Investors have spent years seeking compensation for losses sustained during the housing bust from the firms that made mortgage loans and repackaged them into securities.
Now they are focusing on a new target: the trustees who oversee these deals on their behalf.
So far, the sponsors of residential mortgage-backed securities have dodged much investor litigation and parried astutely to reach settlements that represent pennies on the dollar in terms of investor losses.
Just recently, in fact, investors almost lost an appeal that would have resulted in the outright nullification of most ongoing suits against bank sponsors, because their trusteesí languid representation could have put their claims outside statutes of limitations.
So it's not surprising that some of the biggest RMBS investors have turned their sights on RMBS trustees themselves, even if some observers question their motives.
In mid-June, investors including BlackRock and Pimco filed suits in the New York State Supreme Court against six leading trustees: BNY Mellon, Citibank, Deutsche Bank, HSBC, U.S. Bank and Wells Fargo.
The complaint against U.S. Bank alone points to 841 RMBS private-label trusts for which the bank was trustee, containing $771 billion of loans securitized between 2004 and 2008. By the start of 2010, nearly all of the securities issued by the trusts had been downgraded to junk status, and by January 2011 losses totaled $74 billion.
The crux of their argument is that trustees didnít act on evidence that banks failed to comply with their own underwriting criteria. Investors can't access the underlying loan files and other documents to confirm compliance with the dealís contractual representations and warranties, and they canít monitor the loan servicers' conduct or enforce a trustís contractual rights. Consequently, they "must rely on the trustee to protect their interests," and trustees not only failed to do so but at times appeared to thwart investor interests, according to the complaint.
Investors contend that one of the trustees, U.S. Bank, admitted its knowledge of breaches of reps and warrants when it pursued its own legal action against the same loan originators and RMBS sponsors, alleging the same "systemic and pervasive breaches of representations and warranties" that the RMBS trusts have pursued.
"Despite this knowledge, U.S. Bank has not, however, taken any action to protect the trusts at issue here, which contain billions of dollars in defective loans from the same originators and sponsors," the claim states.
"Rather, U.S. Bank ignored the breaches and unreasonably refused to act while the trusts suffered dramatic and mounting defaults, collateral losses, and other harms."
The change in strategy comes after a significant setback for RMBS investors in December. At that time, the New York First Department Appellate Court reversed an earlier decision by Supreme Court Justice Shirley Kornreich. Kornreich had ruled in favor of the plaintiff, a trust set up by ACE Securities, which argued that the six-year statute of limitations on claims began when the RMBS sponsor was alerted to the breach in contractual reps and warranties and was given time to "cure" it.
The First Departmentís reversal, instead, upheld defendant DB Structured Products' argument that the statute of limitations began when the trust was first formed. The HSBC trustee eventually took over the role of plaintiff from the trust established by ACE, and it filed its claim more than six years after the trustís formation. So the ruling put the kibosh on its suit as well as a slew of others aimed at RMBS sponsors. And even though the ACE trust had pursued litigation before the statute of limitations ran out, and before HSBC took up its role as lead on the litigation, the First Department ruled that it lacked standing to sue on its own behalf.
Isaac Gradman, an attorney at Perry, Johnson, Anderson, Miller & Moskowitz who has closely monitored RMBS litigation stemming from the housing bubble, noted in a July 3 entry in his blog that no issue currently generates more questions from clients than the impact of [ACE] on the future of RMBS litigation. "Consistently, I have answered that regardless of what I think of the merits of the opinion," Gradman wrote, "so long as the First Department's restrictive view of the statute of limitations for these claims remains the law of the land, RMBS trustees will face liability for sitting on their hands and blowing these claims."
To its credit, HSBC, the trustee in the ACE case, took the lead on the litigation, bringing onboard former Solicitor General Paul Clement to head the team appealing the First Departmentís decision. Although the appeals court was not obligated to hear the appeal, it agreed to do so at the end of June. However, a final decision is unlikely before the first quarter of 2015.
If the appeals court sides with investors, it would clarify when the clock starts ticking on the statute of limitations for pursing legal proceedings, and just what constitutes a dereliction of duty on the part of trustees. The uncertainty about whether the case would proceed was likely a significant motivator behind investors' suits against trustees.
The lack of clarity over the daily responsibilities of the trustee may not be the only reason for investors' lack of confidence in the RMBS market, but itís an important one. "Markets thrive on certainty, and you only get certainty through accountability," said Michael Rollin, an attorney at Denver-headquartered law firm Jones & Keller. "If thereís a question about whether trustees can get away with the same failure to protect RMBS investors today that they did before, it canít be good in terms of bringing back that market."
Rollin represents investors in a broad array of matters, such as loan repurchase liability and breach of fiduciary responsibility by RMBS trustees. He has been lead counsel to Lehman Brothers in its put back litigation since 2007, and he was trial counsel for AIG in its challenge to Bank of America's controversial $8.5 billion mortgage settlement.