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 trustees’ 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 didn’t 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 deal’s contractual representations and warranties, and they can’t monitor the loan servicers' conduct or enforce a trust’s 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 Department’s 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 trust’s 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 Department’s 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 it’s 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 there’s a question about whether trustees can get away with the same failure to protect RMBS investors today that they did before, it can’t 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.

Jim Callahan, principal of PentAlpha Global Advisors, which bond issuers include as a third party to monitor RMBS reps and warranty compliance as well as compliance to loan collection requirements, attributes the market’s current malaise to general lack of confidence in the ongoing administration of loan securitization trusts. The lack of clarity around the role of the trustee is one factor, and perhaps a secondary one, he said.

Another factor, Callahan said, is that the rating agencies were burned by various levels of fraud, misrepresentations and unfocused oversight, and they remain unsure of cash flow performance of the pools they rate. As a result, they continue to apply very conservative collateral performance projections that ramp up RMBS costs, which makes private label securitization, and by extension, nonconforming mortgage lending, more expensive relative to government-backed and bank-funded loans.

There are a number of regulatory and industry initiatives that could help restore investor trust in the RMBS market, making private-label securitization more cost-effective. Callahan cited minimum rules in areas such as servicing that were established by the attorneys general at the state level, in the wake of banks' robo-signing and other scandals. He also pointed to new lending and collection rules established by the Consumer Financial Protection Board.

When these items are combined with the more robust governance practices found in some of today’s securitizations—he pointed to those of JPMorgan Chase, for which PentAlpha works—the combination reassures investors that trusts are not dumping grounds for bad loans or bad collections practices.

Clarifying the role of the trustee is also a part of the solution.

"We need trustees to be part of that governance improvement initiative…and the recent lawsuits against trustees make it hard to get them to come to the table to design the best governance solution," Callahan said.

Rollin said trustees have largely argued that they’re not required to do anything other than what is expressly required in the agreements with investors—mainly administrative duties. In fact, trustees' fees have traditionally been insufficient to pursue resource-intensive actions such as investigating the validity of breached claims and seeking loan buy backs from sponsors.

Nevertheless, said Rollin, most agreements stipulate that if any party to the RMBS transaction, including the trustee, gets notice of a breach of reps and warranties, it must give notice to all the other parties, and that notice triggers the repurchase obligation of the seller. In the wake of the housing bubble collapse, indications of breaches abounded, and yet "like the three monkeys with hands over their eyes, ears and mouth, the trustees in the face of all this evidence just remained silent and didn't give any notice."

Some RMBS agreements also have "shall enforce" clauses, Rollin said, requiring the trustee to enforce the repurchase obligation when appropriate. The legal principle when reading a contract is to give meaning to all of its parts, Rollin said, and yet trustees argue that unless they are specifically directed by a certificate holder, and the certificate holder agrees to pay all expenses, the trustee needn’t do anything.

"Trustees are perhaps in the exclusive position to help bondholders, and they just refused to do it," Rollin said, adding that while trustees may have entered into agreements without realizing the extent of the problems to come, "that doesn't eliminate their duties."

A remaining concern is whether the big investors leading the charge against the six trustees are doing so to recoup as much as possible for all investors or instead seeking to lessen damages for the banks with whom they have broad business relationships. Those same investors negotiated in secret with Bank of America and trustee BNY Mellon to reach an $8.5 billion settlement in 2011 over liabilities stemming from the former bank’s acquisition of failed mortgage lender Countrywide.

While that’s a large number, AIG has led a group of 22 other investors who contend that this sum amounts to a fraction of total investor losses. The AIG group has sought to block the settlement, since finalizing it would quash litigation by other parties.

"As the New York Supreme Court recently approved most parts of that settlement, these investors [supporting the settlement] likely have been emboldened to cobble together similar pennies-on-the-dollar global settlements that threaten to put to bed all put back claims against JPMorgan and Citigroup, respectively," Gradman noted in his blog.

The ongoing JPMorgan settlement proceedings may be especially illuminating in terms of revealing the extent to which trustees are truly representing investors' interests, especially should they opt for a settlement despite ongoing put back litigation.

"If a trustee walks into a court and recommends that a trust settles for $5 million, even though there's existing litigation with strong counsel already under way that seeking a couple of hundred million in damages from breaches, then it may be very difficult for the court to conclude the trustee is seeking a good faith settlement," Rollin said.

The deadline for trustees to decide whether to settle has been extended a few times and is now Aug. 1.

It is unsurprising that trustees may align their interests with sponsors, or that the biggest investors may prefer to avoid seeking excessive damages from banks. Many of the trustees rest under the same bank holding companies as the RMBS sponsors facing litigation, and the big investors, while they have also suffered significant RMBS-related losses, have little interest in seeing those banks hobbled by a never-ending stream of lawsuits.

"It's an interesting quagmire that everyone is in. In one instance, investors want to sue these guys for bad acts in past, but then they also want to empower them so they can play a role in returning the market to health," Callahan said.

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