Alison Frankel

Of the 18 banks that challenged MBIA’s restructuring in 2009, only two – Bank of America and Société Générale – remain. On Monday, unless there’s a last-minute settlement this weekend, they will finally go to trial in New York State Supreme Court to argue that New York state insurance regulators should not have approved MBIA’s split, which stripped $5 billion in capital from MBIA’s crippled structured-finance insurance business.

But exactly what shape the trial will take – and what relief BofA and SocGen can ultimately obtain – remains unclear. Bank lawyers from Sullivan & Cromwell, MBIA counsel from Kasowitz Benson Torres & Friedman, and state lawyers from the office of New York Attorney General Eric Schneiderman are all preparing for a proceeding whose parameters have not been set. The banks call it a trial and continue to insist they are entitled to call expert witnesses such as former state insurance officials, who would opine on the adequacy of former Insurance Superintendent Eric Dinallo’s vetting of MBIA’s restructuring. MBIA and the state say the proceeding, brought under an expedited process known as Article 78, should be limited to a few witnesses with direct knowledge of the regulatory investigation. Justice Barbara Kapnick, who is overseeing the case, has called the trial “a glorified oral argument, with some testimony, the crucial testimony, to support it.”

Kapnick agreed at a hearing on Apr. 20 to permit witness testimony at the trial, but she didn’t specify who could be called as a witness. Nor did she set firm rules when she held a conference call this week with all of the parties. So the first order of business Monday will almost certainly be argument on motions to define the trial, though it’s just as likely that the lawyers will end up fighting over the witnesses one by one, as they are proposed. Kapnick has set aside 16 trial days over four weeks for the proceeding.

MBIA has spent more than $1 billion to settle with the 16 other banks that were part of the original coalition challenging its restructuring, including, most recently, Natixis, UBS, Morgan Stanley and Royal Bank of Scotland. According to MBIA’s quarterly filing with the Securities and Exchange Commission on May 10, the insurer has shed tens of billions of dollars of exposure through those deals. In just the first five months of 2012, MBIA commuted $11.5 billion of exposure.

But the insurer’s structured-finance arm, MBIA Insurance, has had to borrow from its better-capitalized municipal bond division, MBIA National, to fund those settlements. Last fall MBIA Insurance took out a $1.1 billion secured loan from MBIA National, at the time it announced a settlement with Morgan Stanley. According to its May 10 filing, MBIA Insurance has borrowed an additional $443 million from MBIA National in the last two months.

MBIA’s balance sheet is also a complicating factor in any global resolution of its disputes with Bank of America. These include a fraud case that parallels the challenge to MBIA’s restructuring, as well as MBIA’s claims against mortgage company Countrywide Financial, which is now part of Bank of America. MBIA claims Countrywide breached representations and warranties on mortgage loans underlying securities insured by MBIA. MBIA, as you surely know, has been in the vanguard of reps and warranties litigation with MBS issuers, and its case against Countrywide has broken important ground in what’s known as put-back litigation. MBIA may well eventually prevail in the case – as I’ve written many times, the judge overseeing the suit, New York State Supreme Court Justice Eileen Bransten, has sided with MBIA and against Countrywide and BofA on most of the big questions she’s confronted so far. But MBIA hasn’t waited for the final judgment to hatch before counting its put-back chickens. Even though the Countrywide case is still in prolonged discovery, MBIA has booked $3.2 billion of “expected recoveries,” according to its May 10 filing.

Bank of America and MBIA, in other words, both believe the other owes it enormous sums of money. MBIA wants Countrywide to pay billions to resolve its put-back claims. BofA wants corresponding billions to commute its MBIA credit default swaps and structured-finance policies through a settlement in the restructuring litigation. Global settlement talks promoted by Benjamin Lawsky, the superintendent of the New York Department of Financial Services, have apparently foundered because Bank of America has balked at the idea that its CDS claims are worth fewer cents on the dollar than MBIA’s put-back claims against Countrywide. BofA seems to be convinced that MBIA needs the bank’s money more than BofA needs MBIA’s.

The bank could well be right. MBIA’s May 10 filing concedes that the insurer “did not write a meaningful amount of U.S. public finance insurance” in the first quarter of 2012, and does not expect to write new muni bond policies unless and until it resolves the litigation challenging its restructuring. That means MBIA doesn’t have a business future as long as the banks keep litigating the propriety of its restructuring.

But BofA faces downside from the continued standoff with MBIA as well. In the case before Bransten, MBIA is poised to move for summary judgment on the bank’s liability for Countrywide’s representations and warranties on deficient mortgage loans. An adverse ruling for Bank of America in MBIA’s put-back case could hurt prospects for court approval of BofA’s proposed $8.5 billion global settlement with investors in Countrywide mortgage-backed securities, since that deal is based partly on the assumption investors won’t be able to establish BofA’s successor liability for Countrywide mortgage-backed securities. Moreover, as I’ve reported, the bank also runs the risk of going to the back of the line of MBIA’s creditors if, for any reason, the state decides to put the insurer into receivership.

Receivership is one possible outcome if Kapnick rules MBIA’s restructuring was improperly approved. The Department of Financial Services could decide that, to protect municipal bond policyholders, it must put MBIA into the insurance equivalent of Chapter 11. In the alternative, if the banks win, the state could appeal, triggering an automatic stay of Kapnick’s ruling.

The banks’ lead counsel, Robert Giuffra of Sullivan & Cromwell, has said in open court that if the banks prevail in the Article 78 proceeding over MBIA’s restructuring, MBIA can just reapply for approval “in open daylight.” But that seems the least likely result of the litigation, particularly with the parallel fraud case brought by the banks against MBIA scheduled for trial in 2013. Without a global settlement, it will take years for these cases to run through the trial and appeals process.

Hotly anticipated trials like the one starting Monday, at least in the early days, are weirdly festive, like a big horse race when the gate first opens. But it’s hard to see how either side wins this case, regardless of the trial’s outcome.

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In an ideal world, the value of a shareholder securities claim rests entirely on its merits. And now that you’ve stopped snickering, let’s talk about the real world, where two disputed settlements test the de facto assumption that securities claims are worth what a company’s directors and officers insurance carriers are willing to pay to resolve them.

