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Aiding & Abetting Fraudulent or Predatory
Lending-W here is the Law Three Years
After Lehman's Liability Was Upheld
by the Ninth Circuit?
By Frank A. Hirsch.Jr. and Tejas Patel
The Mortgage Lending and of the largest financial institutions in the country
Securitization Context Countrywide, Bear Stearns, Wachovia, Merrill Lynch,
to Aiding & Abetting Washington Mutual and IndyMac Bancorp-to name
The determination by the Ninth Circuit that a few of the list of failed banks which presently number
Lehman Brothers, Inc. could be liable under California in excess of I SO institutions.
common-law fraud for aiding and abetting the decep
tive mongage practices of First Alliance Mortgage Most of the largest financial institutions survived
Co. {First Alliance}--one of the early casuahics of the :md acquired {Bank of America, JPMorganChase and
subprime lending meltdown-was a landmark decision CitiCorp} but the litigation fallout from the mortgage
with considerable press coverage. [n hindsight, however. crises came with many of those consolidation deals.
the ruling annOLlllced in December 2006 was a harbin The claim theories to reach upstream into the coffeTS
ger of the mortgage lending crisis-which had many of the large depository and investment banks have been
comributing causes-one of which was the rush to few-but one of the most noteworthy is the aiding
vertical imegratioll of rhe emire process (of mortgage and abetting fraud theory espoused by the hI Re First
origination to ultimate securitization of the bundled Alliana; decision.
loans as securities) which was engaged in by the largest
investment banks and depository institutions in a series So, what is the state of the aiding and abetting juris
of deals mostly in the second half of 2006. 1 prudence now that a couple of years have passed since
the market meltdown? Who is winning and who is
Indeed, a majority of the top 25 subprime lenders losing on the aiding and abetting claim theory? Which
responsible for nearly S1 triWon in loans originated states are the battlegrounds for the claim theory? What
at the market's peak between 2005-2007 had ties to trends are evident in these cases?
major financial insritutiollS.2 For example, Merrill
Lynch owned (#4) First FrankJin Corp., Washington This atticle discusses the seminal 2006 decision of
Mutual owned (#5) Long Beach Mortgage Corp.; /11 Re First Allianct' and then explores a dozen subse
Lehman Brothers owned (#11) BNC Mortgage, Inc.; quent decisions which have vetted the claim theory
Bears Stearns owned (#17) Encore Credit Corp.: AIG in various factual contextS. California and New York
owned (# 18) American General Finance; and Capital have been the dominant locations of this litigation, but
One owned (#23) GrecnPoinr Mortgage. Most of other state ton bws are also implinted. Many of the
these subprime lenders went out of business or declared reponed cases are in the early stages and trials have not
bankruptcy in a quick collapse of the subprime mar yet occurred, but some observations and conclusions
ketplace in mid-2007. By September 200S, the collapse are made at the end of this anicle.
took down Lehman Brothers itself, and a half dozen
Henry v. Lehman Commercial Paper,
Inc. (In re First Alliance)
Frank A. Hirsch. Jr. is co-head of the Alston & Bird Financial
The Ninth Circuit's decision in HaIry 1'. LLlmwlI
Services Litigation Group and is resident in [he R.aleigh. North
CmJlneniaf paper, Inc (In re First Alliance Mortgage Co..}
Carolina office. His practice focuses on defense of financial
services companics.Tejas Patel is an associate in the group and is made clear that a warehouse lender/secondary market
resident in the Atlanta office. loan purchaser can be liable for aiding and abetting
sued Lehman Brothers, Inc. (Lehman) on the basis that been unable to origlnate the loans or to accomplish
First Alliance Mortgage Comp;my (First Alliance) had the fraud.16 The class of plaintiffs brought suit against
allegedly "engaged in a uniform and systematic fraud" Lehman on two theories: (1) aiding and abetting under
against (he mortgage borrowers. The class claimed that section 17200 of California's UCL; and (2) aiding and
Lehman was liable to them for aiding and abening this abetting fraud under California tOrt law.
fraud under California tort law and under California's
Unfair Competition Law {UCL).4 Regarding the UCL claim, the Ninth Circuit
affirmed the trial court's summary judgment in favor
Lehman's Relationship with First Alliance of Lehman on the grounds that aiding and abetting
First Alliance's business model consisted of originat liability pursuant to the UCL requires "personal par
ing mortgages funded by a revolving warehouse line of ticipation" and "unbridled control" over the practices
credit. 5 Through J securitization process, First Alliance found to violate the code. 17 The court further noted
would periodically issue bonds and notes to investors that ",eJven if Lehman's conduct fits within the type
that were secured by the repayment stream from the identified by the UCL, the Iplaintiff class is] not eligible
mortgage loansJ> The money raised vi;} the secur itiza for remedies available under section 17200, which are
tion process would be used to repay First Alliance's limited to forms of equitable relief."18 Thus, the class
warehouse line of credit.1 This was a common place could not utilize the California UCL to recover dam
business model during 2005-07 at the height of the ages from lehman.
mortgage refinancing and subprime boom market.
