Case 1:11-cv-04209-BSJ-JCF Document 23 Filed 06/01/12 Page 1 of 72
UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
x IBEW LOCAL 90 PENSION FUND, On Civil Action No. 1 1-cv-04209-BSJ-JCF Behalf of Itself and All Others Similarly Situated, CLASS ACTION
Plaintiff, • LEAD PLAINTIFFS' AMENDED • COMPLAINT FOR VIOLATION OF THE IY1! FEDERAL SECURITIES LAWS
DEUTSCHE BANK AG, et al., DEMAND FOR JURY TRIAL Defendants. x
683198_i Case 1:11-cv-04209-BSJ-JCF Document 23 Filed 06/01/12 Page 2 of 72
TABLE OF CONTENTS
Page
I. INTRODUCTION ...... 1
II. JURISDICTION AND VENUE...... 4
III. THE PARTIES...... 5
IV. FRAUDULENT SCHEME AND COURSE OF BUSINESS ...... 6
V. MISCONDUCT REVEALED BY THE LEVIN-COBURN SUBCOMMITTEE...... 7
VI. MISCONDUCT REVEALED BY THE DEPARTMENT OF JUSTICE INVESTIGATION...... 28
VII. MISCONDUCT REVEALED BY THE FEDERAL HOUSING FINANCE AGENCY INVESTIGATION AND ALLEGATIONS ...... 45
VIII. DEFENDANTS' FALSE AND MISLEADING STATEMENTS ISSUED DURING THE CLASS PERIOD ...... 48
IX. LOSS CAUSATION/ECONOMIC LOSS ...... 62
X. CLASS ACTION ALLEGATIONS ...... 65
XI. PRAYER FOR RELIEF ...... 66
XII. JURY DEMAND...... 67
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I. INTRODUCTION
1. This is a securities class action on behalf of all persons who purchased or otherwise acquired the ordinary shares of Deutsche Bank AG ("Deutsche Bank" or the "Company") between
January 3, 2007 and January 16, 2009, inclusive (the "Class Period"), against Deutsche Bank and certain of its officers and/or directors for violations of the Securities Exchange Act of 1934 ("1934
Act"). On December 5, 2011, Building Trades United Pension Trust Fund, the Steward Global
Equity Income Fund and the Steward International Enhanced Index Fund were appointed lead plaintiffs in this action pursuant to the Private Securities Litigation Reform Act of 1995 ("PSLRA").
2. Deutsche Bank is a global investment bank based in Frankfurt, Germany, with branch offices in the United States and around the globe. The Company's shares are listed on the New York
Stock Exchange ("NYSE").
3. During the Class Period, executives and officers at Deutsche Bank and its subsidiaries oversaw a scheme to maximize profits by originating and acquiring fraudulent and misrepresented residential mortgages and bundling those mortgages into pools of mortgages called residential mortgage-backed securities ("RMBS"). An RMBS is a type of bond in which investors acquire an interest in the principal and interest payments generated by the underlying pool of residential mortgages. Each RIVIBS, moreover, is subdivided into a series of securities enjoying different levels of seniority, with the most senior securities being the least risky because they are paid first, and the most junior securities being the most risky since they are the first not to be paid if the underlying residential mortgages default. The most risky portions or interests in the various RMBS were re- bundled into yet another security called a Collateralized Debt Obligation ("CDO"), and then resold to other investors, generating even more profits for Deutsche Bank from the poor quality and fraudulent residential mortgages.
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4. Because substantial profits could be made by packaging and selling the RMBS and
CDOs, defendants were willing to ignore the concealed risks associated with the poor quality of the underlying mortgages. Indeed, in order to expand its access to residential mortgages, Deutsche Bank acquired MortgagelT Holdings, Inc. ("MortgagelT"), an aggressive residential mortgage lender, on
January 3, 2007. MortgagelT lent hundreds of millions of dollars of loans to financially unqualified borrowers who ultimately defaulted on their loans. Deutsche Bank eventually incurred billions of dollars of losses due to poor quality and improperly underwritten mortgages originated by
MortgagelT and acquired from other sources, including residential mortgages pooled into RMBS and CDO structures.
5. According to an August 17, 2010 report by Compass Point Research & Trading, LLC, entitled "Mortgage Repurchases Part II: Private Label RMBS Investors Take Aim - Quantifying the
Risks," Deutsche Bank Securities Inc. underwrote $5.6 billion of subprime RMBS in 2005, $4.3 billion in 2006, and $10.1 billion in 2007. According to Deutsche Bank's 2006 Annual Report to investors, the "expan[sion into] residential mortgage-backed securities" helped Deutsche Bank generate "record revenues." Unfortunately, Deutsche Bank's involvement in the origination and sale of RMBS was characterized by rapid growth and improper mortgage underwriting.
6. In fact, Deutsche Bank structured and marketed mortgage-backed securities that were internally described as "crap" and "pigs," and then transferred many of these assets to unknowing third parties. Defendants misrepresented Deutsche Bank's risk management practices and concealed the Company's failure to write down impaired securities containing mortgage-related debt.
Deutsche Bank and its mortgage origination subsidiary intentionally disregarded findings that residential mortgage loans did not comply with underwriting guidelines. As a result of defendants'
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false statements, Deutsche Bank shares traded at artificially inflated prices during the Class Period, reaching a high of $159.59 per share in May 2007.
7. Eventually, Deutsche Bank's shares declined after it reported billions of dollars in losses directly or indirectly related to mortgage-backed securities. After the losses were announced, and following the Class Period, three government entities - the U.S. Senate Permanent
Subcommittee on Investigations ("Levin-Coburn Subcommittee"), the U.S. Department of Justice
("DOJ") and the Federal Housing Finance Agency ("FHFA") - initiated investigations or litigation as a result of Deutsche Bank's misconduct.
8. On April 13, 2011, the Levin-Coburn Subcommittee issued a report entitled "Wall
Street and the Financial Crisis: Anatomy of a Financial Collapse" (the "Levin-Coburn Report"). The report relies on internal Deutsche Bank records and employee interviews, documents numerous occasions where the residential mortgages and related securities were described as "generally horrible," having "a real chance of massively blowing up," and a Ponzi scheme. Indeed, Deutsche
Bank's top RMBS trader stated that he wanted to "try and dupe" an investor into buying an RMBS.
The report demonstrates Deutsche Bank's internal awareness of the poor quality of residential mortgages and the associated securities that Deutsche Bank was marketing.
9. On May 3, 2011, the DOJ sued Deutsche Bank for misrepresenting its mortgage loans and default review procedures. The suit sought as much as $1 billion from Deutsche Bank. A May
4, 2011, The Wall Street Journal headline blared:
U.S. Says Deutsche Bank Lied
Suit Accuses Lender ofMisrepresenting Quality ofLoans Made by Mortgage Unit
10. The DOJ accused Deutsche Bank of lying about the quality of loans. On May 10,
2012, Deutsche Bank entered into a Stipulation and Order of Settlement and Dismissal agreeing to
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pay compensation of $202.3 million and accepting responsibility for failing to comply with federal regulations controlling the U.S. Department of Housing and Urban Development ("HUD") - Federal
Housing Administration ("FHA") mortgage certification.
11. On September 2, 2011, the FHFA, as Conservator for the Federal National Mortgage
Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), sued Deutsche Bank and MortgagelT Securities Corporation in the United States District Court for the Southern District of New York for falsely representing that RMBS sold by Fannie Mae and
Freddie Mac complied with underwriting requirements and standards and alleging that the defendants had significantly overstated the value of the collateralized property and the ability of mortgage borrowers to repay their loans. Throughout the Class Period, however, defendants assured shareholders and analysts that they were "comfortable" with their mortgage exposure and that adequate loss provisions had been taken.
12. As a result of defendants' false statements, Deutsche Bank shares traded at inflated prices during the Class Period. However, after the above revelations seeped into the market, and
Deutsche Bank absorbed billions of dollars of residential mortgage-related losses, the Company's shares were hammered by massive sales, sending them down more than 86% from their Class Period high.
II. JURISDICTION AND VENUE
13. Jurisdiction is conferred by §27 of the 1934 Act (15 U.S.C. §78aa). The claims asserted herein arise under §10(b) and 20(a) of the 1934 Act (15 U.S.C. §78j(b) and 78t(a)) and
U. S. Securities and Exchange Commission ("SEC") Rule lOb-S (17 C.F.R. §240.1Ob-5).
14. Venue is proper here pursuant to §27 of the 1934 Act and 28 U.S.C. § 1391(b). Many of the false and misleading statements were made in or issued from this District. Deutsche Bank has
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offices in this District and many of the acts and transactions giving rise to the violations of law complained of occurred here.
15. In connection with the acts alleged in this complaint, defendants, directly or indirectly, used the means and instrumentalities of interstate commerce, including, but not limited to, the mails, interstate telephone communications and the facilities of the national securities markets.
III. THE PARTIES
16. Lead Plaintiff Building Trades United Pension Trust Fund purchased Deutsche Bank shares during the Class Period, as described in the certification previously filed with the Court and was damaged thereby.
17. Lead Plaintiffs the Steward Global Equity Income Fund and the Steward International
Enhanced Index Fund purchased Deutsche Bank shares during the Class Period, as described in the certification previously filed with the Court and were damaged thereby.
18. Defendant Deutsche Bank is a global investment bank headquartered in Frankfurt,
Germany, and has branch offices in the United States and around the globe.
19. Defendant Josef Ackermann ("Ackermann") is, and at all relevant times was, Chief
Executive Officer ("CEO"), Chairman of the Management Board and Chairman of the Group
Executive Committee of Deutsche Bank.
20. Defendant Clemens Börsig ("Borsig") is, and at all relevant times was, Chairman of the Supervisory Board of Deutsche Bank.
21. Defendant Hugo Bänziger ("Banziger") is, and at all relevant times was, a member of the Management Board, Chief Risk Officer and a member of the Group Executive Committee of
Deutsche Bank.
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22. Defendant Anthony Di Iorio ("Di Iorio") was a member of the Management Board,
Chief Financial Officer ("CFO") and a member of the Group Executive Committee of Deutsche
Bank until he retired from Deutsche Bank on September 30, 2008.
23. Defendants Ackermann, Börsig, Bänziger and Di Iorio (the "Individual Defendants"), because of their positions with the Company, possessed the power and authority to control the contents of Deutsche Bank's quarterly reports, press releases and presentations to securities analysts, money and portfolio managers and institutional investors, i.e., the market. They were provided with copies of the Company's reports and press releases alleged herein to be misleading prior to or shortly after their issuance and had the ability and opportunity to prevent their issuance or cause them to be corrected. Because of their positions with the Company, and their access to material non-public information, available to them but not to the public, the Individual Defendants knew that the adverse facts specified herein had not been disclosed to and were being concealed from the public and that the positive representations being made were then materially false and misleading. The Individual
Defendants are liable for the false statements pleaded herein.
IV. FRAUDULENT SCHEME AND COURSE OF BUSINESS
24. Defendants are liable for: (i) employing a scheme to defraud; (ii) making false statements; (iii) engaging in an act, practice or course of business that operated as a fraud; and (iv) failing to disclose adverse facts known to them about Deutsche Bank. Defendants' fraudulent scheme and course of business was a success, as it: (i) deceived the investing public regarding
Deutsche Bank's prospects and business; (ii) artificially inflated the price of Deutsche Bank shares; and (iii) caused plaintiffs and other members of the Class (defined below) to purchase Deutsche
Bank shares at inflated prices.
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V. MISCONDUCT REVEALED BY THE LEVIN-COBURN SUBCOMMITTEE
25. On April 13, 2011, the U.S. Senate's Levin-Coburn Subcommittee issued the Levin-
Coburn Report in response to the national financial crisis and subprime mortgage scandal. The allegations in this section summarize and incorporate findings and evidence cited in the Levin-
Coburn Report. The Levin-Coburn Report relies on and cites numerous Deutsche Bank documents and employee interviews. The Levin-Coburn Report included a specific case study discussion on how Deutsche Bank contributed to the financial crisis through "a variety of troubling and sometimes abusive practices involving the origination or use of RMBS ... instruments," including the construction ofRMBS "with assets that senior employees within the investment banks knew were of poor quality" and a reliance on "lenders known within the industry for issuing high risk, poor quality mortgages."
26. In fact, Deutsche Bank's top global RMBS trader, Greg Lippmann ("Lippmann"), repeatedly warned Deutsche Bank officers and employees concerning the poor quality of RMBS, describing the securities as "crap" and "pigs," warning that the assets would lose value, admitting he would "try to dupe" an investor into buying a specific RMBS and referring to RMBS marketing as a
Ponzi scheme. In order to preserve executive bonuses and the income generated by the RMBS markets (Deutsche Bank was typically paid $5 to $10 million for an RMBS offering according to
Michael Lamont ("Lamont"), co-head of the Deutsche Bank CDO Group), Deutsche Bank continued to sell misleading RMBS products, even as the U.S. mortgage market deteriorated, and eventually lost $4.5 billion as Lippmann's warnings were proven correct.
27. As revealed by internal Deutsche Bank e-mails, Lippmann repeatedly warned
Deutsche Bank colleagues in 2006 and 2007 of the poor quality of the mortgages underlying RMBS and CDO securities. Lippmann eventually "shorted" mortgage-related securities to the tune of at
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least $5 billion by making investments that relied on declines in the value of mortgage-related securities to make a profit. On February 24, 2006, Lippmaim advised that "THIS BOND BLOWS," in describing an RMBS security named LBMLT 2004-3 M8. An April 5, 2006 e-mail concerning
RMBS "shelves" warned: "[Y]ikes didnt see that[.]. . . [H]alf of these are crap and rest are ok." In the context of recommending a "short" position, a June 23, 2006 e-mail explained that "[t]his is a good pool for you because it has a fair number of weak names but not so many that investors should balk." Again, in the context of recommending a bet against the RMBS, an August 4, 2006 e-mail explained that "you can certainly build a portfolio by picking only bad names and you have largely done that as Rasc ahl is considered bad as is [Fremont] . . . ace, arsi and lbmlt." Lippmann listed
ACE Securities Corporation ("ACE") as a bad name even though it was created by Deutsche Bank itself and acted as its administrative agent.
28. An August 23, 2006 e-mail to Lamont, co-head of the Deutsche Bank CDO Group and Richard d'Albert ("d'Albert"), Global Head of Deutsche Bank's Securitized Products Group, explained: "I was going to reject this [long purchase of a synthetic CDO] because it seems to be a pig cdo position dump 60" but then I noticed [W]inchester [Deutsche Bank affiliated hedge fund] is the portfolio selector ... any idea???" An August 30, 2006 e-mail to a hedge fund trader at
Spinnaker Capital asking about a subprime RMBS security issued by Credit-Based Asset Servicing and Securitization LLC explained: "That said I can probably short this name to some CDO fool."
