Bank & Lender Liability

Westlaw Journal Formerly Andrews Litigation Reporter BANK & LENDER LIABILITY

Litigation News and Analysis • Legislation • Regulation • Expert Commentary VOLUME 16, ISSUE 4 / JULY 2, 2010

COMMENTARY WHAT’S INSIDE

BREACH OF CONTRACT 11 Countrywide says mortgage The case for improved financial reporting: lender failed to buy back fraudulent loan A look at regulation of the global Countrywide Home Loans v. Bank of Ky. (C.D. Cal.) capital markets

CRIMINAL LAW Katherine S. Montague and Andrew J. Walker of MainStreet Advisors discuss financial 12 Mortgage loan exec ran reporting and how it could be improved to better support the efficiency of the global 1.9 billion fraud scheme, feds capital markets. say SEE PAGE 3 United States v. Farkas (E.D. Va.)

CYBERCRIME COMMENTARY 13 FTC approves settlement with restaurant chain over largest- ever data breach In re Dave & Buster’s (F.T.C.) Illinois mortgage foreclosure trends: Defense,

HEDGE FUNDS loan modification and bankruptcy remedies 14 New York sues investment firm over Madoff advice Attorney David P. Leibowitz of Lakelaw discusses the increase in the number of fore- People v. Ivy Asset Mgmt. (N.Y. closures and bankruptcy in the Ohio and the options available to clients to save their Sup. Ct.) homes. SEE PAGE 7 MORTGAGE INSURANCE 15 Bank of America must face bad-faith claim Jones v. Bank of Am. (D. Ariz.) OVERDRAFT FEES RATINGS AGENCIES 16 Securities ratings are not ‘free Florida class action speech,’ California judge rules Cal. Pub. Employees’ Ret. Sys. v. challenges bank’s Moody’s Corp. (Cal. Super. Ct.) overdraft fee system SECURITIES ACT OF 1933 17 Subprime-related suit against A Florida class-action lawsuit claims Merrill Lynch goes forward Compass Bank acted illegally by rear- Miss. Pub. Employees’ Ret. ranging customers’ debit transactions in Sys. v. Merrill Lynch (S.D.N.Y.) an effort to maximize overdraft charges. 18 WaMu execs, investors spar in subprime mortgage suit Boilermakers Nat’l Annuity CONTINUED ON PAGE 10 Trust Fund v. WaMu Mortgage (W.D. Wash.)

40857735 TABLE OF CONTENTS Westlaw Journal Bank & Lender Liability Overdraft Fees: Anderson v. Compass Bank Published since September 1997 Florida class action challenges bank’s overdraft fee system (S.D. Fla.)...... 1 Publisher: Mary Ellen Fox Commentary: By Katherine S. Montague and Andrew J. Walker, CFA Executive Editor: Jodine Mayberry The case for improved financial reporting: A look at regulation of the global capital markets...... 3 Production Coordinator: Tricia Gorman Managing Editor: Phyllis Lipka Skupien, Esq. Commentary: By David P. Leibowitz, Esq. Illinois mortgage foreclosure trends: Defense, loan modification and bankruptcy remedies...... 7 Editor: Catherine A. Tomasko [email protected] Breach of Contract: Countrywide Home Loans v. Bank of Ky. Countrywide says mortgage lender failed to buy back fraudulent loan (C.D. Cal.)...... 11 Westlaw Journal Bank & Lender Liability (ISSN 2155-0700) is published biweekly by Criminal Law: United States v. Farkas Andrews Publications, a Thomson Reuters/ Mortgage loan exec ran $1.9 billion fraud scheme, feds say (E.D. Va.)...... 12 West business. Andrews Publications Cybercrime: In re Dave & Buster’s 175 Strafford Avenue FTC approves settlement with restaurant chain over largest-ever data breach (F.T.C.)...... 13 Building 4, Suite 140 Wayne, PA 19087 Hedge Funds: People v. Ivy Asset Mgmt. 877-595-0449 New York sues investment firm over Madoff advice (N.Y. Sup. Ct.)...... 14 Fax: 800-220-1640 www.andrewsonline.com Mortgage Insurance: Jones v. Bank of Am. Customer service: 800-328-4880 Bank of America must face bad-faith claim (D. Ariz.)...... 15

For more information, or to subscribe, Ratings Agencies: Cal. Pub. Employees’ Ret. Sys. v. Moody’s Corp. please call 800-328-9352 or visit Securities ratings are not ‘free speech,’ California judge rules (Cal. Super. Ct.)...... 16 west.thomsom.com. Securities Act of 1933: Miss. Pub. Employees’ Ret. Sys. v. Merrill Lynch Reproduction Authorization Subprime-related suit against Merrill Lynch goes forward (S.D.N.Y.)...... 17 Authorization to photocopy items for internal or personal use, or the internal or personal Securities Act of 1933: Boilermakers Nat’l Annuity Trust Fund v. WaMu Mortgage use by specific clients, is granted by Andrews WaMu execs, investors spar in subprime mortgage suit (W.D. Wash.)...... 18 Publications for libraries or other users registered with the Copyright Clearance Center News in Brief...... 19 (CCC) for a fee to be paid directly to the Copyright Clearance Center, 222 Rosewood Case and Document Index...... 20 Drive, Danvers, MA 01923; 978-750-8400; www.copyright.com.

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By Katherine S. Montague and Andrew J. Walker, CFA

The debt crisis created by the subprime to understand the role such reporting plays Investors derive their confidence in the mortgage bubble and the ensuing global in the regulatory process. The markets for data released in financial reports based on recession have created a renewed focus on publicly traded debt and equity can even be the perceived quality and transparency of financial regulation and the government’s considered a supplement to governmental financial statements, as well as the corporate role in securing the financial system. At regulatory processes, as investors, in governance of the company. the time of this writing, the reconciled aggregate and in their own self-interest, Financial reports serve as an input to the financial regulatory reform bill has passed monitor the regulatory filings of the investment decision-making process, the U.S. House of Representatives and is companies they own. For these reasons, it allowing investors to influence security prices pending a vote in the Senate. Investors is important that we continue to improve the at securities exchanges, thus acting in a have eagerly awaited the final bill to have a transparency, timeliness and reliability of the market regulatory capacity. However, this better understanding of the future regulatory financial reporting process. process fails if the information investors have environment. relied upon is inadequate or not reflective The bill expands regulatory reach to the REGULATORS of current financial conditions within a monitoring of hedge funds and derivative In her book “Dear Mr. Buffett,” structured company. securities, creates a new consumer financial finance expert Janet Tavakoli says the This is particularly important because the protection agency, provides explicit authority global capital markets are “suffering from breakdown in the flow of accurate information to seize failing financial institutions, and too little competent regulation where it not only influences investor actions but also creates a new high-level council to monitor counts most.”3 When considering regulators, reduces confidence in the process. Realizing 1 systemic risk. traditional bodies such as the SEC, Federal this, the SEC has sought to improve investor These reforms ignore another important regulator: market participants who use the financial reports of publicly traded companies to value and trade public Market participants unofficially serve as efficient regulators. securities. Just as regulators reacted to the accounting scandals of the early 2000s with Deposit Insurance Corp. and the Office of the protection and promote greater market the Sarbanes-Oxley Act of 2002, legislators Comptroller of Currency, receive considerable efficiency, in an effort to ultimately restore should now also consider the financial media attention. However, numerous confidence in financial markets.5 reporting framework and how it might be agencies participate in the regulatory improved to better support the efficiency of A Harvard Business Review article process, making it difficult at times to discern the global capital markets. published in 2003 discussed regulatory the specific responsibilities and authority of themes appropriate for the current market Financial reporting is the process by which each agency. environment.6 Authors Paul M. Healy and public companies report their results to Before the collapse of the subprime Krishna G. Palepu argued that auditors the investing public. In the United States, mortgage market, many regulators and should not only separate themselves from financial reporting is subject to Generally risk professionals received warnings by company managers, but also seek companies Accepted Accounting Principles set forth by experts such as Tavakoli about problems whose interests are better aligned with the Financial Accounting Standards Board, with that market and its strong presence in investors’ and are independent of the audit the organization designated to set domestic structured financial products, but they did process. The most effective organizations in accounting standards by the Securities and not respond quickly enough to ward off the accomplishing this are stock exchanges. Exchange Commission under the Securities crisis.4 This indicates that better-defined Exchange Act of 1934. Healy and Palepu concluded that without roles are needed among regulatory bodies, high-quality information, “investors cannot In international financial markets, the as is an improved framework for compiling set rational prices, and the exchanges International Accounting Standards Board is information. develop reputations for listing unreliable responsible for setting accounting standards securities.” for companies in more than 100 developed INVESTORS AS REGULATORS and developing countries.2 The California Public Employees’ Retirement Market participants unofficially serve as very System, which manages retirement, health As these regulatory bodies consider efficient regulators that support the global and related financial programs to benefit financial reporting reform, it is important capital markets by acting in their self-interest.

