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Case 1:09-cv-03701-JGK Document 92 Filed 09/13/10 Page 1 of 52

UNITED STATES DISTRICT COURT


SOUTHERN DISTRICT OF NEW YORK

x
FORT WORTH EMPLOYEES’ : Civil Action No. 1:09-cv-03701-JGK
RETIREMENT FUND, On Behalf of Itself and :
All Others Similarly Situated, : CLASS ACTION
:
Plaintiff, : LEAD PLAINTIFF’S MEMORANDUM OF
: LAW IN OPPOSITION TO DEFENDANTS’
vs. : MOTION TO DISMISS THE SECOND
: AMENDED COMPLAINT
J.P. MORGAN CHASE & CO., et al., :
:
Defendants.
:
x

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TABLE OF CONTENTS

Page

I. INTRODUCTION ...............................................................................................................1

II. STATEMENT OF FACTS ..................................................................................................2

A. The Offering Documents Misrepresented the Underwriting Practices of the


Key Originators........................................................................................................2

B. The Offering Documents Misrepresented and Omitted Material Facts


Regarding the Appraisals Conducted by or for the Key Originators.......................5

C. The Certificates Purchased by Lead Plaintiff and the Class Were Falsely
Rated and Have Declined in Value as a Result of the Offering Documents’
Misrepresentations and Omissions ..........................................................................6

III. ARGUMENT.......................................................................................................................7

A. Legal Standards........................................................................................................7

1. Pleading Standards Pursuant to Rule 8(a)....................................................7

2. Strict Liability Under §§11 and 12(a)(2) of the Securities Act ...................9

B. The SAC Alleges Actionable False and Misleading Statements Pursuant to


§§11 and 12(a)(2)...................................................................................................10

1. The Offering Documents Misrepresented the Loan Underwriting


Standards Employed by the Key Originators.............................................10

2. The Offering Documents Made Actionable Misrepresentations


Regarding the Appraisal Standards and LTV Ratios.................................13

3. The Credit Ratings Assigned to the Certificates, as Represented in


the Offering Documents, Were False.........................................................15

4. The SAC’s Allegations Regarding the Materially False and


Misleading Representations in Defendants’ Offering Documents
Satisfy the “Plausibility” Standard of Rule 8.............................................17

C. The SAC Properly Asserts §11 Claims Against JP Morgan Chase and JP
Morgan Acquisition ...............................................................................................21

D. Lead Plaintiff Has Standing to Assert the Claims Set Forth in the SAC...............22

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Page

E. The SAC Alleges that Certificate Holders Have Been Injured by the
Certificates’ Significant Decline in Value .............................................................26

F. Defendants Cannot Escape Liability by Pointing to Purported “Cure”


Provisions in the Offering Documents...................................................................30

G. The SAC Adequately States Claims Pursuant to §15 ............................................32

H. Lead Plaintiff’s Claims Are Not Time-Barred.......................................................33

IV. CONCLUSION..................................................................................................................38

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TABLE OF AUTHORITIES

Page

CASES

380544 Can., Inc. v. Aspen Tech., Inc.,


633 F. Supp. 2d 15 (S.D.N.Y. 2009)..........................................................................................7

AIG Global Sec. Lending Corp. v. Banc of Am. Sec. LLC,


646 F. Supp. 2d 385 (S.D.N.Y. 2009), aff’d,
No. 09-2367-cv, 2010 U.S. App. LEXIS 14831
(2d Cir. July 20, 2010) .............................................................................................................29

Ashcroft v. Iqbal,
__U.S.__, 129 S. Ct. 1937 (2009)..................................................................................8, 17, 36

Bano v. Union Carbide Corp.,


361 F.3d 696 (2d Cir. 2004).....................................................................................................35

Bell Atl. Corp. v. Twombly,


550 U.S. 544 (2007).............................................................................................................8, 17

Cent. States Se. & Sw. Areas Health & Welfare Fund v.
Merck-Medco Managed Care, L.L.C.,
504 F.3d 229 (2d Cir. 2007)...............................................................................................23, 24

Chance v. Armstrong,
143 F.3d 698 (2d Cir. 1998).......................................................................................................8

Citiline Holdings Inc. v. iStar Fin., Inc.,


701 F. Supp. 2d 506 (S.D.N.Y. 2010)................................................................................23, 33

Dodds v. Cigna Sec., Inc.,


12 F.3d 346 (2d Cir. 1993).......................................................................................................36

Donelli v. County of Sullivan,


No. 07 Civ. 2157 (JGK), 2009 U.S. Dist. LEXIS 66994
(S.D.N.Y. July 31, 2009)..........................................................................................................19

Dorchester Investors v. Peak Int’l Ltd.,


134 F. Supp. 2d 569 (S.D.N.Y. 2001)......................................................................................36

Ellenburg v. JA Solar Holdings Co. Ltd.,


No. 08 Civ. 10475 (JGK), 2010 U.S. Dist. LEXIS 49220
(S.D.N.Y. May 17, 2010).....................................................................................................8, 20

Erickson v. Pardus,
551 U.S. 89 (2007).....................................................................................................................8
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Page

Foman v. Davis,
371 U.S. 178 (1962).................................................................................................................38

Grasty v. Amalgamated Clothing & Textile Workers Union, etc.,


828 F.2d 123 (3d Cir. 1987).....................................................................................................24

Gregory v. Daly,
243 F.3d 687 (2d Cir. 2001).......................................................................................................7

Grondahl v. Merritt & Harris, Inc.,


964 F.2d 1290 (2d Cir. 1992 )..................................................................................................34

Gustafson v. Alloyd Co.,


513 U.S. 561 (1995).................................................................................................................23

Hayes v. N.Y. City Dep’t of Corrections,


84 F.3d 614 (2d Cir. 1996).......................................................................................................20

Herman & MacLean v. Huddleston,


459 U.S. 375 (1983).............................................................................................................9, 10

Howard v. Everex Sys.,


228 F.3d 1057 (9th Cir. 2000) .................................................................................................33

In re CIT Group Inc. Sec. Litig.,


No. 08 Civ. 6613 (BSJ), 2010 U.S. Dist. LEXIS 57467
(S.D.N.Y. June 10, 2010).........................................................................................................33

In re Citigroup Bond Litig.,


No. 08 Civ. 9522 (SHS), 2010 U.S. Dist. LEXIS 69257
(S.D.N.Y. July 12, 2010) ................................................................................................. passim

In re Countrywide Fin. Corp. Sec. Litig.,


588 F. Supp. 2d 1132 (C.D. Cal. 2008) .......................................................................23, 24, 25

In re Credit Suisse First Boston Corp. Sec. Litig.,


No. 97 Civ. 4760 (JGK), 1998 U.S. Dist. LEXIS 16560
(S.D.N.Y. Oct. 20, 1998) ...................................................................................................23, 24

In re Dreyfus Aggressive Growth Mut. Fund Litig.,


No. 98 Civ. 4318 (HB), 2000 U.S. Dist. LEXIS 13469
(S.D.N.Y. Sept. 20, 2000)........................................................................................................24

In re eSpeed, Inc. Sec. Litig.,


457 F. Supp. 2d 266 (S.D.N.Y. 2006)..................................................................................7, 37
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Page

In re Executive Telecard, Ltd. Sec. Litig.,


913 F. Supp. 280 (S.D.N.Y. 1996) ..........................................................................................36

In re First Union Corp. Sec. Litig.,


128 F. Supp. 2d 871 (W.D.N.C. 2001) ....................................................................................30

In re Fleming Cos. Sec. & Derivative Litig.,


No. 5-03-MD-1530 (TJW), 2004 U.S. Dist. LEXIS 26488
(E.D. Tex. June 10, 2004) ........................................................................................................25

In re Fuwei Films Sec. Litig.,


634 F. Supp. 2d 419 (S.D.N.Y. 2009)........................................................................................9

In re IndyMac Mortgage-Backed Sec. Litig.,


No. 09 Civ. 4583 (LAK), 2010 U.S. Dist. LEXIS 61458
(S.D.N.Y. June 21, 2010)................................................................................................. passim

In re Initial Pub. Offering Sec. Litig.,


241 F. Supp. 2d 281 (S.D.N.Y. 2003)......................................................................................27

In re Juniper Networks Sec. Litig.,


264 F.R.D. 584 (N.D. Cal. 2009).............................................................................................25

In re Lehman Bros. Sec. & ERISA Litig.,


684 F. Supp. 2d 485 (S.D.N.Y. 2010) .............................................................................. passim

In re Marsh & McLennan Cos. Sec. Litig.,


501 F. Supp. 2d 452 (S.D.N.Y. 2006)................................................................................22, 23

In re MobileMedia Sec. Litig.,


28 F. Supp. 2d 901 (D.N.J. 1998) ............................................................................................25

In re Morgan Stanley Info. Fund Sec. Litig.,


592 F.3d 347 (2d Cir. 2010).......................................................................................................9

In re NovaGold Res. Inc. Sec. Litig.,


629 F. Supp. 2d 272 (S.D.N.Y. 2009)........................................................................................8

In re Polaroid Corp. Sec. Litig.,


465 F. Supp. 2d 232 (S.D.N.Y. 2006)......................................................................................35

In re Scholastic Corp. Sec. Litig.,


252 F.3d 63 (2d Cir. 2001).......................................................................................................20

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Page

In re Sumitomo Copper Litig.,


120 F. Supp. 2d 328 (S.D.N.Y. 2000)................................................................................35, 37

In re Tower Auto. Sec. Litig.,


483 F. Supp. 2d 327 (S.D.N.Y. 2007) ......................................................................................20

In re Ulta Salon, Cosmetics & Fragrance, Inc.,


604 F. Supp. 2d 1188 (N.D. Ill. 2009) .....................................................................................28

In re Wells Fargo Mortg. Backed Certificates Litig.,


No. C 09-01376 SI, 2010 U.S. Dist. LEXIS 39825
(N.D. Cal. Apr. 22, 2010) ................................................................................................ passim

In re Westinghouse Sec. Litig.,


90 F.3d 696 (3d Cir. 1996).......................................................................................................24

In re WorldCom, Inc. Sec. Litig.,


No. 02 Civ. 3288 (DLC), 2004 U.S. Dist. LEXIS 4240
(S.D.N.Y. Mar. 19, 2004) ........................................................................................................25

In re WorldCom Sec. Litig.,


496 F.3d 245 (2d Cir. 2007).......................................................................................................9

In re WorldSpace Sec. Litig.,


No. 07 Civ. 2252 (RMB), 2008 U.S. Dist. LEXIS 56224
(S.D.N.Y. July 21, 2008) .........................................................................................................32

Jackson Nat’l Life Ins. Co. v. Merrill Lynch & Co.,


32 F.3d 697 (2d Cir. 1994).......................................................................................................35

Kronfeld v. Trans World Airlines, Inc.,


832 F.2d 726 (2d Cir 1987)........................................................................................................9

Lentell v. Merrill Lynch & Co.,


396 F.3d 161 (2d Cir. 2005).....................................................................................................36

Levine v. AtriCure, Inc.,


508 F. Supp. 2d 268 (S.D.N.Y. 2007)......................................................................................28

Lone Star Fund V (US) v. Barclays Bank PLC,


594 F.3d 383 (5th Cir. 2010) ...................................................................................................31

Mass. Bricklayers & Masons Funds v. Deutsche Alt -A Sec.,


No. CV 08-3178, 2010 U.S. Dist. LEXIS 33976
(E.D.N.Y. Apr. 6, 2010)...........................................................................................................35
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Page

McMahan & Co. v. Wherehouse Entm’t,


65 F.3d 1044 (2d Cir. 1995).........................................................................................27, 29, 31

Miss. Pub. Emps. Ret. Sys. v. Boston Sci. Corp.,


523 F.3d 75 (1st Cir. 2008) ......................................................................................................20

N.J. Carpenters Health Fund v. DLJ Mortg. Capital, Inc.,


No. 08 Civ. 5653 (PAC), 2010 U.S. Dist. LEXIS 47512
(S.D.N.Y. Mar. 29, 2010)................................................................................................. passim

N.J. Carpenters Health Fund v. Residential Capital, LLC,


No. 08 CV 8781 (HB), 2010 U.S. Dist. LEXIS 32058
(S.D.N.Y. Mar. 31, 2010)................................................................................................. passim

