On behalf of Fannie Mae and Freddie Mac (a/k/a Government Sponsored Enterprises or “GSE’s”), the Federal Housing Finance Agency (“FHFA”) sued numerous banks that had underwritten residential mortgage-backed securities (“RMBS”) purchased by the GSEs. RMBS entitled investors to income generated by a pool of mortgage loans. The GSEs suffered losses on their RMBS when the market for RMBS crashed during the financial crisis.

FHFA alleged that the offering documents used to sell the RMBS contained multiple misstatements, including that (i) the loan-to-value ratios disclosed in the offering documents were too low because of inflated appraisals and that (ii) a smaller number of borrowers than represented actually occupied the properties that secured the mortgages. FHFA also alleged that the defendants provided incorrect data to the credit-rating agencies that rated the RMBS.

Critically, FHFA asserted its claims under Section 12(a)(2) of the Securities Act, which requires only proving the falsity and materiality of the alleged misrepresentations but does not require proof of reliance on the misrepresentations.

Both sides retained an army of experts to address various elements of the claims and related factual issues. In a series of decisions in late January through the middle of February, the District Court for the Southern District of New York ruled on multiple motions by FHFA to exclude the testimony of several of defendants’ experts. The decisions offer interesting insights into the process of challenging the admissibility of expert testimony in high-stakes financial services litigation. We’ll discuss several of them in this and upcoming blog posts.

In FHFA v. Nomura Holding America, Inc., 2015 WL 640900 (S.D.N.Y. February 16, 2015), the Court addressed FHFA’s motion to exclude the testimony of John J. Richard, whom defendants retained as an expert on the RMBS industry. Defendants proposed to have Richard testify regarding the loan characteristics considered material by the sophisticated institutional investors that typically purchased RMBS and regarding any idiosyncratic loan characteristics deemed material by the GSEs (such as whether the underlying mortgage loans were eligible for Department of Housing and Urban Development housing goals credit). Separately, Richard also purported to rebut the testimony of FHFA’s experts.

While Richard had greater experience investing in commercial mortgage-backed securities, the Court found that Richard was also qualified to testify regarding RMBS. However, the Court found Richard unqualified to testify regarding any unique investment criteria that the GSEs employed.

The Court also observed that portions of Richard’s report contended that the GSEs did not rely on the alleged misrepresentations in the offering documents when deciding whether to purchase the RMBS. Similarly, Richard attacked FHFA’s experts for failing to prove that the GSEs relied on the alleged misrepresentations when making their investment decision concerning the RMBS. Since Section 12 claims do not require proof of reliance, all of this testimony was stricken as irrelevant.

However, the Court permitted Richard to offer testimony within the scope of his expertise and permitted him to address the issue of the materiality of the alleged misrepresentations.

One of the takeaways from this decision is that defendants appeared to anger the Court by employing Richard’s report to offer expert testimony regarding reliance: “[t]hese portions of Richard’s report are a thinly veiled effort by defendants to put before the factfinder their contention that the GSEs did not in fact rely on any misrepresentations that may have infected the Offering Documents when the GSEs made their investment decision.” It’s not possible to tell from the Court’s decision how subtly this testimony concerning reliance was presented in Richard’s report, but it’s hard to understand how defendants did not expect plaintiff’s counsel to draw the Court’s attention to this irrelevant testimony. Offering expert testimony on an irrelevant element certainly seems like a poorly conceived strategy to undermine the credibility of the plaintiff’s case—and more like a recipe to annoy the Court.

Have you been involved in litigating cases involving losses suffered on RMBS? If so, what experts have you worked with on such cases?