IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MASSACHUSETTS ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) )

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1 IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MASSACHUSETTS MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY, Plaintiff, v. HSBC BANK USA, NATIONAL ASSOCIATION; HSI ASSET SECURITIZATION CORPORATION; HSBC SECURITIES (USA INC.; NEAL LEONARD; GERARD MATTIA; TODD WHITE; and JON VOIGTMAN, Defendants. Civil Action No. COMPLAINT JURY TRIAL DEMANDED

2 Plaintiff Massachusetts Mutual Life Insurance Company ( MassMutual, by and through its attorneys, brings this action against HSBC Bank USA, National Association ( HSBC Bank or the Sponsor ; HSI Asset Securitization Corporation ( HSI Asset or the Depositor ; HSBC Securities (USA Inc. ( HSBC Securities or the Underwriter (the Sponsor, Depositor, and Underwriter shall be collectively referred to hereinafter as the HSBC Defendants or HSBC ; and Neal Leonard; Gerard Mattia; Todd White; and Jon Voigtman (collectively, the Officer Defendants, and alleges as follows: NATURE OF ACTION 1. This action arises out of the sale of certain residential mortgage-backed securities (the Certificates to MassMutual. The Certificates were sold pursuant to public filings and offering materials that contained untrue statements and omissions of material facts, in violation of the Massachusetts Uniform Securities Act, Mass. Gen. Laws ch. 110A, This action involves three securitizations, or issues of residential mortgagebacked securities. HSBC Bank, the Sponsor for all securitizations in which MassMutual purchased securities, began securitizing residential mortgage loans in 2005 to take advantage of the exploding market for residential mortgage-backed securities. HSBC Bank did not originate the residential mortgage loans it securitized and serviced. Instead, HSBC Bank purchased the loans from third-party originators for securitization and sale to investors, such as MassMutual. 3. HSBC Bank worked with HSI Asset and HSBC Securities to structure the three securitizations at issue and sell the Certificates to investors. The securitizations allowed the HSBC Defendants to earn substantial profits, while purportedly transferring the risk of default on the mortgage loans to investors, including MassMutual. 4. In marketing the Certificates to MassMutual, the HSBC Defendants represented that the loans backing the securities were underwritten in accordance with prudent underwriting 1

3 standards that ensured a borrower could repay the loan. The HSBC Defendants also represented that the loans had certain characteristics, including defined loan-to-value ratios and specific owner-occupancy statistics. 5. These representations were material to MassMutual s decision to purchase the Certificates. Unlike the HSBC Defendants, MassMutual did not have access to loan files. MassMutual therefore depended on the HSBC Defendants to verify that the information presented to it and other investors was true and accurate. 6. In reality, however, the loans backing the Certificates deviated substantially from what was represented to MassMutual. To generate an ever-growing volume of loans to sell to investors, the HSBC Defendants abandoned or disregarded underwriting guidelines, often originating or acquiring loans issued to borrowers regardless of the borrowers ability to repay. The loans were issued on the basis of overstated incomes, inflated appraisals, false verifications of employment, and exceptions to underwriting criteria that had no proper justification. 7. The Certificates that MassMutual purchased now qualify as junk. In the securitizations in which MassMutual purchased Certificates, over 35% of the loans backing the securities have now defaulted, have been foreclosed upon, or are delinquent. A subsequent forensic analysis commissioned by MassMutual has demonstrated that the representations about the loans were materially false. Under the Massachusetts Uniform Securities Act, MassMutual is entitled to rescind its purchases of these securities and/or to recover appropriate damages. PARTIES A. Plaintiff 8. Plaintiff MassMutual is a Massachusetts mutual life insurance company with its principal place of business in Springfield, Massachusetts. Founded in 1851, MassMutual is a leading, diversified financial services organization providing life insurance, disability income 2

4 insurance, long-term care insurance, annuities, retirement and income products, investment management, mutual funds, and trust services to individual and institutional customers. B. The HSBC Defendants 9. Defendant HSBC Bank is a national banking association with its principal place of business in New York, New York. HSBC Bank is an indirect wholly owned subsidiary of HSBC Holdings plc. ( HSBC Holdings. HSBC Bank was the Sponsor for all three securitizations at issue in this action. 10. Defendant HSI Asset is a Delaware corporation with its principal place of business in New York, New York. HSI Asset is a direct wholly owned subsidiary of HSBC Markets (USA Inc. ( HSBC Markets and an indirect wholly owned subsidiary of HSBC Bank and HSBC Holdings. HSI Asset was the Depositor for all three securitizations at issue in this action. 11. Defendant HSBC Securities is a Delaware corporation with its principal place of business in New York, New York. HSBC Securities is a direct wholly owned subsidiary of HSBC Markets and an indirect wholly owned subsidiary of HSBC Holdings. HSBC Securities was the Underwriter for all three securitizations at issue in this action. C. Officer Defendants 12. Defendant Neal Leonard is an individual residing in Mount Kisco, New York. Leonard was, at relevant times, Chairman, Principal Executive Officer, and a Director of HSI Asset. He was also co-head of mortgage-backed securities at HSBC Securities. Leonard signed registration statements for all three securitizations at issue in this action: the FFML 2006-FF11, HALO 2007-WF1, and HASC 2007-WF1 securitizations. 13. Defendant Gerard Mattia is an individual residing in Armonk, New York. Mattia was, at relevant times, Treasurer, Principal Financial Officer, Principal Accounting Officer, and 3

5 a Director of HSI Asset. He was also an inside director of HSBC Securities. Mattia signed registration statements for all three securitizations at issue in this action: the FFML 2006-FF11, HALO 2007-WF1, and HASC 2007-WF1 securitizations. 14. Defendant Todd White is an individual residing in Hamel, Minnesota. White was, at relevant times, co-head of mortgage-backed securities at HSBC Securities. He was also an inside director of HSI Asset. White signed registration statements for all three securitizations at issue in this action: the FFML 2006-FF11, HALO 2007-WF1, and HASC 2007-WF1 securitizations. 15. Defendant Jon Voigtman is an individual residing in Summit, New Jersey. Voigtmann was, at relevant times, a Managing Director at both HSBC Securities and HSI Asset. Voigtman signed registration statements for two of the three securitizations at issue in this action: the FFML 2006-FF11 and HALO 2007-WF1 securitizations. D. Relevant Non-Parties 16. The Certificates for each securitization relevant to this action were issued by a trust established by the Depositors. The three issuing trusts (collectively, the Trusts were: First Franklin Mortgage Loan Trust 2006-FF11, HSI Asset Loan Obligation Trust 2007-WF1, and HSI Asset Securitization Corporation Trust 2007-WF At all relevant times, the defendants committed the acts, caused or directed others to commit the acts, or permitted others to commit the acts alleged in this Complaint. Any allegations about acts of corporate defendants mean that those acts were committed through their officers, directors, employees, agents, and/or representatives while those individuals were acting within the actual or implied scope of their authority. 4

6 JURISDICTION AND VENUE 18. This Court has diversity jurisdiction pursuant to 28 U.S.C. 1332(a, as there is complete diversity of citizenship between the parties, and the amount in controversy exceeds $75,000, exclusive of interest and costs. 19. This Court has personal jurisdiction over the defendants by virtue of their securities sales and/or control over securities sales to MassMutual in Massachusetts. 20. Venue is proper in the District of Massachusetts pursuant to 28 U.S.C. 1391, because substantial events giving rise to this Complaint took place in Massachusetts. SUBSTANTIVE ALLEGATIONS 21. During the time that MassMutual purchased the Certificates, the HSBC Defendants were all wholly owned subsidiaries of HSBC Holdings. The HSBC Defendants operated collectively to structure and market the three securitizations at issue in this action. I. THE MARKET FOR RESIDENTIAL MORTGAGE-BACKED SECURITIES 22. In the 1980 s and 1990 s, mortgage originators followed a traditional model for originating mortgage loans. Under the traditional model, they either held the mortgage loans they provided to borrowers through the terms of the loans, or sold the mortgage loans to governmental agencies Federal National Mortgage Association ( Fannie Mae and Federal Home Loan Mortgage Corporation ( Freddie Mac. 23. Loans held by mortgage originators were typically conservative, first-lien loans to prime borrowers because the originator would profit if the borrower made timely interest and principal payments, but would bear the loss if the borrower defaulted and the property value was insufficient to repay the loan. As a result, the originator had economic incentives to establish the creditworthiness of the borrower and the true value of the underlying property by appraising it fairly before issuing the mortgage loan. 5

