Federal Home Loan Bank Of Seattle, App. v. Barclays Capital, Inc., Res.

IN THE COURT OF APPEALS OF THE STATE OF WASHINGTON
FEDERAL HOME LOAN BANK OF No. 75913-2-1
SEATTLE, a bank created by federal
law, DIVISION ONE
Appellant,
V.
BARCLAYS CAPITAL, INC., a PUBLISHED
Connecticut corporation; BCAP LLC, a
Delaware limited liability company; and FILED: December 11,2017
BARCLAYS BANK PLC, a public limited
company registered in England and
Wales,
Respondents.
Cox, J. — Under the Washington State Securities Act("WSSA"), an
investor who sues on the basis that a prospectus contains either untrue
statements or omissions of material facts must prove reasonable reliance on
these statements or omissions.1 Here, the Federal Home Loan Bank of Seattle
("FHLBS") purchased tworesidential mortgage backed securities ("RMBSs") in
1 RCW 21.20.010(2); Hines v. Data Line Sys., Inc., 114 Wn.2d 127, 134,
787 P.2d 8(1990); Stewart v. Estate of Steiner, 122 Wn. App. 258, 264, 93 P.3d
919 (2004), review denied, 153 Wn.2d 1022(2005); Go2Net, Inc. v.
Freeyellow.com, Inc., 158 Wn.2d 247, 251, 143 P.3d 590(2006).
No. 75913-2-1/2
2008 that were described in prospectus supplements. In 2009, FHLBS
commenced this action under the WSSA against Barclays Capital, Inc., BCAP
LLC, and Barclays Bank PLC (collectively, "Barclays"). The essence of its claim
for rescission and other relief is that the prospectus supplements contain untrue
statements or omissions of material facts about the securities FHLBS purchased.
The trial court granted Barclays's motion for summary judgment. In this
appeal, FHLBS fails in its burden to show that there are genuine issues of
material fact. Barclays is entitled to judgment as a matter of law. We affirm the
summary dismissal of these claims.
Some background about the nature of the transactions at issue in this
case may be helpful to provide context. In early 2008, FHLBS purchased the two
RMBSs that are the subjects of this action. These securities were created by a
process known as "securitization."2
The subjects of this securitization are 1,643 loans that IndyMac Bank
made to various residential borrowers throughout the country. IndyMac decided
whether to make each loan by a process called "underwriting." After each loan
approval, each borrower began making monthly payments to IndyMac. For
purposes of securitization, IndyMac was the "originator" of these loans.
After IndyMac originated these loans, it pooled them together and
transferred them to a Barclays subsidiary. The subsidiary then deposited them in
2 See Federal Housing Finance Agency v. Nomura Holding America, Inc.,
60 F. Supp. 3d 479, 486 (S.D.N.Y. 2014).
2
No. 75913-2-1/3
a trust in exchange for investment certificates. The trust issued certificates that
were then sold to FHLBS.
In sum,the stream of income from the monthly payments by borrowers for
the loans from IndyMac, the originator, was transferred to FHLBS,the investor.
On February 13, 2008, FHLBS purchased the first security for
$189,416,000. This RMBS is comprised of 951 of the 1,643 loans originated by
IndyMac. This security is known as BCAP 2008-IND1 ("IND1").
On April 15, 2008, FHLBS purchased the second security for
$232,438,000. This RMBS is comprised of the remaining 692 of the 1,643 loans
originated by IndyMac. This is known as BCAP 2008-IND2 ("IND2").
During the underwriting process, most of these loans were characterized
as "Alt-A", falling between "Prime" and "Subprime" loans in terms of
creditworthiness. As their names suggest, Prime loans are those issued to
borrowers who are the most credit worthy. Subprime loans, on the other hand,
are to borrowers at the other end of the creditworthiness spectrum.
FHLBS purchased these securities at a time that one respected financial
commentator has described as "the mortgage debacle — in 2008. That one
brought world economies to the precipice and wiped out Lehman Brothers and a
raft of troubled banks."3
3 Gretchen Morgenson, After 20 Years of Financial Turmoil, a Columnist's
Last Shot, N.Y. TIMES (Nov. 10, 2017),
https://www.nytimes.com/2017/11/10/business/after-20-vears-of-financial-turmoil-
a-columnists-last-shot.html?emc=eta1 [https://perma.cc/SA9J-9FQK].
3
No. 75913-2-1/4
In 2009, FHLBS commenced this action against Barclays to rescind these
transactions and for further relief. In 2011, the trial court first ruled that
reasonable reliance on the statements in the prospectus supplements is an
element of an investor's claim under the WSSA. In 2016, following extensive
discovery by the parties, the trial court granted Barclays's motion for summary
judgment on lack of reasonable reliance as to the IND1 and IND2 transactions.
The court necessarily decided that FHLBS failed to show any genuine issue of
material fact on this element and that Barclays was entitled to judgment as a
matter of law.
FHLBS appeals.
