Alison Frankel

What a complaint U.S. Attorney Preet Bharara filed against Countrywide and Bank of America on Wednesday!

Earlier this month, when the New York Attorney General filed accusations of securitization fraud against JPMorgan Chase, I said we should put aside cynicism about the AG’s copycat allegations and be grateful that, at last, a government official was demanding accountability for systemic corruption in the mortgage-bundling business. The new complaint against BofA demands no such nose-holding: It asserts powerfully detailed — and original — accusations of billion-dollar fraud in the way Countrywide approved mortgages destined for purchase by Fannie Mae and Freddie Mac, and in Countrywide’s and BofA’s subsequent (alleged) refusal to repurchase defective loans.

To be sure, the U.S. Attorney had help from a whistle-blower, a former Countrywide Home Loans executive vice president named Edward O’Donnell. O’Donnell filed a relatively bare-bones False Claims Act complaint last February. As always in FCA cases, the complaint was sealed as the Justice Department checked out the allegations and deliberated whether to intervene in the case. Those deliberations can take years, but not in this case, when the government is under intense pressure to make good on promises of fighting mortgage fraudsters. Eight months after O’Donnell initiated his action in federal court in Manhattan, the U.S. Attorney’s office intervened, making the suit public.

The result is a complaint that features inside allegations from O’Donnell about Countrywide’s so-called “Hustle” program to funnel increasingly deficient loans to Fannie Mae and Freddie Mac alongside inside information that government investigators presumably obtained from Fannie and Freddie officials. The combination makes for a compelling case that Countrywide systemically deceived the government-sponsored entities about the loans it was selling them, then refused to live up to contractual obligations to repurchase deficient loans. (As Reuters reported Monday, Bank of America said accusations that it failed to repurchase loans are “absolutely false.”)

The U.S. Attorney’s allegations go much deeper than O’Donnell’s initial suit, which suggests that the government has been busily investigating in the months since O’Donnell initiated the case. According to the complaint filed Wednesday, in 2007 — with fewer MBS sponsors in the market for the subprime loans that had been Countrywide’s specialty — the bank was increasingly desperate to sell supposedly better-quality mortgages to Fannie Mae and Freddie Mac. To speed up the process of approving loans, Countrywide’s Full Spectrum Lending unit instituted “the Hustle” (or HSSL, for High Speed Swim Lane) program, which stripped away underwriter review for loans that were deemed acceptable by the bank’s automated mortgage review system. But that automated system, according to the complaint, depended on information supplied by the borrower and input by a loan processor. There were few to no controls in the Hustle approval process; according to the feds, even loans in which the borrower’s income wasn’t independently verified went unreviewed by underwriters.

Brad Karp of Paul, Weiss, Rifkind, Wharton & Garrison and Max Berger of Bernstein Litowitz Berger & Grossmann share an elevator bank at 1285 6th Avenue in New York City. Bernstein Litowitz, a 50-lawyer plaintiffs’ firm, has space on the 36th and 38th floors. Paul Weiss’s 750 lawyers occupy much of the rest of the office building. Karp and Berger are also old frenemies: In 2004, they negotiated Citigroup’s $2.65 billion settlement of shareholder claims in the WorldCom accounting fraud case. Over the last several months, with Karp representing Bank of America and Berger one of the lead counsel for shareholders suing over the bank’s acquisition of Merrill Lynch in 2008, the two have spent a lot of time riding the elevator between Berger’s office on the 36th floor and Karp’s on the 30th, discussing a resolution of the class action.

With an Oct. 22 trial date looming and no sign from U.S. District Judge Kevin Castel that he would end the case by granting summary judgment to either side, those elevator rides (and sessions with mediator Layn Phillips of Irell & Manella) led to the $2.43 billion settlement that Bank of America announced Friday. It’s the fourth-largest-ever securities class action settlement by a single defendant (behind Tyco’s $2.975 billion deal in 2007, Cendant’s $2.83 billion settlement in 1999, and the Citi agreement in 2004) and the largest in a case that involved no accounting fraud or criminal convictions. The settlement is vindication for Richard Cordray of the Consumer Financial Protection Bureau, who launched the litigation on behalf of two Ohio pension funds back in 2009, before he was voted out of office as Ohio’s attorney general, and for the three shareholders’ firms that litigated the case for almost four years: Bernstein Litowitz; Kessler Topaz Meltzer & Check; and Kaplan Fox & Kilsheimer.

