October 30, 2020

Volume X, Number 304

Advertisement

October 29, 2020

Subscribe to Latest Legal News and Analysis

October 28, 2020

Subscribe to Latest Legal News and Analysis

October 27, 2020

Subscribe to Latest Legal News and Analysis

Second Circuit Holds RMBS-issued (Residential Mortgage-backed Securities) Certificates Are Exempt from the Trust Indenture Act (TIA)

On December 23, 2014, the United States Court of Appeals for the Second Circuit issued an opinion on an issue of first impression, namely the scope of § 304(a)(2) of the Trust Indenture Act of 1939, 15 U.S.C. §§ 77aaa-77aaaa (the “TIA”), and its application to certificates issued by trusts under pooling and servicing agreements (“PSAs”).  See Ret. Bd. of Policemen’s Annuity & Benefit Fund v. Bank of N.Y. Mellon, Nos. 13-1776-cv, 13-1777-cv (2d Cir. Dec. 23, 2014).

The United States District Court for the Southern District of New York (Judge William H. Pauley, III) previously granted in part and denied in part Bank of New York Mellon’s motion to dismiss claims relating to the purchase of certificates from certain residential mortgage-backed securities (“RMBS”) trusts.  See Ret. Bd. of Policemen’s Annuity & Benefit Fund v. Bank of N.Y. Mellon, 914 F. Supp. 2d 422 (S.D.N.Y. 2012).  The district court held that the TIA applied to RMBS trusts governed by PSAs. The district court also held that the plaintiffs lacked “class standing,” or standing to assert claims related to RMBS trusts in which they did not invest, since such claims do not raise “the same set of concerns” as the plaintiffs’ own claims. Plaintiffs appealed the district court’s ruling on class standing and defendant Bank of New York Mellon (BNYM) appealed the district court’s holding on the application of the TIA.

Noting that RMBS trusts have “become a familiar subject of litigation” in the Second Circuit, the Second Circuit affirmed the district court’s denial of class standing.  The Court of Appeals held that the plaintiffs lack standing to assert claims against BNYM, the RMBS trustee, related to trusts in which the plaintiffs did not invest because such claims do not “implicate[] the same set of concerns” as the named plaintiffs’ own claims.  The Court of Appeals focused on the fact that the specific terms and parties in each RMBS trust were not identical and would need to be reviewed in each and every case thus making class standing inappropriate.

With regard to the application of the TIA to trusts governed by PSAs, the Second Circuit noted that this issue has generated conflicting decisions from district courts in the Southern District of New York.  The Court then explained that the TIA applies only to certain kinds of instruments, namely “only instruments that do not fall within at least one” of the TIA’s exemptions. In addressing the exemptions, the Second Circuit held that the certificates were exempt because they were “‘certificate[s] of interest or participation in two or more securities having substantially different rights and privileges,’ namely, the numerous mortgage loans held by each trust.”

The Second Circuit found that the certificates issued by the RMBS trusts were “certificate[s] of interest or participation” because (a) they were certificates (as opposed to notes) and (b) payments to certificateholders were contingent on the cash flows from the underlying mortgages.  The Second Circuit held that the certificateholders did not have to receive all of the cash flows in order to make the payments contingent and therefore qualify as a “certificate of interest or participation.”  The issue of whether the certificates remained “certificates of interest or participation” was “arguably [a] more difficult question” for the Second Circuit because the payments on the underlying mortgages were not simply passed through to certificateholders.  Ultimately, the Court held that the contingent nature of the payments together with the administrability concerns “would seem to necessitate rules for parceling out the returns from th[e] underlying securities.”

Next, the Second Circuit held that the certificates were for “two or more securities.”  The Court rejected the plaintiffs’ arguments that the certificates were for a single security, namely, the corresponding tranche.  The Second Circuit noted that a tranche is not a security, but rather a name to describe a group of certificates.  Rejecting the plaintiffs’ arguments, the Second Circuit also held that the underlying mortgages qualify as securities under Section 304(a)(2) of the TIA.

The Court next held that mortgage loans have “substantially different rights and privileges” because the mortgages have different obligors, payment terms, maturity dates, interest rates, and collateral.”  The Second Circuit noted that its decision was consistent with the SEC’s position that instruments such as the ones at issue were exempt under Section 304(a)(2).

The Second Circuit declined to decide whether the certificates at issue qualify as non-exempt “debt” or as an exempt “equity” security under § 304(a)(1) of the TIA, so that issue remains for another day.

Copyright © 2020, Sheppard Mullin Richter & Hampton LLP.National Law Review, Volume IV, Number 363
Advertisement

TRENDING LEGAL ANALYSIS

Advertisement
Advertisement

About this Author

Robert Friedman, Legal Specialist, business and corporate litigation matters
Partner

Mr. Friedman is a partner in the Business Trial and White Collar Practice Groups in the firm's New York office. He heads the Business Trial Practice Group in New York.

Areas of Practice

Mr. Friedman focuses his practice on business and corporate litigation matters. He has particular experience in the areas of securities litigation, internal investigations, corporate trust litigation, real estate litigation, director and officer liability, bankruptcy litigation, restrictive covenants and intellectual property.  He has tried cases involving and counseled...

212-634-3058
Carren Shulman, Finance and Bankruptcy Lawyer, Sheppard Mullin
Partner

Carren B. Shulman is a partner in the firm's Finance and Bankruptcy Practice Group and a member of the firm's Executive Committee.

Areas of Practice

Ms. Shulman focuses her practice on bankruptcy and business reorganization, commercial litigation, and creditors’ rights.  For twenty years she has represented debtors, committees, chapter 11 trustees, trade creditors and lenders in bankruptcy and out of court workouts, and has advised corporate trustees in default administration.  Ms. Shulman also...

212-634-3040
Mark McGrath, Attorney, Sheppard Mullin, Business Trial, Intellectual Property
Partner

Mr. McGrath is a partner in the Business Trial Practice Group and the Intellectual Property Practice Group in the firm's New York office. He is also a member of the firm's Electronic Discovery Group.

Areas of Practice

Mr. McGrath focuses his practice on commercial, business, and intellectual property litigation.  In the commercial and complex business litigation arena, he has particular experience in the areas of breach of contract, fraud and other business torts, Truth-in-Lending and other consumer claims, putative class actions and collective actions,...

212-634-3056
Advertisement
Advertisement