DRC Congratulates Milbank LLP on a Decisive Victory in Its CDO Fraud Dispute

August 28, 2020

Among other things, FGIC’s complaint alleged that Putnam communicated falsely inflated information about the credit quality of the targeted assets for the portfolio of assets underlying Pyxis. In particular, FGIC alleged that, on August 9, 2006, Putnam provided FGIC with an “updated target portfolio,” in a document called the “peach-colored spreadsheet” (“PCS”), showing “that at least $145 million of the Pyxis Portfolio would be prime residential mortgage-backed securities (‘RMBS’) assets,” when “ultimately there were no prime RMBS assets in the final Pyxis Portfolio.” FGIC alleged Putnam intentionally and/or negligently made false and misleading statements that defrauded FGIC into participating in Pyxis. Putnam denied the allegations, arguing that it was not the source of the information in the PCS, which had been prepared by the structuring bank for the Pyxis transaction, Calyon Corporate and Investment Bank (“Calyon”), and that FGIC could not prove the elements of its claims.

In early 2020, the parties agreed to a bench trial, which was scheduled to commence on July 6, 2020. In May, to protect the safety of the witnesses, the Court, and the parties during the COVID-19 pandemic, the Defense requested that the trial proceed “virtually.” Judge Lewis J. Liman agreed, ordering the proceedings to be held remotely, with direct testimony presented through written declarations, and cross-examination and redirect examination administered over Zoom.

To streamline the proceeding, the Court also ordered the trial to be bifurcated, with the parties presenting their cases on the following issues in Phase 1:

(1) whether Putnam was responsible for making a misstatement to FGIC in the PCS and its duty (if any) to correct any such misstatement;
(2) whether Putnam had a duty to correct any such misstatement under the “special circumstances” doctrine;
(3) actual reliance or transaction causation;
(4) reasonable reliance; and
(5) loss causation.

For the remote proceedings, the Court was provided a laptop computer through a video conferencing vendor and the parties arranged for proceedings to be transmitted through Zoom. The lawyers for each side, the witnesses, and the judge were all in separate locations but were all able to view one another continuously during the proceedings. Pursuant to a court order, each witness was permitted only two sets of documents with him or her—a binder containing the witness’s declaration and exhibits on direct examination and a separate binder in a sealed envelope (to be opened only after the cross-examination began) containing cross-examination documents, both of which were delivered to the witnesses prior to his or her appearance. The trial began on July 6 and proceeded through July 22, with very few technical or connectivity issues. Summations were presented, also via Zoom, on July 29, 2020.

On August 27, 2020, Judge Liman held for the Defense on all counts, finding that FGIC had failed to prove any of its claims against Putnam. In particular, the Court found that “the evidence established Putnam was not the source of information in the PCS and was not involved in its creation or transmission.” As a result, the Court determined that Putnam was not responsible for making the alleged misstatement. Judge Liman further determined that FGIC had not proved Putnam had any duty to correct any allegedly false statements in the PCS. FGIC also failed to prove that it had relied on the allegedly false information in the PCS or that such reliance would have been reasonable.

Not only did the PCS contain a forward-looking disclaimer warning FGIC not to rely on any representation in the PCS, but FGIC also received subsequent term sheets before the closing of the transaction that “differed dramatically from what was reflected in the PCS (but approximated what was in the final Pyxis portfolio).” Finally, the Court also determined that FGIC had not proved loss causation. The Court stated, “Pyxis failed during the general credit collapse and financial crisis of 2007–2008. There is no evidence that FGIC’s losses were caused as a result of Putnam’s investment decisions.”

The Court directed the parties to appear for a telephonic conference on September 4, 2020, and terminated all pending motions.

DRC assisted the trial team with trial strategy, a focus group, and demonstrative aids.