In their recent suits against JPMorgan Chase, the New York
attorney general and the Securities and Exchange Commission
borrowed liberally from the record established by the bond
insurers Ambac, Assured Guaranty and Syncora in their
long-running cases against the bank, Bear Stearns and its
erstwhile mortgage arm, EMC. On Tuesday, Chancellor Leo Strine
of Delaware Chancery Court ruled that a Bear Stearns
mortgage-backed securities trustee, acting at the direction of
the hedge fund Baupost, may also quote emails and testimony from
those monoline cases in its breach-of-contract complaint against
Strine's nine-page decision said that in Delaware,
plaintiffs can't merely crib allegations from other complaints
but can make use of borrowed material as long as it's relevant
to their claims and they've conducted their own investigation.
The trustee's complaint in this case, he said, satisfied those
requirements. Its lawyers at Ropes & Gray and Abrams & Bayliss
quoted specific discovery from bond insurer complaints to
support their allegations that EMC routinely ignored
underwriting standards, Strine said.
The ruling will help other trustees who have brought MBS
breach-of-contract cases in Delaware Chancery Court -- including
trustees in at least three other cases against JPMorgan in
Strine's courtroom -- since it means they too can borrow from
the voluminous record in the bond insurer suits. But that's not
the only implication of Strine's opinion. The decision suggests
that the chancellor's view of MBS put-back cases may have
shifted as he considered evidence that comes from the bond
insurer litigation. When this case was first filed, Strine
seemed to regard it as a straightforward contract dispute,
ordering the two sides to get together and talk about which
underlying loans really breached EMC's representations and
warranties. His ruling Tuesday, though, pays heed to the
subtleties of the trustee's argument that EMC systematically
disregarded underwriting standards and applied different sets of
rules in asserting its own put-back claims against mortgage
originators while denying similar claims by MBS investors.
"The (trustee's) allegations are obviously connected to
(its) claim that EMC breached the representations and warranties
in the purchase agreement, because, among other reasons, they
provide a basis for the trustee's contention that EMC did not
adhere to accepted underwriting standards and that EMC's own
understanding of relevant commercial terms in the agreements, as
shown by its course of dealing in analogous circumstances, was
different from what it now contends," Strine wrote.
Those are arguments the trustee can use to counter the
bank's assertion that defaults in the underlying loan pool were
caused by the housing crisis, not by underwriting deficiencies.
"What the emails and documents (from other cases) show is a
pattern or practice of failing to follow guidelines that was
fairly widespread," said trustee counsel Harvey Wolkoff of
Ropes. "The judge thinks it's relevant."
It was JPMorgan's own motion that focused Strine's attention
on the trustee's lax underwriting and double-standard
allegations. After the trustee filed an amended complaint in
September, asserting that negotiations over more than 1,100
supposedly deficient mortgages had broken down, the bank filed a
motion to strike "certain immaterial, impertinent and scandalous
allegations" from the amended complaint. Without conducting an
independent investigation, the bank argued, the trustee had
improperly cribbed the allegations in question from other
complaints for the sole purpose of casting the bank in a bad
light. "Because these allegations are not related to the trust
or loans at issue, they can only serve to prejudice EMC and
distract from the issues that require this court's
adjudication," the motion said.
In its response to the bank motion, the trustee explained
how its allegation that "EMC was a securitization machine"
directly related to its assertion that more than 80 percent of
the underlying loans in the trust breached EMC's representations
and warranties; and it told the judge that evidence of the
bank's put-back demands to originators contradicted what the
bank told the trustee about the standard for repurchase. The
trustee also took the opportunity to quote juicy allegations
that it had not included in its complaint, ostensibly to show
its discretion. Those quotes -- including one by a former EMC
vice president who allegedly said, "Virtually everybody was
frankly slow in recognizing that we were on the cusp of a really
draconian crisis because we were having too much fun waiving
shit in and getting loaded on Miller Lite" -- could hardly fail
to catch Strine's eye.
The chancellor didn't mention specifics in his ruling
Tuesday, but he waved away the bank's concerns about scandal.
"For a court to strike allegations on the ground that they are
scandalous," he wrote, "it is not enough that they may put the
moving party in an unflattering light, as here. Therefore, I
deny the motion to strike."
The bank did succeed in persuading Strine to dismiss the
trustee's claim for indemnification and legal fees. The
chancellor said that under New York law, the purchasing
agreement's indemnification clause covers only claims against
the trustee by a third party (presumably a noteholder), not the
trustee's claims against the MBS sponsor.
Strine has previously said that the trustee cannot rely on
sampling in this case, so assuming the trustee gets past any
summary judgment motions by the bank, he is expected to preside
over a trial on whether a select group of loans breach EMC's
reps and warranties. His ruling will presumably inform talks on
the rest of the allegedly deficient loans but will not
specifically apply to the entire pool.
The bank is represented in the Delaware trustee case by
Sullivan & Cromwell and Landis Rath & Cobb. Robert Sacks of
Sullivan declined to comment. I also emailed two JPMorgan
representatives for comment but did not hear back.
(Reporting by Alison Frankel)
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