N.J. Carpenters Vacation Fund v. Royal Bank of Scot. Group, PLC,


No. 08 CV 5093 (HB), 2010 U.S. Dist. LEXIS 29711
(S.D.N.Y. Mar. 26, 2010)................................................................................................. passim

NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co.,


No. 08 CV 10783 (MGC) (S.D.N.Y. Jan. 28, 2010) ...............................................................29

Pub. Emps. Ret. Sys. of Miss. v. Merrill Lynch & Co.,


No. 08 Civ. 10841 (JSR), 2010 U.S. Dist. LEXIS 53047
(S.D.N.Y. June 1, 2010)................................................................................................... passim

Rescuecom Corp. v. Google, Inc.,


562 F.3d 123 (2d Cir. 2009).......................................................................................................7

Roberts v. Cooperatieve Centrale Raiffeisen-Boeren Leenbank B.A.,


No. 09 Civ. 5271 (JGK), 2010 U.S. Dist. LEXIS 461
(S.D.N.Y. Jan. 5, 2010)............................................................................................................38

Rombach v. Chang,
355 F.3d 164 (2d Cir. 2004).....................................................................................................10

SEC v. Kern,
425 F.3d 143 (2d Cir. 2005).....................................................................................................22

Shah v. Meeker,
435 F.3d 244 (2d Cir. 2006).....................................................................................................35

Staehr v. Hartford Fin. Servs. Group,


547 F.3d 406 (2d Cir. 2008)...................................................................................34, 35, 36, 37

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Page

Stratmore v. Combs,
723 F. Supp. 458 (N.D. Cal. 1989), aff’d sub nom.
McGonigle v. Combs, 968 F.2d 810 (9th Cir. 1992),
and aff’d in part and rev’d in part on other grounds sub nom.
Layman v. Combs, 98 F.2d 1093 (9th Cir. 1992).....................................................................31

Teamsters Local 445 Freight Div. Pension Fund v. Bombardier Inc.,


No. 05 Civ. 1898 (SAS), 2005 U.S. Dist. LEXIS 19506
(S.D.N.Y. Sept. 6, 2005)..........................................................................................................35

Tsereteli v. Residential Asset Securitization Trust 2006-A8,


692 F. Supp. 2d 387 (S.D.N.Y. 2010) .............................................................................. passim

United States SEC v. Universal Express, Inc.,


475 F. Supp. 2d 412 (S.D.N.Y. 2007), aff’d sub nom.
United States SEC v. Altomare, 300 F. App’x 70 (2d Cir. 2008) ............................................22

United States v. Scheffer,


523 U.S. 303 (1998).................................................................................................................20

STATUTES, RULES AND REGULATIONS

15 U.S.C.
§77k.................................................................................................................................. passim
§77k(a)(5) ................................................................................................................................22
§77k(e) ...............................................................................................................................27, 28
§77l(a)(2) ......................................................................................................................... passim
§77m ........................................................................................................................................34
§77n..........................................................................................................................................30
§77o.................................................................................................................................. passim
§77o(a) .....................................................................................................................................32
§78j ..........................................................................................................................................29

Federal Rules of Civil Procedure


Rule 8 .............................................................................................................................8, 17, 19
Rule 8(a)...........................................................................................................................7, 8, 36
Rule 9(b) ............................................................................................................................19, 20
Rule 12(b)(6)......................................................................................................................24, 35
Rule 15(a)(2)............................................................................................................................38
Rule 23(a)(3)............................................................................................................................24

17 C.F.R.
§229.1101(l).............................................................................................................................22

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Page

SECONDARY AUTHORITIES

7AA Charles Alan Wright, Arthur R. Miller & Mary Kay Kane,
Federal Practice and Procedure (3d ed. 2005)
§1785.1.....................................................................................................................................23

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I. INTRODUCTION

The Second Amended Complaint for Violation of §§11, 12 and 15 of the Securities Act of

1933 (“SAC”) is straightforward. On March 27, 2007, defendants filed a Registration Statement

with the U.S. Securities and Exchange Commission (“SEC”) in order to issue billions of dollars of

Mortgage Pass-Through Certificates (collectively, the “Certificates”). ¶1.1 Defendants subsequently

filed numerous Prospectus Supplements, each of which was expressly incorporated by reference into

the Registration Statement. Id. The SAC succinctly alleges the Registration Statement and

Prospectus Supplements (collectively, the “Offering Documents”) included false and misleading

statements with respect to the pools of mortgage loans that supported the Certificates purchased by

Lead Plaintiff and the class. Specifically, the Offering Documents contained false and misleading

statements and material omissions regarding: (1) the loan underwriting standards purportedly used in

connection with the origination of the mortgage loans; (2) the appraisals of the properties underlying

the mortgage loans; (3) the loan-to-value (“LTV”) ratios of the loans; and (4) the credit ratings of the

Certificates. The SAC further alleges that these statements affirmatively misrepresented the true

nature of the risk of investing in the Certificates. The effect of the misrepresentations is now

apparent as the Certificates are now worth a fraction of their offering price. Lead Plaintiff and the

class seek damages and equitable relief for the misstatements defendants made.

Defendants’ motion to dismiss the SAC ignores the fact that multiple courts in this Circuit

have recently upheld nearly identical claims as those asserted here. See In re Lehman Bros. Sec. &

ERISA Litig., 684 F. Supp. 2d 485, 493 (S.D.N.Y. 2010); Pub. Emps. Ret. Sys. of Miss. v. Merrill

Lynch & Co. (“Merrill Lynch”), No. 08 Civ. 10841 (JSR), 2010 U.S. Dist. LEXIS 53047, at *18

1
Paragraph references (“¶_” or “¶¶_”) are to the SAC. Emphasis is added and citations and
footnotes are omitted throughout unless otherwise indicated.

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(S.D.N.Y. June 1, 2010); N.J. Carpenters Health Fund v. Residential Capital, LLC (“Residential

Capital”), No. 08 CV 8781 (HB), 2010 U.S. Dist. LEXIS 32058, at *20 (S.D.N.Y. Mar. 31, 2010);

Tsereteli v. Residential Asset Securitization Trust 2006-A8, 692 F. Supp. 2d 387, 392 (S.D.N.Y.

2010); In re IndyMac Mortgage-Backed Sec. Litig., No. 09 Civ. 4583 (LAK), 2010 U.S. Dist. LEXIS

61458, at *12, *33-*34 (S.D.N.Y. June 21, 2010); N.J. Carpenters Vacation Fund v. Royal Bank of

Scot. Group, PLC (“RBS”), No. 08 CV 5093 (HB), 2010 U.S. Dist. LEXIS 29711, at *45 (S.D.N.Y.

Mar. 26, 2010); N.J. Carpenters Health Fund v. DLJ Mortg. Capital, Inc. (“DLJ”), No. 08 Civ. 5653

(PAC), 2010 U.S. Dist. LEXIS 47512, at *14 (S.D.N.Y. Mar. 29, 2010). Defendants’ motion to

dismiss should be denied.

II. STATEMENT OF FACTS

A. The Offering Documents Misrepresented the Underwriting Practices


of the Key Originators

The SAC alleges in specific detail how the Offering Documents misrepresented the

underwriting practices of American Home Mortgage (“AHM”) and the Chase Originators

(collectively, the “Key Originators”). The Certificates at issue were supported by pools of mortgage

loans primarily originated by the Key Originators. ¶¶71-72.2 Based largely on the accounts of

former employees of the Key Originators, the SAC sets forth how the Offering Documents falsely

represented that the Key Originators’ underwriting practices were designed to determine the

borrowers’ “ability to pay the debt they would be incurring.” ¶¶70, 72, 78-96. In reality, the stated

underwriting practices were systematically ignored and the Key Originators simply originated as

many loans as possible rather than evaluate a borrower’s ability to repay. ¶¶78-96. Of course, the

2
Eighty-five percent of the loans backing the Trust 2007-S3 Certificates purchased by Lead
Plaintiff were originated by AHM or the Chase Originators. ¶¶70, 72.

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risk of borrowers failing to repay these loans was of little concern to the Key Originators or

defendants as they knew the loans were going to be packaged up and sold off to investors such as

Lead Plaintiff and class members.

With respect to AHM, the SAC details that underwriting standards were becoming

increasingly lax throughout the 2005 through 2007 timeframe, and even eroded to the point that

“anybody could buy a house with zero percent down and no proof of ability to pay it [the loan]

back.” ¶80. Allegations from several former AHM loan underwriters also explained that automated

underwriting software used at the company not only overrode the professional judgment of the actual

underwriters, but approved loans that made no financial sense or were so “awful” that they would

not have been approved under the normal, stated loan underwriting guidelines. ¶¶81-82. A former

AHM District Manager provided that the loan pools sold to defendants and other Wall Street banks

were made up of “nothing but junk” and were only approved because the managers were told “to

ignore the issues which should not be ignored, such as the borrower’s ability to repay.” ¶84. Thus,

the loan pools, such as those at issue here, which were rated AAA “investment grade” quality (the

highest and safest rating), were actually anything but that.

Similarly, allegations regarding the underwriting of the Chase Originators include facts

provided by former employees of the Chase Originators. For example, a former Wholesale Account

Executive with Chase Home Financial (“CHF”) stated that the underwriting process was subject to

systematic abuse by brokers who purposely originated loans for people they knew could not repay

them. ¶94. This Account Executive also explained that CHF’s proprietary automated underwriting

system called “Zippy” had extremely loose guidelines, was easily and often overridden, and

routinely approved loans that would otherwise not have seen the light of day. Id. The extent of

Zippy’s lax underwriting standards and the ease by which data could be manipulated to achieve the

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desired loan approval was documented in an internal memo explaining ways to “cheat” and “trick”

Zippy. ¶95.

As a result of AHM and the Chase Originators’ failures to utilize the underwriting standards

referenced in the Offering Documents, the Certificates purchased by Lead Plaintiff were backed by

faulty loans. ¶¶5-7. The SAC specifically references a review of documentation for 60 loans

actually utilized to back the Certificates purchased by Lead Plaintiff. ¶5. This review revealed that,

with respect to 71% of these loans, no determination was made as to whether the borrower could

afford to repay his or her loan. Id. Examples of instances where borrowers were approved for loans

that they clearly could not afford to repay are described in the SAC. ¶¶5-7. For example, a review

of sworn bankruptcy filings related to the borrower for one of the loans originated by AHM and

contained in Trust 2007-S3 reveals that the borrower had no significant liquid assets, reported no

income for 2007 and reported only $2,490 of income for 2008. ¶6. Similarly, a borrower for a loan

originated by a Chase Originator utilized to back Trust 2007-S3 reveals that the borrower had no

significant liquid assets, reported no employment or business income for 2006, 2007 or 2008, had a

monthly car payment of nearly $1,300 per month, and yet was approved for a loan with a monthly

$4,900 mortgage payment. ¶7. If the Key Originators’ underwriting standards were actually

designed and used to determine the borrower’s ability to repay the loan, these loans simply would

not have been approved and funded.

The fact that the Key Originators made loans without regard to whether borrowers could

repay is further evidenced by the skyrocketing default rates on the loans in the Trusts. ¶125. All of

the Trusts have 60+ day delinquency rates3 in excess of 12% and more than a third of the 11 Trusts

3
“60+ day delinquency rate” includes loans that are more than 60 days delinquent plus loans
in foreclosure and loans in which the real estate was foreclosed and retaken by the lender. Id.

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have 60+ day delinquencies rates in excess of 42%. Id. In many of the Trusts, at least 25% of the

loans have experienced foreclosure. Id.

B. The Offering Documents Misrepresented and Omitted Material Facts


Regarding the Appraisals Conducted by or for the Key Originators

The Offering Documents falsely stated the LTV ratios of the underlying mortgages, and that

all property appraisals conformed to the Uniform Standards of Professional Appraisal Practice

(“USPAP”). ¶¶97-98, 102. The appraisals at issue in fact violated USPAP as appraisers utilized by

AHM and the Chase Originators were routinely forced to appraise to certain inflated, pre-determined

levels if they wanted to be hired again. ¶¶101, 103-112. As a result, appraisals were routinely and

falsely inflated and therefore LTV ratios were falsely understated. ¶115.

