Federal Housing Finance Agency v. Nomura Holding America, Inc. et al
Filing
1248
OPINION & ORDER...FHFA's January 8 motion to exclude the expert testimony of Vandell and those aspects of Riddiough's calculation that rely on Vandell's analysis is granted. Defendants' January 8 motion to exclude the expert testimony of Saunders is denied as moot. (Signed by Judge Denise L. Cote on 2/10/2015) (gr)
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
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FEDERAL HOUSING FINANCE AGENCY,
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Plaintiff,
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-v:
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NOMURA HOLDING AMERICA, INC., et al., :
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Defendants.
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11cv6201 (DLC)
OPINION & ORDER
APPEARANCES:
For plaintiff Federal Housing Finance Agency:
Philippe Z. Selendy
Sascha N. Rand
Wing F. (Alex) Ng
QUINN EMANUEL URQUHART & SULLIVAN, LLP
51 Madison Ave., 22nd Fl.
New York, NY 10010
For defendants Nomura Holding America, Inc., Nomura Asset
Acceptance Corp., Nomura Home Equity Loan, Inc., Nomura Credit &
Capital, Inc., Nomura Securities International, Inc., David
Findlay, John McCarthy, John P. Graham, Nathan Gorin, and N.
Dante LaRocca:
David B. Tulchin
Steven L. Holley
Bruce E. Clark
Bradley A. Harsch
Katherine J. Stoller
SULLIVAN & CROMWELL LLP
125 Broad St.
New York, NY 10004
Amanda F. Davidoff
Elizabeth A. Cassady
SULLIVAN & CROMWELL LLP
1700 New York Avenue, NW, Suite 700
Washington, DC 20006
For defendant RBS Securities Inc.:
Thomas C. Rice
David J. Woll
Andrew T. Frankel
Alan Turner
Craig S. Waldman
SIMPSON THACHER & BARTLETT LLP
425 Lexington Ave.
New York, NY 10017
DENISE COTE, District Judge:
This Opinion addresses two motions.
One is plaintiff
Federal Housing Finance Agency’s (“FHFA”) motion to exclude the
expert testimony of defendants’ 1 expert witness Kerry Vandell
(“Vandell”), whom defendants retained to provide expert
testimony on the loss causation defense under Section 12 of the
Securities Act, and those aspects of defendants’ expert witness
Timothy Riddiough’s (“Riddiough”) loss causation damages
calculation that rely on Vandell’s analysis.
Vandell’s loss
causation analysis made use of three “benchmark” groups of
Defendants are Nomura Holding America, Inc., Nomura Asset
Acceptance Corp., Nomura Home Equity Loan, Inc., Nomura Credit &
Capital, Inc., Nomura Securities International, Inc., David
Findlay, John McCarthy, John P. Graham, Nathan Gorin, and N.
Dante LaRocca (“Nomura”); and RBS Securities Inc. (“RBS”)
(collectively, “defendants”). According to FHFA’s brief,
Vandell was retained by Nomura only, and RBS proffered no expert
witness on negative loss causation. Defendants’ brief, while it
does not explicitly respond to this point, refers to Vandell as
having been retained by defendants collectively. The precise
combination of defendants who retained Vandell does not matter
for present purposes, and, for simplicity, this Opinion refers
to Vandell as being defendants’ expert.
1
2
loans.
Because defendants have failed to show that those
benchmarks provide a reliable basis for the comparisons that
Vandell makes, FHFA’s motion to exclude the expert testimony of
Vandell, and those aspects of Riddiough’s calculation that rely
on Vandell’s testimony, is granted.
Because FHFA’s motion to
exclude Vandell’s testimony is granted, defendants’ motion to
exclude the expert testimony of Anthony Saunders (“Saunders”),
offered by FHFA to rebut Vandell, is denied as moot.
BACKGROUND
FHFA, acting as conservator for Fannie Mae and Freddie Mac
(together, the “Government Sponsored Enterprises” or “GSEs”),
filed suit on September 2, 2011 against defendants alleging that
the Offering Documents used to market and sell seven
certificates (“Certificates”) to the GSEs associated with
residential mortgage-backed securities (“RMBS” or
“Securitizations”) contained material misstatements or
omissions.
RMBS are securities entitling the holder to income
payments from pools of residential mortgage loans (“Supporting
Loan Groups” or “SLGs”) held by a trust.
FHFA brought these claims pursuant to Sections 11 and
12(a)(2) of the Securities Act of 1933 (the “Securities Act”),
as well as Virginia’s and the District of Columbia’s Blue Sky
laws.
This lawsuit is the sole remaining action in a series of
similar, coordinated actions litigated in this district by FHFA
3
against banks and related individuals and entities to recover
losses experienced by the GSEs from their purchases of RMBS.
A
description of the litigation and the types of
misrepresentations at issue in each of these coordinated
actions, including the instant case, can be found in FHFA v.
Nomura Holding Am., Inc., --- F. Supp. 3d ---, 11cv6201 (DLC),
2014 WL 6462239, at *3-6, *16-17 (S.D.N.Y. Nov. 18, 2014)
(“Nomura”), as well as FHFA v. UBS Americas, Inc., 858 F. Supp.
2d 306, 323-33 (S.D.N.Y. 2012), aff’d, 712 F.3d 136 (2d Cir.
2013).
