The opinion of the court was delivered by: Hon. Dana M. Sabraw United States District Judge
THIS DOCUMENT RELATES TO: ORDER DENYING PLAINTIFFS' MOTION FOR CLASS
White c. Countrywide Financial Corp., No. CERTIFICATION 08cv1972 DMS (WMC) [Docket Nos. 348, 360, 376, 377, 378, Leyvas v. Bank of America Corp., No. 381, 382, 384, 385] 08cv1888 DMS (WMC)
Jackson v. Countrywide Financial Corp., No. 08cv1957 DMS (WMC)
This matter comes before the Court on Plaintiffs' motion for class certification. Defendants Countrywide Financial Corporation, Countrywide Home Loans, Inc., Countrywide Bank, FSB, Countrywide Tax Services Corp., Countrywide KB Home Loans, LLC, LandSafe, Inc., LandSafe Appraisal Services, Inc., LandSafe Flood Determination, Inc., and Bank of America Corporation*fn1 filed an opposition to the motion, and Plaintiffs submitted a reply. The parties also submitted supplemental briefs at the Court's request. Donna Siegel-Moffa, Alan Mansfield, Joe Whatley, Jr., Nicholas Roth and Amanda Trask appeared and argued on behalf of Plaintiffs, and Thomas Hefferon, Brooks Brown and Michael Sheldon appeared and argued on behalf of Defendants. Having carefully considered the pleadings and arguments of counsel, the Court now denies the motion.
This case is part of a multi-district litigation concerning individuals and several business entities involved in mortgage lending across the country. Plaintiffs filed separate class action complaints in other courts, and those complaints were transferred to this Court pursuant to an order from the Judicial Panel on Multidistrict Litigation. After transfer, several Plaintiffs joined together and filed a Consolidated Class Action Complaint (CAC). Following briefing and argument on Countrywide's motion to dismiss, Plaintiffs filed a First Amended Consolidated Class Action Complaint (FACAC). The FACAC is the operative pleading for purposes of the present motion.
Plaintiffs allege that Countrywide engaged in a scheme to steer borrowers into "inherently toxic and unaffordable" loans, which were then bundled and sold as investments on the secondary market as "mortgage-backed securities." (FACAC at 1-2.) According to Plaintiffs, Countrywide pushed borrowers into these loans irrespective of their ability to repay the loans or whether the loan was appropriate for the particular borrower. (Id.) The sole criteria used by Countrywide for approving a loan was profit-driven, that is, whether the loan could be sold on the secondary market. "Since Countrywide never intended to keep these loans on its balance sheets, it did not care how risky or unaffordable they were." (Mem. of P. & A. in Supp. of Mot. at 9.)
Plaintiffs focus on two of Countrywide's loan products in this litigation: Pay Option Adjustable Rate Mortgage loans (Pay Option loans or POAs), and Subprime loans. Pay Option loans provided borrowers with several monthly payment options: (1) a "minimum Payment," which was less than the amount of interest owed on the loan, (2) an interest only payment, and (3) an interest payment plus a portion of the principal of the loan as fully amortized over a 15, 30 or 40 year period. (FACAC ¶ 5.) The minimum payment option resulted in negative amortization as the unpaid interest was added to the principal. Plaintiffs claim negative amortization made the loan inherently toxic because it "unconscionably increased the debt burden and costs associated with the mortgage." (Mem. of P. & A. in Supp. of Mot. at 4.) Plaintiffs cite an email dated August 19, 2006, from Anthony Mozilo, founder and CEO of Countrywide, in which he acknowledged that some 75% of Pay Option borrowers made only the minimum payment and thus were subjected to negative amortization and a resulting interest rate reset, (id. at 5); nevertheless, he noted the "fact of the matter is that the payoption product represents a very significant amount of profitability in both the bank and the mortgage bank because it is the only product left with margins." (Decl. of Amanda R. Trask in Supp. of Mot. (Trask Decl.), Ex. P). Because of these significant profits, Countrywide "continued to aggressively market POAs to consumers" despite the negative consequences to borrowers. (Mem. of P. & A. in Supp. of Mot. at 5.)
The second loan product pushed by Countrywide, the Subprime loan, is claimed to be "inherently unaffordable" because the front-end debt-to-income ratio (debt service ratio for housing payment, including principal, interest, taxes, and insurance compared to gross monthly income) exceeded 31%, or the back-end debt-to-income ratio (total debt service ratio for total outstanding, recurring obligations including mortgage payments, credit cards, child support or alimony, and car payments compared to gross monthly income) exceeded 45%, either at the time the loan was originated or upon interest rate reset. One of Plaintiffs' experts, Christopher Peterson, opined that the debt-to-income (DTI) ratios of 31% and 45%, respectively, are "hardstops" beyond which point a loan is "objectively unaffordable" for the borrower, and that any borrower whose loan falls outside those parameters has been injured per se. "[D]ebt-to-income ratios matter because these ratios determine [a family's] ability to make ends meet on all of their other monthly expenses." (Mem. of P. & A. in Supp. of Mot. at 6) (quoting Peterson Rebuttal Report ¶ 13.) Plaintiffs contend that Countrywide nonetheless continued to aggressively market Subprime loans because it desired to be the "largest originator of loans in America, capturing 30-40% of America's mortgage market." (Id. at 7);(Decl. of Donna Siegal Moffa in Supp. of Mot. (Moffa Decl.), Ex. 13 at CFC-SP0000147741) ("We believe market dominance really is our destiny.")
