Two lawsuits in New York currently threaten the credit card ABS market. Seeking to leverage the Second Circuit’s decision in the Madden v. Midland case, plaintiffs filed punitive class actions in the Eastern District of New York against Capital One Funding LLC, Capital One Master Trust, and Capital One Multi-Asset Execution Trust (Cohen v. Capital One) and in the Western District of New York against Chase Card Funding LLC and Chase Card Issuance Trust with Wilmington Trust named as sole trustee (Petersen v. Chase). Plaintiffs in both cases allege that the two banks violated New York state laws by setting an interest rate over New York’s current cap of 16% and seek to recoup the interest payments in excess of that rate and cap rates going forward.

Impact on structured finance:

While both cases focus on credit card debt, SFA members warn that the outcome of these cases has the potential to impact all forms of securitized debt by potentially subjecting national banks to overburdensome state-by-state regulation. A favorable outcome for either Plaintiff could have several negative and long-lasting effects on the U.S. securitization and lending market by limiting funding sources and forcing banks to seek more financing away from securitization, thereby impacting their ability to extend credit.

Action taken by the Structured Finance Association:

SFA, in partnership with the Bank Policy Institute, filed a motion on August 13^th supporting the defendants’ motion to dismiss in Petersen v. Chase, and filed a brief in support of defendants in the Cohen v. Capital One case on October 4^th. In both cases, SFA highlights the potential negative impact on lending markets and the cost and availability of credit for U.S. consumers and businesses.

“This case has uniformly raised serious concerns across the industry as the CFPB’s proposed consent order challenges certain sacrosanct contractual rights of transaction parties. We strongly support an appropriate and transparent servicing standard for consumers; however, we believe it’s inappropriate to shift the burden of remedying any alleged third party’s misconduct to another party in contradiction with the agreed contractual arrangement.” – Kristi Leo, Structured Finance Association 

One of the many-cited contributors to the failure of the private-label RMBS market to rebound from its crisis-driven lows is contractual ambiguity, concern around the inviolability of the contract, and a general lack of trust that trust cash flows will be allocated as dictated by the transaction documents. The CFPB v NCSLT case has aggravated these concerns among market participants, and without intervention, the lack of confidence might extend to other asset classes such as credit cards, student loans, and auto loans.

While neither appropriate nor acceptable, the extra-legal re-ordering of legacy RMBS contracts, in retrospect, can at least be attributed to a crisis situation, the Great Financial Crisis. That is not the case in this NCSLT matter.

At the heart of our concerns is the rule of law as it applies to negotiated contracts – a bedrock tenet to the stability of financial markets. The CFPB’s proposed consent order effectively rewrites contractual provisions that parties agreed to and penalizes the underlying investors, who are not accused of any wrongdoing, for the alleged actions of the third-party services. Moreover, the CFPB’s proposed consent order was negotiated without the involvement of any of the transaction parties who have interest, rights and obligations that would be modified by that order.

The ramifications of this lawsuit will have a chilling effect on the broader securitization market if the proposed consent order moves forward. The securitization market provides essential credit to more students and consumers at a lower cost than would be available otherwise. For example, $171 billion of student loans, $223 billion of auto loans, and $206 billion of other consumer loans are currently funded through the securitization markets as of year-end 2018.

The Structured Finance Association took immediate action to submit an amicus brief. Additionally, SFA arranged an Investor D.C. Fly-In to relay the industry’s concerns to Capitol Hill and the CFPB. This multi-pronged approach of addressing the court, legislators, and the CFPB has already shown some impact. Various statements made in a recent court decision granting multiple parties’ motions to intervene where sympathetic to the positions argued by the Structured Finance Association. Likewise, letters sent by Members of Congress to the CFPB outlined the Association’s members’ concerns.

Case Challenges Long-Standing ERISA Debt Characterization – and Claims Trustees are Fiduciaries

The Powell v. Ocwen Financial Corporation case focuses on six plaintiffs from the United Food & Commercial Workers Union & Employers Midwest Pension Fund (“the Plan”) who filed a complaint against Ocwen Financial Corporation, Wells Fargo, and other service providers in connection with investments made by the Plan in notes issued by two American Home Mortgage Investment Corporation Trusts in 2004 and 2005. Plaintiffs allege that since 2008, Ocwen has been engaging in “rampant misconduct” in its capacity as servicer for the Trusts by “exercising sweeping, unchecked control” of the AHMI trusts. Specifically, the Plaintiffs allege that Ocwen violated its fiduciary duty under current ERISA regulations and conducted prohibited transactions. In September 2019, the Plaintiffs amended the complaint to include certificate holders in which Ocwen acted as a servicer for some or all of the securitized mortgages, but which were not included in the original complaint. In November 2019, the court allowed the Plaintiffs to expand their lawsuit to four more additional trusts. The underlying assets of the trusts are residential mortgages.

The plaintiffs in Powell v. Ocwen are attempting to challenge a deal sponsor’s debt characterization of RMBS investment grade rated securities for ERISA purposes, which if successful could result in the securitization vehicle being considered plan assets under ERISA. The plaintiffs also argue that the court should hold for the first time that loan servicer and master servicer of a securitization trust be considered ERISA fiduciaries with fiduciary liability under ERISA.

