J.P. Morgan and Credit Suisse RMBS Securities Enforcement Case: The Loan Review Had a Preferred Answer

J.P. Morgan agreed to pay $296.9 million and Credit Suisse $120 million to settle SEC charges over RMBS mortgage-loan disclosures and repurchase practices. The SEC described missed payments left out of an offering, cash collected on loans the firms no longer owned, and loan reviews that changed with the prospect of getting paid. If you worked on loan data, quality control or repurchases, those are decisions you may recognize from your own desk.

The Securities and Exchange Commission announced the separate resolutions on November 16, 2012. This page follows the conduct in each proceeding and the money each firm agreed to pay. Our broader page on mortgage-backed securities offering fraud explains the product and the protections investors were promised.

The Companies Behind the RMBS Transactions

The SEC’s federal complaint in Washington, D.C. named J.P. Morgan Securities LLC and J.P. Morgan Acceptance Corporation I over the delinquency disclosures. J.P. Morgan Securities underwrote the offering, while J.P. Morgan Acceptance served as the depositor, the company transferring the mortgage loans to the trust. The bulk-settlement charges concerned J.P. Morgan Securities as successor to Bear Stearns’ brokerage business and EMC Mortgage, the company buying and servicing the loans.

Those roles explain the alleged cash diversion. EMC bought mortgages from originators and passed them through the Bear Stearns depositor companies into trusts. Bear Stearns’ brokerage business sold the securities to investors, including banks, pension funds and credit unions. EMC also serviced loans, collecting borrowers’ payments and passing them to trusts for distribution.

Credit Suisse’s proceeding ended in a settled SEC administrative order. It named Credit Suisse Securities and DLJ Mortgage Capital among the companies charged. The SEC addressed Credit Suisse’s bulk settlements and its first-payment-default disclosures separately.

J.P. Morgan’s Delinquency Disclosure Omitted Hundreds of Loans

The SEC alleged that J.P. Morgan understated delinquencies in a $1.8 billion residential mortgage-backed securities offering in December 2006. The prospectus supplement disclosed four loans as 30 to 59 days delinquent. The complaint put the actual number in that category at approximately 623, and alleged that the four disclosed loans were further behind, at 60 to 89 days delinquent.

The cutoff date mattered. According to the complaint, the offering described loan status as of the close of business on December 1, using a method under which a payment due November 1 became thirty days delinquent if it remained unpaid at that cutoff. The SEC alleged that the disclosures excluded the loans with that November payment still due. The internal final issuance tape listed each loan and its next-payment-due date, giving people working on the offering a way to see the discrepancy.

According to the complaint, an investment banker had already raised the delinquency question, and printing of the preliminary prospectus supplement was delayed. The complaint alleged that a proposed disclosure acknowledging widespread missed first payments disappeared when the section containing it was removed after an objection from the originator, WMC Mortgage. The objection concerned the description of WMC’s repurchase obligations. The warning left with the section.

The complaint attributed at least $37 million in actual and projected losses to undisclosed delinquent loans that remained in the trust. J.P. Morgan’s underwriting fee was approximately $2,780,516. If you prepared loan tapes or reviewed disclosure drafts, you may recognize the gap between what the firm knew and what investors were told.

Bear Stearns Collected Cash on Loans the Trusts Owned

The SEC alleged that Bear Stearns collected discounted settlements from originators over defective mortgages, kept most of the proceeds and left most of the loans in the trusts. Originators generally had promised to buy back loans with early payment defaults or other specified defects. When an originator agreed to take a trust-owned loan back, EMC first bought it from the trust. A cash settlement let EMC collect without completing that round trip.

The alleged practice affected loans in 156 RMBS transactions issued from 2005 through 2007. The complaint described approximately 6,535 trust-owned loans covered by bulk settlements, with approximately 13.5% repurchased. According to the SEC, for most affected loans the firm collected while the trusts received nothing.

The complaint also described how Bear Stearns allocated settlement money. Its written allocation procedure first reimbursed the firm for fees and expenses, then covered certain monetary claims, then divided remaining funds between inventory and trust-owned loans. Even the amount allocated to trust-owned loans first reimbursed the firm for repurchases it already owed the trusts. Only a later allocation could fund additional, optional repurchases.

