Securities and Financial Sector Legal Review

NY AG to Sue Bank of America and Wells Fargo over National Mortgage Settlement

By Alison MacGregor on Posted in Mortgage Lending and Foreclosure

Back in February of last year, we posted about the $25 billion settlement between the federal government, 49 states, and the nation’s largest mortgage servicers.  As part of this settlement, New York received $136 million.  This week, New York Attorney General Eric Schneiderman said at a news conference that “Wells Fargo and Bank of America have flagrantly violated their obligations under the settlement,” reported Bloomberg and other news sources. The Attorney General’s website announces that office’s “intention to sue Bank of America and Wells Fargo for repeatedly violating the terms of the National Mortgage Settlement.” The statement further provides:

In response to complaints from New York homeowners put at risk by these banks’ violations of the standards, Attorney General Schneiderman sent a letter to the parties that oversee the National Mortgage Settlement informing them that he intends to sue Wells Fargo and Bank of America. This would be the first time an Attorney General will have brought a legal enforcement claim under the auspices of the National Mortgage Settlement.

….The letter includes written complaints against Bank of America and Wells Fargo, and a significant amount of back up documentation demonstrating the severity of the violations. Schneiderman intends to ask the court to impose injunctive relief and to require strict compliance under the Settlement.

The New York Attorney General’s complaints against Bank of America and Wells Fargo involve four “servicing standards” “relating to the timeline for processing mortgage modifications,” and include failures to comply with requirements such as those providing that borrowers receive written acknowledgement of receipt of a loan modification application within three days and that servicers must give borrowers 30 days to submit missing documentation or correct a deficiency.

Bank of America and Wells Fargo aren’t the only ones dealing with headaches over the National Mortgage Settlement.  The New York Times reported that Rust Consulting, who distributes checks to homeowners under the settlement, had bounced checks to homeowners or issued them in the wrong amounts. The Times further reported that:

With more than 50 federal contracts to its name, and its own political action committee spreading campaign donations across Washington, Rust has become a favored middleman for class-action lawsuits and government settlements.

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But problems emerged soon after the settlement was announced in January. The consulting firm, officials said, was initially slow to alert borrowers to expected payments. Then, the officials say, Rust delayed the checks for weeks as it struggled to gear up for the payments.

Once Rust issued the first round of checks in April, it failed to move money into the bank account used for the settlement. The decision prevented some homeowners from cashing their checks.

Rust played down the mistake at first, saying in a private e-mail to banks that the “perceived issues” with a handful of checks lack “merit,” according to a copy of the e-mail reviewed by The New York Times.

But, in effect, the checks bounced. And after the incident, Rust lost significant credibility with the regulators, officials said.

Judge Rakoff Allows Suit Against Bank of America Under FIRREA Statute

By Lystra Batchoo on Posted in Mortgage Lending and Foreclosure, Notable Decisions

Yesterday, Judge Jed S. Rakoff of the United States District Court for the Southern District of New York denied Bank of America‘s motion to dismiss claims brought by the United States under the Financial Institutions Reform Recovery Enforcement Act (“FIRREA”). We previously reported on the lawsuit when it was filed back in October.

FIRREA was enacted in 1989 in response to the savings and loan crisis and to “reform, recapitalize, and consolidate the Federal deposit insurance system, to enhance the regulatory and enforcement powers of Federal financial institutions regulatory agencies, and for other purposes.” The statute allows the government to bring a civil action and seek substantial penalties based on violations of certain criminal statutes when those violations are ones ”affecting a federally insured financial institution”.

In recent months, the government has relied on FIRREA to bring cases against banks alleged to have been engaged in fraudulent conduct, primarily in the context of the mortgage crisis. FIRREA likely appeals to the government for a number of reasons. It allows the imposition of civil penalties of up to $1 million for a one-time violation and up to $5 million for continuing violations. Furthermore, FIRREA provides a generous statute of limitations of ten years in which the government has to file a lawsuit.

Judge Rakoff had previously expressed being “troubled” by the government’s use of FIRREA in the Bank of America case, but his order allowed the government’s claims to proceed under FIRREA while dismissing claims under another statute, the False Claims Act. He stated that he reached this decision “[a]fter careful consideration” and would issue a formal opinion shortly. His decision follows a similar decision by Judge Lewis Kaplan on April 24th which allowed the government’s FIRREA claims against Bank of New York Mellon to proceed.

