Who’s Watching the Watchmen? RMBS Trustees Come Under Fire as Investors Launch Next Wave of Lawsuits

“When one door closes, another door opens; but we so often look so long and regretfully upon the closed door, that we do not see the ones which open for us.”

Alexander Graham Bell

The face of RMBS litigation took a dramatic turn last month when the focus of aggrieved mortgage bondholders moved beyond seeking recompense from the large banks who packaged and sold defective mortgage loans, and began targeting the other large banks that were hired to protect investors from such wrongdoing.  On June 18, 2014, a large group of investors that includes BlackRock and PIMCO filed six largely identical lawsuits in New York State Supreme Court against the six most prominent mortgage bond Trustees: Bank of New York Mellon (“BNYM”), U.S. Bank (“USB”), Wells Fargo, Citibank, Deutsche Bank, and HSBC.  The lawsuits collectively target over 2,200 residential mortgage-backed securities Trusts with an aggregate original principal balance of over $2 trillion, and alleged losses of over $250 billion.  An exemplar complaint is available here.

With these salvos, the fallout zone from the Mortgage Crisis has officially expanded, leaving very few players untouched.  However, this development was not surprising – at least to this humble long-time observer of and participant in residential mortgage backed securities (“RMBS”) litigation.  I have been predicting since as far back as 2010 that the Trustees who ignored or stood in the way of investor efforts to mitigate their losses would eventually face a day of reckoning.  In early 2011, I laid out the choice facing RMBS Trustees – protect investors or face their wrath – in the context of an iconic protest song by Bob Dylan.  But never did this potentiality come into sharper focus than with the filing of these six massive lawsuits last month.  As us litigation geeks are fond of saying, a complaint is worth a thousand words.

Towards the end of this article, I will delve into what exactly is being alleged in these suits, and what this shift means for existing and future putback lawsuits and settlements, as well as for Trustees, issuers and originators trying to deal with the fallout from the lingering mushroom cloud of the Mortgage Crisis.  But to understand why we have only now seen a major effort in this regard, let’s examine the top 5 developments that brought us to this point.

No. 5 – ACE II Closes Door on Non-Tolled Investor Actions, At Least For Now

No conversation about Trustee suits can take place without first understanding the status of the underlying mortgage repurchase (a.k.a. “putback”) litigation by investors against the issuing and originating banks, and particularly the evolving case law on the statute of limitations for such claims.  In particular, the key development in this space is the decision handed down by New York’s First Department Appellate Court just before the close of 2013 in ACE Securities Corp. v. DB Structured Products, Inc., 112 A.D.3d 522 (1st Dep’t 2013) (“ACE II’).  Therein, the Court held that putback claims filed after the 6-year anniversary of the Closing Date of a particular RMBS Trust are time-barred.

So, what exactly did ACE II entail?  In a three-page opinion that was as short on reasoning as it was long on significance, the First Department reversed the well-reasoned holding by Supreme Court Justice Shirley Korneich and found that contractual rep and warranty claims (i.e., “putback claims”) on ACE 2006-SL2 were time barred.  In doing so, the Court held that the 6-year statute of limitations for putback claims began to run from the RMBS Trust’s Closing Date, when any breach of the seller’s representations and warranties purportedly occurred.  It also held that it was a condition precedent to enforcement of putback claims to provide the seller with contractually-specified notice periods for cure and repurchase, without explaining how the claims could accrue for statute of limitations purposes while a condition precedent remained unfulfilled.  Finally, it held that the Trustee’s later substitution into the case did not “relate back” to an earlier filing by Certificateholders, since those bondholders lacked standing to sue on their own, and therefore the claims were untimely.

There is no topic that generates more questions from my consulting and legal clients these days than the impact of ACE II on the future of RMBS litigation.  Consistently, I have answered that regardless of what I think of the merits of the opinion, so long as the First Department’s restrictive view of the statute of limitations for these claims remains the law of the land, RMBS Trustees will face liability for sitting on their hands and blowing these claims.

However, to the extent it’s not apparent from my description of the holding, let me make something perfectly clear: I disagree completely with the conclusions reached by the First Department in ACE II.  I believe the decision was guided more by pragmatic concerns over the flood of litigation that might result if Justice Kornreich’s opinion became the law of the land than by the well-settled principles of New York Law and the language of the contracts at issue.  This is evidenced by the dearth of any meaningful logical reasoning in the ACE II opinion, as well as by its internal inconsistencies.  For example, the First Department consistently refers to the contractual prerequisite to a repurchase claim of notice, opportunity to cure and demand for repurchase (the “Repurchase Protocol”) as a “condition precedent,” but then does not treat the Protocol as a condition precedent for purposes of the accrual of the repurchase claim (as the relevant authority dictates).

Instead, the Court holds that while filing a repurchase claim before complying with the Repurchase Protocol renders a repurchase claim a “nullity,” it also holds that the clock begins ticking on a repurchase claim before this Protocol has been fulfilled.  In other words, the claims in ACE II had been filed, according to the Court, both too early and too late.

No. 4 – Leave to Appeal ACE II is Granted

I am not the only one who feels that this decision was incorrect, and indeed, HSBC Bank USA (“HSBC”), the Trustee of ACE 2006-SL2, has decided to appeal ACE II all the way up to the Court of Appeals, the highest court in New York.  Though HSBC was not entitled to appeal ACE II as a matter of right, just last week the Court of Appeals granted such leave, while also granted motions from CXA-13 Corp. and the Association of Mortgage Investors to file amicus briefs in support of HSBC’s position.  Briefing on this appeal should now take place over the next few months, with oral argument likely to be scheduled a few months after briefing is complete.  This means that we are unlikely to see a decision on this appeal before the first quarter of 2015.

HSBC has also hired former U.S. Solicitor General and top appellate dog, Paul Clement, to head their appellate team, showing that they take this appeal very seriously.  In his first action as counsel of record, Clement participated in a motion to reargue, or in the alternative, to seek leave to appeal to the Court of Appeals.  Therein, he argued on behalf of HSBC that the First Department’s “brief fails to grapple” with existing New York precedent “in a meaningful way,” and “did not even address, let alone attempt to reconcile” its decision with other New York cases relating to continuing obligations.  Though the Court of Appeals may be inclined, as the First Department likely was, to restrict the flow of future putback litigation that is currently clogging its lower court dockets, they will certainly have a serious legal effort and strong arguments to contend with before doing so.

But this is not to say that the ACE II was a bolt from the blue.  To the contrary, I have been writing for years that this outcome was a possibility, and have been counseling clients that putback claims should be filed before the 6-year anniversary expires in the event that the courts find that the repurchase obligation was not a continuing one (such that it renews each time a party fails to repurchase a defective loan upon notice of same).  And certainly, the Trustees were aware, or should have been aware, that courts examining this relatively new question of law could go in either direction, and thus they should have filed any claims within six years in an abundance of caution.

Unfortunately, many Trustees dragged their heels, despite bondholders’ efforts to compel them to file claims before the 6-year anniversary.  Indeed, as the timing of many investor cases can attest – including ACE II itself – though investors believed that the statute of limitations should be a continuous one, they filed many of these cases in their own name on the eve of the six-year anniversary in an attempt to preserve their claims.  In many of these cases, the Trustees eventually substituted in as plaintiff (albeit after the six-year anniversary and, according to ACE II, too late), thereby acknowledging that the claims were valid and that the Trustee was the proper party to bring them.  Should ACE II survive, these cases will carry with them some of the strongest threats of liability against Trustees.

Certainly, the Court of Appeals may reverse ACE II, which would render much of this moot, so long as the Trustees then take up the mantel of now-timely putback litigation in earnest.  Note that even without a hard and fast time bar, it’s safe to say that bondholders would still have viable claims for damages against Trustees based on, among others, delays by the Trustees in enforcing their rights, the failure to monitor and enforce servicing obligations, and a failure to investigate or enforce a whole host of other practices by the various deal parties that ultimately cost the Trusts money.  However, in the absence of such a reversal, RMBS Trustees and investors alike must assume that this will be the law of the land going forward, just as they should have been assuming before ACE II was handed down.  This means we are likely to see a flood of litigation against Trustees alleging that the banks sat on their hands and blew the statute of limitations on valuable putback claims.

No. 3 – Trustees Begin Facing Suits Even Before Statute of Limitations Issues Arise

A lot of folks have asked me if we can look to any precedents in assessing the recent complaints by BlackRock and PIMCO.  The short answer is yes, but only a few.  The law firm of Scott + Scott LLP filed three lawsuits in the Southern District of New York (Case Nos. 1:11-cv-05459, 1:11-cv-08066 and 1:12-cv-02865), in which they sued Trustees for failing to protect bondholder interests.  These cases were filed well before ACE II brought the statute of limitations into focus, and are framed as class actions rather than derivative actions.  Nevertheless, these suits have been largely successful thus far.

The suits are notable in part for their reliance on the Trust Indenture Act (“TIA”) to support some of their claims against the Trustee.  Under the TIA, indenture trustees are charged with certain minimum fiduciary duties, even in the absence of contractual language in the trust indenture itself.  In fact, while this Act was passed back in 1939, it was intended to address a similar situation as the one we’re faced with today – that investors in a bond structure are forced to rely on a trustee to protect their interests, but the trustee instead takes a passive role in reliance on the minimal language in the indenture.

In response, the trustees and certain amici from the banking industry began jumping up and down and hollering that the industry never intended the TIA to apply to RMBS Trusts, as those trusts were really more like equities than debt securities.  Thus far, two out of three judges in SDNY have rejected this argument in denying motions to dismiss on this theory, and the third ruling is currently being appealed before the Second Circuit.  This suggests that courts are willing to hold Trustees to at least minimum duties of loyalty and care in their oversight of RMBS trusts.