In Bank of America’s proposed $20 million settlement in Manhattan federal court of a derivative suit based on its 2008 acquisition of Merrill Lynch, a group of plaintiffs’ firms with a parallel case in Delaware Chancery Court argue that the settlement is insufficient because $20 million is only a tiny fraction of BofA’s $500 million in D&O coverage. Last week Delaware Chancellor Leo Strine refused to enjoin the New York deal, leaving it up to U.S. District Judge P. Kevin Castel to decide whether the derivative shareholders are getting enough money. That’s a sensible result: Castel, after all, is overseeing consolidated Merrill-related securities litigation against BofA, so he’ll evaluate the proposed derivative settlement with the understanding that there are lots of other claimants waiting in line for a chunk of that $500 million in D&O insurance, even as it’s whittled down by defense fees.

Meanwhile, Castel’s Manhattan federal court colleague, U.S. District Judge Lewis Kaplan, last week expressed reservations about a $90 million settlement of securities class action claims against Lehman’s former officers and directors, including former CEO Richard Fuld. Kaplan said in a May 3 order that he understood $90 million was all that remained of Lehman’s $250 million D&O policy, but wanted to satisfy himself that shareholders wouldn’t be better off if their counsel at Bernstein Litowitz Berger & Grossmann pressed on and obtained judgments against individual defendants. To that end, he ordered five former Lehman officers to turn over to him the financial records they’d already produced to a settlement magistrate, retired U.S. District Judge John Martin.

Kevin LaCroix, who writes the indispensable D&O Diary blog in connection with his day job as executive vice-president at OakBridge Insurance, said it’s all too often the case that securities settlements have more to do with coverage limits than the merits of a claim. “There’s an adage in the insurance business: Limits drive losses,” LaCroix said. “One of the things that gets talked about is, ‘If we buy significant insurance, will it invite claims?’ There’s not a single right answer to that question.”

LaCroix told me policy limits ought to be one of the considerations in settlement negotiations, but shouldn’t dictate the ultimate settlement amount. But Steven Toll of Cohen Milstein Sellers & Toll said that not only do coverage limits drive negotiations, but insurance representatives, who typically square off against shareholder lawyers at mediation sessions, have enormous leverage to determine settlement terms.

The problem, Toll told me, is that over the last decade insurers have splintered D&O coverage into multiple layers. So instead of negotiating with one insurer that wrote a $50 million policy, plaintiffs’ lawyers find themselves across the table from 10 insurers, each controlling $5 million layers of coverage. Often, Toll said, junior layers don’t even show up at mediations, sending a clear signal that their money is not in play because all of the higher tranches won’t commit to exhausting policy limits. “At every step, each carrier puts up a roadblock,” he said. “That dramatically affects the resolution of these cases. In almost every one, it’s the same fight.”

Toll said that even when the first couple of layers of insurance – which know their coverage will be exhausted through a settlement or litigation costs – agree to a settlement, there isn’t a deal if the next layers don’t sign on. A refusal by any one layer to pay its entire policy can preclude a settlement. By way of example, Toll pointed back to a 2005 case, the Globalstar Securities Litigation, in which Cohen Milstein ended up in a trial against Globalstar CEO Bernard Schwartz when his D&O insurers balked. Schwartz ultimately agreed to put up $20 million of his own money to settle the case, then turned around and sued his primary and three excess insurance carriers to recover his contribution. Toll was a witness at Schwartz’s bench trial against the two insurers that refused to settle with him. (They were found liable.)

“D&O insurance is a huge, huge deal in this business,” Toll said. “It’s a real practical dilemma, and plaintiffs’ lawyers have to confront it every day.”

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According to Bank of America’s board, if three Delaware plaintiffs’ firms wanted to settle their shareholder derivative suit accusing the board of breaching its duty when it acquired Merrill Lynch, they should have asked. Instead, the Delaware firms bickered amongst themselves and refused to participate meaningfully in settlement talks, board members’ counsel at Davis Polk & Wardwell and Richards, Layton & Finger wrote in a brief filed in Delaware Chancery Court on Wednesday.

The BofA brief, which offers a rare behind-the-scenes account of the shuttle diplomacy the bank’s lawyers engaged in as they tried to get rid of parallel derivative suits in Delaware and New York, said that the board would have been perfectly willing to reach a deal with either set of plaintiffs’ firms, and actually reached out first to Delaware counsel from Chimicles & Tikellis; Horwitz, Horwitz & Paradis; and Wolf Haldenstein Adler Freeman & Herz. BofA said it was “rebuffed” by those firms, so when shareholders’ counsel in the New York federal court case, Kahn Swick & Foti and Saxena White, approached the board with a settlement offer, the bank began the talks that resulted in a $20 million proposed settlement earlier this month.

Even in the midst of those negotiations, the bank brief said, Davis Polk partner Lawrence Portnoy took a call from a Wolf Haldenstein partner who said the Delaware firms were finally ready to talk about a deal within the limits of BofA’s directors and officers insurance coverage. But before Portnoy could bring his clients into the loop, the other two Delaware shareholder firms informed him that Wolf Haldenstein had spoken out of turn and Delaware wouldn’t settle within the D&O policy limits. (That figure hasn’t been publicly disclosed in either derivative case, but my Reuters colleague Jon Stempel calculated it to be $500 million, based on Delaware plaintiffs’ filings.)

In other words, according to Bank of America, the Delaware firms have only themselves to blame for the mess that the BofA derivative litigation has become.

That’s quite a different story from the one the Delaware firms told in an Apr. 13 preliminary injunction motion in Chancery Court and a simultaneous petition for an order to show cause in Manhattan federal court. (The petition and accompanying affidavits are, unfortunately, under seal.) The Delaware firms, as Gretchen Morgenson reported in the New York Times, accused BofA of settling on the cheap with the firms in the New York case, which hadn’t put anywhere near as much work into the litigation as they had. The bank deliberately excluded them from talks, the Delaware firms said, so it could collude with firms that had ridden sidecar in discovery in the consolidated federal-court securities litigation in New York.

Putting aside the ugliness of the accusations (though I’m always loath to put such things aside), what’s remarkable about the Bank of America derivative turf war is that the New York and Delaware cases proceeded in tandem for as long as they did. And as much as the bank and all of the plaintiffs’ firms blame one another, some responsibility for this state of affairs lies with the two judges overseeing the litigation, U.S. District Judge Kevin Castel in Manhattan federal court and Chancellor Leo Strine in Delaware. Neither has been willing to give an inch on jurisdiction, which is why the cases both got as far as they did.

