united states bankruptcy court district of delaware : case …€¦ · : case no. 08-12229 (mfw)::...
TRANSCRIPT
UNITED STATES BANKRUPTCY COURTDISTRICT OF DELAWARE
------------------------------------------------------xIn re :
: Chapter 11WASHINGTON MUTUAL, INC., et al. :
: Case No. 08-12229 (MFW):: (Jointly Administered)
------------------------------------------------------x
TRANQUILITY MASTER FUND, LTD.’S RESPONSE TO DEBTORS’SUPPLEMENTAL OBJECTION TO PROOF OF CLAIM OF
TRANQUILITY MASTER FUND LTD.
MORRIS, NICHOLS, ARSHT & TUNNELL LLPDonna L. Culver (No. 2983)1201 North Market StreetP. O. Box 1347Wilmington, DE 19899-1347Phone: (302) 658-9200Facsimile: (302) 658-3989Counsel for Tranquility Master Fund, Ltd.
OF COUNSEL:Scott A. MeyersUlmer & Berne LLP500 West Madison Street, Suite 3600Chicago, IL 60661-4587Phone: (312) 658-6500Facsimile: (312) 658-6501
January 21, 2011
i
TABLE OF CONTENTS
PRELIMINARY STATEMENT................................................................................................. 2ARGUMENT ............................................................................................................................. 7I. TRANQUILITY HAS ADEQUATELY PLED CONTROL PERSON LIABILITY. ........... 7
A. Section 25504 Of The California Corporations Code Does Not Require Culpable Participation. ................................................................................................ 7
B. Sections 11 and 15 of the Securities Act Do Not Require Allegations of Culpable Participation. ................................................................................................ 9
C. Tranquility Has Pled Sufficient Facts To Establish Control Person Liability Under the California and Federal Securities Laws. .................................................... 14
D. Debtors’ Other Objections to Tranquility’s Pleading of Control Person Liability are Similarly Baseless. .............................................................................................. 24
II. TRANQUILITY HAS ADEQUATELY PLED WAMU INC.’S INTENT TO DEFRAUD UNDER CALIFORNIA CORPORATIONS CODE SECTION 25504.1. ....... 31
III. THERE IS NO REASONABLE BASIS TO SUBORDINATE TRANQUILITY’S CLAIMS UNDER SECTION 510(B). .............................................................................. 34A. The Debtors’ Effort to Subordinate Tranquility’s Claims Through a Claims
Objection is Procedurally Improper. .......................................................................... 35B. Debtors Have Already Admitted And Should Be Estopped From Recanting
That The Trusts Are Not Affiliates Of The Debtors. .................................................. 36C. Section 510(b) Does Not Apply To Tranquility’s Claims Because The Trusts
Which Issued The Certificates Are Not Affiliates of the Debtors. .............................. 37IV. TRANQUILITY HAS ADEQUATELY PLED THAT IT SUFFERED DAMAGES
FROM PURCHASING INFLATED MORTGAGE BACKED SECURITIES................... 39A. The Court Has Already Rejected This Argument And Debtors Are Thus Barred
From Reasserting It Here Again. ............................................................................... 39B. Debtors’ Argument Remains Factually and Legally Baseless. ..................................... 40
1. Loss causation is not an element of Tranquility’s control person claims under either the California Corporations Code or Section 15 of the Securities Act of 1933. .................................................................................. 40
2. This alleged pleading requirement has been expressly rejected by recent case law......................................................................................................... 41
3. Debtors’ legal authorities are entirely inapposite............................................ 424. The specific mortgage information is within the Debtors’ knowledge
and control and they have refused to provide it to Tranquility. ....................... 45V. TRANQUILITY HAS ADEQUATELY PLED ITS SECTION 15 CLAIMS..................... 46VI. TRANQUILITY HAS NOT IMPROPERLY ADDED NEW MISREPRESENTATION
ALLEGATIONS............................................................................................................... 47CONCLUSION ........................................................................................................................ 50
ii
TABLE OF AUTHORITIES
CASES
AL Tech Specialty Steel Corp. v. Allegheny Int’l Credit Corp.,104 F.3d 601 (3d Cir. 1997) .......................................................................................... 40
Apollo Capital Fund LLC v. Roth Capital Partners, LLC,70 Cal. Rptr. 3d 199 (Cal. Ct. App. 2007) ..................................................................... 31
Bauer v. Prudential Fin., Inc., Civ. Action Nos. 09-1120(JLL), 09-1771, 2010 U.S. Dist.LEXIS 64384, (D. N.J. June 29, 2010) ................................................................................................. 14
Behnabib v. Hughes Electronics Corp., Case No. CV 04-0095 CAS (VBKx), 2007 U.S.Dist.LEXIS 87500,(C.D.Cal. Apr. 2, 2007)............................................................................................30, 31
Boilermakers National Annuity Trust Fund v. WaMu Mortgage Pass Through Certificates,Series ARI, Case No. C09-00037MJP, 2010 U.S. Dist.LEXIS 104427 (W.D. Wash. Sept. 28, 2010)....................................................................................39, 42
Borden, Inc. v. Spoor Behrins Campbell & Young, Inc.,735 F.Supp. 587, 591 (S.D.N.Y. 1990).......................................................................... 12
Bowden v. Robinson, 136 Cal. Rptr. 871, 1977 Cal. App. LEXIS 1268 (Cal. Ct. App. 1977) .................9, 40, 41
Deep Water Brewing, LLC v. Fairway Resources Ltd., 215 P.3d 990 (Wash.Ct.App. 2009)............................................................................... 27
Dofflemyer v. W.F. Hall Printing Co., 558 F. Supp. 372 (D. Del. 1983).................................................................................... 12
Dutton v. Harris Stratex Networks, Inc.,Civ. Action No. 008-755-JJF, 2010 U.S. Dist. LEXIS 76104, (D. Del. July 22, 2010).................................................................................................. 13
Etshokin v. Texasgulf, Inc., 612 F. Supp. 1212 (N.D. Ill. 1984) .....................................................................26, 28, 29
Ferber v. Travelers Corp.,802 F. Supp. 698 (D. Conn. 1992)................................................................................. 45
Fowler v. UPMC Shadyside, 578 F.3d 203 (3d Cir. 2009) ......................................................................................... 25
iii
Harriman v. E. I. Du Pont de Nemours & Co., 372 F. Supp. 101 (D. Del. 1974).................................................................................... 12
Hill v. Equitable Bank, Nat’l Ass’n, 599 F. Supp. 1062 (D. Del. 1984).............................................................................11, 13
In re Adams Golf, Inc. Sec. Litig., 381 F.3d 267 (3d Cir. 2004)........................................................................................... 40
In re Am. Bus. Fin. Servs. Inc. Sec. Litig.,Master File No. 05-232, 2007 U.S. Dist. LEXIS 932, (E.D. Pa. Jan. 9, 2007) ...........10, 12
In re American Bank Note Holographics, Inc. Sec. Litig., 93 F.Supp.2d 424, 445 (S.D.N.Y. 2000)........................................................................ 27
In re Captain Blythers, Inc., 311 B.R. 530, 538 (B.A.P. 9th Cir. 2004)....................................................................... 37
In re Chambers Dev. Sec. Litig.,848 F. Supp. 602, 621 (W.D. Pa. 1994)......................................................................... 14
In re Chase Manhattan Corp. Sec. Litig., No. 90 Civ. 6092 (LMM), 1991 U.S.Dist.LEXIS 10622, (S.D.N.Y. Aug. 1, 1991) ..........................................................................................29, 30
In re Children’s Place Sec. Litig., Civ. Action No. 97-5021(JCL)-, 1998 U.S. Dist. LEXIS 22868, (D.N.J. Sept. 4, 1998).................................................................................................... 14
In re Donson, 434 B.R. 471, 474-75 (Bankr. S.D. Tex. 2010).........................................................35, 36
In re Edison Bros. Stores, Inc., No. 99-532, 2002 Bankr.LEXIS 1228 (Bankr. D. Del. May 15, 2002)......................48, 49
In re FLYi, Inc., No. 05-20011 (MFW), 2008 WL 170555, (Bankr. D. Del. Jan. 16, 2008).................48, 49
In re Indep. Energy Holdings PLC Sec. Litig., 154 F. Supp. 2d 741, (S.D.N.Y. 2001).......................................................... 11, 26, 28, 30
In re Lehua Hoopai, Case No. 04-02511, 2007 Bankr. LEXIS 2867 .............................................................. 30
iv
In re Maruki USA Co., 97 B.R. 166 (Bankr. S.D.N.Y. 1988) ................................................................................................ 38
In re Musicmaker.com Sec. Litig., No. 00-2018, 2001 U.S. Dist. LEXIS 25118, (C.D. Cal. June 4, 2001) ......... 11, 12, 15, 30
In re PMA Capital Corp. Sec. Litig., Master File No. 03-6121, Class Action, 2005 U.S. Dist. LEXIS 15696, (E.D. Pa. July 27, 2005) ................................................................................................ 14
In re Ravisent Techs., Inc. Sec. Litig., No. 00-1014, 2004 U.S. Dist. LEXIS 13255, (E.D. Pa. July 12, 2004)........................... 11
In re Semcrude, L.P., 436 B.R. 317 (Bankr. D. Del. 2010) .............................................................................. 38
In re Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256 (3d Cir. 2006) ...................................................................................... 9, 12
In re Tellium, Inc. Sec. Litig., Civ. Action No. 02-cv-5878(FLW), 2005 U.S. Dist. LEXIS 19467(D. N.J. June 30, 2005) ................................................................................................. 11
In re Vivendi Universal, S.A. Sec. Litig.,381 F. Supp. 2d 158 (S.D.N.Y. 2003)............................................................................ 12
In re Vonage Initial Pub. Offering Sec. Litig., Civ. Action No. 07-177(FLW), 2009 U.S. Dist. LEXIS 28255, (D.N.J. Apr. 2, 2009) .................................................................................................... 14
In re Wells Fargo Mortgage Backed Certificates Litigation,No. C 09-01376 SI, 2010 U.S. Dist. LEXIS 39825 (N.D. Cal. April 22, 2010)..................................................................................41, 42, 43
In re Worldcom Inc.,377 B.R. 77 (Bankr. S.D.N.Y. 2007)........................................................................... 8, 9
In re ZZZZ Best Sec. Litig.,No. CV 87-3574-RSWL, 1989 U.S. Dist. LEXIS 8083 (C.D. Cal. May 25, 1989).............................................................................................. 34
In re ZZZZ Best Sec. Litig.,No. CV 87-3574 RSWL, 1990 WL 132715 (C.D. Cal. July 23, 1990) ........................... 33
v
Kainos Laboratories, Inc. v. Beacon Diagnostics, Inc.,No. C-97-4618 MHP, 1998 WL 2016634 (N.D. Cal. Sept. 14, 1998) .............................. 8
Official Comm. Of Unsecured Creditors v. Aust (In re Network Access Solutions, Corp.), 330 B.R. 67 (Bankr. D. Del. 2005) ................................................................................ 40
Oregon RSA No. 6, Inc. v. Castle Rock Cellular of Oregon Ltd. P’ship, 840 F.Supp. 770, (D.Or. 1993) ...................................................................................... 29
Parilla v. IAP Worldwide Servs, VI, Inc., 368 F.3d 269 (3d Cir. 2004) .......................................................................................... 36
Plumbers Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp.,658 F. Supp. 2d 299 (D. Mass. 2009) .......................................................................43, 44
Protarga, Inc. v. Webb (In re Protarga, Inc.), Adv. 04-53374, 2004 WL 1906145, (Bankr. D. Del. Aug. 25, 2004) ............................. 35
Republic Bank & Trust Co. v. Bear, Stearns & Co., Inc.,No. 09-CV-287, 2010 U.S. Dist. LEXIS 36365 (W.D. Ky. April 13, 2010) ................... 44
Rochez Bros. Inc. v. Rhoades, 27 F.2d 880 (3d Cir. 1975) .......................................................................................10, 13
Sherman v. Lloyd, 226 Cal. Rptr. 495, 502, 1986 Cal. App. LEXIS 1641, (Cal. Ct. App. 1986)................... 8
Tracinda Corp. v. DaimlerChrysler AG, 197 F. Supp. 2d 42 (D. Del. 2002)................................................................................. 13
USA Capital Realty Advisors, LLC v. USA Capital Diversified Trust Deed Fund, LLC (In reUSA Commercial Mortgage Co.), 377 B.R. 608 (9th B.A.P. 2007) .................................................................................... 35
Weiner v. Quaker Oats Co.,129 F.3d 310 (3d Cir. 1997) .......................................................................................... 45
Weintruab v. Texasgulf, Inc., 564 F. Supp. 1466 (S.D.N.Y. 1983)....................................................................26, 27, 28
Youkelsone v. Washington Mutual Inc. (In re Washington Mutual Inc.), Adv. No. 09-50039 (MFW), 2010 WL 3238903, (Bankr. D. Del. Aug. 13, 2010) ..................................................................................... 25
vi
STATUTES
11 U.S.C. § 101(2)(C) ...................................................................................................34, 37, 38
11 U.S.C. § 502(a).................................................................................................................... 35
11 U.S.C. § 510(b)......................................................................................... 5, 34, 35, 37, 38, 39
15 U.S.C. § 77k(e) .................................................................................................................... 40
15 U.S.C. § 77l(b) .................................................................................................................... 41
15 U.S.C. § 77o ...........................................................................................................8, 9, 10, 46
15 U.S.C. § 78j(b) ...........................................................................................................9, 28, 29
15 U.S.C. § 78(t)(a) ............................................................................................... 8, 9, 10, 12, 29
Cal. Corp. Code § 25401 .................................................................................................. 9, 40, 41
Cal. Corp. Code § 25501 .............................................................................................. 2, 8, 40, 41
Cal. Corp. Code § 25504 ...........................................................................................2, 7, 8, 9, 28
Cal. Corp. Code § 25504.1...............................................................................................4, 31, 34
OTHER AUTHORITIES
17 C.F.R. § 230.405.................................................................................................................. 10
17 C.F.R. § 240.12b-2 .............................................................................................................. 10
Federal Rule of Bankruptcy Procedure 3007(b) ...................................................................35, 36
Federal Rule of Bankruptcy Procedure 7001(8) ........................................................................ 35
Federal Rule of Civil Procedure 9(b) ........................................................................................ 45
18B Am.Jur.2d Corporations § 1454 (2010) ............................................................................. 27
1
IN THE UNITED STATES BANKRUPTCY COURTFOR THE DISTRICT OF DELAWARE
In re
WASHINGTON MUTUAL INC., et al.,1
Debtors.
