[authors: Jennifer Broda, Matthew Ferguson, Thomas Orofino, and Eric Scheiner]
This issue of the Credit Crunch Digest focuses on a class action against 12 banks alleging manipulation of the Libor rate; lawsuits, investigations and settlements involving Wells Fargo & Co., Credit Suisse AG, JP Morgan Chase & Co. and Bank of America; additional payouts made by Madoff trustee Irving Picard; bank stress testing under the Dodd-Frank Act; and an increased number of enforcement actions brought by the Commodity Futures Trading Commission.
Litigation and Regulatory Investigations
Fraud and Ponzi Schemes
Government and Regulatory Intervention
12 Banks Named in Class Action Lawsuit Alleging Fraudulent Manipulation of Libor Rate
In the first lawsuit filed by homeowners against banks arising out of the Libor scandal, a group of five borrowers are alleging that 12 banks fraudulently manipulated the lending rate, thereby increasing the payoff amounts for the subject mortgage loans. The banks named in the lawsuit include Bank of America, Barclays, Citigroup, JPMorgan Chase and UBS, among others.
Libor, the London Inter-Bank Offered Rate, is a calculation that measures inter-bank lending and establishes the average rate that a bank would pay to borrow money from another lending institution. When issuing a mortgage loan to a borrower, the banks will use the Libor rate as a benchmark that will be adjusted upwards to account for the amount of risk a particular borrower poses.
In the present lawsuit, the plaintiffs ask the court to certify the lawsuit as a class action in an effort to leverage the parties’ efforts against the defendant banks. The lawsuit alleges that the banks were unjustly enriched through rate manipulation, which allowed them to increase the payments being made by borrowers on adjustable rate loans based upon the Libor rate. The plaintiffs further allege that, as a result of the defendants’ harmful conduct, they suffered financial losses and loss of equity in their respective properties. In addition to compensatory damages, the class seeks a judicial decree permanently prohibiting the banks from rigging the Libor rate. The deadline for defendants to respond to the complaint is early November 2012. (“Banks Sued by U.S. Homeowners Over Rigging of Libor Benchmark,” Bloomberg BusinessWeek, October 15, 2012).
Litigation and Regulatory Investigations
Wells Fargo Sued by DOJ for Mortgage Fraud
U.S. prosecutors have filed a lawsuit alleging that mortgage originator Wells Fargo & Co. fraudulently submitted more than 6,000 problematic mortgages to a federal mortgage insurance program, which the bank knew were at extreme risk of default. The government alleges that Wells Fargo pocketed hundreds of millions of dollars in insurance payments from the Federal Housing Administration’s (FHA) Direct Endorsement Lender Program following the default on these mortgages and despite the bank’s awareness of the problem loans.
The FHA program allowed Wells Fargo and other originators to determine whether mortgages were eligible for the agency’s mortgage insurance program. Under the program, originators are required to report mortgage deficiencies or problems to the agency. The government contends that Wells Fargo, during the height of the housing bubble from 2001 to 2005, certified more than 100,000 mortgages. However, more than half of these mortgages were deficient. The Department of Justice (DOJ) and the U.S. Department of Housing allege that Wells Fargo’s staff churned out thousands of deficient mortgages without adequate underwriting training and provided bonuses for issuing such mortgages. Wells Fargo only began to self-report problem mortgages after the government found issues with the bank’s practices. Even still, Wells Fargo only reported approximately 238 as being problematic through 2010.
The DOJ is asserting claims under the False Claims Act and the Financial Institutions Reform, Recovery and Enforcement Act. Bank of America settled similar claims in February 2012 for $1 billion following a suit by the DOJ. ("US Hits Wells Fargo With FHA Mortgage Insurance Fraud Claims,” Law360, October 9, 2012).
Credit Suisse Probed by Federal and State Prosecutors Over MBS Sales
The U.S. Department of Justice and the New York Attorney General’s Office are investigating practices by Credit Suisse AG in connection with its sales of mortgage-backed securities (MBS). The investigation comes on the heels of the arrest of a former executive of the bank, Kareem Serageldin, who is charged with manipulating mortgage-linked bonds by inflating their value as a part of a $5.35 billion trading book called ABN1 in 2007.
The practices allegedly have cost the bank in excess of a half-billion dollars in damages. Serageldin, the former head of the Structured Credit Group at Credit Suisse, was charged in February 2012. Earlier this year, two of Serageldin’s former colleagues pled guilty to conspiracy for their role in the scheme. (“DOJ, Schneiderman Target Credit Suisse Over MBS: Report,” Law360.com, October 4, 2012).
JP Morgan Faces DOJ Suit Over Mortgage Securities Pool
The U.S. Department of Justice’s mortgage task force has filed its first lawsuit against a unit of JP Morgan Chase in connection with alleged widespread misconduct in the sales and packaging of mortgage-backed securities from 2005 to 2007. The suit targets Bear Sterns & Company, which was acquired by JP Morgan following its collapse in 2008. The complaint asserts that the lending unit made material misrepresentations about the quality of the pooled loans that were sold to investors. It also alleges that even when the loans began failing in large numbers, Bear Sterns did not insist that the originators buy the loans back, which originators were obligated to do. Rather, the originators were allowed to settle the repurchase claims by making cash payments for a small portion of the repurchase price.
The lawsuit, which challenges institution-wide practices rather than specific transactions, was brought in New York State Supreme Court by the New York State Attorney General, who serves as chair of the task force. The lawsuit was brought under New York’s Martin Act, which allows the Attorney General to bring fraud claims without having to prove scienter, or the intent to defraud. The suit seeks restitution for defrauded investors and disgorgement from the bank as a result of the fraud, but does not seek specific damages. (“JPMorgan Unit Is Sued Over Mortgage Securities Pools,” The New York Times, October 1, 2012).
