Phoenix Light SF Limited et al v. The Bank of New York Mellon Corporation

Exhibit 10 - 2018.04.26 Expert Report of Mark Adelson

Southern District of New York, nysd-1:2014-cv-10104

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3 EXHIBIT 10 3 UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK E XPERT R EPORT OF M ARK A DELSON April 26, 2018 Phoenix Light SF Limited, et al. - against - The Bank of New York Mellon 14 CV 10104 Expert Report of Mark Adelson 1 3 Table of Contents I. Introduction ......................................................................................................................... 3 II. Assignment .......................................................................................................................... 5 III. Qualifications ....................................................................................................................... 6 IV. Compensation ...................................................................................................................... 8 V. Overview of Residential MBS ........................................................................................... 8 A. General Structure of MBS ......................................................................................... 8 B. Issuance and Sale Process for Non-Agency MBS ................................................ 18 C. Participants in Non-agency MBS Transactions.................................................... 19 VI. Role of the Trustee in MBS .............................................................................................. 23 A. Origins of the MBS Trustee..................................................................................... 23 B. The Trustee's Duties Prior to an Event of Default .............................................. 25 1. Rating Agency Understanding of MBS Trustee Duties ............................. 26 2. Regulatory View of Trustee Duties .............................................................. 29 3. Duty to Not Be Negligent .............................................................................. 30 4. Contractually Specified Duties ..................................................................... 30 C. The Trustee's Duties After an Event of Default ................................................... 34 D. Trustee Workload vs. Compensation .................................................................... 38 VII. Importance of Complete Mortgage Files ....................................................................... 41 VIII. Importance of Representations & Warranties ............................................................... 47 IX. The Trustee's Role in Enforcing Repurchase Obligations ........................................... 52 X. Regulation AB Disclosure and Reporting...................................................................... 55 XI. Opinions Concerning the Covered Trusts ..................................................................... 57 A. A Prudent Person Would Have Acted Affirmatively to Address Defaults in the EOD Trusts ............................................................................................. 57 B. The Consequences of a Notice of Default in ECR 2005-1 ................................... 63 C. Consequence of Accurate Regulation AB Disclosure ......................................... 64 D. BNYM Should Have Taken Further Action after Receiving Countrywide's Letter of November 29, 2010 regarding the CWALT 2006-OA3 Transaction .................................................................................................... 67 Attachment A .............................................................................................................................. 70 Attachment B .............................................................................................................................. 75 Attachment C .............................................................................................................................. 77 Expert Report of Mark Adelson 2 3 I. Introduction 1. The captioned proceedings relate to The Bank of New York's ("BNYM") role as trustee for 10 trusts (the "Covered Trusts") that were created in connection with the securitization of residential mortgage loans. The Plaintiffs1 purchased securities listed in Exhibit 1 (the "Certificates"). Exhibit 1: Listing of Purchased Certificates Original Face Moody's Rating S&P Rating Security CUSIP Amt. Purchased Initial Dec 2016 Initial Dec 2016 CBASS 2005-CB4 B1 12489WMK7 2,000,000 Baa1 C A- CC CBASS 2005-CB4 B2 12489WML5 5,586,000 Baa2 C BBB+ D CBASS 2005-CB4 B3 12489WMM3 5,585,000 Baa3 WR BBB D CBASS 2005-CB4 B4 12489WMN1 3,000,000 Ba1 WR BBB- D CBASS 2005-CB8 B1 12489WQP2 1,934,000 Baa1 WR A D CBASS 2005-CB8 B2 12489WQQ0 4,053,000 Baa2 WR A- D CBASS 2005-CB8 B3 12489WQR8 3,642,000 Baa3 WR BBB+ D CBASS 2006-CB3 M4 12489WRB2 6,000,000 A1 C A+ D CBASS 2006-CB3 B1 12489WRE6 5,000,000 Baa1 C BBB+ D CBASS 2006-CB3 B2 12489WRF3 4,688,000 Baa2 C BBB D CBASS 2006-CB3 B3 12489WRG1 2,312,000 Baa3 C BBB- D CWALT 2006-OA3 2A3 12668BB93 8,000,000 Aaa C AAA D CWALT 2006-OA6 1A4D 12668BE82 7,324,235 Aaa C AAA D CWALT 2006-OA11 M1 02147DAF8 6,000,000 Aa1 C AA+ NR CWL 2006-4 M2 126670WW4 4,000,000 Aa2 C AA+ D CWL 2006-4 M7 126670XB9 4,100,000 Baa1 WR A- D CWL 2006-4 M8 126670XC7 3,775,000 Baa2 WR BBB+ D CWL 2006-4 B 126670XD5 4,500,000 Baa3 WR BBB D CWL 2006-9 MV7 12666RBC3 6,206,000 Baa1 WR BBB+ D CWL 2006-9 MV8 12666RBD1 5,778,000 Baa2 WR BBB D CWL 2006-14 M4 23243LAH5 12,000,000 A1 WR A+ NR ECR 2005-1 M5 126673VT6 5,000,000 A2 C A D 1The Plaintiffs in this action include Phoenix Light SF Limited, Blue Heron Funding V Ltd., Blue Heron Funding VI Ltd., Blue Heron Funding VII Ltd., Kleros Preferred Funding V PLC, Silver Elms CDO PLC, Silver Elms CDO II Limited, C-BASS CBO XIV Ltd., and C-BASS CBO XVII Ltd. Expert Report of Mark Adelson 3 3 2. The Plaintiffs are asserting claims against BNYM for breach of its contractual duties as trustee of the Covered Trusts and, with respect to the ECR 2005-1 transaction, for breach of its duties under the Trust Indenture Act of 1939 (the "TIA").2 3. This report has eleven parts. The first part is this brief introduction. The second part describes the assignment under which I prepared the report. The third and fourth parts describe my qualifications and compensation. 