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BONY-Countrywide Settlement Removal Reversed by 2d Circuit

posted by Adam Levitin

Lost in the attention to the state-federal mortgage servicing settlement is the other major servicing fraud settlement:  the $8.5B deal between BONY as trustee for various MBS trusts and Countrywide (Bank of America) over putback claims for securitization of mortgages that didn't comply with the requirements of the securitization documents.  

BONY filed an Article 77 action in NY state court, which is a CYA procedure for a court to bless BONY's actions as trustee.  A large group of institutional investors (the Institutional Investors) supported the deal, but many other MBS investors (and the NY Attorney General) intervened in opposition.  

The investors removed the case to Federal District court under the Class Action Fairness Act (CAFA), where the sharp-eyed district judge immediately saw what was up and noted that BONY was dancing around like a marionette with strings being pulled by BoA and the Institutional Investors, rather than acting as an independent trustee and fiduciary.  The removal order was appealed to the 2d Circuit, which reversed.  [Yves Smith is surprised that the NY AG did not file a brief supporting removal.  I'm not (and don't think it would have affected the outcome here).  State AGs have to be very careful about how they treat their state courts; these are relationships that affect many cases. Pushing for removal is not how an AG makes nice with home court judges.  Silence here speaks loudly.]

On the surface, this is just a venue ruling; it is not a substantive ruling on the merits of the settlement of the putback claims.  But there are real concerns in this case that venue matters--why else would BONY fight removal?

The reversal was because CAFA's removal provision has an exception for securities claims. The investors pushing removal argued that their claims were not related to securities but derived independently from NY trust law.  I'm sympathetic with these investors, but I'm having trouble seeing their argument under the statute--while BONY is a trustee, all of the trust's beneficiaries exist only by way of securities; absent the issuance of the RMBS, I'm not sure who BONY would be a trustee for.  Assets are held in trust for someone;  they aren't just held in trust.  The RMBS create the beneficiaries for the trust.  That's why the PSA is both the indenture for the RMBS and creates the trust.  I'm open to being persuaded otherwise, but from reading the 2d Circuit opinion, I just wasn't seeing the removal argument.  

That said, what is up with the 2d Circuit describing "Bank of New York Mellon, acting in its capacity as trustee of trusts established to hold residential mortgage-backed securities"?  BONY is trustee for a trust that holds mortgages, not RMBS.  The trust issues RMBS.  The 2d Circuit generally seems to get securitization, so this misdescription at the beginning of the opinion was pretty glaring.  


Does BoNY--hardly a paradigm of fiduciary responsibility and discretion-- really want the guns of a the New York and Delaware Attorneys General and about a dozen plaintiffs' firms blazing at its conduct as a "trustee"? See e.g., http://newsandinsight.thomsonreuters.com/uploadedFiles/Reuters_Content/2011/08_-_August/NYAGcounterclaimsvBNYM.pdf

The threshold question is whether or not BoNY was ever a trustee at all. BoNY itself has argued in these proceedings that it owed no fiduciary duties to the investors. See: http://newsandinsight.thomsonreuters.com/uploadedFiles/Reuters_Content/2011/09_-_September/BofAMBS--bnytrusteedutiesbrief.pdf

If BoNY itself argues that its duties were and are purely ministerial, then it is owed no presumption that it was ever even concerned about the best interests of the investors. By BoNY's own logic, when BofA approached it to enter into the settlement, BoNY should have told BofA that it had no authority to enter into such a settlement because it was only an "indenture trustee," to use the term BoNY uses in its legal hairsplitting.

In other words, BoNY wants to have the authority of a traditional trustee in order to ram through a collusive settlement with BofA, but only to be held to the standards of an "indenture trustee" in that same proceeding to the extent that the conflicted, reckless and irresponsible nature of its conduct comes to light.

Rights and responsibilities go together. At the end of the day, BoNY's mean-spirited efforts will founder on the foregoing bedrock principle, regardless of the court.

The "misdescription" is in the assertion that "The trust issues RMBS"...

Trusts do not issue ("securitize") securities. In this case, COUNTRYWIDE, the Issuer, securitized the mortgages, which were then held in a trust administered by Bank of New York, the Trustee, for the benefit of the Investors.

Perhaps the clarification of the roles of the Players might shed a more logical light on the Court's opinion on the case.

V V Jewell--I don't think that's right. The securities have to be issued by the trust for the securitization to make any sense. Indeed, the securities are trust certificates. The trust presumably gave CW the securities in exchange for the mortgages, and CW then sold the securities into the market (perhaps through an underwriter).

Thank you for your clarification. I think you and are in agreement. You seem to have been referring to the physical issuing of certificates (yes, by the trust), where I was referring to the process of securitization, which takes place outside of the trust in what the industry refers to as a Special Purpose Vehicle (SPV). I'm not intentionally trying to split hairs, but structured finance is rife with complicated nuances, necessary to manage exposure to risk and to facilitate a certain degree of transparency. A flimsy understanding of the various entities and their functions could easily lead to confusion and miscommunication.

I agree with you about the wording of Judge Jacobs' opinion. It might indicate a subtle misunderstanding of the function of the trust and its relationship to the securities.

"Indeed, the securities are trust certificates. The trust presumably gave CW the securities in exchange for the mortgages,"

Wouldn't the initial transaction then be fraud on the part of the trust? How can you sell shares of a trust that has no property until the proceeds of the sale of empty certificates are acquired?

A little chicken-egg problem I think.

And another thing.
Take a common sense look at this.
It seems like the securitization thing is simply to change the form of debt paper so as to avoid laws, rule, and regulations pertaining to the original form. This is gaming the system plain and simple.

Please see trial court decision in JP Morgan Chase v Ilardo, (3/5/12) by Thomas F. Whelan [NYS Supreme Court - Suffolk Cty]. The court rejected borrowers' claims to a permanent modification under Hamp or under state law. Court found that banks participating in HAMP are not obligated to modify loans under federal law or under state common law theories, even where borrowers successfully perform a trial modification.

Decision available on Westlaw at 2012 wl 695032

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