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The Year in Wall Street Investigations

Karen Weise

Activist Group Stages Mock Crime Scene On Wall Street Over Bank Bonuses. (Spencer Platt/Getty Images)

It's been over three years since credit markets started shaking with the
early tremors of the subprime crisis, and two years since that spread
into a marketwide collapse. Prosecutors, regulators, Congress and
journalists have spent the year uncovering the financial shenanigans
that brought the market to its knees. It's been marked by a few
blockbuster settlements and more revealing investigations -- as well as
by some noticeable inaction in the reckoning.

Let's start at the ground level, with selling risky mortgages to
homeowners. Nobody symbolized the subprime market -- from its growth to
its downfall -- better than former Countrywide CEO Angelo Mozilo. This
fall, the Securities and Exchange Commission reached a $67.5 million settlement [1]
with Mozilo in its only major case against a financial executive. The
SEC charged Mozilo with praising Countrywide to investors while
internally doubting its lending standards. As part of the settlement,
Mozilo admitted no wrongdoing.

Moving up the finance chain, we come to the banks that sold mortgage
deals to investors. Much of the scrutiny focuses on a type of mortgage
deal called collateralized debt obligations, or CDOs, which are
essentially bundles of other mortgage bonds that were sold off to

Though nearly every bank [2]
is rumored to be under investigation, the year was marked by one major
case looking at the CDO business. In April, the SEC accused Goldman
Sachs of creating a mortgage deal [3]
that was designed to fail. The SEC's argument was that Goldman's
hedge-fund client helped design the deal specifically to bet against it
-- without Goldman explaining the relationship to investors. In July,
Goldman settled for $550 million (or about two weeks' worth of profit [4]), admitting a "mistake" but no wrongdoing.

The idea of betting against deals lies at the center of a number of other investigations as well. The SEC is looking into [5]
whether JPMorgan Chase allowed a hedge fund named Magnetar to choose
assets for a mortgage deal without disclosing Magnetar's role in
selecting what went into the deal. As ProPublica reported in April with
the radio programs This American Life and NPR's Planet Money, Magnetar encouraged banks to put together riskier deals [6] and bought the riskiest bond slices that otherwise may have been unsold. Magnetar then bet against some of those deals [7], standing to make far more by shorting its losses on those risky slices if the housing market went south.

U.S. prosecutors are also looking into whether Morgan Stanley created a series of CDOs that its own trading desks bet against [8], the Wall Street Journal reported in May. A few months later it reported on how Deutsche Bank also bet against the souring housing market at the same time [9] it was marketing new mortgage deals.


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The SEC is also looking into whether Citigroup improperly encouraged an independent manager to stuff a deal with leftover pieces [10] of other deals that it couldn't sell in the market. In September, ProPublica and NPR's Planet Money reported on self-dealing [11] among CDOs, showing how banks structured deals to buy portions of each others' [12] often leftover inventory of hard-to-sell pieces. This created a daisy-chain of investments [13] that manufactured demand, thereby prolonging the housing bubble. The SEC has said it is investigating [14] one independent management firm and looking into about 50 others.

The year ended with rumors of mass settlements [15],
where banks and the SEC settle broadly over their CDO practices rather
than battling over individual deals, according to the Wall Street

Deal-by-deal fights may flame up in courts, however, with investors pushing banks to buy back sour deals, egged on by new evidence [16]
that banks may have known the mortgages underlying the deals were
flawed. With such complicated shenanigans going on behind the scenes,
investigators also want to know how banks hid their exposure to these
risky securities from investors. The investigations are looking into
various tactics, from general misstatements, like the Citigroup's $75 million settlement [17]
with the SEC for not disclosing $40 billion in subprime risk, to
accounting maneuvers that moved certain deals off bank balance sheets.

In the spring, a court-appointed examiner in the bankruptcy of failed
investment bank Lehman Brothers shined a light on a practice known as
"Repo 105," where Lehman moved $50 billion in assets off its books right
before it had to submit investor reports. Last week, the New York
attorney general filed civil charges against the accounting firm Ernst & Young [18],
saying it had "substantially assisted" Lehman's "house-of-cards
business model" that misled investors. Executives from the now-bankrupt
Lehman have not been charged.

Despite revelations coming up and down the financial spectrum, there
have been no major criminal charges and almost no civil charges against
executives. And while the SEC and some government prosecutors have been
active, federal bank regulators have so far been quiet [19].

This all comes as Congress passed the Dodd-Frank financial reform bill
this summer, seeking to overhaul the oversight of everything from
mortgage securities to how banks make bets with their own money. As
regulators hammer out the rules of the reforms, the devil may lie in the
hotly contested [20] details.

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