Financial Firms Face Securities Fraud Lawsuits

Washington, DCBanks that were involved in mortgage-backed securities may continue to face lawsuits alleging securities fraud for the way they marketed their stocks and securities. The government is getting in on the fraud litigation, filing lawsuits of its own against financial firms that sold mortgage-backed securities to Fannie Mae and Freddie Mac.

The latest lawsuit was filed by the US Federal Housing Finance Agency (FHFA), which filed a lawsuit against 17 financial firms, including Bank of America, Goldman Sachs and JPMorgan Chase & Co. The lawsuit alleges the firms misrepresented the risks associated with their mortgage-backed securities when it sold the securities. According to The Globe and Mail (09/02/11), the lawsuit is expected to be worth tens of billions of dollars.

A similar lawsuit was filed against UBS AG in July 2011, and seeks unspecified damages. Fannie Mae and Freddie Mac reportedly lost more than $30 billion in mortgage-backed securities sold by UBS when the credit crisis hit.

Allegations against the financial firms in the latest lawsuit include that the firms did not perform due diligence when it sold the mortgages as securities and that they missed warning signs that borrowers were given mortgages higher than what the borrowers could afford. A report in The New York Times (09/02/11) notes that Fannie Mae and Freddie Mac purchased nearly $200 million in mortgage-backed securities from the firms named in the most recent lawsuit. The two mortgage firms have so far received $153 billion in bailouts, Time (09/02/11) reports.

Some banks responded to the lawsuit saying that Fannie Mae and Freddie Mac are sophisticated investors who should have known that there was risk involved in the securities and that the collapse of the market was not caused by fraud but by problems in the housing market.

But The New York Times notes that the lawsuit filings allege borrowers were approved for mortgages without proof of income or proof of creditworthiness, and banks took those loans and packaged them into securities.

According to DealBook (dealbook.nytimes.com; 09/06/11), the Fannie Mae and Freddie Mac lawsuit relies on provisions from The Securities Act of 1933, which allows claims against a company if the prospectus and registration statement contain an untrue statement of material fact or omit a material fact. This tactic means that the plaintiffs do not have to prove intent to defraud.