Broadly speaking, FHFA alleges three categories of
misstatements: (i) the Offering Documents misstated the extent
to which the loans in the SLGs for the seven Certificates
complied with relevant underwriting guidelines; (ii) the loanto-value (“LTV”) ratios disclosed in the Offering Documents were
too low because of inflated appraisals of the properties; and
(iii) the Offering Documents misrepresented the number of
borrowers who occupied the properties that secured the mortgage
loans.
FHFA alleged as well that credit rating agencies gave
inflated ratings to the Certificates as a result of defendants’
providing these agencies with incorrect data concerning the
attributes of the loans.
On January 15, 2015, FHFA was granted leave to withdraw its
claims under Section 11 of the Securities Act.
4
Although neither
Virginia’s nor the District of Columbia’s Blue Sky law provides
a loss causation defense to the claims at issue, Section 12 of
the Securities Act, as amended by the Private Securities
Litigation Reform Act of 1995, Pub. L. No. 104–67, 109 Stat.
737, does.
See FHFA v. HSBC N. Am. Holdings Inc., 988 F. Supp.
2d 363, 367, 369 (S.D.N.Y. 2013).
Pursuant to the defense,
if the person who offered or sold [the] security
proves that any portion or all of the amount
recoverable . . . represents other than the
depreciation in value of the subject security
resulting from such part of the prospectus or oral
communication, with respect to which the liability of
that person is asserted . . . , then such portion or
amount, as the case may be, shall not be recoverable.
15 U.S.C. § 77l(b).
Defendants retained Vandell to provide expert testimony on
loss causation.
Vandell is a real estate and financial
economist whose areas of research specialization include housing
economics and policy, international real estate markets, real
estate market dynamics, and mortgage finance, especially
mortgage-backed securitization, structured finance, and the
pricing of default and prepayment risk.
As set forth in his
July 9, 2014 expert report, to assess whether the categories of
alleged defects in the Offering Documents -- as opposed to other
factors, such as market-wide economic changes that affected
mortgage loans generally -- caused losses to the GSEs as holders
of the seven Certificates, Vandell conducted regression analyses
5
that compared the performance of the loans backing the
Certificates to the performance of three benchmark groups of
loans.
The idea is to create groups of benchmark loans that
lack the problems -- such as noncompliance with underwriting
guidelines and inflated appraisals -- that allegedly plagued the
loans comprising the SLGs at issue here.
Vandell’s first benchmark (the “Industry Benchmark”)
consists of loans from other private label securitizations
(“PLS”) 2 issued during the relevant period, 2005 to 2007, that
are comparable to the loans in the SLGs for the seven
Certificates. 3
To ensure that the Industry Benchmark was truly a
“benchmark,” Vandell excluded all loans that were part of any
securitizations at issue in any of the cases brought by FHFA
against other banks and their related entities and individuals. 4
The term “PLS” distinguishes private label RMBS from those RMBS
sold by federal agencies like the GSEs.
2
FHFA does not appear to argue that the loans with which Vandell
populated the Industry Benchmark, or any of the benchmarks for
that matter, were not comparable to the loans in the SLGs for
the seven Certificates. With respect to the Industry Benchmark,
to select “loans from the same collateral/asset type categories
as the At-Issue Loans,” Vandell used four categories of loans
that he defines in his report: First-Lien Fixed Rate Subprime,
First-Lien ARM/Hybrid Alt-A, First-Lien ARM/Hybrid Subprime, and
Closed-End Second Lien Subprime.
3
Subsequently, in
reran his analysis
Industry Benchmark
subject of certain
Vandell, excluding
4
response to criticism from Saunders, Vandell
after additionally excluding from the
loans from securitizations that were the
lawsuits not involving FHFA. According to
these loans from the Industry Benchmark
6
Vandell’s second benchmark (the “GSE Benchmark”) consists
of loans -- comparable to those in the SLGs for the seven
Certificates -- that were purchased by the GSEs from
originators. 5
The data for Vandell’s GSE Benchmark come from
caused no appreciable difference in his results. FHFA objects
that this supplemental analysis is untimely, as it came after
the expert discovery cutoff. It is unnecessary to decide
whether Vandell’s revised analysis was timely since it does not
cure the underlying defect in his choice of a benchmark.
Mortgage loans are often divided, by credit risk, into
three classes. In order of ascending risk, they are “prime”
loans, “Alt–A” loans, and “subprime” loans. See FHFA v. Nomura
Holding Am., Inc., No. 11cv6201 (DLC), 2014 WL 7234593, at *2
n.2 (S.D.N.Y. Dec. 18, 2014) (“Single Family Diligence Op.”) It
is the Alt-A and subprime PLS that were purchased from
defendants by the PLS side of the GSEs’ business that prompt the
claims in this lawsuit. Id. at *2. The GSEs purchased mortgage
loans from originators through a different side of their
business, known as the “Single Family” side. Id. at *1. The
GSEs principally bought such loans under different standards and
constraints than those that applied to defendants’ PLS
collateral. Id. at *2.
5
Fannie Mae purchased subprime and Alt–A loans to hold, not
to securitize, and it had the ability -- which it exercised -to monitor loan performance and “put back” defective loans to
the seller. Id. Freddie Mac held some of these loans and used
others as collateral for guaranteed Structured Pass–Through
Certificates (“T–Deals”), which were sold to investors. Id.
Freddie Mac retained the credit risk associated with the
subprime and Alt–A loans it securitized, as it guaranteed
payment on T–Deals, which were not governed by the Securities
Act or Blue Sky laws. Id.
