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Federal Magistrate Recommends Court Order Diligence Firm To Respond To RMBS Working Group Subpoena
On November 11, a U.S. Magistrate Judge for the U.S. District Court for the District of Connecticut recommended that the District Court grant the U.S. Attorney’s motion, filed on behalf of the federal-state RMBS Working Group, to enforce a subpoena seeking information and documents from a firm that performed due-diligence work on mortgage loans and loan pools for numerous financial institutions. U.S. v. Clayton Holdings, No. 3:13mc116 (D. Conn. Nov. 11, 2013). In its opposition, the diligence firm objected to the subpoena as a “fishing expedition” that would require it to produce information for all 193 of its clients, even after it has cooperated as a third-party witness in connection with 16 companies the Working Group has identified as subjects of its RMBS investigations. Generally, the magistrate determined that the government’s request was not overly broad and burdensome, and recommended that the court order the firm to produce, for the period 2005 through 2007, (i) its entire database and all data used, maintained, or accessed in connection with due diligence services on mortgage loans and mortgage loan pools, and (ii) all communications, including e-mails, instant messages, or Bloomberg messages, concerning the provision of due diligence services on mortgage loans and mortgage loan pools. The recommended ruling does restrict the response to information and documents related to work performed for specific financial institution clients. The parties have until November 25 to object to the recommendation.
FHFA Announces Substantial RMBS Settlement
On October 25, the FHFA announced that a large bank agreed to pay $4 billion to avoid further litigation over allegations that the offering documents it provided to Fannie Mae and Freddie Mac in connection with the sale of billions of dollars in RMBS included materially false statements or material omissions, resulting in massive losses to the enterprises. The FHFA has now resolved four of the 18 RMBS suits it filed in 2011. The FHFA announcement also noted that the bank had reached separate settlements with Fannie Mae and Freddie Mac totaling $1.1 billion to resolve disputes over representation and warranties in whole loans purchased by those entities.
Nevada AG Announces RMBS Agreement
On October 17, Nevada Attorney General (AG) Catherine Cortez Masto announced that she had finalized an agreement with a financial institution that requires the financial institution to pay $11.5 million, without admitting fault, to resolve the AG’s investigation into the financial institution’s role in purchasing and securitization of subprime, Alt-A, and payment option adjustable rate mortgages. The investigation focused on whether certain lenders had deceived borrowers about the actual interest rate and payments on their loans, and had originated loans with multiple risk features that led to approval of loans without proper consideration of the borrowers’ ability to repay. The investigation also examined the extent to which the financial institution was aware of the lenders’ allegedly deceptive practices when it bought the loans, and whether the financial institution facilitated these lending practices by financing and purchasing such loans. In addition to the monetary penalty, the agreement stipulates that the financial institution will: (i) only finance, purchase, or securitize subprime mortgage loans in Nevada if it has engaged in a review of such loans and determined that the loans comply with the Nevada Deceptive Trade Practices Act and (ii) not securitize loans where upon review it has reason to believe that the lender has not adequately disclosed to the borrowers the existence of an initial teaser rate, the potential for negative amortization on a loan, the maximum adjusted interest rate or payments, and the potential for payment shock if payments increase after a loan reset or recast.
FHFA Updates Status of Common Securitization Platform
On October 7, the FHFA announced steps to formally establish the common securitization platform for mortgages sold to Fannie Mae and Freddie Mac. The FHFA stated that it has filed a Certificate of Formation with the Delaware Secretary of State to establish Common Securitization Solutions, LLC (CSS)—a limited liability company and equally-owned subsidiary of Fannie Mae and Freddie Mac. The company will be based in Bethesda, MD, and the search for its CEO and Chairman has been initiated.
NCUA Files Additional RMBS Actions
On September 23, the NCUA announced that it filed separate lawsuits against nine financial institutions on behalf of five insolvent credit unions for alleged violations of federal and state securities laws in the sale of $2.4 billion in mortgage-backed securities. The complaints, which the NCUA filed in the U.S. District Court for the District of Kansas, claim that the securitizer made numerous misrepresentations and omissions in the offering documents regarding adherence to the originators’ underwriting guidelines, which concealed the true risk associated with the securities and routinely overvalued them. The NCUA claims that when the allegedly risky securities lost value, the credit unions were forced into conservatorship and liquidated as a result of the losses sustained. The NCUA has filed numerous similar suits, and it has previously settled similar claims for more than $335 million with four financial institutions.
