S.D.N.Y. Dismisses German Bank's Claim that Goldman Misrepresented a CDO

Christina DeIasi | Bloomberg Law

Landesbank Baden-Württemberg v. Goldman Sachs & Co., No. 10-CV-07549 (S.D.N.Y. Sept. 28, 2011)

The U.S. District Court for the Southern District of New York dismissed claims that Goldman Sachs & Co. (Goldman) and TCW Asset Management Company (TCW, and together with Goldman, Defendants) misrepresented a mortgage-backed credit default obligation (CDO) that Goldman sold to Landesbank Baden-Württemberg (Landesbank). The Court held that Landesbank failed to allege its common law fraud claim with the particularity required by Rule 9(b) of the Federal Rules of Civil Procedure. It also held that Landesbank failed to state its negligent misrepresentation and unjust enrichment claims.

CDO Offering

As the Court explained, on March 30, 2006, Goldman underwrote and issued a CDO called Davis Square that was collateralized by residential mortgage-backed securities (MBS). TCW managed the collateral for Davis Square. Landesbank purchased two Davis Square notes in the initial offering for $37 million.

Landesbank claimed that Defendants misrepresented Davis Square’s risk when they described it as a “‘High Grade Structured Product CDO’” and touted its triple-A ratings from Moody’s and Standard & Poor’s (together, Rating Agencies). Defendants’ alleged misstatements appeared in an Offering Circular provided to Landesbank and other institutional investors. “The Circular warned investors to ‘consider and assess for themselves the likely level of defaults of the collateral assets, as well as the likely level and timing of recovering on the collateral assets.’” Goldman also filed detailed disclosures with the Securities and Exchange Commission concerning the MBS backing Davis Square.

Fraud Not Alleged

According to Landesbank, Goldman knew before the offering that many of the underlying mortgages did not conform to their originators’ eligibility requirements. Goldman allegedly received loan-level due diligence from Clayton Holdings, Inc. (Clayton), including a 2007 report finding that 22 percent of the loans Goldman reviewed were nonconforming. That report also allegedly revealed that Countrywide Financial Corp. (Countrywide), New Century Financial Corp. (New Century), and Fremont General Corp. (Fremont)—originators of approximately 32 percent of Davis Square’s mortgage-loan collateral—had a higher percentage of nonconforming loans than the industry average. Landesbank also claimed that Goldman concealed the quality of the mortgages from the Rating Agencies to obtain a favorable rating for Davis Square.

An essential problem with Landesbank’s fraud claim, the Court explained, is that the 2007 Clayton report “cannot support a fraud claim for securities sold in March of 2006.” In addition, the Court noted that Landesbank failed to allege a connection between the specific mortgages reviewed in the report and those collateralizing Goldman’s Davis Square CDO.

The Court next held that Landesbank’s allegations regarding Defendants’ due diligence failed to provide notice of the “particulars: the ‘who, what, when, where and how. . . .’” Specifically, the Court explained, Rule 9(b) requires more than a general allegation that Goldman conducted extensive due diligence, revealing “higher than normal exception rates,” when it acquired billions of dollars of mortgage pools from Countrywide, New Century, and Fremont. Nor was it enough to allege that Goldman had a dedicated team to value its mortgage inventory that had become more vigilant in the first quarter of 2006, and that Goldman and TCW were middlemen with “access to loan-level information unavailable to other investors.”

Landesbank’s case against TCW was especially weak and a paradigm of trying to plead “fraud by hindsight.” “All that Landesbank can muster against TCW,” the Court explained, “is that it should have uncovered the substantial number of nonconforming loans originated by Countrywide, New Century, and Fremont, given the subsequent revelations about toxic mortgages.”

Remaining Claims Dismissed

Turning to the remaining claims, the Court held that Landesbank failed to allege an essential element of its negligent misrepresentation claim: justifiable reliance. It explained that “New York courts generally do not permit negligent misrepresentation claims based on arm’s length transactions between sophisticated counterparties.” The existence of a written contract between Landesbank and Goldman precluded the unjust enrichment claim. Again referencing New York law, the Court noted that the “‘existence of a valid and enforceable written contract governing a particular subject matter ordinarily precludes recovery in quasi contract for events arising out of the same subject matter.’”