Alison Frankel

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.

“Once (Allstate’s) legal conclusions are stripped away, the court is left with the rather bare description of (acquisition) transactions contained in the (amended complaint),” Pfaelzer wrote. “Those paragraphs describe the asserts that Countrywide sold and their prices. They do not contain any indication that any other market for these assets existed, or what the assets’ ‘true’ market value was, or what the accounting value of the assets was, or why the court should disregard the very concrete intangible benefit that proceeds from the asset sales were used to pay off debt, increase capital, and otherwise allow Countrywide to remain in business.”

The judge also said Quinn Emanuel hadn’t shown enough evidence that BofA and Countrywide were aware of the mortgage-backed securities claims that awaited Countrywide at the time of the 2008 acquisition. Interestingly, Quinn pointed to a 2007 MBS class action against Countrywide to show that BofA knew about Countrywide’s MBS exposure and structured its acquisition to protect the bank. Pfaelzer relied on the same 2007 class-action filing this summer when she set a time limit on MBS claims against Countrywide. But in Thursday’s ruling, she reasoned that even though the 2007 class action suit put plaintiffs on notice, it didn’t portend insolvency for Countrywide.

Bank of America’s liability for Countrywide MBS failings is a huge issue for investors who want to recover their losses. In the bank’s proposed $8.5 billion breach-of-contract settlement with Countrywide investors, MBS trustee Bank of New York Mellon obtained an expert opinion that Countrywide has less than $5 billion in assets. That’s obviously a lot less money than MBS investors want to wring from BofA (and, for that matter, a lot less than the $15 billion the bank has taken in reserves for MBS liability). But Pfaelzer’s continued resistance to successor liability for BofA, especially given the considerable effort Quinn Emanuel put into the Allstate amended complaint, doesn’t bode well for investors. You can bet that lawyers for Countrywide and Bank of America will use the successor-liability issue as leverage in settlement talks.

I should note that Manhattan State Supreme Court Justice Eileen Bransten, who’s overseeing monoline litigation against Countrywide and BofA, has come down differently than Pfaelzer in a preliminary ruling on successor liability. MBIA and its lawyers at Quinn Emanuel are right now engaged in discovery on BofA’s Countrywide deal, including depositions of the executives who structured the acquisition. Evidence they obtain in that case could eventually impact successor liability rulings in other courts.

Bank of America is represented by O’Melveny & Myers in the Allstate case. Countrywide is represented by Goodwin Procter. A BofA spokesman said the bank is “pleased with Judge Pfaelzer’s ruling.”

Allstate counsel Daniel Brockett of Quinn Emanuel told me his client is considering its options for appeal. “We’re disappointed in the ruling,” he said. “We think Judge Pfaelzer imposed a pleading standard that is impossible to meet without discovery.” He also emphasized that the judge’s successor-liability ruling doesn’t go to the merits of Allstate’s MBS claim against Countrywide. Pfaelzer has already refused to dismiss Allstate’s fraud claim, which is proceeding to discovery, Brockett said.

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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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The drumbeat of calls for Bank of America to put what remains of Countrywide into Chapter 11 has grown so loud and relentless that according to a report last month by Bloomberg, BofA is actually considering what’s been called the “nuclear option.” Resorting to a Countrywide Chapter 11 would be fraught with unknown but surely devastating consequences for a commercial bank, as bankruptcy guru Harvey Miller of Weil, Gotshal & Manges explained in a fascinating Bloomberg video. But more significantly, there’s a good chance it wouldn’t accomplish the intended goal of roping off BofA’s liability for Countrywide’s mortgage-backed securities mess.

If Bank of America can succeed in limiting its MBS litigation losses to Countrywide’s remaining assets, it will have to show that it didn’t assume liability for Countrywide’s conduct when it acquired the mortgage company in 2008. That’s known as successor liability, and it was one of the key questions Bank of New York Mellon considered as it weighed the fairness of BofA’s proposed $8.5 billion settlement with Countrywide MBS investors. BNY Mellon’s expert, Professor Robert Daines of Stanford Law School, produced a 58-page treatise that concluded it would be very difficult for MBS investors to establish BofA’s successor liability.