[Full disclosure: I have worked with Scott + Scott on certain aspects of these cases.]

In April 2014, we saw another effort by investors to hold RMBS Trustees accountable for breaching their contracts, common law duties and the Trust Indenture Act.  In Royal Park Investments v. U.S. Bank National Association, Case No. 14-CV-2590 (S.D.N.Y. 2014), bondholder Royal Park has purported to bring a class action on behalf of holders of bonds in over two dozen RMBS trusts against U.S. Bank.  Royal Park styles the Complaint as a “Class Action and Verified Derivative Complaint,” though the Court is likely to force Royal Park to choose one or the other structure for the litigation.  Though the suit is long-winded and a bit unfocused (here is the Complaint, for those who really want to get into the weeds, and it’s 221 pages long), it seeks over $6.7 billion in damages and contains extensive factual recitation regarding why U.S. Bank failed to live up to its obligations, and thus it must be taken seriously by the Trustee.

But these actions were only a prelude in size and scope of the massive actions we that were filed last month.

No. 2 – Major Investors File Sweeping Actions on Heels of ACE II; But End Game Remains Unclear

Though they never mention ACE II by name, the Complaints filed last month by BlackRock, PIMCO, et al. (collectively, the “Institutional Investors”) repeatedly suggest that by failing to act, the Trustee has lost the chance to do so, and the Trusts have been permanently damaged.  This is, I believe, what prompted these huge institutions to file their suits now.  In essence, the Complaints all allege that the Trustees were conflicted from the outset, in violation of their duty of independence (a.k.a. the duty of loyalty), and that this caused them to breach their contractual, statutory and common law duties to take action against the sponsors of the trusts and the servicers of the loans in the trusts.

I have had a unique view into the potential for claims against Trustees, as a major component of my practice is representing investors in dealings with Trustees, including many in which the Trustees and investors are potentially or actually adverse to one another.  Thus, I have seen firsthand the asymmetry in interests between Trustees and the bondholders they are generally charged with protecting.  But long before I was representing investors, I was writing about the struggles those investors were facing in compelling Trustees to protect their interests.

I wrote an article back in July 2010 about investors firing a warning shot across Trustee bows, and noting that Trustees may be sued for failing to live up to the fiduciary duties they acquire when they become aware of specific breaches by parties to the Trust Agreement.  In January 2011, I wrote about potential Trustee liabilities stemming from their duties to confirm that mortgages were properly transferred into the Trusts.  Later that month, I wrote an apropos article that laid out the choice with which Trustees were being presented – sue or be sued – and how certain Trustees were beginning to cooperate with investors.  Notably, I wrote that, “[t]he [active] trustees seem to be recognizing that while they were willing to drag their heels at first in the name of industry solidarity, this isn’t their battle, and they don’t want to find themselves on the hook for the errors and omissions of subprime lenders.”

Unfortunately, the deals in which Trustees ultimately took action were and remain the minority; and we are now seeing the consequences of this, as major institutions turn on the Trustees for burying their collective heads in the sand on the bulk of the subprime and Alt-A deals where defects ran rampant.

So, who is behind these massive suits, and what are their motives?  At the outset, it’s important to note that the Pooling and Servicing Agreements covering most RMBS Trusts provide the Trustee with rights to indemnity from the Seller or Sponsor against any costs or liabilities arising out of the Seller or Sponsor’s breach of its representations and warranties.  As such, the large RMBS issuers likely will continue to bear the brunt of the liabilities arising out of these latest lawsuits against the Trustees.  It is for this reason that the Institutional Investors’ filing of these six massive Complaints against all six major Trustees gives me pause.

Remember, the Institutional Investors behind these lawsuits are largely the same parties that were the architects of the $8.5 billion Countrywide settlement that I have repeatedly referred to as a “sweetheart deal” because of the size of the potential recoveries and the manner in which the investors and Trustee in that deal showed up to a gun fight with a water pistol.  [For background, see prior articles here, here, here and here.]  As the New York Supreme Court recently approved most parts of that settlement, these investors likely have been emboldened to cobble together similar pennies-on-the-dollar global settlements that threaten to put to bed all putback claims against JP Morgan and Citigroup, respectively.  I could devote an entire article to the similarities and differences between these various deals, but suffice it to say that while these last two settlements are procedurally on stronger footing than the Countrywide deal (giving Trustees the option to accept or reject the settlement on a deal-by-deal basis), they still amount to paltry payoffs compared to what could have been recovered.

Thus, when these latest Trustee cases were filed, my initial reaction was that these were similar efforts to place a cap on liabilities by engineering a global settlement, so that the Institutional Investors could keep their own investors, the large banks (their frequent business partners), and the Trustees (often affiliates of their business partners) happy.  The filing of the Complaints as derivative actions, meaning the plaintiffs are purporting to act on behalf of the entire Trusts to enforce (or settle) all potential claims the Trusts might have, only further suggests that the plaintiffs were setting up a global settlement that would cut off future suits.

And the countervailing fact that the Complaints were filed by respected plaintiff’s law firm Bernstein Litowitz, instead of Kathy Patrick’s Gibbs & Bruns, was not enough to convince me otherwise; it’s clear that Patrick was conflicted and would have had a hard time taking positions adverse to Trustees in any event.  That is, she just spent years in the Countrywide settlement proceedings arguing that BNYM, as Trustee, had acted reasonably, without conflict and above reproach, in an effort to see her settlement (and $85 million payday) approved.  It could potentially harm her efforts to see that settlement finally approved (it is still up on appeal, with oral argument coming sometime this fall) if she were to now file a complaint against BNYM claiming that the bank was actually operating under a massive conflict of interest.

Even so, the Institutional Investors have softened the conflict of interest language in the BNYM Complaint as compared to those of the other Trustees.  While the Plaintiffs allege in their claim for Breach of Fiduciary Duty of Independence (the Third Cause of Action) in the five non-BNYM lawsuits that the Trustees are “economically beholden to the sellers” because so much of their business comes from the sellers, Plaintiffs allege that BNYM is conflicted only because it “did not want to incur the associated transactional costs of exercising the Trusts’ rights against these entities or shine the light on its own wrongful conduct.”  It seems clear that with the New York Supreme Court’s approval of the $8.5 billion Countrywide settlement still subject to appeal, the investors are reluctant to take a position that could be used against them.  At a minimum, this raises questions about how aggressively the Institutional Investors will be pursuing these claims.

However, upon reading the Complaints themselves, I must allow for the possibility that these institutions may truly be seeking justice, or at least to maximize their recoveries, rather than placate the large banks.  The Complaints throw the book at the Trustees, bringing up all of the strongest arguments as to why Trustees had a duty to act, knew about problems in the Trusts, and failed to lift a finger.  They pull in literally thousands of Trusts, which increases the potential size of the claims, and have thrown around the $250 billion number as the potential damage figure, which would make it more difficult to settle for, say, another few billion dollars.

Yet, the aspect of these Complaints that, more than any other, forced me to consider that they were actually bona fide attempts at mitigating losses was not the Trusts and claims included in these Complaints, but the Trusts and claims that were not.  Namely, the six Complaints exclude potentially the strongest claims and the most powerful fact patterns by excluding any deals in which putback litigation has been initiated or significant putback activity has taken place.  That is, they have not sued the Trustees on deals like the one at issue in ACE II, where the investors seemed to take all the right steps to compel the Trustee to act, were forced to file on the day before the statute of limitations expired when the Trustee failed to act, and then had their case dismissed when the Trustee decided to step in only after the six-year anniversary had passed.  These situations present some of the strongest fact patterns for potential lawsuits against Trustees.

Similarly, in deals where active investors submitted repurchase claims through the Trustee to the responsible parties and obtained certain repurchases (but only a fraction of the claimed defective loans), and/or where the responsible parties filed Rule 15Ga-1 disclosures with the SEC regarding repurchase requests, investors also have potentially very strong cases against the Trustees.  There, they can argue that the Trustees were put on actual notice of widespread defects by way of the repurchase demands (and resulting repurchases, which validated those findings), but did nothing to enforce the bulk of the loans where lenders ignored their contractual repurchase obligations.  So, the Institutional Investors’ decision to exclude these deals suggests that they realize that those stronger claims don’t belong in their generic mass action that differentiates very little between deals.

At the same time, the lawsuits by the Institutional Investors also exclude the deals that are currently subject to the global settlements proposed for Countrywide/BofA, JP Morgan and Citigroup.  So, perhaps part of the impetus for these suits was to encourage the Trustees to accept the deals, by insinuating that so long as the Trustee accepts a settlement (even one that’s pennies on the dollar), it won’t face liability.  I think it’s safe to say that the jury’s still out on what is really motivating these suits, and what end game the plaintiffs’ are envisioning, but I think that RMBS Trustees, industry players and observers alike must allow for the possibility that while these Complaints suggest the plaintiffs mean business, the ultimate global settlement may reveal otherwise.

No. 1 – Additional Trustee Lawsuits Continue to Pour In, Suggesting Material Risk to Trustees

Since the Institutional Investors’ filing of their six massive lawsuits, we’ve seen at least four other Trustee suits filed over the last week.  On June 27, 2014, Commerce Bank and several other funds, credit unions, insurance companies and banks, filed a complaint against BNYM (Index No. 651967/2014, available here) requesting an accounting on 93 separate Countrywide RMBS Trusts, alleging that BNYM “engaged in a widespread failure to obtain and hold critical documents evidencing the mortgage loans belonging to the Trusts.”  It also seeks to preserve claims against BNYM for entering into the $8.5 billion settlement with BofA, to the extent the settlement is not finally approved.

