Preliminary conclusions suggest that JPMorgan may have broken federal laws with its sale of mortgage securities

The civil division of the Justice Department has preliminarily concluded that JPMorgan broke federal laws in connection with its sale from 2005 to 2007 of subprime and Alt-A residential mortgage securities, and the bank is now under criminal investigation. Federal prosecutors are examining whether JPMorgan duped investors into buying troubled mortgage securities that later imploded.

The prosecutors are investigating whether JPMorgan put together the loans and mortgage-backed securities without ensuring that the investments met underwriting standards and whether JPMorgan ignored evidence of widespread flaws in many of the loans that were being pooled and sold to investors in that time period.

In this regard, the bank indicated that the investigators have requested information about JPMorgan’s origination and purchase of mortgages, and its packaging of debts into bonds. Investigators also asked for information regarding the “treatment of early payment defaults, potential breaches of securitization representations and warranties, reserves and due diligence in connection with securitizations,” it said.*

If criminal charges are brought, efforts to negotiate with the DOJ may be complicated by a 2003 settlement the bank had reached with the SEC in connection with its dealings with Enron, in which the bank apparently had earlier pledged to refrain from violating federal securities laws in future transactions (such as the bonds now at issue).

Some believe dual investigations are being used to prompt a resolution

However, Professor John Coffee, of Columbia Law School in New York, intimates that the Justice Department may not intend to pursue criminal indictment of the bank, but may be using the “dual investigations, civil and criminal, in order to maximize pressure for a global civil resolution.”

Originators might want to consider the relevance of these actions against the aggregators   

The actions by the regulatory authorities in investigating JPM Chase and other aggregators for a host of alleged transgressions (that often include direct breaches by these aggregators under agreements with third parties), should serve as a reminder to originators that they were making loans to the specifications of these aggregators.

For the most part, the loans were sold to the aggregators under separate contracts (with separate and perhaps different representations and covenants than those that were made by the aggregators to the GSE’s and investors under their contracts).

In a repurchase demand an originator might want to bear that distinction in mind when assessing its obligations to the aggregator in respect of such demand and, moreover might want to consider the impact of the investigations and (ongoing mortgage buyback litigations) in determining the terms and scope of a settlement with an aggregator.