Saturday, August 11, 2007
The fallout from the collapse of the subprime mortgage market has been spreading to hedge funds and financial firms that invested in various securities tied to mortgages, and when there's financial turmoil it has usually been the case that civil and even criminal actions are not too far behind. Reuters reports (here) that the SEC has begun looking at the pricing of securities tied to subprime mortgages, particularly collateralized debt obligations (CDOs), to see whether Wall Street investment banks have been valuing them properly. These firms, and the hedge funds they deal with, have to follow "mark-to-market" rules that require a fair valuation of the securities on a regular basis. Given the precipitous drop in the value of many mortgage-related CDOs over the past month there may be some undisclosed time bombs ticking away inside the financial statements of investment houses. While such investigations do not necessarily lead to criminal prosecutions, when the market heads south any number of questionable practices usually rise to the surface that can trigger the interest of the Department of Justice. Already, there is a federal criminal investigation of the lending practices of Beazer Homes, and state AGs have been looking at the mortgage program at subprime lender New Century Financial, which declared bankruptcy back in April 2007 -- almost a lifetime ago, it seems.
Perhaps an even better signal that governmental investigations are on the way -- kind of like the swallows returning to San Juan Capistrano -- is the formation of practice specialty groups at major law firms to "help" clients deal with the turmoil. A post on the Wall Street Journal Law Blog (here) notes that firms like Paul Hastings, Patterson Belknap, and Pillsbury Winthrop have assembled teams of lawyers to provide assistance, including members of the white collar crime departments. If the firms smell an opportunity, don't be surprised to see this area develop over the next few months with a range of internal investigations that may well bring criminal behavior to the surface. (ph)