BofA: Your Defective Mortgage Problems Aren’t Over Yet

Bank of America

In April of this year, Bank of America (NYSE:BAC) said it would pay $500 million to release it from claims that it allegedly sold securities backed by defective mortgages. The settlement — which, to investors’ surprise, was announced alongside first-quarter earnings — was meant to resolve 80 percent of all the claims filed against Countrywide’s allegedly defective mortgage-backed securities, and 70 percent of the claims filed against Bank of America-created loans.

Allegations that the bank understated loan-to-value when the underwriting guidelines for those securities were disclosed arose in November 2007, with several pension funds launching a lawsuit against Countrywide Financial, the brokerage that Bank of America purchased in 2008 for $2.5 billion and the brokerage whose financial misconduct has cost the institution more than $45 billion. The plaintiffs claimed that by late 2008, virtually all the securities certificates had been downgraded to junk-bond status. In January of 2010, the Maine State Retirement System joined the suit.

When the settlement was announced, the bank noted that it was still subject to court approval, and with regulatory scrutiny growing, the case has indeed been reopened — with the federal government filing an objection that could derail the proposed $500 agreement.

Last Monday, the Federal Deposit Insurance Corporation said it opposed the deal on the grounds that the plaintiffs who negotiated the $500 million settlement “had a conflict of interest in negotiating and accepting the proposed settlement because, under the settlement, they would receive substantial payments at the expense of the rest of the class,” reported the Wall Street Journal. When the court said that subset of the lawsuits’ plaintiffs did not represent the interests of the class overall during an earlier stage of the litigation process, it took away their ability to represent the class and to threaten litigation in order to push for a better offer, said the FDIC.

But the plaintiffs’ lead counsel, Steven J. Toll of Cohen Milstein Sellers & Toll, told the Journal that he does not believe the “objection has a lot of merit.” He argued that the class would likely have received no restitution at all if they were not included by the plaintiffs in the settlement with Bank of America.

The FDIC has a further concern. In the official objection, the agency said that the court should reject the offer because the “amount of the proposed settlement as a percentage of the value of the securities that it covers, is only one-tenth the amount of the average class-action settlement in residential mortgage-backed security cases.” A hearing, which will determine final approval, is scheduled for later this month.

Of course, this mortgage settlement is not the only lingering case on Bank of America’s legal docket, despite Chief Executive Brian Moynihan’s best efforts to resolve all litigation. In late August, U.S. District Judge Jed Rakoff of New York’s Southern District denied the bank’s request to dismiss government allegations regarding Countrywide’s mortgage loan sales, and the lawsuit was cleared to go to trial, making it one of the only cases linked to crisis-era financial misconduct to reach the trial stage.

The federal government has alleged that Countrywide sold Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB) billions of dollars of toxic mortgage loans, and in October of last year, the Justice Department joined a whistleblower lawsuit that was initially brought by Edward O’Donnell, a former Countrywide executive.

The government seeks damages and civil penalties under the False Claims Act and the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 for “engaging in a scheme to defraud the Federal National Mortgage Association [Fannie Mae] and the Federal Home Loan Mortgage Corporation [Freddie Mac].”

Specifically, the complaint claims that between “at least 2007 through 2009,” Countrywide, and later Bank of America, implemented a new loan origination process — known as the “Hustle,” the “High Speed Swim Lane,” or HSSL — which was “intentionally designed” to process loans quickly and without quality checkpoints.

This process allegedly generated thousands of fraudulent and otherwise defective residential mortgage loans that were sold to the government-owned mortgage financiers and subsequently defaulted. The trial began September 23.

Follow Meghan on Twitter @MFoley_WSCS

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