1 THE HONORABLE CATHERINE SHAFFER

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3

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6 7 SUPERIOR COURT OF WASHINGTON IN AND FOR KING COUNTY

8 FEDERAL HOME LOAN BANK OF ) CHICAGO, ) 9 ) Case No. 10-2-36526-5 SEA 10 Plaintiff, ) ) AMENDED COMPLAINT FOR 11 v. ) RESCISSION AND DAMAGES ) 12 BANC OF AMERICA SECURITIES LLC; ) 13 CREDIT SUISSE SECURITIES (USA) LLC; ) GOLDMAN, SACHS & CO.; RBS ) 14 SECURITIES INC. f/k/a GREENWICH ) CAPITAL MARKETS, INC.; MERRILL ) 15 LYNCH, PIERCE, FENNER & SMITH ) INCORPORATED; LONG BEACH ) 16 SECURITIES CORP.; WAMU ASSET ) 17 ACCEPTANCE CORP.; WAMU CAPITAL ) CORP.; and JOHN DOE DEFENDANTS, 1- ) 18 50, ) ) 19 Defendants. ) ) 20 ) 21 )

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1 Table of Contents

2 I. NATURE OF THE ACTION...... 1 3 4 II. JURISDICTION AND VENUE...... 8

5 III. THE PARTIES...... 10 6 A. Plaintiff...... 10

7 B. Defendants...... 12

8 C. The John Doe Defendants ...... 17

9 IV. FACTUAL BACKGROUND ...... 17

10 A. Mechanics of Mortgage Backed Securities ...... 17 11 1. The Securitization Process ...... 17 12 2. The Rating Process for PLMBS ...... 20 13 B. The Mortgage Originators Abandoned Underwriting and 14 Appraisal Standards and Engaged in Predatory Lending...... 22

15 1. The Shift from “Originate to Hold” to “Originate to Distribute” Securitization Incentivized Mortgage 16 Originators to Disregard Loan Quality...... 22 17 2. Mortgage Originators Abandoned Underwriting 18 Guidelines in Order to Initiate Loans for Securitization...... 28 19 3. Mortgage Originators Manipulated Appraisals of Collateralized Real Estate in Order to Initiate Loans for 20 Securitization...... 30

21 4. Mortgage Originators Engaged in Predatory Lending to 22 Initiate Loans for Securitization...... 36 23 5. Widespread Defaults and Delinquencies Reflect the Inevitable Consequence of Loans Issued Without 24 Meaningful Underwriting...... 39

25 C. Federal and State Investigations, Press Reports, Publicly Available Documents Produced in Other Civil Lawsuits, and 26 Analysis of the Loan Pools Underlying the Certificates Identify Systematic Violation of Underwriting Guidelines, Appraisal

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1 Guidelines, and Predatory Lending by Long Beach Mortgage Company and Washington Mutual Bank, Whose Loans Back the 2 PLMBS in this Case...... 42

3 1. Washington Mutual Bank and Long Beach Mortgage Co...... 44 4 a. Government actions and related lawsuits and 5 investigations demonstrate WaMu’s and Long Beach Mortgage’s failure to adhere to sound 6 underwriting practices...... 44

7 b. Long Beach Mortgage and WaMu manipulated the appraisal process...... 49 8 c. Long Beach Mortgage and WaMu engaged in 9 predatory lending...... 58 10 d. Confidential witnesses provide further evidence of 11 WaMu and Long Beach Mortgage’s failure to adhere to sound underwriting practices, predatory 12 lending, and manipulation of the appraisal process...... 60

13 e. The mortgages originated by WaMu and Long 14 Beach Mortgage and securitized in the PLMBS purchased by the Bank provide further evidence of 15 WaMu and Long Beach Mortgage’s failure to adhere to sound underwriting practices...... 71 16 D. The Securitization Process Was Plagued by Conflicts of Interest 17 and Misplaced Incentives...... 72

18 1. WaMu’s Vertical Integration Provided it with Access To 19 Information Regarding the Abandonment of Underwriting Guidelines, Manipulation of the Appraisal Process, and 20 Predatory Lending Practices...... 72

21 a. The WaMu and Long Beach Entities Were Vertically Integrated...... 72 22 b. The Co-underwriter Defendants also had access to 23 information from their own corporate affiliates...... 74 24 2. Conflicts of Interest Undermined Adequate Due Diligence 25 and Disclosure to Investors...... 76 26

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1 a. The Defendants directed the due diligence process and were provided with detailed reports describing 2 the results of the process...... 76

3 b. Defendants misused due diligence results...... 80 4 c. Defendants should have known that the sponsor 5 included defective loans in the loan pools...... 82 6 3. Defendants’ Own Due Diligence Identified a High Number of Defective Loans in the Mortgage Pools 7 Backing PLMBS...... 84

8 E. The Securitization Process Was Supported by Credit Ratings that Materially Misstated the Credit Risk of the PLMBS...... 85 9

10 1. The Credit Ratings Were Unreliable, Based As They Were on Underwriting Standards That the Rating 11 Agencies Knew Had Been Abandoned...... 86

12 2. The Credit Ratings Were Compromised by Conflicts of Interest, Manipulation and Misinformation...... 87 13 3. The Credit Ratings Were Unreliable Due to the Use of 14 Inaccurate, Outdated Models, and Inadequate Resources...... 89 15 4. The Rating Agencies Knew, and the Defendants Should 16 Have Known, That the PLMBS Ratings in This Case Fundamentally Differed from the Ratings of Corporate 17 Bonds...... 92

18 5. Subsequent Downgrades Confirm that the Investment Grade Ratings Reported in the Offering Documents Were 19 Unjustifiably High and Misstated the True Credit Risk of 20 the PLMBS Purchased by the Bank...... 93 21 6. The Bank Reasonably Relied on the Credit Ratings Reported in the Prospectuses...... 95 22 V. DEFENDANTS’ MATERIAL UNTRUE STATEMENTS AND 23 OMISSIONS IN CONNECTION WITH THE SALE OF THESE FIVE CERTIFICATES TO FHLBC ...... 96 24 25 A. Defendants Misrepresented Underwriting Guidelines Utilized by Mortgage Lenders...... 97 26 1. The Materiality of Underwriting Guidelines...... 97

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1 2. Misstatements Regarding Underwriting Guidelines ...... 97

2 3. Evidence Demonstrating Misstatements in the Offering Documents Regarding the Originators’ Underwriting 3 Practices...... 102 4 a. Government investigations, actions and 5 settlements, confidential witnesses and evidence developed in other private lawsuits demonstrate 6 systematic and pervasive abandonment of stated underwriting practices by the originators...... 102 7 b. Analysis of loans that backed the PLMBS 8 purchased by the Bank demonstrate the 9 abandonment of stated underwriting practices by the originators...... 103 10 B. Defendants Misrepresented the Appraisal Process and Loan-to- 11 Value Ratios (“LTVs”) That Were Based Upon Those “Appraisals” ...... 104 12 1. The Materiality of Representations Regarding Appraisals 13 and LTVs...... 104 14 2. Misstatements Regarding Appraisals and LTVs...... 108 15 a. The Offering Documents falsely state that the 16 loan-to-value ratios were based upon appraisals...... 108

17 b. Misstatements regarding the standards to which the purported “appraisals” conformed...... 112 18 c. Misstatements regarding aggregate LTVs...... 113 19 20 3. Evidence Demonstrating Misstatements about Appraisals and LTV Ratios in the Offering Documents ...... 114 21 a. Government investigations, press reports, and 22 confidential witnesses demonstrate systemic and pervasive appraisal manipulation by the mortgage 23 originators...... 114

24 b. Analysis of loans that backed the PLMBS 25 purchased by the Bank demonstrate that appraisals were materially inflated and the LTV ratios were 26 materially understated ...... 116

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1 C. Defendants Misrepresented the Occupancy Status Rates...... 120

2 1. The Materiality of Occupancy Status Rates...... 120

3 2. Evidence Demonstrating Misstatements about the Occupancy Status Rates ...... 120 4

5 D. Defendants’ Statements Regarding the AAA Rating of the PLMBS Were False and Misleading...... 121 6 1. The Materiality of the Credit Rating Process and Ratings ...... 121 7 2. False Representations That the Certificates the Bank 8 Purchased Would Not Be Issued Unless They Earned AAA Ratings ...... 121 9 3. Misrepresentations and Omissions about the Credit Rating 10 Process and Ratings...... 122 11 4. Evidence Demonstrating Misstatements about the Ratings 12 and Ratings Process...... 125

13 E. Defendants Misrepresented the Mortgage Originators’ Compliance with Predatory Lending Restrictions...... 126 14 1. The Materiality of Predatory Lending Practices and the 15 Issuance of Loans that Violate State and Federal Lending 16 Statutes...... 126 17 2. Misstatements about Predatory Lending Compliance...... 127 18 3. Evidence Demonstrating Misstatements about Predatory Lending Practices of the Mortgage Originators ...... 128 19 a. Government investigations, actions and 20 settlements, confidential witnesses and evidence 21 developed in other private lawsuits demonstrate systematic and pervasive predatory lending by the 22 mortgage originators...... 128

23 b. Analysis of loans that backed the PLMBS purchased by the Bank demonstrate that loans in 24 the mortgage pools were the result of predatory lending...... 129 25 26 F. Defendants Misrepresented the Due Diligence Performed on the Mortgage Pools that Backed the PLMBS Purchased by the Bank...... 130

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1 1. The Materiality of Due Diligence on the Mortgage Pools ...... 130

2 2. Misstatements about Due Diligence...... 130

3 3. Evidence of Misstatements about Due Diligence...... 132

4 VI. CAUSES OF ACTION...... 132 5 VII. PRAYER FOR RELIEF...... 153 6 VIII. JURY DEMAND...... 154 7 EXHIBITS 8 EXHIBIT A 9 EXHIBIT B 10 11 EXHIBIT C 12 EXHIBIT D

13 APPENDICES

14 PLMBS CERTIFICATES PURCHASED BY FEDERAL HOME LOAN BANK 15 OF CHICAGO AT ISSUE IN THIS ACTION ...... APPX. I

16 CLAYTON TESTIMONY AND SUPPORTING DOCUMENTS REGARDING DUE DILIGENCE REVIEWS 17 A. CLAYTON SERVICES, INC. REPORT ON DUE DILIGENCE REJECTION AND WAIVER TRENDS 18 B. TESTIMONY OF VICKI BEAL, SENIOR VICE PRESIDENT, CLAYTON 19 HOLDINGS, BEFORE THE FINANCIAL CRISIS INQUIRY COMMISSION, SEPTEMBER 23, 2010 20 C. TESTIMONY OF KEITH JOHNSON, FORMER PRESIDENT, CLAYTON HOLDINGS, BEFORE THE FINANCIAL CRISIS 21 INQUIRY COMMISSION, SEPTEMBER 23, 2010...... APPX. II

22 DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND 23 OMISSIONS REGARDING UNDERWRITING GUIDELINES UTILIZED BY MORTGAGE LENDERS...... APPX. III 24 DEFENDANTS’ MATERIAL UNTRUE STATEMENTS AND OMISSIONS 25 REGARDING THE CREDIT RATING PROCESS AND THE AAA RATING OF THE PLMBS...... APPX. IV 26

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1 DEFENDANTS’ MATERIAL UNTRUE STATEMENTS AND OMISSIONS REGARDING THE MORTGAGE ORIGINATORS’ COMPLIANCE 2 WITH PREDATORY LENDING RESTRICTIONS...... APPX. V

3 DEFENDANTS’ MATERIAL UNTRUE STATEMENTS AND OMISSIONS 4 REGARDING THE DUE DILIGENCE PERFORMED ON THE MORTGAGE POOLS THAT BACKED THE PLMBS PURCHASED 5 BY THE BANK ...... APPX. VI 6

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1 Plaintiff, FEDERAL HOME LOAN BANK OF CHICAGO (hereinafter the “FHLBC”

2 or the “Bank”) alleges the following based upon personal knowledge with regard to its own 3 acts, and upon public information as well as information and belief as to all other matters. The 4 Bank’s information and belief is based on, among other things, the investigation by its counsel. 5 The investigation included but was not limited to: (1) review and analysis of the Offering 6 Documents for the certificates that are the subject of this action; (2) interviews with individuals 7 8 with first hand knowledge of the events alleged herein; (3) examination of relevant SEC filings,

9 press releases and other public statements; (4) review and analysis of pleadings in other civil

10 actions involving certain Defendants; (5) review and analysis of investigations of and 11 complaints filed by state and federal authorities against certain Defendants; (6) published 12 materials, media reports, congressional testimony and additional related materials; and (7) 13 analysis of the performance and composition of the loan pools underlying the certificates. 14 15 Many of the facts related to Plaintiff’s allegations are known only by the Defendants, or are 16 exclusively within their custody or control. Plaintiff believes that substantial additional

17 evidentiary support for the allegations set forth below will be developed after a reasonable

18 opportunity for discovery. 19 I. NATURE OF THE ACTION 20 1. This is an action for rescission and damages under the: (a) Securities Act of 21 Washington, RCW 21.20.005 et seq .; (b) Securities Act of 1933, 15 U.S.C. § 77a et seq . (the 22 23 “33 Act”); (c) Illinois State Securities Law, 815 ILCS 5; and (d) applicable common law. 24 2. The certificates are “securities” within the meaning of RCW 21.20.005(12),

25 Section 2(a)(1) of the 33 Act, 15 U.S.C. § 77b(a)(1), and 815 ILCS 5/2.1. Under these statutes, 26

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1 the Bank is entitled to rescind its purchase of the certificates and/or to be paid damages for its

2 losses on the certificates. 3 3. The action arises from the sale of over $100 million in Private Label Mortgage 4 Backed Securities (“PLMBS”), a type of Residential Mortgage Backed Security (“RMBS”), by 5 the Defendants to the Bank. The Defendants include the depositors/issuers and 6 underwriters/dealers who offered and sold the PLMBS to the Bank. These Defendants’ roles 7 8 are described in detail below.

9 4. Accompanying Defendants’ sales or offers of these PLMBS to the Bank were

10 registration statements, prospectuses, supplemental prospectuses, and other written offering 11 materials (collectively, “Offering Documents”) that Defendants wrote, signed, and/or 12 circulated, and which contained untrue statements of material facts and omitted to state material 13 facts necessary in order to make the Offering Documents not misleading. Attached as 14 15 Appendix I is a list of the PLMBS certificates purchased by the Bank that are the subject of this 16 action due to the Defendants’ material misstatements in, and omission of material information

17 from, the Offering Documents described herein.

18 5. PLMBS are mortgage pass-through certificate securities entitling the holder to 19 income payments from pools of mortgage loans. 1 The securities are referred to as “private 20 label” because they are issued by private entities instead of the Federal National Mortgage 21 Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie 22 23 Mac”), which are U.S. government-sponsored enterprises (“GSEs”). Mortgage securities 24 issued by Fannie Mae and Freddie Mac are referred to as “agency” mortgage securities. 25

26 1 The terms “PLMBS” and “certificate(s)” are used interchangeably herein. Plaintiff identifies the PLMBS certificates using the ticker symbols for each certificate as created by Bloomberg.

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1 6. Traditionally, the GSEs provided liquidity for the residential mortgage market

2 by buying loans that conformed to their underwriting standards and dollar limits. In the early 3 2000s, PLMBS became an increasingly important adjunct to the GSEs, forming a capital 4 market for mortgages that could not be sold to the GSEs. Certain PLMBS were secured by 5 “prime/alt-a” mortgages. These were mortgages that allegedly met the credit score and other 6 underwriting criteria of the GSEs, but were ineligible for GSE purchase either because the 7 8 mortgages exceeded the applicable GSE dollar limit, were supported by reduced

9 documentation, or contained disqualifying terms, such as certain types of adjustable rates.

10 Other PLMBS were secured by “subprime” mortgages. These were mortgages that did not 11 meet the GSE criteria for creditworthiness of the borrower but purportedly satisfied loan 12 underwriting criteria developed by their originators. 13 7. Fundamentally, the value of a mortgage pass-through certificate depends on the 14 15 ability of borrowers to repay the principal and interest on the underlying loans and the 16 adequacy of the collateral the borrowers provide in the event of default. In the event that

17 borrowers fall behind or default, the investor is exposed to loss. For this reason, rigorous and

18 effective loan underwriting by the mortgage originators, performed in accordance with stated 19 underwriting criteria, is of paramount importance; the absence of it – as demonstrated by this 20 case – renders unreliable any credit rating or other attempt to assess the credit risk of the 21 certificates. 22 23 8. PLMBS are segmented into “tranches” with laddered payment priority and 24 varying return potential for certificate holders. Interests in each tranche are issued in the form

25 of certificates identified by a CUSIP code unique to that certificate. Mortgage payments are 26 collected by the servicing agent and provided to a trustee, who then distributes payments to the

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1 investors who hold the certificates in accordance with the priority scheme among the various

2 tranches. The most senior tranches enjoy the highest payment priority and lowest risk of 3 default. Thus, if mortgage payments are not made, the losses are allocated first to the most 4 junior tranches and move upward as the junior tranches are wiped out. 5 9. By policy, and in order to minimize the risk of loss for the certificates at issue 6 the Bank purchased only the most senior, AAA-rated PLMBS tranches. These tranches were 7 8 backed by pools of prime/alt-a as well as subprime mortgage loans. Unfortunately, the

9 Offering Documents contained material misstatements and omitted to disclose material

10 information with respect to the mortgage pools, the creditworthiness of the borrowers, the 11 quality of the collateral, and the underwriting standards employed in originating the mortgage 12 loans. As a result, despite their original AAA ratings and the abundant representations and 13 warranties regarding the underlying mortgage pools, the certificates were far riskier than could 14 15 be determined from the Offering Documents, and the Bank has incurred significant losses on 16 these certificates.

17 10. Though the certificates themselves are complex, the abuses by the Defendants

18 can be put in simple terms. The Defendants did not provide truthful or accurate information 19 about the loans that comprised the mortgage pools securing the PLMBS . The Bank believed it 20 was buying safe and secure certificates with an extremely low risk of default – equivalent, from 21 an investment quality standpoint, to other AAA-rated investments – but in fact, the Bank 22 23 purchased a toxic stew of doomed mortgage loans. 24 11. It is not happenstance that the PLMBS failed to perform and plunged in value

25 and were ultimately severely downgraded. To the contrary, the PLMBS purchased by the Bank 26 collapsed because they are not what the Defendants claimed they were. Contrary to what

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1 Defendants represented, the PLMBS at issue in this case are simply not pools of loans issued to

2 borrowers based on the application of stated underwriting standards or considerations and the 3 performance of a valid appraisal. The ability of the borrowers to pay was not genuinely taken 4 into account by the mortgage originators, exceptions to underwriting standards were not made 5 due to “compensating circumstances,” and governing appraisal standards were routinely 6 disregarded. Instead, the primary motivation was the desire to issue and securitize as many 7 8 loans as possible in order to receive substantial fees. As a result, exceptions to underwriting

9 and appraisal standards became the norm. The issuers and underwriters packaged and sold

10 these certificates without regard to whether the underlying mortgage pools comported with the 11 detailed descriptions contained in the Offering Documents. 12 12. The sale of each PLMBS purchased by the Bank was effected through the 13 Offering Documents provided to the Bank in connection with the offer and sale of these 14 15 PLMBS. The Offering Documents contain extensive statements regarding underwriting 16 guidelines purportedly used by the mortgage originators, and extensive data supporting the

17 credit quality of the mortgage loans. However, the statements and data and the omissions

18 pertaining to them were materially false and misleading. Had the Bank been provided with 19 truthful, complete and accurate information, it would not have purchased the PLMBS, and 20 would not have suffered these losses. 21 13. Defendants’ untrue statements and omissions of material fact went to the heart 22 23 of the risk of the mortgage pools underlying the PLMBS. Specifically, Defendants failed to 24 accurately describe key characteristics of the mortgages and the securitization of the mortgages,

25 including, but not limited to: 26

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1 a. The Mortgage Originators’ Underwriting Guidelines. The Offering Documents contained material misstatements and omitted to disclose 2 material information regarding the underwriting guidelines purportedly utilized by the mortgage originators. The Defendants represented that the mortgage 3 originators applied their stated underwriting guidelines and standards when 4 issuing loans to borrowers. However, as set forth in more detail below, the mortgage originators routinely disregarded their own guidelines and granted 5 exceptions without proper justification. Consequently, the statements in and omissions from the Offering Documents regarding the mortgage originators’ 6 underwriting guidelines rendered the Offering Documents materially false and misleading. 7 8 b. The Loan-to-Value Ratios of the Mortgage Loans and the Appraisal Standards Used to Determine the Ratios . The Offering 9 Documents contained material misstatements and omitted to disclose material information regarding the loan-to-value (“LTV”) ratios of the loans in the 10 mortgage pools, and the appraisal standards that were purportedly applied to determine the home values. The LTV ratios were purportedly based on 11 appraisals but in fact were based on valuations of collateral that were inflated as 12 a result of conflicts of interest and inappropriate influence by the mortgage originators who sought to ensure that the valuations came back at a high enough 13 level to support the loan amount. The severe flaws in the collateral valuation process were not disclosed in the Offering Documents. Consequently, the 14 statements in and omissions from the Offering Documents regarding the LTV ratios, the use of appraisals, and standards applied in conducting the purported 15 appraisals rendered the Offering Documents materially false and misleading. 16 c. Primary Residency . The Offering Documents contained 17 material misstatements and omitted to disclose material information regarding the primary residency status of the mortgage properties – another key 18 characteristic of the risk of the mortgage loans. The Defendants represented that certain specified percentages of the mortgage loan properties were primary 19 residences of the borrower, instead of “second homes” or “investment 20 properties,” which carry more risk. However, in truth, the data provided by Defendants overstated the percentage of homes that were primary residences. 21 Consequently, the statements in and omissions from the Offering Documents regarding the occupancy rates of the homes in the mortgage pools rendered the 22 Offering Documents materially false and misleading.

23 d. The Ratings Process . Many of the Offering Documents 24 contained material misstatements and omitted to disclose material information regarding the bases for the bonds’ AAA ratings and the ratings processes. The 25 Defendants represented that the Credit Rating Agencies conducted analysis that was designed to assess the likelihood of delinquency and defaults in the 26 underlying mortgage pools. However, in truth, the Rating Agencies knew, and the Defendants should have known, that the ratings were based on unreliable

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1 data and faulty assumptions—all of which caused the ratings to vastly understate the true risk of the PLMBS and overstate their creditworthiness. Consequently, 2 the statements in and omissions from the Offering Documents regarding the PLMBS ratings rendered the Offering Documents materially false and 3 misleading. 4 e. Predatory Lending Representations and Warranties. The 5 Offering Documents contained material misstatements and omitted to disclose material information regarding the mortgage originators’ compliance with state 6 and federal predatory lending prohibitions. By policy, the Bank was not permitted to purchase any mortgage backed securities that were secured by 7 mortgage loans that violated these prohibitions. The Defendants represented 8 that the mortgage pools did not contain any mortgage loans that violated state and federal predatory lending prohibitions. However, in truth, the mortgage 9 originators engaged in predatory lending, and, thus, the mortgage pools contained many loans that violated state and federal predatory lending 10 restrictions. Consequently, the statements in and omissions from the Offering Documents regarding predatory lending rendered the Offering Documents 11 materially false and misleading. 12 f. Sponsors' Due Diligence . Many of the Offering Documents 13 contained material misstatements and omitted to disclose material information regarding the sponsors’ due diligence on the mortgage loans in the PLMBS 14 mortgage pools. The Offering Documents stated that the sponsors or third- parties retained by them inspected the underlying mortgage loans for compliance 15 with the mortgage originators’ underwriting and appraisal guidelines and 16 documentation requirements. However, the Offering Documents omit to state that the sponsors pressured the third-party due diligence firms to ignore 17 deviations from the applicable underwriting criteria. The Offering Documents also omitted to state that, despite this manipulation of the review process, the 18 third-party underwriters informed the sponsors that a substantial percentage of loans in the loan pools backing the PLMBS were defective, and that the 19 sponsors nonetheless waived the defects as to a substantial percentage of these 20 loans and, in many cases, used this information about defective loans to negotiate lower prices for the loan pools. Consequently, the statements in and 21 omissions from the Offering Documents regarding the sponsors’ due diligence on the mortgage loans in the PLMBS mortgage pools rendered the Offering 22 Documents materially false and misleading.

23 14. The untrue, incomplete and materially misleading statements summarized above 24 and discussed in detail below were made with respect to each of the certificates purchased by 25 the Bank that are the subject of this lawsuit. The Bank reasonably relied on these statements 26

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1 and was misled by the omissions when deciding to purchase the certificates, and the statements

2 and omissions have caused them massive losses. 3 15. As a result of these untrue statements in and omissions from the Offering 4 Documents, the Bank purchased certificates that were far riskier than represented by the 5 Defendants, and that were not in truth “highest investment grade” as stated in the Offering 6 Documents, but, instead, were low quality, high risk certificates. All of the certificates at issue 7 8 in this case have been downgraded to below investment grade, i.e. , “junk,” indicating a high

9 probability of default. Furthermore, the Bank has already experienced losses on all certificates

10 in this action. 11 16. The value of these certificates has declined dramatically. As a result, the Bank 12 has had to impair the value of these assets, which has caused the Bank’s earnings performance 13 to decline. The Bank has taken significant write-downs on these certificates in the form of 14 15 “other than temporary impairment,” or OTTI charges, on these bonds. 16 II. JURISDICTION AND VENUE

17 17. This Court has jurisdiction over the claims alleged in this action.

18 18. This is an action for rescission and damages in an amount exceeding $50,000. 19 19. Washington law applies to Plaintiff’s state law claims that arise under the 20 Securities Act of Washington, RCW 21.20.005 et seq ., and under the common law of 21 Washington, because the Bank’s claims arise from its transaction of business with Defendants 22 23 in Washington, and Washington has the most significant relationship with this action, as 24 alleged in detail herein.

25 20. Non-party Washington Mutual Bank (headquartered in Seattle, Washington)

26 served either directly or indirectly through its wholly owned subsidiaries and/or divisions Long

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1 Beach Mortgage Company and Long Beach Securities Corp., as the sponsor and servicer of the

2 five certificates at issue in this action. Furthermore, Defendant WaMu Capital Corporation, a 3 Washington corporation, was the lead underwriter on each of these five certificates and from its 4 offices in Seattle, Washington entered into contractual relationships regarding the certificates 5 with each of the other Co-underwriter Defendants and the Depositor/Issuer Defendants named 6 herein. The Offering Documents for these certificates emanated from Washington. In 7 8 particular, Defendants drafted, reviewed, signed, and/or circulated the Offering Documents

9 regarding these certificates in or from the Seattle, Washington offices of lead underwriter

10 WaMu Capital Corporation. WaMu Capital Corporation solicited and consummated the sale of 11 the certificates to the Bank from its offices in Seattle, Washington. Accordingly, the offer and 12 sale to the Bank of the certificates that are the subject of this action, including Defendants’ 13 materially false and misleading statements and omissions of material facts alleged herein, 14 15 occurred in this State. 16 21. This Court has subject matter jurisdiction over Plaintiff’s federal claims, which

17 are brought pursuant to sections 11 and 12(a)(2) of the 33 Act, 15 U.S.C. §§ 77k and 77l(a)(2),

18 and pursuant to section 22 of the 33 Act, 15 U.S.C. § 77v. 19 22. The Defendants are subject to personal jurisdiction in this State pursuant to 20 RCW 4.28.185, because the Bank’s claims alleged herein arise from Defendants’ transaction of 21 business, and their commission of the tort of negligent misrepresentation, within this State. 22 23 23. Furthermore, Defendants Goldman, Sachs & Co.; Merrill Lynch, Pierce, Fenner 24 & Smith Incorporated; and WaMu Capital Corp. are registered to do business in Washington

25 and have thereby submitted to the jurisdiction of this State. Similarly, Defendant Banc of 26 America Securities LLC was registered to do business in Washington during the relevant

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1 period, and is now registered to do business in Washington via its successor Merrill Lynch,

2 Pierce, Fenner & Smith Incorporated ( see infra ¶ 35) and has thereby also submitted to the 3 jurisdiction of this State. 4 24. Because its activities are not localized in one state, the Bank is not a citizen of 5 any state under 28 U.S.C. § 1332(c), so the Federal courts have no jurisdiction of this action 6 under 28 U.S.C. § 1332(a). Furthermore, pursuant to section 22(a) of the 33 Act, 15 U.S.C. § 7 8 77v(a), Plaintiff’s claims arising under the 33 Act may not be removed to federal court.

9 25. Venue is proper in this County pursuant to RCW 4.12.025. The offer and sale to

10 the Bank of the certificates that are the subject of this action, including Defendants’ making of 11 materially false and misleading statements and omissions of material facts alleged herein, see 12 supra ¶ 19-20, occurred in this County. 13 26. The Bank asserts no claims against any entity that has filed for bankruptcy 14 15 protection. 16 III. THE PARTIES

17 A. Plaintiff

18 27. Plaintiff is a bank created by the Federal Home Loan Bank Act. The

19 headquarters of the Bank are Chicago, Cook County, Illinois. Under its Organization 20 Certificate, the Bank is to operate in Federal Home Loan Bank District 7, which comprises the 21 states of Illinois and Wisconsin. The Bank does conduct business in each of those states. From 22 time to time, the Bank also conducts business with the other 11 Federal Home Loan Banks. It 23 24 also operates the Mortgage Partnership Finance Program®, a national mortgage purchase 25 program. 26

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1 28. The public policy mission of the Federal Home Loan Bank system is to support

2 residential mortgage lending and related community investment. The individual Federal Home 3 Loan Banks fulfill this role in housing finance by providing their member financial institutions 4 with access to reliable, economical funding, technical assistance, and special affordable 5 housing programs so that they can provide affordable housing and economic development in 6 their communities. 7 8 29. The Bank’s operations are funded solely by its earnings and funds raised by

9 issuing debt instruments (bonds and notes) in the capital markets through the Office of Finance,

10 a joint Federal Home Loan Bank Office located in Virginia. 11 30. The Bank is capitalized solely by the capital-stock investments of its members 12 and by its retained earnings. 13 31. The Bank’s members are all private financial institutions, including savings 14 15 banks, savings and loan associations, cooperative banks, credit unions, and insurance 16 companies.

17 32. The Bank is not a federal agency, and the Bank is not a citizen of any state. The

18 Bank is federally chartered, but privately capitalized and independently managed. The federal 19 government is not involved in the day-to-day management of the Bank's operations. 20 Management of the Bank is vested by law in the Bank's board of directors, all of whom are 21 either elected by the Bank's shareholder members or appointed by the board of directors. No 22 23 tax dollars are involved in the operation of the Bank, and the federal government does not own 24 any of the Bank's stock.

25 33. The members of the Bank’s board of directors reside in both Wisconsin and 26 Illinois.

11

1 34. Employees of the Bank routinely travel to the offices of the Bank's members. In

2 2009, employees of the Bank made more than 110 business trips to members outside of Illinois. 3 B. Defendants 4 35. Underwriter Defendant Banc of America Securities LLC is a Delaware limited 5 liability corporation that maintained a securities broker-dealer FINRA registration in 6 Washington during the relevant period and that was registered to do business in Washington. 7 8 Working with WaMu Capital Corp. as lead underwriter, Banc of America Securities LLC

9 purchased from Depositor/Issuer Defendant Long Beach Securities Corp. (a wholly owned

10 subsidiary and division of certificate sponsor Washington Mutual Bank) tens of millions of 11 dollars in principal of certificate LBMLT 2006-6. Banc of America Securities LLC was an 12 underwriter of certificate LBMLT 2006-6 2A3, which the Bank purchased. Effective 13 November 1, 2010, Banc of America Securities LLC merged with and into Successor 14 Defendant Merrill Lynch, Pierce, Fenner & Smith Incorporated, a Delaware corporation. All 15 16 references herein to Banc of America Securities LLC are also to Merrill Lynch, Pierce, Fenner

17 & Smith Incorporated, which is liable as a matter of law as successor to Banc of America

18 Securities LLC by virtue of its status as the surviving entity in its merger with Banc of America 19 Securities LLC. 20 36. Underwriter Defendant Credit Suisse Securities (USA) LLC is a Delaware 21 limited liability corporation that maintained a securities broker-dealer FINRA registration in 22 23 Washington during the relevant period. Working with WaMu Capital Corp. as lead 24 underwriter, Credit Suisse Securities (USA) LLC purchased from Depositor/Issuer Defendant

25 Long Beach Securities Corp. (a wholly owned subsidiary and division of certificate sponsor

26 Washington Mutual Bank) hundreds of millions of dollars in principal of certificate LBMLT

12

1 2006-6. Credit Suisse Securities (USA) LLC was an underwriter of certificate LBMLT 2006-6

2 2A3, which the Bank purchased. 3 37. Underwriter Defendant Goldman, Sachs & Co. is a New York corporation that 4 maintained a securities broker-dealer FINRA registration in Washington during the relevant 5 period and that is registered to do business in Washington. Working with WaMu Capital Corp. 6 as lead underwriter, Goldman, Sachs & Co. purchased from Depositor/Issuer Defendant Long 7 8 Beach Securities Corp. (a wholly owned subsidiary and division of certificate sponsor

9 Washington Mutual Bank) hundreds of millions of dollars in principal of certificate LBMLT

10 2006-7. Goldman, Sachs & Co. was an underwriter of certificate LBMLT 2006-7 2A3, which 11 the Bank purchased. 12 38. Underwriter Defendant Greenwich Capital Markets, Inc. is a Delaware 13 corporation. Greenwich Capital Markets, Inc. maintained a securities broker-dealer FINRA 14 15 registration in Washington during the relevant period. Working with WaMu Capital Corp. as 16 lead underwriter, Greenwich Capital Markets, Inc. purchased from Depositor/Issuer Defendant

17 Long Beach Securities Corp. (a wholly owned subsidiary and division of certificate sponsor

18 Washington Mutual Bank) hundreds of millions of dollars in principal of certificate LBMLT 19 2006-8. Greenwich Capital Markets, Inc. was an underwriter of certificate LBMLT 2006-8 20 2A3, which the Bank purchased. Pursuant to its Restated Certificate of Incorporation, dated 21 April 1, 2009, Greenwich Capital Markets, Inc. legally changed its name to RBS Securities Inc. 22 23 All references herein to Greenwich Capital Markets, Inc. are also to RBS Securities Inc. 24 39. Underwriter Defendant Merrill Lynch, Pierce, Fenner & Smith Incorporated is a

25 Delaware corporation that maintained a securities broker-dealer FINRA registration in 26 Washington during the relevant period and was registered to do business in Washington.

13

1 Working with WaMu Capital Corp. as lead underwriter, Merrill Lynch, Pierce, Fenner & Smith

2 Incorporated purchased from Depositor/Issuer Defendant Long Beach Securities Corp. (a 3 wholly-owned subsidiary of Long Beach Mortgage Company which was, in turn, a wholly- 4 owned subsidiary of Washington Mutual Bank at the date of purchase) hundreds of millions of 5 dollars in principal of certificate LBMLT 2006-5. Merrill, Lynch, Pierce, Fenner & Smith 6 Incorporated was an underwriter of certificate LBMLT 2006-5 2A3, which the Bank purchased. 7 8 40. The above defendants are collectively referred to as the “Co-underwriter

9 Defendants”).

10 41. The Washington Mutual Entities 11 A. Depositor/Issuer Defendant Long Beach Securities Corp. is a Delaware 12 corporation. Long Beach Securities Corp. was formed by Long Beach Mortgage 13 Company (a direct wholly-owned subsidiary of Washington Mutual Bank from March 14 15 2006 until July 2006 and a division of Washington Mutual Bank thereafter until 16 September 2008), which originated loans underlying certificates LBMLT 2006-5 2A3,

17 LBMLT 2006-6 2A3, LBMLT 2006-7 2A3, and LBMLT 2006-8 2A3 solely for the

18 purpose of receiving and depositing loans into trusts for PLMBS securitization. Long 19 Beach Securities Corp. was the depositor for certificates LBMLT 2006-5 2A3, LBMLT 20 2006-6 2A3, LBMLT 2006-7 2A3, and LBMLT 2006-8 2A3. Both Long Beach 21 Securities Corp. and Long Beach Mortgage Company maintained a principal office at 22 23 1201 Third Avenue in Seattle, Washington from which they negotiated, drafted, and 24 executed agreements and Offering Documents related to these four certificates. Long

25 Beach Securities Corp also drafted and executed Offering Documents related to these 26 four certificates in Seattle, Washington. Long Beach Securities Corp. was a wholly

14

1 owned direct subsidiary of Long Beach Mortgage Company and a wholly owned

2 indirect subsidiary of Washington Mutual Bank until July 2006 and a wholly owned 3 direct subsidiary of Washington Mutual Bank thereafter until September 2008. 4 B. Depositor/Issuer Defendant WaMu Asset Acceptance Corp. is a 5 Delaware corporation with its principal office located in Seattle, Washington, and, as of 6 the purchase date of the certificates, was a wholly-owned subsidiary of Washington 7 8 Mutual Bank. WaMu Asset Acceptance Corp. was the depositor/issuer for certificate

9 WAMU 2006-AR12 1A1.

10 C. Underwriter Defendant WaMu Capital Corp. is a Washington 11 corporation, is registered to do business in Washington, and maintains its principal 12 office in Seattle, Washington. As of the purchase date of the certificates, WaMu 13 Capital Corp. was a wholly owned subsidiary of Washington Mutual Bank, and an 14 15 affiliate of Depositor/Issuer WaMu Asset Acceptance Corp. WaMu Capital Corp. 16 purchased from Depositor/Issuer Defendant WaMu Asset Acceptance Corp.

17 approximately $1.6 billion in principal of certificate WAMU 2006-AR12. WaMu

18 Capital Corp. also purchased from Depositor Defendant Long Beach Securities Corp. 19 hundreds of million of principal in certificates LBMLT 2006-5, 2006-6, 2006-7, and 20 2006-8. Together with the Co-underwriter Defendants alleged above, WaMu Capital 21 Corp. was an underwriter for the following five certificates: LBMLT 2006-5 2A3, 22 23 LBMLT 2006-6 2A3, LBMLT 2006-7 2A3, LBMLT 2006-8 2A3, and WAMU 2006- 24 AR12 1A1. WaMu Capital Corp. sold certificates LBMLT 2006-5 2A3, LBMLT 2006-

25 6 2A3, LBMLT 2006-7 2A3, LBMLT 2006-8 2A3, and WAMU 2006-AR12 1A1 26 directly to the Bank

15

1 42. In sum, the “ Depositor/Issuer Defendants ,” listed below, received or purchased

2 and transferred or sold pools of assets to the issuing trusts identified below, and securitized the 3 bonds listed below, and were the “issuers” of the certificates. 2 4 Depositor/Issuer Defendant Issuing Trust Certificate 5 LBMLT Long Beach Securities Corp. Long Beach Mortgage Loan Trust 2006-5 6 2006-5 2A3 LBMLT Long Beach Mortgage Loan Trust 2006-6 7 2006-6 2A3 LBMLT Long Beach Mortgage Loan Trust 2006-7 8 2006-7 2A3 LBMLT 9 Long Beach Mortgage Loan Trust 2006-8 2006-8 2A3 10 WAMU WaMu Asset Acceptance WaMu Mortgage Pass-Through Certificates 2006-AR12 Corp. Series 2006-AR12 Trust 11 1A1

12 43. In sum, the following Defendants, collectively referred to as the “ Underwriter 13 Defendants ,” purchased the certificates identified herein from the Depositor/Issuer Defendants 14 (defined and identified above) and offered or sold the securities to the Bank: 15 16 Underwriter Defendants Certificate Banc of America Securities LLC (n/k/a 17 Merrill Lynch, Pierce, Fenner & Smith LBMLT 2006-6 2A3 18 Incorporated) Credit Suisse Securities (USA) LLC LBMLT 2006-6 2A3 19 Goldman, Sachs & Co. LBMLT 2006-7 2A3 20 Greenwich Capital Markets, Inc. LBMLT 2006-8 2A3 Merrill Lynch, Pierce, Fenner & Smith 21 LBMLT 2006-5 2A3 Incorporated 22 LBMLT 2006-5 2A3 23 LBMLT 2006-6 2A3 WaMu Capital Corp. LBMLT 2006-7 2A3 24 LBMLT 2006-8 2A3 WAMU 2006-AR12 1A1 25

26 2 See 17 C.F.R. § 230.191 (“The depositor for the asset-backed securities acting solely in its capacity as depositor to the issuing entity is the issuer for purposes of the asset-backed securities of that issuing entity”).

16

1 C. The John Doe Defendants 2 Defendants John Doe 1-50 are other Depositor/Issuers, Underwriters, and/or others who 3 4 are jointly and severally or otherwise liable for the misstatements, omissions, and other

5 wrongful conduct alleged herein, including the liability with respect to the certificates at issue

6 in this case. The John Doe Defendants may include persons or entities that are not named as

7 defendants at this time because Plaintiff has insufficient information as to the extent, if any, of 8 their involvement in and liability for the matters alleged herein. Plaintiff will amend this 9 Complaint to allege the true names and capacities of these defendants when ascertained. 10 IV. FACTUAL BACKGROUND 11

12 A. Mechanics of Mortgage Backed Securities

13 1. The Securitization Process 14 44. The PLMBS purchased by the Bank were created in a process known as

15 “mortgage securitization.” Mortgage securitization is a process by which mortgage loans are

16 acquired from “mortgage originators,” pooled together, and certificates constituting interests in 17 the cash flow from the mortgage pools are then sold to investors. The securities are referred to 18 as “mortgage pass-through certificates” because the cash flow from the pool of mortgages is 19 “passed through” to the certificate holders when payments are made by the underlying 20 21 mortgage borrowers. 22 45. Securitization involves several entities who perform distinct tasks, though, as

23 was the case here, many or all of the entities in a securitization may be subsidiaries or affiliates 24 of a single parent or holding company. The first step in creating a mortgage pass-through 25 security such as the PLMBS purchased by the Bank is the acquisition by a “ depositor ” 26 (referred to herein as "depositor" or "depositor/issuer") of an inventory of loans from a

17

1 “sponsor ” or “ seller ” which either originates the loans or acquires the loans from other

2 mortgage originators in exchange for cash. The depositor/issuer is often a subsidiary or other 3 affiliate of the sponsor, and indeed, each Depositor named herein was an affiliate of both the 4 sponsor and the originators for that security. See infra § IV.D.1. 5 46. The depositor then securitizes the pool of loans by forming one or more 6 mortgage pools with the inventory of loans, and creating tranches of interests in the mortgage 7 8 pools with various levels of seniority. Interests in these tranches are then issued by the

9 depositor (who then serves as the “ issuer ”) through a trust in the form of bonds, or certificates.

