New Lawsuit by Hedge Funds Against Securitization Trustees Filed in New York State Court Last Week

Here’s a new lawsuit to watch. It was filed in New York’s state court, called the Supreme Court (trial court) division in New York.   I would wager that the Defendants will try to remove it to federal district court soon.

Of course, this isn’t the first lawsuit related to fall-out from the financial crisis and housing collapse.  Pimco and other giants in the hedge fund industry have sued many times to try to recover for the harm caused by their investments in mortgage-backed-securities, and the Big Banks’ (Bank of America, Citi, etc.) refusal to honor their purchase back obligations when they knew, and failed to disclose, to the investors, that their representations and warranties regarding the quality and underwriting of the underlying loans being transferred into the Trusts were false.  Nothing new there.  There have been high profile lawsuits and settlements by investors and by the bond-insurers who insured the deals, like AMBAC. But three days ago, Pimco and others sued the trustees of the MBS Trusts.  The Trustees of these Trusts are typically large banks, commonly Deutsche Bank, U.S. Bank, N.A., Bank of New York Mellon, and the like.  The trusts claim that their responsibilities are much more passive and limited than those of a common law trustee.  Mainly, they claim that all they do is furnish payments on the certificates to the investors.  But the truth is, they have conflicts and interests that impact the investors, because they are predisposed to honor the investment banks, servicers, and depositors (often all related entities and subsidiaries of the underwriting investment bank, which would have been Lehman, or Goldman Sachs, or Bear Stearns). The investors are claiming  that they were owed a higher duty by the securitization trustees. From the Wall Street Journal at

Trustees are appointed by bond issuers to ensure that interest and principal payments are funneled to investors in the bonds. Their role requires they ensure that mortgage servicing firms are following the rules that govern the treatment of loans with defects, or if a homeowner defaults. But the trustees have long argued their responsibilities are limited to functions such as overseeing how payments are directed to investors and providing routine reports on bond servicing, said Ron D’Vari, chief executive of NewOak Capital, a capital markets advisory firm that consults on bond litigation. Trustees believe that a broad oversight role for them “is a misconception of the investors,” Mr. D’Vari said. The suits filed Wednesday allege that the trustees were aware that the bonds were filled with defective loans due to “pervasive” evidence of systemic abuses by loan originators and shoddy construction of bond deals by issuers, according to the lawsuits. In some cases, the trustees were directly informed by bondholders and bond insurers of violations by lenders and issuers, the lawsuits say. The investors say that trustees were conflicted because the issuers that appointed them often had stakes in the firms that serviced the loans.


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