong.  Given the order of the statements—“payments of interest … shall continue to be made in accordance with the Priority of Payments” and then “Subordinate Classes … may continue to be paid prior to payment in full of the principal amount of [the senior tranche],” I would find it reasonable to conclude that “may” here means “it’s possible depending on how many people are paying off their crappy subprime loans” rather than “depending on what the CDO really means, you may get zip.” One of these, of course, is rather more in the control of the CDO creator than the other (though of course plenty of CDOs were deliberately packed full of crappy subprime loans, so I don’t want to say there’s too much of a distinction).

But the court thought it was just opinion, “or, at best, an expression of expectations as to the general impact a possible future event might have on multiple classes of notes.”  (Note that the “future event” in the court’s analysis must necessarily be a determination of the legal meaning of the CDO terms, rather than the housing market collapse, and indeed the court cited several cases about how statements about legal liability are opinion.)

The GBL claims also failed: they require (1) a “consumer-oriented” transaction, (2) deceptive acts or practices/false advertising, and (3) an injury caused thereby.  Most NY and federal district court cases haven’t allowed GBL claims in connection with securities transactions, because they aren’t normal consumer purchases and they’re already heavily regulated by other laws. Even without the great weight of authority, the court found other factors favored rejecting GBL claims.  Though M&T’s status as a business didn’t bar it from suing, the conduct at issue still needs to have a broad impact on consumers at large.  The court didn’t think this conduct was consumer-oriented just because of the “ripple effect” of another CDO implosion on the credit market.  More generally, the amount of money involved, along with the sophistication of the parties, were important factors.  The relevant sections of the GBL offer actual damages or discretionary treble damages up to $500/$10,000.  “The modest recovery available under these statutes weighs against their application to cases involving hundreds of thousands and perhaps millions of dollars and arising from complex transactions among sophisticated parties.”

Case dismissed with prejudice.