In his FundLaw news group, John Baker of Stradley Ronon discussed a recent federal bankruptcy court ruling that investors in TBA contracts do not have claims under the Securities Investor Protection Act of 1970 ("SIPA"). The vast majority of trading in mortgage-backed securities occurs in the TBA market, and the trading volume of the TBA market is second only to that of US Treasuries. A TBA contract is a bilateral agreement to buy or sell, on a delivery-versus-payment basis, "to-be-announced" mortgage backed securities. In these transactions, there is usually an interval of several weeks between the trade date and settlement date. At the trade date, the contract is binding and the key terms of the underlying securities are specified, however the mortgage-backed securities to be conveyed are not identified until 48 hours before the settlement date.
The court found that because TBA contracts are entered into on a delivery-versus-payment basis, the claimants did not meet the SIPA requirement of having "entrusted" cash or securities to a broker-dealer. The court also ruled that TBA contracts are not "securities" for purposes of SIPA.
Baker states that the "ruling places mutual funds that invest in mortgage-backed securities in an odd position." Although TBA contracts trade like securities and have a discernible market value, the ruling suggests that a TBA contract's value is entirely dependent on the solvency of the counterparty broker-dealer. The court's ruling could also hurt broker-dealers active in the TBA market, because the slightest doubt about a broker-dealer's solvency will cause customers to instantly be unwilling to deal with them.