(Reuters) - In what appears to be the first class action settlement in a wave of noteholder suits against banks that served as trustees for mortgage-backed securities trusts, Wells Fargo agreed Friday to a $43 million deal to resolve claims by BlackRock, Pimco and other noteholders in 271 trusts that lost nearly $35 billion in the financial crisis. If the proposed settlement is approved by Manhattan State Supreme Court Justice Charles Ramos, shareholders will also receive $70 million from an indemnity fund Wells Fargo reserved to litigate noteholder suits.
The question, of course, is what the settlement means in the larger context of MBS investor suits against the trustees they accuse of failing to protect noteholders when problems showed up in the home mortgage loans underlying the securities. As I’ve written, these trustee suits are the last big tranche of MBS litigation by noteholders who lost untold billions of dollars in the MBS market. Should investors read the Wells Fargo settlement as a sign the hard-fought MBS trustee litigation is about to pay off or as an acknowledgment that their claims aren’t very valuable?
I’d say the latter is a better reading of the settlement than the former. The noteholders’ lawyer who led the class action against Wells Fargo, Timothy DeLange of Bernstein Litowitz Berger & Grossmann didn’t immediately respond to my email requesting comment, but he is actually quoted in the Wells Fargo press release announcing the deal. He didn’t exactly crow about the result: “Following more than four years of litigation, including fact and expert discovery, we concluded that this agreement provides a fair and reasonable resolution of the claims,” DeLange said. “While we believe the claims are meritorious, the settlement provides an immediate and concrete benefit for class members, while bringing the litigation to a close.”
In the memo asking Judge Ramos to approve the deal, noteholders acknowledged some of the litigation setbacks investors have experienced in their suits against trustees. Although noteholders have broadly survived defense dismissal motions, post-dismissal rulings have turned the litigation into an expensive quagmire for investors. Class certification has been one big problem, with Manhattan federal judges issuing a series of rulings denying class certification to MBS noteholders because, according to the decisions, individual issues of standing and timeliness predominate over classwide concerns. (A BlackRock investors’ class certification motion against Wells Fargo was pending before U.S. District Judge Katherine Failla of Manhattan when the two sides agreed to settle their parallel case in state court.)
Courts have also foreclosed evidentiary shortcuts for noteholders, ruling that noteholders must prove trustees were aware of problems in underlying mortgage pools on a loan-by-loan, trust-by-trust basis. Judges have generally refused to allow investors to prove deficiencies by extrapolating from a sample of underlying mortgage loans. And at least one judge, U.S. District Judge Valerie Caproni of Manhattan, has ruled, on a summary judgment motion, that noteholders must show trustees had actual knowledge that individual underlying loans failed to live up to representations and warranties. (A New York state appeals court took an easier line on trustees’ knowledge, concluding that investors need not allege trustees’ actual knowledge on a loan-by-loan basis.)
Black Rock and the other noteholders suing Wells Fargo acknowledged their tough road ahead in the memo requesting settlement approval. “To defeat summary judgment and prevail at trial, plaintiffs would have been required to prove, among other things, that Wells Fargo discovered breaches of representations and warranties and had actual knowledge of servicing violations with respect to individual loans in the trusts,” the memo said. “Wells Fargo would have had substantial arguments to make concerning each of these issues. For example, Wells Fargo would have argued that plaintiffs must prove, on a loan-by-loan basis, Wells Fargo’s discovery of breaches of representations and warranties and actual knowledge of servicing violations. … In addition, Wells Fargo would have argued that any damages to plaintiffs and the class were caused by factors unrelated to the purported breaches of representations and warranties or servicing violations. Had any of these arguments been accepted in whole or in part, it could have eliminated or, at a minimum, drastically limited any potential recovery.”
And based on sheer math, the settlement looks more like a business decision by Wells Fargo than an admission of the merits of claims that the bank failed to live up to its MBS trustee responsibilities. As I mentioned, the Black Rock investors alleged losses of nearly $35 billion across the 271 trusts covered by the settlement. Their amended complaint sought to hold Wells Fargo liable for all of those losses. Instead, the settlement is for only $42 million.
We can infer, moreover, that Wells Fargo expected the litigation to cost at least that much. Acting in its capacity as MBS trustee, the bank reserved about $90 million from MBS trusts to pay legal expenses stemming from its trustee duties. (BlackRock actually sued Wells Fargo over the reserve fund, asserting that the bank had looted trust assets, but Judge Ramos dismissed the suit in 2017.) By releasing $70 million of the reserve fund to investors as part of Friday’s settlement, Wells Fargo effectively said it would have cost more to defend the Black Rock class action than to settle it.
It’s worth pointing out that Wells Fargo kept $20 million in the reserve fund, presumably to fend off MBS trustee claims by investors in another 58 trusts. Based on the bank’s per-trust payout in the BlackRock case, however, Wells Fargo’s exposure in those cases is less than $10 million.
That calculation assumes Wells Fargo – as well as other MBS trustees such as Bank of New York Mellon, U.S. Bank and Deutsche Bank – will present the Black Rock class settlement as a ceiling for future settlements, not a floor. Individual noteholders may well balk at the idea that they’re on par with the BlackRock group, some of whose affiliated investment advisors were facing third-party claims by Wells Fargo that they, and not the trustee, were responsible for MBS losses. Wells Fargo hasn’t brought analogous third-party claims against the individual noteholders suing that bank as an MBS trustee.
I checked in with a plaintiffs’ lawyer who represents individual certificate-holders in MBS trustee cases, David Wollmuth of Wollmuth Maher & Deutsch. Wollmuth client Phoenix Life reached a confidential settlement last month of claims against Bank of America, which had limited trustee duties in an MBS offering of more than $600 million. The settlement amount was not disclosed and Wollmuth said he could not comment on the agreement. But overall, he said, Phoenix continues to believe in the strength of its claims and is “pleased at how the cases are progressing.”
Wells Fargo is represented in the MBS trustee litigation by Jones Day. Partner Howard Sidman is lead counsel.