10 47. Each tranche has a different level of purported risk and reward, and, often, a 11 different rating. The most senior tranches often receive the highest investment grade rating, 12 AAA. Junior tranches, which usually have lower ratings, are more exposed to risk, but offer 13 higher potential returns. The most senior tranches of certificates are entitled to payment in full 14 15 before the junior tranches. Conversely, losses on the underlying loans in the asset pool – 16 whether due to default, delinquency, or otherwise – are allocated first to the most subordinate

17 or junior tranche of certificate, then to the tranche above that. This hierarchy in the division of

18 cash flows is referred to as the “ flow of funds ” or “ waterfall .” 19 48. The depositor/issuer works with one or more of the nationally-recognized credit 20 rating agencies – Fitch Ratings, Standard & Poor’s Ratings Services (“S&P”), and Moody’s 21 Investors Service, Inc. (collectively, the “Credit Rating Agencies” or “Rating Agencies”) – to 22 23 ensure that each tranche of the mortgage pass-through certificate receives the rating desired by 24 the depositor/issuer (and underwriter). For PLMBS, this meant a AAA rating for the senior

25 tranche, and lower ratings for the subordinated tranches. Once the asset pool is securitized, the 26

18

1 certificates are issued to one or more “ underwriters ” who resell them to investors, such as the

2 Bank. 3 49. Because the cash flow from the loans in the mortgage pool of a securitization is 4 the source of funds to pay the holders of the certificates issued by the trust, the credit quality of 5 the certificates depends largely on the credit quality of the loans in the mortgage pool. The 6 collateral pool for PLMBS often includes thousands of loans. Detailed information about the 7 8 credit quality of the loans is contained in the “loan files” developed and maintained by the

9 mortgage originators when making the loans. For residential mortgage loans, such as the loans

10 that backed the PLMBS purchased by the Bank, each loan file normally contains documents 11 including the borrower’s application for the loan, verification of income, assets, and 12 employment, references, credit reports, an appraisal of the property that will secure the loan 13 and provide the basis for other measures of credit quality, such as loan-to-value ratios, and 14 15 occupancy status. The loan file also generally includes notes from the person who underwrote 16 the loan describing the loan’s purported compliance with underwriting guidelines, and

17 documentation of “compensating factors” that justified any departure from those standards.

18 50. Investors in RMBS, such as the Bank, do not have access to the loan files. 19 Instead, the sponsors, depositors/issuers, and the underwriters are responsible for gathering and 20 verifying information about the credit quality and characteristics of the loans that are deposited 21 into the trust, and presenting summaries of this information in prospectuses or other offering 22 23 documents that are prepared for potential investors. This due diligence process is a critical 24 safeguard for investors and a fundamental legal obligation of the sponsors, the depositor/issuers

25 and the underwriters. Accordingly, the due diligence process supposedly performed by 26 Defendants was critical to the Bank’s decision to purchase the certificates at issue.

19

1 2. The Rating Process for PLMBS

2 51. Because, like many institutional investors, the Bank was permitted to buy only

3 AAA-rated tranches of these certificates, the credit rating of the tranches of PLMBS it 4 purchased was also material to its investment decision. 5 52. In any PLMBS, the credit rating of each tranche is negotiated between the 6 depositor/issuer of the certificates and the credit rating agencies. In this process, the 7 8 depositor/issuer and/or the sponsor and underwriters provide the credit rating agency with

9 information about the credit quality and characteristics of the loans that are deposited into the

10 trust. 11 53. The credit rating agency is then supposed to evaluate, among other things: 12 a. The credit quality of the collateral – i.e. , the underlying obligor’s ability 13 to pay and the obligor’s equity in the asset; 14 b. The experience and underwriting standards of the originators of the 15 16 underlying loans;

17 c. The loan characteristics reported by the depositor/issuer as underlying a

18 particular transaction; 19 d. The default rates, historic recovery rates, and concentration of the loans; 20 e. The ability of the servicer to perform all the activities for which the 21 servicer will be responsible; and 22 23 f. The extent to which the cash flow from the collateral can satisfy all of 24 the obligations of the PLMBS transaction. The cash flow payments which must

25 be made from the asset pool are interest and principal to investors, servicing

26 fees, and any other expenses for which the depositor/issuer is liable. The rating

20

1 agencies are supposed to stress-test the flow of funds to determine whether the

2 cash flows match the payments that are required to be made to satisfy the 3 depositor/issuer’s obligations. 4 54. After evaluating these objective and verifiable factors, the credit rating agency 5 issues a rating for the security. This rating is not a subjective opinion; rather, it constitutes a 6 factual representation regarding the risk of the security with reference to the above objective 7 8 factors, and should therefore be a reflection of both the riskiness of the loans in the asset pool

9 and the seniority of the tranche. If the rating that the credit rating agency assigns to the tranche

10 is not in accord with the issuer’s target, then the depositor/issuer may “ credit enhance ” the 11 structure. Such credit enhancement may include overcollateralization ( i.e. , including in the 12 pool mortgages whose aggregate principal balance exceeds the aggregate principal balances of 13 the certificates secured thereby), cash reserve accounts, excess spread (scheduled cash inflows 14 15 from the mortgages in excess of the interest service requirements of the secured certificates), or 16 third party contracts (whereby losses suffered by the asset pool are absorbed by an insurer or

17 other counter party). By using credit enhancement, a depositor/issuer may be able to elevate a

18 bond to the highest credit rating. 19 55. All of the certificates that the Bank purchased were senior certificates that were 20 rated AAA when the Bank purchased them. 21 56. The following graphic illustrates the securitization process: 22 23 24 25 26

21

1 2

3 4

5 6

7 8

9

10 B. The Mortgage Originators Abandoned Underwriting and Appraisal Standards 11 and Engaged in Predatory Lending.

12 1. The Shift from “Originate to Hold” to “Originate to Distribute” Securitization Incentivized Mortgage Originators to Disregard Loan 13 Quality. 14 57. As noted above, the fundamental basis upon which mortgage pass-through 15 certificates are valued is the ability of the borrowers to repay the principal and interest on the 16 underlying loans and the adequacy of the collateral for those loans. If the borrowers cannot 17 18 pay, and the collateral is insufficient, the cash flow from the certificate diminishes, and the 19 investors are exposed to losses. For this reason, the underwriting standards and practices of the

20 mortgage originators who issued loans that back RMBS, and the representations in the Offering

21 Documents regarding those standards, are critically important to the value of the certificates, 22 and the investors’ decisions to purchase the certificates. 23 58. Yet, unbeknownst to the Bank, during the time frame that the Bank purchased 24 the PLMBS at issue in this case, mortgage originators: (a) effectively abandoned their stated 25 26 underwriting standards; (b) allowed pervasive and systematic exceptions to their stated

22

1 underwriting standards without proper justification; (c) adopted practices such that variance

2 from their stated underwriting practices was the norm; (d) disregarded credit risk and quality 3 controls in favor of generating loan volume; (e) pressured and coerced appraisers to inflate their 4 collateral valuations in order to permit loans to close; and (f) engaged in predatory lending 5 practices. As has become clear recently, this was the result of a fundamental shift in the 6 mortgage securitization markets. 7 8 59. In the 1980s and 1990s, under the traditional model, mortgage originators held

9 the mortgage loans they provided to borrowers through the term of the loan. They would

10 therefore profit from the obligor’s payment of interest and repayment of principal, but also bear 11 the risk of loss if the obligor defaulted and the property value was insufficient to repay the loan. 12 As a consequence of this arrangement, the originator was economically vested in establishing 13 the creditworthiness of the obligor and the true value of the underlying property by appraising 14 15 it before issuing the mortgage loans. 16 60. Additionally, the mortgage securitizations that took place in the 1980s and

17 1990s generally fell within the domain of GSEs Fannie Mae and Freddie Mac. These GSEs

18 purchased the loans from the originators, securitized them, and sold them to investors. 19 Investors in the early GSE securitizations were provided protections because the underlying 20 loans were originated pursuant to strict underwriting guidelines, and the GSEs guaranteed that 21 the investors would receive timely payments of principal and interest. Because the GSEs were 22 23 perceived as being backed by the federal government, investors viewed the guarantees as 24 diminishing credit risk, if not removing it altogether.

25 61. Between 2001 and 2006, however, Wall Street banks moved aggressively into 26 the securitization markets, taking market share away from the GSEs. Unlike the GSEs, the

23

1 Wall Street banks focused primarily on Alt-A, subprime, and jumbo prime mortgage pools

2 because of the higher fees that were available. Likewise, investors sought higher returns 3 offered by non-agency MBS. As a result, non-agency loan originations and securitizations 4 grew dramatically as shown by the following table: 5 6 2001 2006

7 GSE Loan Originations $1.433 trillion $1.040 trillion 8 GSE Securitizations $1.087 trillion $904 billion

9 Non-GSE Loan $680 billion $1.480 trillion Originations 10 Non-GSE Securitizations $240 billion $1.033 trillion 11 (including $87 billion of (including $449 billion of 12 subprime and $11 billion subprime and $366 of Alt- of Alt-A securitizations) A securitizations) 13

14 Adam B. Ashcraft and Til Schuermann, Federal Reserve Bank of New York Staff Report no. 15 318, Understanding the Securitization Subprime Mortgage Credit 2 (Mar. 2008) (citing data

16 from Inside Mortgage Finance (2007)) . 17 62. Thus, from 2001 to 2006, non-GSE loan originations more than doubled and 18 non-GSE securitizations more than quadrupled, while GSE loan originations and securitization 19 contracted. Moreover, during this time the non-GSE Alt-A and subprime securitization activity 20 skyrocketed, increasing eight-fold during the period from $98 billion to $815 billion. 21 22 63. As the Financial Crisis Inquiry Commission (often, “FCIC”) reported in April

23 2010, “[t]he amount of all outstanding mortgages held in non[Agency] MBS rose notably from

24 only $670 billion in 2004 to over $2,000 billion in 2006.” This statistic demonstrates the 25 dramatic growth of the PLMBS market during this time. FCIC, Preliminary Staff Report: 26 Securitization and the Mortgage Crisis 12 (Apr. 7, 2010).

24

1 64. This enormous increase in PLMBS securitization is reflected in the

2 securitization volume of the sponsors of the PLMBS purchased by the Bank. For example, 3 between 2003 and 2006, Washington Mutual Bank reported that its securitization of first lien 4 single-family residential mortgage loans increased from $25.4 billion to $70.8 billion (an over 5 178% increase), and its subprime mortgage securitizations through its Long Beach Mortgage 6 subsidiary increased from $6.0 billion to $26.2 billion (337% increase). 7 8 65. This shift was fueled by the complex interaction between record high global

9 savings, referred to by Federal Reserve Chairman Ben Bernanke as the “global savings glut,”

10 and exceedingly low interest rates. Low interest rates made it easier and more appealing for 11 consumers to take out home mortgage loans. But the low Federal Reserve rate also meant that 12 the global pool of investors received only marginal returns on traditional low-risk investments, 13 in particular U.S. Government Bonds. This created an incentive for Wall Street banks to create 14 15 seemingly low-risk investment options that produced returns in excess of those of government 16 bonds. PLMBS securitization was their answer. Thus, following the model created by the

17 GSEs, the Wall Street banks began buying pools of mortgages from mortgage originators,

18 securitizing the pools, and selling the bonds to global investors. Because mortgage interest 19 rates (and even more so Alt-A and subprime rates) generally exceeded those of U.S. 20 Government bonds, the resulting PLMBS could provide investors with the higher rate of return 21 they were seeking. 22 23 66. The one complication that the Wall Street banks needed to solve was the rating 24 of the certificates. Debt securities secured by pools of mortgages made to lower credit quality

25 borrowers would generally fail to meet the investment grade requirements of most institutional 26 investors. The Wall Street banks’ solution was to structure the financings through the creation

25

1 of tranches as discussed above. As a general rule, the result was that up to 80% of any

2 particular PLMBS would receive an “investment grade” rating. The remaining 20% was often 3 purchased by hedge funds and other entities that were able to buy non-investment grade 4 certificates. This development opened the floodgates for the securitization and sale of PLMBS. 5 67. To ensure that the flood of securitizations and sale of PLMBS did not abate, the 6 Wall Street banks bankrolled the lenders (both the ones they owned and those that were 7 8 independent) so that the lenders had ample capital to issue loans. Indeed, a recent study by the

9 Center for Public Integrity found that 21 of the top 25 subprime lenders (in terms of loan

10 volume) were either owned outright by the biggest banks or former investment houses, or had 11 their subprime lending hugely financed by those banks, either directly or through lines of 12 credit. See Who Is Behind The Financial Meltdown: The Top 25 Subprime Lenders and their 13 Wall Street Backers , The Center for Public Integrity (May 6, 2009), 14 15 http://www.publicintegrity.org/investigations/economic_meltdown/. 16 68. As the PLMBS market expanded, the traditional “originate to hold” model

17 morphed into the “originate to distribute” model. Under the new “originate to distribute”

18 model, mortgage originators no longer held the mortgage loans to maturity. Rather, mortgage 19 originators sold the loans to Wall Street banks and other major financial institutions and shifted 20 the risk of loss to the investors who purchased an interest in the securitized pool of loans. 21 69. The new distribution model was highly profitable for the mortgage originators in 22 23 the short term. By securitizing and selling the mortgages to investors through 24 underwriter/dealers, the mortgage originators shifted loans off their books, earned fees and,

25 thus, were able to issue more loans. Additionally, the securitization process enabled the 26 originators to earn most of their income from transaction and loan-servicing fees, rather than

26

1 (in the traditional model) from the spread between interest rates paid on deposits and interest

2 rates received on mortgage loans. This created an unchecked incentive to originate more and 3 more loans to feed into the securitization machine. 4 70. In testimony before the Financial Crisis Inquiry Commission, Sheila C. Bair, 5 Chair of the Federal Deposit Insurance Corporation, explained both the misalignment of 6 incentives arising from the sale of loans and the misalignment created by flawed compensation 7 8 practices within the origination industry:

9 The standard compensation practice of mortgage brokers and bankers was based on the volume of loans originated rather than the performance and quality of the 10 loans made. From the underwriters’ perspective, it was not important that 11 consumers be able to pay their mortgages when interest rates reset, because it was assumed the loans would be refinanced, generating more profit by ensuring 12 a steady stream of customers. The long-tail risk posed by these products did not affect mortgage brokers and bankers’ incentives because these mortgages were 13 sold and securitized.

14 71. The Attorney General for the Commonwealth of Massachusetts came to the 15 same conclusion when she issued the results of her investigation into the subprime mortgage 16 industry, The American Dream Shattered: The Dream of Homeownership and the Reality of 17 Predatory Lending (“The Massachusetts AG Predatory Lending Report”). This report explains: 18 Historically, the vast majority of home mortgages were written by banks which 19 held the loans in their own portfolios, knew their borrowers, and earned profit 20 by writing good loans and collecting interest over many years. Those banks had to live with their “bad paper” and thus had a strong incentive to avoid making 21 bad loans. In recent years, however, the mortgage market has been driven and funded by the sale and securitization of the vast majority of loans. Lenders now 22 frequently make mortgage loans with the intention to promptly sell the loan and 23 mortgage to one or more entities. … The lenders’ incentives thus changed from writing good loans to writing a huge volume of loans to re-sell, extracting their 24 profit at the front end, with considerably less regard to the ultimate performance of the loans. 25 72. Similarly, as reported in the Seattle Times , executives at Washington Mutual 26 (also termed “WaMu” in reference to Washington Mutual Bank and its parent corporation,

27

1 Washington Mutual, Inc.) recognized and responded to the same incentive. “Now it [WaMu]

2 began bundling ARMs and certain other mortgages into securities and selling them off – 3 pocketing hundreds of millions of dollars in fees immediately, while offloading any potential 4 repayment problems. … [At this time WaMu CEO] Killinger hired Craig Davis, American’s 5 director of mortgage origination, to run WaMu’s lending and financial services. Davis, several 6 former WaMu executives said, began pushing WaMu to write more adjustable-rate mortgages, 7 8 especially the lucrative option ARMs. ‘He only wanted production,’ said Lee Lannoye,

9 WaMu's former executive vice president of corporate administration. ‘It was someone else's

10 problem to worry about credit quality, all the details.’” Drew DeSilver, Reckless Strategies 11 Doomed WaMu , Seattle Times , Oct. 25, 2009 (“ ST Reckless ”), at A1. 12 73. As far as lenders were concerned, their profits were generated by origination of 13 as many loans as possible, and once these loans were packaged and securitized, repayment risk 14 15 was someone else’s problem. 16 74. As Ben Bernanke, Chairman of the Federal Reserve Bank, explained in

17 Congressional testimony:

18 When an originator sells a mortgage and its servicing rights, depending on the 19 terms of the sale, much or all of the risks are passed on to the loan purchaser. Thus, originators who sell loans may have less incentive to undertake careful 20 underwriting than if they kept the loans. Moreover, for some originators, fees tied to loan volume made loan sales a higher priority than loan quality. This 21 misalignment of incentives, together with strong investor demand for securities with high yields, contributed to the weakening of underwriting standards. 22

23 2. Mortgage Originators Abandoned Underwriting Guidelines in Order to Initiate Loans for Securitization. 24 75. The misalignment of incentives following the shift to the “originate to distribute 25 model,” noted by Mr. Bernanke and others following the collapse of the mortgage market, 26 caused mortgage originators to violate their stated underwriting and appraisal standards, and to

28

1 accept, encourage and even fabricate their own untrue information from loan applicants. This

2 was not a problem limited to one or a few mortgage originators, but, rather, was pervasive 3 among mortgage originators, including Long Beach Mortgage Company and Washington 4 Mutual Bank, which originated the loans at issue here. Mortgage originators and the financial 5 institutions that bankrolled them sought loan volume, not loan quality, in order to profit from 6 the securitization market. 7 8 76. In addition, coincident with the widespread transfer to MBS purchasers of the

9 default risk attached to mortgage loans, mortgage originators expanded the practice of

10 originating highly risky nontraditional loans. In a marked departure from traditional mortgage 11 origination procedures, originators offered a variety of reduced documentation programs in 12 which the verification or substantiation of the applicants’ statements of income, assets and 13 employment history was limited or non-existent. While these programs were touted as 14 15 providing for “streamlined” but nonetheless effective underwriting, unbeknownst to the Bank, 16 in fact, the programs were engineered to enable originators to make loans to borrowers who

17 otherwise never would have qualified. When these loans were securitized, investors were

18 assured that reduced documentation programs were available only where the borrower satisfied 19 certain FICO criteria, such as minimum FICO scores, or loan-to-value and debt-to-income 20 ratios. In fact, the originators lacked any principled basis on which to evaluate the increased 21 credit risk posed by what would eventually become colorfully and generally accurately known 22 23 as “Liar Loans,” or “NINJA loans” (for “no income, no job or assets”) loans. Moreover, the 24 widespread granting of exceptions to underwriting standards without legitimate compensating

25 factors meant that the minimal safeguards associated with the reduced documentation programs 26 were often abandoned in the headlong rush to maximize origination volume. Additionally,

29

1 mortgage underwriters would often begin the underwriting of an applicant’s loan under full

2 documentation procedures, only to transfer the loan applicant to a “No Doc” program upon 3 learning of information that would disqualify the applicant under the full documentation 4 procedures. 5 77. As John C. Dugan, Comptroller of the Currency, testified to the Financial Crisis 6 Inquiry Commission on April 8, 2010, following his description of poor underwriting practices: 7 8 The combination of all the factors I have just described produced, on a nationwide scale, the worst underwritten mortgages in our history. When house 9 prices finally stopped rising, borrowers could not refinance their way out of financial difficulty. And not long after, we began to see the record levels of 10 delinquency, default, foreclosures, and declining house prices that have plagued 11 the United States for the last two years – both directly and through the spillover effects to financial institutions, financial markets, and the real economy. 12 3. Mortgage Originators Manipulated Appraisals of Collateralized Real 13 Estate in Order to Initiate Loans for Securitization.

14 78. Accurate appraisals prepared in accordance with established appraisal standards

15 are essential for MBS investors to evaluate the credit risk associated with their investment. 16 Indeed, an accurate appraisal is necessary to calculate an accurate loan-to-value (LTV) ratio, 17 which is the ratio of the amount of the mortgage loan to the lower of the appraised value or the 18 sale price of the mortgaged property when the loan is made. The LTV ratio is strongly 19 20 indicative of the borrowers’ likelihood of defaulting. As a borrower’s equity decreases (and the 21 corresponding LTV ratio increases), particularly to where equity is less than 10% and LTV

22 ratios are greater than 90%, the borrower’s incentive to keep the mortgage current, or the 23 collateral in good condition, decreases dramatically. Consequently, aggregate LTV 24 calculations are among the most significant characteristics of a mortgage pool because LTV 25 ratios both define the extent of the investor’s “equity cushion” ( i.e., the degree to which values 26 may decline without the investor suffering a loss), and are strongly indicative of a borrower’s

30

1 incentive to pay. But in the absence of properly prepared appraisals, the value component of

2 the LTV ratio is unreliable, and the aggregate LTV metrics become meaningless. The appraisal 3 practices of the mortgage originators who issued loans that back PLMBS, and the accuracy of 4 the representations in the Offering Documents regarding those practices, therefore, were 5 critically important to the value of the certificates, and to the investors’ decisions to purchase 6 the certificates. 7 8 79. Appraisers are governed by the Uniform Standards of Professional Appraisal

9 Practice (“USPAP”), which is promulgated by the Appraisal Standards Board. The USPAP

10 contains a series of ethical rules designed to ensure the integrity of the appraisal process. For 11 example, the USPAP Ethics Conduct Rule provides: “An appraiser must perform assignments 12 with impartiality, objectivity, and independence, and without accommodation of personal 13 interests.” 14 15 80. The USPAP Ethics Conduct Rule states: “An appraiser must not accept an 16 assignment that includes the reporting of predetermined opinions and conclusions.”

17 81. The USPAP Ethics Management Rule states:

18 It is unethical for an appraiser to accept an assignment, or to have a 19 compensation arrangement for an assignment, that is contingent on any of the following: 20 1. the reporting of a predetermined results; 21 2. a direction in assignment results that favors the cause of a client; 22 3. the amount of a value opinion; 23 4. the attainment of a stipulated results; or 24 25 5. the occurrence of a subsequent event directly related to the appraiser’s opinions and specific to the assignment’s purpose. 26

31

1 82. The USPAP Scope of Work Acceptability Rule states: “An appraiser must not

2 allow the intended use of an assignment or a client's objectives to cause the assignment results 3 to be biased.” 4 83. The Appraisal Standards Board also issues Advisory Opinions regarding 5 appropriate appraisal conduct. For example, Advisory Opinion 19 states in part: 6 Certain types of conditions are unacceptable in any assignment because 7 performing an assignment under such condition violates USPAP. Specifically, 8 an assignment condition is unacceptable when it:

9 • precludes an appraiser’s impartiality because such a condition destroys the objectivity and independence required for the development of 10 credible results; 11 • limits the scope of work to such a degree that the assignment results are 12 not credible, given the intended use of the assignment; or 13 • limits the content of a report in a way that results in the report being misleading. 14 84. The USPAP Scope of Work Rule states: “For each appraisal . . . an appraiser 15 must . . . determine and perform the scope of work necessary to develop credible assignment 16 17 results.”

18 85. Additionally, USPAP Standard 1 states: “In developing a real property

19 appraisal, an appraiser must identify the problem to be solved, determine the scope of work 20 necessary to solve the problem, and correctly complete research and analyses necessary to 21 produce a credible appraisal.” 22 86. USPAP Standards Rule 2-1 states that “[e]ach written or oral real property 23 24 appraisal report must: 25 (a) clearly and accurately set forth the appraisal in a manner that will not be misleading; 26

32

1 (b) contain sufficient information to enable the intended users of the appraisal to

2 understand the report properly; and 3 (c) clearly and accurately disclose all assumptions, extraordinary assumptions, 4 hypothetical conditions, and limiting conditions used in the assignment.” 5 87. Despite the importance of accurate appraisals and the requirements that are 6 designed to ensure them, during the time frame that the Bank purchased the PLMBS at issue, 7 8 Long Beach Mortgage Company and Washington Mutual Bank routinely manipulated the

9 process for appraising the collateralized real estate properties. They did so by pressuring and

10 coercing appraisers, and blacklisting those that would not “come back at value.” The 11 prevalence of this problem and its impact on the financial crisis has been extensively 12 investigated and examined in the aftermath of the market collapse. 13 88. According to his statements submitted in connection with his April 7, 2010 14 15 testimony before the Financial Crisis Inquiry Commission, Richard Bitner, a former executive 16 of a subprime lender for 15 years and author of the book Confessions of a Subprime Lender ,

17 explains:

18 [T]he appraisal process [was] highly susceptible to manipulation, lenders had to 19 conduct business as though the broker and appraiser couldn’t be trusted . . . .[and] either the majority of appraisers were incompetent or they were 20 influenced by brokers to increase the value. . . . Throwing a dart at a board while blindfolded would’ve produced more accurate results. 21 … 22 If the appraisal process had worked correctly, a significant percentage of 23 subprime borrowers would’ve been denied due to lack of funds. Inevitably, this 24 would have forced sellers to drop their exorbitant asking price to more reasonable levels. The rate of property appreciation experienced on a national 25 basis from 1998 to 2006 was not only a function of market demand, but was due, in part, to the subprime industry’s acceptance of overvalued appraisals, 26 coupled with a high percentage of credit-challenged borrowers who financed with no money down.

33

1 …

2 [T]he demand from Wall Street investment banks to feed the securitization machine couple[d] with an erosion in credit standards led the industry to drive 3 itself off the proverbial cliff. 4 FCIC, Official Transcript, Commission Hearing, Apr. 7, 2010, Session 2, at 9-10. 5 89. In testimony before the Financial Crisis Inquiry Commission, Patricia Lindsay, a 6 former New Century Financial Corporation wholesale lender, described widespread appraisal 7 fraud and abuse: 8

9 The role and practices of appraisers in subprime mortgage origination:

10 Properly valuing a property . . . is one of the most important components in a loan. In my experience at New Century, fee appraisers hired to go to the 11 properties were often times pressured into coming in “at value”, fearing if they didn’t, they would lose future business and their livelihoods. They would charge 12 the same fees as usual, but would find properties that would help support the 13 needed value rather than finding the best comparables to come up with the most accurate value. Some appraisers would take boards off boarded up windows, to 14 take the needed photos, then board the properties back up once the shots were taken. Or they would omit certain important elements of a property by angling 15 the camera a certain way or zooming close in to make the property look the best possible. This level of appraiser activism compromises their objectivity. 16 17 90. Alan Hummel, Chair of the Appraisal Institute, testified before the Senate 18 Committee on Banking that the dynamic between mortgage originators and appraisers created a

19 “terrible conflict of interest” where appraisers “experience[d] systemic problems with

20 coercion” and were “ordered to doctor their reports or else never see work from those parties 21 again.” 22 91. In testimony before the House Financial Services Committee, Subcommittee on 23 Financial Institutions and Consumer Credit, Jim Amorin, President of the Appraisal Institute, 24 25 testified similarly that: 26 In recent years, many financial institutions have lost touch with fundamental risk management practices, including the separation between loan production and

34

1 risk management. Unfortunately, parties with a vested interest in a transaction are often the same people managing the appraisal process within many financial 2 institutions: a flagrant conflict of interest. Appraisers are ordered to doctor their reports or else never receive work from those parties again. 3 4 … 2 2 5 Another coercion tactic is the threat of being placed on a “blacklist: (aka “exclusionary appraiser list”), commonly used to blackball appraisers. It is one 6 thing to maintain a list of reputable businesses to work with, or to maintain a list of firms to avoid as a result of poor performance. However, [it] is another to 7 place an appraiser on a blacklist for refusal to hit a predetermined value.

8 92. Confirming the extent of the problem, a survey of 1,200 appraisers conducted by 9 October Research Corp. found that 90% of appraisers reported that mortgage brokers and 10 others pressured them to raise property valuations to enable deals to go through during the 11 period at issue. The study also found that 75% of appraisers reported negative ramifications if 12 13 they did not cooperate, alter their appraisal, and provide a higher valuation. 14 93. As a result of widespread appraisal abuse, in 2010, the Dodd-Frank Wall Street

15 Reform and Consumer Protection Act, section 1472, amended Chapter 2 of the Truth in 16 Lending Act, 15 U.S.C. § 1631 et seq ., to specifically prohibit actions that violate “appraisal 17 independence.” Under the new Act, acts or practices that violate appraisal independence 18 include: 19 (1) any appraisal of a property offered as security for repayment of the consumer 20 credit transaction that is conducted in connection with such transaction in which 21 a person with an interest in the underlying transaction compensates, coerces, extorts, colludes, instructs, induces, bribes, or intimidates a person, appraisal 22 management company, firm, or other entity conducting or involved in an appraisal, or attempts, to compensate, coerce, extort, collude, instruct, induce, 23 bribe, or intimidate such a person, for the purpose of causing the appraised value 24 assigned, under the appraisal, to the property to be based on any factor other than the independent judgment of the appraiser; 25 (2) mischaracterizing, or suborning any mischaracterization of, the appraised 26 value of the property securing the extension of the credit;

35

1 (3) seeking to influence an appraiser or otherwise to encourage a targeted value in order to facilitate the making or pricing of the transaction; and 2 (4) withholding or threatening to withhold timely payment for an appraisal 3 report or for appraisal services rendered when the appraisal report or services are 4 provided for in accordance with the contract between the parties.

5 94. All of the abuses targeted by the amended Truth in Lending Act were

6 widespread during the time frame that the Bank purchased the PLMBS at issue, and many of

7 these abuses were in fact carried out by Long Beach Mortgage Company and Washington 8 Mutual Bank, causing the appraisals of the collateralized real estate backing the PLMBS at 9 issue to be unreliable. 10 4. Mortgage Originators Engaged in Predatory Lending to Initiate Loans for 11 Securitization. 12 95. Under state and federal predatory lending laws, predatory loans are 13 characterized by excessively high interest rates or fees, and abusive or unnecessary provisions 14 that do not benefit the borrower, including balloon payments, and underwriting that ignores a 15 borrower’s repayment ability. Moreover, according to the Office of the Comptroller of the 16 17 Currency (“OCC”), “a fundamental characteristic of predatory lending is the aggressive

18 marketing of credit to prospective borrowers who simply cannot afford the credit on the terms

19 being offered.” OCC Advisory Letter, Guidelines for National Banks to Guard Against 20 Predatory and Abusive Lending Practices, AL 2003-2 at 2 (Feb. 21, 2003) (“OCC 2003 21 Predatory Lending Advisory Letter”). The Defendants represented and warranted that the 22 mortgage pools that backed the PLMBS purchased by the Bank did not contain predatory loans. 23 24 This was false. 25 96. Predatory lending was part of the mortgage lenders’ effort to increase volume at

26 any cost. The Wall Street banks and other financial institutions that issued and underwrote

36

1 PLMBS depended on a steady stream of higher interest subprime loans, which often were the

2 result of predatory lending practices. As Federal Reserve Bank Chairman Bernanke explained: 3 “[a]lthough the high rate of delinquency has a number of causes, it seems clear that unfair or 4 deceptive acts and practices by lenders resulted in the extension of many loans, particularly 5 high-cost loans, that were inappropriate for or misled the borrower.” 6 97. “The truth is that many of us in the industry were deeply distressed by the 7 8 growing practice of pushing high risk loans on borrowers who had no reasonable expectation of

9 being able to repay the mortgage. Disclosures were often less than adequate, and faced with a

10 bewildering array of loan terms, borrowers tended to trust their mortgage banker or broker.... In 11 our industry, we have frankly seen too much mortgage malpractice.” Scott Stern, CEO of 12 Lenders One, Testimony before the Senate Banking Committee. 13 98. Too often, mortgage loans were issued to “a borrower who ha[d] little or no 14 15 ability to repay the loan from sources other than the collateral pledged,” a predatory practice 16 explicitly identified by the Expanded Guidance for Subprime Lending Programs issued by the

17 OCC, the Board of Governors of the Federal Reserve System, the FDIC, and the Office of

18 Thrift Supervision. The Expanded Guidance stated: 19 Loans to borrowers who do not demonstrate the capacity to repay the loan, as 20 structured, from sources other than the collateral pledged are generally considered unsafe and unsound. Such lending practices should be criticized in 21 the Report of Examination as imprudent.

22 Expanded Guidance for Subprime Lending Programs at 11 (Jan. 31, 2001). Additionally, the 23 OCC warned: 24 When a loan has been made based on the foreclosure value of the collateral, 25 rather than on a determination that the borrower has the capacity to make the scheduled payments under the terms of the loan, based on the borrower's current 26 and expected income, current obligations, employment status, and other relevant financial resources, the lender is effectively counting on its ability to seize the

37

1 borrower’s equity in the collateral to satisfy the obligation and to recover the typically high fees associated with such credit. Not surprisingly, such credits 2 experience foreclosure rates higher than the norm.

3 [S]uch disregard of basic principles of loan underwriting lies at the heart of 4 predatory lending . . . .

5 OCC 2003 Predatory Lending Advisory Letter at 2.

6 99. As detailed below, see infra see § IV.C, numerous investigations have revealed

7 the extent of predatory lending by Long Beach Mortgage Company and Washington Mutual 8 Bank, who originated the loans underlying the certificates at issue here. 9 100. The Massachusetts AG Predatory Lending Report explains the ramifications of 10 such predatory lending: 11 12 Subprime ARM loans typically carry an artificially low, fixed interest rate for two or three years, sometimes called a “teaser” rate. That initial rate eventually 13 adjusts to a higher, variable rate for the remaining term of the loan, causing monthly payments to increase, often dramatically. In recent years, many 14 subprime lenders qualified borrowers based only on their ability to make payments during the “teaser” rate period, ignoring the fact that the borrowers 15 would not be able to make payments when the rate adjusted upwards. As a 16 result, many borrowers had to continually refinance. Borrowers were forced to obtain new loans, each one higher than the last, at increasingly high loan to 17 value (LTV) ratios …. Exacerbating the effects of serial refinancing, subprime mortgages often carry burdensome prepayment penalties, as well as high 18 transaction costs including lender and broker commissions and other fees.… [T]his cycle could continue only so long as home valuations continued to 19 increase []. As soon as real estate prices flattened, however, homeowners – 20 especially those who used high LTV loans – no longer had the same options when monthly payments began to adjust upward. 21 101. Singling out one specific common practice, the Report notes that “When lenders 22 qualify borrowers for ARM loans based only on the ‘teaser’ rate period that reflects an utter 23 24 lack of diligence in determining whether the borrower could actually pay back the loan. This 25 problem is systemic.” According to the Report, this practice was permitted by lax underwriting

26 standards and apparently reached its peak in 2006 (though it also continued into 2007), and was

38

1 directly in violation of the Interagency Guidance on Nontraditional Mortgage Product Risks

2 issued in 2006, which stated that for “nontraditional” loans, “analysis of a borrower's 3 repayment capacity should include an evaluation of their ability to repay the debt by final 4 maturity at the fully indexed rate, assuming a fully amortizing repayment schedule.” 71 Fed. 5 Reg. 58,609, 58,613 (Oct. 4, 2006). 6 102. As FDIC Chairman Sheila C. Bair explained in her January 2010 testimony 7 8 before the Financial Crisis Inquiry Commission:

9 The well-publicized benefits associated with legitimate rate-reducing mortgage refinancing and rising housing prices conditioned consumers to actively manage 10 their mortgage debt. An unfortunate consequence of this favorable environment 11 for refinancing was fraud. Many consumers have only a limited ability to understand details of standard mortgage contracts let alone the complex 12 mortgages that became common during this period. In this environment, unscrupulous mortgage providers capitalized on the widely advertised benefits 13 associated with mortgage refinance, and took advantage of uninformed consumers by refinancing them into mortgage loans with predatory terms that 14 were not readily transparent to many borrowers. 15 5. Widespread Defaults and Delinquencies Reflect the Inevitable Consequence 16 of Loans Issued Without Meaningful Underwriting. 17 103. High payment defaults and delinquency rates are reflective of a systematic

18 disregard for underwriting guidelines by mortgage issuers. When effective underwriting

19 occurs, poor credit risks are screened out. Indeed, that is the purpose of underwriting. In the 20 absence of effective underwriting, loans are made to unqualified borrowers and fraud is not 21 detected. When borrowers are loaned money without regard to their ability to repay it, loan 22 delinquencies (and foreclosures) ensue. Hence, high delinquency rates in loans issued by an 23 24 originator provide further evidence that the originator failed to adhere to prudent underwriting 25 practices. 26

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1 104. Numerous studies and analyses have traced the effect of poor underwriting on

2 payment default and delinquency rates. For example, the Federal Bureau of Investigation 3 Mortgage Fraud Reports of 2006 and 2007 reported on the results of a BasePoint Analytics 4 study of three million residential mortgage loans which found that between 30% and 70% of 5 early payment defaults were linked to significant misrepresentations in the original loan 6 applications. The BasePoint Analytics study found that loans containing egregious 7 8 misrepresentations were five times as likely to default in the first six months as loans that did

9 not.

10 105. An analysis of the same BasePoint Analytics study by Fitch Ratings concludes 11 that “[h]igh risk products, which require sound underwriting and which are easy targets for 12 fraud, account for some of the largest variances to expected default rates.” Fitch notes that 13 “[i]n addition to the inherent risk in … [issuing loans with] the high-risk ‘affordability’ features 14 15 in subprime mortgages …, evidence is mounting that in many instances these risks were not 16 controlled through sound underwriting practices. Moreover, in the absence of effective

17 underwriting, products such as ‘no money down’ and ‘stated income’ mortgages appear to have

18 become vehicles for misrepresentations or fraud by participants throughout the origination 19 process.” 20 106. Academic studies as well have shown that the departure from sound 21 underwriting practices which accompanied the explosion in securitizations contributed to 22 23 substantial increases in early payment defaults and delinquencies. See Keys et al., 125 Q. J. 24 Econ. 307 (2010) (“[W]e show that a doubling of securitization volume is on average

25 associated with about a 10%-25% increase in defaults … within two years of origination 26 …[and] a decline in screening standards ... .”).

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1 107. Data collected on the performance of loans over the past several years and

2 analyzed in these studies show that payment default and delinquency rates have in fact soared 3 as a result of faulty underwriting (a trend that Washington Mutual Bank and Long Beach 4 Mortgage Company were well aware of based on internal reviews, see infra ¶ 116): 5 6

7 8

9

10 11 12 13 14 15 16

17 108. Moreover, economic analysis of recent mortgage default rates has confirmed 18 that increased delinquency rates during this period were not the result of deterioration in the 19 credit characteristics of the borrowers that were disclosed to MBS investors – for example their 20 21 FICO scores, but rather from deterioration in credit characteristics of the borrowers that were

22 not disclosed to investors. Research by University of Michigan economists indicates that

23 increased use of low documentation underwriting – with its higher potential for borrower fraud 24 and other abuses not discernible by MBS investors – correlates to excessive default rates. In 25 other words, even where disclosed characteristics are the same, the low-doc loans exhibit 26 higher default rates, suggesting flaws in the underwriting process.

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1 109. Review of current performance data of the loan pools backing the PLMBS

2 purchased by the Bank similarly show increased rates of default, delinquency and foreclosure, 3 indicating pervasive underwriting failures by the mortgage originators who issued the loans 4 backing the PLMBS at issue in this case. 5 C. Federal and State Investigations, Press Reports, Publicly Available Documents 6 Produced in Other Civil Lawsuits, and Analysis of the Loan Pools Underlying the Certificates Identify Systematic Violation of Underwriting Guidelines, Appraisal 7 Guidelines, and Predatory Lending by Long Beach Mortgage Company and 8 Washington Mutual Bank, Whose Loans Back the PLMBS in this Case.

9 110. Loans backing four of the five PLMBS at issue in this action (certificates

10 LBMLT 2006-5 2A3, LBMLT 2006-6 2A3, LBMLT 2006-7 2A3, and LBMLT 2006-8 2A3) 11 were originated by Long Beach Mortgage Company (“Long Beach Mortgage”), a wholly 12 owned subsidiary of Washington Mutual Bank. 13 111. In materials presented to the Financial Crisis Inquiry Commission in 2010, the 14 Office of the Comptroller of the Currency (“OCC”) presented a list of the worst of the 15 16 subprime lenders based on their mortgage foreclosure rates in the hardest hit metropolitan areas

17 of the country. See Worst Ten in the Worst Ten: Supervisory Status of Mortgage Originators,

18 in Statement of John C. Dugan, Comptroller of the Currency, before the Financial Crisis 19 Inquiry Commission (Apr. 8, 2010). Long Beach Mortgage is prominently featured as second 20 on this list. 21 112. Investigations into the practice of mortgage originator Washington Mutual Bank 22 23 (“WaMu”), which originated the loans underlying certificate WAMU 2006-AR12 1A1, also 24 reveal the depth and breadth of its abandonment of underwriting standards, appraisal standards

25 and its predatory lending practices. 26

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1 113. A review of the investigations and related litigation involving Long Beach

2 Mortgage and WaMu, as well as confidential witness testimony obtained during the Bank’s 3 investigation, demonstrate that these mortgage originators systematically violated and ignored 4 their stated underwriting guidelines, rendering materially misleading the statements in the 5 Offering Documents regarding underwriting practices, appraisals and LTV ratios, and 6 predatory lending. This evidence is reinforced further by the analysis of the performance of the 7 8 actual loan pools backing the PLMBS purchased by the Bank.

9 114. Indeed, in September of 2010, Deutsche Bank National Trust Company, in its

10 capacity as a trustee, filed suit alleging breach of contract and seeking a declaratory judgment 11 and damages over 99 different trusts created, sponsored and/or serviced by WaMu, and which 12 included loans originated by WaMu and Long Beach Mortgage. See Deutsche Bank National 13 Trust Company v. Federal Deposit Insurance Corporation, et al. , 09-cv-1656-RMC (D.D.C.). 14 15 As some of these trusts issued the certificates purchased by the Bank, unsurprisingly the 16 allegations in Deutsche Bank’s complaint are very similar to the ones made by the Bank here.

