Regulatory investigations and the credit crisis: The search for villains

American Criminal Law Review

Volumn 46, Issue 2, 2009, Pages 225-273

  Ceresney, Andrew J ^a   Eng, Gordon ^b   Nuttall, Sean R ^b  

^a Debevoise and Plimpton LLP   (United States)

^b NONE   (United States)

Author keywords

[No Author keywords available]

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EID: 67650519664     PISSN: 01640364     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (365)

1. See, e.g., Rich Miller & Simon Kennedy, Annus Horribilis Peaks in Anxiety for Global Economy, BLO0OMBERG.COM, Dec. 15,2008, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aTblrle.BCkY# (last visited Mar. 20,2009) ("2008 has been the Annus Horribilis for markets, and 2009 is shaping up to be the Annus Horribilis for the economy.") (quoting chief economist at UniCredit MIB in London); Wall Street's Annus Horribilis, ECONOMIST, Dec. 11,2008, available at http://www.econorImt.com/finance/PrinterFriendly.cfm?story- id= 12777703.
2. Pursuant to the Emergency Economic Stabilization Act, passed on October 3, 2008, the Secretary of the Treasury is authorized to establish the Troubled Asset Relief Program ('TARP") to purchase, and to make and fund commitments to purchase, troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary in accordance with the Act. Pub. L. No. 110-343, § 101(a)(1), 122 Stat. 3765,3767 (2008) (codified at 12 U.S.C. § 5211). The Act provides for funding up to a total limit of $700 billion. 12 U.S.C. § 5225. The program has been used in part to fund capital infusions by the government into U.S. financial institutions and other corporations totaling approximately $302 billion as of March 20,2009. See The Committee For a Responsible Federal Budget, US Budget Watch, http.7/www.usbudgetwatch.org/stimulus?filter0= 80&filterl= &filter2=&filter3= (last visited Mar. 20,2009).
3. See Mark Landler, Dire Forecast for Global Economy and Trade, N.Y. TIMES, Dec. 9,2008, at Bl ("As the World Bank's experts struggled to find a historical analog for the slump, they said it had more in common with the Depression of the 1930s than with the severe recessions of the 1970s or 1980s.").
4. We use the term "credit crisis" as a general label for the financial havoc that began in 2007 with the writedowns by banks and other financial institutions due to exposure to subprime residential mortgages and that has since led to a general deterioration in the credit and equity markets.
5. Subprime mortgages are loans made to borrowers who have impaired creditworthiness because of weak credit histories, payment delinquencies, charge-offs, judgments or bankruptcies, lower credit bureau risk scores ("HCO scores"), or other characteristics that are associated with higher probabilities of default. See Julie R. Caggiano et al., Subprime Mortgage and Predatory Lending Law Developments, 63 Bus. LAW. 625, 625-26 (2008);
6. see also DOUGLAS J. LUCAS ET AL., COLLATERALIZED DEBT OBLIGATIONS: STRUCTURES AND ANALYSIS 113 (2d ed. 2006) (describing subprime mortgages).
7. See infra Part JJ..A.
8. In a CDO, issuers offer securities to investors and use the money raised to purchase a portfolio of financial assets such as corporate loans, credit card receivables, or mortgage-backed securities. Under the CDO arrangement, cash flows from the underlying asset portfolio are distributed to investors in a set priority determined by the relative seniority of the securities, called "tranches." See DOUGLAS J. LUCAS ET AL., DEVELOPMENTS IN COLLATERALIZED DEBT OBLIGATIONS: NEW PRODUCTS AND INSIGHTS 3 (2007).
9. See infra Part II.B.
10. See infra Part JJ..C.
11. See infra Part III. A. In many of the areas state law enforcement agencies have been active, federal agencies also have been involved or launched their own investigations. Similarly, state law enforcement agencies have opened investigations into some of the areas where their federal counterparts have focused. As this article discusses, the investigations led by state law enforcement into predatory lending practices, rating agency decisions, and disclosures about auction rate securities provide an interesting contrast to the investigations led by federal law enforcement into mortgage fraud, valuation issues at major financial institutions, and short selling. Thus, it is useful to make a distinction between areas where federal law enforcement has focused and those where state law enforcement has focused, notwithstanding the absence of a completely clean division.
12. See infra Part III.B.
13. See infra Part IH.C.
14. Cf. White Collar Crime Prof Blog, Fraud is the "In" Crime, http://lawprofessors.typepad.com/ whitecollarcrime-blog/2009/03/fraud-is- the-in.html (Mar. 1, 2009) (last visited Mar. 20,2009) (noting that DOJ has growing number of fraud cases "dropping in its lap" as more investors scrutinize their investments).
15. See Amir Efrati et al., Top Broker Accused of $50 Billion Fraud: Sons Turned in MadoffAfter He Allegedly Told Them His Investment-Advisory Business for the Wealthy was Giant Ponzi Scheme, WALL ST. J., Dec. 12., 2008, at Al (describing SEC and FBI actions against Madoff);
16. see also Glenn R. Simpson et al., The Stanford Affair: Madoff Case Led SEC to Intensify Stanford Probe, WALL ST. J., Feb. 19, 2009, at A14 (describing SEC civil action against R. Allen Stanford);
17. Steve Stecklow, In Echoes of Madoff, Ponzi Cases Proliferate, WALL ST. J., Jan. 29,2009, at Al (describing six multimillion dollar fraud cases including alleged Ponzi schemes).
18. This is in sharp contrast to the civil realm, in which class actions suits have been filed at a torrid pace. 607 subprime-related civil cases were filed in the 18 months ending June 30, 2008; 249 (41%) of these cases were securities class actions. See Subprime Mortgage Litigation Filings Surpass S&L Benchmark, Navigant Consulting Study Finds More Subprime-Related Lawsuits Filed So Far in 2008 Than All of2007, REUTERS.COM, Sept.ll, 2008, http://www.reuters.com/article/pressRelease/idUS165694+ll-Sep- 2008+BW20080911 (last visited Mar. 20,2009). By contrast, 599 civil cases were filed during the entire S&L crisis in the early 1990s. See id.
19. IMF's Financial General Plots Strategy to End the Credit Crisis, TELEGRAPH.CO.UK, Apr. 15, 2008, http://www.telegraph.co.uk/finMce/ newsbysecto strategy-to-end-the-credit-crisis.html Oast visited Mar. 20,2009).
20. John C. Dugan, Comptroller of the Currency, Remarks Before the Office of the Comptroller of the Currency's 2008 Managers' Conference (Oct. 20,2008), hrtp://www.occ.treas.gov/ftp/release/2008-126a.pdf Oast visited Mar. 20,2009).
