New York AG files novel lawsuit over Bear Stearns conduct.
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New York State Attorney General filed a civil lawsuit earlier this month against JPMorgan Chase claiming that Bear Stearns—which was purchased by JPMorgan in 2008—fraudulently misrepresented the quality of the mortgage backed securities it sold to investors. It may serve as a new model for regulatory enforcement against banks involved in mortgage-backed securities before the financial crisis.
The complaint alleges that Bear Stearns “managed a fundamentally flawed due diligence process that often, and improperly, gave way to originators’ demands.” It claims that losses on the potentially problematic securities total as much as $22.5 billion to date.
New York’s lawsuit follows several other high-profile enforcement actions by individual agencies, but is unique in important ways. It is the “first legal action” taken collaboratively by the Residential Mortgage-Backed Securities (RMBS) Working Group, a state and federal task force created by the Obama Administration in January to investigate problems in the RMBS market and their relationship to the financial crisis. According to John Walsh, the United States Attorney for the District of Colorado and co-chair of the working group, the lawsuit is a result of collaboration among the New York Attorney General’s Office, the Justice Department, the SEC and the Federal Housing Finance Agency’s (FFHA) Office of Inspector General.
Further, this is the first RMBS lawsuit to allege wide-spread fraudulent business practices at a major bank. In contrast, the SEC’s $550 million settlement with Goldman Sachs in July focused on the bank’s misconduct with a particular financial product.
Moreover, the breadth of this action sets it apart from lawsuits filed by private parties, who can typically only seek a remedy for the actual securities they purchased. Still, JPMorgan argues that the new lawsuit is essentially the same as previous private actions and “rel[ies] on recycled claims already made by private plaintiffs.”
The complaint, which was filed in New York Supreme Court, is also distinctive because it makes use of the Martin Act, a New York law that gives the New York Attorney General wide-reaching power to issue subpoenas and question businesses in order to investigate financial fraud. It allows for both civil and criminal sanctions and, perhaps most importantly, does not require the Attorney General to show any intent to defraud. This sets a lower bar than most other financial fraud statutes, at both the state and federal level.
In response to the suit, JPMorgan noted that the allegations are “entirely about historic conduct” that “relates to Bear Stearns, which [JPMorgan] acquired over the course of a weekend at the behest of the U.S. government.” At the same time, JPMorgan promised to “continue to work with members of the president’s RMBS Working Group and … fully cooperat[e] with their inquiries.”
This case may provide a model for future government enforcement actions, as the Justice Department has called it a “template for future actions against issuers of residential mortgage-backed securities.” New York’s Attorney General Eric Schneiderman told a CNBC television program, “We are by no means singling JPMorgan out. We expect to bring action against a variety of institutions.” Future actions may mirror this lawsuit by focusing on the broad practices of a bank, using the Martin Act, and coordinating with a wide range of state and federal investigators.
Reports are already emerging of additional activity by the RMBS Working Group. Reuters has reported that, according to anonymous sources, Credit Suisse is being investigated by the Justice Department and the New York Attorney General for its involvement in securitization of mortgage-backed securities.