© 2010 Thomson Reuters JULY 2, 2010 n VOLUME 16 n ISSUE 4 | 3 more than 1.6 million public employees, ultimately helps investors to make more ACCOUNTING TECHNIQUES retirees and their families as well as more informed investment decisions and optimally The Generally Accepted Accounting than 3,000 public employers,7 began have greater confidence in those decisions. Principles emphasize the letter of the law corporate governance initiatives in 2008 and over the spirit of the law, giving companies 2009 to promote integrity in the financial TRANSPARENCY some degree of flexibility to comply with reporting process. The need for greater financial transparency is accounting standards while not necessarily It said the process should incorporate more apparent following the global financial reporting the true economics of a business characteristics such as integrity, crisis. Analysts, regulators and investors transaction. Researchers have found strong independence, objectivity and professional alike either did not or could not heed the evidence that companies do indeed manage competence.8 By seeking to improve the signals of the ensuing collapse of the credit their earnings to, on average, slightly exceed accuracy of financial disclosure and audit markets. By the time problems surfaced, Wall Street’s consensus earnings estimate,12 practices, serving on advisory boards and exposure to these toxic assets was too great thus complying with the letter of the law and roundtables, and wanting to give regulators within the global capital markets to limit the not the spirit. feedback to contribute to market reform, damage. While run-of-the-mill aggressive accounting CalPERS, as one of the largest institutional Adequate transparency is critical for the may deceive investors, fraudulent offenders investors, is an example of an investor serving financial markets to function properly. have dominated the news in recent history. In as an activist to support regulatory process. Congress released a study in 2007 that 2002 Adelphia Communications, then the examined the importance of transparency country’s fifth largest cable company,13 filed CORPORATE GOVERNANCE with regard to monetary policy, yet many for bankruptcy in the wake of a corruption Since the passage of the Sarbanes-Oxley of its conclusions are applicable in today’s scandal that started with improperly Act of 2002, corporate boards have been broader financial markets.10 The study disclosed loans the company made to its expected to exercise greater due diligence said a lack of transparency may promote executives. The infamous Enron hid liabilities using off-balance-sheet structures and inflated Legislators should now consider the financial reporting its income with aggressively recorded framework and how it might be improved. revenue from its trading businesses.14 Telecommunications company WorldCom increased net income by capitalizing costs in the preparation and dissemination of rather than expensing them properly. unnecessary market reaction to any news, financial information. Corporate governance positive or negative, that is released. In each of these cases, investors were nearly has become an increasingly important topic wiped out, prompting Congress to pass both in terms of investor awareness and its The quality of financial transparency hinges Sarbanes-Oxley in an attempt to improve impact on the regulatory process. on several key characteristics. Information corporate governance, fix conflicts of interest, released must be direct, not ambiguous Elements of corporate governance include and add civil and criminal consequences for and, more importantly, timely. Facts also responsibility, accountability, ethical corporate executives. must be depicted in such a way that outside behavior, a commitment to shareholders, participants can garner a clear picture of a The creative accounting techniques used by disclosure and transparency. Internal and company’s financial condition. corporations to, at best, manage earnings external controls are utilized to supervise or, at worst, to deceive are as varied as the organizations, yet the effectiveness of Advances in technology have changed companies themselves. Howard Schilit, in his corporate governance varies significantly the landscape, affecting the quantity and book “Financial Shenanigans,” popularized across companies. Consequently, confidence distribution frequency of information. This the seven most common ways companies in the reliability of financial information highlights the trade-off of relevance versus manage their earnings.15 Schilit claims released by companies varies as well. reliability. Just because a company has the that red flags existed in the pre-bankruptcy capability to release copious amounts of Following this growing spotlight on improved financial reports of Enron, Adelphia, information does not mean it should. Data corporate governance, independent WorldCom and others that an astute analyst relevant to regulators and investors may investment research firm Morningstar should have noticed. But why were these red in fact be more difficult to identify if it is Inc. created its “stewardship grade” for flags missed? accompanied by superfluous information, stocks.9 Despite a lack of correlation therefore rendering it less reliable. The question is difficult to answer and likely between company stewardship and financial has a number of reasons. One is the trend performance, investors remain interested Because of the sophistication of information in the late 1990s, after the partial repeal of in how companies rate in more subjective released, investors often look to analysts for the Glass-Steagall Act, of large financial areas such as transparency, shareholder interpretation and should have confidence in institutions to offer a broad array of corporate friendliness, incentives and initiatives. the integrity of that analysis.11 finance products. Banks now acted as a “one- This stewardship rating, intended to measure stop shop,” degrading the firewall between a company’s commitment to its shareholders, commercial banking and investment banking

4 | WESTLAW JOURNAL n BANK & LENDER LIABILITY © 2010 Thomson Reuters and increasing the pressure on sell-side stock In doing so, some market participants were opposed to a reactionary role, in this complex analysts to provide “supportive” research forced to sell into an irrational, illiquid environment. on companies that were customers of other market, thus establishing an observable “fire The FASB has proposed a comprehensive 16 divisions. This conflict of interest may be one sale” price well below the economic value update to its accounting rules for financial reason many analysts missed the red flags of of the security. Financial institutions were, instruments, with a goal of establishing the accounting scandals of the early 2000s. in turn, forced to take inappropriate write- standards that are less complex and that A more recent corollary to this question is downs on investments held on the balance offer a timely and representative depiction the insight by a few hedge funds into the sheets and forced to raise additional capital of an entity’s involvement in financial growing subprime mortgage credit bubble to cover those write-downs. instruments. in 2006 and 2007. Insightful hedge fund In early 2009 the SEC bowed to pressures While the specifics of these changes are managers such as John Paulson of John from financial institutions and revised the beyond the scope of this article, the major Paulson & Co. and Alec Litowitz of Magnetar FASB’s Statement of Financial Accounting changes include: Capital used their keen research into the real Standards 157, which provides guidance to estate markets to make highly leveraged establish the fair value of a security, to afford • Disclosures of both the amortized cost bets against the riskiest mortgage-backed companies more flexibility in determining the and the fair value of held-to-maturity securities, often at the cost of many large fair value of illiquid securities.18 securities. 17 financial institutions. If those financial Market participants, including the CFA • New guidance on accounting for institutions had been subject to more Institute, a global organization for investment expected credit losses. transparent financial reporting criteria, professionals, strenuously objected to the • New qualitative assessments to qualify perhaps more investors would have noticed weakened standard, stating in a letter to for hedge accounting. the ballooning subprime exposures in those then-SEC Chairman Christopher Cox that These rule changes will make financial reports firms. an abandonment of fair-value rules “would more relevant and transparent and therefore be a disservice to the capital markets, would MARK TO MARKET more useful to investors when comparing and be inconsistent with the views of investors, analyzing firms. Unfortunately, the IASB has The financial crisis of 2008-2009 was would harm the credibility and independence rejected the comprehensive reform proposed marked by the growth of the market for of the standards setting process, and would by the FASB, favoring a more incremental mortgage-backed securities. Specifically, run counter to fundamental notice and approach. Such a divergence is unfortunate “non-agency MBS” outstanding nearly comment principles.”19 and goes against the 2004 agreement to doubled from $1.46 trillion in 2004 to Indeed, a recent SEC examination attempted develop significant changes in accounting $2.98 trillion in 2007. Non-agency MBS are to determine the extent to which the bank standards cooperatively.21 bundles of mortgages that do not meet the failures in 2008 could be attributed to size (jumbo) and/or credit quality (subprime) fair-value accounting. The examination CONCLUSION requirements to be included in MBS issued concluded that fair-value accounting did by one of the government-sponsored entities During the financial crisis, we witnessed not play the major role critics expected and such as Ginnie Mae. the domino-like effect and the far-reaching instead that the bank failures were more consequences of inadequate and/or untimely While the issuance of prime jumbo securities likely a symptom of “growing probable credit financial reporting. Agents of investors, was brisk, the growth of subprime securities losses, concerns about asset quality, and, in including analysts and ratings agencies, rely was remarkable, growing from less than certain cases, eroding lender and investor on the quality of financial reporting in order to $200 billion in 2002 to over $500 billion confidence.”20 provide investors with accurate information worth of new securities issued in 2005. Accounting for illiquid securities presents an that serves as an input in the investment Attractive yields and overconfidence in the obvious challenge to companies, regulators process. Improved corporate governance housing market caused many of these non- agency MBS, as well as the exotic structured financial products based on them, to end up on the books of financial institutions It is important that we continue to improve the worldwide. These exotic securities often had transparency, timeliness and reliability limited liquidity under normal circumstances, of the financial reporting process. but as the credit crisis unfolded, any market that existed dried up quickly. Under “mark to market” accounting rules, if and investors. Businesses must evaluate and transparency build confidence in the an observable price is available, that price the risk of investing in illiquid securities, and actions based on such analysis and in the should set the fair value of the security. At regulators and investors must determine global capital markets. the height of the credit crisis, mark-to-market whether the securities are accurately The globalization of the financial markets accounting was often cited as a reason that reflected by a company’s financial reports. has created new challenges to set many banks needed to raise additional Indeed, regulators continue to have difficulty international financial reporting standards capital. acting in an anticipatory capacity, as that encompass the objectives of financial

