The Top 5 RMBS Cases to Watch this Summer: No. 1 – MBIA v. Countrywide, BofA

After a week-long build-up (I’m sure the suspense is killing you), we’ve reached the No. 1 case in our countdown of RMBS Cases to Watch this Summer.  You may wish to catch up with parts I, II, III, and IV, if you haven’t already.  Though Case No. 2, Bank of New York’s Article 77 settlement, may have garnered more media attention thus far, another case gets my vote for No. 1 because it represents a true adversarial process, the best and only way, as far as I know, to establish any semblance of “proof” as to who is to blame for the massive losses associated with mortgage derivatives.  Read on to find out why the nation’s former No. 1 bank may want to stop the freight train that is our No. 1 case, before it’s too late.

No. 1 – MBIA v. Countrywide, Bank of America

Even relative newcomers to this blog should be well aware of the importance that I place on our No. 1 case, MBIA v. Countrywide, et al., No. 602825/2008 in New York State Supreme Court, presided over by Judge Eileen Bransten.  As one of the earliest-filed subprime RMBS cases, and one that has been skillfully and tenaciously litigated since the beginning by MBIA’s counsel, Quinn Emanuel, this case is one of the closest to resolution and to answering some of the tough legal questions hanging over this industry.  And based on what we’ve seen thus far, if and when this case begins producing final judgments, BofA is not going to like the answers.

As recently as April 24, I wrote about the progress MBIA was making in its case against Countrywide and BofA, in which it seeks compensation for the insurance payments it has made based on losses in 15 separate mortgage backed securities trusts.  Therein, I noted that MBIA was on a roll, having won several recent discovery and case management motions, providing the bond insurer with an ever-growing stockpile of ammunition to use in its forthcoming summary judgment motion.  But even since that time, there have been several developments that have only confirmed and continued this trend, as MBIA marches steadily toward a potentially crushing victory at trial.  I will run through those developments below, followed by a head’s up on what to watch for in this case going forward.

Motion to Compel Fraud-Related Documents

One of MBIA’s primary claims is that it was fraudulently induced to provide insurance for Countrywide’s securitizations based on misrepresentations by the lender regarding loan quality and the quality control procedures that it had in place.  Though common law fraud is typically difficult to prove, as it requires showings of knowledge, intent and reliance, a successful fraud claim could return to the aggrieved party the full amount of its loss plus punitive damages.  Usually, this requires some kind of smoking gun – emails or internal documents in which high-ranking corporate officers acknowledge a problem but cover it up and/or fail to disclose it to their business partners.

MBIA has been looking for just this type of smoking gun since the beginning of their case, and it appears they believe they’ve found it, in the form of internal Countrywide documents relating to its fraud hotline and internal fraud investigations.  If Countrywide knew there was widespread fraud in its loan origination processes, and covered up that information, it could certainly form the foundation for a finding that it intentionally misled MBIA into providing insurance coverage.  And Countrywide has certainly acted like MBIA is knocking on the door of a treasure trove of damaging evidence, as it has fought like crazy to avoid producing these documents.

But Judge Bransten is having none of it.  On May 25, Bransten issued her ruling (actually dated May 11 or May 15, depending on which version you pull up on the docket), in which she granted the bulk of MBIA’s discovery requests, and generally only limited the insurer’s requests when they extended to documents unrelated to the securitizations at issue in the case.  In particular, Bransten granted MBIA’s requests for:

  • Documents related to Countrywide’s “fraud hotline” (email, fax, mail and telephone hotline for complaints about illegal behavior by Countrywide employees) as to the loans at issue;
  • Documents related to loans at issue that were referred to Countrywide’s internal Fraud Risk Management Group and Fraud Prevention and Investigation Department;
  • All meeting minutes from 2004 to 2007 from three senior management committees (alleged to reveal Countrywide compliance and underwriting policies and its understanding of how its market share related to the same) and any other minutes that refer generally or specifically to materials relevant to securitizations at issue;
  • Countrywide internal modeling files on the securitizations at issue, if not already produced; and
  • Documents regarding two terminated employees and the fraud investigations  for which they were responsible at Countrywide, as well as documents regarding any fraud cover-up.

Whew!  That document dump should keep Quinn’s associates busy for awhile, and should reveal some very juicy details about what Countrywide knew about fraud and when, and what it did or didn’t do about it.  What might be even more significant about this ruling, however, is that Judge Bransten seems to have found her voice, emerging as a strident champion of the legal process while confronting head-on Countrywide/BofA’s complaints about the mounting burden of this litigation.  In the final paragraph of her Order, she writes:

the court acknowledges, and is sympathetic with, Countrywide’s statements regarding the volume of documents it has produced.  However, past production bears no relation to current and ongoing discovery obligations, and, while colorful, recitations of numbers of pages and volumes of documents produced is unpersuasive and is not considered.  Discovery, though expensive and exhaustive, must be completed in full. (May 25 Order at 16)

This trend only continues in the Judge’s next ruling, discussed below.

Motion to Compel Clawed Back Documents and Sanctions for Delay

On May 4, the parties appeared before Judge Bransten to argue about whether Countrywide had the right to “claw back” documents it had previously produced in the middle of depositions, and right when plaintiff’s counsel was about to use those documents to question opposing witnesses.  At the time, MBIA counsel Peter Calamari asked the Court to sanction Countrywide, stating

I do believe that they should be sanctioned. I also believe that additional depositions should, might need to take place once we get the documents. (May 4 Transcript at 57:11-14)

Yet, Calamari also made clear that he did not want the case schedule slowed down as a result of these issues.  In general, plaintiffs are already incentivized to try to propel their cases forward, both to put pressure on the opposition and to keep costs from spiraling out of control.  But in this case, there’s an additional factor: MBIA wants this case to reach trial before BofA’s separate plenary action against MBIA (alleging violations of debtor-creditor law in connection with MBIA’s restructuring) gets there first.

