COLUMN-NY intervention goes beyond BofA's mortgage deal: Frankel

Fri Aug 5, 2011 4:14pm EDT

-- Alison Frankel writes the On the Case blog for Thomson Reuters News & Insight (newsandinsight.com). The views expressed are her own. --

By Alison Frankel

NEW YORK Aug 5 (Reuters) - Before Thursday night, opposition to Bank of America's (BAC.N) proposed $8.5 billion settlement with Countrywide mortgage-backed securities investors consisted of a handful of investor groups represented by a handful of law firms. Even if you counted the six Federal Home Loan Banks that have moved to intervene but haven't yet gone on record opposing the deal, intervenors represented less than 7 percent of all Countrywide MBS noteholders. The 22 gargantuan institutional investors that negotiated the settlement were a much more potent force.

That all changed when New York Attorney General Eric Schneiderman -- in a move that stunned deal proponents -- filed an explosive motion to intervene in the $8.5 billion settlement [nN1E773268]. Schneiderman didn't just register his opposition to the proposed settlement, which he said had been reached "without ever giving beneficiaries or their representatives an opportunity to test [whether] the proposed settlement is reasonable." He went far, far beyond mere opposition: Schneiderman accused the Countrywide MBS trustee, Bank of New York Mellon (BK.N), of breaching its fiduciary duty and said that Bank of America may have aided and abetted the breach. And to show that he was serious about those assertions, Schneiderman actually filed counterclaims against BNY Mellon along with his intervention motion.

The countersuit -- a truly revolutionary filing -- alleges three causes of action against BNY Mellon, in what is thought to be the first time the AG has accused an MBS trustee of fraud. Schneiderman claimed the bank breached its duty to investors because the settlement includes indemnification for the trustee -- a "direct financial benefit" for BNY Mellon, according to the AG's filing. Schneiderman also asserted that BNYM let down Countrywide MBS investors long before proposing the $8.5 billion settlement, by failing to notify certificate holders that underlying Countrywide mortgages were in default. Finally, the New York AG accused Bank of New York Mellon of securities fraud under New York's Martin Act.

Schneiderman didn't claim that New York pension funds actually have a stake in the Countrywide MBS trusts. Instead, he claimed standing under the parens patriae doctrine, asserting that he intervened "to protect the interests of the public and absent investors." And that raises a question that Bank of New York Mellon -- once it recovers from the shock of the AG's filing -- is sure to argue to Judge Barbara Kapnick as she weighs whether to approve the proposed settlement. Are investors -- and the public at large -- better off if the New York AG kills the proposed BofA settlement?

There are a lot of ways to look at the question. In the narrowest interpretation, will investors be able to recover more money for breach of warranty claims against Countrywide than they would under the settlement? Maybe. There have only been a few investor put-back cases filed against Countrywide, mostly by David Grais of Grais & Ellsworth, and they're not far enough along to lay odds on their success. Mayer Brown, which represents BNY Mellon in the BofA proposed settlement, argues that a lot of obstacles stand between Countrywide noteholders and a windfall recovery from Bank of America. Those range from the loan-by-loan evaluation investors will have to make of individual underlying mortgages to Bank of America's claim that it's not liable for Countrywide's failings.

Grais may be able to surmount those obstacles, which is why his goal in opposing the proposed BofA deal seems to be to force the bank to permit opt-outs for investors who want to take their chances in litigation. If the settlement blows up, however, every Countrywide MBS investor is going to have to slug it out in court, and they're certainly not all represented by lawyers who are prepared for a long, expensive battle with BofA that may end with them getting nothing.

The AG's filing, moreover, has implications beyond the BofA case. Bank of America and Bank of New York Mellon certainly bear a heavy load of responsibility for the MBS fiasco. The New York AG has been engaged in an investigation of their (and other banks') various failures as a trustee, MBS issuer, and mortgage servicer. But this settlement was at least an attempt to mitigate the damage BofA and BNY Mellon have caused investors-and for some reason, Schneiderman waited until now to claim that BNY Mellon committed fraud and that BofA may have abetted it. That timing gives little incentive to any of the other banks facing billions of dollars in MBS breach-of-warranty liability to reach global deals with investors. Why spend months negotiating a settlement if the New York AG, under the broad aegis of protecting the public, attacks you after you reach a deal?

The AG's filing gives MBS trustees even less incentive to push for investor settlements. Trustees have been incredibly slow to take action against MBS issuers, which is why regulators like Schneiderman are scrutinizing them. Bank of New York Mellon took a bold step when it hired Jason Kravitt and Matthew Ingber of Mayer Brown to talk to the Gibbs & Bruns group of 22 investors, instead of continuing to resist investors calls for action against MBS issuers. Its reward for reaching a deal with the Gibbs & Bruns investors? A Martin Act suit. Given that Schneiderman hasn't brought Martin Act claims against MBS trustees that haven't proposed global settlements, why would any trustee try to engineer a deal? For the banks that issued mortgage-backed securities and the banks that acted as trustees on MBS offerings, the Schneiderman filings are a very good reason to keep their profiles low by quietly defending cases by those investors with the fortitude to sue.

Then there's the issue of the mortgage servicing provisions in the BofA settlement proposal. BofA and the Gibbs & Bruns group have touted the servicing provisions, which call for Bank of America to outsource loan service to companies tasked with renegotiating troubled loans, rather than pushing homeowners into default. Bank of America, in fact, regarded the loan modification provisions of the MBS settlement as template for solving the foreclosure crisis.

The AG's filing, on the other hand, blasted the settlement's servicing provisions as "too vague and ill-defined to provide any concrete value to investors." Schneiderman complained that Bank of America's poor track record in modifying troubled loans underscored the inadequacy of the servicing aspects of the settlement. The AG is in the midst of talks to reach nationwide mortgage modification deals with a host of banks, so I'm sure he's speaking knowledgeably. But as a matter of tactics, he doesn't seem to be sending a message of cooperation to BofA -- or other banks.

Finally, there's the message the AG sent to New York businesses. BNY Mellon's response to the AG was as remarkable, in its way, as the AG's filing. "The allegations by the New York attorney general are outrageous, baseless, unsupported by fact and law and we will fight them if necessary in court," the bank said in a rare display of adjectives by a financial institution. "We are confident that we have fulfilled in all respects our responsibilities as trustee. The AG's action is misguided and fails to comprehend the role of the trustee and the benefit the settlement would provide to investors."

A BNY Mellon spokesman told me the bank didn't want to comment on the broader implications of the AG's filing, but directed me to Kathryn Wylde, CEO of the Partnership for New York City, a business development non-profit. She said that the AG's "careless action" hurts New York's standing as a financial center.

"It's disappointing from the standpoint of the business community that the AG would make a fraud accusation against a major financial institution -- in the press," she told me. "And to not have any consultation with the institution? The bank was blindsided by what appears to be an outrageous charge." (The AG's press office didn't respond to my request of comment.)

Thursday's filing unquestionably changes the tenor of the BofA MBS settlement. It could end up changing a lot of other things as well.

This blog post first appeared here: link.reuters.com/kaw92s

(Reporting by Alison Frankel; Editing by Eileen Daspin)