Trust, Trustees, Constructive Trust, Fiduciary Duties

Editor’s Note: I am currently working on the issue of fiduciary duty, so I would appreciate receiving material from any of you that have submissions on the subject.
There is an article in the Florida Bar Journal this month on this topic. “If a fiduciary has special skills or becomes a fiduciary on the basis of representations of special skills or expertise, the fiduciary is under a duty to use those skills” . P. 22 Florida Bar Journal March, 2010 , “Understanding Fiduciary Duty” by John F Mariani, Christopher W Kammerer and Nancy Guffey Landers. So if a party presents itself to a borrower as a “lender” one would reasonable presume that they employed one or more underwriters who would perform due diligence on the loan, property and viability of the transactions including borrower’s income, affordability etc. A borrower would NOT reasonably presume that the “lender” didn’t care whether or not they would make the payments now or at some time in the future when the loan reset.
It is a fascinating subject, but the area I am centering in on, is the presumption of a trusted relationship giving rise to a fiduciary duty where (1) the superior party takes on MORE tasks than called for by the contractual relationship between the two would normally imply, and (2) where the transaction is so complex and the knowledge one of the parties so superior, that the injured party is virtually forced to rely on the superior party.
It doesn’t hurt either where the borrower is told not to bother with an attorney (“You can’t change anything anyway,” or “These documents are standard documents using Fannie Mae, FHA, HUD, Freddie Mac forms” etc.). Trust me, nobody who wrote those forms had nominees or MERS in mind when they were prepared.
The issue is particularly important when we look at the layers of Trustees (implicit or explicit) in each of the securitized transactions. Whether it is the Trustee on the Deed of Trust who obviously has duties to both the Trustor (homeowner) and beneficiary (?!?), the Trustee for the aggregate pool under the pooling and service agreement, The Trustee of the Structured Investment Vehicle which typically off shore, the so-called Trustee for the SPV (REMIC) that issued the mortgage backed securities, each of whom presumptively is the successor to the “Trustees” before it, we are stuck with layers upon layers of documents that contain discrepancies within the documents and between the provisions of the documents and the actions of the parties.
You also have the key issue that the true chronology of events differs substantially from the apparent chronology, starting with the fact that the mortgage backed securities were sold prior to the funding of the loan, the assignment and assumption agreement was executed prior to the borrower being known, and the pooling and service agreement also executed prior to any transaction with the borrower.
The use of “close-out” dates and the requirement that assignments be recorded or in recordable form creates another layer of analysis. On the one hand you have clear provisions that explicitly state that the “loan” is not accepted into the alleged “trust” while on the other hand you have the parties acting as though it was accepted into the “trust.”
You have entities described as trusts that have no property, tangible or intangible in them, and “trustees” named where the enabling documents chips away relentlessly at the powers and duties of the trustee leaving you with an agent whose powers are so limited they could be described as a candidate to be an agent rather than one with actual agency powers.
The laws allowing the borrower to claw back undisclosed fees and profits are obviously based upon the presumption that the party who received those fees had some duty toward the borrower to act in good faith, knowing that the borrower was relying upon them to advise them correctly. Steering them into a loan that is likely or guaranteed to put them into foreclosure is obviously a breach of that trust, and taking compensation to act against the interest of the borrower is exactly what Truth in Lending and deceptive lending laws are all about.
The article below clearly highlights the issues. The agent or broker gets paid only upon “closing the sale.” The agent gets paid a standard industry fee for doing so. But when the fee is a yield spread premium or some other form of kickback or rebate undisclosed to the borrower, the debtor ends up in a product that is not easily understood and is probably better for the “ledner” than the loan product that would have been offered if the “lending parties” were acting in good faith.
So this article should be read with an eye toward applying similar fact patterns to the securitized loan situation where the loan originator was in many cases not even a bank but looked like a bank to the borrower.
In the securities industry the issue is in flux more than the laws applying to mortgages where the investment represents the entire wealth of many borrowers. The stakes are usually much higher than in an individual stock purchase transaction.
March 4, 2010

Trusted Adviser or Stock Pusher? Finance Bill May Not Settle It

You have probably seen the television commercial, the one where you seem to be watching an intimate conversation between family members. But at the end, you learn that the conversation was actually between a broker and his client.

The advertisement is meant to evoke the idea of financial adviser as confidant, and is part of brokerage firms’ broader effort in recent years to recast their image — from mere stock pushers to trustworthy advisers.

But in interviews, former and current brokers said the ad told only part of the story. All said their jobs depended less on giving advice and more on closing sales. The more money they brought in, the more they, and their firms, would earn.

“I learned a lot about being a good salesman at Merrill,” said David B. Armstrong, who left Merrill Lynch after 10 years and with partners started an advisory firm in Alexandria, Va. “The amount of training I sat through to properly evaluate investment opportunities was almost nonexistent relative to the training I got on how to sell them.”

While the issue of broker responsibility is not new, it has resurfaced as Congress has been considering financial overhaul legislation. In his original draft, Senator Christopher J. Dodd, chairman of the Senate Banking Committee, proposed requiring brokers to put their customers’ interests first — what is known as fiduciary duty — when providing investment advice. But in recent weeks, the chances of this proposal’s making it into the bill began to dim.