BofA Faces DOJ $1 Billion Suit Alleging Mortgage Fraud
The U.S. Department of Justice filed a lawsuit against Bank of America (BofA) in the Southern District of New York alleging fraud with regard to the bank’s sale of defective mortgages. In the complaint, the DOJ alleges that the government firms of Fannie Mae and Freddie Mac purchased the mortgages, which have resulted in more than $1 billion in losses for taxpayers. However, the DOJ alleges that the loan program at issue was started by Countrywide Financial, but was continued by Bank America after it acquired Countrywide. The DOJ further alleges that the loan program was essentially designed to process loans at a high rate without checking the quality of the loans, which resulted in the generation of fraudulent and defective loans. Bank of America has denied the alleged wrongdoing. (“Bank of America Sued for Alleged Mortgage Fraud,” CNNMoney.com, October 25, 2012).
BofA Resolves Merrill-Related Suit for $2.43 Billion
Earlier this month, Bank of America (BofA) announced a $2.43 billion settlement of a securities lawsuit related to alleged misleading statements arising out of its 2008 acquisition of Merrill Lynch. BofA was accused by institutional plaintiffs of misleading shareholders about the health of Merrill Lynch at the time it was acquired, and specifically Merrill Lynch’s losses as the credit crunch deepened. BofA denied the allegations, but agreed to settle to resolve ongoing litigation uncertainty. The settlement was far larger than analysts had anticipated and represents the largest securities lawsuit settlement arising out of the credit crunch. It is reportedly surpassed in size only by settlements arising out of the Enron, WorldCom, Tyco and Cendant scandals.
The civil settlement may have an impact on other pending regulatory claims against BofA, in particular, the New York Attorney General’s lawsuit against BofA and its executives for misleading investors about Merrill Lynch’s losses. The securities settlement likely means that the attorney general can no longer seek to recover for shareholder losses, but may still seek a penalty against the bank. (“Bank of America Settles Suit Over Merrill for $2.43 Billion,” New York Times, September 28, 2012).
Fraud and Ponzi Schemes
The Check’s in The Mail: Additional Payouts Sent to Investors in the Madoff Ponzi Scheme
Irving H. Picard, liquidator for the Madoff investment firm, recently mailed out an additional $2.5 billion in checks to certain investors in the largest Ponzi scheme on record. This payment comes more than four years after Bernard L. Madoff was sentenced to prison for his involvement as mastermind of the fraudulent pyramid-style scheme. The average payment mailed to more than 1,200 defrauded investors with approved claims was approximately $2 million.
Uncertainty regarding when the next payment from the fund will occur has caused a run on sales and volatility in price of the distressed debt. While larger claims were trading at 67 cents on the dollar back in July 2012, the anticipation of the recent payment has pushed trading up on these claims to 70 cents. However, it is expected that claims to the Madoff funds will soon be trading at just above 30 cents on the dollar. This is in large part due to the fact that traders believe it could be years before another payment to investors is approved by the court.
Of the approximately $17.3 billion lost in the scheme, the liquidator has successfully recovered more than $9 billion, primarily through settlements. The recent $2.5 billion payment raises the total amount recovered by the burned investors to roughly $3.63 billion. Picard has indicated that the litigation has delayed further distributions. In the meantime, he is appealing certain court decisions that have limited the claims asserted against certain banks, including JP Morgan Chase & Co. (“Madoff Investors Get $2.5 Billion After Almost Four Years,” Bloomberg BusinessWeek, September 20, 2012).
Government and Regulatory Intervention
Final “Stress Test” Rule Released
On October 9, 2012, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC) announced the final rule regarding banking stress tests mandated under Section 165 of the Dodd-Frank Act. Under Dodd-Frank, federal banking regulators were tasked with creating a mechanism whereby federally regulated financial companies with total consolidated assets of more than $10 billion would conduct annual company-run stress tests. Under the published rule, regulated financial institutions with total consolidated assets of $50 billion or greater are required to begin conducting stress tests this year. These institutions are supposed to use financial data as of September 30, 2012, with results due in January of 2013. For regulated institutions with total consolidated assets between $10 billion and $50 billion, the final rule extends the time for compliance until October 2013. Financial regulators are expected to release specific stress testing scenarios and additional guidance next month. (“Large Bank Stress Test Final Rule Published by OCC, FDIC,” Compliance Week, October 9, 2012).
Commodities Futures Trading Commission Has Record Enforcement Year
Due in part to broader powers granted to the agency under the Dodd-Frank Act, the Commodities Futures Trading Commission (CFTC) brought a record number of enforcement actions during the 2012 fiscal year, which ended September 30, 2012. With 102 enforcement cases in the 2012 fiscal year, the CFTC is aggressively pursuing cases against some of the world’s largest financial institutions. Under Dodd-Frank, the agency was given the authority to police the swaps market. Additionally, Dodd-Frank also lowered the burden of proof the CFTC must show in market manipulation cases.
On October 5, 2012, the agency announced that it had levied $585 million in sanctions during the 2012 fiscal year. These sanctions arose out of such scandals as the collapse of MF Global and JP Morgan Chase’s multibillion-dollar trading loss that occurred earlier this year. Of the total $585 million, $200 million is attributable to a penalty the CFTC imposed on Barclays due, in part, to the bank’s role in manipulation of the Libor rate. With Congress seeking to cut the CFTC’s budget, it remains to be seen whether the agency will be as active or successful in recouping fines in 2013. (“Wall Street Regulator Ramps Up Enforcement,” NY Times Dealbook, October 5, 2012).