On the same day, the Federal Home Loan Bank of Topeka, Doubleline Capital, and other funds filed three separate suits against HSBC, Wells Fargo, and Citibank, respectively (Case Nos. 651972/2014, 651973/2014, 651974/2014).  Though these cases are pre-RJI, and thus no Complaint is yet available, the Summonses with Notice indicate that these suits are for breach of contract, violations of the TIA, negligence and breach of fiduciary duty, on behalf of the plaintiffs and the trusts, based on the Trustees’ failure to take action to force Countrywide to repurchase loans sold to Trusts other than Countrywide-sponsored Trusts.  That is, the Summones allege that while BNYM took action as to the Countrywide-sponsored Trusts (which “constitute an attempt, however inadequate, to address defective mortgages in Countrywide trusts”), “[n]othing has been done by Defendant, or anyone else, to address the problem of defective mortgage loans in non-Countrywide trusts.”  The Summonses go on to detail some of the evidence that emerged from the BNYM Article 77 hearing, and seek redress on the remaining Countrywide loans for similar issues.

It’s safe to say that this is only the beginning of Trustee-focused litigation.  But, how do we get our arms around the real risk to Trustees?  As I mentioned, Trustees are indemnified to the extent that they can prove to a court that these losses arose out of breaches of reps and warranties by the issuing banks.  However, Trustees will likely have significant transactional costs in fighting these suits and establishing their indemnity claims against the large Wall St. banks.  In addition, Trustees do not have the right to be indemnified for their own gross negligence, bad faith, or willful misconduct.  In some deals, this exception also applies to plain old negligence.  Since such negligence is being alleged all over these latest complaints, there is some risk that the Trustees themselves will have to pay at least a portion of any judgment or settlement out of pocket.

And what is the size of that potential liability?  Well, the way I see these cases playing out is that they will be similar to an attorney malpractice case, where they will take the form of a “case within a case.”  That is, the plaintiffs will have to prove that the Trustee had a duty to act and didn’t, but also must prove the that underlying action would have had merit and have resulted in sizeable damages.  In theory, the Trustees (or their indemnitors) could be liable for the entire amount of damages that the unfiled putback claims could have recovered.  Also just in theory, but based on my experience in putback cases, that size could average 75-80% of the losses in these deals (so, for example, the damages in the Institutional Investor suits could approach $200 billion on the $250 billion in claimed losses, if all claims were successful) based on typical breach rates in deals of this vintage.

But, with BlackRock and PIMCO already having settled the Countrywide claims for approximately 8% or less of losses, they may be hard pressed to argue they would have recovered much more than that (or approximately $20 billion) through litigation/settlement.  This is yet another reason to be skeptical about the aggressiveness/representativeness of the Institutional Investor actions.  At the end of the day, much of that ultimate damage number is attributed to Trustee negligence or gross negligence depends on how much dirt the plaintiffs can uncover about what the Trustees knew or should have known, and what they did in response, and whether the factfinder is convinced that such conduct rises to the level of negligence or gross negligence.

Epilogue: Other Ramifications and Final Thoughts

In addition to the potential liabilities engendered by these six lawsuits themselves, the suits also put pressure on the Trustees to accept global deals that they’re currently evaluating on the JP Morgan and Citigroup deals, at least as to the deals that are not in active litigation or subject to an active direction letter from bondholders.  In those latter deals, the Trustees open themselves up to even greater liability if they were to settle claims where bondholders have been actively reviewing and/or putting back loans for the same price as claims where very little has been done.

The Trustees would also be biting off their noses to spite their faces, because in those deals, they’re already subject to a binding direction, and being provided indemnity by the bondholders, to pursue putbacks.  But for the remainder of the deals, the BlackRock/PIMCO lawsuits underscore the risks of doing nothing and passing on a deal that would settle the underlying putback claims.

Finally, these lawsuits demonstrate that there are potentially even greater liabilities (on a per-deal basis) awaiting Trustees who failed to act, or acted too late, on deals where active investors with the requisite holdings were putting back loans and/or attempting to direct the Trustees to take action.  As discussed above, these are the cases with the most compelling facts, and those about which the Trustees must be most wary as the tide begins to shift against them.

Posted in ACE, Alt-A, appeals, Bank of New York, Bank of New York Mellon, banks, Bernstein Litowitz, BlackRock, BofA, bondholders, Certificateholders, Citigroup, Commerce Bank, Countrywide, Credit Unions, DB Structured Products, Deutsche Bank, Doubleline Capital, Federal Home Loan Banks, fiduciary duties, global settlement, HSBC, Institutional Investors, investors, JPMorgan, Justice Kornreich, Kathy Patrick, lawsuits, liabilities, litigation, MBS, New York State Supreme Court, Paul Clement, PIMCO, pooling agreements, putbacks, repurchase, RMBS, SEC, servicers, settlements, statutes of limitations, subprime, TIA, Trustees, US Bank, Wall St., Wells Fargo | 7 Comments

Motion to Exclude Frey Testimony from Article 77 Raises Eyebrows, Questions About Role of BlackRock and PIMCO

The backyard brawl between the AIG-led objecting investors on one hand and Bank of New York Mellon (BNYM) and the investors supporting BofA’s $8.5 billion settlement on the other is about to get even messier.  As I last wrote on May 29, before the merits hearing on the Article 77 settlement began in New York Supreme Court, that AIG had subpoenaed the records and testimony of Bill Frey, a bondholder advocate that had been hired to develop evidence against Countrywide.  We had heard very little about that testimony until this past Friday, September 20, when BNYM and the supporting investors filed this motion to prohibit Frey from testifying.

The essence of the 2-page motion is that Frey’s testimony was both irrelevant and protected from disclosure by an NDA.  But both of these arguments may be subject to attack.

BNYM and the institutional investors that support the deal, including BlackRock and PIMCO (the “Institutional Investors”), argue that the only topic at issue in the Article 77 proceeding is whether the Trustee’s conduct in reaching and submitting this settlement was reasonable.  Since the Trustee never hired Frey or considered any of his work, nothing Frey would say could have any bearing on whether the Trustee’s actions were reasonable.

However, Frey’s testimony may reveal that the settlement was actually the product of a non-arms-length transaction, something that the Trustee should have investigated before swallowing the deal and its assumptions whole.  And I believe that this is why the Institutional Investors are afraid of what Frey will say on the stand.

As has long been rumored, and as Debtwire has previously reported, Frey had developed, on behalf of Tal Franklin’s much larger group of investors (a group that originally included BlackRock and PIMCO), a study of whether servicing practices by Countrywide had complied with its servicing obligations.  This study found that, in nearly every deal examined, Countywide had violated its servicing obligations in its treatment of first liens for which it or BofA held the associated second lien (i.e. self-dealing).  Multiple sources have told me that this study was actually verified by Fannie Mae, which confirmed that the methodology and results were accurate.

However, when it came time to submit this information to BNYM and demand that it take action, which would have created an Event of Default and heightened duties for BNYM, the Institutional Investors pulled out, submarining Franklin’s effort.  Instead, the Institutional Investors, led by attorney Kathy Patrick, opted to ignore this hard evidence, stay on friendly terms with BofA and BNYM, and negotiate the sweetheart deal (8 cents on the dollar of potential claims) that’s now at issue in the Article 77 proceeding.

When reached by telephone, Frey told me that he had “no comment” regarding the legal proceedings.  Frey’s attorney, Bob Knuts, and the attorneys for the objectors and the Institutional Investors did not return calls for comment.

While we don’t know exactly what Frey’s testimony would entail, or what his records would reveal, we can only imagine what juicy details would emerge regarding the way this deal came together.  From the lone internal email communication that has been released to the public thus far, we’ve already learned plenty.

Here is a copy of that email from Kathy Patrick to her group of Institutional Investors, informing them that participation in attorney Tal Franklin’s more aggressive effort to declare an Event of Default in a letter to the Trustee “is not in your interests.” [Note that this email was originally published by Reuters in connection with this story - the link remains but the content is now subscription-only, so I have posted it on Scribd.]  Patrick goes on to tell her group that “it would be a terrible shame to waste the traction we have gained with BONY by sending them a default letter at this critical stage.”

Patrick then notes that she believes that sending conflicting instructions to the Trustee would cause it to freeze in place and do nothing.  Tellingly, she concludes with the line, “[w]e don’t want to be forced to go to war with [BONY] if there is an opportunity to achieve victory by different means.”

The email initially came to light during the time that U.S. District Court Judge William Pauley had the case before him, and was considering whether to remand the proceeding back to state court.  Though Patrick was arguing before Judge Pauley that her clients were the only game in town and any amount they got was pure gravy, read this email and tell me you’re not left with the distinct impression that there was another, more serious game in town, and that her clients, instead of playing in the big leagues, opted to play patty-cake with the Trustee.

In short, Frey’s testimony and records could show that Kathy Patrick’s clients, like BlackRock and PIMCO, had purposefully ignored strong evidence at their disposal, and had negotiated a settlement that was better for BlackRock and PIMCO than it was for the pensioners and savers whose money they managed.  In other words, they never really intended to litigate these claims or push BofA for the best deal possible – instead, they may have had business reasons (including liquidity needs supplied by BofA and overlapping ownership with BofA) for wanting to keep BofA happy while looking like they were pursuing remedies.  Why else would the Institutional Investors provide a limited conflict waiver to BNYM attorney Mayer Brown, so that the Trustee’s counsel could only negotiate a settlement, and would not be permitted to litigate?

This raises perhaps the most important question to emerge from this trial – did these Institutional Investors breach their fiduciary duties to their own investors by agreeing to this deal?  This is a question that every union pension fund and college endowment that runs money through these institutions should be asking, whether or not this deal gets approved.  If these money managers gave away valuable claims for pennies on the dollar based on conflicts of interest, they should have to face the music.