)))))
Chapter 11
Case No. 08-12229 (MFW)
(Jointly Administered)
TRANQUILITY MASTER FUND, LTD.’S RESPONSE TO DEBTORS’SUPPLEMENTAL OBJECTION TO PROOF OF CLAIM OF
TRANQUILITY MASTER FUND LTD.
Claimant Tranquility Master Fund, Ltd. (“Tranquility”) (now known as Spectrum Master
Fund, Ltd.) hereby submits this response (the “Response”) to Washington Mutual Inc. (“WaMu
Inc.”) and WMI Investment Corp.’s (collectively, the “Debtors”) Supplemental Objection to
Proof of Claim of Tranquility Master Fund Ltd. (the “Supplemental Response”). Tranquility filed
its initial Proof of Claim on March 30, 2009 (Claim No. 2206) (the “Initial Claim”). Debtors
filed their initial Objection to Proof of Claim of Tranquility Master Fund, Ltd. (Claim No. 2206)
(Docket No. 2531) (the “Initial Objection”) on Mach 15, 2010. Tranquility filed its Response to
Debtors’ Objection to Proof of Claim No. 2206 (Docket No. 3641) (the “Initial Response”) on
May 4, 2010. On November 12, 2010, the Court entered an Order Sustaining in Part and
Overruling in Part Debtors’ Objection to Proof of Claim of Tranquility Master Fund, Ltd.
(Claim 2206) (Docket No. 5882) (the “Initial Order”). Pursuant to the Initial Order, Tranquility
filed an Amended Proof of Claim (Claim No. 3925) (the “Amended Claim”) on November 30,
2010. Debtors then filed their Supplemental Objection to Proof of Claim of Tranquility Master
Fund Ltd. (Docket No. 6426) (the “Supplemental Objection”) on December 23, 2010.
1 The Debtors in these chapter 11 cases along with the last four digits of each Debtor’s federal tax identification number are: (i) Washington Mutual, Inc. (3725); and (ii) WMI Investment Corp. (5395). The Debtors’ principal offices are located at 925 Fourth Avenue Suite 2500, Seattle, WA 98104.
2
The Initial Order states that “[u]pon the filing and service of an amended claim, the
remainder of the arguments raised in the Objection and not addressed by this Order are reserved
for future determination by the Court.” Initial Order at ¶ 7. Accordingly, Tranquility will not
restate all of the arguments raised in its Initial Response. Instead, Tranquility hereby
incorporates the Initial Response by reference into this Supplemental Response.2
PRELIMINARY STATEMENT
1. With their Supplemental Objection, Debtors again ask this Court to disallow and
expunge almost $50 million of claims asserted by Tranquility (the “Claims”). These Claims are
based on the sale to Tranquility of 56 WaMu mortgage backed securities that were issued and
sold in violation of California and federal securities laws. Although Tranquility still has not been
afforded any discovery on these Claims, Debtors once more urge that Tranquility’s Claims
should be dismissed without any opportunity for Tranquility to conduct any discovery or present
a shred of evidence. Debtors attempt to justify this treatment of Tranquility’s Claims by
advancing six arguments – at least one of which this Court has already rejected in the Initial
Order – that are entirely unsupported by the facts, ungrounded in applicable law, and do not in
any way justify the extraordinary sanction of summary dismissal of Tranquility’s Claims.
2. First, Debtors argue that Tranquility has not pled “culpable participation” and has
thus failed to establish control person liability under Sections 25501 and 25504 of the California
Corporations Code (Count I) and under Sections 11 and 15 of the Securities Act of 1933 (Count
III). As an initial matter, neither Sections 25501 and 25504 nor Sections 11 and 15 require
allegations of “culpable participation” as a matter of law. Rather, they require allegations of
control, which Tranquility has more than adequately pled. Indeed, Tranquility has identified at
2 Any capitalized terms not defined herein shall have the meaning ascribed to them in the Amended Claim and/or the Initial Response.
3
least ten separate bases of WaMu Inc.’s control person liability, including but not limited to
specific allegations describing WaMu Inc.’s actual involvement, management, supervision, and
control over the underwriting, appraisal, and securitization processes at issue. All of these
allegations are substantiated by citations to a variety of reliable sources, including WaMu Inc.’s
own internal investigations; the Senate Committee’s investigatory findings and related exhibits
and testimony; sworn testimony from WaMu Inc.’s senior officers, directors, and employees;
WaMu Inc.’s own public disclosures; WaMu Inc.’s internal documents; internal correspondence
and related documents from various regulators; pleadings from related civil actions; as well as
the NYAG Complaint. Each of these bases of control has been found by numerous courts to give
rise to liability under the California and federal statutes at issue here.
3. Debtors ignore the vast majority of Tranquility’s detailed allegations, focusing
instead on only a few minor issues. Debtors first argue that Tranquility’s allegations are
factually inaccurate. This is both untrue and irrelevant for purposes of a motion to dismiss.
Tranquility’s well-pleaded allegations are to be accepted as true, regardless of WaMu Inc.’s
baseless assertions to the contrary. Debtors also argue that the admitted existence of overlapping
board members among WaMu Inc. and its subsidiaries does not establish that WaMu Inc. was a
mere alter ego of the subsidiaries. But Tranquility is not alleging a common law alter ego
theory, but rather asserts statutory control person liability. And again, numerous courts have
expressly recognized that such overlapping board memberships can give rise to control person
liability under the federal and California securities statutes at issue. Debtors also assert that these
overlapping directorships do not “prove” that a WaMu Bank director’s actions should be
imputed to WaMu Inc. Setting aside the fact that Tranquility is not required to “prove” anything
at this stage, this argument is factually and legally baseless. Tranquility has alleged that WaMu
4
Inc.’s officers and directors had direct knowledge of the material facts as a result of their
personal involvement with operations on behalf of WaMu Inc. and their participation on
numerous WaMu Inc. Board of Directors’ committees that directly controlled the securitization
activities at issue. Again, numerous courts have recognized that such allegations properly give
rise to control person liability. Moreover, these courts have also recognized that it is proper to
impute even indirect knowledge to co-mingled directors where, as here, (i) WaMu Inc.’s
executive officers simultaneously served as directors or officers of WaMu Bank and the other
WaMu subsidiaries; (ii) WaMu Inc. operated its business on an integrated basis through its
subsidiaries; and (iii) WaMu Inc. centrally managed, monitored and controlled its subsidiaries’
mortgage underwriting and securities activities at issue through its centralized management
control and reporting structure and its Board committees. Finally, Debtors claim that WaMu
Inc.’s public SEC filings do not establish that WaMu Inc. was merely an alter ego of its
subsidiaries. Again, this is legally irrelevant (because Tranquility is not asserting an alter ego
theory), and is belied by myriad legal authorities recognizing that such public disclosures are
relevant for purposes of establishing control person liability.
4. Debtors next argue that Tranquility’s “material assistance” claim under Section
25504.1 of the California Corporations Code fails to demonstrate scienter. To the contrary,
Tranquility has pled that WaMu Inc. acted with the “intent to induce reliance” on the
misrepresentations and omissions at issue, which allegations fully satisfy the pleading
requirements under Section 25504.1. Indeed, Tranquility has provided numerous allegations
demonstrating the WaMu Inc. knowingly and intentionally acted with the intent to deceive and
defraud, and that there was no innocent reason for WaMu Inc.’s failure to disclose the truth about
its underwriting and appraisal practices. These allegations include specific testimony from
5
David Beck, WaMu Inc.’s Executive Vice President and Chief Investment Officer, that he knew
that WaMu was securitizing loans tainted by underwriting deficiencies and fraud, yet he did
nothing whatsoever to advise the investors who purchased these securities. In addition,
Tranquility has cited to internal reports and investigations that concluded that WaMu Inc. had
longstanding knowledge of its significant underwriting and appraisal problems, yet failed to
disclose this information to investors. Significantly, even Debtors’ own legal authorities
recognize that the totality of these allegations more than adequately establishes scienter.
5. Debtors also argue that Tranquility’s claims should be subordinated under
Section 510(b) of the Federal Bankruptcy Code (the “Code”) because the Trusts that issued the
mortgage-backed securities at issue are purportedly affiliates of the Debtors. This argument is
directly contradicted by Debtors’ recent admission in this case that these Trusts “are not affiliates
of the Debtors.” Moreover, because Debtors are not parties to any of the documents that
purportedly control the Trusts, they are not “affiliates” as a matter of law. And in any event, it is
procedurally improper for Debtors to raise this subordination issue in a claim objection.
6. Debtors next reiterate their earlier objection that Tranquility has failed to
specifically identify a particular inflated loan underlying its securities. Because the Court has
already rejected this particular objection, Debtors are barred from reasserting it here. But even if
the Court were to reconsider this argument, it should again reject it as legally baseless. First,
Debtors’ argument constitutes an impermissible attempt to inject loss causation as a pleading
element, when no such pleading is required under the federal or state securities statutes at issue.
Second, recent case law has expressly rejected Debtors’ proposed pleading requirement,
particularly where, as here, Tranquility has pled that Debtors’ practices permitted the pervasive
6
and systematic use of inflated appraisals that affected all of their mortgage-backed securities.
Third, all of Debtors’ purposed legal authorities are entirely inapposite and easily distinguished.
7. Debtors also claim that Tranquility cannot reassert its Section 15 claims for
privately placed securities. But Tranquility has expressly acknowledged that it is reasserting this
argument solely for purposes of preserving its appellate rights. Debtors further claim that
Tranquility cannot reassert its Section 15 claims even for securities that were issued pursuant to a
registration statement because, as a matter of contested fact, there are none. This argument
directly conflicts with Debtors’ prior written and oral representations and admissions to this
Court that at least five of the securities at issue were validly issued pursuant to a registration
statement.
8. Finally, Debtors a r g u e that Tranquility has improperly added new
misrepresentation allegations. Specifically, Debtors object to allegations taken from the Senate
Committee’s April 13, 2010 report that confirmed, among other things, that WaMu Inc. was
aware of, and exercised control over, the loan underwriting and securitization practices at issue
in this case. These allegations are included in the section of the Amended Claim discussing the
fact that WaMu’s own internal investigations confirmed that material problems with its loan
underwriting and credit risk management activities had resulted in the appraisal fraud that is
directly at issue. Accordingly, these allegations are not new claims, but rather describe the pre-
existing claims in greater detail. Indeed, these allegations involve the same conduct,
transactions, and occurrences that form the basis of Tranquility’s Initial Claim. Moreover,
Debtors do not and cannot argue that they have suffered any unfair prejudice due to these new
allegations. The nature of Tranquility’s claims remains unchanged, discovery has not yet begun,
and Debtors are on notice of the claims against them. For the foregoing reasons, which are
7
described more fully below, Debtors’ Supplemental Objection to Tranquility’s Amended Claim
should be overruled.
ARGUMENT
I. TRANQUILITY HAS ADEQUATELY PLED CONTROL PERSON LIABILITY.
9. Debtors first argue that Tranquility has not adequately pled control person
liability under either the California Corporations Code or the Securities Act of 1933. The
gravamen of Debtors’ objection is that Tranquility has failed to establish that WaMu Inc. had
knowledge of and was a “culpable participant” in the alleged appraiser practices and
securitization practices at issue. Supplemental Objection at ¶ 16. It is important to note that in
the Court’s Initial Order, however, it does not state that Tranquility is required to plead “culpable
participation.” And neither the California nor federal securities statutes at issue impose such
pleading requirements. But even if such pleading were required, Tranquility has done so.
A. Section 25504 Of The California Corporations Code Does Not Require Culpable Participation.
10. Count I of the Amended Claim, pursuant to California Corporations Code Section
25504, seeks to recover against Debtors for control person liability for a violation of Section
25401, which creates liability for any person selling securities by means of written or oral
statements containing false statements or omissions. (Amended Claim at ¶¶ 302-304). The plain
language of Section 25504 contains no requirement that Tranquility make any showing of
fraudulent or intentional conduct in order to prove a violation of this statute, nor does it require
Tranquility to plead or prove either reliance or causation:
Every person who directly or indirectly controls a person liable under Section 25501 . . . are also liable jointly and severally with and to the same extent as such person, unless the other person who is so liable had no knowledge of or reasonable grounds to believe in the existence of the facts by reason of which the liability is alleged to exist.
8
California Corporations Code § 25504.
11. Contrary to the Debtors’ assertions, “[c]ulpable participation is not required”
to establish control person liability under Section 25504. In re Worldcom, Inc., 377 B.R. 77, 105
(Bankr. S.D.N.Y. 2007) (emphasis added). Rather, to establish control person liability under
Section 25504, Tranquility need only plead and prove: (1) a primary violation under Section
25501; and (2) that WaMu Inc. “exercised actual power or control over the primary violator.”
Id. (citing Howard v. Everex Systems, Inc., 228 F.3d 1057, 1065 (9th Cir. 2000).3 See also
Sherman v. Lloyd, 226 Cal. Rptr. 495, 502, 1986 Cal. App. LEXIS 1641, at *19 (Cal. Ct. App.
1986) (affirming grant of summary judgment against certain defendants for a Section 25504
claim based solely on control of entity that violated underlying statute).
12. Here, Tranquility has more than satisfied these pleading obligations. There is no
dispute that Tranquility has pled a primary violation of Section 25501 by WaMu Inc.’s
subsidiaries. Debtors’ only objection is that Tranquility has not adequately pled that WaMu Inc.
exercised actual power or control over its subsidiaries. As set forth in more detail below, such
objection is baseless. See supra at ¶¶ 23-38.
