In ERISA “Plan Assets” Case, Court Orders Limited Discovery Relating to Debt Status of RMBS Notes

A federal judge in the Southern District of New York has issued a ruling¹ in a case brought by pension plans alleging violations of the Employee Retirement Income Security Act (ERISA)² by the servicers in two residential mortgage-backed securitization (RMBS) transactions. The plaintiffs had bought notes that had investment grade ratings when issued and had an intended ERISA and federal income tax characterization of debt. Certificates issued to other investors in the transaction were the intended equity for such purposes and were subject to ERISA-related ownership and transfer restrictions. However, the plaintiffs’ case, which they brought in 2018, depends in part on a finding that the notes were in fact equity, not debt, for ERISA purposes. A finding of equity status would mean that the assets of the RMBS issuers were “plan assets” subject to ERISA and that the servicers were ERISA fiduciaries with respect to the plaintiffs and any other ERISA investors in each issuer. The case has attracted attention as an exceptional challenge to intended ERISA debt status in a prominent court, and the ruling has likewise attracted attention. However, the ruling breaks no new ground as to the characterization of “debt for tax” securitization notes for ERISA purposes.

The court correctly stated the two-prong test for determining the debt status of the notes under ERISA: (i) the notes must be debt under applicable local law; and (ii) the notes must have no substantial equity features.³ In relevant part, the only result of the ruling was that the court in effect converted the defendants’ motion to dismiss to a motion for summary judgment and ordered limited discovery of certain facts relating to the two-prong test, because the facts were not undisputed on the face of the pleadings. Therefore, the ruling should be considered in its procedural context, where it is not surprising. While we are monitoring the case, and any ultimate ruling on the merits could be significant, nothing in the case at this stage suggests that the standards applicable to ERISA structuring or disclosure in securitizations will need to be revised.⁴

In their pleadings, the defendants had already included evidence that (i) a law firm had rendered tax opinions concluding the investment-grade notes would be characterized as debt for federal income-tax purposes and (ii) investors (including the plaintiffs) were deemed to have made representations regarding the ERISA debt status of the notes as a result of acquiring the notes. The court stated that the evidence presented by the defendants “cast considerable doubt on the [p]laintiffs’ ability to support [the] allegations” relating to ERISA but nevertheless ordered the parties to conduct limited discovery on whether the securitized mortgages are “plan assets” under ERISA and whether the defendants are ERISA fiduciaries. The court also correctly observed that if either point were resolved in the defendants’ favor, the plaintiffs’ claims would fail.

¹ Powell v. Ocwen Financial Corporation, 1:18-cv-01951 (S.D.N.Y March 15, 2019).

² As used herein, ERISA refers to the Employee Retirement Income Security Act of 1974 and, where applicable, the prohibited transaction provisions of Section 4975 of the Internal Revenue Code of 1986.

³ See 29 C.F.R. § 2510.3-101, as modified by ERISA § 3(42), which provides rules for determining when the assets of a vehicle are “plan assets” of ERISA plans, individual retirement accounts, and other “benefit plan investors” that hold interests in that vehicle.

⁴ Some securitizations do not rely on the debt status of the issued securities to enable sales to ERISA investors; instead, those securitizations rely on “underwriter exemptions” (substantively identical individual “prohibited transaction” exemptions issued by the Department of Labor to the underwriters of such securitizations) to permit the sale of certain investment-grade debt or equity securities to ERISA investors without causing the assets of the securitization vehicle to be subject to compliance with ERISA.