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

Exhibit 11 - 2018.06.29 Rebuttal Expert Report of Mark Adelson

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

Current View

Full Text

6 EXHIBIT 11 6 UNITED STATE DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK R EBUTTAL R EPORT OF M ARK A DELSON June 29, 2018 Phoenix Light SF Limited, et al. - against - The Bank of New York Mellon 14 CV 10104 Rebuttal Report of Mark Adelson 1 6 Table of Contents I. Introduction ......................................................................................................................... 3 II. BNYM's Actions as Trustee Must Be Viewed in the Context of the Industry-Wide Lender/Issuer Misconduct Occurring in the MBS Market at the Relevant Time ....................................................................................................................................... 5 III. BNYM Was Aware of Significant Problems with Countrywide Covered Trusts Because Its Own Business Records Showed Missing Documents for More than 200,000 Countrywide Loans ................................................................................... 11 IV. The Prospectus Supplements Did Not Disclose the Risk That No Party to the PSA Would Enforce the Seller's Repurchase Obligation ............................................ 12 V. BNYM's Failure to Act in the Face of Massive Problems Was Neither Reasonable nor Prudent ............................................................................................................... 13 VI. Miscellaneous Points ........................................................................................................ 13 Attachment A .............................................................................................................................. 22 Attachment B .............................................................................................................................. 24 Rebuttal Report of Mark Adelson 2 6 I. Introduction 1. Wollmuth Maher & Deutsch LLP has asked me to review the expert reports of Mr. John J. Richard, Mr. Christopher S. Hillcoat, Dr. Faten Sabry, and Dr. Thomas Z. Lys, each dated April 26, 2018 (the "Richard Report," "Hillcoat Report," "Sabry Report," and "Lys Report," respectively, and collectively, the "Defendant's Experts' Reports"), and to offer my reaction to those reports. I refer to my prior report, dated May 4, 2018 (the "Adelson Initial Report" or "Adelson"), with respect to my qualifications and my compensation. Attachment A contains an updated listing of matters for which I have prepared reports or testified as an expert witness during the past four years. 2. In my opinion, the Defendant's Experts' Reports largely address secondary and tertiary issues in the case but fail to address the major issues, and thus are incomplete, flawed and not reliable for the purposes for which they were submitted. 3. This report comprises six 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 BNYM's actions as trustee 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. Defendant's Experts' Reports ignore that context. 4. The third section explains that BNYM was aware of significant problems in the Countrywide Covered Trusts because its own business records showed missing documents for more than 200,000 Countrywide loans. The problems were in plain sight to BNYM and its actions and decisions as trustee for the Countrywide Covered Trusts must be weighed from the standpoint that it knew there were substantial problems in those transactions. 5. The fourth section addresses Dr. Sabry's opinion that the fact that Prospectus Supplements disclosed that sellers might be unwilling or unable to repurchase loans is somehow relevant. The cited disclosure misses the point because the undisclosed risk here was that no party would attempt to enforce the seller's repurchase obligation. If BNYM's proffered experts contend that no party would be responsible for enforcement, then the risk of non-enforcement would have been a key disclosure item in the prospectuses for the transactions. No prospectus disclosed such a risk. 6. The fifth part of this report explains that BNYM's failure to act in the face of massive problems in the Covered Trusts was neither reasonable nor prudent. Refraining from taking any action in the face of (i) the meltdown in the non-agency MBS market and Rebuttal Report of Mark Adelson 3 6 (ii) the massive incidence of missing and defective documents in the Countrywide mortgage files was neither reasonable nor prudent. Moreover, to my knowledge, BNYM has produced no business records showing that it analyzed various possible actions before concluding that taking no action would be in the best interest of investors. 7. The sixth section responds to a variety of specific points from the Defendant's Experts' Reports. These responses include the following opinions: • An MBS trustee has a duty to take action to benefit the trusts as a whole, even if different certificateholders may be impacted differently by such action. • Enforcement costs do not justify non-enforcement. • An MBS trustee is responsible for performing its duties as trustee, regardless of other duties it may have in other contractual capacities. • Breaching loss triggers signals problems in a transaction, often including servicing problems. • An MBS trustee should determine what action is most appropriate for minimizing harm to investors following an Event of Default. • Investors do not view provisions that limit their ability to protect their own interests as safeguards but rather as detrimental to their interests. • Although investors would not expect a trustee to hunt for breaches of representations and warranties ("R&Ws") without reason, investors would expect a trustee to address breaches that are brought to its attention through its own knowledge, or by either investors or other transaction parties. • An MBS trustee must act as a prudent person after an Event of Default regardless of whether it receives instructions from investors to take specific actions. • Abandoning mortgage loan underwriting criteria is not the same thing as having lax criteria. • MBS trustees have taken action to obtain servicing improvements and to enforce repurchase obligations even in the absence of direction and indemnity. Although Mr. Hillcoat argues otherwise, he does not point to any actual evidence. But even if other trustees failed to act under similar circumstances, it does not excuse BNYM's failure to act here. • Risk disclosures do not limit an MBS trustee's duties. Rebuttal Report of Mark Adelson 4 6 • The level of an MBS trustee's fees does not define or limit its duties to investors. • At the relevant times, C-BASS and Countrywide had substantial assets such that seeking enforcement of cure/replace/repurchase obligations would not have been a futile exercise. II. BNYM's Actions as Trustee Must Be Viewed in the Context of the Industry-Wide Lender/Issuer Misconduct Occurring in the MBS Market at the Relevant Time 8. Context matters: Defendant's Experts' Reports ignore 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. 9. 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 $200 billion. 10. Big Settlements: The large settlements that all the major lenders and MBS issuers agreed to pay is the first point that confirms the fact of the massive, industry-wide pattern of misconduct. Exhibit 1 lists the settlements of selected lenders/issuers with the U.S. Department of Justice ("DOJ"): 1Mark Adelson, Lessons of the Financial Crisis for Private-Label MBS, in THE HANDBOOK OF MORTGAGE- BACKED SECURITIES (Frank Fabozzi, ed., Oxford Univ. Press, 7 th ed., 2016). Rebuttal Report of Mark Adelson 5 6 Exhibit 1: Selected Settlements of Justice Department MBS Cases ($ billions) Total Cash Consumer Date Defendant Plaintiff Amount Penalty Relief 11/19/2013 13.0 9.0 4.0 JP Morgan Chase DOJ & various states1 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 3.173 2.773 0.4 Morgan Stanley DOJ & various states2 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 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. 11. The magnitude of these settlement payments demonstrates an acknowledgment of both the wrongdoing and its pervasiveness. 12. 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. The $7 billion settlement with Citigroup included specific findings with respect to the three C-BASS trusts at-issue in this case. 13. Exhibit 2 shows another series of settlements of selected lenders and issuers with the Federal Housing Finance Agency ("FHFA") and the government-sponsored mortgage enterprises (the "GSEs"). The sheer size of these settlements further confirms the widespread misconduct by the banks that funded them. Exhibit 2: Selected Settlements of FHFA & GSE Private-Label MBS Cases Amount Date Defendant Plaintiff ($ 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 Société Générale FHFA 3/21/2014 885 Credit Suisse FHFA Rebuttal Report of Mark Adelson 6 6 Exhibit 2: Selected Settlements of FHFA & GSE Private-Label MBS Cases Amount Date Defendant Plaintiff ($ millions) 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 8/22/2014 3,150 Goldman Sachs FHFA 9/12/2014 550 HSBC FHFA 14. 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 "Struc