Feds hasten financial crisis probes amid election year
NEW YORK, Feb 3 (IFR) - Election-year pressures to deflect the anger of the "99%" -- and a race against time to bring charges before statutes of limitations on crisis-era residential mortgage-backed securities (RMBS) and collateralized debt obligations (CDOs) run out -- are spurring the U.S. government to push ahead with RMBS law enforcement and private investors to pursue litigation, according to people close to the probes.
A surprise criminal indictment by the U.S. this week of three former Credit Suisse traders raised eyebrows across the legal community, both for its proximity to the formation of an Obama-administration federal RMBS fraud task force a week ago and the case's strikingly easy targets: alleged rogue traders. The traders are charged with artificially boosting the prices of battered RMBS in 2007 to earn higher bonuses.
Given two of the traders' plea agreements, this may be the first successful criminal indictment stemming from the financial crisis.
But the case also may foreshadow the fact that federal investigations are likely to focus far more heavily on actions taken by banks and ratings agencies to cover up their mistakes as the market was imploding in 2007 and 2008, rather than on the original assembly of toxic securities in the years prior, according to people familiar with the investigations.
This is partially due to the fact that statutes of limitation are expiring on the creation of the securities.
The DOJ and SEC civil probes into Standard & Poor's, for example, focus far more heavily on the steps the agency took to address the crisis in 2007, rather than on the initial assignment of Triple A ratings in 2005 or 2006, insiders say, which was initially thought to be central to the investigation.
Still, the timing of the Credit Suisse trader charges last week took some by surprise. The incident has been public knowledge for four years, and the Swiss bank, whose early-2008 write-down of US$2.85bn was partially due to the alleged fraud, fired the individuals at that time. The bank itself is not a target at all, and the US Department of Justice has been investigating the case since 2008.
In addition to the DOJ indictment, the SEC revealed its own parallel civil case this week -- which has also been in the works for years -- prompting experts to ask why the charges are being brought now.
"This is a strange prosecution to coincide with the Obama administration's RMBS Working Group. How fortuitous the timing is," said Isaac Gradman, an attorney who has brought legal action over mortgage bonds.
"What's more, this isn't really the typical fraud you'd expect to prosecute from the crisis. These are three rogue traders who defrauded their institution, and were disciplined by their institution back in 2008," he said. "The RMBS Working Group, on the other hand, pledged to look under every rock and down every avenue to go after the financial institutions that assembled toxic RMBS. That's not what this is."
While this rare criminal indictment may be hard for federal enforcers to repeat, there is bound to be an uptick in civil and criminal charges related to the financial crisis in 2012, experts say.
Last Friday, the DOJ issued civil subpoenas to 11 financial institutions as part of the RMBS Working Group's pursuit of cases related to the sale of mortgage bonds and CDOs in the run-up to the crisis.
Although the SEC can only pursue cases where there are violations of civil laws, it is likely that they will refer several cases with possible criminal elements to the DOJ, insiders say.
TAKING ITS TOLL
There has also been acceleration in MBS litigation brought by bondholders or civil actions brought against banks by states due to the short statute of limitations.
"Given that most of the deals were created in New York, the conservative attorney will look at the state's six-year limitations period both for breach of contract and fraud. But every state is different," said another prominent structured finance litigation attorney who has represented investors. "These private civil RMBS lawsuits have only really exploded last year."
But statutes of limitation have become a thorny point of contention between plaintiffs'' attorneys representing competing groups of RMBS investors. There have recently been many creative attempts by various legal teams to get around the statutes, Gradman said.
Some lawyers try to take a more liberal approach, hoping to extend the timeline.
For instance, in the context of loan putbacks to banks, some attorneys take the view that each time an investor tries to enforce putback rights, and the bank refuses, a new breach of contract occurs, and the clock starts ticking anew on the statute of limitation. Others say that if an investor wants to initiate litigation, it should be done six years (in New York) from when the deals close.
Confusing the issue even more is the uptick in plaintiffs asking defendants to "toll" the statutes, which means that the parties agree to stop the clock temporarily on the statute of limitations so that they can possibly negotiate a settlement.
This "time out" has become much more common in private lawsuits, sources say, but can happen in both civil and criminal cases, as well as in federal or state-led probes.
Since plaintiffs may be running out of time to bring their cases, defendants are typically eager to "toll the statute", or stop the clock, lest they be taken to court immediately. It buys them time to negotiate.
However, it's not always easy for lawyers to discover the existence of tolling agreements. One could assume that RMBS created in 2005 might be immune to prosecution at this point, but because of several tolling agreements in existence, the timeline has been suspended, and ultimately, extended.
What's more, as the timeline increases, the losses to investors increase as well. Therefore, knowledge of the existence of tolling agreements can affect how investors' attorneys size the losses taken on a bond.
However, it is impossible to toll a statute that is already expired.
THE FEDERAL ADVANTAGE
The statute of limitations for federal securities fraud, meanwhile, is typically five years, but at least part of the motivation for elevating the pursuit of RMBS fraud to the federal level with the formation of the RMBS Working Group was to take advantage of longer statutes of limitations.
Banks and other financial institutions have special protection under federal criminal laws: various types of bank fraud may have 10-year statutes of limitation, particularly if banks were affected by deceit, as Credit Suisse was.
While it's not clear whether the 10-year statute will apply to all of the Working Group's cases, federal authorities typically operate under US securities laws when engaging in enforcement, and are not encumbered by the same restrictions imposed under the state, lawyers said.
"The federal laws may have longer statutes of limitations than the state laws," said Robert Anello, a white collar defense attorney at Morvillo Abramowitz. "Either way, as statutes get closer, the government, as well as private investors, are going to pull the trigger this year."
(Reporting by Adam Tempkin)
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