THE NEW RMBS WORKING GROUP: NEW INQUIRY OR OVERREACHING?

The Residential Mortgaged Backed Securities Working Group it the newest government initiative to investigate the mortgage securitization process which many believe is at the core of the recent market crisis. The new task force was announced by the President in his State of the Union speech last week. Attorney General Eric Holder added details to that announcement in a Friday press conference.

The Working Group will apparently operate within the construct of the President’s 2009 Financial Fraud task force. That group is an inter-agency task force which was designed to marshal the resources of the federal government by creating a mechanism for agencies to meet and share information regarding their respective law enforcement efforts. It is largely an information sharing mechanism to economize and streamline the efforts of the federal government.

The new Working Group differs since it brings together federal and state law enforcement authorities. Those agencies apparently will contribute specific prosecutors and investigators to a group which ultimately will be composed of about 50 members. The group apparently will operate out of the Department of Justice and within the framework of the 2009 task force but will not overlap prior efforts, according to the Attorney General.

The new Working Group is off to a fast start. By Friday it had issued 11 civil subpoenas to financial institutions for records. The financial institutions have not been identified. The focus of the subpoenas also has not been identified. The question is, what is its purpose? To be sure the President and the Attorney General, along with the SEC Enforcement Director who also participated in the Friday news conference, made it clear that they intend to hold accountable those who broke the law and committed fraud in connection with the securitization process. Consumers apparently will also somehow benefit from all of this.

The question remains however: What is the focus of this new Working Group? The securitization process has already been investigated for years by multiple agencies. The Department of Justice has conducted criminal investigations which resulted in prosecutions such as the one against Lee Farkas, former Chairman of collapsed mortgage lender Taylor, Bean and Whitaker. The SEC has brought civil cases such as those against the former senior executives of sub-prime mortgage giant Countrywide Financial and Wall Street icon, Goldman Sachs & Co. Dozens of private damage actions have been brought, many of which are currently in litigation. Each agency has touted its success in this area. Regardless of one’s view of this record, after all this effort the question remains: What is the point of this new Working Group?

One answer is that it is going to focus more on the impact of the securitization process on consumers and search for ways to aid them and quell the on-going difficulties in the housing market. While this would seem to be the charge of the new Dodd-Frank consumer protection agency, if this is the point, it at least differs from the earlier investigative focus of many agencies. Under these circumstances it may make a positive contribution to the over all situation.

If the purpose of the new Working Group is to quell the populist notion that the architects of the market crisis must go to prison, it is treading on dangerous ground. Any prosecutions of senior financial institutions executives stemming from this new effort will begin with questions about the fairness of the charges. After all the investigative efforts into this question and the determination of many agencies such as the DOJ and the SEC not to charge these executives, it will be difficult at best to establish that suddenly something new, something missed, something meriting criminal prosecution now appeared and justifies the extreme of criminal prosecution. No doubt defense lawyers will scream foul from the very first moment that such charges are brought. And, that claim will have the ring of truth given the circumstances.

Perhaps more importantly, given the pressure from politicians and the public to “put the crooks in jail,” the environment is ripe for prosecutorial over-reaching. The history of such zealous prosecutions is repeat which unsavory and unfair tactics. The option backdating prosecutions are a recent example. Prior to 2006 when the first criminal and civil cases were brought simultaneously, little regulatory attention was given to this issue. Yet once the notion hit the public airwaves in articles published in the Wall Street Journal it became the “flavor of the moment.” The DOJ and the SEC rushed to bring cases. The result was, in many instances, prosecutorial overreaching.

The Broadcom cases are the best example. There co-founds Henry Samueli and Henry Nichols and former CFO William Ruehle were charged criminally and civilly with securities fraud keyed to option backdating claims by, respectively, the DOJ and the SEC. The prosecutions were high profile and headline grabbing. After years of dragging through the courts and millions of dollars in defense fees, the court in the criminal cases found prosecutorial abuse and overreaching which lead to the dismissal of the criminal and civil charges. Kent Roberts, the former General Counsel of McAfee was more fortunate. After years of litigation a jury finally ended his ordeal, rejecting the government’s option backdating claims. While each man has now been cleared, nothing can restore their reputations or the years of agony they endured as a result of over zealous prosecutions.

If the new Working Group is a response to the populist sediment the likelihood of another Broadcom debacle looms large. That type of a result will not quell the populist sediment. More importantly it is not justice. Rather, it undermines the very foundations of the justice system. Perhaps more importantly however, it unfairly destroys the lives and reputations of those caught in its web. Just ask Henry Samueli, Henry Nichols, William Ruehle or Kent Roberts.