13. Based on this foregoing analysis, Debtors’ reliance on Kainos Laboratories, Inc.
v. Beacon Diagnostics, Inc., No. C-97-4618 MHP, 1998 WL 2016634 (N.D. Cal. Sept. 14, 1998)
is misplaced. There, the court mistakenly conflated the different standards for control person
liability under Section 15 of the Securities Act [15 U.S.C. 77o], Section 20(a) of the Securities
Exchange Act of 1933 [15 U.S.C. 78t(a)] and California Corporations Code Section 25504. Id.
at *14. Section 15 of the Securities Act and Section 25504 of the California Corporations Code
3 “After ‘the plaintiff establishes that a defendant is a controlling person, the defendant then bears the burden of proving he acted in good faith, good faith can be demonstrated if a defendant can show no scienter and an effective lack of participation.’” In re Worldcom, 377 B.R. at 105 (quoting In re Homestore Sec. Litig., 347 F. Supp. 2d 790 (C.D. Cal. 2004)).
9
predicate control person liability on violations of underlying strict liability statutes that do not
require scienter (Section 11 of the Securities Act and Section 25401 of the California
Corporations Code, respectively).4 In contrast, Section 20(a) of the Exchange Act predicates
liability on securities fraud violations under Section 10(b), which does require scienter. Thus,
while some courts have recognized that a “culpable participation” standard might make sense in
the context of a Section 20(a) claim because the underlying securities fraud violation similarly
requires culpability, that reasoning is inapplicable to control person liability claims arising under
strict liability statutes such as those at issue here. In re Worldcom, 377 B.R. at 103-05. Indeed,
there is no reasonable basis to hold a primary violator of the securities law strictly liable for a
violation of Section 11 or Section 25401, yet hold a control person liable for this same strict
liability violation only upon a showing of culpable participation. It is for precisely that reason
that In re Worldcom concluded that the California Supreme Court would not require culpable
participation for a Section 25504 claim because scienter is not required for the underlying
violation of Section 25401. Id. at 104-05.
B. Sections 11 and 15 of the Securities Act Do Not Require Allegations of Culpable Participation.
14. “Section 15 of the Securities Act [of 1933, 15 U.S.C. § 77o] provides for joint and
several liability on the part of one who controls a violator of Section 11 or Section 12.” In re
Suprema Specialties, Inc. Sec. Litig., 438 F.3d 256, 284 (3d Cir. 2006). In order to plead and
prove a claim for Section 15 liability, the Third Circuit requires that the plaintiff allege:
(i) a primary violation of the securities laws [Section 11 or Section 12], and (ii) that the Section
15 defendant “controlled another person or entity . . . that committed the primary violation.” Id.
4 Bowden v. Robinson, 136 Cal. Rptr. 871, 878, 1977 Cal. App. LEXIS 1268, at **16-17 (Cal. Ct. App. 1977) (Section 25401 does not require plaintiff to plead or prove scienter, reliance, or causation).
10
at 284 (vacating dismissal of Section 15 claim); see also In re Am. Bus. Fin. Servs. Inc. Sec.
Litig., Master File No. 05-232, 2007 U.S. Dist. LEXIS 932, at *36 (E.D. Pa. Jan. 9, 2007)
(setting forth those two elements in denying motion to dismiss).
15. In this context, “control” means “the possession, directly or indirectly, of the
power to direct or cause the direction of the management and policies of a person, whether
through the ownership of voting securities, by contract, or otherwise.” Rochez Bros. Inc. v.
Rhoades, 527 F.2d 880, 890 (3d Cir. 1975) (emphasis added) (citing 17 C.F.R. § 240.12b-2 in
Section 20(a) case));5 see also 15 U.S.C. § 77o (control is “by or through stock ownership,
agency, or otherwise, or . . . pursuant to or in connection with an agreement or understanding
with one or more other persons by or through stock ownership, agency, or otherwise”).
16. “[I]n determining if one is a ‘controlling person’. . . the courts [give] heavy
consideration to the power or potential power to influence and control the activities of the
person, as opposed to actual exercise thereof.” Rochez, 527 F.2d at 890-91 (3d Cir. 1975)
(emphasis added). The Third Circuit has further set forth the following examples of “controlling
persons”:
a company that established a special division within itself and gave broad authority to employees of the division;
a company that selected a person to develop the corporation in another state and permitted him to deal with any matters concerning the corporation, and required him to make regular reports to the corporation’s executive committee;
a director of a company who, with his family, heavily invested in that company;and
the partner of an investment banking firm who sat as a director of a company that the investment firm had substantial investments in.
5 See also 17 C.F.R. § 230.405 defining control for purposes of the Securities Act same as in Rochez Bros.and Rule 12b-2.
11
Id. at 891 (internal citations omitted); see also In re Tellium, Inc. Sec. Litig., Civ. Action No.
02-cv-5878(FLW), 2005 U.S. Dist. LEXIS 19467, at *72 (D. N.J. June 30, 2005) (“[Section 15
defendant’s] position as CEO, as well as his ownership of 6.6 million shares of [primary
violator’s] stock, [we]re sufficient to demonstrate ‘actual power’ or ‘influence’ over [the primary
violator]”); In re Ravisent Techs., Inc. Sec. Litig., No. 00-1014, 2004 U.S. Dist. LEXIS 13255, at
**59-61 (E.D. Pa. July 12, 2004) (allegations that Section 15 defendants “[we]re respectively
CEO and CFO of [primary violator], they [we]re both [primary violator’s] Directors, and
significant shareholders” sufficiently stated claim).6
17. Under these standards, courts routinely hold that parent corporations are control
persons of both their directly and indirectly held subsidiaries that are alleged to have violated
federal securities laws. See, e.g., In re Musicmaker.com Sec. Litig., No. 00-2018, 2001 U.S.
Dist. LEXIS 25118, at **57-58 (C.D. Cal. June 4, 2001) (holding that allegations of majority or
otherwise controlling stock ownership were sufficient to state a Section 15 claim against parent
corporations for their directly and indirectly held subsidiaries). Similarly, allegations that a
parent corporation conducted its business through its wholly-owned subsidiaries or had common
management with a subsidiary are sufficient to state a claim for control person liability against
the parent corporation. See, e.g., In re Indep. Energy Holdings PLC Sec. Litig., 154 F. Supp. 2d
741, 770-71 (S.D.N.Y. 2001) (allegations “that the [Section 15 defendant] conduct[ed] its
6 See also Hill v. Equitable Bank, Nat’l Ass’n, 599 F. Supp. 1062, 1084 (D. Del. 1984) (explaining that in a Section 15 and 20(a) case that to state a claim a plaintiff need only establish that the “controlling person possessed indirect, de facto control over the wrongful acts of the controlled person” and further explaining that “the liability of a controlling person does not turn upon whether he dictated the wrongful acts of the controlled person, [and] [m]ere inaction on the part of the controlling person is sufficient, if he intended thereby to assist in the wrongdoing.”)
12
business . . . through its wholly-owned subsidiaries” and had common management with
subsidiaries were sufficient to state claim).7
18. Although Debtors contend that culpable participation in the primary securities
violation is an additional requirement to state a Section 15 claim, this is neither the definitive
view nor a basis for dismissing Tranquility’s claim. “Courts in th[e] [Third] [C]ircuit have split
over whether culpable participation must be plead in the complaint.” See In re Am. Bus. Fin.
Servs., 2007 U.S. Dist. LEXIS 932, at **37-38 (rejecting motion to dismiss Section 15 claim for
failure to allege culpable participation); In re Suprema Specialties, 438 F.3d at 284 n. 16 (stating
that culpable participation is only required for claims under Section 20(a), not Section 15);
accord In re Vivendi Universal, S.A. Sec. Litig., 381 F. Supp. 2d 158, 187-88 (S.D.N.Y. 2003)
(explaining that majority of judges in Southern District of New York determined that culpable
participation is not an element of Section 15 claim). See also In re Musicmaker.com Sec. Litig.,
2001 U.S.Dist.LEXIS 25118, at *55 (to make out a prima facie claim under Section 15 it is not
necessary to show actual participation or the exercise of actual power because lack of
participation is an affirmative defense and the burden of showing it is on the defendant). The
court in In re American Bus. Fin. Servs., further “reasoned that the plaintiff need not plead
culpable participation because: (1) the facts establishing culpable participation can only be
expected to emerge after discovery; and (2) virtually all of the remaining evidence, should it
7 See also Dofflemyer v. W.F. Hall Printing Co., 558 F. Supp. 372, 385-386 (D. Del. 1983) (denying motion to dismiss Section 20(a) control person claim where plaintiff alleged that: (i) bank’s subsidiary was a control person of a corporation through its stockholdings as trustee under various trusts, and (ii) parent bank was a control person of corporation as a result of the control parent exercised over its subsidiary); Harriman v. E. I. Du Pont de Nemours & Co., 372 F. Supp. 101, 104 (D. Del. 1974) (plaintiff sufficiently stated a Section 20(a) claim by alleging trust indirectly controlled subsidiary because: (i) trust held title to over 50% of common stock of subsidiary, (ii) they had overlapping directors, and (iii) a number of trust directors owned substantial amounts of stock in subsidiary); Borden, Inc. v. Spoor Behrins Campbell & Young, Inc., 735 F.Supp. 587, 591 (S.D.N.Y. 1990) (finding allegation that parent corporations were sole shareholders of subsidiaries sufficient to state Section 20(a) claim).
13
exist, is usually within the defendants’ control.” 2007 U.S. Dist. LEXIS 932, at **37-38
(internal citations omitted).8
19. Even those courts that have recognized a “culpable participation” pleading
requirement have held that it is satisfied by allegations that the defendant had the potential to
“influence and direct the activities of the primary violator.” See, e.g., Dutton v. Harris Stratex
Networks, Inc., Civ. Action No. 008-755-JJF, 2010 U.S. Dist. LEXIS 76104, at **16-17 (D. Del.
July 22, 2010) (although providing that “plaintiff must allege (1) a primary violation of the
federal securities laws by a controlled person or entity; (2) control of the primary violator by the
defendant; and (3) that the controlling person was in some meaningful way a culpable participant
in the primary violation . . . . With respect to the second and third elements . . . [a]llegations that
support a reasonable inference that defendants had the potential to influence and direct the
activities of the primary violator suffice to plead control person liability” (emphasis added))
(quoting Tracinda Corp. v. DaimlerChrysler AG, 197 F. Supp. 2d 42, 72 (D. Del. 2002)).9
Accordingly, in Dutton, the court denied the defendant’s motion to dismiss the Section 15 claim
because the “[p]laintiffs’ allegations concerning the positions of the Section 15 [d]efendants and
their involvement in the financial reporting . . . . g[a]ve rise to an inference of control” and
because plaintiffs alleged facts that the Section 15 defendants “had the ability to influence” the
8 Indeed, Courts have regularly recognized that control person liability is an inherently factual issue that is inappropriate for resolution on a motion to dismiss. See Rochez, 527 F.2d at 890 (a finding of control liability requires “the courts [to] construe the applicable provisions of the statute along with the evidence adduced at trial” (emphasis added)); see also Hill, 599 F. Supp. at 1084 (denying motion to dismiss Section 15 claim because “[the allegations] certainly could give rise to a set of facts that would support plaintiffs’ bail out theory [and] resolution of this matter must await a fuller development of the facts” (emphasis added)). 9 Despite Debtors’ reliance on Tracinda, that case actually supports denial of its Supplemental Objection. In denying motions to dismiss the Section 20 and 15 claims, the court further explained that “[a]llegations that a director signed a fraudulent SEC filing and was in a position to exercise control over the primary violator are sufficient to withstand a motion to dismiss.” Tracinda, 197 F. Supp. 2d at 72 (internal citations omitted).
14
primary violator (even though the Section 15 defendants were not the owners of the primary
violator at all relevant times). 2010 U.S. Dist. LEXIS 76104, at **19-20 (emphasis added).
20. Additional examples abound. See, e.g., In re Vonage Initial Pub. Offering Sec.
Litig., Civ. Action No. 07-177(FLW), 2009 U.S. Dist. LEXIS 28255, at **78-79 (D.N.J. Apr. 2,
2009) (holding that plaintiffs properly pled Section 15 violations by alleging that the defendants
“(1) signed and were responsible for the truthfulness and accuracy of the Registration Statement;
(2) had access to internal company information; (3) attended board meetings where the IPO was
discussed; and (4) had the power to influence and direct [the primary violator]”); In re Chambers
Dev. Sec. Litig., 848 F. Supp. 602, 621 (W.D. Pa. 1994) (holding that allegations that each of the
defendants was a director and/or officer and each possessed the potential to influence or control,
directly or indirectly, the accounting and auditing activities of the primary violator was sufficient
to plead Section 15 claim).10
21. As set forth in detail below, Tranquility has more than met these pleading
requirements.
C. Tranquility Has Pled Sufficient Facts To Establish Control Person Liability Under the California and Federal Securities Laws.
22. Tranquility has more than satisfied the pleading standards for control person
liability described above, identifying at least ten different bases of WaMu Inc.’s control person
liability in this case.
10 See also Bauer v. Prudential Fin., Inc., Civ. Action Nos. 09-1120(JLL), 09-1771, 2010 U.S. Dist. LEXIS 64384, at **40-41 (D. N.J. June 29, 2010) (finding that plaintiff sufficiently pled a Section 15 violation where “[p]laintiff pleads each [Section 15] [d]efendants’ position of influence and signed the registration statement”); In re PMA Capital Corp. Sec. Litig., Master File No. 03-6121, Class Action, 2005 U.S. Dist. LEXIS 15696, at **67-68 (E.D. Pa. July 27, 2005) (denying motion to dismiss Section 15 claim because “under the plain meaning of § 15, [Section 15 defendant] can be liable because his acts influenced the setting of loss reserves and the reporting of PMA’s financial status”); In re Children’s Place Sec. Litig., Civ. Action No. 97-5021(JCL)-, 1998 U.S. Dist. LEXIS 22868, at **41-42 (D.N.J. Sept. 4, 1998) (denying motion to dismiss Section 15 claim where each of the Section 15 defendants was an executive who participated in the process which allowed the IPO to be successfully completed).