Concerning the aiding and abetting f.. md claim,
Throughout the 1990's, First Alliance was financed the court's ruling was much less favorable for Lehman.
by a number of dife
f rent w;:arehouse lenders.8 In 1995, Previously at the trial level, the jury found that Lehman
Lehman became interested in doing business with First was liable for aiding and abening fraud.19 On appeal,
Alliance and, as was typical of the business model, con Lehman argued that it was legal error for the trial
ducted a due diligence inquiry.9 Lehman's investigation court to refuse to instruct the jury that specific intent,
revealed that First Alliance had been accused of preda rather than mere knowledge, was required for a finding
tory lending practices since at least 1994 and was the of aiding and abetting fraud.zo lehman further con
subject of significant litigation. 10 Furthermore, internal tended that the trial court's denial of Lehman's motion
lehman reports contained unfavorable descriptions of for judgment as a matter of law was made in erroL21
First Alliance's business practices.11 Despite the results The Ninth Circuit disag reed with Lehman. The Ninth
of its inves tigation Lehman agreed to extend a
. $25 Circuit determined that the trial court pro perly deter
million warehouse line of credit to First Alliance.!2 In mined the law in instructing the jury and that sufficient
addition, dur ing 1996 and 1997 Lehman co-managed evidence supported the jury's verdict.22
four securitization transactions for First Alliance.13 By
1998, the increase in scrutiny and litigation against First At the heart of the litigation was the requisite proof
Alliance caused the company's other warehouse lenders of knowledge on behalf of a Defendant in order to
ro withdr;lW all funrlinr,_14 At a time when othl'r warf>_ become directly liabll' II nder an aiding and abetting
house lenders backed away from First Alliance, Lehman fraud claim. Under California law, "p]iability may
increased First Alliance's line of credit to S 150 million be imposed on one who aids and abets the commis
and became the company's sole source of warehouse sion of an intentional tort if the person .. knows the
funding.15 other's conduct constitutes a breach of a duty and gives
substamial assistance or encouragement to the other to
The Ninth Circuit's Holding so act."23 In analyzing the knowledge prong, the court
The aiding and abetting claims against lelmun were made clear that aiding and abetting liability "requires a
based on allegations that when Lehman agreed to pro finding of actual knowledge, not specific intenr."24 The
vide the financing for First Alliance's mortgage busines s . court noted that the actual knowledge standard requires
Lehman did so with the knowledge that the loans were more than a vague suspicion of w rongdoing , and that
Volume 29 • Number 7 • July 2010 Banking & Financial Services Policy Report· J
was deceived by defendant Edwin Parada, a mortgage involved in the initial lending process. The facts of
broker, into taking OUI a financially burdensome loan Quezada v: Loan Or. Ofeal., [IIC. 53 are similar to those
on his home.45 Regarding New Century, the court of Plascellcia. In Quezada, the plaintiff was the named
held that the detailed description in the plaintiff's representative of a class of borrowers who received
complaint of the company's involvement in the loan loans from loan Center of California (LCC).54 After
closing was sufficient to plead actual knowledge of the lCC went out of business, the plaintiff's loan was
fraud.46 Furthermore, the plaintiff's allegations that assigned to EMC.55 Ultimately, the plaintiff filed suit
New Century acted as escrow agent, drafted closing against EMC arising out of the negative amortiza
instructions, and instructed the plaintiff to sign docu tion that occurred pursuant to her OARM.56 Despite
ments were sufficient to demonstrate that it substantially EMC's argument that it could not be held liable under