17 These allegations include that WaMu engaged in “shoddy lending practices,” “performed

18 inadequate underwriting,” and securitized “delinquency prone and fraudulent loans.” The 19 trustee’s contract claim is based on numerous breaches of representations and warranties, 20 including representations and warranties that the loans complied with laws prohibiting 21 predatory lending, that the loans were written in accordance with the seller's underwriting 22 23 guidelines as described in the Prospectus Supplement, that appraisals were conducted generally 24 in accordance with the Seller's underwriting guidelines, that the loan-to-value ratio for each

25 mortgage loan was no greater than 100% at the time of origination, and that “to the best of the 26 seller's knowledge, no misrepresentation, negligence, fraud or similar occurrence with respect

43

1 to a Mortgage loan has taken place on the part of any person, including without limitation, the

2 Mortgagor, any appraiser, builder or developer, or any other party involved in the origination of 3 the mortgage loan . . .”. 4 1. Washington Mutual Bank and Long Beach Mortgage Co. 5 115. WaMu acquired Long Beach Mortgage in 1999 and Long Beach Mortgage 6 served as WaMu’s subprime loan origination division until January 1, 2006, when it became 7 8 known as WaMu’s “specialty mortgage lending” channel. According to the U.S. Senate

9 Permanent Subcommittee on Investigations (often, “Senate Subcommittee”), “in 2005, Long

10 Beach had to repurchase over $875 million of non-performing loans from investors, suffered a 11 $107 million loss, and had to increase its repurchase reserve by nearly $75 million. As a result, 12 Long Beach Mortgage’s senior management was removed, and Long Beach Mortgage’s 13 subprime lending operations were made subject to oversight by Washington Mutual’s Home 14 Loans Division. Despite those changes, early payment defaults and delinquencies surged again 15 16 in 2006, and several 2007 reviews identified multiple lending, credit, and appraisal problems.

17 By mid-2007, Washington Mutual shut down Long Beach Mortgage as a separate entity and

18 took over its subprime lending operation.” WaMu’s loan origination abuses, however, were not 19 limited to Long Beach. To the contrary, both WaMu and Long Beach Mortgage abandoned 20 sound underwriting practices. Because most investigations into the practices of WaMu and 21 Long Beach Mortgage address the conduct of both entities, they are discussed together below. 22

23 a. Government actions and related lawsuits and investigations demonstrate WaMu’s and Long Beach Mortgage’s failure to adhere 24 to sound underwriting practices. 25 116. As reported at the Senate Subcommittee hearing on Wall Street and the

26 Financial Crisis held on April 13, 2010, an internal WaMu audit of Long Beach Mortgage in

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1 2005 found that “relaxed credit guidelines, breakdowns in manual underwriting processes, and

2 inexperienced subprime personnel … coupled with a push to increase loan volume and lack of 3 an automated fraud monitoring tool” led to deteriorating loan quality, with the inevitable result 4 that many Long Beach Mortgage loans defaulted within three months of being sold to 5 investors. 6 117. That Senate Subcommittee hearing particularly identified high risk loan 7 8 practices by Long Beach Mortgage and WaMu, concluding:

9 Shoddy Lending Practices. WaMu and its affiliate, Long Beach Mortgage Co. (“Long Beach”), used shoddy lending practices riddled with credit, compliance 10 and operational deficiencies to make tens of thousands of high risk home loans 11 that too often contained excessive risk, fraudulent information, or errors. 12 Steering Borrowers to High Risk Loans . WaMu and Long Beach too often steered borrowers into home loans they could not afford, allowing and 13 encouraging them to make low initial payments that would be followed by much higher payments, and presumed that rising home prices would enable those 14 borrowers to refinance their loans.

15 Securitizing Delinquency-Prone and Fraudulent Loans. At times, WaMu 16 selected and securitized loans that it had identified as likely to go delinquent, without disclosing its analysis to investors who bought the securities, and also 17 securitized loans tainted by fraudulent information, without notifying purchasers of the fraud that was discovered. 18 Destructive Compensation. WaMu’s compensation system rewarded loan 19 officers and loan processors for originating large volumes of high risk loans, [and] paid extra to loan officers who overcharged borrowers or added stiff 20 prepayment penalties .... 21 118. WaMu’s Chief Operating Officer Steve Rotella called the situation at Long 22 Beach Mortgage “terrible,” with “repurchases (early payment defaults), manual underwriting, 23 very weak servicing/collections practices and a weak staff.” Rotella said that he had once 24 25 considered WaMu’s regular home-loans operation “the worst managed business I had seen in 26 my career.” He added: “That is, until we got below the hood of Long Beach.” Drew DeSilver,

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1 WaMu Execs Knew of Danger; WaMu's Leader Still Continued To Make High-Risk Loans,

2 Documents Show , Seattle Times, Apr. 13, 2010, at A1. 3 119. A November 2005 review of WaMu loans in southern California found “an 4 extensive level of loan fraud ... virtually all of it stemming from employees in these areas 5 circumventing bank policy surrounding loan verification and review.” According to the 6 DeSilver Seattle Times article, “[a]t one California office, 58 percent of loans examined in an 7 8 internal review were fraudulent; at another, 83 percent.” Id.

9 120. A WaMu PowerPoint presentation presented to Kerry Killinger, Steve Rotella

10 and many others, as disclosed at the April 13, 2010 hearing before the Senate Subcommittee, 11 revealed that a WaMu Corporate Credit Review of Wholesale Specialty Lending for September 12 2007 found that “132 of the 187 (71%) files were reviewed [and] … confirmed fraud on 115[; 13 17 were] ‘highly suspect.’ …. 80 of the 112 (71%) stated income loans were identified for lack 14 15 of reasonableness of income[.] 133 (71%) had credit evaluation or loan decision errors … 58 16 (31%) had appraisal discrepancies or issues that raised concerns.”

17 121. Another internal memorandum presented at the Senate Subcommittee hearings,

18 titled “So. California Emerging Markets Targeted Loan Review Results,” explained that “[o]f 19 the 129 detailed loan review[s] that have been conducted to date, 42% of the loans reviewed 20 contained suspect activity or fraud, virtually all of it attributable to some sort of employee 21 malfeasance or failure to execute company policy. … On average, 78% of the funded retail 22 23 broker loans reviewed were found to contain fraud … principally centered in misrepresentation 24 of loan qualifying data and appraisal issues.”

25 122. Another exhibit at the April 13, 2010 Senate Subcommittee hearing explained 26 how: “[o]ne Sales Associate admitted that during that crunch time some of the Associates

46

1 would ‘manufacture’ asset statements from previous loan docs and submit them to the LFC

2 [Loan Fulfillment Center]. She said the pressure was tremendous from the LFC to get them the 3 docs since the loan had already funded and pressure from the Loan Consultants to get the loans 4 funded [sic].” 5 123. WaMu’s internal lending practices were no better than those at Long Beach 6 Mortgage. At one point, the Seattle Times reports that over three quarters of WaMu’s $58.9 7 8 billion portfolio of option-ARM loans had been issued as limited documentation loans. Drew

9 DeSilver, Big Dreams of WaMu Dashed By Risky Loans , Seattle Times , Sept. 21, 2008 at H1.

10 124. As explained in the Seattle Times , WaMu increasingly favored “low- 11 documentation” loans, “lean[ing] more and more heavily on credit scores, which could be 12 ascertained while the borrower was still on the phone.” Nancy Erken, a WaMu loan consultant 13 in Seattle, is quoted as stating that at WaMu at this time “the big saying was ‘a skinny file is a 14 15 good file.’” She also explained how she would try to document borrowers’ ability to afford 16 their loans but that her experience was that when she would “take the files over to the

17 processing center in Bellevue … they’d tell me ‘Nancy, why do you have all this stuff in here?

18 We’re just going to take this stuff and throw it out.’” ST Reckless , supra ¶ 72 at A1. 19 125. In a 2005 memo obtained by the Seattle Times , WaMu risk managers were told 20 they needed to “shift ways of thinking” so they would no longer be a “regulatory burden” on 21 lending operations and instead act as a “customer service” to support growth. Id. 22 23 126. The Seattle Times further reported that Dale George, a senior credit-risk officer 24 in Irvine, California attended a subsequent “all hands” meeting of risk managers where Melissa

25 Martinez, WaMu’s chief compliance and risk oversight officer, emphasized “the softer side of 26 risk management.” George explained that the message was: “They weren’t going to have risk

47

1 management get in the way of what they [production] wanted to do, which was basically lend

2 the customers more money.” Id . 3 127. WaMu Senior Mortgage Underwriter Keysha Cooper, who started at WaMu in 4 2003 and left in 2007, was quoted by the New York Times explaining that: “[a]t WaMu it 5 wasn’t about the quality of the loans; it was about the numbers … They didn’t care if we were 6 giving loans to people that didn’t qualify. Instead it was ‘how many loans did you guys close 7 8 and fund?’” Cooper continued to explain how the pressure became intense in 2007 and

9 admitted that “I swear 60 percent of the loans I approved I was made to …. If I could get

10 everyone’s name, I would write them apology letters.” Gretchen Morgenson, Was There A 11 Loan It Didn’t Like?, N.Y. Times , Nov. 1, 2008 at BU1. 12 128. Another Seattle Times report quotes Mary Kay Morse, a 20-year veteran at 13 WaMu whose job was to persuade independent brokers to make option ARM loans, stating, as 14 15 to option-ARMs: “I hated that loan … It's just not a good loan. It wasn't good for the 16 borrower.” She continued that whereas at one time: “I always felt like I worked for a really

17 honest industry that cared for the borrowers they dealt with,” in her opinion the corporate

18 culture had changed to: “[w]e just want to do the most we can to make money for the bank.” 19 David Heath, Hometown Bank Turned Predatory, Seattle Times, Oct. 26, 2009, at A1 (“ ST 20 Predatory ”). 21 129. The reason for WaMu’s adoption of these highly risky and unsuitable products 22 23 was simple. As the Seattle Times explained: 24 As demand [for traditional loans] waned, lenders tried to entice business by slashing profit margins on conventional mortgages, such as the 30-year fixed. 25 WaMu’s chief business was making home loans, yet it lost money on that segment in the third quarter of 2003. 26

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1 By November, WaMu had eliminated 4,500 full-time jobs in home lending and ousted the division head. By year’s end, its mortgage business had shrunk with 2 alarming speed, down by about half from the summer.

3 After [Kerry] Killinger [WaMu’s CEO] finished speaking, Chief Financial 4 Officer Tom Casey got up and presented WaMu’s solution.

5 WaMu had other types of loans, such as subprime and home-equity lines of credit, that remained highly profitable. He noted there was even a specialty loan 6 for borrowers with good credit that remained lucrative, the option ARM.

7 As Casey explained it, the bank recently had beefed up its commissions and retrained its sales force to push option ARMs. In just the past few months, they 8 had climbed from 15 to 35 percent of its mortgage business. 9 The loan – mind-numbingly complex and highly risky for both the bank and its 10 customers – originally was created for the savviest and most risk-tolerant of borrowers. 11 ST Predatory, supra ¶ 128 at A1 . 12 130. Unsurprisingly, given its predatory practices and abandonment of any genuine 13 14 underwriting standards, the Seattle Times reported that “WaMu’s subprime loans failed at the 15 highest rates in the nation. … In the 10 hardest hit cities, more than a third of WaMu subprime

16 loans went into foreclosure.” ST Reckless , supra ¶ 72 at A1. 17 b. Long Beach Mortgage and WaMu manipulated the appraisal 18 process. 19 131. Mortgage originators, including WaMu and its subprime division, Long Beach

20 Mortgage, manipulated the appraisal process to inflate the reported value of real estate

21 properties thereby artificially depressing the loan-to-value ratios based on the appraisals. 22 Multiple government investigations, including ones by the Senate Permanent Subcommittee on 23 Investigations and the New York Attorney General’s office, have examined the appraisal 24 practices of WaMu and its wholly owned subsidiaries and divisions, including Long Beach 25 26 Mortgage. The internal documents recently released to the public by these investigations reveal

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1 that (1) appraisal fraud infected the origination of mortgages; and (2) WaMu and Long Beach

2 actively pressured appraisers to inflate their appraisals or manipulated the appraisals 3 themselves so that more loans could close and subsequently be securitized. 4 132. Internal WaMu documents released by the Senate Subcommittee on 5 Investigations demonstrate that appraisal fraud infected its mortgage origination process. 6 According to an internal WaMu memorandum presented at the April 2010 Senate 7 8 Subcommittee hearing regarding a review of loans from 2003-2005, 78% of the funded retail

9 broker loans reviewed by WaMu’s Risk Mitigation department were found to contain fraud that

10 principally involved misrepresentation of loan qualifying data and appraisal issues. (Senate 11 Subcommittee Hearing Exhibit 22B at 5.) 12 133. One specific example of appraisal fraud for a WaMu originated loan involved an 13 appraisal value for a property that apparently was based on both the value of the property and 14 15 the value of another house located in Mexico . As the Fraud Report notes, the inclusion of this 16 additional house might explain why the appraisal value of $400,000 was so much higher than

17 the $240,000 sales price of the property. Moreover, the appraisal omitted other important

18 information, including that the property use was “illegal” because there was a third unpermitted 19 unit on the property. This appraisal was not referred to an underwriter because the WaMu 20 office manager waived the requirement for an underwriter to review the appraisal. (Senate 21 Subcommittee Hearing Exhibit 22B at 10.) 22 23 134. Another specific example for a WaMu originated loan involved an appraisal that 24 contained false data regarding the subject property’s site and building sizes as well as numerous

25 warning signs that the appraisal was unreliable. The borrowers were refinancing a first 26 mortgage that they had previously obtained from WaMu a year earlier. According to the Fraud

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1 Report, the appraisal contained multiple red flags. The property had appreciated in value by

2 90% (from $322,000 to $610,000) in a single year ; the occupancy type was an investment 3 property; the AVM model reflected a more probable value of $400,000. Further, the 4 “comparables” – properties with characteristics similar to the appraised property – did not 5 appear comparable; two out of the three “comparable” properties were located 3-4 miles away, 6 and the comparable properties were given large upward adjustments in value to account for 7 8 differences in design, functionality, square footage and lot size. Notwithstanding these

9 warnings, the appraisal was not reviewed by underwriters. The Fraud Report also notes that the

10 refinancing transaction was a “cash out refinance,” and that the funds from this refinancing 11 were needed to close another loan that WaMu was processing for the borrower . (Senate 12 Subcommittee Hearing Exhibit 22B at 11.) In other words, not one, but two transactions were 13 dependent upon the appraisal coming in at value, even if that meant a 90% increase in the 14 15 appraised value over the course of a single year. 16 135. Another internal document dated December 2006 states that “Long Beach

17 represents a real problem for WaMu,” and forwards the results of “post-funding review team”

18 tasked with reviewing, on a monthly basis, 275 loans within 15 days of funding. The review 19 team identified, as a “top five priority” issue “[a]ppraisal deficiencies that could impact value 20 and were not addressed.” The review also emphasized that both the Corporate Credit Review 21 department and the Senior Credit Officer Subprime were focused on “two key facts” – that 22 23 “[t]he non accrual rate had increased year over year from 3.53% to 6.13%,” and that “[o]n a 24 vintage basis the deterioration was accelerating in recent vintages with each vintage since 2002

25 having performed worse than the prior vintage.” As noted above, loan-to-value ratios and a 26 borrower’s equity in his or her home are strongly indicative of a borrower’s likelihood of

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1 defaulting. To the degree that inflated appraisals understate the loan-to-value ratios, and

2 overstate a borrower’s equity, one would expect to find increasing rates of non-accrual 3 correlated with increasingly unreliable appraisals. 4 136. On November 1, 2007, the New York Attorney General filed People of the State 5 of New York v. First Am. Corp. and First Am. eAppraiseIT, No. 46796/2007 (Sup. Ct. Cty of 6 N.Y.) (“eAppraiseIT Compl.”), alleging that eAppraiseIT colluded with WaMu to inflate the 7 8 appraisal value of homes.

9 137. eAppraiseIT was one of two appraisal management firms hired by WaMu in the

10 Spring of 2006 when WaMu decided to close its internal appraisal office. WaMu was 11 eAppraiseIT’s largest client, and on information and belief, eAppraiseIT performed appraisals 12 for loans included in the loan pools for certificates purchased by the Bank. 13 138. The New York Attorney General’s complaint, which relies on multiple internal 14 15 documents and emails, many of which have only recently become publicly available, 16 demonstrates that WaMu actively encouraged the manipulation of appraisals to facilitate the

17 origination of more and more mortgages for securitization. In 2009, the trial court denied

18 eAppraisIT’s motion to dismiss, finding that the complaint sufficiently alleged a violation of 19 New York law, “insofar as the intentional misleading of consumers in this state relating to the 20 accuracy and independence of appraisals constitutes fraudulent and deceptive business 21 practices that the [Attorney General] may seek redress for.” People v. First Am. Corp. , 24 22 23 Misc.3d 672, 682 (Sup. Ct. N.Y. County 2009). 24 139. From its inception, the relationship between WaMu and eAppraiseIT was

25 focused on undermining the appraisal process by pressuring appraisers to come in “at value” -- 26 provide appraisals that were equal to or greater than a property’s purchase price in order for a

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1 transaction to close. WaMu’s efforts to pressure appraisers included: (1) excessive

2 “reconsideration of value” requests to reconsider appraisals that were too low to permit a loan 3 to be funded; (2) demanding that “business managers”—many of whom were former WaMu 4 employees—have the authority to overrule appraisals that were too low; (3) constantly 5 complaining that appraisals by eAppraiseIT appraisers were lower than appraisals from 6 eAppraiseIT’s chief competitor; (4) making clear to senior management at First American 7 8 (eAppraiseIT’s parent company) that any expanded business relationship was contingent upon

9 the “resolution” of the appraisal issue to WaMu’s satisfaction; and (5) ultimately creating a

10 blacklist designed to punish appraisers who failed to inflate their appraisals to come in “at 11 value.” 12 140. According to the New York Attorney General’s complaint, and the internal 13 documents referenced therein: 14 • 15 WaMu retained eAppraiseIT in Spring 2006, after WaMu decided to close its internal appraisal office and terminate its staff appraisers. WaMu quickly 16 became eAppraiseIT’s largest client. (eAppraiseIT Compl. ¶ 25.)

17 • From the beginning, WaMu possessed the ability to pressure eAppraiseIT’s staff and third party appraisers to increase their valuations. WaMu had a contractual 18 arrangement with eAppraiseIT whereby WaMu could challenge an independent 19 appraiser’s conclusions by requesting a “reconsideration of value” (“ROV”), if WaMu disagreed with an appraisal. WaMu frequently ordered ROVs from 20 eAppraise IT. (eAppraiseIT Compl. ¶ 27.)

21 • eAppraiseIT also hired approximately 50 former WaMu appraisers as eAppraiseIT staff appraisers and Appraisal Business Managers. At WaMu’s 22 request, these “business managers” were authorized to override and revise the 23 values reached by staff and third party appraisers. According to a September 29, 2006 email from a WaMu executive to senior executives at eAppraiseIT, the 24 business managers would be responsible for “proactively making a decision to override and correct the third party appraiser’s value or reviewer’s value cut, 25 when considered appropriate and supported . . . .” (eAppraiseIT Compl. ¶ ¶ 26, 28.) 26

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1 • Almost immediately after retaining eAppraiseIT, WaMu’s loan production staff began to complain that eAppraiseIT’s appraisals were too low. On August 9, 2 2006, eAppraise IT’s President informed WaMu executives that “[w]e need to address the ROV issue . . . . The Wamu internal staff we are speaking with 3 admonish us to be certain we solve the ROV issue quickly or we will all be in 4 for some pretty rough seas.” (eAppraiseIT Compl. ¶ 30.)

5 • The following week, eAppraiseIT’s Executive Vice President informed eAppraiseIT’s President that WaMu’s loan officers would often pressure WaMu 6 internal appraisal field managers for a “extra few thousand,” or “tell[] them specifically what they needed,” or “would ask for several ROV’s on the same 7 property.” (eAppraiseIT Compl. ¶ 31.) According to the vice president, 8 “[h]aving loan officers ask for a few thousand dollars because it is within the range is something we do not currently do for any client . . . . It is also direct 9 pressure on the appraiser for a higher value without any additional information.” (eAppraiseIT Compl. ¶ 31.) 10 • During the latter part of 2006, WaMu repeatedly complained to eAppraiseIT 11 regarding low appraisals. On December 2, 2006, an internal eAppraiseIT 12 communication notes that “we know [WaMu is] going to complain about the excessive number of low values because the majority of orders are not going to 13 [WaMu’s] preferred appraisers.” (eAppraiseIT Compl. ¶ 35.)

14 • By December 2006, WaMu had reassigned all of its Northern California appraisal work to Lender Services, Inc. and away from eAppraiseIT. One 15 eAppraiseIT executive told his colleagues that WaMu’s criticism stemmed from 16 the fact that “values are coming in lower with [eAppraiseIT],” than with Lender Services, Inc., its top competitor for WaMu work, and that “[t]he [WaMu] 17 managers indicated that if the loan consultants had a choice they would prefer to use [Lender Services] over eAppraiseIT because they feel they will have less 18 problem with the values.” (eAppraiseIT Compl. ¶ ¶ 33 & 36.) 19 • In addition to pressuring eAppraiseIT regarding low appraisals, WaMu also 20 indicated to First American, eAppraiseIT’s parent company, that WaMu would be open to expanding its business relationship with First American, provided the 21 appraisal issues were “resolved.” According to a First American executive, the President of WaMu mortgage told him that “if the appraisal issues are resolved 22 and things are working well he would welcome conversations about expanding our relationship . . . .” (eAppraiseIT Compl. ¶ 34.) 23 • 24 In early 2007, WaMu directed eAppraiseIT to stop using panels of staff and third party appraisers to perform WaMu appraisals, and demanded that 25 eAppraiseIT use “Proven Appraisers” selected by WaMu. The President of eAppraiseIT explained to First American executives the reason for this change: 26 “Performance ratings to retain position as a Wamu Proven Appraiser will be

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1 based on how many come in on value, negating the need for an ROV.” (eAppraiseIT Compl. ¶ 38.) 2 • eAppraiseIT’s President informed the First American executives that “we have 3 agreed to roll over and just do it. . . .” (eAppraiseIT Compl. ¶ ¶ 38, 41.) The 4 President of eAppraiseIT also wrote to WaMu’s executives stating that “Wamu proven appraisers bring the value in a greater majority of time . . . . I am fine 5 with that, of course, and will happily assign Wamu orders to Wamu proven appraisers instead of eAppraiseIT’s approved panel appraisers whenever 6 possible.” (eAppraiseIT Compl. ¶ 42.)

7 • Internal eAppraiseIT communications indicate that WaMu’s lending department 8 was in charge of selecting the preferred appraisers. An eAppraiseIT Appraisal Specialist contacted the Executive Vice President, the Chief Operating Office 9 and the Chief Appraiser about two “good, solid long-time wonderful appraisers” that were removed from the WaMu panel “for no apparent reason” after having 10 “value issues.” The Chief Appraiser informed him that “[t]he probability that a loan officer requested him to be removed is pretty high I think because that is 11 what they did with the Master List; they sent it out to Lending to choose.” 12 (eAppraiseIT Compl. ¶ 74-75.) 13 • eAppraiseIT was willing to accede to WaMu’s demands that its lending department select its appraisers, despite knowing that these demands violated 14 federal law and professional appraisal standards by compromising appraiser independence. eAppraiseIT’s President expressly acknowledged that “[w]e 15 view this [agreeing to WaMu’s demands] as a violation of the OCC, OTS, 16 FDIC, and USPAP influencing regulation.” (eAppraiseIT Compl. ¶ 48.) 17 141. In addition, documents obtained by the Bank that have only recently become

18 publicly available demonstrate WaMu’s efforts to manipulate the appraisal process. Copies of

19 these documents are attached hereto as Exhibits A-D. 20 142. Exhibit A is an August 10, 2010 affidavit by Peter Gailitis, a former Chief 21 Appraiser for eAppraiseIT. Mr. Gailitis was promoted to Chief Appraiser in 2006, and was 22 Chief Appraiser during the time period that WaMu outsourced its appraisal business to 23 24 eAppraiseIT. 25 143. The Gailitis Affidavit indicates that from the beginning of eAppraiseIT’s

26 relationship with WaMu in Spring 2006, WaMu began pressuring eAppraiseIT appraisers to

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1 inflate their appraisals. (Ex. A, ¶ 5, 6) According to Mr. Gailitis, shortly after eAppraiseIT

2 began performing appraisals for WaMu loans, Mr. Gailitis began receiving “many complaints” 3 from WaMu managers over the “allegedly low values” being provided by eAppraiseIT 4 appraisers. ( Id. ¶ 6) 5 144. One of WaMu’s primary methods for increasing appraisals was to flood 6 eAppraiseIT with reconsideration of value or ROV requests. According to Mr. Gailitis, WaMu 7 8 submitted considerably more ROVs than any other eAppraiseIT client, with the volume from

9 WaMu loan officers reaching 400 ROVs per month at one point. (Ex. A, ¶ 6) WaMu loan

10 officers would file an ROV simply because the appraised value of a property was too low for a 11 loan to close, and use the ROV as a tool for obtaining a sufficient increase in value for the 12 transaction to go forward. (Ex. A, ¶ 6) 13 145. In addition to abusing the ROV process, WaMu also sought to use its 14 15 considerable economic leverage to manipulate the appraisal process. Mr. Gailitis testified that 16 WaMu was eAppraiseIT’s largest client, and that WaMu management would pass along the

17 complaints regarding low appraisals to eAppraiseIT management, along with a threatened loss

18 of business if the complaints from WaMu’s retail divisions did not stop. (Ex. A, ¶ 7) 19 146. An internal email from David Feldman, the Executive Vice President of 20 eAppraiseIT to Anthony Merlo, the President, also makes clear that WaMu’s manipulation of 21 the appraisal process pre-dated its relationship with eAppraiseIT. (Ex. B, August 15, 2006 22 23 email from Mr. Feldman to Mr. Merlo) According to Mr. Feldman, WaMu had an “extra few 24 thousand” policy under which loan officers would ask for, and apparently receive, increases in

25 appraisals of a few thousand dollars if the inflated appraisal was still “within the range.” Mr. 26 Feldman emphasized that this was something that eAppraiseIT does “not currently do for any

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1 client,” and that it constitutes “direct pressure on the appraiser for a higher value without any

2 additional information.” Mr. Feldman also noted that the WaMu staff he spoke with indicated 3 that this “policy was abused in many ways including calling the AFM and telling them 4 specifically what they needed,” or asking for multiple ROVs on the same property (a practice 5 that became so prevalent that the AFMs began allowing only one ROV for free and then 6 charging $175 for each additional one). 7 8 147. A fall 2006 email from eAppraiseIT President Merlo to executives at First

9 American (eAppraiseIT’s parent company) and WaMu further illustrates WaMu’s efforts to

10 manipulate the process and eAppraiseIT’s concerns. (Exhibit C, September 13, 2006 email 11 from Mr. Merlo to Mr. Sando) Mr. Merlo’s email forwards various instances of WaMu 12 pressure on appraisers, including WaMu production staff regularly contacting appraisers to 13 “argue and often berate them” over their appraisals, or informing appraisers that if they do not 14 15 increase their valuations, the appraisal request will be given to another appraiser to get the 16 appropriate “price.” Mr. Merlo warns that these efforts to pressure appraisers are “getting

17 outrageously unethical and now borderline dangerous,” and he implores WaMu’s executives to

18 “respond [with] what you will do to have this stopped within the WaMu organization.” As Mr. 19 Merlo candidly acknowledges, WaMu’s actions are “pure pressure to commit fraud.” 20 148. Notwithstanding President Merlo’s concerns, WaMu continued its efforts to 21 manipulate the appraisal process. In April 2007, eAppraisetIT expressed concern that WaMu 22 23 loan production staff had “a great deal to do with selecting appraisers,” which was “directly in 24 contradiction” with the interagency guidelines adopted by the Office of Thrift Supervision

25 (OTS), the agency responsible for regulating WaMu. (Ex. D, April 17, 2007 memo to WAMU 26 Oversight Team)

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1 c. Long Beach Mortgage and WaMu engaged in predatory lending.

2 149. At WaMu, mortgage originators were paid more for originating loans that

3 carried higher profit margins for WaMu and had commensurately higher risk. The Seattle 4 Times reported how a 2007 compensation grid revealed that “the company paid the highest 5 commissions on option-ARMs, subprime loans and home-equity loans. A $300,000 option 6 ARM, for example, would earn a $1,200 commission, versus $960 for a fixed rate loan of the 7 8 same amount. The rates increased as a consultant made more loans. . . .” ST Reckless, supra ¶

9 72.

10 150. In April 2010, the Senate Permanent Subcommittee on Investigations held a 11 series of hearings into the causes of the financial crisis. The Senate Subcommittee concluded 12 that WaMu and Long Beach Mortgage often steered borrowers into home loans with low initial 13 payments they could not afford, presuming that rising home prices would enable those 14 borrowers to refinance or sell their homes before the loan payments ballooned beyond a level 15 16 they could not afford. Internal compensation schemes encouraged such conduct because loan

17 officers and loan processors were rewarded for originating high risk loans and for placing

18 borrowers in high interest loans with large prepayment penalties. 19 151. A September 21, 2005 internal WaMu audit of Long Beach Mortgage, released 20 by the Senate Committee, found that “[i]n 24 of 27 (88%) of the refinance transactions 21 reviewed, policies established to preclude origination of loans providing no net tangible benefit 22 23 to the borrower were not followed.” (Subcommittee Hearing Ex. 1d.) 24 152. The details of how WaMu paid brokers to press borrowers into buying

25 unsuitable loans at high interest rates, and often pressured borrowers to refinance from a fixed 26

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1 rate loan into a variable rate loan with higher interest rates, is illustrated by the story of Bob

2 Houk: 3 Usually, Bob Houk’s wife handled the family’s money matters. But after being 4 diagnosed with a brain tumor, she was in and out of the hospital, so he took over. In late 2006, he received a postcard with WaMu’s logo on it. 5 Houk already had a 30-year WaMu mortgage at a fixed rate of 4.6 percent. But 6 the postcard promised to lower the monthly payments on their Bainbridge Island home with an adjustable-rate mortgage starting at only 1 percent interest. 7 He liked the idea of cutting expenses. A son was in college, his wife was on 8 disability from her job as a nurse, and Houk, a physician assistant at Group 9 Health, worked only part time to be at her side.

10 Houk called the number on the card, reached an independent mortgage broker in California, and made all the arrangements over the phone. Soon someone came 11 to his house with papers to sign. Houk was impressed at how easy the process was. 12 13 But a couple of months later, Houk noticed something on his monthly statement that gave him a sick feeling. Instead of one low monthly payment, there were 14 now options. His minimum monthly payment of only $1,018 was there. But there were also higher-priced options for paying interest only or for paying 15 interest and principal. Just covering the interest that month would cost him about $1,000 more. 16 The 1 percent interest rate Houk thought he was getting was only good for the 17 first month. It had reset to 7.4 percent, nearly 3 percentage points above his 18 previous WaMu loan. This was buried in the fine print in a sheaf of legal documents he had signed. “Who in their right mind would give up a 4.6 percent 19 loan?” Houk said. “I felt totally duped.”

20 Houk said he called Washington Mutual, but the woman he talked to said nothing could be done. WaMu just gets the loan from the broker, he recalled her 21 saying, so the bank's not responsible. 22 To drum up customers for these overpriced loans, WaMu offered hefty 23 commissions to its sales force. 24 Loan officers working inside WaMu were rewarded with higher commissions for signing up a borrower for an option ARM rather than a conventional loan. 25 But WaMu made the vast majority of its option ARMs through its network of 26 independent mortgage brokers. They worked in a loosely regulated industry. In many states, the job required no education, no background check and no

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1 oversight. While there are reputable brokers, the industry suddenly attracted a motley crew, who could make six figures in a year in commissions. 2 WaMu did not reward brokers for getting its customers the best deal. Just the 3 opposite. The worse the terms were for borrowers, the more WaMu paid the 4 brokers.

5 A WaMu daily rate sheet obtained by The Seattle Times shows how lavish the rewards could be. On an option ARM, WaMu would reward brokers as much as 6 3 percent of the loan amount – more than triple the standard commission at the time. 7 Brokers would get an additional point – 1 percent of the loan – for roughly every 8 half-point in higher interest the borrower paid. So the broker would get 3 percent 9 of the loan if he could get the borrower to pay 1.5 percent above the market rate.

10 WaMu could afford to pay such high commissions, called "yield spread premiums," because the money actually came from the borrower in the form of 11 higher interest rates and prepayment penalties.

12 Houk's broker, for example, got paid a commission of $9,498 on a $316,000 loan, according to loan documents. 13 14 ST Predatory , supra ¶ 128 at A1. 15 153. WaMu and Long Beach Mortgage were among 14 lenders named by the

16 NAACP in a complaint described as alleging “systematic, institutionalized racism in sub-prime

17 home mortgage lending.” According to the lawsuit, African American homeowners who 18 received sub-prime mortgage loans from these lenders were more than 30 percent more likely 19 to be issued a higher rate loan than Caucasian borrowers with the same qualifications. In 20 January 2009, the court denied a motion to dismiss, finding that the plaintiff had sufficiently 21 22 pled a disparate impact claim. 23 d. Confidential witnesses provide further evidence of WaMu and Long Beach Mortgage’s failure to adhere to sound underwriting practices, 24 predatory lending, and manipulation of the appraisal process.

25 154. Confidential witnesses, such as Confidential Witness (“CW”)-A, provided 26 further evidence that WaMu and its subprime division, Long Beach Mortgage, abandoned

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1 sound underwriting practices. CW-A worked at WaMu from 1987 until the fall of 2006.

2 During her time at WaMu, CW-A held such positions as personal financial manager, assistant 3 branch manager, and branch manager. In these capacities, CW-A worked in consumer lending, 4 including loan origination. 5 155. CW-A saw many “stated income” loans at WaMu. If the borrower had false 6 documents or if CW-A believed that the borrower’s income would not be high enough (as 7 8 evidenced by paystubs) to qualify for a loan, CW-A would instruct the borrower not to show

9 her the documents and she would simply offer a “stated income” loan.

10 156. CW-A also said that WaMu underwriters frequently made exceptions on the 11 loans in order to approve them; moreover, she knew who the “lenient” underwriters were and 12 would direct her loans to them so that they would be approved. CW-A used different tactics in 13 order to get loans approved by the underwriter; for example, she would write the documents up 14 15 in a special way so that the loans would always be approved, even if a borrower was not strong 16 enough to otherwise qualify.

17 157. Even if loans were declined by certain underwriters, CW-A said she could

18 always ask for the loan to be reviewed again. Sometimes she would call the borrower to tell 19 them why a loan was denied, and the borrower would come back with new facts or new 20 documentation. According to CW-A, there was a lot of “fudging” that took place in those 21 situations. 22 23 158. CW-A also confirmed that during the time period she was employed at WaMu, 24 including 2005 and 2006, appraisals were manipulated to reach a value necessary for the loan

25 to close. CW-A would order appraisals from the WaMu appraisal department by saying “this is 26 what I need,” or “this is what the customer think’s its worth.” CW-A was trained to forward all

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1 information on the application to the appraisers, including the homeowner’s estimate of value,

2 even if the estimated home value looked high. The FDIC’s Office of Inspector General has 3 found this practice to be inconsistent with “standard residential appraisal methods” because 4 providing the homeowner’s estimate of the value of the home to the independent appraiser 5 biases the appraiser’s evaluation. (Evaluation of Federal Regulatory Oversight of Washington 6 Mutual Bank at p. 11, Report No. EVAL-10-002 (April 2010)). Pursuant to USPAP Rule 1- 7 8 2(b), appraisers must not allow the intended use of an assignment or a client’s objectives to

9 cause the assignment results to be biased.

10 159. While CW-A normally submitted appraisal requests to the appraisal department 11 for a coordinator to handle, CW-A could, and did, request specific appraisers if she needed a 12 certain value in a certain neighborhood. CW-A knew the appraisers’ reputations for being high 13 or low with respect to certain neighborhoods, and she used that knowledge in requesting certain 14 15 appraisers in order to get the value the client needed for the loan to close. 16 160. If an appraisal came back lower than what was needed to close the deal, CW-A

17 had several options available to increase the appraisal. If the appraisal was close to the

18 required value, CW-A would call the appraiser and negotiate for a higher number. For some of 19 the time CW-A worked at WaMu, the appraisal department was either in the same building or 20 across the street, which allowed CW-A to walk to the appraisal department and directly 21 negotiate with the appraisers to see what could be done to increase the value of the appraisal so 22 23 the loan could close. 24 161. If the appraisal was significantly lower than the required value, CW-A would

25 tell the customer to find additional comparable properties within a two-mile radius to justify 26 increasing the appraisal value, even though standard practice generally require a comparable to

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1 be within a one mile radius of the property. If there were not any comparables within a two-

2 mile radius that would justify an increase, the customer would pull higher value comparables 3 from even farther afield. 4 162. In addition to CW-A, CW-F provided additional evidence confirming the 5 manipulation of appraisals by WaMu. CW-F was a staff appraiser at eAppraiseIT from 2002 6 until February 2007. CW-F appraised homes for a variety of lender who used eAppraiseIT’s 7 8 services, including WaMu.

9 163. According to CW-F, after WaMu closed down its in-house appraisal department

10 and chose eAppraiseIT as one of its two preferred appraisal management companies, 11 eAppraiseIT hired several former WaMu appraisers to serve as “business managers.” These 12 business manager supervised the eAppraiseIT staff appraisers and were also “in contact” with 13 WaMu loan officers. 14 15 164. Prior to WaMu retaining eAppraiseIT, the eAppraiseIT staff appraisers were left 16 alone were not routinely pressured to increase values. After eAppraiseIT hired WaMu’s former

17 appraisers as managers, they pressured everyone, including CW-F, to increase appraisal values.

18 Beginning in approximately mid-2006, CW-F began reporting to a business manager in 19 Arizona. CW-F’s manager was in touch with WaMu loan officers who complained about CW- 20 F’s low valuations on refinancing transactions. CW-F’s manager then called her and informed 21 her that she was tired of getting complaints from the loan officers about CW-F’s low values. 22 23 165. CW-F’s manager constantly pressured her to increase values by modest 24 amounts, telling her that “just a couple thousand more and the loan would go through,” or

25 “[t]here’s got to be something you’re not looking at.” In many instances, CW-F’s manager 26 would tell her that WaMu had requested she look at other comparables that simply were not

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1 comparable, and force CW-F to explain why the comparables WaMu identified were not

2 appropriate. CW-F estimates that this occurred for 75% of the appraisals she performed for 3 WaMu. 4 166. CW-F eventually asked not to be assigned any WaMu appraisals, despite the 5 fact that roughly 50% of her workload was WaMu transactions. While eAppraiseIT had other 6 clients, her business manager nevertheless informed her that she “wouldn’t get any work.” In 7 8 February 2007, CW-F left eAppraiseIT. Based on CW-F’s experience, “eAppraiseIT

9 prostituted themselves for WaMu. I can’t understand why they didn’t treat WaMu like any

10 other lender.” 11 167. The testimony of CW-G also confirms the pressure that WaMu exerted on 12 eAppraiseIT and the appraisers working for eAppraiseIT. CW-G is an independent real estate 13 appraiser who received assignments from WaMu through eAppraiseIT. CW-G believes that he 14 15 performed work for WaMu between approximately November 2005 and April 2007. CW-G 16 testified that after WaMu closed its in-house appraisal department, a former WaMu appraiser

17 was hired by eAppraiseIT to serve as his district or regional manager. CW-G also noted that

18 many former WaMu staff appraisers were hired in similar manager capacities at eAppraiseIT. 19 168. According to CW-G, “within the individual purview of the district manager, it 20 was commonplace for them to come back for revision or reconsideration [of an appraisal]. It 21 was understood that when they asked, you complied.” CW-G believes that as a conservative 22 23 estimate, 10% of the reports he wrote for WaMu resulted in a value adjustment that CW-G 24 made at the request of the eAppraiseIT manager.

25 169. CW-H and CW-I provided testimony regarding what occurred if an appraiser 26 refused to bow to WaMu pressure. CW-H was an independent appraiser that received

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1 assignments through eAppraiseIT, LSI, and directly from WaMu. CW-H was placed on

2 WaMu’s list of “approved appraisers,” and estimates that around 75% of her appraisals were 3 for WaMu. 4 170. CW-H recalls being pressured by WaMu to increase appraisal values on several 5 occasions, and she believes that this pressure occurred between November 2005 and April 6 2007. CW-H would be told that she was missing the sales price by a small amount, and that 7 8 because the market was going up, her appraisal should also increase. On one occasion, an

9 appraisal was reassigned from CW-H to staff appraiser because her appraisals were too

10 conservative. 11 171. CW-H was ultimately removed from the “approved appraiser” list because of 12 her view that the market was declining in value. The standard appraisal form that CW-H used 13 included a section on market condition, and required appraisers to check a box indicating 14 15 whether market values were stable, increasing, or decreasing at the time the appraisal was 16 made. Sometime between November 2005 and April 2007, CW-H indicated that property

17 values were decreasing. According to CW-H, this was a “big no-no,” because if the market

18 was in decline, WaMu would not be able to resell the loan on the secondary market, or if they 19 did, the loan would have to be discounted. WaMu “hassled” CW-H for her conclusion, and a 20 WaMu employee even called her to try to convince her that market values were not declining. 21 WaMu subsequently removed CW-H from the approved appraiser list—informing her via a 22 23 telephone call—and she never received work from WaMu again. 24 172. CW-I is an independent appraiser and has prepared appraisals for a variety of

25 lenders, including WaMu. In the spring of 2006, CW-I appraised a home for $2.2 million. 26 While CW-I’s supervisor reviewed the appraisal, and agreed with the valuation, a WaMu staff

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1 appraiser subsequently sent CW-I a letter indicating that she disagreed with the valuation, and

2 was increasing it by $500,000 to $2.7 million. CW-I was confident that his appraisal was 3 accurate, in part because it was based on comparable properties on the same street as the 4 subject property, and contacted the WaMu’s chief appraiser in the area to express his concerns 5 about the inflated appraisal. Far from being concerned, WaMu’s chief appraiser informed CW- 6 I that WaMu “could change the value to anything it wanted.” 7 8 173. After this incident, CW-I’s assignments for WaMu decreased, even though

9 believed he remained on the “panel” of preferred appraisers. CW-I also recalls an instance

10 where an appraisal was assigned to him, only to be reassigned thirty minutes later at the request 11 of the WaMu loan officer, who believed that CW-I was “too conservative.” According to CW- 12 I, this behavior was “typical” – it was either “their way or the highway.” 13 174. In addition, the pressure to inflate appraisals to enable loans to close was not 14 15 limited to loan officers and appraisers, but also infected the quality control process for 16 appraisals. CW-J was a loan auditor for Long Beach Mortgage Company from 2005 to 2007.

