Opinion

Alison Frankel

Bank of New York: We have no fiduciary duty to MBS investors

Alison Frankel
Sep 30, 2011 22:26 UTC

When New York attorney general Eric Schneiderman sued Bank of New York Mellon in August, the AG asserted that the Countrywide mortgage-backed securitization trustee had breached its duty to MBS investors. “As trustee, BNYM owed and owes a fiduciary duty of undivided loyalty,” said the AG’s suit, which was filed as a counterclaim in BNY Mellon’s case seeking approval of the proposed $8.5 billion Bank of America settlement with MBS investors. “[BNYM] breached that duty to [investors'] detriment and disadvantage, by failing to notify them of issues regarding the quality of loans underlying their securities.”

But according to BNY Mellon, it had no such duty.

The bank’s lawyers at Mayer Brown and Dechert filed a 14-page brief this week outlining its interpretation of the responsibilities of an MBS securitization trustee. The filing came at the direction of Manhattan federal Judge William Pauley, who’s deciding whether the BofA MBS settlement should be heard in state court, where BNY Mellon filed it, or in federal court, where key objectors to the proposed settlement want it to proceed. Pauley was concerned with the “securities exception” to the Class Action Fairness Act, which could end up guiding his decision on the forum question. For BNY Mellon, however, any discussion of its trustee responsibilities is fraught with danger. It’s already facing the New York AG’s claims, and several other state attorneys general have threatened similar actions. MBS investors, meanwhile, are pushing BNY Mellon (and other securitization trustees) to bring put-back claims, with the implied threat that investors will take action against trustees unless they do.

BNY Mellon’s brief pushes back against that pressure, asserting that the trustee’s responsibilities don’t extend much beyond the ministerial duties spelled out in the pooling and servicing agreements governing MBS trusts. New York law, the filing said, imposes only two addition burdens: the trustee must avoid conflicts of interest and must perform its ministerial functions “with due care.” According to BNY Mellon, there’s an important distinction between ordinary trustees and indenture trustees. Indenture trustees, it said, do not have “a traditional duty of due care.” Its duties — beyond those two basic responsibilities implied in New York law — are strictly defined by the pooling and servicing trust contracts.

The New York AG argued that the duties of an indentured trustee change when there’s a default. (He also asserted that BNY Mellon failed even to carry out its “ministerial” duties to MBS holders.) Defaults trigger a heightened duty under New York law, which says that a trustee must behave as a “prudent man” would with regard to his own affairs. State-law precedent, the AG brief said, holds that the “prudent man” standard of care is a fiduciary duty — and BNY Mellon breached it when the bank failed to notify Countrywide MBS investors of defaults in underlying mortgage loans.

BNY Mellon’s brief countered with two arguments, one legal and one factual. Even if default triggers a heightened standard of care for indentured trustees, it argued, those new duties are still governed by the trust agreement. The bank quoted language referring to the extra duties as “a relatively minor change in the legal landscape.” Moreover, according to BNY Mellon, there has been no default, under the precise language of the pooling and servicing agreements. “The Events of Default are strictly defined and none has occurred,” the brief said.

Mets ruling could upend Madoff bankruptcy

Alison Frankel
Sep 28, 2011 22:27 UTC

Helen Chaitman of Becker & Poliakoff represents more than 300 investors who had accounts with Bernard Madoff. For more than two years she’s hammered away at one particular argument in federal bankruptcy court, in Congress, even on YouTube: Madoff bankruptcy trustee Irving Picard of Baker & Hostetler shouldn’t be allowed to demand the return of profits that Madoff investors pulled out of their accounts as long ago as 2002, six years before the Ponzi scheme imploded in December 2008. On Tuesday night, Chaitman finally found vindication, even though it wasn’t in any of her cases. Manhattan federal judge Jed Rakoff, ruling in Picard’s fraud case against the owners of the New York Mets, concluded that a section of the federal bankruptcy code precludes Picard from attempting to claw back money Madoff investors pulled out of the Ponzi scheme before 2006.

“This is something I’ve been saying from the beginning,” Chaitman told me. “Anyone who didn’t withdraw their money in the last two years [of Madoff's scheme] is out completely.” Jonathan Landers of Milberg, who represents 30 clawback clients, agreed: “This is a very, very significant ruling.”

That’s putting it mildly. Judge Rakoff’s 18-page ruling could completely upend the Madoff bankruptcy. Among the big-name Madoff investors who would be off Picard’s hook completely if Rakoff’s ruling stands is former Securities and Exchange Commission general counsel David Becker, who’s in hot water for allegedly failing to alert SEC commissioners of a potential conflict of interest stemming from his parents’ long-closed Madoff account. Picard had filed a clawback suit against Becker, who inherited money after his parents’ account was liquidated in 2002; Rakoff’s ruling would wipe out Picard’s suit.

