Commercial Division Blog

Posted: December 24, 2020 / Categories Commercial, Fraud/Misrepresentation, Statute of Limitations/Laches

Fraud Claim Time-Barred Because Plaintiff Was on Inquiry Notice More Than Two Years Before Suit Filed

On December 8, 2020, Justice Friedman of the New York County Commercial Division issued a decision in Ambac Assur. Corp. v. Countrywide Home Loans, Inc., 2020 NY Slip Op. 34044(U), holding that a fraud claim was time-barred because the plaintiff was on inquiry notice of its claim more than two years before the suit was filed, explaining:

A fraud action must be commenced within the greater of six years from the date the cause of action accrued or two years from the time the plaintiff discovered the fraud, or could with reasonable diligence have discovered it. Under CPLR 203(g)(1), where the time within which an action must be commenced is computed from the time when facts were discovered or from the time when facts could with reasonable diligence have been discovered, or from either of such times, the action must be commenced within two years after such actual or imputed discovery. Under these sections, the time at which plaintiff could with reasonable diligence have discovered the fraud is thus the time of imputed discovery. It is undisputed that the statute of limitations accrued on the dates the policies were issued and that this action was commenced more than six years after such dates. It is also undisputed that plaintiffs' claims are untimely if they could have been discovered through the exercise of reasonable diligence by November 21, 2009 - that is, two years prior to the effective date of the parties' tolling agreement.

The applicable standard for determining when fraud could with reasonable diligence have been discovered is well established: The test as to when fraud should with reasonable diligence have been discovered is an objective one. Where the circumstances are such as to suggest to a person of ordinary intelligence the probability that he has been defrauded, a duty of inquiry arises, and if he omits that inquiry when it would have developed the truth, and shuts his eyes to the facts which call for investigation, knowledge of the fraud will be imputed to him.

Under the standard set forth above, Countrywide must make a prima facie showing that Ambac was on inquiry notice of its fraud claim prior to November 21, 2009. The burden then shifts to Ambac to establish that, or to raise a triable issue of fact as to whether, even if it had exercised reasonable diligence, it could not have discovered the basis for its fraud claims. As discussed in detail below, the undisputed evidence shows that misconduct substantially similar to that alleged by Ambac here was widely disclosed, between 2006 and early 2009, in media reports and highly publicized litigation. It is also undisputed that by February 2009, the certificates in the Ambac insured transactions had all been downgraded to junk status, with progressive downgrades beginning in June 2008.

In addressing RMBS fraud claims, the Appellate Division and this court have consistently held that inquiry notice was established based on the existence, more than two years prior to the commencement of the action, of substantially analogous public disclosures accompanied by ratings downgrades to the relevant certificates.

In CIFG, the Appellate Division applied the Gutkin inquiry notice standard to dismiss, as untimely, a financial guarantor's fraud claim involving a collateralized debt obligation (CDO). The Court reasoned: Plaintiff has failed to meet its burden of establishing that even with the exercise of reasonable diligence, it could not have discovered the basis for its claims prior to November 15, 2011. Plaintiff was put on notice of defendant's fraud and scienter as early as 2008, but certainly by 2010, based on certain reports, made public, indicating the alleged actions that form the basis of plaintiffs claims. In addition, plaintiff was put on notice of defendant's alleged fraudulent activities by other lawsuits commenced prior to November 2011. Because plaintiff possessed information suggesting the probability that it had been defrauded, and failed to conduct an inquiry at that time, knowledge of the fraud is imputed.

The Appellate Division addressed the same issue the following year in three separate fraud actions brought by Aozora Bank, Ltd. arising from its investments in CDOs that included RMBS.

In Aozora v Deutsche Bank, the Appellate Division held that public reports and lawsuits of alleged fraud are sufficient to put a plaintiff on inquiry notice of fraud. There, the wealth of public information available by June 2011 (two years before the action was commenced) supported dismissal of the action as untimely. As described by the Court: First, in 2008, Blue Edge [the CDO at issue] was downgraded to junk status and plaintiff incurred substantial losses on its investment. Second, there was considerable publicity about the subprime mortgage crisis from news reports, investor lawsuits, and government investigations well before June 2011. Indeed, by April 2011, defendants had been sued multiple times in connection with RMBS and CDOs, including in connection with a Deutsche Bank CDO known as Gemstone, which plaintiff discusses in its complaint as involving wrongdoing by defendants identical to that involved with respect to Blue Edge. Third, one of the most significant sources of public information putting plaintiff on notice of its fraud claims is the Senate Report and its associated emails, which actually form the centerpiece of plaintiffs complaint. In fact, the Senate Report contains a 45- page section on Deutsche Bank entitled Running the CDO Machine: Case Study of Deutsche Bank. Taken with all the other information available in the public domain, the Senate Report is more than sufficient to have placed Aozora on inquiry notice of possible fraud by April 2011 at the latest.

