August 22, 2012 9:27 pm

Investors try wielding Trust Indenture Act to recover RMBS losses

This article is provided to readers by Debtwire—the most informed news service available for financial professionals in fixed income markets across the world.


Residential mortgage bond investors are testing a novel legal attack, arguing trustees fall under the Trust Indenture Act’s heightened demands for oversight, according to four attorneys. The effort is meeting with much resistance from trustees’ lawyers, court documents show.

The stakes are high for both investors and trustees, as under the TIA, trustees would be held to uniform, nationwide standards, and wouldn’t be able to use clauses they have written into pooling and servicing agreements to protect themselves from negligence claims, an industry attorney said.

Broadly, a ruling that a trustee is subject to the TIA could potentially mean a greater chance of recovery for RMBS investors, if they are able to show the trustee failed in its duties under the act.

Recently, attorneys from Morgan, Lewis & Bockius for defendant U.S. Bank argued in a 3 August court filing that plaintiff Oklahoma Police Pension and Retirement System can’t retroactively apply the TIA to nine of the 14 RMBS at stake in the case — those that issue certificates, as opposed to the remaining five that issue debt under a Delaware law — as per “30 years of SEC guidance.”

In the Oklahoma Police Pension case, trustee U.S. Bank “breached its critical contractual duty to enforce the representations and warranties” and failed to force the seller to “repurchase, substitute or cure mortgage loans that have deficiencies in their documentation” in a timely manner, causing significant losses to the trusts, alleged Scott+Scott attorneys in a 13 July court filing.

They likened the current situation to the period after the Great Depression when the TIA was enacted to outlaw trustee misconduct.

In April, Judge William Pauley said that trustee Bank of New York was subject to the TIA. The case was brought by the Retirement Board of the Policemen’s Annuity and Benefit Fund of the City of Chicago.

The TIA is also a point of contention in a case brought this year by the same plaintiffs against Bank of America.

All three TIA cases are playing out in the United States District Court for the Southern District of New York in front of three different judges and are being argued for the plaintiffs by attorneys from Scott+Scott.

Debt or equity

A defining issue in the TIA cases is whether RMBS are considered equity or debt; the TIA only applies to debt.

Attorneys don’t generally dispute that RMBS structured as notes under Delaware law are subject to the TIA. However, most RMBS are certificates, according to a second industry attorney. The disagreement arises when deciding whether RMBS certificates are considered debt or equity.

Those who say RMBS certificates are equity point out that investors are buying ownership shares in the loan pools — a classic equity structure, the second attorney said. The certificates are pass-throughs, which are generally governed by PSAs under New York common law, as opposed to RMBS, which are notes issued by a trust under Delaware law.

Their opponents argue that RMBS certificates and notes function in the same way. Both RMBS notes and certificates have regular principal and interest payments and a maturity date, like debt, the first attorney said.

The American Bankers Association wrote a letter to Judge Pauley saying its members — who are parties to thousands of PSAs dealing with trillions of dollars of RMBS — believed they were selling or buying TIA-exempt certificates based on counsel opinions.

The ABA and the trustees also point out that the SEC has traditionally considered MBS certificates to be exempt from the TIA. The SEC provides this guidance on its website and cites the law’s section saying it exempts “any certificate of interest or participation in two or more securities having substantially different rights and privileges, or a temporary certificate for any such certificate.”

However, the SEC amended its website on 3 May — shortly after the Pauley ruling — saying that its staff is reconsidering its position.

In the Oklahoma case, the decision hinges on whether Judge John G. Koeltl is willing to agree with his Southern District of New York colleague Judge Pauley, said a third industry attorney.

The issue may wind up in front of the Second Circuit Court of Appeals for a resolution, as it is the appeals court in all three of these cases. Defendants BNY in the Chicago case have already asked Pauley to reconsider his decision or grant leave to bring the question to the appeals court. Pauley has yet to rule on this motion.


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