What was the role of the Securities and Exchange Commission in the collapse of the subprime mortgage bubble? Although mortgage brokers, investment banks, and ratings agencies are frequently held responsible for the demise, little is said about the roles of the Financial Industry Regulatory Industry (FINRA) and the SEC-both watchdog agencies that are responsible for monitoring complex credit derivatives and their suitability requirements for investors.
Yet where was the SEC when it was time to oversee investment banks and determine whether they had sufficient capital for their balance sheets, trading positions, and the appropriate risk management systems so that major losses could be avoided?
One notable problem is that there is not enough clear data available about the credit derivatives market. Structured finance products, including collateralized debt obligations (CDOs) are traded over-the-counter in the United States. This means that price information for these products is not easily accessible.
It wasn’t until 2007 that the SEC, the Commodities Futures Trading Commission (CFTC), and other members of the President’s Working Group recommended that stricter oversight of the over-the-counter market be implemented.
While regulators are now examining the way banks structured, priced, and sold mortgage-laden securities, some industry insiders feel that these steps were taken too late. Should the SEC have noticed the warning signs?
In 2006, Merrill Lynch senior executive Jeff Kronthal was fired when he responded reluctantly to former Chief Executive Stanley O’Neal’s mandate that firms be more aggressive about taking risks with mortgage securities. Morgan Stanley’s new Chief Executive John Thain rehired Kronthal last December.
In 2005, Bear Stearns reported in its 2005 financial disclosure that it was threatened by a possible civil enforcement action related to pricing, analysis, and valuation of $63 billion in CDOs. Bear Stearns also reported that then-New York Attorney General Eliot Spitzer had contacted the firm about $16 billion in CDOs it had sold to an undisclosed client.
Former SEC attorney Gary Aguirre says that while aggressively pursuing Pequote Capital and its alleged involvement in an insider trading case in 2005, he was fired when he tried to interview Morgan Stanley Chief Executive John Mack. Aguirre claims that the SEC is too closely associated with the industry it regulates.
Earlier this month, securities regulators in Massachusetts filed a civil fraud lawsuit against Merrill Lynch over $14 million in CDOs that the firm sold to the town of Springfield. Regulators say they were unsuitable for and sold without the town’s permission. Merrill has admitted to the town’s lack of consent and paid its investment back in full-although it now has little value.
The Federal Bureau of Investigation says it is conducting criminal investigations into 14 firms regarding their involvement in mortgage securitization activities.
Morgan Stanley, Merrill Lynch, Bear Stearns, and Goldman Sachs all admit that different regulators have asked them about their handling of subprime mortgage securities.
If you are an investor who has lost money because of the misconduct or negligence of someone in the securities industry, please contact Shepherd Smith and Edwards today. Your first consultation with one of our stockbroker fraud lawyers is free.
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