While New York Attorney General Eric Schneiderman alleges massive fraud in mortgage-backed securities in a lawsuit filed this week, he's not criminally prosecuting anyone.
Described as a template for more lawsuits to follow, the move signals that Wall Street players won't face state prison for packaging and selling the troubled investments that nearly brought the U.S. economy to its knees. The felony statute of limitations under New York's Martin Act against securities fraud is five years, so it's too late to bring a criminal case.
The civil suit claims misconduct by Bear Stearns & Co. in 2006-2007 cost investors $22.5 billion in losses and left them holding an additional $30 billion in bad loans. The suit filed Monday names Bear Stearns successor JP Morgan Chase, which says it will contest the allegations.
"The statute of limitations is an issue we expect to be in dispute in the litigation," Schneiderman said in describing the civil suit, noting that even then, it's six years under the Martin Act. That also puts pressure on his office to bring cases soon against other investment banks for actions that led to the 2008 market crash.
His office has a so-called tolling agreement with the defendants in this case, waiving their right to dismiss otherwise time-barred matters, Schneiderman said. At issue is conduct dating back to 2005, he said.
The complaint alleges that Bear Stearns failed to properly evaluate pools of mortgages, ignoring their defects and misleading investors by claiming they maintained due diligence and quality controls in order to satisfy big mortgage lenders and meet demand in overheated financial markets that eventually imploded.
"All of these representations were false and misleading," Schneiderman said. "We also contend that their conduct as alleged in the complaint was essentially a scheme to fraudulently conceal from the investors the gross defects of dysfunctionality in their due diligence and quality control systems."
The lawsuit, seeking disgorgement of illicit profits and damages to recoup investor losses, was the first filed under the auspices of the working group established by President Barack Obama to investigate and prosecute alleged misconduct that contributed to the financial crisis. Schneiderman is co-chairman of the group. A Martin Act criminal conviction would carry up to four years in prison.
JPMorgan said the complaint "is entirely about historic conduct" by Bear Stearns, which it acquired in 2008 at the behest of the federal government, and that the executives of the former company criticized in the complaint are gone now. Schneiderman's complaint relied on "recycled claims" made by private plaintiffs and none of those lawsuits have been settled, the company said.
"We intend to contest these allegations," JPMorgan spokeswoman Jennifer Zuccarelli said. The company is cooperating with members of Obama's working group and couldn't confirm any numbers about losses in Schneiderman's complaint, she said. "We plan to live up to obligations under deal documents," she said.
New York Gov. Andrew Cuomo, state attorney general from 2007 to 2010, also didn't prosecute Bear Stearns. Spokesman Richard Bamberger said at the time the office was looking into it, federal prosecutors asked the attorney general to cooperate with their ongoing criminal investigation. "The attorney general's office respected that request," he said.
In 2009, U.S. Attorney Benton Campbell in Brooklyn prosecuted two Bear Stearns executives, accusing them of fraud and conspiracy for allegedly lying to investors about the subprime mortgage market. Both were acquitted. One juror said they were "scapegoats for Wall Street."
Campbell, now a partner and white-collar defense lawyer at a Manhattan firm, did not immediately respond to requests for comment.
A spokesman for the U.S. attorney's office said there have been no other Bear Stearns prosecutions since. He said the statute of limitations on those federal fraud and conspiracy charges is five years.
Both Cuomo and his predecessor as state attorney general, Eliot Spitzer, the so-called "sheriff of Wall Street," made headline-grabbing civil settlements over a decade by alleging wrongdoing in financial markets under New York law. They settled for reform agreements and sometimes money without sending anyone to prison.
In 2008, Cuomo got from the three biggest ratings agencies agreements meant to end inflated investment ratings for mortgage-backed securities. Those securities had already collapsed, and the agencies weren't rating any new ones. The next year he pressured AIG executives to return bonuses after the company received $170 billion in government bailout money.
Spitzer reached a $100 million settlement with Merrill Lynch & Co. in 2002 and a year later helped reach a $1.4 billion "global settlement" involving several state and federal regulators with Wall Street's biggest brokerages. They alleged that analysts inflated ratings, getting agreements to change practices.