Opinion

Alison Frankel

New ruling puts Fannie, Freddie in line for windfall MBS recovery

Alison Frankel
Dec 17, 2013 20:24 UTC

Has there ever been a more lopsided multibillion-dollar case than the Federal Housing Finance Agency’s fraud litigation against the banks that sold mortgage-backed securities to Fannie Mae and Freddie Mac? I don’t think U.S. District Judge Denise Cote of Manhattan, who is overseeing securities fraud suits against 11 banks that haven’t already settled with the conservator for Fannie and Freddie, has sided with the banks on any major issue, from the timeliness of FHFA’s suits to how deeply the defendants can probe Fannie and Freddie’s knowledge of MBS underwriting standards in the late stages of the housing bubble. But even in that context, Judge Cote’s summary judgment ruling Monday – gutting the banks’ defenses against FHFA’s state-law securities claims – is a doozy.

In effect, Cote’s decision will permit FHFA to recover more from MBS issuers than Fannie Mae and Freddie Mac would have made if their MBS investments had paid as promised. Of course, FHFA and its lawyers at Quinn Emanuel Urquhart & Sullivan and Kasowitz, Benson, Torres & Friedman still have to show that the banks knew or had reason to know that their offering documents misrepresented the mortgage-backed securities they were peddling to Fannie Mae and Freddie Mac. But if FHFA meets that burden, the banks can’t ward off claims under the state securities laws of Virginia and the District of Columbia by blaming Fannie and Freddie’s MBS losses on broad declines in the economy and the housing market.

What’s more, those state securities laws give FHFA the right to rescission – or restitution of the entire purchase price of the MBS Fannie and Freddie bought – plus fees, costs and, most importantly, interest. The Virginia statute mandates that securities fraudsters chip up 6 percent interest – more than the scheduled interest rate in many of the MBS trusts in which Fannie and Freddie invested. The banks, in other words, are now exposed to liability far beyond the actual losses Fannie Mae and Freddie Mac suffered – and even beyond what FHFA’s wards would have earned if the MBS trusts had performed exactly as the banks said they would at the time of sale. That extra interest would be a true windfall for FHFA.

Cote rejected the banks’ motion to ask the Virginia Supreme Court for a ruling on whether the state’s securities fraud law permits a so-called loss causation defense. As the judge explains in her ruling, when Congress passed the Private Securities Litigation Reform Act in 1995, it amended Section 12 of the Securities Act of 1933 to permit defendants to limit their liability by showing that a supposed fraud victim’s losses were not attributable to the defendant’s misrepresentations. In the FHFA cases, the banks’ lawyers – led by James Rouhandeh of Davis Polk & Wardwell, for Morgan Stanley, and Thomas Rice of Simpson, Thacher & Bartlett, for Deutsche Bank – tried to persuade Cote that because state securities laws were based on the federal Securities Act, she should look to the amended federal statute to interpret Virginia and D.C. law. Cote rejected the argument, holding that the federal law did not include a loss causation defense until it was amended in 1995. The Virginia and D.C. laws predate that amendment, Cote said, so loss causation cannot be inferred from their texts.

“As defendants concede, no federal court interpreted the ’33 Act as incorporating a loss causation defense before one was added by the PSLRA,” Cote wrote, so “there is no reason to think the Virginia Supreme Court would read a loss causation defense into the Virginia Securities Act if confronted with the question now.”

FHLB demands DOJ draft complaint: ‘What is JPMorgan trying to hide?’

Alison Frankel
Dec 10, 2013 19:23 UTC

If JPMorgan Chase and the Justice Department thought that all the zeroes at the end of the bank’s multibillion-dollar settlement for mortgage securitization failures would foreclose questions about the bank’s actual wrongdoing, clearly they thought wrong. Days after the much-leaked-about $13 billion deal was finally announced, New York Times columnist Gretchen Morgenson looked at the admissions accompanying the settlement and wondered why it had taken the federal government so long to hold the bank accountable for conduct that’s been in the public domain for years. Morgenson’s column echoed posts at Bloomberg and Slate that also scoffed at JPMorgan “admissions.” On Monday, even a commissioner of the Securities and Exchange Commission piled on. Dan Gallagher, a Republican, criticized the settlement as a penalty on the bank’s current shareholders that’s not justified by JPMorgan’s admitted conduct. “It is not rational,” Gallagher told an audience in Frankfurt at an event organized by the American Chamber of Commerce in Germany.

