Opinion

Alison Frankel

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

By Alison Frankel
September 30, 2011

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.

We’ll have to wait for Pauley to say what he thinks of the bank’s description of its duties. In the meantime, there’s a good question for the rest of us to contemplate. BNY Mellon’s brief tells investors in asset-backed securities that they shouldn’t count on indentured trustees to do anything more than their specified administrative duties. That leads to the conclusion that securitization trustees consider all substantive responsibility to police asset-backed deals to lie with investors. Will securitization agreements have to change for that market to be revived? And if investors insist on more accountability for trustees, will anyone agree to take on that duty?

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