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BofA Sways Judge to Reconsider SEC Mortgage Lawsuit

Bank of America Corp. swayed a judge to rethink his tentative opinion that a U.S. Securities and Exchange Commission lawsuit over the issuance of $850 million in mortgage-backed securities should go forward.

The SEC claims the lender failed to file documents with the regulator that it gave potential investors in the securities, which later plummeted in value, obscuring the fact the buyers got false information. At a hearing yesterday in federal court in Asheville, North Carolina, lawyers for the bank argued that SEC rules governing such disclosures were unclear.

The bank “certainly made some points,” said U.S. District Judge Max O. Cogburn Jr. Cogburn told the lawyers that before the hearing he’d “been leaning toward” adopting a magistrate judge’s recommendation that the SEC’s case go forward, but that now he’d take “a look back.”

The SEC suit and a parallel case by the U.S. Justice Department over the same securities are part of a government bid to punish companies for actions the U.S. says helped trigger the financial collapse. The hearing comes as the Justice Department broke off negotiations with Bank of America earlier this week because it was dissatisfied with the lender’s offer to pay more than $12 billion to resolve separate government probes of the lender’s sale of mortgage-backed bonds before the crisis, a person familiar with the matter said.

Loan Tapes

The SEC’s claims related to so-called loan tapes, or preliminary documents about the mortgages that were provided to potential investors early in the process, Bank of America’s lawyer, Kenneth Bell of McGuireWoods LLP, said at the hearing.

The disclosure rules didn’t apply because the “reams and reams of papers” at the center of the case were given to investors before they said they would invest, Bell said. The SEC “is wrong on this” because the investors “hadn’t committed to buying the securities,” he said.

Kristin Wilhelm, the SEC’s lawyer, told Cogburn the bank was misinterpreting the rules, and that Bank of America was required to turn over all documents given to investors both before and after the investors decided to buy the securities.

Bank of America was supposed to “file all materials that are or have been provided,” Wilhelm said. “They never filed the information.”

Cayer’s Recommendations

Yesterday’s hearing was a chance for Cogburn to field objections to the non-binding recommendations of U.S. Magistrate Judge David S. Cayer in Charlotte, North Carolina, who found in March that the SEC’s case should continue and that the Justice Department’s lawsuit should be dismissed.

The Justice Department claimed the bank lied to the Federal Housing Finance Board -- a key element of a claim under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, which is cited in the case.

The lender and the government were both put in the position of praising one of the magistrate’s findings and criticizing another. Cogburn didn’t say when he would issue a final opinion, which either side will have a chance to appeal.

Charlotte-based Bank of America is accused in the SEC case of violating securities laws by hiding what it knew about the shaky future of the mortgages that backed the securities. The Justice Department says the government was a victim of fraud.

Bank of America failed to tell investors that more than 70 percent of the mortgages were from a wholesale channel of unaffiliated brokers, according to the U.S. Some were “PaperSaver” loans that didn’t require proof of borrowers’ income, the U.S. said. By the time the securities were being sold in early 2008, then-Chief Executive Officer Ken Lewis had referred to such loans as “toxic waste,” the U.S. said.

Less Risky

The SEC claims the bank misrepresented in loan documents “material facts about the underlying mortgages” and made them appear less risky.

The Justice Department took a different route using the same facts, seeking to hold the bank liable under Firrea, a previously little-used law stemming from the savings-and-loan crisis of the 1980s.

Bank of America’s CEO Brian T. Moynihan, seeking to move on from the housing-bubble fallout, has spent more than $50 billion to resolve claims related to shoddy mortgages, most tied to his predecessor’s 2008 purchase of Countrywide Financial Corp., once the biggest U.S. mortgage lender.

The lender has denied the claims in both government lawsuits, arguing the securities were sold to “sophisticated” financial institutions that haven’t sued over the deals.

Making a general comment about the allegations, Cogburn said yesterday that “people need to have full information about all this stuff.”

The case is U.S. v. Bank of America Corp. (BAC), 13-cv-00446, U.S. District Court, Western District of North Carolina (Charlotte).

To contact the reporter on this story: Erik Larson in New York at elarson4@bloomberg.net

To contact the editors responsible for this story: Andrew Dunn at adunn8@bloomberg.net Joe Schneider, Peter Blumberg

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