Meanwhile, if Trustee had signs that the deal wasn’t truly arms-length, it shows that the Trustee may not have acted reasonably in accepting the deal.  Instead, it should have asked more questions about the process and how the numbers were reached, and certainly should have invited other stakeholders to participate in the conversations, before seeking the Court’s approval for the settlement, and pre-committing itself to use its “best efforts” to see that the deal was approved, no matter what evidence emerged.

At its heart, our legal system is adversarial in nature, and requires both sides to be pulling as hard as they can for the best result possible, so that the factfinder can find the middle ground.  If nobody was actually acting in an adversarial manner during the settlement negotiations, and if the settlement is then given a presumption of reasonableness in the Article 77 proceeding, it distorts this adversarial process.

As I wrote about recently, this proceeding is odd in that party that stands to lose the most (BofA) isn’t even a party to the proceeding, and the party pulling for the deal to be approved (BNYM) has no stake in the outcome, other than preserving the indemnity provided to it by BofA.  Thus, it makes for an awkward and distorted platform from which to render justice of any sort.  At the very least, Judge Kapnick would have to look more closely at the deal and the Trustee’s actions if it becomes clear that the deal was the product of conflicted self-dealing.

[As an aside, this also raises questions about Fannie Mae's involvement and the reasonableness of its conduct.  If it's true that Fannie had verified data that showed that Countrywide had engaged in widespread servicing defaults, why didn't it (or the FHFA as conservator) pursue claims based on that data to recover funds for taxpayers?  Why would Fannie only be willing to go forward if BlackRock and PIMCO had joined?  Sure, there's a strength in numbers argument, but Fannie's holdings (as revealed through the FHFA lawsuit against Countywide) were sizeable enough for it to pursue significant claims on its own.  Did it lack the political cover to move forward with putback and breach of contract claims, and if so, was that a proper consideration when leaving taxpayer money on the table?]

In short, there are many reasons to think that Frey’s testimony would be relevant to Justice Kapnick’s evaluation of the merits of this Article 77 proceeding.  There is also grounds to believe that the NDA signed by Frey only covered certain aspects of his work, and only a limited time period.  One source, who asked not to be identified, told me that much of Frey’s work and communications with investors took place before any NDA was in place.

All of this raises interesting questions about where this proceeding is heading and what Justice Kapnick will do.  She has stated on the record that she wants objectors to wrap up their case by this Wednesday.  However, she’s also indicated that she may set aside time in Novermber for closing arguments.

This motion throws a wrench in the Justice’s original time frame for wrapping up the hearing.  She must first review briefing and hear oral argument on whether Frey’s testimony should come in.  Then, if she rules that it can, the parties will have to review any documents he intends to produce, and will likely have a fight over which of his communications and other documents are protected or subject to privilege.  Evaluating all of this will take time, and Kapnick is unlikely to exclude potentially relevant evidence based simply on an arbitrary deadline.  Doing so would provide AIG and the other objectors with ample grounds for appeal.

Call me an idealist, but I believe in the American system of justice and the rule of law.  But the system only works if the aggrieved parties actually present their claims.

Here, few can dispute that the aggrieved parties are the pensioners, retirees and savers of the world who were duped into buying mortgage backed securities that didn’t live up to their promises – not even close.  The problem is that there are too many layers of imperfect principal-agent relationships between the aggrieved parties and the responsible parties, to achieve widespread justice.

The savers invest in various BlackRock or PIMCO fixed income funds, for example.  Most of these savers have no idea what those funds actually bought or currently hold.  BlackRock and PIMCO then have a fiduciary duty to manage those funds to get the best returns possible for their investors.  But if things go horribly wrong, they often lack the incentives to stick their necks out and file lawsuits.  Instead, they opt to stay with the pack, preserve their business relationships, and not rock the boat.

Even when certain bold investors decide to press their claims, they must go through passive Trustees, who want to do everything in their power to avoid getting sued, and conflicted servicers, who act to protect their own portfolios rather than acting in the best interests of bondholders.  Only if those bondholders can compel the Trustee and the servicer to act in their interests can they then take advantage of the justice system and the rule of law to see their contracts enforced against the Countrywides, EMCs and GreenPoints of the world.

As you can see, there are many steps along the way in which the incentives to press these claims can be distorted, and the agents do not always act in the best interests of their principals.  This Article 77 proceeding is the product of several of these distortions.  And while it’s not obvious at first to the untrained eye, which only sees that investors managed to squeeze $8.5 billion out of BofA, the more accustomed one gets to the way this deal came together, the more evident it becomes that the process was far from legitimate.

Should Bill Frey’s testimony be allowed in, as I think it should, it will help Justice Kapnick come around to that view, making it incrementally more likely that she’ll reject the deal.  But whether or not the deal goes through, it’s beginning to look more and more obvious that many of the proponents of the deal (and not just BofA) should wind up having to defend themselves in court when all is said and done against claims of breach of fiduciary duty, negligence, and breach of contract.  Should enough aggrieved parties be willing to press such claims, I’d be willing to bet that some form of justice will ultimately prevail.

Posted in AIG, allocation of loss, appeals, Bank of New York, banks, bench trials, BlackRock, BofA, bondholder actions, conflicts of interest, contract rights, Countrywide, demand letter, Event of Default, Fannie Mae, FHFA, fiduciary duties, global settlement, incentives, Investor Syndicate, investors, Judge Barbara Kapnick, Judge William Pauley, Judicial Opinions, Kathy Patrick, lawsuits, liabilities, litigation, MBS, negligence and recklessness, PIMCO, private label MBS, putbacks, remand, rep and warranty, repurchase, responsibility, RMBS, servicers, Trustees, William Frey | Leave a comment

Objectors’ Siren Song Enchants During Article 77 Proceeding

We are 20 days into the monumental bench trial over Bank of America’s proposed $8.5 billion settlement of Countrywide MBS claims, and with the proceedings now taking a break until September 9, we have a chance to sit back and evaluate what we’ve seen thus far.  When I do, I can honestly say that I’ve never seen a plaintiff take such a pounding during the presentation of its own case.  But, of course, this Article 77 proceeding is no ordinary case, and Bank of New York Mellon (BNYM) is no ordinary plaintiff.

As Trustee of all 530 Countrywide MBS Trusts at issue, and by virtue of having brought this odd proceeding before Justice Barbara Kapnick in New York Supreme Court, BNYM’s role is to ask the Court to bless Bank of America’s (BofA) settlement and the conduct of the Trustee as reasonable and beyond reproach.  The odd thing is that BofA – the party with the most at stake – isn’t even a party to this proceeding.  Instead, BNYM – which derives no economic benefit from the settlement dollars themselves – is serving as BofA’s foil – arguing for the settlement to be approved, while absorbing any attacks levied by the opponents to the settlement.

Even stranger, it has now become clear that the Trustee pre-committed itself to advocating for the approval of the settlement, regardless of what evidence or arguments the settlement’s opponents might present.  Much like the famous story from Homer’s The Odyssey in which Odysseus ties himself to the mast of his ship to avoid being persuaded off course by the enchanting sirens, BNYM has agreed to tie its own hands and bind itself to BofA’s chosen course for resolving Countrywide’s potentially massive mortgage liabilities.  The key question that Justice Kapnick and observers must ask is: was this an appropriate action for BNYM to have taken in this situation?

To see why this is so critical, let’s examine an exchange between counsel for BNYM, BofA, and the settlement objectors outside of the courtroom prior to this month’s proceedings (h/t Manal Mehta).  During trial on June 14, 2013, Justice Kapnick requested that the parties consider agreeing to mediation as a method of resolving the objectors’ complaints.  Following this request, two of the most prominent members of the objector Steering Committee – AIG and three of the Federal Home Loan Banks – sent a letter to counsel for BNYM confirming that the Steering Committee believed that mediation was appropriate and requesting that BNYM as Trustee “commence settlement negotiations immediately.”  It based this request, not on any direction by the objecting holders, but based on the Trustee’s “fiduciary duty of loyalty, which mandates that the Trustee act in the best interests of all certificateholders and avoid conflicts of interest.”

In response, Matt Ingber, counsel for BNYM, sent a letter to the Steering Committee and counsel for BofA, which attached the Steering Committee’s request for mediation.  Therein, he noted that “of course, a mediation cannot proceed without the participation of Bank of America and Countrywide.  Accordingly, please let us know the position of Bank of America and Countrywide on the request for mediation.”  This suggested that the Trustee was potentially open to negotiating with the objectors, but wasn’t going to take action without getting the approval of the bank behind the curtain.

Not wanting to keep anyone in suspense, BofA shot back with a response that was as clear as it was pithy.  Elaine Golin, BofA’s counsel from Wachtell Lipton, wrote, “Bank of America and Countrywide will not participate in the mediation that Objectors have proposed and will not otherwise engage in any renegotiation of the Settlement.  The Settlement Agreement reflects the result of lengthy, hard and arms-length negotiation.  It does not permit any of the economic terms to be renegotiated.”

BofA might have stopped there.  BNYM had already stated that the mediation could not proceed without BofA, so BofA’s refusal to participate should have ended the matter.  But, just in case anyone was in doubt about who was running this show, BofA decided to throw its weight around and smack the Trustee back into place.  Golin wrote to BNYM, “[w]e remind you of the Trustee’s obligations under Paragraph 2(a) of the Settlement Agreement to use its ‘reasonable best efforts to obtain Final Court Approval’ and under Paragraph 30 to use its ‘reasonable best efforts and cooperate in good faith to fully effectuate the intent, terms, and conditions of th[e] Settlement Agreement and the Settlement.’”  In other words, if you want us to continue to indemnify you and cover your expenses, don’t even think about questioning or renegotiating any aspect of this settlement.

Now, here’s the problem for BNYM.  It has an obligation to act in the best interests of the Certificateholders in each of the 530 Trusts at issue.  Yet, it negotiated a settlement that released the claims of all Certificateholders, without consulting the majority of those holders.

