A Bellwether Rings for Insurers

, The American Lawyer


U.S. District Judge Jed Rakoff, Southern District of New York

Thanks to a bellwether $100 million judgment that Assured Guaranty Corp. won against Flagstar Bancorp Inc. this past February, monoline bond insurers now have the upper hand in the suits that they've brought against MBS–issuing banks. The judges overseeing most of these cases haven't scheduled trial dates yet, in part because they were waiting to see how U.S. District Judge Jed Rakoff would rule in Assured's case. Now that Rakoff has ruled in Assured's favor, its lawyer, Jacob Buchdahl of Susman Godfrey, has predicted that the banks will start settling. "What this decision does is make it less likely that anyone else will go to trial," Buchdahl says. "A bank is going to have a hard time thinking they're now going to defeat these cases." (Asked in March if settlement talks are ongoing in other insurer suits, Buchdahl coyly said, "There's nothing I can talk about on the record.")

The Assured case is one of more than 30 lawsuits that monoline bond insurers have brought against MBS issuers. The monolines insured mountains of such securities before the subprime crisis hit, and they've since paid out billions in claims after mortgage holders fell behind and the securities went sour. Assured's suit against Flagstar was one of the smallest of the bunch. But all eyes were on it after Rakoff drew the case and fast-tracked it for a bellwether bench trial last year. The judge issued his ruling on February 5, ordering Flagstar to pay Assured $90 million in damages, plus interest and attorney fees — exactly what Buchdahl and his partner Arun Subramanian had asked for. More importantly, Rakoff drew a road map to victory for other bond insurers like MBIA Inc. and AMBAC Assurance Corp, which are seeking billions from defendants such as Bank of America Corporation and JPMorgan Chase & Co.

In 2005 and 2006, Flagstar sold investments in two trusts, with a combined value of roughly $1 billion, that were collateralized by thousands of home loans. When it sought insurance for MBS trusts from Assured, Flagstar represented that the underlying mortgages were originated without fraud and in accordance with certain underwriting standards. But the trusts tanked in value during the housing crisis, and Assured was forced to pay out millions to Flagstar's investors.

Assured filed suit in 2011, alleging that Flagstar never lived up to its contractual duty to buy back and replace thousands of the underlying mortgage loans. Assured's expert constructed a sample of 800 of the mortgages and concluded that 606 of them were materially defective. The mortgages seemed "as if they were rubber-stamped just to get them through the process," the expert later testified.

Flagstar, defended by Arnold & Porter's Veronica Rendon, tried to get the case bounced before trial on various grounds. Perhaps most significantly, the defendant argued that Assured failed to show that Flagstar's alleged breaches of warranties directly caused the underlying mortgages to default. Rakoff forcefully rejected that argument in September 2012, ruling that Flagstar misinterpreted the standard for loss causation. The real question at trial, he said, is whether Flagstar's warranty breaches caused Assured to incur an increased risk of loss — an easy standard for Buchdahl to meet.

At trial, Rendon tried to undermine the credibility of Assured's loan sampling expert, calling her "nothing more than a talking head." According to Rendon, the expert witness had far more experience as a handsomely paid expert witness than as an actual loan underwriter. According to Flagstar's own expert, the vast majority of the 606 home loans targeted by Assured had since been paid in full and were never defective in the first place.

The parties also fought bitterly over the proper model for calculating damages. Assured sought about $100 million — how much it claimed it would have saved if Flagstar had repurchased defective home loans when breaches were first discovered. Flagstar sought to limit damages on the grounds that Assured retained a stake in the trusts and continued to accept periodic payments.

Rakoff demolished Flagstar's defenses one by one in his ruling. The judge held that the conclusions of Assured's experts were "fully credible and corroborated in numerous ways," and he adopted Assured's entire damages model. Crucially, Rakoff also wrote that when the trial was over, he independently reviewed several of the loan files and reached the same conclusions as Assured's expert. By making findings of fact, rather than merely crediting Assured for meeting its burden, Rakoff made his decision more difficult for the U.S. Court of Appeals for the Second Circuit to overturn.

Rendon did not respond to requests for comment, but no doubt Flagstar and its lawyers — as well as other banks facing MBS claims — will fight to undo Rakoff's ruling. Buchdahl seems to like his odds, however. "It's not the wisest thing to speculate about your chances on appeal," Buchdahl says. "But I will say this: Judge Rakoff wrote an incredibly detailed opinion, and reached his conclusions based on his own review. . . . It will be very difficult to overturn his findings."


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