LITIGATION AHEAD: The Mortgage-Backed Securities Mess

Legal/Regulatory

The Mortgage-Backed Securities Mess

October 22, 2010, 10:00 am

White Collar Watch - DealBook

Peter J. Henning follows issues involving securities law and white-collar crime for DealBook’s White Collar Watch.

While much of the focus lately has been on problems with home foreclosures, the greater threat to financial firms like Bank of America is likely to come from potential liabilities related to billions of dollars of mortgage-backed securities. The Federal Reserve Bank of New York and others are trying to force banks to buy back problem mortgage loans, and Bank of America has vowed to fight demands to take back loans that were not underwritten properly.

More troublesome than that, the Securities and Exchange Commission and plaintiffs’ lawyers may start circling Bank of America and other banks that played a large role in the securitization process, possibly pursuing fraud claims in lawsuits that may challenge the truthfulness of disclosures made in peddling the securities.

About White Collar Watch

Peter J. Henning, writing for DealBook’s White Collar Watch, is a commentator on white-collar crime and litigation. A former lawyer at the Securities and Exchange Commission’s enforcement division and then a prosecutor at the Justice Department, he is a professor at the Wayne State University Law School. He is currently working on a book, “The Prosecution and Defense of Public Corruption: The Law & Legal Strategies,” to be published by Oxford University Press.

Mary L. Schapiro, the chairwoman of the S.E.C., said this week that “whenever there are suggestions that there may have been any kinds of issues with respect to disclosure, misrepresentations or omissions, we are always looking at that kind of conduct.” That means disclosures that companies made to their own shareholders will be looked at, as well as what was said about the value of the loans packaged into mortgage-backed securities that the banks sold to various investors.

The mortgage-backed securities market was transformed from a small niche in the bond market into a trillion-dollar sector as companies like Countrywide Financial, later acquired by Bank of America, generated huge numbers of home loans that were quickly packaged and sold to investors to fund even more loans. When the housing market started collapsing in 2007, so too did the value of the securities sold, as more loans went into default and the terms of a number of mortgages were modified to avoid foreclosing on properties.

Some investors have challenged these mortgage modifications, which reduced the value of the mortgages in a securitized pool, by trying to force the lenders to take back the loans at full value.

Unfortunately, the servicing agreements for the mortgage-backed securities, often made by the banks that issued the securities, are quite protective of the issuer — no great surprise there — and provide few means for investors to challenge decisions that affect the pool of loans underlying their investments.

A recent decision from the New York State Supreme Court in a case that Greenwich Financial Services brought against Countrywide highlights how the roadblocks put in place in these servicing agreements prevent investors from suing the lender that put together the mortgage-backed securities. The court dismissed Greenwich Financial’s lawsuit, which sought to force Bank of America to buy back any mortgages that had been modified because mortgage modifications that reduced loan payments undermined the value of the securities.

Under the servicing agreement, an investor can sue for a breach of contract only if it has the voting rights to 25 percent of the securities in the trust created to hold the mortgage loans, and the New York court rejected the plaintiff’s argument that its complaint was in reality a class-action on behalf of all owners of the securities, so it did not need to meet the 25 percent threshold.

The S.E.C. will not face the same hurdle if it determines that an issuer of mortgage-backed securities misled investors about the risks or did not fully disclose potential problems if loans could not successfully go into foreclosure and the properties seized. An investigation of the banks that issued these securities could take months and involve millions of records, with the possibility that the S.E.C. would seek monetary penalties if it finds investors were misled.

The S.E.C. has already sued Goldman Sachs for its disclosures related to a fairly esoteric derivative security, and that case may provide a template for the types of case that the commission may pursue for banks that it accuses of misleading mortgage-backed securities investors — even sophisticated ones — about the risks from foreclosure problems and obligations to take back loans that were improperly issued.

An S.E.C. investigation may also send a signal to plaintiffs’ lawyers to consider pursuing securities-fraud class-action suits on behalf of investors in the mortgage-backed securities. Although the servicing agreements limit the ability to file lawsuits alleging breach of contract, they would not limit the right of an investor to sue issuers and underwriters of the securities for fraud or misstatements in connection with the sales.

