On August 6, the Structured Finance Industry Group released the first edition of a “comprehensive set of proposed industry standards” to promote growth in the private label RMBS market. The SFIG explains that the project “seeks to reduce substantive differences within current market practices through an open discussion among a broad cross-section of market participants,” and, where possible establish best practices related to: (i) representations and warranties, repurchase governance, and other enforcement mechanisms; (ii) due diligence, disclosure, and data issues; and (iii) roles and responsibilities of transaction parties and their communications with investors. The paper is the first in an iterative process, and touches on only a few of the items identified in a sprawling master agenda. With regard to representations and warranties, the paper discusses fraud, regulatory compliance, and objective independent review triggers. For due diligence, data and disclosure, the paper considers underwriting guidelines disclosure and due diligence extract to investors. Finally, the paper addresses the role of transaction parties and bondholder communication.
SDNY Judge Approves RMBS Consent Judgment But Questions Second Circuit’s Standard For Reviewing Agency Consent Judgments
On August 5, U.S. District Court for the Southern District of New York Judge Jed Rakoff approved a consent judgment between the SEC and a financial institution to resolve allegations that the institution violated securities laws in connection with certain mortgage-backed securities. SEC v. Citigroup Global Markets Inc., No. 11-7387, 2014 WL 3827497 (S.D.N.Y. Aug. 5, 2014). Earlier this year, the U.S. Court of Appeals for the Second Circuit vacated and remanded the district court’s earlier decision to reject the proposed settlement, holding that the proper standard for reviewing a proposed enforcement agency consent judgment is whether the proposed consent decree is fair and reasonable, and in the event the agreement includes injunctive relief, whether “the public interest would not be disserved.” On remand, Judge Rakoff approved the consent judgment stating that based on the underlying record, “the Court cannot say that the proposed Consent Judgment is procedurally improper or in any material respect fails to comport with the very modest standard imposed by the Court of Appeals.” Judge Rakoff noted his concern, however, that “as a result of the Court of Appeals decision, the settlements reached by governmental regulatory bodies and enforced by the judiciary’s contempt powers will in practice be subject to no meaningful oversight whatsoever.”
On July 24, House Oversight Committee Chairman Darrell Issa (R-CA) sent a letter to Attorney General Holder raising questions about the DOJ’s “inclination to enter into settlement agreements with respect to mortgage securities fraud” claims. The Chairman notes that large RMBS settlements to date have been predicated on violations of FIRREA, which allows the DOJ to initiate lawsuits seeking civil money penalties. The letter suggests the DOJ’s decision not to litigate or secure a criminal plea diverges from the agency’s strategy in other contexts. Chairman Issa asks the DOJ to produce, by August 14, all documents and communications since January 2011 referring or relating to two recent major RMBS settlements, as well as any policies in effect during that time governing the decision to conclude pre-suit negotiations.
On July 14, the DOJ, the FDIC, and state authorities in California, Delaware, Illinois, Massachusetts, and New York, announced a $7 billion settlement of federal and state RMBS civil claims against a large financial institution, which was obtained by the RMBS Working Group, a division of the Obama Administration’s Financial Fraud Enforcement Task Force. Federal and state law enforcement authorities and financial regulators alleged that the institution misled investors in connection with the packaging, marketing, sale, and issuance of certain RMBS. They claimed, among other things, that the institution received information indicating that, for certain loan pools, significant percentages of the loans reviewed as part of the institution’s due diligence did not conform to the representations provided to investors about the pools of loans to be securitized, yet the institution allowed the loans to be securitized and sold without disclosing the alleged failures to investors. The agreement includes a $4 billion civil penalty, described by the DOJ as the largest ever obtained under FIRREA. In addition, the institution will pay a combined $500 million to settle existing and potential claims by the FDIC and the five states. The institution also agreed to provide an additional $2.5 billion in borrower relief through a variety of means, including financing affordable rental housing developments for low-income families in high-cost areas. Finally, the institution was required to acknowledge certain facts related to the alleged activities.
On June 26, Treasury Secretary Jack Lew announced (i) a new financing partnership between Treasury and HUD designed to support the FHA’s multifamily mortgage risk-sharing program; (ii) an extension of the Making Home Affordable (MHA) program for at least one year; and (iii) a new effort to help jumpstart the private label securities market. Under the Treasury-HUD partnership, the Federal Financing Bank (FFB) will finance FHA-insured mortgages that support the construction and preservation of rental housing. The extended MHA program is aimed at allowing the Administration to continue assisting borrowers facing foreclosure and with underwater homes. Finally, the Treasury Department will publish a Request for Comment and plans to host a series of meetings with investors and securitizers to explore ways to increase private lending.
