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Legal Update

Two Notable Subprime Securities Lawsuit Dismissals for Failure to Allege Scienter Adequately

8 November 2010
Mayer Brown Legal Update

In late September 2010, the US District Court for the Southern District of New York granted motions to dismiss in two subprime lawsuits alleging federal securities fraud due to the plaintiffs’ failure to sufficiently establish the defendants’ culpable knowledge or intent (scienter).


On September 28, 2010, Judge P. Kevin Castel granted a defense motion to dismiss a complaint arising out of the purchase of over $43 million in residential mortgage-backed securities. Footbridge Limited Trust and OHP Opportunity Limited Trust v. Countrywide Home Loans, Inc., et al., 09 Civ. 4050, 2010 WL 3790810 (S.D.N.Y. Sept. 28, 2010).

Plaintiffs Footbridge Limited Trust and OHP Opportunity Limited Trust asserted claims for violations of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, and common law fraud.

Plaintiffs purchased the mortgage-backed securities at issue through two public offerings in June and October 2006. The mortgage loans underlying the securities consisted of “credit-blemished, closed-end, fixed-rate loans that were secured by second liens on one-to four-family residential properties.” Plaintiffs alleged that a “corrupt culture” and “lust for high yields” motivated defendants into making material misstatements and omissions, which were divided into five categories: (i) misrepresentations regarding the percentage of owner-occupied properties in the securitizations; (ii) misrepresentations regarding Countrywide’s adherence to its underwriting guidelines; (iii) omissions of material facts regarding reduced-documentation application programs; (iv) misrepresentations regarding adverse effects on investors’ interests; and (v) misrepresentations regarding Countrywide’s loan servicing.

Notably, plaintiffs did not dispute an awareness of the risky nature of their investments in these “credit-blemished” securities. As Judge Castel pointed out, “this is not a case where risky, subprime mortgage-backed securities were inserted into a structured investment product without adequate disclosure. Plaintiffs acknowledge that they ‘knew, and do not deny, that the loans they purchased were risky.’” Instead, plaintiffs argued that the extent of the risk was simply greater than they anticipated.

In the motion to dismiss, the defendants argued that the complaint failed to allege that the misstatements or omissions amounted to acts of fraud with the requisite degree of particularly. Judge Castel agreed, and dismissed plaintiffs’ section 10(b) claims for failing to meet the heightened pleading standards under Rule 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737.

Judge Castel went on to note that plaintiffs’ allegations also failed to satisfy the pleading standards required for alleging scienter. He explained that the allegations “neither individually nor collectively…raise[d] a strong inference of scienter.”

Plaintiffs’ additional claims for control person liability, successor liability and common law fraud were all dismissed based on the same reasoning.


On September 29, 2010, Oppenheimer Holdings Inc. won a motion to dismiss a subprime-related class action lawsuit alleging that the defendants had misled investors who had purchased auction rate securities (ARS) between March 19, 2003 and February 13, 2008. Vining v. Oppenheimer Holdings Inc. & Oppenheimer & Co., Inc., 08 Civ. 4435, 2010 WL 3825722 (S.D.N.Y. Sept. 29, 2010). The lawsuit arose out of allegations that defendants failed to disclose material facts about the nature and condition of the ARS market and that they misrepresented ARS as “cash-equivalent, highly liquid, short-term investment vehicles….”

Chief Judge Loretta A. Preska dismissed the case on the basis that plaintiffs had failed to adequately allege scienter, i.e., the complaint did not allege facts that either (i) showed that defendants had a motive and opportunity to commit the fraud or (ii) that constituted strong circumstantial evidence of conscious misconduct.

To support an inference of fraudulent intent, plaintiffs’ claimed that Oppenheimer officials issued management directives and uniform sales materials recklessly or with intent to defraud because they either knew or should have known that the market for ARS was about to collapse. Judge Preska was unconvinced, noting that while plausible, “the more compelling inference to be drawn from the facts alleged in the complaint is that Oppenheimer did not predict that all broker dealers would withdraw from the ARS market en masse.”

Plaintiffs’ additional claim for control person liability was also dismissed.

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