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Financial Services Law Insights and Observations


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  • FDIC finalizes securitization safe harbor

    Agency Rule-Making & Guidance

    On January 30, the FDIC adopted the Final Rule to Revise Securitization Safe Harbor Rule (rule) as recommended by FDIC staff in a memorandum dated January 23. In July, as previously covered by InfoBytes, the FDIC approved a proposal to remove the requirement that, for safe harbor treatment, “the documents governing a securitization issuance require compliance with Regulation AB” of the SEC Regulation AB, “in circumstances where Regulation AB is not, by its terms, applicable to that transaction.” The proposal suggested that “it is no longer clear that compliance with the public disclosure requirements of Regulation AB in a private placement or in an issuance not otherwise required to be registered is needed to achieve the policy objective of preventing a buildup of opaque and potentially risky securitizations such as occurred during the pre-crisis years, particularly where the imposition of such a requirement may serve to restrict overall liquidity.” The final rule—which is unchanged from the proposal—eliminates the “significant disclosure requirements” to no longer mandate that private placements of securitization obligations provide Regulation AB disclosures. With the adoption of the final rule, only those transactions that are subject to Regulation AB are required to make the disclosures. The rule is expected to increase the securitization of residential mortgages and will become effective 30-60 days after it is published in the Federal Register.

    Agency Rule-Making & Guidance FDIC Derivatives Bank Regulatory Deposit Insurance Securities Securitization Safe Harbor Rule RMBS Disclosures Mortgages SEC

  • International bank’s motion to dismiss denied in RMBS suit


    On December 10, the U.S. District Court for the Eastern District of New York issued a memorandum and order denying an international bank’s motion to dismiss a DOJ suit filed in 2018. As previously covered in InfoBytes, the DOJ alleges the bank and several affiliates violated the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) by misleading investors and rating agencies in offering documents and presentations regarding the underwriting quality and other important attributes of the mortgages they securitized into residential mortgage-backed securities (RMBS) for sale to investors during the financial crisis. Specifically, the complaint alleges (i) “mail fraud affecting federally-insured financial institutions (FIFIs)”; (ii) wire fraud affecting FIFIs; (iii) bank fraud; (iv) “fraudulent benefit from a transaction with a covered financial institution (FI)”; and (v) “false statements made to influence the actions of a covered FI.” The DOJ seeks the maximum civil penalty.

    According to the district court’s memorandum, the bank’s motion to dismiss sets forth a number of arguments, including, among other things, a failure to sufficiently plead fraudulent intent and the particular circumstances constituting fraud, and a lack of personal jurisdiction, all with which the court rejected. Specifically, the bank suggested that the DOJ’s complaint did not show that the bank “acted with fraudulent intent,” or that the bank committed “bank fraud, [made] fraudulent bank transactions, and [made] false statements to banks.” The memorandum rejects the bank’s claims, adding that personal jurisdiction over the bank and its affiliates is shown “based on [the bank’s] origination of loans” in New York.

    Courts Financial Institutions RMBS Fraud DOJ False Claims Act / FIRREA Securitization

  • District Court rejects sampling-related expert discovery in RMBS action


    On November 18, the U.S. District Court for the Southern District of New York denied an investment company’s request to use “sampling-related expert discovery” in its action against a trustee of five residential mortgage-backed securities (RMBS), concluding that the proposal was not proportional to the needs of the case. As previously covered by InfoBytes, the investment company filed suit against the trustee alleging the trustee “failed to fulfil certain contractual duties triggered by the discovery of breaches of ‘representations and warranties’” when the underlying mortgages allegedly were found not to be of the promised quality. The investment company also alleged that the trustee failed to exercise its rights to require the companies that sold the mortgages in question “to cure, substitute, or repurchase the breaching loans.” After being denied class certification by the court in February, the investment company preemptively moved for an order from the court allowing it to use sampling-related expert discovery—a process which “engage[s] experts to select samples of mortgage loans from each of the five trusts and to perform analyses on those samples of loans to extrapolate information about the quality of all of the loans in the trusts.”