21. Rodney Yap & Dave Pierson, Banks'Subprime Market-Related Losses Top $713 Billion, BLOOMBERG.COM, Nov. 25,2008, http://www.bloomberg.com/apps/news?pid=20601109&sid=aQBNVIONOiAc (last visited Mar. 20,2009). Since July 2007, these financial institutions have raised more than $855 billion in capital to cope with these losses. Id.
22. The IMF in its Global Financial Stability Report ("GFSR"), issued in October 2008, increased its estimate of total near-term global losses on U.S. credit-related debt from $945 billion in its April 2008 GFSR to $1.4 trillion. The upward revision reflects its increased loss estimates on corporate debt and prime residential mortgages, reflecting the "deterioration in the debt of financial institutions since April," and "a more negative base case home price scenario." INT'L MONETARY FUND, GLOBAL FINANCIAL STABILITY REPORT: FINANCIAL STRESS AND DELEVERAGING, MACROECONOMIC IMPLICATIONS AND POLICY, OCTOBER 2008, at 66 (2008), available at http://www.imf.org/external/pubs/ft/gfsr/2008/02/pdf/text.pdf;
23. see also Robin Goldwyn Blumenthal, Yes, That's $2 Trillion of Debt-Related Losses, BARRONS.COM, Aug. 4, 2008, http://online.barrons.com/article/SB 121763156934206O07.html?page=l (last visited Mar. 20, 2009) (quoting estimate by economist Nouriel Roubini that financial crisis will lead to credit losses of at least $1 trillion and "most likely closer to $2 trillion").
24. Knowledge@Wharton, Collateralized Damage: Commercial Mortgage Securities Are at a Standstill, RESEARCH AT PENN, July 23, 2008, htrp://www.upenn.edu/pennnews/researchatpenn/articleprint.php? 1471&bus (last visited Mar. 20,2009) (quoting Wharton Professor Todd Sinai as saying "[t]he liquidity crunch is across the board.").
25. Press Release, Real Estate Roundtable, Real Estate CEOs Foresee Dark Clouds on Economic Horizon; Paralyzed Credit Markets, Property Value Expected to Drop Further 0 (Nov. 19, 2008), http://www.mortgagemag.com/news/2008/1116/ 1000009815070.htm (last visited Mar. 20, 2009) ("Real estate is now experiencing a seismic liquidity shock.").
26. See Dakin Campbell, Broker-Dealers Face Auction-Rate Failures: Fourteen Banks See As Much As $10B Fail, BOND BUYER, Feb. 14,2008, at 1 (describing liquidity shortages in auction rate securities market).
27. See Fitch Comment: Bank Agreements & Revolving Credit Draws, Bus. & FIN. WK., Oct. 11,2008, at 570 (describing lack of liquidity in commercial paper market).
28. Tim Grogan & Steve Setzer, All Sectors Go Negative Next Year As A Real Recession Rattles Markets, ENGINEERING NEWS- RECORD.COM, Nov. 12, 2008, http/ermc»nstruction.comeatures/ bi2ibor/archives/081112-l. asp (last visited Mar. 20, 2009) ( "[TJhere is an unprecedented backlog of long-term project-related municipal debt waiting to come to market, but the market remains frozen.") (citing managing director of Municipal Market Advisors).
29. See E.S. Browning, After the Collapse, Guarded Hope for '09, WALL ST. J., Jan. 2,2009, at Rl (reviewing financial crisis developments in 2008).
30. See Editorial, And Then There Were None: What the Death of the Investment Bank Means for Wall Street, ECONOMIST, Sept. 25, 2008, available at http://www.economist.com/finance/displaystory.cfm?story-id= 12305537&fsrc=rss; Editorial, The End of Wall Street, WALL ST. J., Sept. 23,2008, at A28.
31. See Eric Dash, American Express To Be Bank Holding Company, N.Y. TIMES, Nov. 10,2008, at B2; Kerry E. Grace, CIT Looks to Transform Into Bank, WSJ.COM, NOV. 13, 2008, http://online.wsj.com/article/SB122659073481624621.html (last visited Mar. 20,2009).
32. Even GMAC Financial Services, the financing arm of General Motors, has changed its capital structure to qualify as a bank holding company in order to be eligible for TARP funds. See Maurna Desmond, GMAC's Inside-Out TARP, FORBES.COM, NOV. 20, 2008, http://www.forbes.com/ 2008/ll/20/gmac-tarp-capital-markets-equity-cx-md-1120marketsll.html (last visited Mar. 20,2009).
33. See Laura Meckler, Obama Signs Stimulus into Law, WSJ.COM, Feb. 18,2009, http://online.wsj.com/article/ SB123487951033799545.html (last visited Mar. 20,2009).
34. See Damian Paletta & Stephen Fidler, G-20 Commits to Recovery Measures, Not Stimulus Spending, WALL ST. J., Mar. 16,2009, at A6.
35. For a concise treatment of the catalysts of the credit crisis, see generally JAMES R. BARTH ET AL., MILKEN INSTITUTE, THE RISE AND FALL OF THE U.S. MORTGAGE AND CREDIT MARKETS (2009), available at http://www.milkeninstitute.org/pdf/Riseandfallexcerpt.pdf.
36. Structured products are nonstandard financial instruments specifically tailored to meet client needs. Structured products may not trade actively; in such instances (as has occurred for many structured products during the credit crisis), financial institutions must rely on a model to determine the price they charge for these products. The risk of mispricing these instruments accordingly is much greater than for actively traded products that are regularly quoted on exchanges. See JOHN C. HULL, RISK MANAGEMENT AND FINANCIAL INSTITUTIONS 351-52 (2007).
37. Fixed-income securities typically promise the investor a specified cash flow (or multiple cash flows) at a specified time or times in the future. If all of these cash flows (except for the last one) are of the same size, they are generally referred to as coupon payments. The specified date beyond which the investor will no longer receive cash flows is known as the maturity date. On this date, the investor receives the principal (also known as the par value or face value) associated with the security, along with the last coupon payment. Examples of fixed-income securities range from ultra-safe U.S. Treasury Bonds to bonds issued by private or foreign corporations or other entities of varying degrees of credit risk. See WILLIAM F. SHARPE ET AL., INVESTMENTS ch. 14 (5th ed. 1994).
38. See Timeline: The Credit Crunch of2007/2008, REUTERS.COM, Aug. 5,2008, http://www.reuters.com/article/gc06/idUSL155564520080805 (last visited Mar. 20,2009).
