Federal prosecutors are conducting a criminal probe into whether multiple major Wall Street banks defrauded investors in selling investments called collateralized debt obligations, or CDOs, that were created, sold and shorted, or bet against, by the banks and certain favored clients. See “Wall Street Probe Widens,” by Susan Pulliam, Kara Scannell, Aaron Lucchetti and Serena Ng, Wall Street Journal, May 12, 2010, and “Wall Street said to face new investigations,” CNNMoney.com, May 13, 2010.
Many large Wall Street banks created and sold CDOs, and sometimes bet against the very deals that they had created in order to make money when the mortgage market crashed.
The banks reportedly under scrutiny by federal prosecutors include Goldman Sachs, Morgan Stanley, J.P. Morgan Chase, Citigroup, Deutsche Bank, and UBS.
The CDOs referenced in the WSJ article are ABSpoke, and Baldwin 2006-I, sold by Morgan Stanley, and Cetus, Carina and Virgo, sold by one or more of Citigroup, Deutsche Bank and UBS.
Separately, New York Attorney General Andrew Cuomo has launched a second probe of Goldman Sachs, Morgan Stanley, Deutsche Bank, Credit Suisse, Citigroup, UBS, Credit Agricole, and Merrill Lynch (now owned by Bank of America) regarding whether those Wall Street firms provided misleading information to credit rating agencies in order to obtain inflated ratings for CDOs. Credit rating agencies have themselves been criticized and sued for assigning false and misleadingly high ratings to many of toxic CDOs.
The investigations into these Wall Street banks arose out of the ongoing civil fraud investigations launched by the SEC in 2009, which involve more than a dozen such firms’ selling and trading of mortgage-backed CDOs.
The Wall Street Journal reports that the Manhattan U.S. Attorney’s office and SEC are working hand-in-hand to determine whether the Wall Street firms misrepresented and failed to disclose material facts in marketing, selling and trading CDOs.
The widening criminal probe follows calls by legislators for more prosecutions of those whose fraudulent conduct plunged the country into the worst financial crisis since the Great Depression. Some of that conduct was exposed in recent congressional hearings. So far, prosecutors have brought just one major criminal case stemming from the crisis, against two Bear Stearns traders, which did not result in convictions, according to the article.
As part of the joint probe, the SEC has requested a range of documents, including final and draft prospectuses, final and draft offering documents and investor lists associated with mortgage-related deals, according to the article. A CNNMoney article said that the SEC has issued subpoenas to JP Morgan Chase, Citigroup, Deutsche Bank and UBS.
Last month, the SEC filed a federal court action against Goldman, alleging that the firm and one of its mortgage traders created a product designed to fail for the benefit of a favored hedge-fund client, who bet against the deal, without disclosing that client’s role in picking investments for the deal to other investors. Goldman is reportedly in settlement talks with the government.
A total of $1.08 trillion in CDOs were issued by various Wall Street firms between 2005 and 2007. Merrill Lynch, Citigroup and Deutsche Bank issued the largest dollar amount of CDOs during that time period, while J.P. Morgan, Morgan Stanley, UBS and Goldman were ranked Nos. 5, 7, 10 and 14, respectively, according to research firm Thomson Reuters.
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