    The court denied the request, calling the proposed sampling a “blind corner.” The court noted that the “breach rate evidence” that would be discovered by the sampling “only provides substantial probative value for [the investment company’s] claims if [the investment company] can demonstrate that [the trustee] was under an obligation to conduct an investigation of the loans in each of the trusts,” which the investment company has failed to do. Because “the probative value of that discovery hinges upon a factual theory that [the investment company] has yet to demonstrate is viable,” the court could not justify allowing the parties to expend hundreds of thousands of dollars on the proposed sampling.

    Courts RMBS Mortgages Securities Discovery

  • SEC seeks input on RMBS asset-level disclosure requirements


    On October 30, the SEC requested public input on asset-level disclosure requirements for residential mortgage-backed securities (RMBS). The current requirements, which were adopted in 2014 in response to the financial crisis, require issuers to disclose a wide range of data on each mortgage loan in the underlying pool at the time of an offering and on an ongoing basis. As previously covered by InfoBytes, in September, the U.S. Treasury Department released a Housing Reform Plan, which, among other things, recommended that the SEC review the RMBS asset-level disclosure requirements to assess the number of required reporting fields and to clarify certain defined terms for SEC-registered private-label securitization offerings. In response to Treasury’s plan, Chairman Clayton requests that SEC staff assess the “RMBS asset-level disclosure requirements with an eye toward facilitating SEC-registered offerings,” and seeks public input on a variety of questions related to the topic, including (i) whether the circumstances in the RMBS market have changed since the financial crisis and the 2014 adoption of the requirements; (ii) whether one or more data points in the requirements should be revised and why; and (iii) whether any data points should be eliminated and if elimination would result in any adverse effects. The announcement does not contain a deadline for members of the public to submit their input.

    Securities SEC RMBS Disclosures

  • District Court allows NCUA to substitute plaintiff, denies dismissal of breach of contract claim in RMBS action


    On October 15, the U.S. District Court for the Southern District of New York held that the NCUA may substitute a new plaintiff to represent the agency’s claims in a residential mortgage-backed securities (RMBS) action against an international bank serving as an RMBS trustee. In the same order, the court dismissed certain tort claims, but allowed claims for breach of contract to move forward against the trustee.

    According to the opinion, NCUA brought the action on behalf of 97 trusts for which the international bank served as the trustee, even though NCUA only had direct interest in eight of the trusts. NCUA argued it had derivative standing to pursue the claims on behalf of the other 89 trusts “on the theory that it had a latent interest in the [the 89 trusts] after they wound down and as ‘an express third-party beneficiary under the [89 trusts] Indenture Agreements.’” The trustee moved to dismiss the action and after hearing oral arguments on the motion, the court stayed the case pending the outcome of NCUA’s appeal regarding derivative standing in similar action before the U.S. Court of Appeals for the Second Circuit. In August 2018, the 2nd Circuit held that NCUA lacked standing to bring the derivative claims because the trusts had granted the right, title, and interest to their assets, including the RMBS trusts, to the Indenture Trustee. (Previously covered by InfoBytes here.) Based on the appellate court decision in the similar action, NCUA moved to file a second amended complaint and substitute a newly appointed trustee as plaintiff for the claims made on behalf of the 89 trusts for which it did not have direct standing.

    Despite the trustee’s objections, the district court granted NCUA’s request, concluding that NCUA’s claims were timely and allowing the NCUA’s “Extender Statute”—which gives the agency the ability to bring contract claims at “the longer of” “the 6-year period beginning on the date the claim accrues” or “the period applicable under State law”—to apply to the new substitute plaintiff. Additionally, the court denied the bank’s motion to dismiss NCUA’s breach of contract claim alleging the trustee had notice of the defects in the mortgage files held in the various trusts. The court concluded that NCUA sufficiently plead that the trustee “did indeed receive notice [of the defective mortgages] and should have thus acted,” under the Pooling and Servicing Agreements.

