The mortgage litigation machine is now turning its attention towards RMBS issuers as investors allege fraud and misrepresentation by firms that sold off loans into securitization trusts, with a new putative class-action suit filed Thursday in New York against Goldman Sachs Group Inc. (GS: 67.74 -2.83%) and some of the firm’s individual directors. The case, filed in Southern District Court in New York on Dec. 11 by the San Diego-based law firm of Coughlin Stoia Geller Rudman & Robbins LLP, a well-known securities litigation firm, argues that Goldman made false statements or omitted key information regarding the nature of the mortgages it sold into 17 different trusts during 2007.
The lead plaintiff in the case is a pension fund administered by NECA-IBEW, an electrician’s labor union that purchased securities in the deals in question, and has since seen the value of investments plummet.
The case underscores the potential for growing litigation that centers on the role of issuers and disclosures made to investors, regarding loans that were often originated by monoline mortgage bankers and commercial banks and then sold to the issuing party for securitization; it also underscores the often complex relationships that exist between mortgage originators and participants in the secondary market.
In the Goldman case, NECA-IBEW alleges that Goldman misled investors on the underwriting standards used by various originators, including — who else? — Countrywide Financial; other claims center on the use of inflated appraisals by originating entities for the trusts. Many of the loans in the trusts named in the lawsuit are of the reduced-doc, no-doc, stated-income variety, which NECA-IBEW says are rife with fraud.
“The lenders or lenders’ agents knew that the borrowers either could not provide the required documentation or the borrowers refused to provide it,” the complaint read in part.
“The underwriting, quality control, and due diligence practices and policies utilized in connection with the approval and funding of the mortgage loans were so weak that borrowers were being extended loans based on stated income … with purported income amounts that could not possibly be reconciled with the jobs claims on the loan application or through a check of free “online” salary databases.”
A wave of litigation
For Coughlin Stoia et al, the law firm in San Diego, the case is the second such high-profile class-action suit brought against a secondary mortgage market issuer this year. In October, the firm also sued Citigroup Inc. (C: 7.70 +1.72%) and its mortgage units on behalf of a retirement fund managed by Ann Arbor, Michigan, under similar claims.
In the Goldman case, very few of the mortgages were actually originated by the Wall Street firm itself — instead, mortgages were either originated by companies including Countrywide Financial, American Mortgage Network, Fifth Third Mortgage, and Green Point and then sold to Goldman, or funneled to the issuer via conduit lending channels. Investors in both lawsuits against Citi and Goldman claim that weak quality control by issuers and rampant fraud by third-party brokers and borrowers misled investors as to what was being bought.
The cases also underscore just how far the mortgage securities mess reaches, even in the United States, where many of the firms purchasing AAA-rated mortgage securities were municipalities and pension funds.
Bank of America Corp. (BAC: 14.93 +0.13%) agreed to a settlement on Oct. 6 with fifteeen state attorneys general over claims of predatory lending by Countrywide, in a deal that will see the nation’s largest lender and servicer modify as many as 400,000 loans. That loan modification agreement led to a separate lawsuit from investors, alleging that Countrywide’s pooling and servicing agreements with investors did not permit mass-scale loan modifications unless Bank of America purchased each modified loan out of a securitized pool at par value.
While the claims are different across cases, it’s clear that investors aren’t taking the loss of their investments lying down. And legal experts that spoke with HousingWire have said, emphatically, to expect a wave of litigation surrounding secondary mortgage market contracts in the next year.
“Prosecutors will not be wanting for work, or lacking in class-action claims,” said one source, an attorney that asked not to be identified in this story.
It’s unclear what sort of liability Goldman, or likely other issuers as well, may face as a result of suits surrounding its issuance practices for RMBS deals. But experts have suggested that fraud in Alt-A loans originated during recent years is overwhelmingly common.
“Our data point to the likelihood that a significant number of the loans originated between 2002 and 2008 are ticking time bombs,” said Ann Fulmer, a vice president at fraud detection specialist Interthinx. “When they explode, the costs will be overwhelming.”
In October, Fulmer warned of an “ominous” outcome for existing mortgages. Despite tightened underwriting standards and low origination volumes, misrepresentation indicators for loans reviewed in 2007 averaged 22.54 percent of all loans from the top ten fraud-heavy states, she said.
An Interthinx study of applications originated in the last half of 2007 showed that over 42,000 — representing $11 billion — contained materially misstated borrower income. Potential misrepresentation rates are rising, as well, the company said, accounting for nearly 24 percent of loans reviewed in 2008. Fulmer said the rising incidence fo fraud, even in a down market, tends to reflect the desperation of sellers, over-mortgaged borrowers, commission-starved mortgage professionals as well as nouveau “investors” trying to cash in on foreclosed properties — and, of course, ever-present criminal profiteers.