Strine is well-known for promoting Delaware’s primacy even as plaintiffs’ firms have taken to filing M&A and derivative suits outside of Chancery Court. In a hearing last September in the Delaware case, the chancellor told BofA’s lawyers that he regarded the fiduciary duties of the bank’s board members as a matter of Delaware law, and he wasn’t going to let the Delaware case sit around and wait for developments in federal court. “I want coordination to the extent possible,” Strine said. “But frankly, the predominant interest here is the protection – the application of Delaware law.”

Castel, meanwhile, long ago denied Bank of America’s motion to stay the federal-court derivative case in favor of the Delaware suit. The New York action makes derivative claims not only under Delaware fiduciary law but also under a section of the Exchange Act of 1934 that regulates proxy materials. In a motion to dismiss filed way back in December 2008, Bank of America argued that Castel should toss the Exchange Act claim because shareholders hadn’t served a demand on the board – and should stay whatever Delaware state-law claims remained in the case in deference to the Chancery Court. Castel kept the Exchange Act count in the derivative suit and refused to stay the case.

Castel is concerned enough about the Delaware plaintiffs’ allegations that he ordered a May 4 hearing on their motion to enjoin the deal. We haven’t yet heard from Strine on the simultaneous motion they filed in Delaware, but BofA’s Apr. 25 brief contends the chancellor simply has no power to enjoin a federal-court settlement. Strine isn’t the type who likes to be reminded of the limits of his jurisdiction.

One way or another, these two judges are going to have to agree on what happens next in this litigation. Good luck with that.

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The most important woman in Bank of America’s life right now may well be New York State Supreme Court Justice Barbara Kapnick. In the last five days, Kapnick has presided over two critical hearings, one to determine whether the BofA-led group challenging MBIA’s $5 billion restructuring can put on live witnesses and the other to determine whether BofA’s proposed $8.5 billion settlement with investors in Countrywide mortgage-backed securities will remain a special proceeding under New York trust law.

Bank of America got good news at the end of both hearings. Kapnick agreed on Apr. 20 to hear live testimony in the MBIA regulatory case and ruled on Apr. 24 that objectors to the proposed MBS settlement can’t convert it to a more standard adversary case. But BofA didn’t get everything it wanted.

Kapnick was very clear about limiting the evidence the banks can put on in the MBIA case, which is being brought under a proceeding known as Article 78. “This case is really, really directed towards the actions of the Insurance Department in approving this transaction,” she told bank counsel from Sullivan & Cromwell, according to this transcript of the hearing. “It’s not a case about all the intentional and terrible things that you alleged.” Under Article 78, she said, her job is simply to decide whether the state insurance department (now the Department of Financial Services) made a reasonable determination to approve the MBIA restructuring, or whether its approval was “arbitrary and capricious.” Based on the transcript, Kapnick considers that a high bar for the banks to clear.

Her deference to the regulators should, in an ironic way, have been good news for Bank of America in the other case, its proposed MBS settlement. As you no doubt remember, Bank of New York Mellon, as Countrywide MBS trustee, filed for approval of the settlement under New York’s Article 77, which permits trustees to seek a judge’s endorsement of trust decisions. BNY Mellon, BofA, and the institutional investors who negotiated the $8.5 billion deal have long argued that the standard of review in Article 77 is whether the trustee acted reasonably – precisely analogous to the standard Kapnick said she intends to apply in the MBIA case under Article 78.

But as it happens, there’s a crucial difference between Article 77 and Article 78. The New York code spells out the standard of review in Article 78 proceedings, but not in Article 77 trust proceedings. So there’s no statutory framework to guide Kapnick’s evaluation of the proposed MBS settlement.

At Tuesday’s hearing, BNY Mellon counsel Matthew Ingber of Mayer Brown and the institutional investors’ lawyer, Kathy Patrick of Gibbs & Bruns, urged Kapnick to set a low bar for approving the settlement. The court should defer to the trustee’s power to settle claims on behalf of the trusts, they argued, and override BNY Mellon’s decision only if there’s evidence the trustee abused its discretion or acted in bad faith. “The question before you is, did the trustee act within the bounds of its discretion? What is the standard that governs? What does the contract say?” Patrick told Kapnick. (My Reuters colleague Karen Freifeld was at the hearing and kindly shared her notes.)

Kapnick had defined the scope of review issue in an Apr. 4 show-cause order she referenced Tuesday, calling on objectors to show why the appropriate standard is not “whether (the settlement) decision is within the bounds of the trustee’s reasonable discretion.” The judge declined, however, to rule on that scope.

In fact, objectors’ steering committee member Daniel Reilly of Reilly Pozner (who represents AIG) told me in an email that even though Kapnick decided to keep the case an Article 77 proceeding, her comments at the hearing indicate that she intends to look more critically at the deal than BNY Mellon and the Gibbs & Bruns group want. The judge said that she has researched Article 77 and now believes the proceeding gives her “a lot of discretion.” She said she will probably grant more discovery than the trustee and the Gibbs group want (though less than the objectors want). “I do not see why I cannot do everything that (objectors) want under Article 77,” she said. “I think that’s very broad.”

“We are pleased that Justice Kapnick rejected the efforts of Bank of New York to restrict discovery and made clear that the intervenors can take discovery that will allow the court and the investors to properly evaluate the reasonableness of the settlement and the process by which it was reached,” said Reilly, who argued that BNY Mellon’s own proposed findings require significant discovery.

Investors’ counsel Patrick said the objectors are jumping to a conclusion Kapnick didn’t reach. “Having made (the) threshold determination to keep the case an Article 77 proceeding, Justice Kapnick then set a second hearing to determine what discovery is actually necessary to determine whether the trustee acted within the scope of its reasonable discretion in deciding to settle the trusts’ claims,” Patrick said in an email. “That is the issue to be decided in an Article 77 proceeding, and we believe discovery will be shaped by that standard.”

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Litigation is frequently likened to poker, but there’s actually a big difference. Poker ends with a winner and a loser. In litigation, there’s a third option: settlement. In the overwhelming majority of cases, lawyers and their clients eventually conclude that it’s more sensible to compromise than to test your hand with winner-take-all stakes.

Not Bank of America in its three-pronged litigation with the bond insurer MBIA.

