In a three-year old class action lawsuit against Morgan Stanley arising out of the collapse of the housing market, the Southern District of New York denied class certification to a proposed class of “all African-American individuals who, between 2004 and 2007, resided in the Detroit region . . . and received Combined-Risk Loans from New Century.”   The Court, while not unsympathetic to Plaintiffs’ claims, held that the proposed class was unworkable. Adkins v. Morgan Stanley,No.12-CV-7667(VEC), 2015 WL 2258231 (S.D.N.Y. May 14, 2015)

In October 2012, Plaintiffs brought claims under the Fair Housing Act, seeking to hold Morgan Stanley responsible for discrimination against African-American borrowers based on disparate impact. Plaintiffs’ expert found that, in the Detroit region, the likelihood that an African-American would receive a “Combined-Risk Loan” was 1.347 times greater than that of a non-Hispanic white borrower in the Detroit region with similar characteristics. A “Combined- Risk Loan” was defined by Plaintiffs as a loan that both met the definition of a high-cost loan under the HMDA (i.e., that the loan’s interest rate was substantially higher than the rate on loans to well-qualified borrowers) and also contained two or more high-risk features, including (i) that it was based on stated income rather than verified income; (ii) that it had a high loan-to-value ratio; (iii) that it had an adjustable interest rate; (iv) that it had interest-only features; (v) that it had balloon-payment features; (vi) that it had prepayment penalties; or (vii) that it had other defined high-risk features. 

New Century ranked among the leaders in originating subprime loans and selling its loans to investment banks—such as Morgan Stanley—which then securitized the loans.  The relationship between Morgan Stanley and New Century was indisputably close, although Morgan Stanley’s influence on New Century’s practices, as opposed to investor demand in general, was hotly contested.  Plaintiffs’ theory was that New Century’s lending practices were controlled by Morgan Stanley and that New Century wrote loans based on Morgan Stanley’s preferred terms, even when it did not intend to sell the loan to Morgan Stanley—and thus Morgan Stanley should bear responsibility for the disparate impact of New Century’s lending practices.

In June 2014, Plaintiffs moved for class certification.  The court found that plaintiffs’ definition of “Combined-Risk Loan” yielded hundreds of combinations of risk factors.  At least 33 different combinations of risk factors were present in the putative class.  Some risk factors were preferable to investors and sought after—for example, loans with adjustable interest rates, loans with balloon payments, and loans with prepayment penalties. But other risk factors were less desirable to investment banks, including loans based on stated income (which are generally less desirable than a fully documented loan), loans with interest-only features (which decreased secondary market liquidity), and loans with high loan-to-value ratios. 

The court held that the representative Plaintiffs’ claims were not typical of the putative class.  The representative Plaintiffs reflected only a small subset of the risk factors (four of the 33 known combinations within the putative class). Plaintiffs with loans that Morgan Stanley affirmatively sought (such as loans with adjustable interest rates and prepayment penalties) would face drastically different proof challenges than Plaintiffs with loans with features that were less desirable (such as stated income loans with high loan-to-value ratios).  The class was defined without regard to the outcome of the mortgage (such as whether the borrower defaulted, refinanced, or sold), thus one group may focus on whether sufficient harm exists to confer standing. Another group may focus on whether Morgan Stanley’s appetite for subprime loans contributed to New Century making loans with features that Morgan Stanley did not affirmatively seek and preferred avoiding.

The real differences among the class members would result in arguments available to some on the issue of causation that were not available to others.  The need to conduct separate analyses for these different risk-factor combinations was enough to cause individual issues to predominate over common issues.  Additionally, discretion was exercised by mid-level New Century employees as well as independent brokers who made independent decisions in selecting terms, and thus the connection between Morgan Stanley’s desires and the disparate impact on the African-American community in Detroit could be explained by brokers’ exercise of discretion in writing loans, and such questions of discretion will generally defeat commonality.

The court could envision no uniform trial that could address the issues in the case, and thus it failed the predominance and superiority criteria of Fed. R. Civ. P. 23(b)(3).  Additionally, the court rejected the notion that the court should consider certifying a different class than the one proposed—explaining that Plaintiffs’ theory of the case had been consistent for three years, and to change the theory would unfairly prejudice Defendants, who had spent considerable time and money litigating Plaintiffs’ initial theory.   The court also acknowledged that although Plaintiffs are not barred from pursuing the lawsuit, denial of class certification was likely a “death knell” for Plaintiffs’ lawsuit and that appellate review pursuant to Rule 23(f) may be appropriate.