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NY State Insurance Department Conducting Preliminary Investigation Into Fraud Claims by Bond Insurers

Source: Dow Jones

Posted on 30 Dec 2010

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The New York State Insurance Department is considering whether to conduct an all-out investigation on banks and other agents being accused of misrepresenting material facts on structured finance transactions insured by financial guaranty companies.

Steven Nachman, deputy superintendent for frauds and consumer services, in an interview on Wednesday with the Dow Jones Newswires said the department had received a number of referrals from different bond insurers alleging fraudulent acts on such deals, adding that a preliminary investigation is under way.

"We are conducting a preliminary investigation from those referrals to determine if a full-blown investigation is warranted," he said.
Nachman declined to identify any banks or other institutions under review, nor would he name any of the insurers behind the referrals. Separately, Assured Guaranty--one of the few survivors among the monolines hit with billions of dollars in claims from large subprime mortgage exposures--acknowledged that it was one of them.

"We have encouraged the NYS Insurance Department to investigate the quality of mortgages that went into mortgage securitizations insured by Assured Guaranty and other monoline insurers," Assured said in a statement to Dow Jones Newswires.

On Dec. 21, Sean McCarthy, Assured's chief operating officer and chairman of the Association of Financial Guaranty Insurers, testified before the state Assembly's Standing Committee on Insurance that some originators of these deals "may have committed insurance fraud by knowingly misrepresenting the quality of residential mortgage loans underlying securitizations in order to obtain financial guaranty insurance."

The banks and others who created the securities are already defending themselves in court against accusations of breaching contractual duties, and many have already been forced to buy back loans under so-called "representation and warranty put-backs" where it can be found that the originator was negligent. But the legal battle has been hard fought, and the monolines have accused the originators of dragging their feet.

Some observers said that McCarthy's testimony was the first time they could recall an industry leader explicitly blaming fraud for the monolines' troubles. The hearing itself was largely dedicated to a discussion about the formation of a new financial guaranty company called BondFactor Co., led by former executives of Goldman Sachs (GS).

If it can be proved that the originators intentionally misrepresented the condition of the underlying loans passed onto the monoline insurers--if, for example, they misrepresented the likely default rate--the originators could face fines and other penalties.

New York Insurance Department cases can go to the state attorney general, a local district attorney or to federal prosecutors. The Department itself has jurisdiction over transactions conducted in New York under the state insurance code.