With Feds Trolling, Herring Catches Big Banks Red Handed

Virginia Attorney General Mark Herring is sick of hearing that big Wall Street banks have gotten away with it. Especially, when the evidence of wrongdoing is so pervasive.

So, this week, Herring filed a 302-page lawsuit against some of the largest financial institutions in the world.


Barclays Capital Inc.

Citigroup Global Markets Inc.

Countrywide Securities Corporation

Credit Suisse Securities (USA) LLC

Deutsche Bank Securities Inc.

Goldman, Sachs & Co.

RBS Securities, Inc.

HSBC Securities (USA) Inc.

Morgan Stanley & Co. LLC

UBS Securities LLC

WAMU Capital Corp.

J.P. Morgan Securities LLC (and as current owner of Bear, Stearns & Co.)

Merrill Lynch, Pierce, Fenner & Smith Incorporated(and as current owner of Banc of America Securities LLC)

The lawsuit alleges fraud committed against Virginia taxpayers during the height of the real estate bubble.

A lawsuit unsealed in Richmond Circuit Court seeks $1.15 billion in damages against thirteen banks that are each accused of fraudulently misleading the Virginia Retirement System (VRS) during the sale of residential mortgage-backed securities (RMBS) to the state retirement fund.

The VRS was entitled to accurate information about the underlying mortgages when making decisions on how to invest taxpayer money and contributions by employees. Instead, these large banks purposefully included high-risk mortgages in securities and fraudulently misrepresented the quality of those loans to rating agencies and large investors like VRS.

The securities were purchased starting around 2004, and before 2010, Virginia was forced to sell the vast majority of these toxic securities built on junk mortgages and lost $383 million.

In 2013, VRS was funded approximately 66% by Virginia taxpayers and 33% by contributions from state employees, with nearly 600,000 members including 145,000 teachers, 105,000 employees of city and county governments, and 78,000 state employees, as well as state troopers, local law enforcement, and court employees.

This is a rare state-level action brought by an Attorney General to hold banks accountable specifically for damages their fraud and recklessness caused state taxpayers through a public retirement system.

It is the largest financial fraud action ever brought by the Commonwealth of Virginia and is the largest case ever brought under the Virginia Fraud Against Taxpayers Act.

The Commonwealth will also seek civil penalties against each bank in the amount of $5,500-$11,000 for each violation.

“The message today is clear. It doesn’t matter if you’re a small-time con artist or a multi-billion dollar Wall Street bank. If you try to rip off or defraud Virginia consumers or Virginia taxpayers, you will be caught and you will be held responsible,” Herring said.

“Every Virginian was harmed by the financial crisis. Homes were lost, retirement accounts were devastated, small businesses saw their credit dry up almost overnight, and state and federal budget cuts hurt vulnerable Virginians. It will take many more years to recover the economic strength and stability we lost, but I will not allow Virginians to be left holding the bag for the reckless, fraudulent business practices of a few big banks who thought they were above the law. These banks lied to Virginia, and taxpayers and state employees lost hundreds of millions of dollars as a result.”

Each bank is alleged to have bundled risky residential mortgages into securities which were then sold to VRS in various quantities.

While the banks offered the securities to VRS as stable, solid investments, an analysis shows that nearly 40% of the 785,000 mortgages backing 220 securities purchased by Virginia’s retirement system were fraudulently misrepresented in a way that made them a significantly higher risk for default.

Herring said that these banks knew, or should have known, that claims they made about the quality of the mortgages were false, but they systematically disregarded and hid their own evaluations, and third-party evaluations, that revealed just how risky these securities were.

As a result, the Commonwealth of Virginia suffered hundreds of millions in losses after receiving and relying on this false information.

Herring alleged that the banks misrepresented the loan-to-value ratio of mortgages. A higher loan-to-value ratio significantly raises the risk of default. Across all banks, it was claimed that only 23.4% of loans were for more than 80% of the value of the property, when in reality, it was 54%.

Additionally, 15% of homes were underwater, with mortgages that exceeded the value of the home.

Herring alleged that the banks isrepresented the owner occupancy rate of the homes.

Borrowers are more likely to default on a home they do not occupy, such as a vacation home or rental property.

Herring also alleged that the banks misrepresented the percentage of homes with a second mortgage–This is a major risk factor for default because borrowers with second loans tend to have fewer assets relative to the amount they have mortgaged.

Hundreds of securities that were offered at AAA or similarly high ratings with a 0.00% mortgage delinquency rate were eventually downgraded significantly as delinquency rates of the mortgages skyrocketed, in some cases as high as 75%.

While the losses to the Virginia Retirement System are estimated at $383 million, the law allows Virginia to seek “treble damages,” or three times the actual damage, as compensation and to deter this kind of conduct.

It is expected that money recovered as part of this suit will be returned to Virginia taxpayers and that damages suffered by VRS will be redressed.

The fraud was reported to the Commonwealth using a provision of the Virginia Fraud Against Taxpayers Act which incentivizes and allows whistleblowers to report fraud against Virginia taxpayers.

After closely examining the evidence collected by the whistleblower and finding it to be accurate and convincing, Attorney General Herring is bringing the case on behalf of Virginia taxpayers.

The whistleblower, a financial modeling and analysis firm called Integra REC, LLC, discovered the fraud using sophisticated proprietary methods to match-up the RMBS purchased by VRS with the actual mortgages and properties they contained.

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