Neither GSE purported to exercise due diligence or
reasonable care under Sections 11 or 12(a)(2) of the Securities
Act or under the Blue Sky laws. Id. In addition, the GSEs were
subject to affordable housing goals set by the United States
Department of Housing and Urban Development that required, for
example, the purchase of loans to lower-income borrowers that
are owner occupied and in metropolitan areas. Id. at *3. The
7
CoreLogic’s Loan-Level Market Analytics database, which does not
contain loan files or identify the originator or servicer of the
loans; all that is identified is the initial investor (i.e.,
Freddie Mac or Fannie Mae).
Both Freddie Mac and Fannie Mae had
quality control and originator approval processes.
Vandell’s third benchmark (the “Reunderwriting Benchmark”)
consists of loans that were reunderwritten by FHFA’s experts in
other cases, excluding those that were identified by those
experts as materially defective.
Again, the idea is to test
whether the alleged defects caused the GSEs’ losses by comparing
the loans that formed the SLGs at issue in this action with
loans that lack those same alleged defects.
Vandell used a regression analysis to estimate a model of
loan performance using the loans in each benchmark.
These
models include dozens of explanatory variables (depending on the
benchmark) and estimate the extent to which each explanatory
variable predicts the performance (measured by events of default
GSEs’ decisions to purchase mortgage loans were, at times,
influenced by the GSEs’ desire to purchase loans that met these
housing goals. Id.
To populate the GSE Benchmark, Vandell selected loans with
the same collateral types as the at-issue loans by making use of
two categories that he defines: (1) First-Lien, Non-Negatively
Amortizing, Fixed Rate, and (2) First-Lien, Non-Negatively
Amortizing, Hybrid. It appears that these categories captured
Alt-A and subprime whole loans. Again, FHFA does not appear to
dispute the comparability of these loans.
8
or delinquency) of the loans in the benchmarks.
An “event of
default or delinquency” refers to a loan that was delinquent for
at least ninety days; was in bankruptcy, liquidation, or
foreclosure; or was real-estate-owned 6 or charged-off in the last
month of loan tracking.
Vandell then applied the results of
each model to the actual loans in the SLGs for the seven
Certificates to estimate how those loans would have performed
had they performed the same way as the comparable benchmark
loans.
Vandell opines that, if the actual default and
delinquency rates of the loans underlying a particular
Certificate were not statistically significantly different than
the expected rates predicted by a specific benchmark, then any
difference between the disclosed characteristics and actual
characteristics -- the alleged misstatements in the Offering
Documents -- did not cause the GSEs’ losses.
Vandell found that the loans in the SLGs underlying six of
the seven Certificates, comprising ninety-eight percent of the
loans at issue in this case, performed the same as, or better
than, the performance predicted by both the Industry and
Reunderwriting Benchmarks.
Moreover, loans in the SLGs
underlying all seven of the Certificates performed the same as,
“Real-estate-owned” refers to properties that have been
foreclosed upon and are owned by the mortgage holder. Nomura,
2014 WL 6462239, at *11 n.22.
6
9
or better than, the performance predicted by the GSE Benchmark.
Vandell used the results from the GSE Benchmark to corroborate
his conclusions based on the Industry and Reunderwriting
Benchmarks, and he found that the Reunderwriting Benchmark
provided additional support to the findings generated by use of
the Industry and GSE Benchmarks.
Defendants’ damages expert, Riddiough, relied in part on
Vandell’s opinions to determine the portion of any alleged
damages attributable to factors other than the alleged
misrepresentations in the Offering Documents. 7
Riddiough
reviewed Vandell’s conclusions and determined that, after
accounting for loss causation, damages could be awarded for at
most one Certificate, NAA 2005-AR6, as to which Vandell found a
statistically significant difference between the predicted and
actual default rate using the Industry and Reunderwriting
Benchmarks.
After using Vandell’s regression results in his
model, Riddiough concluded that the resulting damages range from
$5 million to $5.8 million on the Section 12 claim for the NAA
2005-AR6 Certificate.
Because Vandell reported no statistically
significant difference between actual and predicted default and
delinquency rates for any of the other Certificates using any of
Riddiough is the subject of a separate Daubert motion brought
by FHFA.
7
10
the three benchmarks, Riddiough says there are no Section 12
damages for those other Certificates.
FHFA retained Saunders to provide rebuttal expert testimony
that seeks to undermine the reliability of Vandell’s Industry
and GSE Benchmarks.
According to his November 10, 2014 report,
Saunders’s testimony seeks to demonstrate that these two
benchmarks contain loans with the same problems as are alleged
to plague the loans constituting the SLGs at issue here.
In
other words, Saunders seeks to demonstrate that these two
benchmarks are not “clean,” and thus do not serve as reliable
comparators.
On January 8, 2015, (1) FHFA moved to exclude Vandell’s
expert testimony and those aspects of Riddiough’s loss causation
damages calculation that rely on Vandell’s analysis, and (2)
defendants moved to exclude Saunders’s expert testimony.
motions were fully submitted on February 2.
The
FHFA’s motion is
discussed below, and, as a result of the outcome of that
discussion, defendants’ motion is rendered moot.
DISCUSSION
In its motion, FHFA makes several arguments in support of
its position that the testimony of Vandell and Riddiough should
be excluded.