On June 16, the U.S. Supreme Court vacated a Tenth Circuit holding that RMBS claims filed by the NCUA were timely and instructed the circuit court to reconsider that holding in light of the Supreme Court’s recent decision in an environmental case. National Credit Union Admin. Bd. v. Nomura Home Equity Loan, Inc., No. 13-576, 2014 WL 2675836 (U.S. Jun. 16, 2014). On June 9, the Court delivered its opinion in CTS Corp. v. Waldburger, an environmental case that addressed the difference between statutes of limitations and statutes of repose, which are both used to limit the temporal extent or duration of tort liability. In Waldburger, the Supreme Court held that under the environmental statute at issue, Congress intended to preempt state statutes of limitations but not statutes of repose. In light of that decision, the Court asked the Tenth Circuit to reconsider its holding that the federal extender statute supplants all other limitations frameworks, including both the one-year statute of limitations and the three-year statute of repose, included in the limitations provision of the Securities Act of 1933 and the similar state laws at issue in the case.
On June 4, the U.S. Court of Appeals for the Second Circuit vacated and remanded a district court’s decision to reject a proposed settlement between the SEC and a financial institution in a securities fraud suit. SEC v. Citigroup Global Markets Inc., No. 11-5227, 2014 WL 2486793 (2d Cir, Jun. 6, 2014). In November 2011, the SEC and the financial institution entered into a consent judgment to resolve allegations that the institution violated securities laws in connection with certain mortgage-backed securities. Consistent with the SEC consent judgment convention at the time, the institution did not admit or deny any of the allegations as part of the agreement. Judge Jed Rakoff of the Southern District of New York rejected the agreement and held that because the parties agreed to settle without the institution having to admit or deny any of the underlying factual allegations, the settlement would deprive the public “of ever knowing the truth in a matter of obvious public importance,” and the court lacked evidence sufficient to determine whether the agreement was in the public interest. On appeal, the Second Circuit held that the proper standard for reviewing a proposed enforcement agency consent judgment is whether the proposed consent decree is fair and reasonable, and in the event the agreement includes injunctive relief, whether “the public interest would not be disserved.” The court held that in evaluating whether an SEC consent decree is “fair and reasonable” one must review (i) the basic legality of the decree; (ii) whether the terms are clear; (iii) whether the decree resolves the actual claims in the complaint; and (iv) whether the decree is “tainted by improper collusion or corruption.” The court also ruled that the district court abused its discretion by requiring that the agreement establish the “truth” of the allegations, explaining that trials are meant to determine truth, while consent decrees are about “pragmatism.” Finally, the court held that the district court abused its discretion to the extent that it withheld approval of the settlement because it believes the SEC failed to bring the proper charges, which is the exclusive right of the SEC to decide.
Recently, the FHFA announced the resolution of several lawsuits it filed against private label securities issuers. In 2011, the FHFA sued 18 financial institutions alleging federal securities law violations, and in some cases common law fraud, with regard to the sale of private label residential mortgage backed securities to Fannie Mae and Freddie Mac. On March 26, one financial institution agreed to pay $9.33 billion—including cash payments and a purchase of securities from Fannie Mae and Freddie Mac—to resolve a case filed against the institution and cases filed against two other institutions it had acquired. On March 21, a separate institution agreed to pay $885 million to resolve the FHFA’s allegations. The FHFA has claims remaining in seven of the 18 suits it filed.
On March 16, Senate Banking Chairman Tim Johnson (D-SD) and Ranking Member Mike Crapo (R-ID) released long-awaited draft legislation to end the government’s conservatorship of Fannie Mae and Freddie Mac and reform the housing finance system. The Senators also released a summary of the proposal and a section-by-section analysis. The bill adopts many of the principles originally outlined in bipartisan legislation introduced last year by Senators Mark Warner (D-VA) and Bob Corker (R-TN). Like the Warner-Corker bill, the leadership proposal would create a Federal Mortgage Insurance Corporation (FMIC), modeled in part after the FDIC and intended to provide an explicit government backstop for certain MBS. The government backstop would sit behind private investors required to hold at least 10% capital on FMIC-issued securities. FMIC losses in turn would be backed by a reinsurance fund. The FMIC also would (i) oversee a new mortgage securitization platform; (ii) supervise guarantors, aggregators, servicers, and private mortgage insurers; and (iii) collect fees dedicated to support affordable housing and allocated among the Housing Trust Fund, the Capital Magnet Fund, and a new Market Access Fund. Under the bill servicers, aggregators, and others would be subject to capital requirements now only applicable to banks. The bill would establish a 5% down payment requirement for borrowers, 3.5% for first time borrowers. The bill also would create a jointly owned small lender mutual intended to provide small lenders access to the secondary market. The leadership’s small lender mutual would be open to more banks—any depository institution with up to $500 billion in assets—than the Warner-Corker plan would allow. The Committee is expected to markup the legislation in the coming weeks.
