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Steinhardt Group Inc. v. Citicorp

September 12, 1997






Appeal from the United States District Court for the District of Delaware

(D.C. Civ. No. 96-cv-00015)

Before: BECKER and MANSMANN, Circuit Judges, and HOEVELER, District Judge. *fn**

MANSMANN, Circuit Judge.

Filed September 12, 1997

Argued July 24, 1997


In this appeal, we are asked to decide whether a highly structured securitization transaction negotiated between Citicorp and an investor in a limited partnership constitutes an "investment contract" as that term is defined by the Supreme Court in SEC v. W.J. Howey Co., 328 U.S. 293 (1946). Examining the economic reality of the transaction as a whole, we conclude that the limited partner retained pervasive control over its investment in the limited partnership such that it cannot be deemed a passive investor under Howey and its progeny. Accordingly, we find the securitization transaction here does not constitute an investment contract. We will, therefore, affirm the judgment of the district court.


This case comes before us on review of the district court's order granting the Citicorp Defendants' motion to dismiss for failure to state a claim under Fed. R. Civ. P. 12(b)(6). When reviewing such an order, we are required to accept as true the factual allegations in the complaint. D.R. v. Middle Bucks Area Vocational Technical School, 972 F.2d 1364, 1367 (3d Cir. 1992) (citation omitted); Ransom v. Marrazzo, 848 F.2d 398, 401 (3d Cir. 1988). In considering a rule 12(b)(6) motion, "a court may consider an undisputably authentic document that a defendant attaches as an exhibit to a motion to dismiss if the plaintiff 's claims are based on the document." Pension Benefit Guaranty Corp. v. White Consolidated Industries, Inc., 998 F.2d 1192, 1196 (3d Cir. 1993) (citations omitted). Thus, the facts as set forth in the amended complaint and the relevant portions of the defendants' exhibits *fn1 are summarized below.


The controversy here arises out of alleged violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. Section(s) 78j(b), 78t(a), and 78t(b), and Rule 10b-5, 17 C.F.R. Section(s) 240.10b-5 involving the "securitization" of a pool of delinquent residential mortgage loans ("Mortgage Loans") and real estate owned by Citicorp as a result of foreclosed loans ("REO"). *fn2 The plaintiffs are The Steinhardt Group Inc. ("Steinhardt Group") and C.B. Mtge., L.P. ("C.B. Mtge."). The Steinhardt Group is a Delaware investment firm with its main office in New York City. C.B. Mtge., an affiliate of the Steinhardt Group, is organized as a Delaware limited partnership and holds a 98.79% interest as a limited partner in the Bristol Oaks, L.P. ("Bristol" or "Partnership"). Together, the Steinhardt Group and C.B. Mtge. are collectively referred to as "Steinhardt." Bristol Oaks is a limited partnership formed under the laws of the state of Delaware for the express purpose of creating an investment vehicle for issuing debt and equity securities to investors. Bristol is made up of one general partner, BGO, Inc. (1% ownership interest), and two limited partners, C.B. Mtge., L.P. (98.79% ownership interest), and OLS, Inc. (.21% ownership interest).

The Citicorp Defendants are comprised of Citibank, N.A., a national banking association, Citicorp North America, Inc. ("CNAI"), Citicorp Securities, Inc. ("CSI"), Citicorp Mortgage, Inc. ("CMI"), and Citicorp, which controls either directly or indirectly the other Citicorp Defendants. With the exception of Citibank, all of the Citicorp Defendants are organized under the laws of the state of Delaware.

Also named as a defendant in this action is BGO, Inc. ("BGO"), a Texas corporation and the general partner of Bristol. BGO is 100% owned by Ontra, Inc. ("Ontra"). Bristol contracted with Ontra to provide loan servicing, loan workouts, REO sales, and oversight of these asset types to the Partnership. The claims against BGO concern its refusal of the Steinhardt's demand that BGO file suit on behalf of the Partnership against the Citicorp Defendants.

Named as nominal defendants are Bristol and BHT Limited, L.P. ("BHT"), a Delaware limited partnership, which is owned 99% by Bristol. Not parties to this lawsuit are OLS, Inc., an Ontra affiliate owning a .21% limited partner interest in Bristol and BHT, Inc., an Ontra affiliate and 1% general partner in BHT Limited, L.P.