Appraisals conducted for the Key Originators were not based upon the appraiser’s

professional judgment or market data of comparable sales as the Offering Documents stated. ¶¶107-

110. For example, the SAC alleges that AHM’s appraisals were systematically based upon pre-

determined values demanded by brokers. ¶107. Former AHM employees and appraisers recounted

how loan officers pressured appraisers to come up with the “right number” and threatened that the

appraisers would “never do business for us again” if they did not provide the appraisal number the

broker wanted. ¶¶107-110. Indeed, as described by a former AHM Vice President from

March 2003 through May 2007, appraisal fraud was a common occurrence at AHM. ¶107.

Moreover, the SAC specifically ties the alleged faulty appraisal practices to the specific loans

backing the Certificates by, among other things, referencing a review of property information from

60 loans in Trust 2007-S3. ¶116. This review revealed that at least 40% of the appraisals were

inflated by 9% or more compared to the true value of the property at the time of the loan origination.

Id. This overvaluation resulted in an understated LTV ratio for each of these loans. Id.

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C. The Certificates Purchased by Lead Plaintiff and the Class Were


Falsely Rated and Have Declined in Value as a Result of the Offering
Documents’ Misrepresentations and Omissions

The Certificates at issue were secured by loans that had a much greater risk profile than

represented in the Offering Documents. ¶9. Based on their misrepresentations and omissions,

defendants were able to obtain falsely superior “investment grade” ratings on the Certificates. See

¶¶117-123. As a result, the Certificates did not perform in a manner consistent with their ratings.

According to reports of the delinquency rates on the underlying mortgage loans, all of the Trusts

have experienced a 60+ day delinquency rate in excess of 12% and the rate for more than a third of

the Trusts exceeds 42%. ¶125. Additionally, in many of the Trusts, at least one of every four loans

has experienced foreclosure. Id. Thus, the massive foreclosure rate and extraordinary delinquencies

further confirm defendants’ misrepresentations about the lending practices and the risk profile of the

Certificates as set forth in the Offering Documents.

Furthermore, revelation of the misrepresentations and omissions caused the market price of

the Certificates to decline significantly from the offering price. ¶12. This decline in value has

caused damage to Lead Plaintiff and the class. Id. In a non-forced sale in the secondary market in

March of 2009, the time the first lawsuit alleging the wrongful actions herein was filed, Lead

Plaintiff and the Class would have netted, at most, 62 cents on the dollar – a loss of at least 38 cents

on each dollar amount purchased. Id.

Moreover, contrary to defendants’ misleading assertions, the majority of the Certificates at

issue in the SAC were not downgraded by the rating agencies until well after March 11, 2008.

Indeed, with regard to the 2007-S3 Certificates purchased by Lead Plaintiff, none of the tranches

were downgraded before August of 2008. See Declaration of Arthur C. Leahy in Opposition to

Defendants’ Motion to Dismiss the Second Amended Complaint (“Leahy Decl.”), Ex. A (showing

ratings downgrades for all tranches of the 2007-S3 Certificates). In fact, the specific tranche of
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Certificates purchased by Lead Plaintiff – 2007-S3 Class 1A1 – was not downgraded at all until

November 11, 2008 and, even then, it was only downgraded by one rating agency, Standard &

Poor’s (“S&P”), from AAA to A, still an “investment grade” certificate. Id. at 1. It was not until

April of 2009 that Fitch or S&P first downgraded the specific Certificates purchased by Lead

Plaintiff below the “investment-grade” level. Id. While it has subsequently come to light that these

credit ratings were false and unreliable, the ratings were, at the time, considered to be reliable

measures of investment risk. As such, it is reasonable that Lead Plaintiff would have viewed the

“investment grade” ratings assigned to the Certificates as assurance that it had not been misled by

any representations in the Offering Documents.4

III. ARGUMENT

A. Legal Standards

1. Pleading Standards Pursuant to Rule 8(a)

“When reviewing a motion to dismiss, a court must ‘accept as true all of the factual

allegations set out in plaintiff’s complaint, [and] draw inferences from those allegations in the light

most favorable to plaintiff . . . .’” Rescuecom Corp. v. Google, Inc., 562 F.3d 123, 127 (2d Cir.

2009) (quoting Gregory v. Daly, 243 F.3d 687, 691 (2d Cir. 2001)); see also 380544 Can., Inc. v.

Aspen Tech., Inc., 633 F. Supp. 2d 15, 27 (S.D.N.Y. 2009) (“A court should ‘read the complaint

generously, and draw all inferences in favor of the pleader.’”). As the Second Circuit emphasizes:

4
See In re eSpeed, Inc. Sec. Litig., 457 F. Supp. 2d 266, 285 (S.D.N.Y. 2006) (“Courts often
decline to find that plaintiffs were on inquiry notice in the face of such ‘reliable words of comfort’
designed to counter information that might otherwise give rise to inquiry notice.”); Merrill Lynch,
2010 U.S. Dist. LEXIS 53047, at *7 (discussing fact that “certificates at issue were not downgraded
below investment grade until . . . after the . . . limitation date,” and rejecting defendants’ inquiry
notice argument); RBS, 2010 U.S. Dist. LEXIS 29711, at *34-*35 (same).

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It is important to recognize the difference between disposing of a case on a


12(b)(6) motion and resolving the case later in the proceedings, for example by
summary judgment. At the 12(b)(6) stage, “the issue is not whether a plaintiff is
likely to prevail ultimately, but whether the claimant is entitled to offer evidence to
support the claims. Indeed it may appear on the face of the pleading that a recovery
is very remote and unlikely but that is not the test.”

Chance v. Armstrong, 143 F.3d 698, 701 (2d Cir. 1998).5

Because Lead Plaintiff’s claims are based on theories of strict liability and negligence under

§§11 and 12 of the Securities Act of 1933 (“Securities Act”), and expressly allege no fraudulent

conduct on behalf of defendants, they are governed by the notice pleading standard set forth in Fed.

R. Civ. P. 8(a). ¶¶127, 140, 145; DLJ, 2010 U.S. Dist. LEXIS 47512, at *8. Pursuant to the plain

language of this standard, a complaint need only provide a “‘“short and plain statement of the claim

showing that the pleader is entitled to relief.”’” In re NovaGold Res. Inc. Sec. Litig., 629 F. Supp. 2d

272, 283 (S.D.N.Y. 2009). As the Supreme Court recently reaffirmed, “the pleading standard Rule 8

announces does not require ‘detailed factual allegations’” Ashcroft v. Iqbal, __U.S.__, 129 S. Ct.

1937, 1949 (2009).6 Rather, a complaint need only allege “enough facts to state a claim to relief that

is plausible on its face.” Bell Atl., 550 U.S. at 570; In re Citigroup Bond Litig., No. 08 Civ. 9522

(SHS), 2010 U.S. Dist. LEXIS 69257, at *37 (S.D.N.Y. July 12, 2010) (a plaintiff need only

“‘nudge[] [its] claims across the line from conceivable to plausible’” to avoid dismissal).

5
See also Ellenburg v. JA Solar Holdings Co. Ltd., No. 08 Civ. 10475 (JGK), 2010 U.S. Dist.
LEXIS 49220, at *3 (S.D.N.Y. May 17, 2010) (“The Court’s function on a motion to dismiss is
‘not to weigh the evidence that might be presented at trial but merely to determine whether the
complaint itself is legally sufficient.’”).
6
See also Erickson v. Pardus, 551 U.S. 89, 93 (2007) (under Fed. R. Civ. P. 8(a), “[s]pecific
facts are not necessary; the statement need only “‘give the defendant fair notice of what the . . .
claim is and the grounds upon which it rests”’”) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544,
555 (2007)).

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2. Strict Liability Under §§11 and 12(a)(2) of the Securities Act

Sections 11 and 12(a)(2) of the Securities Act impose a stringent standard of liability on

defendants and “‘places a relatively minimal burden on a plaintiff.’” Citigroup Bond, 2010 U.S.

Dist. LEXIS 69257, at *52. Furthermore, “[u]nlike a fraud claim, Section 11 does not require a

plaintiff to plead scienter, reliance, or loss causation, and issuers are subject to ‘virtually absolute’

liability under Section 11, while other potential defendants – including individual officers and

directors or underwriters – may be held liable for mere negligence.” Id. at *52-*53.

In order to state a claim under §11, a plaintiff need only allege “‘that he purchased the

security and that the registration statement contains false or misleading statements concerning a

material fact.’” In re Fuwei Films Sec. Litig., 634 F. Supp. 2d 419, 434-35 (S.D.N.Y. 2009).7

“Section 12(a)(2) ‘provides similar redress’ to section 11 claims, ‘where the securities at issue were

sold using prospectuses or oral communications that contain material misstatements or omissions.’”

Residential Capital, 2010 U.S. Dist. LEXIS 32058, at *18 (quoting 15 U.S.C. §77l(a)(2)); In re

Morgan Stanley Info. Fund Sec. Litig., 592 F.3d 347, 359 (2d Cir. 2010). In turn, a complaint will

allege an actionable misstatement under either §11 or §12(a)(2) if it adequately asserts that the

relevant offering materials (1) “contain[ed] an ‘untrue statement of a material fact’”; (2) “‘omitt[ed]

to state a material fact required to be stated therein’”; or (3) omitted to state a material fact

“‘necessary to make the statements therein not misleading.’” In re WorldCom Sec. Litig., 496 F.3d

245, 248-49 (2d Cir. 2007).

7
See also Kronfeld v. Trans World Airlines, Inc., 832 F.2d 726, 730 (2d Cir 1987) (‘“[a
plaintiff] need only show a material misstatement or omission to establish his prima facie case’”)
(quoting Herman & MacLean v. Huddleston, 459 U.S. 375, 382 (1983)).

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As stated above, §§11 and 12(a)(2) were “designed to assure compliance with the disclosure

provisions of the [Securities] Act by imposing a stringent standard of liability on the parties who

play a direct role in a registered offering.” Herman & MacLean, 459 U.S. at 381-82. As such, the

issuer is held strictly liable for any material misstatements and omissions within the registration

statement, while all other defendants are prima facie liable but may raise the affirmative defense of

“due diligence” at a later stage. See id. at 382. Under both §§11 and 12(a)(2), defendants are liable

for negligent and even innocent misstatements and omissions. Id.; Rombach v. Chang, 355 F.3d

164, 169 n.4 (2d Cir. 2004).

B. The SAC Alleges Actionable False and Misleading Statements


Pursuant to §§11 and 12(a)(2)

1. The Offering Documents Misrepresented the Loan


Underwriting Standards Employed by the Key Originators

As set forth in the SAC, the Offering Documents represented that, regardless of the specific

loan “programs” involved, the loan originators determined whether a borrower had the ability to

repay the debt. See ¶¶68-69. Specifically, the Offering Documents for Trust 2007-S3, the Trust

from which Lead Plaintiff bought, stated that with respect to AHM, its loan underwriting is “based

solely on information that American Home believes is indicative of the applicant’s willingness and

ability to pay the debt they would be incurring.” ¶70. Similarly, the Chase Originators’ loan

underwriting is described in the Offering Documents for Trust 2007-S3 as making “a determination .

. . as to whether the prospective borrower has sufficient monthly income available to meet the

borrower’s monthly obligations on the proposed loan” as well as other related living expenses. ¶72.

The SAC alleges that these statements were false. In stark contrast to the above assurances

that AHM and the Chase Originators would determine whether borrowers could repay their loans,

the Key Originators instead systematically ignored the stated loan underwriting guidelines and made

loans to anyone they could. See ¶¶78-93 (describing AHM’s actual underwriting practices), 94-96
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(describing the Chase Originators’ actual underwriting practices). AHM and the Chase Originators

loaned to anyone they could regardless of whether the borrowers could repay the loans, contrary to

the Offering Documents. Id.

Defendants argue that disclosures in the Offering Documents – that the Certificates would be

backed by “loans originated under low documentation programs” and that originators could make

exceptions to underwriting standards – immunize them from liability for misrepresenting that the

underlying loans were issued based on a borrower’s ability to repay. See Defendants’ Memorandum

of Law in Support of Their Motion to Dismiss the Second Amended Complaint (“Defs.’ Mem.”) at

14-18. Defendants are wrong. None of the disclosures pointed to by defendants warned investors

that loan originators had systematically abandoned their stated loan underwriting guidelines and

completely ignored the most basic loan underwriting guideline – determining whether borrowers

could repay their loans. See IndyMac, 2010 U.S. Dist. LEXIS 61458, at *33 (disclosures regarding

“low-doc” and “no-doc” loan programs do not warn of the risk that underwriting standards were

ignored); RBS, 2010 U.S. Dist. LEXIS 29711, at *42-*45 (same); Residential Capital, 2010 U.S.