BNYM’s argument is that it independently evaluated the settlement and concluded that it was sound.  It has maintained throughout this Article 77 proceeding that it was perfectly reasonable for the Trustee not to consult with any Certificateholders outside of the 22 institutional investors who supported the deal.  Instead, it has argued that the Article 77 proceeding itself was Certificateholders’ opportunity to say their piece and speak out against the settlement.

Yet, this argument rings hollow when juxtaposed with the “best efforts clause.”  In fact, the Trustee has acted consistently with the “best efforts clause” by opposing the objectors’ requests for expanded discovery at every turn.  If this proceeding was the full and fair vetting of the settlement that the Trustee held it out to be, why wouldn’t it want all relevant facts to come to light, such as the actual breach rate in the loan pools at issue?  Wouldn’t this allow all Certificateholders to make a fully-informed decision about whether to support the settlement?

More importantly, what good is this opportunity for the objectors to speak out against the settlement if the Trustee isn’t listening?  Or, more appropriately in the context of the Odyssean metaphor, the Trustee may be listening to the objectors’ siren song, but it can’t change course because it’s tied to the mast of BofA’s settlement vessel.  If the Trustee has an obligation to act in Certificateholders’ best interests, why shouldn’t it be allowed to revisit the settlement if new evidence emerges?  And why should the Trustee work to prevent relevant evidence from seeing the light of day?

The counterargument is that the objectors have their opportunity to present their case to Justice Kapnick, and it’s ultimately the Court that will make the decision.  But, it’s becoming increasingly apparent that the Justice will make this determination based not on the absolute dollar amount of the settlement, but on whether the Trustee’s conduct in negotiating and accepting the settlement was reasonable.

Thus far, objectors’ counsel, led by Dan Reilly, Larry Pozner and Mike Rollin of Reilly Pozner and Beth Kaswan of Scott & Scott, have seized on this conflict to inflict significant damage during cross examination of the Trustee.  They have repeatedly pointed out the internal conflicts that imperiled BNYM as it helped to piece together one of the largest settlements in history between BofA and 22 investors willing to make a deal.  In one of the most compelling moments, during the hearing on July 16, the objectors forced BNYM’s counsel to admit that even if he had learned of facts or law that undermined the settlement, he was contractually prohibited from informing the Court of this (unless it involved intentional wrongdoing by BofA) due to the “best efforts” and related clauses of the settlement agreement.  This seems starkly at odds with the Trustee’s duties under the governing trust agreements.

Indeed, as Trustee of the 530 Countrywide MBS Trusts, BNYM had an obligation to remain loyal to the Certificateholders in those Trusts and avoid conflicts in carrying out that duty.  However, as I’ve often pointed out and the objectors have argued, the realities were that BNYM wanted to keep BofA happy, as BofA supplied it with over 60% of its MBS Trustee business and promised to indemnify it from any liability if the settlement went through.  So, instead of wanting to push for the best deal possible, it simply wanted to see this sweetheart deal get done.

Of course, BofA didn’t trust that these nebulous economic interests would keep BNYM in line.  So it forced the Trustee to swear off objectivity, and agree to use its “best efforts” to get BofA’s settlement approved.  This means that BNYM, the party ostensibly advocating for the settlement, really doesn’t have a dog in this fight, other than a fear that BofA will get really angry and yank their business and/or their indemnity.

The objectors’ arguments about BNYM’s strange conduct and awkward position seem to have finally caught the ear of Justice Kapnick.  She ruled just before trial that objectors had made out a colorable claim of self-dealing and conflicted conduct by BNYM, sufficient to overcome the attorney-client privilege and allow the objectors to obtain emails that traveled between BNYM and its counsel during settlement negotiations.  Armed with these documents, the objectors subjected BNYM’s counsel, Jason Kravitt of Mayer Brown, to withering cross examination during six straight days of testimony at trial that would have worn down even the most grizzled expert witness.  And Kravitt is not a grizzled expert witness – he’s far more accustomed to being the one in the board room or on the other side of the witness stand.  [For a great blow-by-blow of the various lines of questioning, the best resource (aside from the transcripts themselves) is Mark Palmer’s daily coverage of the trial at the BTIG Blog.  Palmer reported that when Kravitt learned he was going to be called back to the stand for a sixth day, he dropped his head into his hands for about ten seconds).

As I look at this trial from a 30,000-foot perspective, I’m struck by how appropriate the Odyssean metaphor really is for this strange position that BNYM finds itself in.  By agreeing to the “best efforts clause,” BNYM has agreed to do everything in its power to support the settlement and see it get approved, regardless of what this trial may unearth about the reasonableness of the deal.  For those who slept through their Classics or Mythology classes in school, a brief refresher: Odysseus was the captain of his ship, and yet asked his crew to tie him to the mast when they sailed past the beautiful sirens, so that he would not be persuaded by their alluring call and plunge his ship into the rocks like so many had before him.  His crew was ordered to place wax in their ears so that they could not hear the call of the sirens or the entreaties of their captain.  But Odysseus had no wax in his ears, so he could still hear the sirens' song; he just had no power to do anything about it.

It's the classic allegory of pre-commitment - binding yourself ahead of time to what you know is the right course because you don't think you'll have the strength to choose that path in the moment.  It's like the friend who gives you cash before you walk into a casino and tells you not to give it to him, no matter how much he protests.  [Never agree to this, by the way.  You'll find yourself out in the parking lot two hours later as your friend yells at you to give him his money back.]

Only here, BNYM, as the plaintiff and the “captain” of the Article 77 ship, has a fiduciary obligation to act in the best interests of all bondholders, which include those they’re treating as the sirens –  the objectors.  And it’s not so clear that BofA’s path is the right one for the Certificateholders as a whole.

At least one of the objectors, AIG, has stated publicly that it holds an interest in 97 of the 530 trusts at issue.  Should the Trustee be permitted to pre-commit itself to a settlement without speaking to investors like AIG, before all the facts have been examined, and before the settlement has been finalized?  What if instead of steering the Trustee into the rocks, these objectors are showing the Trustee how it can reach friendlier shores (Ithaca?) – that is, squeeze a whole lot more money out of BofA?  Wouldn’t the Trustee have a duty to pursue this path and see where it leads?

BNYM’s expert JH Langbein thought so, but after he said in deposition that the Trustee owed a fiduciary duty to bondholders to maximize their recoveries, BNYM pulled him from their witness list.  Now, we won’t hear from him personally at trial, though AIG’s counsel read his deposition testimony into the record.  Same goes for Brian Lin, the now infamous expert from RRMS, whose calculations form the primary basis for BNYM’s determination that the $8.5 billion settlement amount was reasonable.  Lin’s no longer on BNYM’s expert list, but you can be sure that the objectors will call him to the stand as one of their witnesses.

Even without these witnesses showing up to discuss or defend their analyses, the objectors have scored plenty of points and brought many compelling facts to light.  First, they established through Kravitt that the “best efforts clause” could be read to amend the Pooling and Servicing Agreements, the contracts governing the 530 Trusts.  Yet, the Trustee did not follow the protocol established in those documents for amending their terms, which generally require a super-majority of Certificateholder votes.  So, agreeing to this clause may have been an improper amendment of the Trustee’s duties.

Second, they got Kravitt to admit that his firm, Mayer Brown, had no authority to actually sue BofA if settlement negotiations fell through.  That’s because Mayer Brown had also represented BofA, and had only obtained a limited conflict waiver from BofA to negotiate the settlement, not to sue.  At least ten of the institutional investors supporting the deal also had prior relationships with Mayer Brown, and they had all executed similar conflict letters.  This completely undermines BNYM’s position that these were arms-length negotiations and that it took an aggressive approach toward BofA, including an implicit threat of litigation.  If this was true, wouldn’t BNYM have hired a counsel that could hold the sword of litigation over BofA’s head?

Third, the objectors established that BofA was paying BNYM’s legal expenses throughout much of the negotiations and the Article 77 proceeding.  Though Kravitt contended that this was perfectly normal, I have yet to engage in negotiations with a responsible party over RMBS liabilities in which the party we were threatening to sue agreed to pay my legal fees.  I’d like to ask for that at the outset of my next negotiation and see how that goes over.

Fourth, the objectors established that the settlement treats all 530 Trusts alike despite the fact that they have differing legal rights (most importantly, with respect to certain breaches being deemed material and adverse in certain Trusts).  BNYM had not disclosed this to the Court previously, but it has now come out during the trial.  This flies in the face of BNYM’s duty to act, not as the Trustee of all 530 Trusts at once, but as the independent Trustee of each of those Trusts, bound to make a separate determination for each as to what’s in the best interests of that Trust’s bondholders.

When this proceeding resumes on September 9, BNYM will present the last two of its witnesses.  With the bulk of its case now having been presented, you would expect the Trustee to have built up a sizeable lead, since the objectors have still not put on a single of its own witnesses or experts.  And yet, if the Trustee has any lead at all, it’s a small one, and it’s only by virtue of the high standard that objectors must meet to get the Court to reject the Trustee’s Petition (as discussed previously, the standard for approval is simply reasonableness, so the objectors must show the Trustee acted irrationally or arbitrarily for the Petition to be rejected).  Though I still feel it’s unlikely that Justice Kapnick will reject the settlement entirely, it’s beginning to look increasingly likely that she forces the parties back to the negotiating table.