The main antifraud provision of the federal securities laws, Section 10(b) of the Securities Exchange Act of 1934, applies to the sale of any security, and the right to pursue a remedy cannot be eliminated by a contract between the buyer and seller. In addition, some investors may be able to file claims under Sections 11 and 12(a)(2) of the Securities Act of 1933 for misstatements or omissions if a registration statement and prospectus were used in connection with the sale of the mortgage-backed securities.

One problem that investors may face in pursuing a private remedy is avoiding the statute of limitations for their securities claims. For a suit under Section 10(b), they have two years from discovery of the fraud or five years from when it occurred to file their claim, while Sections 11 and 12(a)(2) claims must be brought within one year of discovery and three years of the securities filing. This could limit claims to securities issued in just the last two years or so before the mortgage-backed securities market froze up, although any suits would still involve billions of dollars of securities.

There seems to be the potential for an almost unimaginable amount of litigation arising from the fallout from the collapse of the housing market. The problems with documents in foreclosure proceedings and the attendant government investigations may be just the tip of the iceberg if the S.E.C. finds misstatements and omissions were made in the issuance of mortgage-backed securities and investors pursue fraud claims against the banks that pooled mortgages and peddled them to investors.

– Peter J. Henning

Ruling in Greenwich Financial’s Lawsuit Against Countrywide

19 Responses

  1. Mortgage backed securities mainly issued by United States institutions have become toxic assets in the balance sheets of the world’s banks, whose fault is this?

  2. Can anyone tell me if this FDIC final rule adopted Oct 8, 2010 regarding Securitizations affects the current slew of foreclosure legal issues and will give the lenders a “get of jail free” card to do what they want? see:
    http://www.mondaq.com/unitedstates/article.asp?articleid=112372&tw=0

  3. There are so many legal loss leaders in this quest for the answers to prevailing.

    In California, it appears the loss of ownership for assets (“loan”) and the mere servicing role they maintain is sufficient to bring action for the failure to comply with section 2932.5 of the Code of Civil Procedure which governs the power of sale under an assigned mortgage and Bus. & Prof. Code Section 17200, et seq. (17200) various other provisions of the California Civil Code, various provisions of the Financial Code, and other statutory and common law in effect.

    Whets so amazing to me is the obvious and need to bypass the single most damaging element of fraud. That point of judicial quandary is no doubt the alleged breach of accounting rules and violation attributed to FAS 140.

    Registrants use a separate institution, or special purpose entity for capitalizing the base capital requirements for a proposed securitization of asset backed securities.

    The special purpose capital vehicle creates and sells the securities, using the proceeds of the sale to remunerate for cash the loans pooled and offered by the bank.

    Therefore the underlying assets the FDIC member bank originated are the basis for capitalization used to create a waterfall of term securities instruments. The effort is not possible without the ability of the FDIC member bank to transfer the entire economic benefits of a mortgage whole loan to the SPE in exchange for cash.

    Problem one is the closed whole loans are now recognized as a capital contribution to a balance sheet. The balance sheet is the source of the investment capitalization process used to sell certificates to members of an indentured trust.

    Problems two is this was , till as of late, an accounting scheme used to sell mortgage receivables at a discount, in a way that transferred most—but not all—of the collection risk to a third party.

    Under the old accounting rules such transfers could typically be treated by the bank as a sale, where the asset disappears from the balance sheet and is replaced by cash.

    Therefore the bank should not possess the note of files collateral nor should it be allowed to do much more than authorize its rights to collect checks from a lock box.

    To this extent the bank is lost to the loans it used to capitalize a trust investment and gain tax preferential treatment thought is affiliated REMIC platform.

    Here is the special purpose vehicle responsible for “bundling” the underlying assets into a specified pool that will fit the risk preferences and other needs of investors who might want to buy the securities, for managing credit risk—often by transferring it to an insurance company after paying a premium—and for distributing payments from the securities.

    As long as the credit risk of the underlying assets is transferred to another entity the originating bank removes the value of the underlying assets from its balance sheet and receives cash in return as the asset backed securities are sold. It is a transaction which can improve its credit rating and reduce the amount of capital that it needs.

