A highly publicized suit against the subprime lender Delta Financial Corp. and Bankers Trust has raised questions about the risk that supporting actors take in loan securitizations.
The suit, filed in late December, holds that Bankers Trust should be partly liable for Delta loans that have been securitized since 1995, because the bank acts as trustee for the fund holding the securities.
The loans, the suit says, violate Truth-in-Lending agreements, and the borrowers should get their money back.
Bankers Trust, as assignee, is responsible for those loans, the suit says, citing a provision of the Home Ownership Equity Protection Act: "Any consumer who has the right to rescind a transaction ... may rescind the transaction as against the assignee of the obligation."
As many as 10,000 Delta borrowers should have loans refunded, the suit said.
The plaintiffs are seeking class-action status for the suit. Delta has not been accused of any crime, and Delta officials have denied any wrongdoing.
Nonetheless, the suit has sparked debate about the responsibilities of supporting actors in a booming market-asset-backed securities.
These companies, including Delta, lend to people with poor credit history at higher rates and fees than bank loans carry. More than $85 billion in securities backed by subprime loans were issued in 1998, according to Moody's Investors Services.
Subprime lenders often draw the attention of regulators and class-action lawyers. Several suits have been filed in recent years against subprime lenders on behalf of borrowers, but the Delta suit is the first to name an entity involved with the securitization of the loans.
Bankers Trust officials are especially ruffled because of the coverage the suit received. An expose-style story on the front page of The New York Times said the bank was "Delta's partner" in trying to foreclose on poor homeowners.
Bankers Trust defended itself in a letter to the Times. "A bank does not act in its own capacity or for its own benefit" when it acts as a custodian or a trustee, wrote Gary Hattem, the bank's head of community development.
"Bankers Trust was not the underwriter of Delta's securities, and was not responsible for selling those securities to investors," said the letter, which was circulated to community development groups last week.
Trustees generally act as middlemen for lenders and investors in deals. They hold the titles to the loans, receive funds collected by servicers, and distribute funds to investors.
If the loans go bad, trustees and underwriters of the loans are often sued by investors.
But mortgage-backed securities professionals are hard-pressed to define a trustee's responsibility to borrowers.
The "lines are not clearly drawn," said David S. Wolin, a partner with New York-based Willkie Farr & Gallagher, a law firm that represents investors, underwriters, and securities issuers.
Trustee's duties can vary from "deal to deal," Mr. Wolin said. Trustees generally act as overseers, and have a fiduciary duty to investors, but "generally aren't obligated to investigate the loans," Mr. Wolin said.
"Frankly, they don't get paid all that much" for their duties, he added.
Department of Justice officials, responsible for the Truth-in-Lending acts and the Home Ownership Equity Protection Act, did not return calls by press time.
Some lawyers who have seen the case have speculated that the plaintiffs' attorneys named Bankers Trust because the bank has "deep pockets." Others said the suit it could start a trend.
The plaintiffs' attorneys for the Delta suit declined to comment.
But Edward O'Brien, a class action lawyer who specializes in suing mortgage lenders, said he "would consider going after other parties that have interests in loans. I haven't needed to in the past, because I got recovery from the lender itself."
Subprime lenders were hard hit by falling stock prices last year, and have less equity on hand to settle suits.