You see, one can only deny the facts so long.  And no matter how much BofA hammers on BNYM that it must abide by the “best efforts” clause, at some point, Justice Kapnick herself may start to become persuaded by the objectors’ siren song, and begin to see this settlement for what it is: a sweetheart deal designed to protect BofA from far greater potential liabilities.  At that point, this trial may shift decidedly in favor of the objectors.  And rather than risk having the Court reject the whole thing, send everyone back to square one and erase the indemnity the Trustee covets so badly, BNYM may decide it’s obligated to mediate with the objectors and see what it would take to have them drop their objections.  Though this might send BofA’s $8.5 billion settlement crashing into the rocks, it would also be just what AIG and the other objectors have wanted from the start: to be heard by a Trustee with the incentive and the ability to heed their calls.

[I will be on vacation the remainder of this week, and will respond to any questions or comments as soon as I can upon my return - IMG]

Posted in AIG, Bank of New York, bench trials, BofA, bondholder actions, conflicts of interest, contract rights, Countrywide, damages, discovery, Federal Home Loan Banks, fiduciary duties, global settlement, incentives, investors, Judge Barbara Kapnick, Kathy Patrick, lawsuits, liabilities, litigation, loan files, MBS, pooling agreements, private label MBS, putbacks, re-underwriting, rep and warranty, RMBS, securities, settlements, successor liability, Trustees, waiver of rights to sue | 3 Comments

BREAKING NEWS: Article 77 Hearing Postponed, Bill Frey Subpoenaed by AIG

I wanted to publish a quick update to yesterday’s article breaking down the challenges BofA will face to its $8.5 billion mortgage rep and warranty settlement.  Sources have informed me that the May 30 Merits Hearing for this settlement proceeding has, in fact, been postponed, with new date yet to be determined (likely several months hence).  There has of yet been no formal announcement on this, other than word-of-mouth from the court clerk.  However, my guess is that it has something to do with the the Intervenors’ Notice of Appeal regarding Judge Kapnick’s decision to strike Intervenors’ demand for a jury trial (h/t Manal Mehta).

In other breaking news, Bill Frey has been subpoenaed by AIG. I can only speculate that he will be asked about the circumstances that led Kathy Patrick to split off from the Investor Syndicate and encourage her clients to take a less confrontational approach to Bank of New York Mellon (BNYM) and BofA.

It has long been rumored that Frey developed specific evidence for the Investor Syndicate, which had been verified by Fannie Mae, of thousands of loan defaults in hundreds of Countrywide trusts.  If true, this would severely undermine one of the Institutional Investors’ main arguments supporting the settlement: that they were the only group that was taking action against Countrywide and that they were serious about recouping their constituents’ losses.

Since many of Kathy Patrick’s group of institutional investors were previously part of Tal Franklin’s larger Investor Syndicate, why did they fail to cite any of the specific evidence of default, which they must have known existed, in their letter to BNYM?  Instead, Patrick circulated an email, that has since been brought to light in these settlement proceedings, encouraging her clients not to put BNYM in default as it would “set back significantly the progress we have made to get to get BONY to consider an alternative rep and warranty strategy.”  This alternative strategy became the sweetheart deal for BofA that BNYM is now asking the court to bless in the Article 77 proceeding.

Posted in appeals, BofA, Event of Default, global settlement, Investor Syndicate, Judge Barbara Kapnick, jury trials, Kathy Patrick, specificity, William Frey | Leave a comment

The Bell Tolls for BofA

Memorial Day Weekend is always cause for some reflection, but as we draw closer to the May 30, 2013 merits hearing on Bank of America’s (BofA) proposed $8.5 billion settlement of Countrywide mortgage liabilities, this last one seemed particularly appropriate for reflecting on the battles that have come to pass since Bank of New York Mellon (BNYM) first proposed the settlement on BofA’s behalf back in June 2011.  Though there has been some speculation that a recent win for settlement objectors would delay the merits hearing in BofA’s legacy mortgage D-Day, the lawyers on both sides must prepare as if they’re going to war on Thursday.

The odds have certainly been stacked against the investors who object to this settlement (the “Steering Committee”), as the accord is being presented for approval in New York’s commercial division under Article 77, an obscure vehicle designed to obtain rapid approval for trustees who are performing administrative actions for trusts.  Is BNYM’s decision to release  over $100 billion of mortgage backed securities (MBS) contract claims across 530 different Trusts in exchange for $8.5 billion a reasonable administrative action for trustee?  That’s for Judge Barbara Kapnick to decide.

But she need not make this decision in a vacuum.  Many guiding decisions have been handed down in the most prominent MBS cases over the last few months, and most of them point to flaws in the assumptions made by BNYM in deciding whether this was a good deal for the investors whose trusts it represents.

Earlier this month, MBIA announced that it had finally settled its long-running battle royale with Countrywide and BofA, resulting in a payment to MBIA of over $1.7 billion in cash plus various additional consideration, bringing the total settlement value to somewhere north of $2.7 billion.  This announcement was both vindicating and bittersweet for me; while I had long been predicting a settlement along these lines (see, e.g., here and much earlier, here), MBIA had achieved so many victories in the meantime that I was starting to look forward to seeing BofA get hammered at trial for refusing to acknowledge these liabilities.

And indeed, while BofA saved itself from near-certain disaster by preventing this case from proceeding to trial, it may have waited too long to avoid serious damage to BNYM’s $8.5 settlement of mortgage repurchase or “putback” claims, the centerpiece of its legacy mortgage strategy.

Today, I will looking back on recent events, including evaluating the read-through from the MBIA settlement, but I will also be looking forward to the upcoming merits hearing on the Article 77 proceeding and the challenges BofA and other banks will be facing in putting legacy mortgage issues behind them.  And the more I look at these recent developments, the more I can hear foreboding bells tolling for BofA and the largest issuers of MBS.

In fact, “For Whom the Bell Tolls,” in all of its embodiments, appears to be the perfect theme for this analysis. My younger readers will probably associate this reference with the heavy metal classic from Metallica, which opens with the ominous tolling of bells followed by the driving guitar riffs that suggest the end is coming soon. So I will begin there, as when I consider the predicament of the Big Four Banks, I can’t help but hear the final lines of this song, suggesting that the reality of legal liability cannot be denied forever:

Now they will see what will be
Blinded eyes to see
For whom the bell tolls
Time marches on

Where do Investors Stand?

With MBIA’s multifaceted litigation against BofA now coming to a close, it’s clear to me that we are entering the most critical period yet in the war over who will bear the losses from the country’s pre-crisis credit binge.  The settlement between MBIA and BofA can only be read, as the markets did, as a win for MBIA and monoline insurers in similar positions.  But I also view it as validation for the position that commentators such as myself have been espousing for nearly five years now – that banks are on the hook for billions in bad loans based on faulty underwriting.  Yet, while bond insurers such as MBIA, AGO and Syncora have been overwhelmingly successful in their MBS litigation, and have now settled most of their outstanding disputes on favorable terms, investors have yet to obtain similar results.

As we’ve discussed at length on this blog, this difference stems from a variety of factors, including less robust contractual rights, standing issues, and lack of organization.  However, certain motivated investors have now banded together with like-minded investors to form critical mass, overcome standing issues by wrangling MBS Trustees into acting on their behalf, and compelled those Trustees to institute litigation.  These plaintiffs are now poised to follow the roadmap laid down by the monolines and recoup a significant portion of the Trust’s losses.  That is, of course, unless the largest banks pull off the equivalent of a legal Hail Mary

As my readers are well aware, I have viewed the Article 77 proceeding from the beginning as exactly that – a desperate and aggressive move by an institution with its back against the wall.  Further, as many observers still don’t seem to realize, this was not a typical arms-length settlement between adverse parties.  Instead, this was a sweetheart deal struck between BofA and a small number of conflicted institutions who desired to keep BofA happy and look like they were taking meaningful action, rather than squeezing all they could out of the nation’s former No. 1 bank.

Today, we find the settlement proceeding rapidly approaching an approval hearing before Judge Barbara Kapnick in New York State Court, scheduled for May 30. Battle lines have been drawn between the institutional investors that support the deal, BNYM as the trustee, and BofA/Countrywide on the one hand; and on the other hand the steering committee of institutional investors who oppose the deal, comprised primarily of AIG, Triaxx, and a three of the Federal Home Loan Banks  (up until recently, at least on paper, it included the attorneys general of New York and Delaware; however, these entities turned out to be paper tigers once they were allowed to intervene, saying little in court and doing less, making their exit from the Steering Committee less important than widely thought).

Central to the outcome of the case is the determination of whether BNYM’s decision to settle over $100 billion of potential liabilities for just $8.5 billion was reasonable.  Much is at stake for both sides, as Bank of America’s current loss reserves rest on the assumption that this deal will be approved, and other banks are beginning to use this settlement to estimate their own MBS liabilities.

As far as Hail Mary plays go, this play was drawn up rather well – file an action in a favorable court using a favorable, but obscure, legal vehicle with little precedent regarding its application; have the Trustee file the suit so it appears to be acting on behalf of all investors; and then cross your fingers and hope the judge doesn’t have the gall or the depth of understanding to reject one of the largest settlements (by gross dollar amount) in history.

The problem, of course, is that this is a sweetheart deal parading as an arms-length transaction, and its justifications are illusory.  And, like any illusion, the more you poke and prod and ask questions about it, the more shaky this deal begins to look.  True to form, a flurry of legal rulings and evidentiary developments in recent months has threatened to decimate this settlement.

Punches to the Gut

To supporters of the Article 77 settlement, each of the past few months’ developments must have felt like punches to the gut, continuing to undermine the foundation on which this settlement was built.  For these entities, I’m sure the merits hearing could not come fast enough.

Most prominent among the legal developments was the February 5, 2013 decision of Judge Jed Rakoff in the Southern District of New York in a case brought by monoline bond insurer Assured Guaranty against lesser-known MBS issuer Flagstar Bank. This was the first MBS repurchase case to go to trial, and after hearing weeks of testimony regarding alleged breaches of the underwriting guidelines, Rakoff awarded Assured more than $90 million, an amount sufficient to cover all of its claims payments to date.

