August 11, 2007
Will Subprime Become the Next Source for White Collar Crime?
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)
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One of the problems with the mark-to-market situation might be that nobody is willing to buy the CDOs; as such, they (basically) can't be priced, but they aren't worthless...this could continue for awhile (until firms finally fess up to the extent of losses and fear of the unknown subsides). As for criminal liability, I am sure ignorance is not a crime, but rather a breach of fiduciary duty. As such, I think any criminal issues (if there are any) will be few. Another issue is regulation. As history has shown us, over regulation blunts growth. Furthermore, it is (basically) the governments and their loose interest rate policies that led to this situation. Why would we want to look to the source of this problem for salvation. Companies, people, and governments need to accept the fact that they messed up, take their losses, and move on. As for the plaintiffs, I am sure they are swarming, as there is blood in the water. The lawsuits will drain additional dollars from the markets, force companies to layoff workers, file bankruptcy, or settle...of course, 30% will go to the plaintiff, while the actual victims receieves pennies on the dollar (if they are lucky).
Posted by: David | Aug 14, 2007 3:29:59 PM