394. A fundamental aspect of the mortgage securitization process is that the issuing trust for each offering must obtain good title to the mortgage loans comprising the pool for that offering. This is necessary in order for the holders of the RMBS to be legally entitled to enforce the mortgage loans in the event of default. Two documents relating to each mortgage loan must be validly transferred to the trust as part of the securitization process – a promissory note and a security instrument (either a mortgage or a deed of trust).
395. The rules for these transfers are governed by the law of the state where the property is located, by the terms of the pooling and servicing agreement (“PSA”) for each securitization, and by the law governing the issuing trust (with respect to matters of trust law). In general, state laws and the PSAs require the promissory note and security instrument to be transferred by indorsement, in the same way that a check can be transferred by indorsement, or by sale. In addition, state laws generally require that the trustee of the issuing trust have physical possession of the original, manually signed promissory note in order for the loan to be enforceable by the trustee against the borrower in the event of a default by the borrower.
396. In order to preserve the bankruptcy-remote status of the issuing trusts in RMBS transactions, the notes and security instruments are generally not directly transferred from the mortgage loan originator to the trust. Rather, the notes and security instruments are initially transferred from the originator to the depositor, either directly or via one or more special-purpose entities. After this initial transfer to the depositor, the depositor transfers the notes and security interests to the issuing trust for the particular securitization. Each of these transfers must be valid under applicable state law in order for the trust to have good title to the mortgage loans.
397. To ensure that the trust qualifies as a tax-free real estate mortgage investment conduit, the PSA generally requires the transfers to the trust to be completed within a strict time limit after formation of the trust. Furthermore, the applicable trust law in each state generally requires strict compliance with the trust documents, including the PSA, so that failure to comply strictly with the timeliness, indorsement, physical delivery and other requirements of the PSA with respect to the transfers of the notes and security instruments means that the transfers would be void and the trust would not have good title to the mortgage loans. Adam Levitin, a professor of law at Georgetown University, testified before the United States House Subcommittee on Housing and Community Opportunity, that, “If the notes and mortgages were not properly transferred to the trusts, then the mortgage-backed securities that the investors purchased were in fact non-mortgage backed securities.”
398. On November 18, 2010, Professor Levitin testified about the importance of the chain of title to investors and the consequences of faulty transfers before a hearing of the House Financial Services Committee:
Concerns about securitization chain of title also go to the standing question; if the mortgages were not properly transferred in the securitization process (including through the use of MERS to record the mortgages), then the party bringing the foreclosure does not in fact own the mortgage and therefore lacks standing to foreclose. If the mortgage was not properly transferred, there are profound implications too for investors, as the mortgage-backed securities they believed they had purchased would, in fact be nonmortgage-backed securities, which would almost assuredly lead investors to demand that their investment contracts be rescinded[.]
* * *
Securitization is the legal apotheosis of form over substance, and if securitization is to work it must adhere to its proper, prescribed form punctiliously. The rules of the game with securitization, as with real property law and secured credit are, and always have been, that dotting “i’s” and crossing “t’s” matter, in part to ensure the fairness of the system and avoid confusions about conflicting claims to property. Close enough doesn’t do it in securitization; if you don’t do it right, you cannot ensure that securitized assets are bankruptcy remote and thus you cannot get the ratings and opinion letters necessary for securitization to work. Thus, it is important not to dismiss securitization problems as merely “technical;” these issues are no more technicalities than the borrower’s signature on a mortgage. Cutting corners may improve securitization’s economic efficiency, but it undermines its legal viability.
399. On October 27, 2010, Katherine Porter, then a visiting a professor at Harvard Law School specializing in consumer credit, consumer protection regulation, and mortgage servicing,provided similar testimony before the Congressional Oversight Panel:
The implications of problems with transfer are serious. If the [securitization] trust does not have the loan, homeowners may have been making payments to the wrong party. If the trust does not have the note or mortgage, it may not have standing to foreclose or legal authority to negotiate a loan modification. To the extent that these transfers are being completed retroactively, it raises issues about honesty in creating and dating the assignments/transfers and about what parties can do, if anything, if an entity in the securitization chain, such as Lehman Brothers or New Century, is no longer in existence. Moreover, retroactive transfers may violate the terms of the trust, which often prohibit the addition of new assets, or may cause the trust to lose its REMIC status, a favorable treatment under the Internal Revenue Code. Chain of title problems have the potential to expose the banks to investor lawsuits and to hinder their legal authority to foreclose or even to do loss mitigation.