39. See id.
40. See Jody Shenn & Shannon D. Harrington, Subprime Mortgage Bond Risks Surge, Index Suggests, BLOOMBERO.COM, Feb. 8, 2007, http://www.bloomberg.com/apps/news?pid=20601103&sid=a3ztUp9Z6-UE&refer= us (last visited Mar. 20,2009).
41. See Kate Kelly et al., Two Big Funds at Bear Stearns Face Shutdown, WALL ST. J., June 20,2007, at Al.
42. See Matthew Goldstein & David Henry, Bear Stearns Bets Wrong, Bus. WK., Oct. 22,2007, available at http://www.businessweek.com/magazine/content/07-43/b4055001.htm (detailing the collapse and bankruptcy of the Bear Steams hedge funds).
43. See Jenny Anderson, Goldman and Investors to Put $3 Billion Into Fund, N.Y. TIMES.COM, Aug. 14,2007, http://www.nytimes.com/2007/08/14/business/14goldman.html (last visited Mar. 20,2009).
44. See Serena Ng & Ruth Simon, Rating Cuts By S & P, Moody's Rattle Investors, WALL ST. J.,'July 11,2007, atAl.
45. 'See Bloomberg News, Fitch May Downgrade Bonds Tied to Subprime Mortgages, N.Y. TIMES, July 13, 2007, at C7.
46. See Bradley Keoun, Merrill Lynch Reports Loss on $8.4 Billion Writedown, BLOOMBERG.COM, Oct. 24, 2007, http://ww.bloomberg.com/apps/news?pid=20601087&sid=aL9aYm7aCkqY&refer= hom (last visited Mar. 20,2009).
47. See Mark Landler & Julia Werdiger, UBS Records a Big Write-Down and Sells a Stake, N.Y. TIMES, Dec. 11 2007, at CI.
48. See Joe Bel Bruno, Morgan Stanley Reports $9.4 Billion Writedown, Sells $5 Billion Stake to China, SEATTLE TIMES, Dec. 19, 2007, http://seattletimes.nwsource.com/html/ businesstechnology/2004082759-webmorganl9.html (last visited Mar. 20,2009).
49. See Vikas Bajaj, Bond Insurer Cut to Junk; Negative Outlook for 4 More, N.Y. TIMES, Dec. 20 2007, at CI.
50. See Christine Richard, Ambac, MBIA Outlook Lowered by S&P, ACA Cut to CCC, BLOOMBERG.COM, Dec. 19, 2007, http://www.bloomberg. com/apps/news?pid=20601087&refer=home&sid=aOIcyRVRTZxk (last visited Mar. 20,2009).
51. See Andrew Ross Sorkin, Citi Writes Down $18 Billion; Merrill Gets Infusion, DEALBOOK, Jan. 15,2008, http://dealbook.blogs.nytimes.com/2008/01/15/cid-writes-down-181-billion-and- cuts-dividend (last visited Mar. 20,2009).
52. ARS are taxable and tax-exempt long-term securities-either bonds with maturities up to thirty years or preferred stock with no maturity-issued primarily by municipalities, student loan authorities, and closed-end mutual funds. The interest payments on ARS are determined through a modified Dutch auction, which operates to reset interest rates every seven to forty-nine days. The mechanism thus allows issuers to issue long-term debt while paying short-term interest rates (generally lower than long-term interest rates). See FACTBOX: What Are Auction-Rate Securities?, REUTERS.COM, Aug. 7, 2008, http://www.reuters.com/article/businessNews/idUSN0727775620080807 (last visited Mar. 20,2009).
53. See Auction Rate Securities Market: A Review of Problems and Potential Resolutions: Hearing Before the H. Comm. on Financial Services. 110th Cong. 11,37 (2008) (statement of Linda Thomsen, Director, Division of Enforcement, U.S. Securities and Exchange Commission) [hereinafter Thomsen Testimony].
54. See Andrew Ross Sorkin, JP Morgan Pays $2 a Share for Bear Stearns, N.Y. TIMES, Mar. 17,2008, at Al; see also Landon Thomas Jr. & Eric Dash, Seeking Fast Deal, JPMorgan Quintuples Bear Stearns Bid, N.Y. TIMES, Mar. 15,2008, at CI (describing change in Bear sale terms).
55. Ari Levy & David Mildenberg, IndyMac Seized by U.S. Regulators Amid Cash Crunch, BLOOMBERG.COM, July 11, 2008, http://www.bloomberg.com/apps/news?pid=20601110&sid=afqgUyWiMPuY (last visited Mar. 20,2009). IndyMac specialized in so-called Alt-A mortgages, which were considered less risky than subprime but more risky than prime mortgage loans, and which did not require borrowers to provide documentation of their incomes. See id.
56. Rebecca Christie & Dawn Kopecki, Paulson Engineers U.S. Takeover of Fannie, Freddie, BLOOMBERG, COM, Sept. 7,2008, http://www.bloomberg.com/apps/news?pid=20601087&sid=auCiw0BP4Fyk&refer= home (last visited Mar. 20,2009).
57. Yalman Onaran & Christopher Scinta, Lehman Files Biggest Bankruptcy After Suitors Balk, BLOOMBERG, COM, Sept. 15, 2008, http://www.bloomberg.com/apps/news?pid=20601087&sid=a6cDDYU5QYyw&refer= home (last visited Mar. 20,2009).
58. David Mildenberg & Bradley Keoun, Bank of America to Acquire Merrill as Crisis Deepens, BLOOMBERG, COM, Sept. 15,2008, http://www.bloomberg.com/apps/news?pid=20601087&sid=az4ntq7NOJME&refer= home (last visited Mar. 20,2009).
59. CDS are contracts intended to insure against the risk of a particular company's default. A CDS buyer will make periodic payments to the seller during the swap period or until a default (called a "credit event") occurs. If a credit event occurs at the company during the swap period, the CDS buyer has the right to sell bonds issued by the company for their face value to the seller, who is obliged to purchase them. In this event, the payout is often substantial. See HULL, supra note 33, at 526-27.
60. Fed to Lend $85 Billion to AIG, Take 80 Percent Stake, REUTERS.COM, Sept. 16,2008, http://www.reuters. com/article/ businessNews/idUSN1440161120080917 (last visited Mar. 20,2009).
61. Andrew Ross Sorkin & Vikas Bajaj, Radical Shift for Goldman and Morgan, N.Y. TIMES, Sept. 22,2008, at Al.
62. Ari Levy & Elizabeth Hester, WaMu Assets Sold to JPMorgan in Record Bank Failure, BLOOMBERG.COM, Sept. 26,2008, http://www.bloomberg.corn/apps/news?pid=20601110&sid=aVA8ErWOAjmI (last visited Mar. 20,2009).