Though an unlikely scenario given the current state of the two cases, should BofA’s plenary action (pending before Judge Barbara Kapnick in New York Supreme Court) reach trial first, it would put MBIA in a precarious position.  On one hand, the monoline could go to trial and risk losing, meaning the restructuring could be invalidated and/or MBIA could be hit with massive damages and no longer have the financial wherewithal to prosecute its case; on the other hand, MBIA could settle with BofA out of a position of weakness and on unfavorable terms.  By far, MBIA would prefer to put BofA in that position by accelerating its MBS lawsuit to the point that it’s ready to go to trial first, thereby forcing BofA to make the tough decision from a weakened position.

Another reason that MBIA would like to accelerate its case is that it has an opportunity to score major victories against Countrywide/BofA on summary judgment.  Pursuant to the court’s Amended Pretrial Scheduling Order, opening summary judgment briefs are due by August 31 of this year, and the motions should be fully briefed by the end of October.  At any point thereafter, depending on what’s raised in MBIA’s motion, Bransten could rule on issues such as successor liability, loss causation and even on the merits of MBIA’s contractual arguments, should she find no genuine issue of fact exists.  Adverse rulings in this regard could be devastating for BofA’s proposed $8.5 billion settlement of Countrywide putback claims currently pending before Judge Kapnick, undermining the very assumptions on which the settlement figure is based (for detailed analysis of the loss causation issue and its impact, see my prior article here).

Thus, we have seen MBIA’s counsel emphasize at each turn that they want to keep the case on track, and decrying Countrywide and BofA’s apparent efforts to drag their heels.  At the May 4 hearing, in response to MBIA’s arguments, Judge Bransten also expressed frustration both with the parties’ conduct during discovery and with the overall pace of the litigation.  Though Bransten didn’t limit her comments solely to Countrywide, it’s hard to read the following comments, given the context of MBIA’s discovery motion, without concluding that she has the nation’s former No. 1 lender in her sights:

Really, just in general. We really have got to step up to the plate and take a big deep breath and grow up a bit. All right… Even I, I used to practice, too. But, it has been years. But, nevertheless, you’re practitioners… you don’t go around clawing back things in the middle of depositions. Particularly, when there has been prior notice given. It is just wrong.

Now, you may not get an answer you’re a hundred percent happy with. But, that is litigation. No one gets through this process liking everything that happens, no one.  Even The Judge (Smiles). It just doesn’t happen. So, of course, you’re going to get an answer that you wish you didn’t have. But, that is reality.

MBIA has the same problem. “God, that wasn’t the right answer.” You cannot stop it. Discovery is broad. It is complete. And frankly, I do think it has been, there has been a tendency of delay. Now, Mr. Calamari would want me to merely give sanctions. It is part of his motion, so I’ll be considering that. But, I am getting closer and closer. You don’t want me to get that annoyed that I really consider that what is happening is a tremendous delay, an unnecessary delay. If I do it is going to cost a substantial amount of money. And I don’t want to have that happen. It is humiliating. It is not right. It’s not right. And not professional. (May 4 Transcript at 60:26-62:26.)

Just over a month after that hearing, on June 7, Judge Bransten issued her ruling, which yielded few surprises based on those comments.  Her Honor granted almost every request in MBIA’s Motion to Compel, with the exception of its request for sanctions.  In that regard, she noted in her Order:

All parties in this action are represented by zealous advocates, as is proper and the court appreciates.  However, the court has taken note of conduct up to the present date, including continual allegations of as well as actual delay and apparent failure of both sides to substantively meet and confer.  Interruptions of depositions, inconvenient to the deponent and expensive to all sides, will not be tolerated.  Further interruption by any side will lead to an imposition of costs.

However, the court declines to impose sanctions at this time.  The conduct as related to the court is subject to interpretation, and the court does not find the conduct rises to a sanctionable level. This may change if BAC continues to conduct itself in a manner which may be interpreted as either deceptive or geared towards a goal of delay. (June 7 Order at 16 (internal citations omitted))

The long and short of this is that MBIA will get documents regarding BofA’s alleged de facto merger with, and assumption of liabilities of, Countrywide.  These include loss reserve accounting estimates and Countrywide acquisition-related documents, which should provide further ammunition for MBIA’s claims that BofA bears responsibility for Countrywide’s liabilities as its successor-in-interest.  MBIA also gets to hold the threat of sanctions over defendants’ heads should they play games with discovery going forward.  All-in-all, a big win for the monoline that allows it to continue to obtain damaging evidence while keeping its case on track.

The Track Ahead: What to Watch For

Having had little success before Judge Bransten, BofA has apparently decided that it stands a better chance before the New York Supreme Court’s Appellate Division for the First Department.  Though Bransten has a relatively successful track record on appeal, including in this case, BofA has continued to appeal nearly every meaningful ruling Bransten has made to the higher court.  Most recently, BofA appealed Bransten’s loss causation ruling as it applies to MBIA’s fraud and breach of insurance contract claims (background here), after which MBIA cross-appealed as to her ruling on the issue of loss causation for put-back claims.  The appeal and cross-appeal of the Partial Summary Judgment Order in MBIA v. Countrywide (and the virtually identical Order in the related case of Syncora v. Countrywide) is calendared for hearing before the Appellate Division during the October 2012 term, if the appeal is perfected.

Also up on appeal is Bransten’s Order denying Countrywide’s Motion to Compel discovery regarding MBIA’s practice of insuring similar risks.  Though Countrywide had argued that it was entitled to test whether MBIA followed its stated guidelines in practice, and therefore whether the insurer actually relied on Countrywide’s representations in deciding to insure the deals, Judge Bransten denied the motion.  She found that Countrywide could test that fact based on the documents already produced in this case relating to the securitizations at issue, MBIA’s guidelines or lack thereof, and relevant witness testimony.