17 While CW-J was a Long Beach employee, the header on her paycheck indicated she was paid

18 by WaMu. 19 175. As a loan auditor, CW-J was responsible for reviewing loan files for 20 completeness, accuracy and fraud. The fraudulent loans that CW-J identified usually contained 21 inflated incomes or inflated appraisal values, such as when an appraiser used comparables of 22 23 larger houses in more desirable areas to assess a property’s value. The audit process was 24 driven by an “audit form.” The audit form was a paper questionnaire that was filled out by the

25 auditors and placed in the loan file upon completion. Over time, the audit form shrank 26

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1 substantially. When CW-J first started working at Long Beach Mortgage, the form was

2 approximately ten pages long, by 2006, the form had shrunk to two pages. 3 176. As the scope and thoroughness of the audit was determined by the form, CW-J 4 became frustrated because the audit form limited her ability to adequately scrutinize the quality 5 of the loans she was reviewing. According to CW-J, the auditors were limited to answering 6 only the questions in the questionnaire – auditors that attempted to ask questions that were not 7 8 on the questionnaire “got [their] hand slapped.” As one manager told CW-J, when CW-J

9 attempted to inquire into issues outside the scope of the questionnaire form, “[i]t’s not a

10 question on the form so don’t worry about it.” 11 177. CW-J was among four or five auditors at Long Beach Mortgageg that believed 12 the audit form was insufficient for detecting fraud or inflated appraisal values, and who voiced 13 concerns about the quality of loans being approved by the lender. CW-J’s audit manager 14 15 responded to these concerns by instructing the auditors to limit their review to the questions on 16 the form. For example, CW-J was not permitted to raise concerns if she believed that a

17 borrower’s stated income failed to match his or her employment description, because this

18 inquiry was not on the form. In 2006 and 2007, CW-J reviewed a lot of questionable loans that 19 she felt uncomfortable approving. One particular concern she had was what would happen 20 when a borrower’s payment doubled or tripled in five years due to rate adjustments, and 21 whether the borrower would be able to pay the loan. 22 23 178. If an auditor did answer questions in the negative on the audit form, an 24 automatic “hard stop” was placed on the loan, and it could not be approved for funding. The

25 loan was then sent to the audit manager, who could override the auditor and approve the loan. 26 CW-J’s audit manager emphasized getting along with and pleasing the team managers that

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1 oversaw the loan processors and underwriters. These team managers in turn worked with and

2 maintained relationships with two or three mortgage brokers that fed loans to Long Beach 3 Mortgage. According to CW-J, many of her audit manager’s decisions regarding loan quality 4 were based on conversations he had with team managers, and CW-J believed that her audit 5 manager inappropriately sided with team managers on loan disputes with auditors. 6 179. In addition to limiting the scope of the audit, there was also significant pressure 7 8 at Long Beach Mortgage to review as many loans as possible. Auditors received incentive pay

9 based on the number of loans reviewed. The audit manager’s bonus was based on the number

10 of loans audited by his department, and CW-J was reprimanded by her audit manager if she 11 spent too much time reviewing a loan. As a result, CW-J had roughly 15 minutes to review a 12 loan,which precluded a detailed review. 13 180. CW-K also confirmed that the time pressures placed on auditors impacted the 14 15 quality of the loan review. From 2005 to early 2006, CW-K was a senior staff appraiser at 16 WaMu. CW-K’s position was eliminated in 2006 when WaMu eliminated its in-house

17 appraisal department, but CW-K rejoined WaMu in 2007 as an appraisal reviewer in the quality

18 control department. 19 181. According to CW-K, WaMu senior staff appraisal reviewers had to meet volume 20 quotas that impacted the quality of their reviews. While CW-K is not sure of the exact quota, 21 he believes that “front-end” reviewers were required to review 20 appraisals per day, in 22 23 contrast to quality control reviewers who were only expected to review 8 to 10 appraisals per 24 day. CW-K explained that “front-end” appraisals impacted production in that they were

25 required to fund loans, whereas no one relied on quality control’s appraisals for funding. 26

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1 182. As a quality control review appraiser, CW-K saw many fraudulent appraisals in

2 approved WaMu loans. CW-K estimates that a very high number, probably 15-20% of the 3 appraisals he reviewed were inflated or fraudulent. Most of the fraudulent appraisals were of 4 collateral securing loans approved by Long Beach Mortgage. According to CW-K, “the 5 problem was on the lending side of the business. It was pure greed,” motivated by a desire to 6 make as many loans as possible. 7 8 183. CW-K also explained that WaMu implemented an appraisal tracking and review

9 system called OPTISValue. OPTISValue reviewed an appraisal for key characteristics, and if

10 those characteristics were satisfied, it could approve the appraisal. WaMu could change the 11 key characteristics that the OPTISValue system used to determine whether an appraisal would 12 be approved or flagged for secondary review. CW-K believes that as time went on, the key 13 characteristics were loosened because as a lender, WaMu wanted “to get everything approved.” 14 15 According to CW-K, while OPTISValue was initially designed from a risk standpoint, it was 16 geared towards “cookie cutter loans,” and was not designed to catch fraud. For this reason,

17 there were loans that a human appraiser would have caught, that OPTISValue would not.

18 184. Another Confidential Witness, CW-L, confirmed the flaws in the OPTISValue 19 program. CW-L was a senior staff appraiser at WaMu from 1999 until September 2006. 20 185. Prior to 2002, WaMu administrative staff reviewed appraisals using checklists to 21 assist them in finding risky characteristics that warranted further review by a certified 22 23 appraiser. 24 186. Starting in 2001 or 2002, WaMu began automating its appraisal review process

25 by using OPTISValue. After 2002, all appraisals were automatically reviewed by the 26 OPTISValue system. OPTISValue performed the initial appraisal screening that humans had

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1 previously done, thus eliminating human involvement from the first stage of review, and

2 creating a system where certain appraisals would be automatically approved without ever being 3 reviewed by a person. 4 187. According to CW-L, OPTISValue automatically approved a huge percent of 5 appraisals; CW-L estimates that more than 50% of all appraisals sent to WaMu were never 6 looked at by any human. Both in-house production appraisers and fee appraisers knew that if 7 8 “they came in with a value that worked,” (i.e. a value that was equal to or greater than the

9 purchase price), their appraisal would never be questioned because OPTISValue would approve

10 it without any review. The use of an automated system, coupled with increasingly relaxed 11 appraisal standards, resulted in inflated appraisals. CW-L recalls seeing a “whole bunch of 12 appraisals with inflated values,” and was aware of loans that were supported with inflated or 13 otherwise fraudulent appraisals that were still approved. 14 15 188. The confidential witness statements quoted above demonstrate that WaMu and 16 Long Beach Mortgage routinely accepted - in fact demanded - appraisals that were conducted

17 in violation of USPAP standards. Because WaMu and Long Beach Mortgage insisted upon

18 certain results, negotiated results with appraisers, and pressured appraisers to increase values, 19 the resulting appraisals simply were not performed with "impartiality, objectivity, and 20 independence" as required by the USPAP Ethics Conduct Rule. Instead, appraisers routinely 21 allowed the "intended use of an assignment or a client's objectives to cause the assignment 22 23 results to be biased" in violation of the USPAP Scope of Work Acceptability Rule. 24 Additionally, by threatening appraisers regarding the availability of future work and removing

25 appraisers from the list of accepted appraisers, WaMu and Long Beach Mortgage forced 26 appraisers to violate the USPAP Ethics Management Rule, which precludes the acceptance of

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1 assignments that are contingent upon either "the reporting of a predetermined result" or "a

2 direction in assignment results that favors the cause of a client." Ultimately, the systemic 3 coercion of appraisers caused a fundamental violation of USPAP Standard 1, which requires 4 that appraisers “correctly complete research and analyses necessary to produce a credible 5 appraisal.” As discussed in public reports and confirmed by confidential witnesses, WaMu’s 6 and Long Beach Mortgage’s appraisal abuse was standard operating procedure for both 7 8 companies.

9 e. The mortgages originated by WaMu and Long Beach Mortgage and securitized in the PLMBS purchased by the Bank provide further 10 evidence of WaMu and Long Beach Mortgage’s failure to adhere to 11 sound underwriting practices. 12 189. WaMu and Long Beach Mortgage originated the mortgages that secured the 13 PLMBS purchased by the Bank. As discussed in detail below, the Offering Documents

14 contained serious material misstatements regarding specific characteristics of the loan pools 15 securing these certificates, including misstatements with respect to their weighted average LTV 16 ratio, the percentages of loans with LTV ratios in excess of 100%, 90% and 80%, and the 17 percentage of loans secured by property not the primary residence of the borrower. Moreover, 18 as described in paragraphs 273-275 below, these certificates have exhibited excessive 19 20 delinquency and foreclosure rates. These circumstances are strong evidence of WaMu’s and

21 Long Beach Mortgage’s failure to observe its stated underwriting standards. WaMu’s and

22 Long Beach Mortgage’s actual practices – including use of unreliable and biased collateral 23 valuations in lieu of appraisals, routine granting of underwriting exceptions, and reliance on 24 unverified borrower-supplied information – caused it to originate loans whose actual LTV 25 ratios and primary residence rates were far different from those reported in the Offering 26

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1 Documents. As a result, the likelihood of default for these loans was much higher than that of

2 loans issued under underwriting standards of the type described in the Offering Documents. 3 190. In summary, far from following its underwriting guidelines and making 4 occasional, targeted and justified exceptions when other evidence of ability to repay justified a 5 deviation from the guidelines, in fact at Long Beach Mortgage and WaMu variance from the 6 stated standards was the norm, and many loans were made with essentially little to no 7 8 underwriting or effort to evaluate ability to repay. Nowhere did any Offering Document

9 apprise the Bank of Long Beach Mortgage’s and WaMu’s pervasive and systematic disregard

10 of their stated underwriting guidelines, failure to adhere to standard appraisal practices, and 11 rampant predatory lending. 12 D. The Securitization Process Was Plagued by Conflicts of Interest and Misplaced 13 Incentives.

14 191. A few large financial institutions dominated every aspect of the mortgage 15 securitization process. They owned many of the mortgage originators themselves, and funded 16 the lending activities of many of the originators they did not own outright. As a result, these 17 financial institutions – and the sponsors, depositors and underwriters that were divisions of 18 these financial institutions – were in a position to scrutinize the practices of the originators and 19 20 examine closely the mortgages placed in the pools. Indeed, they had the legal responsibility to

21 do so and to provide investors with complete and accurate information.

22 1. WaMu’s Vertical Integration Provided it with Access To Information 23 Regarding the Abandonment of Underwriting Guidelines, Manipulation of the Appraisal Process, and Predatory Lending Practices. 24 a. The WaMu and Long Beach Entities Were Vertically Integrated. 25 192. All of the PLMBS at issue here were issued by a vertically-integrated firm that 26 was involved in all of the stages of the securitization of the PLMBS – loan origination,

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1 sponsoring, obtaining credit ratings, issuing, underwriting, and selling the certificates. The

2 following table summarizes the vertical integration of the WaMu and Long Beach entities 3 involved in the PLMBS purchased by the Bank: 4 Sponsor Certificate Roles of Affiliated Entities 5

6 Long Beach Mortgage Co./ LBMLT 2006-5 Originators: Long Beach Mortgage Company Washington Mutual Bank 2A3 Washington Mutual Bank 7 (both subsidiaries of LBMLT 2006-6 Washington Mutual, Inc .) 2A3 Lead 8 LBMLT 2006-7 Underwriter: WaMu Capital Corp. 2A3 9 LBMLT 2006-8 Depositors: Long Beach Securities Corp. 2A3 WaMu Asset Acceptance Corp. 10 WAMU 2006-AR12 Master 1A1 Servicers: Long Beach Mortgage Company 11 Washington Mutual Mortgage Securities Corp. 12 Servicer: Washington Mutual Bank 13 14 Calculation Agent: Washington Mutual Mortgage 15 Securities Corp. 193. Where affiliates originated and securitized the mortgage loans, the 16 Depositor/Issuer and Underwriter Defendants had immediate access to information regarding 17 the lending and underwriting practices of the mortgage originators. For example, in all of the 18 19 PLMBS in this case, Long Beach Securities Corp. and WaMu Asset Acceptance Corp., as the 20 Depositors/Issuers, and WaMu Capital Corp. as the lead underwriter for the securities issuance,

21 should have known precisely what Long Beach Mortgage Company and Washington Mutual 22 Bank, as mortgage originators, were doing when they issued loans to people without regard to 23 their ability to pay, and without any meaningful mortgage underwriting. 24 194. The vertical integration of the WaMu entities involved in the securitization of 25 the PLMBS purchased by the Bank created enormous incentives for originators to loosen 26

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1 underwriting and appraisal standards so that more loans could be issued and more securitization

2 sold. 3 195. Rather than use their superior access to information about the underlying 4 mortgage pools and unique ability to exert influence over the underwriting standards 5 responsibly, WaMu Capital Corp., WaMu Asset Acceptance Corp., and Long Beach Securities 6 Corp. blindly accepted defective loans originated by their WaMu and Long Beach affiliates. 7 8 The reason was straightforward. WaMu made more money that way on the front end, when

9 issuing the loans, and on the back end, when securitizing them. As confirmed by the press

10 reports and confidential witness testimony described above, adequate due diligence, accurate 11 appraisals, and exclusion of defective loans would have cut into all affiliated entities’ profits 12 and slowed down the securitization machine. 13 b. The Co-underwriter Defendants also had access to information from 14 their own corporate affiliates. 15 196. Between 2005 and 2007, the number of firms with corporate affiliates involved 16 in all stages of the securitization process grew significantly because investment banks and other 17 issuers of mortgage-backed certificates sought to dominate the market and control access to 18 their underlying product: mortgage loans. By starting or acquiring mortgage originators, these 19 20 entities could ensure a captive source of mortgage pools for securitization and sale to investors.

21 197. In fact, each of the Co-underwriter Defendants also has corporate affiliates

22 (identified below) that serve as depositors/issuers of mortgage backed certificates, including 23 certificates backed by mortgages originated by WaMu and Long Beach Mortgage. For 24 example, Defendant Goldman Sachs served as the sponsor, depositor, sole underwriter and 25 dealer for a certificate (GSR 2006-6F) that was backed by WaMu-originated loans during the 26 same time period that the loans underlying the certificates here were securitized. Similarly,

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1 Greenwich Capital Markets served as the sponsor, depositor and underwriter for a certificate

2 (HVMLT 2006-8) that was also backed by WaMu-originated loans during the same time period 3 as the certificates purchased by the Bank. 4 Co-Underwriter Defendants & Their Depositors/Issuer Corporate Affiliates 5 Co-Underwriter Defendant Corporate Affiliate Depositor 6

7 Banc of America Securities LLC Banc of America Mortgage Securities, Inc. 8 Credit Suisse Securities (USA) LLC Credit Suisse First Boston Mortgage Securities Corp. 9 Goldman, Sachs & Co. GS Mortgage Securities Corp. 10 Greenwich Capital Markets, Inc. Greenwich Capital Acceptance, Inc. 11 Merrill Lynch, Pierce, Fenner & Smith Merrill Lynch Mortgage Investors Inc. 12 Incorporated

13 14 198. More generally, the fact that the Co-Underwriter Defendants had corporate 15 affiliates that were sponsors and/or depositors provided them with access to information

16 regarding the mortgage loan pools backing numerous certificates. Their analysis of these loan

17 pools, and/or the analysis of the loan pools performed by third-parties such as Clayton 18 Holdings and The Bohan Group, see infra § IV.D.2, provided the Co-underwriter Defendants 19 with an insider’s detailed awareness of the industry-wide abandonment of underwriting 20 standards, the manipulation of real estate appraisals, the engagement in predatory lending, and 21 22 the unreliability of credit ratings. In addition, all of the Co-Underwriter Defendants have 23 corporate affiliates that also served as an originator of mortgages for securitization. 24 25 26

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1 2. Conflicts of Interest Undermined Adequate Due Diligence and Disclosure to Investors. 2 199. The multiple roles that affiliated divisions of WaMu played in the securitization 3 4 process created conflicts of interest that prevented it from engaging in adequate due diligence

5 on the loan pools. As a result of corporation affiliations and conflicted relationships in the

6 industry, WaMu Capital Corp. and the other Co-underwriter Defendants failed to appropriately

7 fulfill their due diligence function with respect to the mortgages placed in the pools. Rather 8 than conducting the appropriate due diligence on the loan pools, and either rejecting loans that 9 failed to meet underwriting standards or adequately disclosing the true risks of the certificates, 10 the Defendants utilized the securitization process to pass the risk of default down the line to 11 12 investors, such as the Bank, through the use of materially false and misleading Offering 13 Documents.

14 a. The Defendants directed the due diligence process and were provided with detailed reports describing the results of the process. 15 16 200. Information obtained from press reports, government investigations and 17 confidential witnesses demonstrates that the financial institutions, including the Lead

18 underwriter and Co-underwriter Defendants in this case, that retained third-party due diligence

19 firms to conduct loan pool due diligence, both manipulated the due diligence process and also 20 disregarded the results of the process. They did so in order to maximize the profits they made 21 from issuing and selling mortgage-backed certificates. 22 201. The two firms that dominated the third-party due diligence market were Clayton 23 24 Holdings, Inc. (“Clayton”) and The Bohan Group (“Bohan”). Upon information and belief, 25 both Clayton and Bohan were retained by Defendants or their affiliates to conduct third-party

26 reviews of the loans pools backing the PLMBS at issue. According to Clayton’s Form 10-K for

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1 the fiscal year ended December 31, 2006, Clayton monitored over $418.0 billion in loans

2 underlying mortgage-backed certificates, which represented 22.8% of the total outstanding U.S. 3 non-GSE mortgage-backed certificates at such date. Clayton also reported that during 2006, 4 2005, and 2004, it worked with each of the ten largest non-agency mortgage-backed certificates 5 underwriters, as ranked by Inside MBS & ABS magazine , which accounted for 73%, 73%, and 6 78% of total underwriting volume during those respective periods. 7 8 202. Confidential witnesses, who worked at Clayton during the relevant time period

9 and were familiar with the identity of Clayton’s clients and the due diligence performed by

10 Clayton during the relevant time period, named several different entities they knew had hired 11 Clayton to perform due diligence on loan pools. These confidential witnesses include: CW-B, 12 who worked as a valuation specialist at Clayton from January 2006 until March 2008 and 13 reviewed appraisals and properties in loan files on behalf of financial institutions that had hired 14 15 Clayton; CW-C, an underwriting consultant at Clayton from 1999 until 2006, who underwrote 16 mortgage-backed certificates for a “lot of investment banks” that hired Clayton; and CW-D, an

17 underwriter at Clayton from 2002 until 2008, who also reviewed loans for financial institutions

18 which hired Clayton. CW-B confirmed that WaMu hired Clayton to perform due diligence on 19 underlying loan pools. According to former Clayton employees CW-C, CW-D, and CW-B, 20 Clayton was also hired to perform due diligence on mortgage loan pools by other entities, 21 including RBS Greenwich Capital, 3 Morgan Stanley, Countrywide, Nomura, Webster 22 23 Financial, National City, and Lehman Brothers. Media reports also indicate that Clayton 24

3 25 Until April 1, 2009, RBS Greenwich Capital was the marketing name which encompassed The Royal Bank of Scotland’s North American broker-dealer entities, including Underwriter Defendant Greenwich Capital Markets, 26 Inc., n/k/a RBS Securities Inc. See The Royal Bank of Scotland, “RBS Greenwich Capital Re-Name and Re- Brand FAQ’s,” March 6, 2009, available at http://www.rbsgc.com/images/panels/rbsm/document/faq.pdf (last visited Oct. 3, 2010). As used herein, “RBS Greenwich” is meant to encompass these entities.

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1 Holdings did work for Goldman Sachs and Merrill Lynch. Gretchen Morgenson, Raters

2 Ignored Proof of Unsafe Loans, N.Y. Times , Sept. 26, 2010. 3 203. Less information is publicly available about Bohan’s due diligence business 4 because it is a privately held company. However, press reports and confidential witnesses 5 confirm that Bohan provided third-party loan pool due diligence to a large number of financial 6 institutions. For example, CW-E, who worked as an underwriter at Bohan from 2003 to 2006 7 8 and reviewed loans that Bohan’s clients were considering for securitization, said that Bohan’s

9 clients included Morgan Stanley, Chase, J.P. Morgan, and others.

10 204. The entities (here, WaMu Capital Corp. and the Co-underwriter Defendants) that 11 retained Clayton and Bohan, and other third-party due diligence firms for loan pool review, 12 maintained close contact and control over the process. As explained by Vicki Beal, Senior 13 Vice President of Clayton Holdings in her September 23, 2010 written testimony before the 14 15 Financial Crisis Inquiry Commission: 16 The loan review process is conducted as follows:

17 • A client reviews a pool of loans and selects a sample of loans for diligence review.… 18 • Client hires Clayton to perform diligence on the sample. Client gives Clayton’s 19 Client Services Manager instructions on the type and scope of review and the 20 time frame for the deal. 21 • Client sends or has sent to Clayton a tape containing loan information from the originator, which Clayton programmers “crack” and load into our CLAS system. 22 • At the end of each day, the lead underwriter generates reports for the client that 23 summarizes Clayton’s findings, including exception reports. 24 205. In addition, during the review process, the client financial institutions often put 25 their own employees on-site to oversee the review process. For example, according to CW-D, 26

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1 RBS Greenwich and Morgan Stanley always sent their own employees to the mortgage

2 originator’s site. 3 206. Numerous confidential witnesses confirm that due diligence reports are provided 4 to the financial institutions that retained the third-party due diligence firms. According to CW- 5 B, Clayton’s clients “had access to our [Clayton’s] databases,” and “could see everything.” 6 CW-D also explained that Clayton’s lead underwriters could consult with the client’s 7 8 representatives to determine if the client wanted particular loans “kicked out” of the mortgage

9 pools.

10 207. Indeed, as Ms. Beal reported to the Financial Crisis Inquiry Commission: “The 11 work product produced by Clayton is comprised of reports that include loan-level data reports 12 and loan exception reports. Such reports are “‘works for hire,’ the property of our clients and 13 provided exclusively to our clients.” Thus, on information and belief, the financial institutions 14 15 that hired Clayton (including the Defendants) should have known about the red flags that the 16 third-party underwriters identified.

17 208. Similarly, Bohan employed “lead” underwriters, who communicated directly

18 with the financial institutions that retained them to review loan pools. As was the case with 19 Clayton, CW-E said that many of these entities sent their own employees to the originator’s 20 sites to review the loans that were being considered for inclusion in a mortgage pool and 21 subsequent securitization. CW-E also explained that Bohan’s clients had access to Bohan’s 22 23 computer system and could view which loans were being approved or rejected. Thus, on 24 information and belief, the financial institutions which hired these third-party due diligence

25 firms (including the Defendants) should have known about the red flags that the third-party 26 underwriters identified.

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1 b. Defendants misused due diligence results.

2 209. As Ms. Beal testified with regard to Clayton, the client financial institutions

3 determined the type and scope of review performed on the loan pools. Yet, rather than 4 directing the firms to conduct thorough reviews that were most likely to identify defective 5 loans, the financial institutions pressured the loan reviewers to disregard problem loans through 6 exceptions and offsets that did not satisfy the applicable underwriting guidelines. 7 8 210. According to confidential witnesses, third-party due diligence underwriters were 9 pressured by the banks that hired them to depart from the standards so that loans were not 10 tagged as defective. For example, CW-D, a Clayton employee, stated that one out of every four 11 12 or five loans that he reviewed on behalf of client financial institutions did not meet the 13 originator’s guidelines. Although he felt many of the loans were “dead assets” (the lowest

14 rating Clayton gave), he was required to provide “compensating factors,” which were reasons

15 why the loan should be considered for inclusion in the mortgage pool. 16 211. Similarly, CW-E said that she reviewed many loans requiring no documentation 17 at Bohan. Yet, she was not allowed to challenge the borrower’s claims. As CW-E said, 18 “Whatever [the borrower] filled out on an application got through.” When she informed a lead 19 20 underwriter that she suspected the borrower’s income was inflated, the lead underwriter pointed 21 to the borrower’s signature and fine print at the bottom of the loan application that indicated the

22 borrower swore the information to be true. The lead underwriter told CW-E, “You can’t call 23 the borrower a liar.” Due to such actions by the lead underwriters, CW-E received the 24 impression that the financial institutions who were buying the loans for securitization did not 25 care about inflated income. 26

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1 212. CW-E also recalled other loans in the mortgage pools which included a credit

2 score of 600, no income documentation, and no asset verification, but where the borrowers 3 were receiving 100% financing. At the time, she recalled thinking: “Why would anybody in 4 the world want these loans?” Nevertheless, the financial institutions bought and packaged the 5 loans for securitization. 6 213. Bohan employees were pressured by the financial institutions who hired them to 7 8 leave information out of their reports that detailed non-compliant or predatory loans that should

9 have been excluded from the pool. For example, CW-E explained that many underwriters at

10 Bohan did not include in their reviews the borrower’s fee associated with rebates on wholesale 11 loans. A rebate is negative points on a loan, whereby a borrower pays the lender for a higher 12 interest rate in order to have lower up-front costs. The Bohan employees left such information 13 out of their reports because if they mentioned it, the loans would often be considered predatory. 14 15 CW-E recalled one rebate situation in which the borrower refinanced a property three times 16 over a one-year period. When she reviewed the loan on the third refinancing, she discovered

17 that the borrower was seeking the loan to pay off $5,000 in bills and to obtain $8,000 cash, but

18 the rebate fees totaled $12,000. CW-E thought the loan was ultimately included in the 19 mortgage pool because nothing was wrong with the loan, except that the borrower was getting 20 nothing out of it and was “an older person that was being taken advantage of.” 21 214. Further compounding the problems, Clayton employees were instructed to 22 23 review fewer loans in the loan pools as the securitization market grew. Frank P. Filipps, 24 Clayton’s chairman and CEO, stated that “[e]arly in the decade, a securities firm might have

25 asked Clayton to review 25 to 40 percent of the sub-prime loans in a pool, compared with 26 typically 10% in 2006.” E. Scott Reckard, Sub-Prime Mortgage Watchdogs Kept on Leash;

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1 Loan Checkers Say Their Warnings of Risk Were Met with Indifference , Los Angeles Times ,

2 March 17, 2008, at C1. 3 215. According to Ms. Beal’s 2010 testimony before the Financial Crisis Inquiry 4 Commission, the securitization markets grew even more frenzied, and “when lenders and 5 securitizers were trying to sell off as much as they could before the market collapsed, that 6 [review] figure reached as low as 5 percent.” 7 8 216. Notably, according to Bohan President Mark Hughes: “By contrast, loan buyers

9 who kept the mortgages as an investment instead of packaging them into securities would have

10 50% to 100% of the loans examined.” Reckard, supra at C1. 11 217. Even though the third-party due diligence providers were instructed to review 12 smaller samples of the mortgage pools over time, the demand for mortgage-backed certificates 13 was so great that, in the aggregate, the third-party due diligence firms were reviewing 14 15 staggering quantities of loans. According to Paul Muolo and Matthew Padilla, Chain of Blame 16 228 (2010), “[i]n 2006, rank-and-file clerks hired by Clayton vetted a million individual

17 mortgages for Wall Street firms . . . .”

18 c. Defendants should have known that the sponsor included defective 19 loans in the loan pools. 20 218. Notwithstanding pressures on loan reviewers to look the other way, the third-

21 party due diligence process provided sponsors with extensive information about loan pool

22 defects. As reported by the Los Angeles Times , Clayton and Bohan employees (including eight 23 former loan reviewers who were cited in the article) “raised plenty of red flags about flaws so 24 serious that mortgages should have been rejected outright – such as borrowers’ incomes that 25 seemed inflated or documents that looked fake – but the problems were glossed over, ignored, 26 or stricken from reports.” Reckard, supra at C1.

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1 219. Ironically, while the financial institutions that hired third-party reviewers

2 pressured them to make exceptions for defective loans, these financial institutions often utilized 3 information about bad loans to negotiate a lower price for the pool of loans from the seller (i.e. 4 originator). Indeed, according to Clayton’s former president, D. Keith Johnson’s September 5 2010 testimony before the Financial Crisis Inquiry Commission, negotiating a lower price was 6 one of the primary purposes of the due diligence review. 7 8 220. CW-E, who worked at Bohan from 2003 to 2006, confirmed that Bohan’s

9 review was used in price negotiations between the sponsors and the mortgage originators. The

10 sponsors could request a discount if Bohan’s reviewers rejected a large number of the loans. 11 This is not to say that the financial institutions actually eliminated all of the defective loans 12 from the pools. To the contrary, they obtained a lower price for the pools because the defective 13 loans stayed in the pools. 14 15 221. Recent testimony before the Financial Crisis Inquiry Commission reveals the 16 extent of this activity with regard to loans reviewed by Clayton. During 2006 and the first half

17 of 2007, Clayton reviewed 911,039 loans issued by various originators for securitization by its

18 clients (including WaMu, Bank of America, JPMorgan Chase, Citigroup, Goldman Sachs, 19 Morgan Stanley, Bear Stearns and Lehman Brothers). Clayton determined that 28% or 255,802 20 mortgages that they reviewed did not satisfy applicable underwriting guidelines. Of this 21 number, Clayton’s Wall Street clients “waived” 100,653 of them, or 39 percent of those loans 22 23 that did not meet basic standards. See Testimony of Beal, Johnson, and supporting waiver 24 reports documents, attached hereto at Appendix II.

25 222. Clayton provided the Financial Crisis Inquiry Commission with documents 26 showing the defect and waiver rate of the main financial institutions who had retained Clayton

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1 to conduct loan pool due diligence. Clayton’s documents reveal the following rejection and

2 waiver rates for entities who were involved in the securitization of the PLMBS purchased by 3 the Bank: 4 Percentage of Rejected 5 Percentage of Mortgages Mortgages Subsequently Client: Rejected by Clayton: Waived by Client: 6 Credit Suisse 37% 32% 7 Goldman Sachs 23% 29% 8 JP Morgan Chase 27% 51% 9 WaMu 27% 29%

10 223. The Offering Documents fail to state that (1) Clayton had informed their clients

11 that a substantial percentage of loans in the loans pools backing PLMBS were defective; (2) 12 Defendants, nonetheless, had waived the defects as to a substantial percentage of these loans; 13 and (3) Defendants had used the due diligence reports to negotiate a lower price for the loan 14 pools. As D. Keith Johnson, the former President of Clayton testified to the Financial Crisis 15 16 Inquiry Commission , Clayton “looked at a lot of prospectuses” and the firm was not aware of 17 any disclosure to investors of Clayton’s “alarming’ findings.”

18 3. Defendants’ Own Due Diligence Identified a High Number of Defective Loans in the Mortgage Pools Backing PLMBS. 19 20 224. The financial institutions that dominated the securitization markets did not just 21 obtain information about defective loan pools from third-party due diligence firms, but also

22 through their own in-house due diligence efforts. Investment banks in particular currently are

23 facing a slew of investigations into their knowledge of the mortgage pool defects that were 24 withheld from investors. As stated in a January 12, 2008 New York Times article titled, 25 “Inquiry Focuses on Withholding of Data on Loans”: 26

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1 An investigation into the mortgage crisis by New York state prosecutors is now focusing on whether Wall Street banks withheld crucial information about the 2 risks posed by investments linked to subprime loans. Reports commissioned by the banks raised red flags about high-risk loans known as exceptions, which 3 failed to meet even the lax credit standards of subprime mortgage companies 4 and the Wall Street firms. But the [investment] banks did not disclose the details of these reports to credit-rating agencies or investors. The inquiry, 5 which was opened last summer by New York’s attorney general, Andrew M. Cuomo, centers on how the banks bundled billions of dollars of exception loans 6 and other subprime debt into complex mortgage investments.

7 (emphasis added). 8 225. Upon information and belief, the Defendants should have known as a result of 9 the red flags generated by their own due diligence as well as by third-party due diligence firms 10 hired by the Defendants or their affiliates indicating that the pools of loans they purchased and 11 12 sold in securitizations were far riskier than was represented to investors, including the Bank. 13 E. The Securitization Process Was Supported by Credit Ratings that Materially Misstated the Credit Risk of the PLMBS. 14 226. The triple-A credit ratings of the PLMBS played a crucial role in the Bank’s 15 16 purchase of PLMBS. Indeed, by policy, the Bank could only purchase AAA rated tranches of 17 the certificates. Without the rating, no purchase would have occurred. Thus, the Bank relied to

18 its detriment on the ratings and the Defendants’ representations regarding the ratings in the

19 Offering Documents. 20 227. The Defendants well understood (and banked on) the important role the credit 21 ratings played in the PLMBS markets. They featured the ratings prominently in the Offering 22 Documents and discussed at length the ratings of the different tranches of the PLMBS, and the 23 24 bases for the ratings. Yet the Rating Agencies knew, and the Defendants should have known, 25 that the ratings were not reliable. Those ratings were bought and paid for and were based on

26 flawed information.

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1 1. The Credit Ratings Were Unreliable, Based As They Were on Underwriting Standards That the Rating Agencies Knew Had Been Abandoned. 2 228. The Rating Agencies knew that many mortgage originators, including Long 3 4 Beach Mortgage and WaMu, had abandoned their stated mortgage underwriting guidelines, and

5 thus knew that the Ratings were false when made.

6 229. The Senate Subcommittee on Investigations, for example, uncovered internal

7 Rating Agency emails from the summer and fall of 2006 noting that “there has been rampant 8 appraisal and underwriting fraud in the industry for quite some time”; that “underwriting 9 fraud[,] appraisal fraud and the general appetite for new product among originators [are] 10 resulting in loans being made that shouldn’t be made”; and that “this is like another banking 11 12 crisis potentially looming.” 13 230. Particularly telling was an email from June 2005, which was only publicly

14 disclosed as a result of the Senate Subcommittee’s hearings, specifically discussing 15 Washington Mutual and sent to Susan Barnes, a senior analyst in Standard & Poor’s residential 16 mortgage group. The writer, warning that lenders were originating extraordinarily risky 17 mortgage loans, singled out Washington Mutual as “the biggest perpetrator.” He stated, “I 18 have been a mortgage broker for the past 13 years and I have never seen such a lack of 19 20 attention to loan risk.”

21 231. Standard & Poor’s became so concerned with underwriting standards that, when

22 it was asked to rate certificates backed by subprime loans which Fremont Investment and Loan 23 had originated, one analyst asked his supervisors whether he should treat Fremont collateral 24 differently. “No,” one of his supervisors responded, “we don’t treat their collateral any 25 differently.” The other supervisor said that as long as there were current FICO scores for the 26

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1 borrowers, then the analyst was “good to go,” no matter how little documentation the

2 origination process required, and regardless of any other characteristic of the mortgage loans. 3 232. Based on its investigation, the Senate Subcommittee on Investigations found 4 that from 2004 to 2007, the Rating Agencies knew of the increased risks caused by mortgage 5 fraud and lax underwriting standards, but failed to factor those risks into their rating models. 6 233. Here, just as in other cases, the Rating Agencies did not factor the abandonment 7 8 of underwriting standards into their analysis of the PLMBS that are the subject of this lawsuit.

9 Instead, they based their ratings on underwriting standards they knew to have been abandoned

10 in practice. 11 2. The Credit Ratings Were Compromised by Conflicts of Interest, 12 Manipulation and Misinformation. 13 234. The Credit Rating Agencies received enormous revenues from the issuers who

14 paid them for rating the products they sold. 15 235. Because the desired rating of a securitized product was the starting point for any 16 securities offering, the Rating Agencies were actively involved in helping issuers structure the 17 products to achieve the requested rating. As a result, the Rating Agencies essentially worked 18 backwards, starting with the issuer’s target rating and thereafter working toward a structure that 19 20 could conceivably yield the desired rating.

21 236. A 2008 SEC Report entitled, “Summary Report of Issues Identified in the

22 Commission Staff’s Examinations of Select Credit Rating Agencies” (“Summary Report”) 23 revealed that the issuers and the Credit Rating Agencies worked together so that securities 24 would receive the highest ratings: 25 [t]ypically, if the analyst concludes that the capital structure of the RMBS does 26 not support the desired ratings, this preliminary conclusion would be conveyed to the arranger. The arranger could accept that determination and have the trust

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1 issue the securities with the proposed capital structure and the lower rating or adjust the structure to provide the requisite credit enhancement for the senior 2 tranche to get the desired highest rating. Generally, arrangers aim for the largest possible senior tranche, i.e., to provide the least amount of credit enhancement 3 possible, since the senior tranche—as the highest rated tranche—pays the lowest 4 coupon rate of the RMBS’ tranches and, therefore, costs the arranger the least to fund. 5 237. As a result of this collaboration with the Credit Rating Agencies, the issuers 6 were able to manipulate the system to achieve inflated ratings. For example, through repeated 7 8 interactions with the Credit Rating Agencies, the issuers (and the underwriters working with

9 them) could effectively reverse engineer aspects of the ratings models and then modify the

10 structure of a financing to improve its ratings without actually improving its credit quality. In 11 this process, the issuers and underwriters could change aspects of PLMBS very slightly—but 12 without any real effect on the economic reality of the instruments—or simply present the same 13 data in a different way, and thus get better ratings. Gretchen Morgenson & Louise Story, 14 Rating Agency Data Aided Wall Street in Deals , N.Y. Times, Apr. 23, 2010. 15 16 238. This rating process was further compromised by the practice of issuers “rating

17 shopping.” The issuers did not pay for the Credit Rating Agencies’ services until after the

18 Credit Rating Agencies gave a preliminary rating to the issuer. This practice created, 19 essentially, bidding wars where the issuers would hire the agency that provided the highest 20 rating for the lowest price. The Credit Rating Agencies were paid only if they provided the 21 desired Investment Grade ratings, and only if the transaction closed with those ratings. 22 23 “Ratings shopping” jeopardized the integrity and independence of the rating process. 24 239. Raymond McDaniel, Moody’s CEO, realized that the market-share war had

25 undermined the Ratings Agencies’ work product. In a presentation to Moody’s Board of

26 Directors in 2007, he stated,

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1 The real problem is not that the market does underweights [sic] ratings quality but rather that … it actually penalizes quality by awarding rating mandates 2 based on the lowest credit enhancement needed for the highest rating. Unchecked, competition on this basis can place the entire financial system at 3 risk. 4 4 McDaniel described to the board how Moody’s has “erected safeguards to keep teams from too 5 easily solving the market share problem by lowering standards” but then stated, “This does 6 NOT solve the problem. ” Turning then to a topic he referred to as “Rating Erosion by 7 8 Persuasion,” McDaniel observed, “Analysts and [managing directors] are continually ‘pitched’

9 by bankers, issuers, investors” and sometimes “we ‘drink the kool-aid.’”

10 3. The Credit Ratings Were Unreliable Due to the Use of Inaccurate, Outdated Models, and Inadequate Resources. 11 12 240. The outdated models used by the Rating Agencies turned out PLMBS ratings 13 that were inaccurate.

14 241. The models relied on pre-2000 data—reliance that, for a number of reasons,

15 produced wildly inaccurate results. First, this pre-2000 data ignored the dramatic changes in 16 the mortgage industry following 2000: increased lending to riskier borrowers, increased 17 origination of riskier kinds of mortgage loans, and a dramatic rise in housing prices. Second, 18 the pre-2000 data, as the Congressional Research Service reported in 2009, was based on a 19 20 “benign period of economic moderation in financial markets and rising house prices.” 21 Congressional Research Serv., Credit Rating Agencies and Their Regulation 7 (2009). They

22 were useless in predicting the likelihood of default in a time of macroeconomic crisis and 23 falling housing prices. 24 242. The models had other flaws too. They attached the wrong weights to the effect 25 of falling housing prices on loan default rates, and they miscalculated the interdependence 26 4 Exhibit to October 22, 2008, hearing before the House Oversight Committee.

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1 among loan defaults—the likelihood, in other words, that an economic storm would sink more

2 than one financial ship. 3 243. The Rating Agencies knew of these flaws, but did nothing to fix them. 4 244. In 2007, for example, Vickie Tillman, an S&P Executive Vice President, stated 5 before the Senate Banking Committee: “We are fully aware that, for all our reliance on our 6 historically rooted data that sometimes went as far back as the Great Depression, some of that 7 8 data has proved no longer to be as useful or reliable as it has historically been.”

9 245. In an April 27, 2008 article in the New York Times Magazine , Mark Adelson, a

10 former Managing Director in Moody’s structured finance division, criticized Moody’s use of 11 historical data about 30-year fixed mortgages to predict defaults and delinquencies in the new 12 mortgage market—describing it as “observing 100 years of weather in Antarctica to forecast 13 the weather in Hawaii.” 14 15 246. In fact, the Rating Agencies themselves did not believe the results their models 16 turned out.

