Bank of America Corp. should face U.S. Securities and Exchange Commission claims over $855 million in mortgage-backed securities, said a judge who last week nudged the lender toward victory in a Justice Department suit over the same instruments by advising that it be thrown out.
Bank of America’s request to dismiss the SEC case should be denied because the regulator adequately laid out its claims that the bank didn’t disclose in offering papers that most of the pooled mortgages for the securities were bought wholesale from third-party brokers, U.S. Magistrate Judge David Cayer in Charlotte, North Carolina, said yesterday.
“The complaint alleges sufficient facts to establish that defendants negligently made material misrepresentations and omissions here,” Cayer said in a recommendation to U.S. District Judge Max O. Cogburn Jr., who will make the decision.
The divergent findings in the SEC and Justice Department cases, brought under different laws, come as the U.S. seeks to punish companies for wrongdoing that helped trigger the financial crisis. Investors lost out when the collapse of the U.S. housing market caused the value of related mortgage-backed securities to plummet even after they received high marks from credit-rating companies based on banks’ representations.
The SEC case alleges securities fraud. The Justice Department seeks to hold Bank of America liable under the Financial Institutions Reform, Recovery and Enforcement Act of 1989, or FIRREA, a previously little-used law stemming from the savings-and-loan crisis of the 1980s.
“The magistrate is obviously handling each case on its own merits,” said Jay Williams, a defense lawyer at Schiff Hardin LLP who represents financial institutions in civil cases and isn’t involved in the matter.
“These are different claims with different pleading requirements than the FIRREA claims that may be dismissed in the other case,” he said of the SEC fraud suit.
Cayer said in a March 27 recommendation that the suit under FIRREA, with a 10-year statute of limitations, should be thrown out because the claims weren’t properly supported.
FIRREA has become a tool for federal prosecutors bringing civil claims for alleged wrongdoing in the buildup to the 2008 financial crisis. The recommendation put the viability of using the legislation in such cases in doubt for the first time. It is being used in about a dozen such cases.
The magistrate judge’s findings in both cases will be reviewed by Cogburn. The bank or the government can appeal any order he issues.
“We are reviewing the magistrate judge’s recommendation carefully,” Lawrence Grayson, a spokesman for Charlotte-based Bank of America, said in an e-mail.
Both lawsuits seek penalties for a 2008 transaction in which Bank of America bundled about 1,200 jumbo adjustable-rate mortgages for sale in the secondary market.
About 70 percent of the mortgages were wholesale loans, a type of product the bank’s then-chief executive officer had called “toxic waste,” according to the SEC.
The bank in December 2007 told Wachovia Corp. and the Federal Home Loan Bank of San Francisco, which bought about 98 percent of the securities, that most of the mortgages were acquired wholesale, according to the recommendation. That wasn’t disclosed in the securities prospectus, it said.
In his recommendation to dismiss the FIRREA case, Cayer found that the government didn’t properly establish its claims that the bank, the second-biggest lender in the U.S., lied to the Federal Housing Finance Board.
Cayer said the government in that case failed to make a compelling argument that Bank of America’s alleged misstatements were “material.” The fraud statute on which it relied didn’t pertain to the purchase of securities, he said.
FIRREA allows the government to sue an individual or group, rather than charge it with a crime, for fraud that affects a federally insured financial institution.
In the SEC case, which alleged fraud over sales of securities, the magistrate judge concluded that the complaint lays out “sufficient facts to establish that defendants negligently made material misrepresentations and omissions here.”
“This decision merely determines that the claims have been sufficiently alleged and allows the claims to proceed,” Williams, the Schiff Hardin lawyer, said of yesterday’s recommendation. “It does not purport to suggest that they have merit or will prevail at the end of the day.”
The cases are Securities and Exchange Commission v. Bank of America Corp., 13-cv-00447, and U.S. v. Bank of America Corp., 13-cv-00446, U.S. District Court, Western District of North Carolina (Charlotte).