© 2010 Thomson Reuters JULY 2, 2010 n VOLUME 16 n ISSUE 4 | 5 reporting: understandability, relevance, 7 See http://www.calpers.ca.gov. us_ whats_news; Jesse Eisinger & Jake Bernstein, reliability and comparability.22 8 See http://www.calpers-governance.org/ Your Magnetar Questions, Answered, Propublica, marketinitiatives/initiatives/integrity-financial- Apr. 16, 2010, available at http://www.propublica. With these key concepts in mind, it is reporting. org/feature/your-magnetar-questions-answered. 18 vital that the FASB and IASB continue to 9 Morningstar Research, Fact Sheet: The FASB, Additional Briefing Document work together to improve the quality and Morningstar Stewardship Grade for Stocks Regarding 4/2/09 FASB’s Fair Value and OTTI transparency of financial reports so investors (2007). FSP’s, available at http://www.fasb.org/jsp/ FASB/Page/news/040209_fv_and_otti_fsp.shtml. can construct a timely and accurate depiction 10 U.S. Congress, Joint Econ. Comm., 19 Letter from Cindy Fornelli, Executive Director, of a corporation’s financial condition, Transparency and Federal Reserve Monetary Policy (November 1997), available at http://www. Center for Audit Quality, et al., to Christopher strengthening confidence in the global house.gov/jec/fed/fed/transpar.pdf. Cox, Chairman, SEC, Fair Value Supporters Urge SEC Not to Suspend Mark-to-Market Accounting capital markets. 11 Healy & Palepu, supra note 6. Rule (Oct. 15, 2008), available at http:// 12 David Burgstahler & Ilia D. Dichev, Earnings www.cfainstitute.org/about/press/release/ NOTES management to avoid decreases and losses, J. Pages/10152008_16447.aspx. 1 David M. Herszenhorn, Financial Overhaul Acct. & Fin. (December 1997). 20 SEC, Office of the Chief Account Wins Final Approval in House, N.Y. Times, June 13 See http://web.archive.org/web/200407080 Division of Corporation Finance, Report and 30, 2010, available at http://www.nytimes. 23313/adelphia.com/about/. Recommendations Pursuant to Section 133 of the com/2010/07/01/business/01regulate.html?_ 14 Dan Ackman, Enron the Incredible, Forbes, Emergency Economic Stabilization Act of 2008: r=1&ref=financial_regulatory_reform. Jan. 15, 2002, available at http://www.forbes. Study on Mark-to-Market Accounting (Dec. 30, 2 See http://www.iasb.org/Use+around+the+ com/2002/01/15/0115enron.html. 2008). world/Use+around+the+world.htm. 21 15 Howard Schilit, Financial Shenanigans: How Financial Accounting Standards Board, 3 Janet M. Tavakoli, Dear Mr. Buffett: What an to Detect Accounting Fraud in Financial Reports Exposure Draft: Accounting for Financial Investor Learns 1,269 Miles from Wall Street 205 (McGraw-Hill 2002). Instruments and Revisions to the Accounting for (John Wiley & Sons 2009). Derivative Instruments and Hedging Activities 1-3 16 Roger Lowenstein, The Company They Kept, 4 (May 26, 2010). Id. at 82. N.Y. Times, Feb. 1, 2004, available at http://www. 22 5 Securities and Exchange Commission, nytimes.com/2004/02/01/magazine/the- IASC, Framework for the Preparation and Release Nos. 33-9117 and 34-61858, File No. S7- company-they-kept.html?pagewanted=1&pagew Presentation of Financial Statements paragraph 08-10, Asset-Backed Securities 9 (April 2010). anted=print. 24 (1989), adopted by IASB in 2001. 6 Paul M. Healy & Krishna G. Palepu, How the 17 Serena Ng & Carrick Mollenkamp, A Fund Quest for Efficiency Corroded the Market, Harvard Behind Astronomical Losses, Wall St. J., Jan. 14, Bus. Rev. (July 2003). 2008, available at http://online.wsj.com/article/ SB120027155742887331.html?mod%3Dhpp_

Katherine S. Montague is a portfolio analyst for MainStreet Advisors (www.mainstreetadv.com), an SEC-registered investment adviser in Chicago serving bank trust departments and independent trust companies. She supports the portfolio manager team with investment analysis and portfolio construction. She also serves as the editor of the firm’s research publications. Andrew J. Walker, CFA, is a portfolio manager with the firm, where he provides portfolio analysis and investment management services for clients. He is a chartered financial analyst and a member of the CFA Society of Chicago and the CFA Institute. The opinions expressed are those of the authors, and the information presented has been obtained with care from sources believed to be reliable, but is not guaranteed.

By David P. Leibowitz, Esq.