Senator Tim Johnson, a South Dakota Democrat on the Banking Committee, has proposed an 18-month study of the brokerage and investment advisory industries, an effort that would replace Senator Dodd’s provision.

Imposing a fiduciary requirement could have an impact on investment firms’ profits. Guy Moszkowski, a securities industry analyst at Bank of America Merrill Lynch, said that the impact of a fiduciary standard was hard to determine because it would depend on how tightly the rules were interpreted. But he said it could cost a firm like Morgan Stanley Smith Barney as much as $300 million, or about 6 to 7 percent of this year’s expected earnings, if the rules were tightly defined. “It’s very nebulous, but I think that is a reasonable estimate,” he added.

In a research report about Morgan Stanley last year, Mr. Moszkowski wrote, “Financial advisers will be expected to take into account not just whether a product or investment is suitable for the client, but whether it is priced favorably relative to available alternatives, even though this could compromise the revenue the financial adviser and company could realize.”

Technically speaking, most brokers (including those who sell variable annuities or the 529 college savings plans) are now only required to steer their clients to “suitable” products — based on a customer’s financial situation, goals and stomach for risk.

But Marcus Harris, a financial planner who left Smith Barney 10 months ago to join an independent firm in Hunt Valley, Md., said the current rules leave room for abuse. “Under suitability, advisers would willy-nilly buy and sell investments that were the flavor of the month and make some infinitesimal case that they were somehow appropriate without worrying,” he said.

Kristofer Harrison, who spent a couple of years at Smith Barney before leaving to work as an independent financial planner in Clarks Summit, Pa., said the fact that brokers were paid for investments — but not advice — also fostered the sales mentality.

“The difficulty I had in the brokerage industry” he said, “is that you don’t get paid for the delivery of financial advice absent the sale of a financial product. That is not to say the advice I rendered was not of professional quality, but in the end, I always had the sales pitch in the back of my mind.”

Mr. Armstrong, Mr. Harris and Mr. Harrison all said they had decided to become independent because they felt constrained by their firms’ emphasis on profit-making and their inability to provide comprehensive advice.

A current branch manager of a major brokerage firm who did not want to be identified because he did not have his employer’s permission to speak to the media, confirmed that “you are rewarded for producing more fees and commissions.” While he said that “at the end of the day, I think that the clients’ interests are placed first and foremost by most advisers,” he added that “we are faced with ethical choices all day long.”

Brokers are typically paid a percentage of fees and commissions they generate. The more productive advisers at banks and big brokerage firms could collect 50 percent of the fees and commissions they generate, said Douglas Dannemiller, a senior analyst at Aite Group, a financial services research group.

The firms may also make money through other arrangements, including what is known as revenue sharing, where mutual fund managers may, for instance, agree to share a portion of their revenue with the brokerage firm. By doing this, the funds may land on the brokerage firm’s list of “preferred” funds. Some brokerage firms, including Merrill Lynch and Morgan Stanley Smith Barney disclose their revenue sharing information on their Web sites, or at the point of sale. Edward Jones discloses it as well, as the result of a settlement of a class-action lawsuit. UBS and Wells Fargo Advisors declined to comment on whether it discloses this information.

Unlike fiduciaries, brokers do not have to disclose how they are paid upfront or whether they are have incentives to push one investment over another. “The way the federal securities law regulates brokers, it does not require the delivery of information other than at the time of the transaction,” said Mercer E. Bullard, an associate professor at the University of Mississippi School of Law who serves on the Securities and Exchange Commission’s investment advisory committee.

The legislative language on fiduciary responsibility was one part of the financial overhaul bill aimed at protecting consumers’ interests. Another part, setting up an independent consumer protection agency, may also be watered down.

The study proposal by Senator Johnson may be included in the actual bill, which means it would not be subject to debate. And consumer advocates contended that the study would stop regulators from making any incremental consumer-friendly changes until the study was completed. The study would also require the S.E.C. to go over territory already covered in a 228-page study, conducted by the RAND Corporation in 2008 at a cost of about $875,000, the advocates said.

“In my opinion, the Johnson study is a stalling tactic that will either substantially delay or totally prevent a strong fiduciary standard from being applied,” said Kristina Fausti, a former S.E.C. lawyer who specialized in broker-dealer regulation.

“The S.E.C. has been studying issues related to investment-adviser and broker-dealer regulation and overall market conditions for over 10 years,” she said. “It’s puzzling to me why you would ask an agency to conduct a study when it is already an expert in the regulatory issues being discussed.”

Even after the study was completed, legislation would still need to be passed to give the S.E.C. authority to create a fiduciary standard for brokers who provide advice. “As we all know, the appetite for doing this in one or two years is certainly not going to be what it is today,” said Knut Rostad, chairman of the Committee for the Fiduciary Standard, a group of investment professionals advocating the standard. His group circulated an analysis that tried to illustrate where answers to the study’s questions could be found.

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