Alison Frankel

To say that the hearing to evaluate Bank of America’s proposed $8.5 billion breach of contract settlement with investors in Countrywide mortgage-backed securities got off to a slow start would be something of an understatement. In a courtroom so crowded that New York State Supreme Court Justice Barbara Kapnick repeatedly admonished observers to clear a path to the door, the judge heard hours of pretrial motions, many on issues she regarded as already settled. In particular, objectors to the settlement – led by AIG, several Federal Home Loan Banks and other assorted pension and investment funds – told Kapnick that they should not be forced to proceed with opening statements until they’ve had a chance to take depositions based on privileged communications between Bank of New York Mellon, the Countrywide MBS trustee, and its lawyers at Mayer Brown. Kapnick ordered the documents produced late last month, and AIG counsel Daniel Reilly of Reilly Pozner said it wouldn’t be fair to begin a hearing to determine whether BNY Mellon made a reasonable decision to agree to the $8.5 billion settlement – which resolves potential claims by 530 trusts that Countrywide breached representations and warranties about underlying mortgage loans – until objectors have quizzed witnesses on the confidential material.

Kathy Patrick of Gibbs & Bruns, who represents BlackRock, Pimco, MetLife and other major institutional investors that negotiated the deal with BofA and BNY Mellon, said the objectors just wanted to delay Kapnick’s final reckoning of the settlement, which is being evaluated in a special proceeding under New York trust law. Reilly, who argued unsuccessfully last week for a stay of the case while the state appeals court considers whether it should be heard by a jury, insisted that he just wants the proceeding to be fair. Judge Kapnick, meanwhile, seemed preoccupied with getting the actual hearing under way. “I am trying to make this go ahead,” she told the objectors at one stage. “I am not going to reopen a point we spent an inordinate amount of time arguing about,” she said at another. “At some point, you have to get going with this.”

The delay issue came to a head in the afternoon session, when yet more motions to limit testimony and evidence had to be resolved. Reilly asked the judge to restrict Patrick from asserting that 93 percent of Countrywide MBS investors support the settlement when, in fact, the majority of certificate holders haven’t opined one way or the other. Patrick stood up and promised that she’d henceforth say that 93 percent do not object to the deal.

“You say whatever you want,” Kapnick told Patrick. “I get it.” She then turned to Reilly. “I don’t know who you think you’re talking to,” she said, reminding him, yet again, that there’s no jury hearing the case, just a judge who has been listening to arguments from settlement supporters and detractors for almost two years.

Patrick ventured that perhaps it was finally time for BNYM counsel Matthew Ingber of Mayer Brown to deliver the trial’s first opening statement. “No, he has some more problems,” Kapnick said, referring to Reilly. “I know you want to start,” she said to Patrick. “I want to start too.”

I have a bold assertion: Breach of contract suits by mortgage-backed securities trustees are no longer a rarity. In my daily feed of new filings, I’m seeing a fairly regular trickle of cases asserting trustee claims that mortgage originators didn’t live up to their representations and warranties about the loans they sold to MBS trusts. The roster of firms filing cases for trustees has expanded as well. Kasowitz, Benson, Torres & Friedman still seems to be the likeliest to appear on the signature page of MBS trustee complaints, but last week MoloLamken filed a put-back suit in New York State Supreme Court for the trustee of a Morgan Stanley MBS trust, and Holwell Shuster & Goldberg brought a put-back claim in the same court for the trustee of a Deutsche Bank-backed trust.

So, now that put-back filings have become as relatively commonplace as Miguel Cabrera home runs, it’s time to start asking how successful the cases will be. Banks have been disposing of billions of dollars of put-back demands asserted by bond insurers and by Fannie Mae and Freddie Mac for years, but those claims haven’t been resolved through litigation. And Bank of America reached its proposed $8.5 billion global settlement with private investors in Countrywide mortgage-backed securities before the investors’ lawyers at Gibbs & Bruns filed a complaint claiming that Countrywide breached MBS representations and warranties. As far as I’m aware, there has been no publicly disclosed settlement of a put-back case filed by an MBS trustee acting at the behest of private certificate holders.

With that paucity of precedent, a ruling this week in one of the earliest put-back cases on the dockets is bad news for certificate holders. The suit, filed by Kasowitz Benson against the originators of loans in a $555 million Wells Fargo MBS offering, stemmed from an investigation that noteholders demanded back in April 2010. In a sample of 200 of the 3,000 loans in the underlying pool, investors identified material breaches in 150, or 75 percent, of the sample. When the originators EquiFirst and WMC Mortgage refused to accede to put-back demands based on breaches in the sample, the MBS trustee, U.S. Bank, sued on behalf of noteholders.

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.)

If you’re reasonably literate about the financial crisis, you probably know that the credit rating agencies have slipped through the carnage like a cat walking away from a knocked-over vase. With their opinions on publicly offered mortgage-backed securities protected by the First Amendment, Standard & Poor’s and Moody’s have won dismissals of the vast majority of MBS investor claims against them in state and federal court, despite powerful evidence from congressional investigations that they worked with underwriters to confer investment-grade ratings on securities backed by dreck. With one possible exception, the only surviving cases against rating agencies involve claims by investors in private placements, who have successfully argued that private ratings aren’t protected free speech.

The near-spotless litigation record of the rating agencies means we’ve seen very little internal evidence, in the form of emails between rating execs, emails between the agencies and underwriters and deposition testimony from credit rating agency insiders. The only hard evidence on the agency’s role in the economy’s collapse came from a Senate report.

Until Monday.

