This is big. Though we’ve seen leading indicators over the last few weeks that New York Attorney General Eric Schneiderman might get involved in the proposed Bank of America settlement over Countrywide bonds, few expected a response that might dynamite the entire deal. But that’s exactly what yesterday’s filing before Judge Kapnick could do.
Stating that he has both a common law and a statutory interest “in protecting the economic health and well-being of all investors who reside or transact business within the State of New York,” Schneiderman’s petition to intervene takes a stance that’s more aggressive than that of any of the other investor groups asking for a seat at the table. Rather than simply requesting a chance to conduct discovery or questioning the methodology that was used to arrive at the settlement, the AG’s petition seeks to intervene to assert counterclaims against Bank of New York Mellon for persistent fraud, securities fraud and breach of fiduciary duty.
Did you say F-f-f-fraud? That’s right. The elephant in the room during the putback debates of the last three years has been the specter of fraud. Sure, mortgage bonds are performing abysmally and the underlying loans appears largely defective when investors are able to peek under the hood, but did the banks really knowingly mislead investors or willfully obstruct their efforts to remedy these problems? Schneiderman thinks so. He accuses BoNY of violating:
Executive Law § 63(12)’s prohibition on persistent fraud or illegality in the conduct of business: the Trustee failed to safeguard the mortgage files entrusted to its care under the Governing Agreements, failed to take any steps to notify affected parties despite its knowledge of violations of representations and warranties, and did so repeatedly across 530 Trusts. (Petition to Intervene at 9)
By calling out BoNY for failing to enforce investors’ repurchase rights or help investors enforce those rights themselves, the AG has turned a spotlight on the most notoriously uncooperative of the four major RMBS Trustees. Of course, all of the Trustees have engaged in this type of heel-dragging obstructionism to some degree, but many have softened their stances since investors started getting more aggressive in threatening legal action against them. BoNY, in addition to remaining resolute in refusing to aid investors, has now gone further in trying to negotiate a sweetheart deal for Bank of America without allowing all affected investors a chance to participate. This has drawn the ire of the nation’s most outspoken financial cop.
And lest you think that the NYAG focuses all of his vitriol on BoNY, Schneiderman says that BofA may also be on the hook for its conduct, both before and after the issuance of the relevant securities. The Petition to Intervene states that:
Countrywide and BoA face liability for persistent illegality in:
(1) repeatedly breaching representations and warranties concerning loan quality;
(2) repeatedly failing to provide complete mortgage files as it was required to do under the Governing Agreements; and
(3) repeatedly acting pursuant to self-interest, rather than
investors’ interests, in servicing, in violation of the Governing Agreements. (Petition to Intervene at 9)
Though Countrywide may have been the culprit for breaching reps and warranties in originating these loans, the failure to provide loan files and the failure to service properly post-origination almost certainly implicates the nation’s largest bank. And lest any doubts remain in that regard, the AG’s Petition also provides, “given that BoA negotiated the settlement with BNYM despite BNYM’s obvious conflicts of interest, BoA may be liable for aiding and abetting BNYM’s breach of fiduciary duty.” (Petition at 7) So much for Bank of America’s characterization of these problems as simply “pay[ing] for the things that Countrywide did.”
As they say on late night infomercials, “but wait, there’s more!” In a step that is perhaps even more controversial than accusing Countrywide’s favorite Trustee of fraud, the AG has blown the cover off of the issue of improper transfer of mortgage loans into RMBS Trusts. This has truly been the third rail of RMBS problems, which few plaintiffs have dared touch, and yet the AG has now seized it with a vice grip.
In the AG’s Verified Pleading in Intervention (hereinafter referred to as the “Pleading,” and well worth reading), Schneiderman pulls no punches in calling the participating banks to task over improper mortgage transfers. First, he notes that the Trustee had a duty to ensure proper transfer of loans from Countrywide to the Trust. (Pleading ¶23). Next, he states that, “the ultimate failure of Countrywide to transfer complete mortgage loan documentation to the Trusts hampered the Trusts’ ability to foreclose on delinquent mortgages, thereby impairing the value of the notes secured by those mortgages. These circumstances apparently triggered widespread fraud, including BoA’s fabrication of missing documentation.” (Id.) Now that’s calling a spade a spade, in probably the most concise summary of the robosigning crisis that I’ve seen.
The AG goes on to note that, since BoNY issued numerous “exception reports” detailing loan documentation deficiencies, it knew of these problems and yet failed to notify investors that the loans underlying their investments and their rights to foreclose were impaired. In so doing, the Trustee failed to comply with the “prudent man” standard to which it is subject under New York law. (Pleading ¶¶28-29)
The AG raises all of this in an effort to show that BoNY was operating under serious conflicts of interest, calling into question the fairness of the proposed settlement. Namely, while the Trustee had a duty to negotiate the settlement in the best interests of investors, it could not do so because it stood to receive “direct financial benefits” from the deal in the form of indemnification against claims of misconduct. (Petition ¶¶15-16) And though Countrywide had already agreed to indemnify the Trustee against many such claims, Schneiderman states that, “Countrywide has inadequate resources” to provide such indemnification, leading BoNY to seek and obtain a side-letter agreement from BofA expressly guaranteeing the indemnification obligations of Countrywide and expanding that indemnity to cover BoNY’s conduct in negotiating and implementing the settlement. (Petition ¶16) That can’t be good for BofA’s arguments that it is not Countrywide’s successor-in-interest.
I applaud the NYAG for having the courage to call this conflict as he sees it, and not allowing this deal to derail his separate investigations or succumbing to the political pressure to water down his allegations or bypass “third rail” issues. Whether Judge Kapnick will ultimately permit the AG to intervene is another question, but at the very least, this filing raises some uncomfortable issues for the banks involved and provides the investors seeking to challenge the deal with some much-needed backup. In addition, Schneiderman has taken pressure off of the investors who have not yet opted to challenge the accord, by purporting to represent their interests and speak on their behalf. In that regard, he notes that, “[m]any of these investors have not intervened in this litigation and, indeed, may not even be aware of it.” (Pleading ¶12).
As for the investors who are speaking up, many could take a lesson from the no-nonsense language Schneiderman uses in challenging the settlement. Rather than dancing around the issue of the fairness of the deal and politely asking for more information, the AG has reached a firm conclusion based on the information the Trustee has already made available: “THE PROPOSED SETTLEMENT IS UNFAIR AND INADEQUATE.” (Pleading at II.A) Tell us how you really feel.
[Author's Note: Though the proposed BofA settlement is certainly a landmark legal proceeding, there is plenty going on in the world of RMBS litigation aside from this case. While I have been repeatedly waylaid in my efforts to turn to these issues by successive major developments in the BofA case, I promise a roundup of recent RMBS legal action in the near future. Stay tuned...]