Given the aggressive top-down culture to sell loans, Countrywide "quintupled its subprime origination." (Mem. of P. & A. in Supp. of Mot. at 8.) As Plaintiffs' expert explains:
Countrywide's status as a loan intermediary meant that it could profit even when borrowers did not repay their loans. In Countrywide's originate-to-distribute business strategy, the company profited by linking naive borrowers to unsuspecting investors, and cashing out before the two groups collapsed in on one another. In essence, Countrywide evolved into a predatory structured finance company. (Mem. of P. & A. in Supp. of Mot. at 9) (quoting Peterson Report ¶ 64.)
Plaintiffs contend Countrywide accomplished its goal of selling vast quantities of toxic loans through a number of means. First, it loosened its underwriting standards "beyond objectively reasonable norms, to allow it to increase loan volume and capture market share." (Mem. of P. & A. in Supp. of Mot. at 9.)*fn2 Countrywide freely funded loans to consumers who "could not afford them based on any objectively reasonable criteria. These borrowers operated under the false belief that 'qualifying' for a Countrywide loan meant that they could afford it and that Countrywide had assessed whether or not they could repay the loan and interest." (Id. at 9-10.)
Plaintiffs assert Countrywide's "Fast & Easy program" is emblematic of the sea change in underwriting that occurred at that time, which allowed use of "'stated income' (i.e. no proof of income) loans." (Id. at 10.) Plaintiffs further allege that when Countrywide found that its systems were not approving enough loans, it simply rewrote the programming. Thus, Countrywide rewrote its automated underwriting engine, Countrywide Loan Underwriting Expert System (CLUES), to enable it to approve loans that previously would have been rejected. (Id.)
In addition, Plaintiffs claim Countrywide pushed these loans on borrowers through "uniform sales pitches" by touting the loan products as great opportunities to cut monthly payments, while concealing the true nature and potentially devastating consequences of the loans. (Id. at 10-11.) "Countrywide emphasized that loan representatives should follow designated sales and marketing scripts to the letter." (Id. at 12); (Moffa Decl., Ex. 30, at CFC-SP 0000257668) ("It is our belief that a top sales organization is based on a scripted environment, consequently we require our sales force to memorize the Sales Presentation ...."). Plaintiffs' expert, Dr. Botond Koszegi, opined: the marketing strategies encouraged and supported by Countrywide and carried out in part by loan representatives made highly suboptimal decisions predictable and understandable by preying upon and exacerbating psychological tendencies in economic behavior that are conducive to less than perfectly optimal decision-making.
In particular, Countrywide's conduct highlighted the possible benefits of its products while deliberately obfuscating the costs, leading borrowers to put too little weight on the costs. Countrywide could easily have made modifications to its marketing to mitigate these psychological tendencies, but instead it made choices that exacerbated them. (Mem. of P. & A. in Supp. of Mot.at 11); (Moffa Decl., Ex. 26) (quoting Koszegi Report at 6-7.)
Finally, Plaintiffs allege Countrywide incentivized "participating approved brokers and ... loan originators" through "performance expectations, compensation, bonus and reward programs." (Mem. of P. & A. in Supp. of Mot. at 18.) Plaintiffs provide declarations from loan officers indicating they made more money by selling Pay Option loans and Subprime loans than by selling other types of loans. Countrywide also ran contests to increase production of these loan products, and awarded vacation packages and money to top producers. (Id. at 20.)
Specifically, Plaintiffs allege in their FACAC that Countrywide executed the foregoing scheme through fraudulent means, including:
* incentivizing employees and brokers to place borrowers into subprime loans, (id. at 2-3),
* training and instructing employees to place borrowers into subprime loans without explaining the terms or disclosing the risks, (id.),
* "making false representations to borrowers, as set forth in standardized sales scripts, that they were offering the best loans available to the borrowers[,]" (id. at 4),
* using "an automated, computerized underwriting program that was designed to maximize the number of subprime loans[,]" (id. at 6),
* failing to adequately disclose future interest rate increases, (id. at 7),
* failing to disclose the risk of negative amortization, (id.),
* failing to disclose that underwriting standards had been "virtually abandoned," (id. at 5-6), and
* failing to disclose the overall scheme. (Id. at 1-3, 38.)