To resolve this motion it is only necessary to
address FHFA’s arguments that relate to the “reliability” prong
11
of the analysis under Fed. R. Evid. 702 and Daubert v. Merrill
Dow Pharms., Inc., 509 U.S. 579 (1993).
The applicable rules of law pertaining to exclusion of
expert testimony under Fed. R. Evid. 702 and Daubert are set out
in this Court’s January 28, 2015 Opinion regarding defendants’
motion to exclude the testimony of FHFA’s expert Dr. John A.
Kilpatrick, and that discussion is incorporated by reference.
FHFA v. Nomura Holding Am., Inc., No. 11cv6201 (DLC), 2015 WL
353929, at *3-4 (S.D.N.Y. Jan. 28, 2014).
Here, it bears
reemphasizing that:
whether a witness’s area of expertise [i]s technical,
scientific, or more generally experience-based, Rule
702 require[s] the district court to fulfill the
gatekeeping function of making certain that an expert,
whether basing testimony upon professional studies or
personal experience, employs in the courtroom the same
level of intellectual rigor that characterizes the
practice of an expert in the relevant field.
. . . [R]eliability within the meaning of Rule
702 requires a sufficiently rigorous analytical
connection between [the expert’s] methodology and the
expert’s conclusions. Nothing in either Daubert or
the Federal Rules of Evidence requires a district
court to admit opinion evidence which is connected to
existing data only by the ipse dixit of the expert. A
court may conclude that there is simply too great an
analytical gap between the data and the opinion
proffered. . . . [W]hen an expert opinion is based on
data, a methodology, or studies that are simply
inadequate to support the conclusions reached, Daubert
and Rule 702 mandate the exclusion of that unreliable
opinion testimony.
Nimely v. City of New York, 414 F.3d 381, 396-97 (2d Cir. 2005)
(citation omitted).
A district court’s gatekeeping function
12
under Daubert is meant “to ensure that the courtroom door
remains closed to junk science.”
Amorgianos v. Nat’l R.R.
Passenger Corp., 303 F.3d 256, 267 (2d Cir. 2002).
This
function “entails a preliminary assessment of whether the
reasoning or methodology underlying the testimony is
scientifically valid.”
Daubert, 509 U.S. at 592-93.
“[T]o
qualify as ‘scientific knowledge,’ an inference or assertion
must be derived by the scientific method.
Proposed testimony
must be supported by appropriate validation -- i.e., ‘good
grounds,’ based on what is known.”
Id. at 590.
According to
the Daubert Court, “[s]cientific methodology today is based on
generating hypotheses and testing them to see if they can be
falsified; indeed, this methodology is what distinguishes
science from other fields of human inquiry.”
Id. at 593
(citation omitted).
The “scientific method” is defined as “the process of
generating hypotheses and testing them through experimentation,
publication, and replication.”
(10th ed. 2014).
Black’s Law Dictionary 1547
As explained in the Federal Judicial Center’s
Reference Manual on Scientific Evidence,
A good study design compares outcomes for subjects who
are exposed to some factor (the treatment group) with
outcomes for other subjects who are not exposed (the
control group). . . . [D]ata from a treatment group
without a control group generally reveal very little
and can be misleading. Comparisons are
essential. . . . Observational studies succeed to the
13
extent that the treatment and control groups are
comparable -- apart from the treatment. . . . There
are . . . some basic questions to ask when appraising
causal inferences based on empirical studies[, such
as,] Was there a control group? Unless comparisons
can be made, the study has little to say about
causation.
Federal Judicial Center, Reference Manual on Scientific Evidence
218, 220, 222 (3d ed. 2011) (emphasis added); see also Vern R.
Walker, Theories of Uncertainty: Explaining the Possible Sources
of Error in Inferences, 22 Cardozo L. Rev. 1523, 1554 n.47
(2001) (“The design of a controlled experiment is intended to
create a situation in which a statistically significant
difference between the test group and the control group would
warrant an inference of causation.”).
Indeed, it is axiomatic that, when designing an experiment
to test whether an observed result was caused by given variable,
the control or benchmark group must lack that variable.
the whole point of a control group.
That is
If a scientist wanted to
prove that Medicine X causes rashes, she might design a study
wherein she would observe two patients: Patient 1, who had taken
Medicine X, and Patient 2, who had not.
It would be rather
important to the reliability of her experiment that Patient 2
not also have taken Medicine X.
Indeed, someone assessing the
validity of her methodology would quite reasonably want
assurance that Patient 2 had not been exposed to Medicine X.
If
the only assurance the scientist could provide was an assumption
14
that Patient 2 had not taken Medicine X, it would raise the
specter of junk science.
This idea is so fundamental that, unsurprisingly, there are
few cases in which a court has been forced to exclude an expert
study because the expert was unable to demonstrate that the
control group lacked the very variable requiring isolation.
J.T. Colby & Co. v. Apple Inc., No. 11cv4060 (DLC), 2013 WL
1903883, at *22-23 (S.D.N.Y. May 8, 2013), aff’d, 586 F. App’x 8
(2d Cir. 2014) (“In order to offer sound results, most surveys
must employ an adequate control.”).
There are, however,
multiple examples of courts excluding experts whose analyses
fail to account for significant variables.
See, e.g., Wills v.