* * *
I want to share with the Panel that the lawyers that I have met over years of my research on mortgage servicing both creditor lawyers and debtor lawyers have nearly universally expressed that they believe a very large number (perhaps virtually all) securitized loans made in the boom period in the mid-2000s contain serious paperwork flaws, did not meet underwriting or other requirements of the trust, and have not been serviced properly as to default and foreclosure.
400. It is now clear that Defendants did not transfer securitized loans to the Issuing Trusts in a timely fashion, if they did so at all. According to a Federal Reserve press release, banking organizations including JPMorgan Chase & Co. engaged in “a pattern of misconduct and negligence related to deficient practices in residential mortgage loan servicing and foreclosure processing. These deficiencies represent significant and pervasive compliance failures and unsafe and unsound practices at these institutions.”
401. In April 2011, Defendant JPMorgan Chase entered into a consent order (the “Consent Order”) with the Federal Reserve regarding JPMorgan Chase’s mortgage loan
servicing business, including its servicing of loans pooled in securitization trusts. The Consent Order noted that entities controlled by JPMorgan Chase had allegedly engaged in unsound servicing practices including initiating foreclosures “without always confirming that documentation of ownership was in order at the appropriate time, including confirming that the promissory note and mortgage document were properly endorsed or assigned and, if necessary, in the possession of the appropriate party.” Under the terms of this Consent Order, JPMorgan Chase was required to take steps to remedy deficiencies in its servicing and foreclosure activities, including retaining independent consultants to determine whether foreclosures initiated by JPMorgan entities had been based upon proper documentation, devising a plan to remediate foreclosure errors, and submitting to the Federal Reserve an acceptable written plan to strengthen oversight of risk management, internal audit and legal compliance programs.
402. The Offering Documents for the Certificates represented in substance that the Issuing Trust for each respective offering had obtained good title to the mortgage loans comprising the pool underlying the offering. However, in actual fact, Originators and Defendants routinely and systematically failed to comply with the requirements of applicable state laws and the PSAs for valid transfers of the notes and security instruments.
403. MERS, the electronic mortgage registry used by the banking industry a unit of Merscorp Inc of Reston, Virginia, has faced multiple investigations for its role in thousands of problematic U.S. foreclosure cases. MERS tracks servicing rights and ownership interests in mortgage loans on its electronic registry, allowing banks to buy and sell loans without recording transfers with individual counties.
404. Most recently, MERS has been the subject of a joint Delaware-New York probe. The registry has been sued by the Delaware Attorney General, which accuses MERS of deceptive practices that led to unlawful shortcuts in dealing with the foreclosure crisis. See State of Del v. MERSCORP Inc., C.A. No. 6987 (Del. Ch. Oct. 27, 2011). The Delaware complaint alleges that “MERS engaged and continues to engage in a range of deceptive trade practices that sow confusion among consumers, investors and other stakeholders in the mortgage finance system, damage the integrity of Delaware’s land records, and lead to unlawful foreclosure practices.”
405. New York’s attorney general has also taken action against MERS, subpoenaing the registry for information about how it is used by major banks, including JPMorgan Chase, and a foreclosure law firm.
406. On September 29, 2010, JPMorgan announced that it was freezing foreclosure proceedings in 23 states due to defects in its loan files and foreclosure documents. According to an October 13, 2010 BLOOMBERG article, all 50 state attorneys general have launched a coordinated investigation into whether banks including JPMorgan used false documents to justify foreclosing on mortgages for which they did not possess legal title.
Now, these are all just allegations, which have to be proven, so this will be a case to watch…
Copy of the full complaint at the link. Click here.