The plaintiffs in this case will be asking Castel to approve $150 million in fees, and they’ve earned them. Remember, the SEC was originally willing to settle allegations against BofA for disclosure failures in the Merrill acquisition for $33 million. This settlement reflects the nuanced understanding of Bank of America’s failure to disclose billions of dollars in escalating Merrill Lynch losses that shareholders’ counsel gained through dozens of depositions and millions of pages of discovery. The plaintiffs survived motions to dismiss by the bank and individual defendants, motions to reconsider the denial of their dismissal motions, and opposition to class certification. They clearly persuaded Castel of the value of their claims; his class certification ruling rejected defense arguments that shareholders weren’t injured by the alleged disclosure failures. Bank of America repeated those arguments in its motion for summary judgment, but there’s little chance the judge would have granted the motion. From all indications, Castel had cleared his calendar and planned to try this case, in what would surely have been one of the most celebrated trials stemming from the financial crisis.

Late last month, without any fanfare, a New York appeals court issued a terse, one-page ruling that upheld the dismissal of Walnut Place’s breach-of-contract suit against Countrywide, Bank of America and Countrywide’s mortgage-backed securitization trustee, Bank of New York Mellon. It was an abrupt end for what was once a promising attempt at vindication for an MBS investor. It was also a huge setback for Walnut, its lawyers at Grais & Ellsworth and all the other Countrywide MBS investors who were counting on litigation against BofA as an alternative to the bank’s proposed $8.5 billion global settlement of breach-of-contract, or put-back, claims.

That one-page appellate ruling reverberated powerfully on Monday, when Walnut – otherwise known as the Boston hedge fund Baupost – filed a request to withdraw from the special New York proceeding to evaluate BofA’s MBS settlement. Framed as a letter to New York State Supreme Court Justice Barbara Kapnick from Grais partner Owen Cyrulnik, the request offered no explanation for Walnut’s withdrawal; Cyrulnik and Baupost spokeswoman Elaine Mann declined to comment.

But Baupost was facing an imminent decision about whether to request leave to appeal the dismissal of its case against BofA to New York’s highest court. Given the unlikely prospect that the Court of Appeals would agree to take the case, the hedge fund appears to have decided not to continue to spend money on litigation with little chance of a return. And given that the dismissal of Walnut’s suit makes it very difficult for the hedge fund – or any other MBS investor – to recover on put-back claims outside of the global settlement, Walnut apparently determined that it wasn’t economically rational to continue its challenge to the $8.5 billion deal. (From what I’ve heard, Bank of America did not pay Walnut anything in exchange for the hedge fund’s withdrawal; a Bank of America spokesman declined to comment to my Reuters colleague Karen Freifeld.)

Reporting on the implications of the bond insurer Syncora’s $375 million settlement with Bank of America has been a Rashomon experience: Everyone I talked to had something different to say about what drove Tuesday’s settlement and what it means for MBIA, which has been litigating its own mortgage-backed securities breach-of-contract claims in parallel with Syncora. So if you were expecting a clear-cut answer on whether the Syncora settlement is good or bad for MBIA, you’re going to be disappointed. Syncora and MBIA were both litigating put-back claims against Countrywide and BofA before New York State Supreme Court Justice Eileen Bransten, who has delivered important simultaneous rulings for the bond insurers. But the similarities between Syncora and MBIA end in Bransten’s courtroom. When it comes to negotiations with BofA, they’re in very different postures.

The good news for MBIA: Bank of America’s settlement with Syncora shows that the bank remains willing and able to resolve claims that the mortgages underlying Countrywide-sponsored securities breached representations and warranties. In 2010 and 2011 Bank of America reached reps-and-warranties deals with the bond insurer Assured Guaranty; with the government-sponsored entities Fannie Mae and Freddie Mac; and with 22 institutional investors who backed a global $8.5 billion settlement of MBS investors’ put-back claims. Since then, the bank has been stuck in litigation with objectors to the proposed $8.5 billion global deal and in sniper fire with Fannie Mae. The Syncora settlement puts BofA back on the settlement track.

The settlement also shows that momentum from the litigation helps the monolines. My understanding is that Syncora and Bank of America have been in settlement talks for a long time, negotiating behind the curtain while the litigation plays out on a public stage. Specific events in the monoline cases against the banks – even developments as significant as Bransten’s loss-causation ruling or the battle over Bank of America’s successor liability for Countrywide’s wrongdoing – don’t have a direct impact on negotiations. That said, when U.S. District Judge Paul Crotty of Manhattan delivered a very insurer-friendly ruling on loss causation last month in Syncora’s case against JPMorgan, BofA took note. That’s also a positive for MBIA.

Remember the vicious fight between plaintiffs’ lawyers in competing New York and Delaware derivative suits against Bank of America’s board? In April, plaintiffs in the federal case in New York reached a proposed $20 million settlement with the defendants, which prompted their Delaware Chancery Court rivals to scream that the New York lawyers were settling on the cheap after an inadequate investigation. They attempted in both Delaware and New York to block the deal, arguing that the derivative suit should be worth as much as $500 million, but failed to enjoin the settlement. On Thursday, plaintiffs’ lawyers in the New York case filed a motion for preliminary approval of the $20 million deal.