On February 10, Better Markets, a public interest non-profit organization, announced the filing of a lawsuit in the U.S. District Court for the District of Columbia challenging a November 2012 settlement obtained by the DOJ and several state attorneys general, which resolved allegations that a large bank and certain institutions it acquired misled investors in connection with the packaging, marketing, sale, and issuance of certain RMBS. The suit claims, in short, that by resolving the allegations through a civil settlement without seeking any judicial review and approval, the DOJ violated the Constitution’s separation of powers doctrine. In addition, the suit claims, the DOJ’s failure to commence a civil action (i) violated the Financial Institutions Reform, Recovery, and Enforcement Act of 1989, and (ii) constituted an arbitrary and capricious action in violation of the Administrative Procedures Act. The complaint asks the court to declare the agreement unlawful and invalid and to issue an injunction that would prevent the DOJ from enforcing the agreement until the agreement is reviewed and approved by a court.
On January 2, the FHFA announced that it has obtained nearly $8 billion in connection with its RMBS litigation initiative. In 2011, the FHFA filed lawsuits against 18 financial institutions involving allegations of securities law violations and, in some instances, fraud in the sale of private label securities to Fannie Mae and Freddie Mac. The total recovered to date includes a recently announced $1.9 billion settlement, the FHFA’s sixth RMBS settlement thus far.
On December 30, Massachusetts Attorney General (AG) Martha Coakley announced the state’s sixth settlement related to allegedly unlawful RMBS practices, which resulted from the AG’s ongoing review of subprime mortgage securitization practices in Massachusetts. The most recent agreement requires an underwriting firm to pay a total of $17.3 million, which includes $11.3 million to be dedicated to compensate government entities that had invested with the Massachusetts Pension Reserve Investment Management Board and $6 million to be paid to the state.
On December 18, New Jersey’s Acting Attorney General John Hoffman announced a lawsuit against a mortgage securitizer and related firms for allegedly violating state securities law by making fraudulent misrepresentations and omissions to promote the sale of RMBS to private investors. Specifically, the suit alleges that the firms misrepresented in the offering documents that mortgages underlying certain securities offered over a 12-month period in 2006-7: (i) were in substantial compliance with the underwriting standards of the originators of the loans; (ii) were originated “in accordance with accepted practices and prudent guidelines;” and (iii) did not have a negative equity. The suit alleges that the firms’ traders warned about the high risks of certain types of loans being securitized. The state claims that after the securities were issued, delinquency rates in the underlying pools increased substantially, and resulted in significantly reduced distributions to investors and write downs in the principal of underlying loans. The New Jersey AG is at least the second state attorney general to file such a suit as part of the federal-state RMBS)Working Group. New York Attorney General Schneiderman filed similar suits under New York law last year.
New York Appellate Court Resolves Trial Court Split Over Statute Of Limitations For Repurchase Suits
On December 19, the Supreme Court of New York, Appellate Division, held that the statute of limitations on claims related to mortgage repurchase obligations begins to run as of the date of closing of the loan purchase agreement. Ace Securities Corp v. DB Structured Prods., Inc., No. 650980/12, 2013 WL 6670379 (N.Y. App. Div. Dec. 19, 2013). The decision resolves a split at the trial court level that resulted from diverging opinions issued earlier this year, in which one court held that the clock on claims by trustees that a securitizer breached its contract by failing to repurchase began to run on the date the representations were made (i.e. the date the pooling and servicing agreement closed), while another court held that the statute did not begin to run until the securitizers improperly rejected the trustee’s repurchase demand, i.e. the breach is the failure to comply, not the date of the representation. On appeal of the latter holding, the court rejected the trustee’s and investors’ argument that the statute does not begin to run until the lender refused to cure or repurchase the defective loans, and held that the claims accrued on the closing date of the pooling and servicing agreement, at which time any alleged breach of the representations and warranties contained therein occurred.
On December 10, the U.S. District Court for the Southern District of New York held that the SEC’s promulgation of Rule 430B in 2005—which, among other things, broadened the category of disclosures that can be made in prospectus supplements rather than post-effective amendments to registration statements—did not alter the “liability date” for Section 11 liability for individuals who sign registration statements in the context of the shelf registration process. Fed.Hous. Fin. Agency v. HSBC N. Am. Holdings Inc., No. 1:11-cv-06201 (S.D.N.Y. Dec. 10, 2013). The ruling comes in the consolidated federal cases brought by the FHFA alleging numerous institutions misled Fannie Mae and Freddie Mac in connection with the packaging, marketing, sale and issuance of certain RMBS. The FHFA suits also named numerous individuals as a “control person[s]” under Section 15 of the Securities Act of 1933, or as directors or signing officers under Section 11 of the Securities Act. In response to a motion filed by more than 90 directors who signed the original registration statements but not the subsequent prospectus supplements, the court explained that Rule 430B deems newly disclosed information to be included in the registration statement, and Section 11 creates liability for signers whenever “any part of the registration statement, when such part became effective, contained an untrue statement of material fact or [omission].” The court interpreted the rule to mean that a prospectus supplement containing information representing a fundamental change in the information provided in the registration statement creates Section 11 liability for directors based on that new information. The court held that, as such, where there is a fundamental change in the information provided to the marketplace through the filing of a prospectus supplement, the new trigger dates for Section 11 liability will apply to those persons.