By Teri Buhl: Fallout from JP Morgan trading losses, which led to rater Fitch downgrading
their debt yesterday, aren’t the only financial worries the banking
behemoth is facing. Nestled in that shocking 10-Q filed Thursday is an
admission that their regulator, the Securities and Exchange Commission,
thinks some of the details that lead to the explosive Ambac mortgage security fraud suit
against the naughty stepchild of JPM, Bear Stearns/EMC, are worthy of
an enforcement action. Yep- the SEC is giving or finally gave them a
Wells Notice, which means according to their 10-Q (and their 10-K) in
January 2012 the SEC’s investigation into the sins of Bear’s Mortgage
team run by Tom Morano, Jeff Verschleiser, Mike Nierenberg and the subsequent cover up by JPM was worthy of a civil suit along with some penalties.
JPM’s 10-Q states “In January 2012, the Firm was advised by SEC staff
that they are considering recommending to the Commission that civil or
administrative actions be pursued arising out of two separate
investigations they have been conducting… In both investigations, the
Firm has submitted responses to the proposed actions.”
It’s black letter law
that Wells submissions to the SEC are discoverable in civil litigation.
So lawyers in the monoline suits against JPM/BEAR will surely be trying
to get a copy of the wells notice via discovery.
I first reported the SEC started an investigation into these alleged
securities violations (and possible criminal actions) after I saw the
securities regulator approach the lawyers and whistleblowers in my Bear
Stearns investigative report at The Atlantic the day after the story
came out. Now a year later it appears all the ‘shitty deal’ emails,
internal Bear Stearns documents, and over thirty whistleblowers who’ve
come forward in the monoline suits lead by law firm PBWT was enough to
get the SEC to stand up to JPM and we think say ‘what you did violated
securities laws and harmed investors’. Talk about another wave that
could lead to tsunami style damage to Jamie Dimon’s ‘fortress balance
sheet’.
How many billions in damages JP Morgan will have to pay out is not
yet determined but inside their Mortgage-Backed Securities and
Repurchase Litigation note on the 10-Q the bank tells us “There are
currently pending and tolled investor and monoline claims involving
approximately $120 billion of such securities.”
WOW that means investors think there was a heck of a lot of very bad
mortgage securities that were packaged and sold and they want their
money back along with some fines and are willing to spend a few million
to pay expensive lawyers to sue for it. When I first reported on the
Ambac case and went on RT’s The Keiser Report
to explain what kind of financial trouble JPM could be in the damages
in the monoline suits against Bear were only around $1.2bn. I told Max
Keiser if fraud claims survived the suit that means punitive damages get
lobbed on and who knows many billions JPM will have to pay out because
allegedly emails showed Bear mortgage traders stole billions from their
own damn clients. I threw out a number $10bn, that JPM could be looking
to pay. Now according to JPM’s latest SEC filings there are now “seven
pending actions commenced by bond insurers that guaranteed payments of
principal and interest on approximately $5 billion of certain classes of
21 different MBS offerings.”
The face value amount of securities tied to the monoline suits
against JPM are significant because there was a recent ruling in a
Countrywide RMBS suit that ruled if plaintiffs can prove there were
miss-representations in the bonds then the entire amount of the bond has
to be bought back…not just the amount that defaulted or caused a loss.
Reuters legal columnist Alison Frankel explains the judge’s decision and
impact here.
It has a lot to do with the way insurance laws are structured in New
York State, which is where all the monolines suing have headquarters.
So far we haven’t seen JPM settle any of these mortgage putback suits
including the government’s housing regulator’s whopper of a suit filed
this winter against a bunch of banks including JPM. The governments’
lawyer who filed the suit literally copied the fraud and breach of
contract claims Ambac had laid out against JPM and since then we’ve seen
a multiple of big boy institutional investor file similar suits. Thus
the alarming $120bn number of possible rmbs repurchase litigation
damages JPM was forced to detail in their recent 10-Q. A number which
accompanies a series of motions their lawyers at Sullivan & Cromwell
and Greenberg Traurig have filed to slow down discovery and deny, deny,
deny these aggressive fraud claims in the triple digit billions.
And now that the SEC is about to come out and stamp a ton of merit to
these civil investor lawsuits via an enforcement action that hopefully
says – you guys broke the law, abused free markets, and seriously broke
investor trust then it’s looking harder and harder for JPM not to settle
these investor lawsuits in the mega billions. Just think if Ambac
actually got to trial and a main street jury who’s pissed very few banks
have good to jail for the financial crisis heard some of the whistleblower testimony
about senior Bear executives telling underlings to make up mortgage
info for the raters. Or the third-party due diligence reports Bear got
them to fudge – reports investors relied as due diligence rubber
stamping the quality of the rmbs securities. I’d image punitive damages
up the yin-yang would be award.
