United States: The Giants’ Footsteps: What JP Morgan’s $13 Billion DOJ-State AG Settlement Can Teach Mortgage-Backed Securities Plaintiffs

State AGs have emerged at the forefront of developing, investigating, and asserting claims against financial companies on behalf of both their states and consumers in the wake of the mortgage and financial crisis. Their influence was on full display this week when a number of AGs acted alongside U.S. DOJ to obtain a record $13 billion settlement from JP Morgan over its packaging, marketing, sale, and issuance of residential mortgage-backed securities (MBS). The settlement presents both lessons for private plaintiffs seeking to recover their own losses from banks and financial companies and a demonstration of how AGs are far from finished blazing the trail in investigating and litigating the fallout of the mortgage crisis.

In early 2012, when all 50 AGs coordinated with DOJ and HUD to reach a $25 billion settlement with the country's five largest mortgage servicers, a number of AGs, led by New York AG Eric Schneiderman, successfully lobbied to limit the scope of that settlement to exclude MBS issues. At the time, those AGs noted that such conduct would be a primary subject of future AG action. They made good on that promise in this week's JP Morgan settlement. In addition to the billions of dollars that JP Morgan will pay to the federal government, five states whose AGs have become key leaders in taking action against financial companies, and who cooperated with each other and the federal government in this case, also will receive substantial payments:  $298.9 million to California, $19.7 million to Delaware, $100 million to Illinois, $34.4 million to Massachusetts, and $613 million to New York. AG Schneiderman played a key role in this case as co-chair of the MBS Working Group of President Obama's Financial Fraud Enforcement Task Force, a position to which the President appointed him in the 2012 State of the Union Address. AGs of the other participating states also have been leaders in investigating MBS-related issues, including Massachusetts AG Martha Coakley, who also serves on the Working Group, and California AG Kamala Harris, who established her own MBS task force shortly after taking office in 2011.

The AG-DOJ settlement resolves allegations that JP Morgan failed to disclose to investors that the underlying loans did not comply with underwriting guidelines or were otherwise unfit for securitization. Obviously, this action has implications for the myriad private investors who may have been misled by JP Morgan (and Bear Stearns and Washington Mutual, which JP Morgan bought in 2008). Notably, JP Morgan's "Statement of Facts" that accompanied the settlement, although carefully worded, documents that JP Morgan misrepresented its offering documents and breached the representations and warranties made to investors in MBS. This included knowingly securitizing up to 50 percent of the loans that had been flagged by its third-party due diligence vendor as noncompliant with the originators' underwriting guidelines, as well as loans missing key documentation, such as appraisals and proof of income, employment, or assets. JP Morgan also ignored warnings from its own managers and allowed loans to be originated with no proof of the borrower's income or for which the vendor concluded that the borrowers overstated their incomes. Further, not only did JP Morgan not disclose these practices to investors, but on occasion declined requests from potential investors for specific data on the underlying loan pools or skewed the information that was provided.

Thus, while the Statement of Facts lacks some of the eyebrow raising quality of the allegations from the Federal Housing Finance Agency's complaint against JP Morgan (such as the allegations that Washington Mutual gave O.J. Simpson a second mortgage based on a note in the file stating that "the [civil] judgment [obtained by his deceased ex-wife's parents] is no good, because I didn't do it"), the AGs and DOJ certainly helped private plaintiffs by painting a fairly clear picture that JP Morgan misled investors by promoting its "solid underwriting platforms" while intentionally hiding its knowing disregard of the deficiencies of many of the underlying loans.

That said, while the settlement appears to check the accountability box by paying $4 billion to assist the homeowners allegedly harmed by JP Morgan's misconduct, it pointedly does not set aside any money to compensate the private investors, who by some accounts have experienced losses to the tune of $71 billion. Now that JP Morgan has resolved its regulatory exposure with AGs and DOJ, however, there is the potential that the bank will focus on settling the private investor lawsuits that are percolating in state and federal courts. JP Morgan's $4.5 billion deal announced last week with investors in 330 JP Morgan and Bear Stearns MBS trusts may be an indication that the bank intends to do just that (although it remains to be seen how many trustees will opt-out of that settlement, and whether approval will suffer a tortured fate like that of Bank of America's earlier attempt). Complicating this, however, for any investors who have not yet filed suit against JP Morgan (at least for those bound by New York law) is that a New York state appellate court will soon decide whether contractual putback claims for securitizations that occurred prior to 2008 are extinguished by the statute of limitations, or remain alive and well.

Undoubtedly, AGs have tools and power greater than private plaintiffs (for example, AGs in some states are not bound by the statute of limitations under the doctrine nullum tempus). But plaintiffs still would do well to study AGs' theories, lawsuits, and settlements for leverage that they can use in bringing their own claims. Private plaintiffs also may wish to coordinate their actions with those of AGs and other regulators to maximize pressure on banks and leverage their incentive to seek "global" peace by resolving regulator and private claims all at once.

And there is no doubt that AGs have been and will continue to be out in front on this issue. AG Schneiderman's office independently sued JP Morgan over MBS in October 2012 – which was resolved in this week's settlement – and also sued Credit Suisse asserting similar causes of action. California AG Harris's office subpoenaed Citigroup over its sale of MBS. AG Coakley's office investigated and reached settlements with Goldman Sachs, Morgan Stanley, and RBS, and continues to be active in this space, as does Nevada AG Catherine Cortez Masto, who reached similar settlements with Morgan Stanley and RBS. In addition, 19 states currently are suing Standard & Poor's alleging that it violated state Unfair Trade Practice laws by claiming that the high ratings it gave MBS were independent, while at the same time concealing that it sought and provided lucrative consulting services to the companies creating those same MBS.

The havoc wreaked by the financial crisis and its aftershocks cost homeowners, investors, and governments almost unimaginable losses. This week's $13 billion settlement, like the $25 billion settlement in 2012, represents a milestone in redressing that harm – but it is only one of the first milestones in a marathon that continues. Private plaintiffs should understand and appreciate the key role that AGs and other regulators are playing in this effort and account for and leverage AGs' creativity, authority, and tenacity as they seek their own recoveries.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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