Amerada Hess Corp., 379 F.3d 32, 50 (2d Cir. 2004) (“failure to
account for [major variables] strongly indicated that [expert]’s
conclusions were not grounded in reliable scientific methods, as
required by Daubert”); In re Elec. Books Antitrust Litig., No.
11md2293 (DLC), 2014 WL 1282298, at *10 (S.D.N.Y. Mar. 28, 2014)
(“[Expert]’s . . . analysis fails to support his opinions
because it fails to control for systematic factors . . . .”); In
re Wireless Tel. Servs. Antitrust Litig., 385 F. Supp. 2d 403,
427 (S.D.N.Y. 2005) (“Where an expert conducts a regression
analysis and fails to incorporate major independent variables,
such analysis may be excluded as irrelevant.”).
If the failure
to account for other potential variables can suffice to doom an
15
expert’s study, it follows that the failure to control for the
one variable under review warrants exclusion.
As the proponents of Vandell’s testimony, defendants bear
the burden of “establishing by a preponderance of the evidence
that the admissibility requirements of Rule 702 are satisfied.”
United States v. Williams, 506 F.3d 151, 160 (2d Cir. 2007).
To
demonstrate the reliability of Vandell’s method, see Fed. R.
Evid. 702(c), defendants need to show that his benchmarks
provide adequately “clean” control groups -- after all, if it
turns out that the loans comprising the benchmarks suffered from
the same alleged problems as those comprising the SLGs at issue,
any comparison of performance would not be illuminating.
Here, defendants have not carried their burden.
One way of
ensuring clean benchmarks would have been to reunderwrite a set
of loans and to select compliant loans to use as comparators.
Indeed, a sample of the loans that Vandell selected to populate
his benchmarks could have been, but were not, reunderwritten by
defendants.
After a February 14, 2013 conference that addressed
defendants’ potential use of an alternative set of loans for
purposes of loss causation analysis, a February 27, 2013
Supplemental Expert Scheduling Order set a schedule under which
defendants could have identified any such loans.
opted not to do so.
Defendants
Similarly, while defendants have no doubt
reunderwritten the sample of loans that FHFA identified for use
16
in this coordinated litigation, defendants decided not to make
use of any of their reunderwriting for purposes of loss
causation.
It is worth pausing to note that, because the problems that
allegedly plagued the loans in the SLGs at issue -- such as
noncompliance with underwriting guidelines and inflated
appraisals -- seem to have been widespread in the residential
lending market during the relevant period, absent affirmative
representations of cleanliness, it is difficult to feel
confident about the cleanliness of any untested group of loans.
The Final Report of the National Commission on the Causes of the
Financial and Economic Crisis in the United States (2011),
better known as the “Financial Crisis Inquiry Report,” published
by the U.S. Financial Crisis Inquiry Commission (“FCIC”), 8 paints
a picture of just how prevalent these problems may have been.
It explains that, “[a]s defaults and losses on the insured
mortgages have been increasing, the [private mortgage insurance
(“PMI”)] companies have seen a spike in claims.
As of October
2010, the seven largest PMI companies, which share 98% of the
market, had rejected about 25% of the claims (or $6 billion of
$24 billion) brought to them, because of violations of
Available at http://fcic-static.law.stanford.edu/cdn_media/
fcic-reports/fcic_final_report_full.pdf (last visited February
10, 2015).
8
17
origination guidelines, improper employment and income
reporting, and issues with property valuation.”
Crisis Inquiry Report at 225.
Financial
And, according to the Financial
Crisis Inquiry Report, “[o]ne 2003 survey found that 55% of the
appraisers [surveyed] had felt pressed to inflate the value of
homes; by 2006, this had climbed to 90%.”
Id. at 91. 9
Due to the apparent prevalence of these loan defects, it
may have proved difficult to create a clean benchmark set of
loans to use as a control group.
Despite, or perhaps because
of, that difficulty, in the absence of independent
reunderwriting, defendants claim to be able to infer sufficient
cleanliness based on the way in which Vandell constructed his
benchmarks.
As for the Industry Benchmark, Vandell simply
As reported in Financial Crisis Inquiry Report, in 2006 the
Mortgage Insurance Companies of America, a trade association
that represents mortgage insurance companies, wrote to
regulators that “[w]e are deeply concerned about the contagion
effect from poorly underwritten or unsuitable mortgages and home
equity loans . . . . The most recent market trends show
alarming signs of undue risk-taking that puts both lenders and
consumers at risk.” Financial Crisis Inquiry Report at 21.
And, based on testimony from FDIC Chairman Sheila Bair, who
served at the Treasury Department as the assistant secretary for
financial institutions from 2001 to 2002, the FCIC reports that
“[t]hrough the early years of the new decade, the really poorly
underwritten loans, the payment shock loans[,] continued to
proliferate outside the traditional banking sector.” Id. at 79
(citation omitted). “The term ‘payment shock’ refers to a
significant increase in the amount of the monthly payment that
occurs when an adjustable interest rate adjusts to its fullyindexed basis.” F.J. Ornstein et. al., Interagency Statement on
Subprime Mortgage Lending, 61 Consumer Fin. L.Q. Rep. 176, 177
n.7 (2007).
9
18
excluded loans that were part of securitizations at issue in any
of the RMBS cases brought by FHFA, and, subsequently, removed
more loans that were the subject of other RMBS litigations not
involving FHFA.
Excluding loans that have been the subject of
lawsuits may be a good start for creating a clean benchmark, but
it does little to ensure the quality of the loans remaining in
the group.