REASONABLE RELIANCE
Whether reasonable reliance is a necessary element of an investor's claim
under the WSSA is a core issue in this case. FHLBS argues that the WSSA
does not require that it prove that it reasonably relied on the statements in the
prospectus supplements that it now challenges. We disagree and hold that such
reliance is an essential element of an investor's claim under RCW 21.20.010(2).
We will affirm an order granting summary judgment where there is no
genuine issue of material fact and the moving party is entitled to judgment as a
matter of law.4 A material fact is one on which the outcome of the litigation
4McPherson v. Fishing Company of Alaska, 199 Wn. App. 154, 157, 397 -
P.3d 161, review denied, 189 Wn.2d 1021 (2017).
4
No. 75913-2-1/5
depends.5 We review de novo orders of summary judgment.° We also review de
novo a trial court's legal conclusions.7
In construing a statute, we seek to ascertain and carry out the legislature's
intent.° When the legislature enacts a state statute substantially verbatim from a
federal statute, "it carries the same construction as the federal law and the same
interpretation as federal case law.m° When the legislature passes an
"amendment to a statute without alteration of a section previously interpreted by
the courts," such action may "evidence[] legislative acquiescence in the
interpretation."10
Here, FHLBS focuses its arguments on two statements in the prospectus
supplements for the two RMBSs that it purchased.
The first challenged statement states:
Mortgage loans that are acquired by IndyMac Bank are
underwritten by IndyMac Bank according to IndyMac Bank's
underwriting guidelines, which also accept mortgage loans meeting
Fannie Mae or Freddie Mac guidelines regardless of whether such
mortgage loans would otherwise meet IndyMac's guidelines, or
v. Dep't of Labor & Indus., 181 Wn. App. 788, 795, 321 P.3d 12755 Krliqht
(quoting Ranger Ins. Co. v. Pierce County, 164 Wn.2d 545, 552, 192 P.3d 886(2008)), review denied, 181 Wn.2d 1023(2014).
6 Id.7 Sunnyside Valley Irrigation Dist. v. Dickie, 149 Wn.2d 873, 880, 73 P.3d
369 (2003).
8 Thorpe v. Inslee, 188 Wn.2d 282, 289, 393 P.3d 1231 (2017).
9 Anfinson v. FedEx Ground Package System, Inc., 174 Wn.2d 851, 868,
281 P.3d 289(2012)(quoting State v. Bobic, 140 Wn.2d 250, 264, 996 P.2d 610(2000)).
19 McKinney v. State, 134 Wn.2d 388,403, 950 P.2d 461 (1998).
5
No. 75913-2-1/6
pursuant to an exception to those guidelines based on IndyMac's
procedures for approving such exceptions.[]
The essence of FHLBS's claim is that the statement is untrue or
misleading because IndyMac allegedly did not follow "its own guidelines and
procedures in making [these] loans."12
The other challenged statement deals with the loan to value ("LTV") ratios
of these loans. FHLBS claims that many appraisals that determined the LTV
ratios were not made in accordance with the Uniform Standards of Professional
Appraisal Practice, the national standard of the appraisal profession. The
numerator of this LTV ratio is the amount of a loan and the denominator is the
appraised value of the property securing that loan. The purpose of this measure
is to evaluate how much equity a borrower has in the property securing the loan.
RCW 21.20.010 states the elements of a claim under the WSSA:
It is unlawful for any person, in connection with the offer, sale or
purchase of any security, directly or indirectly:
(2) To make any untrue statement of a material fact or to omit to
state a material fact necessary in order to make the statements
made, in the light of the circumstances under which they are made,
not misleading.
The question is whether the legislature intended reasonable reliance to be
an element of a claim under this provision of the WSSA. We hold that it did.
11 Clerk's Papers at 1554, 1564.
12 Appellant's Opening Brief at 9.
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No. 75913-2-1/7
We begin our analysis by noting the substantial similarity of this state
provision with its federal counterpart. As the following chart shows, the
provisions of these statutes are substantially the same.
SEC Rule 10b-5 RCW 21.20.010
"It shall be unlawful for any person... in "It is unlawful for any person, in
connection with the purchase or sale of connection with the offer, sale or
any security... purchase of any security, directly
or indirectly:
(a)To employ any device, scheme, or
artifice to defraud, (1)To employ any device, scheme,
or artifice to defraud;
(b) To make any untrue statement
ofa material fact or to omit to (2) To make any untrue statement
state a material fact necessary of a material fact or to omit to
in order to make the statements state a material fact
made,in the light of the necessary in order to make
circumstances under which they the statements made,in the
were made, not misleading, or light of the circumstances
under which they are made,
(c) To engage in any act, practice, or not misleading;or
course of business which operates
or would operate as a fraud or (3)To engage in any act, practice,
deceit upon any person....113] or course of business which
operates or would operate as a
fraud or deceit upon any
person."[141
The state supreme court has determined that RCW 21.20.010 "is
patterned after and restates in substantial part the language of the federal
13(Emphasis added.)