63. See David M. Herszenhorn, Bailout Plan Wins Approval; Democrats Vow Tighter Rules, N.Y. TIMES, Oct. 3,2008, at Al.
64. Mark Landler, U.S. Investing $250 Billion in Banks, N.Y. TTMES.COM, Oct. 13, 2008, http://www.nytimes.corn/2008/10/14/business/ economy/14treasury.html?pagewanted=all (last visited Mar. 20, 2009).
65. Diana Henriques & Zachery Kouwe, Prominent Trader Accused of Defrauding Clients, N.Y. TIMES, Dec. 11, 2008, at Al. In a criminal information filed on Mar. 10, 2009, the United States Attorney's Office for the Southern District of New York estimated that on or about December 1, 2008, Madoff's company issued account statements totaling $64.8 billion, when in fact the company held only a small fraction of that balance on behalf of its clients. See Information at 7-8, United States v. Madoff, No. 09 Crim 213 (S.D.N.Y. Mar. 10,2009).
66. See Michael A. Fletcher, Obama Leaves D.C. to Sign Stimulus Bill, WASH. POST, Feb. 18,2009, at A05.
67. See, e.g., Adrian Michaels, From Wall Street to All Streets, DAILY TELEGRAPH (London), Feb. 21,2009, at 17; Ian Bremmer & Nouriel Roubini, Expect the World Economy to Suffer Through 2009, WALL ST. J., Jan. 23, 20O9,atA15.
68. There is no single federal statute covering mortgage fraud. Rather, mortgage fraud may be punishable under a variety of statutes, including 18 U.S.C. § 1341 (2006) (mail fraud), 18 U.S.C. § 1343 (2006) (wire fraud); and 18 U.S.C. § 1344 (2006) (bank fraud). Several specific forms of mortgage fraud are also criminalized under separate statutes. See infra notes 66 & 68 and accompanying text. In addition, mortgage fraud schemes may. include particular actions that are criminalized under separate statutes. See, e.g., 18 U.S.C. § 1005 (2006) (fraudulent bank entries, reports and transactions); 18 U.S.C. § 1028 (2006) (identity theft); 18 U.S.C. § 1029 (2006) (credit card and related "access device" frauds);
69. U.S.C. § 1030 (2006) (computer fraud); 18 U.S.C. § 1342 (2006) (use of fictitious name or address for mail fraud); 18 U.S.C. § 1349 (2006) (conspiracy); 18U.S.C. §§ 1961-1968 (2006) (RICO); 18 U.S.C. §§ 1956-1957 (2006) (money laundering).
70. See 18 U.S.C. § 1014 (2006) (criminalizing knowingly making false statements on loan applications and overvaluing property).
71. See FED. BUREAU OF INVESTIGATION, FINANCIAL CRIMES REPORT TO THE PUBLIC FISCAL YEAR 2007 (2007), http://www.fbi.gov/pubUcations/ financial/fcs-report2007/financial-crime-2007.htm (last visited Mar. 20, 2009) [hereinafter 2007 FBI Financial Crimes Report].
72. See id.;
73. see also 12 U.S.C. § 1709-2 (2006) (criminalizing failing to make payments under mortgage or deed of trust, whenever a person, with intent to defraud, purchases one to four family dwelling subject to loan in default secured by mortgage or deed of trust insured or held by Secretary of Housing and Urban Development or guaranteed or made by Department of Veterans Affairs).
74. See CHARLES R. MORRIS, THE TRILLION DOLLAR MELTDOWN: EASY MONEY, HIGH ROLLERS, AND THE GREAT CREDIT CRASH 65-68 (2008) (noting that home values rose by more than 50% from 2000 to 2005 during period of low interest rates).
75. See 2007 FBI Financial Crimes Report, supra note 67.
76. See James R. Hagerty et al., At a Mortgage Lender, Rapid Rise, Faster Fall, WALL ST. J., Mar. 12,2007, at Al.
77. Cf. MORTGAGE ASSET RESEARCH INST., CURBING MORTGAGE FRAUD: PROACTIVE STRATEGIES 4 (2008), available at http://www.marisolutions.com/rxlf (listing "perfect storm" of factors contributing to growth in mortgage fraud).
78. See FED. BUREAU OF INVESTIGATION, 2007 MORTGAGE FRAUD REPORT (2008), http://www.fbi.gov/ publications/fraud/mortgage-fraud07.htm (last visited Mar. 20, 2009) [hereinafter 2007 FBI Mortgage Fraud Report].
79. See Mortgage Fraud: New Partnership to Combat Problem, FED. BUREAU OF INVESTIGATION, Mar. 9,2007, http://www.fbi.gov/page2/march07/mortgage030907.htm (last visited Mar. 20,2009).
80. Fed. Bureau of Investigation, Mortgage Fraud, http://www.fbi.gov/hq/ mortgage-fraud.htm (last visited Mar. 20,2009).
81. See, e.g., MORTGAGE ASSET RESEARCH INST., supra note 72, at 4 (speculating that mortgage fraud may have helped cause subprime mortgage market collapse);
82. John D. Arterberry, Mortgage and Securitization Fraud: The Department of Justice Enforcement Program, in THE GLOBAL SUBPRIME CRISIS: ISSUES YOU NEED TO KNOW 405, 407 (2008) (same); Lynnley Browning, Mortgage Inquiries Focusing on Florida, N.Y. TIMES, Oct. 16 2008, at B10 (same);
83. Adam Geller, Drawn into Frenzy, Home Loans Too Good To Be True, AUGUSTA CHRON., May 27, 2007, at A16 (citing study linking 70 percent of mortgage defaults to misrepresentations on loan applications).
84. See Eric Lichtblau et al., F.B.I. Struggling to Handle Wave of Finance Cases, N.Y TIMES, Oct. 19,2008, at Al. In 2006, banks reported more than 59,000 cases of mortgage fraud to the FBI, which secured 263 indictments and 204 convictions-ratios of roughly 225 and 290 to 1, respectively. See Daniel Lathrop, FBI Lacks Resources to Fight Boom in Mortgage Fraud, SEATTLE POST-INTELLIGENCER, July 5,2007, at Al.
85. See Home Insecurity: Although the Housing Market has Slumped, Mortgage Fraud is Thriving, S. FLA. SUN SENTINEL, NOV. 23,2008, at 1A (quoting head of FBI's mortgage fraud unit in South Florida);
86. Jeff Ostrowski, Florida Leads U.S. in Mortgage Fraud, PALM BEACH POST (Florida), Mar. 14,2008, at ID.
87. This period may be months or even years. Cf. MORTGAGE ASSET RESEARCH INST., NINTH PERIODIC MORTGAGE FRAUD CASE REPORT TO THE MORTGAGE BANKERS ASSOCIATION 6 (2007), available at http://www.marisolutions.com/pdfs/mba/MBA9thCaseRpt.pdf ("It will likely take three to five years to uncover most of the fraud and misrepresentation in the 2006 book of business.").