4. The fifth part provides an overview of residential mortgage-backed securities ("MBS"). It explains the rationale for mortgage securitization and the basics of underwriting mortgage loans. It describes the participants in the non-agency MBS sector and reviews the process for the issuance and sale of non-agency MBS. 5. The sixth part of the report discusses the role of a trustee in a non-agency MBS. It discusses the types of tasks or functions that a trustee is expected to perform prior to an event of default and discusses the applicable "prudent person" standard that applies to a trustee's conduct after an event of default. The sixth part also discusses how a trustee is insulated from liability and from virtually all economic risk in connection with fulfilling its duties unless it was negligent, reckless, or acted willfully. 6. The seventh part discusses the importance of having complete mortgage files. The eighth part discusses the importance of representations and warranties ("R&Ws") in MBS transactions. The ninth part discusses the role of the trustee in an MBS transaction in enforcing the transactions' R&Ws. The tenth part discusses the disclosure and reporting framework embodied in Securities and Exchange Commission ("SEC") Regulation AB (17 C.F.R. §§ 229.1100- 229.1123), as in effect during the relevant period. 7. The eleventh part of the report explains the basis of my opinions on the matters that I was asked to consider in connection with these proceedings. It explains my reasoning for the following conclusions: • Following the occurrence of Events of Default in the CBASS 2005-CB4, CBASS 2005-CB8, and CBASS 2006-CB3 transactions (the "EOD Trusts"), BNYM should have taken positive action to protect investors' interests. Doing nothing was not reasonable. Appropriate actions would have included (and reasonable market participants would have expected) (i) performing basic inquiries concerning the servicing of loans in the trusts and, where appropriate, 2 Trust Indenture Act of 1939, 15 U.S.C. §§ 77aaa-77bbbb (2016), Pub. L. 76-253, 53 Stat. 1149 (1939). Expert Report of Mark Adelson 4 3 demanding improved servicing procedures (including improved loss mitigation procedures) and (ii) performing inquiries concerning possible defects in loans underlying the trusts and, where appropriate, enforcing cure or repurchase obligations with respect to loans with missing or deficient documentation and with respect to loans that had material breaches of R&Ws. • If defaults occurred under the governing agreements for the ECR 2005-1 transaction, then market participants would have expected BNYM, as trustee, to give notice of such defaults to security holders in accordance with the TIA. Providing the required notices to security holders would have created substantial pressure for the other transaction parties to have addressed the defaults and, if they failed to do so, BNYM would have been obligated to proceed as a prudent person to protect investors' interests. • If BNYM, as trustee of the CWALT 2006-OA3, CWALT 2006-OA6, CWALT 2006-OA11, CWL 2006-4, CWL 2006-9, and CWL 2006-14 transactions ("the Reg AB Trusts"), had disclosed the existence and magnitude of its non- compliance with Item 1122(d)(4) of SEC. Regulation AB, the transaction participants would have faced significant pressure to comply with provisions of the pooling and servicing agreements ("PSAs") concerning the treatment of document exceptions and the remedies for the failure to deliver complete mortgage files. As a practical matter, in the face of such a public disclosure, market participants would have expected BNYM and the other transaction parties to do far more than they did to cure deficiencies or remove defective loans from the Reg AB Trusts. • It was not reasonable for BNYM to take no further action after receiving Countrywide's Letter of November 29, 2010 regarding alleged breaches of R&Ws in the CWALT 2006-OA3 transaction. II. Assignment 8. Wollmuth Maher & Deutsch LLP, which represents Plaintiffs in this action, engaged me to provide an introduction to securitization and the role of the MBS trustee and other transaction participants. 9. I was also asked to review the Covered Trusts and answer the following questions: (a) Was it reasonable for BNYM to take no action, other than providing notices, following the occurrence of Events of Default in the EOD Trusts? Relatedly, what types of actions would reasonable market participants have expected BNYM to have taken in such circumstances? Expert Report of Mark Adelson 5 3 (b) Would reasonable market participants have expected BNYM, as trustee of the ECR 2005-1 transaction, to have given notice following the occurrence of defaults of the type described by the Plaintiffs? Relatedly, what would have been the likely consequence of giving such notice? (c) What would have been the likely consequence if BNYM had disclosed the true extent of document exceptions in Countrywide-sponsored MBS for which it served as trustee? (d) Would reasonable market participants have expected BNYM to do more than it did in response to notices it received concerning representation and warranty violations related to the CWALT 2006-OA3 transaction? III. Qualifications 10. I have more than 30 years of experience with MBS. I have published numerous articles on the subject and lectured extensively on it as well. My curriculum vitae contains a partial listing of my publications and public speaking experience (see Attachment A). My most recent significant article on the subject was Representations and Warranties in Mortgage-Backed Securities, which appeared in the Spring 2017 issue of the Journal of Structured Finance. I am also the author of a chapter in the latest edition of T