In a series of filings in federal court in Manhattan, Abu Dhabi Commercial Bank and its lawyers at Robbins Geller Rudman & Dowd disclosed thousands of pages of internal communications and deposition transcripts to back their claims that S&P and Moody’s are liable for fraud and negligent misrepresentation in connection with their rating of a structured investment vehicle underwritten by Morgan Stanley. Based on a declaration by plaintiffs that accompanied the documents, a huge percentage of the newly disclosed material has never previously been seen by the public – and a good many of the documents deal not just with the Morgan Stanley SIV but more broadly with the rating process inside S&P and Moody’s at a time when the two leading agencies were swamped with mortgage-backed securities to rate.

If the Securities and Exchange Commission were an ordinary investor, it would already be too late in trying to sue the banks that issued (allegedly) deficient mortgage-backed securities.

The SEC is not, of course, an ordinary investor. On Wednesday night, the Wall Street Journal broke the news that the SEC plans to send Wells notices, otherwise known as target letters, to several banks that issued mortgage-backed notes and certificates. The Journal said the agency is looking at whether the banks misled investors about the quality of mortgage loan pools underlying securities issued in 2007 and 2008.

But here’s the thing: The first federal-court MBS class action, against Countrywide, was filed in 2007. By 2008, bond insurers and private investors were busily suing MBS issuers in state and federal courts in New York, starting the clock on the three-year statute of limitations for suits under the federal Securities Act of 1933 and the two-year time limit for fraud cases under the Exchange Act of 1934. Private investors who entertained thoughts of bringing federal claims for mortgage-backed notes issued in 2007 and 2008 would be tossed out of court quicker than you can say “time-barred.”

I follow mortgage-backed securities litigation closely enough to be disgusted at the greed that fueled the securitization of insufficiently underwritten mortgages issued to homeowners who had no hope of paying them off. Sure, MBS investors and the bond insurers that backed MBS trusts were sophisticated and, to some extent, forewarned about the timebombs lurking in those mortgage pools. But you can’t read the voluminous MBS filings by monolines and investors — including the federal agency that oversees Fannie Mae and Freddie Mac — without wishing that someone be held accountable for sending the housing market on a slide, and dragging down the rest of the economy with it.

To date, accountability has been an elusive goal. I’m not talking about private suits or breach-of-contract put-back claims, in which MBS issuers are beginning to acknowledge billions of dollars of exposure to investors and insurers. But state and federal regulators and prosecutors have lagged behind the private plaintiffs bar (and the Federal Housing Finance Agency). As best I can tell, there have been no criminal prosecutions of people or institutions involved in mortgage-backed securitizations. On the civil side, the U.S. Attorney for the Southern District of New York, Preet Bharara, brought an MBS-based suit against Deutsche Bank last May. This summer, the New York Attorney General, Eric Schneiderman, filed Martin Act claims against Bank of New York Mellon for its conduct as Countrywide MBS securitization trustee. In October, the Delaware AG, Joseph Biden III, filed a civil suit against the Mortgage Electronic Registry System that accuses the banks that established MERS of using it as a vehicle to bundle mortgages they didn’t actually own. And last week, the Illinois AG, Lisa Madigan, sued Standard & Poor‘s for giving undeserved AAA ratings to overly risky mortgage-backed notes.

Those, however, are the only major government cases stemming from mortgage-backed securitizations that I’m aware of. For well over a year, the MBS industry has been under intense scrutiny by government investigators, from (among others) Congress, the Justice Department, the Securities and Exchange Commission, and the N.Y., Delaware, and Massachusetts AGs’ offices. So far, we haven’t seen a lot of tangible results from those investigations.

Attention everyone who’s suing or planning to sue JPMorgan Chase, Bear Stearns, or Bear’s onetime mortgage unit EMC over mortgage-backed securities gone bad: Those indefatigable bond insurers are busy amassing whistleblower evidence for you. Last Friday, Patterson Belknap Webb & Tyler — which represents the monolines Syncora, Assured Guaranty, and Ambac in fraud and breach-of-contract suits stemming from EMC mortgages — began deposing witnesses from outside companies that evaluated the underlying loans in Bear’s mortgage-backed offerings. (The Nov. 18 amended complaint in Assured’s Manhattan federal court case against EMC and JPMorgan outlines the whistleblower assertions Patterson has come up with.)

The first deposition was of a former employee of Watterson Prime, a contractor that re-underwrote mortgages in EMC securitizations. The employee has claimed that Watterson simply rubber-stamped the loans; even mortgages that the contractor rejected, she has said, were nevertheless placed in MBS loan pools. Assured and the other monolines argue, of course, that they were deceived about the supposedly independent review of the underlying mortgage loan pools in the securities they agreed to insure. Whistleblower deposition testimony could be powerful evidence to support their arguments.

We only know about the whistleblower depositions because of a letter JPMorgan’s lawyers at Greenberg Traurig sent to Manhattan State Supreme Court Justice Charles Ramos, who is overseeing the Ambac case in state court, and to U.S. District Judge Paul Crotty, who’s presiding over Syncora’s Manhattan federal court case against EMC. (JPMorgan isn’t a defendant in that action.) The Jan. 18 letter identified the Watterson confidential witness by name, accused Patterson Belknap of “ambush litigation tactics,” and asked the judges to order Patterson to turn over a signed affidavit from her in advance of the Jan. 20 deposition. Greenberg also asked for affidavits from three other whistleblowers whose depositions have been scheduled. Despite a Jan. 19 Patterson letter claiming privilege for the whistleblower affidavits it has obtained, the monolines were ordered to turn over the witness statements.

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.