Alison Frankel

If the Securities and Exchange Commission were an ordinary investor, it would already be too late in trying to sue the banks that issued (allegedly) deficient mortgage-backed securities.

The SEC is not, of course, an ordinary investor. On Wednesday night, the Wall Street Journal broke the news that the SEC plans to send Wells notices, otherwise known as target letters, to several banks that issued mortgage-backed notes and certificates. The Journal said the agency is looking at whether the banks misled investors about the quality of mortgage loan pools underlying securities issued in 2007 and 2008.

But here’s the thing: The first federal-court MBS class action, against Countrywide, was filed in 2007. By 2008, bond insurers and private investors were busily suing MBS issuers in state and federal courts in New York, starting the clock on the three-year statute of limitations for suits under the federal Securities Act of 1933 and the two-year time limit for fraud cases under the Exchange Act of 1934. Private investors who entertained thoughts of bringing federal claims for mortgage-backed notes issued in 2007 and 2008 would be tossed out of court quicker than you can say “time-barred.”

The SEC, in other words, is running at least three years behind the private securities bar when it comes to MBS litigation. I’ve heard, in fact, that the agency has recently been working with private lawyers to hone its MBS investigation. That makes sense: The list of plaintiffs’ firms that have sunk thousands of hours and millions of dollars into their MBS cases includes Quinn Emanuel Urquhart & Sullivan; Bernstein Litowitz Berger & Grossmann; Kasowitz Benson Torres & Friedman; Patterson Belknap Webb & Tyler; Cohen Milstein Sellers & Toll; Robbins Geller Rudman & Dowd and others.

The mystery is why the SEC has taken so long to see what’s been in front of its face. Remember, the agency spent years investigating Countrywide and its leadership. Weren’t mortgage-backed securities part of the investigation? Same thing with Fannie Mae and Freddie Mac, the two biggest players in mortgage securitization. The SEC began looking at Fannie and Freddie in 2008, and ultimately sued three top execs from each housing agency for allegedly misleading investors about subprime mortgage exposure. Surely someone at the SEC looked at the MBS portfolios Fannie and Freddie amassed — particularly because both agencies reached MBS settlements with Bank of America and GMAC’s Residential Capital in 2010.

Moreover, Fannie and Freddie’s conservator, the Federal Housing Finance Authority, gave the SEC a pretty good road map for MBS litigation with its 17-suit blitzkrieg last summer. (Interestingly, the FHFA may have its own time-limit problems with those cases.) Another arm of the federal government, the National Credit Union Agency, was one of the first MBS plaintiffs to wrest settlements from some of the banks that issued deficient securities. The Justice Department filed an MBS civil suit against Deutsche Bank last May. And the SEC itself warned MBS issuers about their obligation to disclose put-back claims back in October 2010. (The Financial Times reported last September that the SEC was investigating MBS disclosure failures — a pet peeve of the bond insurers’ trade association — but the Journal‘s story Wednesday suggests a broader SEC probe of securitizations.)

It can only help the monolines and private investors deep in MBS cases to be able to cite parallel SEC suits, but that’s small comfort to Joel Laitman of Cohen Milstein, an MBS litigation pioneer. A year ago, when Laitman was arguing at the U.S. Court of Appeals for the Second Circuit that credit rating agencies should be liable for blessing deficient mortgage-backed notes, Circuit Judge Jose Cabranes asked why the government hadn’t brought a case if the securitization industry was as corrupt as Laitman asserted. “I didn’t have an answer,” Laitman told me Thursday. “No one had an answer.”

Laitman, who lost the Second Circuit appeal, said it’s frustrating that only now has the SEC awakened to MBS abuses. “It’s so late to the game,” he told me. “There’s been a total absence for four years of any meaningful government response.” (An SEC spokesman declined comment, but pointed me to the agency’s “aggressive [record] on the credit crisis front.”)

I’ve been dubious about the new joint MBS task force, but Wells notices to banks means the SEC is serious about its investigation. That’s a good thing. I can’t help joining Laitman, though, in wondering how all of the private MBS cases of the last three years would have been different if the agency had acted sooner.

