Powell v. Ocwen Financial Corporation

Background

The plaintiffs—trustees of The United Food & Commercial Workers Union & Employers Midwest Pension Fund—brought a putative class action under the Employee Retirement Income Security Act of 1974 (ERISA). They sued Ocwen Financial Corporation and related entities, Altisource entities, Assurant entities, HomeSure entities, Southwest Business Corporation, and Wells Fargo Bank, N.A. The plaintiffs alleged that the defendants committed misconduct in managing residential mortgages underlying six mortgage-backed securities trusts in which the Fund invested.

The plaintiffs asserted ERISA claims for breach of fiduciary duty, co-fiduciary liability, failure to prosecute legal actions based on alleged misconduct, and prohibited transactions. The court had previously identified whether the mortgages were ERISA plan assets as a threshold issue because the claims could proceed only if they were plan assets. The court had also previously stated that Ocwen could not be an ERISA fiduciary with respect to the mortgages if they were not plan assets.

Motions and governing rule

Ocwen and Wells Fargo moved for summary judgment, which asks the court to rule without a trial when no genuine dispute of material fact exists and the moving party is entitled to judgment under the law. They argued that the mortgages could not be plan assets because the securities purchased by the Fund were treated as debt and had no substantial equity features. The plaintiffs moved for partial summary judgment to establish that certain purchased securities were plan assets.

The applicable Department of Labor regulation generally provides that a plan’s investment in another entity does not include the entity’s underlying assets. An exception applies when the plan invests in an equity interest in a qualifying entity. The regulation defines an equity interest as an interest other than an instrument treated as indebtedness under applicable local law that has no substantial equity features. Therefore, the court considered whether the securities were treated as debt and whether they had substantial equity features.

Court’s analysis

The court determined that either Delaware or New York law could be applied because the two states’ contract-law principles were materially identical for this issue. Under those principles, the court examined the governing agreements to determine whether the securities were debt or equity.

For the three indenture trusts, the governing agreements referred to the notes as indebtedness and distinguished them from separate certificates representing beneficial ownership interests in the trusts. The agreements also subordinated distributions to certificate holders to creditors, including noteholders. The court concluded that the agreements treated the notes purchased by the Fund as debt.

For the three real estate mortgage investment conduit trusts, the court concluded that the regular-interest certificates purchased by the Fund were debt securities. The certificates entitled holders to payments based on fixed principal amounts and specified interest rates, and the governing agreements established prioritized payment structures. The court distinguished these regular-interest certificates from residual-interest certificates, which could receive whatever remained after regular-interest holders were paid and therefore had the type of upside potential associated with equity.

The court rejected the plaintiffs’ reliance on prospectuses, reasoning that the prospectuses were not contracts and could not change the character of the securities established by the governing agreements. It also found that a Department of Labor advisory opinion concerning certificates that represented percentage participation interests in underlying mortgage pools did not apply because the Fund’s securities provided for payments based on stated principal amounts and interest rates rather than percentage ownership interests. The court likewise found that a cited Second Circuit decision had not decided whether the certificates involved there were debt or equity and addressed a different federal statute.

The court also considered factors used to distinguish debt from equity, including fixed maturity dates, fixed interest rates, enforceability of principal and interest payments, subordination, the parties’ label for the instruments, and their treatment for tax and regulatory purposes. The court found that the securities’ fixed rates and maturity dates, payment protections, investment-grade ratings, and treatment as debt in the Fund’s account statements supported treating them as debt. The plaintiffs did not identify a feature that could amount to a substantial equity feature. Their arguments concerning rating downgrades and variability in interest and principal payments did not establish otherwise.

Disposition

The court held that no reasonable trier of fact could conclude that any of the mortgage-backed securities at issue were ERISA plan assets. Judge Vernon S. Broderick granted the moving defendants’ motion for summary judgment and denied the plaintiffs’ motion for partial summary judgment. The Clerk was directed to enter judgment in favor of all defendants and close the case.