MBIA has said publicly and repeatedly that it’s eager to make deals to resolve accusations that its 2009 restructuring, which split the bond insurer’s healthy muni-bond business from its ailing structured-finance division, was a $5 billion fraud. On Wednesday, the hedge fund Aurelius Capital became the latest plaintiff to reach a deal with MBIA. (Kudos to my colleague Karen Friefeld, who broke news of the settlement.) Aurelius had filed a purported class action in Manhattan federal court on behalf of MBIA policy holders, and its lawyers at Simpson Thacher & Bartlett were litigating that case alongside a group of banks that filed similar fraud claims — as well as a separate regulatory challenge to the restructuring — in New York State Supreme Court. Aurelius’s departure from the litigation means that the bank group, which began with 18 members but has dwindled to Bank of America and two French banks, loses a powerful, well-capitalized ally. (In fact, Aurelius was scheduled to depose MBIA CEO Jay Brown this week; now the banks will depose him next week.)

Meanwhile, in MBIA’s insurance fraud and mortgage-backed securities put-back case against Countrywide and BofA, New York State Supreme Court Justice Eileen Bransten on Wednesday denied the bank’s motion to bar MBIA from deposing BofA CEO Brian Moynihan. As I’ve explained, MBIA’s lawyers at Quinn Emanuel Urquhart & Sullivan want to question Moynihan to help establish Bank of America’s successor liability for Countrywide’s MBS failings. MBIA argued that Moynihan’s public statements about BofA assuming responsibility for Countrywide’s wrongdoing are key to the question of successor liability; Bank of America’s counsel at O’Melveny & Myers countered that MBIA was trying to harass Moynihan, who has no unique knowledge of BofA’s corporate structure or decision-making on Countrywide. Bransten said Moynihan’s public statements are “undoubtedly relevant,” and only the CEO can explain what he meant when he made them. Billions of dollars hang on how Bransten — the leading N.Y. judge on bond insurers’ claims against MBS issuers — decides the question of BofA’s successor liability.

I’m no poker player, but I don’t understand how Bank of America can tolerate the risk of continuing to litigate against MBIA, particularly because of looming capital reserve pressures if it wins the restructuring case. The bank’s leverage against the insurer decreases every time another member of the coalition challenging MBIA’s restructuring departs — and just about every time Bransten issues a major ruling in MBIA’s Countrywide case.

I get that BofA, Natixis, and Societe Generale believe they have a strong case that MBIA’s transformation was an improperly approved fraudulent conveyance. Just Monday, the bank group’s counsel at Sullivan & Cromwell filed the final brief in the regulatory case, submitting what the banks consider to be powerful evidence that MBIA deceived regulators about the health of its structured finance business in order to win approval of its restructuring and save the municipal bond insurance business.

I also understand their frustration with MBIA’s accounting. The bank group has long asserted that MBIA’s structured finance spin-off is insolvent, and that its settlements with more than a dozen former coalition members have only worsened MBIA’s dire straits. The insurer’s $1.1 billion loan from its muni-bond business, taken at the time MBIA announced its settlement with Morgan Stanley last fall, was perceived by its critics as proof of the insurer’s illiquidity. (The insurer and its lawyers at Kasowitz Benson Torres & Friedman always respond that MBIA has never failed to pay a policyholder what it owes, despite the banks’ assertions of insolvency.) No one’s disclosing terms of the Aurelius settlement, but it’s a good assumption that the tough-as-nails hedge fund insisted on a hefty payout. MBIA has not reported to the Securities and Exchange Commission where it’s getting the money for the Aurelius deal, nor, for that matter, for any commutation of UBS policies it agreed to when UBS dropped out of the bank group earlier this month.

But weigh the potential upside for BofA in the MBIA restructuring litigation against the potential downside for the bank in MBIA’s MBS case. Rulings by the judge in the case, Bransten, have generally favored MBIA and not the bank. She’s also been widely upheld by the intermediate state appeals court. I’ve said it before: If I were Bank of America, I would not want Bransten to set precedent on successor liability.

Even though the bank will surely appeal an adverse ruling, Bransten’s thinking in the meantime will affect every state-court judge overseeing an MBS case against Countrywide, and there are sure a lot of them. One of the ways BofA held the proposed global put-back settlement with Countrywide MBS investors to $8.5 billion was by citing uncertainty about successor liability. If Bransten removes some of that uncertainty, BofA’s $18 billion in MBS reserves could look puny.

The bank knows MBIA wants the cash it believes Countrywide owes the insurer for MBS deficiences. MBIA has said publicly that it has already paid out about $3 billion to policyholders with Countrywide MBS claims, all of which it believes Countrywide should be liable for. MBIA has also already booked $3.1 billion in put-back receivables from all MBS issuers. BofA’s leverage lies in MBIA’s need to fortify its balance sheet. That leverage will be considerably lessened if MBIA wins a major ruling from Bransten.

Bank of America, meanwhile has marked about $1.3 billion in MBIA “trades,” based on complex who-owes-who financial instruments. That number will go up if the banks win their challenge to MBIA’s transformation. But according to a very smart hedge fund friend of mine, the catch for BofA is that when the banking reforms enacted after the financial crisis take effect in 2014, BofA will have to hold more than what MBIA owes in capital reserves. Pressure on capital reserves was one of the reasons Morgan Stanley cited for settling with MBIA last fall.

The next critical date for MBIA and Bank of America is May 14, when the bank coalition’s regulatory suit against the insurer and the New York Department of Financial Services is scheduled to go to trial before New York State Supreme Court Justice Barbara Kapnick (who is, of course, also overseeing Bank of America’s proposed $8.5 billion Countrywide MBS settlement). Financial Service Superintendent Benjamin Lawsky, who’s been pushing hard behind the scenes, is widely thought to want a resolution between BofA and MBIA before then.

That’s going to depend, however, on how strong a hand BofA believes it’s holding.

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Bank of America really, really does not want CEO Brian Moynihan to sit for a deposition in bond insurer MBIA’s breach-of-contract case against Countrywide and BofA.

According to the transcript of a hearing on the issue last Friday morning before Manhattan State Supreme Court Justice Eileen Bransten, the bank’s lawyers at O’Melveny & Myers said that under the so-called Apex rule — which essentially says that high-ranking executives shouldn’t have to waste their time responding to deposition questions that lesser-ranking officials can answer just as well — Moynihan should be shielded from testifying because he doesn’t have unique personal knowledge of the disputed facts in the case. He’s also a very busy man, said Jonathan Rosenberg of O’Melveny. Rosenberg displayed a slide that showed all of BofA’s “enormous operations,” which he said demanded “24/7 work from senior executives, especially the CEO.” MBIA’s insistence on taking testimony from Moynihan, when BofA has already offered up for deposition several senior bank executives with the same knowledge as the CEO, amounts to harassment, according to BofA.