29. A September 1, 2006 e-mail explained that a subprime RMBS security issued by
Mortgage Asset Securitization Transactions Asset-Backed Securities Trust "RARELY TRADES IN
[THE] SYNTHETIC MARKET AND WILL BE TOUGH FOR US TO COVER I.E. SHORT TO A
CDO FOOL. THAT SAID IF U GAVE US AN ORDER AT 260 WE WOULD TAKE IT AND
TRY TO DUPE SOMEONE." A September 1, 2006 e-mail described a subprime RMBS security
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that contained Fremont Investment & Loan ("Fremont") loans issued by Mortgage Asset
Securitization Transactions Asset-Backed Securities Trust, as a "CRAP BOND." A September 21,
2006 e-mail: (i) described MSHEL 2006-1 B3, an RMBS security issued by Morgan Stanley, as
"crap we shorted"; (ii) referred to GSAMP 2006-HE3 M9, an RMBS security issued by Goldman
Sachs & Co. ("Goldman Sachs"), as "this bond su[c]ks but we are short 20MM"; and (iii) noted with regard to ACE, which was created by and associated with Deutsche Bank, that "ace is generally horrible." A December 4, 2006 e-mail to a client selecting bonds to short stated: "[You] have picked some crap right away so [you] have figured it out." A December 8, 2006 e-mail regarding GSAMP
06-NC2 M8, an RMBS security issued by Goldman Sachs warned: "[T]his is an absolute pig." A
March 1, 2007 e-mail described ABSHE 2006-HE 1 M7, a subprime RMBS security issued by Asset
Backed Securities Corporation Home Equity Loan Trust, as a "CRAP DEAL"; and described ACE
2006 HE2 M7, a subprime RMBS securitization issued by ACE, as: "DEAL IS A PIG!"
30. Lippmann's warnings were not limited to a limited set of CDOs, but extended to the
RMBS/CDO market as a whole. In August 2006, Lippmann wrote "I DONT CARE WHAT SOME
TRAINED SEAL BULL MARKET RESEARCH PERSON SAYS THIS STUFF HAS A REAL
CHANCE OF MASSIVELY BLOWING UP." In a March 4, 2007 e-mail, Lippmann warned,
"these are blowing up whether people like it or no[t]. . .. Can't blame them because if this blows up lots of people lose their jobs so they must deny[] in hope that [this] will help prevent the collapse."
On June 23, 2007, Lippmann explained to a Deutsche Bank colleague that "how do you think the foreign banks will feel when they see that the true mark [market value] for what they have is. . . this could be the end of the cdo biz."
31. Deutsche Bank also pressured rating agencies into assigning ratings that Deutsche
Bank knew were inflated. For example, in a March 8, 2007 e-mail, obtained by U.S. Senate
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investigators, a Moody's Investors Service, Inc. ("Moody' s") analyst complained to a colleague that after Moody's suggested certain downward rating adjustments for a particular RMBS, a Deutsche
Bank investment banker "push[ed] back dearly saying that the deal has been marketed already and that [Moody's] came back 'too late' with this discovery." According to the analyst, the investment banker further argued that it was "hard" for Deutsche Bank to "change the structure at this point," effectively conceding that the rating assigned to the RMBS would not reflect the actual likelihood of default.
32. A former Senior Vice President and Senior Credit Officer at Moody's, Richard
Michalek, testified to the Levin-Coburn Subcommittee that a Deutsche Bank investment banker once told Richard Michalek: "I'll be gone, you'll be gone. So why are you making life difficult right now over this particular comment?" According to Richard Michalek, the comment exemplified "short- term thinking" on the part the investment banks: "Short term, get this deal done, get this quarter closed, get this bonus booked, because I do not know whether or not my group is going to be here at the end of next quarter, so I have to think of this next bonus."
33. On October 18, 2010, Lippmann told the Levin-Coburn Subcommittee that in the fall of 2005, he requested permission to establish a proprietary trading position that would short RMBS securities. He made this request after reviewing data he received from a Deutsche Bank quantitative analyst, Eugene Xu. The data showed that even a moderate slow down in rising housing prices would result in significant subprime mortgage defaults, that there was considerable correlation among these subprime mortgages, and that the defaults would affect BBB rated RMBS securities.
34. In the fall of 2005, Lippmann approached his supervisor d'Albert, Global Head of the
Structured Products Group, for permission to enter into Credit Default Swap ("CDS") agreements to short RMBS securities totaling $1 billion. He said that he explained that a cost benefit analysis
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favored a short RMBS position. Lippmann also developed a presentation supporting his position entitled, "Shorting Home Equity Mezzanine Tranches." It made the following points:
• "Over 50% of outstanding subprime mortgages are located in MSAs [metropolitan statistical areas] with double digit 5 year average of annual home price growth rates"
• "There is a strong negative correlation between home price appreciation and loss severity"
• "Defaults of subprime mortgages are also strongly negatively correlated with home price growth rates"
• "Nearly $440 billion subprime mortgages will experience payment shocks in the next 3 years"
• "If home-price appreciation rates slow-down to 5% p.a. for MSAs currently having double-digit rates, losses (both defaults and severity ratios) may increase substantially in these MSAs"
35. According to Lippmann, d'Albert approved his taking the short position in or around
November 2005, but said the trade was so big and controversial that Lippmann also had to get the approval of Rajeev Misra ("Misra"), Global Head of Credit Trading, Securitization and
Commodities, based in London. Around November 2005, Misra approved the short position.
36. Throughout 2006, Lippmann accumulated a larger short position, which eventually reached $2 billion and, according to Lippmann, Deutsche Bank senior management went along. At one point in 2006, Boaz Weinstein, who reported to Misra, told Lippmann that the carrying costs of his position, which required the bank to pay insurance-like premiums to support the $2 billion short position, had become so large that he had to find a way to pay for them. Senior management asked
Lippmann to persuade them that he was right by demonstrating that others were willing to "short" the market as well.
37. Lippmann did convince some of his other clients, usually hedge funds, to undertake such shorts, primarily by purchasing single name CDS contracts referencing specific RMBS
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securities. Those trades generated substantial sums for the ABS Correlation Trading Desk which
acted as a market maker in the CDS market for those clients. Lippmann told the Levin-Coburn
Subcommittee that the shorts executed by his clients ultimately generated about $200 million in
revenues for his desk in 2006.
38. In late 2006 and early 2007, Lippmann's short position began to gain in value and
caught the attention of senior management at the bank. Lippmann told the Levin-Coburn
Subcommittee that, in January 2007, he met with a senior bank official, Anshu Jam ("Jam"), Head of
Global Markets at Deutsche Bank and a member of Deutsche Bank's Executive Committee, Misra
and d'Albert at a hotel in Lisbon, where all three again challenged him to defend his short position
by noting that it had required him to pay out $20 million in CDS premiums during 2006. Lippmann
told the Levin-Coburn Subcommittee that he countered by pointing out, while he had paid out $20
million, his desk made $200 million from trading in RMBS and CDO shorts for his clients. He said
that the three concluded he could keep his short position.
39. In February 2007, Jain met with Lippmann again to discuss whether or not to keep his
short position, because Deutsche Bank could cash in the position and take the profits at that time. In
late February or early March 2007, as subprime mortgages continued incurring delinquencies at
record rates, an ad hoc meeting of Deutsche Bank's executive committee took place in London to
discuss the bank's risk exposure in mortgage-related securities. According to Deutsche Bank's
internet page, the executive committee includes Deutsche Bank's management board, including
Ackermann as Chairman of the Management Board, Bänziger as Chief Risk Officer, the bank's
Chief Financial Officer and senior representatives from the business divisions within the client-
facing group divisions, including Jain as Head of Global Markets. Lippmann was in London and was invited to attend. Ten to twelve persons were at the meeting in person, and another two to four
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persons participated by telephone. Deutsche Bank executives discussed whether the bank should make any changes in its holdings. At that time, Lippmann held the only large short position on behalf of the bank, then about $4 to $5 billion in size. In contrast, the Deutsche Bank mortgage group held $102 billion in long RMBS and CDO securities, and Winchester Capital, Deutsche
Bank's hedge fund affiliate, held a net long position of $8.9 billion. According to Lippmann's statements to the Levin-Coburn Subcommittee, he argued for the bank to increase its short position.
He told the Levin-Coburn Subcommittee that the decision at the end of the meeting was for all parties to keep their positions unchanged, including Lippmann.
40. At the time of Lippman's meeting with Deutsche Bank's executive committee, his presentation "Shorting Home Equity Mezzanine Tranches/A strategy to cash in on a slowing housing market" had been revised as of February 2007. The report stated:
• "Nearly 60% of outstanding subprime mortgages are located in the MSAs with double digit 6-year average of annual home price growth rates"
• "Defaults of subprime mortgages are also strongly negatively correlated with home price growth rates"
• "There is a strong negative correlation between home price appreciation and loss severity"
• "Nearly $783 billion subprime mortgages will experience payment shocks [due to interest rate adjustments] in the next 3 years"
• "If home price appreciation rates slow-down to 4% p.a. for MSAs currently having double-digit rates, losses (both defaults and severity ratios) may increase substantially in these MSAs"
The report also noted that rating agency ratings models were unreliable. Although the "housing boom in the past 10 years has come to its end," "[r]ating agencies' rating models for subprime mortgage lending criteria and bond subordination levels are based largely on performance experience that has mostly accumulated since the mid- 1990's, when the nation's housing market has
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been booming." In fact, "[h]istorical data show that losses in subprime mortgage collaeral are strongly negatively correlated with home price appreciation." As a result, "[i]n a flat housing market, most subprime RMBS rated BBB- or BBB may come under severe stress."
41. In July 2007, the major credit rating agencies began issuing downgrades of RMBS and CDO securities, in particular, those that incorporated or referenced subprime mortgages. The value of those securities began to plummet. By the end of the summer of 2007, Deutsche Bank initiated efforts to sell off the long positions held by Winchester Capital and other Deutsche Bank entities, reflecting a shift in the bank's strategy, but its sales force had difficulty due to the lack of customers willing to buy long. During 2007 and 2008, at the direction of senior management,
Lippmann gradually cashed in his short position, obtaining a total return of about $1.5 billion, which
Lippmann told the Levin-Coburn Subcommittee he believed was the largest profit obtained from a single position in Deutsche Bank history. Despite the gain from Lippmann's short position,
Deutsche Bank, overall in 2007, had a long position in mortgage-related holdings, with a face value of about $128 billion and a market value of more than $25 billion. Deutsche Bank told the Levin-
Coburn Subcommittee that, despite the size of these holdings and their declining value, it lost about
$4.5 billion on those mortgage-related holdings.
42. Deutsche Bank pursued the CDO market in order to protect investment bank fees, prestige and to preserve the CDO jobs involved. In an August 26, 2006 e-mail, for example,
Lippmann wrote: "Why have we done this? It is not without reluctance and we are looking for ways to get out of this risk, but for now the view has been, we like the fees and the league table credit (and dammit we have a budget to make)." Similarly, on August 1, 2006, Lippmann wrote, "who has all this crap and let me know which ones to look at looks like a lot of crappy deals."
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43. In January 2007, after a trader asked Lippmann why the CDO market hadn't imploded, Lippmann responded: "[L]eague table, fees, never has one blown up yet." The reference to "league table credit" indicates that investment banks considered it prestigious to be listed as the leading producer of a complex structured finance product like CDOs, and used their standing in the tables that tracked total origination numbers as a way of burnishing their reputations, attracting top talent and generating new business. An October 2006 "Progress Report" on its CDO business, for example, which was prepared internally at Deutsche Bank, included a slide entitled, "CDO Primary
Revenue Forecast and League Tables," in which a chart ranked Deutsche Bank third in CDO issuance, behind Merrill Lynch and Citigroup. The slide indicated that Deutsche Bank had completed 38 CDOs to date, had a 7% share of the CDO market, and "expected to close 50 deals by year end," with the "pipeline for Ql and Q2 2007 building." The final page of the presentation, providing a chart listing the top 20 Deutsche Bank CDO salespersons by region, together with their individual sales credits, identifies some of the bank personnel invested in the continuation of the
CDO business.
44. On the issue of fees, the head of Deutsche Bank's CDO Group, Lamont, told the
Levin-Coburn Subcommittee that he estimated the bank received 40-200 basis points for each CDO created, depending upon the complexity of the CDO. He indicated those fees translated into about
$5 to $10 million per CDO. When asked what he meant by saying "we have a budget to make,"
Lippmann explained that new CDO deals had to be completed continuously to produce the revenues needed to support the budgets of the CDO desks and departments involved with their creation.
45. At the end of September 2006, the head of Deutsche Bank's sales force, Sean
Whelan, wrote to Lippmann expressing concern that some CDO tranches were getting increasingly difficult to sell: "[T]he equity and the AAA were the parts we found difficult to place." Lippmann
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told the Levin-Coburn Subcommittee that once firms could not sell an entire CDO to investors, it was a warning that the market was waning, and the investment banks should have stopped structuring new ones. Lippmann told the Levin-Coburn Subcommittee that he thought Lamont's
CDO Group at Deutsche Bank had too many CDOs in the pipeline in the spring of 2007, when it could not sell all of its CDO securities. He reported that he warned Lamont that defaults would increase. Instead of getting out of the CDO business, however, he said, a new source of CDO demand was found - when new CDOs started buying old CDO securities to include in their assets.
One media report explained how this worked:
As the housing boom began to slow in mid-2006, investors became skittish about the riskier parts of those investments. So the banks created - and ultimately provided most of the money for - new CDOs. Those new CDOs bought the hard-to- sell pieces of the original CDOs. The result was a daisy chain that solved one problem but created another: Each new CDO had its own risky pieces. Banks created yet other CDOs to buy those.
46. Lippmann also told the Levin-Coburn Subcommittee that he believed it was a
"shady" practice when, in 2006, difficult-to-sell BBB CDO tranches began to be placed in new
CDOs. In a June 2007 e-mail to Lippmann, Richard Kim, a Deutsche Bank Managing Director, described placing unsold CDO tranches into a new CDO to be sold to investors as a "CD02 balance sheet dump."
47. In addition to placing unsold CDO securities in newly issued CDOs, Deutsche Bank turned increasingly to non-U.S. investors to keep the CDO machine going. In August 2006,
Lippmann noted that European and Asian banks were being targeted to buy CDOs:
Hear what you are saying and in a normal market your logic would be inarguable, but the demand for this crap is virtually entirely technically dri[]ven, all cdos. And each person at the cdo table thinks someone else is the fool - cdo equity, ostensibly only two buyers one mutual fund[] in [A]ustralia ... and one hedge fund in [C]hicago . . . who is actually putting on a bearish correlation trade: bbb sold mostly ponzi-like to other cdos with limited distribution in [E]urope.... A[A] and
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Junior AAA sold mostly to high grade cdos and to a certain extent [E]uropean and [A] sian banks and lastly the senior AAA, this may ultimately break the cdo market.