Dist. LEXIS 32058, at *21 (same); Lehman Bros., 684 F. Supp. 2d at 493 (same); DLJ, 2010 U.S.

Dist. LEXIS 47512, at *18-*19 (same); Tsereteli, 692 F. Supp. 2d at 392-93 (same); Merrill Lynch,

2010 U.S. Dist. LEXIS 53047, at *18 (same); In re Wells Fargo Mortg. Backed Certificates Litig.,

No. C 09-01376 SI, 2010 U.S. Dist. LEXIS 39825, at *37-*38 (N.D. Cal. Apr. 22, 2010) (same).

Thus, defendants’ disclosures did not sufficiently warn investors. Id.

Indeed, the SAC alleges that the Offering Documents falsely represented that originators

utilized underwriting standards to “evaluate a borrower’s credit standing and repayment ability”

prior to granting a mortgage loan application. See, e.g., ¶¶68-70, 72-74, 76. Any disclosures that

loan originators may have made certain exceptions to the underwriting guidelines, or used reduced

documentation, does not in any way disclose that originators were not making the most basic loan
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underwriting determination of whether a borrower could afford to repay his or her loan. ¶¶4, 77.8

For example, despite the affirmative representation within Trust 2007-S3’s Prospectus Supplement

that AHM underwrote loans based “solely on information” that demonstrated a prospective

borrower’s ability to repay the loan (see ¶70), statements by former AHM employees with direct

knowledge of the company’s loan underwriting procedures paint a very different picture. See ¶¶78-

93. AHM was lending to anyone that it could regardless of a borrower’s ability to repay the loan.

¶78; see also ¶¶80 (at AHM “anybody could buy a house with zero percent down and no proof of

ability to pay [the loan] back”), 81-84, 87, 89.

For the Chase Originators, the situation was virtually identical. See ¶72. Although

defendants represented to investors that, for those mortgage loans originated by the Chase

Originators, an applicant’s ability to repay the loan, along with satisfying his or her other monthly

financial obligations, was key to the determination of whether the loan would be issued (see ¶¶72,

94), the truth was just the opposite. According to a former Wholesale Account Executive with CHF,

had the automated underwriting system not been so loose, the loans it approved would otherwise not

have seen the light of day. ¶94. Similarly, a former Mortgage Loan Officer at JP Morgan Chase

stated that the retail branch offices were pushed to qualify applications even for obviously

unqualified people with very poor credit and little ability to repay loans. ¶96.

Courts both within and outside this Circuit have upheld allegations nearly identical to those

here, while simultaneously rejecting attempts like defendants’ to claim purportedly cautionary

8
See also ¶5 (“A review of documentation for 60 loans backing Trust 2007-S3, including
information from the attendant borrowers which have been made publicly available pursuant to
bankruptcy proceedings or other records, reveals that with respect to 43 of those 60 loans (or 71%)
no apparent determination as to whether the borrower could afford to repay his or her loan occurred,
contrary to representations in the Offering Documents.”).

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disclosures immunized them. In Merrill Lynch, Judge Rakoff noted that “[w]hile defendants argue

that underwriting standards are ‘not strict rules’ and that . . . the registration statements only

promised that underwriting ‘guidelines’ would be ‘generally’ followed, the alleged repeated

deviation from established underwriting standards is enough to render misleading the assertion in the

registration statements that underwriting guidelines were generally followed.” 2010 U.S. Dist.

LEXIS 53047, at *18. Similarly, Judge Kaplan in Lehman Bros. rejected arguments virtually

identical to those raised by defendants here. Judge Kaplan held, contrary to defendants’ arguments,

“[t]he complaint, however, does not allege that the loan originators simply made loans pursuant to

the disclosed exceptions. Rather, it alleges that the originators systematically failed to follow the

underwriting guidelines, including the procedures for using underwriting guideline exceptions.”

Lehman Bros., 684 F. Supp. 2d at 493; see also DLJ, 2010 U.S. Dist. LEXIS 47512, at *18-*19;

Residential Capital, 2010 U.S. Dist. LEXIS 32058, at *20; Tsereteli, 692 F. Supp. 2d at 392;

IndyMac, 2010 U.S. Dist. LEXIS 61458, at *12, *33-*34; RBS, 2010 U.S. Dist. LEXIS 29711, at

*42-*45; Wells Fargo, 2010 U.S. Dist. LEXIS 39825, at *37-*38. As the numerous cases cited

above hold, allegations like those pled here are actionable, and are not immunized by defendants’

“disclosures.”

2. The Offering Documents Made Actionable Misrepresentations


Regarding the Appraisal Standards and LTV Ratios

The Offering Documents for Certificates from Trust 2007-S3 (which Lead Plaintiff bought)

also represented that all property appraisals performed in connection with the underlying loans

would be in accordance with USPAP standards. ¶¶97-98. These standards require, inter alia, that an

appraisal be performed by an objective, independent appraiser, who is under no obligation to provide

pre-determined opinions or conclusions. See ¶102. The SAC alleges that these representations were

false because the appraisals did not conform to USPAP standards. ¶¶100-101, 103-112. Rather than

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complying with the standards, AHM and the Chase Originators stripped their appraisers of any

independence or objectivity, and forced them to provide pre-determined, falsely inflated appraisals

under the threat of being “blackballed” from the industry if they failed to comply. Id. As a result,

the appraisals on the properties underlying the loans were falsely inflated. Id. In turn, the LTV

ratios set forth in the Offering Documents, which were calculated using the inflated appraisals, were

falsely understated, thereby materially concealing the risk associated with the loans. ¶¶114-116.

Relying on both a distortion of the SAC’s allegations, as well as a misreading of recent case

law, defendants argue that their misrepresentations regarding appraisal standards and LTV ratios are

not actionable. However, when the actual allegations of the SAC are compared to those pled in the

cases cited by defendants, it is clear that the SAC’s allegations are sufficient. The SAC alleges,

unlike the cases defendants rely on, that the appraisers did not subjectively believe in their “false”

and “artificially inflated” appraisals due to the fact that they were forced to either provide pre-

determined, inflated appraisals or face being “black-balled” within the industry. See, e.g., ¶¶100,

104-112; cf. Tsereteli, 692 F. Supp. 2d at 393 (“The amended complaint is devoid of any such

allegation [that appraisers did not subjectively believe in their appraisals].”); DLJ, 2010 U.S. Dist.

LEXIS 47512, at *22 (same). Accordingly, the holdings defendants rely on to support their

argument for dismissing these allegations are distinguishable.

Similarly, the falsely understated LTV ratios listed in the Offering Documents are actionable

as they were based on the false and artificially inflated appraisals. As the SAC lays out,

“[i]ncorporating an inflated appraisal into the LTV calculation will result in a lower LTV ratio,” and

these lower LTV ratios helped bolster the illusion that “the Certificates were safe and less risky than

they actually were.” ¶115. The SAC further details how a sampling of the actual loans underlying

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the actual Trusts only serve to reinforce the allegations that the Offering Documents’ representations

concerning appraisal standards and LTV ratios were false and misleading.9 While defendants go to

great lengths to cite cases where allegations regarding LTV ratios were dismissed because they were

connected to insufficient allegations regarding appraisals, defendants fail to address the one relevant

decision in Wells Fargo. Allegations similar to those pled by the SAC, that the offering documents

misstated the LTV ratios “because the calculation of the home’s value was frequently based on an

inflated appraisal . . . [and] that the true loan-to-value ratio frequently exceeded 100% because the

homes were actually worth far less than their stated appraisal value,” were upheld. Wells Fargo,

2010 U.S. Dist. LEXIS 39825, at *39. Defendants never disclosed anywhere in their Offering

Documents that the underlying appraisals were false and artificially inflated, or that the LTV ratios

were false and artificially understated, and therefore they cannot escape liability for their material

misstatements.

3. The Credit Ratings Assigned to the Certificates, as


Represented in the Offering Documents, Were False

Defendants’ disclosure argument regarding the false and misleading credit ratings is

premised on a distortion of Lead Plaintiff’s allegations. See Defs.’ Mem. at 20-22. Contrary to

defendants’ assertions, the SAC alleges much more than a mere failure to disclose that the ratings

were subject to change and that a downtown in the general real estate market could eventually lead

to “increased losses . . . ‘borne, at least in part, by the holder of one or more classes of the

securities.’” Id. at 21. Instead, the SAC alleges that the top-tier, AAA “investment grade” ratings

9
See, e.g., ¶¶111, 116 (“A review of property information from 60 loans backing Trust 2007-
S3, including the automated valuation of the attendant properties, reveals that 24 of those loans (or
40%) overvalued the property by 9% or more, compared to the true value of the property at the time
of origination. This overvaluation resulted in an understated LTV ratio for each of these 24 loans.”).

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assigned to the Certificates at the time they were offered to the public, and which were voluntarily

included by defendants in the Offering Documents, were not merely capable of being downgraded at

the discretion of the ratings agency. Rather, the SAC alleges the ratings were actually false at the

time of the offerings due to the inherently flawed models and inaccurate loan information relied on

to derive the ratings. See ¶¶4, 9-10, 117-126. This information was never disclosed anywhere in the

Offering Documents.

The SAC pleads sufficient factual support for plaintiff’s allegations that the ratings “were

inaccurate, false and misleading because they were based . . . on outdated assumptions, relaxed

ratings criteria, and inaccurate loan information.” ¶119; see also ¶¶120-123. In particular, the SAC

alleges the Certificates’ ratings could not possibly have been accurate because the “models [used] to

produce the ratings . . . were based upon loan performance prior to the year 2000,” which had been

rendered “obsolete” by the time the Certificates were rated. ¶120 (emphasis in original). Moreover,

as alleged in the SAC, “the Ratings Agencies repeatedly eased their ratings standards in order to

capture more market share of the ratings business,” and based their ratings “in large part on [false]

data about each of the mortgage loans that defendants provided to them,” which further prevented

the ratings from accurately reflecting the true level of risk associated with the Certificates. ¶¶121-

123.

In addition, the fact that the 60+ day delinquency rates on the underlying loans have

skyrocketed to as high as 42% for some of the Trusts, combined with the fact that in many of the

Trusts at least one in four loans has experienced foreclosure, starkly illustrates not only the reality

that originators were not determining if borrowers would be able to repay their loans, but also that

the Certificates were never AAA investment grade securities. ¶125.

Having voluntarily chosen to include the ratings in the Offering Documents, defendants are

responsible for their veracity. See Citigroup Bond, 2010 U.S. Dist. LEXIS 69257, at *60 (“‘[T]he
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lack of an independent duty is not . . . a defense to . . . liability because upon choosing to speak, one

must speak truthfully and accurately.’”). Because the ratings were false, their inclusion in the

Offering Documents made those materials themselves false and misleading.

4. The SAC’s Allegations Regarding the Materially False and


Misleading Representations in Defendants’ Offering
Documents Satisfy the “Plausibility” Standard of Rule 8

As discussed supra in §III.A.1., “the pleading standard Rule 8 announces does not require

‘detailed factual allegations.’” Ashcroft, 129 S. Ct. at 1949. A complaint need only allege “enough

facts to state a claim to relief that is plausible on its face.” Bell Atl., 550 U.S. at 570; see also

Ashcroft, 129 S. Ct. at 1949 (“The plausibility standard is not akin to a ‘probability requirement,’ but

it asks for more than a sheer possibility that a defendant has acted unlawfully.”). Thus, a plaintiff

need only “‘nudge[] [its] claims across the line from conceivable to plausible’” to avoid dismissal.

Citigroup Bond, 2010 U.S. Dist. LEXIS 69257, at *37. Defendants claim that the SAC’s allegations

fail because the information provided by former employees and executives who worked for the Key

Originators is not specific enough to meet the “plausibility” standard of Fed. R. Civ. P. 8. Defs.’

Mem. at 22-29. Defendants are wrong for several reasons.

