Orrick's Financial Industry Week in Review

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Financial Industry Developments

FHFA Updates Requirements for Freddie and Fannie Sales of Non-Performing Loans

On March 2, FHFA announced changes to requirements for sales of non-performing loans (NPLs) by Freddie and Fannie to reduce the number of severely delinquent loans held in their inventories and to transfer risk to the private sector. The requirements are expected to encourage broad participation by potential investors and provide for future publication of aggregate data about borrower outcomes. Release. Fact Sheet.

SEC Fee Rate Advisory #4

On February 27, the SEC announced that the Section 31 fee rate for fiscal year 2015 will remain at the current rate of $18.40 per million. Release.

Rating Agency Developments

On March 6, Fitch revised its criteria for rating granular corporate balance-sheet securitizations (SME CLOs). Approach.

On March 5, Moody's revised its global approach to data quality evaluation. Approach.

On March 3, Kroll released CMBS property evaluation guidelines and large loan rating methodology. Guidelines. Methodology.

On March 2, S&P revised its rating criteria for rating transactions that include provisions for changing the payment priority or sale of collateral following a nonmonetary event of default. Criteria.

On February 27, Fitch released a Brazil addendum to RMBS Latin America criteria. Addendum.

On February 25, Moody's released its approach to rating US Prime RMBS issued after 2009. Approach.

Distressed Debt and Restructuring Developments

Overview and Analysis of Select Provisions of the ABI Chapter 11 Reform Commission Final Report and Recommendations, Part Two of Three

Last month, Orrick's Restructuring team began a three-part look at the American Bankruptcy Institute's Chapter 11 Reform Report. In part one we looked at issues related to confirmation, valuation, financing and asset sales. This second part focuses on modifications to the Bankruptcy Code's "safe harbors" for derivatives and other complex financial transactions. The final part will focus on professional compensation, treatment of executory contracts and other interesting topics.

To view the full article, please click here.

RMBS and Other Securities Litigation

Bank of America's $8.5B MBS Settlement Approved

On Thursday, March 5, New York's Appellate Division, First Department affirmed a trial court's approval of an $8.5 billion dollar settlement between Bank of America and plaintiff Bank of New York Mellon, as trustee of 530 RMBS trusts backed by mortgages originated by Countrywide Financial. The trustee entered into the settlement after it was negotiated with Bank of America by a group of 22 of the largest holders of certificates in the trusts. The trial court approved the settlement in most respects. Objecting investors appealed, challenging whether the trustee had properly exercised its discretion in entering into the settlement on behalf of the trusts. The appellate court approved the settlement in all respects, modifying the trial court's ruling by approving the trustee's release of claims concerning loan modification as part of the settlement.  Order.

New York Supreme Court Holds RMBS Claims Are Timely, But Accrual Provision Unenforceable

On March 3, Justice Marcy S. Friedman of the New York Supreme Court granted in part and dismissed in part Defendant Greenpoint Mortgage Funding, Inc.'s Motion to Dismiss an action in which it was said to have misrepresented the quality of loans underlying an RMBS transaction. Plaintiff-Trustee, U.S. Bank National Association, argued that the case was timely under a provision of the governing Mortgage Loan Sale Agreement providing that no claim accrues for breach of a repurchase obligation until the purchaser discovers a breaching loan (or is so notified), the seller fails to cure such breach, and the purchaser makes a demand for cure. The court rejected the plaintiff's reliance on this accrual provision, citing earlier decisions holding that New York law precludes the extension of an applicable statute of limitations by contract. The court nonetheless concluded that the action was timely, finding that the plaintiff had pled sufficient facts to state a claim that Greenpoint was aware of breaches within the limitations period. Additionally, Justice Friedman granted the motion to dismiss the plaintiff's claims for (1) reimbursement of attorney's fees, as these were not encompassed by the MLSA's indemnification provisions, (2) all claims that sought relief beyond that permitted under the contract's sole remedy provision, and (3) claims for breach of the implied covenant of good faith and fair dealing, which the court found to be duplicative of the underlying contract claim.  Order.