7 24. Loans sold to Fannie Mae and Freddie Mac were also conservative loans to prime borrowers because the loans had to meet specific guidelines for sale. By law, Fannie Mae and Freddie Mac can purchase only those mortgage loans that conform to certain regulatory guidelines. These loans are known in the industry as conforming loans, and are historically the most conservative loans with the lowest rates of delinquency and default. Mortgage loans that fail to meet the regulatory guidelines are known in the industry as non-conforming loans. 25. In the 1980 s and 1990 s, Fannie Mae and Freddie Mac securitized the loans they purchased from mortgage originators and sold the securities backed by the loans, referred to as residential mortgage-backed securities, to investors. Investors in these early mortgage-backed securities were provided protections not only because the underlying loans conformed to strict regulatory guidelines, but also because Fannie Mae and Freddie Mac guaranteed that investors would receive timely payments of principal and interest. Because Fannie Mae and Freddie Mac were perceived as being backed by the federal government, investors viewed the guarantees as diminishing credit risk, if not removing it altogether. 26. In the early 2000 s, the demand for securities backed by mortgage loans increased. Private financial institutions stepped in to meet the demand by originating an evergrowing number of non-conforming loans, such as loans based on reduced documentation, loans issued to subprime borrowers, and adjustable loans where the interest rate increases after a period of time. These loans were then securitized and sold to private investors, such as MassMutual. By 2001, $240 billion in residential mortgage-backed securities were issued through private securitizations. By 2006, that amount had increased by almost five times to $1.033 trillion. 6

8 27. The HSBC Defendants took advantage of this exploding market by securitizing a large volume of mortgage loans acquired from various lenders in an effort to boost their fee revenue. II. THE SECURITIZATION PROCESS 28. The mortgage securitization process is used to create residential mortgage-backed securities, such as the Certificates purchased by MassMutual. Mortgage loans are acquired from mortgage originators and pooled together, with securities constituting interests in the cash flow from the mortgage pools then sold to investors. The securities are also referred to as mortgage pass-through securities because the cash flow from the pool of mortgages is passed through to the securities holders when payments are made by the underlying mortgage borrowers. 29. Each securitization involves several entities that perform distinct tasks. The first step in creating a residential mortgage-backed security, such as the Certificates, is the acquisition by the depositor of an inventory of mortgage loans from a sponsor (also referred to as a seller in some securitizations at issue. The sponsor either originates the loans or acquires the loans from other mortgage originators in exchange for cash. The depositor is often a subsidiary or other affiliate of the sponsor. 30. The depositor then securitizes the pool of loans by forming one or more mortgage pools with the inventory of loans, and creating tranches of interests in the mortgage pools with various levels of seniority. Interests in these tranches are then issued by the depositor (who serves as the issuer through a trust in the form of bonds, or certificates. 31. Each tranche has a different level of purported risk and reward, and, often, a different credit rating. The most senior tranches often receive the highest investment grade rating (triple-a. Junior tranches, which usually have lower ratings, are more exposed to risk, but offer higher potential returns. The most senior tranches of securities will be entitled to 7

9 payment in full before the junior tranches. Conversely, losses on the underlying loans in the asset pool whether due to default, delinquency, or otherwise are allocated first to the most subordinate or junior tranche of securities, then to the tranche above that. This hierarchy in the division of cash flows is referred to as the flow of funds or waterfall. 32. The depositor works with one or more of the nationally recognized credit-rating agencies to ensure that each tranche of the mortgage-backed securities receives the rating desired by the depositor (and underwriter. Once the asset pool is securitized, the certificates are issued to one or more underwriters (typically Wall Street banks, who resell them to investors, such as MassMutual. 33. Because the cash flow from the loans in the mortgage pool of a securitization is the source of funds to pay the holders of the securities issued by the trust, the credit quality of the securities depends primarily on the credit quality of the loans in the mortgage pool, which often includes thousands of loans. Detailed information about the credit quality of the loans is contained in the loan files developed and maintained by the mortgage originators when making the loans. For residential mortgage loans, such as the loans that backed the Certificates purchased by MassMutual, each loan file typically contains documents including the borrower s application for the loan, verification of income, assets, and employment, references, credit reports, and an appraisal of the property that will secure the loan and provide the basis for other measures of credit quality, such as loan-to-value ratios and occupancy status. The loan file should also include notes from the person who underwrote the loan, describing the loan s purported compliance with underwriting guidelines, and documentation of compensating factors that justified any departure from those standards. 8

10 34. Investors do not have access to the loan files. Instead, the sponsor, depositor, and underwriter are responsible for gathering and verifying information about the credit quality and characteristics of the loans that are deposited into the trust, and presenting this information in the registration statements, prospectuses, and prospectus supplements (collectively, the Offering Materials prepared for potential investors. This due diligence process is a critical safeguard for investors and a fundamental legal obligation of the sponsor, depositor, and underwriter. III. MASSMUTUAL S PURCHASES OF HSBC CERTIFICATES 35. MassMutual purchased the Certificates between August 2006 and October MassMutual made the following purchases of Certificates, representing a total investment of over $13 million, from the following defendants: Asset Full Name of Offering Purchase Price Seller Defendants FFML Mortgage Pass- $1,000, HSBC Bank USA, Through Certificates, National Association Series 2006-FF11 (Sponsor First Franklin Mortgage Loan ( FFML Series 2006-FF11, Class M9 HSI Asset Securitization Corporation (Depositor HSBC Securities (USA Inc. (Underwriter 9

11 Asset Full Name of Offering Purchase Price Seller Defendants HALO Mortgage Pass- $10,030, HSBC Bank USA, Through Certificates, National Association Series 2007-WF1 (Sponsor HSI Asset Loan Obligation ( HALO Series 2007-WF1, Classes A5 and M5 HSI Asset Securitization Corporation (Depositor HSBC Securities (USA Inc. (Underwriter HSI Asset Securitization Corporation ( HASC Series 2007-WF1, Class M8 HASC Mortgage Pass- Through Certificates, Series 2007-WF1 $2,000, HSBC Bank USA, National Association (Sponsor HSI Asset Securitization Corporation (Depositor HSBC Securities (USA Inc. (Underwriter TOTAL $13,030, IV. DEFENDANTS ABANDONMENT AND DISREGARD OF DISCLOSED UNDERWRITING STANDARDS TO FACILITATE SALE OF LOW-QUALITY LOANS TO INVESTORS A. The HSBC Defendants Representations That Underwriting Standards Were Consistently Followed 36. The fundamental basis upon which residential mortgage-backed securities are valued is the ability of the borrowers to repay the principal and interest on the underlying loans and the adequacy of the collateral for those loans. If the borrowers cannot pay, and the collateral is insufficient, the securities experience losses. For this reason, the underwriting standards and 10