In doing so, Rakoff ruled that that the bond insurer need not show that the underwriting defects actually caused the loans to go into default, but only that the defect increased the risk profile of the loan. Specifically, Rakoff held that, “it is irrelevant to the Court’s determination of material breach what Flagstar believes ultimately caused the loans to default, whether it is a life event or if the underwriting defects could be deemed ‘immaterial’ based on twelve months of payment. Risk of loss can be realized or not; it is the fact that Assured faced a greater risk than was warranted that is at issue for the question of breach.”  This holding effectively sounded the death knell for issuing banks’ best defense to mortgage rep and warranty claims.

Following this holding, on April 2, 2013, New York State’s First Department Appellate Division had occasion to consider the question of whether the putback standard turned on materiality or loss causation, when Judge Bransten’s partial summary judgment holdings from nearly a year ago in MBIA v. Countrywide were finally decided on appeal.  Though Bransten had punted on the question of loss causation for loan-level putbacks, the First Department made the unusual move of ruling that Bransten should have issued a judgment in favor of MBIA on this issue.  Citing Judge Rakoff’s holding in the Flagstar case with approval, the First Department held that MBIA,

is entitled to a finding that the loan need not be in default to trigger defendants’ obligation to repurchase it. There is simply nothing in the contractual language which limits defendants’ repurchase obligations in such a manner. The clause requires only that “the inaccuracy [underlying the repurchase request] materially and adversely affect[] the interest of” plaintiff. Thus, to the extent plaintiff can prove that a loan which continues to perform “materially and adversely affect[ed]” its interest, it is entitled to have defendants repurchase that loan.

If Rakoff’s decision in the Southern District of New York sounded the death knell for BofA’s best putback defense, the New York State Appellate decision put the final nail in the coffin.  This is because the majority of MBS deals from this period are governed by New York law, and a New York Appellate Court decision interpreting the language of those deals is binding precedent for virtually all of them.  Why is this particularly relevant to the Article 77 proceeding?  Because, as we will discuss later in this article, Bank of New York Mellon’s “expert” gave a 60% haircut to his calculation of a reasonable settlement value based on the availability of this defense.

Finally, on April 29, 2013, Judge Bransten handed down her long-awaited rulings on MBIA and Countrywide/BofA’s motions for summary judgment on the separate issues of primary liability for Countrywide and secondary or successor liability for BofA.  Though Bransten did not issue judgment for either side on either of these issues, she did issues several preliminary rulings that were nearly unanimously favorable to MBIA and other MBS plaintiffs.

Though I could devote an entire article to analysis of these decisions – the most detailed and well-informed yet on putback liability -  I will simply summarize for the purposes of this article the most important points of read-through for the Article 77 proceeding.  The biggest impact on the settlement proceeding arises out of Bransten’s holdings on successor liability.  MBIA had based its case for successor liability on two grounds: 1) that there had been a merger in fact though not in form (a.k.a. “de facto merger”) and 2) that BofA had voluntarily assumed Countrywide’s liabilities by holding itself out to the public as doing so.

If you’ll recall, one of the major justifications for the low settlement amount in the Article 77 proceeding was the fact that Countrywide had insufficient resources to pay a large settlement, and BNYM’s expert, Stanford Professor Robert Daines, had opined that a court was unlikely to hold that BofA was on the hook for Countrywide’s liabilities.  On de facto merger, Professor Daines had discounted the likelihood of such a holding based primarily on his findings that Delaware law would likely govern this question and that the “fair value” test would prevent a court from piercing the corporate veil.

On summary judgment in MBIA v. Countrywide, Bransten rejected both of these arguments.  First, she held that New York law governed the question of BofA’s successor liability for Countrywide.  As I’ve written in the past, this determination is hugely significant, as New York law is much more favorable to a finding of de facto merger than Delaware law.  While Delaware law requires a showing of bad faith and values form over substance in making this determination – resulting in Delaware almost never finding that a de factor merger took place – New York law does not require a showing of bad faith and looks at the substance of the transaction over its form.

Second, Bransten rejected BofA’s assertion that MBIA’s successor liability claim failed as a matter of law because BofA paid “fair value” for the assets of Countrywide.  Specifically, Bransten held that,

[w]hether fair value is paid for the assets required has no bearing on whether a New York court will look at a transaction or series of transactions and deem them “in substance a consolidation or merger of seller and purchaser.

Compare this with Professor Daines’ opinion that, “I think a successor liability case would be difficult to win if a court concluded that BAC paid a fair price in the Transactions,” (h/t Manal Mehta) and you see that, once again, BNYM’s settlement determination is on shaky ground.  In fact, based on these holdings and Bransten’s comments on the record throughout this case, I pegged the likelihood at 75% that Bransten would have found for MBIA on the question of successor liability if this case had gone to trial.

Note also that Bransten kept alive MBIA’s alternative successor liability claim against BofA based on the theory that BofA impliedly assumed the liabilities of Countrywide when it made public statements to that effect.  Professor Daines dismissed the value of such a claim based on the express disclaimers to successor liability that were included in the acquisition deal documents and on the fact that MBIA could not have relied on these public statements since it entered into the bond insurance agreements prior to these statements being made.

However, Bransten also rejected these arguments, finding that the express disclaimers did not preclude a finding that BofA impliedly assumed these liabilities at a later date and that subjective third party reliance is immaterial to the question of successor liability (this is why I’ve been saying that the case for successor liability does not differ or depend on who is bringing it).

Now, to be clear, this holding does not constitute binding precedent in New York State – other judges would have had the discretion to find differently.  However, as a well-respected judge that has been the closest to this issue and has been handling mortgage crisis cases since the outset, I believe that Bransten is highly influential in the New York commercial division, and her opinion would have been quite persuasive to other judges in her jurisdiction.  This means that BNYM’s assumption that BofA would not have successor liability for Countrywide was likely inappropriate, further undermining the diligence of its settlement determination.

On the issue of primary liability, Bransten’s summary judgment opinion was helpful to Article 77 objectors in several ways.  First, she adopted the First Department’s loss causation holding, discussed above, and extended it from the single trust that the Appellate Court had ruled upon to every trust in the lawsuit.

Second, she laid down plaintiff-friendly interpretations of several important reps and warranties, including the “no default” rep - that there would be no default of a material obligation with respect to any loan – which is found in many deals.  Rejecting arguments by Countrywide that the representation referred only a default in the payment of the loan, Bransten held that this provision related to any material obligation, including borrower misrepresentations.

Finally, Bransten held that Countrywide could not use “blanket rebuttals” to dispute loan-level breaches found by MBIA, but instead had to go loan-by-loan and provided specific bases for rebutting each breach identified.  This finding took BofA’s loan-by-loan argument and turned it on its head, placing the burden on the bank to come up with specific reasons to rebut every breach.  Further, while BofA had also argued that MBS plaintiffs were only entitled to a loan-by-loan remedy, Bransten ultimately held on summary judgment (just as Judge Crotty had in the Southern District of New York in Syncora v. EMC) that MBIA would be entitled to other forms of monetary relief besides loan-by-loan repurchase.

In addition, Bransten’s opinions on summary judgment were not the only source of ammunition for MBS plaintiffs.  In reading Countrywide’s opposition to MBIA’s summary judgment motion on primary liability, it occurred to me that one of their arguments could be used effectively against them in the Article 77 proceeding.  As to MBIA, Countrywide argued that the monoline could not prove its fraud claim because it had the opportunity to conduct loan-level due diligence before entering into the deals but declined.  This meant that MBIA could not have “justifiably relied” on Countrywide’s misrepresentations.  Countrywide even went so far as to argue that no reasonable bond insurer should have entered into an MBS deal without conducing loan level due diligence to understand the types of loans and risks at issue.  Bransten ultimately rejected this argument, as it was not clear that MBIA even had access to loan files to conduct such a review.

However, in the Article 77 proceeding, the Trustee and BofA have been arguing since the beginning that no loan level due diligence was necessary for the Trustee to determine whether and at what price to settle over $100 billion worth of potential claims!  There, the settlement proponents argued that it was unnecessary and would have been too costly for the Trustee to actually look at loans in these pools to find out how many breaches were present.  But, in this case, the Trustee had full access to loan files and even the Institutional Investors that support the current deal were offering to show the Trustee loan-level data on similar pools.

This will not be lost on the Steering Committee of objectors, who has pointed out the hypocrisy in BofA’s position on this issue in the past.  I would imagine that the Steering Committee will seize on this latest both-sides-of-its-mouth argument by Countrywide to show that it was entirely unreasonable for the Trustee to accept BofA’s representations of its breach rate with respect to Freddie and Fannie conforming loans (a whole different ballgame) in lieu of loan-level review of the actual non-prime loans in these deals.

No Man is An Island

This brings up another appropriate reference to “For Whom the Bell Tolls,” this time to the original 1624 poem by John Donne that is credited with originating the phrase. In the poem of the same name (also known as “No Man is an Island”), Donne wrote:

No man is an island
Entire of itself
Each is a piece of the continent
A part of the main

***

Therefore, send not to know
For whom the bell tolls
It tolls for thee

These words summarize for me both the state of BofA’s settlement with BNYM and the state of the other large MBS issuers and originators watching from the sidelines. As to the former, BofA’s settlement is not an island, self-contained and removed from important legal developments in other MBS cases.

As to the latter, no bank is an island, and the mere fact that BofA has been the earliest target of mortgage litigation due to its acquisition of Countrywide does not mean that plaintiffs will not turn their sights on the other large banks next. In fact, the same group of institutional investors that initiated the BNYM settlement, still represented by Kathy Patrick, has also initiated negotiations and/or legal notices with respect to Morgan Stanley, Wells Fargo and JP Morgan Chase.

