Many observers saw the Bank of America settlement with a group of investors on Countrywide-originated mortgage bonds as an attempt to secure a broad waiver on the chain of title issues that have plagued the industry and led to foreclosure fraud. But in addition, they were a miserable deal for investors, a mere 2-3 cents on the dollar for a settlement that barely 1/4 of them agreed to. The trustee, the Bank of New York Mellon, was basically engineering a deal on behalf of investors with whom they did not consult, and indemnifying themselves for failures of securitization (to which the trustee could be held accountable) in the process.

Well, at least a few investors got wise to this. The settlement requires court approval. And a group of investors want to intervene to block it.

A group of bond investors said it plans to challenge in court last week’s proposed $8.5 billion settlement by Bank of America Corp. with holders of mortgage-backed securities.

In a court filing Tuesday, the group of 11 mortgage-bond investors, who call themselves Walnut Place but otherwise declined to identify themselves, said the parties that crafted the deal with Bank of America have conflicts of interest that raise questions about the fairness of the settlement.

“Walnut Place has serious concerns about the secret, non-adversarial, and conflicted way in which the proposed settlement was negotiated and about the fairness of the terms of the proposed settlement,” the Walnut Place group wrote in a filing in New York County Supreme Court. They said the deal is “inadequate.”

Remember, BofA is paying for the lawyer that’s supposed to be negotiating the settlement on behalf of the investors. The trustee made this deal with BofA without the consent of the majority of the investors in the bond, which would supersede other active litigation over the mortgage backed securities in question, and in fact release BofA from claims against those MBS.

Here’s the petition to intervene from Walnut Place. And it’s a good read. The petition describes the securitization process on Countrywide loans, and how they misrepresented the loans in the deals. And Walnut Place plans to show that they told Bank of New York Mellon about the misrepresentations:

On August 3, 2010, almost a year ago, Walnut Place presented to BNYM the detailed evidence that it uncovered in its investigation of one of those three trusts, Alternative Loan Trust 2006-OA10 (referred to as OA10). That evidence proved that many of the loans in that trust breached the representations and warranties that Countrywide had made about them. Walnut Place demanded that Countrywide repurchase those loans as it had agreed. When it refused, Walnut Place and other investors – which collectively owned more than 25% of the voting rights in that trust – demanded that BNYM sue Countrywide to enforce its promise to repurchase the defective loans. As it has in many cases in which it has been presented with evidence of Countrywide’s breaches, BNYM did nothing. On February 23, 2011, Walnut Place then filed an action in this Court, derivatively on behalf of the OA10 Trust, to enforce Countrywide’s obligation to repurchase the defective loans.

In other words, BYNM ignored the clear findings that would trigger repurchases by Countrywide’s new owner, BofA, and then went behind their back and made a deal that covers the repurchases Walnut Place sought! BYNM didn’t even tell the Walnut Place investors about the settlement until after it was announced. The petition brings up BNYM’s conflicts of interest as a possible reason for this duplicity. (see p.9-10 of the petition)

What’s more, Walnut Place alleges that the institutional investors who have agreed to this settlement have massive conflicts of interest. “During the time in which the Settlement Agreement was being negotiated, Bank of America owned up to 34 percent of BlackRock,” one of the investors in the settlement, just to pick out the most egregious example.

Walnut Place only has securities in three of the 530 deals, but you can see the application to any investor left out of this negotiation. They want their deals excluded from the settlement, just as other investors can come forward and ask for the same. What’s more, if Walnut Place cannot get their deals excluded, they say they will “seek the necessary disclosure to evaluate these concerns and to bring them and the facts that support them to the attention of the Court.” Essentially, the litigation that BofA and BNYM want to avoid would happen in the settlement case. And Walnut Place has done the math:

Bank of America stated in its press release announcing the proposed settlement that the Countrywide mortgage loans in the 530 trusts currently have an unpaid principal balance of $221 billion. An additional $48 billion of loans have been liquidated from those trusts by foreclosure or similar procedures. Under the PSAs, Countrywide is required to repurchase defective loans even if they have been liquidated. Thus, the total principal value of loans that Countrywide could be required to repurchase is approximately $269 billion. Audits of Countrywide loan files have revealed that as many as 90% of those loans breached representations and warranties. Walnut Place’s own analyses of the loans in the OA10 and OA3 Trusts, which were performed without Walnut Place even having access to the loan files themselves, found that 66% and 58% of those loans, respectively, breached representations and warranties. Thus, Countrywide may be liable to repurchase loans with unpaid principal balances of as much as $242 billion. The $8.5 billion that Countrywide and Bank of America have agreed to pay is therefore only a small fraction of the potential liability that they would have faced in litigation on behalf of the trusts.

This doesn’t mean that Walnut Place will be successful in getting this settlement thrown out. But it does mean that it won’t be as easy for Bank of America as they hoped. And they have plenty of other problems as well. NY Attorney General Eric Schneiderman over the weekend subpoenaed the current and former CEOs of BofA in conjunction with the old Merrill Lynch civil fraud investigation originally prosecuted by his predecessor, Andrew Cuomo. More on that here.

This is important for a number of reasons, and not just because I’m terribly interested in investors getting a better deal. The settlement forces investors to waive many chain of title issues for BofA. This will lead to speed-up of foreclosures and more suffering for borrowers. Without investor litigation looming as a threat, banks will have less of an incentive to actually fix the mortgage mess. So real people would be affected by this settlement, which is why they should be cheering for Walnut Place.