Professor Daines looked at a variety of theories plaintiffs could pursue to stick BofA with the hot potato of Countrywide MBS liability. Most, he said, are non-starters, but if there’s any route to successor liability it would probably be through an argument, under New York law, that BofA’s acquisition of Countrywide was a de facto merger. There’s a four-prong test for such a determination, according to the professor, but its interpretation depends to a very large extent on the judge hearing the case. “The doctrine is thus unpredictable and there is even a disagreement about how the four-factor test should be applied: several decisions suggest that the courts apply a ‘flexible’ standard: i.e., they consider all of the factors and that any of these factors could trigger a de facto merger,” Professor Daines wrote in the analysis for BNY Mellon.

In other words, if a New York judge decides an acquiring company should be tagged with the liabilities of its target, the judge has a lot of discretion to make it happen. BofA didn’t have to look very far for proof of that. In April 2010, New York supreme court judge Eileen Bransten refused to dismiss allegations that BofA has successor liability for MBIA’s MBS claims against Countrywide. She found that MBIA offered sufficient evidence — the judge noted in particular that BofA had stripped Countrywide of its assets and shut down the Countrywide brand — to assert the deal was a de facto merger. Judge Bransten ruled that BofA must remain a defendant in MBIA’s case under MBIA’s successor liability theory.

It’s significant that when Countrywide and BofA appealed parts of Judge Bransten’s April 2010 ruling to the state’s appellate division, the defendants didn’t ask for review of her finding on successor liability. Typically, when defendants don’t appeal a ruling like that, it’s because they’re worried about setting appellate precedent that will guide future determinations on the same issue. BofA didn’t show a whole lot of confidence in its arguments against MBIA’s de facto merger theory when it let stand Judge Bransten’s preliminary ruling on its successor liability.

And that brings us to the hearing last Wednesday before the same judge in several bond insurers’ cases against Countrywide and BofA. Yesterday I wrote about the morning session, in which the judge heard arguments about whether Countrywide can argue that the economic downturn — and not its underwriting deficiencies — led to MBS failures. In the afternoon arguments, BofA and the bond insurers addressed BofA’s motion to consolidate all four insurers’ successor liability cases.

The bank’s lawyer, Jonathan Rosenberg of O’Melveny & Myers, told Judge Bransten that the consolidation is a matter of efficiency. All of the insurers will be deposing the same BofA witnesses and looking at the same BofA evidence to assert virtually identical theories, so why not litigate the cases at the same time?

MBIA’s lawyer, Peter Calamari at Quinn Emanuel Urquhart & Sullivan, had an answer to that question: Because MBIA is close to a summary judgment motion on BofA’s successor liability and the other bond insurers aren’t. BofA is stalling, Calamari argued, because it’s afraid Judge Bransten will rule the same way she did on the bank’s motion to dismiss, concluding BofA’s acquisition of Countrywide was a de facto merger so the bank is on the hook for successor liability. “The evidence that has been produced so far and has been obtained so far is extremely strong evidence of a de facto merger,” Calamari argued. “You would think that if this were a weak case or an insignificant claim they would say, ‘Hey, let’s get summary judgment done, let’s get it out of the way, we’ll win the case and it will be over.’ [Instead] they are trying to stop it dead in its tracks.”

BofA may even have given Judge Bransten — who, remember, has broad discretion in analyzing the de facto merger question — additional reasons to confirm her preliminary ruling, according to the transcript. “To the extent [the insurers] want to argue there has been integration activity, yes, there has been integration activities in furtherance of the asset sales,” O’Melveny’s Rosenberg said near the end of the hearing. “To the extent they want to argue that certain Countrywide employees now work for Bank of America and that Bank of America employees have provided services to Countrywide, that’s all undisputed. We’ve acknowledged that in our interrogatories.” The bank also acknowledged earlier in the session that two Countrywide entities, one named as a defendant by MBIA and one by Financial Guaranty, “have de jur [merged] into Bank of America.”

MBIA’s Calamari urged Judge Bransten to push its successor liability case forward because “the underlying defendant could well declare bankruptcy and we would be in a position of sitting around waiting.” But if he wins the successor liability fight, it won’t matter if Countrywide’s in bankruptcy anyway.