At the heart of all of this criticism is a nagging suspicion that we don’t really know what the Justice Department had – or didn’t have – on JPMorgan, that the $13 billion settlement was not pegged to the bank’s actual misconduct but to the public relations benefits to both sides from a supposedly record-setting deal. Attorney General Eric Holder has called the size of the settlement a proportionate response to JPMorgan’s wrongdoing, but it’s tough to take that assertion on faith when the statement of facts that accompanied the settlement revealed so little about the government’s evidence.

The Federal Home Loan Bank of Pittsburgh believes that the government knows a lot more about JPMorgan’s securitization practices than it disclosed in the settlement agreement – and the FHLB’s lawyers at Robins, Kaplan, Miller & Ciresi are pretty sure those additional details are contained in a civil complaint against the bank that was drafted by the U.S. Attorney in Sacramento, California. At a closed-door hearing last Friday, Judge Stanton Wettick of the Allegheny County Court of Common Pleas heard Robins Kaplan argue that release of this “rich source of detailed facts about JPMorgan’s conduct” would serve the public’s interest in understanding the basis of the $13 billion settlement. JPMorgan’s lawyers at Sidley Austin, meanwhile, contend that the Justice Department never intended the complaint to be public but used it only as leverage in negotiations with the bank. Turning the document over to FHLB and the public, the bank asserts, would be contrary to Pennsylvania’s interest in promoting settlements, would violate attorney-client privilege and would accomplish nothing because Justice’s allegations are not related to claims by the FHLB. Judge Wettick did not issue a public ruling from the bench Friday and lawyers for JPMorgan and FHLB didn’t respond to my emails requesting comment. But if we’re ever going to find out more about the government’s dirt on JPMorgan, there’s a good chance it will be in the FHLB litigation.

BofA, JPMorgan travel opposite roads to end MBS liability

Alison Frankel
Oct 31, 2013 19:46 UTC

For a change, JPMorgan’s rollercoaster negotiations with state and federal regulators to resolve the bank’s liability for rotten mortgage-backed securities did not make news Wednesday. Has there ever been more public dealmaking between the Justice Department and a target? It feels as though the public has been made privy to every settlement proposal and rejection, as if we’re all watching a soap operatic reality show. Will there be a reunion episode if the bank and the Justice Department end up finalizing the reported $13 billion global settlement, with Eric Holder and Jamie Dimon shouting imprecations at each other?

Bank of America filled the MBS news vacuum Wednesday. Its quarterly filing with the Securities and Exchange Commission disclosed that the bank – under Justice Department investigation for its securitization practices – has bumped up its estimate of litigation losses in excess of its reserves to $5.1 billion. The filing also said that staff lawyers from the New York attorney general’s office have recommended a civil suit based on Merrill Lynch’s mortgage-backed securities.

BofA also had some good news, though. Late Tuesday, U.S. District Judge Mariana Pfaelzer of Los Angeles granted tentative approval to the bank’s $500 million Countrywide MBS class action settlement, despite objections to the deal from the Federal Deposit Insurance Corporation (on behalf of 19 failed banks that owned Countrywide MBS) and several other institutions. Perhaps even more importantly, on Wednesday, two significant objectors to BofA’s proposed $8.5 billion put-back settlement with private Countrywide MBS investors dropped their challenges to the deal. In separate letters to New York State Supreme Court Justice Barbara Kapnick, who has presided over a sporadic but nearly concluded trial on the settlement, three Federal Home Loan Banks and two Cranberry Park investment vehicles asked to withdraw from the proceeding. The remaining objectors, led by AIG, Triaxx and the FHLB of Pittsburgh, filed a strong post-trial brief summarizing their evidence that the proposed settlement was obtained through a “conflicted, back-room, closed-door process” and “cannot be endorsed without running roughshod over the absent certificateholders’ interests.” But the objectors’ ranks are dwindling, and late withdrawals by MBS certificate holders that actually helped try the opposition case has to increase the pressure on Justice Kapnick to bless the deal.

As MBS trustee put-back suits mount, Minn. case sets bad precedent

Alison Frankel
Oct 4, 2012 22:28 UTC

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.

BofA catches big break: Walnut drops challenge to $8.5 bln MBS deal

Alison Frankel
Jul 24, 2012 15:52 UTC

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.)

Hot new filing claims internal docs show rating agencies lied on MBS

Alison Frankel
Jul 3, 2012 04:40 UTC

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.

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