Chairman Cox Comments on SEC’s Enforcement Role in Subprime Crisis

In a series of House Committee on Appropriations meetings this week, high ranking members of the SEC, FDIC, and IRS have given testimony before the Financial Services and General Government subcommittee concerning the subprime lending crisis.  Notably, SEC Chairman Christopher Cox told the subcommittee that through its newly minted task force, the Commission is examining whether or not sellers of portfolios of subprime mortgages packaged into securities provided proper disclosures to the buyers.  In responding to the recent subprime scandal – subprime loans are loans made to borrowers with low credit scores – Mr. Cox said, according to Bloomberg, “To the extent that these loans are securitized and to the extent that they become part of problems, fraud or accounting problems related to that, we want to be there as enforcers.”  Similarly, according to the AP, in mid-march SEC Director of Enforcement Linda Thomsen indicated that the Commission is looking into “all the actors and their roles.”

The subprime scandal came into focus around the beginning of March when reports surfaced that Federal prosecutors and securities regulators were investigating sales in the shares of New Century Financial Corporation.  Reportedly, the SEC had requested a meeting with New Century executives and, on February 28, New Century learned of a parallel criminal investigation in the United States attorney’s office in Los Angeles.  The “mortgage meltdown” however, has been a building storm for many subprime lenders.  As the housing bubble continued to expand, many lenders looked favorably at providing loans to people unable to qualify for conventional loans.  When housing prices failed to rise and low interest rate ARMs converted to higher interest rates, many of the subprime borrowers defaulted on their loans.  While it is a laudable service to assist people who otherwise would not be able to own a home, since last year several such companies have gone bankrupt.  The resulting scrutiny has put the remaining lenders in the hot seat.

Although Mr. Cox did not provide detail as to the number or identity of the companies the Commission is currently investigating, clearly the SEC poised to launch a wide-scale investigation.  As Ms. Thomsen notes, the SEC will look at all key players, including gatekeepers such as lawyers and accountants.  In view of the current Congressional and regulatory focus in this area and the continuing media coverage, subprime lenders and related persons will continue to be an area of intense interest by the SEC, DOJ and others.  Companies in this line of business would be well advised to carefully review their lending practices and the public disclosures made in connection with any transactions with counsel versed in responding to SEC inquiries before a subpoena or request for information is served, if at all possible.  Being out in front of any such request typically permits the company to control the inquiry and, if there is a difficulty, obtain a better resolution of the matter.