I left a phone message with BofA counsel Rosenberg of O’Melveny and sent a detailed e-mail requesting comment to a BofA spokesman, but didn’t hear back from either of them.

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Last week a rumor made the rounds of hedge funds that trade in Bank of America and MBIA shares: The bank had reputedly agreed to settle the bond insurer’s mortgage-backed securities fraud and put-back claims for $5 billion. The rumor turned out to be false, or at least premature, since no settlement is in the offing at the moment. But the size of the rumored deal gives you a sense of the magnitude of the litigation between the banks that packaged and sold mortgage-backed securities and the bond insurers that wrote policies protecting MBS investors. We are talking about billions of dollars — perhaps tens of billions — at stake in suits by MBIA, Syncora, Ambac, and Financial Guaranty against Countrywide, Credit Suisse, GMAC, Morgan Stanley, and other MBS defendants.

Last week, Manhattan state supreme court judge Eileen Bransten, who has been the leading jurist in the bond insurer cases against MBS issuers, heard oral arguments on the issue that will determine the magnitude of the banks’ liability: Can bond insurers demand damages based on banks’ misrepresentations on the day deals were signed? Or can MBS issuers point to the housing bust, and not their deficient underwriting, as the reason so many loans have gone bad in the years after the MBS were sold? The case argued Wednesday before Judge Bransten concerned summary judgment motions in the MBIA and Syncora suits against Countrywide, but as the judge noted in her introductory remarks to the overflow crowd in her courtroom, “I understand that this [argument] has a major impact on lots of people.”

For everyone who couldn’t squeeze into Judge Bransten’s courtroom, I’ve gotten hold of transcripts of the day-long hearing. I’m going to focus on the morning session on the loss causation issue, but here’s a link to the afternoon session on consolidating the issue of Bank of America’s successor liability for Countrywide MBS, which is specific to BofA.

The loss causation question is central to two of the bond insurers’ categories of claims. The insurers assert they never would have agreed to cover Countrywide mortgage-backed securities offerings if Countrywide hadn’t misrepresented the quality of the underlying mortgages. They claim Countrywide fraudulently induced them to enter those contracts, so it must pay what they call “recissionary damages” in compensation. The insurers also assert that Countrywide must agree to buy back any underlying loans that breach the representations and warranties it made about them, regardless of whether the loans subsequently went into default or not. The monolines want Judge Bransten to keep things simple: If Countrywide lied in order to obtain insurance on MBS offerings, it’s liable to the insurers.

As MBIA counsel Philippe Selendy of Quinn Emanuel Urquhart & Sullivan told Judge Bransten: “It is immaterial that there is no causal or other relationship between the actual loss which is sustained under the policy and the falsity of the representation.The insurer has to be able to elect what risks to insure, and its assessment of whether to issue the policy at all is based on Day One risk attributes,” he said. Debevoise & Plimpton partner Donald Hawthorne, who represents Syncora, followed Selendy. “In order to prove our entitlement to rescission for breach of contract, rescission for fraud, and in order to show our entitlement to put-backs,” he said, “all we have to show is that these provisions were breached at the time of the transaction, and there is no need to provide any evidence of whether loans defaulted or what might have caused them to default.”

Both Selendy and Hawthorne pointed Judge Bransten to an April 2011 ruling from Oklahoma City federal judge Robin Cauthron, who held in Wells Fargo Bank v. LaSalle Bank that Wells Fargo, as securitization trustee in a commercial mortgage-backed securities offering, only had to show that LaSalle had committed material and adverse breaches as of the closing date of the offering. “Evidence regarding the post-securitization market conditions is inadmissible,” she wrote.

If Judge Bransten followed Judge Cauthron’s reasoning, a main line of defense for Countrywide and the other MBS issuers would be knocked out. Countrywide counsel Mark Holland and Paul Ware of Goodwin Procter, however, argued that Judge Bransten must consider the meltdown in the U.S. housing market. That’s been the banks’ defense in every MBS case, in which they assert that the real reason underlying mortgages soured isn’t because pieces of paper were missed from loan files or because underwriters didn’t check whether mortgaged houses were primary residences but because the recession hit, people lost their jobs, and housing prices fell. That was a risk, Holland argued, that the bond insurers assumed when they agreed to write MBS policies.