12 practices of the mortgage originator that issued the loans backing the certificates, and the representations in the Offering Materials regarding those standards, are critically important to the value of the securities, and to investors decisions to purchase the securities. 37. As the Sponsor of the securitizations at issue, HSBC Bank purchased the underlying mortgage loans from third-party originators. Each loan was purportedly underwritten according to a set of underwriting guidelines, which are specified criteria that the mortgage loans must meet depending upon the individual loan program and circumstances of each mortgage loan. In general, the underwriting guidelines stipulated what documentation was required to be included in the mortgage loan files for each loan product (which may include, depending upon the loan product, verifications of income, assets, closing funds and payment histories, among others and criteria for eligibility, including tests for debt-to-income ( DTI and combined loanto-value ( CLTV ratios. 38. The HSBC Defendants represented to investors, including MassMutual, that the securitized loans were underwritten according to prudent underwriting standards. As detailed below, for each securitization, the HSBC Defendants made specific representations about the underwriting standards that the originators followed. B. Specific Misrepresentations in the Offering Materials (1 FFML 2006-FF HSBC Bank acquired the mortgage loans underlying the FFML 2006-FF11 securitization from First Franklin Financial Corporation ( First Franklin Financial. First Franklin Financial acquired the loans from its parent, First Franklin, which originated substantially all the mortgage loans, and from third parties, which originated the remainder (approximately 1.13% of the mortgage loans. The Prospectus Supplement referred to the originators as third party originators. 11

13 40. The Offering Materials for the FFML 2006-FF11 securitization represented that all the mortgage loans were originated in accordance with First Franklin Financial s underwriting criteria. 41. The Prospectus Supplement promised investors that First Franklin Financial confirmed a borrower s credit standing, the borrower s ability to repay, and the sufficiency of the collateral before acquiring a loan: [First Franklin Financial] s acquisition underwriting standards are primarily intended to assess the ability and willingness of the borrower to repay the debt and to evaluate the adequacy of the mortgaged property as collateral for the mortgage loan.... In accordance with [First Franklin Financial] s guidelines for acquisition, the third party originators must consider, among other things, a mortgagor s credit history, repayment ability and debt service to income ratio ( Debt Ratio, as well as the value, type and use of the mortgaged property. 42. The Prospectus Supplement also represented that the third party originators verified the income and/or employment of the borrowers: [T]he third party originators underwriters are required to verify the income of each applicant under various documentation programs as follows: under the Full Documentation Program, applicants are generally required to submit verification of stable income for the periods of six months to two years preceding the application dependent on credit score range; under the LIV Program, the borrower is qualified based on the income stated on the application and applicants are generally required to submit verification of adequate cash flow to meet credit obligations for the six month period preceding the application; the Stated Plus Program allows income to be stated, but requires borrowers to provide verification of liquid assets equaling three months of income stated on the mortgage application; under the NIV Program, applicants are qualified based on monthly income as stated on the mortgage application and the underwriter will determine that the stated income is reasonable and realistic when compared to borrower s employment type, assets and credit history. For Direct Access first lien mortgage loans from selfemployed or 1099 borrowers with a credit score greater than or equal to 540 and not originated in conjunction with a second lien mortgage, bank statements (for 12 months are acceptable as full 12

14 documentation. For Direct Access first lien mortgage loans from self-employed or 1099 borrowers with credit scores greater than or equal to 600, regardless of being originated with a corresponding second lien mortgage, twelve months of bank statements are acceptable as full documentation. In all cases, the income stated must be reasonable and customary for the applicant s line of work. Although the income is not verified under the LIV and NIV Programs, a preclosing audit should be conducted to confirm that the business exists. Verification may be made through phone contact to the place of business, obtaining a valid business license, CPA/Enrolled Agent letter or through Dun and Bradstreet Information Services. 43. In addition, the Prospectus Supplement represented that the third party originators conducted quality control procedures to assure asset quality: The third party originators are required to conduct a number of quality control procedures, including a post funding compliance audit as well as a full re-underwriting of a random selection of loans to assure asset quality. Under the compliance audit, all loans are required to be reviewed to verify credit grading, documentation compliance and data accuracy. Under the asset quality procedure, a random selection of each month s originations must be reviewed by each third party originator. The loan review is required to confirm the existence and accuracy of legal documents, credit documentation, appraisal analysis and underwriting decision. A report detailing audit findings and level of error is sent monthly to each branch for response. The audit findings and branch responses must then be reviewed by the third party originator s senior management. Adverse findings are to be tracked monthly and over a rolling six month period. This review procedure allows the third party originator to assess programs for potential guideline changes, program enhancements, appraisal policies, areas of risk to be reduced or eliminated and the need for additional staff training. 44. The Prospectus Supplement also promised investors that the third party originators established standards to ensure a borrower could repay the loan: Under the mortgage loan programs, various risk categories are used to grade the likelihood that the applicant will satisfy the repayment conditions of the loan. These risk categories establish the maximum permitted loan-to-value ratio and loan amount, given the occupancy status of the mortgaged property and the applicant s credit history and Debt Ratio. 13

15 45. The Prospectus Supplement further represented that all the mortgage loans were acquired by First Franklin Financial under the Direct Access Program, which required borrowers to meet certain credit guidelines: In accordance with [First Franklin Financial] s guidelines for acquisition, under the Direct Access Program, the third party originators must require that the Credit Bureau Risk Score of the primary borrower... be used to determine program eligibility. Credit Bureau Risk Scores must be obtained from at least two national credit repositories, with the lower of the two scores being utilized in program eligibility determination. If Credit Bureau Risk Scores are obtained from three credit repositories, the middle of the three scores can be utilized. In all cases, a borrower s complete credit history must be detailed in the credit report that produces a given Credit Bureau Risk Score or the borrower is not eligible for the Direct Access Program. Generally, the minimum Credit Bureau Risk Score allowed under the Direct Access Program is The Prospectus Supplement promised investors that borrowers in the Direct Access Program must meet additional guidelines for income, assets, employment and collateral: The Credit Bureau Risk Score, along with the loan-to-value ratio, is an important tool in assessing the creditworthiness of a Direct Access borrower. However, these two factors are not the only considerations in underwriting a Direct Access loan. The third party originators are required to review each Direct Access loan to determine whether the Mortgage Loan Seller s guidelines for income, assets, employment and collateral are met. 47. The Prospectus Supplement promised investors that loans issued under the Direct Access Program would be made only to borrowers with limited debt-to-income ratios: The Debt Ratio generally may not exceed 50.49% for all credit scores on full documentation and LIV loans. Loans meeting the residual income requirements may have a maximum Debt Ratio of 55.49%. The Debt Ratio for NIV loans may not exceed 50.49%. 48. Finally, the Prospectus Supplement assured investors that any deviation from underwriting guidelines was supported by sufficient compensating factors: 14

16 On a case by case basis, a third party originator may determine that, based upon compensating factors, a prospective mortgagor not strictly qualifying under the underwriting risk category guidelines... warrants an underwriting exception. Compensating factors may include, but are not limited to, low loan-to-value ratio, low Debt Ratio, substantial liquid assets, good credit history, stable employment and time in residence at the applicant s current address. (2 HALO 2007-WF1 49. HSBC Bank acquired all the mortgage loans underlying the HALO 2007-WF1 securitization from Wells Fargo Bank, N.A. ( Wells Fargo Bank, which originated or acquired the loans. The Prospectus Supplement stated that the loans were underwritten in accordance with one or more of the following: (i Wells Fargo Bank s general underwriting standards; (ii Wells Fargo Bank s modified underwriting standards applicable to its alternative mortgage loan underwriting program; and (iii the underwriting standards of participants in Wells Fargo Bank s non-agency conduit program. 50. The Prospectus Supplement made specific representations about Wells Fargo Bank s general underwriting standards and its modified standards. 51. The Prospectus Supplement represented that Wells Fargo Bank s general underwriting standards were applied to confirm a borrower s credit standing, the borrower s ability to repay, and the sufficiency of the collateral: Wells Fargo Bank s underwriting standards are applied by or on behalf of Wells Fargo Bank to evaluate the applicant s credit standing and ability to repay the loan, as well as the value and adequacy of the mortgaged property as collateral. The underwriting standards that guide the determination represent a balancing of several factors that may affect the ultimate recovery of the loan amount, including, among others, the amount of the loan, the ratio of the loan amount to the property value (i.e., the lower of the appraised value of the mortgaged property and the purchase price, the borrower s means of support and the borrower s credit history. 15