First, the allegations contained in the SAC are based on detailed factual information

regarding the actual lending practices employed during the relevant time period by the specific loan

originators who underwrote most of the actual loans that were in the Trusts. See, e.g., ¶¶78-93

(discussing AHM’s originating and underwriting practices), 94-96 (detailing Chase’s originating and

underwriting practices). The SAC further details, via statements from former employees and

executives with direct knowledge of the practices of these loan originators, how loans were being

issued to borrowers who could not afford to repay them. See ¶¶78 (“According to a former [AHM]

District Manager, employees responsible for selling loans were told to ignore the issues which

should not be ignored, such as a borrower’s ability to repay, and just sell the loan programs.”), 94
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(statement by a former Wholesale Account Executive with Chases’ “Home Financial” arm that “the

underwriting process was subject to abuse by brokers who purposely originated loans for people they

knew could not repay them”). This is sufficient.10 To further establish the plausibility of Lead

Plaintiff’s lending guideline allegations, and to tie those allegations to the specific loans in the

Trusts, the SAC further alleges that a sampling of the loans in one of the Trusts establishes that a

large percentage of the loans therein (71%) were made to borrowers who could not afford to repay

the loans. ¶5.

The SAC also alleges with sufficient detail how appraisers were forced to provide false,

inflated, pre-determined values for properties they knew were worth far less. See, e.g., ¶¶107-112.

Plaintiff’s allegations not only demonstrate that appraisals were conducted in direct contravention of

USPAP guidelines, but further contradict defendants’ contentions that these allegations are mere

generalizations (Defs.’ Mem. at 26). See §III.B.2., supra. Moreover, the SAC further establishes the

plausibility of the appraisal allegations, and ties them directly to the loans in the Trusts, through a

sampling of the very loans in the Trusts. ¶8. This sampling of the actual loans in one of the Trusts

reveals that at least 40% of the loans had inflated appraisals. Id. And just as the allegations

regarding appraisal practices are sufficient, so too are the allegations that the stated LTV ratios in

defendants’ Offering Documents were false and misleading, as they were materially understated

because of the falsified inflated appraisals. See Wells Fargo, 2010 U.S. Dist. LEXIS 39825, at *39.

10
See Wells Fargo, 2010 U.S. Dist. LEXIS 39825, at *38-*39 (“Defendants argue that
plaintiffs’ allegations are insufficient to state a claim because plaintiffs have not tied any inconsistent
underwriting conduct to the specific Certificates at issue in this case. . . . [P]laintiffs rely heavily on
the statements of confidential witnesses who assert, among other things, that Wells Fargo placed
‘intense pressure’ on its loan officers to close loans, including by coaching borrowers to provide
qualifying income information, accepting implausible or falsified income information, and lowering
its standards near the end of the calendar year. . . . In the Court’s view, plaintiffs’ allegations with
respect to defendants’ underwriting practices are sufficiently specific to state a claim.”).

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Seven courts within this very District have recently upheld allegations under Rule 8 that were

pled with even less specificity and plausibility than the SAC does here. See, e.g., DLJ, 2010 U.S.

Dist. LEXIS 47512, at *19 (“The allegations here are extreme, yet plausible in light of the rapid and

precipitous decline in market value, concurrent with skyrocketing mortgage loan delinquency rates

and plummeting credit ratings.”); Residential Capital, 2010 U.S. Dist. LEXIS 32058, at *22 (“these

factual allegations about [the originator’s] improper underwriting practices coupled with the loan

pools’ near-total credit rating collapse and default rate spike are sufficient to create a fair inference

that [the originator] totally disregarded the underwriting guidelines, contrary to what was stated in the

Offering Documents”); Tsereteli, 692 F. Supp. 2d at 392 (finding that allegations “that there was

widespread abandonment of underwriting guidelines at [the originator] during the period of time at

issue and that the percentage of ‘defaulting’ loans rose dramatically shortly after the Certificates were

issued . . . create a sufficient nexus between the alleged underwriting standard abandonment and the

loans underlying the Certificates”).11 The SAC plausibly pleads claims under §§11, 12 and 15 of the

Securities Act. Id.

Defendants attempt to have this Court discount allegations provided by former executives,

originators and appraisers who have direct knowledge regarding the facts on which they speak

because they claim they are not described with “sufficient particularity,” or that their statements are

only “subjective generalizations.” Defs.’ Mem. at 23-26. First, this action is not a fraud action where

a plaintiff must plead with particularity under Fed. R. Civ. P. 9(b). Rather, this case is subject to

Rule 8’s requirement of “‘a short and plain statement of the claim.’” Donelli v. County of Sullivan,

No. 07 Civ. 2157 (JGK), 2009 U.S. Dist. LEXIS 66994, at *5 (S.D.N.Y. July 31, 2009); DLJ, 2010

11
IndyMac, 2010 U.S. Dist. LEXIS 61458, at *34; Lehman Bros., 684 F. Supp. 2d at 494; RBS,
2010 U.S. Dist. LEXIS 29711, at *43-*45; Merrill Lynch, 2010 U.S. Dist. LEXIS 53047, at *18.

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U.S. Dist. LEXIS 47512, at *8. Thus, defendants require too much. Second, defendants’ argument

essentially urges the Court to make findings concerning the weight and credibility of witness

statements, subjects long reserved for a jury and therefore inappropriate for resolution at the pleading

stage. United States v. Scheffer, 523 U.S. 303, 313 (1998); Ellenburg, 2010 U.S. Dist. LEXIS

49220, at *3 (“The Court’s function on a motion to dismiss is ‘not to weigh the evidence that

might be presented at trial but merely to determine whether the complaint itself is legally

sufficient.’”). Furthermore, defendants’ contention that plaintiff’s witness statements must be more

specific and must address each and every loan underlying the Trusts (Defs.’ Mem. at 25) would

virtually require the pleading of pre-discovery evidence; a standard not even mandated under the

heightened pleading requirements of Rule 9(b) and the Private Securities Litigation Reform Act of

1995 (“PSLRA”). See, e.g., In re Tower Auto. Sec. Litig., 483 F. Supp. 2d 327, 335 (S.D.N.Y. 2007)

(“The Second Circuit has stated that it does ‘not require the pleading of detailed evidentiary matter in

securities litigation.’”) (quoting In re Scholastic Corp. Sec. Litig., 252 F.3d 63, 72 (2d Cir. 2001));

Miss. Pub. Emps. Ret. Sys. v. Boston Sci. Corp., 523 F.3d 75, 90 (1st Cir. 2008) (“‘in determining the

adequacy of a complaint . . . we cannot hold plaintiffs to a standard that would effectively require

them, pre-discovery, to plead evidence’”).

Finally, defendants argue that Lead Plaintiff’s analysis of a sample of actual loans underlying

the Trusts at issue was neither large enough, nor its results conclusive enough, to avoid dismissal.

Defs.’ Mem. at 27-29. Notwithstanding that defendants’ fact-intensive argument insisting that the

Court “weigh evidence” again falls within the exclusive province of the jury (see Hayes v. N.Y. City

Dep’t of Corrections, 84 F.3d 614, 619 (2d Cir. 1996)), this argument fails for another reason.

Contrary to defendants’ distortion of the SAC’s actual allegations, the analysis conducted on this

sample grouping of loans is simply one additional specific allegation making an already sufficient

set of allegations even more plausible. As the previously cited cases illustrate, seven courts in this
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District have held that allegations of systematic departures from stated loan underwriting guidelines,

coupled with skyrocketing loan delinquencies, and plummeting credit ratings, alone are sufficient to

allege claims under the Securities Act. See IndyMac, 2010 U.S. Dist. LEXIS 61458, at *34; RBS,

2010 U.S. Dist. LEXIS 29711, at *42-*45; Residential Capital, 2010 U.S. Dist. LEXIS 32058, at

*21; Lehman Bros., 684 F. Supp. 2d at 493; DLJ, 2010 U.S. Dist. LEXIS 47512, at *18-*19;

Tsereteli, 692 F. Supp. 2d at 392-93; Merrill Lynch, 2010 U.S. Dist. LEXIS 53047, at *18; cf. Wells

Fargo, 2010 U.S. Dist. LEXIS 39825, at *37-*38. The SAC contains all of the foregoing allegations

(¶¶3, 63, 77-96), plus it goes one step further in alleging the plausibility of the claims by providing

an analysis of actual loans in the Trusts at issue that confirm the systematically false and inflated

appraisals and the failure to conduct even the most basic loan underwriting determination of whether

a borrower could repay his or her loan. Thus, the SAC exceeds the allegations establishing

plausibility in the seven other cases already upheld in this District by making an additional specific

allegation further establishing the plausibility of the claims. Defendants’ arguments should be

rejected.

C. The SAC Properly Asserts §11 Claims Against JP Morgan Chase and
JP Morgan Acquisition

Defendants contend that Lead Plaintiff does not allege a §11 claim against defendant JP

Morgan Chase (“JP Morgan”) and JP Morgan Acquisition (“JPM Acquisition”). Defs.’ Mem. at 36-

37. Defendants’ argument is misguided because it fails to acknowledge the absolutely vital role that

JP Morgan played in the offering of the Certificates. As the SAC pleads, JP Morgan acted as an

underwriter in the sale of all the Certificate offerings, and furthermore owns and controls JPM

Acquisition, the “sponsor” of the challenged securitizations. ¶¶16, 18, 131, 133. In addition, the

SAC alleges JP Morgan participated in drafting and disseminating the Offering Documents. Id.

Whether JP Morgan or JPM Acquisition were specifically listed as “underwriters” in the Offering

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Documents is of no moment. Defendants fail to recognize the Second Circuit’s holding that the term

“[u]nderwriter[],” as used in the Securities Act, is defined to “include any person who is ‘engaged in

steps necessary to the distribution of security issues.’” SEC v. Kern, 425 F.3d 143, 152 (2d Cir.

2005); see also United States SEC v. Universal Express, Inc., 475 F. Supp. 2d 412, 431 (S.D.N.Y.

2007), aff’d sub nom. United States SEC v. Altomare, 300 F. App’x 70 (2d Cir. 2008). As the

“sponsor” of the Certificate offerings, JPM Acquisition was responsible for organizing and initiating

the entire transaction by acquiring the underlying loans from third-party loan originators. JPM

Acquisition then bundled the loans together and conveyed them to the Trusts so that they could be

offered to the public via the false and misleading Offering Documents. ¶¶18, 36.12 JP Morgan and

JPM Acquisition played an absolutely vital role in the offering of the Certificates. Indeed, without

their crucial involvement, the Certificates never would have even come into existence. As such, both

JP Morgan and JPM Acquisition are properly subject to liability under §11 as underwriters for the

Certificates. See 15 U.S.C. §77k(a)(5).

D. Lead Plaintiff Has Standing to Assert the Claims Set Forth in the
SAC

Courts in the Second Circuit and elsewhere have consistently held that the “pleading

requirement for Section 11 standing is satisfied by ‘general allegations that plaintiff purchased

“pursuant to” or traceable to [a] false registration statement.’” In re Marsh & McLennan Cos. Sec.

Litig., 501 F. Supp. 2d 452, 491 (S.D.N.Y. 2006).13 Similarly, in order to have standing to assert

12
See also Regulation AB, 17 C.F.R. §229.1101(l) (“Sponsor means the person who organizes
and initiates an asset-backed securities transaction by selling or transferring assets . . . to the issuing
entity.”).
13
See also Citigroup Bond, 2010 U.S. Dist. LEXIS 69257, at *43 (“if ‘any part of the
registration statement . . . contained an untrue statement of a material fact or omitted to state a
material fact,’ then any person acquiring a security pursuant to that registration statement has

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claims under §12(a)(2), a plaintiff need only generally allege that it purchased securities in a public

offering directly pursuant to a false and misleading prospectus. 15 U.S.C. §77l(a)(2); see also

Gustafson v. Alloyd Co., 513 U.S. 561, 577-78 (1995); Citiline Holdings Inc. v. iStar Fin., Inc., 701

F. Supp. 2d 506, 511-12 (S.D.N.Y. 2010). Here, the SAC clearly satisfies the standing requirements

for both §§11 and 12(a)(2), by setting forth the details regarding Lead Plaintiff’s purchase of

Certificates. ¶15.

