Last week, Delaware attorney general Beau Biden indicated he might join New York state attorney general Eric Schneiderman in objecting to the proposed $8.5 billion settlement of a sweeping range of areas of possible liability by securitization trustee the Bank of New York. Bank of New York is allegedly acting on behalf of investors. 22 very large institutions were involved in the process, but as we pointed out, some of them, as well as Bank of New York, have substantial conflicts of interest.
Biden did file his petition yesterday, as was reported in Bloomberg just after midnight. The article is skeletal, and thanks to alert reader Deontos, we have the entire filing here. The meat of it is short, but don’t mistake short for unimportant.
The immediate basis for the objection sounds modest:
The Delaware Department of Justice objects to the proposed settlement on the basis that it does not have sufficient information to evaluate the reasonableness of the proposal.
But it builds up steam as it lists concerns, first, that many investors have been kept in the dark:
The Delaware Department of Justice… has significant concerns that the proposed settlement does not adequately remedy the harm suffered by the beneficiaries of the Covered Trusts, some of whom are undoubtedly Delaware investors. Many of these investors have not intervened in this litigation and, indeed, may not even be aware of it…With its intervention, the Delaware Department of Justice will ensure that the interests of absent Delaware investors are adequately represented.
Second, as we have said and has been echoed in other petitions, the Bank of New York has a massive conflict of interest:
The Delaware Department of Justice’s intervention is particularly important given the evidence suggesting that BNYM negotiated the settlement on behalf of the trust beneficiaries under a conflict of interest. The proposed settlement confers substantial direct benefits to BNYM, primarily by a provision, contained in a side letter to the proposed settlement agreement, in which BoA agrees to expressly guarantee the indemnification obligations of Countrywide to BNYM under the terms contained in the PSAs. This expanded indemnification provision also covers BNYM’s negotiation and implementation of the terms of the settlement. The potential conflicts of BNYM go directly to the heart of the issue in this special proceeding, which is “did BNYM act reasonably in negotiating this settlement?”
And it goes straight to an issue we flagged, that the trustee makes annual certification in SEC filings, and the bar for securities fraud is much lower than under contract law theories. Delaware’s securities laws follow SEC 10(b)5 language re disclosure (that it not merely be narrowly accurate, but that it be free of material omissions). Boldface ours:
The acts and practices ofBNYM alleged herein may have violated 6 Del. C. § 7303(2), in that BNYM may have made untrue statements of material fact and/or omitted to state material facts in order to make the statements made, in light of the circumstances under which they were made, not misleading. BNYM’s conduct as described above may have violated the Delaware Securities Act insofar as the Trust PSA requires the Trust annually to certify the following “servicing criteria”:
• “Collateral or security on mortgage loans is maintained as required by the transaction agreements or related mortgage loan documents.”
• “Mortgage loan and related documents are safeguarded as required by the transaction agreements;” and
• “Any addition, removals or substitutions to the asset pool are made, reviewed and approved in accordance with any conditions or requirements in the transaction agreements.” [See generally, Trust PSA, [Ex W to NY Petition]].
The Delaware investors in the Trusts may have been misled by BNYM into believing that BNYM would review the loan files for the mortgages securing their investment, and that any deficiencies would be cured.
As we reported in September, lawyers had found evidence that Countrywide did not transfer the notes (the borrower IOUs) to the securitization trusts as stipulated in the pooling and servicing agreements. This was confirmed in the lawsuit Kemp v. Countrywide, in which a senior employee in Countrywide’s servicing operation said it was a matter of policy for Countrywide to keep the notes.
Additional support came from a small scale study by lawyer Abigail Field, published in Fortune, who looked at foreclosures in two New York counties. Her conclusions were damning not just from the standpoint of the validity of the securitizations, but also for Bank of New York’s conduct in Countrywide and other deals:
DeMartini….testified that Countrywide didn’t deliver the notes to the securitization trustee, and that Countrywide notes weren’t endorsed except on a case-by-case basis generally long after securitization ostensibly occurred. Both steps are required, in one form or another, under all securitization contracts…
To check DeMartini’s testimony, Fortune examined the foreclosures filed in two New York counties (Westchester and the Bronx) between 2006 and 2010. There were 130 cases where the Bank of New York (BK) was foreclosing on behalf of a Countrywide mortgage-backed security. In 104 of those cases, the loan was originally made by Countrywide; the other 26 were made by other banks and sold to Countrywide for securitization.
None of the 104 Countrywide loans were endorsed by Countrywide – they included only the original borrower’s signature. Two-thirds of the loans made by other banks also lacked bank endorsements. The other third were endorsed either directly on the note or on an allonge, or a rider, accompanying the note.