88. See 2007 FBI Financial Crimes Report, supra note 67 (estimating that 80 percent of all reported mortgage fraud losses involve industry insiders).
89. See Richard B. Schmitt, FBI Saw Threat of Loan Crisis, L.A. TIMES, Aug. 25,2008, at Al;
90. Patrik Jonsson, Real Estate Fraud Rises in U.S., CHRISTIAN SCI. MONITOR, Dec. 14, 2006, at 2 ("When the market was booming ⋯ lenders were loathe to publicize the fraud, especially since a rising market often erased their losses.").
91. See Terry Sheridan, Too Many Crooks: Investigators, Prosecutors Can't Keep Pace as They Try to End Florida's Reign as Nation's Worst for Mortgage Fraud, BROWARD DAILY BUS. REV. (Fla.), June 11, 2008, at 1 (quoting South Florida prosecutor);
92. Tom Kelly, Keeping Fraud Cases from Falling Through the Cracks, L.A. TIMES, July 30,2006, Real Estate Section, at 17.
93. See Lathrop, supra note 77;
94. Jonsson, supra note 81.
95. See Jonsson, supra note 81 ("One of the toughest things for prosecutors is sorting out who's guilty.") (interviewing Assistant U.S. Attorney in Atlanta).
96. See Lathrop, supra note 77.
97. See Lichtblau, supra note 77.
98. For example, in September 2004, 205 people were arrested in an operation known as "Operation Continued Action," which targeted a variety of fraud schemes directed at financial institutions, including mortgage and loan fraud. See Press Release, Fed. Bureau of Investigation, FBI Announces Operation Continued Action Targeting Financial Institution Fraud (Sept. 17,2004), available at http://www.fbi.gov/pressrel/pressrel04/ contaction091704.htm. Similarly, in December 2005, the FBI announced operation "Quick Flip," a joint operation in cooperation with the Department of Housing and Urban Development, the Office Inspector General, Internal Revenue Service, the U.S. Postal Inspection Service, and the DOJ, designed to address mortgage fraud. Press Release, Fed. Bureau of Investigation, Mortgage Fraud Operation "Quick Flip" (Dec. 14, 2005), available at http://www.fbi.gov/pressrel/pressrel05/quickflipl21405.htm.
99. See Lichtblau, supra note 77;
100. Schmitt, supra note 81.
101. See Schmitt, supra note 81 (quoting FBI agent who oversaw FBI financial crime investigations during S&L crisis). Indeed, this figure was up from only 15 full time agents in 2005. See Lichtblau, supra note 77.
102. Former Attorney General Michael B. Mukasey has labeled these frauds "white-collar street crime." See Eric Lichtblau, Mukasey Declines to Create a U.S. Task Force to Investigate Mortgage Fraud, N.Y. TIMES, June 6, 2008, at C4.
103. See, e.g., Rep. Kline Sends Letter to FBI Director Mueller, U.S. FED. NEWS, Oct. 18,2008;
104. Reps. Carney, Kirk: FBI Needs to Triple Resources to Target Corporate Criminals, U.S. FED. NEWS, Oct. 10, 2008; Schmitt, supra note 81.
105. Press Release, Fed. Bureau of Investigation, More than 400 Defendants Charged for Roles in Mortgage Fraud Schemes as Part of Operation "Malicious Mortgage" (June 19, 2008), available at http://www.fbi.gov/ pressrel/pressrel08/mortgagefraud061908.htm.
106. See Lichtblau, supra note 77.
107. See Fed. Bureau of Investigation, supra note 75.
108. Cf. Lichtblau, supra note 77;
109. Lathrop, supra note 77.
110. See Schmitt, supra note 81.
111. See Alex Viega, New Century Subpoenaed, Faces Delisting, FOXNEWS.COM, Mar. 13, 2007, http://www.foxnews.com/printer- Mendly-wires/2007M (last visited Mar. 20,2009); Vikas Bajaj & Julie Creswell, Authorities Investigate Big Lender, N.Y. TIMES, Mar. 3,2007, at CI.
112. See Raymond Hernandez, Countrywide Said to be Subject of Federal Criminal Inquiry, N.Y. TIMES, Mar. 9 2008, at A20;
113. Glenn R. Simpson & Evan Perez, FBI Investigates Countrywide, WALL ST. J., Mar. 8,2008, at A3.
114. See Press Statement, Jeffrey C. Sullivan, U.S. Attorney, W. Dist. Of Wash., Statement by United States Attorney Jeffrey C. Sullivan Regarding Washington Mutual (Oct. 15 2008) http://www.usdoj.gov/usao/waw/press/2008/oct/ washingtonmutual.html (last visited Mar. 20, 2009). Washington Mutual was also the subject of an investigation initiated in December 2007 by the Securities and Exchange Commission, in conjunction with the Office of Thrift Supervision, into how the bank reported mortgage loans that potentially involved inflated appraisals. See AmirEfrati, SEC Probes WaMu onAppraisals, WALL ST. J., Dec. 21,2007, at A2.
115. See, e.g., Peter S. Goodman & Gretchen Morgenson, Saying Yes to Anyone, WaMu Built Empire on Shaky Loans, N.Y. TIMES, Dec. 28, 2008, at Al (describing corporate culture at Washington Mutual);
116. David Cho, Pressure at Mortgage Firm Led to Mass Approval of Bad Loans, WASH. POST, May 7, 2007, at Al (describing corporate culture at New Century).
117. See infra Part II.B. In addition to the mortgage-related securities discussed in the next section, mortgage lenders had large numbers of mortgage loans "held for sale" to third-party securitizers on their books. Accounting for these loans (under either fair value or lower of cost and market accounting) involved a calculation of the loans' value once securitized. See, e.g.. Countrywide Financial Corp., Annual Report (Form 10-K), at 53 (2007) (stating that loans held for sale generally were valued "based on quoted market prices for securities backed by similar types of loans" or, if market prices were not available, "based on other relevant factors" including valuation models). Thus, calculating the value of these loans presented the same difficulties as did valuing mortgage-related securities as the market grew more and more illiquid during the credit crisis. Cf. Vikas Bajaj, Inquiry Assails Accounting Firm in Lender's Fall, N.Y. TIMES, Apr. 13,2008, atAl (quoting conclusion by examiner for United States Bankruptcy Court that accounting irregularities did not provide "sufficient evidence to conclude that New Century engaged ureamings management or manipulation").
