Before the mortgage market meltdown even began, in early 2008, Merrill Lynch was forced to reimburse the city of Springfield, Mass., more than $10 million following losses in a CDO investment that the firm, now part of Bank of America, conceded had been sold improperly, without the city's permission. Massachusetts Secretary of the Commonwealth William Galvin later filed a separate lawsuit against Merrill.
Merrill, along with UBS and Deutsche Bank, were the largest arrangers of CDOs and are expected to be among the firms targeted by federal regulators in a probe that now shows no sign of letting up any time soon.
"A lot of this stuff would have seemed like fairly standard operating procedure at the time these deals were being sold," said one Wall Street CDO veteran who asked not to be named, citing the possibility of losing his job. "But take it against the backdrop of the meltdown ... and add in some incendiary emails ... it's a problem that is not going away."
Large investment banks earned about $1 billion in fees creating and selling mortgage-laden CDOs, according to the Wall Street Journal. A Credit Suisse report on the largest CDO underwriters during the boom period, 2005-2008, shows that Merrill Lynch, UBS, JPMorgan, Citi and Morgan Stanley were the five largest players, and, combined, arranged more than $50 billion worth of deals.
Klayman said he has more than a half dozen arbitration cases currently pending against Wall Street firms, including UBS, in which sophisticated investors, pension funds and hedge funds, are seeking damages over CDO investments gone bad.
Doug Morris, a UBS spokesman, had no comment.
These cases are pending before the Financial Industry Regulatory Authority.
"The Wall Street banks like to say that they sold these to sophisticated investors who knew what they were getting into," Klayman said. "No matter how sophisticated someone is, if they don't have the full story, if things are misrepresented, it's fraud."
Goldman has vigorously defended itself via a slew of written statements reiterating that it made no misrepresentations to clients and that the SEC failed to mention in its complaint that Goldman lost $90 million on the CDO deal, proving Goldman did not deliberately booby-trap the deal by allowing John Paulson, a mortgage market short seller, to handpick mortgages that went into it so as to line the deal with investments sure to fail. Investors surely knew there were investors on the other side of the deal, Goldman stressed.
Klayman, for his part, isn't buying the argument.
"Goldman lost $90 million, so that is supposed to make us think they are innocent? I wonder how much they made facilitating Paulson's trades," Klayman said. "We'll never know. The investors never knew that Paulson, a short seller, helped build the portfolio. If they did, do you think they still would have invested? We all know right from wrong. To me, this clearly was wrong."