On March 3, 2017, the First Department of the Appellate Division of New York Supreme Court reversed a lower court’s ruling and ordered summary judgment to be entered in favor of the defendant, TCW Asset Management Company (“TCW”), because plaintiffs failed to meet their burden of showing loss causation. Basis Pac-Rim Opportunity Fund (Master) v. TCW Asset Management Co., No. 654033/12 (N.Y. App. Div. Mar. 3, 2017). Plaintiffs asserted fraud claims against TCW alleging that it misled investors about the quality of the securities backing the collateralized debt obligation (“CDO”) at issue. In reversing the trial court’s decision denying TCW’s motion for summary judgment, the First Department concluded that plaintiffs failed to produce any evidence demonstrating that “it was TCW’s misrepresentations, rather than market forces, which caused the investment losses.”
TCW, an investment advisor, served as the collateral manager for a $400 million CDO that took a net long position in risky residential mortgage-backed securities (“RMBS”). Plaintiffs, who purchased $27 million of particularly risky notes in the CDO in May 2007, alleged that TCW misrepresented its investment strategy. In moving for summary judgment, TCW relied on expert evidence that market conditions caused plaintiffs’ investment losses. The lower court denied TCW’s motion for summary judgment, finding that issues of fact existed as to the cause of plaintiffs’ losses.
In reversing the lower court, the First Department, citing decisions by the Second Circuit, held that when a plaintiff’s loss “coincides with a marketwide phenomenon causing comparable losses to other investors,” then the plaintiff’s fraud claim fails unless it proves “that its loss was caused by the alleged misstatements as opposed to intervening events.” Plaintiffs here failed to raise any facts or introduce adequate expert testimony to counter evidence that the intervening financial crisis and collapse of the RMBS market would have caused the investment’s losses even if the CDO was comprised of the types of assets that were consistent with TCW’s investment strategy. The court was careful to note that it did “not mean to suggest that all cases in which a plaintiff alleges fraud will be unable to survive summary judgment in the event of a market collapse.” But plaintiffs’ “complete failure to meet its burden on the issue of loss causation . . . compel[led] the court’s decision.”
The argument that investment losses arising out of the financial crises, and RMBS-related investments in particular, were caused by general market conditions rather than fraud has been frequently made but difficult to prevail on, particularly at earlier stages of litigation. This case highlights that defendants should continue to make this type of argument where available. The fact that the CDO here was “created as an investment vehicle used for the purpose of taking a net long position on extremely risky [RMBS]” and plaintiffs purchased “the riskiest portions of the investment vehicle” made this case particularly amenable to TCW’s loss causation argument.
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