17 52. The Prospectus Supplement also represented that Wells Fargo Bank collected a variety of financial information about a borrower to ensure that the borrower could repay the loan: A prospective borrower applying for a mortgage loan is required to complete a detailed application. The loan application elicits pertinent information about the applicant, with particular emphasis on the applicant s financial health (assets, liabilities, income and expenses, the property being financed and the type of loan desired. A self-employed applicant may be required to submit his or her most recent signed federal income tax returns. With respect to every applicant, credit reports are obtained from commercial reporting services, summarizing the applicant s credit history with merchants and lenders. Generally, significant unfavorable credit information reported by the applicant or a credit reporting agency must be explained by the applicant. 53. The Prospectus Supplement promised investors that Wells Fargo Bank confirmed a borrower s ability to repay by conducting verifications: Verifications of employment, income, assets or mortgages may be used to supplement the loan application and the credit report in reaching a determination as to the applicant s ability to meet his or her monthly obligations on the proposed mortgage loan, as well as his or her other mortgage payments (if any, living expenses and financial obligations. A mortgage verification involves obtaining information regarding the borrower s payment history with respect to any existing mortgage the applicant may have. This verification is accomplished by either having the present lender complete a verification of mortgage form, evaluating the information on the credit report concerning the applicant s payment history for the existing mortgage, communicating, either verbally or in writing, with the applicant s present lender or analyzing cancelled checks provided by the applicant. Verifications of income, assets or mortgages may be waived under certain programs offered by Wells Fargo Bank, but Wells Fargo Bank s underwriting guidelines require, in most instances, a verbal or written verification of employment to be obtained. 54. The Prospectus Supplement also promised investors that Wells Fargo Bank limited a borrower s debt-to-income ratio to ensure the borrower s ability to repay the loan: 16

18 In general, borrowers applying for loans must demonstrate that the ratio of their total monthly debt to their monthly gross income does not exceed a certain maximum level. 55. The Prospectus Supplement assured investors that any borrower receiving a loan under Wells Fargo Bank s modified underwriting standards had satisfied stringent, detailed requirements: To be eligible for Alt-A Prime, a borrower must have (i a minimum FICO Score of 680 and (ii a mortgage or rent history with (a no mortgage or rent payments 30 days late at application time, (b no mortgage or rent payments 60 days late in the last twelve months, (c no more than two 30-day late mortgage or rent payments in the last twelve months and (d no rolling late payments. To be eligible for Alt-A Minus, a borrower must have (i a minimum FICO Score of 620 and (ii a mortgage or rent history with (a no mortgage or rent payments 30 days late at application time, (b no mortgage or rent payments 60-days late in the last twelve months, (c no more than two 30-day late mortgage or rent payments in the last twelve months and (d no more than six rolling late payments for delinquencies no longer than 30 days. 56. Finally, the Prospectus Supplement represented that exceptions to underwriting guidelines were justified by acceptable compensating factors. For example, the Prospectus Supplement represented: On a case-by case basis, Wells Fargo Bank may have made the determination that the prospective borrower warrants loan parameters... based upon the presence of acceptable compensating factors. Examples of compensating factors include, but are not limited to, loan-to-value ratio, debt-to-income ratio, long-term stability of employment and/or residence, statistical credit scores, verified cash reserves or reduction in overall monthly expenses. (3 HASC 2007-WF1 57. HSBC Bank acquired all the mortgage loans underlying the HASC 2007-WF1 securitization from Wells Fargo Bank, which originated or acquired the loans. The Prospectus 17

19 Supplement stated that the loans were underwritten in accordance with Wells Fargo Bank s underwriting guidelines. 58. The Prospectus Supplement made specific representations about Wells Fargo Bank s underwriting guidelines. 59. The Prospectus Supplement represented that Wells Fargo Bank s underwriting guidelines were applied to confirm a borrower s credit standing, the borrower s ability to repay, and the sufficiency of the collateral: The underwriting guidelines used by Wells Fargo Bank are primarily intended to evaluate the prospective borrower s credit standing and ability to repay the loan, as well as the value and adequacy of the proposed mortgaged property as collateral. 60. The Prospectus Supplement also represented that Wells Fargo Bank collected a variety of financial information about a borrower to ensure the borrower could repay the loan: A prospective borrower applying for a mortgage loan is required to complete a detailed application. The loan application elicits pertinent information about the applicant with particular emphasis on the applicant s financial health (assets, liabilities, income and expenses, the property being financed and the type of loan desired. A self-employed applicant may be required to submit his or her most recent signed federal income tax returns. With respect to every applicant, credit reports are obtained from commercial reporting services, summarizing the applicant s credit history with merchants and lenders. Under certain circumstances, significant unfavorable credit information reported by the applicant or a credit reporting agency must be explained by the applicant and is taken into account in the credit decision. 61. The Prospectus Supplement further represented that Wells Fargo Bank confirmed a borrower s ability to repay by conducting verifications: Verifications of employment, income, assets or mortgages may be used to supplement the loan application and the credit report in reaching a determination as to the applicant s ability to meet his or her monthly obligations on the proposed mortgage loan, as well as his or her other mortgage payments (if any, living expenses and financial obligations. A mortgage verification involves obtaining 18

20 information regarding the borrower s payment history with respect to any existing mortgage the applicant may have. This verification is accomplished by either having the present lender complete a verification of mortgage form, evaluating the information on the credit report concerning the applicant s payment history for the existing mortgage, communicating, either verbally or in writing, with the applicant s present lender or analyzing cancelled checks provided by the applicant. Verifications of income, assets or mortgages may be waived under certain programs offered by Wells Fargo Bank, but Wells Fargo Bank s underwriting guidelines require, in most instances, a verbal or written verification of employment to be obtained. 62. The Prospectus Supplement also promised investors that Wells Fargo Bank limited a borrower s debt-to-income ratio to ensure the borrower s ability to repay the loan: In general, borrowers applying for loans must demonstrate that the ratio of their total monthly debt to their monthly gross income does not exceed a certain maximum level. 63. For subprime loans, the Prospectus Supplement represented that a borrower s credit profile was scrutinized, with meaningful limitations placed on the terms of the loan and the size of the borrower s debt-to-income ratio: Terms of subprime mortgage loans made by Wells Fargo Bank, as well as maximum Loan-to-Value Ratios, vary depending on the credit level classification of the applicant. Loan applicants with less favorable credit profiles generally are restricted to consideration for loans with higher interest rates, lower maximum loan amounts and lower Loan-to-Value Ratios than applicants with more favorable credit profiles. Generally, the maximum Debt-to- Income Ratio for each credit level is 55%. 64. For Alt-A Minus loans, the Prospectus Supplement represented that any borrower receiving a loan had satisfied stringent, detailed requirements: To be eligible for Alt-A Minus, a borrower must have (i a minimum FICO Score of 620 provided that Wholesale and Correspondent Loans originated under any documentation program other than the Full documentation program have a minimum FICO Score of 640 and (ii a mortgage or rent history with (a no mortgage or rent payments 30 days late at application time, (b no mortgage or rent payments 60-days late in the last twelve months, 19

21 (c no more than two 30-day late mortgage or rent payments in the last twelve months and (d no more than six rolling late payments for delinquencies no longer than 30 days. 65. Finally, the Prospectus Supplement represented that exceptions to underwriting guidelines were justified by acceptable compensating factors. For example, the Prospectus Supplement represented: On a case-by-case basis, a Wells Fargo Bank loan underwriter may make the determination that the prospective borrower warrants loan parameters beyond the general underwriting criteria described above or the specific criteria applicable to subprime Mortgage Loans or Alt-A Minus Loans described below based upon the presence of acceptable compensating factors. Examples of compensating factors include, but are not limited to, Loan-to-Value Ratio, Debt-to-Income Ratio, long-term stability of employment and/or residence, credit scores, verified cash reserves or reduction in overall monthly expenses. For example, Wells Fargo Bank permits Debt-to-Income Ratios to exceed guidelines when the applicant has documented compensating factors for exceeding ratio guidelines such as documented excess funds in reserves after closing, a history of making a similar sized monthly debt payment on a timely basis, substantial residual income after monthly obligations are met, evidence that ratios will be reduced shortly after closing when a financed property under contract for sale is sold, or additional income has been verified for one or more applicants that is ineligible for consideration as qualifying income. C. The HSBC Defendants Disregard of Underwriting Standards to Generate a Large Volume of Loans for Securitization and Sale to Investors 66. The HSBC Defendants representations about the applicable underwriting practices were false. The securitization process incentivized the HSBC Defendants to disregard underwriting standards so they could purchase huge volumes of low-quality loans to securitize. 67. As the private residential mortgage-backed securities market expanded, the traditional originate to hold model morphed into the originate to distribute model. Under the originate to distribute model, mortgage companies no longer held the mortgage loans to 20