15
23. First, WaMu Inc. directly owned 100% of the stock of and thus controlled WaMu
Capital and WaMu Bank, and through WaMu Bank it wholly-owned and controlled WaMu Bank
fsb, WaMu Asset Acceptance, and WaMu Mortgage Securities. (Amended Claim, ¶¶ 3, 29-33
and p. 14, Diagram 1). As such, WaMu Inc. had the power to direct or cause the direction of the
management of each of the WaMu subsidiaries. In re Musicmaker.com Sec. Litig., 2001
U.S.Dist.LEXIS 25118, at *58 (a majority or otherwise controlling shareholder is prima facie a
control person of the corporation in which it owns a majority or controlling stake).
24. Second, WaMu Inc. has repeatedly acknowledged that it conducted its business
through its subsidiaries as a fully integrated company under WaMu Inc.’s actual control.
Specifically, WaMu Inc.: (1) employed overlapping management and consolidated systems and reporting with its subsidiaries; (2) represented in SEC filings that it operated as an integrated business and that its banking subsidiaries were under its “common control;” (3) exercised control and influence over its workforce through common codes of conduct and ethics for employees and senior financial officers; (4) reported WaMu Inc.’s and its subsidiaries financial statements on a consolidated basis; and (5) organized its business into four operating segments for management reporting and control purposes by WaMu Inc. (Amended Claim at ¶¶ 36-52.)
These consolidated operations included the management and control of the loan securitization processes at issue here. Tranquility alleges that WaMu Inc.’s Home Loans Group was directly responsible for “acquiring home loans from a variety of sources, pooling and securitizing those loans from a variety of sources, pooling and securitizing those loans, selling the resulting mortgage-backed securities to secondary market participants and providing ongoing servicing and bond administration for all securities issued.” (Id. at ¶ 52.) The Home Loans Group was managed by, and reported to David Schneider (“Schneider”), WaMu Inc.’s Executive Vice President. (Id. at ¶ 53.) Also, WaMu Inc.’s capital markets operations were managed by and reported to David Beck (“Beck”), WaMu Inc.’s Executive Vice President and Chief Investment Officer. (Id. at ¶ 54.) “In short, WaMu Inc. operated it business through its subsidiaries, including its loan underwriting and MBS securitization activities, all of which were centralized under WaMu Inc.’s management and control.” (Id. at ¶ 55.)
25. Third, WaMu Inc. has repeatedly acknowledged and admitted in public
documents filed with the SEC that it controlled and was involved on an integrated basis with its
16
subsidiaries in the securitization activities at issue in this case, and that it generated substantial
profits from these activities. (Id. at ¶¶ 107-115.)
26. Fourth, WaMu Inc. centrally managed its underwriting and securitization
operations through WaMu Inc.’s executive officers and Board of Directors. These individuals
included WaMu Inc.’s: (1) Chairman and Chief Executive Officer Kerry Killinger (“Killinger”);
(2) President and Chief Operating Officer Stephen Rotella (“Rotella”); (3) Executive Vice
President and Chief Financial Officer Thomas Casey (“Casey”); (4) Executive Vice President
and Chief Risk Officer Ronald Cathcart (“Cathcart”); (5) Executive Vice President and President
of Home Loans David Schneider; and Executive Vice President and Chief Investment Officer
David Beck. (Id. at ¶¶ 56-92 and p. 23, Diagram 3).
Killinger has already been found by the U.S. District Court for the Western District of Washington to be a control person of WaMu Inc. for purposes of Section 15. (Id. at ¶ 64.) The heads of WaMu Inc.’s and its subsidiaries day-to-day operations, risk management, and control functions, all reported directly to Killinger, including Rotella who oversaw the daily operations of the banking subsidiaries, the Enterprise Risk Management committee (which encompassed the credit risk management function, internal auditing, regulatory relations, and compliance), finance, legal, and human resources. Killinger also managed WaMu Inc.’s response to the NYAG allegations of inflated appraisals. “Thus WaMu Inc., through Killinger, directed and controlled WaMu’s entire strategy and operations including WaMu’s appraisal and securitization practices described herein.” (Id. at ¶¶ 63-67.)
Rotella, who admitted before the Senate Committee that he reported directly to Killinger, controlled the day-to-day operations of WaMu Inc.’s subsidiaries, and had a central role in the management of their underwriting and appraisal practices, including the use of third-party appraisal outsourcing, which was at the core of the NYAG Complaint. This is confirmed by OTS internal communications. (Id. at ¶¶ 68-73.)
Casey, who oversaw all aspects of WaMu’s corporate finance, strategic planning, and investor relations functions, has already been found by the U.S. District Court for the Western District of Washington to be a control person of WaMu Inc. for purposes of Section 15. (Id. at ¶¶ 74-75.)
Cathcart, as WaMu Inc.’s Chief Risk Officer, was responsible for overseeing the identification, measurement, monitoring, control and reporting of credit, market
17
and operational risks. Cathcart admitted in his written statement to the Senate Committee that: (1) he provided numerous reports to WaMu Inc.’s senior management and Board of Directors outlining control weaknesses at the company; (2) Internal Audit produced a number of reports to WaMu Inc.’s Board of Directors with ratings of “Requires Improvement;” and (3) the Credit Review group, which was charged with reviewing compliance with credit policies, produced metrics demonstrating deficiencies in the company’s adherence to its credit policies. Cathcart testified that WaMu Inc.’s efforts to improve operations “were not sufficiently effective.” And this view was shared by Cathcart’s predecessor from 1999 to 2005, James Vanesek, who stated in his written submission to the Senate Committee that WaMu had a continual problem with adherence to policy, particularly in the mortgage area where WaMu line managers not only authorized but encouraged policy exceptions.” (Id. at ¶¶ 76-81.)
Schneider was responsible for all aspects of WaMu’s Home Loans business, which was an integral component of WaMu’s loan origination and securitization activities. This included the origination of mortgages through loan officers and mortgage brokers, as well as securitizations of non-agency loans. These securitizations directly involved the activities of WaMu Capital, WaMu Asset Acceptance, and WaMu Mortgage Securities. In addition, Schneider’s Home Loans group was responsible for managing and coordinating the relationships with LSI and eAppraiseIT, which are at issue in this case. (Id.at ¶¶ 82-85.)
Beck, as WaMu Inc.’s Chief Investment Office and the Director and President of WaMu Asset Acceptance, was responsible for WaMu’s capital markets activities and for overseeing the WaMu entities that purchased and held loans that were to be sold into the secondary market. These activities included purchasing loans from WaMu; holding the loans until they were sold into the secondary market; and acting as an underwriter of WaMu’s securitization deals through WaMu Capital. Beck testified under oath before the Senate Committee that “WaMu Inc.’s senior management was responsible for monitoring fraud in the securitization process.” He further admitted under oath that “WaMu Inc.’s senior management, including he and Schneider, were directly involved in the decisions to securitize and sell Option ARM mortgages with significant known (but undisclosed) delinquencies and related underwriting problems.” Beck also signed the Registration Statements filed by WaMu Capital with the SEC. (Id. at ¶¶ 86-92.)
27. Fifth, WaMu Inc. designed and implemented in 2005 a high risk corporate
strategy that resulted in significant deficiencies in its underwriting and appraisal practices. This
High Risk Lending Strategy, which was approved by WaMu Inc.’s Board of Directors, was
designed to achieve rapid growth, shift WaMu’s lending activities to more high-risk high-margin
18
loan products, and make WaMu a national leader in consumer lending. WaMu Inc. hired Rotella
to oversee daily operations so Killinger could focus on this High Risk Lending Strategy. In
practice, this strategy overtaxed WaMu’s already weak loan underwriting, control, and risk
management systems, and resulted in the loosening and/or complete abandonment of WaMu’s
loan underwriting and appraisal standards. (Id. at ¶¶ 93-97).
28. Sixth, WaMu Inc. controlled its “company-wide” risk management and
compliance activities through various Board of Directors’ committees, including Audit,
Enterprise Risk Management, and Credit Risk Policy. The Audit Committee “provides
independent assessment of WaMu Inc.’s compliance with risk management controls, policies and
procedures,” and oversees WaMu Inc.’s “monitoring and controlling of significant risk
exposures, including the Company’s guidelines and policies governing risk assessment and risk
management.” The Audit Committee also manages the company-wide “risk of loss resulting
from human fallibility, inadequate or failed internal processes and systems, or from external
events including loss related to legal risk.” Enterprise Risk Management works with the lines of
business to establish appropriate policies, standards and limits designed to maintain risk
exposure within the Company’s risk tolerance.” It also “oversees compliance with laws and
regulations.” “The Operational Risk Management Committee ensures consistent communication
and oversight of significant operational risk issues across the Company.” It is also responsible
for “assessing and managing operation risk across the Company.” (Id. at ¶¶ 98-101.)
29. Seventh, WaMu Inc. specifically directed, controlled, and “actively managed” the
underwriting standards and credit risk policies through its Finance Committee and Credit Policy
Committee. “The Credit Policy Committee, chaired by the Chief Credit Officer and comprised
of senior management, evaluates and approves credit standards (including key features of
19
residential loans) and is responsible for oversight of the credit risk management function.” Such
oversight includes: (1) monitoring of “the availability and quality of the collateral;” (2) “setting
underwriting criteria for credit-related products and programs;” and (3) monitoring and
analyzing “[t]rends in loan performance and risk attributes such as loan-to-value ratios, credit
scores, negative amortization, minimum payment adjustments, degree of minimum payment
utilization, and geographic concentrations . . . ” Significantly, WaMu Inc. has expressly stated
that it “actively manages the credit risk inherent in its Option ARM portfolio primarily by
ensuring compliance with its underwriting standards, monitoring loan performance and
conducting risk modeling procedures.” (Id. at ¶¶ 102-106.)
30. Eighth, WaMu Inc. exercised control over its securitization activities through its
Market Risk Committee (the “MRC”). The MRC was a subcommittee of WaMu Inc.’s Audit
Committee, which monitored and controlled WaMu Inc.’s and its subsidiaries securitization
activities. The MRC, which operated as a joint committee of WaMu Inc., WaMu Bank, WaMu
Bank fsb, and the Asset Liability Committee of WaMu Bank fsb, included both Casey (WaMu
Inc.’s Executive Vice President and Chief Financial Officer) and Beck (WaMu Inc.’s Executive
Vice President and Chief Investment Officer). Minutes of two MRC meetings (released by the
Senate Committee) establish WaMu Inc.’s active participation, oversight, knowledge, and
control of WaMu’s securitization activities. (Id. at ¶¶ 116-128)
a. At the December 12, 2006, meeting, the MRC directly addressed delinquencies
for securitized loans that had not been underwritten in accordance with WaMu’s
underwriting standards, were delinquent when they were securitized and sold, or
were otherwise plagued with defects. In a report by MRC staff member Lehman,
20
who reported to Beck and was a Director of WaMu Capital, the MRC minutes
state:
Mr. Lehman then alerted the Committee to an analysis in-process whose preliminary results show an abnormally high number of delinquencies in a number of 2006 Conduit Program securitizations. Mr. Lehman noted that delinquency behavior was flagged in October for further review and analysis whenrecent securitization deals appeared to have more severe delinquency behavior than experienced in past deals. The primary factors contributing to increased delinquency appear to be caused by process issues including the sale and securitization of delinquent loans, loans not underwritten to standards, lower credit quality loans and seller servicers reporting false delinquent payment status. A discussion ensued on next steps. Mr. Lehman will provide another status update at the next MRC meeting. (Emphasis added.)
b. WaMu’s MRC also met on March 9, 2007, and Cathcart participated in this
meeting. At this meeting the MRC reviewed the status of four “mortgage-backed
securitizations totaling $6.4 billion” for WaMu’s Prime Alt A (Bank and Conduit)
securitization activities. Among other items, MRC staff member Lehman:
informed the Committee of incidents of non-compliance with Regulation AB requirements related to delayed reconciliations, erroneous repurchase of seventeen loans and miscellaneous investor distribution errors. A discussion ensued on remediation efforts.
c. In addition, WaMu Inc. through the MRC actively participated in the development
of policies and procedures for WaMu’s capital markets activities and its
subsidiaries involved therein, as reflected by the report of MRC member Novak
who:
reported that the Conflicts of Interest Policy for [WaMu Capital], [WaMu Mortgage Securities] and Capital Markets … are moving forward. She has reviewed a draft of the Policy with Mr. Cathcart.
21
d. The MRC minutes state that Cathcart required progress on completion of the
Conflicts Policy for WaMu Capital, WaMu Mortgage Securities, and WaMu’s
capital markets in order to protect WaMu Inc. from potential liability.
Specifically, the MRC minutes state that:
Mr. Cathcart noted that without a clearly defined policy on information sharing [WaMu Inc.] is vulnerable to potential mishandling of information. He requested Ms. Novak return to MRC with a set deliverable date for completion of the Information Sharing Policy.
e. In short, WaMu Inc. actively managed and controlled its capital markets
subsidiaries and their activities, including their policies and procedures in light of
WaMu Inc.’s exposure to potential liability due to their activities.11 (Id. at ¶ 128)
31. Ninth, former employees have confirmed that WaMu Inc. was responsible for the
specific conduct at issue in this case. (Id. at ¶¶ 129-132). For example, a former Regional
Manager in WaMu’s Appraisal Department from 1999 until September 2006 (before leaving for
eAppraiseIT) has stated that:
WaMu’s senior management was aware of WaMu’s dubious practices and in many cases directed them, and many of the same undisclosed problems escalated in degree, if not kind, once WaMu outsourced its appraisals.
32. Similarly, a WaMu Inc. Senior Operations Excellence professional, who from
July 2006 to December 2006 reported directly to Cathcart in WaMu’s Enterprise Risk
Management Group, stated the following:
Killinger was intimately involved in analyzing WaMu’s loan performance and was well-informed about numerous other facts concerning WaMu’s business risks and risk management;
11 In addition to the foregoing, the Senate Committee also released partial minutes for WaMu’s MRC meeting of WaMu Inc, WaMu Bank, and WaMu Bank fsb for July 11, 2008, also confirming WaMu Inc.’s management and control of its bank subsidiaries. Casey and Beck also attended this meeting.