Since 2008, there has been a strong • Servicing issues including claims under Illinois homeowners do not want to suffer correlation between the number of the Real Estate Settlement Procedures foreclosure. Their first intention is to honor foreclosure cases filed in Illinois’ Cook County Act. their commitments. If they cannot, their next Circuit Court and the number of bankruptcy thought is to obtain a mortgage modification cases filed in the Northern District of Illinois, MODIFYING MORTGAGES TO agreement. Borrowers sincerely believe Eastern Division (see table below). MAINTAINING HOME OWNERSHIP they can get these agreements. This belief Mortgage-foreclosure cases almost always Illinois clients with foreclosure problems is fueled by massive publicity through both proceed independently of any efforts to generally have two objectives: to maintain public and private channels. It is further obtain mortgage modification. While occupancy of their home during the fueled by scam artists who once sold bogus courts in some states other than Illinois, foreclosure process and to obtain mortgage mortgages and now sell bogus “help” to particularly Wisconsin, have allowed for a modification in order to retain ownership. obtain the modification agreements. stay of mortgage-foreclosure proceedings In theory, a mortgage modification should to consider a modification under the federal MAINTAINING SHELTER WITH THE be rather readily available. One should be Home Affordable Modification Program, this VIEW OF ULTIMATE SURRENDER able to obtain a modification agreement by has not been the case in Illinois. People who face foreclosure in Illinois fear using the freely available resources of HUD- that they are required to vacate their homes There is no need to repeat the litany of approved agencies. Nobody should have to almost immediately. They are relieved to frustration homeowners have experienced pay to obtain a mortgage modification. In discover that they have the opportunity to in their efforts to obtain loan modifications. practice, however, mortgage modifications retain possession of their homes for almost a Many “trial modifications” commence; few are difficult to obtain. Banks that have year, owing to the seven-month redemption result in permanent modifications. All too received Troubled Asset Relief Program funds period, as well as the rather slow pace of frequently, people fail to protect their interests are theoretically under certain obligations to mortgage-foreclosure proceedings in Cook in the foreclosure court, operating under the consider and grant mortgage modifications. County and other busy foreclosure courts in mistaken belief that the foreclosure has abated Mortgage servicers for securitized trusts that surrounding counties. while they pursue the loan modification. have not received TARP funds do not consider Borrowers who seek loan modification have themselves under much, if any, obligation to Some homeowners may want to defend consider and grant modifications. against their foreclosure cases. They may a challenging economic decision to make. In want to delay the entry of a judgment of almost every instance, they find themselves It is possible to obtain a mortgage foreclosure. They certainly want to avoid owning real estate in which they have no modification. However, they are rare these entry of a deficiency judgment. Competent equity. There is no assurance that property days. Moreover, modification agreements counsel can help them attain these values will increase at any time in the near that have been granted are not as aggressive objectives. future. Under almost every loan-modification as they ought to be in order to avoid program, the borrower may retain home re-default. Others have written extensively about the ownership. Nevertheless, the borrowers Most observers have concluded that defense against mortgage foreclosures must do a calculated economic analysis to mortgage modifications have been severely in Illinois. However, both offensive and make an informed decision. Essentially, they wanting as a response to foreclosures. defensive responses are possible, including: must compare the cost of maintaining home Instead, foreclosures have accelerated not ownership with the cost of renting equivalent • Procedural issues. only in Illinois but throughout the nation property elsewhere. • Loan origination issues. as well. The best anyone can say is that Regrettably, not every lender will grant a mortgage foreclosures are accelerating at a A. Truth in Lending Act violations. mortgage modification. Moreover, not every decreasing rate. This is of small comfort to B. Fraud in the inducement. homeowner who might be qualified for a homeowners who are becoming renters and C. Consumer fraud and deceptive mortgage modification will receive one. even homeless. business practices. Cook County Northern District, Eastern Division Foreclosures Bankruptcy Cases 2008 48,675 35,883 2009 52,836 49,774

© 2010 Thomson Reuters JULY 2, 2010 n VOLUME 16 n ISSUE 4 | 7 Today, however, two important developments behind in payment or in imminent danger of The dispute can be for a variety of reasons, can be reported. default. Only loans with less than 75 percent including: loan-to-value ratio are eligible. • Identity of the lender. HAMP 10-2 For eligible borrowers, Bank of America will • Standing of the claimant. The Treasury Department issued the reduce interest rates, extend terms and in Home Affordable Modification Program some instances reduce principal. • Challenge as to principal due. Supplemental Directive 10-2 in March. While For those who are not eligible to participate • Challenges to a variety of charges, such HAMP remains voluntary, no less of an in the bank’s program, aggressive defense as: authority than Mark Zandi, chief economist of against a mortgage foreclosure either in the A. Late charges. Moody’s Analytics, has said HAMP 10-2 will, state court or in bankruptcy proceedings can at the least, require every lender to “do the B. Force-placed insurance. offer encouragement to the lender to offer a math” to see whether additional mortgage favorable modification to the borrower. C. Escrow disputes. modifications make sense. These changes D. Attorney fees. went into effect June 1. E. Title charges. F. Inspections. All too frequently, people fail to protect their G. Appraisals. interests in the foreclosure court. An objection to claim is a contested matter. Discovery is available. This takes time and costs money. While aggressive debtor’s counsel objects to claims, lender’s counsel has two options: Defend or encourage Under this directive, servicers may not refer BANKRUPTCY RESPONSES a mortgage for foreclosure without having modification. Intelligent debtor’s counsel made reasonable efforts for solicitation. This Historically, homeowners have sought refuge will use the time gained by challenging a would include at least four phone calls and in bankruptcy in order to protect equity when claim as an opportunity to see a favorable two letters over a 30-day period. they temporarily were unable to pay their modification as a part of a consensual mortgage. The standard practice would be Chapter 13 plan. Even after a homeowner has been turned to file a “cure and maintain” plan whereby Adversary proceeding down, a lender should wait another 30 the arrearage would be satisfied over the days before referring to foreclosure. Once three- to five-year plan period. In the Frequently, an objection to claim is an a borrower is in a trial modification based meantime, the debtor would be required to insufficient forum within which to adjudicate on verified income, all foreclosure activity make the normal monthly payment. the exact extent of a mortgagee’s secured will have to cease. This is in complete claim. That is because the borrower might contravention to prior practice and policy. At the end of the plan period, the court find it advantageous to pursue counterclaims would declare the mortgage cured and Unfortunately, HAMP 10-2 only applies to against the lender under several laws, affirm that there are no further defaults. including the: new foreclosures and will not help those This was not always sufficient. Lenders already in foreclosure cases. However, there frequently declared post-petition defaults • Truth in Lending Act. likely will not be careful compliance with and borrowers found themselves back in • Real Estate Settlement Procedures Act. HAMP 10-2, and knowledgeable counsel will foreclosure even after having fully performed • Fair Debt Collection Practices Act. be able to invoke the directive as a defense in their obligations under Chapter 13 of the many state court foreclosure cases. Bankruptcy Code. • Illinois Consumer Fraud and Deceptive Business Practices Act. NATIONAL HOMEOWNERSHIP Today, debtor’s counsel frequently finds that • Fair Credit Reporting Act. RETENTION PROGRAM the borrower has no equity in the real estate. This is understandable since so many people • Other consumer protection laws. Another development worth noting is Bank acquired real estate within the past five years of America’s National Homeownership Such claims have been received with with 100 percent financing and no money Retention Program to reduce principal in increasing interest by bankruptcy judges down. Yet even under this circumstance, up to 45,000 loans. This program sounds throughout the United States. Illinois a variety of remedies are available in the attractive but will have little impact given its bankruptcy judges are likely to consider bankruptcy court. relatively small size. these claims with care and receptivity as they Objections to claim see them more and more frequently. Bank of America will offer this only to those borrowers who had Countrywide option It is much easier to object to a mortgage- Lien stripping related claim in a Chapter 13 case than it adjustable-rate mortgage loans (so-called Congress failed to enact legislation that is in the mortgage-foreclosure court. In a “pay option” loans or negatively amortizing would have allowed courts to bifurcate Chapter 13, the debtor schedules the debts of loans) that originated before Jan. 1, 2009. undersecured mortgages into a secured The borrower must be at least 60 days the lender as disputed.

