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Royal Bank of Canada Sued by Rakuten Bank Over CDOs

Royal Bank of Canada, the country’s largest lender, and several units were sued by Rakuten Bank Ltd. over claims it marketed and sold unsuitable securities backed by deteriorating mortgage loans that wiped out a $10 million investment.

RBC induced Rakuten to invest 1 billion Japanese yen ($10.3 million) in a tranche of notes in a collateralized debt obligation called Logan CDO III Ltd. in June 2007. The notes ultimately became worthless when Rakuten sold them in December 2008 “for a nominal sum equivalent to approximately one cent,” according to a summons filed yesterday in state court in Manhattan. The lawsuit, which accuses RBC of fraudulent misrepresentation, is seeking to recover the U.S. dollar equivalent of the investment plus interest.

“RBC engaged in wrongful and unjust acts, including without limitation fraudulent misrepresentations and omissions of material facts relating to Logan III and its collateral,” lawyers for Rakuten said in the filing. “But for this and other misrepresentations and nondisclosures by RBC, plaintiff would never have invested in the notes.”

Logan III consisted of a diversified portfolio of CDOs and residential mortgage-backed securities, according to the filing. Pools of home loans securitized into bonds were a central part of the housing bubble that helped send the U.S. into the biggest recession since the 1930s. The housing market collapsed, and the crisis swept up lenders and investment banks as the market for the securities evaporated.

Adequate Warning

Bankers and underwriters being sued have argued that offering documents for those bonds adequately warned of risks. They claimed the securities performed as intended and investors were paid what they were owed from underlying mortgages.

RBC knew the underlying mortgage loans that comprised collateral securities were deteriorating in quality, safety and value. The company wrongfully withheld this crucial information and presented the CDO collateral as “high grade” and stable, according to the filing. Instead, the collateral pool carried significant losses of approximately $270 million “rending it akin to a pool of junk bonds,” according to the filing.

“RBC did not select collateral that was safe, stable and expected to perform,” lawyers for Rakuten said in the filing. “Instead, for its own benefit, RBC adversely selected collateral that it expected to fail.”

Rakuten Bank is a unit of Rakuten Inc., Japan’s biggest online retailer.

Kevin Foster, a spokesman for RBC in New York, didn’t immediately respond to a phone call and e-mail seeking comment on the filing.

The case is Rakuten Bank Ltd. v. Royal Bank of Canada,652057/2013, New York state Supreme Court, New York County (Manhattan).

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