Federal Housing Finance Agency v. Nomura Holding America, Inc. et al

Filing 997

OPINION & ORDER....FHFA's motion in limine of October 14, 2014 to prohibit defendants from introducing documents or testimony related to the GSEs AUS is granted in connection with any evidence concerning minimum industry standards or the other issues identified in FHFA's motion. (Signed by Judge Denise L. Cote on 12/18/2014) (gr)

UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
--------------------------------------- X
:
FEDERAL HOUSING FINANCE AGENCY,
:
:
Plaintiff,
:
:
-v:
:
:
NOMURA HOLDING AMERICA, INC., et al., :
:
Defendants.
:
:
--------------------------------------- X

11cv6201 (DLC)
OPINION & ORDER

APPEARANCES:

For plaintiff Federal Housing Finance Agency:
Philippe Z. Selendy
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
SULLIVAN & CROMWELL LLP
125 Broad St.
New York, NY 10004
For defendant RBS Securities Inc.:
Thomas C. Rice
SIMPSON THACHER & BARTLETT LLP
425 Lexington Ave.
New York, NY 10017

DENISE COTE, District Judge:
This Opinion addresses a motion in limine brought by
plaintiff Federal Housing Finance Agency (“FHFA”) to prohibit
defendants 1 from introducing documents or testimony related to
Fannie Mae’s or Freddie Mac’s automated underwriting systems or
from relying on recommendations from those systems in arguments
concerning falsity or materiality of the misrepresentations
alleged in this action. 2

For the following reasons, the motion

is granted.
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 (“Offering Documents”) used to market and
sell seven securities (the “Certificates”) to the GSEs
associated with residential mortgage-backed securities (“RMBS”)
contained material misstatements or omissions.

RMBS are

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”).
1

FHFA also requested an order barring defendants from relying on
these recommendations in arguments concerning defendants’
statute of limitation defenses, but those defenses have since
been stricken. See FHFA v. Nomura Holding Am., Inc., --- F.
Supp. 3d ---, 11cv6201 (DLC), 2014 WL 6462239 (S.D.N.Y. Nov. 18,
2014) (“Nomura”).
2

2

securities entitling the holder to income payments from pools of
residential mortgage loans (“Supporting Loan Groups”) 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
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 Nomura,
2014 WL 6462239, at *3-6, *16-17.
The GSEs purchased the seven Certificates between November
30, 2005 and April 30, 2007.

The Certificates had an original

unpaid principal balance of approximately $2.05 billion, and the
GSEs paid slightly more than the amount of the unpaid principal
balance when purchasing them.

Six were purchased by Freddie

Mac; one was purchased by Fannie Mae.

The GSEs have retained

the Certificates.
Nomura acted as sponsor and depositor for all seven of the
Certificates, and as the sole lead underwriter and seller for
two of them.

RBS was the sole lead underwriter for three of the
3

Certificates and a co-lead underwriter for a fourth.

For an

explanation of the RMBS securitization process, including the
roles of mortgage loan originators, sponsors, and underwriters,
see Nomura, 2014 WL 6462239, at *4-6.
I.

The GSEs
Fannie Mae and Freddie Mac are government-sponsored

enterprises created to ensure liquidity in the mortgage market.
Id. at *6.

Fannie Mae was established in 1938, Freddie Mac in

1970.

Their primary business is to purchase mortgage loans

Id.

from originators that conform to the GSEs’ standards
(“conforming loans”) and then either hold those loans on their
own books or securitize them for offer to the public.

Id.

This

side of their business is known as the “Single Family” side.
Id.
The GSEs’ charters require that they assist “activities
relating to mortgages on housing for low- and moderate-income
families involving a reasonable economic return that may be less
than the return earned on other activities,” as well as “promote
access to mortgage credit throughout the Nation (including
central cities, rural areas, and underserved areas).”

12 U.S.C.

§ 1716(3)-(4) (Fannie Mae); id. § 1451 note (Freddie Mac).

The

Federal Housing Enterprises Financial Safety and Soundness Act
of 1992, Pub. L. 102-550, §§ 1331-36, 106 Stat. 3672 (1992),
authorizes the U.S. Department of Housing and Urban Development
4

to set annual housing goals for the GSEs with respect to lowand moderate-income family housing, underserved areas, and
special affordable housing (the “Housing Goals”).