22
From July until September 2006, this employee was “100% devoted” to assisting Killinger, Cathcart, and other WaMu senior executives in preparing for WaMuInc.’s 2006 Investor Day, during which period this employee regularly attended meetings among Killinger, Rotella, Cathcart, and Schneider discussing information they knew about the company’s financial health, risk exposure, and to what degree to present information about those topics to investors;
Killinger attended a monthly Enterprise Risk or “Executive Risk” Committee meeting chaired by Cathcart, for which this employee served as secretary, and which was attended by Casey, Rotella, Schneider and each business unit’s President, Chief Financial Officer, and Chief Risk Officer. These meetings were a forum where all aspects of risk across the bank were discussed, including credit, market and operational risk. Because the Enterprise Risk Committee was “formally sanctioned” by WaMu Inc.’s Board of Directors, meetings typically were held in WaMu Inc.’s main boardroom;
At these monthly meetings Killinger, Rotella, Casey, Cathcart and Schneider engaged in detailed discussions regarding WaMu’s risk exposure, specifically focused on the allocation of risk to each WaMu business unit’s product lines. In preparation for the meetings, the business units would have previously provided to other executive committees of the Board their financial forecasts or projections, and during the meetings of the Executive Risk Committee these forecasts were reviewed in detail for the purpose of allocating risk across the company. Examples of this intensive review included the Executive Risk Committee’s acknowledgement of particularly high risk in its loan portfolio relating to specific geographic regions, and discussion of minimum FICO scores for WaMu’s particular loan products;
From July to September 2006, to further prepare for the 2006 Investor Day, Killinger, Rotella, Casey, Cathcart, and Schneider also regularly held more informal meetings, during which time they discussed default rates within WaMu’s loan portfolios, and in particular its Option ARM and subprime loans, and detailed information regarding levels of delinquencies concerning WaMu’s specific loan product types. Killinger’s, Cathcart’s, Rotella’s and Casey’s objective for their public statements was to mitigate perceived problems with WaMu’s loans by highlighting the fact that subprime lending represented a relatively small percentage of WaMu’s overall loan portfolio and bank assets. As a result, these executive officers decided to focus their discussion on the weakening state of the housing market because they saw what was coming; and
Killinger, Cathcart, Casey, Rotella and Schneider were all knowledgeable about and involved in establishing and approving the Company’s lending policies and guidelines, and Schneider would not have been able to adjust the Company’s lending practices as they related to risk without the knowledge and consent of the others.
23
33. Similarly, a Senior Vice President of WaMu’s Enterprise Risk Management
Group from August 2001 until he resigned in September 2006, stated that: (a) the group had
overall responsibility for establishing risk management policies, corporate governance and
reporting frameworks; (b) WaMu began to cause its risk management policies and practices to
deteriorate in late 2005; and (c) risk reports were distributed weekly to Casey, Rotella and
Cathcart. These reports specifically quantified that the Company was exceeding certain risk
parameters as dictated by WaMu’s risk guidelines, but senior management simply chose to
ignore those clear and direct warnings.
34. Likewise, an Assistant Vice President from January 2006 until January 2008, in
the Risk Analytics Group which conducted credit risk analyses on the various portfolios
managed by the separate WaMu business units including Home Loans, stated that her group
compiled a monthly written report called the Credit Risk Review that was distributed to all of the
business groups, and to Schneider and Cathcart. The Group also compiled an abridged version
of these reports specifically for the Board of Directors including Killinger.
35. Tenth, WaMu Inc. exercised actual and direct control over WaMu’s securitization
activities that are at issue in this case, including but not limited to WaMu Inc.’s design and
approval of the MBS securitization strategy employed by WaMu for the origination,
securitization and sale of WaMu mortgage loans as MBS through WAMU and WMALT Trusts
to investors such as Tranquility, as well as the loan underwriting and appraisal standards and
practices used by WaMu. WaMu Inc. also exercised actual power and control over its
subsidiaries through its (i) 100% ownership of WaMu Capital and WMB; (ii) placement of its
executive officers on WaMu Capital’s Board of Directors; and (iii) indirect 100% ownership of
WaMu Asset Acceptance, WaMu Mortgage Securities, and WaMu Bank fsb. (Id. at ¶¶ 133-135.)
24
36. In addition, Tranquility has further alleged that both WaMu’s own internal
investigations and the Senate Committee’s investigation corroborated these foregoing
allegations. (Id. at ¶¶ 283-289.) These investigations specifically revealed that WaMu Inc. had
actual knowledge of the underwriting and securitization problems at issue in this case, yet did not
disclose this information to investors. See also Amended Claim at ¶¶ 24-25, 79-81, 89, 116-
124, 283-289, 327-336.
37. Based on these foregoing allegations, it is unquestionably the case that Tranquility
has adequately stated a claim for control person liability under both California and federal
securities law.
D. Debtors’ Other Objections to Tranquility’s Pleading of Control Person Liability are Similarly Baseless.
38. In addition to their baseless objection as to “culpable participation” discussed
above, Debtors also argue that Tranquility’s allegations of control “are grossly inaccurate with
respect to the role of WMI.” Supplemental Objection at ¶ 13 (citing Smith Declaration).
Specifically, Debtors claim that WaMu Inc. had no involvement in the securitization or appraisal
processes at issue. This is nothing more than a denial of Tranquility’s detailed factual allegations
that WaMu Inc. was involved in such securitization and appraisal process; allegations that are
supported by WaMu Inc.’s own internal investigations, the Senate Committee’s investigation and
related exhibits, sworn testimony from WaMu Inc.’s senior officers, directors, and employees,
WaMu Inc.’s own public disclosures, WaMu Inc.’s internal documents, internal correspondence
and documents from various regulators, and the NYAG Complaint. (Amended Claim at ¶¶ 22-
25, 50-55, 86-135, 201-289).12 Debtors’ efforts to argue the truth of Tranquility’s allegations are
12 Indeed, the NYAG’s Complaint specifically identifies WaMu Inc. as the WaMu entity that retained WaMu’s outside appraisers and engaged in the appraisal practices at issue in this case. See, e.g., NYAG Compl., ¶¶ 5, 25.
25
inappropriate at this stage of the proceedings, which the parties have asked should be treated as a
motion to dismiss for failure to state a claim. Under such circumstances, Tranquility’s well-
pleaded facts must be accepted as true. Fowler v. UPMC Shadyside, 578 F.3d 203, 210-211 (3d
Cir. 2009). The only issue presently before the Court is “whether the facts alleged in the
complaint are sufficient to show that the plaintiff has a plausible claim for relief.” Id.
Accordingly, Debtors’ factual objections to the veracity of Tranquility’s claims can and should
be addressed at the evidentiary hearing on this matter after completion of discovery.
39. Debtors also argue that “[s]imply because various members of WMI’s Board were
also members of WMB’s Board, or because WMI’s officers had overlapping roles at WMB or at
other WaMu subsidiaries, does not mean that these separately established, separately
functioning, legally separate entities were all the same ‘Company.’” Supplemental Objection at
¶ 13 (citing Youkelsone v. Washington Mutual Inc. (In re Washington Mutual Inc.), Adv. No. 09-
50039 (MFW), 2010 WL 3238903, at *14 (Bankr. D. Del. Aug. 13, 2010). In Youkelsone,
however, claimant was attempting to pierce the corporate veil based on theories of corporate
disregard and alter ego. These theories required him to demonstrate, among other things, that
WaMu Inc. so “dominated” its subsidiaries that the subsidiaries were “merely an adjunct” to
WaMu Inc. Id. at *13 (internal quotation omitted). As acknowledged by Debtors, however,
Tranquility is not proceeding on such a “veil piercing” theory.13 Rather, it is proceeding on a
theory of control person liability under California and federal securities law, which as set forth in
detail above, requires an entirely different standard of control. Thus, the issue here is not
whether WaMu Inc. was a “separate legal entity” from its subsidiaries, but rather whether WaMu 13 Debtors’ counsel acknowledged at the October 22, 2010 hearing that Tranquility’s control person liability claims were not based on piercing the corporate veil, and that such claims involved a different standard of control. Hearing Transcript at 68:13-15. (“And I was not suggesting, your Honor, that the same standard applies. I mean this is not a piercing the veil argument. I recognize they’re not making that argument.”)
26
Inc. “controlled” its subsidiaries, even if they were legally separate. In this regard, the fact that
WaMu Inc. had overlapping officers and directors with its subsidiaries demonstrates such
control. See, e.g., In re Indep. Energy Holdings PLC Sec. Litig., 154 F.Supp.2d at 770-71
(allegations that parent corporation was running subsidiaries through common management,
specifically that its three highest officers were on the subsidiaries’ operating committee, were
sufficient to state Section 15 claim).
40. Debtors next argue that WaMu Inc.’s overlapping directorship does not mean that
a WaMu Bank director’s actions on behalf of the bank should be imputed to WaMu Inc. simply
because the director was also a director of WaMu Bank. Supplemental Objection at ¶ 13 (citing
Weintruab v. Texasgulf, Inc., 564 F. Supp. 1466, 1470 (S.D.N.Y. 1983) and Etshokin v.
Texasgulf, Inc., 612 F. Supp. 1212, 1218 (N.D. Ill. 1984)). Debtor’s argument is unavailing. It
is unnecessary to impute knowledge of the WaMu subsidiaries’ conduct to WaMu Inc. across
their common directors and officers because WaMu Inc. had direct knowledge of such behavior.
Specifically, WaMu Inc. centrally managed, monitored and controlled its subsidiaries’ mortgage
underwriting and securities activities through a management control and reporting structure
comprising its executive officers, who also served on a series of WaMu Inc. Board committees
such as Market Risk, Audit, Enterprise Risk, Credit Policy, and Finance which centrally set
policy for, monitored, and controlled WaMu’s mortgage and securitization activities. All of
these functions were performed by WaMu Inc.’s executive officers directly in their capacity as
officers of WaMu Inc., for the benefit of WaMu Inc. and its business. (Amended Claim at ¶¶ 56-
92, 98-134, and p.23, Diagram 3). Thus, as a matter of black letter agency law, WaMu Inc. had
direct knowledge of its subsidiaries’ conduct at issue in this case. See Etshokin, 612 F.Supp. at
1218 (the general rule is that knowledge of a corporate officer or agent is attributed to the
27
corporation if the officer or agent acquired the knowledge while acting in the course of his
employment with the corporation within the scope of his authority); Weintraub, 564 F.Supp. at
1470 (same). See also Deep Water Brewing, LLC v. Fairway Resources Ltd., 215 P.3d 990,
1011-12 (Wash.Ct.App. 2009) (principal is chargeable with notice of facts known to its agent
and may be liable for unauthorized conduct of its agent acting on the principal’s behalf).
41. Even if it were necessary, however, to impute the knowledge of WaMu Inc.’s
directors and officers indirectly across entities to WaMu Inc. on the basis of WaMu’s common
management, Tranquility has plead the requisite allegations to do so. It is well-established that
knowledge gained by an individual officer or director of one corporation is carried over and
imputed to the other corporation when: (i) such knowledge is present in the individual’s mind
and memory at the time he or she engages in a transaction on behalf of the other corporation;
(ii) when such knowledge comes to the individual while acting as an agent for such other
corporation in his or her official capacity; or (iii) while the individual is acting as an agent of
such corporation and within the scope of his or her authority. 18B Am.Jur.2d Corporations
§ 1454 (2010). That the common officer or director is the managing officer of the corporation to
which his or her knowledge is sought to be imputed is a circumstance of importance. Id. In
addition, knowledge of one company’s designees placed in the second company about the second
company, or their access to such knowledge, may be imputed to the first company –
circumstances which are specifically alleged to exist in this case. Id. See also In re American
Bank Note Holographics, Inc. Sec. Litig., 93 F.Supp.2d 424, 445 (S.D.N.Y. 2000) (finding
Weintraub wholly inapposite as the alleged wrongdoer was affiliated with two related parent and
subsidiary corporations, the director’s allegedly misleading statements were made to bolster both
companies regardless of the letterhead used, and he had knowledge of the actual sales of the
28
subsidiary in his capacity as CEO of both companies, thereby allowing his scienter to be
attributed to parent). Again, while scienter is not an element of Tranquility’s claims under either
California Corporations Code Section 25504 or Section 15 of the Securities Act, the knowledge
of WaMu Inc.’s executive officers and directors regarding the conduct of the WaMu subsidiaries
is properly attributable to WaMu Inc. given that: (i) WaMu Inc.’s executive officers
simultaneously served as directors or officers of WaMu Bank and the other WaMu subsidiaries;
(ii) WaMu Inc. operated its business on an integrated basis through its subsidiaries; and (iii)
WaMu Inc. centrally managed, monitored and controlled its subsidiaries’ mortgage underwriting
and securities activities at issue through the centralized management control and reporting
structure and its Board committees noted above, on which its executive officers all served for the
benefit of WaMu Inc. (Amended Claim at ¶¶ 56-92, 98-134, and p.23, Diagram 3). Indeed,
under these circumstances, WaMu Inc. was unquestionably aware of its subsidiaries’ activities,
and courts regularly rely on such allegations of common management in evaluating allegations
of control. See, e.g., In re Indep. Energy Holdings PLC Sec. Litig., 154 F. Supp. 2d at 770-71
(allegations “that the [Section 15 defendant] conduct[ed] its business . . . through its wholly-
owned subsidiaries” and had common management with subsidiary were sufficient to state
claim).