While these appeals are being heard in the higher court, there will be no shortage of activity in Bransten’s trial court this summer.  MBIA will continue to plow through discovery, including trying to obtain and digest all of the new documents Countrywide has been compelled to produce, as well as squeeze in all of its fact depositions, prior to the August 31 deadline for submission of summary judgment motions.  This may include forcing BofA CEO Brian Moynihan to sit for deposition a second time, after Judge Bransten suggested that this would be the logical result of Moynihan’s statement that he couldn’t remember facts about certain meetings without having the meeting minutes in front of him (the same minutes Countrywide was trying to withhold and is now being forced to produce).  Does anyone doubt that Moynihan is sick of talking about, let alone participating in, legacy mortgage litigation?

Expert discovery will also continue throughout the summer, with August 1, 2012 being set as the deadline for expert depositions relating to primary liability against Countrywide.  In short, while this should be a long, hot summer for all parties to this litigation, I have a feeling that BofA is starting to feel the heat a bit more acutely, as the victories continue to pile up for MBIA.

Let’s be clear: BofA is relying heavily on the success of BNYM’s $8.5 billion settlement as part of its plan to put its legacy mortgage issues behind it. For the bank to allow this much smaller (by dollar amount at stake) but far less auspicious RMBS case to chug forward and potentially derail its settlement would be to make a tactical mistake of epic proportions.  With statutes of limitations windows closing, and the threat of additional litigation from MBS investors beginning to subside, BofA should become far more cognizant of the threat of litigation from its own shareholders if, after eating tens of billions of dollars in losses in mortgage liabilities, it stubbornly refuses to settle with MBIA for a few (billion) dollars more.

I hope you enjoyed this week-long rundown of the Top 5 RMBS Cases to Watch this Summer.  Keep an eye out for the epilogue to this series in the coming weeks, as I begin to evaluate end game scenarios and endeavor to tackle the big question on everyone’s mind – how will all this subprime madness ultimately shake out?

Posted in accounting, allocation of loss, appeals, Bank of New York, banks, BofA, bondholder actions, contract rights, costs of the crisis, Countrywide, damages, discovery, fraud, global settlement, impact of the crisis, incentives, investors, irresponsible lending, Judge Barbara Kapnick, Judge Eileen Bransten, Judicial Opinions, jury trials, lawsuits, lenders, lending guidelines, liabilities, litigation, litigation costs, loss causation, MBIA, MBS, media coverage, misrespresentation, monoline actions, monolines, mortgage fraud, private label MBS, putbacks, quinn emanuel, rep and warranty, repurchase, responsibility, RMBS, securitization, settlements, statutes of limitations, subprime, successor liability, The Subprime Shakeout, timeline, Trustees, underwriting guidelines, underwriting practices, vicarious liability | 4 Comments

The Top 5 RMBS Cases to Watch this Summer: No. 2 – In re the Application of Bank of New York Mellon

This is the fourth installment in my countdown of the Top 5 RMBS Cases to Watch this Summer.  Click on the following links to read parts I, II, and III.  Today, we address a case that is anything but typical, but which if successful, could become the template for global RMBS settlements for many of the banks burdened by legacy mortgage liabilities.

No. 2 – In re the Application of Bank of New York Mellon (Article 77 Proceeding)

It’s no secret that BNYM’s proposed $8.5 billion settlement with BofA and Countrywide over breaches of reps and warranties (a.k.a. mortgage put-backs) is one of the most important and influential pieces of ongoing RMBS litigation.  The approval of this settlement could put the bulk of BofA’s legacy mortgage issues behind it while creating a framework for other RMBS originators, issuers and trustees to settle their outstanding mortgage liabilities.

What many people with whom I speak don’t seem to understand, however, is how this settlement came about, and the fact that it was not the product of a typical adversarial process.  Namely, certain large institutional investors with complex and interwoven relationships with BofA, a bank’s bank that could face liabilities for wasting valuable put-back claims if it doesn’t act, and a too-big-to-fail bank that is being crushed under the weight of its legacy mortgage liabilities are endeavoring to settle claims on behalf of the entire universe of Countrywide bondholders.   And in order to do so, they have to convince a New York state court judge that the decision to settle settlement amount and process are reasonable.

In the epilogue to this series of articles, I’m going to talk about end game scenarios for mortgage litigation, and how the concept of “proof” will be an integral factor.  Currently, there is so little precedent in RMBS litigation and thus so few established facts or “proof” of wrongdoing or liability, that it’s possible for the various players to have wildly differing views of the potential outcomes and associated liabilities.  This greatly affects their loss reserves and settlement posture associated with legacy mortgage obligations.

Thus, it remains possible for the major banks to justify under-reserving for private label mortgage repurchases by stating that they have insufficient experience with these types of put-backs to set an accurate reserve amount (see this recent repurchase report from Natoma Partners for an accounting perspective on the banks’ ever-growing loss reserves).  It also allows BNYM, BofA and the Kathy Patrick-led institutional investors to justify settling Countrywide bonds with over $200 billion of losses to date for a mere $8.5 billion by appealing to untested legal defenses and repurchase statistics from BofA’s dissimilar deals with the GSEs.  I’m reminded of a Shel Silverstein poem from one of my favorite childhood books, Where the Sidewalk Ends, entitled, “No Difference.” Though at its core, this was probably a poem about racial bias, this stanza seems particularly applicable here:

Rich as a sultan,
Poor as a mite,

We’re all worth the same
When we turn off the light.

So long as we’re in the dark about how courts will interpret RMBS trust agreements, all arguments and defenses are worth the same.  But if those defenses are rejected by courts or the GSE repurchase numbers are shown to be wildly disparate from private label liabilities, it would begin to illuminate the true value of these arguments, and this settlement could come under heavy fire and ultimately be rejected by Judge Barbara Kapnick (yes, the same judge who heard BofA’s Article 78 challenge to MBIA’s restructuring).

In the context of the final RMBS case to watch (coming tomorrow), we will talk about how some of BofA’s untested legal defenses (which BNYM used to justify the $8.5 billion settlement amount) could be tested in court, and why BofA and BNYM are thus eager to complete the Article 77 settlement approval process before other major RMBS cases reach trial.  In this segment, I’ll review how developments in the Article 77 proceeding itself threaten to undermine the metrics used to justify the settlement.