17 247. In a December 2006 email, an S&P analyst expressed concern by describing the

18 “CDO market” as a “monster” and concluding: “Let’s hope we are all wealthy and retired by 19 the time this house of cards falters.” In an April 2007 electronic communication uncovered by 20 the Senate Subcommittee on Investigations, two S&P analysts agreed that a particular 21 mortgage-backed deal was “ridiculous,” and that the model “definitely does not capture half the 22 23 ris[k].” A month later, one of those analysts complained that “no body [sic] gives a straight 24 answer about anything around here,” and that there were no “clear cut parameters on what the

25 hell we are supposed to do.” 26

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1 248. Eric Kolchinsky, a former managing director at Moody’s who oversaw the

2 rating of subprime-mortgage-backed CDOs during 2007, testified before the House Oversight 3 and Government Reform Committee on September 30, 2009 that “[m]ethodologies produced 4 by Moody’s for rating structured finance securities are inadequate and do not realistically 5 reflect the underlying credits. Rating models are put together in a haphazard fashion and are 6 not validated if doing so would jeopardize revenues.” (emphasis added). 7 8 249. Compounding the inherent problems with the rating models was the fact that the

9 Rating Agencies simply did not commit the resources necessary to adequately rate residential-

10 mortgage-backed financial products. 11 250. Frank L. Raiter, who from 1995 until 2005 was a Managing Director at Standard 12 & Poor’s and head of its Residential Mortgage Rating Group, stated in prepared testimony 13 before the Senate Subcommittee on Investigations that “in the residential ratings group[,] . . . 14 15 between 1995 and 2005[,] rating volumes grew five or six fold without similar increases in 16 staffing. Rating production was achieved at the expense of maintaining criteria quality.”

17 251. This inadequate staffing had practical consequences: it meant that the Rating

18 Agencies were not able to improve the models they knew to produce inaccurate and misleading 19 ratings. As Raiter testified, by early 2004 S&P had developed a model that took into account 20 much more historical data than had been analyzed previously—a new model suggesting that the 21 model then in use “was underestimating the risk of some Alt-A and subprime products.” Due 22 23 to inadequate staffing, Raiter testified, this model “was never implemented.” If S&P had 24 implemented the new model, stated Raiter, it would have required much greater credit

25 enhancement from PLMBS issuers in 2005, 2006, 2007—at the price of being assigned much 26 less favorable ratings.

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1 252. Similarly, Jerome Fons, a former Managing Director of Credit Policy at

2 Moody’s, testified before the House Oversight Committee on October 22, 2008 that when 3 evidence arose that previously assigned ratings of PLMBS were inaccurate, the Rating 4 Agencies “did not update their models or their thinking.” 5 4. The Rating Agencies Knew, and the Defendants Should Have Known, That 6 the PLMBS Ratings in This Case Fundamentally Differed from the Ratings of Corporate Bonds. 7 8 253. Neither the Rating Agencies nor Defendants disclosed to investors that the

9 ratings of PLMBS were materially different from standard corporate bond ratings.

10 254. Instead, the Credit Rating Agencies represented that the credit ratings were 11 comparable to corporate bonds. Moody’s stated in a 2004 presentation that, “The 12 comparability of these opinions holds regardless of the country of the issuer, its industry, asset 13 class, or type of fixed-income debt.” A May 2007 S&P document on rating methodology 14 stated: “Our ratings represent a uniform measure of credit quality globally and across all types 15 16 of debt instruments. In other words, an ‘AAA’ rated corporate bond should exhibit the same

17 degree of credit quality as an ‘AAA’ rated securitized debt issue.”

18 255. In fact, however, the Rating Agencies did not simply estimate expected loss 19 and/or probability of default in determining the PLMBS ratings in this case, as they do with 20 corporate bonds. Rather, the agencies employ mathematical credit risk models based on 21 random event simulations to determine the estimated loss distributions associated with the great 22 23 many separate assets that back the PLBMS. These models require the rating agencies to make 24 many estimates and assumptions regarding each of the various assets, including the degree to

25 which losses or defaults on these assets would be correlated with each other. 26

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1 256. The Rating Agencies in this case knowingly made unreasonable assumptions

2 about how frequently defaults on the assets would be correlated with each other. See supra ¶¶ 3 241-245. And, unlike the assumptions the Rating Agencies use for rating other instruments, 4 such as corporate bonds, the correlation assumptions used to rate the PLMBS in this case were 5 based on dramatically incomplete historical data or on pure speculation. 6 257. Defendants, by virtue of their close working relationship with the Rating 7 8 Agencies, should have known that the rating of the PLMBS differed fundamentally from the

9 rating of corporate bonds in the way just described.

10 5. Subsequent Downgrades Confirm that the Investment Grade Ratings 11 Reported in the Offering Documents Were Unjustifiably High and Misstated the True Credit Risk of the PLMBS Purchased by the Bank. 12 258. “Investment grade” products are understood in the marketplace to be stable, 13 secure and safe. Using S&P’s scale, “investment grade” ratings are AAA, AA, A and BBB, 14 and represent, respectively, high credit quality, upper-medium credit quality and medium credit 15 16 quality. Any instrument rated below BBB is considered below investment grade or “junk”

17 status.

18 259. Each Prospectus Supplement states that the issuance of the PLMBS was 19 conditioned on the assignment of particular, investment-grade ratings, and listed the ratings in a 20 chart. 21 260. The Bank purchased only AAA-rated tranches of PLMBS. However, the AAA 22 23 ratings of the PLMBS misstated the credit quality of the underlying loans. The AAA rating 24 denotes “high credit-quality,” and is the same rating as those typically assigned to bonds

25 backed by the full faith and credit of the United States Government, such as Treasury Bills. 26

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1 261. On or about July 10, 2007, S&P publicly announced it was revising the

2 methodologies used to rate numerous MBS because the performance of the underlying 3 collateral “call[ed] into question” the accuracy of the loan data. S&P announced it was revising 4 its methodology assumption to require increased “credit protection” for rated transactions. 5 S&P reiterated that it would seek in the future to review and minimize the incidence of 6 potential underwriting abuse given “the level of loosened underwriting at the time of loan 7 8 origination, misrepresentation and speculative borrow behavior reported for the 2006 [ratings].”

9 262. One the same day, July 11, 2007, Moody’s announced it was also revising its

10 methodology used to rate the MBS, and anticipated MBS downgrades in the future. Moody’s 11 did in fact significantly downgrade most of the MBS, noting “aggressive underwriting” used in 12 the origination of the collateral. 13 263. Yet, at the time these statements were made in July 2007, all of the PLMBS at 14 15 issue in this case retained their investment grade ratings. 16 264. Historically, investments with AAA ratings had an expected loss rate of less

17 than 0.05%. The default rate on investment-grade corporate bonds from 1981 to 2008, for

18 example, averaged about 0.106% with no year higher than 0.41%. 19 265. Beginning in the spring of 2008, the PLMBS purchased by the Bank also 20 became subject to these rating agency downgrades. All five of the AAA-rated certificates at 21 issue in this case (originally valued at over $100 million) now have been downgraded to non- 22 23 investment grade ratings, i.e. junk status. 24 266. The en masse downgrade of AAA rated PLMBS indicates that the ratings set

25 forth in the Offering Documents were false, unreliable and inflated. As the SEC has noted, 26 “[a]s the performance of these securities continued to deteriorate, the three rating agencies most

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1 active in rating these instruments downgraded a significant number of their ratings. The rating

2 agencies[’] performance in rating these structured finance products raised questions about the 3 accuracy of their credit ratings generally as well as the integrity of the ratings process as a 4 whole.” Summary Report of Issues Identified in the Commission Staff’s Examinations of Select 5 Credit Rating Agencies by the Staff of the Securities and Exchange Commission at 2 (July 6 2008). The Depositor/Issuer Defendants and the Underwriter Defendants should have known 7 8 the Offering Documents’ statements with respect to these ratings were misleading because of

9 their direct involvement and manipulation of the rating process, and awareness of the poor

10 credit quality of the underlying loan collateral. 11 6. The Bank Reasonably Relied on the Credit Ratings Reported in the 12 Prospectuses. 13 267. The Bank did not know and reasonably could not have known that the credit

14 ratings set forth in the Offering Documents were flawed. The Bank did not know that when 15 they secured the credit ratings reported in the Offering Documents, the Depositor/Issuer 16 Defendants and the Underwriter Defendants had done so by manipulating the system. 17 Moreover, the Bank did not know that the specific statements regarding the ratings contained in 18 the Offering Documents were false – specifically, that the ratings did not in fact address the 19 20 risk of the certificates and the likelihood of payment by borrowers on the underlying mortgage

21 loans. Indeed, no disclosure in any Offering Document informed the Bank that the rating was

22 the unreliable result of inaccurate information and deficient modeling, as opposed to a 23 legitimate evaluation of credit risk. 24 268. The Credit Rating Agencies continued to assure the market of the integrity of 25 their MBS ratings long after the PLMBS at issue here were purchased by the Bank. In a letter 26 to the editor of the Wall Street Journal dated September 17, 2007, Vickie Tillman, then

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1 Executive Vice President of Credit Market Services at S&P, stated: “We have numerous

2 safeguards in place that have helped us effectively manage” potential conflicts of interest. 3 “Our credit ratings provide objective, impartial opinions on the credit quality of bonds.” 4 Tillman likewise testified before the Senate Committee on Banking, Housing and Urban 5 Affairs on September 26, 2007: 6 S&P maintains rigorous policies and procedures designed to ensure the integrity 7 of our analytical processes. For example, analysts are not compensated based 8 upon the amount of revenue they generate. Nor are analysts involved in negotiating fees. Similarly, individuals responsible for our commercial 9 relationships with issuers are not allowed to vote at rating committees. These policies, and others, have helped ensure our long-standing track record of 10 excellence. 11 269. The Rating Agencies also assured the market that the ratings assigned to 12 PLMBS were just as reliable as ratings assigned to corporate bonds. See supra ¶ 254. 13 270. At the time these statements were made in September 2007, all of the PLMBS at 14 issue in this case retained their investment-grade ratings. 15 16 V. DEFENDANTS’ MATERIAL UNTRUE STATEMENTS AND OMISSIONS IN CONNECTION WITH THE SALE OF THESE FIVE CERTIFICATES TO FHLBC 17 271. As detailed above, the Sponsor purchased mortgage loans and deposited them 18 into issuing trusts, from which the Depositor/Issuer issued the certificates, and the Underwriter 19 20 Defendants – Wall Street banks and other large financial institutions – offered and sold the 21 certificates to the Bank through the Offering Documents. The Depositor/Issuer and

22 Underwriter Defendants drafted the Offering Documents for each securitization. In addition, 23 each Depositor/Issuer Defendant and Underwriter Defendant was identified in these documents 24 as the depositor/issuer or underwriter, respectively, of the certificates, and approved the 25 versions of these documents that were delivered by the Underwriter Defendants to Plaintiff. 26

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1 272. The Offering Documents contained extensive material misstatements and

2 omissions of material facts with regard to the underwriting guidelines and practices purportedly 3 applied by the mortgage originators whose loans backed the PLMBS purchased by the Bank, 4 the appraisal process underlying the LTV ratios, predatory lending abuses by the mortgage 5 originators, and a number of key characteristics of the mortgage pools that pertain to the risk of 6 the certificates. These misstatements are not predictions of future events or subjective 7 8 opinions, rather these misstatements constitute misrepresentations of material facts that were

9 false when made. Moreover, the misstatements all concern information that the Bank did not

10 have access to and could not independently verify – this information was only available to the 11 Defendants, and thus the Bank relied upon the Defendants to accurately present the 12 information. Specifically, the misstatements and omissions of material fact are as follows: 13 A. Defendants Misrepresented Underwriting Guidelines Utilized by Mortgage 14 Lenders. 15 1. The Materiality of Underwriting Guidelines 16 273. As alleged above, the originator’s underwriting standards, and the extent to 17 which the originator departs from its standards, are key indicators of the risk of the mortgage 18 loans made by the originator. And because the mortgage loans back the certificates that are 19 20 issued to investors such as the Bank, the loan underwriting standards are also material to 21 assessing the risk of the PLMBS certificates. For these reasons, the originator’s underwriting

22 standards as described in the Offering Documents were material to the Bank’s decision to 23 purchase the PLMBS certificates at issue here. 24 2. Misstatements Regarding Underwriting Guidelines 25 274. The Offering Documents contained material untrue or misleading statements 26 and omissions regarding the underwriting guidelines allegedly employed in the origination of

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1 the mortgage loans that secure the PLMBS. Appendix III attached hereto and incorporated

2 herein sets forth those statements and omissions and the reasons each is misleading. For 3 example, the Long Beach Mortgage Loan Trust 2006-5 Prospectus Supplement (incorporated 4 herein by this reference) provides the following with respect to mortgages originated or 5 acquired by Long Beach Mortgage Company (referred to therein as “Long Beach”): 6 • 7 That the underwriting standards were “primarily intended to evaluate the prospective borrower’s credit standing and repayment ability as well as 8 the value and adequacy of the mortgaged property as collateral.” LBMLT 2006-5 Pros. Sup. S-34. 9 • That Long Beach collected and considered the following information in 10 determining a mortgagor’s eligibility for a mortgage:

11 [F]inancial information regarding the amount of income and related 12 sources, liabilities and related monthly payments, credit history and employment history, as well as certain other personal information. 13 LBMLT 2006-5 Pros. Sup. S-34. 14 • That Long Beach used the following “credit scoring methodology as part 15 of its underwriting and re-underwriting process”:

16 The credit scoring methodology assesses a prospective borrower’s 17 ability to repay a mortgage loan based upon predetermined mortgage loan characteristics and credit risk factors . The credit scoring 18 methodology generates a credit score usually ranging from around 300 to 800, with a higher score indicating a borrower with a relatively more 19 favorable credit history. The credit score is based upon such factors as the prospective borrower’s payment history, delinquencies on accounts, 20 levels of outstanding debt, length of credit history and types of credit and 21 bankruptcy experience. 22 LBMLT 2006-5 Pros. Sup. S-34.

23 • That “[u]nder the sponsor’s underwriting programs, various risk categories [labeled C through ‘Premium A’] are used to grade the 24 likelihood that the prospective borrower will satisfy the repayment conditions of the mortgage loan. ” LBMLT 2006-5 Pros. Sup. S-36. 25 26 • That “[t]hese risk categories establish the maximum permitted loan-to- value ratio and loan amount, given the occupancy status of the

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1 mortgaged property and the prospective borrower’s credit history and debt ratio.” LBMLT 2006-5 Pros. Sup. S-36. 2 • That borrowers were assigned to risk categories as follows: 3 In general, higher credit risk mortgage loans are graded in categories 4 which permit higher debt ratios and more (or more recent) major 5 derogatory credit items such as outstanding judgments or prior bankruptcies; however, the sponsor’s underwriting programs establish 6 lower maximum loan-to-value ratios and maximum loan amounts for loans graded in such categories. The sponsor’s underwriting guidelines 7 permit first lien mortgage loans with loan-to-value ratios at origination of 8 up to 100%, or 80% if at the time of origination of the first lien mortgage loan, the originator also originated a second lien mortgage loan. The 9 sponsor’s second lien mortgage underwriting guidelines permit second lien mortgage loans with a combined loan-to-value ratios at origination 10 of up to 100%.

11 . . .

12 The maximum allowable loan-to-value ratio varies based upon the 13 residential loan program, income documentation, property type, creditworthiness and debt service-to-income ratio of the prospective 14 borrower and the overall risks associated with the loan decision. The maximum combined loan-to-value ratio, including any second lien 15 mortgage subordinate to the sponsor’s first lien mortgage, is generally 100% under the “Premium A,” “A,” “A-,” “B+” and “B” risk categories, 16 and 95% under the “C” risk category. 17 LBMLT 2006-5 Pros. Sup. S-35-38. 18 • That “[o]n a case-by-case basis and only with the approval of an 19 employee with appropriate risk level authority ,” Long Beach “may determine that, based upon compensating factors, a prospective 20 borrower not strictly qualifying under its underwriting risk category guidelines warrants an underwriting exception.” LBMLT 2006-5 Pros. 21 Sup. S-35. 22 • That exceptions were granted based on the following compensating 23 factors:

24 [L]ow loan-to-value ratio, low debt-to-income ratio, good credit history, stable employment and time in residence at the prospective borrower’s 25 current address. It is expected that some of the mortgage loans owned by 26 the trust will be underwriting exceptions. LBMLT 2006-5 Pros. Sup. S- 35.

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1 • That “a mortgage loan will be considered to be originated in accordance with a given set of underwriting guidelines if, based on an overall 2 qualitative evaluation, the mortgage loan is in substantial compliance with those underwriting guidelines.” For example: 3 4 [A] mortgage loan may be considered to comply with a set of underwriting guidelines, even if one or more specific criteria included in 5 those underwriting guidelines were not satisfied, if other factors compensated for the criteria that were not satisfied or if the mortgage 6 loan is considered to be in substantial compliance with the underwriting guidelines. The sponsor applies its underwriting guidelines in 7 accordance with a procedure that complies with applicable federal and 8 state laws and regulations.

9 LBMLT 2006-5 Pros. Sup. S-38.

10 • That “[a]ll of the mortgage loans owned by the trust have been, or will be, originated by the sponsor through wholesale brokers or re- 11 underwritten upon acquisition from correspondents by the sponsor generally in accordance with the sponsor’s underwriting guidelines 12 described in this section.” LBMLT 2006-5 Pros. Sup. S-34. 13 • That the following “quality control” process was applied by Long Beach: 14 As part of its quality control system, the sponsor re-verifies information 15 that has been provided by the mortgage brokerage company prior to funding a loan and the sponsor conducts a post-funding audit of every 16 origination file. In addition, Washington Mutual Bank, as servicer, 17 periodically audits files based on a statistical sample of closed loans. In the course of its pre-funding review, the sponsor re-verifies the income 18 of each prospective borrower or, for a self-employed prospective borrower, reviews the income documentation obtained under the full 19 documentation and limited documentation residential loan programs. The sponsor generally requires evidence of funds to close on the mortgage 20 loan. 21 LBMLT 2006-5 Pros. Sup. S-36. 22 275. Similarly, the WaMu Loan Trust 2006-AR12 Prospectus Supplement 23 (incorporated herein by this reference) provides the following with respect to mortgages 24 originated or acquired by WaMu: 25 26 • That “[t]he sponsor’s underwriting guidelines generally are intended to evaluate the prospective borrower’s credit standing and repayment

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1 ability and the value and adequacy of the mortgaged property as collateral.” 2 Additionally, the Prospectus asserts that “[t]he sponsor’s credit risk 3 oversight department conducts quality control reviews of statistical 4 samplings of previously originated mortgage loans on a regular basis.”

5 WAMU 2006-AR12 Pros. Sup. S-26-28 6 • That “[e]xceptions to the sponsor’s loan program parameters may be 7 made on a case-by-case basis if compensating factors are present. In those cases, the basis for the exception is documented, and in some cases 8 the approval of a senior underwriter is required. Compensating factors 9 may include, but are not limited to, low loan-to-value ratio, low debt-to- income ratio, good credit standing, the availability of other liquid assets, 10 stable employment and time in residence at the prospective borrower’s current address.” WAMU 2006-AR12 Pros. Sup. S-28. 11 276. These statements were materially misleading for multiple reasons, which are 12 13 described in detail on Appendix III hereto, along with the materially misleading statements 14 contained in other Offering Documents. Fundamentally, they grossly distort the underwriting

15 process that was actually employed by indicating that it was a principled process that followed

16 stated standards and employed enumerated safeguards. Unfortunately, as described above in 17 sections IV.B. and IV.C., both Long Beach Mortgage and WaMu, the originators of mortgage 18 loans that secured the PLMBS purchased by the Bank, effectively abandoned their stated 19 underwriting standards in an effort to maximize their mortgage origination volume. Thus, 20 21 Long Beach Mortgage and WaMu did not follow the underwriting standards set forth or 22 otherwise referred to in the Offering Documents. “Exceptions” to standards became the rule.

23 Reduced documentation was employed not to streamline the process where warranted, but 24 instead to mask the borrower’s disqualification. 25 277. In addition, the Long Beach statements above, as well as those detailed in 26 Appendix III, were materially misleading because they fail to disclose that Long Beach

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1 Mortgage had no reliable basis upon which to assign risk categories or reliably “grade the

2 likelihood that the prospective borrower will satisfy the repayment conditions of the mortgage 3 loan.” Further, the statements omit to state that Long Beach Mortgage lacked historical 4 performance data with respect to loans issued using equivalent underwriting practices 5 (including the widespread granting of exceptions to underwriting guidelines). Thus, Long 6 Beach Mortgage, like others in the industry, constructed “models” to justify their underwriting 7 8 programs that were based on scant historical data and were therefore utterly unreliable. Indeed,

9 the explosion in Alt-A, subprime and other untraditional lending, described supra § IV.B.1.,

10 rendered irrelevant the industry’s historical models based on traditional underwriting practices. 11 But Long Beach Mortgage and others continued to use this data to construct their “models,” to 12 justify their ever-less rigorous underwriting programs, and continued to present these models 13 and programs to investors as prudent, thoroughly tested and well-grounded in reliable and 14 15 objective data. 16 278. The statements were further materially misleading because they fail to disclose

17 that Long Beach and WaMu, lacked adequate procedures and practices to monitor or evaluate

18 their mortgage loan underwriters’ exercise of judgment, or to provide appropriate training and 19 education to their mortgage loan underwriters. 20 3. Evidence Demonstrating Misstatements in the Offering Documents 21 Regarding the Originators’ Underwriting Practices

22 a. Government investigations, actions and settlements, confidential 23 witnesses and evidence developed in other private lawsuits demonstrate systematic and pervasive abandonment of stated 24 underwriting practices by the originators. 25 279. As alleged in detail above, the failure of the mortgage originators who issued the

26 loans backing the PLMBS purchased by the Bank to apply their stated underwriting guidelines,

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1 ensure that compensating factors justified exceptions, and obtain accurate appraisals is well

2 documented in government investigations and lawsuits, press reports, and statements of 3 confidential witnesses who are former employees of the mortgage originators. Additional 4 evidence has been generated by the many other private lawsuits against many of the same 5 Defendants in connection with the sale of MBS and related certificates. This evidence – and 6 the allegations herein based on this evidence – demonstrates that the statements in the Offering 7 8 Documents regarding the mortgage originators’ underwriting and appraisal practices are false

9 and misleading. Contrary to the representations in the Offering Documents, the mortgage

10 originators did not genuinely attempt to determine the borrowers’ ability to pay, or the 11 adequacy of the collateral provided for the loans they issued, but instead, abandoned these 12 efforts in order to issue and sell for securitization as many loans as possible. 13 b. Analysis of loans that backed the PLMBS purchased by the Bank 14 demonstrate the abandonment of stated underwriting practices by 15 the originators. 16 280. Analysis of the specific loans that backed the PLMBS purchased by the Bank

17 show high rates of loan delinquencies and foreclosure, evidencing a pervasive disregard of

18 sound underwriting practices. 19 281. For loans originated by Long Beach Mortgage, all of the Long Beach certificates 20 had delinquency rates of well over 50%. As of December 2010, certificates LBMLT 2006-5 21 2A3, LBMLT 2006-6 2A3, LBMLT 2006-7 2A3, and LBMLT 2006-8 2A3 had total loan 22 23 delinquency rates of over 58%, 59%, 54% and 55%, respectively. Similarly, certificate 24 WAMU 2006-AR12 has a total loan delinquency rate of over 30%.

25 282. As of December 2010, the same certificates all had foreclosure rates, as a

26 percentage of total loans, in the double digits. Certificates LBMLT 2006-5 2A3, LBMLT

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1 2006-6 2A3, LBMLT 2006-7 2A3, LBMLT 2006-8 2A3 and WAMU 2006-AR12 had

2 foreclosure rates of over 20%, 22%, 18%, 17%, and 13%, respectively. 3 B. Defendants Misrepresented the Appraisal Process and Loan-to-Value Ratios 4 (“LTVs”) That Were Based Upon Those “Appraisals”

5 1. The Materiality of Representations Regarding Appraisals and LTVs

6 283. The loan-to-value ratio of a mortgage loan is the ratio of the amount of the

7 mortgage loan to the value of the mortgaged property when the loan is made. For example, a 8 loan of $200,000 secured by property valued at $500,000 has an LTV of 40%; a loan of 9 $450,000 on the same property has an LTV of 90%. The LTV is one of the most important 10 measures of the risk of a mortgage loan because it is a primary determinant of the likelihood of 11 12 default. The lower the LTV, the greater the borrower’s equity relative to the value of the 13 house. Thus when an LTV is low, it is less likely that a decline in the property’s value will

14 wipe out the owner’s equity and give the owner an incentive to stop making mortgage

15 payments and abandon the property (a “strategic default”). Additionally, lower LTV ratios 16 indicate that the losses on loans that do default will be less severe – i.e. , loans with lower LTVs 17 provide greater “cushion” because there is an increased likelihood that the proceeds of 18 foreclosure will cover the unpaid balance on the mortgage loan. 19 20 284. Because the numerator (the amount of the loan) is predetermined, the key to an 21 accurate LTV is an accurate denominator (the value of the property). The key to an accurate

22 denominator, in turn, is an accurate appraisal of the property. In a purchase of a property, the 23 denominator in the LTV is usually determined by choosing the lower of the purchase price or 24 the appraised value. In a refinancing or home equity loan, the denominator is always an 25 appraised value because there is no purchase price. Accordingly, an inflated appraisal will 26 inflate the denominator of the LTV. Here, as explained below, see infra ¶ 298, what the

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1 Offering Documents refer to as “appraisals” are in fact not appraisals at all because they fail to

2 satisfy the definition of an appraisal as set forth in controlling regulations. For example, it is 3 not an “appraisal” as that term is defined in the regulations to conclude based on pressure from 4 the mortgage underwriter that a home’s value is equal to its purchase price. Inflated valuations 5 were accepted, whether through appraisals performed without regard for applicable appraisal 6 standards, or through alternative valuation processes aimed at producing the result necessary to 7 8 permit the loan to be made.

9 285. A denominator that is too high will understate, sometimes greatly, the LTV and

10 thus the risk of a loan. In the example above, if the property’s actual value is $500,000, but is 11 valued incorrectly at $550,000, then the LTV of the $200,000 loan falls from 40% to 36.4%, 12 and the LTV of the $450,000 loan falls from 90% to 81.8%. In either case, an LTV that is 13 based upon an improperly inflated appraisal value understates the risk of the loan. 14 15 286. Additionally, it is important to note that at higher LTV ratios or higher loan 16 amounts, even minor inflations in a property’s value can translate into significantly riskier

17 loans. In the example above, although the risk of a loan with an LTV of 40% is greater than

18 the risk of one with an LTV of 36.4%, both imply a relatively safe loan because of the large 19 equity cushions. By contrast, a loan with an LTV of 90% is much riskier than one with an LTV 20 of 81.8%. In the case of a loan with an LTV of 81.8%, there is an equity cushion of 18.2% of 21 the value of the property, while in the case of the 90% LTV loan, the equity cushion is only 22 23 10% – just over half as much. Thus, in the example in the preceding paragraph, the $50,000 24 overstatement in the appraisal has a far more dramatic effect on the risk profile of the $450,000

25 loan than on the $200,000 loan. 26

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1 287. Because the riskiness of the underlying loans in the asset pool (including the risk

2 of default and the severity of the losses on default) impacts the risk of the associated PLMBS 3 certificates, aggregate LTV metrics are material to an investor’s decision to purchase PLMBS, 4 and specifically, were material to the Bank. The sole source of payment on the certificates is 5 the cash flow from the mortgage loans that back them. If borrowers fail to make their 6 payments, there is less cash to pay the investors in the certificates. The safety of their 7 8 certificates consequently depends upon the quality of the loans, and a key indicator of loan

9 quality is an LTV ratio resulting from an appraisal conducted in accordance with governing

10 standards. Indeed, credit rating agencies use LTVs to determine the proper structuring and 11 credit enhancement necessary to assign a particular rating to a security. If the LTVs of the 12 mortgage loans in the asset pool of the securitization are not based on appraisals conducted in 13 accordance with governing standards, as the Bank alleges here, see infra ¶¶ 292-94, the ratings 14 15 of the certificates sold in that securitization will also be incorrect. Investors will therefore be 16 misled about the risk of investing in a particular PLMBS certificate.

17 288. LTVs also serve as indicators of prepayment patterns – that is, the number of

18 borrowers who pay off their mortgage loans before maturity. LTVs thus predict the expected 19 lives of the loans and the associated PLMBS certificates that are backed by the loans. 20 Prepayment patterns affect many aspects of the PLMBS certificates that are material to the 21 investors purchasing them, such as the life of the certificate and the timing and amount of cash 22 23 that the investor will receive during that life. 24 289. Even seemingly minor differences in the aggregate LTV metrics had a

25 significant effect on both the risk and rating of each certificate sold in the securitization. For 26 example, assume the Offering Documents assert that the loan pool had a weighted average

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1 LTV ( i.e. , the average of the LTVs for the mortgages in the pool, weighted by the principal

2 amount thereof) of 80%. If that true weighted average LTV (after correcting flawed procedures 3 in “appraisals” that overstated the value of the properties securing the mortgages) was 82%, the 4 Offering Documents’ assertion would constitute a material misstatement of the risk profile of 5 the mortgage pool – and the PLMBS it secured – because the equity cushion (and the 6 borrowers’ equity interest in the properties) would be eroded by 10 percent. 7 8 290. Finally, because an LTV is only as reliable as the appraisal used to determine

9 the value of the collateral, LTVs and aggregate LTV metrics are meaningless to PLMBS

10 investors unless the appraisals underlying the LTVs are done in accordance with governing 11 standards. Thus statements regarding the valuation of collateral – including that “appraisals” 12 were conducted in calculating the LTVs and that such appraisals conformed to uniform 13 standards – are material to an investor’s decision to purchase PLMBS, and specifically, were 14 15 material to the Bank: 16 Mortgage bankers and investors consider the property appraisal one of the most important documents contained in the loan file since it establishes the value of 17 the property securing the mortgage loan. In fact, investors put review of the appraisal on the same level as the review of credit. The appraisal assists the 18 mortgage banker in assessing the collateral risk . . . . Obviously, the ultimate 19 investor wants to mitigate such risk and relies on the appraisal to ensure that the property falls within the investor's valuation parameters." 20 Handbook of Mortgage Lending 165 (Mortgage Bankers Ass'n of Am. 2003). 21 Furthermore, assertions that appraisals conformed to the applicable standards are material to 22 PLMBS investors like the Bank because such investors like the Bank have no reasonable means 23 24 of verifying the LTV metrics asserted in the offering documents at the time of sale. When 25 conducted in accordance with governing standards, appraisals and their resulting LTVs are

26 based on knowledge of particular facts that are not available to investors in mortgage backed

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1 securities - an investor simply does not have access to the data, let alone the time and resources,

2 necessary to conduct an independent valuation of each piece of collateral underlying each 3 certificate. 4 291. Statements regarding appraiser independence and impartiality are important as 5 they provide assurance that the LTVs were not artificially inflated due to mortgage originator 6 manipulation. Likewise, statements in the Offering Documents that the appraisals conformed 7 8 to USPAP or Fannie Mae and Freddie Mac standards, including requirements that appraisals be

9 independently and impartially conducted, indicate that the appraisals and the aggregate data

10 included in the Offering Documents based on the appraisals properly assess the value of the 11 collateral, and provide a reliable measure of the risk of the loan pools. 12 2. Misstatements Regarding Appraisals and LTVs 13 a. The Offering Documents falsely state that the loan-to-value ratios 14 were based upon appraisals

15 292. The Offering Documents contained numerous material untrue or misleading 16 statements regarding the valuation of collateral and the “appraisal” process conducted upon the 17 origination of the mortgages underlying the PLMBS. The Prospectus for each certificate states 18 the following with respect to the calculation of loan-to-value ratios: 19 20 The loan-to-value ratio of a mortgage loan at any given time is the ratio, expressed as a percentage, of the then outstanding principal balance of the 21 mortgage loan . . . to the value of the related mortgaged property. The value of a single-family property or cooperative unit generally is the lesser of (a) the 22 appraised value determined in an appraisal obtained by the originator at origination of the loan and (b) if the mortgaged property is being purchased in 23 conjunction with the origination of the mortgage loan, the sales price for the 24 property. 25 WaMu 2006 AR12 Pros. 31; LBMLT2006-5 Pros. 13; LBMLT2006-6 Pros. *135;

26 LBMLT2006-7 Pros. *137; LBMLT2006-8 Pros. *122 (emphasis added).

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1 293. Additionally, the Prospectus for each certificate states that “the adequacy of the

2 mortgage property as collateral generally is determined by an appraisal . . .” WaMu 2006 3 AR12 Pros. Sup. S-27; LBMLT2006-5 Pros. Sup. S-35; LBMLT2006-6 Pros. Sup. S-35-40; 4 LBMLT2006-7 Pros. Sup. *42-46; LBMLT2006-8 Pros. Sup. S-37-42 (emphasis added). 5 294. These are false statements of material fact because, contrary to Defendants’ 6 representations that the LTV ratios were based on “appraisals,” in reality the biased and 7 8 coerced valuations of collateral that Defendants labeled as “appraisals” failed to meet the

9 federally required definition of “appraisal” applicable to entities that are regulated by the Office

10 of Thrift Supervision (OTS). Thus, the LTVs were not based on appraisals at all as that term is 11 used and understood in the industry. 12 295. The originators of the mortgages underlying the PLMBS were federally 13 regulated entities governed by OTS regulations of appraisal practices. The loans underlying 14 15 certificate WAMU 2006-AR12 1A1 were originated by Washington Mutual Bank, which was a 16 “federal savings association” within the meaning of 12 U.S.C. § 1813(b) and 12 U.S.C.

17 § 1462(5). Pursuant to 12 U.S.C § 1813(q)(4), the Director of the Office of Thrift Supervision

18 (OTS) is the “appropriate Federal banking agency” with jurisdiction to regulate a “savings 19 association.” Long Beach Mortgage originated the loans underlying the remaining certificates 20 (LBMLT 2006-5 2A3, LBMLT 2006-6 2A3, LBMLT 2006-7 2A3, and LBMLT 2006-8 2A3). 21 Long Beach Mortgage became a direct wholly owned subsidiary of WaMu on March 1, 2006, 22 23 and became a division of WaMu on July 1, 2006. See, e.g. , LBMLT 2006-7 Pros. Sup. S-34. 24 Pursuant to 12 U.S.C. § 1828(m), an insured savings association that establishes or acquires a

25 subsidiary “shall conduct the activities of the subsidiary in accordance with regulations and 26 orders” of the OTS. See also 12 C.F.R. § 559.3(h)(1). Thus, at the time the mortgages were

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1 originated, both WaMu and Long Beach Mortgage Company were within the regulatory

2 jurisdiction of the OTS. 3 296. OTS regulations issued pursuant to Title XI of the Financial Institutions Reform 4 Recovery and Enforcement Act of 1989 (FIRREA), 12 U.S.C. § 1339, govern the appraisal 5 practices of institutions regulated by the OTS. The OTS regulations define an “appraisal” as a 6 “written statement independently and impartially prepared by a qualified appraiser setting forth 7 8 an opinion as to the market value of an adequately described property as of a specific date(s) . .

9 .” (emphasis added). Therefore, by representing that the LTV ratios were based on “appraisals”

10 of the collateral, Defendants represented that the LTV ratios were based on independent and 11 impartial valuations of the collateral. 12 297. OTS regulations define appraiser independence as follows: 13 (a) Staff appraisers. If an appraisal is prepared by a staff appraiser, that 14 appraiser must be independent of the lending, investment, and collection 15 functions and not involved, except as an appraiser, in the federally related transaction, and have no direct or indirect interest, financial or otherwise, in the 16 property . . . .

17 (b) Fee appraisers. (1) If an appraisal is prepared by a fee appraiser, the appraiser shall be engaged directly by the regulated institution or its agent, and 18 have no direct or indirect interest, financial or otherwise, in the property or the transaction . . . . 19 20 12 C.F.R. § 564.5 (emphasis added). In 2005 federal regulators, including the OTS, further 21 elaborated on the standards for appraiser independence, stating that “[l]oan production staff

22 should not select appraisers.” Additionally, regulators specified that although loan production 23 staff may use a “revolving, board approved list to select a residential appraiser,” the “[s]taff 24 responsible for the development and maintenance of the list should be independent of the loan 25 production process. . .” See“Frequently Asked Questions on the Appraisal Regulations and the 26 Interagency Statement on Independent Appraisal and Evaluation Functions ,” (questions 3, 5).

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1 298. Defendants’ statements in the Offering Documents are materially misleading

2 because the LTV ratios were not based on impartial and independent “appraisals,” but rather 3 were the result of manipulation and coercion by loan production staff. As described above in 4 sections IV.B and IV.C, loan production staff at Long Beach Mortgage and WaMu pressured 5 and coerced appraisers to inflate values, demanded and obtained the ability to have “business 6 managers” overrule staff and third party appraisers, and routinely fed improper information to 7 8 appraisers in an effort to manipulate their valuations, all of which served to undermine the

9 independence of the appraisal process. Contrary to the OTS guidance, the WaMu and Long

10 Beach Mortgage lending departments constantly pressured appraisers to increase their 11 valuations, made clear that their continued access to work from these originators depended 12 upon the appraisers coming in “at value,” and in some cases simply overruled appraisers that 13 refused to cooperate. WaMu and Long Beach Mortgage ultimately resorted to using an 14 15 approved list of appraisers that excluded appraisers whose appraisals in the past had come in 16 “too low” and were unwilling to increase their appraisals to satisfy the lending departments.

17 All of this resulted in appraisers having an indirect financial interest in each property they

18 appraised, since their ability to obtain future work was impacted by their willingness to come in 19 “at value” for each property they appraised. Because these valuations were not “independently 20 and impartially prepared” as required by the OTS definition of “appraisal,” Defendants made a 21 false statement of material fact in the Offering Documents by stating that the LTV ratios were 22 23 based on “appraisals.” 24 25 26

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1 b. Misstatements regarding the standards to which the purported “appraisals” conformed 2 299. In addition, the Offering Documents contained materially untrue or misleading 3 4 statements and omissions regarding the standards to which the purported “appraisals”

5 conformed. The Prospectus Supplement for certificate WAMU 2006-AR12 1A1 states:

6 “[a]t origination, all appraisals are required to conform to the Uniform Standards of Professional Appraisal Practice adopted by the Appraisal Standards 7 Board of the Appraisal Foundation . . . .” 8 WAMU 2006-AR12 Pros. Sup. S-27. The Prospectus Supplements for each of the remaining 9 four certificates (LBMLT 2006-5 2A3, LBMLT 2006-6 2A3, LBMLT 2006-7 2A3, and 10 LBMLT 2006-8 2A3) state: 11 12 The adequacy of the mortgaged property as collateral is generally determined by an appraisal of the mortgaged property that generally conforms to Fannie Mae 13 and Freddie Mac appraisal standards . . . . 14 LBMLT2006-5 Pros. 13; LBMLT2006-6 Pros. *135; LBMLT2006-7 Pros. *137;

15 LBMLT2006-8 Pros. *122. The Fannie Mae and Freddie Mac appraisal standards require that 16 appraisals be conducted in accordance with the Uniform Standards of Professional Appraisal 17 Practice (USPAP). See 2006 Single Family Selling Guide, Part XI, 102.02. 18 300. These statements in the Offering Documents were materially misleading 19 because the mortgage originators routinely accepted – and in fact overtly sought – valuations of 20 21 collateral that were conducted in violation of USPAP and Fannie Mae and Freddie Mac

22 Standards. As detailed above, the USPAP requires that an appraiser “perform assignments with

23 impartiality, objectivity, and independence, and without accommodation of personal interests.” 24 Similarly, the Fannie Mae standards provide that “it is essential that a lender obtain an 25 independent, disinterested examination.” As alleged above in paragraph 298, and further 26 described in sections IV.B and IV.C, the appraisals used by the mortgage originators WaMu

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1 and Long Beach Mortgage, were the product of manipulation and coercion and thus were not

2 impartial, objective, and independent as required by USPAP. 3 301. Additionally, USPAP precludes acceptance of an appraisal assignment where 4 compensation is contingent upon “reporting a predetermined result” or “a direction in 5 assignment results that favors the cause of a client.” Similarly, it is an “unacceptable appraisal 6 practice” under Fannie Mae standards to develop and report an appraisal “that favors either the 7 8 cause of the client . . . [or] the attainment of a specific result . . . in order to receive

9 compensation . . . and/or in anticipation of receiving future assignments.” However, these are

10 precisely the conditions that loan production staff at WaMu and Long Beach Mortgage forced 11 upon appraisers when they repeatedly pressured appraisers to increase their valuations, 12 implicitly or explicitly linked the receipt of continued work to “at value” appraisals, and even 13 threatened to place appraisers on a blacklist if they did not “come back at value.” 14

15 c. Misstatements regarding aggregate LTVs 16 302. Because the LTV ratios were not based on “appraisals” conducted in

17 conformance with applicable appraisal standards, the statements in the Offering Documents

18 regarding the LTV ratios of the mortgage pools were materially untrue and misleading. These 19 statements include: the extent to which loans in the pools underlying each certificate had LTVs 20 in excess of 100%, 90% or 80%, and the weighted average LTV of each pool. Section V.B, 21 infra sets forth those statements for each certificate as well as the reasons each is misleading. 22 23 24 25 26

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1 3. Evidence Demonstrating Misstatements about Appraisals and LTV Ratios in the Offering Documents 2 a. Government investigations, press reports, and confidential witnesses 3 demonstrate systemic and pervasive appraisal manipulation by the 4 mortgage originators

5 303. As alleged in detail above, see supra §§ IV.B and C, failure on the part of the

6 mortgage originators to obtain accurate ap praisals for the loans backing the PLMBS purchased

7 by the Bank has been well documented in government investigations and lawsuits, press 8 reports, and statements of confidential witnesses. Furthermore, as alleged above, this evidence 9 demonstrates that WaMu and Long Beach Mortgage manipulated the appraisal process and 10 undermined the independence and impartiality of appraisers that is crucial to the determination 11 12 of credible collateral valuations. This evidence – and the allegations herein based on this 13 evidence – demonstrates that the statements in the Offering Documents regarding the appraisals

14 and appraisal process are false and misleading.

15 304. The Bank’s claim with respect to appraisals and LTVs is that the Defendants are 16 liable for false statements of fact in the Offering Documents by representing that the LTVs 17 were based upon appraisals conducted pursuant to governing standards. In fact, the 18 “appraisals” underlying the LTVs were not appraisals at all – they were not independent 19 20 assessments of a property’s value, but rather were simply coerced or otherwise misleading 21 statements from appraisers to enable loans to close.