118. See 18 U.S.C. § 2 (2006).
119. See RICHARD S. GRUNER, CORPORATE CRIMINAL LIABILITY AND PREVENTION, § 13.12[2] (2004);
120. KATHLEEN F. BRICKEY, CORPORATE CRIMINAL LIABILITY § 5:09 (2d ed. 1992). To be clear, a corporate employee who knows that a colleague has committed a felony but conceals this knowledge may be found guilty for misprision of a felony. 18 U.S.C. § 4 (2006). However, the employee must still take "an affirmative step to conceal the crime"-a "mere failure to make a felony known to public authorities" is not sufficient. GRUNER, supra, § 13.12[2][c];
121. cf. Audrey Strauss, Corporate Liability for Misprision of Felony, N.Y.L.J., May 2,1996, at 5 (describing historical use of misprision of felony and its application in 1995 guilty plea of Daiwa Bank for concealing trading loss of employee).
122. See Hagerty et. al, supra note 71 (noting that majority of mortgage loans involve mortgage brokers).
123. See Lichtblau, supra note 77 ("The reason we saw such huge growth in independent brokers was because [lenders and investment banks] wanted brokers to do the dirty work-They were able to put a shield between themselves and liability for wrongdoing.") (quoting Kathleen Engel, Professor at Cleveland-Marshall College of Law).
124. See BRICKEY, supra note 103, § 5:02 & § 5:09 (stating that corporate managers may be accountable for crimes committed by subordinates under principles of accomplice liability or for knowingly failing to control corporate misconduct).
125. See GRUNER, supra note 103, § 13.12[2] ("In most cases this [accomplice liability] rule will shield corporate executives or direcors from criminal liability based on offences by subordinates or fellow managers.");
126. cf. Cho, supra note 100 (exploring whether accepting fraudulent loan applications was systematically promoted by New Century)
127. See N.Y. Cent. & Hudson River R.R. Co. v. United States, 212 U.S. 481, 494-95 (1909) (establishing general standard for corporate criminal liability under respondeat superior);
128. see also GRUNER, supra note 103, § 3.03[2]. Indeed, under the principles of collective knowledge and action, criminal liability may exist for corporations even where no one employee committed a crime, if the aggregated knowledge or actions of employees amounts to criminal behavior. See generally id. §§ 4.01-.04.
129. See, e.g., Eric Dash & Andrew Ross Sorkin, Government Seizes WaMu and Sells Some Assets, N.Y. TIMES, Sept. 26,2008, at Al (detailing bank's seizure by federal regulators and sale of bank's assets to JPMorgan Chase);
130. Vikas Bajaj & Julie Creswell, Home Lender is Seeking Bankruptcy, N.Y. TIMES, Apr. 3, 2007, at CI (reporting New Century's bankruptcy filing);
131. Heidi N. Moore, Winners & Losers in Bank of America's Purchase of Countrywide, WSJ.COM, July 1,2008, http://logs.wsj.cora/deals/2008/ 07/01/winners-losers-in-bank-of-americas- purchase-of-countrywide/(last visited Mar. 20, 2009) (reporting closing of Bank of America's acquisition of Countrywide);
132. see also Gretchen Morgenson & Eric Dash, Troubled Giant in Home Loans Close to Rescue, N.Y. TIMES, Jan. 11, 2008, at Al
133. See GRUNER, supra note 103, §§ 5.03 & 5.05 (discussing effect of dissolution and bankruptcy on corporate criminal liability);
134. see also BRICKEY, supra note 103, § 3:10 (same).
135. See GRUNER, supra note 103, § 5.04 (discussing effect of merger or acquisition on corporate criminal liability);
136. see also BRICKEY, supra note 103, § 3:11 (same).
137. See Dina ElBoghdady, Mortgage Fraud up as Credit Tightens, WASH. POST, Mar 17. 2009, at D01 (reporting that mortgage fraud jumped 26% in 2008);
138. see also 2007 FBI Mortgage Fraud Report, supra note 73 ("The downward trend in the housing market provides an ideal climate for mortgage fraud perpetrators to employ a myriad of schemes suitable to a down market.").
139. See Zachary E. Davies, Rescuing the Rescued: Stemming the Tide of Foreclosure Rescue Scams in Washington, 31 SEATTLE U. L. REV. 353,353 (2008) (calling foreclosure rescue "a nationwide epidemic").
140. See Lichtblau, supra note 77;
141. Michael R. Crittenden, TARP Fraud Could Cost Taxpayers Billions, Watchdog Warns, WSJ.COM, Feb. 24, 2009, http://online.wsj.com/ article/SB123549501648160845.html (last visited Mar. 20, 2009). Indeed, several investigations of TARP-related fraud have already been launched. See Jason Ryan, 'Fraud Directly Related' to Financial Crisis Probed, ABC NEWS.COM, Feb. 11, 2009, http://abcnews.go.com/TheLaw/Economy/Story?id= 6855179&page= 1 (last visited Mar. 20,2009).
142. Federal law enforcement may be continuing to ramp up efforts against mortgage fraud as this article goes to press. See Posting of Joe Palazzolo to The BLT: The Blog of LegalTimes, 2009/03/ag-talks-about-gitmo- fraud-and-pot.html (Mar. 18 2009,17:39) (noting discussions about establishing a federal mortgage fraud task force are ongoing, according to Attorney General Eric Holder).
143. In February 2009, the FBI confirmed that it had 38 open investigations of large financial institutions See Ryan, supra note 114. In September 2008, then SEC Chairman Christopher Cox confirmed that the SEC had over 50 open subprime-related investigations. See Christopher Cox, Chairman, Sec. and Exch. Comm'n, Testimony Before U.S. Senate Committee on Banking, Housing, and Urban Affairs Concerning Turmoil in U.S. Credit Markets: Recent Actions Regarding Government Sponsored Entities, Investment Banks, and Other Financial Institutions (Sept. 23, 2008), http://www.sec.gov/news/ testimony/2008/ts092308cc.htm (last visited Mar. 20, 2009). According to the SEC, the investigations are divided into three broad categories: "(1) the retail aspect involving broker-type elements;
144. (2) insider trading;
145. and (3) cases involving valuation of securitized products," the last of which is further subdivided into two subcategories: mortgage originators and securitizers/underwriters. See Yin Wilczek, SEC, DOJ Subprime Investigations Focused on Misrepresentations, Manipulation, 40 BNA SEC. REG. & L. REP. 1603 (2008) (quoting Andrew Calamari, SEC New York associate regional director).
