Election Results: Preliminary Thoughts and Reactions

As a result of last Tuesday’s election, Republicans will control the White House and both houses of Congress in 2017. It is likely there ultimately will be some significant changes affecting financial services regulation and enforcement, but they will take time to implement. The President-elect has articulated sympathy for less regulation and opposition to the Dodd-Frank Act but also an unconventional economic populism. The Congressional Republicans have already prepared, and in some cases passed, more specific changes to limit and cabin the CFPB. We anticipate efforts focused on changing the CFPB Director and CFPB structure, reduced regulation that may encourage product innovation (particularly in the FinTech space), and potentially less emphasis on certain Department of Justice (“DOJ”) enforcement initiatives such as fair lending and the Residential Mortgage-Backed Securities (“RMBS”) task force. Nonetheless, we expect continued enforcement and supervisory activity, including by states and by prudential regulators that are less directly tied to shifting political winds.

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Questions regarding the matters discussed in this alert may be directed to any of our lawyers listed below, or to any other BuckleySandler attorney with whom you have consulted in the past.

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Connecticut AG Jepsen and Banking Commissioner Perez Resolve RMBS Investigation

On October 3, Connecticut AG Jepsen, alongside Banking Commissioner Jorge Perez, resolved a four-year investigation into a Connecticut-based investment bank’s residential mortgage-back securities (RMBS) practices. According to the consent order, from January 2005 to December 2008, the investment bank was the lead securities underwriter of about 250 RMBS deals with a value of more than $250 billion. The state alleged, among other things, that the bank’s due diligence process on the 250 RMBS deals was “inadequate and resulted in omissions and misstatements in the representations made to the public and investors about the securities.” The $120 million settlement is Connecticut’s largest single settlement in history.

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New York Supreme Court Appellate Division Affirms Six-Year Statute of Limitations Applicable to Breach of Contract Action

On August 11, the Appellate Division of the New York Supreme Court First Department affirmed a trial court’s decision that the statute of limitations bars a breach of contract action brought more than six years after the seller (defendant) of mortgage loans made allegedly false representations and warranties to the purchaser (plaintiff) regarding the characteristics, quality, and risk profile of the loans. Deutsche Bank Nat’l Trust Co. v. Flagstar Capital Mkts. Corp., 2016 NY Slip Op. 05780 (N.Y. App. Div. Aug. 11, 2016). In this case, the plaintiff purchased loans from defendant with closing dates between December 7, 2006 and May 31, 2007. Through various assignments, the loan pool was conveyed to a Trust, of which the plaintiff was a trustee, securitized, and sold to investor certificateholders on October 2, 2007. In 2013, at the request of one of the certificateholders, an underwriting firm performed a forensic review of the loans underlying some of the certificates and found that “a large number of the loans breached representations and warranties made by defendant regarding the quality and characteristics of the loans.” Although the defendant was notified of the breaches, it failed to comply with the repurchase protocol set forth in the agreement between the seller and purchaser.

The plaintiff commenced action against the defendant on August 30, 2013, subsequently filing a complaint on February 3, 2014 “seeking specific performance, damages and/or rescission, and asserting a cause of action for breach of contract  and a cause of action for breach of the implied covenant of good faith and fair lending.” The defendant moved to dismiss the case on the ground that the action was time barred, since it began more than six years after the plaintiff’s accrual date of the loans. The trial court ruled in favor of the defendant, reasoning that in the Court of Appeal’s recent decision in ACE, it “held that a breach of contract claim in an RMBS put-back action accrues on the date the allegedly false representations and warranties were made.” ACE Sec. Corp. v DB Structured Products, Inc., 36 N.E.3d 623 (N.Y. June 11, 2015). The Appellate Division affirmed, holding that “New York’s statutes of limitation codify the public policies of ’finality, certainty and predictability that [our] contract law endorses’ (ACE, 25 NY3d at 593). The parties’ accrual provision runs afoul of these important policies.”

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New York Supreme Court Appellate Division Reverses Trial Court Ruling in RMBS Case

On August 11, the Appellate Division of the New York Supreme Court First Department reversed a trial court’s decision and held that the trustee plaintiff’s allegations against a financial institution were sufficient to support breach of contract and negligence claims arising from the securitization and sale of residential mortgages. Morgan Stanley Mortg. Loan Trust 2006-13ARX v. Morgan Stanley Mortg. Capital, 2016 NY Slip Op. 05781 (N.Y. App. Div. Aug. 11, 2016). According to the plaintiff, the defendant’s alleged breach of its contractual duty to notify the trustee of defective loans resulted in the sale of “virtually worthless” residential mortgage-backed securities (RMBS) to outside investors. The plaintiff further alleged that the defendant failed to “adhere to the barest minimum of underwriting standards,” claiming that many of loans had incorrect and/or unsatisfactory debt-to-income ratios and that the defendant represented the loans to appear less risky than they actually were. In reversing the lower court’s ruling that the “complaint did not contain facts to sufficiently support” an independent, separate claim for breach of contract, the court cited its recent decision in Nomura Asset Acceptance Corp. Alternative Loan Trust v. Nomura Credit & Capital, Inc., stating that “under similar RMBS agreements, a seller’s failure to provide a trustee with notice of material breaches it discovers in the underlying loans states an independently breached contractual obligation, allowing a plaintiff to pursue separate damages” (internal citation omitted).

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FDIC Settles with Financial Institutions to End RMBS Claims

On June 2, the FDIC announced a settlement with eight financial institutions to resolve federal and state securities law claims based on the institutions’ residential mortgage-backed securities (RMBS) practices. As the receiver for five failed banks from November 2011 through August 2012, the FDIC filed six lawsuits for alleged violations of federal and state securities laws. Specifically, according to the FDIC, the eight financial institutions made misrepresentations in offering documents in connection with the sale of 21 RMBS to the five failed banks. The $190 million in settlement funds will be distributed among the receiverships for the five failed banks.

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