Impact on structured finance:

This case is particularly noteworthy for the market because it indicates the first time a judicial decision raises the issue whether a sponsors’ debt characterization issued by the sponsors of a securitization vehicle may be incorrect Plaintiffs argue that a security that was classified as, considered to be, and treated as a debt instrument, should be treated instead as equity – after the fact – for purposes of ERISA. Many structured finance deals are structured as “debt” deals where pension plans can buy certain classes of Notes, subject to making certain ERISA representations. If, however, the investment grade rated securities issued in a structured finance transaction are treated as equity for purposes of ERISA, as a general matter either 1) the securities will be ERISA restricted, or 2) the transaction will need to comply with certain special DOL exemptions known as the “Underwriter Exemptions” (which are commonly used in CMBS transactions).  If this matter is decided in favor of the plaintiffs, this would upend long-standing fundamental market assumptions and could have significant repercussions for the structured finance market

Action taken by the Structured Finance Association:

While market participants and industry experts agree that a ruling in favor of the plaintiffs is highly unlikely, this case is very important given the significant negative impact it could have on the market. The case is in the US District court for the Southern District of New York, an important and influential district. For these reasons, SFA plans to author an amicus brief to be submitted in support of the defendants in early March 2020. SFA has published a more detailed summary of the case, available here.

The Madden v. Midland case centers on a plaintiff, Saliha Madden, a New York resident who had defaulted on $5,000 under a credit card she opened with Bank of America (now doing business as FIA Card Services).  As is very common FIA Card Services later sold Madden’s defaulted debt to Midland Funding LLC, a California-based company specializing in the collection of past due loans. Midland Funding sought repayment from Madden for the principal outstanding along with an interest rate of 27% consistent with the terms of the credit card agreement governed by Delaware law. In 2011 the plaintiff filed suit alleging that Midland violated the Fair Debt Collection Practices Act by falsely representing the amount of interest it was entitled to collect on the basis Midland is not a national bank and therefore must adhere to the applicable state usury laws regardless of the fact the loan was originated by a national bank under which the interest rate terms were valid.

Impact on structured finance:

Madden v. Midland calls into question whether the terms of a bank loan originated pursuant to the National Bank Act are still valid following the sale or assignment of the loan to a non-bank third party. A ruling in favor of Madden would have a significant impact on the valuation of certain loans originated by depository institutions as well as those previously sold by banks to non-bank, including securitizations trusts.  The ability to ‘export’ rates is critical to loan market including the current securitization market. In fact, there is evidence that the lower court decision has already impacted consumer lending activity in Second Circuit states (NY, VT and CT) including decreasing the number of loans that are originated by banks and/or financed by or sold to non-banks.

Action taken by the Structured Finance Association:

While the Southern District Court for New York ruled in favor of Midland, the Second Circuit Court of Appeals reversed its ruling finding that the National Bank Act pre-emption did not apply to Midland because Midland was not a national bank.  In 2016, SFA filed an amicus brief in support of Midland petition to be heard by the Supreme Court, however, the Supreme Court ultimately denied the petition.

• Lehman Brothers Special Financing v. Branch Banking and Trust Co., et al – amicus brief and summary
• Taberna Preferred Funding IV LTD. – amicus brief
• Blackstone v. Sharma – amicus brief
• Eminent Domain – position paper and letter to Senators Johnson and Crapo

Significant Implications for the LIBOR Transition

The plaintiffs, who are consumer borrowers, in the case of McCarthy v. Intercontinental Exchange, Inc., allege that the setting of the LIBOR benchmark rate violates the federal antitrust laws. Defendants include LIBOR panel banks as well as the Intercontinental Exchange, which administers LIBOR. Plaintiffs do not allege that defendants did anything to circumvent the rules governing the setting of LIBOR, but instead allege that the rules themselves are unlawful and lead to higher interest rates in consumer loans. Additionally, plaintiffs allege in conclusory terms that the bank defendants reached an unlawful agreement to each use LIBOR in the loans they issued. An injunction to unwind every financial instrument that uses LIBOR as a reference rate, and to suspend the publication of LIBOR is being sought by the plaintiffs.

SFA jointly filed an amicus brief with the Chamber of Commerce, SIFMA, ISDA, BPI, and LSTA, in this case in the Northern District of California. The case has significant implications for the LIBOR transition and global financial markets. The plaintiffs request to bring the publication of the U.S. LIBOR benchmark rate to an immediate halt threatens to disrupt financial transactions all over the world and undermine years of planning for an orderly transition from LIBOR.

 Impact on Structured Finance

Suddenly suspending the publication of LIBOR and thereby enjoining the performance of contracts that reference it would be unfair to the industry. Because millions across the globe, including the structured finance market, rely upon LIBOR’s publication, halting it without an orderly transition process could, among other things, inject great uncertainty into financial transactions, pose systemic risks to the financial system, and leave parties to millions of contracts without a mechanism to calculate their payment obligations.

 Action taken by the Structured Finance Association

On December 11, 2020, SFA jointly filed an amicus brief with the Chamber of Commerce, SIFMA, ISDA, BPI, and LSTA, in the case. Given the overwhelming SFA member support for a smooth transition away from LIBOR and interest in finding solutions to reduce negative impacts on legacy LIBOR contracts, SFA’s participation in this amicus brief aligned with those objectives.