“There’s no basis to say they have to have Brian Moynihan when they have access to all these other people,” including former BofA CEO Ken Lewis, Rosenberg said. “This effort to depose Brian Moynihan is for harassment purposes.” If Bransten allowed the deposition in MBIA’s case, other bond insurers suing Countrywide would “seek their own shot,” the O’Melveny lawyer said, which “would clearly be disruptive to the business of Bank of America to lose their CEO to substantial time in prepping for and taking depositions.”

You will not be surprised to hear that MBIA’s counsel, Peter Calamari of Quinn Emanuel Urqhart & Sullivan, told Bransten that Moynihan has unique knowledge that’s relevant to the bond insurer’s attempt to prove BofA’s successor liability for Countrywide’s failings. (You may, however, be surprised when you read the transcript and see that among those in the audience for Calamari’s argument were 30 grade school kids on a field trip to court, who were permitted to ask questions about what they’d heard; Calamari joked that the kids’ description of the proceeding as “jibber-jabber” put things into perspective.) MBIA said that only Moynihan can testify about why he made public statements such as “At the end of the day, we’ll pay for the things Countrywide did,” and “We’ll stand up, we’ll clean it up.”

“They’re sitting there and saying oh, no, no, no, it’s just some statement we made in the press, it doesn’t mean anything,” Calamari told Bransten. “Well, that’s their opinion, but that’s not our case. And these were statements made directly by Mr. Moynihan…. And more importantly, you know, Mr. Moynihan backed up these statements. It wasn’t that he just made naked statements, when he was CEO, case after case was settled where Bank of America ponied up the money for Countrywide’s liability…. All of those facts, when you put them together make out an assumption of liabilities case. We’re entitled to a deposition from the man who is behind it all.”

Bransten didn’t rule from the bench, noting that she wanted to review the case law that Rosenberg and Calamari had sparred over. She might also consider the precedents being developed in another case involving MBIA and BofA. On Friday afternoon, around the corner at the federal courthouse, Bank of America and three other banks in a coalition challenging MBIA’s 2009 restructuring argued alongside the hedge fund Aurelius for (among many other things) two days of depositions of MBIA CEO Jay Brown.

MBIA, in contrast to BofA, has offered up its CEO for all sorts of depositions, including a session in the insurer’s put-back case. Brown has also testified on two occasions in the bank group’s regulatory case, which alleges that the New York Insurance Department didn’t properly vet MBIA’s $5 billion spin-off of its healthy municipal bond business. In their fraud suits against MBIA that parallel the regulatory action, Aurelius, represented by Simpson Thacher & Bartlett, and the bank group, represented by Sullivan & Cromwell, argue that they need yet more deposition time with Brown.

MBIA’s counsel in the restructuring cases, Marc Kasowitz of Kasowitz Benson Torres & Friedman, asked U.S. District Judge Richard Sullivan (overseeing the Aurelius-led class action) and State Supreme Court Justice Barbara Kapnick (in charge of the bank case) to postpone any additional Brown depositions until after the conclusion of the regulatory trial, which is now scheduled for May. He also argued that the bank group’s S&C counsel already asked Brown questions beyond the scope of the regulatory case at Brown’s preceding depositions, including questions about Brown’s purchase of MBIA shares before the restructuring was approved. (Here’s a link to the letters the three sides submitted to the judges; here’s the transcript of the March 9 hearing, at which allegations of Brown’s insider trading led to considerable fireworks.)

Notably, MBIA has not argued in the restructuring cases or in its own case against BofA that Brown is an Apex witness who is too important to be tied up with a deposition. Nor, for that matter, did Aurelius claim that its chairman, Mark Brodsky, is too busy to sit for a deposition, even though he is the hedge fund’s sole portfolio manager (Simpson did request that the deposition be limited to one day.)

So is Bank of America talking out of both sides of its mouth, arguing in MBIA’s case that its CEO shouldn’t be deposed yet calling for the deposition of MBIA’s CEO in its case against the bond insurer?

Not according to BofA spokesperson Lawrence Grayson. “The positions are wholly consistent with each other and the applicable legal standards,” he told me. “We believe Mr. Brown has unique knowledge pertaining directly to the legal disputes at issue regarding MBIA’s restructuring. Further, the company Mr. Brown heads focuses solely on litigation. By contrast, Mr. Moynihan does not have unique knowledge relevant to MBIA’s claim against Bank of America and is the head of a global financial services institution.”

On Monday Sullivan and Kapnick both ruled that Brown’s deposition can’t be postponed until after the regulatory trial.

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Late Tuesday, U.S. District Judge Barbara Jones of Manhattan federal court denied Bank of America’s motion to disqualify Quinn Emanuel Urquhart & Sullivan from representing AIG in its $10 billion mortgage-backed securities case against BofA, Merrill, and other bank subsidiaries. BofA’s lawyers at Munger, Tolles & Olson had argued that a former Munger partner, Marc Becker, acquired confidential information about Merrill’s MBS litigation strategy before departing to join Quinn Emanuel in 2008, then proceeded to work on AIG’s case against BofA and Merrill. The judge faulted Quinn’s screening process for failing to identify Becker’s potential conflict. But she said Becker had performed only non-substantive editorial work on AIG’s complaint and remand motion, didn’t share any confidences, and took steps to segregate himself from the AIG case as soon as he was reminded of his previous work for Merrill Lynch and its former mortgage unit. “There is no meaningful showing here that the trial process will be tainted,” Jones wrote. “The court finds that it would be unduly prejudicial to disqualify Quinn.”

But what about Marc Becker?

In October, after learning that Munger Tolles had raised the issue of his previous work for Merrill Lynch and First Franklin Financial, Becker resigned from Quinn Emanuel’s London office. In a Nov. 3 declaration, Becker said that he hadn’t remembered working for First Franklin when he spent a total of 5.8 hours reviewing the two AIG documents. “Had I remembered it, I never would have had anything to do with the [BofA] action,” he wrote. “None of what I did during those 5.8 hours on the [BofA] action was in any way focused on, or specific to, First Franklin or Merrill Lynch. I did not use or disclose any confidential information of First Franklin or Merrill Lynch. In fact, I did not at that time, and do not now, recall any confidential information of First Franklin or Merrill Lynch.” Becker asserted that Munger’s account of his work for Merrill — which cast him as a lead partner in Merrill and First Franklin’s MBS defense strategizing — didn’t jibe with his refreshed recollection of a “far more limited” role.