The fraudulent conduct alleged in the amended complaint arises out of a severe financial crisis faced by Citicorp during the early 1990's. With bad loans and illiquid assets threatening the very existence of the nation's then-largest banking institution, Citicorp was looking for a way to extricate itself from its financial problems. The securitization transaction was thus conceived by Citicorp to remove the nonperforming assets from its financial books and replace them with cash.

In essence, the securitization required Citicorp to create an investment vehicle--a limited partnership ultimately named Bristol Oaks, L.P.--that would issue both debt securities, in the form of nonrecourse bonds, and equity securities, in the form of partnership interests, to investors. Bristol would acquire title to the non-performing Mortgage Loans and REO properties and would retain Ontra, Inc. to manage and liquidate the assets. Then Bristol would obtain bridge financing from Citibank and CNAI; shortly thereafter, CSI would securitize and underwrite a public offering of bonds and other debt securities to pay off the bridge financing. All of the investors' money was to be paid to Bristol and become the capital of that investment vehicle. The return on these investments was to come from the same pool of assets.

During late 1993 and the first half of 1994, representatives of CSI made a series of written and oral presentations to the Steinhardt Group in which they described returns of 18% or more annually by investing in Bristol. Throughout these presentations and in other meetings and telephone discussions, Citicorp explained how it had created the proprietary "Citicorp Non-Performing Loan Model" (the "Pricing Model"), based on its own past experience, intimate knowledge of the assets at issue, and the valuation of such assets. Citicorp represented the Pricing Model to be an accurate means of pricing the Mortgage Loans and REO properties in the portfolio and of providing the Steinhardt Group with the promised 18% or greater returns. In particular, Citicorp represented to the Steinhardt Group that no institution in America had more experience in single-family residential mortgages, or more knowledge about the process of collecting on defaulted mortgage loans. Moreover, Citicorp touted not only its longstanding reputation in the banking industry, but also how the assumptions in the Pricing Model were firmly grounded upon Citicorp's own unparalleled experience and expertise.

A series of factual assumptions lies at the core of the Pricing Model. First, Citicorp assumed that the most accurate "proxy" for the values of the REO and the properties mortgaged for the Mortgage Loans would be Broker's Price Opinions ("BPOs"). These BPOs would be obtained from independent real estate brokers reflecting collateral value as well as the proceeds that would be obtained within six months if the properties were listed for sale. In addition, these BPOs were to provide "as is" values indicating what the properties were worth in light of their overall exterior and interior physical condition. Finally, an integral component of Citicorp's valuation methodology was obtaining BPOs for all of the assets, rather than just a sampling, thereby resulting in a more accurate valuation of the portfolio and significantly reducing the investment risk.

Under the Pricing Model, Citicorp represented the BPOs would be used to calculate a current Loan-to-Value ("LTV") ratio for each of the properties. The LTV ratio was used to project the probability of possible outcomes with respect to each of the Mortgage Loans, as well as the ultimate cash proceeds that would flow from each of the possible resolutions. *fn3 The Pricing Model further assumed that each of the existing and to-be-foreclosed REO properties could be sold for 98% of the BPO, which Citicorp represented to be conservative and designed to assure realization of its promised 18% return on the portfolio.

The Pricing Model also assumed that Ontra, as service-provider, would be able to resell the reinstated Mortgage Loans through a pre-existing "conduit" for such loans developed by Citicorp. Citicorp expressly stated in its written presentations to Steinhardt that the Pricing Model's assumptions were predicated on Citicorp creating a market in these loans to facilitate the stated time frames. Without such a conduit, Bristol could be left without an existing method to dispose of reinstated loans, with little choice but to foreclose on these Mortgage Loans, and holding reinstated loans for up to 30 years, negating the possibility of receiving an attractive resale price within six months as the Pricing Model assumed.

Citicorp further represented that CMI, in the past, had made little or no attempt to collect a substantial number of the delinquent Mortgage Loans and, thus, estimated that 45% of the total portfolio collections could be quickly restructured or worked out through payoffs or settlements. Finally, based on its own experience, Citicorp included several other assumptions in the Pricing Model: the average cost of repairs and maintenance for each of the properties in its portfolio would be $1,000; the foreclosures would take an average of less than nine months at an ...

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