14 (Emphasis added.)
7
No. 75913-2-1/8
Securities Exchange Act of 1934."15 And this court has clarified that RCW
21.20.010 is "related" to Section 10(b) of that act, as well as SEC Rule 10b-5.16
The words "reasonable reliance" do not appear in Rule 10b-5 or in RCW
21.20.010(2), its state counterpart. But the United States Supreme Court has
long required reliance in Rule 10b-5 actions.17 And Washington law holds that
once a court makes a controlling interpretation of a statute, that interpretation
controls what the statute has always meant's Thus, Rule 10b-5 has always
required a showing of reasonable reliance, and did so when this state's
legislature drew upon it to craft RCW 21.20.010(2).
Accordingly, we conclude that the state legislature enacted RCW
21.20.010(2) with the intent that it be construed in the same way as Rule 10b-5
and have the same interpretation as federal case law of that rule.19 In short,
reasonable reliance is a necessary element of this state claim.
It is particularly noteworthy that since Washington courts began
recognizing a reliance requirement in 1970,20 the legislature has amended the
15 Clausing v. DeHart, 83 Wn.2d 70, 72, 515 P.2d 982(1973).
Guarino v. Interactive Obiects, Inc., 122 Wn. App. 95, 110, 86 P.3d
161175 (2004).
17 See, e.a., JanusCapital Group, Inc. v. First Derivative Traders, 564
U.S. 135, 140 n.3, 131 S. Ct. 2296, 180 L. Ed. 2d 166 (2011); Basic Inc. v.
Levinson, 485 U.S. 224, 242, 108 S. Ct. 978,99 L. Ed. 2d 194 (1988); Ernst &
Ernst v. Hochfelder, 425 U.S. 185, 206,96 S. Ct. 1375,47 L. Ed. 2d 668 (1976)).
16 In re Pers. Restraint of Johnson, 131 Wn.2d 558, 568, 933 P.2d 1019(1997).
19 Anfinson, 174 Wn.2d at 868 (quoting Bobic, 140 Wn.2d at 264).
29 Shermer v. Baker, 2 Wn. App. 845, 858, 472 P.2d 589 (1970).
8
No. 75913-2-1/9
WSSA eight times.21 Not once did it modify the requirement that reliance is a
required element. This is telling.
As the Ninth Circuit Court of Appeals has explained,"the Washington
Legislature may be presumed to have known" about the requirements of Rule
10b-5.22 With this presumed knowledge and no amendment of the WSSA to omit
the reasonable reliance element, we must presume that the legislature intended
that element to remain a part of this state statute.
FHLBS fails to argue why these principles do not control the determination
of the legislature's intent in enacting this statute. Instead, it rests its arguments
on reading case law and statutes in unpersuasive ways.
We note that our interpretation of the legislative intent of the statute has
been consistently stated by the state supreme court and other appellate courts of
this state. The supreme court held in Hines v. Data Line Systems, Inc. that
plaintiffs proceeding under RCW 21.20.010 must show that they "relied on the
misrepresentations in connection with the sale of the securities."23 Only "an
investor who is wrongfully induced to purchase a security may recover his
investment."24
21Laws of 1998, ch. 15,§ 20; Laws of 1986, ch. 304,§ 1; Laws of 1985,
ch. 171,§ 1; Laws of 1981, ch. 272,§ 9; Laws of 1979, Ex. Sess., ch. 68,§ 30;
Laws of 1977, Ex. Sess., ch. 172,§ 4; Laws of 1975, 1st Ex. Sess., ch. 84,§ 24;
and Laws of 1974, Ex. Sess., ch. 77,§ 11.
v. Skipper's, Inc., 915 F.2d 1324, 1331 (9th Cir. 1990)(quoting
22 Wade
WPPSS Securities Litigation, 1986 Blue Sky Law Rptr. 1171,675(W.D. Wash.,
MDL 1986)).
23 114 Wn.2d 127, 134, 787 P.2d 8(1990).
24 Id. at 135.
9
No. 75913-2-1/10
Subsequent opinions have consistently followed this holding.25 And in no
case has any Washington court departed from this interpretation of the statute.
Notably, in Stewart v. Estate of Steiner, this court reiterated the
requirement of reasonable reliance when holding that the investor in that case
did not have a cause of action under the WSSA.26 As this court stated in that
opinion,'The question is whether [the investor] reasonably relied on any of [the
written materials] in making his investment decision."27 If he did not, he failed to
establish "an essential element of his claim."28
Notably, the supreme court denied review in that case. Had the court
believed that this court had misstated the law by holding that reasonable reliance
is an essential element of a claim under the WSSA, it seems likely that the court
would have granted review to address the issue. It did not.
FHLBS advances a number of arguments why this statute does not
require reasonable reliance. They are not persuasive.
FHLBS argues that the decision of the trial court violates the jurisprudence
of this state that the WSSA is to be interpreted to protect investors. We disagree.
