Alison Frankel

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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There is never a dull moment in Bank of America’s attempt to resolve its Countrywide mortgage-backed securities liability. In a stunning move Friday, the law firm leading the fight against BofA’s proposed $8.5 billion settlement with Countrywide MBS noteholders removed the case from New York state supreme court to federal court. “The purpose of removal is to make sure that this proceeding is adjudicated in the proper forum,” Grais & Ellsworth wrote in a letter to lawyers for Bank of New York Mellon (the Countrywide MBS trustee) and for the big institutional investors who crafted the proposed settlement. “We believe in good faith that this proceeding is subject to federal jurisdiction as a mass action under the Class Action Fairness Act.” (Here’s the Grais & Ellsworth letter with the removal petition attached.)

The removal to federal court plunges the proposed settlement, at least temporarily, into more uncertainty than ever. Judge Barbara Kapnick, who is presiding over the unusual state court proceeding to evaluate the proposed deal, had imposed an August 30 deadline for Countrywide MBS investors to intervene in the case. She had also established a preliminary schedule for the discovery Grais & Ellsworth and other objectors’ counsel have demanded from BNY Mellon, BofA, and the institutional investors and their Gibbs & Bruns counsel. The removal to federal court means that Judge Kapnick isn’t in charge of the case, so it’s not clear whether lawyers are required to abide by her schedule.

The Grais & Ellsworth filing was a surprise tactic. The firm has been in the state court litigation since early July, filing its initial petition to intervene only days after Bank of New York Mellon, as Countrywide trustee, filed a suit asking for court approval of the settlement of investors’ claims. David Grais even appeared before Judge Kapnick at an August 5 hearing on objectors’ requests for expedited discovery. Grais & Ellsworth apparently waited to remove the case to federal court until Judge Kapnick granted the firm’s motion to intervene in the state court case on Monday. (Grais, who was not in the office Friday, didn’t respond to my e-mail; his partner Owen Cyrulnik, who signed the letter to opposing counsel, didn’t respond to an e-mail and phone message.)

You can bet that BNY Mellon and the institutional investors will move quickly to try to get the case back to Judge Kapnick, whose first substantive ruling, albeit on a minor procedural matter, went their way. Lawyers from Mayer Brown and Dechert (for BNY Mellon) and Gibbs & Bruns (for the investors backing the settlement) will be filing remand motions next week, possibly as soon as Monday or Tuesday. Whoever hears the remand fight — Grais & Ellsworth’s petition said the case is related to a Countrywide MBS investor suit before Manhattan federal judge William Pauley -- will have to deal with all kinds of novel questions. Among them: Grais & Ellsworth’s own previous precedent on put-back claims in federal court.

Grais’s argument for sending the $8.5 billion proposed settlement to federal court comes under the Class Action Fairness Act, the 2005 law that requires big-money class actions to be litigated under the oversight of a federal judge. CAFA also mandates that mass actions, in which at least 100 plaintiffs have filed parallel suits seeking money damages against the same defendant, be transferred to federal court. Grais & Ellsworth is asserting that because the proposed Countrywide MBS settlement will resolve the claims of investors in 530 trusts, it’s a mass action under CAFA.

But here’s the thing: there’s actually only one plaintiff in the proceeding before Judge Kapnick. As I’ve explained, the banks and the Gibbs & Bruns investor group that negotiated the proposed settlement are seeking court approval for the $8.5 billion deal under Article 77, a provision of the New York rules of civil procedure that’s typically invoked in small-time family trust matters. The lawyers behind the settlement opted for an Article 77 proceeding — instead of a class action — specifically because New York trust laws give broad leeway to trustees, who are presumed to be acting in the interests of trust beneficiaries unless someone can show they acted unreasonably. It may turn out that the banks’ Article 77 strategy also undermines Grais & Ellsworth’s attempt to move the case to federal court because technically the case is not a mass action.

There’s also the little matter of a previous ruling by the U.S. Court of Appeals for the Second Circuit, upholding a Manhattan federal court’s remand of a Countrywide MBS put-back case to state court. It’s worth taking a moment to consider that case, in which a plaintiff called Greenwich Financial Services asserted in New York state supreme court that Countrywide had breached representations and warranties about the mortgage loans underlying notes Greenwich bought. Those are the exact sort of investor claims, remember, that are at issue in the proposed $8.5 billion settlement.

Countrywide removed the case to federal court under the Class Action Fairness Act. (Sound familiar?) Greenwich successfully remanded the case to state court, arguing that CAFA didn’t apply to its put-back suit because of an exception in the class action law for cases related to rights and duties, including fiduciary duties, over securities. It was a smart argument by Greenwich’s lawyers, who badly wanted to keep the case in state court. Put-back suits argue that the MBS sponsor is required to buy back underlying mortgages that breach the representations the sponsor made about them. They’re based on the issuer’s contractual duty, not on fraud allegations.