For additional information, see Bank of America Faces Narrow Claims in U.S. Lawsuit Over Mortgages and U.S. Can Pursue Case Against Bank of America Over Mortgages.

 

MBIA Suit Against Bank of America May Proceed

By Lystra Batchoo on Posted in Mortgage-Backed Securities, Notable Decisions

We have been following the MBIA lawsuit against Bank of America (see here and here).  In the latest development, Justice Eileen Bransten of New York State Supreme Court ruled on Monday that MBIA’s lawsuit may proceed. The lawsuit involves allegations regarding mortgage-backed securities that accompanied Bank of America’s 2008 acquisition of Countrywide Financial Corp (“Countrywide”).  MBIA alleges Bank of America, as Countrywide’s successor, fraudulently induced MBIA to insure fifteen residential mortgage-backed securities.

In the ruling, Justice Bransten denied Bank of America’s argument that it could not be held liable for claims against Countrywide because it had paid fair value for Countrywide’s assets.  The court stated the following:

 Here, the issue is whether two of those successor liability exceptions – de facto merger and assumption of liability – are viable in light of the evidentiary record.  Whether payment of fair value in the ordinary course would result in ‘fairness’ to creditors is collateral to the matter at bar . . . The principle underlying the de facto merger doctrine is that a purchaser cannot escape the assumption of liabilities ordinarly attendant with a merger by labeling the transaction something else.  Whether fair value is paid for the assets acquired has no bearing on whether a New York court will look at a transaction or series of transactions and deem them ‘in substance a consolidation or merger of seller and purchaser.’  Thus, BAC’s argument that its payment of ‘fair value’ defeats MBIA’s successor liability claim fails.

Although the opinion allowed MBIA’s suit to proceed, Justice Bransten also found that MBIA was not entitled to summary judgment on its successor liability theory.  Some commentators have speculated whether this ruling will have an affect on a proposed $8.5 billion settlement between Bank of America and investors in another case (we’ve also reported on it here).  For more information, see MBIA Can Continue Its Fraud Case Against Bank of America and Judge in MBIA v. Countrywide Gives Boost to Monolines, MBS Investors.

UPDATE

Various news outlets reported on May 6, 2013 that MBIA and Bank of America had settled the lawsuit for $1.6 billion in cash.  For more information, visit MBIA, Bank of America Reach Legal Settlement: Sources,  MBIA Surges After Report Insurer Settled with Bank of America, and Bank of America and MBIA Said to Agree to $1.7 Billion Settlement.

CFTC Focuses on High-Frequency Trading

By Lystra Batchoo on Posted in Regulatory Actions

At a meeting this week of its Technology Advisory Committee, the Commodity Futures Trading Commission discussed the need for new regulations aimed at high-frequency trading following a high-profile hacking incident involving theAssociated Press’ Twitter account earlier this month.

In a statement to the Committee, Commissioner Bart Chilton stated:

we should open our eyes to the fact that technology has placed us, at times, in a perilous position with regard to financial markets.  It’s worrisome that markets could move so fast based on a hoax. It’s likely that high frequency traders made money on the way down and the way up but there undoubtedly were folks who got caught, lost money and then couldn’t get back in.  This only serves to underscore the importance of better regulation of cheetah traders. While I don’t believe we should be out to make these cats extinct, we need the regulatory tools to keep them in their cages when they go feral.

Yesterday, Commissioner Chilton announced a proposal to impose a transaction fee in hopes of curbing high-frequency trading.  The proposal calls for a charge of $0.0006 per transaction.  For more information, visit CFTC’s Chilton: High Speed Traders Likely Made Money on Twitter Hack Attack, U.S. Regulator Seeks Tax For Fast-Speed Traders, CFTC Commissioner Proposes Derivatives Transaction Fee, and New Fee Could Slow High Speed Traders: CFTC Commissioner.

Corporate Governance Update: April 2013

By Patricia Lee on Posted in Corporate Governance, Municipal Bonds and Bond Derivatives, Regulatory Actions

Law Clerk Aartie Manansingh co-authored this article.