    Therefore there is no way in hell the bank foreclosing or the nominee it identified on the deed can be shown to have any controlling interest, as in a foreclosure or even failed modification effort.

    It’s a simple pleading we assist counsel with in allowing plaintiffs to zero in on the facts and show proper cause for claiming a right to rescind a sale.

    expert.witness@live.com

  4. I have sued for conspiracy to commit fraud, between MERS, the servicer, the lender, the securitizer, and the trustee.

  5. Would claiming 15-15d status so quickly indicate that there were never more than 300 investors so as soon as they could they quit filing, or that multiple smaller investors sold off their interests to larger entities??? and if they did, we would have an additional non-disclosed transfer??? My trust shows 4 investors, yes 4.

  6. All the SEC Trusts I have ever looked at had a Form 15d filed usually within a few months of the initial filing. It can mean that the Trust was disolved or that there were less than 300 certificates sold…<300 they don't have to report in SEC filings anymore .

  7. Order the Orange Jump Suits

  8. donna – thru discovery and then I went to the SEC website and found the PSA and Prospectus.Basically the Trustee gave me all the info on them.

    withdrawn- I believe the 15-15d is just a suspension of the need to file because of a limitednumber of investors. But don’t qoute me onit.

  9. Since I haven’t got a response in other postings, I’ll try here. Can anyone familiar with SEC filings tell me what, exactly, a 15-15d filing represents? Does it indicate a closure of the trust, just a suspension of the need to file because of a limited number of investors (with the requirement to resume at a later date if the number goes up again), and if the latter, why did every CWALT trust I’ve looked at file a 15-15d within a couple of months of closing date?

  10. Donna

    That’s a federal statute. The fraud has to be against the U.S. Govt or an agency thereof. The counties are not agencies thereof.

    Bob

  11. Sounds like a successful summary judgement motion.

  12. The originator or OL is defunct, The Depositor went under and was bought out by the trustee.

  13. If your note was never sold to the depositor or trust, they will likely try and go back to the originator(or whomever took over their assets) and get them to recreate the paper trail. I can’t believe that would/can be legal. But if you read Gretchen Mortenson’s article in the NYT today, she seems to think a “recreate the paper trail” solution is viable.

  14. My PSA says cut off date was 6/1/2003, prospectus says the closing date was 6/30/2003 can’t go back and fix it now.

  15. right now I’m awaiting a jury trial, but I’m ready to file a motion for summary judgement.

  16. Oh Donna I know, Mers, the Trustee,the successor trustee and the servicer upon information and belief has conspired together. the servicer said they sold the Note but they didn’t, then the successor trustee filed an assignment in the ROD stating Mers hereby assigns, set over transfers all it’s interest in the NOTE and mortgage. Two things in my case , 1: Mers said that they acting in the name of the corporation which was my original lender that is defunct since 2005. And #2 the most important part of this sham , The original lender deactivated the MIN # and removed the loan from the MERS system in 2002! The unlawful and fraudulent assignment was filed in 2009. A robo -signer signed that document from MERS.

  17. I have the info to prove securities fraud, I have a sworn affidavit from the servicer which was also the seller into the Bear Stearns Asset Backed Securities that they say although they sold the Note to the trustee it appears that a written assignment was never prepared. Well that is all good because the seller couldn’t sell directly to the trust! The seller sold to the depositor and the depositor sold to the trust, so in my case they was never a sale into the securities. So the successor trustee that is foreclosing on me is not and will never be able to be owner and holder of the note, the depositor either. As for the seller/servicer all they could give was a lost Note affidavit and no where in that document is an assignment or transfer of right, title or interest.

  18. WHAT if you have a loan that was not securtized? But the lender/creditor knew the loan could not be paid back, has the 2nd worst ranking in FLorida for non perfromting loans at 23% and even after admission by the bank, that it knew the borrower could not make the payments of $1600 as agreed the lender raised the payments to $3,100. WHAT CAN I SUE FOR.

    oh they got TARP funds too.

  19. Great, but will courts find that a nullity as to the mortgage deed was created when the notes were transferred into the trusts? That is the real question.

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