“The insurance companies are trying to make Countrywide pay for risks that they assumed by asking you to exclude all evidence of the mortgage market meltdown,” he told Judge Bransten. “It is our position that before the monolines can recover any damages, they have to show that their losses were caused by something Countrywide did and not by a risk that they agreed to insure.” (The Goodwin lawyers also distinguished between the LaSalle ruling and their case because LaSalle didn’t involve New York law.)

But Judge Bransten’s repeated questions for Holland showed that the bond insurers’ arguments made an impression. “My problem, Mr. Holland, is that can’t we agree that is this not a case concerning the decline of the housing market, but rather a case involving claims for fraud and breach of contract?” the judge said. “So, therefore, when does the issue — at what point does Countrywide say it should be [that] fraud and breach of contract should be shown?” The judge went on to ask virtually the same question twice again, with Holland never exactly answering. Instead, he continued to try to reframe the questions, arguing that Countrywide didn’t commit fraud, but suffered from the mortgage meltdown.

Countrywide’s argument did prompt one question from Judge Bransten for the bond insurance lawyers. (“There was one thing that I think Mr. Holland pointed out that interested me,” she said.) The insurers had argued that they can seek so-called recessionary damages under an old insurance law. Countrywide countered that the law was actually passed to protect policyholders from insurers attempting to cancel policies. The bond insurers were now “overreaching” in asking Judge Bransten “to use a statute designed to protect consumers from the sharp practice of insurance companies to somehow expand the right of insurance companies to seek damages,” Holland said.

The judge asked MBIA counsel Selendy to respond. He said that the insurance law “simply clarified that rescissionary relief can be awarded provided there is this threshold showing, either a material increase in risk in the event that it is a breach of conditions precedent, warranties, and the insurance agreement, or a material misrepresentation but for which the insurer wouldn’t have written the policy on the same terms.”

The judge didn’t give any clear indication of how she was leaning or even when she’ll rule. But if I were Countrywide, I’d be thinking hard about the power and appeal of Philippe Selendy’s words to Judge Bransten. “The housing crisis does not give Countrywide a defense to its Day One misconduct and its misconduct leading into these transactions. There would be no insurance policies and no losses but for that fraud,” he said. “When you think about it, what Countrywide is trying to do here, having first caused the housing crisis, together with other reckless loan originators and underwriters, they want to turn around and profit from it again. They want you to rule that the crisis is in effect a Get Out of Jail Free card that allows them to escape liability for their fraud and shift the costs to innocent parties. Well, luckily we’re in a country governed by the rule of law, and the law doesn’t work that way.”

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The most dramatic moment at the Sept. 21 hearing on Bank of America’s proposed $8.5 billion settlement with Countrywide mortgage-backed securities investors came near the end, when Gibbs & Bruns partner Robert Madden stood up to address Manhattan federal judge William Pauley’s concerns about how the settlement came to be. Tall and clear-spoken, Madden captured the judge’s attention as he explained that his clients, a group of 22 large institutional investors, hadn’t entered a sweetheart deal with BofA, but had banded together to force the bank to pony up billions to investors for claims BofA thought it would never have to deal with.

“The problem was that these repurchase claims were lying fallow,” Madden said, according to the transcript of the hearing. “No one was doing anything. None of (the investors now objecting to the deal) were doing anything. And, I’m sorry to say, the trustee wasn’t doing anything. Limitations were running on those claims, and nothing was happening.”

Or was it?

I’ve learned that in the summer of 2010, as Gibbs & Bruns began to push Countrywide MBS trustee Bank of New York Mellon to act on its assertions that mortgages underlying the Countrywide securities were deficient, another group of Countrywide MBS investors was finalizing its own notice of default to serve on BNY Mellon. Members of the RMBS Clearinghouse, run by former Patton Boggs partner Talcott Franklin, had undertaken an extensive analysis of the underlying Countrywide mortgages, and, according to two sources familiar with the Clearinghouse’s activities, were on the verge of sending BNY Mellon a notice that would trigger put-back litigation.

