It was a point raised early and often during a recent motion to dismiss hearing on a residential mortgage-backed securities repurchase case, but its significance in the greater context of such litigation is debatable: The role hedge funds play behind the scenes.
Joseph Frank, a partner at Orrick, Herrington & Sutcliffe, referred to so-called “made for litigation hedge funds” in statements to the court on Nov. 12 in the case, Nomura Asset Acceptance, Alternative Loan Trust, Series 2006-S3 v. Nomura Credit & Capital, 652619/2012, pending before Manhattan Supreme Court Justice Marcy Friedman.
On behalf of defendant sponsoring financial institution Nomura, Frank argued that the plaintiff trust is time-barred from bringing breach of contract repurchase claims due to New York’s six-year statute of limitations. Nomura Asset Acceptance bought the loans from Nomura Credit & Capital pursuant to a mortgage loan purchase agreement dated July 1, 2006, then transferred the loans to the trust per a pooling and servicing agreement; the lawsuit was filed July 27, 2012.
According to Orrick’s dismissal brief, hedge fund Fir Tree Partners created smaller funds known as the Zambezi Funds, which urged the trustee to sue Nomura for breach of the underlying representations and warranties for mortgage loans packaged into securities and sold off to investors ahead of the financial crisis.
In a Oct. 20, 2011 letter sent to trustee HSBC Bank, attached as a defense exhibit in the Nomura case, Zambezi Funds’ attorney William Urquhart of Quinn Emanuel Quinn Urquhart & Sullivan informs the recipient that “an argument can be made that the six-year statute of limitations for breach of contract claims under New York law runs on the six-year anniversary of the issuance of the applicable representations and warranties.”
“In light of the uncertainty in the case law,” Urquhart writes in the letter, “HSBC should take immediate steps to protect the Trusts and their Certificateholders from the possible loss of repurchase claims in the near future.”
Orrick’s motion to dismiss seizes upon this communication, pointing out that “ ‘The Zambezi Funds warned that ‘Time Is of the Essence.’ ”
“The Zambezi Funds did not invest in the certificates when they were issued in 2006 and did not experience any of the losses that the certificates suffered due to the financial crisis,” the brief notes, before detailing how the hedge fund offered the trustee full indemnification “for all costs” related to litigation against Nomura.
The role such hedge funds play in these RMBS repurchase lawsuits circling through the Commercial Division has emerged as a new wrinkle in ongoing litigation, though plaintiffs’ attorneys have pushed back against such attacks with fervor, arguing they have no relevance to the legal issues.
“Defendants are raising issues about these directing certificate-holders to divert attention from the real contractual and legal issues that the courts need to decide,” said Michael Shuster, partner at Holwell Shuster & Goldberg, in an interview with CLI.
During the Nomura Nov. 12 motion to dismiss hearing, plaintiff’s counsel Michael Fay, partner at Kasowitz Benson Torres & Friedman, told the judge it was “simply not true” that the Zambezi hedge fund was established merely to pursue litigation.
And when the same point was raised by Orrick’s Frank a day later in the related case, HSBC Bank USA, National Association, in its capacity as trustee of Nomura Home Equity Loan, Series 2007-2 v. Nomura Credit & Capital, 650337/2013, Shuster, on behalf of HSBC Bank, pronounced to the court that it was peculiar for defense attorneys to “make some argument about the equities or what have you” when “Nomura dumps these defective loans to trusts that were sold to investors.”
“Under those circumstances, I felt the need to point that out and set the record straight and to remind the court that the real issue in these cases is that Nomura placed so many defective loans into these trusts,” Shuster later told CLI.
One of those very legal issues is headed to the Appellate Division, First Department on Wednesday in Ace Securities v. Deutsche Bank Securities Products, 965 N.Y.S.2d 844 (Sup. Ct. N.Y. Cnty. 2013). A five-judge panel will decide whether the statute of limitations for RMBS put-back claims begins on the date the agreements took effect (the appellant’s position) or when demand was first made on the issuing sponsor to cure or repurchase these loans (the respondent’s position).
The role hedge funds purportedly have in compelling trustees to bring suit – in the Nomura case, by virtue of Zambezi Fund’s control of 27.6 percent of the voting rights in the trust – is embedded in these arguments.
In an amicus curiae brief in support of Deutsche Bank submitted to the First Department, the Securities Industry and Financial Markets Association, a trade group representing securities firms, notes that hedge funds “that speculate in distressed assets and debt stepped in to take advantage of this drastically dislocated market.”
“At the same time, however, many of the sophisticated hedge funds began speculating not just in low-priced RMBS, but in RMBS litigation. They have bought RMBS with the idea of adding to their profits by hiring lawyers and pursuing repurchase litigation against RMBS sellers and sponsors,” states the amicus brief, filed on behalf of SIFMA by Wachtell, Lipton, Rosen & Katz.
Business law experts say that hedge funds that purchased such securities during the height of the crisis still owe a fiduciary duty to investors.
“The SIFMA brief takes some rather oblique shots at these hedge funds for sweeping in and purchasing these RMBS, and then commencing litigation. I don’t see why that’s necessarily problematic in the first place,” said Brent Horton, assistant professor at Fordham University Gabelli School of Business. “They really were taking advantage of a good investment opportunity, and once the hedge fund purchases the RMBS, they have a fiduciary duty to maximize the return for their investors and this litigation allows them to do that.”
The Association of Mortgage Investors, another trade group, has filed a motion for leave to file an amicus brief in support of Ace Securities in the upcoming appeal.
Represented by McKool Smith principal Robert Scheef, AMI argues in its brief that “at least” one-third of filed RMBS lawsuits have been brought by the Federal Housing Finance Agency, as conservator of Freddie Mac – not hedge funds.
“Even if the identity of directing investors is relevant at all (it is not), repurchase litigation is far from the exclusive province of hedge funds,” the brief notes.
“I’m not sure why the type of investor alters the analysis,” Scheef added in an interview with CLI. “The contract is the contract. [Defense attorneys] are certainly trying to obfuscate the issues by seeking to malign hedge funds who are directing trustees to file some of these actions.”
Horton, of Fordham, pointed out that regardless of the behind-the-scenes role hedge funds play, the underlying claims in these repurchase suits have merit.
“These aren’t frivolous claims. They’re grounded in fact. There really are problems with these mortgages that underlie the RMBS,” Horton said. “The RMBS is only as good and profitable as the underlying mortgages.”