Tag Archives: fraud

More Misrepresentations, More Litigation

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Judge Pfaelzer (C.D. Cal.) issued an order in American International Group Inc. v. Bank of America Corp., No. 2:11-CV-10549 (May 6, 2013), which allowed AIG to proceed with its claim that it was fraudulently induced to buy MBS by Countrywide (now a part of BoA). This case joins a long list of cases where judges have allowed fraud and misrepresentation allegations to proceed in the context of MBS issuances (for instance, here, here and here).  AIG claims that the deal documents for the MBS “fraudulently misrepresented and concealed the actual credit quality of the mortgages by providing false quantitative data about the loans, thus masking the true credit risk of AIG’s investments.” (5, quoting the Amended Complaint)

in allowing some of the claims to proceed, the Court notes that  AIG “plausibly alleges that the underwriting guidelines stated in the Offering Documents were false. The Amended Complaint describes a company-wide culture of abandonment of underwriting standards and wholesale use of ‘exceptions’ to the normal standards. This raises an inference, however strong, that the loans in AIG’s RMBS deviated from the underwriting standards.” (28, citations omitted)

Judge Pfaelzer notes that she has repeatedly issued similar rulings regarding Countrywide’s behavior in other cases, so this comes as no surprise.  But once all of these MBS cases alleging fraud misrepresentation are decided, it will be interesting to see just what the contours of this body of law will look like.  Clearly, issuers can’t avoid liability by means of general disclaimers in the offering documents.  Will they provide clearer, more explicit disclaimers and carve-outs in the hopes of  avoiding liability in future deals or will they ensure that future deals hew more closely to the deal documents?  Time will tell.

Servicing Fraud Claim Survives Motion To Dismiss

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Judge Gonzalez Rogers issued an opinion in Ellis v. J.P. Morgan Chase, No. 4:12-cv-03897-YGR (N.D. Cal. June 13, 2013) in which she denied a motion to dismiss a fraud claim in this class action lawsuit arising from Chase’s servicing business. The plaintiffs allege that “Chase engaged in fraudulent practices by charging marked-up or unnecessary fees in connection with Defendants’ home mortgage loan servicing businesses.” (1)

The opinion states that

Plaintiffs have alleged numerous instances where deficient information was provided and could have been revealed—namely, in the mortgage agreements themselves, in the mortgage statements reflecting the marked-up fees, or during communications with Chase where it told Plaintiffs that the fees were in accordance with their mortgage agreements.  Plaintiffs provide specific dates for statements in which they believe they were charged the marked-up fees, and allege they paid the fees without knowing their true nature.  Plaintiffs describe the content of the omission as the failure to inform them that the fees were marked-up and that the majority of the fees ultimately went to Chase, and not third-party vendors performing the services.  As discussed above, Plaintiffs have also sufficiently alleged that they did pay the marked-up fees. (36)

It continues,

Defendants allegedly demanded payment for fees that, in some cases, were never actually incurred. Moreover, Plaintiffs allege that false representations were made to borrowers when Chase told them that the fees were in accordance with their mortgage contracts—this is distinguishable from an omission. As alleged, the fraud is equally about the failure to disclose material information as it is that the amounts demanded on mortgage statements were false because they did not correspond to the actual amounts owed pursuant to the mortgage agreements relied upon by Defendants. Based on the alleged nature of the fraudulent scheme, the lack of an explicit “duty to disclose” is not dispositive in light of affirmative fraud that is also alleged. (37, citations omitted)

Denying the motion to dismiss this claim exposes servicers to great potential liability for their acts and omissions.

Borden and Reiss on Dearth of Prosecutions for Mortgage Misrepresentations

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We published Cleaning Up the Financial Crisis of 2008:  Prosecutorial Discretion or Prosecutorial Abdication? (paywall) today in the BNA Criminal Law Reporter.  (You can also get a copy on SSRN or BEPress).  It builds on things we have said here and here.  In short, we argue

When finance professionals play fast and loose, big problems result. Indeed, the 2008 Financial Crisis resulted from people in the real estate finance industry ignoring underwriting criteria for mortgages and structural finance products. That malfeasance filled the financial markets with mortgage-backed securities (MBS) that were worth a small fraction of the amount issuers represented to investors. It also loaded borrowers with liabilities that they never had a chance to satisfy.

Despite all the wrongdoing that caused the financial crisis, prosecutors have been slow to bring charges against individuals who originated bad loans, pooled bad mortgages, and sold bad MBS. Unfortunately, the lack of individual prosecutions signals to participants of the financial industry that wrongdoing not only will go unpunished but will likely even be rewarded financially. Without criminal liability, we risk a repeat of the type of conduct that brought us to the edge of financial ruin.

Seems straightforward to us, but many other lawyers seem to disagree, including the outgoing Assistant Attorney General in charge of the Criminal Division, Lanny Breuer.  He told the NY Times, “I understand and share the public’s outrage about the financial crisis. Of course we want to make these cases. … If there had been a case to make, we would have brought it. I would have wanted nothing more, but it doesn’t work that way.”  More interesting stuff in the article.

A Bransten Trio Join Judicial Chorus on Misrepresentation

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Justice Bransten, a judge in the Commercial Division of the N.Y. S. Supreme (trial) Court, issued three similar decisions last week denying motions to dismiss lawsuits by Allstate over its purchase of hundreds of millions of dollars of MBS. The net result is that various Deutsche Bank, BoA’s Merrill Lynch and Morgan Stanley entities must continue to face allegations of fraud relating to those purchases.