146. See Elizabeth Hester & Adam Haigh, Write-offs Predicted to Add Up at 3 Firms, Cm. TRIB., Dec. 28, 2007, at CI; David Reilly, Heard on the Street: For Banks, the Hurt Just Goes On, Wall St. J., Nov. 26,2007, at CI;
147. Write-Downs May Rise, N.Y. TIMES, Nov. 9,2007, at C6;
148. Randall Smith, Storm May Hit Morgan Stanley After its Calm, WALL ST. J., Nov. 7,2007, at CI;
149. Serena Ng & Carrick Mollenkamp, Merrill Takes $8.4 Billion Credit Hit, WALL ST. J., Oct. 25, 2007, at Al;
150. see also Al Yoons & Dan Wilchin, Wall Street's Subprime CDO Write-downs Seen $64 billion: Citi, REUTERS.COM, Nov. 8, 2007, http://www.reuters.com/article/gc06/idUSN082340152007 U08 (last visited Mar. 20,2009) (questioning whether banks had faced up to reality).
151. See, e.g., Amir Efrati et al., Prosecutors Widen Probes into Subprime-U.S. Attorney's Office Seeks Merrill Material; Sec Upgrades Inquiry, WALL ST. J., Feb. 8, 2008, at CI;
152. Kara Scannell et al., The Subprime Cleanup Intensifies: Did UBS Improperly Book Mortgage Prices? Several Probes Expand, WALL ST. J., Feb. 2, 2008, at Bl;
153. see also Lori A. Richards, Director, Office of Compliance Inspection & Examinations, Sec. and Exch. Comm'n, Focus Areas in SEC Examinations of Investment Advisers: The Top 10, Speech at the IA Compliance Best Practices Summit 2008 (Mar. 20, 2008), available at http://sec.gov/news/speech/2008/spch0320081ar.htm (listing valuation of securities as one of SEC's top ten areas of concern).
154. See Amir Efrati & Susan Pulliam, Three U.S. Attorneys Probe If Lehman Misled Investors, WALL ST. J., Oct.7,2009,atA3.
155. The United States Attorney's Office for the Southern District of New York is also investigating whether Lehman valued its $32.6 billion of commercial real estate assets at artificially inflated levels and whether the company improperly transferred $8 billion from its London office to New York shortly before its bankruptcy filing. The United States Attorney's Office for the Eastern District of New York is investigating whether Lehman misled investors about the firm's financial condition by making positive remarks during conference calls with analysts and investors. The United States Attorney's Office for the District of New Jersey is investigating whether Lehman misled New Jersey's pension fund about its financial condition in connection with a June 2008 $6 billion stock offering in which New Jersey invested $180 million. See id.;
156. see also Lehman Brother's Demise Probe Launched in Jersey, N.J. LAWYER, Oct. 20,2008, at 2.
157. Amir Efrati, Chart: Credit Crisis Probes, WSJ.COM, Oct. 22,2008, http://online.wsj.com/public/resources/documents/st-creditcrisis- 20081022.html (last visited Mar. 20,2009).
158. Zachary A. Goldfarb, Probe Into Fannie Mae, Freddie Mac Widens, WASH. POST, Sept. 30,2008, at Dl. Several additional investigations appear focused on misconduct by individual traders, including unauthorized trading, insider trading, and inaccurate pricing of securities. For example, the SEC and the DOJ reportedly are investigating possible insider trading by a board member of Soci6t6 Generate shortly before the company's announcement on January 24, 2008 that a rogue trader had caused 4.9 billion in derivative trading losses. See Peggy Hollinger et al., SocGen Faces US Investigation, FINANCIALTIMES.COM, Feb. 6, 2008, http://www.ft.com/cms/s/0/517a5fe2-d4f3-lldc-9afl-0OO0779fd2ac.html? nclick-check=l (last visited Mar. 20, 2009). The U.S. Attorney for the Eastern District of New York is taking the lead in investigating possible criminal violations concerning the same board member's sale of Soctete' Generate shares. See Randall Mikkelsen & Rachelle Younglai, U.S. Regulators Probe Stock Sales of SocGen Director, REUTERS.COM, Feb. 4, 2008, http://www.reuters.com/article/ousivMolt/idUSWEN376420080204?pageNumber= l&virtualBrandChannel=0 (last visited Mar. 20,2009).
159. 17 C.F.R. § 240.10b-5 (2008);
160. see also 15 U.S.C. § 78j(b) (2006) (authorizing SEC to prescribe rules "necessary or appropriate in the public interest or for the protection of investors");
161. U.S.C. § 78ff(a) (2006) (establishing criminal penalties for willful violations of Securities Act of 1934 and SEC rules promulgated under the Act).
162. See 4 THOMAS LEE HAZEN, TREATISE ON THE LAW OF SECURITIES REGULATION § 12.8[1] (6th ed. 2009) ("In the context of a criminal case ⋯ the prosecution must establish that the defendant acted willfully, which means that he or she acted with a realization that the acts were wrongful.").
163. See, e.g., SEC v. Collins & Aikman Corp. 524 F. Supp 2d 477,487 & n. 83 (2007);
164. see also SEC v. U.S. Environmental, Inc., 155 F.3d 107, 111 (2d Cir. 1998). At least one circuit, however, has held that recklessness may be sufficient for criminal liability under 10b-5. See United States v. Tarallo, 380 F.3d 1174,1188-89 (2004).
165. 18 U.S.C. § 1341(2006).
166. 18 U.S.C. § 1343 (2006).
167. See, e.g.. United States v. Smith, 133 F.3d 737,743 (10th Cir. 1997).
168. See, e.g., United States v. Stewart, 185 F.3d 112,126 (3d Cir. 1999). At least some circuits have held that recklessly disregarding the accuracy of statements' accuracy may also be grounds for criminal liability under these statutes. See, e.g., United States v. Munoz, 233 F.3d 1117,1136 (9th Cir. 2000); United States v. Prows, 118 F.3d 686,692 (10th Cir. 1997).
169. See Holman W. Jenkins, Jr., Op-Ed, Mark to Meltdown?, WALL ST. J., Mar. 5,2008, at A16 (discussing introduction of fair value accounting for banks' financial assets).
170. Pub. Co. Accounting Oversight Bd., Staff Audit Practice Alert No. 2, Matters Relating to Auditing Fair Value Measurements of Financial Instruments and the Use of Specialists 3 (2007) (citing Section 137 of Statement of Financial Accounting Standards No. 115 ("Accounting for Certain Investments in Debt and Equity Securities"), Section 540 of Statement of Financial Accounting Standards No. 133 ("Accounting For Derivatives And Hedging Activities"), and Section 69 of Statement of Financial Accounting Standards No. 140 ("Accounting For Transfers And Servicing Of Financial Assets And Extinguishments Of Liabilities")).
