Litigation between mortgage-backed securities investors and the MBS trustees they accuse of failing to safeguard noteholders’ interests has been a bit of a seesaw ride.
Last summer, as I reported, trustees were up. They’d won a 2014 ruling from the 2nd U.S. Circuit Court of Appeals that not only restricted the standing of noteholders trying to bring class actions but also indicated investors would have to prove trustees’ misconduct at a granular, loan-by-loan level. In 2016, trustees won a new decision, this time from the New York State Appellate Division, First Department, that they hoped would allow them to knock out noteholder cases before they reached class certification. Ruling on a motion to dismiss by BNY Mellon, the state appeals court said MBS trustees did not have a duty to “nose to the source” of potential problems with underlying mortgage loans.
But as I told you last month, the state appellate decision turned out not to be a magic bullet. Federal judges have continued to allow at least certain categories of noteholder claims to move past trustee dismissal motions. Most recently, my Reuters colleague Jon Stempel reported, U.S. District Judge Katherine Polk Failla of Manhattan ruled on March 30 that a consortium of big institutional investors can proceed with breach of contract and conflict of interest claims against Wells Fargo, the trustee in 53 MBS trusts in which the investors held certificates.
That’s not the last teeter of the seesaw, though. A handful of recent decisions shows that once noteholders get past dismissal motions, trustees still have a lot of defenses at their disposal. Noteholders may still win their cases against MBS trustees, but they’re going to have to work for it.
In February, U.S. District Judge Jesse Furman of Manhattan declined to dismiss a big swath of claims by Black Rock, Pimco and a raft of other big funds against MBS trustee Deutsche Bank. But at the hearing explaining his reasoning, according to a transcript subsequently cited in a different MBS case, the judge balked at noteholders’ claims that Deutsche Bank is liable for failing to take action on loans issued by mortgage lenders that have gone out of business, such as IndyMac, New Century and American Home.
Furman said that investors would have statute of limitations problems if they alleged the trustee was on notice before those lenders went bust - but could have only asserted claims in the bankruptcies thereafter. He gave noteholders a chance to amend their complaint to figure out a way to navigate between those limitations but plaintiffs' lawyer Timothy DeLange of Bernstein Litowitz Berger & Grossmann told the judge in a Feb. 16 letter that the complaint wouldn’t be amended. The upshot is that noteholders, at least in the Deutsche Bank trustee case, can’t hold the trustee liable for breaches in loans originated by now-defunct lenders.
In March, the federal magistrate overseeing discovery in several MBS trustee cases before different U.S. district judges in Manhattan ruled in noteholder suits against Wells Fargo and HSBC that investors cannot rely on sampling to prove their claims that trustees should have acted to protect noteholders from deficient underlying loans. Referring to the 2014 2nd Circuit decision, U.S. Magistrate Judge Sarah Netburn held that investors must establish “loan-specific proof” that trustees “failed to act with respect to the loan-specific remedies available for a particular defect, and that such failure caused the plaintiffs harm.” Loan-by-loan re-underwriting is a very expensive proposition, even for deep-pocketed plaintiffs like Black Rock and Pimco.
Finally, on Tuesday, U.S. District Judge Alison Nathan of Manhattan made public a decision in which she denied certification to a proposed class of noteholders suing Deutsche Bank. The judge said plaintiffs hadn’t shown members of the class could be ascertained, given that the securities have traded in the secondary market and it’s not easy to figure out who would be owed damages for the trustee’s alleged failures. The judge did allow lead plaintiff Royal Park Investments a chance to resubmit its class certification motion.
I left messages for Royal Park counsel Lucas Olts of Robbins Geller Rudman & Dowd and for DeLange of Bernstein Litowitz, who represents noteholders in the case before Judge Furman. Neither got back to me.