Bank Fails After Purchasing $2 Billion in Residential Mortgage-Backed Securities

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Court: United States District Court for the Western District of Texas, Austin Division
Jurisdiction: Federal
Case Name: FDIC v. RBS Sec., Inc.
Citation: 2019 U.S. Dist. LEXIS 48586

Facts

Guaranty Bank bought residential mortgage-backed securities from the defendant for $2.1 billion. The bank later failed. The plaintiff became the Guaranty Bank’s receiver, and after obtaining all the defendant’s certificates, proceeded to resecuritize and convey them to a trust and through that, sell it off to other buyers. The plaintiff brought this alleging that the defendant sold the certificates to the Guaranty Bank after making material misrepresentation in its supplemented prospectus. The Daubert motions included a motion to exclude the defendant’s accounting expert witness.

The Accounting Expert

The defendant’s accounting expert was a long-standing and celebrated accounting professor at New York University’s Stern School of Business. His primary research areas included accounting-based valuation, accounting measurement, and accounting-based risk assessment, as well as financial reporting for financial instruments done by financial institutions. The accounting expert received his bachelor’s degree from Dartmouth College and his Ph.D. in business from Stanford University. The expert wrote several books on accountancy and was published in numerous journals of repute. Before his employment with New York University, the accounting expert worked with the Yale School of Organization and Management as well as Bain and Company. The expert served in many advisory groups. He was chairman of the American Accounting Association’s Financial Accounting Standards and Financial Reporting Issues Conference committees. He also sat on the Federal Reserve Bank of New York’s Financial Advisory Roundtable.

The accounting expert, while rebutting the plaintiff’s damages expert, advanced two major opinions. First, he was of the opinion that Financial Accounting Standard (FAS) 140, applied to the resecuritization, showed that generally accepted accounting principles would require the receiverships to account for their transfers of the underlying securities to the trust as secured borrowings, not sales. He based his opinion on the lack of reasonable assurance of isolation of the Underlying Securities from the Receiverships. He also based his opinion on the principle that the FDIC-C retained effective control over the underlying securities through its option to call any class of senior notes once losses reach a certain threshold and its ability to direct the indenture trustee to conduct an auction of all the underlying securities related to such class of senior notes.

The accounting expert also opined that the resecuritization would be viewed as a secured borrowing by market participants because the FDIC-C retained the collective credit risk of the underlying securities. The account expert supported his opinion with credit rating agency rating manuals, which indicated that these kinds of agencies look to view securitizations in which recourse is provided by sellers as secured borrowings, whereas investors saw as secured borrowings the kinds of securitizations where all the rewards and risks of all the transferred assets were retained by the transferors. The accounting expert drew further support in empirical evidence that equity and debt investors and credit rating agencies view securitizations in which sellers retain sufficiently large first-loss interests as secured borrowings.

Discussion

The court believed that the reasoning in National Credit Union Admin. Bd. v. UBS Secs., LLC applied partially to this case as the accounting expert was disallowed from substituting standards under any financial accounting rule for the standard adopted by the judge. The court prohibited parties and their witnesses from supplanting the usual meaning of the phrase “disposed of,” which it determined to be “transferring to another’s care or possession, or relinquishing of property.” The court, however, deferred from the aforementioned order in not excluding the accounting expert’s testimony about market participants, as it felt that there was no attempt to couch legal opinions on the expert’s part. Furthermore, the court did not share the same concerns as the NCUA court had when considering the opinion of a law professor on the general behavior in a law firm.

Held

The plaintiff’s motion to exclude the accounting expert’s testimony was granted in part and denied in part.