As for the GSE Benchmark, presumably Vandell decided to
use, or was asked to use, the benchmark on the theory -- nowhere
supported in Vandell’s report or any of the accompanying
documents -- that loans purchased by the GSEs from originators
would be less likely to have the problems that allegedly plagued
the loans comprising the SLGs at issue.
One cannot know for
sure, however, why Vandell decided to use the GSE Benchmark, as
he provides no reasons for believing that the loans in the
benchmark are free of the defects whose impact his analysis
attempts to measure.
Vandell himself provides no expert opinion
as to the quality of the loans in the GSE Benchmark, and
defendants proffer no additional expert in support thereof.
Vandell removed no loans from the pool that he used to populate
the benchmark and, apparently, assumed their quality simply
because they were purchased by the GSEs.
It is true, as defendants say in their opposition to FHFA’s
motion to exclude Vandell’s testimony, that the GSEs adhered to
19
processes that were meant to ensure a certain quality in the
loans they purchased, but a loan’s having been purchased by the
GSEs is, standing alone, insufficient to demonstrate a lack of
the defects at issue here.
A statement from defendants’ brief
is telling: “There is no evidence that a significant number of
the loans purchased by Freddie Mac and Fannie Mae were not
originated generally in accordance with originator underwriting
guidelines.”
The absence of evidence of noncompliance is not
evidence of compliance.
The loans comprising Vandell’s GSE
Benchmark have never been certified to be free of the defects
relevant to this specific action; Vandell simply assumes the
cleanliness of the benchmark.
Under Daubert scrutiny, something
as fundamental to his analysis as the quality of his control
group cannot be assumed.
Defendants complain that there was no method for Vandell to
commission a reunderwriting of the loans in the GSE Benchmark
because FHFA has “steadfastly refused in this case to provide
discovery concerning ‘single-family’ loans” purchased from the
GSEs.
As a result, say defendants, Vandell was forced to obtain
the loan data for the GSE Benchmark from CoreLogic’s Loan-Level
Market Analytics database, which does not identify the
originator or servicer of the loans.
In this coordinated
litigation, defendants were granted extensive discovery of the
GSEs’ business, including its PLS operations and the committees
20
overseeing the operations of both the Single Family and PLS
operations.
*2.
Single Family Diligence Op., 2014 WL 7234593, at
Targeted discovery requests reaching additional Single
Family documents were permitted, including discovery regarding
the GSEs’ evaluations of originators; general requests for
discovery about Single Family were denied, the Court noting that
the GSEs principally bought loans through their Single Family
businesses under different standards and constraints than those
that applied to defendants’ PLS collateral.
Id.
In any event,
the nature of the discovery in this action concerning the GSEs’
Single Family loans is largely irrelevant, given that defendants
had the opportunity to identify alternative sets of loans to
reunderwrite for purposes of loss causation analysis but chose
not to do so.
Indeed, in opposing this motion to exclude,
defendants reject the assertion as “baseless” that they were
required to reunderwrite loans to create a suitable benchmark
for Vandell’s study.
As for the Reunderwriting Benchmark, Vandell states that it
consists of loans that, “according to [FHFA]’s reunderwriting
experts, were underwritten entirely or substantially in
accordance with underwriting guidelines or deviated from
guidelines only in a manner that did not substantially increase
their credit risk.”
Vandell has mischaracterized FHFA’s
reunderwriting experts’ conclusions.
21
According to Vandell’s
description of how he populated the Reunderwriting Benchmark, he
“beg[a]n with the samples of loans that were reunderwritten by
FHFA experts Richard W. Payne, Robert W. Hunter, and Steven I.
Butler,” and then, as is relevant here, “[e]xclude[d] all
reunderwritten loans that were identified by FHFA reunderwriting
experts as Materially Defective.”
Vandell defines as
“Materially Defective” “loans for which the three experts
concluded: ‘It is my opinion, to a reasonable degree of
professional certainty, that this loan was originated with one
or more underwriting defects that meaningfully and substantially
increased the credit risk associated with the loan.’”
In other
words, Vandell took the loans that these reunderwriting experts
started with, removed the worst loans (those the reunderwriting
experts concluded were meaningfully defective and had a
substantially increased credit risk), and now proclaims that
FHFA’s reunderwriting experts concluded that the non-excluded
loans were underwritten entirely or substantially in accordance
with underwriting guidelines or deviated from guidelines only in
a manner that did not substantially increase their credit risk.
Defendants have not shown, however, that FHFA’s
reunderwriting experts reached any conclusion about the loans
that Vandell retained in his Reunderwriting Benchmark that would
permit those loans to serve as an appropriate benchmark for
Vandell’s study.
The loans examined by FHFA’s experts were a
22
sample of loans taken from each Supporting Loan Group backing a
Certificate purchased by one of the GSEs.
FHFA has used its
analysis of those sample loans to support its claims in these
coordinated litigations that the Offering Documents contained
the material misrepresentations described above.
In the January
17, 2014 Corrected Expert Report of Robert W. Hunter Regarding
the Underwriting of Mortgage Loans Underlying the Ally
Securitizations, Hunter “rendered one of the following
conclusions for each Mortgage Loan in the sample”:
1. It is my opinion, to a reasonable degree of
professional certainty, that this Mortgage Loan was
originated with one or more underwriting defects that
meaningfully and substantially increased the credit
risk associated with the Mortgage Loan.
