For institutional investors who lost money in questionable mortgage investments sold to them by Wall Street, the Securities and Exchange Commission's new focus on derivatives fraud might seem long overdue. For Wall Street investment banks, it may seem like a witch hunt.
Regardless, industry members and securities lawyers say, a tidal wave of regulatory complaints could soon strike Wall Street's powerhouses, and not just Goldman Sachs. On Friday, the SEC slapped Goldman with a civil suit alleging fraud.
"All of the major banks got their hands dirty," said Lawrence Klayman, a partner at Klayman & Toskes, which specializes in securities litigation. "Where there were structured products, such as collateralized debt obligations, there were investors who weren't given full and fair disclosure. That's at the heart of all these cases."
In bringing its first fraud case following the mortgage securitization market's implosion, the SEC made it abundantly clear that it is also probing other subprime mortgage-pool-tethered deals peddled by Wall Street.
Institutions that bought in -- and got burned -- are already taking matters into their own hands. Over the past few years, from western New York to the eastern Caribbean, institutional investors are filing lawsuits over CDO schemes gone sour.
Since the housing market and credit derivatives markets collapsed beginning in 2007 there have been more than 100 lawsuits tied to $400 billion in losses, according to industry research cited by the New York Times.
In Buffalo, N.Y., regional lender M&T Bank filed suit against global behemoth Deutsche Bank, alleging that executives at the New York City arm of the German bank sold M&T a CDO investment called Gemstone VII without fully disclosing the hidden layers of subprime loans that comprised the synthetic security. M&T also alleged that Deutsche Bank kept secret the fact that the loans were turning toxic even as the triple-A rated investment was being consummated in 2007. Deutsche Bank, which has contended it gave M&T all the information it would have needed to assess the deal, some 300 pages worth, filed a motion to dismiss the suit as having no basis, but a New York State Supreme Court judge in Buffalo has ruled the case should go forward. M&T, which has more than $60 billion in assets and counts Warren Buffet among its largest shareholders, lost $80 million in the Gemstone deal. A Deutsche Bank spokeswoman declined comment.
On the island of St. Thomas in the U.S. Virgin Islands, a government workers' pension fund has sued Morgan Stanley alleging that the firm sold it on a CDO deal called Libertas that Morgan Stanley fully expected to fail. According to a copy of the complaint, filed in U.S. District Court, Southern District of New York, the Employees Retirement System of the Government of the Virgin Islands lost more than $1 billion. The pension fund accused Morgan Stanley of being highly motivated to defraud investors because it was shorting the assets in the CDO.
"Morgan Stanley was betting the entire investment it was promoting would fail," the complaint said.