JPMorgan Faces Securities Lawsuit

New York, NYThe New York attorney general has filed a securities lawsuit against JPMorgan Chase & Co. alleging securities fraud on the part of Bear Stearns before Bear Stearns was sold to JP Morgan. JPMorgan has said it will fight the securities fraud litigation.

According to Attorney General Eric T. Schneiderman (10/2/12), the lawsuit involves allegations that Bear Stears made "fraudulent misrepresentations and omissions to promote the sale of residential mortgage-backed securities (RMBS) to investors." Among the misrepresentations were exaggerations about the amount of care put into evaluating the quality of mortgage loans that were packaged into residential mortgage-backed securities.

The lawsuit alleges Bear Stearns told investors that the quality of the loans had been carefully evaluated and would be monitored. "Instead, it [Bear Stearns] systematically failed to evaluate the loans, largely ignored defects that its limited review did uncover, and kept its investors in the dark about the inadequacy of the review procedures and defects in the loans," Schneiderman claims. When executives knew about issues, they failed to give that information to investors.

In the end, the residential mortgage-backed securities included loans given to borrowers who were unable to repay those loans and ultimately defaulted. The lawsuit alleges that defective loans were overlooked even when they were found and furthermore that Bear Stearns knew about deficiencies in its due diligence review process but ignored those deficiencies.

"Even when these flawed processes did identify defective loans, Bear Stearns nonetheless routinely overlooked negative findings and continued to package the loans into securities for sale to investors," Schneiderman alleges. Furthermore, Bear Stearns' quality control department, set up to detect red flags in the loans, was allegedly overwhelmed and unable to function properly.

The lawsuit claims Bear Stearns knew loan originators were selling defective loans, but continued to buy and securitize those loans. For example, according to the lawsuit, a June 2006 internal Bear Stearns email shows that almost 60 percent of conduit-purchased AHM loans were 30 or more days delinquent, but after learning this, Bear Stearns continued to issue securitizations that included the AHM loans. The lawsuit states that one of the originators, American Home Mortgage, has been implicated in a criminal matter related to mortgage fraud.

Cumulative losses related to the residential mortgage-backed securities are reportedly approximately $22.5 billion.