In Aozora v Credit Suisse, the Appellate Division dismissed the action in reliance on similar public disclosures more than two years prior to commencement of the action: Aozora sustained substantial investment losses in 2007 and 2008, and by August 2008, the Jupiter V notes in which Aozora invested had been downgraded from the highest possible Moody's rating to the lowest. Next, in March 2009, a complaint was filed in the Southern District of New York alleging misconduct by defendant Harding similar to that alleged in Aozora's complaint here. This federal lawsuit was discussed in a 2010 article in Bloomberg, which also described another lawsuit alleging that Harding was beholden to a bank that allowed it to dump unwanted holdings into their deals. There were other published reports that should have put a sophisticated financial investor like Aozora on notice of a possible fraud. In March 2009, Time magazine published an article about Jupiter V entitled One Bad Bond, reporting that 59% of its investments were worthless. The article described Jupiter Vas a toxic asset and one of those financial instruments at the root of the economic meltdown. In 2010, Michael Lewis's best-selling book The Big Short: Inside the Doomsday Machine was published. That book contained allegations presenting a negative portrayal of Harding in its management of CDOs.

The Court again dismissed the fraud claims as untimely in Aozora v UBS based on substantially similar evidence: The record demonstrates that plaintiff could, with reasonable diligence, have discovered the alleged fraud by April 2010, rendering its fraud claims untimely. By that date, numerous lawsuits had been filed against the UBS defendants for misconduct similar to that alleged in this complaint. Also by that date, the Securities and Exchange Commission had commenced an investigation into UBS's CDO practices. In addition, news articles disclosed the alleged misconduct involving hedge fund Magnetar and the Constellation CDOs at issue. The foregoing lawsuits, investigations and articles also sufficed to put plaintiff on inquiry notice of defendant Deutsche's alleged fraud.

This court has also dismissed RMBS claims upon a showing of inquiry notice based on substantially similar evidence.

Here, Ambac's fraud claim is based principally on Countrywide's alleged pervasive, imprudent, and unlawful origination practices and wholesale abandonment of reasonable underwriting standards. Ambac alleges that these practices violated representations made by Countrywide prior to issuance of the policies. As shown by the record on this motion, substantially similar allegations against Countrywide were made in multiple, highly publicized lawsuits prior to November 2009. Specifically, in June 2009, the SEC brought a civil fraud action against three senior Countrywide executives alleging, among other things, persistent misrepresentations concerning origination and underwriting guidelines and a pervasive practice of concealing negative information from investors. Ambac's complaint in fact cites the June 2009 Mozilo complaint in support of its fraud claim.

Other highly publicized litigation in 2008 and 2009 disclosed wrongdoing with respect to Countrywide's origination and underwriting practices. In September 2008 and January 2009, two other monoline insurers brought actions in this court alleging that Countrywide fraudulently induced issuance of policies insuring RMBS transactions. In addition, numerous state consumer protection actions, filed in 2008, made detailed disclosures regarding Countrywide's allegedly predatory lending practices that are a basis for Ambac's fraud claim. For example, Ambac's complaint alleges that the specific PayOption ARM loan programs at issue in the 2008 state consumer protection actions are precisely those pursuant to which loans in the Transactions were originated. As further alleged, the manner in which such programs were actually conducted, as disclosed in those actions, violated specific representations Countrywide made to Ambac regarding its origination and underwriting standards. Ambac was also placed on notice of wrongdoing by Countrywide similar to that alleged in this action by widespread media reports concerning the financial crisis and related mortgage fraud. Many of these reports addressed alleged wrongdoing at Countrywide.

All of the above information was available to Ambac prior to November 2009. In addition, as noted above, the relevant RMBS securities had all been downgraded to junk status by February 2009. This information should, at the least, have suggested to Ambac, a sophisticated financial institution, that there was a probability that it had been defrauded by Countrywide by the same wrongdoing, including pervasive deviation from origination and underwriting standards.

In so holding, the court rejects Ambac's contention that the public disclosures at issue here are distinguishable from the public disclosures that supported the finding of inquiry notice in the Aozora cases. Ambac argues that the disclosures in the Aozora cases were directed to either the particular instrument in controversy or the particular collateral backing that instrument. The Aozora cases do not, however, require public disclosure as to a specific instrument to establish inquiry notice. In each of those cases, there were public disclosures that referenced a specific instrument at issue. While the Court considered this information, among other public disclosures, the Court did not state or even suggest that the public disclosures that referenced a specific instrument were determinative of the finding of inquiry notice or given greater weight in the Court's analysis. This court has also found, without relying on evidence of a disclosure of fraud specific to the RMBS instrument or underlying loans at issue, that the plaintiff was on inquiry notice as of November 2009.