Based on its purchase of Certificates pursuant and traceable to the sole Registration

Statement at issue, Lead Plaintiff unquestionably has standing in its own right to assert at least some

claims vis-à-vis each named defendant. Id.; Marsh & McLennan, 501 F. Supp. 2d at 491. As such,

the standing requirement is satisfied, and any remaining questions regarding the proper scope of

plaintiff’s claims are actually not questions of standing at all, but rather, challenges to plaintiff’s

adequacy and typicality as a class representative, which will be addressed at the class certification

stage. See In re Credit Suisse First Boston Corp. Sec. Litig., No. 97 Civ. 4760 (JGK), 1998 U.S.

Dist. LEXIS 16560, at *31 (S.D.N.Y. Oct. 20, 1998) (holding that, where plaintiffs “have standing to

sue the defendants in connection with [their own purchases] . . . [w]hether [they] . . . can also

adequately represent the claims of those class members who purchased [other securities] is a

question that goes to the typicality and adequacy of the plaintiffs as class representatives”).14

standing to sue a variety of participants in the security’s issuance”); In re Countrywide Fin. Corp.
Sec. Litig., 588 F. Supp. 2d 1132, 1165 (C.D. Cal. 2008) (“[Section 11] grants standing to anyone
who buys ‘such security’ – one traceable to a defective registration statement.”).
14
See also 7AA Charles Alan Wright, Arthur R. Miller & Mary Kay Kane, Federal Practice
and Procedure §1785.1, at 388-89 (3d ed. 2005) (“Representative parties who have a direct and
substantial interest have standing; the question whether they may be allowed to present claims on
behalf of others who have similar, but not identical, interests depends not on standing, but on an
assessment of typicality and adequacy of representation.”); Cent. States Se. & Sw. Areas Health &
Welfare Fund v. Merck-Medco Managed Care, L.L.C., 504 F.3d 229, 241 (2d Cir. 2007) (“‘for every

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Defendants do not and cannot contest Lead Plaintiff’s standing in its own right to assert at

least some claims vis-à-vis each named defendant. See Defs.’ Mem. at 10-11. Instead, they ask the

Court to rule on class certification now. See Grasty v. Amalgamated Clothing & Textile Workers

Union, etc., 828 F.2d 123, 130 n.8 (3d Cir. 1987) (“[defendants] confuse standing and the typicality

requirement of Rule 23(a)(3)”). As numerous courts have held, defendants’ “standing” argument is

improper at the motion to dismiss stage. See Credit Suisse, 1998 U.S. Dist. LEXIS 16560, at *31;

Cent. States, 504 F.3d at 241.15 As set forth above, Lead Plaintiff has demonstrated its standing to

assert claims in its own right against each named defendant, and nothing more is required at this

stage of the litigation.

Moreover, even when courts have addressed the issue at the motion to dismiss stage, they

have frequently held that, where as here, multiple securities are issued pursuant to a common

registration statement, standing to assert §11 claims based on all such securities lies with any

plaintiff who acquires any of the securities pursuant and/or traceable to the common registration

statement. See, e.g., Citigroup Bond, 2010 U.S. Dist. LEXIS 69257, at *41-*44 (finding that

plaintiffs who purchased securities in 19 of 48 offerings issued pursuant to common registration

named defendant there must be at least one named plaintiff who can assert a claim directly against
that defendant, and at that point standing is satisfied and . . . the inquiry shift[s] to a class action
analysis’”).
15
See also In re Dreyfus Aggressive Growth Mut. Fund Litig., No. 98 Civ. 4318 (HB), 2000
U.S. Dist. LEXIS 13469, at *8 (S.D.N.Y. Sept. 20, 2000) (addressing similar argument and finding
“[c]ourts have not addressed this concern vis a vis the doctrine of standing, but rather have examined
such concerns pursuant to Rule 23(a)(3)’s typicality requirement”); In re Westinghouse Sec. Litig.,
90 F.3d 696, 718 n.22 (3d Cir. 1996) (“While these concerns might be relevant on a motion for class
certification, they do not address whether, as a threshold matter, plaintiffs properly stated a
[§12(a)(2)] claim under Rule 12(b)(6).”); Countrywide, 588 F. Supp. 2d at 1167 (“The well
developed class certification framework will better guide this inquiry and lead to more efficient
resolution of class claims than standing’s sometimes-arbitrary distinctions.”).

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statements had sufficient standing “to raise claims on behalf of all those who purchased pursuant to

those shelf registration statements and thus to challenge all forty eight offerings”); In re WorldCom,

Inc. Sec. Litig., No. 02 Civ. 3288 (DLC), 2004 U.S. Dist. LEXIS 4240, at *6-*7 (S.D.N.Y.

Mar. 19, 2004) (finding purchasers of one type of debt security had standing to pursue claims on

behalf of purchasers of a second type of debt security issued pursuant to the same

registration statement).16

This is particularly true in the instant situation, where a plaintiff alleges actionable

misstatements that are common to all class members. Citigroup Bond, 2010 U.S. Dist. LEXIS

69257, at *43 (“where a plaintiff alleges untrue statements in the shelf registration statement or the

documents incorporated therein . . . that plaintiff has standing to raise claims on behalf of all

purchasers from the shelf”); accord Countrywide, 588 F. Supp. 2d at 1165-66 (“If the initial shelf

registration statement contained an actionable statement or omission that is common to more than

one issuance under the shelf registration, then purchasers in those issuances may be able to trace the

same injury to the same ‘registration statement.’”). Here, as in Citigroup Bond and Countrywide, the

SAC alleges Lead Plaintiff was injured as a result of material misstatements and omissions in the

sole Registration Statement; misrepresentations that were common to all Certificate holders. ¶¶67-

16
Accord Countrywide, 588 F. Supp. 2d at 1165 (finding §11 standing for all offerings pursuant
to an “initial shelf registration statement contain[ing] an actionable statement or omission that is
common to more than one issuance”); In re Juniper Networks Sec. Litig., 264 F.R.D. 584, 594 (N.D.
Cal. 2009) (finding §11 standing for stockholders to represent note holders and holding, “plaintiffs
with a valid securities claim may represent the interests of purchasers of other types of securities in a
class action where the alleged harm stems from the same allegedly improper conduct”); In re
Fleming Cos. Sec. & Derivative Litig., No. 5-03-MD-1530 (TJW), 2004 U.S. Dist. LEXIS 26488, at
*153 (E.D. Tex. June 10, 2004) (“case law holds that purchasers of one type of security have
standing to sue on behalf of purchasers of other types of security issued pursuant to a single
registration statement”) (emphasis in original); In re MobileMedia Sec. Litig., 28 F. Supp. 2d 901,
911 (D.N.J. 1998) (finding §11 standing for stock purchasers to represent note purchasers where the
different types of securities were both issued pursuant to the same registration statement).

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68, 97, 117, 129. As such, Lead Plaintiff clearly has standing to represent all Certificate

purchasers.17

Lead Plaintiff respectfully submits that the cases relied on by defendants to support their

argument that a purchaser of mortgage-backed securities may not assert claims on behalf of other

similar purchasers who acquire their securities pursuant to the same misleading registration

statement, but not the identical prospectus supplement, are wrongly decided on the standing issue.

See Defs.’ Mem. at 10 n.26. However, should the Court be inclined to dismiss any portion of the

case on the standing basis set forth in these opinions, Lead Plaintiff submits that an additional party

will file contemporaneous with the filing of this opposition (or shortly thereafter) a motion to

intervene with respect to identical claims and causes of action relating to its purchases of the Series

2007-S1 and Series 2007-A2 Certificates. Allegations regarding these Certificates are already

included in the SAC (see ¶¶19, 28, 70-72, 78-96), and therefore should not be dismissed.

E. The SAC Alleges that Certificate Holders Have Been Injured by the
Certificates’ Significant Decline in Value

Defendants argue that the SAC “does not plead a legally cognizable economic loss,” and

therefore has failed to state a claim under §§11 and 12(a)(2). Defs.’ Mem. at 32. Contrary to

defendants’ assertions, the SAC alleges that Lead Plaintiff and the class have suffered a legally

cognizable loss as a direct result of the Certificates’ decline in value. See ¶¶10-12, 124-126. In

support of this allegation, the SAC alleges substantial factual detail regarding: (i) the massive ratings

17
Contrary to defendants’ assertions, the SAC also establishes Lead Plaintiff’s standing to
assert claims pursuant to §12(a)(2), by setting forth the details of Lead Plaintiff’s Certificates
purchase and alleging that defendants “promoted and sold the Certificates to Lead Plaintiff and other
member of the Class.” ¶¶15, 141; IndyMac, 2010 U.S. Dist. LEXIS 61458, at *12 (finding
allegations nearly identical to those alleged in the SAC to be sufficient to establish standing pursuant
to §12(a)(2)).

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downgrades experienced by all tranches of the Certificates (¶¶10, 124-125); (ii) the skyrocketing

delinquency rates associated with the underlying loans (¶125); and (iii) the dramatic price declines

experienced by the Certificates in the secondary market (¶12). Indeed, the SAC specifically alleges

that a secondary market for the purchase and sale of the Certificates does exist, and that in March of

2009, the time at which the initial complaint in this action was filed, the Certificates were trading

for, at most, 62 cents on the dollar, or approximately 38% less than the offering price. Id. As such,

Lead Plaintiff and the entire class have suffered actual cognizable injuries. In fact, the plain

language of §11 explicitly recognizes the kind of injury alleged in the SAC. Specifically, the statute

provides:

“The suit . . . may be to recover such damages as shall represent the


difference between the amount paid for the security (not exceeding the price at
which the security was offered to the public) and (1) the value thereof as of the time
such suit was brought, or (2) the price at which such security shall have been
disposed of in the market before suit, or (3) the price at which such security shall
have been disposed of after suit but before judgment if such damages shall be less
than the damages [as calculated under subsection (1), above] . . . .”

McMahan & Co. v. Wherehouse Entm’t, 65 F.3d 1044, 1047-48 (2d Cir. 1995) (quoting 15 U.S.C.

§77k(e)). Interpreting this plain language, courts routinely hold that plaintiffs who retain possession

of their securities at the time of the lawsuit’s filing need only allege a decline in the value of those

securities, in order to state a cognizable injury under §11. See id. at 1048 (holding that, under §11, a

“decline in market value permits plaintiffs to recover damages under the statutory scheme”); DLJ,

2010 U.S. Dist. LEXIS 47512, at *12 (“Plaintiff’s alleged injury is the loss of market value.”); In re

Initial Pub. Offering Sec. Litig. (“IPO II”), 241 F. Supp. 2d 281, 347, 351 n.80 (S.D.N.Y. 2003)

(“Section 11(e) sets the measure of damages for a plaintiff still holding her securities at the ‘value’

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of those securities at the time of suit.”).18 As set forth above, the SAC here alleges precisely that.

¶¶10-12, 124-126.

In light of the plain language of 15 U.S.C. §77k(e), and the SAC’s allegations regarding the

Certificates’ actual decline in value, defendants’ argument that Lead Plaintiff and other members of

the class may suffer actionable damages “only if there is a failure to distribute the pass-through

payments,” is entirely misplaced. Defs.’ Mem. at 32-33. This same argument was recently

addressed, and summarily rejected, by Judge Crotty in DLJ, a decision that addressed §11 claims

related to mortgage-backed securities very similar to those at issue here. See DLJ, 2010 U.S. Dist.

LEXIS 47512, at *12-*16. There, defendants argued, as they do here, that the plaintiff had “failed to

allege a cognizable injury” because it did “not allege that it failed to receive any principal or interest

payments due under its Certificates.” Id. at *13. The court, however, rejected this strained

reasoning, deeming it “too cramped a reading of damages,” and analogizing mortgage-backed

securities to corporate bonds, which share many of the same characteristics. Id. at *14 (“Many

fixed-income debt securities, such as corporate bonds do not trade on national exchanges and yet

institutional investors routinely purchase corporate bonds hoping to realize a profit through resale.”).

The court then explicitly rejected defendants’ lack of damages argument, holding that, because

18
Accord Levine v. AtriCure, Inc., 508 F. Supp. 2d 268, 276 (S.D.N.Y. 2007) (“To avoid
dismissal for lack of constitutional standing, the Court finds that a plaintiff need only allege that he
purchased a security pursuant to a false or misleading registration statement, and that at the time of
the sale of the security or at the end of the class period, the value of the security had declined.”); In
re Ulta Salon, Cosmetics & Fragrance, Inc., 604 F. Supp. 2d 1188, 1194 (N.D. Ill. 2009) (“Because
the stock was selling below the IPO price at the time suit was filed [plaintiff] has alleged damages.”).