Why FHFA IG report doesn’t mean big new liability for banks

Alison Frankel
Sep 27, 2011 21:44 UTC

When I first read the Federal Housing Finance Agency Inspector General’s report criticizing Freddie Mac’s $1.35 billion MBS put-back settlement with Bank of America, I wondered if the FHFA IG had just exposed billions of dollars in untapped bank liability. The IG report notes, after all, that Freddie’s deal with BofA (unlike Fannie Mae’s simultaneous $1.52 billion BofA settlement) resolves not only pending breach of contract claims, but also any future claims that Countrywide breached representations and warranties on the mortgages it sold Freddie. Those are exactly the kinds of global settlements banks are going to have to reach if they have any hope of resolving their MBS put-back liability.

So if the FHFA Inspector General is castigating Freddie for overlooking BofA’s liability for mortgages that defaulted four or five years after they were issued — and FHFA is generally reckoned to be the most experienced evaluator of reps and warranties claims there is — have other put-back claimants underestimated potential bank liability? Are bond insurers and MBS investors making the same supposed mistake as Freddie Mac?

The short answer is no.

The IG report faults Freddie for failing to account for the exotic mortgage loans that proliferated in the housing bubble. Homeowners with interest-only or adjustable-rate mortgages often made it through the early teaser-rate years, only to default when they had to begin making higher payments. The FHFA IG report indicates that Freddie Mac has seen tens of thousands of these mortgages go into default three to five years after they were issued.

Fraud and the feeder fund: How Merkin dodged fed. class action

Alison Frankel
Sep 26, 2011 22:05 UTC

You had to be a sophisticated investor if you wanted to give J. Ezra Merkin your money. The hedge fund director made that clear in the offering documents for three of his funds: investors had to entrust considerable assets to him (at least $5 million for individuals and $25 million for businesses); had to conduct their own due diligence before deciding to invest; and had to accept the risk that Merkin’s funds might lose their money. Unsaid, but well-understood by many of the investors in Merkin’s Ascot fund (at least according to Merkin lawyer Andrew Levander of Dechert), was that Merkin would be feeding investors’ money to Bernard Madoff.

Merkin earned between 1 and 5 percent fees on the hundreds of millions of dollars he funneled to Madoff beginning in the early 1990s. At the same time, his own Madoff investment blossomed to more than $100 million. When Madoff’s Ponzi scheme was exposed in December 2008, Merkin was as stunned as his hedge fund clients, according to his lawyers. Merkin also claimed that he and his family were among Madoff’s biggest victims, with nine-figure paper losses.

Many doubted that depictions of events, including the New York attorney general, who filed a state-law fraud action against Merkin; real estate developer and Merkin investor Morton Zuckerman, who brought in Susman Godfrey for a New York state supreme court suit; and investors in Merkin’s Ascot, Gabriel, and Arial funds, whose cases were consolidated in June 2009 in a Manhattan federal court securities class action. The hedge fund investors, represented by lead counsel from Abbey Spanier Rodd Abrams & Paradis and Wolf Haldenstein Adler Freeman & Herz, alleged that Merkin had misrepresented the operation of his funds in offering documents that implied Merkin himself — and not Bernie Madoff — would be making investment decisions. They also asserted that Merkin ignored warning signs.

Want more board accountability? It won’t come via litigation

Alison Frankel
Sep 23, 2011 20:55 UTC

Lucy Marcus, a consultant, Harvard Business Review writer, and corporate director, posted an HP- and Yahoo-inspired cri de coeur Friday at HBR. “How bad does it have to get before we come to terms with the fact that we need to fix the boardroom?” she wrote, in a piece entitled “It Is Time to Fix Our Boardrooms.” Marcus’s idea is that boards should fix themselves. Independent directors have to think hard about who’s sitting around the table with them, she said, and “assess whether the board and the individual directors have the skill and the will to rise to the challenge of future-proofing the organizations that they serve.”

Marcus doesn’t discuss the role shareholders should play in board reform, but the truth is that unless they’re Carl Icahn or CalPERS, they have precious little power over corporate directors. (Thanks to the Securities and Exchange Commission’s recent decision not to challenge an appellate decision striking down the proxy access rule, shareholders don’t even stand much of a chance of ousting directors in favor of their own board candidates.) Ordinary investors should have maximum leverage over corporate boards when they’re gathered together in a class action demanding accountability. That vehicle does exist. Derivative suits, in which shareholders stand in the shoes of the corporation to bring class action claims against directors and officers, give investors an opportunity to blame boards for breaching their duties.