25 See, e.g., Go2Net, Inc., 158 Wn.2dat 251; Guarino, 122 Wn. App. at
110; Helenius v. Chelius, 131 Wn. App. 421, 441, 120 P.3d 954 (2005); Stewart,
122 Wn. App. at 264.
26 122 Wn. App. 258, 264, 93 P.3d 919(2004), review denied, 153 Wn.2d
1022(2005).
27 Id. at 265 (emphasis added).
28 Id. at 266.
10
No. 75913-2-1/1 1
First, FHLBS is correct that a purpose of this act is to protect investors.29
With this purpose in mind, we construe the WSSA liberally.39 But this general
statement of purpose does not eliminate the clear legislative intent that we have
already discussed in this opinion that reasonable reliance is a necessary element
for a claim under RCW 21.20.010(2).
Second, FHLBS also argues that the legislature intended to eliminate, not
impose, a requirement to prove reasonable reliance. Not so.
A basis for this argument is that the supreme court has held that certain
elements of common law fraud, on which a WSSA action is based, are
unnecessary to prove. For example, the supreme court held that a plaintiff need
not show scienter in Kittilson v. Ford.31 An earlier court of appeals decision had
held otherwise, following the United States Supreme Court's holding in Ernst &
Ernst v. Hochfelder.32
The Ernst & Ernst court had explained that because Rule 10b-5 derived
from Section 10(b) of the 1934 Securities Exchange Act, and because Section
10(b) speaks of manipulation and deception, a Rule 10b-5 suit "clearly connotes
intentional misconduct."33 Section 10(b) imposed this requirement even though
29 FutureSelect Portfolio Management, Inc. v. Tremont Group Holdings,
Inc., 180 Wn.2d 954, 970, 331 P.3d 29 (2014).
30 Id.31 93 Wn.2d 223, 225-27, 608 P.2d 264(1980).
32 Ludwig v. Mutual Real Estate Investors, 18 Wn. App. 33, 41,567 P.2d
658(1977) (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375,47
L. Ed. 2d 668 (1976)).
33 425 U.S. at 201.
11
No. 75913-2-1/12
the language of Rule 10b-5, standing alone, reached "any type of material
misstatement or omission, and any course of conduct, that has the effect of
defrauding investors, whether the wrongdoing was intentional or not."34 But
Section 10(b) conveyed to it the scienter requirement.35
But our state supreme court held that RCW 21.20.010 neither
incorporated nor derived from a statute incorporating Section 10(b)'s scienter
language.36 And the legislative history of RCW 21.20.010 did not suggest a
scienter requirement.37
Furthermore, the supreme court in Hines concluded that a WSSA plaintiff
need not show loss causation but it did not suggest that liability is strict under the
statute.38 It based this decision on the nature of the remedy the WSSA provided.
The "basic remedy" of that statutory scheme was rescission.39 Under this
scheme, an investor received the same remedy regardless of the size or
occurrence of loss.40 Thus, loss was irrelevant and unnecessary to prove in a
WSSA suit.41
34 Id. at 212.
36 Id. at 215.
36 Kittilson, 93 Wn.2d at 226.
37 Id.38 114 Wn.2d at 135.
39 Id.4° Id.41 Id.12
No. 75913-2-1/13
These cases do not support the generalized proposition that RCW
21.20.010 is a strict liability statute. They merely illustrate that scienter and loss
causation are not part of the statute. More importantly, they do nothing to
support the argument that reliance is not an essential element of a WSSA claim,
as Hines and other appellate decisions in this state have consistently held.
Third, FHLB argues that the legislature intended WSSA actions to be strict
liability actions because it borrowed language from Section 12(2) of the 1933
federal Securities Act. We again disagree.
It is undisputed that Section 12(2) of the 1933 act created a strict liability
cause of action.42 Moreover, the state legislature borrowed language from that
section in crafting the scheme of the WSSA.43 But the legislature only borrowed
Section 12(2)'s remedy to draft the WSSA's remedy provisions in RCW
21.20.430. In contrast, it borrowed the state act's liability provisions from Rule
10b-5.
We note that RCW 21.20.430 clearly states by cross reference that RCW
21.20.010 defines liability.44 Thus, RCW 21.20.430 and Section 12(2) are
irrelevant to whether RCW 21.20.010 requires a plaintiff to show reliance to
establish liability.
42 Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 576, 115 S. Ct. 1061, 131
L. Ed. 2d 1 (1995).
43 See RCW 21.20.430; 15 U.S.C.§ 771.
44 RCW 21.20.430(1).
13
No. 75913-2-1/14
Fourth, FHLBS contends that the statutes of other states persuasively
suggest that RCW 21.20.010 is a strict liability statute. But the statutes of other
states are largely irrelevant to determining the legislative intent of Washington's
legislature.