Id. §§ 1332-

34.
In 2000, the GSEs began to purchase quantities of Alt-A and
subprime loans as well. 3

Nomura, 2014 WL 6462239, at *7.

During

this period, some portion of the Alt-A and subprime loans the
GSEs purchased were non-conforming loans -- that is, they were
underwritten to the seller’s guidelines (with certain
modifications), not the GSEs’.

Id.

Each GSE also conducts a second business, purchasing and
holding private label RMBS (“PLS”).

Id.

This is a

substantially smaller portion of their activities.

Id.

It is

the PLS that the GSEs purchased from defendants that prompt the
claims in this lawsuit.

Id.

The GSEs held approximately $100

billion in PLS in 2002, with roughly $35 billion in subprime and
$3 billion in Alt-A PLS; at their peak, in 2005, the GSEs’ PLS
holdings had grown to approximately $350 billion, with roughly
$145 billion in subprime and $40 billion in Alt-A PLS.

Id.

In

the two years prior to September 7, 2007, the GSEs purchased

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. Nomura, 2014 WL 6462239,
at *2 n.5.
3

5

more than $251 billion in PLS, approximately 8% of the $3
trillion in PLS issued in those years.
II.

Id.

The GSEs’ Automated Underwriting Systems
Between 2005 and 2007, the GSEs made available to mortgage

loan originators certain rule-based automated underwriting
systems (“AUS”).

Fannie Mae’s AUS was called Desktop

Underwriter (“DU”); Freddie Mac’s was called Loan Prospector
(“LP”).

In Fannie Mae’s “Guide to Underwriting with DU” (“DU

Guide”), Fannie Mae defined DU as “an automated underwriting
system developed by Fannie Mae to help mortgage lenders make
informed credit decisions on conventional conforming and
government loans.”

As the DU Guide explained:

Fannie Mae is committed to working with lenders
to achieve our shared goals of increasing
homeownership, especially for low- and moderateincome borrowers, while at the same time preventing
unlawful housing discrimination. DU helps lenders
thoroughly evaluate the credit risk of home mortgage
loans. It complements -- not replaces -- the
considered judgment of experienced underwriters. DU
provides an objective assessment of the risk of each
mortgage application based on the past performance
of more than two million mortgage loans. With DU,
lenders have access to fast, objective underwriting
recommendations that are specific to each mortgage
application. The system conducts this analysis
uniformly, and without regard to race, gender or
other prohibited factors.
According to the DU Guide, an originator would access DU
online, input certain information concerning the loan, and then
receive a report and “recommendation” from DU that “identifie[d]

6

both the credit risk assessment of the loan and the eligibility
of the loan according to Fannie Mae’s guidelines that are in
place in DU.”

An “Approve/Eligible” recommendation would

indicate that, “[b]ased on the data submitted to DU, the loan
appears to meet both Fannie Mae’s credit risk and eligibility
requirements;” but originators were warned they “must apply due
diligence when reviewing the documentation in the loan file to
determine if there is any potentially derogatory or
contradictory information that is not part of the data analyzed
by [DU].”

(Emphasis supplied.)

Custom DU was a related AUS

that allowed originators to “develop their own automated
underwriting guidelines for conforming and nonconforming loans”
in order to assist in originators’ underwriting to their own
guidelines.
Like Fannie Mae’s DU, Freddie Mac’s LP was a rules-based
underwriting program in which originators input loan
characteristics and then received a report and recommendation
concerning credit risk and eligibility for purchase by the GSE.
LP was only available to prime originators -- not subprime or
Alt-A lenders -- who had passed Freddie Mac’s approval process.
LP’s report concerning credit risk rated loan applications
either “accept,” which meant an eligible loan could be sold to
Freddie Mac’s Single Family business with a release from certain
representations and warranties, or “caution,” which meant an
7

eligible loan could be sold to Freddie Mac without that release.
If Freddie Mac’s Single Family business did purchase a loan
processed by LP, it retained the right to require the originator
to repurchase the loan if it did not comply with credit criteria
or did not meet underwriting guidelines.
III. Minimum Industry Standards
In connection with his reunderwriting of a sample of the
mortgage loans at issue in this action -- which are subprime or
Alt-A loans -- FHFA’s expert Robert W. Hunter (“Hunter”)
compiled a set of “minimum industry standards” for the years
2002 to 2007 based on his experience in the RMBS industry,
discussions with underwriters, consultations with other
underwriting experts, and reviews of guidelines in use during
that time for subprime and Alt-A products.

