The U.S. District Court for the Southern District of New York has issued an opinion in an area of ERISA-governed securities that has until now provided few cases or guidance to issuers of residential mortgage-backed securities (RMBS).
Although the opinion in Powell, et al. v. Ocwen Financial Corporation, will certainly be appealed and may not be the final word in this area, for now, it provides insight into this seldom-litigated aspect of whether RMBS could be offered or owned by ERISA-governed plans.
At issue in the Ocwen case is whether the underlying assets of the trusts that issued the securities were "plan assets" within the meaning of ERISA. A Department of Labor "plan asset regulation," states that in general, when an ERISA plan invests in another entity, the plan's assets include its investment, but do not, solely by reason of such investment, include any of the underlying assets of the entity. However, if the plan's investment is in the equity interest of an entity that is neither a publicly offered security nor a security issued by a registered investment company, the ERISA plan's assets include both the equity interest and an undivided interest in each of the underlying assets of the entity. Thus, whether an entity can be "looked through" and have its assets deemed to be plan assets due to an investment by an ERISA plan depends on whether the ERISA plan's investment is an "equity interest."
In Ocwen, the plaintiff plan claimed its purchase of RMBS was an equity interest, making those securities subject to ERISA, and thus imposing a fiduciary duty on the defendants who offered the securities to the ERISA plan. The defendants claim the securities were debt instruments, not equity instruments, and were thus not included in the DOL regulation as an equity interest, and thus not subject to ERISA duties.
The court, after analyzing the laws under which the RMBS' were created, IRS definitions, and DOL regulations, granted summary judgment in favor of the defendants, holding that no reasonable trier of fact could conclude that any of the mortgage-backed securities at issue in the case could cause any of such underlying assets to be "plan assets" within the meaning of ERISA. "District Court Rules In Favor Of RMBS Issuers In long-Running ERISA Challenge" www.morganlewis.com (Aug. 07, 2023).
The Ocwen decision is consistent with the current practice among investment entities that have always treated RMBS' as debt products.
A decision to the contrary could have seriously disrupted the ERISA plan market for all types of securities issued as notes, not just for asset-backed securities. Issuances of securities as notes are structured on the assumption that notes do not constitute equity interests.
If that assumption were no longer warranted, note issuances would have to be structured very differently to market them to investors subject to ERISA or would be prohibited from being acquired by ERISA plans entirely.