New York Attorney General Eric Schneiderman has filed a motion to intervene in the $8.5 billion settlement between Bank of America and mortgage backed securities investors, calling the proposed settlement “unfair and inadequate,” and seeking to represent those investors who would be unrepresented at court but bound by the judgment. In addition, Schneiderman alleges “fraudulent and deceptive conduct” on the part of Bank of New York Mellon, the trustee in the case.

For background, BofA announced the settlement with investors in Countrywide mortgage backed securities back in June. Only 22 investors signed on to the settlement, but it would release BofA and its trusteee, Bank of New York Mellon, from liability on a broad range of violations of securities statutes, including the agreements made with investors, the representations and warranties contained within and overcharging of fees by BofA. This would apply to almost all Countrywide MBS. BofA promised the cash settlement (which amounts to about 3 cents on the dollar for these loans) and some changes to their servicing conduct. It was a sweetheart deal, and almost immediately, investors not part of the settlement started to object.

In the filing, Schneiderman writes that “BNYM (Bank of New York Mellon) stands to benefit from the settlement agreement and that the relief sought here appears designed to largely insulate BNYM from fiduciary duty claims arising from the settlement,” so there is no reason to believe that the trustee will act in the interests of the investors rather than in its own self-interest. Schneiderman also points out that the settlement is meager compared to the losses felt by investors on these MBS. In addition, he writes, “the purported servicing improvements are too vague and ill-defined to provide any concrete value to investors.”

Schneiderman, who had already sought documents in the settlement, cites as his rationale for intervening both New York common law interests to protect state investors, his executive authority to step in when “alleged misconduct touched many investors, many of whom are New York State residents,” and the fact that “a judgment in this proceeding may interfere with his ability to assert claims against BNYM, BoA, or Countrywide” in future cases. Indeed, with this filing, Schneiderman is making the basic claim that he has made against rushing to a settlement in the 50-state AG investigation: that he would not relinquish a liability claim against banks, servicers and trustees for their role in foreclosure fraud and securitization failures. Here’s the key section:

In addition, the Attorney General is entitled to intervene because a judgment in this proceeding may interfere with his ability to assert claims against BNYM, BoA, or Countrywide. Id. The proposed pleading in intervention submitted with the Attorney General’s motion includes counterclaims against BNYM for: (1) breach of fiduciary duty, brought in the Attorney General’s capacity as parens patriae; (2) violations of Executive Law § 63(12), which prohibits persistent fraud or illegality in the conduct of business; or (3) violations of General Business Law § 352 et seq. (the Martin Act), for fraud in connection with a securities transaction, summarized below. The Attorney General also has potential claims against Countrywide and BoA under the same or similar causes of action.

Schneiderman adds that “At this preliminary stage, the available facts surrounding the settlement suggest that the Trustee breached its fiduciary duties under New York State common law, in the course of administering the Trusts or in concluding the Settlement or both… And given that BoA negotiated the settlement with BNYM despite BNYM’s obvious conflicts of interest, BoA may be liable for aiding and abetting BNYM’s breach of fiduciary duty.”

That the Martin Act, a New York state securities law, has been invoked here is crucial. It is arguably a stronger regulation than federal securities law, because there is no need to demonstrate intent as part of the violation. Schneiderman is going right to the heart of the matter with his Martin Act claim. All of the securitization failures are alleged here:

The Trustee violated the Martin Act by misleading investors about its conduct in the Pooling and Servicing Agreements governing the Trusts (“PSAs”), which provided that the Trustee would review and ensure mortgage file integrity, alert investors to events of default, and take action where necessary to remedy breaches. To the contrary, the Trustee failed to ensure mortgage file integrity, failed to alert investors to events of default, and took no actions to remedy the disastrous collapse in value of the Trusts it was supposedly safeguarding.

Second, Countrywide and BoA face Martin Act liability because there are repeated false representations in the Governing Agreements that the quality of the mortgages sold into the Trusts would be ensured, that servicing would be conducted to ensure value for the investors, and the integrity and completeness of mortgage files would be maintained.

Finally, the Trustee aided and abetted these violations of the Martin Act by failing, to take any action to correct Countrywide’s misrepresentations, which the Trustee knew to be false or misleading and knew would be used to induce the sale of securities.

This is a major allegation. Schneiderman is saying that the game-playing with securitizations, which has been well-documented, represent violations of securities law on the part of the trustee and the originator of the loans. They knowingly sold junk to investors and violated their own agreements. And now they’re trying to whitewash it through a settlement where the bank and the trustee are colluding with one another. As Schneiderman says, “the Trustee stands to receive direct financial benefits under the Proposed Settlement.”

And here’s the real bombshell: Schneiderman alleges that Bank of New York Mellon was aware that Countrywide failed to transfer loans properly to the trust. This means they sold what amounted to non-mortgage backed securities to investors, who should then be granted the full value of these bonds back. The pooling and servicing agreements governing the loan transfers are very precise, and were violated in this case, according to the AG. As he writes:

These provisions are central to any mortgage securitization, but they are now vitally important to trust investors in light of the housing market collapse. Any action to foreclose requires proof of ownership of the mortgage. This must be demonstrated by actual possession of the note and mortgage, together with proof of any chain of assignments leading to the alleged ownership. Moreover, complete mortgage files give borrowers assurance that their properties are properly foreclosed upon. The failure to properly transfer possession of complete mortgage files has hindered numerous foreclosure proceedings and resulted in fraudulent activities including, for example, “robo-signing.” These fraudulent activities have burdened borrowers as well as the courts with flawed foreclosure proceedings.

I couldn’t have summed up foreclosure fraud better myself.

Here is the Memorandum in support of the Motion to Intervene, as well as a support document from Assistant Attorney General Amir Weinberg. And here is the pleading in the case, which makes for some interesting reading. And if you like, you can slog through this sample pooling and servicing agreement from Bank of New York Mellon, which shows you all the things they promised to do, and then neglected.

Schneiderman has really stepped up here. He is blowing the whistle on the entire whitewash of foreclosure and securitization fraud, and acting on behalf of his interests. All of these settlement efforts by other state and federal regulators should come to a screeching halt in light of this action. Because this is the kind of action that an Attorney General would not be able to take if they released claims against the big banks in a global settlement.