These allegations serve as the factual basis for the claims alleged in the FACAC, including: (1) violation of the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1962(c), (2) conspiracy to violate RICO, 18 U.S.C. § 1962(d), (3) violation of California Business and Professions Code § 17200 ("the UCL"), (4) violation of California Business and Professions Code § 17500 ("the FAL"), and (5) unjust enrichment.*fn3
B. Countrywide's Response
Countrywide asserts that in the years leading up to and including the putative class period, banks and other mortgage lenders faced increased demand from public policy makers to expand their offerings of residential mortgage loans. (Opp'n to Mot. at 5.) Congress and bank regulators encouraged industry innovations, including making adjustable rate mortgages (ARMs) and encouraging lenders to increase lending to under-served communities. (Id.) Among the products that first became popular in the years leading up to, and during, the class period were Pay Option loans and Subprime loans. (Id.)
Countrywide point outs the Pay Option loan was a type of prime loan that was made to borrowers with strong credit characteristics and was popular for a number of legitimate reasons. The Pay Option loan "met the needs of borrowers buying property for investment and anticipating a rise in its price, borrowers with limited present income who anticipated substantially greater income in the near future, and borrowers with variable monthly incomes (for example, from commissions)." (Id. at 6.) The loans also were attractive to borrowers who desired to divert money to other investments. (Id.)
Subprime loans included loans with fixed interest rates and adjustable rates that reset as early as six months or as late as five years later. These loans were referred to as "subprime" because of the credit characteristics of the borrowers, who typically had "weakened credit histories." Subprime borrowers generally did not qualify for Pay Option loans. Defendants contend there are many kinds of borrowers for whom such loans were beneficial, even when the loans exceeded the debt-to-income ratios complained about in this litigation. Defendants claim, for example, that such loans were desirable for: a borrower who has incurred other debts and reasonably will use cash back from the loan to repay those more expensive debts, for a borrower who values spending a relatively greater portion of his or her income on housing to live in a better school district for her children, and for a borrower who expects her income to rise substantially in the foreseeable future. (Id. at 7.)
Countrywide further contends that during the loan origination process at issue, the potential borrower selected a loan product by working with a Countrywide loan officer or with an independent mortgage broker. Loan officers and brokers, according to Countrywide, often had multiple discussions with borrowers as the borrower considered the various loan options available to them and the loan products that best fit their needs.
Countrywide emphasizes that it made loans through four separate divisions, each of which executed the origination process in a different manner. (Id. at 8.) Two of Countrywide's divisions made loans through independent brokers. The Wholesale Lending Division (WLD) made prime loans, including Pay Option loans, and its Specialty Lending Group (SLG) made subprime loans. Countrywide asserts it had relationships with approximately 30,000 independent mortgage brokers nationwide, and funded at least 248,791 loans to the class members through these brokers. Countrywide further notes it had no ability to control how these brokers advertised loans or explained loan terms to the borrower, and it did not provide any scripts for these brokers to use with prospective borrowers. (Id. at 8-9.)
Two other divisions, the Consumer Markets Division (CMD) and Full Spectrum Lending (FSL), made loans through loan officers employed by Countrywide. CMD originated only prime loans, like POAs, and most of these loans were made through Countrywide branch offices located in local communities. The sales and marketing conducted by CMD loan officers "were the personalized efforts of each individual loan consultant reaching out to her own contacts in the community -- former borrowers, realtors, and builders." (Id. at 9.) According to Countrywide, "CMD loan officers did not have any 'script' or set of standard oral communications that they were instructed to follow for their communications with prospective borrowers." (Id.) The FSL division primarily made subprime loans by telephone solicitation, through a loan officer "who generally used a script to establish a dialogue with the potential borrower." (Id.) Countrywide claims the script was used only during initial calls, and thereafter, the conversation with prospective borrowers varied based on borrower need and preference. (Id.)
C. Plaintiffs' Proposed Class: The POA Sub-Class and DTI Parameter Sub-Class
Plaintiffs now move to certify a class consisting of borrowers who received a Pay Option loan and borrowers who received a Subprime loan for which the debt-to-income ratio exceeded certain ratios, as follows:
All individuals located in the United States who, between September 19, 2003 and July 1, 2008, either:
(1) received a PayOption ARM or Payment Advantage loan from Countrywide Bank, FSB, Countrywide Home Loans, Inc., and/or Countrywide KB Home Loans, LLC and made at least one monthly "minimum payment" on such loan (the "POA SubClass");*fn4 or
(2) received a mortgage loan from Countrywide Bank, FSB, Countrywide Home Loans, Inc. and/or Countrywide KB Home loans, LLC identified by Countrywide as a subprime loan product, listed in Appendix A to this Memorandum of Law, for which their Front End Debt-to-Income Ratio (debt service ratio for housing payment, including principal, interest, taxes, and insurance compared to gross monthly income) ("front end DTI") exceeded 31%, or their Back-End Debt-to-Income Ratio (total debt service ratio for total outstanding recurring obligations including mortgage payments, credit cards, child support or alimony, and car payments to compared to gross monthly income) ("back end DTI") exceeded 45%, either at the time the loan was originated or upon interest rate reset (the "DTI Parameter Sub-Class").
Plaintiffs assert the proposed class satisfies the requirements of Federal Rule of Civil Procedure 23(a) and 23(b)(3). Defendants dispute that this class satisfies the commonality, typicality and adequacy elements of Rule 23(a) and the requirements of Rule 23(b)(3).