Law360, New York (March 08, 2012, 5:34 PM ET) — Galena Street Fund LP sued Wells Fargo Bank NA in Colorado federal court on Wednesday for allegedly breaching its responsibilities as both a trustee and servicer for certain residential mortgage-backed securities, costing the hedge fund millions of dollars in losses.
When homeowners fail to make payments on the underlying loans for such securities, loan servicers can advance those payments to the securitized trusts and reimburse themselves from foreclosure and mortgage insurance proceeds. However, Washington Mutual Bank FA, the predecessor servicer for the residential mortgage-backed securities at issue, badly mishandled that process, Galena contends in its complaint.
WaMu, which collapsed in 2008, made servicing advances for missed borrower payments but botched the insurance claim process, leaving it unable to collect insurance proceeds, the complaint said. WaMu ended up reimbursing itself from trust assets and passed the losses on to the trusts, according to the complaint, which said Wells Fargo failed to correct the problems.
“Plaintiff implored Wells Fargo, as trustee, to prevent WaMu from reimbursing itself and imposing losses on the trusts in this manner — but not only did Wells Fargo fail to act, it compounded the harm by passing on the losses itself when it later bought WaMu’s servicing portfolio,” the complaint said.
Wells Fargo purchased the servicing rights for the mortgage-backed securities loans in 2006, according to the complaint.
Pooling and servicing agreements covering the securities prohibited that transaction, and it exposed Wells Fargo to multiple conflicts of interest with its investor beneficiaries, the complaint said. The sale, according to the complaint, helps explain why Wells Fargo did nothing to stop WaMu.
“Wells Fargo’s conflict of interest continues to this day — more than five years later — despite its acknowledgment in July 2011 that it is presented with what it calls a potential conflict of interest and commitment to expedite the process of finding a successor trustee,” the complaint said.
“Instead, Wells Fargo remains both the trustee for the two at-issue trusts and the servicer for many of the loans in those trusts,” the complaint added.
Galena, which is affiliated with Braddock Financial Corp., contends that it was hit especially hard as a junior certificate holder.
When the banks wrongfully paid servicing advances into the trusts, investors holding senior classes of bonds were paid first, according to complaint. However, when the losses were passed to the trusts, they were absorbed from the bottom up, wiping out Galena’s entire investment, the complaint said.
“Had WaMu and Wells Fargo simply reversed the advances — that is, taken them from the investors who received them, rather than leaving them with the investors who received them and taking them from plaintiff’s holdings — all investors would have been left in the position they should have been in, minus the fact that WaMu should have perfected the insurance claims in the first place,” the complaint said.
Galena also claims WaMu made a number of duplicate withdrawals from the trusts, costing it millions of dollars.
The suit brings claims against Wells Fargo for breach of fiduciary duty, breach of contract, breach of the duty of good faith and fair dealing, negligence and unjust enrichment.
Representatives for the parties did not immediately return requests for comment on Thursday.
Galena is represented by Daniel M. Reilly and Michael A. Rollin of Reilly Pozner LLP.
Counsel information for Wells Fargo was not immediately available.
The case is Galena Street Fund LP v. Wells Fargo Bank NA, case number 1:12-cv-00587 in the U.S. District Court for the District of Colorado.
–Editing by Katherine Rautenberg.