A. SEC Says Social Media OK for Company Announcements if Investors are Alerted

In a press release on April 2, 2013, the SEC issued a report that makes clear that companies can use social media forums to announce key information in compliance with regulation FD (Fair Disclosure) “so long as investors have been alerted about which media will be used to disseminate such information.”

The report was triggered by a Facebook post made by Netflix, Inc. CEO Reed Hastings on his personal Facebook page in July 2012. Mr. Hastings posted that Netflix had streamed 1 billion hours of content during June 2012. Netflix did not report this information to investors through a press release or Form 8-K filing, and a subsequent company press release later that day did not include this information. The SEC decided not to pursue an action against Netflix or Mr. Hastings, and admitted that the case’s facts reflect new territory for the SEC.  However, the SEC report stated that in the future the SEC would generally not consider the release of material nonpublic information on a company officer’s personal social media site to be an acceptable method of Regulation FD disclosure unless the company had previously announced that the site was a potential source of company information.

The SEC issued a Report of Investigation that can be found here.

B. SEC CHARGES City of Victorville, Underwriter, and Others with Defrauding Municipal Bond Investors.

On April 29, 2013, “The Securities and Exchange Commission . . . charged that the City of Victorville, Calif., a city official, the Southern California Logistics Airport Authority, and Kinsell, Newcomb & DeDios (KND), the underwriter of the Airport Authority’s bonds, defrauded investors by inflating valuations of property securing an April 2008 municipal bond offering.” The press release may be found here.

C. PCAOB Proposes Framework for Reorganizing Existing Interim and PCAOB-issued Auditing Standards

The new Public Accounting Oversight Board (PCAOB) proposal will reorganize the auditing standards “into a topical structure with a single integrated number system.” Additionally, “the PCAOB is proposing certain conforming amendments to rule 3101, Certain Terms Used in Auditing and Related Professional Practice Standards, and Rule 3200T, Intermin Auditing Standards.” More information and the proposed framework may be found here.

Terminating Bailouts for Taxpayer Fairness Bill Introduced

By Alison MacGregor on Posted in Legislation

 

Last week, Sherrod Brown (D-OH) and David Vitter (R-LA) introduced S. 798, the Terminating Bailouts for Taxpayer Fairness Act to the United States Senate.  The bill seeks to address the issue of “too big to fail” banks, largely through increased capital requirements.

A one-page summary of the bill, available on Senator Brown’s website, provides that

Regulators would walk away from BASEL 3, and institute new capital rules that don’t rely on risk weights and are simple, easy to understand, and easy to comply with.

o Regulators will determine the appropriate level for banks under $50 billion in assets.

o Regional banks will be required to have 8 percent equity to total assets.

o The largest banks will have a minimum 15 percent capital requirement. They will be faced with a clear choice: either become smaller or raise enough equity to ensure they can weather the next crisis without a bailout. Federal regulators have the option of increasing the capital level as an institution grows.

o Capital requirements will focus on common equity and other pure, loss-absorbing forms of capital.

o Regulators will calculate firms’ balance sheets in a more accurate way, by counting off-balance-sheet assets and obligations and considering counterparty credit risk in calculating derivatives exposures.

o Regulators would be able to use risk-based capital as a supplement for banks over $20 billion, if their supervisory authority proves insufficient to prevent institutions from over-investing in risky assets.

The proposed legislation resulted in a flurry of media comment. The New York Times Dealbook questioned why the capital requirements were lower for smaller banks:

Mr. Vitter and Mr. Brown acknowledge that their bill would set the capital bar for regional banks even lower than current market practices, including by lowering leverage capital ratios to 8 percent from 10 percent of assets. Yet this would increase, rather than decrease, the risk of bank failures.

The bill also contains a number of other benefits for community banks. It would expand the definition of “rural” lenders that could offer balloon mortgages; reduce some impediments for small banks and thrifts to raise capital or pay dividends; create an independent bank examiner ombudsman that institutions could appeal to if they felt they had been treated unfairly by their examiner; and adopt privacy notice simplification legislation.

