September 28, 2012 9:35 pm
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MBIA’s recent lawsuit accusing Bear Stearns of fraud involving a 2006 residential mortgage bond deal could benefit similar securitization cases, said three industry attorneys.
MBIA’s 14 September New York State court complaint against JPMorgan, which acquired Bear Stearns in 2008, alleges Bear intentionally deleted information in a due diligence report it gave to MBIA. The full report, including the allegedly deleted information, showed that one-third of a GMAC securitization’s 17,000 loans didn’t conform to underwriting standards.
As a result, MBIA has paid out USD 168m in claims on GMAC Mortgage Home Equity Loan Trust 2006-HE-4. In its complaint, the bond insurer argues that it never would have insured the securitization had it known the truth about the loans. MBIA is seeking to recover the payout amount plus other costs and punitive damages.
Out of the GMAC deal’s original balance of USD 1.16bn, USD 1.6m in total interest has been paid and USD 8m in principal paid down. The remaining balance has been written off, according to a source familiar.
MBIA obtained the original September 2006 report sent to Bear from Mortgage Data Management Corporation, as well as relevant emails, in the process of discovery against GMAC Mortgage in a 2010 case. The bond insurer then compared that report with what it received from Bear, and found the investment bank had removed 50 columns of information, which included the data showing how many loans didn’t conform to underwriting standards or applicable laws, according to the complaint.
“That’s always the danger when you give discovery to a law firm, they might use it against you in a different case,” said a second industry attorney. “That’s how the game is played. There’s a lot of interconnectedness in the RMBS world, so this kind of thing is bound to happen.”
While this case is most immediately relevant to other RMBS cases filed by bond insurers, “what it shows is that the issuer of the securities knew that the loans didn’t meet guidelines in a large portion,” said the first attorney. The attorney said he has reason to believe that this case is not an isolated instance.
If MBIA’s attorneys at Quinn Emanuel can prove their allegations of fraud, RMBS investors’ attorneys could use the discovery and precedent-setting rulings to pursue their own fraud claims regarding alleged misrepresentations or omissions of material fact in offering documents, the first attorney said.
Precedent and discovery in this case could also weigh in favor of claims based on violations of representations and warranties if an issuer rejected a demand to repurchase a defective loan, the first attorney said.
“That starts to look like bad faith, and that can open the door to additional penalties,” the first attorney said. “It shows that the RMBS machine was corrupt.”
No doubt JPMorgan’s attorneys will have their defenses, said a third industry attorney. The second attorney said there may have been reasons other than fraud for changing the MBIA document, although the first attorney said that idea seems unlikely.
Although there may not be widespread fraud in the industry, there will likely be some “bad actors,” the third attorney said.
“It’s one thing to be wrong and be liable, it’s another thing to have actual fraudsters running about your building doing things in furtherance of those fraudulent means,” the third attorney said.
The banks have huge RMBS exposure, the third attorney said. They have every incentive to resolve these cases before they reach potentially-unsympathetic juries and before judges make precedent-setting rulings against them, the third attorney said.
A spokesperson for JPMorgan didn’t return a request seeking comment. An MBIA spokesperson declined to comment.
If MBIA’s attorneys can prove their allegations in this case, it could lead to criminal fraud charges, the attorneys said. Only government attorneys can bring a criminal case, but they have been reluctant to do so thus far for a variety of reasons.
For one reason, said the second attorney — a former federal prosecutor who worked on the savings and loan cases — RMBS cases are harder for the public to understand than S&L failures and insider trading.
Also, a criminal fraud case comes with a higher burden of proof than does a civil case, said the third attorney. However, he said, “It does open the door for maybe an investigative body to rethink it.”
“If the regulators haven’t already looked at these allegations, they will look at them now,” said the former federal prosecutor.
The case is MBIA Insurance Corporation v. J.P. Morgan Securities LLC, case number 64676-2012.
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