11th Circuit Certifies Insurable Interest Questions in Pruco Cases to the Florida Supreme Court

On February 27, 2015, the United States Court of Appeals for the Eleventh Circuit certified two important questions of Florida insurable interest law to the Florida Supreme Court. The Eleventh Circuit asked the Supreme Court to determine: (1) whether under Florida law, an insurer may challenge a policy for lack of insurable interest after expiration of the statutory two-year contestability period; and (2) whether Florida insurable interest law requires that an individual procuring life insurance do so in "good faith" and not with the intent to effect an assignment of the policy to one without an insurable interest. The certified issues arose in separate appeals from conflicting decisions rendered by two federal courts in the Southern District of Florida interpreting Florida law. In both Pruco Life Ins. Co. v. Brasner and Pruco Life Ins. Co. v. U.S. Bank, the insurer filed suit years after the statutory contestability period expired, alleging that the policies at issue were procured as part of a stranger-originated life insurance ("STOLI") scheme and seeking to invalidate them for lack of insurable interest.

In Brasner, an infamous insurance broker, Stephen Brasner, arranged for an elderly couple, Arlene and Richard Berger, to participate in a "STOLI scheme." On Brasner's application, which contained fraudulent misrepresentations concerning Ms. Berger's net worth and annual income, Pruco issued a policy on Ms. Berger's life. Her husband was the beneficiary, but the Bergers claimed they did not need and never intended to keep the insurance. Brasner secured third-party financing to pay the policy premiums, and arranged the transfer of the policy to a trust. More than two years after the policy was issued, the trust, with Ms. Berger's consent, surrendered the policy to the third-party premium lender in satisfaction of the debt incurred to finance the premiums. The beneficial interest in the policy was subsequently sold to a different investor.

The U.S. Bank case involved a different insurance broker and insured but, like Brasner, the case concerned a similar "STOLI scheme" in which Pruco issued a policy based on a fraudulent application submitted by an insurance broker. The policy named the insured's daughter as the primary beneficiary, although it was understood that the insured and her named beneficiary intended to transfer the beneficial interest in the policy to an investor. As in Brasner, a third party paid the policy premiums, and the beneficial interest in the policy was sold to an investor.  

While the facts of the two cases were similar, the courts reached vastly different decisions. In Brasner, the court invalidated the policy for lack of insurable interest, notwithstanding that Pruco initiated its challenge outside the contestability period. In so holding, the Brasner court ruled that because the policy at issue was void ab initio, the clause in the policy providing for a two-year contestability period never took effect. The court then ruled that Florida law required persons procuring life insurance policies to do so in "good faith" and that purchasing a policy with the intent of effecting an assignment to a person without an insurable interest, as was the case in Brasner, did not satisfy that requirement.

By contrast, the U.S. Bank court dismissed Pruco's claim on the grounds that it was initiated outside of the two-year contestability period, and therefore barred as a matter of law. The court reasoned that in the STOLI context, a lack of insurable interest is inseparable from the fraud employed to procure the insurance policy, and because Florida law required insurers to contest fraudulently procured policies within the two-year contestability period, Pruco's challenge to the policy was time-barred. Having dismissed Pruco's claim as untimely, the U.S. Bank court did not address the substance of Pruco's insurable interest claims. 

Because the Florida Supreme Court has the final word on the interpretation of Florida law, and insurable interest is governed by state law, the resolution of the certified questions by the Florida Supreme Court should provide answers to issues that have long remained unclear under Florida law. The Eleventh Circuit's certification order provides an opportunity for the Florida Supreme Court to upend rulings issued by federal trial courts that have largely interpreted Florida law unfavorably for investors.