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I follow mortgage-backed securities litigation closely enough to be disgusted at the greed that fueled the securitization of insufficiently underwritten mortgages issued to homeowners who had no hope of paying them off. Sure, MBS investors and the bond insurers that backed MBS trusts were sophisticated and, to some extent, forewarned about the timebombs lurking in those mortgage pools. But you can’t read the voluminous MBS filings by monolines and investors — including the federal agency that oversees Fannie Mae and Freddie Mac — without wishing that someone be held accountable for sending the housing market on a slide, and dragging down the rest of the economy with it.

To date, accountability has been an elusive goal. I’m not talking about private suits or breach-of-contract put-back claims, in which MBS issuers are beginning to acknowledge billions of dollars of exposure to investors and insurers. But state and federal regulators and prosecutors have lagged behind the private plaintiffs bar (and the Federal Housing Finance Agency). As best I can tell, there have been no criminal prosecutions of people or institutions involved in mortgage-backed securitizations. On the civil side, the U.S. Attorney for the Southern District of New York, Preet Bharara, brought an MBS-based suit against Deutsche Bank last May. This summer, the New York Attorney General, Eric Schneiderman, filed Martin Act claims against Bank of New York Mellon for its conduct as Countrywide MBS securitization trustee. In October, the Delaware AG, Joseph Biden III, filed a civil suit against the Mortgage Electronic Registry System that accuses the banks that established MERS of using it as a vehicle to bundle mortgages they didn’t actually own. And last week, the Illinois AG, Lisa Madigan, sued Standard & Poor‘s for giving undeserved AAA ratings to overly risky mortgage-backed notes.

Those, however, are the only major government cases stemming from mortgage-backed securitizations that I’m aware of. For well over a year, the MBS industry has been under intense scrutiny by government investigators, from (among others) Congress, the Justice Department, the Securities and Exchange Commission, and the N.Y., Delaware, and Massachusetts AGs’ offices. So far, we haven’t seen a lot of tangible results from those investigations.

That’s why I’m skeptical that the new MBS fraud task force, introduced Friday at a press conference headlined by U.S. Attorney General Eric Holder, SEC Enforcement Director Robert Khuzami, and N.Y. AG Eric Schneiderman, is going to wreak vengeance on MBS wrongdoers.

Both Khuzami and Holder, in fact, emphasized what their lawyers have already done in probing financial fraud. “To be clear, investigations into RMBS offerings have been ongoing at the SEC. Along with experts across the agency, we have a specialized unit dedicated to the effort,” Khuzami’s press release said. “We already have issued scores of subpoenas, analyzed more than approximately 25 million pages of documents, dozens and dozens of witnesses, and worked with our industry experts to analyze the terms of these deals and the accuracy of the disclosures made to investors.” (Under Khuzami, the SEC has brought several actions against companies and banks that allegedly under-reported their exposure to subprime mortgages; and several more against banks and individuals that allegedly deceived investors in MBS derivatives.) Holder’s press release pointed to the securities, bank, and investment fraud cases the Justice Department has recently prosecuted, along with DOJ’s Fair Lending settlement with Countrywide parent Bank of America.

The benefits of creating an umbrella task force to oversee investigations already underway by state and federal regulators aren’t clear to me from the task force’s announcements. There will apparently be additional resources dedicated to MBS fraud. Holder said that there are now 15 DOJ lawyers, investigators, and analysts working on MBS matters. They will be supplemented right away with 10 FBI agents, and another 30 DOJ staffers will join the team “in the coming weeks.” Khuzami and the DOJ also said the task force will enhance coordination and streamline processes. “It will ensure that we pool the different capabilities, resources, legal theories and remedies that each of us bring to the effort,” Khuzami’s press release said.

Okay, streamlining is good. So is the apparent expansion of the state AGs’ mandate. “We have jurisdiction to go after every aspect of the mortgage bubble and the crash of the financial market,” Schneiderman said at the press conference, according to Housing Wire. (Here’s the AG’s press release.) “We have jurisdiction over every MBS issued over the last decade with Delaware and New York joining the group.” As if to underline that point, the task force announced that in recent days it has subpoenaed 11 financial institutions.

But the AGs, according to a DOJ spokesperson, won’t have any greater prosecutorial reach via the task force than they already have in their own states. “Membership in the RMBS Working Group will not empower state Attorneys General to enforce any statute that they could not otherwise enforce,” the DOJ told me in an email. “The Working Group and its federal and state co-chairs will coordinate investigations and make decisions about which office or offices should conduct various pieces of these investigations and which should be done jointly depending on the facts, the law and the jurisdiction.”