22 maturity. Rather, they purported to shift the risk of loss to the investors who purchased an interest in the securitized pool of loans. 68. The new distribution model was highly profitable for the HSBC Defendants and other mortgage companies. By securitizing and selling mortgage loans to investors through underwriters, mortgage companies received immediate payment for the loans, shifted the loans off their books, and were able to purchase more loans. The securitization process enabled the mortgage companies to earn most of their income from transaction and loan-servicing fees. Because the mortgage companies and the HSBC Defendants did not have to bear the risk of loss, they had an unchecked incentive to acquire more and more loans to feed into the securitization machine. 69. The Attorney General for the Commonwealth of Massachusetts explained this unchecked incentive in her investigation into the subprime mortgage industry: Historically, the vast majority of home mortgages were written by banks which held the loans in their own portfolios, knew their borrowers, and earned profit by writing good loans and collecting interest over many years. Those banks had to live with their bad paper and thus had a strong incentive to avoid making bad loans. In recent years, however, the mortgage market has been driven and funded by the sale and securitization of the vast majority of loans. Lenders now frequently make mortgage loans with the intention to promptly sell the loan and mortgage to one or more entities.... The lenders incentives thus changed from writing good loans to writing a huge volume of loans to re-sell, extracting their profit at the front end, with considerably less regard to the ultimate performance of the loans. 70. Ben Bernanke, Chairman of the Federal Reserve Bank, also explained the incentive to abandon underwriting standards in Congressional testimony: When an originator sells a mortgage and its servicing rights, depending on the terms of the sale, much or all of the risks are passed on to the loan purchaser. Thus, originators who sell loans may have less incentive to undertake careful underwriting than if they kept the loans. Moreover, for some originators, fees tied to 21

23 loan volume made loan sales a higher priority than loan quality. This misalignment of incentives, together with strong investor demand for securities with high yields, contributed to the weakening of underwriting standards. 71. To take advantage of the exploding market for residential mortgage-backed securities, the HSBC Defendants disregarded disclosed underwriting guidelines and failed to conduct adequate due diligence so that they could purchase as many loans as possible for securitization. 72. Unbeknownst to MassMutual, and contrary to the representations in the Offering Materials, the HSBC Defendants securitized loans that had been issued to borrowers regardless of their ability to pay. The loans were often issued on the basis of overstated incomes, inflated appraisals, false verifications of employment, or exceptions to underwriting criteria that had no appropriate compensating factors. The practices engaged in by the HSBC Defendants and the selling originators were in blatant disregard of the disclosed underwriting standards, and any semblance of reasonable and prudent underwriting. D. Widespread Defaults That Confirm the HSBC Defendants Disregard of Underwriting Standards 73. The poor performance of the mortgage loans underlying the Certificates provides additional evidence that the representations about underwriting practices were false. Even though the Certificates purchased by MassMutual were supposed to be long-term, stable investments, just years after their issuance, a substantially high percentage of the mortgage loans backing the Certificates have defaulted, have been foreclosed upon, or are delinquent, resulting in massive losses to the Certificateholders, including MassMutual. The following table contains the most recent performance data available for the loan pools: 22

24 Transaction Number of Loans in Pool at Closing Number of Current Loans in Pool Number of Loans Liquidated or Foreclosed Upon Number of Loans in Default or Delinquent % of Loans Liquidated, Foreclosed Upon, in Default or Delinquent FFML 2006-FF11 10,253 2,696 3, % HALO 2007-WF1 1, % HASC 2007-WF1 4,051 1,578 1, % 74. Defaults are usually caused by a large and unexpected disruption to a borrower s income. In a properly underwritten pool of loans, one would not expect to see such a large spike of defaults occurring shortly after origination, because it is unlikely that many borrowers would all incur a sudden and unexpected change to their repayment ability so soon after purchasing a home. Indeed, economic studies have confirmed that high default rates early in a loan s life are highly correlated with loans that were not properly underwritten. This makes sense when borrowers are put in loan products they cannot actually afford, they quickly and predictably fall behind on their payments. 75. Not only have the loans backing MassMutual s Certificates experienced extraordinary rates of default, but the majority of the Certificates ratings have also significantly deteriorated. Because of the high delinquency and default rates, among other things, most of the Certificates have been downgraded to junk-bond ratings, as can be seen in the following table: Certificate Original Current S&P Original Current Moody s S&P Rating Rating Moody s Rating Rating FFML 2006-FF11 M9 BBB- N/A 1 Baa3 N/A HALO 2007-WF1 A5 AAA CCC Aaa Ca HALO 2007-WF1 M5 BBB C Baa1 C HASC 2007-WF1 M8 BBB D Baa1 C 1 This Certificate has been entirely written off due to losses and therefore has no rating. 23

25 76. The poor performance of the loan pools and the rapidly dropping credit ratings of the Certificates have caused a massive decline in the market values of the Certificates. According to the most recent data, the Certificates should be worth approximately $11.4 million, but their market value is substantially lower approximately $4.8 million. 77. The economic downturn cannot explain the abnormally high percentage of defaults, foreclosures, and delinquencies observed in the loan pools. Loan pools that were properly underwritten and contained loans with the represented characteristics would have experienced substantially fewer payment problems and substantially lower percentages of defaults, foreclosures, and delinquencies. The poor performance of the mortgage loans underlying MassMutual s Certificates is itself evidence that the loans were improperly underwritten, and that the representations about underwriting practices were false. V. MISREPRESENTATIONS ABOUT APPRAISALS AND LOAN-TO-VALUE RATIOS REVEALED BY A FORENSIC REVIEW OF THE MORTGAGE LOANS A. Appraisal and LTV Testing 78. MassMutual commissioned a forensic review of the mortgage loans underlying the Certificates to determine whether the characteristics of the mortgage loans, as represented in the Offering Materials, were accurate. 79. As part of the forensic review, data relating to the collateral loans underlying each of the securitizations was gathered from multiple public sources, including assessor, DMV, credit, and tax records, as well as proprietary sources such as loan servicing, securitization, and mortgage application records. The data relating to individual mortgage loans was then compared to the representations made in the Offering Materials. 24

26 80. The forensic review tested the appraised values and loan-to-value ratio ( LTV of each property, as represented in the Offering Materials, through an industry-standard automated valuation model ( AVM. 81. The LTV is the ratio of a mortgage loan s original principal balance to the appraised value of the mortgaged property. This ratio was material to MassMutual and other investors because higher ratios are correlated with a higher risk of default. A borrower with a small equity position in a property has less to lose if he or she defaults on the loan. There is also a greater likelihood that a foreclosure will result in a loss for the lender if the borrower fully leveraged the property. LTV is a common metric for analysts and investors to evaluate the price and risk of mortgage-backed securities. 82. For each of the loans reviewed, the underlying property was valued by an industry-standard AVM. AVMs are routinely used in the industry as a way of valuing properties during prequalification, origination, portfolio review, and servicing. AVMs have become ubiquitous enough that their testing and use is specifically outlined in regulatory guidance and discussed in the Dodd-Frank Act. AVMs rely upon similar data as in-person appraisals primarily county assessor records, tax rolls, and data on comparable properties. AVMs produce independent, statistically-derived valuation estimates by applying modeling techniques to this data. The AVM that MassMutual used incorporates a database of 500 million mortgage transactions covering ZIP codes that represent more than 97% of the homes, occupied by more than 99% of the population, in the United States. Independent testing services have determined that this AVM is the most accurate of all such models. 83. For purposes of MassMutual s forensic review, a retrospective AVM was conducted for each loan to calculate the value of the underlying property at the time each loan 25