There are certainly policy considerations that might justify favoring smaller banks over larger ones. Historically, these have included keeping capital in local hands, favoring agrarian lending to industrial lending and avoiding concentration of power in urban elites.

Prohibition against branch banking by national banks for most of American history is an example of a law in furtherance of these policies. Those laws have for the most part been scrapped because they fostered inefficient uses of capital and, in many cases, bad management. But at least they were honest about what they were trying to do.

And, S&P  released a report (covered by Business Insider) that was critical of the effect the proposed legislation might have on banks’ ability to extend credit, and the resulting effect on the economy:

We would be most concerned about the impact on the economy because it appears banks would need to build significantly more capital, which would likely impede their ability to extend credit. In addition, the proposal does not appear to be comprehensive–it focuses primarily on capital and does not address liquidity. Under our methodology, we would potentially no longer factor in government support if we believed that once large banks are broken up, we would not classify these banks as having high systemic importance. Clearly, if enacted, a transition period will be required as many moving parts in this legislation are absorbed by management teams and investors alike.

The American Banker published an editorial criticizing the bill, arguing that “[e]ven if Brown-Vitter’s capital requirements were implemented, U.S. banks would be at a competitive disadvantage vis-à-vis European banks and other international banks that have not implemented Basel III.”

Court Okay’s FHFA $6.4 Billion Suit Against UBS

By Lystra Batchoo on Posted in Mortgage-Backed Securities, Notable Decisions, Regulatory Actions

We previously reported on the lawsuit the Federal Housing Finance Agency (“FHFA”) filed against the Swiss bank, UBS, for securities violations based on the bank’s alleged misrepresentations and fraud relating to residential mortgage-backed securities. Earlier this month, the Second Circuit ruled that the lawsuit can move forward.

District Court Judge, Denise Cote, had previously ruled that the FHFA filed suit within the applicable statute of limitations. The Second Circuit agreed and found that the statute, the Housing and Economic Recovery Act (“HERA”), which created the FHFA in September 2008, allowed the FHFA to bring lawsuits within three years of that date. The instant lawsuit was filed on July 27, 2011, within the three year time period.

The opinion stated:

Congress enacted HERA and created FHFA in response to the housing and economic crisis, precisely because it wanted to address the dire financial condition of Fannie Mae and Freddie Mac. As HERA makes clear, Congress intended FHFA to take action to “collect all obligations and money due” to the GSEs, to restore them to a “sound and solvent condition.” Congress obviously realized that it would take time for this new agency to mobilize and to consider whether it wished to bring any claims and, if so, where and how to do so. Congress enacted HERA’s extender statute to give FHFA the time to investigate and develop potential claims . . . and thus it provided for a period of at least three years from the commencement of a conservatorship to bring suit.

For additional analysis, see Court Says UBS Must Face Mortgage Lawsuit, UBS Bid to Dismiss FHFA Mortgage-Bond Suit Denied, and UBS Loses Bid to Dismiss FHFA Mortgage Debt Lawsuit.

 

DOJ v. S&P: S&P’s Motion to Dismiss

By Alison MacGregor on Posted in Mortgage-Backed Securities

We previously posted (here and here) about the Justice Department’s civil suit against Standard & Poor’s concerning its ratings of CDO transactions, which was filed in February in the Central District of California (the complaint is available here). The Complaint brings claims against S&P under the Financial Institutions Reform, Recovery & Enforcement Act (“FIRREA”) and seeks $5 billion from S&P.  Among other things, the DOJ claims that S&P was aware of the deteriorating housing market and did not adjust its methodologies. In support of these allegations, the government cites internal S&P emails, instant message exchanges, and a employee-created video parading the imploding housing market. (For coverage of these emails and videos, please see here and here).

Yesterday, S&P filed its moving brief in support of its motion to dismiss the DOJ’s complaint. S&P argues that the Complaint should be dismissed because it fails to properly allege either a “scheme to defraud” or specific intent as required by the fraud statutes. S&P argues that:

Each of the representations identified by the Government is the type of vague, generalized statement that court after court—in this District, this Circuit and elsewhere across the country—has held to be non-actionable in a federal fraud case such as this. Most notably and revealingly, the Government has simply chosen to ignore a Second Circuit opinion, filed just six weeks before the Government filed its Complaint and of which the Government was fully aware, holding that the very same S&P statements the Government relies upon here cannot be the basis for a finding of fraud under federal law.

