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From Securities Regulation Daily, September 6, 2016

Loss causation again provides no defense to FHFA’s blue sky claims

By John M. Jascob, J.D., LL.M.

The Federal Housing Finance Agency (FHFA) has succeeded in striking loss causation defenses to claims that the Royal Bank of Scotland and certain affiliates violated state laws by making material misrepresentations in their sales of residential mortgage-backed securities. The federal district court in Connecticut ruled that loss causation does not provide a defense to misrepresentation claims under the securities laws of either Virginia or the District of Columbia. Accordingly, the claims against the bank may proceed (FHFA v. Royal Bank of Scotland Group plc, August 31, 2016, Thompson, A.).

The FHFA had brought the suit in its capacity as conservator of the Federal Home Loan Mortgage Corporation (Freddie Mac), alleging that the defendants had violated federal and state securities laws in connection with certain private-label mortgage-backed securities purchased by Freddie Mac during 2005 to 2007. Although one of the defendants, RBS Securities, Inc., had entered into a $99.5 million settlement with the FHFA in June 2014, the settlement expressly did not resolve any of the claims in the present action.

No collateral estoppel. As an initial matter, the court rejected the FHFA’s argument that the defendants were precluded from asserting a loss causation defense because RBS Securities had already fully litigated and lost that issue on summary judgment in a related action, FHFA v. HSBC North America Holdings (S.D.N.Y. 2013). The FHFA failed to meet its burden of establishing that RBS Securities, which had not been sued in a representative capacity, had fairly represented the interests of itself and the other defendants. In any event, the FHFA’s collateral estoppel arguments raised substantial and disputed issues that could not be resolved on a motion to strike.

Blue sky claims and loss causation. The court agreed with the FHFA, however, that loss causation is not a defense to claims under the District of Columbia or the Virginia securities laws. The court observed that both statutes are modeled on the Uniform Securities Act, which in turn was modeled on the original version of Section 12 of the federal Securities Act. Until it was amended by the Private Securities Litigation Reform Act in 1995, Section 12 did not contain a loss causation defense. As noted by the U.S. Supreme Court in Randall v. v. Loftsgaarden (U.S. 1986), the original version of Section 12 reflected Congress’s decision to shift the risk of an intervening decline in the value of the security to defendants, whether or not that decline was actually caused by the fraud.

In the court’s view, the statutory history supports the conclusion that the pertinent provisions of the three laws should have been construed similarly prior to the PSLRA. While none of the three provisions originally provided for a loss causation defense, Section 12 was amended to provide for such a defense, but the relevant provisions of the District of Columbia and Virginia blue sky laws were not. The fact that the pertinent provisions of the District of Columbia and Virginia blue sky laws expressly enumerate defenses but do not include loss causation among them provides further support for the conclusion that loss causation is not available as a defense under those statutes. Accordingly, the court granted the FHFA’s motion to strike.

The case is No. 3:11CV1383 (AWT).

Attorneys: Leron Thumim (Quinn Emanuel Urquhart & Sullivan, LLP) for Federal Housing Finance Agency. Alan C. Turner (Simpson Thacher & Bartlett LLP) and Matthew C. Brown (Wiggin and Dana LLP) for Royal Bank of Scotland Group PLC, RBS Holdings USA, Inc., RBS Securities, Inc., RBS Financial Products, Inc., and RBS Acceptance, Inc.

Companies: Federal Housing Finance Agency; Royal Bank of Scotland Group PLC; RBS Holdings USA, Inc.; RBS Securities, Inc.; RBS Financial Products, Inc.; RBS Acceptance, Inc.

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