A whopping $13.6 million of the money, they said in the motion, should go to them for fees and expenses. That’s 68 percent of the entire settlement, which will be paid by one of BofA’s carriers of directors and officers insurance. This, folks, is what breeds skepticism about shareholder litigation.

Let me say upfront that it’s not completely outside the realm of possibility that the fee request is justified. Lead plaintiffs’ lawyers at Saxena White and Kahn Swick & Foti made what appears to be a tactical decision to divide the fee issue from the settlement approval process, so they’ll file a formal motion for approval of their request for $13 million in fees and $600,000 in expenses after the settlement itself gets a thumbs-up from U.S. District Judge Kevin Castel. Thursday’s filing said only that the plaintiffs’ lawyers have sunk 24,000 hours into the litigation, representing $10.4 million in time, and that they deserve a 25 percent enhancement of their hourly billings. (Just as an FYI, there are 8,760 hours in a 365-day year, and this case was filed in 2009.) I left phone messages with four partners at Saxena and Kahn Swick, as well as with liaison counsel Curtis Trinko of the Law Offices of Curtis V. Trinko, requesting more information on what they did in those 24,000 hours. None of them called me back.

The megabillion-dollar game of chicken between Bank of America and the bond insurer MBIA just got even more perilous. On Monday MBIA filed a notice that it is cross-appealing the ruling by Manhattan State Supreme Court Justice Eileen Bransten. MBIA wants reconsideration of Bransten’s finding that the bond insurer is not entitled to summary judgment on its claims that Countrywide breached representations and warranties on the mortgage-backed securities MBIA agreed to insure. You might think MBIA’s decision to appeal is a surprise, given the many routes to recovery Bransten gave MBIA on its insurance fraud claims against Countrywide. But as always in the incredibly complex litigation between Bank of America and MBIA, there are many layers to every move by either side.

Bransten’s rulings were undoubtedly a boon for the monolines Syncora and MBIA. The judge said the bond insurers don’t have to establish a direct causal link between the alleged deficiencies in the mortgage loans underlying the securities they agreed to insure and the subsequent payouts the insurers had to make on those MBS policies. Under Bransten’s opinion, MBIA and Syncora can prove insurance fraud merely by establishing that they relied on Countrywide’s alleged misrepresentations when they agreed to write the policies at issue in the litigation. And to prove a breach of the insurance agreements, they need only prove that Countrywide materially misrepresented the risk profile of the underlying mortgage pools.

Nevertheless, two days after Bransten issued her opinion, Syncora’s lawyers at Debevoise & Plimpton filed a notice of appeal. That’s because the decision wasn’t all good news for the monolines: Bransten denied Syncora and MBIA summary judgment on their interpretation of the MBS contracts they signed with Countrywide. The monolines argued that Countrywide was required to buy back every underlying mortgage that didn’t live up to the representations and warranties the issuer made about the mortgage pool. Bransten, however, said the contract language was too ambiguous for the issue to be decided on summary judgment. Syncora said it was seeking a reversal of that part of the ruling.

None of the firms battling Countrywide and Bank of America on behalf of mortgage-backed securities investors has dedicated more resources to the fight than Quinn Emanuel Urquhart & Sullivan. Quinn represents some of the biggest MBS claimants in suits against Countrywide, including AIG and the Federal Housing Finance Agency. The firm also represents MBIA in the bond insurer’s long-running New York State case against Countrywide. If anyone on the plaintiffs’ side has the goods on Countrywide and Bank of America, in other words, it’s Quinn Emanuel.

That’s why a ruling Thursday by U.S. District Judge Mariana Pfaelzer of Los Angeles federal court is such a blow to Countrywide MBS investors. Pfaelzer, who’s overseeing the consolidated federal-court MBS litigation against Countrywide, dismissed Allstate’s successor-liability and fraudulent-conveyance claims against Bank of America, with prejudice. Quinn represents Allstate, and offered detailed allegations that Bank of America’s 2008 acquisition of Countrywide was structured to deliver Countrywide’s revenue-producing businesses to BofA while simultaneously walling off the mortgage company’s looming liability for subprime mortgages and mortgage-backed securities.

Pfaelzer said, however, that Quinn Emanuel hadn’t come up with sufficient facts to back its assertions. She rejected two different theories: first, that Bank of America and Countrywide engaged in a fraudulent conveyance or transfer; and second, that BofA’s acquisition of Countrywide was a de facto merger. The judge has previously found for Bank of America in two other rulings on the de facto merger question (here’s Pfaelzer’s April 2011 opinion in an MBS class action against Countrywide), but this is the first time she’s delivered a definitive ruling on fraudulent-conveyance allegations.