42. Against this backdrop, Debtors’ reliance on Weintraub and Etshokin, which are
based on the same underlying efforts by one company to sell its stake in another and the alleged
misrepresentations of their common directors and officers in effecting such transactions, are
clearly inapposite. In Weintraub, the court granted summary judgment – not a motion to
dismiss – on a Section 10(b) securities fraud claim for failure to establish scienter because
plaintiff had not provided evidence that (i) the corporate defendant had actual knowledge of the
29
material facts; and (ii) the directors of the corporate defendant learned of the material facts in
their capacities as directors of that defendant, 564 F.Supp. at 1470. In contrast, as noted above,
Tranquility has not brought a scienter-based Section 10(b) claim, but rather has alleged strict
liability claims that do not require Tranquility to plead scienter at all. Moreover, Tranquility has
pled that WaMu Inc. itself (not just through its directors and officers) had actual knowledge of
the securitization problems at issue here, and that its directors and officers also obtained such
knowledge in their capacity as directors and officers of WaMu Inc., including through their
service on the various Board committees outlined above. Etshokin – another summary judgment
case – actually supports Tranquility’s position because the court in that case found that plaintiff
commodity trader was entitled to discovery to determine on which company’s behalf the
interlocking directors and officers were acting. 612 F.Supp. at 1218-19.
43. Next, Debtors admit that WaMu Inc.’s SEC filings state that WaMu Inc.
controlled its banking subsidiaries, but argue that this does not mean that they actually had or
exercised such control. Supplemental Objection at ¶ 14. Again, the Debtors are simply
contesting a question of fact. The evidentiary weight to be afforded to WaMu Inc.’s public
filings with the SEC and facts stated therein are not proper matters for consideration by the Court
at this stage. Moreover, WaMu Inc.’s statements in its 10-K reports constitute a party admission,
the accuracy of which the Debtors are estopped from denying in a dispositive motion on the
pleadings. See, e.g., In re Chase Manhattan Corp. Sec. Litig., No. 90 Civ. 6092 (LMM), 1991
U.S.Dist.LEXIS 10622, at *6 (S.D.N.Y. Aug. 1, 1991) (finding plaintiff’s allegations in support
of Section 10(b) and 20(a) claims based on defendant’s SEC filings, annual reports and
admissions in its third quarter 10-Q sufficient to state claim); Oregon RSA No. 6, Inc. v. Castle
Rock Cellular of Oregon Ltd. P’ship, 840 F.Supp. 770, 778 n.7 (D.Or. 1993) (estopping
30
defendants in summary judgment motion from disputing accuracy of their Form 10-Q as it is a
statutorily mandated admission).14 Significantly, in those SEC filings, WaMu Inc.
acknowledged that it controlled its subsidiaries. That is an allegation the Court can and should
consider in evaluating whether Tranquility has satisfied its pleading obligations. See, e.g., In re
Indep. Energy Holdings PLC Sec. Litig., 154 F. Supp. 2d at 770-771 (allegation that parent
corporation conducted its business through wholly-owned subsidiaries and had common
management with subsidiary sufficient to state claim); In re Musicmaker.com Sec. Litig., 2001
U.S. Dist. LEXIS 25118, at **57-58 (holding allegations of majority or otherwise controlling
ownership are sufficient to state claim). And in any event, as set forth above, such allegations
(Amended Claim at ¶¶ 34-55) comprise but one part of the totality of Tranquility’s
comprehensive pleading on the issue of control. See Amended Claim at ¶¶ 56-135 (identifying
at least ten bases of control person liability).
44. Debtors also argue that WaMu Inc.’s 10-K filings state that WaMu Inc. is a
separate legal entity distinct from its subsidiaries. Supplemental Objection at ¶ 15. As discussed
above, this is irrelevant. The legal issue is not whether WaMu Inc. is a separate legal entity, but
whether it controlled its subsidiaries. And for the reasons set forth above, it clearly did. And
courts have regularly considered Form 10-Ks and similar corporate disclosures in evaluating
allegations of control and the interrelatedness of parent and subsidiary corporations. In re Chase
14 See also Behnabib v. Hughes Electronics Corp., Case No. CV 04-0095 CAS (VBKx), 2007 U.S.Dist.LEXIS 87500, at *21-22, n. 11 (C.D.Cal. Apr. 2, 2007) (taking judicial notice of defendant’s 10-K statements on motion for summary judgment regarding plaintiff’s employment claim against parent corporation as integrated enterprise with its subsidiary and holding that to the extent the 10-Ks contained statements about the interrelatedness of operations they were party admissions); In re Lehua Hoopai, Case No. 04-02511, 2007 Bankr. LEXIS 2867, at *8-9 (Bankr.D.Haw. Aug. 27, 2007) (taking judicial notice of and finding that debtor’s statements in its SEC filings regarding its financial situation constituted admissions for purposes of determining whether to grant appeal bond).
31
Manhattan Corp. Sec. Litig., 1991 U.S.Dist.LEXIS 10622, at *6; Behnabib, 2007
U.S.Dist.LEXIS 87500, at *21-22, n. 11.
II. TRANQUILITY HAS ADEQUATELY PLED WAMU INC.’S INTENT TO DEFRAUD UNDER CALIFORNIA CORPORATIONS CODE SECTION 25504.1.
45. Debtors next argue that Tranquility’s cause of action under California
Corporations Code Section 25504.1 (Count II) should be dismissed because Tranquility has pled
only that WaMu Inc. acted “recklessly,” which Debtors claim is insufficient as a matter of
California law.
46. But California courts interpreting Section 25504.1 have recognized that it is
sufficient for plaintiffs to plead that defendants acted with an “intent to induce reliance” on the
knowing misrepresentations and omissions at issue. Apollo Capital Fund LLC v. Roth Capital
Partners, LLC, 70 Cal. Rptr. 3d 199, 224-26 (Cal. Ct. App. 2007) (citing Lazar v. Superior
Court, 909 P.2d 981 (Cal. 1996)). Here, Tranquility has pled precisely that:
WaMu Inc. acted with the intent to deceive or defraud Tranquility and other investors by inducing them to rely on the knowing misrepresentations and omissions in the Offering Documents. In particular, WaMu Inc. knew that the Offering documents were materially false and misleading; knew that the Offering Documents would be provided to investors, including Tranquility; and knowingly and substantially participated or acquiesced in the preparation, issuance, and/or dissemination of the Offering Documents. (Amended Claim at ¶ 320.)
47. Indeed, Tranquility has pled far more than recklessness. Rather, it has provided
seventeen paragraphs of allegations demonstrating that WaMu Inc. knowingly and intentionally
acted with the intent to deceive and defraud, and that there was no innocent reason for WaMu
Inc.’s failure to disclose the truth about its underwriting and appraisal practices. (Amended
Claim at ¶¶ 320-337).
48. Tranquility’s allegations include specific testimony from David Beck, who was
WaMu Inc.’s Executive Vice President and Chief Investment Officer, that he knew that WaMu
32
was securitizing loans tainted by underwriting deficiencies and fraud and that he did nothing
whatsoever to alert or otherwise protect the purchasers of these tainted securities. (Amended
Claim at ¶ 327).
49. Tranquility further alleges that senior WaMu employees, including WaMu Inc.’s
Beck and Schneider, “mobilized to securitize and sell a larger than usual pool of Option ARM
loans after learning that WaMu’s inventory of such loans had experienced high delinquency rates
in fourth quarter 2006 and that such delinquency rates were anticipated to increase. WaMu
ultimately securitized and sold approximately $1.5 billion of such loans in 2007.” Id. at ¶¶ 329-
336 (quoting testimony and exhibits from the Senate Committee Hearings).
50. “In short, WaMu Inc., through its executive officers Beck and Schneider,
encouraged by its Chairman and CEO Killinger, consciously utilized the securitization process to
materially assist WaMu Bank in transferring these loans off its books to investors without full
disclosure of the delinquency risk inherent therein before the market could ascertain and price
these factors into WaMu’s MBS.” Id. at ¶ 336.
51. In addition to these seventeen paragraphs, Tranquility further alleges that WaMu
had longstanding knowledge of its profound underwriting and appraisal problems, yet failed to
disclose this information to investors. Indeed, during the relevant time period, WaMu had
received “repeated criticisms from OTS and the FDIC, for unsatisfactory underwriting
procedures, loans that did not meet credit requirements, loans subject to fraud, appraisal
problems and errors.” (Id. at ¶ 284(ii)). “From 2003 to 2008, OTS repeatedly identified
significant problems with Washington Mutual’s lending practices, risk management and asset
quality.” (Id. at ¶ 286(i).) And from 2005-2008, they “consistently found Washington Mutual’s
risk management practices lacking.” (Id. at ¶ 286(ii).) “OTS also continuously criticized
33
Washington Mutual’s underwriting standards and practices as ‘less than satisfactory,’ and found
loans that contained ‘erroneous or fraudulent information,’ ‘did not comply with the bank’s
credit requirements’ and contained ‘other problems.’” (Id. at ¶ 287(iii).) Indeed, even WaMu’s
own internal investigations (of which WaMu Inc. was aware) disclosed that its underwriting and
appraisal problems had “existed for some time.” (Id. at ¶ 283). And as the Senate Committee
confirmed, although WaMu had identified these problems by at least 2005, these problems
continued – and in fact got worse – through 2008. (Id. at ¶ 285.) Yet despite WaMu Inc.’s
actual knowledge of these persistent problems, no such information was ever disclosed to
Tranquility.
52. Ignoring these myriad paragraphs alleging fraudulent intent, Debtors instead focus
on eight words in one paragraph: “knew, or was reckless in failing to know.” Supplemental
Objection at ¶ 10 (quoting Amended Claim at ¶ 323). From these eight words, Debtors urge this
Court to dismiss the entire Amended Claim for alleging only recklessness, citing In re ZZZZ Best
Sec. Litig. No. CV 87-3574 RSWL, 1990 WL 132715, at *18 (C.D. Cal. July 23, 1990).
Significantly, Debtors’ own legal authority expressly rejected this approach and instead allowed
plaintiffs to proceed in light of the totality of their allegations:
In the current version of the complaint, the class plaintiffs have alleged that HH&R materially assisted ZZZZ Best, Minkow and/or the other defendants in violation of § 25401 “recklessly or with the intent to deceive or defraud.” (Fourth ACC para. 216(a)). The Court finds that the portion of the pleading that attempts to establish liability for allegedly “recklessly” materially assisting fails to state a claim for which relief can be granted. However, to the extent that the class plaintiffs have alleged that HH&R acted with the statutorily required “intent to deceive or defraud,” the Court finds the pleadings are sufficient to state a claim for which relief can be granted. This latter allegation, when read in conjunction with prior allegations against HH&R that have been incorporated (e.g., paras. 109 and 154) entails that the defendant has been alleged to have “actual knowledge.”
The Court will thus GRANT the motion to the extent that HH&R has been alleged to have acted “recklessly.” The Court finds that the pleadings properly allege
34
secondary liability against HH&R under Cal. Corp. Code § 25504.1 by stating that HH&R’s actions were undertaken with “the intent to deceive or defraud” and therefore DENIES the motion with respect to this part of the pleadings.
Id. at 18-19.
53. Indeed, such a ruling is fully consistent with the same court’s prior ruling in this
case that plaintiffs could proceed under California Corporations Code § 25504.1 based on
allegations of both “knowing” and “reckless” conduct. In re ZZZZ Best Sec. Litig., No. CV 87-
3574-RSWL, 1989 U.S. Dist. LEXIS 8083 at **42-43 (C.D. Cal. May 25, 1989) (“Section
25504.1 creates liability for those who aid and abet in § 25401 violations. Parties must have
engaged in such actions knowingly and recklessly. Plaintiffs have alleged intent sufficient for
§ 25504.1.”) (internal citations omitted), modified on other grounds, 1990 U.S. Dist. LEXIS
20867, Fed. Sec. L. Rep. (CCH) ¶ 94,881 (C.D. Cal. Jan. 8, 1990).
54. Accordingly, because Tranquility has adequately pled that Debtors acted with the
requisite intent to defraud Tranquility, dismissal of Tranquility’s material assistance claim in
Count II would be improper.
III.THERE IS NO REASONABLE BASIS TO SUBORDINATE TRANQUILITY’S CLAIMS UNDER SECTION 510(B).
55. Debtors also argue that to the extent WaMu Inc. controlled the WaMu
securitization process, then Tranquility’s Amended Claim should be subordinated pursuant to
Section 510(b) of the Bankruptcy Code because the Trusts that issued the MBS certificates that
Tranquility purchased would purportedly be “affiliates” of the Debtors under Section 101(2)(C)
of the Code. Debtors’ argument is procedurally improper, legally unsupported, and flatly
rejected by Debtor’s own admissions in the Plan confirmation process. As such, the Debtors’
objection should be overruled.
35
A. The Debtors’ Effort to Subordinate Tranquility’s Claims Through a Claims Objection is Procedurally Improper.
56. As an initial matter, it is procedurally improper for Debtors to attempt to
subordinate Tranquility’s claims as part of a claims objection. Subordination addresses the order
of distribution of payment to which a claim is entitled, not whether the claim should be allowed
in the first instance.
57. Specifically, Federal Rule of Bankruptcy Procedure 7001(8) expressly provides
that a proceeding to subordinate any allowed15 claim must be brought as an adversary proceeding
rather than as part of a claim objection as Debtors have done here. Protarga, Inc. v. Webb (In re
Protarga, Inc.), Adv. 04-53374, 2004 WL 1906145, at *3 (Bankr. D. Del. Aug. 25, 2004)
(“Claims for equitable subordination must be brought as a separate adversary proceeding
pursuant to Rule 7001(8) of the Federal Rules of Bankruptcy Procedure.”); In re Donson, 434
B.R. 471, 474-75 (Bankr. S.D. Tex. 2010) (sua sponte denying claim objection on the grounds
that the relief sought must be brought in an adversary proceeding under Federal Rule of
Bankruptcy Procedure 7001).
58. Moreover, the 2007 amendments to Federal Rule of Bankruptcy Procedure
3007(b) make clear that parties may not include in a claims objection a request to subordinate a
claim under Section 510(b). Following the 2007 amendments, Rule 3007(b) now states: “A
party in interest shall not include a demand for relief of a kind specified in Rule 7001 in an
objection to the allowance of a claim, but may include the objection in an adversary proceeding.”