The biggest recent development is that Judge Kapnick has approved the petition of the New York and Delaware Attorneys General to intervene in the case.  In her ruling, Kapnick first noted that “[t]here appears to be no precedent to the scenario here,” which she called “admittedly a very unique proceeding, and which is also arguably ‘the largest private litigation settlement in history.’”

Ultimately, however, Kapnick found that the AGs had articulated legitimate “quasi-sovereign” interests in the litigation – securing an honest marketplace and eliminating fraudulent and deceptive business practices – and ruled that the AGs had parens patriae standing to intervene.  She further found that there was no reason to believe that the AGs’ intervention would be the source of unnecessary delay, as “the Court will control the discovery process and is already working with the parties to move discovery forward.”

Interestingly, Judge Kapnick cited Judge Pauley’s prior Order granting the AGs’ petition to intervene while the case was in federal court.  She found that while Pauley had been overturned by the Second Circuit as to his Order Denying Remand, the Second Circuit had not specifically or explicitly vacated his Order granting the AGs’ motion to intervene, meaning she could consider it as an “advisory opinion.”  As I noted in an article a few weeks back, though Judge Pauley is no longer overseeing this case, he continues to have a major impact on these proceedings.

What AG intervention means is that a vocal, independent and influential party will have the right to participate in the case as if it were any other party to the proceeding.  New York AG Eric Schneiderman has already shown that he believes BNYM was one of the bad actors that perpetuated and worsened the mortgage crisis, and will likely continue to take aggressive steps to uncover evidence of trustee misconduct in discovery.  These may include tackling the issue of whether home loans were incorrectly transferred into the trust in the first place, an issue that investors have been reluctant to touch (until recently), but which the AGs have indicated that they seek to investigate.  So, while Kapnick does not anticipate AG intervention causing “unnecessary delay,” this does not mean that the AGs won’t influence the scope of discovery, and potentially lengthen the discovery timeline.

Should the AGs threaten to expose particularly damaging evidence in discovery, it could force BNYM and BofA to negotiate with the AGs to find out what it would take to make them go away.  Should the AGs, to whom Judge Kapnick will likely show some deference as the highest-ranking prosecutors of their respective states, actually expose damning evidence of misconduct by those parties, it will make it more difficult for Kapnick to rubber stamp the settlement.

The other major development in the Article 77 proceeding has been the battle over loan files, the outcome of which is something to watch closely this summer.  Debtwire reports that Judge Kapnick will hold a hearing on this topic at 2 PM ET today.  While Kapnick had initially told the parties to meet and confer to select an initial number of loan files to review between 150 and 500, the investor Steering Committe now argues that this will take over seven months and yield little of use.

I’ve spoken at length about the importance of loan files, the documents that contain black and white evidence of whether loans met underwriting guidelines, and this case is no different.  Investors challenging the settlement want access to files to show how many loans are actually deficient; BofA and BNYM want to avoid getting too granular about the trustee’s estimates of deficiencies and focus instead on the reasonableness of the process used by the trustee to reach the settlement figure.

BofA has actually intervened with a petition on its own behalf for the first time in the state court case (note that BofA is not technically a party to the Article 77 proceeding, but is now the subject of a third-party request for documents, as it holds the loan files), to argue as to why the court should not order the production of significant loan files.  Interestingly, BofA states that, “[l]oan-file review will answer no questions. It will lead only to interminable delay and unnecessary litigation, loan-by-loan-by-loan. It will bog down this proceeding for no good reason.”  I can’t resist pointing out the irony of this statement after CEO Brian Moynihan famously said during BofA’s Q3 2010 earnings call, in minimizing the company’s potential put-back losses:

This really gets down to a loan-by-loan determination and we have, we believe, the resources to deploy against that kind of a review… we will go in and fight this.  It’s worked to our benefit to—we have thousands of people willing to stand and look at every one of these loans.

Curious how the bank will advocate a loan-by-loan review when it works to its benefit (by driving up the timeline and costs of put-backs), but will argue just as ferociously that loan level review is unnecessary when asking a court to approve as reasonable its sweetheart settlement with a favored group of investors.

This irony is not lost on the counsel for the Steering Committee of investors who are challenging this deal.  Though in their first letter, they argued that this issue was not yet ripe for review and that BofA’s opposition brief is untimely, they have now responded with a short brief of their own, which is well worth reading.  Therein, they note that:

  1. Loan files are essential to test the Trustee’s assumption that the settlement was reasonable;
  2. BofA has produced hundreds of thousands of loan files in other litigation, so the burden cannot be that great; and
  3. BofA is exaggerating the time it will take to review and present evidence of breaches, since this info can be presented in the aggregate.

Most interestingly, the Steering Committee attacks head-on BofA’s claim that its repurchase experience with the GSEs is an appropriate measuring stick, and the result of an extended, adversarial and arm’s length process.  In that regard, counsel points out that:

  • GSE Guidelines were less stringent with respect to credit, repayment ability and collateral;
  • The FHFA has since reported that Freddie Mac had a flawed loan review methodology and failed to review 300,000 loans potentially subject to repurchase by BofA; and
  • The FHFA’s office of the inspector general reported that Freddie Mac management asserted the need to maintain relationships with loan sellers such as BofA as a factor weighing against more expansive loan review and put-back process, which undermines the argument that BofA’s GSE experience reflects actual arms-length, adversarial negotiations.

The Steering Committee ultimately advocates for a review of between 4,630 and 6,470 loans in order to generate a statistically significant sample.  It maintains that the sample of about 150 non-random loans that BofA has purportedly offered to produce would not be statistically significant or inform the opinion of its expert.

At the end of the day, Article 77 provides BNYM and BofA a highly advantageous playing field on which to litigate the reasonableness of this settlement, as it restricts the Judge to a binary decision (to accept or reject the settlement) under a favorable standard (arbitrary and capricious).  The banks would prefer that Judge Kapnick not look too closely or shine too much light on the deal, and instead presume that it was the product of honest, adversarial negotiations.