    Courts RMBS NCUA Appellate Second Circuit Standing Securities

  • Washington Supreme Court: No reliance required under state securities act for RMBS claims


    On October 3, the Washington Supreme Court reversed the dismissal of an action against two international banks, concluding that the Securities Act of Washington (the Act) does not require a plaintiff to prove reliance on misleading statements during the purchase of residential mortgage-backed securities (RMBS). According to the opinion, a Seattle Federal Home Loan Bank (FHL Bank) purchased over $900 million in RMBS from two international banks in 2005 and 2007, and in 2009, brought separate actions against the banks for allegedly making untrue or misleading statements in connection with the RMBS in violation of the Act. Specifically, the FHL Bank argued that the banks (i) made false statements concerning the loan-to-value ratios of the mortgage loans pooled in the RMBS; (ii) misrepresented the quality of their underwriting standards; and (iii) made false statements about the occupancy status of the mortgaged properties in the pool. The trial court granted summary judgment in favor of both banks, and the Court of Appeals affirmed, concluding that reasonable reliance on the misleading statements was required under the Act and that the FHL Bank did not rely on the statements from one bank and unreasonably relied on statements of the other. The FHL Bank appealed both decisions.

    The Supreme Court consolidated the actions and disagreed with the appeals court conclusions in both. Specifically, the Court determined that the plain language under the Act is clear and “unambiguously does not require reliance.” The Court emphasized that the refusal to “read reliance into the statue” furthers the Act’s foal of protecting investors, ensuring “that those harmed when a seller misrepresents material facts can recover.”

    In dissent, one state Justice argued that the Court’s opinion undermines nearly “50 years of case law and legislative acquiescence,” noting that federal courts “frequently resolve state securities fraud claims, and they too have consistently treated reliance as an element of our state-law claim.”

    Courts State Issues RMBS Securities

  • New York Supreme Court Appellate Division says repurchase obligations not limited to defaulted loans


    On September 17, the New York Supreme Court, Appellate Division, affirmed a trial court’s decision to grant partial summary judgment in favor of four residential mortgage-backed securities (RMBS) trusts (plaintiffs) on breach of contract allegations related to pooling and servicing agreement (PSA) repurchase obligations. The appellate court also concluded that the trial court correctly denied a motion for summary judgment filed by the seller of the mortgage loans (defendant). At issue were PSAs—entered between the plaintiffs and the defendant—containing a “repurchase protocol,” which dictate that the defendant is required to “cure, substitute, or repurchase” any defective loans “within 120 days of the earlier of the discovery by the defendant . . . or [the defendant’s] receipt of written notice from any party of a breach of any representation or warranty in the PSAs which ‘materially and adversely affects’ the interest of certificateholders in any mortgage loan.” The trial court denied the defendant’s motion for summary judgment, which, among other things, sought dismissal of claims related to the defective loans that the defendant argued were not specifically identified in timely breach notices. According to the appellate court, the trial court had correctly held that the trustee had delivered “timely presuit letters” concerning the defective loans that were placed in the trusts and had provided sufficient “notice that the breaches plaintiffs were investigating might uncover additional defective loans for which claims would be made.” The appellate court also agreed with the trial court’s decision to grant the plaintiffs’ motion for partial summary judgment to the extent that it sought a ruling that a breach that “materially and adversely” affects the certificateholders’ interest—as outlined in the repurchase protocol—is not limited to loans in default, but also “applies to any breach that ‘materially increased a loan’s risk of loss.’” Further, the appellate court also concurred with the trial court’s decision to grant the plaintiffs’ motion for partial summary judgment and deny the defendant’s motion concerning the use of statistical sampling to prove breach of contract claims for both liability and damages. However, both courts agreed that the defendant will have an opportunity to raise those arguments if it chooses to challenge the sample size or the loans chosen as part of the sample.

    Courts RMBS Appellate Breach of Contract

  • SEC settles with U.S. affiliate of Japanese financial institution for mortgage-backed securities failures


    On July 15, the SEC announced an approximately $25 million settlement with the U.S. affiliate of a Japanese financial holding company, resolving allegations that the company failed to adequately supervise mortgage-backed securities traders. According to the orders, covering commercial mortgage-backed securities (CMBS) and residential mortgage-backed securities (RMBS), from approximately January 2010 through April 2014 several traders allegedly made false or misleading statements while negotiating the sales of CMBS and RMBS, including information about (i) the company’s purchase price of the securities; (ii) the compensation the company would receive on the trades; and (iii) the current ownership of the securities. The SEC alleges the company failed to reasonably supervise traders to prevent the alleged violations of federal antifraud provisions. The orders acknowledge the company’s significant cooperation in the matter and require the company to reimburse customers the full amount of profits earned from the identified trades, totaling over $4.2 million to CMBS customers and over $20.7 million to RMBS customers. Additionally, the orders penalize the company $500,000 related to the CMBS trades and $1 million related to the RMBS trades.