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“[t]his is a securities claim, not a breach of contract case . . . [p]laintiff’s market value allegations are

sufficient.” Id.19

DLJ also explicitly rejected defendants’ reliance on AIG Global Sec. Lending Corp. v. Banc

of Am. Sec. LLC, 646 F. Supp. 2d 385 (S.D.N.Y. 2009), aff’d, No. 09-2367-cv, 2010 U.S. App.

LEXIS 14831 (2d Cir. July 20, 2010), the main case relied on by defendants here, finding it

distinguishable and therefore inapplicable to plaintiff’s §11 claims. See DLJ, 2010 U.S. Dist. LEXIS

47512, at *14-*16. As explained by the DLJ court, the plaintiffs in AIG brought claims under §10 of

the Securities Exchange Act of 1934, not §11 of the Securities Act, and based not on their securities’

decline in value, but instead, on the issuing trust’s “fail[ure] to contractually deliver.” Id. at *15. As

such, the DLJ court held that “[AIG] is not on point,” because it “does not hold that investors in

mortgage-backed securities do not allege a cognizable injury when they allege a loss arising from a

decrease in market value.” Id. *14-*15.20

Here, as in DLJ, Lead Plaintiff alleges that, irrespective of any continued pass-through

payments, the actual value of the Certificates has declined significantly due to the realization that

19
See also McMahan, 65 F.3d at 1048 (holding that “benefit of the bargain” damages, such as
those defendants seek to focus on here, are unavailable under §11).
20
Defendants’ reliance on Judge Cedarbaum’s remarks following oral argument in NECA-
IBEW Health & Welfare Fund v. Goldman Sachs & Co., No. 08 CV 10783 (MGC) (S.D.N.Y.
Jan. 28, 2010), is similarly misplaced. As an initial matter, plaintiff respectfully submits that Judge
Cedarbaum is plainly incorrect to the extent she purports to impose a contract-based theory of
damages to plaintiff’s claims, as opposed to the value-based concept explicitly set forth under §11.
See Declaration of Dorothy J. Spenner in Support of Defendants’ Motion to Dismiss the Second
Amended Complaint (“Spenner Decl.”), Ex. Q at 11; see also DLJ, 2010 U.S. Dist. LEXIS 47512, at
*13-*14; McMahan, 65 F.3d at 1048. Moreover, defendants conveniently ignore the fact that Judge
Cedarbaum granted plaintiffs in that case leave to amend in order to state facts regarding those
securities’ value on the secondary market, and indicated that such facts would likely state a claim for
damages under §11. Spenner Decl., Ex. Q at 17, 26. Here, Lead Plaintiff has already alleged such
facts. ¶12.

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“holders of the Certificates are exposed to much more risk, with respect to both the timing and

absolute cash flow to be received.” ¶11. Defendants’ argument that this kind of injury is

“speculative” and “not actionable” is incorrect. Defs.’ Mem. at 33. As set forth above, damages

under §11 focus on “value,” not contractual rights, and as the cases defendants cite recognize, the

question of whether Certificate holders are likely to receive less absolute cash flow in the future is

directly relevant to – in fact, determinative of – the present value of the Certificates. See id. at 32

n.74 (citing In re First Union Corp. Sec. Litig., 128 F. Supp. 2d 871, 895 n.22 (W.D.N.C. 2001)

(“Valuation of mortgage-backed securities . . . is an exercise in estimating expected future cash

flows.”)). Like DLJ, “[t]his is a securities claim, not a breach of contract case,” and therefore

defendants’ argument that plaintiff has failed to allege a legally cognizable loss must fail. 2010 U.S.

Dist. LEXIS 47512, at *14.

F. Defendants Cannot Escape Liability by Pointing to Purported “Cure”


Provisions in the Offering Documents

Effectively admitting that the class has suffered damages, defendants contend that they

should be relieved of liability because the Offering Documents purportedly describe a process by

which bad loans could be “cured” or replaced at the request of the investor. See Defs.’ Mem. at 29-

30. But this “cure” procedure does not apply here, as liability exists under §§11 and 12(a)(2) for a

misstatement in the Offering Documents irrespective of any other remedial relief. See 15 U.S.C.

§77k. These provisions may not be waived, and language to the contrary in any offering document

is void ab initio. 15 U.S.C. §77n (“Any condition, stipulation, or provision binding any person

acquiring any security to waive compliance with any provision of this title or of the rules and

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regulations of the Commission shall be void.”).21 Significantly, “[t]he statutory framework of the

1933 and 1934 Acts compels the conclusion that individual securityholders may not be forced to

forego their rights under the federal securities laws due to a contract provision.” McMahan, 65 F.3d

at 1050-51 (holding that claims under the federal securities laws cannot be precluded by a “no-action

clause” in an indenture).

Moreover, defendants’ citation to Lone Star Fund V (US) v. Barclays Bank PLC, 594 F.3d

383 (5th Cir. 2010), is inapposite to the law of this Circuit. Whatever the law may be in the Fifth

Circuit, the Second Circuit clearly holds that, “individual securityholders may not be forced to

forego their rights under the federal securities laws due to a contract provision.” McMahan, 65 F.3d

at 1050-51 (voiding a “no-action clause” in a registered security that put “Limitation on Suits”

because it would “bar that plaintiff from commencing a securities law claim”). Further, Lone Star is

wholly distinguishable on its facts, as the court’s holding there was based on its finding that

defendants “made no actionable misrepresentations.” 594 F.3d at 389. Here, that is clearly not the

case. In addition, unlike the Lone Star plaintiffs, who alleged that a small number of specific loans

in each of the pools were delinquent, the SAC alleges that the Offering Documents misrepresented

the entire process by which the vast majority of the loans at issue were underwritten. ¶¶5-12, 63-96,

124-126.

21
Because of the express terms of the Securities Act, “courts have been careful in securities
cases to preserve the rights of private action under the securities laws.” Stratmore v. Combs, 723
F. Supp. 458, 461 (N.D. Cal. 1989) (“‘Since the securities laws are a remedial measure intended to
encourage the prosecution of securities fraud actions, the Court refuses to enforce this indemnity
provision.’”) (emphasis in original), aff’d sub nom. McGonigle v. Combs, 968 F.2d 810 (9th Cir.
1992), and aff’d in part and rev’d in part on other grounds sub nom. Layman v. Combs, 98 F.2d
1093 (9th Cir. 1992).

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In any event, defendants’ purported “cure” remedy is not available to Lead Plaintiff and is

thus irrelevant. This is so because only an investor with “Percentage Interests aggregating not less

than 25%” of a Trust is entitled to institute such a remedy. See Leahy Decl., Ex. B at §6.01(e)

(quoting from Pooling and Servicing Agreement for Trust 2007-S3) It is undisputed that Lead

Plaintiff’s Certificates constitute much less than 25% of Trust 2007-S3, since Lead Plaintiff bought

approximately $3 million in certificates and the offering for Trust 2007-S3 was for over $1.8 billion.

See Declaration of Mario Alba Jr. in Support of the Motion of Employees’ Retirement System of the

Government of the Virgin Islands for Appointment as Lead Plaintiff and for Approval of Selection

of Lead Counsel, Ex. B [Docket No. 40]; Spenner Decl., Ex. B at 1. Moreover, defendants’ “cure”

remedy is not available at this time as such remedy had to be requested “within two years after the

Closing Date.” Leahy Decl., Ex. B at §2.05(b). The Closing Date was July 27, 2007 (id. at §1.01

(Closing Date)). Therefore, defendants’ “cure” argument is a red herring.

G. The SAC Adequately States Claims Pursuant to §15

Section 15 extends liability created under §§11 and 12(a)(2) to “[e]very person who, by or

through stock ownership, agency, or otherwise, . . . controls any person liable under section 11 or

12.” 15 U.S.C. §77o(a). “In order to state a claim for control person liability under Section 15, ‘a

plaintiff must allege “(a) a primary violation by a controlled person, and (b) control by the defendant

of the primary violator.”’” In re WorldSpace Sec. Litig., No. 07 Civ. 2252 (RMB), 2008 U.S. Dist.

LEXIS 56224, at *20 (S.D.N.Y. July 21, 2008); see also Citigroup Bond, 2010 U.S. Dist. LEXIS

69257, at *76 (“control for purposes of Section 15 entails only “‘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”’”). As set forth fully above, the SAC adequately alleges

primary violations of both §§11 and 12(a)(2) by the defendants. Thus, plaintiff’s §15 claim is viable,

as the underlying §§11 and 12(a)(2) claims are actionable as a matter of law. Moreover, the control
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person liability of JP Morgan is alleged by its complete ownership and control of the primary

violators, JP Morgan Acceptance and JP Morgan Securities, as well as JP Morgan’s participation in

drafting and disseminating the Offering Documents. See ¶¶16-19, 147. The SAC also alleges that

each of the Individual Defendants was an officer and/or director of JP Morgan Acceptance during

the relevant time period, each signed the Registration Statement, and that JP Morgan Acceptance

was the Depositor and the Issuer of the Certificates while JP Morgan Securities was an underwriter.

¶¶20-25, 148-149. The SAC further alleges that each Individual Defendant: (1) was responsible for

the preparation of the contents of the Registration Statement and the Prospectus Supplements which

were incorporated therein; (2) prepared, reviewed, and signed or authorized the signing of the

Registration Statement; and (3) was responsible for the formation of the Trusts, as well as the

operation of the Trusts. ¶¶148-150. These facts are more than sufficient to establish a claim

pursuant to §15. See Lehman Bros., 684 F. Supp. 2d at 495; In re CIT Group Inc. Sec. Litig., No. 08

Civ. 6613 (BSJ), 2010 U.S. Dist. LEXIS 57467, at *23-*24 (S.D.N.Y. June 10, 2010) (same).22

Accordingly, defendants’ motion to dismiss the SAC for failing to plead a claim under §15 should be

denied.

H. Lead Plaintiff’s Claims Are Not Time-Barred

Defendants contend that Lead Plaintiff was on inquiry notice of its claims before March 11,

2008 – more than one year prior to the commencement of this action – and, therefore, its claims are

22
Moreover, the question of whether the Individual Defendants exercised sufficient control
over a corporation is an inherently factual question and one that should not be resolved at the
pleading stage. Citiline, 701 F. Supp. 2d at 516-17; see also Howard v. Everex Sys., 228 F.3d 1057,
1065 (9th Cir. 2000) (“‘Whether [the defendant] is a controlling person is an intensely factual
question, involving scrutiny of the defendant’s participation in the day-to-day affairs of the
corporation and the defendant’s power to control corporate actions.’”).

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time-barred under §13 of the Securities Act.23 Defendants are wrong.24 As an initial matter, it is

difficult to understand how Lead Plaintiff could have been on notice of its clams by March 11, 2008,

when it did not even acquire the Certificates at issue until more than fourth months later, on

July 18, 2008. ¶15. It seems elementary that a plaintiff’s cause of action cannot accrue, and the

statute of limitations cannot begin to run, until the plaintiff purchases the security. Grondahl v.

Merritt & Harris, Inc., 964 F.2d 1290, 1294 (2d Cir. 1992 ) (“The statute of limitations in federal

securities law cases starts to run on the date that the parties have committed themselves to complete

the purchase or sale transaction.”) (emphasis in original). Moreover, even if Lead Plaintiff had

acquired its Certificates prior to the date by which defendants contend it should have been aware of

its claims, numerous courts from within this Circuit have recently rejected the same inquiry notice

arguments advanced by defendants here. See, e.g., RBS, 2010 U.S. Dist. LEXIS 29711, at *34-*35

(holding that defendants’ argument based on “publicly available documents generally related to the

weakening and outright disregard for underwriting guidelines by subprime originators” provided

“insufficient information . . . to determine that Plaintiffs’ claims are time-barred as a matter of law”);

23
Section 13 of the Securities Act governs the timeliness of claims brought pursuant to §§11,
12(a)(2) and 15, and provides, in relevant part, that “[n]o action shall be maintained . . . under [§§11
or 12(a)(2)] unless brought within one year after the discovery of the untrue statement or the
omission, or after such discovery should have been made by the exercise of reasonable diligence.”
15 U.S.C. §77m. Because plaintiff commenced this action on March 11, 2009, defendants must
demonstrate inquiry notice of probable wrongdoing and legal claims prior to March 11, 2008 in
order for plaintiff’s claims to be barred.
24
Defendants’ argument relies extensively on the availability of various materials from outside
the pleadings. While plaintiff recognizes the Court may take judicial notice of the fact that such
materials were in existence at the time, plaintiff objects to the use of any such materials to support
the truth of the matters asserted therein. Staehr v. Hartford Fin. Servs. Group, 547 F.3d 406, 424
(2d Cir. 2008) (noting with approval that, “[t]he District Court took judicial notice of, inter alia,
media reports . . . and regulatory filings” but “did ‘not take judicial notice of the documents for the
truth of the matters asserted in them, but rather to establish that the matters [had] been publicly
asserted’”).