22 305. In the event that the Court determines otherwise, and concludes that the property 23 valuations underlying the LTVs are statements of opinion (albeit inaccurate and false ones), the 24 Bank also alleges, to the degree that the law requires knowledge (which Plaintiff disputes), that 25 the WaMu defendants knew that the appraisals were unreliable and false or misleading. 26

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1 306. The Depositor Defendants, Long Beach Securities Corp. and WaMu Asset

2 Acceptance Corp., and the lead underwriter Defendant, WaMu Capital Corp., by virtue of being 3 vertically integrated with the mortgage originators (WaMu and Long Beach Mortgage) that 4 originated the loans underlying the certificates purchased by the Banks, see supra § IV.D.1., 5 knew that the appraisals were inflated and were the product of manipulation and coercion in 6 violation of the requirements of the USPAP. 7 8 307. Similarly, the Co-underwriter Defendants should have known that the appraisals

9 were the product of manipulation and coercion because their corporate affiliates served as

10 depositors/issuers for multiple other deals, including deals backed by loans originated by 11 WaMu and Long Beach Mortgage. See supra section IV.D.2. Indeed, the Co-underwriter 12 Defendants should have known of the manipulation of the appraisal process because their 13 corporate affiliates sought to use the knowledge of the inaccurate appraisals and other 14 15 violations of underwriting standards to their advantage in purchasing loan pools at reduced 16 prices. See supra § IV.D.2.

17 308. Moreover, as Underwriters for the certificates purchased by the Bank, the Co-

18 underwriter Defendants performed reviews on the mortgage pools underlying the certificates. 19 By virtue of these reviews, the Co-underwriter Defendants should have known that the 20 originators had manipulated the appraisal process to inflate the appraisals and the LTV ratios 21 based on the appraisals, but failed to take the necessary action of replacing substandard loans or 22 23 adequately disclosing the risks to investors. 24 25 26

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1 b. Analysis of loans that backed the PLMBS purchased by the Bank demonstrate that appraisals were materially inflated and the LTV 2 ratios were materially understated

3 309. As part of its investigation of the claims asserted herein, the Bank has 4 analyzed the LTV ratios of mortgage loans that secure each of the PLMBS that it purchased. 5 The Bank has tested the LTV ratios as represented in the Offering Documents against the 6 LTV ratios that would have been calculated had the properties been valued at the time of loan 7 8 origination in accordance with accepted and reliable appraisal practices (as was represented in

9 the Offering Documents). To perform this analysis, the Bank has employed an industry-

10 standard automated valuation model (“AVM”) that reliably calculates the values of the 11 subject properties as of the date of mortgage loan origination. The AVM draws upon a 12 database of 500 million sales covering ZIP codes that represent 98.7% of the homes, 13 occupied by 99.8% of the population, in the United States, and calculates a valuation based 14 on criteria including the type, condition, and location of the property, as well as the actual 15 16 sale prices of comparable properties in the same locale shortly before the specified date. The

17 extensive independent testing of the AVM confirms that the AVM is highly reliable and

18 accurate means of determining the value that would have been determined for a property as of 19 a historical date had that property been valued in accordance with accepted and reliable 20 appraisal practices. 21 310. This analysis demonstrates stark misstatements in the LTV ratio information 22 23 as represented in the Offering Documents. Because the LTV calculation is simply a ratio of 24 loan amount to value, and because the loan amounts are unquestioned, the reason for the

25 discrepancies is inescapable: the LTV ratios represented in the Offering Documents were the

26 result of inflated and unreliable collateral valuations that were misleadingly labeled as

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1 “appraisals.” Had the collateral valuation practices comported with the OTS definition of

2 “appraisal” and with the USPAP and Fannie Mae/ Freddie Mac standards as represented in 3 the Offering Documents, the resulting aggregate LTV ratios would have been materially 4 different from those represented in the Offering Documents. 5 311. The aggregate LTV ratio representations in the Offering Documents were key 6 metrics in the Bank’s decision to purchase the PLMBS, and the Bank was materially misled 7 8 by the inaccurate information reported in the Offering Documents. Morever, as a result of

9 their knowledge of the manipulation of the appraisal process in the origination of mortgage

10 loans as described herein, see supra §§ IV.C.1.b & d, the WaMu Defendants knew that the 11 collateral valuations were unreliable and that statements made in the Offering Documents 12 based in whole or in part on the collateral values, including statements regarding LTV ratios 13 and credit ratings, were false and misleading. 14 15 312. The following summarizes four types of material LTV ratio understatements 16 contained in the Offering Documents: the percentage of loans with over 100% LTV; the

17 percentage of loans with over 90% LTV; the percentage of loans with over 80% LTV; and

18 the weighted average LTV ratio for the mortgage pool. Each is a distinct and significant 19 representation in the Offering Documents. 20 313. The 100% LTV representation is obviously significant because loans with 21 over 100% LTV afford the lender no equity cushion and leave the lender with inadequate 22 23 collateral from the outset. The Offering Documents consistently assured the Bank that there 24 were no such loans in the mortgage pools. Unfortunately, as the following table indicates, the

25 recalculated LTV ratios (which, based on the AVM, indicate what the reported LTV would 26

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1 have been had proper appraisal methods been employed) indicate that there were a material

2 number of mortgage loans with LTV ratios in excess of 100%: 3 Q Q` Q:J 11 . `V: V` VH:CH%C: VR Q Q` 4 .:J Q  ]V` .V Q:J 11 . `V: V` `Q]VH %
V` 1`1H: V `Q]VH % .:J Q  JRV` : VIVJ 5

 R   8Q  8 Q  8 Q 6

 R   8Q  8Q  8Q

 R   8Q  8 Q  8 Q 7

 R   8Q  8 Q  8 Q 8   R   8Q 8Q 8Q 9

10 314. The following table lists the certificates purchased by the Bank in which the 11 LTV calculated using the AVM exceeds 90%, and lists the representations in the associated 12 Offering Documents with respect to the percentage of the mortgages in the subject pool with 13 LTVs greater than 90%. An LTV in excess of 90% represents an extremely risky mortgage for 14 the investor, as the borrower has little equity in the property and there is a significant risk that 15 16 upon foreclosure the collateral will be inadequate to pay the debt. Accordingly, for each of the

17 certificates listed in the following table, the statement regarding the percentage of mortgages in

18 the subject pool with LTVs in excess of 90% was materially misleading. 19 Q Q` Q:J 11 . `V: V` VH:CH%C: VR Q Q` 20 .:J Q  V` .V Q:J 11 . `V: V` `Q]VH %
V` 1`1H: V `Q]VH % .:J Q  JRV` : VIVJ 21

 R    8 Q 8 Q 8Q 22

 R    8Q 8 Q 8 Q 23   R   8Q 8Q 8Q

24 315. The following table lists the certificates purchased by the Bank in which the 25 26 LTV calculated using the AVM exceeds 80%, and lists the assertion in the associated Offering

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1 Documents with respect to the percentage of the mortgages in the subject pool with LTVs

2 greater than 80%. The 80% LTV metric is very significant to a PLMBS investor such as the 3 Bank, because in traditional mortgage underwriting an LTV in excess of 80% was generally 4 considered as affording the lender little value cushion to protect against borrower default and 5 loss upon foreclosure. Accordingly, for each of the certificates listed in the following table, 6 the statement regarding the percentage of mortgages in the subject pool with LTVs in excess of 7 8 80% was materially misleading.

9 Q Q` Q:J 11 . `V: V` VH:CH%C: VR Q Q` .:J Q  V` .V Q:J 11 . `V: V` `Q]VH % 10
V` 1`1H: V `Q]VH % .:J Q  JRV` : VIVJ 11

 R   8 Q 8 Q 8 Q   R    8 Q  8 Q  8 Q 12

13 316. With respect to bond WAMU 2006-AR12 1A1, the representation contained in 14 15 its related Offering Documents regarding the weighted average LTV of the mortgage pool 16 securing that certificate was materially understated. The weighted average LTV representation

17 is significant because it provides the investor with an important gauge as to the overall riskiness

18 of the mortgage pool. The Prospectus asserts that the weighted average LTV for the mortgages 19 securing this bond was 68.30%. However, the Bank’s analyses reveals that its actual weighted 20 average LTV was 80.15%. Thus, the Offering Documents materially understated the weighted 21 average LTV by 11.85%, and therefore materially misled the Bank regarding the true risk of 22 23 this certificate. 24 25 26

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1 C. Defendants Misrepresented the Occupancy Status Rates.

2 1. The Materiality of Occupancy Status Rates

3 317. Residential real estate can be divided into the following occupancy status 4 categories: primary residences, second homes, and investment properties. Mortgages on 5 primary residences are less risky because they are less likely to default than mortgages on non- 6 owner-occupied residences. Thus, the percentage of loans in the asset pool of a securitization 7 which are secured by mortgages on other than primary residences is a key indicator of the risk 8

9 of certificates sold in the securitization. Occupancy status rates also influence prepayment

10 patterns (which in turn affects the timing and payments on the PLMBS certificates).

11 318. For these reasons, the occupancy status of the collateral backing the mortgages 12 in the loan pools was material to the Bank’s decision to invest in the PLMBS. The Offering 13 Documents for each of the PLMBS the subject hereof contained specific assertions as to the 14 occupancy status rates of the mortgages in the subject pools. 15

16 2. Evidence Demonstrating Misstatements about the Occupancy Status Rates 17 319. The following table lists mortgage pools securing the PLMBS purchased by the

18 Bank, sets forth the assertion contained in the related Offering Documents with respect to the

19 percentage of the mortgages that were on properties that were not the borrower's primary 20 residence, and sets forth the non-primary residence occupancy status rates generated by a 21 review of information contained in various public and private databases. The databases 22 reviewed contain information regarding , inter alia, the address to which borrower’s tax bills 23 24 were sent, the addresses used by borrower’s other creditors to send billings, whether borrowers 25 claimed the property as a homestead under applicable law, and whether borrowers owned other

26 properties of record and how the amount of the subject loan compared to the amounts of

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1 mortgage loans on other properties owned. Defendants should have known that as set forth in

2 the following table, the occupancy status rates set forth in the Offering Documents for the 3 PLMBS listed below were materially misstated, and materially misled the Bank regarding the 4 true risk of the certificates it purchased: 5 Q Q` Q` $:$V QJ Q Q` Q` $:$V QJ 6 "QJR`1I:`7 "QJR`1I:`7 7 V1RVJHV V` V1RVJHV V` `Q]VH %
V` 1`1H: V `Q]VH % %: :G:V V01V1 JRV` : VIVJ 8

 R    8 Q   8 Q  8Q 9

 R   8 Q   8Q  8 Q

10 D. Defendants’ Statements Regarding the AAA Rating of the PLMBS Were False and 11 Misleading.

12 1. The Materiality of the Credit Rating Process and Ratings 13 320. The Bank only was authorized to purchase investment grade, AAA-rated

14 tranches of the certificates. Hence, the ratings issued by the Credit Rating Agencies were

15 manifestly material to the Bank’s decision to purchase the PLMBS at issue in this case. The 16 ratings were not mere subjective opinions, rather they were factual representations that 17 purported to assess the risk of the certificates based on factual information pertaining to the 18 loans in the mortgage pools and modeling based on this factual information and the likelihood 19 20 that the bank would receive the payments contemplated by the certificates. Thus, the ratings 21 provided material information for investors, including the Bank.

22 2. False Representations That the Certificates the Bank Purchased Would Not Be Issued Unless They Earned AAA Ratings 23 321. As alleged above, the Rating Agencies knew, and the Defendants should have 24 25 known, that the ratings were unreliable and substantially understated the riskiness of the

26 mortgage loans which underlie the PLMBS. Consequently, the Rating Agencies knew, and the

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1 Defendants should have known, that the PLMBS certificates did not in fact possess the

2 characteristics necessary to qualify for accurate, bona fide AAA ratings. 3 322. All the Offering Documents for the PLMBS in this action stated that it was “a 4 condition to the issuance of the offered certificates” purchased by the Bank that those 5 certificates received AAA ratings. LMBLT 2006-5 Pros. Sup. S-134; LMBLT 2006-6 Pros. 6 Sup. S-138; LMBLT 2006-7 Pros. Sup. S-140; LMBLT 2006-8 Pros. Sup. S-139; WAMU 7 8 2006-AR12 Pros. Sup. S-93. The representation that the certificates the Bank purchased would

9 not have been issued unless they had received AAA ratings was misleading because the

10 certificates had not received accurate, bona fide AAA ratings. The AAA ratings the certificates 11 received were fundamentally flawed because they were based on information about the 12 underlying assets that was factually inaccurate. 13 3. Misrepresentations and Omissions about the Credit Rating Process and 14 Ratings 15 323. The Offering Documents omitted to disclose that the credit ratings were based 16 on materially false and misleading information with respect to underwriting standards, loan-to- 17 value ratios and other matters pertaining to the mortgages that secured the PLMBS purchased 18 by the Bank. 19 20 324. Furthermore, their affirmative representations about what the ratings did

21 consider were materially false and misleading.

22 325. The Offering Documents for four of PLMBS in this action stated that the ratings 23 took “into consideration the characteristics of the mortgage loans.” LMBLT 2006-5 Pros. Sup. 24 S-134; LMBLT 2006-6 Pros. Sup. S-138; LMBLT 2006-7 Pros. Sup. S-140; LMBLT 2006-8 25 Pros. Sup. S-139. In fact, however, the ratings did not take into consideration the true 26 characteristics of the mortgage loans, because the credit ratings were based on false factual

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1 information about the underwriting standards, the “appraisals” and their resulting loan-to-value

2 ratios, and similar characteristics of the loans. 3 326. The Offering Documents for these four PLMBS also represented that the ratings 4 “addresse[d] the likelihood of the receipt by a certificateholder of distributions on the mortgage 5 loans.” LMBLT 2006-5 Pros. Sup. S-134; LMBLT 2006-6 Pros. Sup. S-138; LMBLT 2006-7 6 Pros. Sup. S-140; LMBLT 2006-8 Pros. Sup. S-139. But because—for the reasons just given— 7 8 the ratings did not take into consideration the true characteristics of the mortgage loans, the

9 ratings necessarily did not address the true likelihood of the receipt of distributions on those

10 loans. 11 327. The Offering Documents for the certificate WAMU 2006-AR12 in this action 12 stated that the ratings took into account “the nature of the underlying mortgage assets and the 13 credit quality of the guarantor, if any.” WAMU 2006-AR12 Pros. 140. In fact, the ratings did 14 15 not take the true nature of the underlying mortgage assets and creditworthiness of the mortgage 16 guarantors into account, because the ratings were based on false factual information about the

17 underwriting standards, borrower income, loan-to-value ratios, and similar characteristics of the

18 loans. 19 328. The Offering Document for this same PLMBS also represented that the ratings 20 “address[ed] the likelihood of receipt by the holders of [the certificates] of all collections on the 21 underlying mortgage assets to which such holders are entitled.” WAMU 2006-AR12 Pros. 140. 22 23 Because—for the reasons just given—the ratings did not take into consideration the true 24 characteristics of those underlying mortgage assets, the ratings necessarily did not address the

25 likelihood the receipt of collections on those assets. 26

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1 329. The Offering Documents did not disclose the Credit Rating Agencies’ conflicts

2 of interest, which compromised the rating process. 3 330. The Offering Documents did not disclose the manipulation of the credit rating 4 process and “ratings shopping” by the Defendant Issuers and Underwriters. 5 331. The Offering Documents did not disclose that the credit ratings were based on 6 false and misleading information with respect to underwriting standards, loan-to-value ratios 7 8 and other matters pertaining to the mortgages that secured the PLMBS purchased by the Bank.

9 The Offering Documents did not disclose the scope and limitations of the Credit Rating

10 Agencies’ rating models, including that they relied on outdated data and failed to adequately 11 protect against misinformation provided by issuers and borrowers. 12 332. The Offering Documents did not disclose that the investment-grade ratings 13 given to the PLMBS were not, in fact, comparable to investment-grade ratings given to 14 15 corporate bonds or other instruments. 16 333. The Offering Documents did not disclose that the investment-grade ratings

17 stated and discussed in the Offering Documents failed to reflect the true credit risk of the

18 PLMBS purchased by the Bank. 19 334. In sum, the ratings provided by the Credit Rating Agencies did not in fact assess 20 the likelihood of the receipt of all payments on the mortgage loans by the related certificate 21 holders under the agreements pursuant to which such certificates are issued, the credit quality 22 23 of the related mortgage pool, or the extent to which the payment stream on the mortgage pool 24 was adequate to make the payments required by such certificates. As a result, the statements in

25 the Offering Documents regarding the ratings assigned by the Credit Rating Agencies and the 26 rating process materially misled the Bank regarding the true risk of the certificates it purchased.

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1 4. Evidence Demonstrating Misstatements about the Ratings and Ratings Process 2 335. As alleged in detail above, see supra § IV.E, the credit rating process was 3 4 subject to false information about underwriting standards, conflicts of interest, issuer and

5 underwriter manipulation, inflated appraisals, and faulty and outdated models. Furthermore, as

6 alleged above, the Depositor/Issuers manipulated the rating process through ratings shopping,

7 through their direct involvement in the rating process, and their knowledge that the loan pools 8 were of far worse quality than they represented to the Rating Agencies. As set forth above, 9 these allegations are all well documented in government investigations, other litigation, and 10 press reports. This evidence—and the allegations herein based on this evidence—demonstrates 11 12 that the statements in the Offering Documents regarding the ratings and the rating process are 13 false and misleading.

14 336. In addition, the en masse downgrade of the PLMBS purchased by the Bank from 15 AAA to junk status indicates that the initial ratings were incorrect and without any legitimate 16 basis. Likewise, delinquency and foreclosure rates indicate that the PLMBS were far riskier 17 and more prone to loss than the initial ratings indicated. As explained above, Defendants, by 18 virtue of their access to information held by their corporate affiliates, their intimate 19 20 involvement in the securitization process, and their own due diligence, see supra § IV.D.3, had

21 access to ample information about the quality of the loan pools and should have known that the

22 bundled certificates, even though tranched and credit-enhanced, did not possess the 23 characteristics of a AAA-rated investment; that the AAA rating that was obtained as a result of 24 the Depositor/Issuers’ and the Underwriters’ influence over the ratings process; and that the 25 rating was the direct product of inaccurate information about the underwriting standards 26 actually used in originating the mortgages backing the PLMBS. Defendants failed to state that

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1 the ratings were unreliable as a result of the Rating Agencies’ failure to take into account the

2 actual underwriting standards being used by mortgage originators, that the Defendants had 3 access to important information about the characteristics and quality of the loans in the loan 4 pools that was not shared with the Rating Agencies, that the models used to produce the credit 5 ratings were inaccurate and outdated, that the ratings were the product of manipulation and 6 conflicts of interest, and that the ratings were not anywhere near as reliable as the ratings given 7 8 to other financial instruments such as corporate bonds. As a result, the rating misrepresented

9 the risk of the PLMBS purchased by the Bank.

10 337. The following table sets forth the original face amounts and ratings of the 11 PLMBS that are the subject of this action, and the first date on which these certificates’ ratings 12 were downgraded to below investment grade: 13 Date 14 First Downgrade 15 Original Moody’s S&P Fitch to Face Original Original Original Junk 16 Ticker Amount Rating Rating Rating Status LBMLT 2006-5 2A3 $20,000,000 Aaa AAA n/a 10/16/08 17 LBMLT 2006-6 2A3 $20,000,000 Aaa AAA AAA 9/9/08 18 LBMLT 2006-7 2A3 $25,000,000 Aaa AAA AAA 4/7/08 LBMLT 2006-8 2A3 $15,000,000 Aaa AAA n/a 4/2/08 19 WAMU 2006-AR12 1A1 $25,000,000 n/a AAA AAA 4/6/09 20 E. Defendants Misrepresented the Mortgage Originators’ Compliance with 21 Predatory Lending Restrictions.

22 1. The Materiality of Predatory Lending Practices and the Issuance of Loans that Violate State and Federal Lending Statutes. 23 24 338. As a matter of policy, the Bank was not permitted to purchase PLMBS backed 25 by mortgage pools that contained predatory loans. 26

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1 339. Accordingly, the Bank insisted as an absolute requirement that as to any security

2 it purchased the issuer warrant that none of the underlying mortgages violated any state or 3 federal law concerning predatory lending. Representations and warranties regarding 4 compliance with predatory lending laws are generally contained in either a Mortgage Loan 5 Purchase Agreement (MLPA) or a Pooling and Service Agreement (PSA) executed prior to the 6 securitization of the mortgages. 7 8 340. Prior to purchasing any of the subprime PLMBS, the Bank reviewed the “reps

9 and warranties” contained in either the actual agreements for each bond or the agreements from

10 prior closed transactions that were presented to the Bank as containing “reps and warranties” 11 that would be substantially similar to those included in the final agreements executed for each 12 PLMBS it purchased. Additionally, each subprime PLMBS Prospectus either contained the 13 required “rep and warranty” regarding predatory lending or a representation that such a “rep 14 15 and warranty” would be contained in the relevant MLPA or PSA for each bond. 16 341. Thus, statements in the Offering Documents representing and warranting that

17 the subprime mortgage pools did not contain loans that violated state or federal predatory

18 lending laws were material to the Bank’s decision to purchase the PLMBS from Defendants. 19 2. Misstatements about Predatory Lending Compliance 20 342. The Offering Documents contained material untrue or misleading statements 21 and omissions regarding compliance with applicable predatory lending laws. As an example of 22 23 the representations and warranties reviewed by the Bank prior to the purchase of each PLMBS, 24 the Mortgage Loan Purchase Agreement backing bond LBMLT 2006-5 2A3, dated June 7,

25 2006, between Long Beach Securities Corp., the Purchaser (Depositor/Issuer), and Long Beach 26

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1 Mortgage Company, the Seller (originator and sponsor), included the following representations

2 and warranties made to the Purchaser: 3 A … Each Mortgage Loan at origination complied in all material respects with 4 applicable local, state and federal laws, including, without limitation, predatory and abusive lending, usury, equal credit opportunity, real estate settlement 5 procedures, truth-in-lending and disclosure laws, and consummation of the transactions contemplated hereby, including without limitation the receipt of 6 interest does not involve the violation of any such laws;

7 B … No Mortgage Loan is subject to the requirements of the Home Ownership 8 and Equity Protection Act of 1994, as amended;

9 C … No Mortgage Loan is . . . is a "high cost" or "predatory" loan under any state or local law or regulation applicable to the originator of such Mortgage 10 Loan or which would result in liability to the purchaser or assignee of such Mortgage Loan under any predatory or abusive lending law; 11 D . . . No Mortgage Loan is a "High Cost Loan" or "Covered Loan" (as such 12 terms are defined in the then current version of Standard & Poor's LEVELS® 13 Glossary in effect on the Closing Date . . . .) 14 343. Substantively identical provisions were included in the MLPAs and PSAs

15 reviewed by the Bank and relied upon by the Bank prior to the purchase of each PLMBS.

16 Additionally, representations that substantively similar “reps and warranties” would be 17 included in the MLPAs and PSAs executed for each PLMBS purchased by the Bank were 18 included in each Prospectus. Appendix V attached hereto and incorporated herein sets forth 19 those statements. 20

21 3. Evidence Demonstrating Misstatements about Predatory Lending Practices of the Mortgage Originators 22 a. Government investigations, actions and settlements, confidential 23 witnesses and evidence developed in other private lawsuits demonstrate systematic and pervasive predatory lending by the 24 mortgage originators. 25 344. As alleged in detail above, predatory lending practices by mortgage originators, 26 including those who issued the loans backing the PLMBS purchased by the Bank, is well

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1 documented in government investigations and lawsuits, press reports, and statements of

2 confidential witnesses who are former employees of the mortgage originators. Additional 3 evidence has been generated by the many other private lawsuits against many of the same 4 Defendants in connection with the sale of MBS and related certificates. This evidence – and 5 the allegations herein based on this evidence – demonstrates that the statements in the Offering 6 Documents regarding compliance with state and federal predatory lending rules are false and 7 8 misleading. Contrary to the representations in the Offering Documents, the mortgage

9 originators underlying these PLMBS engaged in predatory lending, and regularly and routinely

10 issued loans to borrowers who lacked the ability to make the required payments. 11 b. Analysis of loans that backed the PLMBS purchased by the Bank 12 demonstrate that loans in the mortgage pools were the result of predatory lending. 13 345. An examination of the underlying mortgage loans that back the PLMBS 14 purchased by the Bank provides strong evidence of the violation of predatory lending 15 16 restrictions by the mortgage originators. This evidence takes several forms. For example,

17 given that the issuance of a loan to a borrower who is not qualified for the loan is itself a form

18 of predatory lending, high rates of delinquency in the mortgage pools suggest predatory 19 lending. Hence, the data presented in paragraphs 281-82 provides strong evidence of predatory 20 lending practices of the mortgage originators who issued loans that back the PLMBS purchased 21 by the Bank. 22 23 346. For many of the certificates purchased by the Bank the data is telling. For 24 example, with respect to the four certificates that included loans originated by Long Beach

25 Mortgage Company, total delinquencies averaged over 56%, and foreclosures over 19%. 26

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1 Overall, for the loans (both prime and subprime) backing the PLMBS purchased by the Bank,

2 delinquencies averaged over 53%, and foreclosures averaged over 18%. 3 347. This analysis demonstrates that the representation and warranty of no predatory 4 lending or high cost loans made with respect to the underlying loan pools is materially 5 inaccurate and misleading. 6 F. Defendants Misrepresented the Due Diligence Performed on the Mortgage Pools 7 that Backed the PLMBS Purchased by the Bank. 8 1. The Materiality of Due Diligence on the Mortgage Pools 9 348. As alleged in detail above, the Bank did not have access to loan file information 10 generated by the mortgage originators when the loans were issued; only the Defendants had 11 12 access to this information. Consequently, the Bank was dependent on representations made by 13 the Defendants regarding the quality of the mortgage loans backing the PLMBS it purchased.

14 Additionally, the Defendants represented that the sponsors conducted due diligence reviews of

15 the mortgages prior to their acquisition and securitization. These due diligence reviews 16 allegedly were undertaken to ensure that the mortgages were of adequate credit quality and that 17 they were underwritten in compliance with applicable underwriting standards. 18 349. The representations regarding the underwriting standards employed by the 19 20 originators and those regarding the sponsor’s due diligence reviews of the mortgage loans 21 provided the Bank with critical reassurances that the overall credit quality of the mortgage

22 pools securing the PLMBS it purchased were as represented in the Offering Documents. The 23 Bank relied on these representations in making its decisions to purchase these certificates. 24 2. Misstatements about Due Diligence 25 350. The Prospectuses provided to the Bank contained material untrue or misleading 26 statements and omitted material information regarding the due diligence that the sponsors

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1 purportedly conducted when they acquired the loans from the mortgage originators. For

2 example, the Long Beach Mortgage Loan Trust 2006-5 Prospectus Supplement provides: 3 As part of its quality control system, the sponsor re-verifies information that has 4 been provided by the mortgage brokerage company prior to funding a loan and the sponsor conducts a post-funding audit of every origination file. In addition, 5 Washington Mutual Bank, as servicer, periodically audits files based on a statistical sample of closed loans. In the course of its pre-funding review, the 6 sponsor re-verifies the income of each prospective borrower or, for a self- employed prospective borrower, reviews the income documentation obtained 7 under the full documentation and limited documentation residential loan 8 programs. The sponsor generally requires evidence of funds to close on the mortgage loan. 9 LBMLT 2006-5 Pros. Sup. S-36. 10 351. Substantively similar provisions were included in the Prospectuses for many of 11 12 the PLMBS purchased by the Bank. Appendix VI attached hereto and incorporated herein sets 13 forth those statements. These statements were materially misleading because they omitted to

14 state the following information: 15 • The sponsors routinely manipulated the due diligence process by 16 determining the type and scope of review performed and pressuring the third-party due diligence firms to ignore deviations from the applicable 17 underwriting criteria if alleged “compensating factors” were present;

18 • Due diligence review conducted by third-party underwriters often overlooked questionable claims by borrowers in stated income and other 19 reduced documentation loans; 20 • The third-party underwriters informed the sponsors that a substantial 21 percentage of loans in the loans pools backing PLMBS were defective;

22 • The sponsors nonetheless waived the defects as to a substantial percentage of these loans; 23 • 24 In many cases, these reportedly defective loans were not removed from PLMBS deals, but rather were used by the sponsors to negotiate lower 25 prices for the pools of mortgages they acquired and subsequently securitized; and 26

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1 • Even where the defective loans in the sample were removed from the pool, no further review was conducted to ensure that none of the 2 remaining mortgages was plagued by similar defects as those in the sample. 3

4 3. Evidence of Misstatements about Due Diligence

5 352. As alleged in detail above, see supra §§ IV.D.2. and IV.D.3, the disregard of the

6 third-party due diligence process by sponsors of PLMBS, including those who sponsored the

7 PLMBS purchased by the Bank, is documented in public testimony and press reports, as well as 8 confidential witness testimony discussed above. This evidence – and the allegations herein 9 based on this evidence – demonstrates, and the Defendants should have known, that the 10 statements in and omissions from the Offering Documents regarding the due diligence review 11 12 process were materially false and misleading. 13 VI. CAUSES OF ACTION

14 FIRST CAUSE OF ACTION

15 UNTRUE OR MISLEADING STATEMENTS IN THE SALE OF SECURITIES

16 (Securities Act of Washington, RCW 21.20.005 et seq. )

17 353. This cause of action is alleged against the following Defendants in connection 18 with the sale of the following certificates: 19 In connection 20 with certificate: Against Defendant: As: 21 LBMLT 2006-5 Long Beach Securities Corp. Depositor 2A3 Merrill Lynch, Pierce, Fenner & Smith 22 Underwriter Incorporated 23 WaMu Capital Corp. Underwriter 24 LBMLT 2006-6 Long Beach Securities Corp. Depositor 2A3 Banc of America Securities LLC, n/k/a 25 Merrill Lynch, Pierce, Fenner & Smith Underwriter 26 Incorporated Credit Suisse Securities (USA) LLC Underwriter

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1 In connection with certificate: Against Defendant: As: 2 WaMu Capital Corp. Underwriter 3 LBMLT 2006-7 Long Beach Securities Corp. Depositor 4 2A3 Goldman, Sachs & Co. Underwriter 5 WaMu Capital Corp. Underwriter LBMLT 2006-8 Long Beach Securities Corp. Depositor 6 2A3 Greenwich Capital Markets, Inc. Underwriter 7 WaMu Capital Corp. Underwriter 8 WAMU 2006- WaMu Asset Acceptance Corp. Depositor AR12 1A1 WaMu Capital Corp. Underwriter 9

10 354. The Bank hereby incorporates by reference all allegations herein.

11 355. Long Beach Securities Corp. is the Depositor of certificates LBMLT 2006-5

12 2A3, LBMLT 2006-6 2A3, LBMLT 2006-7 2A3 and LBMLT 2006-8 2A3, and WaMu Asset 13 Acceptance Corp. is the Depositor of certificate WAMU 2006-AR12 1A1, and therefore each is 14 also the Issuer of the certificates in those securitizations. In connection with the offer and sale 15 of these certificates to the Bank, Long Beach Securities Corp. and WaMu Asset Acceptance 16 17 Corp. made the statements of material fact about these certificates (or omitted to make 18 statements of material fact necessary in order to make the statements made not misleading) that

19 were in the prospectus supplements and other written Offering Documents and communications

20 that Defendants sent to or directed at the Bank. As alleged in detail above, including but not 21 limited to ¶ 41 and § IV.A.1., Long Beach Securities Corp. and WaMu Asset Acceptance Corp. 22 each served as a substantial contributing factor in the sale of the certificates for which it served 23 as the Depositor/Issuer, and therefore acted as a seller of these certificates under RCW 24 25 21.20.430(1). 26

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1 356. WaMu Capital Corp. acted as underwriter of the securitization of certificates

2 LBMLT 2006-5 2A3, LBMLT 2006-6 2A3, LBMLT 2006-7 2A3, LBMLT 2006-8 2A3 and 3 WAMU 2006-AR12 1A1, sold each of these certificates to the Bank, and therefore acted as a 4 seller of these certificates. Merrill Lynch, Pierce, Fenner, and Smith, Inc. was a substantial 5 contributing factor in the sale of certificate LBMLT 2006-5 2A3, because it was an underwriter 6 of this certificate, and therefore also acted as its seller. Banc of America Securities LLC and 7 8 Credit Suisse Securities (USA) LLC were each a substantial contributing factor in the sale of

9 certificate LBMLT 2006-6 2A3, because they were underwriters of this certificate, and

10 therefore also acted as its sellers. Goldman, Sachs & Co. was a substantial contributing factor 11 in the sale of certificate LBMLT 2006-7 2A3, because it was an underwriter of this certificate, 12 and therefore also acted as its seller. RBS Securities, Inc., f/k/a Greenwich Capital Markets, 13 Inc., was a substantial contributing factor in the sale of certificate LBMLT 2006-8 2A3, 14 15 because it was an underwriter of this certificate, and therefore also acted as its seller. 16 357. The Defendants named above solicited the Bank to purchase these certificates,

17 and sold the certificates to the Bank, by means of the prospectus supplements and other written

18 Offering Documents and communications which they drafted, reviewed, signed, and/or 19 circulated, as alleged above. 20 358. The prospectus supplements and other written Offering Documents and 21 communications contained untrue statements of material fact and omitted to state material facts 22 23 necessary in order to make the statements, in light of the circumstances under which they were 24 made, not misleading. These untrue and misleading statements included all of the untrue and

25 misleading statements described in all preceding paragraphs of this complaint and the exhibits 26 and appendices attached hereto, which are incorporated herein by this reference.

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1 359. In doing the acts alleged, the Defendants named above violated RCW 21.20.010.

2 The Defendants offered to sell securities under RCW 21.20.430(1). The Defendants made 3 untrue statements of material facts or omissions of material facts. The Bank relied on the 4 Defendants’ misstatements in connection with the sale of the certificates in the securitizations 5 referred to above. 6 360. In the alternative, the Co-underwriter Defendants are jointly and severally liable 7 8 under RCW 21.20.430(3) as entities who materially aided in the sale transactions of the

9 certificates to the Bank with and to the same extent as underwriter WaMu Capital Corp.,

10 Depositor/Issuer Long Beach Securities Corp., and Depositor/Issuer WaMu Asset Acceptance 11 Corp. 12 361. The Bank expressly excludes from this cause of action any allegation that could 13 be construed as alleging fraud or intentional reckless conduct. This cause of action is based 14 15 solely on strict liability or negligence claims under the Securities Act of Washington. 16 362. The Bank did not know when it purchased these certificates that the statements

17 in the prospectus supplements and other written Offering Documents and communications that

18 the Defendants sent the Bank, were untrue or misleading. 19 363. The Bank has suffered a loss on each of these certificates. The Bank has had to 20 impair the value of these assets, which has caused the Bank’s earnings performance to decline. 21 364. The Bank has identified litigation that provides for tolling of the statute of 22 23 limitations on this claim for certificate WAMU 2006-AR12 1A1, as set forth infra ¶ 373. The 24 Bank will seek leave to amend this complaint as appropriate as it identifies additional actions

25 that provide for tolling of the statute for additional certificates purchased by the Bank. 26

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1 365. This action is brought within three years after the discovery of the untrue and

2 misleading statements or omissions in the prospectus supplements and other written Offering 3 Documents and communications that the dealers sent the Bank, or within three years of these 4 certificates having been sold to the public, or within any applicable period as tolled by the 5 pendency of other actions. Despite having exercised reasonable diligence, the Bank did not and 6 could not reasonably have discovered earlier the untrue and misleading statements or omissions 7 8 in the prospectus supplements and other Offering Documents and communications that the

9 dealers sent the Bank.

10 366. Under RCW 21.20.010, RCW 21.20.430(1), and RCW 21.20.430(3), the Bank is 11 entitled to recover the consideration it paid for each of these certificates, plus interest of 8% per 12 annum from the date of payment, plus costs and the reasonable fees of its attorneys in this 13 action, less the amount of any income it has received on each certificate upon the tender of the 14 15 security. Pursuant to RCW 21.20.430(6), the Bank will tender each certificate before entry of 16 judgment.

17 SECOND CAUSE OF ACTION

18 UNTRUE OR MISLEADING STATEMENTS IN REGISTRATION STATEMENTS

19 (Section 11 of the Securities Act of 1933) 20 367. This cause of action is alleged jointly and severally against the following 21 Defendants in connection with the sale of certificate WAMU 2006-AR12 1A1: 22 23 In connection with certificate: Against Defendant: As: 24 WAMU 2006- WaMu Asset Acceptance Corp. Depositor 25 AR12 1A1 WaMu Capital Corp. Underwriter

26 368. The Bank hereby incorporates by reference all allegations herein.

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1 369. WaMu Asset Acceptance Corp. is the depositor of the certificate listed above,

2 and therefore is the issuer of the certificate in that securitization. 3 370. WaMu Capital Corp. acted as the underwriter of the certificate listed above and 4 sold it directly to the Bank. 5 371. In doing the acts alleged, the Defendants named above violated Section 11 of the 6 Securities Act of 1933 in connection with the sale to the Bank of the certificate in the 7 8 securitization referred to above.

9 372. The certificate listed in this cause of action was issued pursuant and/or traceable

10 to a false and misleading registration statement and prospectus supplement that was filed in 11 connection with the public offering of this security. 12 373. The Bank has identified litigation that provides for tolling of the statute of 13 limitations and/or statute of repose on this claim for certificate WAMU 2006-AR12 1A1. The 14 15 bona fide public offering date of the certificate was September 22, 2006. Within two years of 16 the bona fide public offering of this security and the sale of this security to the Bank, but before

17 the certificate had been downgraded or before the Bank had discovered, or with reasonable

18 diligence could have discovered, Defendants’ materials misstatements and omissions with 19 respect to this certificate, a class action complaint relating to this security was filed in this 20 court, sub nom. New Orleans Employee’s Ret. Sys. & MARTA/ATU Local 732 v. Washington 21 Mutual, Inc., et al ., No. 08-2-26210-3 (Wash. Super. Ct., King Cty.) (“New Orleans WaMu ”). 22 23 New Orleans WaMu alleged, inter alia , class claims under sections 11 and 12 of the Securities 24 Act of 1933 for various certificates, including WAMU 2006-AR12. New Orleans WaMu was

25 later removed and transferred to the United States District Court for the Western District of 26 Washington, and consolidated into Boilermakers National Annuity Trust Fund v. WaMu

137

1 Mortgage Pass Through Certificates, Series 2006-AR1, No. 09-0037 (W.D. Wash.)

2 (“ Boilermakers ”). The lead plaintiff in the Boilermakers consolidated class action, 3 Policemen’s Annuity and Benefit Fund of the City of Chicago (“Chicago PABF”), purchased 4 the same security as the Bank: WAMU 2006-AR12. On September 28, 2010, Judge Pechman 5 issued an order in Boilermakers , upholding many of Chicago PABF’s claims under sections 11 6 and 12 with respect to WAMU 2006-AR12. Accordingly, the Bank’s section 11 and 12 claims 7 8 for this certificate were either still tolled when the Bank filed its original complaint on October

9 15, 2010, or were within the applicable statutes of limitation or repose as set forth in section 13

10 of the Securities Act of 1933. The Bank’s claims under the Securities Act of Washington were 11 similarly tolled. 12 374. The Bank will seek leave to amend this complaint as appropriate as it identifies 13 additional actions that provide for tolling of the statute for additional certificates purchased by 14 15 the Bank. 16 375. This action is brought within one year after the discovery of the untrue and

17 misleading statements or omissions in the registration statement, as amended by the prospectus

18 supplement, and within three years of this certificate having been sold to the public, or within 19 any applicable period as tolled by the pendency of other actions, as detailed above. Despite 20 having exercised reasonable diligence, the Bank did not and could not reasonably have 21 discovered earlier the untrue and misleading statements or omissions in the registration 22 23 statement, as amended by the prospectus supplement. 24 376. The registration statement, as amended by the prospectus supplement, contained

25 untrue statements of material fact and omitted to state material facts necessary in order to make 26 the statements, in light of the circumstances under which they were made, not misleading.

138

1 These untrue and misleading statements included all of the untrue and misleading statements

2 described in this complaint, its exhibits, and its appendices, and incorporated herein by this 3 reference. 4 377. The Bank expressly excludes from this cause of action any allegation that could 5 be construed as alleging fraud or intentional reckless conduct. This cause of action is based 6 solely on claims of strict liability or negligence under the Securities Act of 1933. 7 8 378. The Bank did not know when it purchased this certificate that the statements in

9 the registration statement, as amended by the prospectus supplement, were untrue or

10 misleading. 11 379. The Bank has suffered a loss on this certificate. The Bank has had to impair the 12 value of this asset, which has caused the Bank’s earnings performance to decline. 13 380. The Bank is entitled to recover damages as described in 15 U.S.C. § 77k(e). 14 15 THIRD CAUSE OF ACTION 16 UNTRUE OR MISLEADING STATEMENTS IN THE SALE OF SECURITIES 17 (Section 12(a)(2) of the Securities Act of 1933)

18 381. This cause of action is alleged jointly and severally against WaMu Capital Corp.

19 and WaMu Asset Acceptance Corp. in connection with the sale of certificate WAMU 2006- 20 AR12 1A1. 21 382. The Bank hereby incorporates by reference all allegations herein. 22 383. WaMu Capital Corp. acted as the underwriter of the certificate listed above and 23 24 sold the certificate directly to the Bank in the initial public offering/primary offering of the 25 security. 26

139

1 384. WaMu Asset Acceptance Corp. acted as the Depositor/Issuer of the certificate

2 listed above. In such capacity, WaMu Asset Acceptance Corp. offered and/or sold WAMU 3 2006-AR12 1A1 to Plaintiff in a registered, primary offering pursuant to a registration 4 statement containing a prospectus that it had prepared and filed, or by means of other 5 communications that constituted offers made by, on behalf of, used, or referred to by the 6 Depositor/Issuer. The Depositor/Issuer or its agents authorized or approved the information or 7 8 communication regarding WAMU 2006-AR12 1A1 before it was provided or used.