Hunter notes that,

after the late 1990s, the industry saw a “bifurcation of the
market into prime and subprime guidelines.”

Hunter’s guidelines

reflect his “assessment of the minimum requirements across the
industry at that time for different [mortgage loan] product
types.”

FHFA explains that it is offering testimony regarding

the minimum industry standards for reunderwriting its sample of
loans drawn from the Supporting Loan Groups backing the
Certificates in the following three circumstances: where an
originator’s guidelines “did not address a fundamental
underwriting requirement;” where the effective date of the
8

originator’s guidelines predated the loan origination date by
more than 90 days; and where no originator guidelines for the
sample loans were located.

Defendants’ expert rebuttal of

Hunter makes no mention of the GSEs’ AUS. 4
DISCUSSION
FHFA filed the instant motion in limine on October 14,
requesting that defendants be prohibited from introducing
documents or testimony related to the GSEs’ AUS or from relying
on recommendations from those systems in arguments concerning
falsity or materiality of the alleged misrepresentations about
the Certificates.

Defendants opposed on October 24, arguing

that the GSEs’ AUS are relevant to a single issue: the existence
of certain minimum industry standards among mortgage loan
underwriters.

Defendants did not argue that this evidence was

relevant on any other of the many grounds anticipated in FHFA’s
motion.

This motion was fully submitted on November 3.

Pursuant to Rule 403, Fed. R. Evid., “[t]he court may
exclude relevant evidence if its probative value is
substantially outweighed by a danger of . . . unfair prejudice,
confusing the issues, misleading the jury, undue delay, wasting
Defendants’ rebuttal expert does cite to Freddie Mac’s Single
Family business’s use of certain Alt-A and subprime mortgage
loans as collateral for guaranteed Structured Pass-Through
Certificates (“T-Deals”), which were sold to investors. Freddie
Mac guaranteed payments on its T-Deals, which were not governed
by the Securities Act or Blue Sky laws.
4

9

time, or needlessly presenting cumulative evidence.”

Accord

United States v. Dupree, 706 F.3d 131, 138 (2d Cir. 2013).

A

court must “conscientiously balance[] the proffered evidence’s
probative value with the risk for prejudice.”

United States v.

Massino, 546 F.3d 123, 132 (2d Cir. 2008) (citation omitted).
“‘[U]nfair prejudice’ speaks to the capacity of some concededly
relevant evidence to lure the factfinder into [rendering its
verdict] on a ground different from proof specific to the
[claims brought].”

Id. (citation omitted).

For instance, the

proffered evidence may have a “tendency . . . to prove some
adverse fact not properly in issue or unfairly excite emotions
against the [opposing party].”

Id. at 133 (citation omitted).

When conducting this balancing, a court “should consider the
possible effectiveness of a jury instruction and the
availability of other means of proof in making a Rule 403
determination.”

Dupree, 706 F.3d at 138.

Evidence concerning the GSEs’ AUS is inadmissible.

The AUS

were rules-based tools to be used with conforming prime loans,
not the nonconforming subprime and Alt-A loans at issue in these
actions.

Whether a rules-based implementation of a GSE’s

guidelines for conventional prime loans set certain standards
says very little about industry standards for underwriting
guidelines addressing the riskiest nonconforming loans.

Second,

to the extent that the GSEs securitized any of the loans they
10

purchased after the loan had survived AUS review, the GSEs
retained the risk of a loan’s default and did not pass on that
risk to the buyer of the security.

In contrast, in the

securitizations at issue here, defendants passed on the risk of
default to certificate-buyers.
Moreover, one of the GSEs’ purposes was to promote
affordable housing goals and to promote liquidity in the
secondary market for mortgages generally.