Let’s address the former first. BNYM has now admitted in the Article 77 settlement proceedings that it reached the $8.5 billion number based entirely on the work of one expert, Brian Lin, of the relatively unknown firm, RRMS Advisors. Lin is a former Merrill Lynch trader with no disclosed experience in evaluating MBS settlements and no disclosed clients other than BNYM. He reached his number based on a number of questionable assumptions that resulted in “haircuts” applied to the original loss estimates for the 530 trusts.

One of these assumptions was that only 30 percent of loans that were between 60 and 179 days delinquent would eventually default (the actual percentage is closer to 90 percent). Another assumption, as mentioned above, was that it was reasonable to forego reviewing individual loans from the Countrywide MBS for defects in favor of borrowing data from BofA’s experience with Freddie Mac and Fannie Mae on higher-quality conforming loans. Finally, the analysis relied on the aforementioned “loss causation” haircut – the assumption that BofA would not be compelled to repurchase 60 percent of the loans that contained defects because the identified breaches could not be tied to the reason the borrower stopped paying the mortgage.

In a March 13 filing in the Article 77 proceeding, the Steering Committee of investors who oppose the deal submitted the expert report of Dr. Charles Cowan.  Cowan marched through Lin’s expert report methodically and scientifically, dismantling several of the assumptions on which it relied. Notably, he argues that Lin had better evidence at his disposal than the Freddie and Fannie repurchase experience, and could have used that to estimate the pool’s breach rate rather than swallowing whole the non-analogous number provided by BofA itself. He also discussed why Lin had not used proper estimates of default and loss severity rates, and why Lin’s 60 percent “success rate” haircut was entirely improper.

Using what he represented as a “scientifically valid approach to the use of the limited information provided to Mr. Lin,” Dr. Cowan concluded that “the estimated average total repurchase liability is $56.34 billion” rather than the $8.5 billion that was at the low end of Lin’s range of reasonableness and which figure the Trustee eventually accepted.  Dr. Cowan also noted that this was not his view on the actual repurchase liability, but only the logical conclusion that Mr. Lin should have reached had he pursued “a scientifically sound approach to the task.”

While I found Dr. Cowan’s analysis compelling, I don’t think the outcome of the Article 77 proceeding will come down to a battle of the experts and whose number was more accurate or appropriate.  Instead, it will turn on an analysis of the process - that is, did the BNYM undertake a reasonable approach to determining whether to settle and at what price.  Dr. Cowan’s report does an excellent job of addressing this aspect, as well, pointing out the fact that Mr. Lin ignored better data at his disposal.

But the subsequent legal decisions we’ve discussed above will likely be most influential in showing that many of the legal assumptions and others underpinning the settlement were unreasonable when made. As noted above, the loss causation defense has been rejected by every court that considered it, showing it never had legs in the first place.  Even BofA’s own attorneys in the MBIA case, O’Melveny & Meyers, published a client alert back on July 27, 2012 (before Rakoff or the First Department had issued their opinions) warning that banks that issued MBS may have to increase reserves due to the failure of the losss causation defense. This defense, which has been repeated by every major MBS defendant in the fallout from the mortgage crisis, is simply not supported by the governing trust agreements themselves.

Bank of America has itself acknowledged the importance of this defense, stating in its 2010 third quarter 10-Q that, “if courts, in the context of claims brought by private-label securitization trustees, were to disagree with our interpretation that the underlying agreements require a claimant to prove that the representations and warranties breach was the cause of the loss, it could significantly impact the estimated range of possible loss.” BofA has also stated that its reserves may have to increase if courts reject its argument that statistical sampling should not be allowed in these types of cases, and that plaintiffs should have to prove their claims on a loan-by-loan basis. Both of these arguments have now been rejected in every MBS case to have reached that determination.

Still, even more influential to Judge Kapnick’s decision may be the allegations that the Trustee was conflicted when it made its determination.  The Steering Committee has argued this from the beginning, and this argument has now been supported by the expert opinion of Georgetown Law Professor Adam Levitin, who pointed out how much of BNYM’s custodial business is based on keeping BofA happy, and how the structure of MBS transactions does not provide Trustees with the incentives to act on behalf of investors.

Just last week in the Article 77 proceeding (h/t Manal Mehta), Judge Kapnick held that the Steering Committee had alleged a colorable claim of conflict of interest on the part based on, “1) the event of default and the Trustee’s related decision to enter into a forebearance agreement; 2) the Trustee’s decision not to provide notice to the certificateholders at any point before settlement was reached; and 3) the broad release of claims BNYM sought for itself at any point before settlement was reached.”  (J. Kapnick, May 20, 2013 Order at p. 16.)

Based on this, Judge Kapnick forced BNYM to turn over attorney-client communications on those three subjects.  It is unclear whether this additional discovery will force the postponement of the May 30 hearing date, but at the very least it provides an indication that Kapnick is questioning BNYM’s good faith and independence, and provides the Steering Committee with a pathway to evidence that could potentially prove a breach of fiduciary duty by the Trustee.

I further expect the Steering Committee to pull out all the stops in the merits hearing, examining how Kathy Patrick’s efforts came about in the first place, and questioning whether she was really the only game in town, as she claimed.  As I’ve written about at length in the past, there is plenty of documentation showing that this was not the case, and that Patrick steered her investor clients away from the more aggressive and effective strategy of Tal Franklin’s Investor Syndicate.

I consult on developments in RMBS litigation on a regular basis, and while most of my clients are interested in a detailed analysis of timing, inflection points and influential precedent, they always ask for a bottom line estimate of the odds that the case will go one way or another.  As a reward for making it through this lengthy post, I’d love to give my readers the same on the Article 77 proceeding.  But while I’ve made strong predictions in the past (see here on MBIA), I’m simply not as confident in doing so when it comes to the Article 77 settlement hearing.

Yes, many of the assumptions on which the settlement were based were unreasonable, even at the time they were made.  Yes, the process the Trustee followed likely ran afoul of due process, as they consulted with a small group of interested investors and failed to give Certificateholders notice and an opportunity to respond until the deal was done.  And yes, BNYM was operating under several conflicts of interest.  But all of this serves, in my mind, only to even the scales, which were decidedly tilted in BofA’s favor at the outset.  This inherent advantage to BofA was based on 1) the deference provided under Article 77 to the Trustee’s decision; 2) the fact that Judge Kapnick is not as proactive or assertive a judge as say a Jed Rakoff, William Pauley or Eileen Bransten (see her reluctance to delve into the details of MBIA’s transformation in BofA’s Article 78 proceeding); and 3) the fact that the Trustee of all 530 trusts and a large group of investors support the deal, while only a small group of investors have spoken out against the deal.

Add to this the fact that there is virtually no precedent for a proceeding like this, and I’m left feeling like the outcome of this proceeding is pretty close to a coin flip.  I probably give a slight edge to BNYM-Bofa (say 55% likelihood of approval), but this is down from the 65-75% likelihood of success that I would have given it after the case returned to state court and before all of the aforementioned legal developments were handed down in related cases.  Still, this is a far greater probability of the settlement being rejected than I feel like most observers are giving the deal.

For Whom Does the Bell Toll?

This brings me to a final comment about the impact of this proceeding on the rest of the RMBS landscape.  As discussed, Bank of America has made it abundantly clear in its earning statements that its loss reserves on its private label putback liabilities are predicated on the success of the BNYM settlement, and that if final court approval is not obtained, the bank’s representations and warranties provisions could prove insufficient. Given the aforementioned developments in the last few months and other losses for BofA in its epic battle against MBIA (including losing its Article 78 challenge to MBIA’s 2009 transformation), it appears that BofA will be making its stand on a settlement with numerous cracks in its foundation.

Should it lose, it may finally have to face the music and recognize that the bulk of Countrywide’s non-prime mortgage loans met no semblance of their stated underwriting guidelines. But, no bank is an island, and the other major issuers will soon have to face the same reality. As I have seen during my representation of investors and mortgage insurers, irresponsible lending was not confined to Countrywide, it was endemic.

As the battle over approval of the $8.5 billion settlement unfolds over the next few weeks, I’m reminded of yet another reference to “For Whom the Bell Tolls,” this one to the final chapter of Ernest Hemingway’s famous book:

Today is only one day in all the days that will ever be. But what will happen in all the other days that ever come can depend on what you do today…All of war is that way.

The world’s largest banks take notice: BofA is in a particularly bad position because of its ill-conceived of Countrywide, but it is not on an island by itself.  What happens this week and in the weeks to come in the Article 77 proceeding will affect the other major players in the non-prime mortgage securitization game from 2005 to 2007.  Either the deal goes through and becomes a template for how to extract oneself from this mess, or it gets rejected and signals that far more pain is coming down the pike.  Either way, do not ask for whom BofA’s bell tolls, it tolls for thee.

Posted in Adam Levitin, AIG, allocation of loss, Alt-A, appeals, Attorneys General, bad faith, Bank of New York, banks, BofA, bondholder actions, conflicts of interest, contract rights, Countrywide, damages, Federal Home Loan Banks, Flagstar, global catastrophe defense, global settlement, incentives, Investor Syndicate, investors, irresponsible lending, Judge Barbara Kapnick, Judge Eileen Bransten, Judge Jed Rakoff, Judge Paul Crotty, Judge William Pauley, Judicial Opinions, Kathy Patrick, lawsuits, liabilities, litigation, loan files, loss causation, MBIA, MBS, monoline actions, O'Melveny & Myers, private label MBS, procedural hurdles, putbacks, rep and warranty, repurchase, RMBS, securitization, sellers and sponsors, sole remedy, standing, statistical sampling, successor liability, summary judgment, Trustees, vicarious liability | 3 Comments