However, the more evidence the Steering Committee and the AGs can compile to show that the Trustee ignored evidence, relied on unreasonable assumptions, and/or chose a dollar figure far below what it could have expected from litigation, the better chance they have of making Judge Kapnick just uncomfortable enough to send BNYM back to the drawing board.  And the decisions of other courts adjudicating RMBS litigation could also help to illuminate the problems with this settlement, discouraging other issuers from using the Article 77 template to resolve their own mortgage problems.  The implications of this case make it one to watch throughout this summer, and until its resolution (likely sometime in late 2013).

Click here to continue to the final post in this series on the No. 1 RMBS Case to Watch this Summer. 

Posted in accounting, allocation of loss, Attorneys General, Bank of New York, banks, BofA, bondholder actions, conflicts of interest, contract rights, damages, discovery, Freddie Mac, global settlement, improper documentation, investors, Judge Barbara Kapnick, Judge William Pauley, Judicial Opinions, lawsuits, lending guidelines, liabilities, litigation, loan files, loss causation, MBIA, MBS, pooling agreements, private label MBS, putbacks, rep and warranty, repurchase, RMBS, securities, securitization, sellers and sponsors, settlements, timeline, too big to fail, Trustees, underwriting guidelines | Tagged , | 10 Comments

The Top 5 RMBS Cases to Watch this Summer: No. 3 – ABN AMRO Bank v. Dinallo (Article 78)

My Top 5 RMBS Cases to Watch series began earlier this week with a look at a long-running lawsuit by bond insurer Syncora against EMC and a novel investor lawsuit against Bank of New York Mellon, as Trustee, both of which are being heard in federal court in New York.  Today, I will tackle a state court case that doesn’t deal directly with RMBS, but which was engendered by, and could have a major influence over, the allocation of mortgage derivative losses.  As our Top 5 Countdown continues with Case No. 3, let’s examine how the impact of a Judge’s forthcoming decision after weeks of “quasi-trial” will reverberate throughout other ongoing lawsuits, including several cases over which the same Judge will be presiding.

No. 3 – ABN AMRO Bank v. Dinallo (Article 78 proceeding)

A few weeks ago, I wrote about some last-minute shenanigans that took place in ABN AMRO Bank v. Dinallo and were worthy of a prime time television courtroom drama.  Namely, with only a few days to go before the parties were to present what has variously been called a “quasi-trial” or a “glorified oral argument” on BofA and Societe Generale’s challenge to MBIA’s restructuring, the parties held an impromptu call with the Judge to argue over the scope of the proceeding and whether there should be a “trial” at all.  On the call, Judge Barbara Kapnick reiterated that there would be some kind of trial, that she would hear from live witnesses on any questions of fact she deemed relevant, and then ultimately hung up on the parties when they overstayed their welcome.

Since that time, Judge Kapnick has indeed conducted what amounted to a “glorified oral argument” on the Article 78 challenge (a special vehicle under New York law for challenging agency decisions), but declined to hear from any live witnesses, and instead opted for no less than seven rounds of oral argument from the various parties.  This has resulted in a proceeding with very little of the drama or entertainment value that preceded it.

In fact, the banks challenging the restructuring wrapped up their final arguments last Thursday, clearing the way for Judge Kapnick to make a ruling in this widely-followed precursor to BofA’s plenary action against MBIA (over which Judge Kapnick will also preside) and MBIA’s put-back case against BofA (before Judge Eileen Bransten). As Judge Kapnick begins her deliberations on the merits of the Article 78 challenge, she can’t help but be cognizant of the following external factors:

  1. That her decision will likely be appealed;
  2. That she’ll have a chance in BofA’s plenary action to address head-on whether MBIA violated debtor-creditor law or withheld material information when seeking approval of its restructuring from regulators, and
  3. That she has another major case pending in her court that has also been brought via a special vehicle under New York law (Bank of New York Mellon’s Article 77 action to obtain approval for the trustee’s settlement), in which the standard of review (arbitrary and capricious) is virtually identical to that of the instant case.

These external conditions will certainly factor into the Judge’s decision, even if not cited directly.

For example, Judge Kapnick has stated on the record that she expects her decision to be appealed, which gives us some clues as to how she might be leaning based on how the “quasi-trial” played out.  As Alison Frankel has pointed out on her blog, the fact that Judge Kapnick declined to hear testimony from live witnesses such as Jack Buchmiller and Eric Dinallo, the two New York Insurance Department (NYID) officials whose names came up repeatedly during these proceedings, supports the impression that she’s not inclined to rule in the banks’ favor.  Should Kapnick have had serious doubts about the steps they took in approving MBIA’s transaction, I would have expected her to want to hear from those gentlemen herself, to see them subjected to thorough cross-examination (either by the banks’ counsel or by Her Honor herself), and have them explain to the Court what they did and why.  This would lay the groundwork for Kapnick to make a finding against the Department based on a credibility determination, something about which appellate courts are generally highly deferential.

Suffice it to say, if Judge Kapnick was going to stick her neck out and make the extraordinary ruling that the NYID acted arbitrarily and capriciously in approving MBIA’s restructuring, I would expect to have seen her take pains to create a record in support, which would bolster her ruling on appeal.  Instead, the outcome of the “trial” suggests that Kapnick did not feel there were disputed issues of fact, or that anything raised in the banks’ presentation constituted reversible error by the NYID on its face, which leads me to believe she’ll rule in favor of the NYID.

Ms. Frankel has noted that this factor could also point the other way, in that Kapnick may face reversal for not allowing live testimony and giving the banks a full and fair hearing, but I think that the limited nature of the Article 78 proceeding will work in Kapnick’s favor in this case.  Rather than holding a de novo review of the merits of the NYID’s decision, Kapnick’s role was to provide a highly deferential review of an agency decision, informed largely by the administrative record.  Unless she intends to rule against the NYID without even reaching the “arbitrary and capricious standard” (unlikely, as my reading of the case law would not support such a finding in this case), the absence of live testimony signals a rubber stamp of the transformation.