15 The Ninth Circuit BAP in USA Capital Realty Advisors, LLC v. USA Capital Diversified Trust Deed Fund, LLC (In re USA Commercial Mortgage Co.), 377 B.R. 608, 620 n. 13 (9th B.A.P. 2007), held that a party could not avoid the requirement under Federal Rule of Bankruptcy Procedure 7001(8) that an adversary proceeding be filed to subordinate an “allowed claim” by objecting to the claim (thus, rendering it no longer “allowed” under 11 U.S.C. § 502(a), which states that “[a] claim or interest . . . is deemed allowed, unless a party in interest . . . objects.”). The BAP held that “Rule 7001 would have little meaning if you could avoid it by filing an objection.”
36
(emphasis added). See also In re Donson, 434 B.R. at 474-75 (noting that the 2007 amendments
to Federal Rule of Bankruptcy Procedure 3007(b) supported its denial of claims objection based
on adversarial claim).
59. Additionally, the Advisory Committee Notes to 2007 Amendments to Federal
Rule of Bankruptcy Procedure 3007(b) expressly provide that “the amendment prohibits a party
in interest from including in a claim objection a request for relief that requires an adversary
proceeding.” Fed. R. Bankr. P. 3007(b) (emphasis added).
60. Accordingly, it is procedurally improper for Debtors to seek subordination of
Tranquility’s claims in this objection proceeding.
B. Debtors Have Already Admitted And Should Be Estopped From RecantingThat The Trusts Are Not Affiliates Of The Debtors.
61. Even if the Court is inclined to consider Debtors’ procedurally infirm objection, it
should reject this argument because the Debtors have already admitted in this case that special
purpose entities such as the Trusts that issued asset-backed securities are not affiliates of the
Debtors:
It should be noted that special purpose entities that issued certain asset-backed securities, such as those referenced on page 81 of the Opinion16 are not affiliates of the Debtors.
Notice of Status Conference Regarding, Among Other Things, The Opinion With Respect To
Confirmation Of The Sixth Amended Joint Plan of Affiliated Debtors Pursuant To Chapter 11 Of
The United States Bankruptcy Code, Exhibit A, p. 3, n.2, January 17, 2011 [Docket No. 6564]
(emphasis added). The Debtors’ admission is sufficient to lay this matter to rest, and Debtors are
estopped from now disclaiming their prior position. See, e.g., Parilla v. IAP Worldwide Servs,
VI, Inc., 368 F.3d 269, 275 (3d Cir. 2004) (instructing that a party is bound by what it states in its 16 The Court’s Opinion, which denied confirmation of the Debtors’ Sixth Amended Plan in part due to the scope of releases proposed, is dated January 7, 2011. See Docket No. 6528.
37
pleadings as judicial admissions are formal concessions that are binding) (citations omitted); In
re Captain Blythers, Inc., 311 B.R. 530, 538 (B.A.P. 9th Cir. 2004) (judicially estopping debtor
from taking position inconsistent with statements made to secure plan confirmation).
C. Section 510(b) Does Not Apply To Tranquility’s Claims Because The Trusts Which Issued The Certificates Are Not Affiliates of the Debtors.
62. Finally, even if the Court were to disregard both the procedural impermissibility
of Debtors’ new subordination argument and Debtors’ admission that the Trusts are not affiliates,
the Court should still reject this argument because Tranquility’s claims do not arise from the
rescission of a purchase or sale of a security of the Debtors or their affiliates as required by
Section 510(b) of the Bankruptcy Code. The mortgage-backed securities in question were issued
by the Trusts, not the Debtors. And the Trusts are not “affiliates” of the Debtors as a matter of
law.
63. Section 510(b) provides in pertinent part, that:
[A] claim arising from rescission of a purchase or sale of a security of the debtor or of an affiliate of the debtor, for damages arising from the purchase or sale of such a security, or for reimbursement or contribution allowed under section 502 on account of such a claim, shall be subordinated to all claims or interests that are senior to or equal the claim or interest represented by such security, except that if such security is common stock, such claim has the same priority as common stock11 U.S.C. § 510(b) (emphasis added).
64. The term “affiliate” in this context is defined in Bankruptcy Code Section
101(2)(C) and includes a “person whose business is operated under a lease or operating
agreement by a debtor, or person substantially all of whose property is operated under an
operating agreement with the debtor.” 11 U.S.C. § 101(2)(C). It is solely this subsection of
Section 101(2) upon which the Debtors rely in support of their newly-minted argument that
Tranquility’s claims should be subordinated under Section 510(b).
38
65. In the Supplemental Objection, Debtors assert that because certain activities of the
Trusts are governed by Pooling and Servicing Agreements, this gives rise to subordination. But
Debtors entirely fail to establish that such Pooling and Servicing Agreements constitute
“operating agreements” within the meaning of Section 101(2)(C).
66. Even if Debtors had done so, their subordination argument would still fail because
Debtors did not, and indeed cannot, establish that all of the Trusts’ property is operated by or
with WaMu Inc. under these Pooling and Servicing Agreements within the meaning of Section
101(2)(C). To the contrary, Debtors openly admit that “WMI is not a party to the Pooling &
Servicing Agreements.” Supplemental Objection, ¶22. As a result, under the plain meaning of
Section 101(2)(C), the Trusts that issued the securities are not “affiliates” of the Debtors and
Tranquility’s claim is not subject to subordination pursuant to Section 510(b).
67. Debtors attempt to salvage their argument by claiming that their “control” over
the non-debtors who were parties to the Pooling and Servicing Agreements somehow renders the
Trusts affiliates of the Debtors. That is incorrect as a matter of law. Indeed, that very argument
was considered and rejected by this Court in In re Semcrude, L.P., 436 B.R. 317, 320-21 (Bankr.
D. Del. 2010) wherein the Court overruled an objection under 11 U.S.C. § 510(b) on facts nearly
identical to those present here, finding that the debtor had failed to establish that the non-debtor
partnership that had issued the securities at issue was an “affiliate” of the debtor because the
debtor was not a party to the agreement with the partnership. In so ruling, the Court concluded
that it was constrained by the plain meaning of the statute and that debtors had failed to identify
any relevant ambiguities in the text of Sections 510(b) or 101(2) that would enable the Court to
look beyond the terms of the relevant statutes. See also In re Maruki USA Co., 97 B.R. 166, 169
(Bankr. S.D.N.Y. 1988) (rejecting argument that an entity is rendered an affiliate of a debtor
39
where it is 50% owned by its general partner, which is wholly owned and controlled by a
debtor).
68. For the same reasons here, the Trusts do not constitute “affiliates” of the Debtors,
and Debtors’ effort to subordinate Tranquility’s claims pursuant to Section 510(b) should be
denied.
IV. TRANQUILITY HAS ADEQUATELY PLED THAT IT SUFFERED DAMAGES FROM PURCHASING INFLATED MORTGAGE BACKED SECURITIES.
69. Debtors next argue that Tranquility’s claims should be dismissed for failure to
identify a specific inflated loan underlying its mortgage-backed securities because the United
States District Court of the Western District of Washington dismissed purportedly similar claims
in Boilermakers National Annuity Trust Fund v. WaMu Mortgage Pass Through Certificates, Series
ARI, Case No. C09-00037MJP, 2010 U.S. Dist.LEXIS 104427 (W.D. Wash. Sept. 28, 2010)
(“Boilermakers”).
A. The Court Has Already Rejected This Argument And Debtors Are Thus Barred From Reasserting It Here Again.
70. As an initial matter, Debtors have already raised this argument in their Initial
Objection. (See Initial Objection at ¶ 45). Debtors even supplemented this argument by filing a so-
called Notice of Supplemental Authority in Support of Debtors’ Objection to Tranquility’s Proof
of Claim No. 2206 (Docket No. 5621), which was, in reality, an additional three-page brief
(supplementing Debtors’ 83 pages of prior briefing) arguing that Tranquility’s claims should be
dismissed pursuant to Boilermakers, and attaching a copy of the opinion.
71. This Court summarily rejected this argument both at the hearing and in its Initial
Order. Indeed, Paragraph 5 of the Initial Order states that “[e]xcept as expressly set forth in this
Order, the Objection is overruled with respect to those arguments raised in Sections II.A through
II.C.1.” (emphasis added). Because there is nothing “expressly set forth” in the Initial Order that
40
sustained this particular argument raised in the Initial Objection, it is therefore overruled and
Debtors are barred from reasserting this previously rejected argument here. AL Tech Specialty
Steel Corp. v. Allegheny Int’l Credit Corp., 104 F.3d 601, 605 (3d Cir. 1997) (stating that the law
of the case doctrine precludes a court from revisiting a question it previously decided, including
decisions expressly or implicitly decided in judgment orders); Official Comm. Of Unsecured
Creditors v. Aust (In re Network Access Solutions, Corp.), 330 B.R. 67, 76 (Bankr. D. Del. 2005)
(the doctrine applies when a court makes a decision on a rule of law, thereby promoting finality
and efficiency of the judicial process by protecting against the agitation of settled issues).
B. Debtors’ Argument Remains Factually and Legally Baseless.
1. Loss causation is not an element of Tranquility’s control person claims under either the California Corporations Code or Section 15 of the Securities Act of 1933.
72. Even if the Court permits Debtors to reassert this argument, the Court should
maintain its prior ruling and again reject this baseless objection. First, Debtors’ argument
constitutes an impermissible attempt to inject the element of loss causation into Tranquility’s
claims. As previously explained, causation is not an element of the primary violations under either
Sections 25401-25501 of the California Corporations Code or Section 11 of the Securities Act of
1933. Bowden v. Robinson, 136 Cal. Rptr. 871, 878, 1977 Cal. App. LEXIS 1268, at **16-17
(Cal. Ct. App. 1977) (“no proof of causation is required”); see also In re Adams Golf, Inc. Sec.
Litig., 381 F.3d 267, 277 (3d Cir. 2004) (unlike a Rule 10b-5 case which requires a plaintiff to
plead loss causation, Section 11 claims are critically different and plaintiffs do not bear the burden
of proving causation). Rather, under Section 11, absence of loss causation or “negative causation”
constitutes an affirmative defense for which the defendant bears the burden. In re Adams Golf, 381
F.3d at 277 (instructing same and that a defendant may not use an affirmative defense to defeat a
plaintiff’s claim on a motion to dismiss). See also 15 U.S.C. § 77k(e) (requiring defendant to
41
prove absence of damages). California law is even stricter on this front as the absence of loss
causation does not constitute a defense to an underlying violation of Section 25401. See Cal. Corp.
Code Section 25501 (providing for liability unless defendant proves that: plaintiff knew the facts
concerning the untruth or omission; or that defendant exercised reasonable care and did not know,
or if he had exercised reasonable care would not have known, of the untruth or omission); Bowden,
136 Cal. Rptr. 871, 878, 1977 Cal. App. LEXIS 1268, at **16-17 (same).17
73. As such, Debtors’ continued attempt to inject the element of loss causation as an
element into Tranquility’s claims is legally unavailing and should be disregarded by the Court.
2. This alleged pleading requirement has been expressly rejected by recent case law.
74. Second, the Northern District of California recently rejected the same argument in
denying defendants’ motion to dismiss a securities class action involving inflated appraisals in
mortgage-backed securities. In re Wells Fargo Mortgage Backed Certificates Litigation,
No. C 09-01376 SI, 2010 U.S. Dist. LEXIS 39825 (N.D. Cal. April 22, 2010). These
consolidated cases were brought by purchasers of mortgage pass-through certificates (like those
at issue here), alleging that the offering documents for these mortgage-backed securities
contained false and misleading statements, including misstatements as to: (i) Wells Fargo’s
underwriting process and loan standards; and (ii) the appraisal value and loan-to-value ratios of
the underlying mortgaged properties. Defendants argued that these allegations were insufficient
“because they are not linked to the specific types of prime mortgages that were packaged into the
securities at issue in this case.” Id. at *38. In rejecting this argument, the court recognized that
17 Furthermore, unlike Section 12 of the Securities Act of 1933 on which California Corporations Code Section 25501 is generally modeled, section 25501 does not contain a statutory equivalent to Section 12(b) of the Securities Act of 1933, 15 U.S.C. § 77l(b), providing for the absence of loss causation as a defense to a claim under Section 12. As such, Debtors’ attempt to inject loss causation into Tranquility’s control person claim based on an underlying violation of Sections 25401 and 25501 is inappropriate for this reason as well.
42
plaintiffs’ allegations were sufficient because they “alleged that the challenged conduct infected
the entire underwriting process” on a “systematic” basis. Id. “In particular, plaintiffs have
alleged that Wells Fargo’s practices permitted the pervasive and systematic use of inflated
appraisals, affecting all types of mortgages. Plaintiff need not allege anything further in order to
state a claim.” Id. at **40-41.
3. Debtors’ legal authorities are entirely inapposite.
75. Third, the cases cited by the Debtors do not dictate a contrary result. As an initial
matter, and contrary to Debtors’ representation, Boilermakers did not dismiss all of plaintiffs’
claims. Rather, it expressly recognized that “Plaintiffs’ underwriting allegations survive dismissal
because the statements maybe be misleading if they mask the extent to which the sponsor’s
underwriting guidelines were disregarded.” 2010 U.S.Dist.LEXIS 104427, at **21-22. Here,
Tranquility makes similar claims as to Debtors’ underwriting guidelines. See, e.g., Amended Claim
at ¶¶ 14, 16-21, 25, 283-99. Accordingly, the Debtors own case law dictates that their objection be
overruled.
76. Also, Boilermakers dismissed some of plaintiffs’ claims relating to inflated
appraisals and loan-to-value ratios because of plaintiffs’ almost exclusive reliance on the New
York Attorney General’s allegations against eAppraiseIT to establish liability for all of the
mortgages at issue, including those that were not appraised by eAppraiseIT. Boilermakers at 23.
In contrast, Tranquility does not rely only on the New York Attorney General’s complaint against
eAppraiseIT, but also on separate and independent allegations against Lender’s Services Inc.