8 | WESTLAW JOURNAL n BANK & LENDER LIABILITY © 2010 Thomson Reuters At the cutting edge in the area of lien Knowledgeable counsel will be able to invoke stripping are those who seek to strip a lien HAMP 10-2 as a defense in many state court in a Chapter 7 case. The Supreme Court’s foreclosure cases. decision in Dewsnup v. Timm, 502 U.S. 410 (1992), would seem to preclude lien stripping in Chapter 7 cases. However, this issue too has not been authoritatively decided. Lien loan and an unsecured loan. Nevertheless, Another issue that has not been stripping in Chapter 7 cases has not been there remains an important opportunity to authoritatively decided is whether a debtor allowed in Illinois. But it has been allowed in recharacterize a mortgage as an unsecured can obtain lien stripping in a Chapter 13 a few bankruptcy courts around the country. claim in Chapter 13 bankruptcy proceedings. case having previously discharged the junior Chapter 13 is presently the best venue for Under Chapter 13, a loan secured by a mortgage debt in a Chapter 7. In bankruptcy effectively restructuring residential mortgage mortgage that is junior to an undersecured the lien survives a Chapter 7 discharge even loans in Illinois. If a debtor has adequate mortgage is fully unsecured. Since such a though the debt can no longer be collected income to sustain a Chapter 13 plan, he loan is a lien upon the debtor’s residence, it against the debtor personally because of the should certainly consider using Chapter 13 as is nevertheless an unsecured loan within the discharge. part of his arsenal of weapons in seeking to meaning of Section 506(a) of the Bankruptcy Lien stripping in a Chapter 13 is a device maintain home ownership. WJ Code. So, pursuant to Bankruptcy Code that may be used to get rid of a lien that is Section 506(d) and Federal Rule of not supported by any value in the collateral. Bankruptcy Procedure 3012, the bankruptcy There is no issue that a lien might be stripped court can determine that the junior mortgage in a Chapter 13 if it is fully unsecured. is fully unsecured and thus treated as an However, the unsecured claim is paid in unsecured claim for purposes of the debtor’s the Chapter 13 as part of the other claims Chapter 13 plan. addressed under the plan. On completion of This means the debtor can fully satisfy the plan, the debt is discharged and the lien the junior mortgage claim by making all is eliminated. necessary payments during the plan period. A Chapter 13 following a Chapter 7 does not Upon having done so, the debtor gets a have to deal with the debt. It has already discharge. The debtor’s plan can provide been discharged. So the question is whether that upon the discharge, the debtor has fully you can strip a lien if there is no personal satisfied this undersecured mortgagee’s debt to be discharged in a Chapter 13. claim and that the lien upon the property is This so-called “Chapter 20” procedure has therefore deemed to have been released. been met with a degree of skepticism by Since there are so many properties that many judges. However, theoretically, there were acquired with so-called 80-20 loans, is no reason why a lien could not be held and since property values have declined by to be fully unsecured in a Chapter 13, even substantially more than 20 percent in many if the underlying debt has been discharged David P. Leibowitz is managing member of areas, innumerable junior mortgages might in a Chapter 7. Completion of the Chapter Lakelaw, with offices in Chicago and Waukegan, be stripped in Chapter 13 cases. 13 plan should be sufficient to strip the lien Ill., and Kenosha, Wis. He is certified as both a consumer bankruptcy attorney and a business In Illinois bankruptcy courts, there is a split in the successive Chapter 13 case even if a bankruptcy attorney by the American Board of Certification and has become nationally of authority as to whether lien-stripping discharge is not available. The discharge from the prior case has already discharged recognized for his work in mortgage related proceeding must be accomplished by motion issues arising in consumer bankruptcy cases. or adversary proceeding. More judges the debt relating to the lien sought to be require an adversary proceeding. stripped.

© 2010 Thomson Reuters JULY 2, 2010 n VOLUME 16 n ISSUE 4 | 9 Overdraft fees In addition, the bank lumps together debit CONTINUED FROM PAGE 1 transactions that occurred on different dates The complaint poses this and posts them on a single day so customers hypothetical situation as an Anderson v. Compass Bank, No. 10-CV- incur more overdraft fees, the suit says. example of an overdraft fee: 60704, complaint filed (S.D. Fla. May 4, “As a result of Compass’ manipulation and 2010). A Compass bank customer with alteration of customers’ transaction records a current account balance of The suit alleges the bank manipulated the and processing, funds in a customer’s $50 makes five subsequent debit debit transactions by deducting the highest account are depleted more rapidly and more transactions on the same day in ones first. overdraft fees are likely to be charged for the following order: “Compass Bank’s overdraft practice is smaller transactions,” the suit claims. • 1st transaction: $10 unconscionable and substantially increases The lawsuit also says Compass failed to the likelihood that customers’ smallest inform its customers that they can opt out of • 2nd transaction: $10 charges will result in multiple overdraft fees,” the overdraft fee program and further claims • 3rd transaction: $10 the suit says. the bank uses posting delays so its account • 4th transaction: $10 Plaintiff Stephen Anderson sued Alabama- holders never know their exact account based Compass in the U.S. District Court for balances. • 5th transaction: $100 the Southern District of Florida. In such a scenario, the suit claims, Compass would reorder the transactions from highest to lowest and charge the customer a Compass Bank uses software to maximize the total of four overdraft fees. quantity of overdrafts, according to the complaint. If the $100 debit transaction had been subtracted last, as is consistent with the order the Anderson, who resides in Broward County, The proposed class includes all Compass transactions were made, the Fla., has a Compass account. customers who were charged overdraft customer only would be assessed Compass operates more than 740 banks fees due to the bank’s alleged transaction a single overdraft fee, the suit says. in Florida, Alabama, Arizona, California, re-sequencing scheme. Colorado, New Mexico and Texas, according The lawsuit asserts causes of action for to the suit. breach of contract, bad faith, conversion and Anderson says he was charged overdraft fees unjust enrichment. because Compass re-sequenced his debit It seeks a declaration that Compass’ policies card transactions. are unconscionable, restitution of all The bank uses “sophisticated software” to overdraft fees, disgorgement of the bank’s run its overdraft system, which “maximizes” profits, and unspecified actual and punitive WJ the quantity of overdrafts, as well as the damages. bank’s profits, according to the complaint. Attorneys: Plaintiff: Lawrence D. Goodman, Devine Specifically, Compass reorders debit Goodman Rasco & Wells, Miami transactions from highest to lowest and fails Related Court Document: to communicate this practice to its account Complaint: 2010 WL 2422515 holders, the complaint says.

REUTERS/Rick Wilking BREACH OF CONTRACT Countrywide says mortgage lender failed to buy back fraudulent loan

Countrywide Home Loans Inc. claims in a federal lawsuit that the Bank of Kentucky Inc. owes it more than $90,000 for failing to repurchase a fraudulent loan.

Countrywide Home Loans Inc. v. Bank of Specifically, Countrywide claims that the In September 2009 Countrywide demanded Kentucky Inc., No. 10-CV-03482, complaint loan: the Bank of Kentucky buy back the loan filed (C.D. Cal. May 10, 2010). • Misrepresented the income of the pursuant to the agreement, but the The suit, filed in the U.S. District Court for the mortgagees. defendant bank refused, the suit says. Central District of California, maintains the • Included an "unacceptable" appraisal. The property has since been foreclosed Bank of Kentucky breached a loan purchase upon and was bought by Countrywide at the agreement with Countrywide when it failed • Breached the requirements detailed in foreclosure sale, according to the complaint. to buy back the loan. a loan purchase agreement between Countrywide and the Bank of Kentucky. Countrywide says the Bank of Kentucky owes The suit asserts a single cause of action for it the $90,709 purchase price plus interest, breach of contract. Under the agreement signed by the two as well as attorney fees and costs. companies in February 1996, Countrywide The controversy stems from a home loan with Attorneys: purchased numerous mortgage loans from Plaintiff: David B. Epstein and Robyn L. Ikehara, an unpaid principal balance of $182,400 that the Bank of Kentucky, the complaint alleges. Epstein, Turner & Song, Los Angeles Countrywide says it purchased from the Bank Related Court Document: of Kentucky in October 2005. Countrywide says the agreement provided that the Bank of Kentucky would buy back Complaint: 2010 WL 1975917 When a subsequent investor bought the within 20 days any loans that set off a See Document Section A (P. 21) for the complaint. loan and then demanded that Countrywide "repurchase trigger." repurchase it, Countrywide allegedly discovered that the loan was fraudulent and One of those triggers was "evidence of fraud lacked adequate investment quality. in the origination or sale of the loan," the complaint claims.