The asset management firms BlackRock and PIMCO were key members of Franklin’s Clearinghouse. But they were also Gibbs & Bruns clients. On Aug. 4, 2010, Gibbs & Bruns partner Kathy Patrick sent an email to her MBS clients, including BlackRock, PIMCO, the New York Federal Reserve Bank, and MetLife. In that email, Patrick made it clear that Gibbs & Bruns clients should not support the Clearinghouse’s effort.

“Since some of you were previously in the Clearinghouse, it may be that Mr. Franklin believes (mistakenly) that he is authorized to send a notice of default on your behalf,” the email said. “If you have not already done so, it is important that you promptly advise him that he is not authorized to send a notice of default on your behalf … You should also make clear that he should not include your bonds in the count of any bonds he uses to reach the percentages required to tender such a notice.”

After Patrick’s email went out, PIMCO and BlackRock left the Clearinghouse, which never sent its notice of default to BNY Mellon. Gibbs & Bruns’s clients were left as the only investors pushing the trustee to act on their breach-of-contract claims against Countrywide successor BofA.

Patrick told me there was nothing inappropriate about her confidential email to her own clients. Nor did any action by her clients prevent the Clearinghouse from proceeding without them. (More on both points below.) Moreover, she said, Madden’s comments to Judge Pauley were true: Gibbs & Bruns’s clients were the only Countrywide MBS investors who took meaningful action to enforce their claims.

Nevertheless, in a deal that has generated so much controversy — including complaints that the Gibbs & Bruns group shut other investors out of the settlement process — the Kathy Patrick email is going to give opponents of the proposed $8.5 billion agreement new ammunition. At the very least, the new disclosures will mean more complications and delay for supporters of the embattled settlement.

This story begins back in 2009, when Tal Franklin (who did not return my phone calls) had a brilliant idea: because investors have to have significant voting rights to demand action from securitization trustees, Franklin devised a sort of dating service for MBS holders. They could register their bonds with the Clearinghouse, then investors with holdings in particular trusts could team up to obtain the requisite voting rights for asserting put-back claims. The Clearinghouse attracted some of the biggest MBS investors in the country, including Fannie Mae, BlackRock, and PIMCO.

Franklin wasn’t the only lawyer interested in mortgage-backed securities litigation, though. By February 2010, PIMCO had already retained its longtime lawyers at Gibbs & Bruns to represent it in investigating potential MBS claims. That month, Gibbs & Bruns participated in a PIMCO-organized conference for MBS investors. According to Patrick, Franklin also spoke at the conference, making a pitch for investors to join the Clearinghouse. Patrick and Franklin spoke once on the phone later that month, Patrick said. Since then, they haven’t talked.

BlackRock was at the February 2010 conference. By April or May, it had also signed a client agreement with Gibbs & Bruns. (Kathy Patrick goes way back with BlackRock: she represented a predecessor mutual fund in a 1990s case involving for-profit prisons in Texas.)

On June 17, Gibbs & Bruns sent the first letter on behalf of its clients to BNY Mellon. The letter, according to Patrick, asserted that the securitization trustee was obligated to take action on non-performing Countrywide mortgages. Gibbs & Bruns also demanded a meeting with BNY Mellon’s then-lawyers at Pillsbury Winthrop.

Meanwhile, a leading member of Franklin’s Clearinghouse, Bill Frey of Greenwich Financial, was pulling together data on Countrywide MBS defaults, based on first-lien mortgages BofA agreed to modify despite second-lien mortgages on the same property. (Frey subsequently discussed the strategy at an October 2010 MBS investors’ conference organized by David Grais of Grais & Ellsworth.) Frey found, according to his comments at that conference, “defaults in every single (Countrywide MBS) trust.” Fannie Mae, another Clearinghouse member, reviewed and ultimately endorsed Frey’s analysis.

Throughout the early summer of 2010, Clearinghouse leaders held long conference calls to decide how to proceed against Bank of New York Mellon and Countrywide, based on Frey’s evidence of default. By early August, Franklin had prepared a draft notice of default to be sent to BNY Mellon. I’ve been told the draft notice — which I’ve been unable to obtain — included the evidence Frey had assembled of specific breaches in specific trusts.