48. In a December 2006 e-mail, Lippmann wrote to a client: "[W]ho owns the cdos... insurance company and [G]erman and [A]sian banks. . . and high grade cdos (can you say ponzi scheme)[?]" In early 2007, Lippmann wrote:
[T]he other side is all cdos . . [.] so it is the cdo investors who [are] on the other side who buys cdos: aaa - reinsurance, [Wall Street] conduits, [E]uropean and [A]sian banks, aa - high grade cdos, [E]uropean and [A]sian banks and insurers.. [.] some [US] insurers, bbb - o[th]er [mezzanine] [asset-backed security] cdos (i.e., ponzi scheme), [E]uropean banks and insurers, equity some [US] hedge funds, [A]sian insurance companies, [A]ustralian and [J]apanese retail investors through mutual funds.
49. In February 2007, when an investor wrote to Lippmann inquiring about the status of the "CDO machine," Lippmann responded: "[G]etting slower but not dead yet[.].. . 2-5 ramping a day instead of 10-1 5[.]... [H]earing of many investors in [A]sia especially shutting down.. . but the window is not completely shut yet." Deutsche Bank e-mails demonstrate that in 2007, like other investment banks, it was actively trying to sell CDOs in Asia.
50. The Levin-Coburn Report also provides detailed information concerning a specific
$1.1 billion CDO, Gemstone 7, that Deutsche Bank assembled and marketed from October 2006 to
March 2007, even as the CDO market was collapsing and that the Levin-Coburn Report provides as a case study. Deutsche Bank issued the Gemstone 7 securities in March 2007. Six out of the seven tranches received investment grade ratings, including AAA ratings for the top three tranches. Two months later, in July 2007, the major credit rating agencies downgraded 19 of the 115 RMBS included or referenced in Gemstone 7. In November 2007, the credit rating agencies began to downgrade the Gemstone 7 securities. All seven tranches were downgraded to junk status.
Gemstone 7 securities, initially valued at $1.1 billion, were nearly worthless.
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51. Gemstone 7 suffered from significant risks and poor quality assets which Deutsche
Bank was aware of, but failed to disclose to investors in Gemstone 7. According to the Levin-
Coburn Report, in December 2006, Lamont's CDO Group prepared a Credit Report for Deutsche
Bank's credit risk management group to obtain internal approval for the securitization of Gemstone
7. The Credit Report noted the following business risks for Deutsche Bank regarding Gemstone 7,
including the possibility that the bank would be unable to sell $400 million of the Gemstone
securities, which carried "significant" risk:
• "The portfolio is concentrated on RMBS obligations, with 67.6%, 20.2% and 1.9% of the RMBS exposure represented by 2005, 2006, and 2007 vintages, respectively, which results in significant vintage risk."
• "RMBS accounts for 90.0% of the initial collateral portfolio"
• "All unsold tranches have been taken back by HBK except for the Class A-1B ($400mm). Currently, we are working with [redacted] to see if they will be interested to take the tranche."
The business risks described in the internal Deutsche Bank credit report relating to "significant
vintage risk" for the 2005, 2006 and 2007 vintage RMBS securities were not disclosed in the
Gemstone 7 offering materials given to investors, and even though the March 15, 2007 Offering
Circular contained a "Risk Factor" section, the Offering Circular was silent with respect to the above
risks identified in the credit report, which were highlighted for Deutsche Bank management.
52. In fact, while securities were being assembled for Gemstone 7 in late 2006 and early
2007, Lippmann frequently disparaged many of the same assets he and his traders allowed to be
included in Gemstone 7. About $27 million of these assets came from Deutsche Bank's own inventory. In e-mails to colleagues and his clients, Lippmann used words like "crap" and "pig" to describe the assets.
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53. Lippmann brought some of the assets of Gemstone 7 to the attention of some of his clients that shorted these assets. On October 20, 2006, for example, one of Lippmann's clients sent him an e-mail seeking advice about certain subprime bonds issued by Long Beach Mortgage Loan
Trust ("LBMLT") and other originators. Lippmann responded:
LBMLT 06-5 M9 - 375. Long Beach is one of the weakest name[s] in the market. We shorted this bond to a CDO in the mid-300s on [O]ctober 13. Deal was done . . . before S & P changed their criteria on July 1. Lots of 40 year mortgages .... Less than half the loans have full documentation and 10% are investor properties. This is a real pig.
LBMLT 06-2 M9 350. See above on Long Beach. This one is already performing poorly with substantial delinquencies. Further the FICO is less than the 06-5 and there are fewer full doc loans. This seems a better short than the 06-5. Only reason[] I can think for my guys showing you a tighter level is that we are very short this one and that the June 06 deals have a taint that earlier months dont due to the theory that late June deals were crammed with bad stuff in order to beat the S & P revisions.
54. Despite these negative views of LBMLT, Lippmann's group raised no concerns when
$25 million in LBMLT 2006-5 M9 securities was purchased for Gemstone 7's warehouse account,
$20 million of which was purchased on October 24, 2006, four days after Lippmann's e-mail.
Altogether, a total of $79.5 million in LBMLT bonds went into Gemstone 7.
55. Lippmann was similarly critical of RMBS securities containing subprime loans originated by Fremont, but did not object to including Fremont securities in Gemstone 7. On
December 6, 2006, Lippmann's traders included $20 million of an RMBS known as SABR 2005-
FR4 B3 for Gemstone 7, which contained Fremont loans. One week earlier, in a November 29, 2006 e-mail, when asked by a bank colleague about the same RMBS security, Lippmann labeled it a
"PIG." Two days later, on December 1, 2006, Lippmann declared in an e-mail to a client that the security was "blowing up." On November 29, 2006, Lippmann called still another RMBS security with Fremont loans, FHLT 2005-A M9, a "pig." Yet a month earlier, on October 30, 2006,
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approximately $1 million of FHLT 2005-A M9 had been purchased for Gemstone 7, with no objection from Lippmann's trading desk.
56. Lippmann made similar negative remarks about RMBS securities containing subprime loans originated by New Century Financial Corporation ("New Century"). On November
28, 2006, Lippmann wrote: "MABS 2005-NC2 M9 ... huge payment shock coming." Yet six weeks later, on January 17, 2007, $10 million of this exact asset, MABS 2005-NC2 M9, was purchased by Gemstone 7, without objection from Lippmann's traders. On December 8, 2006,
Lippmann wrote about another New Century security underwritten by Goldman Sachs: "gsamp 06- nc2 m8 this is an absolute pig." Although Gemstone 7 did not purchase the GSAMP 2006-NC2 M8 securities, it did purchase a total of $30 million in GSAMP 2006-NC2 M9 securities - from a lower tranche in the same securitization with less subordination.
57. Lippmann was also critical of New Century loans securitized by ACE, an entity created by and associated with Deutsche Bank. On September 21, 2006, for example, when asked by a Deutsche Bank salesperson for his opinion of ACE 2006-NC 1 M9, an RMBS issued by ACE with New Century subprime loans, Lippmann responded that ACE was "generally horrible." On
March 2, 2007, a client sent an e-mail to Lippmann stating: "[Y]ou were right - ace is crap."
Lippmann responded: "INDEED. . . IT IS." Yet on December 19, 2006, Lippmann's traders did not object to the purchase of $10 million of ACE 2006-NC1 M9 for Gemstone 7.
58. Lippmann confirmed to the Levin-Coburn Subcommittee that he believed ACE was
"horrible." In a May 19, 2006 e-mail, Lippmann wrote to a Deutsche Bank colleague: "WE
TRADED THAT ACE PIECE 0 CRAP WITH IKE AT 380" In a May 29, 2007 e-mail,
Lippmann wrote with regard to ACE 2006-ASP3 M7, "this stinks though [I] didn[']t mention it."
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59. These negative evaluations also applied to Deutsche Bank's own inventory that was included in Gemstone 7. Lippmann, and his trader Jordan Milman ("Milman"), shared negative views of one of the bonds, ACE 2006-HE 1 M10, a security in which over 75% of the loans had been originated by Fremont. In an instant message conversation in December 2006, Lippmann asked
Milman his thoughts on ACE 2006-HE1 M10. Lippmann asked: "DOE[SN'T] THIS DEAL
BLOW," to which Milman replied: "[Y]es it blows[.] I am seeing 20-40% writedowns." Not only did HBK Capital Management ("HBK") include $10 million of this asset in the Gemstone 7 warehouse account, HBK purchased it from Deutsche Bank that same month through one of
Lippmann' s traders.
60. Lippmann was similarly negative about other securities purchased for Gemstone 7.
On March 1, 2007, Lippmann wrote that ABSHE 2006-HE 1 M7 was "CRAP." Five million dollars of this same security had been purchased three months earlier by Gemstone 7, on November 16,
2006, without objection from Lippmann's trading desk. On March 19, 2007, Milman described
FFML 2006-FF13 as "a piece of crap." Yet over the prior five months, the Lippmann trading desk approved the purchase of a total of $38.5 million of this exact bond, FFML 2006-FF 13, for inclusion in Gemstone 7.
61. On August 26, 2006, Lippmann wrote to a client about more securities "blowing up," including SABR 2005-OP 1:
I am encouraged that in spite of the virility of the cdo bid, there are numerous examples of bonds blowing up. . . the tripling of serious delinq[uencies] in sabr 05- opi to over 6.5% since feb even though the [average] mortgage age is now only 21 months i.e. hasn't reset yet .... What I'm saying is that there is plenty of fundamental evidence that bonds are blowing up even as the new issue and index market are remaining buoyant.
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On December 12, 2006, with no objection from Lippmann's desk, Gemstone 7 purchased $5.5 million of SABR 2005-OP 1 B4 from Deutsche Bank, the same asset that he had described months earlier as incurring "serious delinquencies."
62. On April 6, 2006, Lippmann called AMSI 2005-R7 M8 a "crap name." In a June 16,
2006 e-mail, Lippmann called Ameriquest Mortgage Securities Inc. generally a "weakish name."
On December 12, 2006, Gemstone 7 purchased $5 million of another RMBS, AMSI 2005-Ri 1 M10, with no objection from the Lippmann trading desk.
63. Deutsche Bank officers and employees, were however, fully aware that purchasers of the CDOs were relying on Deutsche Bank to select appropriate assets (i.e., not "pigs" and "crap") for inclusion in the CDOs. As a July 6, 2006 e-mail from Axel Kunde to Lippmann explained, "[i]f you tell the sales guy the bond is really bad[,] his investor will use that as an argument against us and demand that we buy back his note, because he trusted [Deutsche Bank] to pick a good portfolio etc, etc."
64. Deutsche Bank began aggressively marketing Gemstone 7 in January 2007.
According to M&T Bank Corporation, one Gemstone investor who listened to the Deutsche Bank sales pitch, believed that Gemstone 7 securities posed minimal investment risk after it received
Deutsche Bank's assurances in connection with its solicitation efforts.
65. Internally, however, Deutsche Bank was concerned about its exposure should
Gemstone 7 not be fully subscribed and worked hard to sell the deal. On February 27, 2007,
Abhayad Kamat ("Kamat") of Deutsche Bank wrote in connection with Gemstone offerings: "[W]e are trying to reduce our exposure right now given internal very senior mgmt review of our business."
In January 2007, Lamont, head of Deutsche Bank's CDO Group, and Kevin Jenks ("Jenks"), the
HBK senior collateral manager, discussed the urgency of selling Gemstone 7 in the face of a
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deteriorating market. On January 9, 2007, Jenks wrote to Lamont: "With this market this way and probably going to get worse we would like [to] really move on the cdo. Please allocate the resources to expedite this." Four minutes later, Lamont responded: "[W]e are focused on this as well. [W]e don[']t have a deal in the market and you will be first."
66. CDO personnel at Deutsche Bank were well aware of the worsening CDO market and were rushing to sell Gemstone 7 before the market collapsed. On February 7, 2007, Lippmann raised concerns with Lamont about the ability of Deutsche Bank to continue to sell CDO securities:
"I WAS CALLING ABOUT W[]AREHOUSE MARKS AND DISTRIBUTION RISK [BECAUSE]
HEARING RUMORS ABOUT OTHER DEALERS HAVING BIG TROUBLE PLACING THIS
STUFF."
67. The next day, February 8, 2007, Lamont told Kamat, the CDO Group employee structuring Gemstone 7: "[R]egardless we need to sell [Gemstone 7] now while we still can." The same day, Lamont wrote an e-mail stating: "Keep your fingers crossed but! think we will price this just before the market falls off a cliff."
68. On February 13, 2007, the head of Deutsche Bank's syndicate group, Anthony
Pawlowski, wrote to Lamont: "[I] am not sure how to push guys upstairs without having them crack.
[E]veryone wants to price this deal asap ([S]ean [W]helan [co-head of Deutsche Bank's CDO sales force] is pushing for Friday to lock up his guys on the AAA and AA)[.] [L]et me know."
69. The Levin-Coburn Report also uncovered evidence that Deutsche Bank had deliberately misled CDO investors in order to offload overpriced CDO securities. Some potential investors inquired about the mark-to-market ("MTM") value of Gemstone 7's underlying assets.
MTM is a valuation of an asset at the price it would sell in the marketplace on the day it is marked.
Investors at times inquired about MTM values to determine if the underlying assets of a CDO have
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dropped in value since their inclusion. Traders who closely follow buy and sell activity for a particular class of assets are generally best able to provide the most accurate current valuation. At
Deutsche Bank, the CDO Trading Desk marked the value of assets monthly as a service to its clients and at times provided this service to HBK for the assets underlying Gemstone 7. HBK also prepared its own internal marks valuing Gemstone 7's assets.
70. During the marketing phase of Gemstone 7, potential investors asked Deutsche Bank to provide MTM values for the underlying assets in the CDO. In response, those potential investors were given HBK's marks, rather than the generally lower valuations assigned to the assets by
Deutsche Bank's CDO Trading Desk. On January 23, 2007, Kamat sent an e-mail to HBK explaining that some potential investors had requested marks for the Gemstone 7 assets:
Some investors are asking for current marks on the Gemstone CDO 7 portfolio. The attached file has the purchase price and the current marks that we got from our desk. There are many bonds where the price difference between purchase price and current mark is more than 4% .... I have asked Jordan [Milman, a Deutsche Bank trader] to review the marks but it would be great if you could have someone at HBK review also to check if the current marks seem correct. It seems as if the entire portfolio price has dropped since purchase by 1.74% which does not show well to investors.
71. Before he heard back from HBK, Kamat sent a very similar request to Milman to review the marks to verify them. He wrote:
There are many [Gemstone 7] bonds where the price difference between purchase price and the current mark is more than 4%.... Before we send these over to CDO investors, pis could you review to check if the current marks are correct. It seems as if the entire portfolio price has dropped since purchase by 1.74% which does not show well to investors.
72. The next day, a Deutsche Bank trader verified the marks: "I checked the names that
Abhayad [Kamat] highlighted [and] most are marked within the context of recent color[.] [T]here are 4 which should be tightened." On January 23, 2007, Kamat learned that HBK's marks showed a loss of 0.9% or $9.4 million in the Gemstone 7 portfolio, while Deutsche Bank's marks showed a
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greater loss of 1.7% or $19 million. On January 24, 2007, Kamat directed Deutsche Bank's
syndicate group to share HBK's marks with investors instead of Deutsche Bank's. He wrote: "[F]or
investors who have asked for current marks on the Gemstone CDO 7 portfolio, tell them: HBK says
that the overall current portfolio is down USD 9mm."