2. It is my opinion, to a reasonable degree of
professional certainty, that although this Mortgage
Loan was originated with one or more underwriting
defects, the underwriting defects did not meaningfully
and substantially increase the credit risk associated
with the Mortgage Loan.
3. Based on the documents provided to me, I did not
find any underwriting defects in the origination of
this Mortgage Loan.
Before presenting the number of loans falling into the first
enumerated category, Hunter explicitly states, “It is not my
opinion that the remaining mortgage loans were properly
underwritten or should have been included in the
Securitizations.
The remaining mortgage loans may have also
suffered from defects, but in my opinion these defects did not
23
materially increase the credit risk of the loans.”
(Emphasis in
original.)
The three potential conclusions enumerated above appear
effectively verbatim in the October 25, 2013 Corrected Expert
Report of Richard W. Payne III Regarding the Underwriting of
Mortgage Loans Underlying the Merrill Lynch Securitizations.
Attached to the third conclusion -- “Based on the documents
provided to me, I did not find any underwriting defects in the
origination of this Mortgage Loan.” -- is a footnote that reads,
“Based on the evidence currently available to me, I did not
identify defects in the remaining Mortgage Loans that
substantially increased their credit risk.
If, however,
additional data subsequently become available to me, I may
identify further defects that increase the credit risk of these
loans.”
Similarly, in both the March 7, 2014 Expert Report of
Steven I. Butler Regarding the Underwriting of Mortgage Loans
Underlying the HSBC Securitizations, and the March 11, 2014
Expert Report of Steven I. Butler Regarding the Underwriting of
Mortgage Loans Underlying the First Horizon Securitizations,
after presenting a chart reflecting the number of loans from
each securitization that had an increased credit risk as a
result of the underwriting defects found during the review,
Butler stated, “At this point in time, based on the evidence
24
currently available to me, I did not identify defects in the
remaining Mortgage Loans that substantially increased their
credit risk.
If, however, additional data subsequently becomes
available to me, I may identify further defects that increased
the credit risk of these loans.
It is not my opinion that the
remaining mortgage loans were properly underwritten or should
have been included in the Securitizations.”
(Emphasis in
original.) 10
Stating that, based on the information provided,
underwriting defects were not found for a given loan is not the
same thing as affirmatively certifying that the loan was free of
defects.
Put differently, contrary to Vandell’s assumption, the
fact that a loan was not placed by a reunderwriting expert into
the “materially noncompliant” category does not, of necessity,
mean that the reunderwriting expert concluded that the loan was
“materially compliant.”
And what ultimately dooms the Reunderwriting Benchmark is
that there will be no opportunity at trial to explore what these
FHFA experts meant when they reached something along the lines
The fifth reunderwriting expert report on which Vandell claims
to rely, the January 21, 2014 Expert Report of Steven I. Butler
Regarding the Underwriting of Mortgage Loans Underlying the
Credit Suisse Securitizations, was incomplete and provided
merely “a summary of certain categories of underwriting breaches
that, at this point, have been more prevalent across the
Mortgage Loans.”
10
25
of the third conclusion enumerated above.
FHFA will proffer
Robert Hunter in this case but to testify to his reunderwriting
of the loans in this case; 11 Richard Payne and Steven Butler were
retained by FHFA in some of the now-settled matters that FHFA
brought against other financial institutions; since no trials
occurred in those cases, they never testified at trial there and
will not testify at trial here.
In short, their expert reports
constitute inadmissible hearsay.
Defendants argue that the findings of FHFA’s reunderwriting
experts’ are not hearsay because they are admissions of a party
opponent under Fed. R. Evid. 801(d)(2).
Defendants cite no
controlling law for this argument; in the principal case on
which they rely, Collins v. Wayne Corp., the Fifth Circuit held
that the deposition testimony of an expert employed by a bus
manufacturer to investigate an accident was an admission under
Rule 801(d)(2).
621 F.2d 777, 781-82 (5th Cir. 1980),
superseded by rule on other grounds as stated in Mathis v. Exxon
Corp., 302 F.3d 448, 459 n.16 (5th Cir. 2002).
But, as was
Notably, Vandell did not populate his Reunderwriting Benchmark
with loans that Hunter reunderwrote in this action. Of the 723
loans that Hunter reviewed, he found that 571 (or all but 152)
had underwriting defects that substantially increased the credit
risk associated with the loan. FHFA’s rebuttal expert G.
William Schwert applied Vandell’s methodology to the loans
reunderwritten by Hunter in this action and found actual losses
totaling more than twenty-six times the amount estimated by
Vandell’s Industry Benchmark.
11
26
noted by the Third Circuit, “in [Collins] the court made a
finding that the expert witness was an agent of the defendant
and the defendant employed the expert to investigate and analyze
the bus accident.
The court determined that in giving his
deposition, the expert was performing the function that the
manufacturer had employed him to perform.”
Kirk v. Raymark
Indus., Inc., 61 F.3d 147, 163-64 (3d Cir. 1995) (citation
omitted).
The Third Circuit went on:
. . . In theory, despite the fact that one party
retained and paid for the services of an expert
witness, expert witnesses are supposed to testify
impartially in the sphere of their expertise. Thus,
one can call an expert witness even if one disagrees
with the testimony of the expert. Rule 801(d)(2)[]
requires that the declarant be an agent of the partyopponent against whom the admission is offered, and
this precludes the admission of the prior testimony of
an expert witness where, as normally will be the case,
the expert has not agreed to be subject to the
client’s control in giving his or her testimony.