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Merrill Lynch, 2010 U.S. Dist. LEXIS 53047, at *6-*9 (rejecting similar argument based on the

court’s holding that “where there are plausible inferences to be drawn in either direction, the issue of

‘whether a plaintiff had sufficient facts to place it on inquiry notice is “often inappropriate for

resolution on a motion to dismiss under Rule 12(b)(6)”’”).25

The statute of limitations is “an affirmative defense on which the defendant has the burden of

proof.” Bano v. Union Carbide Corp., 361 F.3d 696, 710 (2d Cir. 2004). In order to meet this

burden, defendants must present uncontroverted evidence of so-called “storm warnings,” which

must be directly related to the legal claims asserted by plaintiff. Staehr, 547 F.3d at 427. In the

Second Circuit, defendants’ evidence of storm warnings must be such that they would apprise a

person of reasonable intelligence that the wrongdoing and legal claims which form the basis of

plaintiff’s suit were “‘probable, not merely possible.’” Shah v. Meeker, 435 F.3d 244, 249 (2d Cir.

2006); Jackson Nat’l Life Ins. Co. v. Merrill Lynch & Co., 32 F.3d 697, 701 (2d Cir. 1994). As such,

“Southern District courts have variously described defendants’ burden in this regard as

‘extraordinary’ and appropriate only in ‘extreme circumstances.’” In re Sumitomo Copper Litig.,

120 F. Supp. 2d 328, 347 (S.D.N.Y. 2000).26 Here, defendants’ conclusory assertions that “[t]he

25
See also Mass. Bricklayers & Masons Funds v. Deutsche Alt -A Sec., No. CV 08-3178, 2010
U.S. Dist. LEXIS 33976, at *3 (E.D.N.Y. Apr. 6, 2010) (rejecting similar statute of limitations
argument based on its finding that “[q]uestions of fact regarding circumstances of discovery of
allegedly false information preclude the entry of judgment at this stage of the proceedings”);
Teamsters Local 445 Freight Div. Pension Fund v. Bombardier Inc., No. 05 Civ. 1898 (SAS), 2005
U.S. Dist. LEXIS 19506, at *39 (S.D.N.Y. Sept. 6, 2005) (denying motion to dismiss brought on
behalf of purchasers of mortgage-backed certificates alleging material misrepresentations and
omissions regarding the integrity of defendants’ underwriting standards for loan origination, and
noting that “[a] close reading of the [analyst] reports cited by defendants in support of their claim of
inquiry notice reveals that few of the facts necessary to establish plaintiff’s core claims are found in
those reports”).
26
See also In re Polaroid Corp. Sec. Litig., 465 F. Supp. 2d 232, 246 (S.D.N.Y. 2006) (“the
U.S. Court of Appeals for the Second Circuit has stressed the caution with which courts must

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crisis in the mortgage-backed securities market was widely known and reported long before

March 11, 2008” (Defs.’ Mem. at 35) fall well short of satisfying this “extraordinary” burden.

Notably, none of the so-called “prominent reports” or other publicly available information

relied on by defendants to establish inquiry notice specifically mention the Certificates, the Trusts,

the specific underlying loans, or any of the defendants at issue here. See Defs.’ Mem. at 34-36.

As numerous courts have held, such generic, non-specific materials cannot satisfy the extremely

heavy burden of irrefutably establishing that a reasonable investor would have been put on notice

that its Securities Act claims were probable. See, e.g., Staehr, 547 F.3d at 426-33 (rejecting

defendants’ inquiry notice argument based on finding that “nearly all of the stories in the record are

devoid of company-specific information”); RBS, 2010 U.S. Dist. LEXIS 29711, at *34-*35

(rejecting argument similar to defendants’ here because the information relied on by defendants

“[did] not ‘relate directly’ to the misrepresentations and omissions alleged in the [Complaint]”).27

approach the inquiry notice question on a motion to dismiss”) (citing Lentell v. Merrill Lynch & Co.,
396 F.3d 161, 168 (2d Cir. 2005)); In re Executive Telecard, Ltd. Sec. Litig., 913 F. Supp. 280, 283
(S.D.N.Y. 1996) (inquiry notice should be resolved as a matter of law only where “no reasonable
fact finder analyzing the circumstances as presented, could determine that inquiry notice did not
exist”) (citing Dodds v. Cigna Sec., Inc., 12 F.3d 346, 350 (2d Cir. 1993)); Dorchester Investors v.
Peak Int’l Ltd., 134 F. Supp. 2d 569, 577 (S.D.N.Y. 2001) (finding that “the issue of whether
Plaintiffs were on inquiry notice, and thus whether their claims are barred by the statute of
limitations, is a factual one to be resolved by the trier of fact”).
27
Defendants contend that Lead Plaintiff “cannot simultaneously rely upon unspecific
allegations to state a claim and ignore that public information regarding industry deviation from
underwriting guidelines placed it on inquiry notice of its claims.” Defs.’ Mem. at 35 (emphasis in
original). Defendants, however, overlook the significant distinctions between the respective
standards for stating a claim and demonstrating inquiry notice as a matter of law. As set forth above,
the totality of facts alleged in the SAC – which include information publicly available after
March 11, 2008, as well as information derived from Lead Plaintiff’s counsel’s non-public
investigatory efforts – satisfy Rule 8(a)’s liberal pleading standards by stating claims that are clearly
much more than “plausible.” See Ashcroft, 129 S. Ct. at 1949 (“The plausibility standard is not akin
to a ‘probability requirement’ . . . .”). By contrast, however, the generic materials relied on by
defendants – which include only information publicly available before March 11, 2008 – cannot

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Moreover, contrary to defendants’ misleading assertions, the majority of the Certificates at

issue in the SAC were not downgraded by the rating agencies until well after March 11, 2008.

Indeed, with regard to the 2007-S3 Certificates purchased by Lead Plaintiff, none of the tranches

were downgraded before August of 2008. See Leahy Decl., Ex. A (showing ratings downgrades for

all tranches of the 2007-S3 Certificates). In fact, the specific tranche of Certificates purchased by

Lead Plaintiff – 2007-S3 Class 1A1 – was not downgraded at all until November 11, 2008 and, even

then, it was downgraded only by one Rating Agency, S&P, from AAA to A, still “investment grade”

quality. Id. at 1. It was not until April of 2009 that the specific Certificates purchased by Lead

Plaintiff were downgraded below the “investment-grade” level. Id. While it has subsequently come

to light that these credit ratings were inherently false and unreliable, the ratings were, at the time,

considered to be reliable measures of investment risk. As such, it is reasonable that Lead Plaintiff

would have viewed the “investment grade” ratings assigned to the Certificates as assurance that it

had not been misled by any representations in the Offering Documents. See eSpeed, 457 F. Supp. 2d

at 285 (“Courts often decline to find that plaintiffs were on inquiry notice in the face of such

‘reliable words of comfort’ designed to counter information that might otherwise give rise to inquiry

notice.”); Merrill Lynch, 2010 U.S. Dist. LEXIS 53047, at *7 (discussing fact that “certificates at

issue were not downgraded below investment grade until . . . after the . . . limitation date,” and

rejecting defendants’ inquiry notice argument); RBS, 2010 U.S. Dist. LEXIS 29711, at *34-*35

(same).

possibly satisfy the “extraordinary” burden of irrefutably demonstrating that a reasonable investor
would have understood, at that time, that its Securities Act claims were not merely plausible, but
probable. See, e.g., Staehr, 547 F.3d at 426-33; Sumitomo, 120 F. Supp. 2d at 347.

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IV. CONCLUSION

For the foregoing reasons, Lead Plaintiff respectfully requests that the Court deny

defendants’ motion to dismiss in its entirety.28

DATED: September 13, 2010 Respectfully submitted,

ROBBINS GELLER RUDMAN


& DOWD LLP
ARTHUR C. LEAHY
THOMAS E. EGLER
SUSAN G. TAYLOR
SCOTT H. SAHAM
NATHAN R. LINDELL
MATTHEW I. ALPERT

s/ ARTHUR C. LEAHY
ARTHUR C. LEAHY

655 West Broadway, Suite 1900


San Diego, CA 92101
Telephone: 619/231-1058
619/231-7423 (fax)
artl@rgrdlaw.com
tome@rgrdlaw.com
susant@rgrdlaw.com
scotts@rgrdlaw.com
nlindell@rgrdlaw.com
malpert@rgrdlaw.com

28
Should the Court grant any part of defendants’ motion, plaintiff respectfully requests leave to
amend the SAC. See Fed. R. Civ. P. 15(a)(2) (“The court should freely give leave when justice so
requires.”); see also Foman v. Davis, 371 U.S. 178, 182 (1962) (“In the absence of any apparent or
declared reason – such as undue delay, bad faith or dilatory motive on the part of the movant,
repeated failure to cure deficiencies by amendments previously allowed, undue prejudice to the
opposing party by virtue of allowance of the amendment, futility of amendment, etc. – the leave
sought should, as the rules require, be ‘freely given.’”); Roberts v. Cooperatieve Centrale Raiffeisen-
Boeren Leenbank B.A., No. 09 Civ. 5271 (JGK), 2010 U.S. Dist. LEXIS 461, at *2 (S.D.N.Y. Jan. 5,
2010) (citing Foman).

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Case 1:09-cv-03701-JGK Document 92 Filed 09/13/10 Page 49 of 52

ROBBINS GELLER RUDMAN


& DOWD LLP
SAMUEL H. RUDMAN
DAVID A. ROSENFELD
CAROLINA C. TORRES
JARRETT S. CHARO
58 South Service Road, Suite 200
Melville, NY 11747
Telephone: 631/367-7100
631/367-1173 (fax)
srudman@rgrdlaw.com
drosenfeld@rgrdlaw.com
ctorres@rgrdlaw.com
jcharo@rgrdlaw.com

Lead Counsel for Plaintiff

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Case 1:09-cv-03701-JGK Document 92 Filed 09/13/10 Page 50 of 52

CERTIFICATE OF SERVICE

I hereby certify that on September 13, 2010, I authorized the electronic filing of the foregoing

with the Clerk of the Court using the CM/ECF system which will send notification of such filing to

the e-mail addresses denoted on the attached Electronic Mail Notice List, and I hereby certify that I

caused to be mailed the foregoing document or paper via the United States Postal Service to the non-

CM/ECF participants indicated on the attached Manual Notice List.

I certify under penalty of perjury under the laws of the United States of America that the

foregoing is true and correct. Executed on September 13, 2010.

s/ ARTHUR C. LEAHY
ARTHUR C. LEAHY

ROBBINS GELLER RUDMAN


& DOWD LLP
655 West Broadway, Suite 1900
San Diego, CA 92101-3301
Telephone: 619/231-1058
619/231-7423 (fax)

E-mail: artl@rgrdlaw.com

577179_1
SDNY CM/ECF Version 4.0.3- Page 1 of 2
Case 1:09-cv-03701-JGK Document 92 Filed 09/13/10 Page 51 of 52

Mailing Information for a Case 1:09-cv-03701-JGK


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 Floyd Abrams
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tlaughlin@scott-scott.com,efile@scott-scott.com

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srudman@rgrdlaw.com,e_file_ny@rgrdlaw.com

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scotts@csgrr.com

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therefore require manual noticing). You may wish to use your mouse to select and copy this list into
your word processing program in order to create notices or labels for these recipients.

Geoffrey M. Johnson
Scott + Scott, LLC
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