assisted in the fraud.47 California's UCl since it was merely an assignee of the
loan and not the original lender. the court disagreed.57
With respect [Q Argent as lender, the court found The court denied EMC's motion to dismiss, stating that
that it lent directly to the plaintiff with the aid of Edwin plaintiff's allegations that EMC was "acting in concert"
Parada as a broker. and its close participation was suf with LCC and was "promoting, marketing, distribming
ficient to satisfy the knowledge prong of the aiding and and selling the Option ARM loans" were sufficient to
abetting claim.48 In a Rule 12(b)(6) motion to dismiss state a claim for aiding and Jbcning fraud pursuant to
context, the funding of the fraudulently obtained loan the UCL.58
satisfactorily established the substantial assistance ele
ment of the claim.49 Another case involving an aiding and abetting
claim against a purchaser of Option A.RM loans is
Defendant is a Secondary Market Loan Purchaser Velazquez II. GMAC AtJortgilge Corporalioll.59 In the
Entities that purchase loans on the secondary market case, GMAC Mortgage Corporation (GMAC) pur
may also face liability claims for aiding and abetting chased OARM loans originJted by Aegis Wholesale
predatory lending. For example, in Plascencia v. Ullditlg Corporation (Aegis).60 Aegi� was the (#25) subprime
lsI MOTIgage50, borrowers pursuant to an option acljust lender from 2005-07 and was owned by Cerberus
able rate mortgage (OARM) and who were unaware that Capital Management. The pbintifls brought a claim
their loan was subject to negative amortization brought against GMAC for liabiliry pursuant to California's
an aiding and abetting claim against EMC Mortgage UCL.61 NonvithstJnding the fact that rhe compiaim
Corporation (EMC), which purchased, packaged, and did not use the phrase "aiding and abetting," the court
securitized loans for lending 1st Mongage (Lending concluded that the plaintiffs' Jilegations were sufficient
1st). EMC is now an affiliate of JPMorganChase and to survive a motion to dismiss.62 In making its decision,
was acquired in March 2008 when JPMotganChase the court noted that the plaintifis alleged that:
purchased Bear Stearns, the previous owner of EMC as
well as Encore Credit. By refusing to dismiss the claim Aegis and GMAC Mortgage Corp. worked
against EMC, the court agreed with the plaintiffs that togethet in distributing, selling, and servicing rhe
EMC might be Liable for its involvement with Lending loans, that they initiated the scheme in order to
1s[.51 The court explained: maximize the loans they sold to consumers and
to maximize profits, that GMAC MortgJge Corp.
By showing that EMC purchased Lending 1st's had full knowledge of Aegis's wrongful acts,
OARMs with knowledge of Lending 1st's TILA Jnd actively participated as an assignee and/or
violations, Plaintiffs may be able to establish that buyer.63
EMC gave Lending 1 st a financial incentive to
continue to commit those violations, and there The Defendant is a Party Assisting in the Transaction
fore may be subjected to liability for aiding and (e.g.. escrow agent, attorney, etc.)
abetting violations of the UCL.52 Potential liability for aiding and abetting predatory
lending is not limited to financial entities that origi
Loan assignees may also face Liability for aiding nate or purchase mortgages. For eXJmple. in Marceills,
and abetting predatory lending, even if they weren't discussed supra, a claim of aiding and abetting against
4 • Banking & Finaocia/ Services Policy Report Volume 29 • Number 7 • July 2010
an escrow agent survived a mmion to dismiss.Cain v. Another illustrative SUlllmary judgrnenr case is
Bethea,64 is a case implicating a non-financial entity jordan v. Paul Financial, LL C,7 6 in which the Northern
as a defendant-an individual perpetrating fraud. In District of California denied defendant HSBC National
Cain, the claims arose out of a scheme to defraud the Association's (HSBC) motion for summary judgrnent.