Since an expert witness is not subject to the control
of the party opponent with respect to consultation and
testimony he or she is hired to give, the expert
witness cannot be deemed an agent.
Because an expert witness is charged with the
duty of giving his or her expert opinion regarding the
matter before the court, we fail to comprehend how an
expert witness, who is not an agent of the party who
called him, can be authorized to make an admission for
that party. We are unwilling to adopt the proposition
that the testimony of an expert witness who is called
to testify on behalf of a party in one case can later
be used against that same party in unrelated
litigation, unless there is a finding that the expert
witness is an agent of the party and is authorized to
speak on behalf of that party.
Id. at 164 (citation omitted).
27
Here, there has been no showing that FHFA’s reunderwriting
experts were agents of FHFA authorized to speak on its behalf.
Accordingly, Rule 801(d)(2) does not provide a solution to the
hearsay problem presented by Vandell’s reliance on FHFA’s
experts’ reports.
Nor does Rule 703.
For while, under that Rule, “[a]n
expert may base an opinion on” inadmissible evidence “[i]f
experts in the particular field would reasonably rely on those
kinds of facts or data in forming an opinion on the subject,”
(emphasis added), there has been no showing in this case that
experts in Vandell’s particular field -- econometrics -- would
reasonably rely on home-loan reunderwriting reports in forming
an opinion on negative loss causation.
Defendants offer no
precedent for the proposition that an expert in one field may
blindly rely on reports prepared for other cases by nontestifying experts in other fields.
Defendants could have avoided this hearsay problem by
offering their own reunderwriting experts from these coordinated
actions, who may have been able to make the affirmative
representations that FHFA’s experts are unwilling to make about
the positive quality of a subset of the sample of loans on which
FHFA has litigated its claims.
Had defendants done so, the
reliability of the conclusions drawn by defendants’ experts on
the absence of underwriting defects, and the admissibility of
28
their testimony generally under Rule 702, could have been
tested.
Indeed, this would have provided the corpus of data to
which Vandell could have applied his econometric expertise.
For
reasons that may only be guessed at, defendants opted not to
take this tack.
In sum, defendants and Vandell have failed to demonstrate
that the benchmarks are sufficiently clean to serve as reliable
control groups.
This “flaw is large enough that [Vandell] lacks
good grounds for his . . . conclusions,” such that his testimony
must be excluded.
Amorgianos, 303 F.3d at 267 (citation
omitted). 12
Defendants contend that Vandell’s benchmarking analysis is
similar to methods used in published, peer-reviewed articles
that study loan-level data and estimate default probability
models, because the authors of those articles, like Vandell, did
not reunderwrite any loans to determine the adequacy of
benchmarks. In particular, defendants point to two studies that
test for the impact of misrepresentations on loan defaults by
comparing the performance of loans purportedly affected by those
misrepresentations against other loans: Tomasz Piskorski, Amit
Seru & James Witkin, Asset Quality Misrepresentation by
Financial Intermediaries, Colum. Bus. Sch. Res. Paper No. 13-7
(February 12, 2013) (forthcoming in J. Fin.) (the “Piskorski
Article”), and John M. Griffin & Gonzalo Maturana, Who
Facilitated Misreporting in Securitized Loans? (December 20,
2013) (forthcoming in J. Fin.) (the “Griffin Article”).
12
The Piskorksi Article compares “loan-level data on
mortgages from BlackBox with data on consumer credit files from
Equifax, to construct two measures of misrepresentation
regarding the quality of mortgages backing the RMBS pools. The
mortgage-level data include characteristics of loans that were
disclosed to the investors at the time of asset sale. The
consumer credit data, which were not available to investors at
the asset sale date, contains the actual characteristics of
29
In light of the conclusion that Vandell’s testimony must be
excluded under Rule 702 and Daubert, any testimony of
Riddiough’s that relies on any of Vandell’s analysis must also
be excluded.
Also in light of the exclusion of Vandell’s
testimony, defendants’ motion to exclude the testimony of
Saunders, who was offered by FHFA to rebut Vandell’s testimony
based on his Industry and GSE Benchmarks, is moot.
CONCLUSION
FHFA’s January 8 motion to exclude the expert testimony of
Vandell and those aspects of Riddiough’s calculation that rely
loans at the same time.” Piskorksi Article at 2 (emphasis in
original). And the Griffin Article uses “[a] matching
algorithm . . . to link large datasets of non-agency MBS loan
data from 2002 to 2007 with county-level official transaction
information and perform detailed loan monitoring . . . [such as]
examin[ing] cases where loan-level MBS data indicates that a
house is owner occupied, and yet county-level data shows that
the tax records are sent to a different, non-business address.”
Griffin Article at 1. In short, both of these articles used
data from other sources to compare, for example, the performance
of a loan that was misrepresented as owner occupied with the
performance of a loan that was accurately represented as owner
occupied. By contrast, Vandell simply assumed the comparator
loans he was using were clean along the relevant dimensions.
30
on Vandell’s analysis is granted.
Defendants’ January 8 motion
to exclude the expert testimony of Saunders is denied as moot.
SO ORDERED:
Dated:
New York, New York
February 10, 2015
__________________________________
DENISE COTE
United States District Judge
31
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