Diligence Firm Objects to RMBS Working Group Subpoena
On September 24, a firm that handles due-diligence matters for financial institutions filed its opposition to a motion filed by the U.S. Attorney’s Office for the District of Connecticut, on behalf of the federal-state RMBS Working Group, to compel production of documents and information the group sought in a July subpoena. In its brief, the firm reviews its cooperation to respond to “six years of subpoenas, investigatory demands, and formal and informal requests for information,” and summarizes the volume and types of information it has provided to the DOJ and the Working Group to date as a third-party witness in connection with the 16 companies the Working Group has identified as subjects of its RMBS investigations. The firm notes the “substantial expense” it has incurred “to educate an ever-growing, and often-changing, number government attorneys and investigators.” The firm argues that the Working Group’s most recent subpoena, which seeks “every document and communication for all 193 clients and for almost 5,000 e-mail custodians,” constitutes a “fishing expedition” and violates the firm’s rights under the Fourth Amendment.
Massachusetts AG Announces RMBS Settlement
On September 9, Massachusetts Attorney General Martha Coakley (AG) announced the state’s fourth mortgage-securitization related enforcement action. The AG alleged that during 2006 and 2007 a U.K. bank financed, purchased, and securitized residential loans that were presumptively unfair under Massachusetts law. Under an Assurance of Discontinuance, the bank, without admitting the allegations, agreed to pay $36 million to resolve the state’s claims. Under the terms of the agreement over $25 million will be dedicated to principal reduction and related relief for more than 450 subprime borrowers, while approximately $2 million will compensate municipalities that claim to be impacted by foreclosures resulting from the allegedly faulty loans.
Third Circuit Holds Securities Act Statute of Limitations Runs from Discovery, RMBS Claims Still Untimely
On September 17, the U.S. Court of Appeals for the Third Circuit held that the one-year statute of limitations in section 13 of the 1933 Securities Act establishes a discovery standard for evaluating timeliness, but held that claims brought by a putative class of investors in certain mortgage backed securities (MBS) still were untimely. Pension Trust Fund for Operating Engineers v. Mortg. Asset Securitization Transactions, Inc., No. 12-3454, 2013 WL 5184064 (3rd Cir. Sept. 17, 2013). The investors claimed that a mortgage securitizer made material omissions and misstatements in the offering and sale of certain MBS. On appeal, the court agreed with the investors that they need not plead compliance with the Section 13 statute of limitations and that the district court erred when it determined the claims to be untimely based on its holding that an inquiry standard applied to the statute of limitations. The court held that the discovery standard announced by the U.S. Supreme Court’s in Merck & Co. v. Reynolds, 130 S.Ct. 1784 (2010), in which the Court rejected the Third Circuit’s application of an inquiry standard under the Securities Exchange Act of 1934 and instead applied a discovery standard, also applies to the Securities Act. However, the court held that the investors, based on “storm warnings” they acknowledged existed more than a year before they filed their claims, could have conducted a reasonably diligent investigation earlier that would have yielded the same results as their later investigation that led to the filing of the action. The court concluded that the investors’ claims therefore were untimely and affirmed the district court’s dismissal.
FDIC to Consider QRM Proposal Next Week
This week, the FDIC released the agenda for an August 28, 2013 Board Meeting at which the Board will consider the re-proposal of a rule to implement the credit risk retention requirements of the Dodd-Frank Act, including provisions regarding “qualified residential mortgages” or QRMs. The FDIC and other federal banking and housing agencies originally proposed a rule in April 2011 that would have required sponsors of asset-backed securities (ABS) to retain at least five percent of the credit risk of the assets underlying the securities. Exemptions to the proposed rule included U.S. government-guaranteed ABS and mortgage-backed securities that are collateralized exclusively by residential mortgages that qualify as QRMs. The proposed rule would have established a definition of QRMs incorporating criteria designed to ensure that such QRMs were of very high credit quality, including a 20% down payment requirement or a requirement that the borrower’s debt-to-income ratio not exceed 36%. It recently has been reported that, in response to overwhelming objections from industry participants, the re-proposed rule will loosen those standards and align the QRM definition with the CFPB’s qualified mortgage or QM definition.
RMBS Task Force Announces New Suits Over Sale of Jumbo Prime RMBS
On August 6, the DOJ and the SEC announced parallel civil fraud actions filed in the U.S. District Court for the Western District of North Carolina. The DOJ alleged that a national bank and related entities misled investors about the residential jumbo prime mortgage loans backing an $850 million RMBS the bank offered for sale, made false statements after failing to perform proper due diligence, and filled the securitization with a disproportionate amount of risky mortgages originated through third party mortgage brokers. The DOJ action represents the enforcement agency’s latest effort to employ the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) to seek civil penalties. The SEC is seeking an order requiring disgorgement and civil penalties under the Securities Act. The complaints were announced as part of the Financial Fraud Enforcement Task Force’s RMBS Working Group, and Task Force participants Attorney General Eric Holder, Associate Attorney General Tony West, and New York Attorney General Eric Schneiderman all promised additional investigations and actions, using every tool and resource available to the group.