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Financial Services Law Insights and Observations


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  • 2nd Circuit addresses preclusion standard in dismissal of RMBS actions


    On April 26, the U.S. Court of Appeals for the Second Circuit upheld the dismissal of three residential mortgage-backed securities lawsuits tied to losses incurred during the 2008 financial crisis. The plaintiffs, issuers of collateralized debt obligations secured by RMBS certificates, sued several trust entities in separate lawsuits over the losses. According to the opinion, the district courts in each action assumed the plaintiffs had Article III standing but determined that they “were precluded from relitigating the issue of prudential standing” due to a related case they had previously brought against a different bank.

    The 2nd Circuit explained that the district court in the related case had determined that the plaintiffs lacked standing because they had “conveyed all right, title, and interest in the RMBS certificates”—including the full power to file lawsuits—to third parties when issuing their notes, which were secured by certificates in RMBS trusts, among other assets. Following the decision, the third parties reassigned the litigation rights associated with the RMBS certificates back to the plaintiffs, but the court granted summary judgment in favor of the bank, holding that the plaintiffs lacked both Article III and prudential standing. The 2nd Circuit “affirmed on the ground that the assignments were champertous and that [p]laintiffs thus lacked prudential standing,” assuming but not deciding the issue of Article III standing.

    With respect to the current lawsuits, the district court premised its dismissal on the finding that the plaintiffs were precluded from relitigating the issue of prudential standing by the holding in the related action. “In resolving an issue of first impression in this Circuit, we join the [9th] Circuit in concluding that the district courts permissibly bypassed the question of Article III standing to address issue preclusion, which offered a threshold, non-merits basis for dismissal,” the appellate court wrote. “In short, we fully agree with the district courts that [p]laintiffs were not entitled to a second bite at the prudential-standing apple after the [related] action. The district courts therefore did not err in taking this straightforward, if not ‘textbook,’ path to dismissal.”

    Courts Appellate Second Circuit RMBS Securities

  • Banking company pleads guilty to mortgage fraud

    Federal Issues

    On March 15, a Michigan-headquartered bank holding company agreed to plead guilty to securities fraud for filing misleading statements related to its 2017 initial public offering (IPO) and its 2018 and 2019 annual filings. According to the DOJ’s announcement, the bank holding company and its wholly owned subsidiary were under investigation over allegations that loan officers were encouraged to increase the volume of residential mortgage loan originations in order to artificially inflate bank revenue leading up to and following the IPO. The DOJ explained that the bank filed false securities statements about its residential mortgage loan program in its IPO, as well as in subsequent annual filings that “contained materially false and misleading statements that touted the soundness of the [] loans.” These loans were actually “rife with fraud,” the DOJ said and cost non-insider victim-shareholders nearly $70 million. Senior management allegedly knew that loan officers were falsifying loan documents and concealing the fraudulent information from the bank’s underwriting and quality control departments, the DOJ maintained, noting that the actions caused the bank to originate loans and extend credit to borrowers who would have otherwise not qualified.

    Under the terms of the plea agreement (which must be accepted by the court), the bank holding company will “be required to serve a term of probation through 2026, submit to enhanced reporting obligations to the department, and pay more than $27.2 million in restitution to its non-insider victim-shareholders.” The DOJ considered several factors when determining the criminal resolution, including the nature and seriousness of the offense and the pervasiveness of the misconduct at the most senior levels. The bank holding company received credit for its cooperation and for implementing extensive remedial measures, and has agreed to continue to fully cooperate with the DOJ in all matters relating to the covered conducts and other conduct under investigation. It is also required to self-report criminal violations and must continue to implement a compliance and ethics program to detect and deter future violations of U.S. securities law.

    As previously covered by InfoBytes, the bank holding company’s subsidiary paid a $6 million civil money penalty to the OCC last September for alleged unsafe or unsound practices related to the residential mortgage loan program.

