False information provided to a regulating body considering the division of bond insurer MBIA into two parts should invalidate the split, according to the attorney for the banks suing MBIA in a hearing Tuesday.

MBIA experienced major losses on MBS following the housing bust. It petitioned the New York State Insurance Department (NYSID) to allow it to split into two companies, with one of the companies focusing on insuring municipal bonds.

In February 2009, the NYSID approved the transformation. In June 2009, several banks sued MBIA and the department seeking to reverse the transformation, claiming the split reduced the value of their insurance.

For almost three years the Article 78 case has advanced through the submission of depositions of witnesses, relevant documents and other written material. This is one of two cases seeking to reverse the transformation.

Along with MBIA and its two subsidiaries, NYSID and Eric Dinallo, in his former capacity as department superintendent, are defendants.

Tuesday was the second day of trial for the case in New York Supreme Court, New York County.  In the morning Robert Giuffra Jr., attorney for the plaintiffs Bank of America and Societe Generale, started what he said would be a several day argument on the banks’ view of the transformation.

“In order to sustain this decision [to split MBIA] you have to find that all the information before [the New York Insurance Department] was accurate,” Giuffra told Judge Barbara Kapnick.

Giuffra acknowledged that one high standard for overturning an agency decision in New York under Article 78 was that the decision was “arbitrary and capricious.” But if the facts that the department based its decision on were wrong, than this standard does not apply, he said.

Giuffra, an attorney with Sullivan & Cromwell, cited several court decisions to support his position.

Giuffra also told Kapnick that when MBIA applied to NYSID be split, it hid the most up-to-date analysis by Lehman Brothers of projected commercial-mortgage-backed-securities losses at MBIA.

Also, Giuffra spoke of when the department put MBIA through a hypothetical stress test in the transformation application. The insurer’s $1.4 billion error in the deferring of assets allowed it to pass the test when it otherwise would have failed, he said.

Early Tuesday afternoon David Holgado, the attorney for NYSID and the superintendent, objected to Giuffra’s arguments. He noted that at an April 20 hearing the judge had said the case should focus on the facts that the department saw and ignore facts that it did not see.

The New York State Insurance Department’s Jack Buchmiller was the sole analyst who looked into the application to split MBIA, Giuffra told the court.

Buchmiller only spent one month full-time in early 2009 along with a little extra time in December 2008 looking at MBIA and considering the application, Giuffra said.

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