Washington courts strive to "construe [the WSSA]as to effectuate its
general purpose to make uniform the law of those states which enact" and adapt
the Uniform Securities Act." That uniform act also provided the basis for the
WSSA. But this "does not mean our courts must imitate" the example of other
states when Washington law differs." Simply stated, the legislatures of other
states do not decide what the Washington legislature intended by the WSSA. It
is Washington law, in the end, that governs.47
Finally, FHLBS argues that the language in Hines, stating that reliance is
an element under the WSSA, was mere dicta, which this court should not have
followed in two previous decisions and should not follow now. We disagree with
reading Hines and the cases that follow in this way. To the contrary, they clearly
establish that reasonable reliance is an essential element of this claim.
Even if we were persuaded that the statement in Hines regarding reliance
was dicta, that would not change our conclusion that the legislature intended
reasonable reliance to be an essential element of a claim under RCW
45 RCW 21.20.900.
46 Go2Net, Inc., 158 Wn.2d at 258 (quoting Kittilson, 93 Wn.2d at 227).
47 In re Petersen, 138 Wn.2d 70, 80-81, 980 P.2d 1204(1999).
14
No. 75913-2-1/15
21.20.010(2). That is the core question, not whether the statement in Hines is
dicta.
For the reasons we have explained, we are convinced that the legislature
intended that an investor must prove reasonable reliance in a claim under the
WSSA.
GENUINE ISSUES OF MATERIAL FACT
Having concluded that reasonable reliance is an essential element that
FHLBS must prove in this case, the question that follows is whether it met its
burden to show the existence of any genuine issue of material fact on that
element in response to Barclays's motion for summary judgment. We conclude
that it failed in this burden.
It is not enough that a plaintiff relied upon the defendant's statements in
purchasing securities. The WSSA requires that such "reliance must be
reasonable under the surrounding circumstances."48
Reasonable reliance is generally a factual question." However, if
reasonable minds could reach only one conclusion, summary judgment on this
element is proper.8°
Our inquiry focuses on determining the existence of genuine issues of
material fact whether FHLBS reasonably relied on the two statements it
FutureSelect Portfolio Management, Inc. v. Tremont Group Holdings,
48
Inc., 175 Wn. App. 840, 868, 309 P.3d 555 (2013).
48 Morgan v. Irving, 8 Wn. App. 354, 356,506 P.2d 316(1973).
M.A. Mortenson Co., Inc. v. Timberline Software Corp., 140 Wn.2d 568,
88
579, 998 P.2d 305 (2000).
15
No. 75913-2-1/16
challenges. After carefully reviewing the extensive record before us, we
conclude that FHLBS failed to show any genuine issue of material fact supporting
the argument that it reasonably relied on these statements.
FHLBS is, without question, a sophisticated investor in RMBSs. Yet
minutes of its risk management committee dated February 2008 warn that all but
three of the regional FHLB banks, the Seattle branch within this minority, had
stopped purchasing securitized "Alt-A" loans.51 The minutes also report that
another regional bank---Boston---was advised not to buy any additional mortgage
backed securities for its portfolio. Credit Analysis Manager Len Reininger alerted
his colleagues at the meeting to "how rapidly housing prices have plummeted
and foreclosures and delinquencies have increased."52 But at that time, Joel
Adamo, Portfolio Manager on both the IND1 and IND2 transactions, was already
considering purchase of IND2.
The risk management committee decided on February 29, 2008 that "with
the uncertainty in the markets and the issues discussed that it would be desirable
to look at alternative investment opportunities to those the Bank had been
utilizing recently."53
The committee thus directed Reininger and Adamo to develop together "a
proposal for the[RMBS]investment criteria that would be used in the current
51 Clerk's Papers at 662.
52 Id. at 663.
53 Id. at 662-63.
16
No. 75913-2-1/17
market conditions."54 Until then, the committee directed a ban on the purchase of
such securities.
Reininger preferred to maintain a total ban, until "the market settle[d]
down."55 But senior FHLBS staff differed and sought a compromise that would
let them "still make some money."56 Adamo and Reininger reached such a
compromise to recommend lifting the ban for certain RMBS purchases.
In spite of these internal warnings, FHLBS continued purchasing IndyMac
originated securities, comprised of Alt-A loans.
The record also shows that FHLBS initially made an internal decision not
to purchase further securities of this type, only to change that decision to use
available funds to purchase IND1 and IND2.
A November 2007 internal FHLBS memorandum also provides notice
about IndyMac, the originator of the loans that were securitized and purchased
by FHLBS. The memo states in relevant part:
"IndyMac, the second-largest independent U.S. mortgage lender,
lost $202.7 million in the third quarter, five times bigger than the
company predicted. The company stated,'We are in the midst of
the most severe downturn our industry has experienced in modern
times.'"[571
54 Id. at 663.
55 Id. at 690.
56 Id.
57 Id. at 1706.
17
No. 75913-2-1/18
Three months later and despite this and other information, FHLBS
proceeded with the purchase of securities that were originated by IndyMac, the
author of this warning.
Notably, the record shows that FHLBS was deeply involved in selecting
the loans originated by IndyMac that ultimately constituted the two securities the
bank purchased. This record also shows the selections occurred during
communications directly between FHLBS and IndyMac, without involvement of
Barclays.
