A ruling in the Retirement Board of the Policemen’s Annuity and Benefit Fund of the City of Chicago et al v. Bank of New York Mellon is a game-changer in mortgage investor litigation.
Readers may recall that we’ve moaned about the failure of investors to sue originators, servicers, and trustees for their grotesque violations of contractual and other duties. Generally, the reluctance to take action is the consequence of terrible incentives. The “investors” are often
fee whores agents, meaning fund managers who are hired by the parties that actually have money, such as pension funds. The fund managers don’t want to devote time and money to suing, even though they have a fiduciary duty to their investors, nor do they want to jeopardize their relationships with bank that they think they need for market intelligence and trade execution.
But the fund managers had an excuse. For them to sue under the pooling & servicing agreement, they needed to have 25% of the investors in a particular trust. It was difficult to find the other investors, and even then, hard to get them to act.
But I never really bought the 25% excuse. There were other legal theories that didn’t require having 25% because you wouldn’t be suing on the basis of a violation of the PSA. For instance, it looks to be blindingly obvious that the trustees in these deals made multiple false certifications, which are SEC filings. That sort of action would not be subject to a procedural hurdle.
But a ruling on Tuesday by Judge William Pauley against Bank of New York on 26 Countrywide securitizations may have opened the floodgates to trustee litigation. Heretofore, trustees have effectively told investors to pound sand when they’ve petitioned them to take action against servicers, relying on their belief that it would be unlikely that they’d be able to get a day in court, thanks to the barriers built into the PSA.
But four pension funds which are investors in $30 billion of Countrywide trusts, sued under the Trust Indenture Act of 1939. I haven’t seen the actual original filing or Pauley’s ruling, but here is the background, per Alison Frankel:
…the pension funds accused Bank of New York Mellon of negligence and breach of fiduciary duty for doing nothing to remedy Countrywide’s inadequate servicing of home loans contained in the trusts.
The bondholders said Bank of New York Mellon failed to take possession of loan files, including the original mortgage notes, or require Countrywide to fix or buy back defective loans.
Such failures “created considerable uncertainty” and should make the bank responsible for bondholder losses, regardless of the fairness of the $8.5 billion settlement, the complaint said.
Pauley said the bondholders could pursue claims that Bank of New York Mellon did not properly notify them that Countrywide had defaulted on some obligations, whether as a servicer or as a mortgage lender.
The judge nonetheless said the bondholders could sue only on the basis of the 26 trusts in which they invested, not all 530 trusts covered by the $8.5 billion settlement.
This is extremely significant. This lawsuit provides a road map for any investor unhappy with the Bank of America settlement to take action against Bank of New York and Countrywide. As we noted in earlier posts, the 22 investors that Kathy Patrick of Gibbs & Bruns rounded up to act as a Trojan horse for the deal don’t have 25% of the 530 trusts involved in the settlement. Not even close. There are many trusts in which they own no bonds at all.
So now any investors who are unhappy with the settlement don’t have to go through the effort of trying to intervene in the settlement in New York court, where the deck is very much stacked against them. I am told the judge is very much out of her league on the settlement, and her inclination is to rubber stamp what the banks put before her (which she can pretend isn’t unreasonable if she follows the bank line that an Article 77 hearing is appropriate, since the bar for refusing a trustee’s request in that procedure is very high).
And of course, this decision opens up an entirely new front for other relatively small investors (pension funds, endowments, foundations) to take action. If other parties follow the lead of these four pension funds against Countrywide trusts, you could see enough holes shot in the settlement deal so as to render it useless to Bank of America (indeed, worse than useless: the deal provides for expanded indemnification for Bank of New York Mellon, so if angry investors saddle up to sue BoNY and BofA, it might find itself worse off, depending on the nature and level of damages awarded against BoNY).
Moreover, this action also threatens the Federal/state mortgage settlement. As we have discussed at some length, the Administration has repeatedly trotted out the canard that it has investor consent for principal modifications of securitized mortgages. We’ve explained that’s bogus: most deals have a cap on mods (all Countrywide deals appear to) and to exceed the cap, “consent” doesn’t cut it. You need an amendment to the PSA. That takes a minimum of 51% of the investors (in some deals, of each tranche, in some, as much as 2/3 of each tranche).
But the Administration appears to be trying to pull the wool over the eyes of the public and investors. It has repeatedly told journalists (as well as the Association for Mortgage Investors) that the investor mods will be coming mainly out of Countrywide deals, and that it has consent for that via the Bank of America settlement. Nothing in that deal provides consent of any sort, plus it seems awfully reckless even if that were true to pin one part of a major initiative on a pact that has not yet been sealed. But having the BofA deal fall apart, and that might be the eventual consequence of this action, would also remove the the smokescreen the Administration relied on to legitimate its actions in the Federal/state settlement.
So let’s hope that this important ruling emboldens other investors. They’ve been complacent for much too long.