So when you put aside the press releases, what the MBS task force really adds to existing investigations is some additional DOJ manpower and better coordination among the various state and federal agencies.

There are clearly political benefits that come with the announcement of the new task force. It’s a gesture to critics who want to see MBS securitizers and trustees answer for their actions. Reuters has also obliquely suggested that membership in the MBS task force may persuade Schneiderman and other AGs who have voiced opposition to the Obama Administration-backed mortgage abuse settlement with top banks to support the proposed $25 billion deal.

I hope that’s not why the President called for an MBS task force. I hope the task force will, in some manner, tell the country whether it’s true that MBS issuers abandoned even their own lax underwriting standards, ignored warnings from inside and outside mortgage loan reviewers, and packaged deficient loans into doomed securities. I hope that even if regulators and prosecutors don’t bring cases, they tell us who got rich in the securitization business. I want everyone who lost money through their mutual fund or pension fund’s investment in MBS — and all the people whose mortgage lenders told them they could afford a loan they really couldn’t — to know those names.

That’s what I want. But I’m not holding my breath.

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Attention everyone who’s suing or planning to sue JPMorgan Chase, Bear Stearns, or Bear’s onetime mortgage unit EMC over mortgage-backed securities gone bad: Those indefatigable bond insurers are busy amassing whistleblower evidence for you. Last Friday, Patterson Belknap Webb & Tyler — which represents the monolines Syncora, Assured Guaranty, and Ambac in fraud and breach-of-contract suits stemming from EMC mortgages — began deposing witnesses from outside companies that evaluated the underlying loans in Bear’s mortgage-backed offerings. (The Nov. 18 amended complaint in Assured’s Manhattan federal court case against EMC and JPMorgan outlines the whistleblower assertions Patterson has come up with.)

The first deposition was of a former employee of Watterson Prime, a contractor that re-underwrote mortgages in EMC securitizations. The employee has claimed that Watterson simply rubber-stamped the loans; even mortgages that the contractor rejected, she has said, were nevertheless placed in MBS loan pools. Assured and the other monolines argue, of course, that they were deceived about the supposedly independent review of the underlying mortgage loan pools in the securities they agreed to insure. Whistleblower deposition testimony could be powerful evidence to support their arguments.

We only know about the whistleblower depositions because of a letter JPMorgan’s lawyers at Greenberg Traurig sent to Manhattan State Supreme Court Justice Charles Ramos, who is overseeing the Ambac case in state court, and to U.S. District Judge Paul Crotty, who’s presiding over Syncora’s Manhattan federal court case against EMC. (JPMorgan isn’t a defendant in that action.) The Jan. 18 letter identified the Watterson confidential witness by name, accused Patterson Belknap of “ambush litigation tactics,” and asked the judges to order Patterson to turn over a signed affidavit from her in advance of the Jan. 20 deposition. Greenberg also asked for affidavits from three other whistleblowers whose depositions have been scheduled. Despite a Jan. 19 Patterson letter claiming privilege for the whistleblower affidavits it has obtained, the monolines were ordered to turn over the witness statements.

A blogger named Teri Buhl got wind of the scuffle over the whistleblower affidavits and published a post accusing JPMorgan and Greenberg Traurig of attempting to intimidate the monolines’ whistleblower witnesses. The bank’s lawyers promptly responded with a letter to Crotty, complaining that Patterson Belknap was leaking non-public information. “We do object to plaintiff’s counsel’s repeated use of reporters such as this one to generate articles like this,” the letter said. “We would appreciate the court directing plaintiff’s counsel to refrain from this activity in the future.”

Patterson countered Greenberg’s assertion in a fiery Jan. 23 letter to Crotty. (All of the correspondence in the flap is here.) “[EMC's] letter falsely asserts that our firm disclosed non-public information to the press,” the Patterson response said. “That simply is not true.” Patterson pointed out that all of the factual information in Buhl’s post came from public-record documents — in a flap EMC itself precipitated when it disclosed the Watterson witness’s name in its demand for her affidavit.

Patterson also took the opportunity to needle EMC about the whistleblowers’ depositions: “EMC seeks to divert attention from the fact that the testimony the whistleblower gave on Friday (as well as testimony offered by a Georgia law enforcement officer on Saturday) confirmed the statements in the affidavits that EMC knowingly misrepresented in its due diligence process, which was fundamentally and deliberately deficient,” the Jan. 23 letter said.