Becker remained at Quinn Emanuel for a month after Munger first alerted the firm of his potential conflict. During that time, according to his declaration, he met with Quinn’s outside counsel, Gregory Joseph, to discuss his work for Merrill, without any Quinn partners present. “Thus, even if I had recalled any confidential information regarding Merrill Lynch or First Franklin, which I did not, Quinn Emanuel would not have been exposed to it,” he wrote. “I understand that defendants have suggested that I was aware of and deliberately ignored the existence of a conflict of interest arising from my work on the First Franklin matter. That is totally untrue.”

Nevertheless, on Oct. 19, Becker resigned from Quinn Emanuel. “The firm and I agreed to take this step because … we wanted to do everything in our power to eliminate any possible basis for disqualification,” Becker wrote. Quinn Emanuel name partner John Quinn had told Munger Tolles in an email when he first learned of the potential Becker conflict that Becker might have to resign if Munger pressed for Quinn’s disqualification. So Becker’s declaration includes a poignant paragraph hinting at his sense of betrayal: “I am deeply disappointed that my former partners at [Munger] — with whom I worked as a trusted and respected colleague and partner for almost 20 years — would contend that I improperly shared client confidences. I do not believe that they genuinely believe that I did or ever would do so. But by having claimed that there is a risk of future disclosure of confidences by me, they precipitated my departure from Quinn Emanuel, and have caused me great professional and personal hardship.”

Becker said in the declaration that he was planning to start up a solo practice as a solicitor in London, but hoped to be able to return to Quinn Emanuel when the conflict question was resolved. Quinn Emanuel, in its response to the disqualification motion, reiterated that Becker’s resignation was voluntary. “This step was not taken because of any doubt as to the fact that no confidences were or would be shared, or as to the efficacy of the firm’s screen,” the firm’s response said.

In fact, according to Jones’s decision denying the disqualification motion, Quinn Emanuel asked the judge to rule that the firm’s ethical wall between Becker and the AIG case is sufficient to permit Becker to return to the firm. Unfortunately for Becker, the judge said she “declines to do so.”

That would appear to leave Becker in limbo, unless BofA agrees he’s adequately walled off from the case against it. Quinn Emanuel, after all, is engaged in other cases against BofA and Merrill Lynch — most notably the Federal Housing Finance Agency’s suits — and the firm doesn’t want to face another disqualification motion based on Becker’s previous work for Merrill.

In a brief phone interview, Becker told me he’s pleased that Jones found he behaved ethically. “I am deeply gratified that the court agreed I did not share any client confidences,” he said, adding, “I believe this motion was a tactic move to [by Munger] to eliminate an adversary that they would prefer not to face.” Becker declined any additional comment, but it’s well-known that Munger Tolles and Quinn Emanuel have butted heads in two big trials in the last year: star bond-trader Jeffrey Gundlach’s dispute with his former employer TCW, which resulted in a split verdict in September; and Rambus’s antitrust trial against Micron and Hynix, in which a jury last month cleared Quinn client Micron.

Quinn Emanuel declined comment on the Becker matter. Munger partner Marc Dworsky didn’t respond to Reuters’ request for comment.

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In 1998, 400 investors in a trust that distributed revenue from a communications satellite got word that their securitization trustee had settled a $41 million suit against the satellite’s fuel supplier. The trustee, IBJ Schroeder, filed a New York State Article 77 proceeding to obtain a judge’s endorsement of the $8.5 million settlement. Some of the investors protested the deal, arguing that the trustee didn’t have the power to settle the case without consulting them. In 2000, a New York appeals court ruled that, in fact, IBJ Schroeder did have that power, under both New York law and the contract governing the satellite revenue trust. The lower court ultimately ruled in the Article 77 case that even if investors considered the settlement amount too low, Schroeder hadn’t acted unreasonably or imprudently in striking the deal.

If you’re wondering why I’m telling you about an 11-year old ruling involving a defunct communications satellite, it’s because the IBJ Schroeder opinion is sure to be invoked by Bank of New York Mellon, the trustee of those Countrywide mortgage-backed securities, as well as the 22 Countrywide MBS investors represented by Gibbs & Bruns as they appeal last week’s decision by U.S. District Judge William Pauley III of Manhattan federal court. In holding that the federal courts have jurisdiction over Bank of America’s proposed $8.5 billion settlement, Pauley took issue with BNY Mellon’s use of an Article 77 proceeding to get the deal approved. The judge wrote that Article 77 is usually employed to resolve garden-variety trust administration issues; BNY Mellon and Gibbs & Bruns will use the IBJ Schroeder ruling to argue at the U.S. Court of Appeals for the Second Circuit that, contrary to Pauley’s assertion, there’s precedent for using Article 77 exactly as they did in the BofA MBS case.

But even as the Second Circuit decides whether to take up the issue of the rights and responsibilities of securitization trustees, state attorneys general are likely to pounce upon some of the language in Pauley’s 21-page ruling. I warned that there might be unintended consequences for indentured trustees when the judge asked for briefing on the BNY Mellon’s duties. After Pauley’s ruling, that warning is now a red alert. New York attorney general Eric Schneiderman and his faithful follower, Joseph Biden III of Delaware, have both announced that they’re investigating MBS securitization trustees. Schneiderman showed he’s serious by filing state-law fraud claims against BNY Mellon along with his petition to intervene in the BofA Article 77 proceeding. In his complaint against BNY, Schneiderman argued that once an investment goes south, as many of the MBS trusts have, the indentured trustee has a fiduciary duty to trust beneficiaries under New York common law.

BNY Mellon’s lawyers, on the other hand, argued in a brief to Pauley that an indentured trustee does not have a fiduciary duty to beneficiaries. The investment contract, BNY Mellon said, governs the trustee’s responsibilities. Standard securitization contracts, known as pooling and servicing agreements, say the indentured trustee serves a ministerial function, mostly making revenue distributions to investors. BNY Mellon told the judge that its only responsibilities, aside from those specified in pooling and servicing agreements, are common law duties to avoid conflicts of interest and to exercise due care.