27 was originated. The inputs for each calculation included, inter alia, (1 any subsequent sale prices of the target property, (2 sale prices and appraisals of comparable properties in the neighborhood, and (3 changes in home price indices over time. 84. Applying the AVM results to the available data for the loans underlying the Certificates shows that the appraised values given to the properties were often significantly higher than what the properties were actually worth. This affected the LTV ratios by decreasing the actual value of the properties relative to the loan amounts, which increased the overall ratios. This overvaluation affected numerous statistics in the Offering Materials, as described in detail for each transaction in the next section (Section V.B. B. Specific Misrepresentations in the Offering Materials (1 FFML 2006-FF The Prospectus Supplement for the FFML 2006-FF11 securitization represented that the weighted average LTV ratio of the mortgage loans was 82.61%. It also represented that only 2,159 mortgage loans had an LTV ratio above 90%, which was 16.50% of the collateral pool. 86. Additionally, the Prospectus Supplement for the FFML 2006-FF11 securitization represented that appraisals generally conformed to Freddie Mac or Fannie Mae standards, were conducted by independent appraisers, and were subject to review appraisals if appropriate: In accordance with [First Franklin Financial] s guidelines for acquisition, the third party originators... generally require an appraisal of the mortgaged property which conforms to Freddie Mac and/or Fannie Mae standards; and if appropriate, a review appraisal. Generally, appraisals are provided by appraisers approved by [First Franklin Financial]. Review appraisals may only be provided by appraisers approved by [First Franklin Financial]. In some cases, the third party originator may rely on a statistical appraisal methodology provided by a third party. 26

28 Qualified independent appraisers must meet minimum standards of licensing and provide errors and omissions insurance in states where it is required to become approved to do business with the third party originators. Each Uniform Residential Appraisal Report includes a market data analysis based on recent sales of comparable homes in the area and, where deemed appropriate, replacement cost analysis based on the current cost of constructing a similar home. The review appraisal may be an enhanced desk, field review or an automated valuation report that confirms or supports the original appraiser s value of the mortgaged premises. 87. These representations regarding appraisals were material to MassMutual and other investors because they signaled the reliability of the LTV ratios discussed above. MassMutual s forensic review revealed that these representations were false. The true LTV ratios for the collateral loans were actually much higher than represented, as shown in the chart below: As Represented in the Offering Materials Actual Values Per Forensic Review Weighted Average LTV of the Collateral Loans 82.61% 91.08% Percentage of Collateral Loans with LTV of Greater than 90% 16.50% (2,159 loans % (3,352 loans 88. In total, 38% of the loans tested were shown to have appraisals that were inflated by 10% or more, and 32% of the loans tested had LTVs that were 10 or more percentage points higher than was represented. These results not only demonstrate that the loan statistics in the Offering Materials were false, but also that the representations relating to appraisal practices were false. Independent appraisers following proper practices would not systematically generate 2 The percentages shown are based on the total outstanding principal balance of the loans. 27

29 appraisals that deviate so significantly (and so consistently upward from the true values of the appraised properties. 89. The HSBC Defendants had full access to the appraisal records and all data relating to the collateral loans. They had an affirmative obligation to conduct due diligence to verify the accuracy of the LTV and appraisal representations. Based on their involvement in securitizing the loans and conducting due diligence, the HSBC Defendants knew that the estimations of the properties values bore no reasonable relationship to the actual data and characteristics of the properties. They knew that the estimations of the properties values were unreasonable, inaccurate, and not justified. (2 HALO 2007-WF1 90. The Prospectus Supplement for the HALO 2007-WF1 securitization represented that the weighted average LTV ratio of the mortgage loans was 81.73%. It also represented that only 231 mortgage loans would have an LTV ratio above 90%, which was 16.21% of the collateral pool. 91. Additionally, the Prospectus Supplement for the HALO 2007-WF1 securitization represented that appraisals generally conformed to Fannie Mae and Freddie Mac requirements and were subject to an internal appraisal review: Wells Fargo Bank s underwriting of every Mortgage Loan submitted consists of a separate appraisal conducted by (i a thirdparty appraiser, (ii an appraiser approved by [Valuation Information Technology, LLC], or (iii [Valuation Information Technology, LLC] itself. Appraisals generally conform to current Fannie Mae and Freddie Mac secondary market requirements for residential property appraisals. All appraisals are subject to an internal appraisal review by the loan underwriter irrespective of the loan-to-value ratio, the amount of the Mortgage Loan or the identity of the appraiser. Certain loans require a third-party review in the form of either a desk review or field review. At the discretion of Wells Fargo Bank, each Mortgage Loan is subject to 28

30 further review in the form of a desk review, field review or additional full appraisal. 92. These representations regarding appraisals were material to MassMutual and other investors because they signaled the reliability of the LTV ratios discussed above. MassMutual s forensic review revealed that these representations were false. The true LTV ratios for the collateral loans were actually much higher than represented, as shown in the chart below: As Represented in the Offering Materials Actual Values Per Forensic Review Weighted Average LTV of the Collateral Loans 81.73% 92.58% Percentage of Collateral Loans with LTV of Greater than 90% 16.21% (231 loans 39.10% (512 loans 93. In total, 45% of the loans tested were shown to have appraisals that were inflated by 10% or more, and 40% of the loans tested had LTVs that were 10 or more percentage points higher than was represented. These results not only demonstrate that the loan statistics in the Offering Materials were false, but also that the representations relating to appraisal practices were false. Independent appraisers following proper practices would not systematically generate appraisals that deviate so significantly (and so consistently upward from the true values of the appraised properties. 94. The HSBC Defendants had full access to the appraisal records and all data relating to the collateral loans. They had an affirmative obligation to conduct due diligence to verify the accuracy of the LTV and appraisal representations. Based on their involvement in securitizing the loans and conducting due diligence, the HSBC Defendants knew that the 29

31 estimations of the properties values bore no reasonable relationship to the actual data and characteristics of the properties. They knew that the estimations of the properties values were unreasonable, inaccurate, and not justified. (3 HASC 2007-WF1 95. The Prospectus Supplement for the HASC 2007-WF1 securitization represented that the weighted average LTV ratio of the mortgage loans was 83.44%. It also represented that only 1,446 mortgage loans had an LTV ratio above 90%, which was 29.19% of the collateral pool. 96. Additionally, the Prospectus Supplement for the HASC 2007-WF1 securitization represented that appraisals generally conformed to Fannie Mae and Freddie Mac requirements and were subject to an internal appraisal review. For example, the Prospectus Supplement represented: In addition, Wells Fargo Bank s underwriting of every Alt-A Minus Mortgage Loan submitted consists of a separate appraisal conducted by (i a third-party appraiser, (ii an appraiser approved by [Valuation Information Technology, LLC], or (iii [Valuation Information Technology, LLC] itself. Appraisals generally conform to current Fannie Mae and Freddie Mac secondary market requirements for residential property appraisals. All appraisals are subject to an internal appraisal review by the loan underwriter irrespective of the Loan-to-Value Ratio, the mortgage loan amount or the identity of the appraiser. Certain loans require a third party review in the form of either a desk review or field review. At the discretion of Wells Fargo Bank, any mortgage loan is subject to further review in the form of a desk review, field review or additional full appraisal. 97. The Prospectus Supplement also represented that each mortgage file contained an appraisal conducted by a qualified, independent appraiser: The mortgage file contains an appraisal of the related Mortgaged Property signed by a qualified appraiser who had no interest, direct or indirect, in the Mortgaged Property or in any loan made on the security of the Mortgaged Property, whose compensation is not 30