Crotty — who still hasn’t issued the loss-causation summary judgment ruling that was expected by the end of last month — denied Greenberg’s request for a gag order on Tuesday, writing that “as to talking to the press about public judicial events, the parties should be guided by the code of conduct and related opinion on ethics, concerning good behavior of attorneys.”

I’ve reported that MBS suits against JPMorgan are suddenly in vogue. That trend continued this week with the 256-page complaint John Hancock’s lawyers at Grant & Eisenhofer filed in Manhattan State Supreme Court. The public record is already full of grist for the plaintiffs’ lawyers filing these suits, but deposition testimony from underwriting whistleblowers is going to be quite a significant addition to the record. Once again, the monolines are trailblazing for MBS investors.

I left a phone message for JPMorgan counsel Richard Edlin of Greenberg and sent an email request for comment to a bank spokesperson. Neither got back to me.

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Tuesday’s parallel rulings by Manhattan State Supreme Justice Eileen Bransten in MBIA and Syncora suits against Countrywide were a big win for the bond insurers. The judge concluded that MBIA and Syncora need only show that Countrywide materially misled them at the time they agreed to write insurance on Countrywide mortgage-backed notes, not that the alleged misrepresentations led directly to MBS defaults and subsequent insurance payouts. Bransten is considered a leading judge on MBS issues, so her grant of summary judgment on the insurance fraud and contract issues should be a boon to all of the monolines engaged in do-or-die litigation with MBS issuers.

But for MBS investors hoping Bransten would set a low bar for claims that Countrywide breached mortgage-backed securitization agreements, the rulings have to be considered a disappointment. Both Syncora’s lawyers at Debevoise & Plimpton and MBIA’s counsel at Quinn Emanuel Urquhart & Sullivan had moved for summary judgment on a baseline question: could they demand that Countrywide repurchase any underlying mortgage loan that materially breached the MBS issuer’s representations and warranties in securitization agreements?

If Bransten had agreed with the Syncora and MBIA interpretations of the agreements’ put-back clauses, the bond insurers would have had to show only that an underlying loan was deficient, not that the alleged deficiency contributed to the mortgage’s default — or, for that matter, that the underlying loan even was in default. The insurers wanted the judge to rule that as a matter of contract, Countrywide was required to repurchase every flawed mortgage in underlying pools.

Had Bransten adopted that reading of the contracts, she could have swung untold billions in MBS liability from investors to issuers. As you surely recall, the embattled BofA $8.5 billion settlement with Countrywide MBS investors was the result of put-back claims of an institutional investor group led by Black Rock and Pimco and represented by Gibbs & Bruns. The same investors have since asserted put-back claims against Morgan Stanley (based on notes with a face value of $6 billion) and JPMorgan Chase (based on $95 billion in MBS). Other investors, publicly and anonymously, have called upon MBS trustees to act on their put-back claims; most recently, U.S. Bank, as trustee in some Bear Stearns MBS trusts, filed a $95 million summons against JPMorgan Chase in New York state court. A ruling from a leading judge that set a low bar for put-backs would have given the investors asserting reps and warranties claims huge leverage over MBS issuers.

But Bransten denied the MBIA and Syncora summary judgment motions on Countrywide’s put-back liability. Specifically, she found that the securitization contracts were ambiguous on several points so the bond insurers’ contract-related claims couldn’t be decided on summary judgment. That doesn’t necessarily mean that after considering the two sides’ interpretations of the contract, as well as industry practice, an ultimate fact-finder won’t agree with Syncora and MBIA on put-backs; Bransten said, in fact, that MBIA had “posited a strong argument” for its view of one securitization contract. Moreover, MBIA and Syncora have alternate routes to the same recovery they’re claiming from alleged reps and warranties breaches.

Nevertheless, the implication of Bransten’s rulings is that put-backs will remain a loan-by-loan slugfest, at least until another judge considers the issue. That’s good news for BofA — which has signaled in regulatory filings that an adverse ruling on put-back loss causation would significantly change its reported liability — and for other MBS issuers as well. Bank disclosure of put-back liability has become a heated topic, and several banks beefed up disclosures in third-quarter 2011 filings. But MBS issuers escaped calamity thanks to Bransten’s refusal to endorse the bond insurers’ liberal reading of securitization agreements.

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