Over the past year we’ve been watching a handful of financial crisis class actions in which investors sued banks that served as mortgage-backed securities trustees, rather than targeting the banks that issued or underwrote the securities. In addition to bringing breach of contract claims, plaintiffs lawyers at Scott + Scott dusted off a 1939 law called the Trust Indenture Act that makes trustees liable for failing their duties to investors. That litigation campaign has so far survived motions to dismiss in cases against Bank of New York Mellon, Bank of America, and U.S. Bancorp’s U.S. Bank National Association unit.
On Monday the plaintiffs finally hit a snag. Lawyers for U.S. Bank at Morgan, Lewis & Bockius persuaded U.S. District Judge John Koeltl in Manhattan to dismiss a big chunk of a case that Scott + Scott brought on behalf of investors in mortgage-backed securities issued by Bear Stearns. The decision endangers hundreds of millions of dollars in claims in the case before Koeltl, and if it holds up on appeal it could do the same to parallel claims in other trustee suits.
A Scott + Scott team led by Beth Kaswan and David Scott brought the case in 2011 on behalf of investors in 14 MBS trusts. Their complaint claims that U.S. Bank violated the Trust Indenture Act by failing to police the mortgages underlying the securities for inadequacies or defaults and by not forcing Bear Stearns to repurchase loans that went sour. The plaintiffs also claimed breach of contract based on U.S. Bank’s alleged failure to live up to pooling and servicing agreements and indenture agreements that together cover all 14 trusts. (The PSA-governed trusts issued certificates; those covered by indenture agreements issued notes.)
Morgan Lewis’s Michael Kraut and John Vassos moved to dismiss the case last June on a host of grounds. They argued that the investors, who only purchased securities in two of the trusts, lacked standing to bring class claims over most of the securities. And they targeted the plaintiffs’ core theory of liability under the TIA, arguing that they failed to state a claim and that most of the trusts aren’t covered by the statute.
Koeltl sided with the plaintiffs on the standing issue, citing the U.S. Court of Appeals for the Second Circuit’s September 2012 ruling in NECA-IBEW Health & Welfare Fund v. Goldman Sachs. He also refused to throw out the investors’ claims for breach of contract, finding that they’d sufficiently made their case that U.S. Bank skirted its obligations under the governing agreements for the securities.
But the judge was swayed by Morgan Lewis’s argument that the Trust Indenture Act only applies to five of the 14 trusts in the case: those that issued certificates rather than notes. Koeltl agreed with U.S. Bank that an exemption to the TIA covers securities that are governed by a pooling and servicing agreement rather than an indenture, placing nine of the trusts beyond the statute’s reach.
"The certificates are exempt from the TIA pursuant to section 304(a)(2) because they are certificates of participation in two or more securities with substantially different rights and privileges," Koeltl wrote. "This conclusion is consistent with the plain text of the TIA, the SEC’s interpretation of the TIA, and the legislative history of the TIA."
At first glance Koeltl’s ruling seems to be at odds with two previous decisions in MBS trustee cases, since U.S. District Judges William Pauley III and Katherine Forrest in Manhattan have both ruled (here and here) that the TIA applies to MBS certificates. But as Koeltl noted in Monday’s ruling, the defendants in the case before Pauley relied on a different exemption to the TIA in their motion to dismiss. (To be fair, Bank of New York Mellon’s lawyers at Mayer Brown did cite the second exemption in a motion for reconsideration, but Judge Pauley ruled they were too late.) Forrest, meanwhile, concluded that neither of the two TIA exemptions applied to MBS certificates in trusts overseen by Bank of America and U.S. Bank.
On May 7 the Second Circuit agreed to hear an interlocutory appeal of Pauley’s ruling in the BNY Mellon case, so the issue of MBS trustee liability under the TIA is already before the appeals court. Now that Koeltl has handed a different trustee a partial victory, we won’t be surprised if the U.S. Bank case winds up there as well.
David Scott of Scott + Scott acknowledged Tuesday that the plaintiffs suffered a blow on the TIA exemption question, but he emphasized the bright side. “The ruling creates some open issues, but the bottom line is that the case is going forward on the breach of contract claims, and we have 14 trusts covered on class-wide standing,” Scott told us. “It shows the courts understand that these trustees have real obligations and they have to be held to them.”
Morgan Lewis’s Kraut declined to comment. A spokesman for U.S. Bank had this statement: “We are pleased that the court held that the TIA does not apply to PSA certificates and narrowed the plaintiffs’ key claims.”