(“LSI”), which in conjunction with eAppraiseIT, handled all of Debtors’ home loan appraisal
business. (Amended Claim at ¶¶ 44, 205-05, 266-78) (attaching as Exhibit 3 a complaint filed
against Washington Mutual Bank, et al., by a former LSI appraiser alleging that she was
terminated for refusing to inflate appraisals).
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77. In addition, Tranquility relies on a wide variety of sources, including but not limited
to: (1) Senate Committee findings regarding WaMu’s underwriting and securitization activities;
(2) sworn statements and testimony provided by former WaMu Inc. officers made to the Senate
Committee; (3) documents released by the Senate Committee including the results of reviews and
communications by former employees and regulators regarding WaMu’s banking and
securitization practices; (4) statements by former employees regarding WaMu Inc.’s underwriting,
including appraisal, and securitization activities; and (5) newspaper articles conducting
investigations of WaMu and interviews with its former employees regarding WaMu’s
underwriting, appraisal, and risk management practices. (Amended Claim at ¶¶ 25, 65-73, 79-81,
84, 87-97, 113, 116-132, 196-200, 283-289, 327-336). Taken as a whole, Tranquility has alleged
that during the relevant time periods at issue, Debtors permitted the pervasive and systematic use
of inflated appraisals that affected their entire underwriting process and thus all of Debtors’
mortgages, including those supporting the mortgage-backed securities sold to Tranquility. Under
similar circumstances, the United States District Court for the Northern District of California has
held that “Plaintiff need not allege anything further in order to state a claim.” In re Wells Fargo
Mortgage Backed Certificates Litigation, No. C 09-01376 SI, 2010 U.S. Dist. LEXIS 39825 (N.D.
Cal. April 22, 2010) (cited in Initial Response at ¶ 43).
78. The Debtors’ reliance on Plumbers Union Local No. 12 Pension Fund v. Nomura
Asset Acceptance Corp., 658 F. Supp. 2d 299, 307-10 (D. Mass. 2009) is likewise misplaced. In
Plumbers Union the court dismissed plaintiffs’ claims because they had alleged general
information regarding appraisal practices in the mortgage industry as a whole, rather than
making any allegations about the defendant’s specific fraudulent appraisal practices. Here, by
contrast, Tranquility has made detailed allegations spanning more than 100 paragraphs regarding
44
WaMu’s particular improper practices with respect to the appraisals underlying WaMu’s
particular mortgages – not those of the industry generally. (Amended Claim at ¶¶ 3, 8-18, 22-23,
67-68, 73, 136-37, 188-94, 201-83, 290-93, 297-99, and Exhibits 2-3).
79. Similarly, in Republic Bank & Trust Co. v. Bear, Stearns & Co., Inc., No. 09-CV-
287, 2010 U.S. Dist. LEXIS 36365 (W.D. Ky. April 13, 2010), plaintiff brought common law
fraud and state securities law claims against several underwriters who sold mortgage-backed
securities that were supported by underlying mortgages from a number of different originators,
none of which originators were named as defendants. In seeking to impose liability, plaintiff
relied on “news articles and general statements about typical practices in the mid-2000’s” rather
than, as here, providing specific allegations about the conduct of the loan originators and
appraisers. Id. at 21. The court dismissed the complaint, citing Plumbers’ Union, which is
discussed in detail above. Thus, this case is inapposite for the same reasons as the Plumbers’
Union case on which it relies.
80. In addition, Republic Bank & Trust Company also predicated dismissal on the fact
that it found plaintiff’s allegations “implausible given that [defendants] disclosed the originators’
lax lending standards and the fact that exceptions even from these lenient rules were permitted.”
Here, no such factual issues are before this Court, and there is no basis for dismissing
Tranquility’s claims on the basis of such implausibility. Finally, it is important to note that the
holding cited by Debtors in Republic Bank & Trust Company is based on Kentucky common-law
fraud, which claim is materially different – in both substance and required pleading elements –
from the statutory securities laws claims at issue here. Tellingly, Debtors fail to mention that
that court did not apply this same analysis to plaintiff’s Kentucky statutory securities law claim,
which it dismissed based on its unrelated finding that “[defendant] disclosed its lending and
45
valuation practices.” Id. at *29. Again, this factual disclosure issue is not presently before the
Court and it would be inappropriate for it to make such a factual finding at this time.
81. Finally, in Ferber v. Travelers Corp., 802 F. Supp. 698, 706 (D. Conn. 1992),
plaintiffs alleged that Travelers had “current” property appraisals for only twenty-seven percent
of the loans in its real estate related asset portfolios which were in the process of foreclosure, and
that this “small percentage” of assets with current appraisals allegedly rendered false and
misleading the federal disclosure statements Travelers made about its loan-monitoring efforts.
Id. Significantly, the court did not require plaintiffs to identify which of the particular loans at
issue were subject to allegedly inaccurate appraisals. Rather, the court dismissed the claim
because plaintiffs: (1) failed to allege facts suggesting the absence of current property appraisals
undermined the accuracy of Traveler’s federal disclosures about the value of its mortgages and
real estate assets; and (2) failed to allege that Travelers did not employ reasonable valuation
methods. Id. In contrast, as demonstrated above, Tranquility has alleged exactly what the
Ferber court claimed was missing: (i) that WaMu’s actual conduct undermined the accuracy of
its disclosures about its appraisal process and resulting loan-to-value ratios; and (ii) that WaMu
failed to follow the independent appraisal methods it represented to investors that it would
employ. (See, e.g., Amended Claim ¶¶ 188-94, 196-200, 225, 232-38).
4. The specific mortgage information is within the Debtors’ knowledge and control and they have refused to provide it to Tranquility.
82. Fourth, importantly, although nowhere acknowledged by the Debtors, the
information regarding what appraisals supported particular mortgages that underlay the value of
the Certificates is uniquely within the Debtors’ knowledge and control. Rule 9(b)’s pleading
requirements may be relaxed where the factual information is within the defendant’s knowledge
or control. See Weiner v. Quaker Oats Co., 129 F.3d 310, 319-20 (3d Cir. 1997). Tranquility
46
did not have, and continues not to have, any access to the loan files that would show what
appraisals supported which mortgages that comprised the Certificates purchased by Tranquility.
Prior to filing its Amended Claim, Tranquility sought to obtain this information from WaMu, but
WaMu refused to provide it. (See Declaration of Jeffrey M. Saye attached as Exhibit 1 to Initial
Response at ¶ 3). Accordingly, although Tranquility maintains that allegations relating to
particular appraisals are not necessary to properly plead its claim in Count II, Tranquility also is
unable to do so because this information is within the exclusive control of Debtors or their
controlled subsidiaries.
V. TRANQUILITY HAS ADEQUATELY PLED ITS SECTION 15 CLAIMS.
83. Debtors argue that Tranquility cannot reassert its claims under Section 15 of the
Securities Act of 1933, 15 U.S.C. § 77o, for those securities that were sold pursuant to private
placement exemptions because the Court already rejected this claim. But as expressly
acknowledged by Tranquility in its Amended Claim, this claim remains subject to the Court’s
Initial Order, and is reasserted solely “for purposes of preserving its appellate rights with respect
to those securities.” (Amended Claim, p. 117 n.82.)
84. But oddly, Debtors further claim that Tranquility may not proceed with its Section
15 claims with respect to securities that were actually issued pursuant to a registration statement
because, as a matter of fact, none of the mortgage-backed securities at issue was issued pursuant
to a registration statement, but rather solely pursuant to a private placement memorandum. This
argument flatly contradicts Debtors’ prior representation to this Court that at least five of the
securities at issue were validly issued pursuant to a registration statement. Initial Objection at
¶¶ 37-39; see also Transcript of October 22, 2010 Hearing at 33:16-25 (Debtors’ counsel
acknowledging that Tranquility purchased at least $2.6 million of securities issued pursuant to
registration statements).
47
85. Accordingly, there is no dispute in this case that some of these securities were
issued pursuant to a registration statement and are thus actionable pursuant to Section 15.
Although there is some disagreement as to the particular identity and designation of these
registered securities, this factual issue as to which of the particular securities were registered can
and should be resolved at the hearing on the merits.
VI. TRANQUILITY HAS NOT IMPROPERLY ADDED NEW MISREPRESENTATION ALLEGATIONS.
86. Finally, Debtors argue that Tranquility has improperly amended its Initial Claim
to include the following new allegations of misrepresentation: “WaMu . . . selected and
securitized loans that it had identified as likely to be delinquent and/or fraudulent; . . . employed
shoddy lending and underwriting practices riddled with credit, compliance and operational
deficiencies; and . . . made high-risk home loans that contained excessive risk and inaccurate
information about the borrowers and the collateral.” Supplemental Objection at ¶ 31 (citing
Amended Claim at ¶ 290).
87. Although Debtors claim these allegations appear in paragraph 290 of the
Amended Claim – which is in a section captioned “WaMu’s Material Misrepresentations and
Omissions in the Offering Documents” – they do not. Rather, these allegations appear in
paragraph 289, which is part of the section captioned “WaMu’s Own Internal Investigations
Confirmed that Material Problems With Its Loan Underwriting and Credit Risk Management
Activities Had Resulted in Appraisal Fraud.” Indeed, these specific allegations come verbatim
from the Senate Committee’s April 13, 2010 Report, which confirmed, among other things, that
WaMu Inc. was aware of, and exercised control over, the loan underwriting and securitization
practices at issue in this case. Accordingly, these allegations further demonstrate the Debtors’
48
requisite level of knowledge and control over the events at issue as required by the Court in its
Initial Order and thus are entirely proper.
88. Moreover, Debtors ironically claim that “Tranquility had every opportunity to
include such allegations in its original proof of claim . . . .” Supplemental Objection at ¶ 29. To
the contrary, these facts were not available from the Senate Committee until April 13, 2010,
which was over one year after Tranquility filed its Initial Claim on March 27, 2009.
89. In any event, these additional allegations – which describe the Initial Claim with
greater particularity and relate to the same underlying conduct and transactions without seeking
any additional damages – are not “new claims.”
90. In determining whether a subsequent claim is an amendment or a “new claim”
courts look at whether the amendment “(1) corrects a defect of form in the original claim; (2)
describes the original claim with greater particularity; or (3) pleads a new theory of recovery on
the facts set forth in the original claim.” In re FLYi, Inc., No. 05-20011 (MFW), 2008 WL
170555, at *2-3 (Bankr. D. Del. Jan. 16, 2008). “In comparing the proof of claim and the
amendment, if the initial proof did not give fair notice of the conduct, transaction or occurrence
that forms the basis of the claim asserted in the amendment then the amendment asserts new
claims and will not be allowed.” In re Edison Bros. Stores, Inc., No. 99-532, 2002 Bankr.LEXIS
1228, at *12 (Bankr. D. Del. May 15, 2002) (internal quotations omitted).
91. Here, Tranquility’s addition of new allegations to its claim is clearly an
amendment to Tranquility’s original claim and does not constitute a “new claim” under this
Court’s precedent. These new allegations simply add “greater particularity” to the allegations of
Tranquility’s original claim.
49
92. Moreover, the new allegations involve the same conduct, transactions, and
occurrences that form the basis of the Original Claim: that there were material undisclosed
problems with the underwriting and appraisal process used in connection with the mortgages
underlying the securities sold to Tranquility. That these pre-existing allegations were
subsequently confirmed in greater detail by the Senate Committee does not mean that they are
new claims. It means that they are truthful claims.
93. Finally, this Court’s precedent unquestionably allows a claimant to freely amend
its claim in the absence of prejudice to other parties. In re FLYi, 2008 WL 170555 at *2-4
(internal citation omitted); In re Edison Bros., 2002 Bankr.LEXIS 1228, at *9 (“It is a well
settled principle that, absent contrary equitable considerations or prejudice to the opposing party,
amendments to proofs of claim should be freely permitted.”) (citations omitted). “Furthermore, a
court will deny leave to amend, only if there is undue delay, motivated by bad faith, or it would
be prejudicial to the opposing party.” In re Edison Bros., 2002 Bankr.LEXIS 1228, at *10
(internal quotation omitted).
94. Here, Debtors do not, and cannot, allege that they have suffered any prejudice
whatsoever. To the contrary, the nature and basis of Tranquility’s claims remains unchanged.
Discovery has not yet begun. And Debtors are fully on notice of the claims against them.
95. Finally, it is also important to note the prejudicial double-standard Debtors seek to
employ in their objection, given that Debtors themselves have advanced at least two entirely new
arguments (“subordination” and “scienter”) in their Supplemental Objection that they could have
and should have included in their Initial Objection.
50
CONCLUSION
96. For the foregoing reasons, Debtors’ Supplemental Objection should be overruled,
and the parties should be permitted to proceed with discovery.
MORRIS, NICHOLS, ARSHT & TUNNELL LLP
/s/ Donna L. CulverDonna L. Culver (No. 2983)1201 North Market StreetP. O. Box 1347Wilmington, DE 19801(302) 658-9200Counsel for Tranquility Master Fund, Ltd.
OF COUNSEL:Scott A. MeyersUlmer & Berne LLP500 West Madison Street, Suite 3600Chicago, IL 60661-4587Phone: (312) 658-6500Facsimile: (312) 658-6501
January 21, 2011
1811570v1735375.00000
4052178
CERTIFICATE OF SERVICE
I, Donna L. Culver, certify that I am not less than 18 years of age, and that service of
the foregoing TRANQUILITY MASTER FUND, LTD.’S RESPONSE TO DEBTORS’
SUPPLEMENTAL OBJECTION TO PROOF OF CLAIM OF TRANQUILITY MASTER FUND
LTD. was caused to be made on January 21, 2011, in the manner indicated upon the persons
below in the manner indicated:
BY HAND DELIVERY
Mark D. Collins, Esq.Chun I. Jang, Esq.Travis A. McRoberts, Esq.Richards Layton & Finger, P.A.One Rodney Square920 N. King StreetWilmington, DE 19801
BY FIRST CLASS MAIL
Brian S. Rosen, Esq.Adam P. StrochakWeil Gotshal & Manges LLP767 Fifth AvenueNew York, NY 10153
/s/ Donna L. Culver Donna L. Culver (#2983)
Dated: January 21, 2011