Then Patrick sent the Aug. 4 email to her clients and the Clearinghouse effort fell apart.

“Several of you have contacted me to indicate that the alternative clearinghouse organized by Tal Franklin may be on the verge of sending a letter to Bank of New York declaring BONY in default of its obligations under the Countrywide (pooling and servicing agreements),” the email said. “That is not in your interests.”

Gibbs & Bruns, the email said, believed it was making progress with BNY Mellon and did not want that progress to be halted by the Clearinghouse notice of default. “We were aggressively pushing BNY Mellon to take action throughout the summer,” Patrick told me. “Our clients were understandably anxious that a lawyer they had not engaged was purporting to act on their behalf.”

Patrick said the email, which was sent only to her clients, didn’t seek to squelch the Clearinghouse, but just to remind her clients to make sure Franklin knew what they wanted to do. “All our clients did was say, ‘You can’t use our holdings (to reach the 25 percent voting rights threshold),’” Patrick told me. “If the Clearinghouse had 25 percent in any deal and had information indicating default, they should have sent the notice. I don’t know why they didn’t.”

They didn’t because without PIMCO and BlackRock, the Clearinghouse couldn’t muster the requisite voting rights. The other Clearinghouse investors were effectively stranded. And that leads to a question that has dogged supporters of the proposed $8.5 billion BofA settlement: why didn’t Gibbs & Bruns invite more Countrywide MBS investors and their lawyers into talks with BNY Mellon and BofA? I’ve previously reported on AIG’s claim that Patrick didn’t return a call from its lawyers at Quinn Emanuel Urquhart & Sullivan (Patrick said the Quinn lawyer who called didn’t identify himself as counsel to AIG) and David Grais’s assertion that he was told he could not participate directly in settlement talks (Patrick has said that Grais’s discussions were with BofA and the trustee, not her). Patrick has always said that she responded to any Countrywide MBS investors who contacted Gibbs & Bruns, but she declined to disclose whether Clearinghouse members who supported the draft notice of default subsequently called Gibbs & Bruns, citing client confidentiality.

After BlackRock and PIMCO made it clear that they would not support the Clearinghouse’s letter to BNY Mellon, Gibbs & Bruns continued to pursue the trustee. Patrick sent the bank a letter on Aug. 20, following an unsuccessful meeting with BNY Mellon’s Pillsbury lawyers. On Sept. 3, the trustee told Gibbs & Bruns that it did not intend to take any action on her letter. Patrick told me she received BNY Mellon’s letter in the middle of the day. By day’s end, she said, she was circulating a draft notice of non-compliance among her clients.

Gibbs & Bruns made the final version of that letter public in October 2010. One source familiar with Franklin’s Clearinghouse draft notice told me the Gibbs notice read like a “watered down” version of Franklin’s draft, “with less evidence.”

Patrick heatedly rejected the suggestion that she borrowed strategy or language from Franklin or the Clearinghouse. She never even saw his draft letter to BNY Mellon, she said, nor did she receive any Clearinghouse materials from her clients. The notice of deficiency Gibbs & Bruns sent to the trustee, she said, “was based on binders of evidence I and my team put together over the course of months of investigation, none of which came from the Clearinghouse.”

Patrick also rejected speculation that BlackRock backed away from the Clearinghouse effort and threw in with Gibbs & Bruns because it didn’t want to take a hard line with Bank of America, which still owned 34 percent of the asset manager in the summer of 2010. (David Grais raised the issue of BlackRock’s alleged conflict of interest in Walnut Place’s petition to intervene.) BlackRock had already signed on with Gibbs & Bruns by the time the Clearinghouse draft default notice was circulating, she said. The asset manager didn’t change course in August 2010, according to Patrick. It had already picked its course.

And as Gibbs partner Bob Madden told Judge Pauley at the Sept. 21 hearing, that course forced Bank of America to the negotiating table for a year of hard-fought talks. “This was no effort to help Bank of America. This was an effort to bring Bank of America to justice,” Madden said. “This was no collusive, self-selected group of people who decided to get in a room with Bank of America and cut a sweetheart deal.”

