Wall Street firms coming under closer U.S., state scrutiny

McClatchy NewspapersMay 13, 2010 

WASHINGTON — The Wall Street investment banks at the center of the subprime mortgage meltdown face broadening state and federal inquiries into whether they duped investors into buying dicey mortgage securities or manipulated ratings agencies into bestowing investment grades on those faulty products.

The Justice Department and the Securities and Exchange Commission have expanded preliminary criminal inquiries into conduct by Goldman Sachs and Morgan Stanley to four other banks, a person who's familiar with the inquiry said Thursday, speaking on the condition of anonymity because of the sensitivity of the matter.

The agencies have requested information from JPMorgan Chase, Citigroup Inc., Deutsche Bank AG and UBS AG, and federal prosecutors have sought advice from Wall Street experts in complex securities to help unravel the banks' layered offshore deals, the person said.

Meanwhile, New York Attorney General Andrew Cuomo subpoenaed eight banks Wednesday to determine whether they'd deceived rating agencies into minimizing the securities' risks for investors, said a person knowledgeable about that inquiry, who's prohibited from discussing the matter publicly and therefore asked not to be identified. The rating agencies also are subjects of a Connecticut attorney general's suit accusing them of misleading investors and of federal inquiries into whether they engaged in deceptive practices.

Asked whether the rating agencies or the banks were at greater fault, the person familiar with the inquiry said that Cuomo's investigators are "looking at the entire process to see what went wrong and when."

Cuomo's office, which polices Wall Street under New York laws, is especially interested in the hiring by Goldman Sachs and other investment banks of key employees of major rating agencies who then helped to procure ratings, many of them of triple A stature, that attracted institutional investors. The agencies gave top ratings to hundreds of billions of dollars in securities, many of which later were downgraded to junk status.

Those subpoenaed are Merrill Lynch, now owned by Charlotte, N.C.-based Bank of America Corp.; Goldman Sachs; Morgan Stanley; Citigroup; the Swiss banks UBS and Credit Suisse; Germany-based Deutsche Bank and French bank Credit Agricole.

Last October, McClatchy reported that Moody's and its ratings competitors sold out investors by compromising their standards while garnering huge fees to rate complex securities deals.

The next month, McClatchy reported that Goldman began unloading tens of billions of dollars in mortgage securities as early as December 2006 while its traders secretly bet on a housing downturn. Legal experts have said that the firm's failure to disclose its contrary bets to investors could be a violation of securities law.

The rapidly expanding investigations suggest a new determination among law enforcement agencies to hold accountable Wall Street executives and firms found to have engaged in illegal conduct that contributed significantly to the global financial crisis.

A spokesman for Goldman Sachs, named in a civil fraud suit by the Securities and Exchange Commission last month, declined to comment on either inquiry.

Spokesmen for two of the banks now facing a preliminary Justice Department inquiry — Citigroup and UBS — also declined to comment. Deutsche Bank didn't immediately respond to requests for comment.

Regarding Cuomo's inquiry, spokesman Bill Halldin of Bank of America/Merrill Lynch said the firm had received the subpoena and added: "We're cooperating with the attorney general's office."

Representatives of Citi, UBS and Credit Suisse said those firms also would cooperate by turning over subpoenaed documents to the New York attorney general. Morgan Stanley declined to comment. Credit Agricole couldn't be reached.

JPMorgan, also identified in state and federal inquiries, didn't respond to requests for comment.

The Wall Street Journal first reported the broadening of the preliminary Justice Department inquiry by the U.S. attorney in Manhattan, and The New York Times first reported Cuomo's New York state investigation.

Cuomo's inquiry is focusing on whether investment banks fraudulently manipulated the model that rating firms, including Moody's Investors Service, Standard & Poor's and Fitch Ratings, used to evaluate pools of mortgage securities, the knowledgeable person said.

Such manipulation could have created an "unlevel playing field" for the rating agencies and for investors, this person said.

The attorney general's office also wants to know whether investment banks hired away rating agency specialists who then assisted in obtaining investment-quality ratings from their former employers.

For example, Goldman hired a Fitch employee, Shin Yukawa, who helped assemble a bundle of securities known as Abacus-AC1 that's now the subject of the SEC suit against Goldman, according to the complaint. The SEC suit alleges that Goldman allowed a longtime client to stack the deal with highly risky mortgage securities and then to bet secretly on their default, reaping the investor $1 billion at the expense of two European banks.

Goldman and one of his vice presidents cited individually in the suit have denied wrongdoing.

It's unclear whether either investigation will lead to criminal indictments, requiring evidence that the companies or their investigators intended to mislead investors or others in a chain of profit extending from real estate agents to mortgage lenders, investment banks and rating agencies.

(Kevin G. Hall contributed to this story.)

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