Unfortunately, that’s about all derivative suits give shareholders, though: an opportunity to air allegations without a lot of hope they’ll make a difference. As Tom Hals reported Thursday in an insightful Reuters piece on the dim prospects for derivative suits against Hewlett-Packard, Delaware law makes it incredibly hard for shareholders to win these cases. The Chancery Court’s entrenched “business judgment rule,” which dates back to 1984, presumes that “in making a business decision the directors of a corporation acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the company.” In the 2006 dispute over Disney CEO Michael Ovitz’s $100 million golden parachute, the Chancery Court affirmed that under the business judgment rule, “the board’s decision will be upheld unless it cannot be attributed to any rational purpose.”

How Covington won $500 ml case of shipwrecked Spanish frigate

Alison Frankel
Sep 22, 2011 22:12 UTC

In a way, it’s a shame that James Goold of Covington & Burling isn’t a historical novelist.

He’s come up with some great fodder, like the story of Captain Diego de Alvear. In 1804, as Spain girded for war with England in the ever-shifting enmities of the Napoleonic era, Spain assembled a four-ship squadron to transport gold and silver from Peru, then a Spanish territory, to Spanish coffers. At the last minute, the second-in-command of one of the ships, the Medea, fell ill, so de Alvear was transferred to the Medea from another ship, the Mercedes. The rest of his large family — his wife, three sons, four daughters, and a nephew — stayed aboard the Mercedes as the ships sailed from South America to Spain. One day before the squadron was due to reach port in Cadiz, the British Navy intercepted the ships. The Spanish Navy refused to surrender, touching off what became known as the Battle of Cape Saint Mary, a pivotal moment in the history of the Spanish Empire. As de Alvear watched from the Medea, British artillery struck the Mercedes. The ship exploded. De Alvear’s entire family disappeared, along with scores of Spanish sailors, chests of treasure, and two ancient bronze cannons, destined to be melted down and recast as modern weapons.

Of course, Goold would never have come across the tragic story of Diego de Alvear if it weren’t for his real job. The Covington counsel has carved out one of the most interesting microniches I’ve ever run across: he represents foreign sovereigns in disputes with commercial treasure hunters over the rights to shipwreck recoveries. On Wednesday the U.S. Court of Appeals for the Eleventh Circuit, in a 53-page opinion that cites the de Alvear story, ruled that the Foreign Sovereign Immunity Act bars U.S. courts from hearing a case involving rights to treasure that a company called Odyssey Marine Exploration recovered from the site of the 1804 Mercedes explosion. The three-judge appellate panel didn’t decide who owns the treasure — which Odyssey has estimated to be worth $500 million — but the ruling in effect grants it to Spain, since the court ordered the booty to be transferred to Spanish custody.

Federal judge gives shareholders green light for say-on-pay suit

Alison Frankel
Sep 21, 2011 21:48 UTC

One of the verdant new fields the Dodd-Frank act has opened for litigators involves the Securities and Exchange Commission’s say-on-pay rule, which requires public companies to put executive compensation up for an advisory shareholder vote every two years. The rule went into effect in January. By May, Dena Aubin of Reuters was already reporting on a surge in shareholder derivative suits claiming boards breached their fiduciary duty by pushing through pay packages that shareholders voted down.

Darren Robbins of Robbins Geller Rudman & Dowd, whose firm has led the shareholder say-on-pay litigation, said there have been about a dozen derivative suits filed in state and federal courts. At least two have settled, according to a July 2011 report from Drinker Biddle & Reath (one settlement included $1.75 million in legal fees). But the say-on-pay rule — and ensuing litigation — is so new that plaintiffs lawyers didn’t really know whether it would provide a reliable income stream.

That prospect looks a little more likely after a ruling Tuesday by Judge Timothy Black of Cincinnati federal court. In a tart 12-page ruling, Judge Black noted shareholders’ “overwhelming rejection” of a multimillion-dollar pay package for three officers of Cincinnati Bell, even as the company’s earnings and share price slid. “Normally, a board of directors is protected by the ‘business judgment rule’ when making decisions about executive compensation,” the judge wrote. But shareholder lawyers from Robbins Geller, he said, had adequately alleged that the Cincinnati Bell board isn’t entitled to that protection.

