If trust in capital markets is to return, investors must be able to believe due diligence has been conducted
by GRETCHEN MORGENSON 05:55 AM Jul 14, 2010
Investors who lost billions on boatloads of faulty mortgage securities have had a hard time holding Wall Street accountable for selling the things in the first place.
For the most part, banks have said they cannot be called out in court on any of this because they had no idea that so many of these loans went to people who lacked the resources to make even their first mortgage payment.
Wall Street firms were intimately involved in the financing, bundling and sales of these loans, so their defence rings hollow. They provided hundreds of millions of dollars in credit to dubious underwriters and some even had their own people on site at the loan factories. Many Wall Street firms owned mortgage lenders outright.
Because many of the worst lenders are now out of business, investors in search of recoveries have turned to the banks that packaged the loans into securities. But successfully arguing that Wall Street aided lenders in a fraud is tough under United States federal securities laws. This is largely a result of Supreme Court decisions barring investors from bringing federal securities fraud cases that accuse underwriters and other third parties as enablers.
Where there’s a will, however, there’s a way. And state courts are proving to be a more fruitful place for mortgage investors seeking redress, legal experts say.
Late last month, for example, Massachusetts Attorney-General Martha Coakley extracted US$102 million ($140 million) from Morgan Stanley in a case involving Morgan’s extensive financing of loans made by New Century, a notorious and now-defunct lender that was based in California.
Morgan packaged the loans into securities and sold them to clients, even after its due diligence uncovered problems with the underlying mortgages that New Century fed to the firm, Ms Coakley said. In settling the matter, Morgan neither admitted nor denied the allegations. The investigation is continuing.
On Friday, an investment management firm that lost US$1.2 billion in mortgage securities it bought for clients filed suit in Massachusetts state court against 15 banks, accusing them of abetting a fraud.
The firm, Cambridge Place Investment Management of Concord, Massachusetts, purchased US$2 billion in mortgage securities from the banks and it says the banks misrepresented the risks in the underlying loans – both in prospectuses and sales pitches (see box).
The complaint says the banks misled Cambridge Place by maintaining that the mortgages in the securities it bought had met strict underwriting requirements related to the borrowers’ ability to repay the loans. Cambridge also contends it relied on the banks’ claims of having conducted due diligence to verify the quality of the loans bundled into the securities.
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