The lack of Countrywide endorsements, combined with the bank’s representation to the court that these documents are accurate copies of the original notes, calls into question the securitization of these loans, as well as Bank of New York’s right, as trustee, to foreclose on them. These notes ostensibly belong to over 100 different Countrywide securities and worse, they were originally made as long ago as 2002. If the lack of endorsement on these notes is typical — and 104 out of 104 suggests it is — the problem occurs across Countrywide securities and for loans that pre-date the peak-bubble mortgage frenzy.
And that means they were not transferred through and endorsed by intermediary parties as stipulated by the pooling and servicing agreement.
Because those agreements had strict cut off dates as to when those transfers had to be completed, and governing law for the overwhelming majority of the trusts (New York law) is unforgiving on this matter (New York trusts are not permitted to deviate from their written directives) the failure to perform as stipulated cannot be remedied. Securitization expert and Georgetown Law professor Adam Levitin has described securitization agreements as “immutable contracts”. Hence the widespread use of document fabrication to get around this mess.
Note that Biden is not going directly after Bank of New York. He is merely seeking to question and perhaps block the settlement with Bank of America. But the issue he raises is a nuclear weapon. Bank of New York was the preferred trustee for Countrywide. There is good reason to believe the Countrywide securitizations were a total fail as far as living up to the requirements of the PSA are concerned. Bank of New York nevertheless piously made multiple false certifications on which investors relied (if you doubt the evidence above, a Pacer scrape of foreclosures on Countrywide trusts will provide further support).
This liability would almost certainly wipe out Bank of New York, which has $34 billion in equity. But Bank of New York is too big to fail by virtue of playing a crucial role in settlement, transfers, and custody. But the real reason no one is likely to sue on this issue is that confirming that the transfers were not done correctly and that this impairs the value of residential mortgage securitizations on a widespread basis. It makes them, again per Levitin, at best “non mortgage backed securities” (as counterintuitive as it sounds, treating regular borrower payments as if the deal were done correctly may well be a viable legal position but the ability of the trust to foreclose would be hopelessly impaired).
And if that isn’t enough, Biden has more goodies in his petition:
The acts and practices of BNYM alleged herein also may have violated Delaware’s Deceptive Trade Practices Act, 6 Del. C. § 2432(12), in that BNYM’s conduct created “a likelihood of confusion or misunderstanding” in the investors in the Trusts, for the reasons cited above.
Finally, the Delaware AG notes that at least two of the 530 trusts involved in the settlement are Delaware trusts, hence the state has a “substantial” interest in making sure they are not used to violate the law. This may sound like a throwaway argument, but a securitization expert commented via e-mail:
WaMu and Chase, in particular, typically issued their private label MBS via agreements governed by Delaware law and Delaware trusts.
In addition, Chase and WaMu typically did not have a requirement that the issuer deliver the mortgage loan files to the trustee in their trust agreements. Instead, they allowed the mortgage loan files to remain with the seller. In their prospectuses for the deals, they disclose that this could create risks for investors in the event the seller became insolvent. The reason this could be a problem is that the loans could be clawed back to the estate of the seller, at the expense of the investors in the MBS. (It is possible that the status of the mortgage loans held by WaMu as seller to MBS trusts played a role in how the FDIC resolved WaMu.)
MBS trusts governed by NY law clearly require the mortgage loans to be transferred to the trustee. For NY Law MBS, it is a pretty straight forward argument that notes or assignments of mortgage which fail to follow the chain of title create a liability problem for both the seller and the trustee.
However, for the Delaware trust deals which do not have a mortgage file delivery requirement, it is much harder to win the argument on bad chain of title.
I’ll be very interested to see what Biden’s investigation into these issues has turned up and whether he makes similar arguments to AG Scheiderman about the trustee’s liability for improper mortgage loan delivery and chain of title issues. If Biden does make such an argument, it seems to me like he would be advancing the legal issues on this front in a significant way.
Notice that Biden has not made such an argument in this filing; it looks (unlike the New York petition, which it includes in its submission) to be minimalist. That may reflect the fact that Biden regards the grounds he has spelled out as more than sufficient. However, the petition’s “we don’t know enough to know if this deal is fair” may be an accurate description of how he intends to play this matter, as in he may add more issues or flesh out the ones already set forth as the process moves forward.
It is encouraging to see the old saw, “The wheels of justice grind slowly, but the grind exceedingly fine,” proves true now and again. The fact that the rule of law is not completely dead in the US is looking increasingly likely to provide a very costly lesson to some very large banks and their asleep at the wheel regulators.