Last March, U.S. District Judge Louis Stanton of Manhattan
refused to dismiss a case against Barclays by a Florida credit
union that claimed it had been defrauded by the bank's
misrepresentations about the collateral underlying a CDO called
Markov. According to the credit union's all-too-familiar
allegations, Barclays stuffed the CDO with doomed-to-fail
mortgage-backed securities, then shorted the vehicle even as it
flogged the CDO to investors. Stanton said that the credit union
had shown enough evidence in its complaint to proceed with
discovery on its claims.
You might think, based on Stanton's ruling in that case,
that Bayerische Landesbank, a fellow Markov investor, had a
slam-dunk case against Barclays, at least as far as surviving
the bank's motion to dismiss. But Barclays and its lawyers at
Cleary Gottlieb Steen & Hamilton thought they had a game changer
in the case: a ruling last April by the 2nd Circuit Court of Appeals. The appeals court upheld U.S. District Judge William
Pauley's dismissal of claims by the investor Landesbank
Baden-Wuerttemberg that Goldman Sachs rigged an MBS-stuffed CDO
Even though the 2nd Circuit's ruling was a summary order
that involved a CDO sponsored by a different bank, Barclays
argued in its motion to dismiss the Bayerische case last August
that the appellate decision was directly on point. "The circuit
held that dismissal under (the pleading standard for fraud) was
required because the plaintiff failed to identify specifically
any reports or statements that allegedly provided the defendants
with such contrary information at the time the CDO was issued,"
Cleary wrote. "The same is true here. Indeed, plaintiff relies
on the very same generalized allegations as in Landesbank when
insisting that Barclays 'knew' Markov's collateral would fail."
Barclays also raised the familiar defense that Bayerische
Landesbank was a sophisticated investor, and added, to boot,
that the German bank's claims couldn't be litigated in U.S.
courts under Morrison v. National Australia Bank.
Stanton didn't buy any of Cleary's arguments. In a terse
11-page ruling entered last week but issued Monday when federal
courts in Manhattan reopened after Sandy, the judge said that
none of Barclays' new arguments in the Bayerische case overcame
his reasoning in the Florida credit union decision.
In the Goldman CDO case before Pauley, Stanton wrote,
Landesbank Baden-Wuerttemberg failed to identify the specific
due diligence reports that allegedly revealed Goldman Sachs's
knowledge of the toxic securities underlying the CDO. By
contrast, in the Bayerische case against Barclays, plaintiffs'
lawyers from Bernstein Litowitz Berger & Grossmann offered
sufficient allegations, not confined to documentary evidence,
that Barclays and the collateral manager State Street
misrepresented the underlying collateral. Besides, Stanton said,
the 2nd Circuit's decision affirming Pauley in the Goldman case
was a summary order, not intended to have precedential effect.
"It is clear that the 2nd Circuit did not intend its
decision in Landesbank to work a sweeping change in the law of
this district," Stanton wrote.
He also rejected Barclays' Morrison defense, finding that
even though the Markov CDO wasn't traded on a U.S. exchange,
investment decision-making and transfer of the securities took
place in New York. Stanton offered surprisingly little analysis
of Barclays' argument that the German bank was a sophisticated
investor that did not justifiably rely on statements in the CDO
offering materials; the judge ruled that the sophisticated
investor question was too fact-specific to be decided on a
I've previously noted that Pauley's Landesbank ruling,
despite affirmation by the 2nd Circuit, is looking more and more
like an outlier as investors in doomed-to-fail CDOs proceed with
their cases. It's still early, and we'll have to see how
subsequent appeals courts look at sophisticated investor
defenses. But for now, leverage seems to favor investors.
(Reporting by Alison Frankel)
Follow us on Twitter @AlisonFrankel, @ReutersLegal | Like us on Facebook