Will Judge Pauley agree — or will news of the Clearinghouse’s aborted pursuit of BoA and BNY Mellon lead him to authorize discovery on that question? I bet I’m not the only one who can’t wait to find out.

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Monitoring the docket Tuesday afternoon, as motions to intervene in Bank of America’s proposed $8.5 billion settlement with Countrywide mortgage-backed securities noteholders piled up, was sort of like watching guests arrive a cocktail party. Oh, here come the hedge funds. Look, there’s a bunch of insurance companies. The public pension funds always head straight for the shrimp. Homeowners? Did anyone invite them? And, of course, Goldman Sachs had to show up fashionably late.

Other party guests may have looked glitzier, but none of Tuesday’s intervention motions is more important to the ultimate determination of the proposed settlement’s fairness than the one filed by the Federal Housing Finance Agency, the government agency that oversees Fannie Mae and Freddie Mac. No one knows the value of mortgage repurchase claims-the claims the proposed BofA deal resolves-better than FHFA.

Here’s why. In the MBS boom years, Fannie Mae and Freddie Mac bought hundreds of billions of dollars of mortgages from Countrywide and many other lenders. The government-sponsored entities packaged the loans into mortgage-backed bonds, just like other MBS issuers. But after the housing bubble burst, and Fannie and Freddie were placed under the federal government’s conservatorship, FHFA had both more of an incentive to get information about those underlying loans than other MBS issuers–and more power to get the information. In July 2010 the agency announced that it had issued 64 subpoenas for mortgage loan documents. Last October it brought in Quinn Emanuel Urquhart & Sullivan to advise on litigation against mortgage lenders that breached representations and warranties about the loans they sold to Fannie and Freddie.

In January the agency’s efforts produced their first fruit: a $3 billion settlement with Bank of America to resolve Fannie and Freddie’s mortgage repurchase claims against Countrywide. BofA announced at the time that the settlement addressed the $130 billion in unpaid principal balance on the loans Countrywide had sold to Fannie and Freddie. But the more significant number was contained in a presentation on the deal that the bank offered analysts. Fannie and Freddie’s total repurchase claims against Countrywide (for mortgages written between 2004 and 2008) were $21.6 billion. The $3 billion settlement, the bank said, substantially resolved those claims.

Those are important benchmarks, and I’m absolutely sure it will turn out that both Bank of America and the 22 Countrywide MBS investors represented by Gibbs & Bruns looked at Fannie and Freddie’s repurchase claims-and how much FHFA got for them-as they negotiated the proposed $8.5 billion settlement.

FHFA took some heat for settling on the cheap with Countrywide and was under political pressure to scrutinize the proposed $8.5 billion deal, in which Fannie and Freddie have a stake as Countrywide MBS investors. (In addition to buying loans directly for their own securitizations, they also purchased mortgage-backed securities from other issuers.) So it’s not at all surprising that the agency filed its 3-page “conditional objection” to the settlement. “FHFA has insufficient information concerning the proposed settlement,” the filing said. “FHFA seeks to be eligible to receive additional relevant information, if any, developed in discoveryto assist FHFA in its ongoing due diligence with respect to the proposed settlement.”

But this was a funny kind of “objection”: FHFA didn’t stop with a request for more information. It went on to note the “positive” aspect of the proposed settlement’s servicing provisions and to say that the agency is “encouraged” that a group of “significant market participants” supports the deal. A press release FHFA put out in conjunction with its filing went even farther: The agency, it said, “is aware of no basis upon which it would raise a substantive objection to the proposed settlement at this time.”

That sure seems to be a provisional endorsement, albeit in the guise of a conditional objection.

I called Marc Kasowitz, who’s representing FHFA in the BofA litigation. He referred me to an agency spokeswoman who said only that the FHFA statement “stands on its own.”

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Last October, when BofA’s proposed $8.5 billion settlement of Countrywide mortgage-backed securities breach of contract claims was just a twinkle in Kathy Patrick’s eye, David Grais of Grais & Ellsworth told me that one of the biggest problems for lawyers representing disgruntled MBS noteholders was the investors’ reluctance to come forward. Noteholders were afraid to provoke the banks that issued mortgage-backed securities, Grais said, so they didn’t want to sue under their own names. That’s why one of Grais & Ellsworth’s early put-back cases was filed on behalf of an ad hoc coalition of anonymous Countrywide MBS investors operating under the name Walnut Place.

