Introduction

In the case of Retirement Board of the Policemen's Annuity and Benefit Fund of the City of Chicago et al. v. The Bank of New York Mellon, the United States Court of Appeals for the Second Circuit addressed two pivotal legal questions concerning residential mortgage-backed securities (RMBS). The plaintiffs, comprising various pension funds, sought to hold Bank of New York Mellon (BNYM) accountable for alleged breaches related to RMBS trusts they did not directly invest in. The primary issues revolved around the plaintiffs' standing to represent absent class members and the applicability of the Trust Indenture Act of 1939 (TIA) to certificates issued under pooling and servicing agreements (PSAs).

This commentary dissects the court's decision, exploring its implications for class actions in the RMBS sector and the regulatory landscape governing trust indentures.

Summary of the Judgment

The Second Circuit rendered a nuanced decision on December 23, 2014, affirming in part, reversing in part, and remanding the lower court's ruling. The court concluded that:

• Plaintiffs lack standing to assert breach-of-duty claims on behalf of class members who did not invest in the RMBS trusts in question.
• The TIA does not apply to the certificates issued by PSA-governed New York trusts, rendering BNYM unbound by certain fiduciary and contractual obligations under the TIA for those instruments.

Consequently, claims related to non-invested trusts were dismissed, while TIA-related claims for PSA-governed trusts were allowed to proceed.

Analysis

Precedents Cited

The court's decision heavily relied on prior cases to navigate the complexities of class standing and statutory interpretation:

• NECA–IBEW Health & Welfare Fund v. Goldman Sachs & Co. – Established a two-part test for class standing in putative class actions.
• LUJAN v. DEFENDERS OF WILDLIFE – Defined the requirements for standing under Article III.
• BLUM v. YARETSKY and LEWIS v. CASEY – Explored the limits of class standing and the relationship between named plaintiffs and absent class members.
• TCHEREPNIN v. KNIGHT – Provided guidance on interpreting "certificates of interest or participation" under the Securities Exchange Act.
• Fort Worth Employees' Retirement Fund v. J.P. Morgan Chase & Co. – Clarified the definition of a "tranche" in RMBS offerings.

Legal Reasoning

The court applied NECA’s two-part test to evaluate class standing:

1. The named plaintiff must have personally suffered an injury.
2. The alleged misconduct must implicate the same concerns as those experienced by class members.

While plaintiffs satisfied the first criterion by demonstrating personal injury due to BNYM's alleged inaction, the court found that the second criterion was unmet. The diverse nature of the trusts and the necessity for individualized proof of misconduct across numerous trusts meant that plaintiffs could not credibly represent absent class members.

Regarding the TIA, the court scrutinized the exemptions under §304(a)(1) and §304(a)(2). Even assuming the certificates were not classified as debt instruments, the court held that they qualified under §304(a)(2) as certificates of interest or participation in multiple securities, given their involvement with numerous mortgage loans.

Impact

This judgment has significant implications for future class actions involving RMBS trusts:

• Class Standing Limitations: Plaintiffs must have a direct investment in the specific trusts they seek to litigate against, restricting the ability to represent absent members in cases of diverse trust structures.
• TIA Applicability: Clarifies that certificates under PSAs with multiple underlying securities are exempt from the TIA, potentially reducing the fiduciary obligations of trustees in such structures.

These outcomes may deter broad-based class actions in the RMBS sector and influence how trustees manage their obligations under existing agreements.

Complex Concepts Simplified

Class Standing

Class Standing refers to a legal requirement that a plaintiff must have a sufficient connection to and harm from the law or action challenged to support that plaintiff's participation in the case. In class actions, this extends to whether the named plaintiffs can adequately represent the interests of all class members.

Residential Mortgage-Backed Securities (RMBS)

RMBS are financial instruments secured by a collection of residential mortgages. Investors in RMBS receive payments derived from the mortgage payments made by homeowners.

Trust Indenture Act of 1939 (TIA)

The TIA is a federal law that regulates the relationship between bond issuers and bondholders by requiring the appointment of a trustee to represent the interests of bondholders in indenture agreements.

Pooling and Servicing Agreements (PSAs)

PSAs are contracts between the issuer of RMBS and the servicer (e.g., Countrywide) outlining the responsibilities for managing the underlying mortgage loans, including collection of payments and handling defaults.

Certificates of Interest or Participation

These are financial instruments that represent an investor’s ownership stake in a trust holding multiple underlying securities or assets, such as mortgage loans in an RMBS trust.

Conclusion

The Second Circuit’s decision in the Bank of New York Mellon case underscores the stringent requirements for class standing in complex financial litigation and delineates the boundaries of the Trust Indenture Act’s applicability to modern RMBS structures. By affirming the dismissal of claims lacking direct investment ties and excluding certain RMBS certificates from TIA oversight, the court has set clear parameters that will shape the strategy and feasibility of future class actions within the mortgage-backed securities market. This judgment reinforces the necessity for plaintiffs to establish a concrete and direct stake in the specific financial instruments they seek to challenge, thereby ensuring that class actions remain grounded in individual injuries rather than broad, generalized grievances.