73. A couple weeks later, a question arose about using Deutsche Bank marks for
Gemstone 7. On February 7, 2007, Ilinca Bogza, from the syndicate group, wrote to Kamat: "Why
can we not show a priced [marked] portfolio?? [W]e need to show this [to investors]." Kamat
responded: "[T]he marks we got from [J]ordan [Milman] are too low. . . and it will take quite some
time if we try to take on an exerci[s]e where we try to get [K]evin [Jenks] and [J]ordan [Milman] to
agree on the correct marks." Kamat wrote to another colleague later that day: "[U]se this for the
current prices to be sent to investors, but pls note to investors that this is frm hbk."
74. Deutsche Bank's trading desk was one of the biggest traders in RMBS and CDOs on
Wall Street, making it unlikely that the desk could not adequately price the assets that it traded.
Deutsche Bank also chose not to share both sets of marks with investors; it shared only the HBK
marks showing higher asset values. When HBK was asked about this matter, Jenks told the Levin-
Coburn Subcommittee that he did not authorize Deutsche Bank to give out HBK's marks to
investors and would be "surprised" if Deutsche Bank had given out HBK's marks. Eight days before
the Gemstone CDO closed and its securities issued, HBK estimated that its portfolio marks were
down approximately $30 million.
75. Some $400 million of Gemstone 7 was unsold and Deutsche Bank was forced to split
the unsold $400 million of Gemstone 7 securities between itself and HBK. Meetings concerning taking back the $400 million were held at the highest levels of both Deutsche Bank and HBK,
according to Lamont's September 29, 2010 interview by the Levin-Coburn Subcommittee. In a
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March 14, 2007 e-mail, Fred Brettschneider, head of Deutsche Bank Institutional Sales, wrote to
Jam: "We believe that we have reached an acceptable compromise with HBK. We will be restructuring the unsold mezz A[AA] and we will underwrite the senior portion leaving [HBK] with the junior piece." On March 27, 2007, Larry Pike, Director of Structured Products Sales at Deutsche
Bank, wrote with regard to Gemstone 7, "400mm of the unsold bonds were a middle (mezz) AAA class that were expected to be purchased by an investor who backed out at a late stage due to a deteriorating market. . . HBK was upset about this and wanted [Deutsche Bank] to take these bonds down, threatening to curtail business globally with HBK if we didn't." As Lippmann put it: "[W]e don't have much choice. . . either we repo for them or we take it down." Deutsche Bank and HBK were unable to sell 36% of the securities and instead kept those securities on their books.
76. Between December 2006 and December 2007, Deutsche Bank issued 15 new CDOs worth approximately $11.5 billion. The Levin-Coburn Report concluded that other Deutsche Bank
CDOs suffered from similar problems as Gemstone 7. For example, Deutsche Bank underwrote a
CDO for Magnetar Capital ("Magnetar") and served as trustee for two other Magnetar CDOs.
Magnetar' s investment strategy was to purchase the riskiest portion of a CDO - the equity - and, at the same time, to purchase short positions on other tranches of the same CDO. Magnetar worked with several financial institutions to create CDOs with riskier assets and then bet on those CDOs to fail. Magnetar would receive a substantial payment from its short positions if the securities lost value. Lippmann disapproved of the Magnetar CDOs and understood that Magnetar was distorting the market. When asked how in a August 31, 2006 e-mail, Lippmann responded: "EASY BUT
LENGTHY ANS[]WER ... CALL ME." In August 2006, when asked about Magnetar, Lippmann responded that it was a "[C]hicago based hedge fund that is buying tons of cdo equity and shorting the single names.... [T]hey [are] buying equity and shorting the single names. . . a bit devious."
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77. In May 2006, Magnetar created its first CDO, Orion 2006-1 Ltd, a $1.3 billion hybrid
CDO with cash and synthetic assets. Although Orion received investment grade ratings from Fitch
Ratings Ltd. ("Fitch") and Moody's in June 2006, a little over a year later, on August 21, 2007, Fitch issued the first of several rating downgrades. In November 2007, Moody's downgraded the Class A notes six notches and the Class B notes seven notches. By May 2008, every class of Orion's securities had been downgraded to junk status.
78. Deutsche Bank also underwrote six START CDOs valued at $5.25 billion from June
2005 to December 2006. In one of the deals, Deutsche Bank worked with Elliot Advisors, a hedge fund that bought the equity tranche in the CDO and simultaneously bought CDS protection against the entire structure, essentially shorting the deal and betting that the value of its assets would fall.
On four of the deals, Deutsche Bank worked with Paulson & Co. Inc. ("Paulson"), a hedge fund that bought the equity tranche and apparently shorted the rest of the CDO, while Deutsche Bank sold the rest of the securities. An internal Deutsche Bank e-mail explained one of the 2005 START CDOs as follows:
The $1 billion START 2005-B trade was backed by a static pool of CDS on mezzanine RMBS for Paulson Advisors ($4 bln risk arb hedge fund). Paulson retained the bottom 6% of the trade and we sold the rest of the capital structure. Paulson, who came to us with the strong desire to short the US housing market, wrote CDS on underlying ABS (over 100 names) to DB [Deutsche Bank] and DB [Deutsche Bank] intermediated them into the deal.
Lamont told the Levin-Coburn Subcommittee that Paulson shorted the START deals. Lippmann himself admitted to the Levin-Coburn Subcommittee that he shorted their underlying assets. In a
December 14, 2006 e-mail discussing START with a Deutsche Bank colleague, Lippmann wrote:
"Start is crap you should short because I bet we'll have to. [B]uyback cash ones next year."
79. Lippmann told the Levin-Coburn Subcommittee that Deutsche Bank ended up losing a great deal of money on the START deals. One Deutsche Bank employee wrote to Lippmann -27 - 6831981 Case 1:11-cv-04209-BSJ-JCF Document 23 Filed 06/01/12 Page 30 of 72
regarding one of the deals in June 2007: "This along with our remaining held inventory if we can't sell away we repack into a CDOA2 balance sheet dump later this summer[.] Worst case we hold it but it is probably the lesser of two evils (the greater evil being our held START position)[.]"
80. Based on an exhaustive review of evidence, the Levin-Coburn Subcommittee concluded that Deutsche Bank continued to issue CDOs after mortgages began losing money at record rates, investor interest waned, and its most senior CDO trader concluded that the specific
RMBS securities being included in the bank's own CDOs were going to lose value. Lippmann derided specific RMBS securities and advised his clients to short them, at the same time his desk was allowing the very same securities to be included or referenced in Gemstone 7, a CDO that the bank was assembling for sale to its clients. In fact, the bank was selling some assets that Lippmann believed contained "crap." The Gemstone 7 CDO was constructed and marketed by the bank's CDO desk, which is separate from the trading desk controlled by Lippmann, but both desks knew of
Lippmann's negative views. Deutsche Bank sold $700 million in Gemstone 7 securities which then failed within months, leaving the bank's clients with worthless investments.
VI. MISCONDUCT REVEALED BY THE DEPARTMENT OF JUSTICE INVESTIGATION
81. On May 3, 2011, the DOJ filed a complaint alleging that Deutsche Bank and
MortgagelT repeatedly lied in order to be able to endorse mortgage loans they originated with a federal guarantee in order to be able to sell and generate substantial profits from those mortgages.
United States v. Deutsche Bank AG, et al., No. 1:1 1 -cv-02976-LAK (S .D.N.Y. May 3, 2011). This section summarizes and incorporates allegations and Deutsche Bank's stipulation and admissions in that action. The FHA is the largest mortgage insurer in the world. In order to protect its financial interests, the FHA sets specific requirements both as to the requirements for loans that can be guaranteed and requirements for entities that approve loans for a federal guarantee. Rather than -28 - 6831981 Case 1:11-cv-04209-BSJ-JCF Document 23 Filed 06/01/12 Page 31 of 72
evaluate and approve mortgages itself as qualifying for a federal guarantee, the FHA allows certain loan originators to act as "Direct Endorsement Lenders" subject to specific requirements. Loan originators that act as Direct Endorsement Lenders are required to certify that they comply with FHA requirements.
82. Direct Endorsement Lenders must implement a mandatory quality control plan to ensure that they follow all government rules, and to provide procedures for correcting problems in a lender's underwriting operation. A critical aspect of the control plan is the audit of early payment defaults, i.e., mortgages that default soon after closing. Early defaults raise a red flag that problems may exist in a company's underwriting process. Identifying early defaults allows a Direct
Endorsement Lender to monitor and correct problems, and report them to the FHA. Direct
Endorsement Lenders must certify their compliance with the Direct Endorsement Lender program's qualification requirements annually, including the implementation of a mandatory quality control plan. Without a truthful annual certification, lenders are not entitled to endorse loans for FHA insurance. For each loan, Direct Endorsement Lenders are required to conduct due diligence to ensure that each mortgage is eligible for FHA insurance. These rules exist to prevent HUD from insuring mortgages that exceed the risk levels set by statute and regulations. A Direct Endorsement
Lender must assure HUD that every endorsed mortgage meets all HUD rules and certify that the lender has conducted due diligence in accordance with all HUD rules.
83. Deutsche Bank and MortgagelT had powerful financial incentives to invest resources into generating as many FHA-insured mortgages as quickly as possible for resale to investors, but had few financial incentives to invest resources into ensuring the quality of its FHA-insured mortgages through the maintenance of the mandatory quality control program, or into ensuring that
MortgagelT limited its endorsement of mortgages to those loans that were eligible for FHA
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insurance under HUD rules and in fact repeatedly lied to HUD to obtain and maintain MortgagelT's
Direct Endorsement Lender status.
84. A DOJ investigation determined that: (i) Deutsche Bank and MortgagelT failed to audit all early payment defaults, despite the requirement that this be done; (ii) Deutsche Bank and
MortgagelT made it impossible for their few quality control employees to conduct the required quality control by grossly understaffing their quality control units; (iii) Deutsche Bank and
MortgagelT repeatedly failed to address dysfunctions in the quality control system, which were reported to upper management; (iv) after its acquisition by Deutsche Bank in January 2007,
MortgagelT took the only staff member dedicated to auditing FHA-insured mortgages, and reassigned him to increase production instead; and (v) when an outside auditor had provided findings to MortgagelT revealing serious problems prior to the acquisition, those findings were literally stuffed in a closet and left unread and unopened.
85. Despite Deutsche Bank's and MortgagelT's egregious violations of the basic eligibility requirement of a compliant quality control plan, every year for a decade, Deutsche Bank or MortgagelT annually certified that MortgagelT complied with the eligibility criteria of the Direct
Endorsement Lender program in order to maintain MortgagelT's Direct Endorsement Lender status.
On various occasions when HUD discovered evidence that MortgagelT was violating the quality control requirement, MortgagelT deceived HUD by falsely promising HUD that it had corrected or would correct the failures.
86. As of June 2011, HUD had paid more than $368 million in FHA insurance claims and related costs arising out of MortgagelT's approval of mortgages for FHA insurance. Many of these losses were caused by the false statements MortgagelT made to HUD to obtain FHA insurance on thousands of individual loans. The government estimates it will be required to pay hundreds of
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millions of dollars in additional FHA insurance claims as additional mortgages underwritten by
MortgagelT continue to default.
87. On July 12, 2006, MortgagelT announced that it would be acquired by Deutsche
Bank and stated that its "management team and infrastructure will become the cornerstone of
[Deutsche Bank]'s existing and planned mortgage lending operations and strategy in the U.S. As part of the deal, [Deutsche Bank]'s existing U.S. mortgage operations will be combined under
MortgagelT." Deutsche Bank also issued a press release in which it described the merger as "a key element of the Bank's build-out of a vertically integrated mortgage origination and securitization platform." Deutsche Bank explained that its "acquisition of MortgagelT is the latest in a series of steps taken to significantly increase its presence in the US mortgage markets."
88. In the Deutsche Bank press release, Philip Weingord ("Weingord"), Head of Global
Markets Americas at Deutsche Bank, and Jam, Head of Global Markets at Deutsche Bank and a member of the Deutsche Bank Group Executive Committee, described Deutsche Bank's strategy to incorporate MortgagelT into its existing mortgage business. Weingord stated:
"As Deutsche Bank continues to grow its RMBS business, we believe the vertical integration of a leading mortgage originator like MortgagelT will provide significant competitive advantages, such as access to a steady source of product for distribution into the mortgage capital markets".. .. "MortgagelT is a significant lender in the prime Alt-A residential mortgage sector. Uniting their business with our other channels of mortgage loan origination coupled with our trading, structuring and distribution capabilities will further advance our position as a leading RMBS player."
Jan added: "The MortgagelT team has built an outstanding business, and we are extremely pleased to have them join our effort as we continue to expand our mortgage securitization platform in the US and globally."
89. After the merger, Deutsche Bank retained MortgagelT's management and workforce.
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Gary Bierfriend ("Bierfriend") was MortgagelT's President, Andy Occhino ("Occhino") was
MortgagelT's General Counsel and Secretary, Robert Gula was MortgagelT's CFO, and Patrick
McEnerney ("McEnerney") was MortgagelT's Chief Operating Officer. MortgagelT also continued to have the same Director of Government Lending and the same Government Loan Auditor. A number of MortgagelT officers became Deutsche Bank principals after the acquisition. Naidus became a Managing Director of Deutsche Bank and the Head of Mortgage Origination within
Deutsche Bank's RMBS group and McEnerney became a Managing Director of Deutsche Bank.
90. To supervise credit risk, Deutsche Bank established the Credit Risk Committee, which consisted of seven senior managers from MortgagelT and five from Deutsche Bank. This committee met biweekly. To supervise operational risk, Deutsche Bank established five committees whose members also included representatives from the senior management of both MortgagelT and
Deutsche Bank. One of those committees was the Quality Control Committee, which consisted of
15 senior managers from MortgagelT and two from Deutsche Bank.
91. After the merger, Naidus, MortgagelT's Chairman and CEO, reported to Weingord, a
Managing Director and Head of Global Markets Americas at Deutsche Bank. Occhino,
MortgagelT's General Counsel and Secretary, reported to Jeffrey Welch, a Managing Director in
Deutsche Bank's Legal Department. Deutsche Bank also reconfigured MortgagelT's Board of
Directors to consist of three members, all of whom were Managing Directors of Deutsche Bank:
Naidus, Weingord and Michael A. Commaroto ("Commaroto"). In 2008, Deutsche Bank replaced
Commaroto and Weingord on the MortgagelT Board of Directors with two Deutsche Bank
Directors: Joseph Rice and Joy Margolies.
