Objectors’ Siren Song Enchants During Article 77 Proceeding
Subprime Shakeout, July 29, 2013
We are 20 days into the monumental bench trial over Bank of America’s proposed $8.5 billion settlement of Countrywide MBS claims, and with the proceedings now taking a break until September 9, we have a chance to sit back and evaluate what we’ve seen thus far. When I do, I can honestly say that I’ve never seen a plaintiff take such a pounding during the presentation of its own case. But, of course, this Article 77 proceeding is no ordinary case, and Bank of New York Mellon (BNYM) is no ordinary plaintiff.
As Trustee of all 530 Countrywide MBS Trusts at issue, and by virtue of having brought this odd proceeding before Justice Barbara Kapnick in New York Supreme Court, BNYM’s role is to ask the Court to bless Bank of America’s (BofA) settlement and the conduct of the Trustee as reasonable and beyond reproach. The odd thing is that BofA – the party with the most at stake – isn’t even a party to this proceeding. Instead, BNYM – which derives no economic benefit from the settlement dollars themselves – is serving as BofA’s foil – arguing for the settlement to be approved, while absorbing any attacks levied by the opponents to the settlement.
Even stranger, it has now become clear that the Trustee pre-committed itself to advocating for the approval of the settlement, regardless of what evidence or arguments the settlement’s opponents might present. Much like the famous story from Homer’s The Odyssey in which Odysseus ties himself to the mast of his ship to avoid being persuaded off course by the enchanting sirens, BNYM has agreed to tie its own hands and bind itself to BofA’s chosen course for resolving Countrywide’s potentially massive mortgage liabilities. The key question that Justice Kapnick and observers must ask is: was this an appropriate action for BNYM to have taken in this situation?
To see why this is so critical, let’s examine an exchange between counsel for BNYM, BofA, and the settlement objectors outside of the courtroom prior to this month’s proceedings (h/t Manal Mehta). During trial on June 14, 2013, Justice Kapnick requested that the parties consider agreeing to mediation as a method of resolving the objectors’ complaints. Following this request, two of the most prominent members of the objector Steering Committee – AIG and three of the Federal Home Loan Banks – sent a letter to counsel for BNYM confirming that the Steering Committee believed that mediation was appropriate and requesting that BNYM as Trustee “commence settlement negotiations immediately.” It based this request, not on any direction by the objecting holders, but based on the Trustee’s “fiduciary duty of loyalty, which mandates that the Trustee act in the best interests of all certificateholders and avoid conflicts of interest.”
In response, Matt Ingber, counsel for BNYM, sent a letter to the Steering Committee and counsel for BofA, which attached the Steering Committee’s request for mediation. Therein, he noted that “of course, a mediation cannot proceed without the participation of Bank of America and Countrywide. Accordingly, please let us know the position of Bank of America and Countrywide on the request for mediation.” This suggested that the Trustee was potentially open to negotiating with the objectors, but wasn’t going to take action without getting the approval of the bank behind the curtain.
Not wanting to keep anyone in suspense, BofA shot back with a response that was as clear as it was pithy. Elaine Golin, BofA’s counsel from Wachtell Lipton, wrote, “Bank of America and Countrywide will not participate in the mediation that Objectors have proposed and will not otherwise engage in any renegotiation of the Settlement. The Settlement Agreement reflects the result of lengthy, hard and arms-length negotiation. It does not permit any of the economic terms to be renegotiated.”
BofA might have stopped there. BNYM had already stated that the mediation could not proceed without BofA, so BofA’s refusal to participate should have ended the matter. But, just in case anyone was in doubt about who was running this show, BofA decided to throw its weight around and smack the Trustee back into place. Golin wrote to BNYM, “[w]e remind you of the Trustee’s obligations under Paragraph 2(a) of the Settlement Agreement to use its ‘reasonable best efforts to obtain Final Court Approval’ and under Paragraph 30 to use its ‘reasonable best efforts and cooperate in good faith to fully effectuate the intent, terms, and conditions of th[e] Settlement Agreement and the Settlement.’” In other words, if you want us to continue to indemnify you and cover your expenses, don’t even think about questioning or renegotiating any aspect of this settlement.
Now, here’s the problem for BNYM. It has an obligation to act in the best interests of the Certificateholders in each of the 530 Trusts at issue. Yet, it negotiated a settlement that released the claims of all Certificateholders, without consulting the majority of those holders.
BNYM’s argument is that it independently evaluated the settlement and concluded that it was sound. It has maintained throughout this Article 77 proceeding that it was perfectly reasonable for the Trustee not to consult with any Certificateholders outside of the 22 institutional investors who supported the deal. Instead, it has argued that the Article 77 proceeding itself was Certificateholders’ opportunity to say their piece and speak out against the settlement.
Yet, this argument rings hollow when juxtaposed with the “best efforts clause.” In fact, the Trustee has acted consistently with the “best efforts clause” by opposing the objectors’ requests for expanded discovery at every turn. If this proceeding was the full and fair vetting of the settlement that the Trustee held it out to be, why wouldn’t it want all relevant facts to come to light, such as the actual breach rate in the loan pools at issue? Wouldn’t this allow all Certificateholders to make a fully-informed decision about whether to support the settlement?