    Federal Issues DOJ Fraud Enforcement Mortgages RMBS

  • 8th Circuit affirms almost $20 million in damages and attorney’s fees in RMBS action


    On February 2, the U.S. Court of Appeals for the Eighth Circuit affirmed a district court order requiring a mortgage lender to pay $5.4 million in damages and $14 million in attorney’s fees for selling mortgages that did not meet agreed-upon contractual representations and warranties to a now-defunct company that packaged and resold the loans to residential mortgage-back securities (RMBS) trusts. The now-defunct company was sued by the RMBS trusts after loans underlying the securitizations began defaulting at a high rate during the 2008 financial crisis. A liquidating trust was established to oversee wind-down measures after the company filed for bankruptcy. The liquidating trust later began suing originators for indemnification over the allegedly defective mortgages. In 2020, the district court ruled in favor of the liquidating trust and entered judgment for $5.4 million in damages, $10.6 million in attorney’s fees, $3.5 million is costs, $2 million in prejudgment interest, and $520,212 in “post-award prejudgment interest.” The district court found, among other things, that the lender had breached its client contracts, and that in doing so, contributed to the now-defunct company’s “losses, damages, or liabilities within the scope of the contractual indemnity.” The court also found the liquidating trust’s damages methodology to be reasonable and nonspeculative. The lender appealed, disagreeing with how the underlying contracts were interpreted, as well as the allocation of multi-party damages and the post-trial award of fees, costs, and interest.

    On appeal, the 8th Circuit disagreed, concluding that the terms of the parties’ contract made the lender liable. The appellate court also rejected the lender’s contention that it should not be expected to pay the claims against the now-defunct company because they were extinguished in bankruptcy, and that the methodology used to calculate the damages was inaccurate. In awarding $5.4 million in indemnification damages, the appellate court held that the district court properly found that the expert’s “‘calculation of damages was reasonable and non-speculative,’ and that his methodology produced a reasonably certain measure of [the liquidating trust’s] indemnifiable damages.” The 8th Circuit further concluded that the fee award was fair and that the district court had accounted for the complexity of the case and the importance of conducting a detailed loan-by-loan analysis. The appellate court also accused the lender of relitigating already decided issues and driving up the costs. However, the 8th Circuit did order the district court to recalculate the post-judgment interest award using guidance under 28 U.S.C. § 1961(a) rather than the 10 percent prejudgment interest rate under Minnesota law.

    Courts Appellate Eighth Circuit Mortgages RMBS Settlement Attorney Fees Interest

  • New Jersey reaches $495 million RMBS settlement with Swiss bank


    On October 17, the New Jersey attorney general’s office announced it had reached a $495 million agreement in principle with a Swiss bank to resolve allegations related to its residential mortgage-backed securities (RMBS) practices leading up to the 2008 financial crisis. The AG stated that if finalized, the settlement will be one of the state’s largest civil monetary recoveries in history. According to the AG, the bank violated New Jersey’s securities laws by making material misrepresentations about the risks of the RMBS in offering documents, including by purportedly failing to disclose to investors material defects about the underlying mortgages. The announcement further stated that the bank allegedly sold the RMBS through registration statements, prospectuses, and other offering materials that contained fraudulent representations about the quality of the underlying loans, and allegedly “failed to disclose to investors the wholesale abandonment of underwriting guidelines designed to ensure that the mortgage loans underlying its securities trusts were made in accordance with appropriate lending guidelines; that numerous loan originators had poor track records of defaults and delinquencies; and that some loan originators had even been suspended from doing business with [the bank].” While neither admitting nor denying the allegations, the bank agreed to pay a $100 million civil monetary penalty and will provide approximately $300 million in restitution for affected investors. The bank is also permanently enjoined from future violations of state securities laws.

    Securities State Issues Enforcement New Jersey State Attorney General Settlement RMBS Mortgages Of Interest to Non-US Persons

  • Bank agrees to pay $1.8 billion to settle RMBS bond insurance claims


    On October 7, a national bank announced in a regulatory filing that it has agreed to pay $1.84 billion to settle claims brought by a bond insurer concerning policies provided on residential mortgage-backed securities before the 2008 financial crisis. According to the regulatory filing, the agreement will “resolve all pending [bond insurer] lawsuits” (containing damages claims of more than $3 billion) against the bank and its subsidiaries, will cause all pending litigation to be dismissed with prejudice, and will release the bank and its subsidiaries from “all outstanding claims” related to bond insurance policies for certain securitized pools of residential mortgage loans.

    Courts Settlement RMBS Mortgages Insurance

  • New York Court of Appeals narrows trust’s RMBS repurchase action


    On March 17, the New York Court of Appeals majority narrowed the scope of a 2013 repurchase action brought by the trustee of a residential mortgage-backed securities trust (trustee) against the trust’s sponsor (sponsor). The trustee filed suit after flagging roughly 1,204 nonconforming loans that were allegedly “in breach of the representations and warranties based on, among other things, borrower misrepresentation of income and occupancy status, miscalculations of borrowers’ debt to income ratios, and the charging of high-cost interest on the loans.” The trustee demanded that the sponsor buy back the defective loans as contractually promised. A separate, smaller set of loans was eventually added to the suit after being identified as defective during the discovery phase. The trustee contended that the original repurchase demands were sufficient under the repurchase protocol to satisfy the notice requirement for all allegedly problematic loans in the trust, including loans flagged after litigation had begun.

