A Labyrinthine Path to Justice
FBI, SEC Join Complex Probe of Housing Crisis
Thursday, February 14, 2008; Page D01
Congress approved an economic stimulus package. The Treasury Department pressed lenders to reset mortgage rates for millions of troubled homeowners. And New York's insurance regulator is attempting to bail out a critical sector of the industry.
But progressing more slowly is the work of investigators probing dozens of companies for fraud and insider trading in connection with the subprime mortgage crisis that set off the country's current economic woes.
FBI officials said yesterday that they are conducting criminal investigations of 16 companies, while their partners at the Securities and Exchange Commission are probing nearly two dozen more. Those federal investigations follow subpoenas from attorneys general in at least four states and class-action lawsuits that target home builders, lenders, credit-rating agencies and the banks that packaged groups of mortgages into securities.
"These are going to be complex investigations," FBI section chief Sharon E. Ormsby said in an interview. Policing mortgage and credit-related fraud is the "number one priority" of the FBI's financial crimes unit, she added.
FBI agents are working hand-in-hand with the SEC, which has enlisted 100 lawyers as part of its nationwide subprime mortgage working group and which has made criminal referrals to other government agencies. Legal experts say most probes are in early stages and that if the economic downturn continues, they could widen.
"This subprime-credit crisis is going to be vastly more expensive and vastly longer running from a legal perspective than [recent] accounting frauds," said James D. Wareham, head of litigation for the Paul Hastings law firm, which represents banks and home builders involved in the mortgage probes. "These are not easy cases to understand, but the money is so huge that people are going to want to get to the bottom of it."
Law enforcement officials have yet to roll out their first major case related to the downturn in the housing market. That could take some time, although civil and criminal investigators are sharing documents and interviewing witnesses at major Wall Street banks and mortgage lenders, according to lawyers involved in the probes.
The cases are challenging for the government because they concern complex accounting and business decisions and often are accompanied by loads of paperwork and trading records.
"We are devoting significant resources to this area and looking at a broad range of possible misconduct," said Cheryl J. Scarboro, an associate SEC enforcement director who leads the subprime working group.
On the criminal side, where prosecutors must meet a higher burden of proof to secure convictions, the government is looking for clear documentary evidence that bankers and lenders intended to run afoul of the rules, such as companies keeping two sets of books that conflict with each other, experts said.
Justice Department lawyers first must find insiders who understand mortgage loans and the ways in which they are bundled and sold.
"With every layer of complexity," said Leslie R. Caldwell, the former director of the Justice Department's Enron Task Force, "the case becomes less likely to be a criminal one" because the deals have been vetted by accountants and lawyers, giving banks a good-faith defense that they relied on paid advisers.
Instead, criminal investigators at the FBI are looking for the most blatant misconduct, such as executives at lenders, builders and investment banks unloading shares of stock in advance of bad news.
"Prosecutors are looking for discrete cases on which they can focus their ammunition," said Richard W. Grime, a defense lawyer at O'Melveny & Myers who used to work at the SEC. "You need a relatively simple story with an obvious bad guy."
Investigators are starting with their usual tack: trying to determine whether sky-high valuations and delayed announcements of big losses on mortgage investments were mistakes made by many bankers and lenders or part of a pattern of deceit intended to improve financial results.
"Are people trying to delay the bad news?" asked Susan G. Markel, chief accountant in the SEC's enforcement unit. "That's something that we are looking for . . . not just in subprime but in other contexts, too."
Pat Huddleston, a former SEC lawyer who now runs Investors' Watchdog, an Atlanta company that provides vetting services for investors, predicted that civil authorities would bring several accounting fraud cases alleging that brokerage firms inflated values on subprime loan packages or disguised their own losses on the bum investments.
"A significant area of concern is whether firms were using different models to price securities on their own books versus those of clients," said Doria Bachenheimer, assistant regional director in the SEC's New York office. "Is the bank giving itself better prices than it's giving its own clients?"
Huddleston added: "It is a story as old as the SEC -- corporations hiding the truth from investors in order to prop up their stock price."
In recent interviews, SEC officials have pointed to a few recent cases as a guide to how they might approach the spate of subprime probes, particularly the issue of how to value complicated securities and whether companies engaged in accounting tricks to move under-performing assets off their books.
Doral Financial, a Puerto Rican bank holding company, paid a $25 million penalty to the SEC two years ago after investigators alleged that the bank had improperly accounted for risky mortgage loans, unloaded the troubled investments through secret agreements with other companies and overvalued the portions of the investments that remained on its books.
Last year agency officials charged First BanCorp, another Puerto Rican holding company, with helping Doral unload the problem mortgages in exchange for $100 million. First BanCorp agreed to pay $8.5 million to resolve the charges but did not admit wrongdoing.
A third company, R&G Financial, yesterday settled SEC charges that it had inflated its profit by $180 million by improperly accounting for mortgage deals.