More importantly, what good is this opportunity for the objectors to speak out against the settlement if the Trustee isn’t listening? Or, more appropriately in the context of the Odyssean metaphor, the Trustee may be listening to the objectors’ siren song, but it can’t change course because it’s tied to the mast of BofA’s settlement vessel. If the Trustee has an obligation to act in Certificateholders’ best interests, why shouldn’t it be allowed to revisit the settlement if new evidence emerges? And why should the Trustee work to prevent relevant evidence from seeing the light of day?
The counterargument is that the objectors have their opportunity to present their case to Justice Kapnick, and it’s ultimately the Court that will make the decision. But, it’s becoming increasingly apparent that the Justice will make this determination based not on the absolute dollar amount of the settlement, but on whether the Trustee’s conduct in negotiating and accepting the settlement was reasonable.
Thus far, objectors’ counsel, led by Dan Reilly, Larry Pozner and Mike Rollin of Reilly Pozner and Beth Kaswan of Scott & Scott, have seized on this conflict to inflict significant damage during cross examination of the Trustee. They have repeatedly pointed out the internal conflicts that imperiled BNYM as it helped to piece together one of the largest settlements in history between BofA and 22 investors willing to make a deal. In one of the most compelling moments, during the hearing on July 16, the objectors forced BNYM’s counsel to admit that even if he had learned of facts or law that undermined the settlement, he was contractually prohibited from informing the Court of this (unless it involved intentional wrongdoing by BofA) due to the “best efforts” and related clauses of the settlement agreement. This seems starkly at odds with the Trustee’s duties under the governing trust agreements.
Indeed, as Trustee of the 530 Countrywide MBS Trusts, BNYM had an obligation to remain loyal to the Certificateholders in those Trusts and avoid conflicts in carrying out that duty. However, as I’ve often pointed out and the objectors have argued, the realities were that BNYM wanted to keep BofA happy, as BofA supplied it with over 60% of its MBS Trustee business and promised to indemnify it from any liability if the settlement went through. So, instead of wanting to push for the best deal possible, it simply wanted to see this sweetheart deal get done.
Of course, BofA didn’t trust that these nebulous economic interests would keep BNYM in line. So it forced the Trustee to swear off objectivity, and agree to use its “best efforts” to get BofA’s settlement approved. This means that BNYM, the party ostensibly advocating for the settlement, really doesn’t have a dog in this fight, other than a fear that BofA will get really angry and yank their business and/or their indemnity.
The objectors’ arguments about BNYM’s strange conduct and awkward position seem to have finally caught the ear of Justice Kapnick. She ruled just before trial that objectors had made out a colorable claim of self-dealing and conflicted conduct by BNYM, sufficient to overcome the attorney-client privilege and allow the objectors to obtain emails that traveled between BNYM and its counsel during settlement negotiations. Armed with these documents, the objectors subjected BNYM’s counsel, Jason Kravitt of Mayer Brown, to withering cross examination during six straight days of testimony at trial that would have worn down even the most grizzled expert witness. And Kravitt is not a grizzled expert witness – he’s far more accustomed to being the one in the board room or on the other side of the witness stand. [For a great blow-by-blow of the various lines of questioning, the best resource (aside from the transcripts themselves) is Mark Palmer’s daily coverage of the trial at the BTIG Blog. Palmer reported that when Kravitt learned he was going to be called back to the stand for a sixth day, he dropped his head into his hands for about ten seconds).
As I look at this trial from a 30,000-foot perspective, I’m struck by how appropriate the Odyssean metaphor really is for this strange position that BNYM finds itself in. By agreeing to the “best efforts clause,” BNYM has agreed to do everything in its power to support the settlement and see it get approved, regardless of what this trial may unearth about the reasonableness of the deal. For those who slept through their Classics or Mythology classes in school, a brief refresher: Odysseus was the captain of his ship, and yet asked his crew to tie him to the mast when they sailed past the beautiful sirens, so that he would not be persuaded by their alluring call and plunge his ship into the rocks like so many had before him. His crew was ordered to place wax in their ears so that they could not hear the call of the sirens or the entreaties of their captain. But Odysseus had no wax in his ears, so he could still hear the sirens’ song; he just had no power to do anything about it.
It’s the classic allegory of pre-commitment – binding yourself ahead of time to what you know is the right course because you don’t think you’ll have the strength to choose that path in the moment. It’s like the friend who gives you cash before you walk into a casino and tells you not to give it to him, no matter how much he protests. [Never agree to this, by the way. You’ll find yourself out in the parking lot two hours later as your friend yells at you to give him his money back.]
Only here, BNYM, as the plaintiff and the “captain” of the Article 77 ship, has a fiduciary obligation to act in the best interests of all bondholders, which include those they’re treating as the sirens – the objectors. And it’s not so clear that BofA’s path is the right one for the Certificateholders as a whole.