    The sponsor moved for partial summary judgment on the trustee’s claims, arguing that the trustee could not pursue recovery for loans “not specifically identified in the pre-suit letters to the extent that the trustee relied on a notice, rather than an independent discovery, theory.” The sponsor also sought summary judgment with respect to the method of calculation of the repurchase price. The New York Supreme Court denied the sponsor’s motion for partial summary judgment, concluding, among other things, that “‘because the repurchase letters identified some timely claims, the later identified claims relate back to the original filing.’” The appellate division affirmed, stating that the trustee’s December 2011 letter timely informed the sponsor “that a substantial number of identified loans were in breach, and that the pool of loans remained under scrutiny, with the possibility that additional nonconforming loans might be identified.” The appellate division also agreed “that ‘interest could be calculated on liquidated loans, at the applicable mortgage rate, up until the repurchase date.’”

    In narrowing the scope of the loans subject to repurchase, the Court of Appeals majority held that it would be “inconsistent” with the contractual language of the repurchase protocol to conclude that loan-specific notice is not required, adding that the trustee could not rely on the relation back doctrine “to avoid the consequences of its failure to comply with the contractual condition precedent with respect to the loans in question prior to commencing this action.” “The parties agreed to a limited remedy for the inclusion of nonconforming loans in the trust and made that remedy available only if the trustee first complied with certain loan-specific notice requirements, providing the sponsor an opportunity to cure or repurchase the identified loans,” the majority wrote. “We cannot rewrite the contract by substituting a different, post-suit notice procedure in place of the one chosen by the parties.” The majority further concluded that under the parties’ agreement, interest recoverable on liquidated loans was limited to interest that accrued prior to liquidation.

    The dissenting judge disagreed, stating that “[i]t could not have been the intent of the parties to provide a remedy for a few defective loans but allow for systemwide breaches affecting thousands of loans in the pool—allegedly 80% here—or to permit the sponsor to escape the contractual cure and repurchase obligations simply because [the sponsor] was informed there was a significant problem with its securitization but not given the corresponding number for every loan it allegedly failed to properly vet.”

    Courts RMBS State Issues Mortgages

  • District Court says NY champerty statute bars RMBS suit


    On February 8, the U.S. District Court for the Southern District of New York issued an opinion granting in part and denying in part defendants’ motion for summary judgment and denying plaintiffs’ motions for partial summary judgment in parallel actions concerning pre-2008 residential mortgage-back securities (RMBS) trusts. In both cases, plaintiffs—RMBS certificateholders—filed suit alleging breaches of contractual, fiduciary, statutory, and common law duties with respect to certificates issued by RMBS trusts for which two of the defendants’ units served as trustee. Both plaintiffs alleged that the defendants failed to follow through on obligations to monitor the pre-2008 RMBS trusts that they administered. However, the court partially ruled in favor of the defendants, concluding that one set of plaintiffs could not avoid their loss in an RMBS trustee case brought against a different national bank, in which the court deemed the plaintiffs lacked a valid legal right to sue. In that matter, the U.S. Court of Appeals for the Second Circuit issued an opinion last October, agreeing with a different New York judge that “found the assignments champertous under New York law, rendering them invalid and leaving Plaintiffs without standing.” According to the 2nd Circuit, district court findings showed it was clear that the assignments were champertous “as they were made ‘with the intent and for the primary purpose of bringing a lawsuit.’”

    The district court noted that the assignments of all the claims in the current matter were essentially identical to the issue already decided by the 2nd Circuit, and saw sufficient overlap to find the plaintiffs’ vehicles “collaterally estopped” from relitigating the issues of prudential standing and champerty. “The issues decided by the court of appeals relating to champerty and prudential standing are dispositive of the present action,” the court wrote. “Without prudential standing, the [] plaintiffs cannot assert claims arising out of the certificates and the entire [] action must be dismissed.” With respect to the other set of plaintiffs, while the court allowed certain claims to stand, it declined to grant any portion of the joint partial summary judgment related to the defendants’ alleged responsibilities as trustee, ruling that plaintiffs must prove those claims at trial.