The former head of a mortgage lending company faces criminal charges in Virginia federal court for allegedly participating in a $1.9 billion fraud scheme that caused an Alabama-based bank to fail.

United States v. Farkas, No. 10-CR-200, indictment unsealed (E.D. Va. June 16, 2010). A 16-count indictment filed in the U.S. District Court for the Eastern District of Virginia charges Lee Bentley Farkas and several unidentified co-conspirators in connection with the failure of Colonial Bank. Farkas is the former chairman and majority shareholder of Taylor, Bean & Whitaker Mortgage Corp., one of the largest privately owned mortgage lenders in the country. The indictment was unsealed June 16, the day after federal agents arrested him. Prosecutors say Florida-based TBW began to have cash flow problems in 2002. Farkas and his co-conspirators allegedly resorted to fraud to bolster the company’s finances. REUTERS/Jonathan Ernst To cover overdrafts on the company’s accounts at a Florida branch of Colonial Bank, Farkas and his co-conspirators at TBW and Colonial Bank shifted funds between The defendant and various co-conspirators resorted to the company’s accounts on a daily basis, the fraud to bolster Taylor, Bean & Whitaker Mortgage Corp.’s indictment says. finances, the Justice Department said. When the overdrafts grew to tens of millions of dollars, Farkas and others hatched a scheme to cover TBW’s operating losses Farkas and his co-conspirators also are When TBW filed for bankruptcy in August by arranging for the bank to buy more than accused of defrauding TBW subsidiary Ocala 2009, Ocala’s financial-institution investors $400 million in mortgage loan assets from Funding out of $1.5 billion, according to the were unable to redeem their commercial the company, the charges say. Justice Department. paper for full value, the Justice Department This asset sale was fraudulent because TBW Ocala sold asset-backed commercial paper said. had already sold the underlying loans to to financial-institution investors and had The investors held nearly $1.7 billion in other investors, prosecutors say. to hold collateral, consisting of cash or Ocala commercial paper backed by only Even though the loans involved in the sale mortgage loans, equal to the paper’s value, $150 million in collateral, the agency said. actually were worthless as a result of the the agency said. Farkas faces a significant prison term if fraud, Colonial Bank carried them on its Farkas and others used $1.5 billion of convicted. WJ books at the $400 million face value, the Ocala’s money to prop up TBW, causing the charges say. amount of Ocala’s collateral to decrease, the Colonial Bank failed in August 2009. indictment alleges.

12 | WESTLAW JOURNAL n BANK & LENDER LIABILITY © 2010 Thomson Reuters CYBERCRIME According to the FTC’s complaint, Dave & Buster’s FTC approves settlement with restaurant failed to: chain over largest-ever data breach • Take sufficient measures to detect and prevent unauthorized access to A settlement between the Federal Trade Commission and a chain of its network. bar-and-grill restaurants arising from the largest theft of credit card numbers • Adequately restrict outside access in U.S. history has received final agency approval. to the network, including access by its service providers. In the Matter of Dave & Buster’s Inc., As a result of the plea, Gonzalez was sentenced No. 082 3153, settlement approved to 20 years’ imprisonment, one of the longest • Monitor and filter outbound (F.T.C. June 8, 2010). sentences ever imposed on a hacker. data traffic to identify and block The FTC voted unanimously to give final Because Dave & Buster’s used unsecured the export of sensitive personal approval to a deal with the Dave & Buster’s wireless access points in its restaurants, information without authorization. restaurant chain. The vote followed a public Gonzalez was able to steal customer comment period after the agreement was information using relatively unsophisticated • Use readily available security initially approved last March. attacks. In his guilty plea, Gonzalez explained measures to limit access to its computer networks through The deal settles the agency’s civil charges that he and his accomplices gained access by wireless access points. that the company’s lax information security “wardriving,” or scanning for open wireless procedures resulted in the theft of more access points with a portable computer while than 130,000 customer credit card numbers driving in a car. In all the cases, the defendants used the stolen and hundreds of thousands of dollars in As these networks were unsecured, the data to make millions of dollars in unauthorized unauthorized charges. defendants were then able to “sniff” customers’ withdrawals from customers’ bank accounts. credit card information in real time as the cards The man responsible for the attack, Albert Blocks of stolen data, known as “dumps,” were were being swiped. Gonzalez, pleaded guilty last year in Boston sold over the Internet and to other organized federal court to a raft of charges, including In other cases, Gonzalez and the accomplices crime groups, the government alleged. conspiracy to violate the Computer Fraud stole the credit card data by posing as To settle the charges, Dave & Buster’s has and Abuse Act, 18 U.S.C. § 1030, and repairmen and installing monitoring agreed to establish and maintain an information conspiracy to commit wire fraud under equipment, or “sniffers,” on the point-of-sale security program. The company must also 18 U.S.C. § 1349. systems at several Dave & Buster’s locations, submit to independent, professional security he said in the plea. audits every other year for the next decade. WJ

WestlaW journal bankruptcy

This reporter offers comprehensive coverage of significant issues in both business and consumer bankruptcy proceedings. The editors track dockets, summarizing recent developments and their implications for the debtor, its creditors, officers and directors, employees, and other parties. This reporter covers a wide range of topics regarding business and consumer bankruptcies and includes analysis of the most noteworthy case law and legislation. Important litigation documents are also included.

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An investment company affiliated with Bank of New York Mellon secretly steered more than $227 million in clients’ money to investment fraudster Bernard Madoff in violation of New York securities laws, the state’s attorney general has charged.

People v. Ivy Asset Management LLC et al., No. 450489/2010, complaint filed (N.Y. Sup. Ct., N.Y. County May 11, 2010). WESTLAW JOURNAL In a complaint filed in the New York Supreme Court in Manhattan, Attorney General Andrew Cuomo says Ivy Asset Management SECURITIES LLC and former executives “put their own interests first” by feeding clients’ money into LITIGATION & Madoff’s now-notorious Ponzi scheme. In a Ponzi scheme unwitting investors get REGULATION “returns” drawn from money contributed by new investors. This reporter provides ongo- Madoff is in federal jail after pleading guilty ing coverage of shareholder in March 2009 to criminal fraud charges suits against public compa- REUTERS/Brendan McDermid stemming from the scheme, estimated to New York Attorney General Andrew Cuomo have cost investors $50 billion over two nies, officers and directors, decades. broker-dealers, investment While handing over money to Madoff, Ivy banks, and other participants fraudulently collected more than $40 million “Seventy-six upstate New York in the securities industry. in investment management fees, according union pension and welfare The publication covers the to Cuomo’s suit. plans were victimized,” most noteworthy securities The suit names as defendants Ivy’s ex-CEO state Attorney General Lawrence Simon and former chief investment Andrew Cuomo said. fraud disputes, Securities and officer Howard Wohl. Exchange Commission en- “New York families paid the price for forcement actions, and related defendants’ fraud,” the complaint says. their clients in the dark about Ivy’s Madoff criminal proceedings. Each “Seventy-six upstate New York union pension concerns,” the complaint says. issue provides timely coverage and welfare plans were victimized.” According to the suit, the defendants warned In a statement, Cuomo said the defendants at least three other clients, who had not of ongoing proceedings, in- saw Madoff trouble “coming around the invested with Madoff, to keep their money cluding financial crisis–related away from him. bend” but decided to do nothing about it. suits, and features important “They shamelessly profited off of their own The complaint alleges the defendants appellate and district court clients’ impending misfortune and we are violated the Martin Act, N.Y. Gen. Bus. Law holding them accountable for their actions,” § 352, which is New York’s securities fraud decisions. he said. law, and the state’s Executive Law, N.Y. Exec. Law § 63(12), which prohibits “persistent The complaint alleges the defendants knew fraud in the conduct of business.” or should have known by December 1998 that Madoff’s reported trading strategy and The suit seeks punitive damages, restitution investment gains were fraudulent. for defrauded investors and disgorgement of fees. WJ Call your West representative for more information “Despite their statutory and fiduciary about our print and online subscription packages, obligations to do otherwise, defendants Related Court Document: or call 800.328.9352 to subscribe. Complaint: 2010 WL 1976425 abdicated their responsibility and left

An Arizona man can proceed with his claims that Bank of America acted in bad faith and caused him emotional distress when financing his mortgages and selling him mortgage protection insurance, a federal judge has ruled.

