Pacific Life Insurance Company et al v. The Bank of New York Mellon

Exhibit B

Southern District of New York, nysd-1:2017-cv-01388

Current View

Full Text

2 EXHIBIT B 2 UNITED STATE DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK REBUTTAL REPORT OF MARK ADELSON July 2, 2020 Pacific Life Insurance Company and Pacific Life & Annuity Company - against- The Bank of New York Mellon 17-cv-01388 Rebuttal Report of Mark Adelson CONFIDENTIAL 1 2 Table of Contents I. Introduction ......................................................................................................................... 3 II. The Trustee's Actions Must Be Viewed in the Context of the Industry-Wide Lender/Issuer Misconduct Occurring in the MBS Market at the Relevant Time ·······································································································································4 III. Investors View the Role of the MBS Trustee as More than Merely Administrative. 9 IV. An MBS Trustee Is Expected to Act Unilaterally ......................................................... 11 V. MBS Investors Do Not Expect an MBS Trustee to Be Relieved of Its Duty to Act Merely Because Holders of Different MBS Classes May Have Differing Interests ..................................................................................................................... 15 VI. Role of an MBS Trustee After an Event of Default ....................................................... 15 VII. BNYM Had Notice of Problems in the Covered Trusts so the Theoretical Possibility that Other Factors Could Have Contributed to Losses Would Not Relieve BNYM of Its Duties .................................................................................................. 16 VIII. Miscellaneous Points ........................................................................................................ 18 Attachment A .............................................................................................................................. 24 Attachment B .............................................................................................................................. 30 Rebuttal Report of Mark Adelson CONFIDENTIAL 2 2 I. Introduction 1. Wollmuth Maher & Deutsch LLP has asked me to review the expert reports of Mr. John J. Richard and Dr. Thomas Z. Lys, both dated February 7, 2020 (the "Richard Report" and "Lys Report" respectively), and to offer my reaction to those reports. I refer to my prior report, dated January 17, 2020 (the "Adelson Initial Report" or" Adelson Report"), with respect to my qualifications, my compensation, and matters for which I have prepared reports or testified as an expert witness during the past four years. Attachment A is copy of my curriculum vitae, including an updated, partial listing of my publications and public speaking experience. 2. This report comprises eight main sections. The first is this brief introduction. The second section explains the importance of understanding the prevailing practices in the mortgage-backed securities ("MBS") market at times relevant to this case. In particular, it explains that the Trustees' actions for the trusts at-issue in this action (the "Covered Trusts") must be viewed in the context of the industry-wide misconduct on the part of mortgage lenders and MBS issuers. The Richard Report ignores that context. 3. The third section addresses Mr. Richard's incorrect assertion that investors view the role of an MBS trustee as "administrative." The fourth part addresses Mr. Richard's incorrect assertion that investors would not expect an MBS trustee to act unilaterally. The fifth part addresses Mr. Richard's assertion that an MBS trustee may be relieved of its duty to act because holders of different classes in an MBS transaction may have differing interests. 4. The sixth section discusses an MBS trustee's role after an event of default. In particular it explains that investors would expect an MBS trustee to pursue enforcement or take action consistent with its prudent person duties following a default. 5. The seventh section addresses Mr. Richard's assertion that investors would not expect MBS trustees to take action because factors other than breaching loans may have contributed to losses. 6. The eighth section addresses a number of miscellaneous points, including Mr. Lys's opinion regarding the availability of assets to satisfy repurchase claims. Rebuttal Report of Mark Adelson CONFIDENTIAL 3 2 II. The Trustee's Actions Must Be Viewed in the Context of the Industry-Wide Lender/Issuer Misconduct Occurring in the MBS Market at the Relevant Time 7. Context matters: The Richard Report ignores the fact that by mid-2009 the mortgage sector was in utter turmoil because of the widespread breakdown of prudent lending practices by U.S. mortgage lenders, combined with the lenders' fraudulent non- disclosure of that breakdown when they sold securities during the period from 2005 through 2007.1 The securities trustees, who were supposed to act "for the benefit of" investors, often did nothing-and never did all that they should have-to protect investors' interests. Rather, as more facts have come to light (in this case and in others), inaction by the trustees may have actually assisted and furthered the lenders' /issuers' wrongful conduct. 8. The effects of this meltdown are huge. MBS investor losses from bad mortgage loans are on the order of $1 trillion. Investors and the federal government have recovered less than $200 billion. 