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NYS Attorney General Sues Investment Bank for Issuing MBS with Weak Due Diligence

The New York State Attorney General has filed a lawsuit against a large investment bank alleging “multiple fraudulent and deceptive acts” in connection with mortgage-backed securitizations sponsored by a purchased firm. Making several broad allegations, the New York State Attorney General essentially alleges that the defendant did not conduct sufficient due diligence on the underlying mortgages even though it hired a third party. The NYSAG argues that the defendant intentionally pressured the third party with volume and turnaround requirements to ensure weak due diligence. Although the alleged conduct occurred at a firm purchased by the defendant, the NYSAG argues that the defendant could not have purchased the MBS sponsor without a $29 billion loan from the Federal Reserve Bank of New York. The lawsuit, filed in New York State court, charges violations of New York State’s Martin Act, which prohibits deceptive practices in securities transactions.

OUR TAKE: We think that the NYSAG makes a weak case. The defendant hired a third due diligence firm on which it relied, and the NYSAG does not suggest that the due diligence firm was somehow unqualified or incompetent. Also, it appears that the defendant purchased substantially all the assets of the predecessor firm, raising questions about whether the defendant is legally responsible for liabilities left at the purchased firm. Also, the generalized allegations do not allege a particular fraud or deception, but broadly assert that the defendant engaged in a systematic deceptive program. It is unclear whether such broad allegations will stand, even under New York State’s Martin Act, one of the broadest and most ambiguous state securities law statutes.

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