Jones v. Bank of America N.A., No. CV-09- 2129-PHX-JAT, 2010 WL 2228517 (D. Ariz. June 1, 2010). U.S. District Judge James A. Teilborg of the District of Arizona found that the lender acted as an insurer and, as a result, was bound by a duty of good faith and fair dealing. According to the opinion, Kevin Jones took out two mortgage loans with Bank of America in June and July 2006 on his Phoenix home. Jones also signed up for BofA’s “borrowers protection plan,” in which the company agreed to pay his monthly mortgage payments if he became disabled or unemployed. Jones claimed that he was seriously injured in a car accident in February 2008 and could no longer work or pay his mortgage.

However, he continued to make payments REUTERS/Shannon Stapleton on the protection plan, and BofA made his mortgage payments until sometime in late 2008 or early 2009, the opinion says. The judge agreed Bank of America is a lender as to the The bank allegedly scheduled a foreclosure mortgage loans but said it is an insurer for purposes of sale for November 2009 but never foreclosed the mortgage protection plan because it offered clients on the property. “protection and peace of mind.” Jones sued BofA for breach of contract, insurance bad faith and other tort claims. The company moved to dismiss the tort claims. The judge agreed that Bank of America is a Judge Teilborg also said Jones can move Judge Teilborg rejected Jones’ claims for lender as to the mortgage loans but said it forward with his claims for negligent and negligence and wrongful foreclosure. is an insurer for purposes of the mortgage intentional infliction of mental anguish. protection plan because it offered clients Jones said he has suffered emotional distress He said Arizona does not recognize a cause “protection and peace of mind.” of action for negligent breach of contract as a result of BofA’s threats to foreclose on and that the claim for wrongful foreclosure ”Defendant created an insurer/insured the property and harassing letters and phone WJ is premature because a foreclosure sale has relationship with plaintiff, when the parties calls. not occurred. entered into the borrowers protection plan Attorneys: agreements,” he said. Plaintiff: Robert M. Back, Phoenix Judge Teilborg held that Jones can proceed The judge further found that Jones’ bad-faith Defendant: Lawrence Robert Moon and Michael with his insurance bad-faith claim. N. Poli, Poli & Ball, Phoenix claim was sufficiently pleaded because it BofA had argued that it is a lender, not an alleged that BofA lacked a reasonable basis Related Court Document: Order: 2010 WL 2228517 insurer. for its claim denial.

The First Amendment’s free-speech clause does not protect credit rating agencies that allegedly gave “wildly inaccurate” grades to subprime-mortgage-backed securities and cost the California Public Employees’ Retirement REUTERS/Jessica Rinaldi System more than $1 billion, a state court judge has ruled.

California Public Employees’ Retirement District of New York, reached the same System v. Moody’s Corp. et al., No. CGC-09- conclusion last year in Abu Dhabi Commercial 490241, 2010 WL 2286924 (Cal. Super. Ct., Bank v. Morgan Stanley & Co., 651 F. Supp. 2d S.F. County May 24, 2010). 155 (S.D.N.Y. 2009). In a 2009 complaint filed in the San Judge Kramer said CalPERS may proceed Francisco County Superior Court, CalPERS with its negligent-misrepresentation claim accused Moody’s, Standard & Poor’s and but tossed the negligent-interference Securities ratings are Fitch of “negligent misrepresentation” and allegation. “not something that “negligent interference with prospective “The allegation appears to be that there was economic advantage” in violation of should be afforded no income available [through the SIVs], yet First Amendment California law. the negligence of defendants made it seem CalPERS in 2006 invested a combined as though there was,” the judge said. protection,” $1.3 billion in three “structured investment “That is not sufficient to state a cause the judge said. vehicles,” entities whose assets consisted of action for negligent interference with mainly of securities backed by risky subprime prospective economic advantage,” he said. mortgages and home equity loans, according to the suit. The judge also rejected the agencies’ argument that the Martin Act, New York’s CalPERS says the SIVs were “opaque” but securities fraud law, preempts the California still received the agencies’ highest ratings. court’s jurisdiction over the suit. In a motion to dismiss, the agencies said the The complaint says lucrative fees paid by the ratings are “free speech” protected by the SIV marketers motivated the agencies to give First Amendment. the high triple-A ratings. Judge Richard A. Kramer rejected the free- Without a triple-A rating, there would have speech claim in a recent ruling. been no market for the SIV notes, which were SIV ratings are not “an issue of public exempt from registration and disclosure concern,” he said, noting that ratings are requirements under federal securities laws, “an economic activity designed for a limited according to the suit. target for the purpose of making money.” Under Securities and Exchange Commission “That is not something that should be rules, public pension funds like CalPERS are afforded First Amendment protection and among the few types of investors that qualify the defendants are not akin to members of to invest in unregistered securities, the suit the financial press,” he said. says. WJ He noted that a federal judge, U.S. District Related Court Document: Opinion: 2010 WL 2286924 Judge Shira Scheindlin of the Southern

An investor suit alleging Merrill Lynch illegally sold tens of billions of dollars worth of purportedly investment-grade mortgage securities that in fact were “junk bonds” may proceed in part, a federal judge in Manhattan has ruled.

Public Employees’ Retirement System of In a recent ruling, U.S. District Judge Jed For similar reasons, the judge dismissed the Mississippi et al. v. Merrill Lynch & Co. Inc. Rakoff of the Southern District of New York suit against the offerings’ “sponsors,” Credit- et al., No. 08-CV-10841, 2010 WL 2175875 rejected the defendants’ argument that the Based Asset Servicing & Securitization, (S.D.N.Y. June 1, 2010). suit, filed in December 2008, is barred by the Merrill Lynch Mortgage Lending and First The class-action suit says Merrill, top Securities Act’s one-year limitations period. Franklin Financial Corp. executives, securities rating agencies and The judge noted that the rating agencies did A sponsor is a company that participates in others violated the Securities Act of 1933, not downgrade the securities to “junk,” or a mortgage-backed-securities transaction by 15 U.S.C. § 77a, by making misleading below investment grade, until April 2008. selling or transferring assets to the trust that statements in prospectuses relating to 84 Judge Rakoff agreed with the defendants that issues the securities. separate securities offerings in 2006 and the plaintiffs have standing to sue only as to Like the rating agencies, the three sponsors 2007. the 19 offerings in which they participated. did not qualify as “underwriters” under the law because they were not involved in the sale or distribution of the securities, the judge said. The Securities Act does not cover the rating agencies’ Judge Rakoff denied the dismissal motions role in making securities marketable, the judge said. of securities’ issuer Merrill Lynch Mortgage Investors, underwriter Merrill Lynch Pierce Fenner & Smith and the Merrill executives who signed the misleading documents.

The plaintiffs, led by the Public Employees’ He tossed the other 65 offerings from the “While it may be true that the complaint is Retirement System of Mississippi, are suit. more rambling than precise, it still manages, in the court’s view, to adequately plead seeking compensation on behalf of a class The judge dismissed rating agencies Moody’s of investors who bought the securities based plausible [Securities Act] violations,” he said. and Standard & Poor’s from the suit. Their WJ on documents that allegedly exaggerated role in rating the securities to make them the soundness of the underlying mortgage Related Court Document: marketable did not involve any “sale or Opinion: 2010 WL 2175875 loans. distribution” and therefore was not covered The defendants filed motions to dismiss the by the Securities Act, he said. suit on various grounds in June 2009.

Investors who say former Washington Mutual execs and securities rating agencies illegally sold them more than $47 billion worth of subprime-mortgage-backed securities are urging a federal judge to let their lawsuit go forward.