But the most telling sign JPM will have to payout big time is that
HUGE jump in litigation reserves they sunk in this week. In the banks
first quarter earnings press release, filed on April 13th, JPM told
investors they were adding $2.5bn to existing litigation reserves for
mortgage-related suits. And then three weeks later while all my jurno
peers are focused on writing stories about what JPM’s trading screw up
means to their reputation, their master public relations spin machine
figures lets thrown in all the bad news we can cause we know the market
will punish our stock. So they added on another $1.7bn in litigation
reserves for a total hit to income of $4.2bn. That’s more than 4 times
the net amount ($800 million) they claim they lost on their bad
corporate bond trade.
On top of that I’ve seen top housing analyst Mark Hanson tell hedges
funds they might want look at how JPM repurchase risk will affect net
income and thus the stock price. Francine McKenna, former Big 4 auditor
and influential columnist
for American Banker told me this is just the first phase. Accounting
rules allow JPM to slowly add each quarter to litigation reserves and
take smaller hits to net income then waiting for a big money suit to
finalize and wipe-out a whole year’s earnings. Some financial editors
like Joe Weisenthal at Business Insider allowed his team to write this
week the $4.2bn addition to litigation reserves was due to trading loss
but that’s not what the 10-Q explains. Number one these are reserve
additions for events up to March 31st and JPM worrisome trading loss
began in April. Number two the bank has to explain all the litigation
that gets to that reserve number and there is not a word about suits
from trading losses in their 10-Q litigation notes. Nope this big jump
was from progress being made by rmbs plaintiffs and a looming SEC action
which you see if you know how to read the litigation notes.
McKenna, founder of www.retheauditors.com says, “Banks tend to
account in one lump litigation reserve number what they think they will
have to payout from a suit but that’s really a disguise so that no one
across the table from the litigation can see what they might be willing
to settle for.”
There is another dirty accounting trick JPM is possibly playing with
here. McKenna told me in an interview this week reserves are like a
cookie jar, banks can increase and decrease this balance sheet number
each quarter which shows up as a loss or earning to net income. So let’s
say Jamie Dimon thinks the mark to market loss of $800 million he just
took for the trading screw up is going to be a lot more when they are
done unwinding the trade. So the bank they could lower their litigation
reserves and boom that trading loss doesn’t look so bad on next
quarter’s net income. Then going into Q3, when say maybe they settle
with the SEC and the rest of the Street wakes up to how many billions
they will have to pay out for the sins of Bear Stearns RMBS fraud, JPM
can just re-up the litigation reserves. Now of course their Big 4
auditor has to allow them do this by signing off on the SEC financial
filings but part of the Abmac suit showed PricewaterhouseCoopers tried
to stand up to JPM/Bear accounting tricks before and the bank just
ignored it. A detail the lawyers at PBWT discovered for us. In that case
it would be up to the SEC to say ‘Hey JPM your RMBS repurchase risk is
more than you are accounting for and you’d better represent a more
realistic number.” This in turn hurts JPM’s income and also can lead to
additional downgrades by the raters, so an accounting scolding by the
SEC on top of an enforcement action might not be something they’ll man
up to. But clever analyst and hedge funds will see it and the result
could be free market participants take a club to the CEO, who the
financial press once hailed America’s angle banker, all on their own.
Editors Note: When the Bloomberg/ Wall Street Journal editors
figure out I’ve beat them to this story and reported JPM got a Wells
Notice for mortgage securities no-no’s I’d like to remind them jurno
standards mean you need to credit Teri Buhl for reporting this first.
Thanks in advance to Matt Taibbi at Rolling Stone and Max Keiser at RT
who always link and mention the Bear RMBS fraud cheating their own
clients news created a whopper of a problem for JPM, was a result of my
original reporting at The Atlantic. Here is a shout out thanks from me
to Daniel Indiviglio, my editor at The Atlantic, who understood the
importantence of impact to the market in this story back in May 2010 and
made sure it got published. And most important I’d like to recognize
Nick Verbitsky, doc film maker of Confidence Game, a move now playing
about the greed and fraud that lead to the downfall of Bear Stearns, for
finding the first whistleblowers to speak out against the Bear Mortgage
executives. Awareness of how these Wall Street titans cheated and stole
damaging free markets was a result of investigative journalism and the
PBWT attorneys not our regulators figuring it out first.
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