The loan review had a financial consequence. According to the complaint, EMC nearly always found a breach of its promises to the trust when an originator had agreed to repurchase the loan. In a July 2007 email, its quality-control head described the desired result when the originator would not repurchase:

A PSA breach meant a breach of the promises supporting the pooling and servicing agreement, which could require EMC to take the loan back from the trust. If you worked in loan review, you may know who chose the criteria and what happened when a review produced an expensive answer. In the SEC’s account, we see quality control with its answer already chosen.

Credit Suisse’s Repurchase Practices Left Investors Out

The SEC charged that Credit Suisse misled investors in 75 RMBS transactions through its bulk-settlement practice. As the agency described it, Credit Suisse negotiated cash settlements with originators from 2005 through 2010, retained the proceeds and failed to disclose the practice to investors. The SEC alleged that in nine transactions Credit Suisse failed to repurchase certain early-defaulting loans as its offering documents required.

The SEC also alleged that Credit Suisse applied different quality-review procedures to loans it sought to return to originators, repurchasing them from trusts only when the originators agreed to repurchase them. According to the agency, Credit Suisse failed to disclose the bulk-settlement practice when investors asked about early payment defaults. Someone handling repurchase demands or investor responses could see whether the answer given outside the firm matched the decisions made inside it.

First Payment Default Protection Left Loans Behind

Credit Suisse’s first-payment-default disclosures concerned two separate RMBS offerings. Under the provision described by the SEC, the originator had to repurchase or replace loans with missed payments shortly before or after securitization. The SEC alleged that Credit Suisse claimed to have removed “all First Payment Default Risk” while limiting the number of qualifying loans sent back to the originator.

The SEC attributed more than $10 million in investor losses to Credit Suisse’s first-payment-default practices. The promised protection depended on what happened after a borrower missed a payment: which loans qualified and which ones actually went into the repurchase demand. For an employee maintaining those demands, the loan list could tell a different story from the promise in the offering.

Separate SEC Resolutions for Separate Conduct

The SEC said Bear Stearns’ bulk-settlement practice brought in at least $137.8 million. J.P. Morgan agreed to repay $162,065,536 in gains and interest for that practice.

The SEC put Credit Suisse’s profits and losses avoided from bulk settlements at $55.7 million. Its resolution required $68,747,769 in repayment of gains and interest for that practice.

The SEC said it would seek to distribute the money through separate Fair Funds for harmed investors. That plan connected each recovery to investors in the transactions affected by the corresponding conduct.

What Evidence Shows RMBS Repurchase and Disclosure Fraud?

For these RMBS practices, useful evidence connects the offering’s promises to the loan data, repurchase decisions and money received. Our approach to securities fraud evidence starts with the person who can explain that connection. In the J.P. Morgan complaint, the final issuance tape, the cutoff-date language and successive disclosure drafts made the delinquency discrepancy testable.

For the bulk settlements, the comparison runs from the originator’s promise to the repurchase demand, quality review, settlement allocation and trust receipt. The complaint’s account shows why a demand alone tells only part of the story: the firm could pursue the originator and collect money while leaving the loan in the trust. An employee who understood the review criteria or allocation procedure could explain how that happened.

The Significance of Whistleblowing as an Anti-Fraud Measure, published in the Journal of Forensic & Investigative Accounting in 2018, found that whistleblowing detected 35.9% of its sample of 4,943 occupational frauds, compared with 21.4% detected through internal controls. In an RMBS matter, we want to understand both the control and the decision behind it: who changed the review, which loans it affected and where the resulting money went.

Who Investigated the J.P. Morgan and Credit Suisse RMBS Actions?

The SEC investigated and brought these RMBS actions, coordinating with the federal-state Residential Mortgage-Backed Securities Working Group. We work with you on how your information connects to the authorities responsible for the conduct.

The whistleblower award and investor recovery serve different purposes: the SEC program rewards qualifying information contributing to enforcement, while the Fair Funds announced here were intended for harmed investors. The False Claims Act addresses fraud against the government through a separate program. A whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. We assess the conduct and the money involved with you to identify the whistleblower opportunity your evidence supports.

You Know What the Loan Review Found

If you saw a delinquency disappear from an offering or a repurchase review change when the firm had to pay, talk with our whistleblower experts about the decision behind it. We build the case with you and bring in securities fraud whistleblower lawyers who understand mortgage-loan disclosures, repurchase obligations and trust cash flows. You bring the view from inside the business; we bring the expertise and partnership to pursue what it reveals.