INVESTMENTS IN MORTGAGE-BACKED SECURITIES CANNOT ALLEGEDLY VIOLATE FIDUCIARY DUTIES, two Judges say.
Two Judges on the Second Circuit Court of Appeals stressed the lack of "factual detail" in a group of pension funds' allegations that the defendant investment bank, Morgan Stanley, violated "its fiduciary duties under the Employee Retirement Security Act of 1974 ("ERISA"), 29 U.S.C. § 1001 et seq." by investing in mortgage-backed securities ("RMBS").[1] The two Judges did not say that investing in residential-mortgage back securities, which in this case included a wide assortment of RMBS including subprime mortgages, was a good thing. They said that the plaintiffs did not support their claims of "imprudence" with "well-pleaded factual allegations" that investments backed by subprime mortgages were a breach of the defendant's fiduciary duties.
Here is what the two Judges said:
In sum, viewing the allegations in the Amended Complaint as a whole, and drawing every reasonable inference in favor of Saint Vincent's, the Amended Complaint does not allege facts plausibly showing that Morgan Stanley knew, or should have known, at the relevant times, that the securities held in the fixed-income Portfolio were imprudent investments. Instead, the Amended Complaint alleges imprudence by association, reasoning that because the Portfolio contained nonagency mortgage-backed securities—of which subprime mortgage-backed securities are now the most infamous type—and because the whole world knows (in hindsight) that many subprime mortgages turned out to be disastrous investments, the Portfolio's concentration in mortgage-backed securities generally and nonagency securities in particular was imprudent. The relevant pleading standards do not permit such general accusations of imprudence, unsupported by well-pleaded factual allegations.[2]
The two Judges shared the view, then, that the plaintiffs' allegations of breach of fiduciary duties were based on nothing more specific than "imprudence by association". Everyone knows now, they said, that subprime mortgages are risky investments and poor collateral, but that is hindsight.
That is not what the plaintiffs alleged. Their allegations are reproduced more or less verbatim in the third Judge's opinion, and they will be examined in detail not only in the third Judge's opinion, but in the next post continuing this article. Suffice it to say now that the plaintiffs were much more specific than the majority described. The plaintiffs alleged that at the time it engaged in the RMBS transactions, the defendant fiduciary used methods of investigation inadequate to the task, and that even the investigation conducted by the defendant turned up bad results which did not dissuade the fiduciary from making the investments, to the detriment of the plaintiffs.
The majority ignored these allegations and attempted to re-label them.
There is a saying which is familiar in many parts of the United States. If you take a cow, and hang a sign around its neck that says, "Horse," if it has horns and an udder, it is still a cow.
To be continued ....
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