    Securities SEC RMBS CMBS Settlement Of Interest to Non-US Persons

  • District Court dismisses most of trust insurer’s settlement suit, allows breach of contract claim to proceed


    On July 16, the U.S. District Court for the Southern District of New York dismissed the majority of the claims brought by the insurer of a trust against a national bank acting as trustee of the securitization trust. The claims accused the bank of breaching its responsibilities as trustee for residential mortgage-backed securities (RMBS) that were allegedly backed by bad loans, and the court’s dismissal left only a claim for breach of contract against the bank “for failing to correctly account for recoveries” to proceed. The insurer commenced the action against the bank asserting, among other claims, that the “unreasonably low settlement” the bank agreed to in a separate action the bank had taken against the mortgage lender seeking damages for the lender’s alleged breach of representations and warranties with respect to 87 percent of liquidated loans, would breach the bank’s obligations to the trust’s beneficiaries. According to the insurer, the bank initiated a “wasteful” trust instruction proceeding in Minnesota state court and agreed to stay an ongoing New York state lawsuit against the mortgage lender for over a year and a half.

    The court noted, however, that the insurer’s complaint “does not allege any non-speculative ‘concrete or imminent’ injury sufficient to confer standing with respect to the breach of contract and breach of fiduciary claims based on [the bank’s] acceptance of the settlement,” and subsequently dismissed the insurer’s claims that the bank’s acceptance of an “unreasonably low settlement” violated contractual and fiduciary duties owed to the trust as trustee, noting that any harm depends on whether the Minnesota court approves the settlement agreement. Moreover, the court stated that “[i]t is too speculative to assume that [the bank] would have obtained a favorable outcome in the New York action or that rejecting the stay would have strengthened [the bank’s] bargaining position.” Additionally, the court dismissed the insurer’s request for declaratory judgment that the bank must account for and distribute recoveries—“amounts received from defaulted mortgage loans that have already been liquidated”—under the pooling agreement, finding that the issue as it relates to past recoveries is addressed in the breach of contract claim, and all other instances are conditioned on the Minnesota court’s approval of the settlement agreement and are therefore hypothetical. However, the court did find that the insurer adequately pled a claim for breach of contract against the bank pertaining to its accounting of recoveries. The court noted that the insurer’s complaint sufficiently alleged damages and outlined the bank’s alleged failure to correctly “write up” the recoveries as laid out in the pooling agreement, and how this affected the timing and amount of payouts the insurer was required to make.

    Courts Mortgages RMBS

  • 3rd Circuit holds trustee not liable for RMBS losses


    On May 21, the U.S. Court of Appeals for the 3rd Circuit affirmed the trial court’s dismissal of an investor action against Residential Mortgage-Backed Securities (RMBS) trustees, concluding the investors failed to show that the trustees breached any duties owed under the governing documents. According to the opinion, investors filed suit against the owner trustee for fifteen RMBS trusts, which became “worthless in the wake of widespread loan defaults,” claiming breach of contract and the implied covenant of good faith. The investors argued the trustee (i) abdicated its responsibilities relating to the loan files; (ii) failed to provide written notice of default; and (iii) failed to intervene when other parties exercised their duties carelessly. The trial court dismissed all claims against the trustee.

    On appeal, the appellate court concluded the trial court correctly dismissed the claims. Specifically, the appellate court noted that under the trusts’ governing documents, the trustee was acting as an “owner trustee,” which was “primarily ministerial, involving limited duties such as executing documents on behalf of the trusts and accepting service of legal process.” The trustee did not have an overarching duty to protect the trusts, as it agreed “to perform only the modest functions” under the governing agreements and therefore, was shielded from that general liability. The appellate court concluded that the investors failed to show the trustee breached any actual duties owed under the governing agreements, rejecting the investors’ three specific claims for breach of contract. Moreover, the court emphasized that the governing agreement “forecloses the implied duty [the investors] propose,” noting that the trustee negotiated for limited liability and received a fee in exchange for modest functions, making it “difficult to imagine” the trustee would willingly agree to “sweeping supervisory responsibility.”

    Courts Appellate Third Circuit RMBS Mortgages


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