Sense on Cents

To this point in our economic crisis, Wall Street and Washington have utilized the ‘perfect storm’ excuse to cover themselves from investors’ cries of negligence, incompetence, and potentially corruption. Despite those cries, America has seen few, if any, credible and comprehensive legal complaints brought on behalf of investors. Select investor suits have largely been adjudicated on behalf of the defendants, those being Wall Street banks and brokers, under the mantle that sophisticated investors are responsible for all investment analysis and live with the consequences. Will Wall Street always be accorded the cover of ‘caveat emptor’? If so, then our markets are a much riskier proposition than most investors would appreciate.

I have been surprised to this point that more investors have not filed suit against Wall Street banks for willful and wanton misrepresentation of risks in the underwriting of an array of securities. Well, I am surprised no longer as a large mortgage investor, Cambridge Place Investment Management based in Concord, MA, recently dropped a napalm bomb on Wall Street. This bomb, a 234-page suit, filed in the Massachusetts courts, is comprehensive in addressing the violations of reps and warranties, underwriting standards, and other material facts in the entire mortgage securitization and distribution process on Wall Street.

Cambridge leaves no stone unturned in naming names, highlighting the failures and shortcomings of the entire business, and looking for compensatory damages. For those with even a passing interest in what transpired to bring our nations to its knees, this complaint is a must read.

The New York Times’ Gretchen Morgenson provided a nice review of the complaint the other day in writing, Mortgage Investors Turn to State Courts for Relief:

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 can’t 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 Sergeant Schultz defense 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 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.

What does the Cambridge complaint expose, and what does Morgenson’s article highlight? How about the following:

Interviews in the complaint with 63 confidential witnesses turned up such gems as Fremont Investment & Loan, which had been based in California, approving loans for pizza delivery men with reported monthly incomes of $6,000, and management at Long Beach Mortgage, also in California, directing underwriters to “approve, approve, approve.”

One Long Beach program made loans to self-employed borrowers based on three letters of reference from past employers. A former worker said some letters amounted to “So-and-so cuts my lawn and does a good job,” adding that the company made no attempt to verify the information, the complaint stated.

Such tales are hardly shockers. But they provide important context when Cambridge moves up the ladder to the banks that bundled and sold the loans.

This complaint may take a while to wend its way through the Massachusetts courts, but I would think a lot of investors in a lot of other states will be watching this case very closely. I would encourage individual investors to do likewise. As Morgenson concludes:

If trust in capital markets is to return, investors must be able to believe what they read in prospectuses. Without that minimum standard, how can Wall Street expect the markets to function again?

That statement is the very essense of sense on cents.

For those interested in the Cambridge complaint, please access it by clicking on the following image:

LD

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