Preet Bharara, United States Attorney for the Southern District of Small Fry

Preet Bharara, the US Attorney for the Southern District of New York filed a civil complaint last Fall against Bank of America and Country for fraudulent sales of garbage mortgages to Fannie Mae and Freddie Mac. It’s a civil fraud complaint, not a criminal indictment. When the original complaint was filed, Bharara’a office said that it might be amended to add individual defendants, and now we see who that is, yet another minion, not a CEO. Now we have an amended complaint naming one human person, Rebecca Mairone, as a defendant. She was the Chief Operating Officer of the Full Spectrum Lending division of Countrywide.

The Rules of Civil Procedure require that a complaint alleging fraud “…must state with particularity the circumstances constituting fraud or mistake.” The amended complaint should meet that requirement; it is full of particularity. In 2007, the private market for resale of mortgages dried up. The only loan purchasers were Fannie Mae and Freddie Mac, which are called Government Sponsored Entities (GSEs). They began to tighten their requirements for purchase of mortgage loans. That tightening was reflected in the documents governing purchase of loans, which means that Countrywide knew that the standards were tighter.

Countrywide had focused on subprime loans, but the GSEs weren’t buying those any more. Countrywide responded by increasing its efforts to originate prime loans. As part of that program, it established the High Speed Swim Lane to move those loans through the acceptance process. The acronym HSSL was quickly converted to the more telling “Hustle”. The complaint allegesthe steps taken to speed up the process. Among other things,

1. Layers of quality control were removed; staff was required to close a loan a day, and could not leave until they had done so;

2. The compensation structure was changed to award bonuses solely based on speed, while quality of loans was irrelevant, in that bad loans did not undercut the bonus;

3. Inexperienced people were given authority to approve loans, again with bonuses based on the number approved:

4. Countrywide used a system called CLUES for inputting loans and getting a preliminary assessment of viability. It turns out that you can reenter the data over and over until you get an acceptance; and the complaint alleges that this was regularly done.

As a result, material defects increased to nearly 40%, far in excess of the industry standard defect rate of 4-5%. Countrywide executives, including Mairone, knew this.

The Amended Complaint asserts that Countrywide knew all this and intentionally concealed it from the GSEs as it sold the loans to them:

103. Well aware that its defect rates drastically exceeded the industry standard, Countrywide concealed them from the GSEs with the knowledge that the GSEs would not conduct any meaningful review of the loan files for many months.

There was a fear that internally generated reports of material defect rates would threaten the sale of Countrywide to Bank of America. Countrywide aggressively worked to reduce material defects by paying its quality control people bonuses based on rebuttals. This process was an open door to further fraud. For example, the allegation that a borrower’s stated income was unreasonable could be rebutted by arguing that it made sense. Paragraph 107. That caused the reported material defect rate to drop from 37% to 13%

The Complaint alleges that Countrywide misrepresented that its loans met the requirements of the GSEs for purchase. It gives six examples of bad loans, describing the misrepresentations in detail. The government says that Countrywide and Bank of America intentionally thwarted the mortgage repurchase process by refusing to repurchase loans after material defects were uncovered, usually after a default on allegedly specious grounds. The GSEs incurred about $14 billion in losses on loans it demanded that Countrywide repurchase.

In summary, a nice complaint, replete with detail and explanation.

Here is the claim against the bank defendants:

219. For purposes of fraudulently obtaining money from the GSEs, from at least 2006 through 2010, the Bank Defendants knowingly, or acting in deliberate ignorance and/or with reckless disregard of the truth, executed a scheme and artifice to defraud, using interstate mail carriers and interstate wires, in violation of 18 U.S.C. §§ 1341 and 1343. Specifically, the Bank Defendants knowingly, or acting in deliberate ignorance and/or with reckless disregard of the truth, originated loans in violation of GSE guidelines; concealed the Hustle model and the resulting defect rates on Hustle loans; and sold loans originated under the Hustle model to the GSEs while knowingly, or acting in deliberate ignorance and/or with reckless disregard of the truth, misrepresenting that they complied with the guidelines.

The statute of limitations for a criminal violation is 10 years, but as we all know, there are no criminals on Wall Street, only greedy people. The worst part is that once again we see the lowest possible person get the blame. It is inconceivable that others in the management group, both above and below Mairone, were unaware of these facts. Yet only Mairone is sued; Angelo Mozilo, the principle in the company is walking with all his money and all his reputation intact.

Preet Bharara is mentioned as a possible replacement for Attorney General Eric Holder, if Holder ever agrees to leave. His supporters point to his cases against Wall Street, mostly insider trading, and the favorable press they generate, like this cover of Time Magazine. This amended complaint shows once again why Wall Street will cheer the guy on. He hasn’t done anything to anyone who counts.