92. MortgagelT's directors were closely affiliated with Deutsche Bank. Commaroto was a Director and Officer of DB Structured Products, Inc. as well as the Head of Asset Backed Whole
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Loan Trading at Deutsche Bank. Joseph Rice was a Director of DB Structured Products, as well as the Director of Corporate Treasury and of Group Treasury Americas at Deutsche Bank. Joy
Margolies was an Officer of DB Structured Products. In addition, Deutsche Bank managed the quality control functions of the Direct Endorsement Lender business, and had its employees sign and submit MortgagelT's Direct Endorsement Lender annual certifications to HUD.
93. MortgagelT became a Direct Endorsement Lender in October 1999. After January
2007, Deutsche Bank filed with HUD annual certifications of MortgagelT's purported compliance with the Direct Endorsement Lender program requirements, including the implementation of a compliant quality control plan, a requirement of which is the review of all early payment defaults.
As a Direct Endorsement Lender, MortgagelT approved more than 39,000 mortgages for FHA insurance, totaling more than $5 billion in underlying principal obligations. For each mortgage,
MortgagelT certified that it complied with all HUD rules.
94. According to the DOJ, as of June 2011, of the more than 39,000 mortgages for FHA insurance endorsed by MortgagelT, more than 12,900 of those mortgages (i.e., approximately a third) had defaulted. More than 3,200 defaulted within six months, more than 4,500 defaulted within a year, and more than 6,900 defaulted within two years of closing.
95. As of June 2011, HUD had paid more than $368 million in FHA insurance claims and related costs arising out of more than 3,200 mortgages. Of these, HUD has paid more than $92 million in FHA claims and related costs arising out of more than 690 mortgages that defaulted within six months, more than $151 million in FHA claims and related costs arising out of more than 1,200 mortgages that defaulted within one year, and more than $245 million in FHA claims and related costs arising out of more than 2,000 mortgages that defaulted within two years.
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96. As of June 2011, more than 7,400 additional mortgages, totaling more than $857 million in calculated unpaid principal balances, have defaulted, without any claims yet having been paid by HUD. Of these, there are more than $255 million of calculated unpaid principal balances for more than 1,700 mortgages that defaulted within six months, there are more than $337 million of calculated unpaid principal balances for more than 2,300 mortgages that defaulted within a year, and there are more than $473 million of calculated unpaid principal balances for more than 3,400 mortgages that defaulted within two years.
97. After the investigation, the DOJ concluded that Deutsche Bank and MortgagelT maintained MortgagelT's Direct Endorsement Lender status by making false representations to HUD about MortgagelT's purported compliance with HUD rules and regulations regarding quality control, when in truth, MortgagelT's quality control procedures egregiously violated HUD rules and regulations.
98. In annual certifications, Deutsche Bank and MortgagelT certified MortgagelT's compliance with all HUD rules and regulations necessary for maintenance of its Direct Endorsement
Lender status. Between 1999 and 2006, MortgagelT filed the annual certifications with HUD. On
February 1, 2005, Bierfriend, President of MortgagelT, signed an annual certification stating, "I know or am in the position to know, whether the operations of this mortgagee conforms to all HUD regulations and guidelines. I certify that to the best of my knowledge, the mortgagee conforms to all
HUD regulations necessary to maintain its HUD/FHA approval." MortgagelT officers filed similar certifications each year between 1999 and 2006.
99. Between 2007 and 2009, Deutsche Bank filed the annual certifications with HUD.
On March 9, 2007, McEnerney, a Managing Director of Deutsche Bank, signed an annual certification stating, "I know, or am in the position to know, whether the operations of the above
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named mortgagee conform to HUD-FHA regulations, handbooks and policies. I certify that to the
best of my knowledge, the above named mortgagee conforms to all HUD-FHA regulations necessary
to maintain its HUD-FHA approval." On February 6, 2009, Joseph Swartz ("Swartz"), a Deutsche
Bank Director, signed an identical certification. Deutsche Bank officers filed these certifications
each year after 2007, until MortgagelT ceased its operations as a Direct Endorsement Lender in
2009. McEnerney signed the 2007 annual certification in his capacity as a Managing Director of
Deutsche Bank and below his signature on the 2007 annual certification, McEnemey handwrote the
title, "Managing Director." A Deutsche Bank officer also signed the annual certifications in 2008
and 2009.
100. One requirement to maintain Direct Endorsement Lender status is a HUD regulation
mandating continuous implementation of a quality control plan conforming to HUD rules, including
the rule requiring review of all early payment defaults. The individuals who signed the annual
certifications - including the Deutsche Bank officers who signed after January 2007 - either knew,
deliberately ignored, or recklessly disregarded that MortgagelT did not have a quality control plan
that conformed to HUD rules when they signed.
101. For example, when McEnerney signed the 2007 annual certification representing that
MortgagelT was in compliance with the HUD rules necessary to maintain Direct Endorsement
Lender status, he knew that the certification was false, consciously avoided learning whether it was
true or false, or recklessly disregarded whether it was true or false. Indeed, in 2007, the Government
Loan Auditor at MortgagelT was in a position to tell McEnemey, or anyone else who asked, that
MortgagelT was not reviewing all early payment defaults on FHA-insured loans.
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102. The other MortgagelT and Deutsche Bank employees who signed the annual certifications would have learned that MortgagelT was not reviewing all early payment defaults on
FHA-insured loans if they had conducted even a minimal inquiry before signing.
103. In fact, MortgagelT had a long history of falsely representing to the government that it was complying with the requirement to review early payment defaults. According to the DOJ' s investigation, a HUD audit conducted during the week of September 13, 2003, by the HUD Quality
Assurance Division, Philadelphia Homeownership Center, revealed that MortgagelT had "not maintained a Quality Control Plan, (QC) plan in accordance with HUD/FHA requirements," and that, among other failures, MortgagelT had failed to "ensure that loans that go into default within the first 6 months are reviewed."
104. The 2003 audit required MortgagelT to provide a statement of corrective action to prevent a recurrence of the violation. MortgagelT responded to the 2003 audit by informing HUD that it had altered its quality control procedures to follow HUD rules, including by ensuring the review of all early payment defaults. That representation was false.
105. A subsequent HUD audit conducted during the week of September 20, 2004, by the
HUD Quality Assurance Division, Philadelphia Homeownership Center, again revealed that
MortgagelT still failed, among other things, to ensure "that loans which go into default within the first six months are reviewed." The 2004 audit required MortgagelT to provide a statement of corrective action to prevent a recurrence of the violation. In response to the 2004 audit, MortgagelT promised HUD that it would review all early payment defaults. In particular, by letter dated June 24,
2005, the Director of Government Lending at MortgagelT acknowledged that MortgagelT's failure to review all early payment defaults was "unacceptable," and that "mortgagees must review all loans going into default within the first six payments." The Director of Government Lending at
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MortgagelT further represented that MortgagelT "understands HUD's directive" to review all early
payment defaults, and that MortgagelT would "comply with this request." That representation was
false.
106. Yet again, in February 2006, the HUD Quality Assurance Division, Philadelphia
Homeownership Center, discovered, through communications with MortgagelT, that MortgagelT
was not reviewing early payment defaults. HUD officials scolded personnel at MortgagelT for their
failure to review all early payment defaults.
107. The DOJ further determined that despite repeated representations to HUD that
MortgagelT would conduct early payment default reviews as part of MortgagelT's quality control,
MortgagelT quality control personnel did not know how to identify early payment defaults until
February 2006. After MortgagelT quality control personnel learned how to identify early payment
defaults, MortgagelT nevertheless failed to review all early payment defaults. This failure to review
all early payment defaults continued after Deutsche Bank acquired MortgagelT in January 2007.
The MortgagelT employee who monitored early payment defaults on FHA-insured loans after
February 2006, the Government Loan Auditor, did not review all early payment defaults in 2006 or
2007. He was not instructed to do so. Moreover, by the end of 2007, the Government Loan Auditor
was not reviewing any early payment defaults, because he had been reassigned to assist with loan production. In addition, outside vendors failed to review all early payment defaults for MortgagelT.
Although, in certain years, MortgagelT contracted with outside vendors to conduct audits of certain
MortgagelT loans, the outside vendors were unable to review all early payment defaults because
MortgagelT failed to identify early payment defaults to the vendors.
108. By 2004, MortgagelT had contracted with an outside vendor, Tena Companies, Inc.
("Tena"), to conduct quality control reviews of closed FHA-insured loans. Throughout 2004, Tena
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prepared findings letters detailing underwriting violations it found in FHA-insured mortgages underwritten by MortgagelT. The findings letters included the identification of serious underwriting violations. No one at MortgagelT read any of the lena findings letters as they arrived in 2004.
109. Instead, MortgagelT employees stuffed the letters, unopened and unread, in a closet in Mortgagell's Manhattan headquarters. The letters remained unopened until December 2004 or
January 2005. In December 2004, MortgagelT hired its first quality control manager. The quality control manager asked to see the Tena findings, but was not provided with any findings. After searching throughout the office, the head of the credit department at MortgagelT showed the quality control manager to a closet. The quality control manager opened the closet and found a series of envelopes, unopened and still sealed, in the closet. The quality control manager opened the Tena findings, for the first time, in December 2004 or January 2005. The quality control manager quickly identified serious underwriting violations, which had remained undiscovered over the course of the preceding year, because no one had bothered to read the lena reports. The quality control manager reported the Tena findings to her supervisor, the Senior Vice President of the Audit Department.
The quality control manager subsequently discussed the lena findings with the Vice President of
Credit and, thereafter, with the President of Mortgagell.
110. MortgagelT's quality control manager attempted to implement a quality control system, but the system did not work because the branches never provided responses to the preliminary quality control findings of the outside vendor. As a result, the Mortgagell quality control manager was not able to generate an assessment of quality issues to present to management in a quarterly report. The Mortgagell quality control manager complained to upper management at
Mortgagell that the quality control system was broken. Around August 2005, the quality control manager's supervisor, the Senior Vice President of the Audit Department, sent a letter to upper
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management at MortgagelT describing the problems that the quality control manager was facing.
MortgagelT, however, failed to make any changes in response to the complaints and requests of the quality control manager or her supervisor.
111. Deutsche Bank and MortgagelT also failed to provide guidance, including the required quality control plan, to its personnel conducting quality control. From the first quarter of
2006 until 2009, MortgagelT's quality control for FHA-insured loans was conducted by the
Government Loan Auditor. During that period, the Government Loan Auditor was the only employee at Deutsche Bank and MortgagelT tasked with reviewing closed FHA-insured mortgage files. Deutsche Bank and MortgagelT never provided the Government Loan Auditor with a copy of
MortgagelT's required quality control plan. Deutsche Bank and MortgagelT never explained the contents of the required quality control plan to the Government Loan Auditor. Deutsche Bank and
MortgagelT never provided the Government Loan Auditor with any guidance concerning his review of closed FHA-insured mortgage files. Deutsche Bank and MortgagelT never provided the
Government Loan Auditor with criteria as to which mortgage files to review, or how many mortgage files to review. As a result, the Government Loan Auditor was wholly without guidance as to any quality control plan at MortgagelT.
112. Deutsche Bank and MortgagelT also grossly understaffed or actually failed to staff the quality control function for reviews of closed FHA-insured mortgages. In order to review all early payment defaults as required by HUD rules, Deutsche Bank and MortgagelT would have needed to employ a staff of at least six to eight employees, according to the DOJ investigation. In fact, Deutsche Bank and MortgagelT never employed more than one person to conduct quality control reviews of closed FHA-insured mortgages.
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113. Between 2006 and 2009, the sole employee at Deutsche Bank or MortgagelT conducting quality control reviews of closed FHA-insured mortgages was the Government Loan
Auditor. His review of closed FHA-insured mortgages continually declined during that period, and declined most significantly after Deutsche Bank acquired MortgagelT. By the end of 2007, the
Government Loan Auditor was no longer spending any time conducting quality control reviews of closed mortgage files. Rather, to increase sales, Deutsche Bank and MortgagelT shifted his work from quality control reviews of closed mortgages (i.e., quality control audits) to assistance with production. By the end of 2007, not a single person at Deutsche Bank or MortgagelT was conducting quality control reviews of closed FHA-insured mortgages, as required by HUD rules.
114. The failure to conduct the required quality control reviews after Deutsche Bank acquired MortgagelT in January 2007 resulted in additional defaulted loans, a dramatic increase in early payment defaults. For example, throughout 2004, the Tena findings identified underwriting violations by this MortgagelT underwriter in Michigan who engaged in a pattern of serious underwriting violations with common brokers. If the Tena findings had been read in a timely manner, MortgagelT could have terminated the underwriter and MortgagelT's relationship with the brokers, and reported the problems to HUD pursuant to HUD rules. MortgagelT failed to do so. In
December 2004 or January 2005, MortgagelT's quality control manager read the Tena findings for the first time, and identified the MortgagelT underwriter engaging in the pattern of serious underwriting violations with common brokers. The quality control manager informed upper management within MortgagelT, including the President of the company, about these serious problems. In mid-2005, the quality control manager asked the President and other upper management at MortgagelT to take action. The President of MortgagelT failed to do so. The underwriter continued her pattern of serious underwriting violations, and the brokers continued their
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pattern of submitting ineligible and/or fraudulent mortgages. In September 2005, a MortgagelT employee employed outside of the quality control group identified the same pattern of underwriting violations described above. She likewise informed upper management of the problem. MortgagelT, however, once again failed to take action against the underwriter. In February 2006, HUD discovered the pattern of underwriting violations described above and discussed the pattern with
MortgagelT. MortgagelT failed to take effective action for months.
115. Both before and after its merger with Deutsche Bank, MortgagelT falsely certified, on a loan-by-loan basis, that it had complied with HUD rules and that the mortgages it endorsed were eligible for FHA insurance under HUD rules. Between 1999 and 2009, MortgagelT approved more than 39,000 mortgages for FHA insurance. For each mortgage, Mortgagell certified that it complied with all HUD rules, including BUD rules requiring due diligence.
116. In fact, MortgagelT engaged in a nationwide pattern of failing to conduct due diligence in accordance with HUD rules and with sound and prudent underwriting principles.
MortgagelT knew that its certifications of compliance with HUD rules were false or alternatively acted with deliberate ignorance and/or reckless disregard of the truth. The DOJ complaint provides examples (representing a small fraction nationwide) of mortgages that were improperly given a federal guarantee despite MortgagelT's failure to comply with HUD requirements and which resulted in false certifications of compliance, some of which are described below.
117. A mortgage closed on or about June 29, 2004 for a property on Bittercreek Drive, in
Colorado Springs, Colorado (FHA case number 052-3466494). MortgagelT failed to comply with a
HUD requirement to develop a credit history for a borrower who did not have an established credit history by assembling payment records for recurring expenses such as utilities, rentals and
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automobile insurance. Within six months after closing, the Bittercreek Drive Mortgage went into default.
118. A mortgage closed on or about June 27, 2002 for a property on Center Street in
Waterloo, New York (FHA case number 372-3209567). MortgagelT failed to comply with a HUD requirement to document the gift funds used as a down payment with a letter signed by the borrower, stating the amount of the gift, or stating that repayment was not required. The property went into default within two months after closing.
