FBI, IRS, USAO, SEC Subprime Investigations Ongoing; Accounting Update: Roper, Bellaire Weigh In on Principles vs. Rules in WSJ

A slew of federal and state agencies continue to examine whether fraud was a component of the subprime mortgage debacle and related losses on loans and investments in mortgage-backed securities and related derivatives.

The investigation into potential fraud is focusing on at least three fronts, as described in the article “Wall Street, Lenders Face Subprime Scrutiny” by Amir Efrati in today’s Wall Street Journal:

• “whether officials made misrepresentations in securities filings about a company’s financial posiion and the quality of its mortgage loans, including failing to disclose a rising number of loan defaults, or engaged in questionable accounting to hide losses.”
  
• “whether companies doctored information about borrowers, such as credit histories, before making loans and selling those loans to banks or Wall Street firms, which packaged them into securities and sold them to investors.”
  
• “whether brokers at Wall Street firms lied to investors, orally or otherwise, by stating that their investments in vehicles known as collateralized-debt obligations were backed by, for example, corporate debt rather than assets such as subprime-mortgage loans.”
  

Efrati describes a task force of federal, state and local agencies being led by prosecutors from the U.S. Attorney’s Office in the Eastern District of New York, and that the task force held its first formal meeting on Friday with representatives from the FBI, U.S. Secret Service, and others. He notes additional investigations are being pursued by the U.S. attorney’s office in Manhattan, the New York State Attorney General’s Office, and the SEC.

Separately, Lynnley Browning reports in “Government Intensifies Mortgage Investigation,” in today's New York Times that an FBI-IRS led task force formed in January is stepping up its examination of the mortgage crisis and related write-downs and losses. Browning notes this task force includes federal prosecutors from five states.

Accounting Update
On the topic of accounting for subprime, see also: “Rule Clouds American Capital – Revaluing of Loans is Likely to Force Big Write-Downs,” by Peter Eavis in today’s WSJ. Referring to FAS 157, Fair Value Measurement, Eavis says: “The new accounting rule, with its emphasis on sale prices, could force American Capital to write down the value of its loans so those values are more in line with values posted by its peers.” He adds, “These valuation gaps aren’t small.”

See also our summary of last week’s FASB board meeting: “FASB Moves Closer To Proposing Guidance On Credit Derivatives, Hedging.”

Principles vs. Rules and FINRA
Another article of interest in today’s WSJ is an article by Jaime Levy Pessin highlighting a ‘debate’ on the topic of principles vs. rules – with particular emphasis on the Financial Industry Regulatory Authority (FINRA) – including the views of Consumer Federation of America’s Barbara Roper (Roper is also a member of the PCAOB's Standing Advisory Group or SAG), and Financial Services Institute Inc.’s David Bellaire. The article is entitled: “Is It All in the Details? Broad principles vs. nitpicky rules: a debate over the best way to get securities brokers to behave.”

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