MIAMI In a ruling with enormous ramifications for Wall Street, a federal court here yesterday dismissed a fraud suit brought by Space Coast CU against several Wall Street banks and ratings agencies over $150 million of risky investments known as collateralized debt obligations—or CDOs—they sold to Eastern Financial Florida CU, the huge Florida credit union that failed in 2009 and was subsequently acquired by Space Coast.
In dismissing the case, U.S. Judge James Cohn ruled that Space Coast CU failed to prove that the Wall Street banks or ratings agencies engaged in fraud when they marketed the CDOs to the one-time $2.4 billion Eastern Financial, the biggest non-corporate credit union failure ever. “Space Coast’s Complaint must be dismissed because it does not plead Defendants’ alleged fraud with particularity, nor does it state a plausible claim for relief,” wrote Judge Cohn.
Specifically, the Judge rejected Space Coast’s claims that S&P adjusted its ratings on CDOs to make them more marketable for its Wall Street banking clients. But the Judge ruled there is no evidence that S&P engaged in fraud with respect to the specific CDOs bought by Eastern Financial. “Space Coast has failed to plead in detail how each Defendant defrauded Eastern through use of S&P’s ratings adjustments,” wrote the Judge.
Judge Cohn also rejected Space Coast’s claims that the Wall Street banks “used CDOs, particularly in 2007, to dump bad assets from their own balance sheets onto investors at inflated prices.” The credit union failed to prove these allegations, the Judge wrote.
The ruling is a major victory for the bank defendants in the case, Merrill Lynch (now a unit of Bank of America); Bearn Stearns (now a unit of JP Morgan Chase); Wachovia Securities (now part of Wells Fargo); UBS Securities and Barclay’s Capital, as well as Moody’s Investors Service and Standard & Poor’s, all of which are defending against dozens of investor suits making similar claims.
In fact, S&P is being sued by the U.S. Justice Department for the same CDOs sold to Eastern Financial, and investments sold to WesCorp FCU and several banks that it had rated beforehand.
The Space Coast suit, filed in the U.S. District Court for the Southern District of Florida, alleges the Wall Street players engaged in fraud, negligent misrepresentation and unjust enrichment in the sale of the CDOs—which are mortgage-backed securities constructed from other MBS—to Eastern Financial. Eastern Financial was the only non-corporate credit union in the country authorized to invest in CDOs, by special permission of the Florida credit union regulator.
The 72-year-old credit union, originally chartered to serve employees of now-defunct Eastern Airlines, lost almost its entire investment on the CDOs and was subsequently acquired by Space Coast, a $1.6 billion credit union 100 miles north along Florida’s Space Coast, in Melbourne. The merger of the failed Eastern Financial gave Space Coast $3.2 billion in assets and transformed it into one of the biggest credit unions in the country.
Judge Cohn rejected the Space Coast argument that Eastern Financial’s collapse was due “directly and proximately to defendants’ fraud.” Judge Cohn said Space Coast’s allegations did not rise above the “speculative level”.
Space Coast has another civil suit pending against Barclay’s Capital for the sale of a separate CDO worth $10 million to Eastern Financial. That case is being litigated in federal court in New York.
Eastern Financial acquired $94.8 million of CDOs in March and June of 2007, bringing its CDO portfolio to $149.2 million. According to a study by NCUA’s Office of Inspector General, “Most of those CDOs deteriorated rapidly in value once purchased.” By 2009, the credit union had “essentially charged off 18 CDO investments resulting in losses of $149.2 million,” a staggering 99% of those investments.
The CDOs were bought in private placements and were not registered with the Securities and Exchange Commission, according to the Inspector General.
Eastern Financial’s losses, which amounted to $68.9 million in 2007 and $113.5 million in 2008, eventually erased all of its capital and spelled the end of the one-time airline credit union, which had survived the 1991 demise of its chief sponsor to thrive for almost two decades serving more than 1,000 select groups.