119. A mortgage closed on or about February 15, 2005 for a property on Kentucky Street in Dearborn, Michigan (FHA case number 261-8886675). MortgagelT failed to comply with a HUD requirement to verify current employment by telephone, and to record the name and telephone number of the person who verified employment on behalf of the employer. Contrary to this rule,
MortgagelT failed to contact the employer, and, after the mortgage closed, the listed employer verified that the borrower was never its employee. Within four months after closing, the Kentucky
Street Mortgage went into default.
120. A mortgage closed on or about November 4, 2005 for a property on Monument
Avenue in Portage, Indiana (FHA case number 151-7978818). MortgagelT failed to comply with a
HUD requirement to verify and document a borrower's cash investment in a property. Within nine months after closing, the Monument Avenue Mortgage went into default.
121. A mortgage closed on or about August 27, 2007 for a property on NE Lakeside Drive in Madras, Oregon (FHA case number 431-4301440). MortgagelT failed to comply with a HUD requirement to obtain the required documentation to verify the borrower's mortgage payment history and income. Within ten months after closing, the Lakeside Drive Mortgage went into default.
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122. A mortgage closed on or about September 28, 2007 for a property on West Wrigley
Street in Boise, Idaho (FHA case number 121-2377843). MortgagelT failed to comply with a HUD requirement to obtain the required documentation to verify the borrower's employment, income and depository assets. Within one month after closing, the Wrigley Street Mortgage went into default.
123. A mortgage closed on or about October 15, 2007 for a property on Chestnut Street in
Michigan City, Indiana (FHA case number 151-8415100). MortgagelT failed to comply with a
HUD requirement to verify a borrower's current employment and obtain the borrower's most recent pay stub. Within eight months after closing, the Chestnut Street Mortgage went into default.
124. A mortgage closed on or about November 30, 2007 for a property on Ilona Drive in
Hellertown, Pennsylvania (FHA case number 441-8039970). MortgagelT failed to comply with a
HUD requirement to obtain a credit report on the borrower, and failed adequately to analyze the borrower's credit prior to the loan closing. Within three months after closing, the Ilona Drive
Mortgage went into default.
125. Prior to the merger, and beginning on or about May 22, 2006, Deutsche Bank conducted substantial due diligence of MortgagelT. This due diligence included access to
MortgagelT's books, records and personnel, as well as direct communications with MortgagelT's management, including Naidus, MortgagelT's Chairman and CEO, and Bierfriend, MortgagelT's
President.
126. As a result of its due diligence efforts, Deutsche Bank had access to documents evidencing MortgagelT' s violations of HUD rules and its related false representations to HUD. For example, Deutsche Bank had access to the June 24, 2005 letter from MortgagelT to HUD in which
MortgagelT's Director of Government Lending acknowledged that MortgagelT had not been reviewing all early payment defaults on closed FHA-insured loans and falsely represented that
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MortgagelT would do so in the future. Deutsche Bank also had access to prior letters from HUD addressing MortgagelT' s failure to review all early payment defaults, including letters dated
September 27, 2004, December 8, 2004 and March 14, 2005. In addition, Deutsche Bank had access to MortgagelT managers who had knowledge of these violations and false representations, including the Director of Government Lending.
127. According to the DOJ investigation, the improper mortgage origination, the failure to comply with required underwriting standards and the misrepresentation to the FHA not only continued after Deutsche Bank acquired MortgagelT in January 2007, but got worse. Contrary to
Deutsche Bank's representations to HUD, MortgagelT was not doing the required quality control reviews after January 2007. And, by the end of 2007, MortgagelT was not reviewing early payment defaults on closed FHA-insured loans. This failure to conduct the requisite quality control reviews resulted in an explosion of early payment defaults.
128. Before Deutsche Bank acquired MortgagelT, approximately 30% of all FHA loans
MortgagelT originated entered into default, with approximately 10% of the defaults constituting early payment defaults. After Deutsche Bank acquired MortgagelT, the percentage of loans that defaulted increased to approximately 46%, while the percentage of defaults constituting early payment defaults skyrocketed to approximately 65%. Approximately 9,477 defaults and 992 early payment defaults for loans that closed between June 2000 and January 2007, and approximately
3,461 defaults and 2,223 early payment defaults for loans that closed between January 2007 and
March 2009. On the approximately 3,461 loans that defaulted after Deutsche Bank acquired
MortgagelT, HUD has paid more than $58 million in claims, and there are more than $350 million in principal balances that have not yet been submitted to HUD as insurance claims.
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129. On May 10, 2012, Deutsche Bank, and three of its subsidiaries, including
MortgagelT, entered into a Stipulation and Order of Settlement and Dismissal with the United
States, in order to resolve the claims made against them by the DOJ. The stipulation requires
Deutsche Bank to pay compensation of $202.3 million. In the stipulation:
The [Deutsche Bank] Defendants admit, acknowledge, and accept responsibility for the fact that after MortgagelT became a wholly-owned, indirect subsidiary of DBSP and DBAG in January 2007, the [Deutsche Bank] Defendants were in a position to know that the operations of MortgagelT did not conform fully to all of HUD-FHA's regulations, policies, and handbooks; that one or more of the annual certifications was signed by an individual who was also an officer of certain of the [Deutsche Bank] Defendants; and that, contrary to the representations in MortgagelT's annual certifications, MortgagelT did not conform to all applicable HUD-FHA regulations.
VII. MISCONDUCT REVEALED BY THE FEDERAL HOUSING FINANCE AGENCY INVESTIGATION AND ALLEGATIONS
130. On September 2, 2011, the FHFA sued Deutsche Bank, and certain related entities and individuals, on behalf of Fannie Mae and Freddie Mac. Federal Housing Finance Agency v.
Deutsche BankAG, et al., No. 1:11 -CV-6192 (S.D.N.Y. filed Sept. 2,2011). The allegations in this section summarize and incorporate the allegations and findings of the FHFA. Deutsche Bank had sold RMBS to Fannie Mae and Freddie Mac. According to the FHFA's investigation, Deutsche
Bank had falsely represented that the underlying mortgages complied with the represented underwriting guidelines and had significantly overstated both the value of the underlying property and the borrowers' ability to repay the mortgages, and had misrepresented the percentage of owner- occupied properties and the loan-to-value ratios. Deutsche Bank had been paid over $14.2 billion for the misrepresented RMBS between September 28, 2005 and June 29, 2007, including one RMBS composed of loans originated by MortgagelT itself.
131. After discovering that the default rates for the underlying loans were unexpectedly high, Fannie Mae and Freddie Mac analyzed a random sample of 1,000 loans from each of the 40
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RMBS acquired from Deutsche Bank. If the RMBS contained 1,000 or less loans, they analyzed each loan.
132. The analysis revealed that Deutsche Bank had grossly misrepresented the underwriting standards and material characteristics relevant to each of the 40 RMBS. Deutsche
Bank had misrepresented the percentage of owner-occupied properties by at least 7.9% and in many cases by 10%.
133. The analysis also revealed that Deutsche Bank had misrepresented loan-to-value data.
Deutsche Bank had falsely represented that none of the loans in the various RMBS equaled or exceeded the value of the underlying property securing the loan (i.e., a 100% loan-to-value ratio). In fact, the analysis revealed that in some of the RMBS, over 40% of the loans exceeded the value of the underlying property, meaning that those loans were "underwater" from day one.
134. Contrary to the representations that none of the loans in the 40 RMBS had loan-to- value ratios over 100%, approximately 21% of the sampled loans had loan-to-value ratios over
100%. In 33 RMBS, more than 10% of the loans had ratios over 100% and 25 RMBS had ratios over 15%. Similarly, contrary to representations that 62% of the loans had loan-to-value ratios at or below 80%, in fact, only 31% of the loans met that criteria. The loans underlying the RMBS eventually defaulted at the astounding rates with 13% to 74% of the loans in each RMBS failing.
Indeed, in July 2010, the Financial Industry Regulatory Authority, Inc. ("FINRA") fined Deutsche
Bank Securities Inc. $7.5 million after finding that Deutsche Bank Securities Inc. had misrepresented the delinquency rates in its mortgage pools, failed to correct and continued to refer investors to false information concerning delinquency rates even after the errors were brought to its attention.
135. Deutsche Bank and its employees' knowledge of the false and improper underwriting practices impacting its mortgages and RMBS is demonstrated, inter alia, by the systemic
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misrepresentations of the loan characteristics of its RMBS, by the repeated waiver of underwriting
guidelines for approximately half of the 34.9% of the loans Clayton Holdings, Inc. ("Clayton") had
determined were unqualified, and by Deutsche Bank's reliance on subprime lenders known for
issuing poor quality, high-risk loans, as the Levin-Coburn Report concluded. Indeed, of the nine
banks examined by the Financial Crisis Inquiry Commission ("FCIC"), Deutsche Bank had the
second highest number of loans rejected by Clayton and the second highest number of loans waived
in notwithstanding the failure to comply with underwriting guidelines, i.e., Deutsche Bank
systematically ignored the advice of its own advisor that the loans had not been properly
underwritten. According to Clayton Senior Vice President Vicki Beal ("Beal"), Deutsche Bank
waived a high number of loans Clayton had rejected because it was "trying to get this stuff out the
door," and that the reasoning behind the waivers was: "We're not holding it on our books. We're
pushing it out. We'll take anything [any loan] and do it."
136. In 2006, Clayton also began providing Deutsche Bank with trending reports which
specified the extent to which Clayton was detecting faulty loans. Beal recalled that Deutsche Bank's
Managing Director, Commaroto, did not receive the first trending report well and expressed concern
that "[i]n the hands of the wrong people it could be misunderstood." Beal concluded that
Commaroto was probably defensive about the fact that Deutsche Bank was securitizing loans
without regard for their quality. A former Executive Vice President of Clayton, Kerry O'Neill
("O'Neill"), reported to the FCIC that not only did the meeting with Commaroto not "go over so
well," but that it was "explosive." According to O'Neill, Commaroto "was displeased - certainly unhappy," so much so, that "what happened was scary."
137. Clayton's reports revealed that from the first quarter of 2006 ("1Q06") to the 2Q07,
34.9% of the mortgage loans Deutsche Bank submitted to Clayton for review in RMBS groups were
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rejected by Clayton as falling outside applicable underwriting guidelines. However, 50% of those loans were subsequently waived in by Deutsche Bank without proper consideration and analysis of compensating factors and included in securitizations which Fannie Mae and Freddie Mac invested here.
138. In addition, according to RMBS prospectuses, Deutsche Bank itself conducted its own "re-underwriting of a random selection of mortgage[s]" in order to evaluate the quality of the loans it was acquiring, which was reviewed by the RMBS sponsor's senior management. According to Swartz, a Deutsche Bank vice president in the department responsible for due diligence of
Deutsche Bank's residential mortgage business, his team reviewed "hundreds and hundreds" of the questionable loans that Deutsche Bank securitized. Swartz and his team would have necessarily seen the same widespread problems identified by Clayton and the systemic misrepresentations identified by Freddie Mac's and Fannie Mae's analysis of those same loan pools.
VIII. DEFENDANTS' FALSE AND MISLEADING STATEMENTS ISSUED DURING THE CLASS PERIOD
139. On January 3, 2007, Deutsche Bank announced the acquisition of MortgagelT in a cash transaction. The press release stated in part:
Deutsche Bank. . . today announced the completion of the acquisition of MortgagelT Holdings, Inc., a residential mortgage real estate investment trust (REIT), for $14.75 in cash per share of common stock, or $430 million (EUR 324 million). The acquisition is expected to be accretive to earnings in 2007 and will add significant scale and synergies to Deutsche Bank's US residential mortgage business.
MortgagelT will become a part of Deutsche Bank's Residential Mortgage Backed Securities group and Doug Naidus, CEO of MortgagelT, will become a Managing Director and Head of Mortgage Origination within the group. The acquisition is the latest in a series of investments Deutsche Bank has made in the US mortgage markets....
"As a leader in the US fixed income markets with a strong and growing residential mortgage business, adding a top mortgage originator like MortgagelT
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is a compelling strategic fit for our business," said Phil Weingord, Head of Global Markets in the Americas. "Expanding our origination platform provides us with access to a steady source of product for distribution into the mortgage capital markets."
"I am very enthusiastic about the possibilities afforded by this combination of two entrepreneurial groups," said Doug Naidus. "Uniting our origination capabilities with Deutsche Bank's structuring and capital markets expertise positions us well to grow our business in a wide range of market conditions."
MortgagelT Holdings owns MortgagelT, Inc., a residential mortgage lender that employs approximately 2,100 people in 47 branches, and is licensed to originate residential mortgage loans in all 50 states. MortgagelTis one ofthe fastest-growing and largest residential mortgage loan originators in the US.
140. In fact, by this time the U.S. residential mortgage market was beginning to generate excessive problem loans. The statements concerning MortgagelT and the benefits associated with the acquisition were misleading because they failed to disclose the widespread underwriting misconduct at and poor quality mortgages originated by MortgagelT as revealed by the DOJ investigation and alleged in detail above. Defendants knew or recklessly disregarded that many loans being issued would default. Nevertheless, defendants continued to originate, securitize and offload to the government loans originated under suspect practices, creating future problems for buyers and future liabilities for Deutsche Bank.
141. On March 27, 2007, the Company filed with the SEC its Form 20-F for its 4Q06 and
FY06. In the filing, Deutsche Bank represented that:
RISK AND CAPITAL MANAGEMENT PRINCIPLES
The following key principles underpin our approach to risk and capital management:
- Our Management Board provides overall risk and capital management supervision for our consolidated Group as a whole. Our Supervisory Board regularly monitors our risk and capital profile.
- We manage credit, market, liquidity, operational, business and reputational risks as well as our capital in a coordinated manner at all relevant levels within our
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organization. This also holds true for complex products which we typically manage within our framework established for trading exposures.
CREDIT RISK RATINGS
A primary element of the credit approval process is a detailed risk assessment of every credit exposure associated with a counterparty. Our risk assessment procedures consider both the creditworthiness of the counterparty and the risks related to the specific type of credit facility or exposure. This risk assessment not only affects the structuring of the transaction and the outcome of the credit decision, but also influences the level of decision-making authority required to extend or materially change the credit and the monitoring procedures we apply to the ongoing exposure.
The statements concerning the risk management and credit practices at Deutsche Bank were
misleading because they failed to disclose and were inconsistent with the poor quality RMBS and
CDO assets that Deutsche Bank was securitizing and marketing and the improperly underwritten
residential mortgages originated and acquired by Deutsche Bank as revealed by the Levin-Coburn
Report and the DOJ and FHFA investigations and complaints alleged in detail above.
142. The Form 20-F also stated:
We intend to continue to invest in our platform in the United States, as evidenced in 2006 by our acquisition of MortgagelT Holdings, Inc., a residential mortgage originator, which significantly expands our scope in residential mortgage-backed securities.