Countrywide appealed, but the Second Circuit found that “as long as a plaintiff’s claim seeks enforcement of a right that arises from an appropriate instrument, its falls within the [CAFA] exception.” (Technically, the appellate court found that it didn’t have jurisdiction to hear Countrywide’s appeal.)

The Article 77 proceeding that Grais & Ellsworth has now removed to federal court is distinct from the Greenwich case because it was filed by the Countrywide MBS trustee, not by an investor. Nevertheless, the Second Circuit seemed pretty clear that put-back claims, which the Article 77 proceeding addresses, are an exception to the Class Action Fairness Act.

Grais & Ellsworth, as it happens, knows the Greenwich precedent very well: Grais represented the plaintiff who fought so hard — and effectively — to remand the put-back case to state court. And guess who oversaw the Greenwich case when it returned to state court? Judge Kapnick! Last October, she dismissed Grais’s case on procedural grounds, finding that Greenwich didn’t own the requisite 25 percent voting rights that would have permitted it to demand put-backs.

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Kathy Patrick wants to set the world straight.

The Gibbs & Bruns partner, who represented 22 major Countrywide mortgage-backed securities investors in the negotiations that led to the June 29 proposed $8.5 billion Bank of America deal, has come East from her home office in Houston to sell Countrywide MBS noteholders and anyone else who will listen on the settlement she and her partner Scott Humphries negotiated with BofA and Countrywide MBS trustee Bank of New York Mellon.

In the face of questions about the deal from six Federal Home Loan Banks, the New York State Attorney General, and a North Carolina Congressman, Patrick and Humphries spent Thursday in Washington and Friday in New York, meeting with MBS investors and “other interested parties” they declined to identify. The Gibbs lawyers’ message: The proposed BofA settlement represents a far better outcome for noteholders than continued litigation of loan-by-loan breach of contract claims against Countrywide. In that scenario, they insist, there would be no guaranteed outcome, no assurance investors can obtain a judgment against BofA as Countrywide’s successor, and none of the mortgage loan-servicing provisions that are a big part of the proposed deal. (The Gibbs & Bruns lawyers and some of their institutional investor clients argue that the servicing component of the deal, in which Bank of America has agreed to outsource loan servicing to specialists tasked with renegotiating troubled mortgages, could end up being as valuable as the cash part of the settlement.)

Patrick is particularly exercised that one objector to the proposed settlement has asserted that the deal “fails to address” securities claims pending against Countrywide. The settlement agreement specifically states that securities fraud claims are not part of the deal, and even if BNY Mellon, as trustee, wanted to give away investors’ right to sue for securities fraud, it has no power to do so. Patrick said she was so determined to preserve her own clients’ securities law claims that Gibbs & Bruns very nearly walked away from late-stage negotiations when Bank of America’s lawyers from Wachtell, Lipton, Rosen & Katz demanded a release. “We said not only no, but hell no,” Patrick said, adding that she was ready to leave $8.5 billion on the table.

Patrick said that so far, the only announced objectors to the settlement-as opposed to the New York AG, the Federal Home Loan Banks, and others who’ve said they want more information– are clients of Grais & Ellsworth, including a coalition of MBS investors that sued Bank of America after David Grais learned of the Gibbs & Bruns group’s settlement discussions. “There’s a misperception out there that lots of investors are unhappy with the deal,” Patrick said. “Look very carefully: They’re all represented by one lawyer at one law firm,” she said. Moreover, she added, no objector has suggested a viable alternative to the proposed settlement.

“Here’s a fundamental question any of these objectors will have to answer,” Patrick said. “What’s your plan? What is your plan to fix the servicing?…Unless you have a credible plan, unless you’re going to indemnify all of us against losing this bird in the hand, then you have nothing.”

OTC reached out to David Grais and Owen Cyrulnik for a response. Grais declined comment.

(Reporting by Alison Frankel)

Faced with a barrage of investor criticism (see here, here, and here) of its proposed $8.5 billion mortgage-backed securities settlement with Bank of America, Bank of New York Mellon, the MBS trustee, has released the expert reports underlying the agreement. The reports—in particular the valuation report by Brian Lin, the managing director of RRMS Advisors—provide an extraordinary window into how this deal got done. They may not change anyone’s mind about the fairness of the settlement proposal, but they answer a lot of the questions that challengers of the deal have raised.

Let’s start with the numbers that were on the table when Gibbs & Bruns and its group of 22 major Countrywide MBS investors sat down across from Bank of America and its lawyers from Wachtell, Lipton, Rosen & Katz. The outside range of the investor group’s demands was $52.6 billion, according to Lin’s report. At the low end, the investors asked for $27 billion. Bank of America, according to the Lin report, calculated that investors could claim no more than $4 billion.