These purposes might

lead the GSEs to accept certain risks, including looser
underwriting in certain respects, at which the industry at large
would have balked if applied to nonconforming loans to be sold
to others.

Accordingly, the GSEs’ AUS have little to do with

any minimum industry standards applicable to nonconforming
subprime and Alt-A loans.

It is thus unsurprising that

defendants’ expert rebuttal of Hunter makes no mention of the
GSEs’ AUS. 5
Yet, such evidence poses a real danger of confusing and
misleading the jury, as well as wasting the jury’s time.

The

AUS are complicated, and evidence concerning their purpose,
their structure, and the reasons behind the GSEs’ decisions to

Custom DU, which was simply a tool permitting originators to
create their own automated underwriting system based on rules of
their choosing, has even less relevance to Hunter’s proposed
minimum industry standards, as it did not reflect any particular
underwriting guidelines.
5

11

include or not include certain features, would take substantial
time.

Even after proper instructions, a jury is likely to

improperly compare the AUS to defendants’ underwriting processes
and improperly consider the structure of the AUS in determining
the existence of any minimum industry standards in underwriting
the nonconforming subprime and Alt-A loans at issue in this
case.

At best, this mini-trial concerning the AUS would be a

substantial distraction and waste of time.

The limited

probative value of evidence concerning the AUS is substantially
outweighed by these dangers.

Accordingly, it is inadmissible

under Rule 403.
In their opposition, defendants set out seven
“[i]llustrative examples of the relevance of Loan Prospector and
Desktop Underwriter concerning ‘minimum industry standards.’”
None is persuasive.

A discussion of the first two examples will

suffice.
In the first example, defendants purport to challenge
Hunter’s claim that it was a minimum industry standard not to
permit the combined loan-to-value (“CLTV”) ratio to exceed
100% -- i.e., to extend a loan for more than the borrower’s
remaining equity in the house.

They claim that Fannie Mae’s DU

rebuts this, because it permitted a single exception to this
rule (for conforming prime loans), which permitted a CLTV ratio
up to 105% where the subordinate financing was a “Community
12

Seconds loan” provided by a governmental housing finance agency,
a nonprofit organization, or an employer.

The Community Seconds

program “supports affordable housing partnerships among
government entities, nonprofit organizations, . . . and
employers in a community” and “enables [such entities] to
leverage [their] limited . . . funds they have earmarked for
homeownership programs . . . to help more families achieve
homeownership.”

Fannie Mae, Announcement 06-02, Enhancements to

the Community Seconds Option (Mar. 13, 2006), available at
https://www.fanniemae.com/content/announcement/06-02.pdf.

The

fact that Fannie Mae permitted a limited exception (among
conforming prime loans) to Hunter’s proposed industry standard
in order to facilitate a discrete program promoting
homeownership in accordance with Fannie Mae’s statutory mission
has very little relevance to industry standards for
nonconforming loans, many of which were approved with the
intention that they be securitized and sold by private financial
institutions to the public.
Defendants’ second example concerns Hunter’s proposed
standard of “verify[ing] the borrower’s employment by obtaining
at least a verbal or written Verification of Employment (‘VOE’)
form.”

Defendants argue that evidence that LP “merely

recommended that the lender” verify the borrower’s source of
income but did not “require” it, and that DU “only requires a
13

verbal [VOE],” is relevant to rebut Hunter’s claim.

That DU

“requires a verbal [VOE]” supports Hunter’s standard, and the
fact that LP “recommended” the lender obtain a VOE is fully
consistent with it.

Again, LP did not purport to set out

comprehensive guidelines and concerned conforming prime loans.
This evidence has very little relevance to Hunter’s list of
minimum industry standards in the subprime and Alt-A origination
industry, and any relevance is substantially outweighed by the
burden on the jury’s time that would necessarily accompany
receipt of this evidence and argument, and by the risk of juror
confusion.
CONCLUSION
FHFA’s motion in limine of October 14, 2014 to prohibit
defendants from introducing documents or testimony related to
the GSEs’ AUS is granted in connection with any evidence
concerning minimum industry standards or the other issues
identified in FHFA’s motion.
SO ORDERED:
Dated:

New York, New York
December 18, 2014
__________________________________
DENISE COTE
United States District Judge

14