    Courts RMBS Mortgages Champerty Appellate Second Circuit New York State Issues

  • FDIC discusses post-financial crisis legal claims and enforcement proceedings

    Recently, the FDIC reported on legal claims and enforcement proceedings taken by the agency during the financial crisis in the years from 2008 to 2013. During this time period, the FDIC stated it “pursued and defended more legal claims in both its receivership and corporate capacities than during the savings and loan and banking crisis of the 1980s and early 1990s.” In its receivership capacity, the FDIC investigated and litigated many professional liability claims and sought to enter and collect on criminal restitution and forfeiture orders related to failed banks. The agency also pursued many enforcement claims and other actions related to both open and failed banks in its corporate capacity. The report discussed numerous topics, including the FDIC’s investigation into the residential mortgage-backed security (RMBS) portfolios of failed insured depository institutions (IDIs), which often “revealed that RMBS portfolios suffered heavy losses because the credit quality of loans collateralizing the RMBS was much lower than the credit quality represented in the RMBS offering documents.” Ultimately, 19 lawsuits were filed by the FDIC on behalf of eight receiverships seeking damages based on the IDIs’ purchases of RMBS. Other significant topics discussed within the report focus on LIBOR suppression claims, residential mortgage malpractice and/or mortgage fraud, criminal claims and recovery, income tax refund litigation, and administrative enforcement proceedings, among others.

    Bank Regulatory Federal Issues FDIC Enforcement RMBS

  • Bank subsidiary to pay $604 million for RMBS defects


    On January 25, the Supreme Court of the State of New York ordered an investment bank subsidiary (defendant) to pay nearly $604 million, plus pre-judgment contractual interest, to an insurance company (plaintiff) for allegedly breaching the representations and warranties contained in a pooling and servicing agreement (PSA) for mortgages contained in the residential mortgage-backed securities (RMBS) it sold in 2007. According to the November 2020 post-trial order, the plaintiff issued irrevocable insurance policies that “unconditionally guaranteed payment of principal and interest to certificate holders of the RMBS transactions.” After the 2008 financial crisis, 51 percent of the original loan balances of the related mortgages held in the insured trust defaulted, and in July 2009, the plaintiff began to send mortgage repurchase demand letters to the defendants. Following the defendant’s refusal to repurchase the loans, the plaintiff subsequently commenced the action, alleging that the defendant breached the representations and warranties contained in the PSA. At trial, the trial court concluded that the plaintiff “convincingly proved” that “more than half of the securitized loans were materially non-conforming” and should be awarded compensation for its losses, as the plaintiff “did not assume the risk of loss that [the non-confirming loans] posed.” However, the court further determined that the plaintiff could not recover damages that were not “directly attributable to the materially non-confirming loans.” After directing the parties to file letters addressing remaining issues before the entry of monetary judgment, the court determined that the repurchase date for determining damages should be 90 days after the repurchase trigger (the date of notice from plaintiff) and not the date of breach. Therefore, based on a repurchase date of October 28, 2009, the court ordered the defendant to pay nearly $604 million in damages to the plaintiff. 

    Courts RMBS Mortgages

  • District court grants bank’s partial summary judgment in FDIC RMBS suit


    On March 11, the U.S. District Court for the Southern District of New York granted partial summary judgment in favor of the securities arm of a large banking group (defendant) in an FDIC suit alleging securities violations in the offering, sale, or distribution of residential mortgage-backed security (RMBS) certificates to a now failed bank. As receiver for the failed bank, the FDIC filed suit in 2007 concerning, among other things, two senior certificates purchased by the failed bank. The FDIC alleged that the defendant omitted key facts and made numerous false statements of material fact to sell RMBS certificates to the failed bank and additionally performed due diligence on the underlying loans, thus participating in the distribution of the certificates. The agency further alleged that although the defendant “did not directly purchase or sell the senior certificates, [the defendant] is still an underwriter as defined under the Securities Act because of its ‘direct or indirect participation’ in the distribution of the senior certificates.”

    The court sided with the defendant, finding that even though its “due diligence and review of prospectus supplements helped facilitate the securities offerings, those activities do not involve the purchase, offer, or sale of the securities and thus are not part of their distribution.” The court reasoned that the prospectus supplements of the senior class certificates specifically state that the defendant was only an underwriter for the subordinated class certificates and not for the senior class certificates purchased by the failed bank. Accordingly, the court granted the defendant’s motion for partial summary judgment, dismissing the two claims with respect to the senior certificates.

    Courts FDIC RMBS


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