June 11, 2013
My last post examined Judge Rakoff’s key pre-trial legal rulings that set the stage for a bench trial in which Judge Rakoff awarded Assured Guaranty, a financial guaranty insurer, $90.1 million against a securitizer of subprime mortgage bonds. This post will examine the key evidentiary rulings supporting Judge Rakoff’s verdict following a 12-day bench trial. See, 2013 WL 440114 (S.D.N.Y. Feb. 5, 2013).
Judge Rakoff’s Resolution of the “War of Experts”
In finding that Assured had carried its burden of proving that Flagstar’s material misrepresentation caused more than $90 million damages during a 12-day bench trial, Judge Rakoff provided monoline financial guarantee insurers with a roadmap for how to prove claims against subprime mortgage securitizers. Insurers seeking to establish material breaches and resulting damages from a mortgage backed security comprised of thousands of loans are presented with a practical proof issue: Must the insurer identify each breach in order to give the bond issuer the opportunity to cure the breach or repurchase the loan, or can it prove the existence of breaches throughout the loan pool and resulting damages based on statistical extrapolations from a small loan pool?
Several courts have accepted the general proposition that statistical sampling is permissible, without endorsing a particular methodology or approach. See Syncora Guarantee Inc. v. EMC Mortg. Corp., No. 09 Civ. 3106, 2011 WL 1135007, at *4 (S.D.N.Y. Mar. 25, 2011); MBIA v. Countrywide Home Loans, Inc., 30 Misc.3d 1201(A), 2010 WL 5186702 at *4 (N.Y.Sup.Ct.2010). Judge Rakoff’s ruling is the first to rely on a particular expert’s analysis to support imposition of liability on a subprime mortgage securitizer in a dispute with a financial guaranty insurer. Based on a random sample of 800 loans from the 15,000 loan pool backing Flagstar’s securities, the expert determined that in excess of 75 percent of the loans were materially defective.
Despite acknowledging certain flaws in the expert’s analysis, Judge Rakoff concluded that the expert’s testimony proved that Flagstar had “pervasively breached” its representations and warranties. Judge Rakoff did so despite Assured’s expert’s inability to articulate mechanical standards for determining what constitutes a material breach. He interpreted the absence of a consistent standard to “reflect not a failure of methodology, but a candid recognition of the multi-variable nature of the inquiry.”
In so ruling, Judge Rakoff rejected Flagstar’s argument that random sampling conflicts with its contractual right to cure or repurchase the loan. Judge Rakoff explained that “Flagstar’s right to cure a breach is irrelevant because it is impossible to entirely cure any breach as to a mortgage loan that has already defaulted.”