Monolines accuse Credit Suisse of misleading financial reports

Alison Frankel
Sep 20, 2011 22:24 UTC

The Association of Financial Guaranty Insurers doesn’t exactly mince words. In a newly-released letter to Credit Suisse CEO Brady Dougan, the executive director of the bond insurance group, Teresa Casey, accused the bank of “materially” understating its obligation to repurchase deficient underlying mortgage loans securitized in Credit Suisse MBS offerings. “We estimate that Credit Suisse’s obligations in respect of the securities insured by AFGI members aggregate billions of dollars,” the AFGI letter said. “We seek to understand the reasons why the full magnitude of the liability has not yet been recognized by Credit Suisse.”

The letter is further evidence of the looming issue of bank liability for breaches of the representations and warranties on underlying mortgage loans. You’ll recall that the Securities and Exchange Commission sent MBS players a letter last October, warning them about disclosing reps and warranties liability and reserves; the Public Company Accounting Oversight Board also put out an MBS alert for auditors in December 2010.

The bond insurers that comprise the membership of AFGI have been in the vanguard on MBS reps and warranties claims; both MBIA and Ambac have been litigating against Credit Suisse in New York state supreme court for years. The AFGI letter cites that litigation, as well as more than a dozen other MBS cases against Credit Suisse, in asserting that “well more than half” of the mortgage loans backing Credit Suisse MBS “were ineligible for securitization.”

Banks beware: Time is ripe for MBS breach-of-contract suits

Alison Frankel
Sep 19, 2011 21:59 UTC

Over the last couple of months Bank of America has taken a stock market and regulatory beating so brutal that it’s reportedly considering the previously unthinkable option of putting Countrywide into Chapter 11. BofA’s mortgage-backed securities exposure seems to have no upper limit; throughout BofA’s long hot summer, it felt like every week investors surfaced with new claims that BofA, Countrywide, or Merrill Lynch violated state and federal securities laws in MBS offerings.

Investors and bond insurers have, of course, made the same claims about Deutsche Bank, Credit Suisse, JPMorgan Chase, Morgan Stanley, Goldman Sachs, and a host of other MBS securitizers. Most notably, the Federal Housing Finance Agency ruined a lot of people’s Labor Day weekend when it filed 17 suits against just about every financial institution in the MBS game (except for Wells Fargo), asserting state and federal securities law claims.

But the difference, so far, between Bank of America and everyone else has been that BofA is facing litigation not just for securities claims but also for breaching contracts with MBS investors. Mortgage-backed securities, remember, were typically sold through trusts governed by pooling and servicing agreements. Those pooling and servicing contracts usually included provisions calling for the originator of the underlying mortgages to repurchase any loans found to violate the lender’s representations and warranties about their quality. Suits based on alleged breaches of reps and warranties are known as put-back claims — and there’s good reason to believe that banks’ put-back exposure may ultimately dwarf their securities law liability.

Patent troll Oasis under attack on two fronts in Texas megacase

Alison Frankel
Sep 16, 2011 22:05 UTC

This summer, thanks to NPR’s This American Life, a patent holding company called Oasis Research became one of the most famous patent trolls in the land. The brilliant radio segment, When Patents Attack! (also available as a Planet Money print story), homed in on a sweeping patent for “an online back-up system,” which Oasis acquired from Intellectual Ventures in July 2010 and proceeded to assert in an Eastern District of Texas case against a dozen tech defendants. When NPR’s reporters tried to find out who or what Oasis is, they struck out. No one answered the door at Oasis’s deserted “office” in Marshall, Texas, and the company’s lead lawyer, John Desmarais of Desmarais LLP, politely declined to answer NPR’s questions when the reporters tracked him down at a tech IP conference. (He also declined, via e-mail, to answer mine for this story.)

But even as NPR exposed the troll, Oasis was winning key rulings in the East Texas case, which featured EMC, AT&T, and GoDaddy.com, among lots of other defendants. In May, federal magistrate Amos Mazzant recommended that Judge Michael Schneider deny the defendants’ motions to sever Oasis’s claims. In July, the judge adopted the magistrate’s recommendations. In August, Oasis’s Desmarais lawyers filed an amended complaint, asserting infringement of four patents in more than 100 claims against 12 defendants.

The defendants fought back on two fronts. EMC filed a petition at the U.S. Court of Appeals for the Federal Circuit, asking the appellate court to reverse Judge Schneider’s ruling on the question of joinder. “The district court committed clear error,” EMC’s petition said, “by allowing [Oasis] to join many unrelated companies in a single infringement action based merely on an allegation that the companies each independently offer the same type of service. In doing so, the district court endorses an increasingly common practice of nonpracticing entities who file patent infringement suits in the Eastern District of Texas. Their newest tactic is to sue a large number of unrelated and geographically dispersed defendants, accuse them of infringing the same patent without regard to service or product differences, resist severance, and then oppose transfer of the action to a different forum.”

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