The case cited by S&P, Boca Raton Firefighters and Police Pension Fund v. Bahash, was decided by the Second Circuit in December, 2012, and dismissed a 10b-5 action brought by shareholders against S&P.  The Second Circuit held that “[t]he statements alleged in the Fund’s complaint regarding McGraw-Hill’s integrity and credibility and the objectivity of S&P’s credit ratings are the type of mere “puffery” that we have previously held to be not actionable.”

S&P also takes issue with the government’s allegations on intent, arguing that:

In addition, the Complaint fails to allege that S&P possessed the requisite intent to defraud the investors in the CDOs at issue. It is more than ironic that two of the supposed “victims,” Citibank and Bank of America—investors allegedly misled into buying securities by S&P’s fraudulent ratings—were the same huge financial institutions that were creating and selling the very CDOs at issue. In other words, the Complaint charges S&P with intending to defraud these financial institutions about the likely performance of their own products. With respect to other investors—those who were not also issuers of the securities at issue—the Government relies entirely on a claim that runs contrary to the rest of its case. For this narrow purpose, the Government claims that in fact the investors paid S&P’s fees, even though for all other purposes it claims that S&P was motivated by the fact that issuers pay its rating fees, not investors. Such contradictory pleadings cannot suffice as an allegation of intent to defraud.

 

Crowdfunding: The JOBS Act and the SEC’s Missing Rules

By Alison MacGregor on Posted in Corporate Governance, Legislation

Kelley Drye & Warren LLP attorneys Jeanne Solomon, Matthew Zucker and Maura Gallagher recently gave a presentation on the JOBS Act and crowdfunding. The JOBS Act of 2012 required the SEC to adopt rules allowing equity crowdfunding in the United States; the deadline for implementing those rules was December 31, 2012.  The SEC has yet to propose or adopt such rules.  In light of the JOBS Act mandate and the pending SEC rule proposals, the presentation explains what crowdfunding is and lists some current crowdfunding sites in the U.S. and internationally; describes the JOBS Act rulemaking mandate, political climate and status of SEC no-action letters and other guidance on crowdfunding; and discusses some of the potential challenges and benefits of the future crowdfunding rules.

New Rule Defines Non-Bank Financial Firms for Purposes of Dodd-Frank

By Lystra Batchoo on Posted in Regulatory Actions

Last Wednesday, the Federal Reserve approved a final rule that sets the parameters for when a non-bank company can be designated by the Financial Stability Oversight Council (FSOC) as subject to regulation under Dodd-Frank.  According to a press release,

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, a nonbank financial company can be designated by the FSOC for supervision by the Federal Reserve only if it is “predominantly engaged in financial activities.” A company is considered to be predominantly engaged in financial activities if 85 percent or more of the company’s revenues or assets are related to activities that are defined as financial in nature under the Bank Holding Company Act. Additionally, the FSOC may issue recommendations for primary financial regulatory agencies to apply new or heightened standards to a financial activity or practice conducted by companies that are predominantly engaged in financial activities.

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The final rule also defines the terms “significant nonbank financial company” and “significant bank holding company.” Among the factors the FSOC must consider when determining whether to designate a nonbank financial company for consolidated supervision by the Federal Reserve is the extent and nature of the company’s transactions and relationships with other significant nonbank financial companies and significant bank holding companies. If designated, those nonbank financial companies will be required to submit reports to the Federal Reserve, the FSOC, and the Federal Deposit Insurance Corporation on the company’s credit exposure to other significant nonbank financial companies and significant bank holding companies as well as the credit exposure of such significant entities to the company. Consistent with the proposal, a firm will be considered significant if it has $50 billion or more in total consolidated assets or has been designated by the FSOC as systemically important.

The new rule will be effective as of May 13, 2013.  For analysis, see Regulators Move Closer to Oversight of Nonbanks, U.S. Regulators Approve Rule to Designate Non-Banks Systemic, and Fed Releases Rule Defining Predominantly Financial Firms.