Importantly, the Aozora cases affirmed that the objective test for inquiry notice is whether the totality of the given circumstances suggest the probability of fraud. Here, the circumstances suggest the probability of fraud, even in the absence of evidence of a public disclosure addressed to the Ambac insured RMBS transactions and underlying mortgage loans. Put another way, given the widely publicized disclosures between 2006 and 2009 concerning pervasive fraud at Countrywide, it would have been objectively unreasonable for a person of ordinary intelligence not to conclude that there was a probability of fraud with respect to the Ambac transactions and loans.

The court accordingly holds that Countrywide has met its burden of making a prima facie showing that Ambac was on inquiry notice of its fraud claim prior to November 21, 2009 - that is, more than two years before November 21, 2011. The burden accordingly shifts to Ambac to show that, or to raise a triable issue of fact as to whether, even if it had exercised reasonable diligence, it could not have discovered the basis for its fraud claim. Ambac fails to meet this burden.

Ambac does not dispute that the information discussed above was publicly available prior to November 2009. Ambac also does not claim that it conducted an investigation at that time based upon the public disclosures. Rather, Ambac contends that the two year period could not begin to run until it reasonably could have performed a loan-level analysis, which was not until 2010. More particularly, Ambac contends that inquiry notice was not triggered until Ambac could reasonably have conducted a loan level analysis to identify individual loans in the RMBS transactions that breached Countrywide's representations. Similarly, Ambac contends that it could not have exercised reasonable diligence without the ability to conduct a loan level analysis. It thus asserts that without loan files, the exercise of reasonable diligence did not enable Ambac to conduct a loan-level analysis of the Transactions by November 2009. According to Ambac, until it was able to identify loan-level misrepresentations, Ambac could not have discovered the basis for a viable fraud claim. This contention is, in turn, premised upon Ambac's argument that loan level allegations were required to sufficiently plead its fraud claim.

Ambac appears to conflate the standard for determining whether a party is on inquiry notice with the standard for pleading a fraud cause of action with particularity. Inquiry notice does not require actual knowledge of the fraud or of each of the elements constituting the fraud. As explained by the Appellate Division, a plaintiff need only be aware of enough operative facts so that, with reasonable diligence, it could have discovered the fraud. Ambac's contrary argument - that the statute of limitations does not begin to run until plaintiff is on notice of every element of the claim - relies principally on Phoenix Lighht SF Ltd. v ACE Securities Corp. (39 Misc 3d 1218[A], 2013 WL 1788007, at *12 [Sup Ct, NY County 2013]). While Phoenix Light indicates that the statute of limitations is not triggered until the plaintiff has notice of every element of the fraud claim, the decision applies an actual notice standard under foreign (Irish and Caymans and Delaware and German) law. The decision is inapposite, as it does not address the inquiry notice standard.

Ambac's claim that loan level allegations were required to sufficiently plead its fraud claim is also without merit. According to Ambac, as of November 2009 courts had shut their doors to RMBS plaintiffs unable to connect general allegations of wrongful conduct to the specific transactions or loans at issue. Ambac does not cite any New York case decided at or about that time. Nor do the 2009 federal cases cited by Ambac hold that, in order to adequately plead an RMBS fraud claim, the plaintiff must allege deviations from origination or underwriting standards in specific loans. There was no basis on which Ambac could reasonably have concluded, as of November 2009, that the law was settled that pleading of deviations in specific loans was required, or that a loan level analysis was required to meet such a pleading standard. Nor is there any evidence in the record of this motion that Ambac actually failed to pursue its fraud claim sooner based on an understanding that it was required to plead loan level deviations.

Ambac also suggests that numerous cases continued, after 2009, to hold that a fraud claim is not sufficiently pleaded absent allegations tying the alleged misconduct to specific loans. As this court has previously explained, although there are cases that have dismissed complaints for failure to plead a sufficient nexus between deviations from underwriting standards and specific loans, the weight of authority holds that allegations of systematic underwriting failure are sufficient to state a fraud claim and need not be accompanied by reference to specific loans in the RMBS securitization. Here, the court will not, and need not, again undertake an exhaustive review of the pleading standard because, as held above, the standard for determining whether a plaintiff is on inquiry notice is different than the pleading standard for fraud.

(Internal quotations and citations omitted) (emphasis added).

Schlam Stone & Dolan represents investors in RMBS actions against underwriters and trustees and in related proceedings, such as trust instruction proceedings where an RMBS trustee seeks court guidance regarding the management of an RMBS trust. If you or a client are RMBS investors and have questions regarding potential claims against a trustee or how to influence the trustee's prosecution of a put back or repurchase action, contact Schlam Stone & Dolan partner John Lundin at