2 9. Big Settlements: The large settlements that all the major lenders and MBS issuers agreed to pay is the first point that confirms the fact of the massive, industry-wide pattern of misconduct. Exhibit 1 lists the settlements of selected lenders/issuers with the U.S. Department of Justice ("DOJ"): Exhibit 1: Selected Settlements of Justice Department MBS Cases ($ billions) Total Cash Consumer Date Defendant Plaintiff Amount Penalty Relief 11/19/2013 13.0 9.0 4.0 JP Morgan Chase DOJ & various states 1 7/14/2014 7.0 4.5 2.5 Citigroup DOJ & various states 8/21/2014 16.65 9.65 7.0 Bank of America DOJ & various states 2/25/2015 2.6 2.6 0.0 Morgan Stanley DOJ 2/11/2016 3.:1:73 2.773 0.4 Morgan Stanley DOJ & various states 2 4/11/2016 5.06 3.26 1.8 Goldman Sachs DOJ & various states 1/17/2017 7.2 3.1 4.1 Deutsche Bank DOJ 1/18/2017 5.28 2.48 2.8 Credit Suisse DOJ 3/29/2018 2.0 2.0 0 Barclays DOJ 1Adelson, M., Lessons of the Financial Crisis for Private-Label MBS, in THE HANDBOOK OF MORTGAGE- BACKED SECURITIES (Frank Fabozzi, ed., Oxford Univ. Press, 7 th ed., 2016). 2Adelson, M. "The Mortgage Meltdown and the Failure of Investor Protection," J. Struct. Fin. 26 (1): 63-86 (Spring 2020), https://doi.org/10.3905/jsf.2020.l.095. Rebuttal Report of Mark Adelson CONFIDENTIAL 4 2 Exhibit 1: Selected Settlements of Justice Department MBS Cases ($ billions) Total Cash Consumer Date Defendant Plaintiff Amount Penalty Relief 8/1/2018 2.09 2.09 0 Wells Fargo DOJ 8/14/2018 4.9 4.9 0 Royal Bank of Scotland DOJ 10/9/2018 0.765 0.765 0 HSBC DOJ 10/16/2018 0.48 0.48 0 Nomura DOJ 4/12/2019 1.5 1.5 0 General Electric DOJ 1 Includes $4 billion of a previously announced settlement with the FHFA. 2 Reported as $3.2 billion but includes $2.6 billion of a previously announced settlement with DOJ. 10. The magnitude of these settlement payments demonstrates an acknowledgment of both the wrongdoing and its pervasiveness. Additionally, many of the settlements included findings of fact in which the subject banks admitted to misconduct. 11. The findings of fact released by the DOJ in connection with the $16.65 billion settlement by Bank of America ("B-of-A") discussed in detail the activities of Countrywide, which B-of-A acquired in 2008, and involved all of the at issue trusts in this action. 12. Exhibit 2 shows another series of settlements of selected lenders and issuers with the Federal Housing Finance Agency ("FHFA") and the government-sponsored mortgage enterprises (the "GS Es"). The sheer size of these settlements further confirms the widespread misconduct by the banks that funded them. Exhibit 2: Selected Settlements of FHFA & GSE Private-Label MBS Cases Amount Date Defendant Plaintiff ($ millions) 12/31/2010 1,520 Bank of America Fannie Mae 12/31/2010 1,350 Bank of America Freddie Mac 5/28/2013 250 Citigroup FHFA 7/25/2013 885 UBS FHFA 10/25/2013 5,100 JP Morgan Chase FHFA 11/6/2013 335 Wells Fargo FHFA 12/2/2013 404 Bank of America Freddie Mac 12/20/2013 1,925 Deutsche Bank FHFA 12/31/2013 475 Ally Financial FHFA 1/7/2014 10,300 Bank of America Fannie Mae 2/7/2014 1,250 Morgan Stanley FHFA 2/27/2014 122 Societe Generale FHFA 3/21/2014 885 Credit Suisse FHFA Bank of America, Countrywide 3/26/2014 9,300 FHFA Financial, and Merrill Lynch 4/24/2014 280 Barclays FHFA 4/29/2014 110 First Horizon FHFA 6/19/2014 100 RBS FHFA Rebuttal Report of Mark Adelson CONFIDENTIAL 5 2 Exhibit 2: Selected Settlements of FHFA & GSE Private-Label MBS Cases Amount Date Defendant Plaintiff ($ millions) 8/22/2014 3,150 Goldman Sachs FHFA 9/12/2014 550 HSBC FHFA 7/12/2017 5,500 RBS FHFA 6/25/2018 847 Nomura FHFA* * Case was tried and affirmed on appeal. Federal Housing Finance Agency v. Nomura Holdings America et al., 104 F. Supp. 3d 441 (S.D.N.Y. 2015) (https://cite.case.law/f-supp- 3d/104/441/), aff'd. 873 F.3d 85 (2d Cir. 2017), cert. denied 138 S.Ct. 2679 (No. 17-1302, 25 Jun 2018). 13. Admissions of Wrongdoing: The aforementioned admissions of wrongdoing by the major lenders and issuers further confirm the existence of the massive, industry-wide pattern of fraudulent behavior. In particular, the statement of facts in the B-of-A settlement with the DOJ highlighted Countrywide's improper underwriting and included colorfully named policies and programs such as "Shadow Guidelines" and "Extreme Alt-A." For example, the statement of facts described how the Shadow Guidelines allowed Countrywide to evade its disclosed underwriting limitations and risk controls: When branch underwriters received loan applications that did not meet the program parameters in the Loan Program Guides (e.g., credit score, LTV, loan amount}, the branch underwriters were authorized to refer the applications to more experienced underwriters at the relevant divisional "Structured Loan Desk" ("SLD") for consideration of an "exception." Underwriters at the SLD were authorized to approve requests to make an "exception" to the Loan Program Guides if the proposed loan and borrower complied with the characteristics described in another set of guidelines, referred to as so-called "Shadow Guidelines," and the loan contained compensating factors supporting the exception request. The Shadow Guidelines generally permitted loans to be made to borrowers with lower credit scores and allowed for higher LTV ratios than the Loan Program Guides .... If a loan application did not meet the credit standards of the Shadow Guidelines, Structured Loan Desk underwriters were authorized to submit a request to Countrywide's Secondary Marketing Structured Loan Desk ("SMSLD"), which would then determine whether the requested loan, if originated, could be priced and sold in the secondary market. If a loan could be priced and sold, SMSLD Rebuttal Report of Mark Adelson CONFIDENTIAL 6 2 would provide a price for the loan and ultimately it would be returned to the branch underwriter. 3 14. The statement of facts also describes how Countrywide used less stringent underwriting guidelines for due diligence reviews than for originating loans: In certain instances, Countrywide provided the due diligence providers with what were known as "Seller Loan Program Guides," which were guidelines based on the characteristics of loans that Countrywide had been able to make and sell in the past. Seller Loan Program Guides reflected the credit attributes of the loans that Countrywide had previously made and sold, and as a result they frequently listed lower credit scores or higher DTI