Mortgage-backed securities investors have recently turned their litigation sights on trustees, and this does not bode well for the mortgage industry. The gist of two new cases is that trustees allegedly do not exercise their trusts’ repurchase rights. Previously, most of the large class action investor suits have been directed at MBS issuers and underwriters.

While the outcome of the new cases may be unclear at this point, it is inevitable that there will be a domino effect on the industry.

Last month, an investor group filed a federal court class action in New York against Bank of America and U.S. Bank, alleging breaches of the MBS trustee agreements and violations of a heretofore relatively obscure federal statute known as the Trust Indenture Act (TIA). Filed in the Southern District of New York, Policemen’s Annuity and Benefit Fund of the City of Chicago v. Bank of America, NA, et al. relates to putbacks that the MBS trustees allegedly should have made to the originator and servicer of loans. While the lawsuit tracks allegations made in Retirement Board of the Policemen’s Annuity and Benefit Fund of the City of Chicago, et al. v. The Bank of New York Mellon—a similar suit against Bank of New York Mellon filed last year—it also follows on the heels of a refusal by the judge in that case, just days before, to dismiss.

The significance of these cases is twofold. First, plaintiffs argue that this means investors can sue trustees under the TIA, even if they cannot garner at least 25 percent of the voting rights in any particular trust—a requirement under many pooling and servicing agreements. At the same time, even though the TIA generally provides no different standards than a trust agreement itself, the opinion establishes an entree into federal court, where, particularly in New York (the epicenter of MBS litigation), the judges on both the trial and appellate courts are generally more hostile to the financial institutions.

Ironically, some of these disputes arise in a context where investors do not even allege a default, suffering loss only due to resales on the open market. Prodded by threats and lawsuits, trustees over the last year have already taken a more aggressive stance pursuing originators. For example, last summer, U.S. Bank sued Bank of America in New York state court alleging breaches of representations and warranties concerning the mortgages underlying Greenwich Financial’s Harborview MBS issuances.

As opposed to MBS issuers and underwriters, there are relatively few financial institutions that operate a pure MBS trustee business. This historically has been a sleepy, low-margin undertaking. It is safe to say that banks did not count on these sorts of disputes when they signed up to be trustees. Irrespective of the merits of the trustee cases, litigation expense and exposure were not priced into trust or Pooling and Servicing Agreements.

Investor groups have suffered some setbacks, most notably in Bank of America’s campaign, successful so far, to effectuate an $8.5 billion settlement with major trustees. Bank of America filed an action in New York state court, seeking court protection for such an agreement. Investors were unsuccessful at getting the case removed to federal court. And the state court judge who received the case back after remand has recently dismissed a case by one investor group attempting to usurp the trustee’s role. See Walnut Place LLC, et al. v. Countrywide Home Loans, Inc., et al., Index No. 650497/11. The parties to the settlement believe the agreement will shield the trustees, too, albeit in a manner limited to the four corners of the document. Nonetheless, this has not deterred the filing of new lawsuits alleging trustee liability, as demonstrated by the most recent New York filing. The BNY Mellon opinion is one with which all MBS attorneys will now have to contend, although it should come as no surprise to anyone familiar with MBS agreements.

The economy’s doldrums mask for now the long-term effects of the trustee lawsuits. Nonetheless, some of the shakeout is already apparent. Bank of America sold its trust business to U.S. Bank a few months ago. Financial institutions that want to remain trustees will also want more money for future issuances. While this may not lead to interest rates of 18 percent—an experience some first-time homeowners of the early ’80s may remember—it is unrealistic to assume that the cost of recent history will not ultimately be passed on to consumers.