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Minimal Work To Indict For Securities Fraud In Real Estate Mortgage-Backed Securities

One of the excuses given by the media for the repulsive failure to charge anyone with crimes arising from the Great Crash is that the FBI is too busy fighting terrorism. That’s nonsense. As Yves Smith points out in her explanation of criminal violations of Sarbanes-Oxley, investigators are not starting from scratch. A lot of the work has already been done.

For example, as the Final Report [large .pdf] of the FCIC says, the underwriting firms knew in detail the statistical make-up of the sour loans they bought to put into real estate mortgage-backed securities. Most hired outside firms to examine a random selection of the loans proposed for the RMBS, and received reports showing, among other things, compliance with underwriting guidelines of the originators of the mortgages.

That means that all the work necessary for a solid criminal case like this one is sitting at the offices of the firms that did the due diligence, including Clayton Holdings, the firm that cooperated with the Financial Crisis Inquiry Commission, and figures prominently in its Final Report. Suppose you have a prosecutor and a couple of investigators and lawyers from the SEC. Here’s the work flow.

1. Get a report from one of the firms that follows real estate mortgage-backed securities (RMBS), showing the worst performers by name. All three of the rating services, Fitch, Moody’s and Standard and Poor produce these reports, and so does Clayton Holdings. Clayton Holding’s report is free, though a bit delayed.

2. Pick out the 20 worst performers, the Dogs, for which the statute of limitations hasn’t run. You don’t need an FBI agent, get your paralegal to do it.

3. Subpoena Clayton Holdings and the other due diligence firms to appear and bring with them their reports and all their files on the Dogs. The Final Report says that one or two underwriters did their own limited due diligence on the loan files. If they underwrote Dogs, subpoena all of their files, including their due diligence files. As with all subpoenas, demand production in searchable electronic form.

4. Get the SEC filings on the Dogs. These are available on-line, so you can easily search them for the disclosure or non-disclosure of the critical information.

5. Subpoena all documents related to the Dogs from the underwriters who used due diligence firms.

6. Compare the offering materials with the documents you now have. A quick review will tell you if there are issues beyond those in my simple criminal case.

7. Convene a grand jury in SDNY. As you can tell, we are now in imaginary land, because Preet Bhahara, the US Attorney there, thinks that the only kind of securities fraud worth prosecuting is insider trading. After all, that reduces income other Wall Streeters want to grab for themselves.

8. Subpoena people from the firms that underwrote the Dogs to the Grand Jury. You want the people who signed off on the SEC documents first. Question each of them in the following areas:

a) did you see the due diligence report?
b) why isn’t it in the offering materials?
c) which lawyers inside and outside the firm passed on the disclosure documents?
d) who is your supervisor, and did that person see the due diligence report, and up the chain
e) how much did you get paid the year of issuance?
f) other questions you can think up if you spend more than the 5 minutes I took to write this.

9. Subpoena the people whose names you got in response to 8, especially the lawyers. You know that one defense is going to be reliance on the advice of counsel. If the lawyers knew about the due diligence report and didn’t insist on disclosure, you may want to indict them for something like conspiracy, wire fraud, mail fraud, or securities fraud, or you may want to take other appropriate action. If they didn’t know about the due diligence report, then the defense will fail.

10. Write up indictments.

11. Tell the target they have one week to discuss plea bargains, because the statute of limitations is running quickly. You want higher-ups. Continue this until you aren’t getting anyone.

12. Indict the higher-ups. Don’t plead out. Go to trial. Bring in the investors to testify about their losses. Surely there are some pension plans or mutual funds. Get them to talk about the losses they incurred for workers and small investors. Ask them if they can point to some damaged individual. These witnesses put blood on the floor for the jury to contemplate as they deliberate.

It doesn’t take an army. It just takes courage. Or am I back in imaginary land?

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