143. On May 8, 2007, Deutsche Bank issued its results for 1Q07. On the quarterly
conference call following the press release of Deutsche Bank's 1Q07 results, defendant Di Iorio
stated in part:
This quarter was much more challenging, with equity market volatility, significant corrections in emerging market equities, credit spreads widening substantially and dislocations in the U.S. mortgage market. In these conditions, our business model has proved to be resilient and we are proud and happy to be reporting outstanding results. *
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First on MortgagelT and the sub-prime effects, we're very positive about MortgagelT and we see it as a very strong long-term acquisition as well as short-term for us. As far as our expectations are concerned, because of the softening in the U.S. market and the decision that we made to even tighten further our credit standards, we had very tight credit standards but we've tightened them further, we see production softening from what we had first anticipated.
The statements concerning MortgagelT and the benefits associated with the acquisition were misleading because they failed to disclose the widespread underwriting misconduct at and poor quality mortgages originated by MortgagelT as revealed by the DOJ investigation and alleged in detail above. The statements concerning the risk management and credit practices at Deutsche Bank were misleading because they failed to disclose and were inconsistent with the poor quality RMBS and CDO assets that Deutsche Bank was securitizing and marketing and the improperly underwritten residential mortgages originated and acquired by Deutsche Bank as revealed by the Levin-Coburn
Report and the DOJ and FHFA investigations and complaints alleged in detail above.
144. On June 14, 2007, Bänziger participated in a Goldman Sachs European Financials
Conference and made a presentation entitled "Managing Risk in a Bull Market." Bänziger assured investors that Deutsche Bank employed "[p]rudent risk management" and "[h]igh underwriting standards." The statements concerning the risk management and credit practices at Deutsche Bank were misleading because they failed to disclose and were inconsistent with the poor quality RMBS and CDO assets that Deutsche Bank was securitizing and marketing and the improperly underwritten residential mortgages originated and acquired by Deutsche Bank as revealed by the Levin-Coburn
Report and the DOJ and FHFA investigations and complaints alleged in detail above.
145. On August 1, 2007, Deutsche Bank issued its 2Q07 results in a press release stating in part:
Deutsche Bank . . . reported income before income taxes for the second quarter 2007 of EUR 2.7 billion, up 32% versus EUR 2.0 billion in the second quarter 2006. Net income was EUR 1.8 billion, up 31% versus EUR 1.4 billion in
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the prior year quarter. Pre-tax return on average active equity was 36%, versus 33% in the second quarter 2006, on average active equity which was up by EUR 5.3 billion, or 22%, over the prior year quarter. Diluted earnings per share were EUR 3.60, up 48% versus the prior year quarter. Per the bank's target definition, which excludes certain significant gains and charges, pre-tax return on average active equity was 35%.
For the first six months of 2007, income before income taxes was EUR 5.9 billion, up 26% versus the first six months of 2006. Net revenues were EUR 18.4 billion, up 23%, while net income rose 30% to EUR 3.9 billion. Pre-tax return on average active equity was 40%, compared to 38% in the first half 2006, and diluted earnings per share rose 41% to EUR 7.86. Per target definition, pre-tax return on average active equity was 38%.
Dr. Josef Ackermann, Chairman of the Management Board, said: "After an excellent first quarter, we delivered another outstanding quarterly result, with significant earnings growth over the same period last year. All our business divisions contributed to this growth. As a result, we delivered a very strong first half year, clearly demonstrating the power and resilience of our platform."
He added: "Looking forward, uncertainties persist in the world's financial markets in the short term. Some areas of the credit markets may continue to experience turbulent conditions, and investors may adopt a more conservative stance toward leveraged finance. Our business model which benefits from rigorous risk management and independent control processes is structured to deliver performance also in the face of such challenges. We have consistently adopted a prudent approach to risk-taking, and the current environment is no exception. We firmly believe that these qualities will enable us to continue to perform strongly."
The statements concerning the risk management and credit practices at Deutsche Bank were misleading because they failed to disclose and were inconsistent with the poor quality RMBS and
CDO assets that Deutsche Bank was securitizing and marketing and the improperly underwritten residential mortgages originated and acquired by Deutsche Bank as revealed by the Levin-Coburn
Report and the DOJ and FHFA investigations and complaints alleged in detail above.
146. On the quarterly conference call following the press release of Deutsche Bank's 2Q07 results, defendant Di Iorio stated:
"[A]y sub-prime exposure we have is currently relatively flat."
. "[BJefore we issue a commitment, we go through a very thorough credit review similar or the same as we would if we were making the loan to the borrower, and..
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• as if we were going to be the holder of the loan.... Me 're comfortable with the credit quality of the names on which we've extended these commitments, and we do not see the current volatility or issues in the leveraged finance business. . . as a credit risk."
. "We're comfortable with our exposure at the end of the quarter, not because of hedging, but because we did go through a very thorough discussion,. . . and where appropriate, we took some charges."
The statements concerning the risk management and credit practices at Deutsche Bank were misleading because they failed to disclose and were inconsistent with the poor quality RMBS and
CDO assets that Deutsche Bank was securitizing and marketing and the improperly underwritten residential mortgages originated and acquired by Deutsche Bank as revealed by the Levin-Coburn
Report and the DOJ and FHFA investigations and complaints alleged in detail above.
147. On September 4, 2007, Ackermann made a presentation in Frankfurt, Germany at the
12. Handelsblatt Jahrestagung. The presentation included slides that assured investors that
"[Deutsche Bank] is not exposed to further deterioration in US sub-prime mortgages across its books" and "[e]xposure to US mortgage originators [is] tightly managed and largely hedged."
148. In Deutsche Bank Roadshows held in Paris, London and Zurich on September 10-14,
2007, Ackermarin made presentations which again included presentation slides that assured investors that "[Deutsche Bank] is not exposed to further deterioration in US sub-prime mortgages across its books" and "[e]xposure to US mortgage originators [is] tightly managed and largely hedged."
149. On September 12, 2007, Bänziger made a presentation in the Merrill Lynch
Wholesale Banking Risk Seminar. The presentation materials similarly assured investors that
"[Deutsche Bank] is not exposed to further deterioration in US sub-prime mortgages across its books" and "[e]xposure to US mortgage originators [is] tightly managed and largely hedged."
150. The September 2007 statements concerning the risk management and credit practices at Deutsche Bank were misleading because they failed to disclose and were inconsistent with the
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poor quality RMBS and CDO assets that Deutsche Bank was securitizing and marketing and the improperly underwritten residential mortgages originated and acquired by Deutsche Bank as revealed by the Levin-Coburn Report and the DOJ and FHFA investigations and complaints alleged in detail above.
151. On October 31, 2007, Deutsche Bank announced 3Q07 results in a press release stating in part:
Deutsche Bank. . . reported income before income taxes for the third quarter 2007 of EUR 1.4 billion, down 19% versus the third quarter of 2006. Net income for the quarter rose 31% to EUR 1.6 billion, reflecting a net positive tax impact on earnings arising from specific items. Pre-tax return on average active equity was 19% in the quarter versus 28% in the third quarter 2006. Per the bank's target definition, which excludes certain significant gains and charges, pre-tax return on average active equity for the quarter was 12%. Diluted earnings per share were EUR 3.31 for the quarter, up 36% versus EUR 2.43 in the third quarter 2006.
152. On the quarterly conference call following the press release of the Company's 3Q07 results, Ackermann said, "it could very well be that there are further corrections, but I don't believe they will be at Deutsche Bank." The Company would not be affected by a worsening of the U.S. subprime market, he said.
153. On February 7, 2008, Deutsche Bank issued its 4Q07 and FY07 financial results in a press release that stated in part:
Dr. Josef Ackermann, Chairman of the Management Board, said: "I am pleased to report robust earnings for the fourth quarter, which concludes one of our best years ever and a year of solid performance in challenging times. In 2007 we clearly strengthened our competitive position and delivered another year of profit growth while simultaneously maintaining our capital strength. This performance enables us to recommend to our shareholders another increase in our dividend, to EUR 4.50 per share."
He added: "In the fourth quarter, we again demonstrated the quality of our risk management. We had no net write-downs related to sub-prime, CDO or RMBS exposures. Those trading businesses in which we reported losses in the third quarter produced a positive result in the fourth quarter. In leveraged finance, where
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we had significant write-downs in the third quarter, net write-downs in the fourth quarter were less than EUR 50 million."
154. On the quarterly conference call following the press release of Deutsche Bank's
4Q07 and FY07 results, defendant Banziger stated the following:
We are very happy with the credit quality of our LBO books. One of the principals we always follow, and was something that was quite criticized by the markets, it was that banks originate then walk awayfrom the deal, have no stake in the whole thing and therefore they don't care what they originate, they just sell it off. We never did that. We always keep 10% in everything we do, be that the CDO, there we keep less, there we keep about 5%, be that the CLOs when we issue collateralized loan obligations from our own German mid-cap loan book, we always keep something because the clients like it. That's for them a guarantee that we have good quality.
Now, that has an immediate effect. So if you keep some of the stuff on your books, even if it's 10%, you apply these very high underwriting standards.
155. During the same analyst conference call, di Iorio's written presentation materials assured investors that Deutsche Bank employed "[s]trong risk management in turbulent markets and monitoring of exposures, including monoliners." These statements concerning the risk management and credit practices at Deutsche Bank were misleading because they failed to disclose and were inconsistent with the poor quality RMBS and CDO assets that Deutsche Bank was securitizing and marketing and the improperly underwritten residential mortgages originated and acquired by
Deutsche Bank as revealed by the Levin-Coburn Report and the DOJ and FHFA investigations and complaints alleged in detail above.
156. On March 26, 2008, Deutsche Bank filed with the SEC its Form 20-F for its 4Q07 and FY07. The Form 20-F made the following statements concerning Deutsche Bank's risk practices:
RISK AND CAPITAL MANAGEMENT PRINCIPLES
The following key principles underpin our approach to risk and capital management:
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- Our Management Board provides overall risk and capital management supervision for our consolidated Group as a whole. Our Supervisory Board regularly monitors our risk and capital profile.
- We manage credit, market, liquidity, operational, business, legal and reputational risks as well as our capital in a coordinated manner at all relevant levels within our organization. This also holds true for complex products which we typically manage within our framework established for trading exposures. *
CREDIT RISK
Credit risk makes up the largest part of our risk exposures. We measure and manage our credit risk following the below principles:
- In all our group divisions consistent standards are applied in the respective credit decision processes.
- The approval of credit limits for counterparties and the management of our individual credit exposures must fit within our portfolio guidelines and our credit strategies.
- Every extension of credit or material change to a credit facility (such as its tenor, collateral structure or major covenants) to any counterparty requires credit approval at the appropriate authority level. *
MONITORING DEFAULT RISK
We monitor all of our credit exposures on a continuing basis using the risk management tools described above. We also have procedures in place to identify at an early stage credit exposures for which there may be an increased risk of loss. Counterparties that, on the basis of the application of our risk management tools, demonstrate the likelihood of problems, are identified well in advance so that we can effectively manage the credit exposure and maximize the recovery. The objective of this early warning system is to address potential problems while adequate alternatives for action are still available. This early risk detection is a tenet of our credit culture and is intended to ensure that greater attention is paid to such exposures. In instances where we have identified counterparties where problems might arise, the respective exposure is placed on a watchlist. *
CREDIT RISK RATINGS
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A primary element of the credit approval process is a detailed risk assessment of every credit exposure associated with a counterparty. Our risk assessment procedures consider both the creditworthiness of the counterparty and the risks related to the specific type of credit facility or exposure. This risk assessment not only affects the structuring of the transaction and the outcome of the credit decision, but also influences the level of decision-making authority required to extend or materially change the credit and the monitoring procedures we apply to the ongoing exposure.
157. The Form 20-F also included a table of Deutsche Bank's exposure to U.S. residential mortgages:
OTHER U.S. MORTGAGE BUSINESS EXPOSURE: We also have ongoing exposure to the U.S. residential mortgage market through our trading, origination and securitization businesses in residential mortgages. These are summarized below, which does not include agency CMOs and agency eligible loans.
Other U.S. Mortgage business exposure: Exposure in € m. Dec 31, 2007 Alt-A 7,908
Subprime 216
Other 1,679
Total other U.S. residential Mortgage gross assets 9,803
Hedges and other protection purchased (7,592)
Trading related net positions 803
Total net other U.S. Mortgage business exposure 3,014
158. The Form 20-F concealed MortgagelT's violations of origination standards, the poor quality of the mortgages and mortgage-backed assets and Deutsche Bank's disregard of findings of such violations by due diligence firms.
159. On April 1, 2008, Ackermann participated in a Morgan Stanley European Banks &
Financials Conference in London. His presentation materials assured investors with respect to
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CDOs and the bank's U.S. Mortgage Business, that "[a]l1 of them are marked-to-market." The presentation materials also assured investors that Deutsche Bank's "[n]on-sub-prime exposure" in its
RMBS business was "[p]redominately AAA-rated securities based on Alt-A collateral." RMBS assets were not however properly being marked to market. In addition, defendants knew the credit ratings were inaccurate and relied on outdated ratings models.
IX. DEUTSCHE BANK BEGINS TO ANNOUNCE LOSSES AND MAKE NEGATIVE DISCLOSURES.
160. On April 29, 2008, Deutsche Bank issued its financial results for the 1Q08 in a press release that stated in part:
Deutsche Bank.. . reported a net loss of EUR 141 million, or 27 cents per share, for the first quarter of 2008, and a loss before income taxes of EUR 254 million. Markdowns of EUR 2.7 billion were recorded in respect of leveraged loans and loan commitments, commercial real estate and residential mortgage-backed securities (predominantly Alt-A). A gain of EUR 77 million arose from the widening of credit spreads on certain Deutsche Bank debt, for which the fair value option was elected. The Tier 1 capital ratio at the end of the quarter, reported under Basel II, was 9.2%.
Dr. Josef Ackermann, Chairman of the Management Board, said: "Deutsche Bank's position is clear. We remain rigorous in controlling costs and monitoring investment spending. We are redeploying both human and capital resources towards growth businesses and regions. We are swiftly and decisively reducing our risk exposures. We have consolidated our capital strength.
161. This was Deutsche Bank's first loss in five years, and was followed by a series of additional negative disclosures.
162. On the quarterly conference call after releasing the 1Q08 results, defendant Di Iorio explained that a head count reduction of 1,000 people was largely due to cut-backs at MortgagelT:
A lot of the people, just over half, came from a mortgage banking operation in the United States, MortgagelT. And the rest of it came from various parts of our sales and trading and Corporate Finance business.
163. Defendant Di Iorio also stated:
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Our U.S. Residential Mortgage business, our exposures continue to come down there. The Alt-A book was reduced from EUR7.8b to EUR5.2b and this came from some liquidations, markdowns and the effect of FX, particularly the dollar weakening during the quarter. Our net exposure dropped from EUR3.6b to EUR1 .7b.
164. On July 31, 2008, Deutsche Bank released its 2Q08 results, including the Company's second straight loss at its securities unit due to $3.6 billion in write-downs. The Company wrote down the value of residential mortgage-backed securities, mostly so-called Alt-A mortgages, by€1 billion. On the same day, Bloomberg reported:
Ackermann said he "remains cautious" after the investment bank posted a 311 million-euro pretax loss on markdowns of mortgage securities, loans and debt backed by bond insurers.