It’s also why the Gibbs & Brun investor group that negotiated the BofA deal made such a splash. Kathy Patrick’s big institutional investor clients, including Pimco, BlackRock, and the New York Federal Reserve’s Maiden Lane funds, showed their faces when they offered public support for the proposed $8.5 billion settlement. In fact, after Grais’s Walnut Place investors filed an objection to the proposed deal, supporters of the settlement drew a contrast between the Gibbs group’s public face and Walnut’s anonymity.

But as time runs out for investors to claim a place in the litigation over the proposed settlement, more and more Countrywide MBS noteholders are shrugging off secrecy. On Monday, six new interventions motions appeared in either the original state court docket or in federal court, where Grais & Ellsworth removed the case last week. (A seventh intervention petition, by American Fidelity Assurance, popped up Tuesday morning.) The big news was the placeholder petition Grais filed on behalf of the Federal Deposit Insurance Corporation, which says it is “the receiver of numerous banks and owner of many certificates issued by many of the trusts that would be covered by the proposed settlement.” (Hard to know from that how big a stake the FDIC has in the Countrywide MBS offerings.) Like the six Federal Home Loan Banks that have already intervened in the proposed settlement, the FDIC isn’t yet objecting to the deal, but said it wants more information to evaluate the fairness of the deal.

I was intrigued by a point Squitieri & Fearon made in an intervention petition on behalf of Waterfall Eden Master Fund, which owns certificates in six Countrywide MBS offerings. Waterfall’s lawyers cited the class action bombshell in the recent appellate opinion tossing out a settlement between freelancers and publishers. The BofA MBS settlement isn’t a class action — it was filed as a special proceeding under a New York State law permitting trustees to seek court approval of their actions. But as Waterfall notes, if Grais & Ellsworth manages to keep the case in federal court as a mass action under the Class Action Fairness Act, the Second Circuit’s new requirement that subclasses have their own counsel could turn out to be quite a messy complication for Bank of America.

Perhaps the most intriguing of the latest filings came from Peter N. Tsapatsaris, who’s working with Talcott Franklin of the Investors Clearinghouse. Franklin has worked closely with Grais & Ellsworth in the past, but the request for information he filed Monday isn’t as aggressive as some of David Grais’s intervention papers. It’s not a formal objection to the proposed settlement or even a motion to intervene, but is instead styled as an “objection in the form or a request for more information.”

The filing’s big revelation is the long list of noteholders Franklin represents. The petition names almost three dozen Countrywide MBS noteholders — mostly insurance companies, hedge funds, and small and medium-sized banks — with a stake in almost 250 Countrywide MBS trusts. That’s more noteholders than the Gibbs & Bruns group supporting the settlement, though it’s unlikely that the Franklin group crosses the all-important threshold of 25 percent voting rights in all of the trusts listed in the petition. (When BofA announced the MBS settlement at the end of June, the Gibbs group crossed the 25 percent threshold in 225 of the 530 Countrywide MBS trusts.)

Emerging publicly, of course, means enduring the spotlight. I wrote last week about the irony of the CDO manager Triaxx objecting a deal supported by its biggest noteholder, the New York Fed. There’s a similarly ironic tidbit in the Franklin filing. Among the hedge funds seeking more information about the proposed Countrywide MBS deal is LibreMax Capital, which was cofounded by Greg Lippman, the former Deutsche Bank trader who famously made a pile of money by betting against mortgage-backed securities. Lippman recently turned up in TIAA-CREF’s suit against Deutsche Bank as the author of a bunch of damning e-mail describing Deutsche Bank’s own mortgage-backed offerings as “pigs” and “crap.” Lippman is now making his money by investing in the same instruments he once derided — including, apparently, Countrywide MBS notes.

Talcott Franklin declined comment. A spokesman for LibreMax also declined comment.

I’ll keep checking the BofA MBS dockets all day and post significant new filings on Twitter.

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