Regardless of the outcome, though this is not technically a case about RMBS, this decision is certainly one to watch for, as a win for BofA could force MBIA to unwind its company-saving restructuring (or at least into a favorable settlement of its put-back claims), while a win for the Department of Insurance would clear the way for MBIA to inflict major mortgage put-back pain on its bank counterparties as it continues to push forward with its put-back lawsuits.  Recall that the reason MBIA was forced to restructure is that mounting losses from its mortgage-related insurance products threatened to overwhelm the monoline’s healthier municipal bond business.

Yet, even with the restructuring, MBIA has apparently been able to satisfy all of its mortgage-related insurance policy claims.  As I have discussed in the past, I view the banks’ challenge to MBIA’s restructuring to have been brought as a litigation counterweight in the first place, to provide the banks (and particularly BofA) with a bargaining chip with which to drive down the settlement cost of MBIA’s auspicious mortgage repurchase claims.  The fact that all but a handful of the 16 or so of the banks originally challenging the restructuring have now settled with MBIA, save the one bank with the most potential exposure to MBIA’s claims, only bolsters this view.

For those interested in reading through the nitty-gritty details of this Article 78 “trial,” MBIA has conveniently posted transcripts from each day of proceedings on its website.  Though most of the parties’ presentations dealt with arcane issues of financial modeling and accounting rules, one argument in particular caught my attention and illustrated the overlap between this case and other RMBS litigation.

In arguing that the NYID’s decision to approve MBIA’s restructuring was “arbitrary and capricious,” the banks raised an allegation that either MBIA or the Department of Insurance should have hired BlackRock to conduct a solvency analysis on the bond insurer, as BlackRock “is the best modeling firm in the world.”  (June 1 Transcript at 1509:24)  MBIA attorney Mark Kasowitz responded, in turn, that the NYID had no responsibility to hire a third party to conduct a solvency analysis when the third party’s process lacked transparency, stating:

Your Honor, the idea that this court should null the transformation because Superintendent Dinallo did not outsource his regulatory obligations to a third-party firm that wouldn’t let him see what their proprietary models are, frankly, absurd. (June 4 Transcript at 1779:2-6)

But what really caught my eye was that the banks raised the fact that BlackRock had asserted put-back claims against Countrywide and BofA as evidence that BlackRock was impartial and non-conflicted.  In response, Kasowitz proceeded to identify several conflicts of interest that existed between BlackRock and Bank of America as further support of MBIA’s decision not to hire the firm.  These arguments are very likely to be raised in the separate Article 77 proceeding in which Judge Kapnick is being asked to approve Bank of New York’s $8.5 billion settlement with, among others, BlackRock.  This may make Judge Kapnick more open to conflict-of-interest-based challenges to the supposedly adversarial process through which the trustee and institutional investors reached their settlement over Countrywide put-back claims.

In the Article 77 case (which just might make our Countdown later this week), BlackRock is part of an investor group that claims to represent the interests of the majority of bondholders.  However, as I’ve detailed in the past, there are many reasons to believe that BlackRock, PIMCO and the other funds supporting this sweetheart settlement have little interest in obtaining fair value for their claims.  Kasowitz touched on some of those reasons during his sur-reply presentation in the Article 78 proceeding:

BlackRock during the relevant time period here was owned almost 50 percent by B of A, who is a policyholder and a petitioner in this case and a plaintiff in the DCL matter and the like. We pointed out that, you know, that’s a pretty egregious conflict to hire as a consultant the people  who are, in effect, your counterparty and potentially your adversary.  It sounds like a conflict to me, your Honor.  We point out something else.  That wasn’t just our view about things.  We cited during our last presentation the report that was issued by the General Accountability Office of the federal government, which said in situations involving Bank of America or Merrill Lynch, BlackRock is off the list.  They have an inherent conflict.  They’re off the list.  (June 4 Transcript at 1782:20-1783:4)

While the argument over the failure to hire BlackRock evoked interesting parallels to ongoing RMBS litigation, it is ultimately a sideshow in the Article 78 proceeding.  It does, however, highlight how much subjectivity and how many judgment calls were involved in the NYID’s decision to approve MBIA’s restructuring.  It’s just these types of subjective calls that Kapnick is unlikely to second guess.  Though the banks make much of the fact that MBIA had insufficient earned surplus to issue the dividend it did as part of the transaction (and indeed, this is likely the banks’ best argument), I just don’t see Judge Kapnick feeling confident enough that this transformation ran afoul of the complex accounting and insurance law standards at play to find that the Insurance Commissioner’s decision was wholly irrational.

At the end of the “trial,” Kapnick suggested that it would take her several weeks, if not months, to go through all the evidence presented by the parties during their 3 years of litigation, meaning we should expect a decision on the propriety of MBIA’s restructuring sometime before the end of the summer.  Though this certainly will not be the last we hear of the challenges to MBIA’s restructuring, this initial ruling should have a major influence on the risk analyses of, and the course of negotiations between, two of the biggest players in RMBS litigation.

Click here to continue to Case No. 2 in our Top 5 Countdown, and find out why time is of the essence in one big bank’s efforts to put the mortgage crisis behind it.

[Correction: an earlier version of this article featured an typo in the name of the Article 78 case (hat tip reader Alex Ryer) - IMG]

Posted in accounting, Alison Frankel, allocation of loss, appeals, Bank of New York, banks, bench trials, BlackRock, BofA, CDSs, conflicts of interest, contract rights, counterparty risk, Countrywide, Judge Barbara Kapnick, Judge Eileen Bransten, Judicial Opinions, lawsuits, MBIA, MBS, media coverage, monoline actions, monolines, putbacks, Regulators, rep and warranty, repurchase, RMBS, securitization, settlements, Trustees, valuation | 9 Comments

The Top 5 RMBS Cases to Watch this Summer: No. 4 – Retirement Board v. Bank of New York Mellon

Yesterday, I kicked off a countdown of the top 5 RMBS cases to watch this summer with a post about Syncora v. EMC and the impending summary judgment decision on loss causation.  Today, I’d like to talk about another case to watch this summer: Retirement Board of the Policemen’s Annuity and Benefit Fund v. Bank of New York Mellon, Case No. 11-CV-5459 in the Southern District of New York.  This case seeks to blaze an entirely new pathway to recovery – suing mortgage backed securities Trustees for failing to live up to their contractual and statutory duties to investors.  A win here for investors in this case could mean significant trustee liability and/or negotiating leverage to force trustees to act as fiduciaries for bondholders going forward.