This and other evidence in the record before us supports our conclusion
that FHLBS did not reasonably rely on the statements it now claims induced it to
buy IND1 and IND2. Reasonable minds could only reach this conclusion.
An alternative analysis further supports our conclusion that there are no
genuine issues of material fact on reasonable reliance. In Stewart v. Estate of
Steiner, this court utilized eight factors for considering whether reliance was
reasonable under the circumstances of that case.58 Stewart borrowed this test
from an opinion of the First Circuit Court of Appeals, Jackvonv v. RIHT Financial
Corp., authored by then Judge Stephen Breyer.58
58 122 Wn. App. 258, 274, 93 P.3d 919 (2004).
89 873 F.2d 411 (1st Cir. 1989).
18
No. 75913-2-1/19
The First Circuit's test has been widely applied by the federal courts,
including the Second, Fourth, Sixth, Eighth, Tenth, and Eleventh circuits, in
considering Rule 10b-5 claims.60
We again apply these factors, as we did in Stewart, to determine whether
there are any genuine issues of material fact, recognizing that no such issue
exists where reasonable minds could reach only one conclusion.61 FHLBS
provides only cursory mention of these factors in a footnote in its brief. We
consider this footnote, as well as the record generally, in applying these factors.
No individual factor of this test is necessarily dispositive.62 The factors
are:
(1)[T]he sophistication and expertise of the plaintiff in financial and
securities matters;(2) the existence of long standing business or
personal relationships;(3) access to the relevant information;(4)
the existence of a fiduciary relationship;(5) concealment of the
fraud;(6)the opportunity to detect the fraud;(7) whether the
plaintiff initiated the stock transaction or sought to expedite the
transaction; and (8) the generality or specificity of the
misrepresentations.[63]
60 Brown v. E.F. Hutton Grp., Inc., 991 F.2d 1020, 1032(2d Cir. 1993);
Davidson v. Wilson, 973 F.2d 1391, 1400 (8th Cir. 1992); Myers v. Finkle, 950
F.2d 165, 167(4th Cir. 1991); Molecular Technology Corp. v. Valentine, 925 F.2d
910, 918 (6th Cir. 1991); Bruschi v. Brown, 876 F.2d 1526, 1529 (11th Cir. 1989);
Zobrist v. Coal-X, Inc., 708 F.2d 1511, 1516 (10th Cir. 1983).
61 M.A. Mortenson Co., Inc., 140 Wn.2d at 578.
62 Stewart, 122 Wn. App. at 274.
63 Id.19
No. 75913-2-1/20
Plaintiff's Sophistication
As for the first factor, "a sophisticated investor requires less information to
call a Imislrepresentation into question' than would an unsophisticated
investor."64
Here, FHLBS is indisputably sophisticated in the purchase of RMBSs.
Along with other Federal Home Loan Banks, it was established by federal charter
to facilitate mortgage lending.65 By its own admission, it serves more than 300
members,"mainly community banks and credit unions" throughout the Western
United States and the Pacific Territories.66 It invests, including in RMBSs,to
provide mortgage loan financing to borrowers. In doing so, it amassed an $8
billion portfolio of RMBSs.
Importantly, Joel Adamo,the portfolio manager for these two transactions,
when testifying at deposition, was asked whether he was a sophisticated
mortgage backed securities purchaser. He answered that he was "really
knowledgeable about all the different securities types that are out there in the
market."67 He identified himself as an "expert on mortgage-backed securities."68
Reasonable minds could not differ that FHLBS is a sophisticated
purchaser of these two RMBSs. FHLBS does not argue otherwise.
64 Banca Cremi, S.A. v. Alex. Brown & Sons, Inc., 132 F.3d 1017, 1028
(4th Cir. 1997).
65 12 C.F.R.§ 1265.2.
66 Clerk's Papers at 159.
67 Id. at 1654.
68 Id. at 1657.
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No. 75913-2-1/21
Longstanding Relationships
FHLBS and Barclays lacked a longstanding business or personal
relationship prior to these two transactions. Thus, reasonable minds could not
differ whether Barclays was in a position to more easily defraud FHLBS.
Nothing in FHLBS's briefing suggests otherwise.
Access to Relevant Information
FHLBS argues that it lacked access to information necessary to avoid
relying on Barclays's alleged statements in the prospectus supplements. This is
an unproven assertion that fails to create a genuine issue of material fact.
A plaintiff relies unreasonably when he "possesses information sufficient
to call [a mis-]representation into question,' but nevertheless 'close[s] his eyes to
a known risk.'"69 A plaintiff conscious of such risk relies unreasonably when he
refuses to make necessary further investigations."
We have already explained why FHLBS was warned both about IndyMac
and the Alt-A loans that comprised the securities it purchased. Yet, despite
these prior warnings, it proceeded with these transactions. FHLBS fails to point
to any evidence in the record to show that it asked for any additional information
it believed material to either of the two statements it now challenges.