32 affected by the approval or disapproval of the Mortgage Loan and who met the minimum qualifications of Fannie Mae and Freddie Mac. Each appraisal of the Mortgage Loan was made in accordance with the relevant provisions of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989[.] 98. These representations regarding appraisals were material to MassMutual and other investors because they signaled the reliability of the LTV ratios discussed above. MassMutual s forensic review revealed that these representations were false. The true LTV ratios for the collateral loans were actually much higher than represented, as shown in the chart below: As Represented in the Offering Materials Actual Values Per Forensic Review Weighted Average LTV of the Collateral Loans 83.44% 90.64% Percentage of Collateral Loans with LTV of Greater than 90% 29.19% (1,446 loans 41.42% (1,678 loans 99. In total, 45% of the loans tested were shown to have appraisals that were inflated by 10% or more, and 35% of the loans tested had LTVs that were 10 or more percentage points higher than was represented. These results not only demonstrate that the loan statistics in the Offering Materials were false, but also that the representations relating to appraisal practices were false. Independent appraisers following proper practices would not systematically generate appraisals that deviate so significantly (and so consistently upward from the true values of the appraised properties The HSBC Defendants had full access to the appraisal records and all data relating to the collateral loans. They had an affirmative obligation to conduct due diligence to verify the accuracy of the LTV and appraisal representations. Based on their involvement in 31

33 securitizing the loans and conducting due diligence, the HSBC Defendants knew that the estimations of the properties values bore no reasonable relationship to the actual data and characteristics of the properties. They knew that the estimations of the properties values were unreasonable, inaccurate, and not justified. VI. MISREPRESENTATIONS ABOUT OWNER-OCCUPANCY STATISTICS REVEALED BY A FORENSIC REVIEW OF THE MORTGAGE LOANS A. Owner-Occupancy Testing 101. The forensic review commissioned by MassMutual also tested the accuracy of the representations of owner occupancy in the Offering Materials Owner-occupancy statistics were material to MassMutual and other investors because high owner-occupancy rates would have made the Certificates safer investments than Certificates backed by second homes or investment properties. Homeowners who reside in mortgaged properties are less likely to default than owners who purchase homes as investments or second homes and live elsewhere MassMutual s forensic review tested the accuracy of the representations of owner occupancy in the Offering Materials. To determine whether a given borrower actually occupied the property as claimed, MassMutual investigated tax information for the loans. One would expect that a borrower residing at a property would have the tax bills sent to that address, and would take applicable tax exemptions available to residents of that property. If a borrower had his or her tax records sent to another address, that is evidence that the borrower was not actually residing at the mortgaged property. If a borrower declined to make certain tax exemption elections that depend on the borrower living at the property, that also is evidence the borrower was living elsewhere. MassMutual also reviewed: (1 borrower credit records, because one would expect that people have bills sent to their primary address. If a borrower was telling 32

34 creditors to send bills to another address, even six months after buying the property, that is evidence the borrower was living elsewhere; (2 property records, because it is unlikely that a borrower lives in any one property if in fact that borrower owns multiple properties. It is even more unlikely that the borrower resides at the mortgaged property if a concurrently owned separate property did not have its own tax bills sent to the property included in the mortgage pool; and (3 records of other liens, because if the property was subject to additional liens but those materials were sent elsewhere, that is evidence the borrower was not living at the mortgaged property. If the other lien involved a conflicting declaration of residency, that too would be evidence that the borrower did not live in the subject property If a property fails more than one of the above tests, that is strong evidence the borrower did not in fact reside at the mortgaged property. As described more fully in the next section (Section VI.B, the results of MassMutual s loan-level analysis of true owner-occupancy rates on the mortgage loans underlying its Certificates show that, despite the prospectus representations, a much higher percentage of borrowers did not occupy the mortgaged properties than was represented. B. Specific Misrepresentations in the Offering Materials (1 FFML 2006-FF The Offering Materials for the FFML 2006-FF11 securitization represented that 9,793 mortgage loans were for primary residences, i.e., owner-occupied properties. In MassMutual s subsequent loan-level analysis, however, 10.56% of the mortgage loans reported to be owner-occupied failed multiple tests for owner occupancy. Thus, the number of mortgage loans that actually were owner occupied was much lower than represented, as shown in the following chart: 33

35 As Represented in the Offering Materials Actual Values Per Forensic Review Number of Loans Covering Primary Residences 9,793 loans (95.51% 3 8,759 loans (85.43% (2 HALO 2007-WF The Offering Materials for the HALO 2007-WF1 securitization represented that 1,012 mortgage loans were for primary residences, i.e. owner-occupied properties. In MassMutual s subsequent loan-level analysis, however, 10.85% of the mortgage loans reported to be owner-occupied failed multiple tests for owner occupancy. Thus, the number of mortgage loans that actually were owner occupied was much lower than represented, as shown in the following chart: As Represented in the Offering Materials Actual Values Per Forensic Review Number of Loans Covering Primary Residences 1,012 loans (71.02% 902 loans (63.30% (3 HASC 2007-WF The Offering Materials for the HASC 2007-WF1 securitization represented that 3,767 mortgage loans were for primary residences, i.e., owner-occupied properties. In MassMutual s subsequent loan-level analysis, however, 8.75% of the mortgage loans reported to be owner-occupied failed multiple tests for owner occupancy. Thus, the number of mortgage loans that actually were owner occupied was much lower than represented, as shown in the following chart: 3 The percentages shown are based on the total number of loans in the relevant mortgage pool. 34

36 As Represented in the Offering Materials Actual Values Per Forensic Review Number of Loans Covering Primary Residences 3,767 loans (92.99% 3,437 loans (84.84% VII. LIABILITY OF THE SPONSOR, DEPOSITOR, UNDERWRITER, AND TRUSTS AS SELLERS OF SECURITIES TO MASSMUTUAL 108. The following entities qualify as sellers of securities under the Massachusetts Uniform Securities Act: the Sponsor (HSBC Bank, the Depositor (HSI Asset, the Underwriter (HSBC Securities, and the Trusts. Each of these is primarily liable for misrepresentations in the Offering Materials under Massachusetts General Laws, Chapter 110A, Section 410(a( As the Sponsor for the securitizations at issue in this action, HSBC Bank acquired the mortgage loans that were pooled together in the securitizations, and then sold, transferred, or otherwise conveyed title to those loans to the Depositor. HSBC Bank had responsibility for preparing the Offering Materials that were used to solicit purchases of the Certificates, and was identified on the Prospectuses and Prospectus Supplements as the Sponsor. HSBC Bank earned revenue based on the sales of the Certificates to investors, including MassMutual As the Depositor for the securitizations at issue, HSI Asset purchased the mortgage loans from HSBC Bank. The Depositor then sold, transferred, or otherwise conveyed the mortgage loans to the Trusts, which held the loans as collateral for the Certificates. The Depositor had responsibility for preparing the Offering Materials that were used to solicit purchases of the Certificates, and was identified on the Prospectuses and Prospectus Supplements as the Depositor. In addition, the Depositor was responsible for registering the offerings with the Securities and Exchange Commission ( SEC. The Depositor earned revenue based on the sales of the Certificates to investors, including MassMutual. 35