9 385. In doing the acts alleged, WaMu Capital Corp. and WaMu Asset Acceptance

10 Corp. violated Section 12(a)(2) of the Securities Act of 1933 in connection with the sale to the 11 Bank of certificate WAMU 2006-AR12 1A1. 12 386. WaMu Capital Corp. and WaMu Asset Acceptance Corp. solicited the Bank to 13 purchase this certificate, and sold the certificate to the Bank, by means of the prospectus 14 15 supplement and other written Offering Documents and communications. Defendants WaMu 16 Capital Corp. and WaMu Asset Acceptance Corp. passed title to the security to Plaintiff, or

17 solicited the sale of the security to serve their own financial interests or the financial interests of

18 the security’s owner. Plaintiff purchased WAMU 2006-AR12 1A1 in the initial distribution of 19 such certificates. The settlement date for the transaction was September 26, 2006. 20 387. The prospectus supplement and other written Offering Documents and 21 communications that WaMu Capital Corp. and WaMu Asset Acceptance Corp. sent to the Bank 22 23 contained untrue statements of material fact and omitted to state material facts necessary in 24 order to make the statements, in light of the circumstances under which they were made, not

25 misleading. These untrue and misleading statements included all of the untrue and misleading 26

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1 statements described in this complaint, its exhibits, and its appendices, and incorporated herein

2 by this reference. 3 388. The Bank expressly excludes from this cause of action any allegation that could 4 be construed as alleging fraud or intentional reckless conduct. This cause of action is based 5 solely on claims of strict liability or negligence under the Securities Act of 1933. 6 389. The Bank did not know when it purchased this certificate that the statements in 7 8 the prospectus supplement and other written Offering Documents and communications that

9 WaMu Capital Corp. and WaMu Asset Acceptance Corp. directed at the Bank were untrue or

10 misleading. 11 390. The Bank has suffered a loss on this certificate. The Bank has had to impair the 12 value of this asset, which has caused the Bank’s earnings performance to decline. 13 391. The Bank has identified litigation that provides for tolling of the statute of 14 15 limitations and/or statute of repose on this claim as set forth in detail above, see ¶ 373. The 16 Bank will seek leave to amend this complaint as appropriate as it identifies additional actions

17 that provide for tolling of the statute for additional certificates purchased by the Bank.

18 392. This action is brought within one year after the discovery of the untrue and 19 misleading statements or omissions in the prospectus supplement and other written Offering 20 Documents and communications that WaMu Capital Corp. and WaMu Asset Acceptance Corp. 21 directed at the Bank, and within three years of these certificates having been sold to the public, 22 23 or within any applicable period as tolled by the pendency of other actions. Despite having 24 exercised reasonable diligence, the Bank did not and could not reasonably have discovered

25 earlier the untrue and misleading statements or omissions in these Offering Documents. 26

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1 393. The Bank is entitled to recover the consideration it paid for this certificate, plus

2 interest at the legal rate from the date of purchase to the date on which it recovers the purchase 3 price, minus the amount of income it has received on this certificate. Pursuant to Section 4 12(a)(2) and in anticipation of the remedies thereunder, the Bank hereby offers to tender each 5 certificate set forth in this Cause of Action. 6 FOURTH CAUSE OF ACTION 7 8 NEGLIGENT MISREPRESENTATION

9 (Under the Common Law and Seeking a Damages Remedy)

10 394. This cause of action is alleged against the following Defendants in connection

11 with the sale of the following certificates: 12 In connection with 13 Against Defendant: As: certificate: 14 Long Beach Securities Corp. Depositor LBMLT 2006-5 2A3 LBMLT 2006-6 2A3 15 LBMLT 2006-7 2A3 16 LBMLT 2006-8 2A3 WaMu Asset Acceptance Corp. Depositor WAMU 2006-AR12 1A1 17 Banc of America Securities LLC Underwriter LBMLT 2006-6 2A3 18 Credit Suisse Securities (USA) LLC Underwriter LBMLT 2006-6 2A3 19 Goldman, Sachs & Co. Underwriter LBMLT 2006-7 2A3 Greenwich Capital Markets, Inc. Underwriter LBMLT 2006-8 2A3 20 Merrill Lynch, Pierce, Fenner & Smith Underwriter LBMLT 2006-5 2A3 21 Incorporated WaMu Capital Corp. Underwriter LBMLT 2006-5 2A3 22 LBMLT 2006-6 2A3 23 LBMLT 2006-7 2A3 LBMLT 2006-8 2A3 24 WAMU 2006-AR12 1A1 25 395. The Bank hereby incorporates by reference all allegations herein. 26

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1 396. The Defendants are and were in the business of providing information for the

2 guidance of others in their business transactions: namely they provided Offering Documents to 3 investors that were central to the business transaction of purchasing the certificates. The 4 information in the Offering Documents was provided with full knowledge that it would be used 5 in guiding the Bank in its business transaction of whether to purchase the offered certificates. 6 397. Defendants had a duty to make accurate and truthful statements in and about the 7 8 information they provided to the Bank.

9 398. As alleged above and incorporated herein, the Defendants breached this duty by

10 making untrue or misleading statements of material facts in the Offering Documents. These 11 material misrepresentations pertain to the following non-exclusive list: (1) the originators’ 12 abandonment of their stated underwriting guidelines; (2) the LTVs of the mortgage loans in the 13 collateral pools of these securitizations, and the “appraisals” upon which those LTVs were 14 15 based; (3) the occupancy status rates of properties that secured the mortgage loans in these 16 securitizations; (4) the ratings and the ratings process by which AAA-ratings were assigned,

17 and the conditions under which those ratings were assigned; (5) compliance with predatory

18 lending restrictions; and (6) due diligence purportedly conducted on the loan pools. 19 399. When the Defendants made these representations, they had no reasonable 20 ground for believing them to be true. The Bank is informed and believes, and based thereon 21 alleges, that Defendants had access to loan files on the mortgage loans in the collateral pools 22 23 for these securitizations, and thus should have known that the information they gave the Bank 24 contained untrue or misleading statements. In addition, Defendants should have been aware

25 but for their negligence that the “due diligence” review of the loans that were being securitized 26 and sold to the Bank identified serious concerns and that a significant percentage of these loans

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1 were identified as defective but were nonetheless bundled and sold to the Bank as part of the

2 securitization. Thus, the Bank is informed and believes, and based thereon alleges, that 3 Defendants had access to information that should have made the Defendants aware, had they 4 heeded that information; that the representations they made to the Bank contained material 5 untrue or misleading statements about the mortgage loans in the collateral pools and the 6 originators’ adherence to their stated underwriting guidelines. The Defendants were careless or 7 8 negligent in ascertaining the truth of their statements.

9 400. In making the representations referred to above, the Defendants intended to

10 induce the Bank to rely on those representations in making its decision to purchase the 11 certificates. The Bank is a member of a limited group of investors that the Defendants knew 12 would receive the information, and Defendants knew that the Bank would rely on these 13 representations in making a decision to purchase the certificates. 14 15 401. The Bank did reasonably and justifiably rely on the truth of the representations 16 described above and alleged herein in its purchase of the certificates. The Bank did not have

17 access to the underlying loan files, and therefore was justified in relying on the Defendants’

18 statements regarding the credit quality of the mortgage pools. But for the Defendants making 19 the false and misleading representations alleged herein, the Bank would not have purchased 20 these certificates. 21 402. As a direct and proximate result of the negligent misrepresentations by the 22 23 Defendants, the Bank was damaged in an amount to be proven at trial. 24 403. This action is brought within the applicable period after the discovery of

25 Defendants’ negligent misrepresentations, or within the applicable period after notice of facts 26 which in the exercise of reasonable diligence would lead the Bank to discover the factual basis

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1 for the alleged negligent misrepresentations, and/or within any applicable period as tolled by

2 the pendency of other actions. Despite having exercised reasonable diligence, the Bank did not 3 and could not reasonably have discovered earlier Defendants’ negligent misrepresentations 4 alleged in this Count. 5 404. The Bank expressly excludes from this cause of action any allegation that could 6 be construed as alleging fraud or intentional reckless conduct. This cause of action is based 7 8 solely on claims of negligent misrepresentation under the common law.

9 FIFTH CAUSE OF ACTION

10 UNTRUE OR MISLEADING STATEMENTS IN THE SALE OF SECURITIES

11 (Illinois Securities Law, 815 ILCS 5/12(F) & (G)) 12 405. This cause of action is alleged only to the extent that Washington law does not 13 apply, and is alleged jointly and severally against the following Defendants in connection with 14 the sale of the following certificates: 15 16 In connection with certificate: Against Defendant: As: 17 LBMLT 2006-5 Long Beach Securities Corp. Depositor 18 2A3 Merrill Lynch, Pierce, Fenner & Smith Underwriter Incorporated 19 WaMu Capital Corp. Underwriter 20 LBMLT 2006-6 Long Beach Securities Corp. Depositor 2A3 21 Banc of America Securities LLC Underwriter Credit Suisse Securities (USA) LLC Underwriter 22 WaMu Capital Corp. Underwriter 23 LBMLT 2006-7 Long Beach Securities Corp. Depositor 2A3 24 Goldman, Sachs & Co. Underwriter WaMu Capital Corp. Underwriter 25 LBMLT 2006-8 Long Beach Securities Corp. Depositor 26 2A3 Greenwich Capital Markets, Inc. Underwriter

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1 In connection with certificate: Against Defendant: As: 2 WaMu Capital Corp. Underwriter 3 WAMU 2006- WaMu Asset Acceptance Corp. Depositor 4 AR12 1A1 WaMu Capital Corp. Underwriter

5 406. The Bank hereby incorporates by reference all allegations herein. 6 407. In doing the acts alleged in selling to the Bank the certificates in the 7 securitizations referred to above, the Underwriter and Issuer Defendants violated 815 ILCS 8 5/12(F) & (G) by: i) engaging in transactions, practices, or courses of business which worked a 9

10 fraud or deceit upon the Bank as the purchaser of these certificates; and ii) obtaining money or

11 property through the sale of securities by means of untrue statements of material facts or

12 omissions to state material facts necessary in order to make the statements made not 13 misleading. 14 408. The offer and sale to the Bank of the certificates that are the subject of this 15 action took place in Illinois when the Bank, from its offices in Illinois, received Defendants’ 16 17 solicitations to purchase these certificates and accepted Defendants’ offers to purchase these 18 certificates.

19 409. In purchasing the certificates that are the subject of this cause of action, the

20 Bank reasonably relied on Defendants’ business courses of action and the material 21 misstatements and material omissions incorporated in the documents provided by Defendants 22 to the Bank. 23 410. Defendants’ misstatements and omissions alleged herein were material and were 24 25 the cause of the Bank’s decision to purchase these certificates. If Defendants had not engaged 26 in these material misstatements or omissions, and had instead provided full and accurate

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1 disclosures, the Bank would not have purchased – and in fact its own internal policies would

2 have prevented it from purchasing – the certificates at issue. 3 411. This action is brought within two years after the discovery of the untrue and 4 misleading statements or omissions in the prospectus supplements and other Offering 5 Documents that the Defendants sent to the Bank, or within two years after notice of facts which 6 in the exercise of reasonable diligence would lead to actual knowledge of the alleged violation, 7 8 and within five years of the Bank’s purchase of those certificates, or within any applicable

9 period as tolled by the pendency of other actions. Despite having exercised reasonable

10 diligence, the Bank did not and could not reasonably have discovered earlier the untrue and 11 misleading statements or omissions in the prospectus supplements and other documents and the 12 other violations of the Illinois Securities Law alleged in this Count. 13 412. The Bank has timely given notice in accordance with 815 ILCS 5/13B to 14 15 Defendants of its election to void its purchases of the certificates listed in this Count, and has 16 offered to tender the securities to the seller or into court.

17 413. Under 815 ILCS 5/13A(1), the Bank is entitled to void the transactions and have

18 Defendants pay the Bank, jointly and severally, the amount paid for each certificate, plus 19 interest, as set forth in 815 ILCS 5/13A(1), less any amounts received by the Bank with respect 20 to each certificate. 21 414. The Bank expressly excludes from this cause of action any allegation that could 22 23 be construed as alleging fraud or intentional reckless conduct. This cause of action is based 24 solely on claims under the Illinois Securities law.

25 SIXTH CAUSE OF ACTION

26 SIGNING OR CIRCULATING SECURITIES DOCUMENTS THAT CONTAINED MATERIAL MISREPRESENTATIONS

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1 (Illinois Securities Law, 815 ILCS 5/12(H))

2 415. This cause of action, together with the Fifth Cause of Action, is alleged only to

3 the extent that Washington law does not apply, and is alleged jointly and severally against the 4 following Defendants in connection with the sale of the following certificates: 5 In connection 6 with certificate: Against Defendant: As: 7 LBMLT 2006-5 Long Beach Securities Corp. Depositor 2A3 Merrill Lynch, Pierce, Fenner & Smith 8 Underwriter Incorporated 9 WaMu Capital Corp. Underwriter 10 LBMLT 2006-6 Long Beach Securities Corp. Depositor 2A3 Banc of America Securities LLC Underwriter 11 Credit Suisse Securities (USA) LLC Underwriter 12 WaMu Capital Corp. Underwriter 13 LBMLT 2006-7 Long Beach Securities Corp. Depositor 2A3 Goldman, Sachs & Co. Underwriter 14 WaMu Capital Corp. Underwriter 15 LBMLT 2006-8 Long Beach Securities Corp. Depositor 16 2A3 Greenwich Capital Markets, Inc. Underwriter 17 WaMu Capital Corp. Underwriter WAMU 2006- WaMu Asset Acceptance Corp. Depositor 18 AR12 1A1 WaMu Capital Corp. Underwriter 19 416. The Bank hereby incorporates by reference all allegations herein. 20 417. In doing the acts alleged in selling to the Bank the certificates in the 21 22 securitizations referred to above, the Underwriter and Issuer Defendants violated 815 ILCS 23 5/12(H) by signing or circulating papers or documents pertaining to these certificates which it

24 reasonably should have known contained material misrepresentations. 25 418. The offer and sale to the Bank of the certificates that are the subject of this 26 action took place in Illinois when the Bank, from its offices in Illinois, received Defendants’

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1 solicitations to purchase these certificates and accepted Defendants’ offers to purchase these

2 certificates. 3 419. In purchasing the certificates that are the subject of this cause of action, the 4 Bank reasonably relied on Defendants’ untrue or false statements of material fact about the 5 certificates they offered and sold to the Bank, and which were incorporated in the documents 6 provided by Defendants to the Bank. 7 8 420. Defendants’ false or untrue statements alleged herein were material and were the

9 cause of the Bank’s decision to purchase these certificates. If Defendants had not made these

10 false or untrue statements, and had instead provided full and accurate disclosures, the Bank 11 would not have purchased – and in fact its own internal policies would have prevented it from 12 purchasing – the certificates at issue. 13 421. This action is brought within two years after the discovery of the untrue and 14 15 misleading statements or omissions in the prospectus supplements and other documents that the 16 Defendants sent to the Bank, or within two years after notice of facts which in the exercise of

17 reasonable diligence would lead to actual knowledge of the alleged violation, and within five

18 years of the Bank’s purchase of those certificates, or within any applicable period as tolled by 19 the pendency of other actions. Despite having exercised reasonable diligence, the Bank did not 20 and could not reasonably have discovered earlier the untrue and misleading statements or 21 omissions in the prospectus supplements and other documents and the other violations of the 22 23 Illinois Securities Law alleged in this Count. 24 422. The Bank has timely given notice in accordance with 815 ILCS 5/13(B) to

25 Defendants of its election to void its purchases of the certificates listed in this Count, and has 26 offered to tender the certificates to the seller or into the court.

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1 423. Under 815 ILCS 5/12(H), the Bank is entitled to void the transactions and have

2 Defendants pay the Bank, jointly and severally, the amount paid for each certificate, plus 3 interest at 10% per annum, less any amounts received by the Bank with respect to each 4 certificate. 5 424. The Bank expressly excludes from this cause of action any allegation that could 6 be construed as alleging fraud or intentional reckless conduct. This cause of action is based 7 8 solely on claims under the Illinois Securities law.

9 SEVENTH CAUSE OF ACTION

10 NEGLIGENT MISREPRESENTATION

11 (Under the Common Law and Seeking a Rescission Remedy) 12 425. This cause of action is alleged only to the extent that Washington law does not 13 apply, and is further alleged in the alternative with the Fourth Cause of Action against the 14 following Defendants in connection with the sale of the following certificates: 15 16 In connection with Against Defendant: As: certificate: 17 Long Beach Securities Corp. Depositor LBMLT 2006-5 2A3 18 LBMLT 2006-6 2A3 LBMLT 2006-7 2A3 19 LBMLT 2006-8 2A3 20 WaMu Asset Acceptance Corp. Depositor WAMU 2006-AR12 1A1 Banc of America Securities LLC Underwriter LBMLT 2006-6 2A3 21 Credit Suisse Securities (USA) LLC Underwriter LBMLT 2006-6 2A3 22 Goldman, Sachs & Co. Underwriter LBMLT 2006-7 2A3 23 Greenwich Capital Markets, Inc. Underwriter LBMLT 2006-8 2A3 Merrill Lynch, Pierce, Fenner & Smith Underwriter 24 LBMLT 2006-5 2A3 Incorporated 25 26

150

1 In connection with Against Defendant: As: certificate: 2 WaMu Capital Corp. Underwriter LBMLT 2006-5 2A3 3 LBMLT 2006-6 2A3 4 LBMLT 2006-7 2A3 LBMLT 2006-8 2A3 5 WAMU 2006-AR12 1A1 6 426. The Bank hereby incorporates by reference all allegations herein. 7 427. The Defendants are and were in the business of providing information for the 8 guidance of others in their business transactions: namely they provided Offering Documents to 9

10 investors that were central to the business transaction of purchasing the certificates. The 11 information in the Offering Documents was provided with full knowledge that it would be used

12 in guiding the Bank in its business transaction of whether to purchase the offered certificates. 13 428. Defendants had a duty to make accurate and truthful statements in and about the 14 information they provided to the Bank. 15 429. As alleged above and incorporated herein, the Defendants breached this duty by 16 making untrue or misleading statements of material facts in the Offering Documents. These 17 18 material misrepresentations pertain to the following non-exclusive list: (1) the originators’

19 abandonment of their stated underwriting guidelines; (2) the LTVs of the mortgage loans in the

20 collateral pools of these securitizations, and the “appraisals” upon which those LTVs were 21 based; (3) the occupancy status rates of properties that secured the mortgage loans in these 22 securitizations; (4) the ratings and the ratings process by which AAA-ratings were assigned, 23 and the conditions under which those ratings were assigned; (5) compliance with predatory 24 25 lending restrictions; and (6) due diligence purportedly conducted on the loan pools. 26

151

1 430. When the Defendants made these representations, they had no reasonable

2 ground for believing them to be true. The Bank is informed and believes, and based thereon 3 alleges, that Defendants had access to the loan files on the mortgage loans in the collateral 4 pools for these securitizations, and, had the Defendants inspected those files, they would have 5 learned that the information they gave the Bank contained untrue or misleading statements. In 6 addition, Defendants should have been aware but for their negligence that the “due diligence” 7 8 review of the loans that were being securitized and sold to the Bank identified serious concerns

9 and that a significant percentage of these loans were identified as defective but were

10 nonetheless bundled and sold to the Bank as part of the securitization. Thus, the Bank is 11 informed and believes, and based thereon alleges, that Defendants had access to information 12 that should have made the Defendants aware, had they heeded that information; that the 13 representations they made to the Bank contained material untrue or misleading statements 14 15 about the mortgage loans in the collateral pools. The Defendants were careless or negligent in 16 ascertaining the truth of their statements.

17 431. In making the representations referred to above, the Defendants intended to

18 induce the Bank to rely on those representations in making its decision to purchase the 19 certificates. The Bank is a member of a limited group of investors that the Defendants knew 20 would receive the information, and Defendants knew that the Bank would rely on these 21 representations in making a decision to purchase the certificates. 22 23 432. The Bank did reasonably and justifiably rely on the truth of the representations 24 described above and alleged herein in its purchase of the certificates. The Bank did not have

25 access to the underlying loan files, and therefore was justified in relying on the Defendants’ 26 statements regarding the credit quality of the mortgage pools. But for the Defendants making

152

1 the false and misleading representations alleged herein, the Bank would not have purchased

2 these certificates. 3 433. As a direct and proximate result of the negligent misrepresentations by the 4 Defendants, the Bank was damaged in an amount to be proven at trial. 5 434. This action is brought within the applicable period after the discovery of 6 Defendants’ negligent misrepresentations, or within the applicable period after notice of facts 7 8 which in the exercise of reasonable diligence would lead the Bank to discover the factual basis

9 for the alleged negligent misrepresentations, and/or within any applicable period as tolled by

10 the pendency of other actions. Despite having exercised reasonable diligence, the Bank did not 11 and could not reasonably have discovered earlier Defendants’ negligent misrepresentations 12 alleged in this Count. 13 435. To the extent it was required to do so under Illinois law, the Bank has timely 14 15 given notice in accordance with 815 ILCS 5/13(B) to Defendants of its election to void its 16 purchases of the certificates listed in this Count, and has offered to tender the certificates to the

17 seller or into the court.

18 436. The Bank expressly excludes from this cause of action any allegation that could 19 be construed as alleging fraud or intentional reckless conduct. This cause of action is based 20 solely on claims of negligent misrepresentation under the common law. 21 VII. PRAYER FOR RELIEF 22 23 A. On the First Cause of Action, the consideration the Bank paid for each of the 24 certificates, plus interest of 8% per annum from the date of payment, plus costs and the

25 reasonable fees of its attorneys in this action, less the amount of any income it has received on

26 each certificate upon the tender of the security;

153

1 B. On the Second Cause of Action, damages in an amount to be determined at trial;

2 C. On the Third Cause of Action, the consideration the Bank paid for each 3 certificate with interest thereon, less the amount of any income that the Bank has received 4 thereon, upon the Bank’s tender of each certificate; 5 D. On the Fourth Cause of Action, damages in an amount to be determined at trial; 6 E. On the Fifth and Sixth Causes of Action, in the alternative, an order voiding the 7 8 transactions at issue and ordering Defendants to pay the Bank, jointly and severally, the amount

9 paid for each certificate, plus interest at 10% per annum, less any amounts received by the

10 Bank with respect to that certificate; 11 F. On the Seventh Cause of Action, in the alternative, an order of rescission 12 voiding the transactions at issue and ordering Defendants to pay the Bank the amount paid for 13 each certificate, plus interest at 10% per annum, less any amounts received by the Bank with 14 15 respect to that certificate; 16 G. Reasonable attorneys’ fees and expenses or costs of suit, including expert

17 witness fees; and

18 H. Such other and further relief as permitted by law or equity or as the Court may 19 deem just. 20 VIII. JURY DEMAND 21 The Bank demands a jury on all issues so triable. 22 23 24 25 26

154

1 RESPECTFULLY SUBMITTED this 28th day of January, 2011.

2 KELLER ROHRBACK L.L.P.

3

4 By s/ Amy Williams-Derry 5 Lynn L. Sarko, WSBA #16569 [email protected] 6 Derek W. Loeser, WSBA #24274 [email protected] 7 Amy Williams-Derry, WSBA #28711 8 [email protected] Elizabeth A. Leland, WSBA #23433 9 [email protected] 1201 Third Avenue, Suite 3200 10 Seattle, WA 98101 11 Telephone: (206) 623-1900 Facsimile: (206) 623-3384 12 OF COUNSEL: 13 KELLER ROHRBACK P.L.C. 14 Gary A. Gotto 15 [email protected] 3101 North Central Avenue, Suite 1400 16 Phoenix, Arizona 85012 (602) 248-0088, Fax (602) 248-2822 17 Attorneys for Plaintiff 18 Federal Home Loan Bank of Chicago 19 20 21 22 23 24 25 26

155

1 CERTIFICATE OF SERVICE

2 I certify that on the date noted below I electronically filed this document entitled 3 Amended Complaint for Rescission and Damages with the Clerk of the King County 4 Superior Court using the CM system. A copy of this document will be served on the following 5 individual(s) via King County Superior Court e-service, if opted in, otherwise served via 6 electronic mail: 7 8 Michael R. Scott, WSBA #12822 Laurie Lootens Chyz, WSBA #14297 Michael J. Ewart, WSBA #38655 Mary E. Crego, WSBA #31593 9 HILLIS CLARK MARTIN & PETERSON P.S. HILLIS CLARK MARTIN & PETERSON P.S. 1221 Second Avenue, Suite 500 1221 Second Avenue, Suite 500 10 Seattle WA 98101-2925 Seattle, Washington 98101-2925 Telephone: (206) 623-1745 Tel: (206) 623-1745; Fax: (206) 623-7789 11 Facsimile: (206) 623-7789 [email protected] [email protected] [email protected] 12 [email protected] Counsel for Defendants Long Beach 13 Richard W. Clary Securities Corp., WAMU Asset Michael T. Reynolds Acceptance Corp., WAMU Capital Corp. 14 CRAVATH , SWAINE & MOORE LLP Worldwide Plaza 15 825 Eighth Avenue New York, NY 10019 16 Telephone: (212) 474-1000 Facsimile: (212) 474-3700 17 [email protected]; [email protected] 18 Attorneys for Defendant 19 Credit Suisse Securities (USA) LLC

20 John A. Schwimmer (WSBA# 36558) R. Alexander Pilmer, CBA No. 166196 SUSSMAN SHANK LLP David I. Horowitz, CBA No. 248414 21 1000 SW Broadway, Suite 1400 Jay L. Bhimani, CBA No. 267689 Portland, Oregon 97205 KIRKLAND & ELLIS LLP 22 Telephone: (503) 227-1111 333 South Hope Street Facsimile: (503) 248-0130 Los Angeles, CA 90071 23 [email protected] Telephone: 213-680-8400 Facsimile: 213-680-8500 24 Richard H. Klapper [email protected] Theodore Edelman [email protected] 25 Harsh N. Trivedi [email protected] Christopher J. Dunne 26 Jessica P. Stokes J. Thomas Richardson, WSBA No. 18437 SULLIVAN & CROMWELL LLP Michael S. Brunet, WSBA No. 35764

156

1 125 Broad Street Ana-Maria Popp, WSBA No. 39614 New York, New York 10004 CAIRNCROSS & HEMPELMANN , PS 2 Telephone: (212) 558-4000 524 Second Avenue, Suite 500 Facsimile: (212) 558-3588 Seattle, WA 98104 3 [email protected] Telephone: 206-587-0700 [email protected] Facsimile: 206-587-2308 4 [email protected] [email protected] [email protected] [email protected] 5 [email protected] [email protected]

6 Attorneys for Defendant Attorneys for Defendant Goldman, Sachs & Co. RBS Securities Inc., f/k/a Greenwich 7 Capital Markets, Inc.

8 John S. Devlin III, WSBA # 23988 Lane Powell PC 9 1420 Fifth Avenue, Suite 4100 Seattle, WA 98101-2338 10 Telephone: (206) 223-6280 Facsimile: (206) 223-7101 11 [email protected]

12 Jay B. Kasner Christopher P. Malloy 13 Scott D. Musoff (pro hac vice applications forthcoming) 14 Skadden, Arps, Slate Meagher & Flom LLP 15 Four Time Square New York, New York 10036 16 Telephone: (212) 735-3000 Facsimile: (212) 735-2000 17 [email protected] [email protected] 18 [email protected]

19 Counsel for Defendants Banc of America Securities LLC and Merrill Lynch, Pierce, 20 Fenner & Smith Incorporated

21

22 DATED this 28th day of January, 2011. 23

24 KELLER ROHRBACK L.L.P.

25 s/ Amy Williams-Derry Amy Williams-Derry, WSBA # 28711 26

157

EXHIBIT A

EXHIBIT B

EXHIBIT C

EXHIBIT D

APPENDIX I

PLMBS CERTIFICATES PURCHASED BY FEDERAL HOME LOAN BANK OF CHICAGO AT ISSUE IN THIS ACTION

CUSIP Certificate 54251PAD9 LBMLT 2006-5 2A3 54251RAD5 LBMLT 2006-6 2A3 54251TAD1 LBMLT 2006-7 2A3 54251UAD8 LBMLT 2006-8 2A3 93363NAA3 WAMU 2006-AR12 1A1

1 APPENDIX II

A. CLAYTON SERVICES, INC. REPORT ON DUE DILIGENCE REJECTION AND WAIVER TRENDS

B. TESTIMONY OF VICKI BEAL, SENIOR VICE PRESIDENT, CLAYTON HOLDINGS, BEFORE THE FINANCIAL CRISIS INQUIRY COMMISSION, SEPTEMBER 23, 2010

C. TESTIMONY OF KEITH JOHNSON, FORMER PRESIDENT, CLAYTON HOLDINGS, BEFORE THE FINANCIAL CRISIS INQUIRY COMMISSION, SEPTEMBER 23, 2010

TESTIMONY OF VICKI BEAL SENIOR VICE PRESIDENT CLAYTON HOLDINGS

BEFORE THE FINANCIAL CRISIS INQUIRY COMMISSION SEPTEMBER 23, 2010 Good afternoon. I am Vicki Beal, Senior Vice President of Clayton Holdings, a mortgage services outsourcing, analytics and consulting company headquartered in

Shelton, Connecticut.

CLAYTON HISTORY

Clayton pioneered the residential mortgage loan due diligence business with its formation in 1990. In 2005, the company combined with the top credit risk management surveillance firm (which was founded in 1997) creating a leading information and analytics company serving investment banks, commercial banks, mortgage insurance companies, fixed income investors and loan servicers, primarily in the secondary market for non-agency mortgages. With a full suite of outsourced services, information-based analytics and specialty consulting services, Clayton helps its clients enhance liquidity, grow revenues, reduce costs and manage risk.

COMPETITION

The market for due diligence services is highly fragmented, highly competitive and rapidly changing. Because there are very few publicly traded firms specializing in due diligence, little is known about the majority of service providers in terms of loan review volume, market share and revenue. Nevertheless, some of our competitors include

Core Logic’s Bohan Group unit, Fidelity Information Services Watterson Prime unit, 406

Partners, Allonhill, American Mortgage Consultants, Opus Capital Markets Consultants, and RR Donnelly.

1 DUE DILIGENCE – INTRODUCTION

We are retained by our clients to review samples of closed loan pools that they are considering for purchase. Clayton is not retained by its clients to provide an opinion as to whether a loan is a good loan or a bad loan. Rather, our clients use Clayton’s due diligence to identify issues with loans, negotiate better prices on pools of loans they are considering for purchase, negotiate expanded representations and warranties in purchase and sale agreements from sellers, and, on occasion, to negotiate an increase in pool sample sizes where the results indicate to the client that a broader review is necessary.

The type and scope of our due diligence work is dictated by our clients based on their individual objectives . Our assessments are performed on a sample of loans being purchased for likely placement in a residential mortgage-backed security (RMBS).

Clients select the samples, generally 10% to 20% of the total pool of loans.

Clayton typically reviews loans against the seller or originating institution’s guidelines and the client’s tolerance. Clayton reviews for: (1) adherence to seller credit underwriting guidelines and client risk tolerances; (2) compliance with federal, state and local regulatory laws, and; (3) the integrity of electronic loan data provided by the seller to the prospective buyer. This review scope is commonly referred to as a credit and compliance review .

Our diligence clients include investment banks, commercial banks and other financial institutions, mortgage and bond insurance companies and more recently government agencies, private equity firms and hedge funds. Clayton’s contractual relationships with its diligence clients are standard, fee for service vendor contract

2 arrangements. Clayton’s fees are not contingent on its findings; rather we are typically compensated with a standard service fee for each loan reviewed.

Accordingly, Clayton is not paid any fees based on: (1) its grading of the loans it reviews, (2) the ultimate performance of the loans it reviews, (3) the securitization of any loans it reviews, or (4) the ultimate disposition of the loans in any structured finance transaction.

The work product produced by Clayton is comprised of reports that include loan- level data reports and loan exception reports. Such reports are “works for hire”, the property of our clients and provided exclusively to our clients. When Clayton provides its reports to its clients, its work on those loans is generally completed —

Clayton is not involved in the further processes of securitizing the loans and does not review nor opine on the securitization prospectus . To our knowledge, prospectuses do not refer to Clayton and its due diligence work. Moreover, Clayton does not participate in the securities sales process, nor does it have knowledge of our loan exception reports being provided to investors or the rating agencies as part of the securitization process.

DUE DILIGENCE REVIEW STAFFING

The individuals who conduct the due diligence reviews for Clayton consist of (1) a client services manager, (2) loan underwriters, (3) a lead underwriter and (4) a quality control specialist. The client services manager works with a client’s transaction manager to facilitate the flow of information between the operations at Clayton and the client. The client services manager is responsible for providing the reports that Clayton produces to its clients.

3 The actual review of the loan files is performed by contract underwriters, who review the loan file, compare tape data with hard copy or scanned file data to verify loan information and identify discrepancies of key data points, calculate income (for full verification loans) and grade loans based on seller guidelines and client tolerances (if applicable to a transaction). These individuals are managed by “lead underwriters,” who are more experienced underwriters. Lead underwriters manage the transaction, coordinate the delivery of the loan files, set up equipment (for deals at a seller or client site), manage underwriters and quality control, and run reports that summarize the daily findings. The lead underwriters communicate with the client services manager and clients about particular loan exceptions. They also clear stipulations, meaning that they will regrade loans after a seller cures a loan exception (such as when a seller provides missing file documentation). A quality control (QC) specialist, helps ensure that the data in the

CLAS system is accurate and complete and verifies that the loan grades and, in particular, exceptions are warranted.

With the deterioration of the non-agency and mortgage market since mid-2007,

Clayton has not had enough due diligence work for many underwriters — forcing them to find other types of work.

THE DUE DILIGENCE REVIEW PROCESS

The loan review process is conducted as follows:

 A client reviews a pool of loans and selects a sample of loans for diligence

review. The sample can be adverse or random – Clayton is generally not told

whether sample is adverse or random. An example of an adverse sample is

4 loans where a certain characteristic (i.e. below x borrower credit score) might

be of concern to a client in their assessment of the pool value.

 Client hires Clayton to perform diligence on the sample. Client gives

Clayton’s Client Services Manager instructions on the type and scope of

review and the time frame for the deal.

 Client sends or has sent to Clayton a tape containing loan information from

the originator, which Clayton programmers “crack” and loads into our CLAS

system.

 At the end of each day, the lead underwriter generates reports for the client

that summarizes Clayton’s findings, including exception reports.

 Exception reports are provided to the client and seller. The seller then begins

process of “stip-clearing” (usually providing additional information to Clayton

on specific loans). The seller tries to cure an exception by providing missing

documentation or otherwise explaining to Clayton why a loan should not be

graded EV-3 (more particularly defined below). This iterative process is on-

going throughout the transaction and continues until a deal “tie-out” call is

conducted between the client and seller.

 Once stips have been cleared by Clayton and reports are given to client,

Clayton’s review is complete.

 Prior to closing date, the seller and client have an independent “tie-out” call

where they discuss EV-3 loans, negotiate prices and additional representations

and warranties, and finalize the purchase of loans. Clayton generally does not

participate in that “tie-out” call unless the client and/or seller have a question

5 about a specific loan. Clayton generally does not know which or how many

loans the client ultimately purchases.

Any time a grade change is made, Clayton documents the basis for the change in the exception report. Clayton will make changes to loan grades if they are justified, meaning:

 Clayton clearly made a mistake in grading the loan;

 The seller provided missing documentation; or

 Clayton determines that compensating factors were sufficient or insufficient, thereby warranting a grade change.

Separately, a client can waive an exception, which results in the loan received a grade of EV-2W.

EXCEPTIONS

An important part of Clayton’s diligence service is the production of exception reports. Prior to Clayton instituting an exception tracking system across its client base in late 2005, continuing through 2006, loans were simply graded as follows:

EV-1: Loans that meet guidelines;

EV-2: Loans that do not meet guidelines, but have sufficient compensating factors; and

EV3: Loans that did not meet guidelines and had insufficient compensating factors.

Exceptions to underwriting guidelines can vary from being severe — such as the valuation of a property not being supported by an appraisal, stated income not being reasonable for the job stated, or missing critical documents in a file such as a HUD-1, loan application, or an appraisal — to benign, such as a debt to income ratio exception of

6 less than 5%, or a loan to value exception of 5% or less, or a credit score that is within an acceptable tolerance (i.e. 650 score required, 640 actual).

Our exception numbers should not be viewed in isolation. Exceptions must be reviewed in conjunction with the corresponding underwriting guidelines and client tolerances. Simply stated, a Clayton grade of EV-1 does not mean that a loan is good or is likely to perform. Nor does a Clayton grade of EV-3 mean that a loan is bad and is not likely to perform. Moreover, it may not be possible to draw an “apples to apples” comparison of deals from different clients and/or different sellers.

Beginning in 2003, Clayton worked to develop a more comprehensive scoring system for its clients, one which would allow Clayton to expand its exception review system to more specifically identify and track exceptions. The new system was called

Exception Tracking and it allowed our clients to better manage exceptions (E.g. , show client what portfolio would look like if seller cured what it could) and it allowed for better reporting to clients.

Exception Tracking provided more granularity into the reporting of loan exceptions to its clients. All exceptions to guidelines or client tolerances are tagged with specific exception codes. Underwriter comments and exceptions are then tied together so they can be reviewed and discussed by relevant parties. Under Exception Tracking

Clayton grades loans as follows:

EV-1: Loans that meet guidelines

EV-2: Loans that do not meet guidelines but have sufficient compensating factors

EV-2W: Loans that are graded EV-3 by Clayton, but waived by the client

7 EV-2T: Loans for which side letters are issued allowing seller 30 days after

closing to cure exceptions

EV-3C: Loans that do not meet guidelines but have curable exceptions

EV-3D: Loans that do not meet guidelines due to missing material documentation

EV-3: Loans that do not meet guidelines and have insufficient compensating

factors

DUE DILIGENCE – WHAT IT IS NOT

It is important to understand what Clayton does not do. Clayton does not :

 Confirm the authenticity of information in the file — the loan has already

closed, and due diligence firms historically have relied on the

documentation within the file for the review

 Know whether a loan was placed into securitization, the type of

securitization or if it was held in portfolio by the client

 Tell clients which loans to buy or not buy

 Participate in the actual trading of or pricing of the loans

 Participate in the structuring or rating of a security

 Participate in deciding which rating agency should be used to rate a

security.

8 DUE DILIGENCE IN THE FUTURE

There are many improvements that need to be made throughout the mortgage industry, which will help restore investor confidence and rebuild the mortgage market.

Clayton fully supports the Asset Securitization Forum (ASF) and Securities Industry and

Financial Markets Association (SIFMA) who are making significant contributions to the development of asset securitization markets that investors will have confidence in.

Specifically in the area of due diligence, we have seen the rating agencies adopt specific improvements that relate to mortgage securitization which call for:

1. Independent, third-party pre-securitization review of samples of underlying

mortgage loans, and including disclosure to investors of all exceptions found-

and an assessment of underwriting guidelines

2. Standardized post-securitization forensic reviews

3. Expanded loan-level data reporting of initial mortgage pool and ongoing loan

performance

It should also be noted that the rating agencies in a limited number of mortgage transactions they have recently rated, have taken a more active role in the due diligence review process, reviewing due diligence findings prior to issuing ratings in those transactions. Clayton views this as a significant and positive change that over time will help the market to recover.

We are also hopeful that the SEC will adopt these requirements and others as part of their new Regulation AB, following the enactment of Financial Reform legislation. We believe that such reforms will provide greater disclosure and transparency for investors.

9 Testimony of Keith Johnson

Former President of Clayton Holdings, Inc. and

Former President of Washington Mutual’s Long Beach Mortgage

Before the Financial Crisis Inquiry Commission

September 23, 2010

Chairman Angelides, Vice-Chairman Thomas, and Members of the Commission, my name is Keith Johnson. I have been in the financial services and banking industry for 30 years. From 1986 to 2000, I was employed by Bank United of Texas (“Bank United”) where I held a variety of executive positions involving finance, capital markets, loan origination, securitization and servicing. In 2000, Bank United was sold to Washington

Mutual (“WaMu”) were I became the Chief Operating Officer of WaMu’s Commercial

Segment. In mid-2003, I was asked to assist the existing management of Long Beach

Mortgage. In June 2005, while remaining an employee of WaMu, I became the acting

President of Long Beach Mortgage for approximately 9 months. In May 2006, I left

WaMu and became President and Chief Operating Officer of Clayton Holdings, Inc.

(“Clayton”) the largest residential loan due diligence and securitization surveillance company in the United States and Europe. I left Clayton at the beginning of 2009 shortly after its sale to a private real estate investment fund.

I thank the Commission for the invitation to appear, and I hope that my testimony will assist in your efforts to better understand the causes of the financial crisis. The

Commission has asked me to address several topics related to loan securitization,

S mortgage brokers and their related impact to the Sacramento region and other communities in the Central Valley.

In my opinion, this crisis is not the result of a single cause, but a combination of significant factors operating at the same time and feeding each other. Low interest rates, increased housing goals, creative securitization, lack of assignee liability, compromised warehouse lending, flawed Rating Agency process, relaxed and abusive lending practices, rich incentives, shortfalls on regulation and enforcement provided the fuel to inflate home prices and excess borrowings by consumers.

Financial Factories & Securitization

In addition to the factors previously mentioned, improvements in technology, credit scoring and financial engineering transformed traditional lending platforms into large financial factories. Several of these factories were originating, packaging, securitizing and selling at the rate of $1 billion a day. The quality control process failed at a variety of stages during the manufacturing, distribution and on-going servicing. Traditional regulatory examination procedures were not able to evaluate neither processing exceptions nor their resulting cumulative risk. The lack of accountability and failure by many parties to “present value the pain” allowed for the process to continue. Lastly, the lingering impact of this transformation has been the severing of practical solutions between borrowers facing a financial hardship and the investors with principal at risk.

Many have blamed this crisis on the growth of securitization. I believe that mortgage

T securitization process was flawed and abused, but can and will be beneficial to the public, as it provides a vehicle for lenders to sell loans in exchange for the capital necessary to make additional loans. Hopefully, this crisis will lead to reform of common sense improvements to bring back a prudent robust securitization market.

Mortgage Brokers

As it relates to doing business with mortgage brokers, I can share with you my experience at Long Beach and observations while at Clayton.

Unlike most large mortgage companies that contain multiple origination channels, retail, direct mail, telephone and refinance desks, Long Beach was a sub prime lender that relied

100% on mortgage brokers.