At least one of the objectors, AIG, has stated publicly that it holds an interest in 97 of the 530 trusts at issue. Should the Trustee be permitted to pre-commit itself to a settlement without speaking to investors like AIG, before all the facts have been examined, and before the settlement has been finalized? What if instead of steering the Trustee into the rocks, these objectors are showing the Trustee how it can reach friendlier shores (Ithaca?) – that is, squeeze a whole lot more money out of BofA? Wouldn’t the Trustee have a duty to pursue this path and see where it leads?
BNYM’s expert JH Langbein thought so, but after he said in deposition that the Trustee owed a fiduciary duty to bondholders to maximize their recoveries, BNYM pulled him from their witness list. Now, we won’t hear from him personally at trial, though AIG’s counsel read his deposition testimony into the record. Same goes for Brian Lin, the now infamous expert from RRMS, whose calculations form the primary basis for BNYM’s determination that the $8.5 billion settlement amount was reasonable. Lin’s no longer on BNYM’s expert list, but you can be sure that the objectors will call him to the stand as one of their witnesses.
Even without these witnesses showing up to discuss or defend their analyses, the objectors have scored plenty of points and brought many compelling facts to light. First, they established through Kravitt that the “best efforts clause” could be read to amend the Pooling and Servicing Agreements, the contracts governing the 530 Trusts. Yet, the Trustee did not follow the protocol established in those documents for amending their terms, which generally require a super-majority of Certificateholder votes. So, agreeing to this clause may have been an improper amendment of the Trustee’s duties.
Second, they got Kravitt to admit that his firm, Mayer Brown, had no authority to actually sue BofA if settlement negotiations fell through. That’s because Mayer Brown had also represented BofA, and had only obtained a limited conflict waiver from BofA to negotiate the settlement, not to sue. At least ten of the institutional investors supporting the deal also had prior relationships with Mayer Brown, and they had all executed similar conflict letters. This completely undermines BNYM’s position that these were arms-length negotiations and that it took an aggressive approach toward BofA, including an implicit threat of litigation. If this was true, wouldn’t BNYM have hired a counsel that could hold the sword of litigation over BofA’s head?
Third, the objectors established that BofA was paying BNYM’s legal expenses throughout much of the negotiations and the Article 77 proceeding. Though Kravitt contended that this was perfectly normal, I have yet to engage in negotiations with a responsible party over RMBS liabilities in which the party we were threatening to sue agreed to pay my legal fees. I’d like to ask for that at the outset of my next negotiation and see how that goes over.
Fourth, the objectors established that the settlement treats all 530 Trusts alike despite the fact that they have differing legal rights (most importantly, with respect to certain breaches being deemed material and adverse in certain Trusts). BNYM had not disclosed this to the Court previously, but it has now come out during the trial. This flies in the face of BNYM’s duty to act, not as the Trustee of all 530 Trusts at once, but as the independent Trustee of each of those Trusts, bound to make a separate determination for each as to what’s in the best interests of that Trust’s bondholders.
When this proceeding resumes on September 9, BNYM will present the last two of its witnesses. With the bulk of its case now having been presented, you would expect the Trustee to have built up a sizeable lead, since the objectors have still not put on a single of its own witnesses or experts. And yet, if the Trustee has any lead at all, it’s a small one, and it’s only by virtue of the high standard that objectors must meet to get the Court to reject the Trustee’s Petition (as discussed previously, the standard for approval is simply reasonableness, so the objectors must show the Trustee acted irrationally or arbitrarily for the Petition to be rejected). Though I still feel it’s unlikely that Justice Kapnick will reject the settlement entirely, it’s beginning to look increasingly likely that she forces the parties back to the negotiating table.
You see, one can only deny the facts so long. And no matter how much BofA hammers on BNYM that it must abide by the “best efforts” clause, at some point, Justice Kapnick herself may start to become persuaded by the objectors’ siren song, and begin to see this settlement for what it is: a sweetheart deal designed to protect BofA from far greater potential liabilities. At that point, this trial may shift decidedly in favor of the objectors. And rather than risk having the Court reject the whole thing, send everyone back to square one and erase the indemnity the Trustee covets so badly, BNYM may decide it’s obligated to mediate with the objectors and see what it would take to have them drop their objections. Though this might send BofA’s $8.5 billion settlement crashing into the rocks, it would also be just what AIG and the other objectors have wanted from the start: to be heard by a Trustee with the incentive and the ability to heed their calls.
[I will be on vacation the remainder of this week, and will respond to any questions or comments as soon as I can upon my return – IMG]
I am an attorney, consultant, book editor, and one of the nation’s leading experts on mortgage backed securities litigation. I author The Subprime Shakeout mortgage litigation blog, am the Managing Member of MBS consulting firm IMG Enterprises, LLC, and am the editor of the newly released book, “Way Too Big to Fail: How Government and Private Industry Can Build a Fail-Safe Mortgage System,” by Bill Frey. Follow me on Twitter @isaacgradman