The judge, however, took a broader view of the source of the trustee’s responsibilities — and that’s good news for regulators who are trying to find routes to liability for securitization trustees. Pauley considered the question in the context of determining whether the proposed BofA settlement falls into an exception to federal court jurisdiction in the Class Action Fairness Act. But his reasoning, of course, can be cited in other contexts.

Pauley cited Judge Learned Hand — who sat on the same court a century ago — to conclude that indentured trustees can’t evade a duty of loyalty to beneficiaries just because their responsibilities are defined by a contract. BNY Mellon had asserted its only duty to act in good faith came from the Countrywide pooling and servicing agreements. Pauley said it comes instead from state common law. As New York and Delaware regulators consider causes of action against securitization trustees, they’re going to have stronger claims if they can argue that trustees breached their state-law duties to investors. Similarly, trustee defenses are weakened if they can’t argue that their responsibilities were strictly defined by pooling and servicing agreements.

The New York and Delaware AGs are in an awkward limbo right now in the BofA MBS litigation. When Grais & Ellsworth removed the case to federal court, their intervention petitions were pending before Judge Barbara Kapnick in New York State Supreme Court. (BNY Mellon and Gibbs & Bruns, you may recall, filed fiery briefs opposing the N.Y. AG’s intervention.) The AGs stayed out of the federal court case while Pauley decided whether to remand it. But now they’re likely to renew their intervention petitions before the federal court judge, who has already raised a lot of the same questions as the AGs about the fairness of a binding settlement that was reached without consulting most of the investors it will affect. (The New York AG’s Martin Act counterclaim against BNY Mellon, in case you’re wondering, can technically proceed in federal court as well.) As I’ve said before, it’s too soon to say for sure that the proposed settlement will stay with Pauley. But if it does, invigorated attorneys general are the last thing BofA, BNY Mellon, and the Gibbs & Bruns group need.

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It’s way too early to assume that Manhattan federal judge William Pauley III will end up deciding the fate of Bank of America’s proposed $8.5 billion settlement with investors in Countrywide mortgage-backed securities. But that doesn’t mean it’s too early to start wondering what will happen to the proposed deal if he does.

First, a caveat: Bank of New York Mellon, the Countrywide securitization trustee that filed the case in New York state Supreme Court , has the right to request appellate review of Pauley’s ruling that the case belongs instead in federal court under the Class Action Fairness Act. And when BNY Mellon asks the U.S. Court of Appeals for the Second Circuit to hear the appeal, the bank will surely remind the appellate court of its own language in a previous Countrywide MBS case, in which the Second Circuit decided the suit should go back to state court. In his ruling Wednesday, Pauley cited the “paramount federal interests” at stake in the BofA MBS settlement. But the previous Second Circuit MBS ruling expressly rejected that rationale. “If Congress meant the consideration of a class action’s importance to the nation as a whole to trump these limiting provisions [under CAFA], it would have indicated that intent,” the Second Circuit panel wrote in Greenwich Financial v. Countrywide. “Congress wisely chose not to leave it to the federal courts to assert jurisdiction over whatever class actions seemed to judges to be ‘of national importance’ — a standard much too amorphous to admit of consistent judicial application — but instead to define concrete criteria for federal jurisdiction under CAFA.”

That language doesn’t seem to bode well for the Countrywide MBS investors who want Pauley to evaluate the proposed settlement. But this is a weird, unpredictable case. I wouldn’t bet anything more valuable than an ice cream sundae on whether the Second Circuit will take the appeal and overturn Pauley.

If the case stays in federal court, there’s going to be a preliminary fight over what shape it takes. There’s no federal analog for New York state’s Article 77, the vehicle under which BNY Mellon filed this case. Article 77 permits a trustee to obtain a judge’s endorsement of its actions, under a standard that requires only that the trustee behaved reasonably. In his ruling Wednesday, Pauley called on all of the parties to submit a joint proposal for how the case should proceed in federal court. BNY Mellon and the Gibbs & Bruns investor group that supports the proposed settlement are likely to argue that Pauley should hear the case as a declaratory judgment action that would essentially replicate the Article 77 state court proceeding. They’ll argue that Pauley should only decide the question at issue in the case as it was filed: Did BNY Mellon act reasonably as a trustee in reaching the proposed settlement?

But Grais & Ellsworth – the law firm that moved the proposed settlement to federal court — is likely to have a different idea of how Pauley should structure the case. At a Sept. 21 hearing, Owen Cyrulnik of Grais & Ellsworth proposed that the case be treated as a class action, with each of the 530 trusts in the proposed settlement treated as a class member. (Keep in mind that Grais & Ellsworth’s goal is to win the right to litigate outside of the settlement on behalf of investors in three of the Countrywide MBS trusts.) That would presumably permit Pauley much more power over the merits of the settlement. Pauley has already shown considerable skepticism about BofA’s attempt to settle the claims of thousands of noteholders in 530 trusts through a vehicle that doesn’t give investors any right to opt out. Whatever structure he devises if he keeps the case, he’s probably not going to permit BofA, BNY Mellon, and the Gibbs & Bruns group to bind all Countrywide mortgage-backed noteholders to a settlement they had no hand in negotiating.

That brings us to the big question: If the case stays before Pauley, and if he permits opt-outs, can BofA walk away from the $8.5 billion settlement? The short answer is yes, although it may depend on how many opt-outs there are.

There are two relevant portions of the June 29 settlement agreement. One seems to me to be an absolute out for BofA. In a provision called “Withdrawal from Settlement,” the agreement says that if trusts holding a pre-set percentage of the total unpaid principal balance of the Countrywide MBS included in the deal don’t participate in the settlement, then BofA can withdraw. The big question mark there is the percentage. The settlement agreement says it’s “confidential,” but says that it’s already been determined by BofA and BNY Mellon.

If opt-outs don’t hit the specified percentage under the withdrawal clause, I think the banks could also fashion a case for withdrawing under the settlement agreement’s specification that New York state Supreme Court is the “settlement court” under which BNY Mellon agrees to seek approval of the deal under Article 77. The agreement says that the settlement is subject to final court approval from the settlement court — i.e., New York state Supreme. If the parties cannot obtain final approval from the court, the agreement says, the deal is void. So if the banks were desperate to walk away from the settlement in federal court, they could argue that they never agreed to have the case heard there.