Boilermakers National Annuity Trust mortgage underwriting and bogus property each month for five years. The payment Fund v. WaMu Mortgage Pass Through appraisals in a drive to securitize more and balloons after five years, including principal Certificates et al., No. 09-CV-37, reply more loans. and usually a higher interest rate. memo filed (W.D. Wash. May 28, 2010). “Through the offering documents, [WaMu] The option ARMs frequently ended up in The suit alleges WaMu Asset Acceptance transferred the risk of toxic loans to investors, default, the suit says. Corp., WaMu Capital Corp. and top executives including public pension funds, while Judge Pechman ruled last year that the violated the Securities Act of 1933, 15 U.S.C. profiting handsomely,” the plaintiffs say in a investors could not sue Washington Mutual § 77a, by distributing misleading securities memo opposing dismissal. Bank because the Federal Deposit Insurance offering documents. In a separate memo the plaintiffs insist that Corp. seized it in September 2008. The It also names as defendants rating agencies the rating agencies are liable as “control agency later sold the bank’s assets to Moody’s and Standard & Poor’s, which persons” under Section 15 of the Securities JPMorgan Chase. WJ allegedly gave undeserved high grades to Act, 15 U.S.C. § 77o. Attorneys: the securities. Plaintiffs: Nancy A. Pacharzina and Kim Stephens, Tousley Brain Stephens PLLC, Seattle; The securities, called mortgage pass- Arthur L. Shingler III and Hal D. Cunningham, through certificates, pay dividends drawn The plaintiffs insist that Scott & Scott, San Diego; Joseph P. Guglielmo, from principal and interest payments made Scott & Scott, New York; Christopher Lometti, Joel P. Laitman, Daniel B. Rehns and Kenneth by borrowers whose loans have been bundled the rating agencies are M. Rehns, Cohen Milstein Sellers & Toll, New into a trust. liable as “control per- York; Steven J. Toll, Joshua S. Devore, Matthew The plaintiffs, led by the Boilermakers sons” under Section 15 B. Kaplan and S. Douglas Bunch, Cohen Milstein Sellers & Toll, Washington National Annuity Trust, the Chicago of the Securities Act. Defendants (WaMu): David M. Balabanian Policemen’s Annuity & Benefit Fund and and John D. Pernick, Bingham McCutchen, Doral Bank of Puerto Rico, are seeking San Francisco; Susan L. Hoffman, Bingham compensation on behalf of investors who “The complaint more than adequately McCutchen, Los Angeles; Brian C. Free and relied on the offering documents in deciding pleads that the rating agencies had the Louis D. Peterson, Hillis Clark Martin & Peterson, Seattle to buy the certificates. ability to control or influence the issuer of the mortgage-backed securities,” the memo Defendant (Standard & Poor’s): Paul J. Kundtz The case is pending before U.S. District Judge says. and Gavin W. Skok, Riddell Williams, Seattle; Marsha Pechman of the Western District of Floyd Abrams, Adam Zurofsky and Tammy L. Washington. The issuer was defendant WaMu Asset Roy, Cahill Gordon & Reindel, New York Acceptance Corp., according to the plaintiffs. Defendant (Moody’s): Larry S. Gangnes, Lane In April the WaMu defendants and the rating Powell, Seattle; Joshua M. Rubins and James J. agencies filed motions asking the judge to “WMAAC was directed by the rating agencies Coster, Satterlee Stephens Burke & Burke, New toss the suit. in determining what loans went into each York trust and the characteristics of each of the The investors do not have a case because the Related Court Documents: numerous classes issued by the trusts,” the Plaintiffs’ opposition memo (WaMu): 2010 WL offering documents fully informed them of plaintiffs say. 2103201 the risks, WaMu said in court memos. Plaintiffs’ opposition memo (rating agencies): The complaint says WaMu subsidiary The agencies said in memos that the 2010 WL 2103202 Washington Mutual Bank specialized WaMu reply memo: 2010 WL 2300511 Securities Act simply does not apply to them. in “option ARM” loans, adjustable-rate Rating agencies’ reply memo: 2010 WL 2300510 In response the plaintiffs say the WaMu mortgages that give borrowers an option to defendants “turned a blind eye” to poor make a minimum “interest-only” payment

BANK WILL LAUNCH EXCHANGE- REGULATORS REPORT ON BANKS’ FDIC MOVES DEPOSITS FROM TRADED FUNDS COMPLIANCE WITH CRA FAILED NEVADA BANK Huntington Bank announced June 21 that its The Office of the Comptroller of the The Federal Deposit Insurance Corp. said investment advisory unit, Huntington Asset Currency has released the results of its latest June 18 that it has arranged for Oregon-based Advisors, plans to launch two exchange- evaluations on how banks are complying with Umpqua Bank to assume all the deposits traded funds in the first quarter of 2011. ETFs the Community Reinvestment Act. The CRA and assets held by the failed Nevada Security are similar to mutual funds in that they allow says financial institutions must serve the Bank. The agency made the announcement investors to buy shares in a fund representing credit needs of low- and moderate-income immediately after regulators from the a range of publicly offered investments customers in their neighborhoods. Under Nevada Financial Institutions Division acted such as stocks and bonds, according to the the law federal regulators must assess how on liquidity concerns and closed Nevada Columbus, Ohio-based bank. In anticipation each bank is complying with the statutory Security, which is headquartered in Reno. of launching the funds, which will be known obligations. The OCC said June 16 that its The FDIC, as the failed bank’s receiver, said as the Huntington Ecological Strategy list of compliance results for 22 institutions that as of March 31 Nevada Security had Fund and the Huntington Global Rotating examined between October and March is $480.3 million in assets and $479.8 million Strategy Fund, Huntington Asset Advisors available at http://www.occ.treas.gov/cra/ in deposits. The bank is the 83rd FDIC- will be filing a registration statement with the jun10.htm. insured bank to fail this year and the third in Securities and Exchange Commission. Nevada, according to the agency.

WESTLAW JOURNAL GOVERNMENT CONTRACT

This publication focuses on litigation between private contractors and the federal government arising out of contracts for the military and the Department of Defense. It also covers those entered into by various branches of government for construction, communications and computer systems, and transportation. Disputes between contractors and state and local governments are covered, primarily those involving discrimination in public contracting. Rulings and filings in the U.S. Court of Federal Claims, the federal district and circuit courts and the various Boards of Contract Appeals are featured. You’ll also find coverage of litigation involving The False Claims Act and its whistleblower provisions.

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Anderson v. Compass Bank, No. 10-CV-60704, complaint filed (S.D. Fla. May 4, 2010)...... 1

Boilermakers National Annuity Trust Fund v. WaMu Mortgage Pass Through Certificates et al., No. 09-CV-37, reply memo filed (W.D. Wash. May 28, 2010)...... 18

California Public Employees’ Retirement System v. Moody’s Corp. et al., No. CGC-09-490241, 2010 WL 2286924 (Cal. Super. Ct., S.F. County May 24, 2010)...... 16

Countrywide Home Loans Inc. v. Bank of Kentucky Inc., No. 10-CV-03482, complaint filed (C.D. Cal. May 10, 2010)...... 11 Document Section A...... 21

In the Matter of Dave & Buster’s Inc., No. 082 3153, settlement approved (F.T.C. June 8, 2010)...... 13

Jones v. Bank of America N.A., No. CV-09-2129-PHX-JAT, 2010 WL 2228517 (D. Ariz. June 1, 2010)...... 15

People v. Ivy Asset Management LLC et al., No. 450489/2010, complaint filed (N.Y. Sup. Ct., N.Y. County May 11, 2010)...... 14

Public Employees’ Retirement System of Mississippi et al. v. Merrill Lynch & Co. Inc. et al., No. 08-CV-10841, 2010 WL 2175875 (S.D.N.Y. June 1, 2010)...... 17

United States v. Farkas, No. 10-CR-200, indictment unsealed (E.D. Va. June 16, 2010)...... 12

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