(Reuters) - If there is any silver lining to the lingering black cloud of the mortgage crisis, it’s the incredibly creative legal theories devised by investors who lost hundreds of billions of dollars in overhyped mortgage-backed securities. In a decade of MBS litigation, investors figured out how to hold banks, mortgage issuers and even credit rating agencies accountable for misrepresenting the quality of the mortgages underlying the complex instruments they were peddling. It took ingenuity and persistence, but MBS investors, including hedge funds betting on the eventual success of the litigation, managed to get past contractual and procedural obstacles to recover tens of billions of dollars.
Until yesterday, MBS litigation seemed to be in its final throes. Time has run out for claims based on allegedly deceptive MBS offerings. Investors are still trying to pin MBS trustees with liability for supposedly failing to live up to their obligations once underlying mortgages began to fail, but, as I’ve said many times, the trustee cases appeared to be the last tranche.
That may no longer be true. On Monday, the trustees of a union pension fund that invested in MBS filed a prospective class action against the mortgage servicer Ocwen and related defendants, accusing them of breaching their duties to ERISA beneficiaries. And according to Brad Miller of Guttman Buschner & Brooks – a crusading former North Carolina congressman who is a leading architect of the new suit – mortgage servicers’ exposure to ERISA claims could be vast. The Ocwen suit is apparently the first of its kind, Miller told me in an email, but he is hoping it won’t be the last.
The theory is complicated but I’ll try to simplify it. Unlike most previous MBS litigation, the Ocwen class action focuses not on misrepresentations about the underlying loans but on what happened when homeowners ran into trouble paying their mortgages. Foreclosure is bad for MBS investors because it affects the net present value of the securities.
According to the complaint, Ocwen and the other defendants were obligated, as MBS mortgage servicers, to work with homeowners to modify their mortgages rather than hurting investors by allowing homes to go into foreclosure. But the ERISA plan trustees claim Ocwen and the other defendants put their own interests ahead of the interests of MBS investors. The mortgage servicers, according to the complaint, “profited more from mortgages in default or foreclosure than from performing mortgages,” so they allegedly “sabotaged mortgage modifications and otherwise pushed struggling homeowners into needless default.”
Those are fairly straightforward allegations, adding an MBS gloss to mortgage servicing accusations Ocwen has already faced from state and federal regulators. The really audacious part of the new complaint is asserting claims under ERISA, the federal statute protecting workers who entrust their money to pension funds.
The lawsuit contends that Ocwen and the other defendants have fiduciary duties to the union pension fund under ERISA because they exercise control over securities in which the pension fund invested. “If a person exercises control over plan assets, regardless of formal contractual delegation of authority, that person is a fiduciary to the plan,” the complaint said. The pension fund cited a 1996 advisory opinion from the Department of Labor that said pension fund investments in “pooled investment vehicles” like asset-backed securitizations must be managed in accordance with ERISA’s provisions for fiduciary responsibility. Those responsibilities, according to the Ocwen complaint, extend beyond the plan’s trustees to the parties, like Ocwen, that manage the actual investment.
How does ERISA help the pension fund’s case? Because, according to the complaint, ERISA overrides any contractual barriers to investors suing over MBS, as a matter of public policy. “The duty that ERISA imposes on fiduciaries is the highest known to the law,” the suit said. “ERISA provides that ‘any provision in an agreement or instrument which purports to relieve a fiduciary from responsibility or liability for any responsibility, obligation or duty … shall be void as against public policy.’”
I asked Ocwen what it thought of the pension plan’s theory but the company said only (via spokesman John Lovallo) that it is reviewing the new suit and intends to defend itself vigorously.
Miller, the ex-congressman, said he expects the defendants to contest the assertion that they have ERISA duties to pension funds that invested in mortgage-backed securities. “I can’t imagine that Ocwen and other servicers won’t contest that they have a fiduciary duty, because the stakes are too high — there’s no way to square their conduct with a fiduciary duty,” he said in an email. But he said he’s confident the fund’s reading will hold up because of the authority mortgage servicers wielded in managing the pooled investments.
“Servicers have a world of discretion over mortgages,” he said. “The governing documents give them the authority to do ‘anything and everything’ they see fit. And the statutory definition is functional – not what power the person had contractually, but what power the person exercised.”
For Miller, a Democrat who served in Congress from 2003 to 2013, the Ocwen suit could cure 11 years of frustration over the conduct of mortgage servicers. He said then-Congressman Barney Frank first asked him to investigate mortgage servicers all the way back in 2007, when Frank and Miller began to sense the housing bubble was going to burst. He said he developed responses to the foreclosure crisis, “but the banks blocked all of it except what helped them.
I know that there’s an obsessive, ‘My name is Inigo Montoya’ quality to my bringing a claim against mortgage servicers,” Miller said in an email, referring to “The Princess Bride” character who spent half of his life seeking revenge against his father’s killer. “I’m okay with that … The banks recovered and millions of families lost their homes and life’s savings to foreclosures, a great many of which could have been avoided. I hold grudges.”