37 111. The Trusts issued the Certificates that were sold to investors, including MassMutual. The Trusts were agents of the Depositor and were created for the sole purposes of holding the pools of mortgage loans assembled by the Sponsor and Depositor and issuing the Certificates for sale to the investors The Sponsor, the Depositor, and the Trusts used HSBC Securities as the Underwriter to market and sell the Certificates. The Underwriter was responsible for underwriting and managing the sale of Certificates, including screening the mortgage loans for compliance with the appropriate underwriting guidelines. The Underwriter profited from the sales of the Certificates The Sponsor, the Depositor, the Underwriter, and the Trusts successfully solicited MassMutual s purchase of the Certificates at issue in this action. The Underwriter transferred title to the Certificates to MassMutual. VIII. LIABILITY OF THE SPONSOR, DEPOSITOR, AND OFFICER DEFENDANTS AS CONTROL PERSONS HSBC Bank 114. HSBC Bank, as the Sponsor for all three securitizations at issue, had day-to-day control over the Depositor, HSI Asset, and, through HSI Asset, the Trusts. HSBC Bank acquired and selected the loans that would be securitized and determined the terms under which those loans were sold to HSI Asset and then to the Trusts. HSBC Bank also determined and approved the structure of the securitizations and the manner in which HSI Asset and the Trusts sold the Certificates, and controlled the disclosures made in connection with each securitization. HSI Asset 115. HSI Asset, as the Depositor, had day-to-day control over the Trusts. HSI Asset created the Trusts and used them as agents to hold the pools of underlying mortgage loans and to 36

38 issue the Certificates for sale to the investors. HSI Asset formed the pools of mortgage loans underlying the Certificates, and determined the tranches of interests in the pools and their various levels of seniority. HSI Asset then transferred the pools to the Trusts, which had no discretion or control over the mortgages in the pool. HSI Asset also controlled the disclosures made in connection with each securitization and registered the offerings with the SEC. Neal Leonard 116. As Chairman, Director, and Principal Executive Officer of HSI Asset (the Depositor, Leonard was involved in and controlled the day-to-day affairs of this primary violator. As co-head of mortgage-backed securities at HSBC Securities (the Underwriter, Leonard was intimately involved in the HSBC Defendants securitization business and controlled this primary violator. Leonard also had control over the securitizations at issue, as evidenced by his signature on the registration statements for the following three securitizations: the FFML 2006-FF11, HALO 2007-WF1, and HASC 2007-WF1 securitizations. Gerard Mattia 117. As Treasurer, Principal Financial Officer, Principal Accounting Officer, and a Director of HSI Asset (the Depositor, Mattia was involved in and controlled the day-to-day financial affairs of this primary violator. As an inside director of HSBC Securities (the Underwriter, Mattia controlled the strategic business direction of this primary violator. Mattia also had control over the securitizations at issue, as evidenced by his signature on the registration statements for the following three securitizations: the FFML 2006-FF11, HALO 2007-WF1, and HASC 2007-WF1 securitizations. 37

39 Todd White 118. As co-head of mortgage-backed securities at HSBC Securities (the Underwriter, White was intimately involved in the HSBC Defendants securitization business and controlled this primary violator. As an inside director of HSI Asset (the Depositor, White controlled the strategic business direction of this primary violator. White also had control over the securitizations at issue, as evidenced by his signature on the registration statements for the following three securitizations: the FFML 2006-FF11, HALO 2007-WF1, and HASC WF1 securitizations. Jon Voigtman 119. As Managing Director of HSBC Securities (the Underwriter and HSI Asset (the Depositor, Voigtman was involved in and controlled the day-to-day affairs of these primary violators. Voigtman also had control over the securitizations at issue, as evidenced by his signature on the registration statement for the following two securitizations: the FFML FF11 and HALO 2007-WF1 securitizations. FIRST CAUSE OF ACTION (Primary Violations of the Massachusetts Uniform Securities Act 120. MassMutual incorporates by reference and realleges each and every allegation as set forth above in paragraphs 1 through 119 as if fully set forth herein Under Massachusetts General Laws, Chapter 110A, Section 410(a(2, any person who offers or sells a security by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading, is liable to the purchaser of the security. 38

40 122. The Sponsor (HSBC Bank, the Depositor (HSI Asset, the Underwriter (HSBC Securities, and the Trusts (although not named as defendants qualify as sellers of the Certificates because they issued, marketed, and/or sold the Certificates to the public for their own financial benefit The Sponsor, the Depositor, the Underwriter, and the Trusts offered to sell and sold the Certificates to MassMutual in the State of Massachusetts The Sponsor, the Depositor, the Underwriter, and the Trusts offered and sold the Certificates to MassMutual by means of false and misleading statements of material fact and omissions of material facts necessary to make the statements made not misleading As set forth in more detail in paragraphs 36 to 107 above, the public statements of the Sponsor, the Depositor, the Underwriter, and the Trusts in the Offering Materials were materially false and misleading because, among other things, the Offering Materials misrepresented the underwriting standards applicable to the mortgage loans backing the Certificates, misrepresented the LTV and appraisal information for the loans, and misrepresented the owner-occupancy information for the loans MassMutual did not know, and in the exercise of due diligence could not have known, of the untruths and omissions MassMutual will elect its remedy before the entry of judgment. For each Certificate, MassMutual will seek statutory damages, including interest, or will make or arrange a tender before entry of judgment. SECOND CAUSE OF ACTION (Joint and Several Liability Under the Massachusetts Uniform Securities Act 128. MassMutual incorporates by reference and realleges each and every allegation as set forth above in paragraphs 1 through 127 as if fully set forth herein. 39

41 129. Under Massachusetts General Laws, Chapter 110A, Section 410(b, [e]very person who directly or indirectly controls a seller liable under subsection (a, every partner, officer, or director of such a seller, [and] every person occupying a similar status or performing similar functions is liable jointly and severally with and to the same extent as the seller As set forth above, the Sponsor (HSBC Bank, the Depositor (HSI Asset, the Underwriter (HSBC Securities, and the Trusts qualify as sellers and primary violators under subsection (a Defendant HSBC Bank is jointly and severally liable to the same extent as the primary violators because it controlled one or more primary violators, including their operations and the securitizations at issue Defendant HSI Asset is jointly and severally liable to the same extent as the primary violators because it controlled one or more primary violators, including their operations and the securitizations at issue Defendant Leonard is jointly and severally liable to the same extent as the primary violators because he was an officer and director of one or more primary violators and controlled their operations, including the securitizations at issue Defendant Mattia is jointly and severally liable to the same extent as the primary violators because he was an officer and director of one or more primary violators and controlled their operations, including the securitizations at issue Defendant White is jointly and severally liable to the same extent as the primary violators because he was an officer and director of one or more primary violators and controlled their operations, including the securitizations at issue. 40

42 136. Defendant Voigtman is jointly and severally liable to the same extent as the primary violators because he was an officer and director of one or more primary violators and controlled their operations, including the securitizations at issue. PRAYER FOR RELIEF WHEREFORE MassMutual prays for relief as follows: 1. On the first cause of action, for primary violations of the Massachusetts Uniform Securities Act, relief in the form of damages and/or statutory recovery upon tender; 2. On the second cause of action, for joint and several liability under the Massachusetts Uniform Securities Act, relief in the form of damages and/or statutory recovery upon tender; and 3. Such other and further relief as the Court may deem just and proper. JURY DEMAND Pursuant to Federal Rule of Civil Procedure 38(b, MassMutual hereby demands a trial by jury on all issues triable by jury. DATED: May 20, 2011 EGAN, FLANAGAN AND COHEN, P.C. By: /s/ Edward J. McDonough Jr. Edward J. McDonough Jr. (SBN Egan, Flanagan and Cohen, P.C. 67 Market Street, P.O. Box 9035 Springfield, Massachusetts Telephone: ( Fax: (

43 MASSACHUSETTS MUTUAL LIFE INSURANCE COMPANY By: /s/ Bernadette Harrigan Bernadette Harrigan (SBN Assistant Vice President & Counsel Massachusetts Mutual Life Insurance Company 1295 State Street Springfield, Massachusetts Telephone: ( Fax: ( Of counsel: QUINN EMANUEL URQUHART & SULLIVAN, LLP Philippe Z. Selendy Jennifer J. Barrett 51 Madison Avenue, 22nd Floor New York, New York Telephone: ( Fax: ( A. William Urquhart Harry A. Olivar, Jr. Molly Stephens 865 South Figueroa Street, 10th Floor Los Angeles, California Telephone: ( Fax: (