Another one of Schneiderman's warmed-over securities fraud cases which haven’t delivered major payouts

Continuing on the theme of prosecutions for fraud during the housing collapse, though in this case civil rather than criminal ones, New York Attorney General Eric Schneiderman just announced a new lawsuit against Credit Suisse for defrauding investors in its mortgage backed securities business. The case mirrors the previous suit filed by Schneiderman against JPMorgan Chase over Bear Stearns’ MBS business. Curiously, both of these banks engaged in settlements just this past week with the SEC over precisely the same conduct, settlements where they didn’t have to admit wrongdoing. Here’s what I wrote about that at the time:

So in one part of New York, you have the Attorney General pursuing a securities fraud case, and in another part, you have the SEC settling for pennies on the dollar. And Khuzami sits on the same financial fraud task force that Schneiderman said was the “aegis” under which he brought the Bear Stearns case! This comes incredibly close to undermining the NY AG’s case. DoJ, incidentally, didn’t bring follow-on charges in the Schneiderman suit, and now that the federal government’s main securities fraud regulator has settled, it’s doubtful they ever will.

The Credit Suisse complaint is merely the second half of the two cases the SEC settled, then, and the New York AG is using his authority under the state’s Martin Act, the securities law for New York, to add on with his own attempt at restitution for investors.

In the complaint, which again Schneiderman claims was conducted as part of the RMBS working group, even though he said he started it before the working group came into being in 2011, New York State alleged that Credit Suisse systematically misrepresented to investors about the quality of the loans in their mortgage backed securities deals. Credit Suisse claimed that they “had a careful and rigorous due diligence process when they sold mortgage backed securities to investors,” Schneiderman said on a conference call announcing the complaint. But “that was false, they had no effective way of evaluating loans.” Further, Schneiderman alleges that, based on internal documents, emails and testimony from former employees, Credit Suisse was more focused on their relationship to the originators generating the loans than their duty to inform investors about the product. A group called “The Conduit” inside Credit Suisse basically overruled any complaints internally about the bad loans, and told traders they had to put up with them so they could keep getting more loans from the originators. As there was competition with other Wall Street firms for the loans, keeping good relationships with the originators to get their hands on more of them was paramount. In addition, Credit Suisse obtained settlements with originators on defective loans without passing the money into the hands of the investors.

Like the JPMorgan/Bear Stearns case, this is a “platform case,” focused on the entire course of conduct by Credit Suisse rather than one or two individual deals. Yet the lawsuit borrows heavily from prior cases from private litigants that did sue Credit Suisse over individual deals. Schneiderman said that his office reviewed the other cases from private litigants and “would not duplicate work and waste taxpayer money” by not borrowing from those suits in making their claims. The platform case, he further argued, does have greater value because it brings in a greater level of exposure. The total issuance of mortgage backed securities by Credit Suisse in 2006 and 2007, the years covered here, totals $93.8 billion, with over $11.2 billion in losses. The damages sought are unclear (the suit seeks “disgorgement” of all amounts gained as a result of the violations of law, as well as damages, restitution for investors and other “equitable relief”), but could conceivably approach those numbers.

Basically, it’s the same case as the JPM/Bear case: Credit Suisse deceived investors by claiming to evaluate the mortgages they pooled into securities, had a very limited pre-pooling and post-pooling evaulation system, ignored defects uncovered by that limited review, and failed to inform investors about those problems.

That said, the facts of this and the JPM/Bear case have been known for years, were present in other cases for years, and could have been prosecuted at any time in the two years that Schneiderman has held the AG post. “We proceeded as quickly as we possibly could,” Schneiderman said, saying he had to start the cases from the bottom up. However, the previous AG, Andrew Cuomo, had a cooperation agreement with the key third party due diligence specialist, Clayton Holdings, to collaborate on these cases. Schneiderman acknowledged this but said that they broadened the investigation out from what Cuomo started.

The fact that the SEC saw such potential in these cases that they settled them for a combined $400 million does not suggest that Schneiderman will be able to get much more. Clearly this was not the expectation when state and federal officials inaugurated the RMBS working group, designed explicitly to generate much more homeowner relief for the sins of the housing bubble and collapse than the foreclosure fraud settlement. Schneiderman claims there are more lawsuits to come. But if they’re all just these warmed-over securities fraud cases which haven’t delivered major payouts, the ultimate effect will be minimal to non-existent.

Finally, this represents another case from state and federal prosecutors that doesn’t implicate individuals in the engagement of fraud. “Credit Suisse” committed fraud and deception rather than individuals involved with Credit Suisse. Maybe the actions of the US Attorney in Florida today break this pattern, but to date, no criminal subpoenas have been filed in any of the RMBS working group cases. Schneiderman said there’s “still an opening” for such claims, including through the use of alternative statutes like FIRREA (which has a 10-year statute of limitations). But it would be hard to trust this very much, given past performance.