Broker originated loans was and can be a viable loan production channel. The model serves a purpose in helping financial institutions reach out to the unbanked and underbanked areas.

However, performance data has shown that the broker model became flawed with greed, fraud and deception. Low barriers of entry, lack of regulatory supervision or enforcement, coupled with rich incentives for production created an environment that contributed to the surge in defaults. During my period of time at Clayton, I was able to observe the operations of close to 40 of the largest mortgage originators and servicers in the United States. To late to be effective, it became obvious that the only way to correct the broker model was to shut it down and wait for regulatory reform and enforcement.

Recent regulatory changes have been made to improve the broker channel and I would

U encourage additional supervision and enforcement. For me, one of the underlying conflicts with the broker model is the question of “whom does the broker work for?” The main problem is that, counter to common perception, mortgage brokers do not represent the borrowers who pay them for advice. Instead, they are more like independent salespeople who are often paid as much by the lenders in addition to the borrowers they represent. When brokers are paid commissions by both parties to a loan transaction, confusion results about whom the brokers actually "work for."

In my opinion, the broker should be acting as a fiduciary of the borrower, and have the responsibility for making sure that the borrower understands and benefits from the transaction by receiving fair terms. A criticism of this approach is that implementing will have an adverse impact on the low to moderate-income applicants. I would suggest to you that the benefits would tilt toward the consumer, with alternatives to encourage financial institutions to invest in low to moderate housing.

Issues impacting Sacramento and Central Valley

As it relates to the Sacramento and other communities in the Central Valley, I have three areas of concern.

Special Servicing

Effective loan servicing, foreclosure avoidance and loss mitigation are necessary to help families work through a financial hardship. Servicer incentive, the borrower’s lack of financial literacy and the threat of investor litigation are limiting effective loan servicing.

V Current servicing fees provide little to no economic incentive for servicers to spend the time, money and effort working with a borrower to arrive at a fair solution. For some servicers, the most profitable path is to move the loan to foreclosure. Special Servicing should be engaged which has incentives to cure defaults and avoid foreclosure. My recommendation for all future securitizations (including Fannie Mae, Freddie Mac and

FHA) is that once a loan goes 90 days delinquent it is assigned to a Special Servicer who will evaluate the collateral and borrower’s financial condition and perform a “Lowest

Cost Solution” that will take into consideration loan modification, short-sale, deed-in- lieu, foreclosure etc. The Special Servicer will receive a market rate of compensation based on their results.

As for financial literacy, I have worked with many delinquent borrowers and it clear that we have not stressed in our education system skills and knowledge necessary to make financial decisions. There has been much press about the streamlined modification processes offered during the past two years. I have worked with borrowers in educating them and helping them complete the modification checklists. However, the process is still complicated by the lack of borrower’s financial knowledge and communication barriers.

The last servicing issue relates to fear of litigation from investors. The legal and loss waterfall structures of legacy securitizations are creating conflicting incentives for investors to resolve delinquent loans via modifications. My recommendation is to follow, the FDIC in their “Low Cost Solution” process for all delinquent loans. The “Lowest

W Cost Solution” should be followed regardless of the impact to structured waterfall losses.

Servicers who adopt the “Low Cost Solution” methodology should be held harmless from investor litigation.

Foreclosed Inventory of Homes

The second concern for the Sacramento region and other communities in the Central

Valley is the increased inventories of abandon homes resulting from foreclosure. Empty homes do not pay the salary of schoolteachers, police and fire departments. The compounding impact of vacant homes is a real threat to the recovery of a community.

The issue of unsold inventory is also linked to my third concern for the area, the availability of credit to purchase homes.

Availability of Credit

Home prices are down, inventory for sale has increased, credit standards have tightened and prospective homebuyers will have difficulty meeting the down payment requirements. One suggestion, which I found to work during the 1980’s Texas recession, is to promote an active “Loans to Facilitate the Sale of Foreclosed Homes” program.

Ironically, this is a program of relaxed underwriting guidelines. Borrowers would qualify based on their existing rental or housing income being equal to or lower then a fully loaded (principal, interest, taxes and insurance) mortgage payment that amortizes over a

30 year period. The program would encourage minimum down payments, but be willing to offer 100%+ financing that rolls in all the closing costs.

X One would argue that relaxed underwriting and 100% loan to value loans put us into this mess, why would we ever use this to pull us out? I would offer these factors as defense, home values have significantly declined reducing the risk on collateral, absorption helps to slow any further price deterioration, communities and neighborhoods become more stable with higher comparables and real estate taxes are being paid to support infrastructure.

Again, I thank the Commission for the invitation to appear. I appreciate the opportunity to share my views, and would be happy to answer any of your questions.

Y APPENDIX III

TABLE OF CONTENTS

DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND OMISSIONS REGARDING UNDERWRITING GUIDELINES UTILIZED BY MORTGAGE LENDERS ...... 1

A. PLMBS backed by mortgages originated by or through Long Beach Mortgage Company (“Long Beach”)...... 1

B. PLMBS backed by mortgages originated by or through Washington Mutual Bank (“Washington Mutual”) ...... 6

i APPENDIX III

DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND OMISSIONS REGARDING UNDERWRITING GUIDELINES UTILIZED BY MORTGAGE LENDERS

A. PLMBS backed by mortgages originated by or through Long Beach Mortgage Company (“Long Beach”).

Security CUSIP Defendants Long Beach Securities Corp. (Depositor Defendant) LBMLT 2006-5 2A3 54251PAD9 Merrill Lynch, Pierce, Fenner & Smith Incorporated (Underwriter Defendant) WaMu Capital Corp. (Underwriter Defendant) Banc of America Securities LLC (Underwriter Defendant) Credit Suisse Securities (USA) LLC (Underwriter Defendant) LBMLT 2006-6 2A3 54251RAD5 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant) Goldman, Sachs & Co. (Underwriter Defendant) LBMLT 2006-7 2A3 54251TAD1 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant) Greenwich Capital Markets, Inc. (Underwriter Defendant) LBMLT 2006-8 2A3 54251UAD8 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant)

Statements Material Misstatements and Omissions

1. General Statements Regarding Borrower Evaluation. These statements are materially misleading because:

According to each Prospectus, “[t]he sponsor’s underwriting guidelines are primarily intended to 1. Far from following its underwriting guidelines evaluate the prospective borrower’s credit standing and repayment ability as well as the value and and making occasional, targeted and justified adequacy of the mortgaged property as collateral .” Each Prospectus asserts that Long Beach exceptions when other evidence of ability to repay collected and considered the following information in determining a mortgagor’s eligibility for a justified a deviation from the guidelines, in fact at mortgage: Long Beach, variance from the stated standards was the norm, and many loans were made with [F]inancial information regarding the amount of income and related sources, liabilities and essentially little to no underwriting or effort to related monthly payments, credit history and employment history, as well as certain other evaluate ability to repay. Nowhere did any of the personal information. Offering Documents apprise the Bank of the extent to which Long Beach deviated from its underwriting guidelines.

1 Each Prospectus states that 2. The underwriting practices actually followed by The sponsor uses a credit scoring methodology as part of its underwriting and re- Long Beach, including the widespread use of underwriting process. The credit scoring methodology assesses a prospective borrower’s exceptions to the stated underwriting guidelines, ability to repay a mortgage loan based upon predetermined mortgage loan were not "primarily intended to evaluate the characteristics and credit risk factors. The credit scoring methodology generates a credit prospective borrower’s credit standing and score usually ranging from around 300 to 800, with a higher score indicating a borrower repayment ability,” nor of “the value and with a relatively more favorable credit history. The credit score is based upon such factors adequacy of the mortgaged property as as the prospective borrower’s payment history, delinquencies on accounts, levels of collateral.” outstanding debt, length of credit history and types of credit and bankruptcy experience. 3. They omit to state that: Source: LBMLT 2006-5 Pros. Sup. S-34; LBMLT 2006-6 Pros. Sup. S-35-40; LBMLT 2006-7 Pros.

Sup. *26-27; LBMLT 2006-8 Pros. Sup. S-37-42. • Due to the industry’s inexperience with Each Prospectus further states that: lending to borrowers with increased credit risks, Long Beach lacked sufficient data Under the sponsor’s underwriting programs, various risk categories [labeled C through regarding historical patterns of default "Premium A"] are used to grade the likelihood that the prospective borrower will satisfy experienced by borrowers with similar the repayment conditions of the mortgage loan. These risk categories establish the profiles upon which it could accurately maximum permitted loan-to-value ratio and loan amount, given the occupancy status of the predict “a prospective borrower’s ability to mortgaged property and the prospective borrower’s credit history and debt ratio. repay a mortgage loan based upon In general, higher credit risk mortgage loans are graded in categories which permit higher predetermined mortgage loan characteristics debt ratios and more (or more recent) major derogatory credit items such as outstanding and credit risk factors.” judgments or prior bankruptcies; however , the sponsor’s underwriting programs establish lower maximum loan-to-value ratios and maximum loan amounts for loans graded in • Long Beach did not employ reasonable such categories . The sponsor’s underwriting guidelines permit first lien mortgage loans methods to verify or substantiate borrower with loan-to-value ratios at origination of up to 100%, or 80% if at the time of origination income, which rendered decisions based on of the first lien mortgage loan, the originator also originated a second lien mortgage loan. the purported debt-to-income ratios The sponsor’s second lien mortgage underwriting guidelines permit second lien mortgage unreliable. loans with a combined loan-to-value ratios at origination of up to 100%. • Each Prospectus further asserts: Long Beach's underwriters routinely accepted appraisals that were not prepared in The maximum allowable loan-to-value ratio varies based upon the residential loan accordance with the applicable appraising program, income documentation, property type, creditworthiness and debt service-to- standards in the underwriting guidelines. income ratio of the prospective borrower and the overall risks associated with the loan Consequently, Long Beach used unreliable decision . The maximum combined loan-to-value ratio, including any second lien mortgage appraisals to determine the value of the subordinate to the sponsor’s first lien mortgage, is generally 100% under the “Premium collateral, which rendered decisions based on A,” “A,” “A-,” “B+” and “B” risk categories, and 95% under the “C” risk category. LTV unreliable.

Source: LBMLT 2006-5 Pros. Sup. S-35-38; LBMLT 2006-6 Pros. Sup. S-35-40; LBMLT 2006-7 • Long Beach lacked any reasonable basis Pros. Sup. *27-29; LBMLT 2006-8 Pros. Sup. S-37-42. upon which to assign risk categories or

2 reliably “grade the likelihood that the prospective borrower will satisfy the repayment conditions of the mortgage loan.” Further, the statements omit to state that Long Beach lacked historical performance data with respect to loans issued using equivalent underwriting practices (including the widespread granting of exceptions to underwriting guidelines), and therefore could not reliably assign borrowers to risk categories.

• Long Beach lacked adequate procedures and practices to monitor or evaluate its underwriters' exercise of judgment, or to provide appropriate training and education to its underwriters.

2. Statements Regarding Exceptions to Standards. The statements are materially misleading because they

omit to state that: Each Prospectus states:

• On a case-by-case basis and only with the approval of an employee with appropriate risk Long Beach routinely granted exceptions to level authority, the sponsor may determine that, based upon compensating factors, a the risk category limitations on LTV ratios prospective borrower not strictly qualifying under its underwriting risk category guidelines and loan amounts despite the absence of warrants an underwriting exception. meaningful compensating factors. Moreover, the statements are materially misleading Each Prospectus lists the following compensating factors: because they fail to disclose that Long Beach had no reasonable basis on which to evaluate [L]ow loan-to-value ratio, low debt-to-income ratio, good credit history, stable alleged compensating factors that might employment and time in residence at the prospective borrower’s current address . It is warrant exceptions to the underwriting expected that some of the mortgage loans owned by the trust will be underwriting standards. exceptions. • Long Beach lacked adequate practices, Each Prospectus further states: policies or procedures to monitor or evaluate the exercise of underwriter discretion in There can be no assurance that every mortgage loan owned by the trust was originated in granting exceptions, or to provide conformity with the applicable underwriting guidelines in all material respects. The underwriters with training or education with sponsor’s underwriting guidelines include a set of specific criteria pursuant to which the respect thereto. underwriting evaluation is made. The application of the sponsor’s underwriting guidelines

3 does not imply that each specific criterion was satisfied with respect to every mortgage • By stating that "some" of the loans in the loan. Rather, a mortgage loan will be considered to be originated in accordance with a pool will be underwriting exceptions, they given set of underwriting guidelines if, based on an overall qualitative evaluation, the suggest that the number will be limited, when mortgage loan is in substantial compliance with those underwriting guidelines. For in fact exceptions were routinely granted. example, a mortgage loan may be considered to comply with a set of underwriting Moreover, neither Long Beach nor the Issuer guidelines, even if one or more specific criteria included in those underwriting guidelines nor any Underwriter had any procedure in were not satisfied , if other factors compensated for the criteria that were not satisfied or place to evaluate whether the actual if the mortgage loan is considered to be in substantial compliance with the underwriting composition of the pool was consistent with guidelines. The sponsor applies its underwriting guidelines in accordance with a procedure the statement that "some of the mortgage that complies with applicable federal and state laws and regulations. loans" would be underwriting exceptions.

Source: LBMLT 2006-5 Pros. Sup. S-35-38; LBMLT 2006-6 Pros. Sup. S-35-40; LBMLT 2006-7 • Long Beach lacked a reliable factual Pros. Sup. *27-29; LBMLT 2006-8 Pros. Sup. S-37-42. foundation on which to evaluate certain alleged "compensating factors," including a borrower’s "debt-to-income ratio" and "stable employment," because income and employment history were not verified for many mortgages in the pool. 3. Statements Regarding Appraisals . The statements are materially misleading because they omit to state that: Each Prospectus describes Long Beach’s appraisal process as follows: • Long Beach routinely accepted appraisals The adequacy of the mortgaged property as collateral is generally determined by an that were not prepared in accordance with appraisal of the mortgaged property that generally conforms to Fannie Mae and Freddie applicable appraisal standards and were Mac appraisal standards and a review of that appraisal . The mortgaged properties are therefore unreliable. appraised by licensed independent appraisers who have satisfied the servicer’s appraiser screening process. • Long Beach lacked any reliable basis on which to assess the accuracy of the values Additionally, each Prospectus states: yielded by the described appraisal practices.

Each appraiser is selected in accordance with predetermined guidelines established for • Long Beach lacked adequate policies, appraisers. The appraiser is required to inspect the property and verify that it is in good practices, and procedures to monitor and condition and that construction, if new, has been completed. The appraisal is based on the evaluate compliance with applicable market value of comparable homes, the estimated rental income, if considered applicable appraisal standards. by the appraiser, and, when deemed appropriate, the cost of replacing the home. With respect to multifamily properties, commercial properties and mixed-use properties, the • Long Beach lacked adequate policies, appraisal must specify whether an income analysis, a market analysis or a cost analysis practices, and procedures to determine the was used. An appraisal employing the income approach to value analyzes a property’s qualifications of employees reviewing projected net cash flow, capitalization and other operational information in determining the appraisals or to provide training or education property’s value. The market approach to value analyzes the prices paid for the purchase to those employees.

4 of similar properties in the property’s area, with adjustments made for variations between those other properties and the property being appraised. The cost approach to value requires the appraiser to make an estimate of land value and then determine the current cost of reproducing the improvements less any accrued depreciation. The value of the property being financed, as indicated by the appraisal, must be high enough so that it currently supports, and is anticipated to support in the future, the outstanding loan balance.

Source: LBMLT 2006-5 Pros. Sup. S-35, Pros. 27; LBMLT 2006-6 Pros. Sup. S-35-40; LBMLT 2006- 7 Pros. Sup. *42-46; LBMLT 2006-8 Pros. Sup. S-37-42. 4. Statements Regarding Verification of Borrower Income and Assets: The statements are materially misleading because they omit to state that: Each Prospectus states that “[d]uring the underwriting or re-underwriting process, the sponsor reviews and verifies the prospective borrower’s sources of income (only under the full documentation • residential loan program).” Long Beach routinely did not obtain the required documentation and did not employ reasonable methods to verify or substantiate Each Prospectus describes three levels of documentation – Full Documentation; Limited borrower income and assets as purportedly Documentation; Stated Income – as follows: required by the various levels of documentation. Under the full documentation residential loan program, salaried prospective borrowers are

generally required to submit their most recent W-2s and pay stubs and self-employed • prospective borrowers are generally required to submit their most recent federal income tax Long Beach lacked adequate practices and return. procedures to monitor or evaluate the compliance by the employees involved with loan origination with the requirements of the

various levels of documentation or to provide training or education to those employees. Under the limited documentation residential loan program, salaried prospective borrowers

or self-employed prospective borrowers are generally required to submit their most recent • Even with respect to "stated income" six months of personal bank statements or business bank statements. programs, industry standards required that borrower income information be reasonable Under the stated income documentation residential loan program, prospective borrowers in light of the borrower's occupation. are required to state their income on the application but are not required to submit any documents in support.

Source: LBMLT 2006-5 Pros. Sup. S-34-36; LBMLT 2006-6 Pros. Sup. S-35-40; LBMLT 2006-7 Pros. Sup. *42-46; LBMLT 2006-8 Pros. Sup. S-37-42.

5 B. PLMBS backed by mortgages originated by or through Washington Mutual Bank (“Washington Mutual”)

Security CUSIP Defendants WAMU 2006-AR12 1A1 93363NAA3 WaMu Asset Acceptance Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant)

Statements Material Misstatements and Omissions

1. General Statements Regarding Borrower Evaluation. The statements are materially misleading because:

According to the Prospectus, “[t]he sponsor’s underwriting guidelines generally are intended to evaluate the 1. Far from following its underwriting prospective borrower’s credit standing and repayment ability and the value and adequacy of the guidelines and making occasional, targeted mortgaged property as collateral. ” Additionally, the Prospectus asserts that “[t]he sponsor’s credit risk and justified exceptions when other evidence oversight department conducts quality control reviews of statistical samplings of previously originated of ability to repay justified a deviation from mortgage loans on a regular basis.” the guidelines, in fact at Washington Mutual, variance from the stated standards was the The Prospectus further states: norm, and many loans were made with essentially little to no underwriting or effort Prospective borrowers are required to complete a standard loan application in which they to evaluate ability to repay. Nowhere did any provide financial information regarding such factors as their assets, liabilities and related of the Offering Documents apprise the Bank monthly payments, income, employment history and credit history. of the extent to which Washington Mutual deviated from its underwriting guidelines. To evaluate a prospective borrower’s credit history, the loan underwriter obtains a credit report 2. The underwriting practices actually followed relating to the borrower from one or more credit reporting companies, usually in the form of a by Washington Mutual, including the merged credit report. The credit report typically contains information relating to such matters widespread use of exceptions to the stated as credit history with local and national merchants and lenders, installment debt payments and underwriting guidelines, were not “intended any record of defaults, bankruptcy, repossession, suits or judgments. In most cases the credit to evaluate the prospective borrower’s . . . report provides a credit score for the borrower, which represents a numerical weighing of the repayment ability and the value and adequacy borrower’s credit characteristics. of the mortgaged property as collateral.” . . . Some mortgage loans originated through the sponsor’s retail and wholesale lending divisions 3. They omit to state that: have been underwritten in whole or in part through the sponsor’s proprietary automated • underwriting system, known as Enterprise Decision Engine or “EDE”. Based on the borrower’s Washington Mutual had no reliable basis credit report and the information in the borrower’s loan application, the system either (a) on which to conclude that the proprietary approves the loan subject to the satisfaction of specified conditions, which may include the automated underwriting system allegedly receipt of additional documentation, or (b) refers the loan application to an underwriter for employed provided an accurate manual underwriting. In making the underwriting decision, EDE distinguishes between ten assessment of credit standing, or that the different levels of credit standing, based on both the credit score and characteristics of the loan. resulting “ten levels of credit standing” were a reliable indicator of the

6 The sponsor has developed these ten levels of credit standing based on a statistical analysis probability of default. of the past performance of approximately 193,000 mortgage loans originated by the sponsor for its own portfolio between 1998 and 2001. The sponsor has been using EDE for • Due to the industry’s inexperience with underwriting of mortgage loans since January 2005. The sponsor has also used in the past, and lending to borrowers with increased currently uses, other automated underwriting systems. All or some of the mortgage loans credit risks, Washington Mutual lacked owned by the Trust may have been underwritten through EDE or other automated underwriting sufficient data regarding historical systems. patterns of default experienced by borrowers with similar profiles. The Prospectus further states: Consequently, Washington Mutual’s alleged “statistical analysis of the past In evaluating a prospective borrower’s ability to repay a mortgage loan, the loan underwriter performance of . . . mortgage loans considers the ratio of the borrower’s mortgage payments, real property taxes and other originated . . . between 1998 and 2001” monthly housing expenses to the borrower’s gross income (referred to as the “housing-to- was an unreliable foundation upon which income ratio” or “front end ratio”), and the ratio of the borrower’s total monthly debt to predict the credit standing of these (including non-housing expenses) to the borrower’s gross income (referred to as the “debt-to- riskier borrowers. Additionally, the lack income ratio” or “back end ratio”). The maximum acceptable ratios may vary depending on of sufficient historical data rendered the other loan factors, such as loan amount and loan purpose, loan-to-value ratio, credit score and assignment of “maximum acceptable the availability of other liquid assets. ratios” unreliable. . . . For purposes of calculating the “front end” and “back end” ratios for certain Option ARM • Washington Mutual did not employ Loans (which are adjustable-rate mortgage loans whose interest rates are tied to an index, reasonable methods to verify or which have an initial fixed- rate period of between one and twelve months, and which have a substantiate borrower income, which negative amortization feature), the borrower’s monthly mortgage debt is determined based on rendered decisions based on the the fully indexed rate and a predetermined factor as set by the sponsor’s credit department purported debt-to-income ratios from time to time (which rate may be greater than the rate in effect for the mortgage loan unreliable. during the initial fixed-rate period). In addition, for purposes of calculating these ratios for an Option ARM Loan with a 40-year term, the borrower’s monthly mortgage debt is determined • Washington Mutual 's underwriters based on 30-year term. For purposes of calculating the “front end” and “back end” ratios for a routinely accepted appraisals that were Hybrid ARM Loan (which is an adjustable-rate mortgage loan whose interest rate is tied to an not prepared in accordance with the index and which has an initial fixed-rate period of five, seven or ten years), the borrower’s applicable appraising standards in the monthly mortgage debt is the initial scheduled monthly payment, except for certain Hybrid underwriting guidelines. Consequently, ARM Loans with certain loan-to-value ratios or credit scores, that during the initial fixed-rate Washington Mutual used unreliable period require payment of interest only, for which the borrower’s monthly mortgage debt is the appraisals to determine the value of the fully amortizing payment. collateral, which rendered decisions based on LTV ratios unreliable. Source: WAMU 2006-AR12 Pros. Sup. S-26-28. • Washington Mutual lacked an adequate basis upon which it could reliably determine a borrower’s maximum acceptable “housing-to-income” or

7 “debt-to-income” ratio.

• Washington Mutual lacked adequate procedures and practices to monitor or evaluate its underwriters' exercise of judgment, or to provide appropriate training and education to its underwriters.

2. Statements Regarding Exceptions to Standards. The statements are materially misleading because they omit to state that: The Prospectus states: • Washington Mutual routinely granted Exceptions to the sponsor’s loan program parameters may be made on a case-by-case basis if exceptions to its loan program compensating factors are present . In those cases, the basis for the exception is documented, parameters despite the absence of and in some cases the approval of a senior underwriter is required. Compensating factors may meaningful compensating factors. include, but are not limited to, low loan-to-value ratio, low debt-to-income ratio, good credit Moreover, the statements are materially standing, the availability of other liquid assets, stable employment and time in residence at the misleading because they fail to disclose prospective borrower’s current address. that Washington Mutual had no reasonable basis on which to evaluate Source: WAMU 2006-AR12 Pros. Sup. S-28. alleged compensating factors that might warrant exceptions to the underwriting standards.

• Washington Mutual lacked adequate practices, policies or procedures to monitor or evaluate the exercise of underwriter discretion in granting exceptions, or to provide training or education to underwriters.

• Washington Mutual lacked a reliable factual foundation on which to evaluate certain alleged "compensating factors," including a borrower’s "debt-to-income ratio" and "stable employment," because income and employment history were not verified for many mortgages in the pool.

8 3. Statements Regarding Appraisals . The statements are materially misleading because they omit to state that: The Prospectus describes Washington Mutual’s appraisal process as follows: • Washington Mutual routinely accepted The adequacy of the mortgaged property as collateral generally is determined by an appraisal appraisals that were not prepared in made in accordance with pre-established appraisal guidelines. At origination, all appraisals are accordance with applicable appraisal required to conform to the Uniform Standards of Professional Appraisal Practice adopted by standards and were therefore unreliable. the Appraisal Standards Board of the Appraisal Foundation, and are made on forms acceptable to Fannie Mae and/or Freddie Mac. Appraisers may be staff appraisers employed by the • Washington Mutual lacked any reliable sponsor or independent appraisers selected in accordance with the pre-established appraisal basis on which to assess the accuracy of guidelines. Such guidelines generally require that the appraiser, or an agent on its behalf, the values yielded by the described personally inspect the property and verify whether the property is in adequate condition and, if appraisal practices. the property is new construction, whether it is substantially completed. However, in the case of mortgage loans underwritten through the sponsor’s automated underwriting system, an • Washington Mutual lacked adequate automated valuation method may be used, under which the appraiser does not personally policies, practices, and procedures to inspect the property but instead relies on public records regarding the mortgaged property monitor and evaluate compliance with and/or neighboring properties. In either case, the appraisal normally is based upon a market applicable appraisal standards. data analysis of recent sales of comparable properties and, when deemed applicable, a replacement cost analysis based on the current cost of constructing or purchasing a similar • Washington Mutual lacked adequate property. For mortgage loans underwritten under the sponsor’s streamline documentation policies, practices, and procedures to programs, the appraisal guidelines in some cases permit the appraisal obtained for an existing determine the qualifications of mortgage loan to be used. Title insurance is required for all mortgage loans, except that for employees reviewing appraisals or to mortgage loans secured by shares of cooperative apartments, title insurance is not required for provide training or education to those the cooperative apartment building (but a lien search is provided by the title company). employees. Specific additional title insurance coverage is required for some types of mortgage loans.

Source: WAMU 2006-AR12 Pros. Sup. S-27. 4. Statements Regarding Verification of Borrower Income and Assets: The statements are materially misleading because they omit to state that: The Prospectus describes the Washington Mutual’s Full Documentation Program as follows: • Washington Mutual routinely did not Under the sponsor’s full/alternative documentation program, the prospective borrower’s stated obtain the required documentation and income is verified through receipt of the borrower’s most recent pay stub and most recent W-2 did not employ reasonable methods to form or, in the case of self-employed borrowers or borrowers with more than 25% of their verify or substantiate borrower income income from commissions, two years of personal (and, if applicable, business) tax returns. For and assets as purportedly required by the self- employed borrowers, profit and loss statements may also be required. Under the various levels of documentation. full/alternative documentation program, the borrower’s stated assets are verified through receipt of the borrower’s two most recent bank or brokerage statements. In addition, the • Washington Mutual lacked adequate borrower’s employment may be verified with the employer by telephone or by other practices and procedures to monitor or

9 independent means. evaluate the compliance by the employees involved with loan The Prospectus asserts that “[i]n the case of some mortgage loans originated under the sponsor’s origination with the requirements of the streamline documentation programs (described below), the prospective borrower is not required to provide various levels of documentation or to certain financial information, including information about income and assets.” provide training or education to those employees. The Prospectus describes its low and streamline documentation programs as follows: • Many loans were approved under the The sponsor’s low documentation program places increased reliance on the value and “low documentation program” where adequacy of the mortgaged property as collateral, the borrower’s credit standing and (in some borrowers’ stated incomes were not cases) the borrower’s assets. It is available to borrowers with certain loan-to-value ratios, loan “reasonable for the borrower’s amounts and credit scores. Under this program, the income as stated in the borrower’s loan occupation.” application is not verified, although the borrower’s employment may be verified by telephone. The borrower’s stated income must be reasonable for the borrower’s occupation and assets • Because the “streamline” documentation (as determined in the underwriter’s discretion). Assets may be verified for higher risk program does not require verification of transactions and when exceptions are approved, such as when specific loan-to-value ratios or income, Washington Mutual did not have loan amount limits are exceeded. a reliable basis upon which to determine debt-to-income ratios, and thus the The sponsor has several “streamline” documentation programs under which the prospective asserted “maximum debt-to-income borrower’s income and assets either are not required to be obtained or are obtained but not ratios” were not reliable criteria for verified. Eligibility criteria vary but may include minimum credit scores, maximum loan waiving verification of income and amounts, maximum debt-to-income ratios and specified payment histories on an existing employment. mortgage loan (generally, a history of timely mortgage payments for the past twelve months, or for the duration of the mortgage loan if less than twelve months old) or on other debt. Purchase loans as well as refinance loans may be eligible under the streamline documentation programs. For some mortgage loans that qualify under these programs, the borrower’s income and assets are not required to be obtained. For some other mortgage loans that qualify under these programs, the borrower’s income and assets are obtained but not verified, the borrower’s employment is verified with the employer by telephone, and the borrower’s stated income must be reasonable for the borrower’s occupation and assets (as determined in the underwriter’s discretion).

Source: WAMU 2006-AR12 Pros. Sup. S-26-28.

10 APPENDIX IV

TABLE OF CONTENTS

DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND OMISSIONS REGARDING THE CREDIT RATING PROCESS AND THE AAA RATING OF THE PLMBS...... 1

A. PLMBS Issued by Depositor Long Beach Securities Corp...... 1

B. PLMBS Issued by Depositor WaMu Asset Acceptance Corp...... 2

i APPENDIX IV

DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND OMISSIONS REGARDING THE CREDIT RATING PROCESS AND THE AAA RATING OF THE PLMBS

A. PLMBS Issued by Depositor Long Beach Securities Corp.

Security CUSIP Defendants Long Beach Securities Corp. (Depositor Defendant) Merrill Lynch, Pierce, Fenner & Smith Incorporated LBMLT 2006-5 2A3 54251PAD9 (Underwriter Defendant) WaMu Capital Corp. (Underwriter Defendant) Banc of America Securities LLC (Underwriter Defendant) Credit Suisse Securities (USA) LLC (Underwriter Defendant) LBMLT 2006-6 2A3 54251RAD5 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant) Goldman, Sachs & Co. (Underwriter Defendant) LBMLT 2006-7 2A3 54251TAD1 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant) Greenwich Capital Markets, Inc. (Underwriter Defendant) LBMLT 2006-8 2A3 54251UAD8 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant)

Each Prospectus states the following with respect to the credit ratings received by the bonds:

A securities rating addresses the likelihood of the receipt by a certificateholder of distributions on the mortgage loans. The rating takes into consideration the characteristics of the mortgage loans and the structural, legal and tax aspects associated with the certificates . The ratings on the offered certificates do not, however, constitute statements regarding the likelihood or frequency of prepayments on the mortgage loans, the payment of the Net WAC Rate Carryover Amount or the possibility that a holder of an offered certificate might realize a lower than anticipated yield. . . . A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating organization. The rating assigned to each class of offered certificates by each rating agency is based on that rating agency’s independent evaluation of that class of certificates. The rating assigned to a class of offered certificates by one rating agency may not correspond to any rating assigned to that class by any other rating agency. In the event that the ratings initially assigned to any of the offered certificates by the rating agencies are subsequently lowered for any reason, no person or entity is obligated to provide any additional support or credit enhancement with respect to such offered certificates.

Source: LBMLT 2006-5 Pros. Sup. S-134-35; LBMLT 2006-6 Pros. Sup. S-138; LBMLT 2006- 7 Pros. Sup. S-140; LBMLT 2006-8 Pros. Sup. S-139.

1 B. PLMBS Issued by Depositor WaMu Asset Acceptance Corp.

Security CUSIP Defendants WaMu Asset Acceptance Corp. (Depositor Defendant) WAMU 2006-AR12 1A1 93363NAA3 WaMu Capital Corp. (Underwriter Defendant)

The Prospectus states the following with respect to the credit ratings received by the bonds:

The ratings on the offered certificates address the likelihood of the receipt by holders of the offered certificates of all distributions on the underlying mortgage loans to which they are entitled. They do not address the likely actual rate of prepayments. The rate of prepayments, if different than originally anticipated, could adversely affect the yield realized by holders of the offered certificates or cause the holders of the certificates entitled to interest only to fail to recover their initial investment. . . . A security rating is not a recommendation to buy, sell or hold securities and may be subject to revision or withdrawal at any time by the assigning rating agency. The rating assigned to each class of offered certificates by each rating agency is based on that rating agency's independent evaluation of that class of certificates. The rating assigned to a class of offered certificates by one rating agency may not correspond to any rating assigned to that class by any other rating agency.

The ratings assigned to this issue do not constitute a recommendation to purchase or sell these securities. Rather, they are an indication of the likelihood of the payment of principal and interest as set forth in the transaction documentation. The ratings do not address the effect on the certificates' yield attributable to prepayments or recoveries on the underlying mortgage loans. Further, the ratings on the Class X Certificates do not address whether investors will recover their initial investment. Additionally, the ratings on the Class 2-P Certificates address only the return of the Class 2-P Principal Balance, and the ratings on the Class R Certificates address only the return of the Class R Principal Balance and interest on that balance at the stated rate.

The ratings on the offered certificates address the likelihood of the receipt by certificateholders of all distributions with respect to the underlying mortgage loans to which they are entitled. The ratings do not represent any assessment of the likelihood that the rate of principal prepayments by mortgagors might differ from those originally anticipated. As a result of differences in the rate of principal prepayments, certificateholders might suffer a lower than anticipated yield to maturity.

Source: WAMU 2006-AR12 Pros. Sup. S-15, S-93.

2 APPENDIX V

TABLE OF CONTENTS

DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND OMISSIONS REGARDING THE MORTGAGE ORIGINATORS’ COMPLIANCE WITH PREDATORY LENDING RESTRICTIONS ...... 1

A. PLMBS Issued by Long Beach Securities Corp...... 1

B. PLMBS Issued by Depositor WaMu Asset Acceptance Corp...... 2

i APPENDIX V

DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND OMISSIONS REGARDING THE MORTGAGE ORIGINATORS’ COMPLIANCE WITH PREDATORY LENDING RESTRICTIONS

A. PLMBS Issued by Long Beach Securities Corp.

Security CUSIP Defendants Long Beach Securities Corp. (Depositor Defendant) Merrill Lynch, Pierce, Fenner & Smith Incorporated LBMLT 2006-5 2A3 54251PAD9 (Underwriter Defendant) WaMu Capital Corp. (Underwriter Defendant) Banc of America Securities LLC (Underwriter Defendant) Credit Suisse Securities (USA) LLC (Underwriter Defendant) LBMLT 2006-6 2A3 54251RAD5 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant) Goldman, Sachs & Co. (Underwriter Defendant) LBMLT 2006-7 2A3 54251TAD1 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant) Greenwich Capital Markets, Inc. (Underwriter Defendant) LBMLT 2006-8 2A3 54251UAD8 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant)

Each Prospectus states the following with respect to compliance with predatory lending laws:

Under the mortgage loan purchase agreement pursuant to which the sponsor will sell the mortgage loans to the depositor, the sponsor will make representations and warranties in respect of the mortgage loans, which representations and warranties the depositor will assign to the trust pursuant to the pooling agreement. Among those representations and warranties are the following . . . [e]ach mortgage loan at origination complied in all material respects with applicable local, state and federal laws, including , without limitation, predatory and abusive lending usury, equal credit opportunity , real estate settlement procedures, truth-in-lending and disclosure laws. . . . The sponsor will represent that at origination each mortgage loan complied with all applicable federal and state laws and regulations. In addition, the sponsor will represent that none of the mortgage loans is subject to the requirements of the Home Ownership and Equity Protection Act of 1994 (“HOEPA”) or is a “high cost” or “predatory” loan under any state or local law or regulation applicable to the originator of such mortgage loan , or which would result in liability to the purchaser or assignee of such mortgage loan under any predatory or abusive lending law. In the event of a breach of any of such representations, the sponsor will be obligated to cure such breach or repurchase or replace the affected mortgage loan . . . .

1 Under the anti-predatory lending laws of some states, the mortgagor is required to meet a net tangible benefits test in connection with the origination of the related mortgage loan. This test may be highly subjective and open to interpretation. As a result, a court may determine that a mortgage loan does not meet the test even if an originator reasonably believed that the test was satisfied. Any determination by a court that a mortgage loan does not meet the test will result in a violation of the state anti-predatory lending law, in which case the sponsor will be required to repurchase such mortgage loan from the trust.

In addition to HOEPA, a number of legislative proposals have been introduced at the federal, state and local level that are designed to discourage predatory lending practices. Some states have enacted, or may enact, laws or regulations that prohibit inclusion of some provisions in mortgage loans that have mortgage rates or origination costs in excess of prescribed levels, and require that mortgagors be given certain disclosures prior to the consummation of such mortgage loans. In some cases, state law may impose requirements and restrictions more stringent than those in HOEPA. An originator’s failure to comply with these laws could subject the trust, and other assignees of the mortgage loans, to monetary penalties and could result in mortgagors exercising their rights to rescind their mortgage loans against either the trust or subsequent holders of the mortgage loans. Lawsuits have been brought in various states making claims against assignees of high cost mortgage loans for violations of state law. Named defendants in these cases include numerous participants within the secondary mortgage market, including some securitization trusts.

Source: LBMLT 2006-5 Pros. Sup. S-26-27; LBMLT 2006-6 Pros. Sup. (34-35); LBMLT 2006- 7 Pros. Sup. (34-35); LBMLT 2006-8 Pros. Sup. (34-35).

B. PLMBS Issued by Depositor WaMu Asset Acceptance Corp.

Security CUSIP Defendants WaMu Asset Acceptance Corp. (Depositor Defendant) WAMU 2006-AR12 1A1 93363NAA3 WaMu Capital Corp. (Underwriter Defendant)

The Prospectus states the following with respect to compliance with predatory lending laws:

Under the mortgage loan sale agreement pursuant to which the sponsor will sell the mortgage loans to the depositor, the sponsor will make representations and warranties in respect of the mortgage loans, which representations and warranties the depositor will assign to the Trust pursuant to the pooling agreement. Among those representations and warranties [is the warranty that e]ach mortgage loan at the time it was made complied with all applicable local, state and federal laws, including, without limitation, usury, equal credit opportunity, disclosure and recording laws, and predatory and abusive lending laws applicable to the originating lender . . . .

2 In addition to HOEPA, a number of legislative proposals have been introduced at the federal, state and local government levels that are designed to discourage predatory lending practices. Some state and local governments have enacted, and other states or local governments or the federal government may enact, laws that impose requirements and restrictions greater than those of HOEPA. These laws prohibit inclusion of some provisions in mortgage loans that have interest rates or origination costs in excess of prescribed levels, and require that borrowers be given certain disclosures prior to the consummation of the mortgage loans. Purchasers or assignees of a mortgage loan, including the related trust, could be exposed to all claims and defenses that the mortgagor could assert against the originator of the mortgage loan for a violation of law. Claims and defenses available to the borrower could include monetary penalties, rescission and defenses to a foreclosure action or an action to collect.

Source: WAMU 2006-AR12 Pros. Sup. S-46, Pros. 92-93.

3 APPENDIX VI

TABLE OF CONTENTS

DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND OMISSIONS REGARDING THE DUE DILIGENCE PERFORMED ON THE MORTGAGE POOLS THAT BACKED THE PLMBS PURCHASED BY THE BANK ...... 1

A. PLMBS Issued by Long Beach Securities Corp...... 1

B. PLMBS Issued by Depositor WaMu Asset Acceptance Corp...... 2

i APPENDIX VI

DEFENDANTS’ MATERIALLY MISLEADING STATEMENTS AND OMISSIONS REGARDING THE DUE DILIGENCE PERFORMED ON THE MORTGAGE POOLS THAT BACKED THE PLMBS PURCHASED BY THE BANK

A. PLMBS Issued by Long Beach Securities Corp.

Security CUSIP Defendants Long Beach Securities Corp. (Depositor Defendant) Merrill Lynch, Pierce, Fenner & Smith Incorporated LBMLT 2006-5 2A3 54251PAD9 (Underwriter Defendant) WaMu Capital Corp. (Underwriter Defendant) Banc of America Securities LLC (Underwriter Defendant) Credit Suisse Securities (USA) LLC (Underwriter Defendant) LBMLT 2006-6 2A3 54251RAD5 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant) Goldman, Sachs & Co. (Underwriter Defendant) LBMLT 2006-7 2A3 54251TAD1 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant) Greenwich Capital Markets, Inc. (Underwriter Defendant) LBMLT 2006-8 2A3 54251UAD8 Long Beach Securities Corp. (Depositor Defendant) WaMu Capital Corp. (Underwriter Defendant)

Each Prospectus states the following with respect to the Sponsor’s due diligence:

As part of its quality control system, the sponsor re-verifies information that has been provided by the mortgage brokerage company prior to funding a loan and the sponsor conducts a post-funding audit of every origination file. In addition, Washington Mutual Bank, as servicer, periodically audits files based on a statistical sample of closed loans. In the course of its pre-funding review, the sponsor re-verifies the income of each prospective borrower or, for a self- employed prospective borrower, reviews the income documentation obtained under the full documentation and limited documentation residential loan programs. The sponsor generally requires evidence of funds to close on the mortgage loan.

Source: LBMLT 2006-5 Pros. Sup. S-36; LBMLT 2006-6 Pros. Sup. S-37; LBMLT 2006-7 Pros. Sup. S-39; LBMLT 2006-8 Pros. Sup. S-39.

1 B. PLMBS Issued by Depositor WaMu Asset Acceptance Corp.

Security CUSIP Defendants WaMu Asset Acceptance Corp. (Depositor Defendant) WAMU 2006-AR12 1A1 93363NAA3 WaMu Capital Corp. (Underwriter Defendant)

Each Prospectus states the following with respect to the Sponsor’s due diligence:

The sponsor’s credit risk oversight department conducts quality control reviews of statistical samplings of previously originated mortgage loans on a regular basis.

Source: WAMU 2006-AR12 Pros. Sup. S-28.

2