After being formed to great fanfare in January 2012, the Residential Mortgage-Backed Securities Working Group, part of President Obama’s Financial Fraud Enforcement Task Force, stayed largely silent for eight months. No longer. With its October 1 filing of what could be a $87 billion lawsuit against Bear Stearns successor J.P, Morgan—as well as not-so-subtle hints of more lawsuits to come—the RMBS Working Group made its presence felt with a bang, not a whimper.
The lawsuit is unique among RMBS cases in that it does not focus on alleged misrepresentations or omissions made in connection with individual RMBS deals. Instead, the RMBS Working Group, acting through co-chair Eric Schneiderman, New York’s Attorney General, is taking on Bear Stearns’ entire RMBS business over a multi-year period. The complaint focuses on alleged defects in Bear Stearns’ due diligence process, accusing Bear Stearns of disregarding due diligence results showing the allegedly poor quality of the loans underlying its securitizations and of ignoring its own employees’ requests to correct perceived deficiencies in its due diligence process. The complaint also charges Bear Stearns with failing to comply with its stated post-closing obligations, including by not taking adequate steps to ensure that loan originators repurchased problematic loans from the RMBS trusts. Bear Stearns allegedly arranged side deals with the originators for confidential cash payments at a fraction of the contractual repurchase price, thus securing recovery for itself without passing it on to investors. The suit seeks a variety of remedies, including “restitution of all funds obtained from investors”—potentially all of the $87 billion in RMBS allegedly sold by Bear Stearns during the relevant period.
The lawsuit is also unique among RMBS cases because it takes advantage of the Martin Act, an enforcement tool available only to the New York Attorney General. Significantly, the Martin Act does not require any proof of scienter or fraudulent intent on the part of the defendant; instead, negligence on the part of the defendant is sufficient to impose liability. The Martin Act’s more liberal standard for liability and its lengthy statute of limitations—six years—makes New York a likely candidate for future lawsuits brought by the RMBS Working Group. The Attorney General signaled as much in the press release announcing the filing of the complaint, calling the Bear Stearns lawsuit a “workable template for future actions against issuers of residential mortgage-backed securities.” Some commentators have observed that while future civil lawsuits may be in the works, the Working Group’s reliance on the Martin Act suggests that criminal indictments against large issuers of RMBS, which carry a significantly higher burden of proof, may be few and far between.
Who the next target of the RMBS Working Group’s attention will be remains to be seen, but the Group’s leaders insist that more will be coming. Addressing the Group’s membership at the announcement of the Bear Stearns lawsuit, co-chair John Walsh, U.S. Attorney for the District of Colorado, stated that there was “much work on many investigations [that] remains to be done” and that there would be “more announcements from the Working Group in the coming months.” To date, the Working Group estimates that it has reviewed millions of pages of documents, read more than 50 deposition transcripts, and interviewed more than 40 “significant market participants.” The New York Times has also reported that a cooperation agreement with Clayton Holdings, a major due diligence firm responsible for evaluating mortgages in connection with several RMBS deals, resulted in production of documents and correspondence related to RMBS issuers’ purported awareness of major defects on loans they were securitizing. Attorney General Schneiderman refers to information from these sources in the Bear Stearns complaint and it is likely that future complaints will rely on these sources as well.
More information about the RMBS Working Group may be found here.