Earlier this week, a federal judge in Manhattan gave a green light to a lawsuit filed by an investor against Bank of New York Mellon. The investor claims it lost over $1 billion because of BNY Mellon’s poor performance as trustee over several Residential Mortgage Backed Securities (RMBS) trusts. The suit is similar to others filed against HSBC, Deutsche Bank and Wells Fargo.
The suit was filed by a Belgian institutional investor, Royal Park Investments SA/NV.
According to the complaint, BNY Mellon served as the trustee for five large RMBS trusts. As the trustee, BNY Mellon owed the investors certain duties. Those duties are typically spelled out in a Pooling and Servicing Agreement (“PSA”). Those agreements are frequently in excess of 1000 pages.
Like Royal Park, we believe that a trustee occupies a unique role in overseeing mortgage backed securities trusts. It is the only independent party to the PSA and other governing agreements. As such, it has a duty to watch out for the interests of the noteholders – investors like Royal Park.
A typical RMBS trust contains numerous representations and warranties by parties to the agreement, especially the loan originators. (The same holds true for Commercial Mortgage Backed Securities or CMBS trusts.) These “reps and warranties” attest to the credit quality of the loans within the trust. When the trustee discovers a problem with one of the loans or representations, it should alert all the parties to the agreement and force the entity breaching the warranty to fix any defects or repurchase the bad loans.
After years of CMBS and RMBS experience, we know that many of the loans contained in the typical trust are riddled with problems. If this sounds overly technical, we suggest watching the movie The Big Short. Originators wrote bad loans and then attempted to pawn them off by packaging them into large pools.
Credit rating agencies and ultimately investors such as Royal Park relied on these representations and warranties. Today, we know that many of those representations were false.
Royal Park says that by early 2011, BNY Mellon learned that many of the loans in these pools or trusts were bad. (We think they should have realized this much earlier!) Despite learning that there were multiple problem loans and thus breaches of the representations and warranties, BNY Mellon did nothing. They did not sound an alarm and didn’t enforce the terms of the PSA and governing agreements.
In fact, by doing nothing, they allowed the statute of limitations to lapse in some cases meaning it became too late to later enforce these agreements.
Royal Park goes one step farther and says that as trustee, BNY Mellon also had the duty to insure the loan servicers were doing their job. Once again, we know today that the servicers frequently did a terrible job collecting payments, promptly sending out default letters and foreclosing when necessary.
No one is saying that Bank of New York Mellon could have foreseen all the bad loans or been able to prevent the problems. But had they acted earlier, Royal Park says their losses would be much lower.
The bank predictably asked the court to dismiss the lawsuit. It denies most of the allegations in the complaint and says it had no special duty to the investors. We believe they were wrong. Ultimately, so did the court.
In our opinion, BNY Mellon has a fiduciary duty to the investors. It has a duty to protect their interests.
Assuming the allegations in the complaint are true, why did BNY Mellon do nothing? We think because of the many inherent conflicts on interest within the mortgage backed securities world. Just like rating agencies (S&P, Fitch and Moody’s) want to keep the trust issuers happy so they can generate more fees, the trustees share these same conflicts.
The trust originators decide who will be the trustee. If BNY Mellon were suddenly to hold the originators responsible for bad loans, they would no longer be selected as trustee. A New York Times article reported that RMBS trustees like Bank of New York Mellon “are a dog that could have barked but didn’t.” In our opinion, they didn’t even whimper.
So who exactly was the loan originator and therefore the one making the representations and warranties? For most of the loans at issue, it was Countrywide / Bank of America.
Suddenly the problem becomes clearer. The bad loan originators were being watched (or not watched) by their friends. Whether it is the blind leading the blind or the corrupt watching over the criminals, no one was watching out for the investors, not even the rating agencies.
Now that the bank’s motion to dismiss was mostly denied, the case will proceed to discovery. Bank of New York Mellon hasn’t been found guilty of any wrongdoing. Yet.
This week’s court decision is important for the many noteholders and others suing trustees. For years, many trustees simply accepted millions of dollars in fees yet did nothing for the money. If anything, they hurt the folks they were obligated to protect. Suddenly, the investors are fighting back.
The originators, servicers, rating agencies and trustees traditionally have an incestuous relationship; a relationship filled with conflict. Although not very well organized, the noteholders and investors are no longer willing to sit back and suffer billions of dollars in losses. These suits are very closely watched. Banks have deep pockets but so do the institutional investors.
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The law firms of Judge, Lang & Katers and MahanyLaw concentrate in lender liability case. Most lawyers who handle banking matters defend banks. Few lawyers are willing to sue banks. Because so many lender liability lawyers work for big firms, hourly rates often approach $1000!
Not with us. We are a national boutique of plaintiff focused lawyers that sue banks, servicers, special servicers and trustees. Our rates are reasonable and because we are boutique, our hours billed are usually far less too.
For more information on quality legal representation in CMBS and RMBS cases, contact attorney Chris Katers at 414-777-0778 or by email at [hidden email]. The author of this post, attorney Brian Mahany can be reached at [hidden email].
Judge, Lang & Katers –and- MahanyLaw: We Sue Banks