August 2, 2018
My case heading to the warehouse involved the same thing by SunTrust Bank, and I could not help thinking, as I read about Wells Fargo and thought about other cases that came before it, that our work on SunTrust had not entirely gone to waste. Sure, I'd rather have had a piece of a billion-dollar settlement. But this is still a tale worth the telling.
The go-go mortgage days were well portrayed in the movie The Big Short. We knew the end was near when a stripper told Steve Carrell's character that she had bought several expensive condos on borrowed money, even though she made barely enough to buy clothes. Under the delusion that real estate is a safe investment that always goes up in value, investors were pouring trillions of dollars into mortgage-backed securities. Investment banks were making a ton of money selling MBSs, and they demanded a flood of mortgages to create them. That voracious appetite for mortgages is how it all started.
The Federal National Mortgage Association -- FNMA -- had long been in the business of buying mortgages from banks and packaging them into MBSs. But in 2006 or so, FNMA was facing stiff competition from all the big investment banks who were then also creating MBSs. So, FNMA created a special mortgage that, if the property was valuable enough, allowed borrowers to say they earned or were worth whatever they wanted, no questions asked. They'd get a mortgage that FNMA would consider "prime."
Sounds crazy, doesn't it? That's what the SEC thought too. After the market crashed, it sued FNMA's president Daniel Mudd and others for misrepresenting FNMA's risk of mortgage defaults in its filed financial statements. We cribbed the SEC's case against Mudd in filing an SEC whistleblower complaint in 2012. Our client asserted that SunTrust's mortgage company had partnered with FNMA to generate these no-verification mortgages, calling them "Agency Shortcuts," and sold them to FNMA as prime mortgages even though they were subprime at best. If FNMA was guilty of securities fraud for misrepresenting the quality of the mortgages it bought, then SunTrust was equally guilty for misrepresenting the quality of the mortgages it sold. It seemed pretty straightforward. Our case got a lot of attention. We submitted hundreds of pages of documents. We updated our presentation several times. We had meetings with SEC enforcement staff. Gretchen Morgenson twice wrote about it in The New York Times:
The Department of Justice requested a copy of our material. Soon, SunTrust's filed financial statements bore a footnote to the effect that it was cooperating with a DOJ investigation of its loan origination practices. Then, various cases began to appear against other players in the MBS game. Countrywide Financial Corp. was sued for bank fraud because it adopted a program -- the "high-speed swim lane," or "HSSL" (you truly can't make this stuff up) -- that it should have known would degrade the quality of mortgages it sold to FNMA as "prime". Later, the SEC and DOJ sued Bank of America for scheming to do the same thing, through another program called "PaperSaver." The arguments in those cases were the same as those we had raised against SunTrust. Agency Shortcut, HSSL and PaperSaver were all the same gimmick: Dispense with income and asset verification, just call it a prime mortgage, and fast-track that mortgage into an MBS pool.
In fact, some of the language used against Bank of America could have been cut and pasted from our whistleblower submissions. And small wonder: The same SEC staff that we had dealt with prosecuted the case against Bank of America! I was flattered. But then, after settling the Bank of America case in 2014, the SEC closed the SunTrust investigation. To say I was disappointed is an understatement, but so it goes.
Now, four years later, Wells Fargo agreed to pay $2 billion for having originated billions of dollars of subprime mortgages that it sold, through MBSs, as prime. It's the same old thing! Why is Wells Fargo different from SunTrust? One detail gives a clue. Wells Fargo found wide disparities between the incomes stated in a random sample of its mortgage applications and accurate data from the IRS. Therefore, Wells Fargo knew that its "prime" mortgages were no such thing. They were trapped by what their own analysis showed them.
SunTrust didn't do that kind of analysis -- because it couldn't. Agency Shortcut borrowers didn't have to provide a Form 4506T, the IRS document SunTrust needed to get tax data. SunTrust couldn't "know" that fraud origination was taking place because FNMA didn't require it to get the form it would have needed to figure it out!
Make of all this what you will. To me, this is a lesson in how things are interconnected. Fraud itself -- that sin that Dante thought deserved placement in the eighth out of nine circles in hell because only a human being could commit it -- is seldom a solo act. Only a network of co-actors can pull off a big fraud like the residential mortgage scam. Everyone involved acted in their own self-interest playing by rules imposed by another player in the game. When it all went wrong, mortgage originators blamed their issuing banks, who blamed FNMA and the investment banks, who blamed the rating agencies, who blamed the originators. How very convenient. And the investors whose voracious appetite for high-yield, low-risk investments started it all? They could blame everyone, I suppose. But they should start with the guys in the mirror.
ABOUT THE AUTHOR
Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice
380 Lexington Avenue
New York, NY 10168
Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters. Mr. Frumento has also represented clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents.
Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.
He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.
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