Commercial Division Blog
RMBS Fraud Claim Dismissed for Inability to Tie Losses to Misrepresentations
On March 2, 2017, the First Department issued a decision in Basis PAC-Rim Opportunity Fund (Master) v. TCW Asset Management Co., 2017 NY Slip Op. 01644, dismissing an RMBS fraud action on summary judgment for failure to tie the plaintiff's losses to the defendant's misrepresentations, explaining:
A fraud claim requires proof by clear and convincing evidence as to each element of the claim. One such element is causation, and to establish causation, plaintiffs must prove both that defendant's misrepresentation induced plaintiffs to engage in the transaction in question (transaction causation) and that the misrepresentations directly caused the loss about which plaintiffs complain (loss causation). Transaction causation is akin to reliance, and requires only an allegation that but for the claimed misrepresentations or omissions, the plaintiff would not have entered into the detrimental securities transaction.
Loss causation is the causal link between the alleged misconduct and the economic harm ultimately suffered by the plaintiff. To establish loss causation a plaintiff must prove that the subject of the fraudulent statement or omission was the cause of the actual loss suffered. Moreover, when the plaintiff's loss coincides with a marketwide phenomenon causing comparable losses to other investors, the prospect that the plaintiff's loss was caused by the fraud decreases, and a plaintiff's claim fails when it has not proven that its loss was caused by the alleged misstatements as opposed to intervening events. Indeed, when an investor suffers an investment loss due to a market crash of such dramatic proportions that the losses would have occurred at the same time and to the same extent regardless of the alleged fraud, loss causation is lacking. Although the Loreley case concerned a motion to dismiss and thus focused on pleading requirements for loss causation, that court did note that whether plaintiffs can prove their allegations - and whether defendants in turn can proffer evidence that the CDOs would have collapsed regardless, due to the larger crash in the mortgage-backed securities market - are evidentiary matters for later phases of this lawsuit.
Here, TCW has proffered evidence that Dutch Hill would have collapsed regardless of the assets selected by TCW due to the housing market crash - a marketwide phenomenon causing comparable losses to other investors. TCW submitted an expert affidavit in which the expert opined that even if TCW had selected assets that complied with the Dutch Hill model and comported with TCW's representations to Basis, Basis would still have suffered a loss due to an external and intervening cause - namely, the housing market crash. The expert conducted a common form of regression analysis to analyze the effect that macroeconomic factors had on pools of collateral consistent with Dutch Hill II's core asset portfolio in order to create a benchmark against which to compare the performance of the loan pools analyzing the collateral in Dutch Hill II. The TCW expert found that any CDO backed by pools of loans consistent with Dutch Hill II's core asset portfolio would have suffered losses as a consequence of the general market downturn. Ultimately, the expert concluded that Basis's economic losses were caused by unforeseeable macroeconomic events.
In response, Basis failed to raise an issue of fact. Despite having pleaded in its amended complaint that TCW allowed Dutch Hill to contain toxic securities that performed significantly worse than a benchmark portfolio comprised of similar mortgage-backed bonds, Basis failed to produce any evidence that under the circumstances here involving the collapse of the RMBS market, it was TCW's misrepresentations, rather than market forces, that caused the investment losses. Instead, Basis's expert, in response, provided a general overview of the role of various players involved in CDO transactions as well as his opinion and interpretation of internal TCW emails discussing the investment vehicle at issue and the health of the market. However, Basis's expert failed to address or even discuss Basis's argument that no suitable collateral then existed and that TCW lied about its existence, and that this misrepresentation caused Basis to lose their entire investment. Basis's expert did not analyze the quality or performance of the assets purchased by TCW. Basis's expert's conclusory assessment of the economic damages suffered by Basis addressed only transaction causation, stating that in the absence of fraudulent inducement and concealment, plaintiffs aver that Basis would not have invested $27,000,000 plus and would therefore not have suffered this total loss. This was insufficient to raise an issue of fact as to loss causation.
We do not mean to suggest that all cases in which a plaintiff alleges fraud will be unable to survive summary judgment in the event of a market collapse. However, in this case, it is Basis's complete failure to meet its burden on the issue of loss causation that compels our decision.
(Internal quotations and citations omitted).