No. 4 – Retirement Board of the Policemen’s Annuity and Benefit Fund v. Bank of New York Mellon

As I discussed a few months back, Judge William Pauley issued a groundbreaking decision in Retirement Board v. Bank of New York Mellon that sent ripples through the RMBS litigation world.  Specifically, Pauley found that the Trust Indenture Act (TIA) applied to the RMBS Trusts at issue because they were in actuality more like debt than equity.  This meant that investors could sue and impose liability on RMBS Trustees directly for failing to comply with their obligations to protect investors in the trusts they oversee.

At the time, I predicted that the decision would go up to the Second Circuit on appeal, and it now seems like that is the route Bank of New York Mellon (BNYM) is hoping to go.  On April 17, BNYM filed a Motion to Reconsider, in which it asks Judge Pauley to reconsider and reverse his prior decision or, in the alternative, to certify his Order for interlocutory review.  In layman’s terms, this means that BNYM wants to appeal a non-final Order prior to the end of the case, for which it needs the Court’s permission.

Not surprisingly, a number of bank advocacy groups, including SIFMA, the American Bankers Association and the Clearing House Association, have lined up behind BNYM in support of the Trustee’s Motion to Reconsider.  Their basic argument is that Pauley’s decision threatens to upset the market’s settled understanding regarding the obligations of RMBS Trustees (minimal) and delay the return of the moribund private label mortgage market (which isn’t coming back anytime soon, regardless).  In their Opposition, the investors’ counsel does a good job of pointing out that the TIA was intended to protect investors from just these sorts of passive Trustees and that investors will be none too eager to flock back to private label RMBS if they’re not adequately protected.

But all policy arguments aside, the outcome of this decision turns in large part on case precedent (or lack thereof) surrounding the TIA’s application to RMBS, and the SEC’s historical interpretation of the same.  The investors argue, consistent with Pauley’s Opinion, that the SEC’s interpretation of the applicability of the TIA is only persuasive if the reasoning behind that interpretation is persuasive.  In its Reply, BNYM blows right past this point, saying, “but plaintiffs do not deny that the SEC consistently, over many years, has adhered to the view that the TIA is not applicable to PSA-governed certificates.”

Well, plaintiffs may not have denied that the SEC has interpreted this issue consistently, but that doesn’t make it so.  In fact, I’ve uncovered evidence that the SEC itself has waffled on its characterization of RMBS.  Specifically, readers may recall that, earlier this year, Option One agreed to pay $28.2 million to the SEC to settle charges that the H&R Block subsidiary misled investors about its deteriorating financial condition.  In connection with this settlement, the SEC filed a Complaint on April 24, 2012 in which it discussed the RMBS issued by Option One as follows:

Option One’s RMBS were debt obligations that represented claims to the cash flows from pools of residential mortgage loans… [Those trusts] issued RMBS that represented claims on the principal and/or interest payments made by borrowers on the loans in the pool.”  (Complaint, SEC v. Option One, 12-SACV-633, at 5:20-25 (emphasis mine))

BNYM has argued vigorously that RMBS are equity securities and that investors have an ownership stake in the mortgage loans themselves, rather than the cash flows from those mortgages, to support the position that the TIA does not apply (by its terms, it only applies to debt securities).  Without much legal precedent, BNYM has had to rely extensively on the fact that the SEC has consistently interpreted RMBS as equity securities.  And yet, this passage from the Option One Complaint shows that even the SEC has interpreted RMBS governed by similar pooling and servicing agreements as debt securities representing claims on mortgage cash flows.  This undermines whatever persuasive impact the SEC’s interpretation may have had whatever court ultimately rules on this issue.

With BNYM’s Motion to Reconsider now fully briefed, counsel for the Retirement Board of the Policemen’s Annuity may wish to seek leave to file a supplemental brief to bring this juicy revelation to Hizzoner’s attention.  In any event, we should know by the end of the summer whether Pauley intends to reverse his original decision (unlikely) or certify the issue for interlocutory review (somewhat more likely).

Should the issue go up to the Second Circuit on appeal, BNYM runs the risk of creating unfavorable binding precedent for all lower courts in the Second Circuit, which is where most of these cases have been and would be brought.  But given the vehemence with which it and the bank advocacy groups have fought the application of the TIA, this is apparently a risk they feel is worth taking.  Since the onset of the mortgage crisis, RMBS trustees have done all they could to limit their own liability first and foremost, and minimize the costs they would incur to satisfy their obligations under the governing trust documents to boot.  This makes sense, as trustees are paid very little for their troubles.  Indeed, why should they incur liabilities or costs that they can avoid?

But investors and bond insurers have complained early and often about the fact that trustees have not lived up to their contractual obligations and should have been doing more to protect the certificateholders that have limited rights to take action on their own behalf.  Since standard trust agreements (known and pooling and servicing agreements) impose very few concrete obligations on trustees while providing them with broad indemnification rights at every step, getting trustee assistance has been quite difficult… up to now.

If RMBS trustees are actually subject to extra-contractual duties under the TIA, that changes everything.  This is especially true now that certain Attorneys General (see here and more recently here) and certain bondholders (see here and more recently here) are delving into whether mortgages were properly transferred into trusts in the first place – one area for which trustees are thought to be contractually responsible, and certainly a failure that could lead to liability under the TIA.  Aside from constituting a breach of reps and warranties, a finding that loans were not properly transferred into the trusts has been held to preclude the trusts from foreclosing on delinquent borrowers, meaning massive losses (and claims) for bondholders.  In short, the success of this novel pathway to recovery under the TIA could have a major impact on whether bondholders can look to trustees to shoulder some of their losses or, in the alternative, use the threat of direct liability to wrangle trustee cooperation in enforcing their substantial mortgage put-back claims against originators and issuers.