Which leads, of course, to the question of why BofA might want to get out of the proposed $8.5 billion settlement. The bank reached the Countrywide MBS deal to end uncertainty about the size of its MBS liability. The settlement was supposed to reassure shareholders and permit the bank to put the MBS issue behind it. Obviously, things haven’t worked out that way. There’s more investor attention than ever on BofA’s liability for mortgage-backed securities, and the bank’s share price hasn’t exactly rebounded. Meanwhile, BofA has already taken the financial hit of setting aside MBS reserves. At some point, the bank could decide that opt-outs from the settlement so compromise the value of certainty that it would rather take its chances in the courts, where crucial questions like BofA’s successor liability for Countrywide’s mistakes are still undecided.

We’re a long, long way from there. But Countrywide MBS investors should be starting to ask themselves whether they’re better off with the settlement BofA agreed to or, in the best-case scenario in which they band together to get standing, with years of litigation.

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The key paragraph in Manhattan federal judge William Pauley III‘s 21-page ruling Wednesday in Bank of America’s proposed $8.5 billion settlement with Countrywide mortgage-backed-securities investors is the last one.

“The settlement agreement at issue here implicates core federal interests in the integrity of nationally chartered banks and the vitality of the national securities markets,” Pauley wrote. “A controversy touching on these paramount federal interests should proceed in federal court.”

That sentiment infuses the judge’s analysis of where BofA’s proposed deal should be evaluated: Before Justice Barbara Kapnick in Manhattan state Supreme Court, where Countrywide MBS trustee Bank of New York Mellon filed the case as a special proceeding under an obscure state law; or before Pauley in federal court, where there’s no analogous procedure for binding thousands of investors in 530 trustees to a settlement only 22 of them had a hand in negotiating. Pauley’s decision to keep the case in federal court throws the settlement off the carefully-designed track the bank, the trustee, and the investor group that supports the deal hoped to keep it on.

The judge opted for a broad interpretation of the federal Class Action Fairness Act, a 2005 law intended to keep big cases involving lots of claimants out of state court. Grais & Ellsworth, which represents a group of Countrywide MBS investors who don’t like the proposed BofA settlement, removed the case to federal court under CAFA’s provisions for mass cases. (I’ve written here and here about Grais & Ellsworth’s rationale for the removal and BNY Mellon’s arguments against removal.) The test for a mass action involves three questions: Does the case involve monetary relief; does it involve 100 or more plaintiffs; and do their claims involve common questions of law or fact? In siding with Grais & Ellsworth on each of those questions, Pauley considered the implications of the proposed settlement, not the technicalities of Article 77, the New York law under which the case was filed.

“BNYM’s argument exalts form over substance,” he wrote with regard to arguments by BNY Mellon’s Mayer Brown lawyer Matthew Ingber that the Article 77 proceeding didn’t involve a claim for monetary relief, since all the trustee sought was a ruling that BNY Mellon had acted reasonably in reaching the settlement. Pauley was similarly scornful of the trustee’s assertion that the Article 77 proceeding involved only one plaintiff, BNY Mellon. “BNY Mellon’s argument is untenable,” he wrote. “BNYM is trustee for 530 separate and unique trusts and seeks approval for its decision to settle the claims of each individual trust.”

In all, Pauley seemed to find the settlement supporters’ Article 77 gambit to have been too clever by half. He noted that his research uncovered only 28 Article 77 decisions in the last 40 years, many of which involved uncontested proceedings and garden-variety trust administration issues. He said, in fact, that he could find no authority to support the idea that a single Article 77 proceeding can be used to evaluate a decision affecting 530 trusts.

BNY Mellon had also argued that Grais & Ellsworth’s client, an investor group called Walnut Place, doesn’t have the right to remove the proposed settlement to federal court because it’s not a defendant in the case. Indeed, as Ingber of Mayer Brown argued at the Sept. 21 hearing before Pauley, Walnut Place will receive money if the proposed settlement is approved, so it can’t be considered a defendant under the traditional definition. Pauley concluded, however, that BNY Mellon was once again looking at form rather than substance, calling its argument “crabbed.” Walnut Place, he wrote, was adverse to BNY Mellon, the Article 77 plaintiff, so it is a defendant for the purposes of removal.

Finally, the judge shredded settlement supporters’ hole card: a ruling by the U.S. Court of Appeals for the Second Circuit that concluded a previous Countrywide MBS case — a Grais & Ellsworth suit — belonged in state court under the “securities exception” to the Class Action Fairness Act. As I’ve explained, the securities exception is counterintuitive. If the only claims at issue in a case involve federal securities laws, the case falls under the exception and goes back to state court. If state law claims are involved, it stays in federal court. (Weird, right?)

Pauley found that even though the previous Second Circuit ruling involved Countrywide mortgage-backed securities, it concerned the rights of MBS investors. The proposed settlement, on the other hand, involves the rights and duties of BNY Mellon as securitization trustee. The bank had argued that those duties derive from the contracts that govern the Countrywide MBS; but even BNY Mellon conceded in a round of briefing earlier this month that it also had common-law trustee duties. “Because a court evaluating BNYM’s conduct as trustee must rely on New York common law, and not simply the bare text of the [trust contracts],” the judge wrote, “the securities exception does not apply here.”

BNY Mellon and the Gibbs & Brun investor group that supports the proposed settlement will surely ask for Second Circuit review of Pauley’s ruling, although it’s not clear to me whether they’ll have to get Pauley’s leave to file an interlocutory appeal. (Remember, Bank of America is technically not a party to the case.) If the Second Circuit upholds the ruling, it’s very bad news for BofA. Given the harsh treatment Pauley has dished out to settlement supporters in two hearings and in Wednesday’s ruling, it’s clear the lawyers who crafted the $8.5 billion dollar deal have a long way to go before they get Pauley to sign off. (There’s also the rather enormous matter of what Pauley called the “procedural difficulty inherent in continuing this action in federal court,” where there’s nothing remotely like an Article 77 proceeding.)

I believe there’s support for the assertion that Judge Pauley interpreted the Class Action Fairness Act too broadly in a pair of recent rulings by two federal circuits considering whether state attorney general parens patriae suits are mass actions. Both the Ninth Circuit and the Fourth Circuit have said that judges must hew closely to the language of CAFA in deciding whether a case is a mass action. Pauley wrote that he was “reluctant to indulge” BNY Mellon’s reliance on CAFA’s legislative history. We’ll have to wait and see if the Second Circuit supports his reluctance.

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