165. On the 2Q08 conference call, defendant Di Iorio attributed much of the loss to the
RMBS issues:
Many of our peers began aggressively selling down their RMBS positions in the second quarter and we, as others, experienced a mark-down here because of the drop in the valuations in the market.
166. On August 1, 2008, Bloomberg issued an article entitled "Deutsche Bank Debt Rating
Cut by S&P After Writedowns (Update 4)," which stated in part:
Deutsche Bank AG, Germany's largest bank, had its long-term credit rating lowered by Standard & Poor's after announcing higher-than-estimated second-quarter writedowns of 2.3 billion euros ($3.6 billion).
S&P cut the long-term counterparty credit rating one step to AA- from AA, and affirmed the bank's A-1+ short-term rating. The outlook on all the ratings is negative, S&P said, adding that the investment-banking industry is still under "heavy pressure."
"The downgrade reflects that we no longer consider Deutsche Bank's performance to be materially stronger than that of the leading peers in the currently difficult environment," said S&P analysts led by Bernd Ackermann in Frankfurt in a statement today. *
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"It's the negative outlook that's worrisome," said Dirk Becker, a Frankfurt- based analyst at Landsbanki Kepler. "Deutsche Bank wouldn't be able to conduct a lot of their business with a lower rating."
167. In September and October 2008, the financial markets dropped as problems in the financial industry became apparent, including the failure of Lehman Brothers. Deutsche Bank's stock also dropped as market observers recognized Deutsche Bank's precarious position. Deutsche
Bank shares declined from $90.50 per share in mid August 2008, to $35.65 per share in late October
2008, as market participants realized that banks' past lending practices (including at Deutsche Bank) could lead to their collapse.
168. On October 30, 2008, Deutsche Bank issued a press release announcing its 3Q08 financial results, which stated in part:
Deutsche Bank. . . today reported net income of EUR 414 million, versus EUR 1.6 billion in the third quarter 2007. Earnings per share on a diluted basis were EUR 0.83 for the third quarter 2008, versus EUR 3.31 per share in the prior year quarter. Income before income taxes was EUR 93 million, versus EUR 1.4 billion in the prior year quarter. Mark-downs of EUR 1.2 billion were recorded on leveraged loans and loan commitments, residential mortgage-backed securities, monoline insurers, commercial real estate and on available for sale positions. The Tier 1 capital ratio, reported under Basel II, was 10.3%, versus 9.3% at the end of the second quarter 2008.
169. Deutsche Bank's 3Q08 press release showed that Deutsche Bank's investment- banking unit reported a third straight quarterly pretax loss of €789 million. The Company booked write-downs of €1.2 billion on leveraged buyouts, RMBS, assets secured by bond insurers and commercial real estate.
170. Deutsche Bank's subprime market-related losses were pegged by Bloomberg on
November 12, 2008 at $11.6 billion.
171. In December 2008, Deutsche Bank made the following announcement regarding its
MortgagelT subsidiary:
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Deutsche Bank has made the difficult decision to close the MortgagelT US Wholesale Lending Division. Mortgagell will cease accepting new business as of December 11th and focus on existing business.
172. On January 16, 2009, Fitch placed Deutsche Bank's AA- rating on Rating Watch
Negative following the Company's 4Q08 performance update.
173. On this news, Deutsche Bank shares fell to close at $21.27 per share on January 20,
2009 (the next trading day) - a decline of more than 86% from their Class Period high of$ 159.59 in
May 2007.
174. Further disclosing the deterioration caused by the Company's toxic trading portfolio, the Company issued its 2008 Annual Report on March 23, 2009, which stated in part:
Net gains (losses) on financial assets/liabilities at fair value through profit or loss from CIB - Sales & Trading (debt and other products) were a loss of €6.6 billion in 2008, compared to a gain of €3.9 billion in 2007. This development was mainly driven by mark-downs relating to reserves against monoline insurers, provisions against residential mortgage-backed securities and commercial real estate loans and significant losses in our credit trading businesses, including our proprietary trading businesses in the third and fourth quarter of 2008, which are described in more detail in the discussion of the results in CB&S.... The main contributor to the net loss of €1.8 billion on financial assets/liabilities at fair value through profit or loss from Other products were net mark-downs of€1. 7 billion on leveraged finance loans and loan commitments during 2008.
*
Sales & Trading (debt and other products) revenues for the year were €124 million, compared to €8.4 billion in 2007. Key drivers of the decline were mark- downs of €5.8 billion, relating to additional reserves against monoline insurers (€2.2 billion), further mark-downs on residential mortgage-backed securities (€2.1 billion) and commercial real estate loans (€1.1 billion), and impairment losses on available for sale positions (€490 million), compared to a total of €1.6 billion in 2007. If reclassifications, in accordance with the amendments to lAS 39, had not been made, the income statement for the year would have included additional negative fair value adjustments of €2.3 billion in Sales & Trading (debt and other products).
*
As of December 31, 2008, the [€868 million in] Super Senior and Mezzanine [subprime residential mortgage-related available-for-trading CDO] gross exposures
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and hedges consisted of approximately 1% 2007, 30% 2006, 35% 2005 and 34% 2004 and earlier vintages.
175. The true facts, which were known by defendants but concealed from the investing public during the Class Period, were as follows:
(a) Deutsche Bank's MortgagelT subsidiary was issuing and had issued billions of dollars of mortgage loans which did not comply with stated lending practices due to the practices identified by the DOJ investigation, leading to thousands of defaults;
(b) Deutsche Bank was aware that billions of dollars of U.S. residential mortgages were improperly underwritten, that RMBS and CDOs holding those mortgages were incorrectly rated and that the securities had a high and undisclosed risk of default; and
(c) Deutsche Bank had knowingly securitized and transferred billions of dollars in poor quality, defaulting, or soon-to-default, mortgages to unwitting investors and government programs due to its disregard of adverse findings by outside consultants as revealed by the Levin-
Coburn investigation.
176. As a result of defendants' false statements, Deutsche Bank shares traded at inflated prices during the Class Period. However, after the above revelations seeped into the market, the
Company's shares were hammered by massive sales, sending them down more than 86% from their
Class Period high.
X. LOSS CAUSATION/ECONOMIC LOSS
177. By misrepresenting Deutsche Bank and MortgagelT's intentionally reckless mortgage origination and securitization practices, defendants presented a misleading picture of the Company's financial condition and operations. Thus, instead of truthfully disclosing during the Class Period that
Deutsche Bank's business was not as healthy as represented, Deutsche Bank falsely concealed conduct which caused it to retain and securitize impaired mortgage-related assets.
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178. Defendants' claims of profitability and strong risk management practices caused and maintained the artificial inflation in Deutsche Bank's share price during the Class Period and until the truth about its exposure to the problems in the U.S. residential mortgage market were revealed to the market.
179. Defendants' false and misleading statements had the intended effect and caused
Deutsche Bank shares to trade at artificially inflated levels throughout the Class Period, reaching as high as $159.59 per share.
180. By the fall of 2008, it became apparent to the market that Deutsche Bank's debt securities were impaired, including its mortgage-related assets. In November 2008, the extent of
Deutsche Bank's exposure to problematic mortgages became more apparent to the market, causing its stock to drop below $30 per share. Later in December 2008, Deutsche Bank announced it would shut down MortgagelT's wholesale lending division, and in January 2009, after the Company announced disappointing 4Q08 results and additional losses, Fitch placed its AA- rating on Rating
Watch Negative. However, investors were not aware of Deutsche Bank's intentional and reckless conduct with respect to its mortgage operations until: (i) the Levin-Coburn Report was released in
April 2011; (ii) the DOJ sued Deutsche Bank in May 2011 for misrepresenting the quality of the loans made by its MortgagelT subsidiary; and (iii) the FHFA sued Deutsche Bank in September
2011.
181. As a direct result of the public revelations regarding the truth about Deutsche Bank's profitability and its actual business prospects going forward, Deutsche Bank's share price fell 86%, falling from $159.59 per share in May 2007 to $21.27 per share on January 20, 2009, including a
$7.71 or 26% decline from January 14, 2009 to January 20, 2009. Deutsche Bank's shares on the
German and other exchanges dropped by similar amounts. In response to inquiries by the Levin-
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Coburn Subcommittee Investigation, Deutsche Bank ultimately admitted that it had incurred $795 million in losses due to products backed by U.S. residential mortgages in 2007 and $3.66 billion of such losses in 2008, for total losses of $4.5 billion. These drops removed the inflation from
Deutsche Bank's share price, causing real economic loss to investors who had purchased the shares during the Class Period.
COUNT I
For Violation of Section 10(b) of the 1934 Act and Rule lOb-5 Against All Defendants
182. Plaintiffs incorporate ¶J1 -181 by reference.
183. During the Class Period, defendants disseminated or approved the false statements specified above, which they knew or deliberately disregarded were misleading in that they contained misrepresentations and failed to disclose material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.
184. Defendants violated § 10(b) of the 1934 Act and Rule 1 Ob-5 in that they:
(a) employed devices, schemes and artifices to defraud;
(b) made untrue statements of material facts or omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading; or
(c) engaged in acts, practices and a course of business that operated as a fraud or deceit upon plaintiffs and others similarly situated in connection with their purchases of Deutsche
Bank ordinary shares during the Class Period.
185. Plaintiffs and the Class have suffered damages in that, in reliance on the integrity of the market, they paid artificially inflated prices for Deutsche Bank ordinary shares. Plaintiffs and the
Class would not have purchased Deutsche Bank ordinary shares at the prices they paid, or at all, if
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they had been aware that the market prices had been artificially and falsely inflated by defendants' misleading statements.
186. Plaintiffs could not have learned of the extent of Deutsche Bank's intentional conduct with respect to MortgagelT and its RMBS and CDOs until 2011.
COUNT II
For Violation of Section 20(a) of the 1934 Act Against All Defendants
187. Plaintiffs incorporate ¶f 1 -186 by reference.
188. The Individual Defendants acted as controlling persons of Deutsche Bank within the meaning of §20(a) of the 1934 Act. By reason of their positions with the Company, and their ownership of Deutsche Bank shares, the Individual Defendants had the power and authority to cause
Deutsche Bank to engage in the wrongful conduct complained of herein. Deutsche Bank controlled the Individual Defendants and all of its employees. By reason of such conduct, defendants are liable pursuant to §20(a) of the 1934 Act.
XI. CLASS ACTION ALLEGATIONS
189. Plaintiffs bring this action as a class action pursuant to Rule 23 of the Federal Rules of Civil Procedure on behalf of all persons who purchased or otherwise acquired Deutsche Bank ordinary shares during the Class Period (the "Class"). Excluded from the Class are defendants.
190. The members of the Class are so numerous that joinder of all members is impracticable. The disposition of their claims in a class action will provide substantial benefits to the parties and the Court. Deutsche Bank has over 925 million shares outstanding, owned by thousands of persons. The shares trade on the NYSE and other exchanges.
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191. There is a well-defined community of interest in the questions of law and fact
involved in this case. Questions of law and fact common to the members of the Class which
predominate over questions which may affect individual Class members include:
(a) whether the 1934 Act was violated by defendants;
(b) whether defendants omitted and/or misrepresented material facts;
(c) whether defendants' statements omitted material facts necessary to make the
statements made, in light of the circumstances under which they were made, not misleading;
(d) whether defendants knew or deliberately disregarded that their statements
were false and misleading;
(e) whether the prices of Deutsche Bank shares were artificially inflated; and
(f) the extent of damage sustained by Class members and the appropriate measure
of damages.
192. Plaintiffs' claims are typical of those of the Class because plaintiffs and the Class
sustained damages from defendants' wrongful conduct.
193. Plaintiffs will adequately protect the interests of the Class and has retained counsel
who are experienced in class action securities litigation. Plaintiffs have no interests which conflict
with those of the Class.
194. A class action is superior to other available methods for the fair and efficient
adjudication of this controversy.
XII. PRAYER FOR RELIEF
WHEREFORE, plaintiffs pray for judgment as follows:
A. Declaring this action to be a proper class action pursuant to Fed. R. Civ. P. 23;
B. Awarding plaintiffs and the members of the Class damages, including interest;
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C. Awarding plaintiffs' reasonable costs and attorneys' fees; and
D. Awarding such equitable/injunctive or other relief as the Court may deem just and
proper.
XIII. JURY DEMAND
Plaintiffs demand a trial by jury.
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DATED: June 1, 2012 ROBB[NS GELLER RUDMAN & DOWD LLP JOHN K. GRANT
Post Montgomery Center One Montgomery Street, Suite 1800 San Francisco, CA 94104 Telephone: 415/288-4545 415/288-4534 (fax) E-mail: [email protected]
ROBB[NS GELLER RUDMAN & DOWD LLP SAMUEL H. RUDMAN 58 South Service Road, Suite 200 Melville, NY 11747 Telephone: 631/367-7100 631/367-1173 (fax) E-mail: [email protected]
Lead Counsel for Plaintiff
LAW OFFICE OF ALFRED G. YATES, JR., P.C. ALFRED G. YATES, JR. 519 Allegheny Building 429 Forbes Avenue Pittsburgh, PA 15219 Telephone: 412/391-5164 412/471-1033 (fax) E-mail: [email protected]
Additional Counsel for Plaintiff
683198_i Case 1:11-cv-04209-BSJ-JCF Document 23 Filed 06/01/12 Page 71 of 72
CERTIFICATE OF SERVICE
I, Kelly Stadelmann, hereby certify that on June 1, 2012, I caused a true and correct copy of the annexed document to be served by U.S. mail to all counsel listed on the attached service list.
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DEUTSCHE BANK AG 11 Service List - 5/30/2012 (11-0129) Page 1 of I
Counsel For Defendant(s) David G. Januszewski Charles A. Gilman Cahill Gordon & Reindel LLP 80 Pine Street New York, NY 10005-1702 212/701-3000 212/269-5420(Fax)
Counsel For Plaintiff(s) Alfred G. Yates, Jr. Samuel H. Rudman Law Offices of Alfred G Yates Jr., P.C. Robbins Geller Rudman & Dowd LLP 519 Allegheny Building 58 South Service Road, Suite 200 429 Forbes Avenue Melville, NY 11747 Pittsburgh, PA 15219 631/367-7100 412/391-5164 631/367-1173(Fax) 412/471-1033(Fax)
Darren J. Robbins John K. Grant Danielle S. Myers Robbins Geller Rudman & Dowd LLP Robbins Geller Rudman & Dowd LLP Post Montgomery Center 655 West Broadway, Suite 1900 One Montgomery Street, Suite 1800 San Diego, CA 92101 San Francisco, CA 94104 619/231-1058 415/288-4545 619/231-7423(Fax) 415/288-4534(Fax)
Gregory S. Campora Robert M. Cheverie & Associates Commerce Center One 333 E. River Drive, Suite 101 East Hartford, CT 06108 860/290-9610 860/290-9611 (Fax)