A fair reading of the relevant portions of the supplements further undercuts
this claim of lack of access to information.
69
Banca Cremi, S.A., 132 F.3d at 1028 (quoting Teamsters Local 282
Pension Trust Fund v. Angelos, 762 F.2d 522, 530 (7th Cir. 1985)).
70 id.21
No. 75913-2-1/22
First, Barclays provided information regarding the relevant risks in the
prospectus supplements themselves. Regarding internal IndyMac guidelines
adherence, the IND1 prospectus supplement explained that the loans were
originated "generally" in accordance with described underwriting guidelines. It
explained that IndyMac used both traditional and electronic underwriting. But it
also explained that IndyMac had processes to override its guidelines and make
exceptions. It stated that IndyMac determined a borrower's FICO credit score by
selecting the middle score of those provided by each of the major credit
repositories and then choosing the lowest of these, making exceptions when a
borrower had higher income or assets. And it explained that IndyMac could
consider "compensating factors that would allow mortgage loans not otherwise
meeting IndyMac Bank's guidelines."71
Barclays provided similar statements in the prospectus supplement for
IN02, explaining that IndyMac approves loans under six different documentation
programs. These vary, ranging from full verification of employment, income, and
asset verification, to programs requiring no documentation or verification for
borrowers with better credit scores and more valuable collateral property.
It also explained that loans failing to meet IndyMac guidelines could be
"manually re-underwritten and approved under an exception to those
underwriting guidelines."72 It explained the compensating factors that would
support an exception might include "significant financial reserves, a low loan-to-
71 Clerk's Papers at 1554.
72 Id. at 1555, 1566.
22
No. 75913-2-1/23
value ratio, significant decrease in the borrower's monthly payment[,] and long-
term employment with the same employer."73 Thus, the prospectus supplements
alerted FHLBS to possible divergences from the mortgage approval and
guidelines.
In sum,this unproven claim that FHLBS lacked access to information it
needed is without any support in the record.
Adamo himself expressed similar sentiments. He testified at his
deposition that he "monitor[ed] market developments impacting the mortgage-
related assets[he] bought."74 He further testified that there was "turmoil in the
RMBS market" at the time he made the relevant purchases.78 During that
discussion, he stated that"RMBS bonds backed by collateral pools of 2006
vintage collateral would never fully recover in price."78 Further, he knew that any
problems regarding subprime loans in the market could "leak into the rest of the
market."77 Bluntly, he testified that the "market was just plummeting" in late
2007.78
But, after purchasing IND1, FHLBS still had several hundred million
dollars to invest. As discussed above, risk managers at FHLBS repeatedly
73 Id. at 1556, 1567.
74 Id. at 1655.
75 Id. at 534.
76 Id. at 537.
77 Id. at 580.
78 Id. at 527.
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No. 75913-2-1/24
warned about the riskiness of investing in RMBS based on loans originated with
IndyMac. These warnings appear in the minutes of the risk management
committee and in internal FHLBS memos from the relevant times. The record
thus clearly indicates that FHLBS knew that these transactions carried great risk.
FHLBS possessed access to similar information regarding LTV ratios.
This information was less extensive but that which was available was explicitly
concerning. This information was provided in the prospectus supplements.
These explained that IndyMac appraised the relevant mortgaged property in
accordance with the Uniform Standards of Profession Appraisal Practice, and
would either do a traditional inspection appraisal or else employ the algorithmic
automated valuation model. But it also noted that "the determination of the value
of a mortgaged property used in the calculation of the loan-to-value ratios of the
mortgage loans may differ from the appraised value of such mortgaged
properties or the actual value of such mortgaged properties."78
FHLBS was further aware that "appraisals are an art and not an exact
science."8° Vice President Gregory Teare explained that "Mypically, most
appraisers will state the an [sic] appraisal of +/- 10% of the actual value."81 This
is relevant to the second challenged statement in the prospectus supplements.
79 Id. at 1548, 1562.
80 Id. at 1422.
81 id.
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No. 75913-2-1/25
Fiduciary Relationship
FHLBS and Barclays lacked a fiduciary relationship that might have
enabled Barclays to defraud FHLBS. Reasonable minds could not differ on this
factor.
FHLBS does not argue otherwise in its briefing on appeal.
Concealment
FHLBS fails to point to anything in this record to indicate any concealed
fraud. As explained previously in this opinion, the prospectus supplements
warned FHLBS about the integrity of the underlying collateral. They alerted
FHLBS to possible variances from guideline adherence and LTV accuracy. And
FHLBS cannot show that Barclays barred it from accessing the loan files. Thus,
reasonable minds could not differ on this factor.
Opportunity to Detect the Fraud
As discussed above, FHLBS fails to demonstrate it lacked an opportunity
to detect that alleged fraud. Adamo claimed that he could not obtain the loan
files, but he never claimed to have asked for them. Similarly, the record indicates
that neither Adamo nor anyone else at FHLBS asked for the underwriting or
appraisal guidelines or information on possible divergences therefrom.
