Articles Posted in Mortgage-Backed Securities

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Recently, we published a blog entitled Former Jefferies & Co. Executive Charged with Defrauding Investors. It detailed a former executive of Jefferies & Co. and his fraudulent investment scheme centered on selling mortgage-backed securities with falsely inflated prices and fictional sellers. This case illustrates that investors far too often are kept in the dark about the true risks of investing. With regard to the Jefferies & Co.’s fraud, the victims had no reasonable way to determine the accurate prices of the mortgage-backed investments. This is not an isolated incident. It is a symptom of a larger problem. According to Marilyn Cohen, founder of Envision Capital Management Inc. in Los Angeles, “Wall Street’s mortgage investors remain largely at the mercy of middlemen, a decade after regulators forced brokers of other types of bonds to publish data electronically on a system called TRACE.” TRACE does not provide data on all types of securities, so investors are dependent on dealers who often mislead them on securities’ prices and quotes.

In 2002, FINRA started a program called Trade Reporting and Compliance Engine (TRACE). It is a system that provides online pricing data on corporate bond trading. The problem is that TRACE does not capture the entire bond market. According to Steve Joachim, FINRA’s executive vice president of transparency services, TRACE is currently starting to “provide trade data on government-backed mortgage bonds but, it’s still analyzing how to roll out the system in the $1 trillion market for so-called private label debt.”

Transparency is the key for investors and in the past, transparency has only increased trading and investor confidence. Joseph Fichera, CEO of a New York-based financial advisory firm echoed this in stating that, “in every other market we’ve seen since they’ve started bringing transparency, it has improved trading.” Fichera is also a supporter of expanding the TRACE system.

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On January 28, 2013, the SEC charged Jesse Litvak, a former executive of Jefferies & Co. a New York based broker-dealer, with defrauding investors in a mortgage-backed securities (MBS) investment scheme.

According to the SEC’s complaint, Litvak allegedly purchased MBS investments from some customers of Jefferies & Co. and subsequently sold the investments to other Jefferies & Co. customers at falsely inflated prices. Additionally, Litvak misled subsequent purchasers by creating fictional sellers. Remarkably, Jefferies & Co. kept the proceeds from the fraudulently scheme, approximately $2.7 million, and the firm also paid Litvak bonuses to reward his sales activity.

The MBS investments at issue are illiquid and difficult to price, thus making it especially important for brokers to provide accurate information. “Brokers must always tell their customers the truth, particularly in complex securities transactions in which it is difficult for investors to determine market prices on their own, said George Canellos, Deputy Director of the SEC’s Division of Enforcement. Litvak repeatedly lied to his customers and invented facts to bring additional profits into his firm and ultimately his own pocket at their expense.”

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Multiple class action and individual lawsuits filed by investors recently have been filed because of the precipitous collapse of Oppenheimer’s Champion Income Fund (OCHCX).

This bond fund was down approximately 82% in value at the end of 2008.  Other similar bond funds were down only approximately 30%.  This enormous difference can be attributed to the Oppenheimer Champion Income Fund investing heavily in mortgage related investments. 

Lawsuits that have been filed have alleged that the Oppenheimer fund prospectus failed to disclose the risks associated with the investments. In addition, the lawsuits have alleged that the mutual fund was marketed as a relatively safe income producing investment.

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Credit-rating firms, such as Moody’s Corp., McGraw-Hill Cos.’ Standard and Poor’s and Fimalac SA’s Fitch Ratings, are facing a multitude of lawsuits regarding their ratings of mortgage-backed securities, according to the Wall Street Journal. These lawsuits stem from investors’ losses in the securities due to homeowner defaults.

In response to the litigation, these credit-rating firms hope to be protected by the Constitution, specifically the First Amendment right to free speech. However, according to the Wall Street Journal, this protection is being questioned as a result of allegations that the credit-rating firms had conflicts of interest which prompted them to give “unduly rosy” opinions with regard to the credit-worthiness of mortgage-backed securities. A survey conducted by the Securities and Exchange Commission revealed that rating firms have put profits ahead of providing a quality rating for mortgage-backed securities.

Unfortunately, investors may have a tough time dealing with the credit-rating firms’ assertion of the free-speech right. Traditionally, the ratings that are provided by the firms, which designate a security on a scale from triple-A to junk, have been considered “opinion.”  Courts have held that rating firms are protected against claims that the firms issued ratings that were too high or low and have held that in order to usurp the Constitutional protection a litigant would have to show that the firm made false statements with “actual malice.” Showing that a firm acted with “actual malice” is a high burden.