plaintiff in which she was told that she was merely In the case, the plaintiff's aUegations arose out of the
refinancing her mortgage and would at all times negative amortization attributable co the plaintiff's
retain title to her propeny.6:' In fact, at the clming option ARM loan.?7 Paul Financial was the originator
the plaintiff signed a deed conveying her property of the loan, but eventually sold the loan to Luminent
to defendant Bethea.66 The plaintiff brought claims Mor tgage Capital, Inc (Luminent).Luminent in turn
for fraud against various defendants, among which pooled the loan with other adjustable rate mortgages in
included claims against a law firm, an attorney and a a "mortgage backed securities trust," for which HSBC
title closer.67 was the trustee.?8The plaintiff claimed thal HSBC was
liable on a theory of aiding and abetting fraud.79 The
After some period of discovery. all of these defen court denied HSBC's motion for summary judgment
dants filed motions for summary judgrnent.68The court and recognized that if the plaintiff could locate evi
denied aU of the motions, finding that the plaintiff's dence showing that Paul Financial had an agreement
evidence was sufficielll to raise an issue of disputed with HSBC for HSBC to take a financial interest in the
material fact whether each of rhe defendants was liable loans, then that evidence could support the plaintiff's
for aiding and abetting fraud.69 claim that HSBC acted as an aider and abettor in Paul
Financial's scheme to originate loans based on false
As to the defendant law firm, D'Angelo & Associates, and misleading disclosures,so Accordingly, the court
the court found that the firm's review and certification extended the time allowed for discovery and denied
of a false HUD-I Settlement Statement and the inclu HSBC's motion for summary judgmenl.�l
sion in the loan file of a fraudulelll check for $24,000
satisfied the substantial assistance prong and emitled Cases Where the Plaintiff Was Unable to Withstand
a jury to decide liability.7o AdditionaUy, evidence of a Motion to Dismiss or Was Otherwise Unsuccessful
a wiretapped conversation of Ms. D'Angelo which Notwithstanding the foregoing cases, courtS are not
included discussions 011 how to manufacture fraudulent rubber-stamping every complaint alleging a claim of
balance checks was sufficient (0 support a finding that aiding and abetting predatory lending and aUowing
the law firm had actual knowledge of wrongdoing.?] the cases to proceed toward trial. At a minimum, the
complaint must aUege particular facts that demonstrate
Turning to the defendant anorney, Gregory Nanton, both the actual knowledge element and the substan
the court ruled that his representation of the plaintiff tial assistance element of an aiding and abetting claim.
in the transaction coupled with evidence consisting Otherwise, the claim for aiding and abetting \ViU not
of "statements ...describing Nanton's role in the survive a motion to dismiss. For example, in Coelho v.
transaction and his appearance in other questionable Alliance Mortgt!,gc Banking Corp.,82 a title insurance pro
transactions involving the same group of individuals" vider was sLLccessful in its motion to dismiss the aiding
was sufficient to support a finding that he was liable for and abetting fraud claims brought against it.The federal
aiding and abetting. ?2 court in New Jersey held that the complaint failed [0
abetting test for actual knowledge/substantial assistance 2 A5. r("ported by th(" Cemer for Publie- Integrity Research-
becomes easier. 3v.1ilable �t u�vw.publicimrg'iry.org lillveJrigtlliollsIt(otlotllic_,,,l'IlIiow.,1
IlIcsl-lbprimc25/
Third, the risk of class actions milizing the aiding 3 471 F.3d 977 (9th Cir. 2006).
and abetting claim theory is moderated by the genesis 4. Id. Jt 987.
of the claim success in the fraud context. If UDAP 5. Sa id. ;u 986
claims become successful then class aggregation is more 6. Sa id.
likely. Fraud claims have sustained the J.iding and J.bet 7. Sa id
ting theory-but these claims arc not subject to class 8 Sa id.
aggregation because the Rule 23 class certification test
9. Sa id.
cannot be satisfied (too many individualized issues such
10 Sa id.
as reJ.sonable reliance to meet the predominance of
11. Sa id.
common issues element).
12 Sa id.
actual intent, and no major court has certified an ;(iding 15 Sa id. 411 987.
;(nd abetting VDAP class citing/distinguishing In Re 16. Sa id.
First A /limlcc. 17. Sa id. "t 996
18 Id.
Fifth, Plaintifsf luvc found it easier to hold the claims 19. Sa id. �t983.
against direct lenders or warehouse lenders than against
20. Sa id �t 993.
secondary market securitizers where the financial
21 5« iii
entity-defendam was not integrated with the mortgage
22 fd
originations channel.
23 fd
impact rhe ultimate outcome of aiding and abetting 26. Iii. at 994.
52 ld 89. 2009 Us. Dist. LEXIS 84863 (N.D. C31. Sept. 16. 20(9).
53. No. Cw. 08-177 was KJM . 2008 US Dis!. LEXIS 96479 (ED. 90. OIK"�Cst Bank is the renamed entity for wh3t was formerly
CJi. Nov. 24. 2008) IndyMac Bank after the FDIC took IndyMac Oller in July 2008.
59 605 E5upp.2d 10"9 (CD. Cal. DI."c. 22, 20(8). 96 2009 U.s. Dm. LEXIS (N.D. C31 Aug. 2 1 . 20(9).
60. Sa lkl''''
:qua:. 605 ESupp.2d at 1053 97 Se.. ;,1. at � I I .
8 • Banking & Finandol Semces Policy Reporl Volume 29 • Number 7 • July 2010