In the Deutsche Bank case, the court rejected “the notion that defendants are immunized from liability because the Offering Materials generally disclosed that the representations were based on information provided by the originators.”  (22)

The court also found that “defendants can be held liable for promoting the securities based upon the high ratings from the credit rating agencies, if, as alleged, thy knew the ratings were based on false information provided to the agencies.” (22)  Finally, the court found that “Defendants’ occasional disclaimers cannot be invoked to excuse the wholesale abandonment of underwriting standards and practices.”  (24-25)

Justice Bransten joins a growing chorus of judges who reject the notion that vague disclosures can protect parties who engage in rampant misrepresentation.  One wonders how this body of law will impact the behavior of Wall Street firms during the next boom.

 

Asset Quality Misrepresentation in RMBS Market

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Piskorski, Seru & Witkin have posted Asset Quality Misrepresentation by Financial Intermediaries:  Evidence from RMBS Market, in which they “identify misrepresentations by comparing the characteristics of mortgages in the pool that were disclosed to the investors at the time of sale with actual characteristics of these loans at the same time and show that such misrepresentations constitute a significant proportion of the loans.” (2) In particular, they

identify two, relatively easy-to-quantify, dimensions of asset quality misrepresentation by intermediaries during the sale of mortgages. The first misrepresentation concerns loans that are reported as being collateralized by owner-occupied properties when in fact these properties were owned by borrowers with a different primary residence (e.g., a property acquired as an investment or as a second home). The second form of misrepresentation concerns loans that are reported as having no other lien when in fact the properties backing the first (senior) mortgage were also financed with a simultaneously originated closed-end second (junior) mortgage. (3)

The paper has some extraordinary findings:

  • there “are instances where, in the process of contractual disclosure by the sellers, buyers received false information on the characteristics of assets.” (2)
  • “loans with misrepresented borrower occupancy status have about a 9.4% higher likelihood of default (90 days past due on payments during the first two years since origination), compared with loans with similar characteristics and where the property was truthfully reported as being the primary residence of the borrower.” (3-4)
  • “loans with a misrepresented higher lien . . . have about a 10.1% higher likelihood of default . . ..” (4)
  • lenders were “aware of the presence of second liens, and hence their misreporting likely occurs later in the supply chain.” (5)

The conclude that these “results suggest that RMBS investors had to bear a higher risk than they might have perceived based on the contractual disclosure.” (4)

SEC Complaint on Improper Trading of MBS — Much Ado?

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Floyd Norris, the only journalist to whom I have written fan mail (sorry Gretchen, you’re next), has another interesting column about a case that the SEC has brought against an MBS trader, Jesse Litvak.  The complaint alleges that

On numerous occasions from 2009 to 2011, Litvak lied to, or otherwise misled, customers about the price at which his firm had bought the MBS and the amount of his firm’s compensation for arranging the trades. On some occasions, Litvak also misled the customer into believing that he was arranging a MBS trade between customers, when Litvak really was selling the MBS out of Jefferies’ inventory. Litvak’s misconduct misled customers about the market price for the MBS, and, thus, about the transaction they were agreeing to. Litvak also misled customers about whether they were getting the best price for their MBS trades and how much money they were paying in compensation. MBS are generally illiquid and discovering a market price for them is difficult. Participants trading in the MBS market must rely on informal sources, including their broker, for this information.(1-2)

Norris is right to highlight what this case can reveal about the lack of transparency in the trading of MBS, a lack of transparency that does not exist in many other major secondary markets for securities.

But I was struck by how little is at stake in this SEC case.  The complaint alleges that the misconduct occurred in 25 (count ’em, 25!) trades from 2009 through 2011 (7) and that Litvak’s behavior “generated over $2.7 million in additional revenue for his firm.”  (2)  Not for him personally, mind you, but for his firm!  He, of course, should be punished if the allegations prove to be true.  And yet . . ..

Time after time, the government brings cases against mid-level players somehow involved in the financial crisis.  Time after time, people wonder why these are the best cases that can be brought.  My earlier thoughts about this can be found here and here.  Is it possible that even the SEC lacks the resources to investigate the massively document intensive cases that would get to the heart of the matter?

 

Further Thoughts on Prosecutorial Abdication

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I was discussing Prosecutorial Abdication with a friend who used to work in a prosecutorial office.  While she agreed with what Brad and I had written, she also highlighted the technical and training challenges that prosecutors face in putting together an effective investigation.

Where an insider trading or corporate fraud case might be very difficult and involve tens of thousands of emails, it usually only involves a few key people.  As a result, it is easier to get a handle on the case.  In contrast, she noted, a securities fraud case based on even a single mortgage-backed security involves thousands of mortgages originated by many different lenders.  Numerous different hands touch those files at origination as well as during the securitization process.  On top of that, many of the key documents are missing or at least their chain of custody is uncertain.

The net result, according to her, is that building such a case can be exponentially harder than building an insider trading case.  This is particularly true because many prosecutor offices will not have the sophisticated software (Excel is not enough!) to track all of the relevant data nor the training (forensic accounting skills would be nice) to do an effective job. Let’s see what the Financial Fraud Enforcement Task Force can do with the resources made available to it . . ..