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December 2016: Significant Interim Victory in First Trial of RMBS “Putback” Claims

December 2016

The firm recently achieved an important trial victory for its client U.S. Bank in U.S. Bank v. UBS Real Estate Securities, Inc., otherwise known as “MARM,” following a month-long bench trial before Judge Kevin Castel of the Southern District of New York. The case involved allegations by U.S. Bank, as trustee for three residential mortgage-backed securities (“RMBS”) trusts, that UBS breached key contractual representations and warranties it had made about the thousands of loans backing those trusts. MARM was the first RMBS case involving claims brought by a trust on behalf of investors to go to trial.

During fact discovery, the firm gathered extensive evidence that the securitized loans were not as warranted, and that UBS knew it. During expert discovery, a re-underwriting expert sampled hundreds of loans and found rampant deficiencies throughout the sampled population. After the former presiding judge passed away, Judge Castel took over the case and told the parties that they could not rely on sampling, but rather had to be prepared to litigate the case loan-by-loan, for many thousands of loans. The Court briefly reopened expert discovery, and in an extensive effort, the expert and his expanded team reviewed over 12,000 loans in six months, finding material breaches in about 9,300 of them.

During the month-long trial spanning from April to May 2016, U.S. Bank provided its experts’ findings, and also showed the problems that pervaded UBS’s business during the lead-up to the financial crisis, including their failure to adequately review the loans they securitized and their willingness to turn a blind eye to red flags. One UBS employee admitted that, upon re-running borrower credit scores and seeing that some scores dropped by almost 200 points from the initial numbers, UBS chose to report the higher score to investors in offering documents, and never edited those documents to reflect the new, lower, scores. These problems, among many others, resulted in UBS securitizing thousands of shoddy loans and representing that the characteristics of these loans (e.g. borrowers’ FICO scores and debt to income ratios) were much better than they actually were.

U.S. Bank also explained why UBS’s theories for why it could avoid liability were ill-founded. Among other things, UBS argued that: U.S. Bank’s experts should be excluded; that UBS’s warranties did not actually promise that the information provided to investors was true and correct; the contracts made it impossible for U.S. Bank to recover for loans that had been liquidated; and there was no way for U.S. Bank to show that the breaches it had uncovered had a material and adverse effect on the interests of the trusts’ investors.

In its September 6, 2016 decision, the Court ruled in U.S. Bank’s favor on these and other key legal issues. Based on these findings, Judge Castel then proceeded to examine 20 “exemplar” loans and ruled in U.S. Bank’s favor on 13 of the 20. The Court ruled that it would appoint a group of special masters to apply these rulings to the remaining nearly 9,300 loans. Although the final amount of U.S. Bank’s recovery will not be known until the special master process is completed, based on Judge Castel’s rulings, it appears the recovery will be substantial.