State Attorneys General Will Aggressively Pursue Actions During The Credit Crisis
Introduction
While much of the press reports during the credit crisis has focused on the United States Treasury’s Troubled Asset Relief Program and the financial woes of Bear Stearns, Lehman Brothers, Washington Mutual (“WaMu”), Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”), Wachovia National Bank, American International Group (“AIG”) and the automobile industry, little notice has been paid to the aggressive actions that have been taken by state Attorneys General.
With its direct influence over the nation’s financial center, the New York Office of the Attorney General (“NYOAG”) has acted aggressively under the Martin Act to impose its own agreements and requirements on alleged culprits in the credit crisis.
The MartinAct
Enacted in 1921, the Martin Act arms the NYOAG to combat financial fraud. The Martin Act empowers the NYOAG to, among other things, (1) subpoena documents from anyone doing business in New York State, (2) keep an investigation secret or make it public, and (3) pursue criminal or civil charges or both. The Act’s legal standards are extremely broad, and the courts have liberally interpreted many of the most important terms in the Act, including “security,” “material,” “public offering,” and “fraud.” In addition, there is no “scienter,” or knowledge, requirement to prove a violation of the Act in a civil context. That is, the NYOAG does not have to prove that a defendant intended to defraud anyone, that a transaction took place, or that anyone actually was defrauded. Furthermore, the Act may be combined with other state statutes to enable the NYOAG to pursue almost any type of violation, including anti-trust as well as labor and environmental claims. Indeed, the NYOAG’s powers under the Act are unmatched by most other state agencies in any other state.
The NYOAG’s Actions During the Current Credit Crisis
The NYOAG had used the Martin Act throughout the phases of the current financial crisis:
Mortgage Origination Violations and the Demise of WaMu: The NYOAG’s early enforcement actions focused on the loss of integrity in the home appraisal process. Specifically, in November 2007, the NYOAG’s Investor Protection Bureau investigated collusion between WaMu and eAppraisal to inflate the appraised value of homes. Although the NYOAG did not sue WaMu directly, instead filing claims against eAppraisal and its parent corporation, First American Corp., the public disclosure of the investigation was followed by the collapse of WaMu’s share price, further investigation by the Securities and Exchange Commission, and the eventual demise of the company. The NYOAG’s case against eAppraisal is ongoing.
NY Rules for Fannie and Freddie: The NYOAG required agreements in March 2008 with Fannie Mae and Freddie Mac, whereby the two largest securitizers of mortgages in the United States were, among other structural reforms, forced to abide by standards and codes of conduct in the terms they dictate to banks and mortgage lenders in their home appraisal policies.
Rating Agencies: In June 2008, the NYOAG entered into agreements with the nation’s three principal credit rating agencies, Standard & Poor’s, Moody’s Investors Service, Inc., and Fitch, Inc. to further assure the independence of the ratings agencies, ensure that crucial loan data is provided to the agencies before they rate loan pools, and increase transparency in the credit rating industry. Among other safeguards, the agreements require the agencies to institute a fee-for-services model, disclosure and due diligence reforms, and loan-originator and annual reviews.
Auction Rate Securities: The NYOAG entered into an agreement in August 2008 with UBS to return over $11 billion to investors based upon allegations that UBS misrepresented auction rate securities to investors as safe, cash-equivalent products when, in fact, the securities faced increasing liquidity risk. In October of this year, the OAG also entered into a $6.5 million settlement with UBS’s then-General Counsel, David Aufhauser, regarding insider trading of auction rate securities. As part of the settlement, Mr. Aufhauser was subjected to a two-year ban from the securities industry and from practicing law in the State of New York.
Credit Default Swaps: In addition, the NYOAG, along with other law enforcement and regulatory agencies, is investigating short-selling – a trading technique that has been criticized for being used by some traders illegally to manipulate markets – in the credit default swaps market, which many commentators believe contributed to the collapses of Lehman Brothers Holdings Inc., the financial problems of AIG, and the near collapse of the monoline insurers such as MBIA, Ambac, and Financial Guaranty Insurance.
Executive Compensation: This month, the OAG turned its attention to executive compensation and bonuses, issuing a subpoena to Bank of America, asking for details on how it allocates its bonuses, and urging Citigroup, AIG, and other executives of companies that have received Federal financial assistance to forego their bonuses this year.
Conclusion
The Martin Act has enabled the NYOAG to take aggressive and forceful action against financial institutions and other companies during the credit crisis. The actions of the NYOAG have been wide-ranging and decisive, involving hundreds of millions of dollars in fines and penalties against dozens of the leading financial institutions in the country, and against individuals employed by those companies. As part of its agreements with these financial institutions, the NYOAG has also instituted an active regulatory oversight scheme, which it will no doubt enforce with further fines and penalties if the companies fail to follow through on their agreements with the NYOAG.
Recognizing that timely response to the imminent challenges of such government intervention calls for integrated skills, Troutman Sanders has formed its Credit Crisis & Government Intervention Task Force. The Task Force can help with NYOAG actions under the Martin Act. Our lawyers have extensive experience in helping our clients address issues raised not only by state Attorneys General across the country, but also by the Department of Justice and its United States Attorneys and state and county prosecutors. If you would like assistance from us, please contact a member of the Credit Crisis and Government Intervention Task Force.