Rather, Adamo stated that:
[he]!bi[ied] on the securitization people who are making this — on
their due diligence and their writings in the security. There is [sic]
weaknesses and strengths with every factor, and I would try to take
those into account. But I had limited knowledge as to what exactly
happened between a loan officer and the security.(82]
82 Id. at 4300.
25
No. 75913-2-1/26
Adamo recognized there could be fraud in the pool but explained that he was not
buying the pool but rather its securitization. He "relied on the representations
given to [him] by the securitizer" despite "[r]ecognizing that there are risks in an
investment."83
But Adamo's reliance on Barclays does not imply he lacked the
opportunity to detect any possible fraud. Thus, reasonable minds could not differ
whether FHLBS had an opportunity to detect the alleged fraud.
Initiation or Expedition of Transaction
The parties hotly dispute this seventh factor. Each alleges that the other
drove the purchases of IND1 and IND2. Because this nondispositive factor does
not appear to us to create a genuine issue of material fact, we need not decide
who, Barclay or FHLBS, initiated this transaction.
After careful review of the record, we conclude that nothing in the
discussion about this factor is material in determining the dispositive question:
whether FHLBS reasonably relied on the quoted statements in the prospectus
supplements regarding variances in IndyMac guideline adherence and the
accuracy of LTV ratios. At no point does either party reference IndyMac's
alleged divergence from loan underwriting guidelines. Nor does either party call
into question the accuracy of LTVs. For these reasons, we conclude that any
factual dispute on this factor is not material for summary judgment purposes.
83 Id. at 4304.
26
No. 75913-2-1/27
Specificity of Statements
Regarding this factor, FHLBS only challenges two statements in the
prospectus supplements. The question here is how general or specific these
statements were, not whether they were untrue or misleading.
The first challenged statement reads:
Mortgage loans that are acquired by IndyMac Bank are
underwritten by IndyMac Bank according to IndyMac Bank's
underwriting guidelines, which also accept mortgage loans meeting
Fannie Mae or Freddie Mac guidelines regardless of whether such
mortgage loans would otherwise meet IndyMac Bank's guidelines,
or pursuant to an exception to those guidelines based on IndyMac
Bank's procedures for approving such exceptions.[84]
The second statement noted that the appraisals underlying the LTVs were
made in accordance with the Uniform Standards of Professional Appraisal
Practice.
These statements, especially when accompanied by certain qualifying
language, were highly general. The first statement did not purport to explain
what the underwriting guidelines were, or the procedures for overriding them.
But both prospectus supplements explained that IndyMac could make exceptions
from its guidelines if a loan application included compensating factors. Such
factors might include "significant financial reserves, a low loan-to-value ratio,
significant decrease in the borrower's monthly paymentm and long-term
employment with the same employer."85
84 Id. at 1554, 1564.
85 Id. at 1556, 1567.
27
No. 75913-2-1/28
The statement regarding appraisal practice standards was similarly
general and qualified. The statement itself made no claim as to the accuracy of
the appraisals, only naming the standards employed. But the prospectus
supplements also stated that "the determination of the value of a mortgaged
property used in the calculation of the loan-to-value ratios of the mortgage loans
may differ from the appraised value of such mortgaged properties or the actual
value of such mortgaged properties."86
Read alone or in the context of the respective prospectus supplements,
these statements were highly generalized and subject to qualifications. They did
not provide FHLBS any specific assurance or detail regarding the nature or
quality of the collateral. They noted only the general procedure for acquiring
loans and appraising properties, both subject to wide variances.
Reasonable minds could not differ that these statements were highly
general and provided no specific assurances.
Applying the Stewart factors, we conclude that FHLBS fails to meet its
burden in showing a genuine issue of material fact whether it reasonably relied
on the challenged statements.
FHLBS also argues for the existence of other minor genuine issues of
material fact. We disagree with its unconvincing arguments.
FHLBS argues that statements in the supplements that the readers should
only rely on information in those documents creates an issue of fact. FHLBS
similarly argues that Barclays assured investors that it was meticulous in
86 Id. at 1548, 1562.
28
No. 75913-2-1/29
preparing the supplements. But these arguments are directly contrary to settled
law that reasonable reliance is determined by considering all the circumstances,
not just what is in a prospectus supplement.
FHLBS also argues that Barclays's statements were specifically about the
1,643 loans constituting these two securities, and not the general climate of
RMBS investments. That is true. But it does not create a genuine issue of
material fact, given there were both internal and external warnings that put
FHLBS on notice that it could not solely or reasonably rely merely on the
supplements.
And FHLBS also argues that it had no access to loan files and that it was
therefore unable to detect whether the prospectus supplements contained untrue
or misleading statements. But, given the information that was available, FHLBS
was on notice that the loans constituting the securities were risky and that the
originator of those loans was also troubled. It could have asked for more
information, but there is no evidence that it did.
We affirm the summary dismissal of these claims.
J.
WE CONCUR:
1
29