Click here to continue to Case No. 3 in our Top 5 Countdown, and learn why a non-RMBS lawsuit has been garnering so much attention in mortgage litigation circles.

[Update: since this post was first published, Judge Pauley has granted plaintiffs' counsels' request to file in the public record the SEC documents referring to RMBS as "debt obligations" - IMG]

Posted in allocation of loss, appeals, Attorneys General, Bank of New York, bondholder actions, chain of title, Complaints, contract rights, costs of the crisis, fiduciary duties, improper documentation, investors, Judge William Pauley, Judicial Opinions, lawsuits, liabilities, litigation, litigation costs, MBS, motions to dismiss, pooling agreements, private label MBS, procedural hurdles, putbacks, responsibility, RMBS, SEC, securitization, TIA, Trustees | 8 Comments

The Top 5 RMBS Cases to Watch this Summer: No. 5 – Syncora v. EMC

As summer approaches and the weather turns warmer, RMBS litigation is also heating up, generating long-awaited precedent that will dictate how mortgage losses are likely to be allocated by the courts.  In order to keep my readers apprised on what to watch for over the next three months in the key mortgage derivative lawsuits, I am launching a series called the Top 5 RMBS Cases to Watch this Summer.   Starting today, and continuing over the next week, I will be analyzing the latest developments in one bellwether case per day in the world of RMBS litigation.  I will conclude the series with an article on possible end game scenarios, so that we can begin to understand how the subprime crisis will finally shake out, and what it will mean for the future of mortgage finance.  So, without further ado, I present case number 5 in the Top 5 RMBS Cases to Watch this Summer.

Case No. 5 – Syncora v. EMC

Though patience is ordinarily a virtue, it’s a prerequisite in the world of residential mortgage backed securities (RMBS) litigation.  That’s because progress in complex litigation always takes longer than anyone expects.

Take the lawsuit by bond insurer Syncora against mortgage lender EMC Mortgage (formerly a subsidiary of Bear Stearns that’s now wholly owned by JP Morgan Chase) as a prime example.  On December 19, 2011, Syncora v. EMC, Case No. 09-cv-3106 (S.D.N.Y. 2009) became the focus of significant attention when Reuters blogger Alison Frankel wrote that a partial summary judgment decision on the issue of loss causation was “imminent” and anticipated that we’d have a ruling in the case “before the end of this week.”  Sitting here nearly six months later, we are still awaiting that decision.

Of course, this isn’t Ms. Frankel’s fault – she provides some of the best and most timely coverage of RMBS litigation in the business.  Ms. Frankel was relying on statements made by His Honor himself, when Judge Paul Crotty announced at a hearing on October 12, 2011 that, “I think it would be in everybody’s interest to get a decision [on summary judgment] before we break for the holidays.  That’s what I’ll try to do.” (October 12 Transcript at 24:22-24)  Apparently, progress takes longer in complex litigation than even judges expect.

The good news is that we can finally see the light at the end of the tunnel.  A hearing on the summary judgment motion has been set for this Wednesday, June 13, 2012.  With the motion fully briefed and oral argument complete, Judge Crotty certainly should be able to hand down a decision by the end of the summer.  In fact, given the delay we’ve already seen and the importance of this decision to the case and the broader litigation landscape, I would expect the decision to come down by mid-July – but don’t hold me to it.  Judges work on their own schedules, and the demands of their dockets may force things to the back burner for far longer than we (or they) would like.

Whenever the decision comes down, there’s good reason to believe that Syncora’s patience will be rewarded.  Judging by Crotty’s previous decision on summary judgment, which I analyzed here, Hizzoner is none too pleased with EMC’s interpretation of its contractual responsibilities or conduct thus far in living up to those responsibilities.  Having previously declined to limit Syncora’s relief to the put-back remedy (which he famously described as being designed for “onesies and twosies”) and having authorized Syncora to use statistical sampling to prove its claims, I anticipate that Crotty will be similarly disinclined to limit Syncora’s access to the put-back remedy by adopting a narrow definition of materiality.

I’ve discussed at length how important the definition of materiality/loss causation will be to the ease of proof in put-back litigation.  No single issue would cause a bigger swing in the pendulum of losses from investors to banks than a ruling that put-backs do not require a showing that the identified breach of reps and warranties actually caused the loan to go into default.

Since Judge Eileen Bransten punted on that issue in her partial summary judgment ruling in another major monoline suit – MBIA v. Countrywide – Crotty could be the first to rule definitively on whether this is a viable defense.  If he goes the way I expect he will (and the way he should, given the strength of the arguments on each side) and rules that a breach must merely have a material impact on the riskiness of the loan rather than actually cause the borrower to stop making payments, it will provide clarity on the scope of repurchase liabilities and facilitate significantly larger recoveries for the monolines and RMBS investors.  It would also undermine the assumptions made by Bank of New York Mellon in settling Countrywide put-back claims for pennies on the dollar (tune in later this week to see if BNYM’s Article 77 proceeding makes the Top 5 list).

On the other hand, Crotty could also decide to punt on the issue, forcing litigants and commentators to put Guns N’ Roses’ classic track on repeat and dig deep for what’s left of our “Patience.”  Either way, this ruling is certainly one to watch for in the months to come.

Click here to continue to the next post in this series – Case No. 4 – and find out what recent ruling has the securitization industry worried and mobilizing against it…

Posted in Alison Frankel, allocation of loss, Bank of New York, banks, Bear Stearns, broader credit crisis, contract rights, costs of the crisis, Countrywide, emc, investors, JPMorgan, Judge Eileen Bransten, Judge Paul Crotty, Judicial Opinions, lawsuits, lending guidelines, liabilities, litigation, loss causation, loss estimates, monoline actions, monolines, mortgage market, private label MBS, putbacks, rep and warranty, repurchase, responsibility, RMBS, subprime, The Subprime Shakeout, Trustees, underwriting guidelines, underwriting practices | 12 Comments