Tuesday’s parallel rulings by Manhattan State Supreme Justice Eileen Bransten in MBIA and Syncora suits against Countrywide were a big win for the bond insurers. The judge concluded that MBIA and Syncora need only show that Countrywide materially misled them at the time they agreed to write insurance on Countrywide mortgage-backed notes, not that the alleged misrepresentations led directly to MBS defaults and subsequent insurance payouts. Bransten is considered a leading judge on MBS issues, so her grant of summary judgment on the insurance fraud and contract issues should be a boon to all of the monolines engaged in do-or-die litigation with MBS issuers.

But for MBS investors hoping Bransten would set a low bar for claims that Countrywide breached mortgage-backed securitization agreements, the rulings have to be considered a disappointment. Both Syncora’s lawyers at Debevoise & Plimpton and MBIA’s counsel at Quinn Emanuel Urquhart & Sullivan had moved for summary judgment on a baseline question: could they demand that Countrywide repurchase any underlying mortgage loan that materially breached the MBS issuer’s representations and warranties in securitization agreements?

If Bransten had agreed with the Syncora and MBIA interpretations of the agreements’ put-back clauses, the bond insurers would have had to show only that an underlying loan was deficient, not that the alleged deficiency contributed to the mortgage’s default — or, for that matter, that the underlying loan even was in default. The insurers wanted the judge to rule that as a matter of contract, Countrywide was required to repurchase every flawed mortgage in underlying pools.

There’s a cautionary note to MBIA deep in Manhattan State Supreme Court Justice Eileen Bransten‘s long-awaited, 27-page loss-causation decision in MBIA’s mortgage-backed securities case against Countrywide. The bond insurer, Bransten warned, must prove that it was damaged as a “direct result” of Countrywide’s allegedly material misrepresentations about the MBS certificates MBIA agreed to insure. “As has been aptly pointed out by Countrywide, this will not be an easy task,” the judge wrote.

But unless I am seriously misreading Bransten’s ruling (and her companion decision in Syncora’s case) it’s going to be a lot easier for the bond insurers to recover against Countrywide as a result of the judge’s reasoning. Yes, MBIA and Syncora have to prove they were duped into writing insurance policies on Countrywide mortage-backed securities. The monolines have never asserted that they don’t have to show Countrywide made material misrepresentations at the time they agreed to issue insurance. They believe they’ve got plenty of evidence — from the MBS pooling and servicing agreements, from the loan tapes they were permitted to see, and from the shadow credit ratings conferred on the MBS notes — that Countrywide misled insurers about the quality of the mortgages in the underlying loan pools.

Instead, the key question before Bransten was whether the insurers would also have to show that Countrywide’s alleged misrepresentations were the direct cause of the MBS failures for which insurers had to pay out policy claims. And on this issue, the judge sided squarely with the monolines. “No basis in law exists to mandate that MBIA establish a direct causal link,” she concluded.

The folks who follow every development in the mega-billions poker match between Bank of America and the bond insurer MBIA have last week been buzzing even more loudly than usual about the prospect of a global deal. Tuesday’s settlement between MBIA and Morgan Stanley leaves BofA as the most important remaining member of the dwindling bank group challenging MBIA’s 2009 restructuring. There’s a de facto deadline of Dec. 30 for settlements in that case, since that’s the day New York’s top financial regulator, Benjamin Lawsky of the Department of Financial Services, has to file a key response to the banks’ allegations. Both Lawsky and MBIA execs have been very clear: they want resolution. So the pressure is on BofA to make a deal.

Moreover, MBIA really needs a global settlement with BofA, in which the bank not only drops out of the restructuring case but also ponies up to resolve the bond insurer’s mortgage-backed securities claims. MBIA filed an 8K with the Securities and Exchange Commission Thursday, disclosing the good news that its commutation deals have wiped out $20 billion in exposure, including more than $10 billion its has eliminated just in the fourth quarter of 2011. The bad news in the filing, however, is that MBIA’s payments to banks have exceeded its statutory loss reserves by $500 million, and the insurer may not have enough liquidity to reach more settlements. Remember, MBIA has already booked a $2.8 billion anticipated recovery on MBS put-back claims. Clearly, the bond insurer is counting on getting some big money from BofA on the MBS side.

The wild card in this poker game is loss causation and MBS liability for BofA (and other issuers). You’ll recall that in early October, New York State Supreme Court Justice Eileen Bransten heard arguments on a summary judgment motion by MBIA in its case against Countrywide. MBIA asked the judge to rule on the issue that will determine the magnitude of bank exposure to MBS claims by bond insurers: are the banks liable for misrepresenting the underwriting on loans in underlying mortgage pools starting from the day they signed deals with monoline insurers? Or can the banks cite the economic crisis — and not their own deficient underwriting — as the reason so many mortgage loans have gone bad? Bransten’s reasoning on loss causation could swing billions, or even tens of billions, of dollars of liability between the banks and the monolines.