SDNY Declines to Reconsider Denial of Plaintiffs' Summary Judgment Motion in RMBS Putback Case

On February 25, Judge P. Kevin Castel of the S.D.N.Y. issued an opinion denying reconsideration of a January 9, 2015 order that granted in part and denied in part the parties' competing motions for summary judgment in MASTR Adjustable Rate Mortgages Trust 2006-OA2 v. UBS Real Estate Secs., Inc., 1:12-cv-07322 (S.D.N.Y.). The plaintiff trusts moved the court for reconsideration of the prior ruling to the extent it (i) denied the trusts' motion for summary judgment as to a purported repurchase obligation for a specified percentage of the underlying loan pool based on statistical sampling, and (ii) dismissed the trusts' claims based on a "pervasive breach" theory. First, the Court concluded that plaintiff's submission of the results of their experts' re-underwriting of a sample of loans in which the experts concluded that 37% of the sampled loans were "materially defective" was not sufficient to require repurchase of 37% of the entire loan pool. Judge Castel reasoned that the reunderwriting conclusions "did not align with the materiality requirement of the parties' agreements," which require that the breach of a representation "materially and adversely affect the interest of the Certificateholders" in order to trigger a repurchase obligation. Second, the Court reaffirmed its prior rejection of the plaintiffs' "pervasive breach" theory, by which they argued that notice of "many" defective loans put the sponsor on inquiry notice and triggered an obligation to repurchase all defective loans. The Court relied on the parties' agreements, explaining that the parties could have, but did not, bargain for an inquiry notice standard.  Order.

European Financial Industry Developments

European Court Rules in Favor of the UK in ECB Dispute Over the Relocation of Clearing Houses

After a three year dispute over the place of the City of London in Europe's single market, the EU General Court has ruled that the European Central Bank ("ECB") lacked the legal powers to enforce a ban on clearing and settlement of euro-denominated deals in the UK. The ECB's 2011 policy required all clearing houses that handle more than €5 billion euros per day per product category to move inside the Eurozone, claiming this would make it easier to oversee the clearing and settlement activities of such organizations. Though never implemented in practice, the policy was challenged by the UK on grounds that it went against the single market.

For the UK an unsuccessful challenge would have forced the London Stock Exchange's LCH. Clearnet clearing house, which clears about €250 billion euro-denominated instruments every day, and ICE Clear Europe, the world's largest processor of credit default swaps, to shift large portions of their euro-denominated operations to continental Europe, resulting in the loss of London's financial center's influence to the Eurozone and further ammunition for anti-EU campaigners in the lead up to the May national elections.

The General Court found that the ECB policy went beyond oversight to regulating market infrastructure companies – a power the ECB does not have as its competence is limited to payment systems under Article 127 (2) of the Treaty on the Functioning of the European Union. The Court did not address the question of whether the ECB policy had discriminated against UK operators or undermined the fundamental freedoms on which the EU single market is based. These issues could be further considered in the event of an appeal by the ECB to the Court of Justice of the European Union, or a proposal to grant the ECB the necessary authority through EU legislation.

Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2015

On February 25, the Financial Services and Markets Act 2000 (Regulated Activities) (Amendment) Order 2015 (SI 2015/369) was published with an explanatory memorandum.

The Order comes into force on April 1, 2015, and implements the recommendations of the Fair and Effective Markets Review (set out in a report dated August 2014) to extend the existing UK regulatory and legislative framework for benchmarks to include the additional benchmarks, which are used in the fixed income, commodity and currency markets .The order therefore amends:

  • Schedule 5 to the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544) by extending the existing UK regulatory and legislative framework, in addition to governing the London Interbank Offered Rate (LIBOR), to apply also to ISDAFIX, Sterling Overnight Index Average (SONIA), Repurchase Overnight Index Average (RONIA), WM/Reuters (WMR) 4pm London Closing Spot Rate, London Gold Fixing, LMBA Silver Price and ICE Brent Index; and
  • The Financial Services Act 2012 (Misleading Statements and Impressions) Order 2013 (SI 2013/637), which specifies the relevant activities, investments and benchmarks for the purposes of a criminal offence in section 91 of the Financial Services Act 2012 (that is, making false or misleading statements in relation to benchmarks), to bring the additional benchmarks into its scope.

The FCA has consulted on bringing the additional benchmarks into its regulatory and supervisory regime and intends to publish a policy statement and final Handbook text in the first quarter of 2015 with a view to the relevant provisions being in force when the Order takes effect.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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