As part of the RMBS Working Group, the U.S. Attorney’s Office for the District of New Jersey conducted a FIRREA investigation into misrepresentations made by Merrill Lynch to investors in 72 RMBS throughout 2006 and 2007. As the statement of facts describes, Merrill Lynch regularly told investors the loans it was securitizing were made to borrowers who were likely and able to repay their debts. Merrill Lynch made these representations even though it knew, based on the due diligence it had performed on samples of the loans, that a significant number of those loans had material underwriting and compliance defects - including as many as 55 percent in a single pool. In addition, Merrill Lynch rarely reviewed the unsampled loans to ensure that the defects observed in the samples were not present throughout the remainder of the pools. Merrill Lynch also disregarded its own due diligence and securitized loans that the due diligence vendors had identified as defective. This practice led one Merrill Lynch consultant to “wonder why we have due diligence performed” if Merrill Lynch was going to securitize the loans “regardless of issues.”
Disclaimer: I was privy to this having known several mortgage underwriters who identified this fraud, and despite reporting it with extensive documentation (which I personally collated and delivered via FedEx) to the SEC, DOJ, and OCC, were ignored.
"Fraud" can be civil fraud, or criminal fraud. Criminal fraud is something like "they said they were going to sell me something, but just took my money instead." Civil fraud might be something like "they sold me 10-inch sandwiches as 12-inch sandwiches."
What you're describing in the paragraph above is even one step removed from the sandwiches. Knowing that "loans had material underwriting and compliance defects" doesn't prove that Merrill Lynch lied when it said "the borrowers ... were likely and able to repay their debts." It might lead to an inference to that effect, but it's not indisputable proof. Likewise, the fact that it "rarely reviewed the unsampled loans to ensure that the defects observed in the samples were not present throughout the remainder of the pools" might lead to an inference of negligence, but is not indisputable proof of fraud.
Everything described in that paragraph is classic civil fraud and negligence, not criminal fraud.
> Criminal fraud is something like "they said they were going to sell me something, but just took my money instead." Civil fraud might be something like "they sold me 10-inch sandwiches as 12-inch sandwiches."
Is it purely a matter of partial delivery, or does magnitude matter? What if it's "they sold me 10 tons of gold as 12 tons of gold?" Because that's a big difference.
Then again, 10 inch sandwhiches sold as 12 inch sandwhiches allows you to save over 15% of materials, which if you're a nationwide chain could be quite a lot of money as well.
Civil fraud versus criminal fraud is very fuzzy. it often comes down to what you think you can prove about fraudulent intent. I gave the sandwich example because you can create “reasonable doubt” by saying the mistake was due to bad QA, rather than fraudulent intent. The fact that the sandwiches are shorter, by itself, does not prove fraudulent intent.
The mortgages are even harder. The banks are accused of lying about whether borrowers could pay. The fact they couldn’t pay doesn’t prove that. The fact that the banks ignored warning signs doesn’t prove that. The fact they knew about underwriting failures doesn’t prove that. Not beyond a reasonable doubt.
The author's theory is that Dimon is liable under SOX Section 906, because he certified that JP Morgan has "adequate internal controls" under SOX Section 404, but admitted that their controls need some work a month later.
But Section 404 is addressed to "internal control structure and procedures for financial reporting." I.e. do you have controls in place to address the Enron-style situation of people using creative accounting to cook the books. What Dimon was talking about, in the context of the London Whale, were risk management controls. The author tries to lump them together, but the statute clearly addresses accounting controls, not risk management controls. See 15 U.S.C. 7262(a). There's lots of different kinds of "controls" in a company. E.g. there are controls to make sure employees don't pay bribes in foreign countries so as to expose the company to FCPA liability. SOX only addresses controls in connection with financial reporting.
Even if you got past that hurdle, the article is wrong to suggest that you could bring a SOX 906 prosecution for violation of a SOX 404 requirement.
SOX 906 states:
> The statement required under subsection (a) shall certify that the periodic report containing the financial statements fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) and that information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer. That's the result of the Enron debacle, where the company and its auditors were misrepresenting the financial status of the company (revenues, liabilities, etc.).
Securities Exchange Act Sections 13(a) or 15(d) don't say anything about adequate internal controls. That's part of SOX Section 404. By the plain terms of the statute, Section 906 liability doesn't attach to misrepresentations directed to Section 404 requirements.
There is a separate certification provision that covers the Section 404 requirements, SOX Section 302.[1] But to bring a criminal action for violation of the Section 302 certification, you have to get a little creative, applying the other securities criminal statutes: http://dodd-frank.com/u-s-brings-criminal-charges-for-false-....
The problem is, those other criminal statutes are directed to protecting people who own or are considering buying JP Morgan stock, not people who bought financial products from JP Morgan. They're designed to prevent Dimon from misrepresenting JP Morgan's financial health to JP Morgan's investors, not to prevent JP Morgan employees from lying to transactional counterparties.
This article [1] states that the nature of the offense doesn't necessarily distinguish civil from criminal fraud, but rather the party pursuing the legal action:
> A single act of fraud can be prosecuted as a criminal fraud by prosecutors, and also as a civil action by the party that was the victim of the misrepresentation.
> It might lead to an inference to that effect, but it's not indisputable proof.
Again we're back to the lack of evidence not implying innocence if the supposed crime wasn't adequately investigated. That's what an investigation is for, to find and assemble evidence for a suspected crime.
Its a common belief that no serious effort to incriminate top bankers was initiated. To me it is beyond argument at this point. Do you still believe that is a questionable supposition?