Lin began his evaluation of the investors’ Countrywide MBS claims by reviewing the presentations that the Gibbs group and BofA made to one another. (His company, RRMS, is a mortgage-backed securities consultant that advises MBS investors, packagers, and issuers. BoNY and its Mayer Brown lawyers selected Lin’s firm to provide an expert opinion after beauty contest interviews with several candidates, which had to have MBS expertise but couldn’t have a significant relationship with Bank of America.) Interestingly, Lin’s report indicates that the valuation methodology employed by both the investors and BofA was almost the same, although the two sides obviously plugged different assumptions into the basic formula.

Here’s how the investors and the bank came to their numbers. As OTC explained earlier this week, the key metric is the value of the investors’ valid claims that Countrywide breached its representations and warranties on the mortgage loans underlying the securities. To determine that number, both the bank and the investor group began with a calculation of how many of the mortgages in the underlying pools would go into default. They next considered what percentage of the value of a defaulted underlying mortgage would be lost to investors—a figure Lin calls the “severity rate.” (If, for instance, a homeowner defaulted on a $100,000 mortgage and the mortgage-holder was later able to sell the mortgaged property for $75,000, the severity rate would be 25 percent.) Two more numbers then come into play: the breach rate, which represents the percentage of mortgages in the pool that breached Countrywide’s assurances to investors; and the success rate, which is the percentage of claims on which investors could successfully demand a bank buyback.

To arrive at its demand of $27 billion to $52.6 billion, the Gibbs & Bruns group asserted that $107.8 billion of the underlying mortgage pool would go into default. The investors applied a severity rate of 66 percent, a breach rate of 60 percent, and a success rate of 50 to 75 percent. (Lin said the latter two rates were too high, based on his “industry knowledge.”) The bank used different figures to reach its $4 billion estimate of investors’ claims, but Lin didn’t spell out BofA’s exact numbers.

In any event, Lin and his team arrived at their own conclusions for default, severity, breach, and success rates, based on the two sides’ presentations and their own expertise. RRMS said 36 percent of the defaulted underlying loans breached Countrywide’s representations and warranties, and investors would prevail on 40 percent of their buy-back claims on those loans. Lin made calculations using two different severity rate models—one estimating that investors would recover only 40 percent of the value of defaulted underlying mortgages; the other estimating a 55 percent recovery. He also offered two different default models.

In the end, Lin arrived at a range of $8.8 billion to $11 billion for investors’ claims. Importantly, he reached those results without knowing that negotiations between BofA, BoNY, and the Gibbs & Bruns group had produced a tentative $8.5 billion settlement agreement. In a second opinion, Lin says the servicing aspects of the proposed settlement “can be viewed as an industry precedent-setting, pro-active approach in regard to establishing a framework to enhance recovery efforts.” (Supporters of the proposed settlement assert that the servicing provisions, which require BofA to hand off responsibility for renegotiating troubled mortgage loans, could be worth as much or more to investors as the cash part of the deal.)

When Mayer Brown submitted BoNY’s petition for court approval of the $8.5 billion settlement proposal, partners Jason Kravitt and Matthew Ingber said that their expert’s valuation didn’t include discounts for BofA’s legal defenses against the investors’ claims. The other three expert reports released Tuesday explain what those legal defenses would have been—and may still be if the proposed settlement isn’t approved.

First off, Mayer Brown obtained an opinion from Capstone that said the trustee could recover no more than $4.8 billion from Countrywide, based on Countrywide’s assets. That’s important because in another expert opinion, Stanford Law School professor Robert Daines said it would be “difficult” for MBS investors to prevail in claims that Bank of America is responsible for Countrywide’s breaches of representations and warranties on the underlying mortgages. (There’s a lot more nuance in Professor Daines’s scholarly 58-page analysis, but the takeaway is that investors can’t be sure they could pierce the corporate veil and hit Bank of America for Countrywide’s failings.)

Finally, New York University School of Law professor Barry Adler opined on the standard for investor breach of contract claims against MBS issuers. Bank of America asserted in negotiations that unless the breaches were material—meaning that Countrywide misrepresented the facts that led to the mortgage’s default—the bank isn’t liable. Investors argued that every breach is material because they wouldn’t have purchased the securities without Countrywide’s representations and warranties about the underlying mortgages. Professor Adler’s 13-page opinion concludes that the law is unsettled but that the bank “appears to [have] a reasonable position.”

Kathy Patrick of Gibbs & Bruns, who represents the investor group that negotiated the deal, told OTC she’s glad the expert reports have come out. “We believe investors will find it very helpful ,” she said. “The trustee’s expert opinions… confirm and support the trustee’s decision to enter into the settlement.”