Opinion

Alison Frankel

Who owns AIG’s MBS fraud claims? Billions ride on the answer

By Alison Frankel
January 14, 2013

Amid the furor last week over whether AIG would thumb its nose at its federal rescuers and join former chairman Hank Greenberg’s $25 billion constitutional case against the United States, a curious side deal by AIG and Greenberg’s Starr International was mostly overlooked. Last year, as government lawyers prepared motions to dismiss Starr’s suits against both the United States and the Federal Reserve Bank of New York, AIG signed an agreement with Starr that kept the insurer out of the fray — even though one of the most powerful defenses against the claims Starr was asserting on behalf of AIG was that Greenberg’s lawyers had served the requisite presuit demand on the corporation’s board.

We still don’t know exactly why AIG agreed to the side deal with Greenberg and we probably won’t ever get a direct answer now that AIG is out of the case. (AIG’s board voted Wednesday to stay out of Starr’s Fifth Amendment “takings” case and Starr lawyer David Boies of Boies, Schiller & Flexner subsequently said Greenberg won’t sue the board for breach of duty.) But a filing Friday by AIG shows that the insurer has its own megabucks dispute under way with the Federal Reserve. That could be one of the reasons AIG didn’t help the government defend against Starr’s suits — and, more importantly, at this point, it could affect AIG’s $10 billion claims against Bank of America, as well as BofA’s proposed $8.5 billion breach-of-contract settlement with holders of Countrywide mortgage-backed securities.

AIG’s new filing, styled as a New York State Supreme Court complaint against the New York Federal Reserve’s Maiden Lane special purpose vehicle, requests a declaration that in 2008, when the Fed paid $20.8 billion to acquire AIG’s mortgage-backed portfolio through the Maiden Lane vehicle, Maiden Lane did not acquire AIG’s rights to sue MBS issuers for securities fraud. (The Fed has since sold off the Maiden Lane MBS portfolio, at a profit of more than $2 billion.) The complaint explains that the suit is a response to recent declarations by Fed officials in AIG’s case against Countrywide, which (as I’ve told you) Bank of America has moved to dismiss on the grounds that the Fed, and not AIG, owns the fraud claims AIG has asserted.

What’s really fascinating, however, is the suit’s discussion of AIG’s long-running feud with the New York Fed over which of them has the right and the responsibility to bring MBS issuers to account. AIG’s new filing suggests that if the Fed’s interpretation of the Maiden Lane transaction is correct, then the Federal Reserve Bank has failed American taxpayers by neglecting to bring securities fraud claims against BofA. So while AIG’s suit, in one sense, is yet more litigation gamesmanship with its archenemy Bank of America, the insurer’s dispute with the Fed also raises some really serious policy questions about federal bailouts. Can taxpayers count on the Fed — which, of course, has extremely complex relationships with U.S. banks — to sue those banks for fraud on their behalf? And if not, should the Fed leave the right to sue with the bailed-out company, but pay less for the securities?

This particular dispute dates back to the fall of 2011, when New York Fed general counsel Thomas Baxter sent a letter to AIG counsel Michael Carlinsky of Quinn Emanuel Urquhart & Sullivan. Baxter took note of AIG’s suit against Bank of America and asked Carlinsky to confirm that the suit did not make any claims based on supposed breach of contract by BofA. The Fed GC didn’t discuss it in his letter, but it’s important to remember that in the fall of 2011, the Fed and AIG were on opposite sides of the fight over Bank of America’s proposed $8.5 billion breach-of-contract, or put-back, settlement with holders of Countrywide notes. The Fed’s Maiden Lane vehicle, you will recall, was part of the noteholder group that negotiated the deal with BofA. AIG, on the other hand, was one of the most prominent objectors to the proposed settlement.

In a response to Baxter’s letter, AIG GC Thomas Russo confirmed that the insurer wasn’t bringing put-back claims based on securities it had sold to Maiden Lane and wasn’t demanding that Bank of America buy back securities AIG didn’t own. But he also said that AIG has the right to bring so-called “rescissory” damages, seeking cash for the value of securities AIG was supposedly duped into buying. In a series of ensuing letters, AIG and the Fed tried and failed to reach an understanding of precisely what the Maiden Lane purchase agreement had to say about the suit AIG had brought against BofA.

In October 2012, the bank’s lawyers at Reed Smith and Munger, Tolles & Olson filed a motion to dismiss AIG’s claims against Countrywide that specifically cited AIG’s release of fraud claims to the Fed. (The Countrywide piece of AIG’s case was severed from claims against BofA and Merrill Lynch and sent to the Countrywide MBS multidistrict litigation before U.S. District Judge Mariana Pfaelzer in Los Angeles.) After AIG’s lawyers at Quinn Emanuel filed a response that disclosed the letters AIG had exchanged with the Fed and argued that the Fed had conceded ownership of the fraud claims, BofA submitted rebuttals from former Fed vice president James Mahoney and Fed deputy GC Stephanie Heller.

In Mahoney’s declaration, the former Fed official, who negotiated the Maiden Lane deal, said the Fed’s intent was to retain all litigation claims stemming from the MBS it bought from AIG. Heller’s declaration said that AIG was misrepresenting the end result of the letters between the Fed and AIG in the fall of 2011. The Fed, she said, never agreed that AIG had the right to bring securities fraud claims, and “when the exchange with AIG turned into a negotiation, the FRBNY discontinued its dialogue with AIG concerning this matter as the FRBNY was not interested in negotiating a new allocation of claims or other after-the-fact agreement.”

Those declarations led to AIG’s new complaint, which shrugs off Mahoney’s “vague” assertion and says Heller’s argument that the Fed walked away from discussions with AIG in the fall of 2011 “is difficult to reconcile with how sophisticated counsel typically behave in matters involving billions of dollars.” If the Fed really disagreed with the position AIG outlined in its final letter, AIG said, “its counsel would not have remained silent while AIG asserted its unambiguous position and the (BofA) action advanced.”

The Fed certainly hasn’t acted like it owned billions of dollars of securities fraud claims against BofA, AIG argued in the declaratory judgment complaint. It never tried to intervene in AIG’s case and, unlike the Federal Deposit Insurance Corporation and the Federal Housing Finance Agency, didn’t file its own securities case against BofA or Countrywide. Instead, the complaint pointed out, the Fed has sided with BofA in the proposed $8.5 billion put-back deal, in which AIG is now the leading objector. The Fed actually asked AIG in a letter in October 2011to drop its objections to the put-back settlement, which the Fed accused AIG of using as leverage in its securities litigation against BofA. (AIG responded in November 2011 that it wasn’t objecting just for leverage but was “pursuing all avenues of recovery” against BofA.)

With the ownership of the securities claims already briefed before Judge Pfaelzer in AIG’s case against BofA, I’m not sure AIG can seriously expect a declaratory judgment ruling in New York state court before Pfaelzer decides the question. There are optics to consider, though. State Supreme Court Justice Barbara Kapnick is scheduled to hold hearings on whether to approve BofA’s $8.5 billion deal in May, with AIG’s lawyers at Reilly Pozner leading opposition to the deal. By filing its declaratory judgment suit against the Fed in the same court, AIG underlines its argument that the Fed and other noteholders in its group were too quick to reach a deal with Bank of America.

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