171. See, e.g., Neil Unmack, CDO Buyers Put Investments on Hold, Royal Bank of Scotland Says, BLOOMBERG, Sept. 20, 2007 (available via Bloomberg Professional service); Jody Shenn, Credit Suisse CDO is Sole Sale in Past Week, JPMorgan Says, BLOOMBERG, Sept. 11, 2007 (available via Bloomberg Professional service); Darrell Hassler, CDO Spreads are Unchanged; New Sales "Meager," JP Morgan Says, BLOOMBERG, Aug, 27,2007 (available via Bloomberg Professional service).
172. Accord David M. Zomow et al., Simple Twist of Fate or Outlaw Blues? Not All Incorrect Valuations of Complex Securities Will Lead to Government Action, N.Y.L.J., Feb. 9,2009, at S3, S10 ("Valuation [of CDOs and mortgage-related securities] was a genuinely, difficult task in the increasingly illiquid marketplace that unfolded in
173. 2007 and 2008-"). During this period, the bid-ask spread (the difference between what sellers are willing to accept and buyers are willing to offer) on these securities widened, as buyers and sellers struggled to reach agreement on the appropriate market price. See Aleksandrs Rozens, Pop Goes the Credit Bubble, INVESTMENT DEALERS DIGEST, Aug. 13,2007, http://www.iddmagazine.com/issues/20070812/14210- l.html (last visited Mar. 20,2009).
174. FIN. ACCOUNTING STANDARDS BD., STATEMENT NO. 115, ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES (1993).
175. Id. at §110.
176. Id. at § 111.
177. See FIN. ACCOUNTING STANDARDS BD., SUMMARY OF STATEMENT NO. 157, FAIR VALUE MEASUREMENTS (2006) [hereinafter FAS 157].
178. See id.
179. See FAS 157, supra note 137, at § 5, (giving definition of fair value as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date");
180. see also id. at § C25 (clarifying that an orderly transaction is distinct from "a forced transaction (for example, if the seller is experiencing financial difficulty)" and that an orderly transaction "assumes exposure to the market for a period prior to the measurement date to allow for information dissemination and marketing in order to transact at the most advantageous price for the asset or liability at the measurement date").
181. Id. at § 22.
182. Id. at § 24. An active market "is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis." Id.
183. Level 1 assets include publicly-traded securities, listed futures and options, government and agency bonds, and mutual funds. See Susan Pulliam et al., U.S. Investors Face an Age of Murky Pricing, WALL ST. J., Oct. 12,2007, at Al.
184. Assets in this category include emerging market government bonds, some infrequently-traded corporate and municipal bonds, structured notes, some mortgage and asset-backed securities, and some derivatives that are not publicly traded. See id.
185. FAS 157, supra note 137, at § 30;
186. see also Pulliam, supra note 142.
187. FAS 157, supra note 137, at § 30.
188. See Pulliam, supra note 142.
189. See, e.g., John Hull & Alan White, Valuation of a CDO and an Nth to Default CDS Without Monte Carlo Simulation, 12 JOURNAL OF DERIVATIVES passim (2004) (describing one proposed model for CDO tranche valuation).
190. For example, assumptions must be made concerning such arcane factors as statistical correlation among the mortgages within the asset pool; probabilistic estimates of default and prepayment rates based on best-guess scenarios of future interest rates and economic conditions; "one-size fits all" recovery rates (the estimated "salvage" value of defaulted mortgages based on estimated real estate values prevailing at the time of default); and estimates of the appropriate interest rates to use in discounting future cash flows. See generally LUCAS ET AL., supra note 6.
191. See supra notes 132-133 and accompanying text.
192. Press Release, Sec. and Exch. Comm'n, SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting (Sept. 30,2008), available at http://www.sec.gov/news/press/2008/2008-234.htm.
193. See id. In addition, the September 2008 guidance provided that "disorderly transactions" are not determinative of fair value because the concept of fair value embodies an orderly transaction between market participants. According to the guidance, "[determining whether a particular transaction is forced or disorderly requires judgment." Id. At the same time, the guidance provides that, even if a transaction is orderly, if management judges that the price does not reflect current prices for the same or similar assets, "adjustments may be necessary to arrive at fair value." Id. Similarly, the FASB recently has issued a proposed Staff Position to provide additional guidance to firms for determining when a market is active or inactive and transactions are orderly or disorderly for purposes of fair value measurements under FAS 157. See News Release, Fin. Accounting Standards Bd., FASB Issues Proposals to Improve Guidance on Fair Value Measurements and Impairments (Mar. 17, 2009), available at http://www.fasb.org/news/nr031709.shtml. Consistent with previous guidance, the proposed Staff Position gives considerable flexibility in determining whether a market is active or inactive and suggests that firms evaluate and consider "the significance and relevance" of seven nonexclusive factors before "usfing] their judgment." See FIN. ACCOUNTING STANDARDS BD., PROPOSED FASB STAFF POSITION, NO. FAS 157-e, at 4 (Mar. 17,2009), available at http://www.fasb.org/fasb-staff-positions/prop-fsp-fasl57-e.pdf.
194. Cf. infra notes 159-169 and accompanying text (discussing prosecution of two Bear Stearns fund managers).
195. As this article goes to print, the future of mark to market accounting is uncertain. Section 133 of the Emergency Economic Stabilization Act stipulated that the SEC conduct a study on fair value accounting standards. See 12 U.S.C. § 5238 (Supp. 2008). In its report to Congress, the SEC, among other things, made recommendations to improve the application of fair value standards in inactive markets, but also concluded that fair value accounting should not be suspended (as the Act gave it the authority to do under 12 U.S.C. § 5237). See Press Release, Sec. and Exch. Comm'n, Congressionally-Mandated Study Says Improve, Do Not Suspend, Fair Value Accounting Standards (Dec. 30, 2008), available at http://www.sec.gov/news/press/2008/2008-307.htm. Accordingly, the FASB recently has issued a proposed staff position to provide additional guidance to firms on fair value accounting in inactive markets. See supra note 151. Nonetheless, Congress is reportedly considering whether to eliminate mark-to-market accounting entirely. See Ronald D. Oral, Mark-to-Market Rule Compromise Is on the Way, MARKETWATCH, Mar. 11, 2009, http://www.marketwatch.com/news/story/mark- to-market-rule-compromise-way/story.aspx?guid = %7B05985C4F-D2CC-4E27-A691- 0CEC8EDBABFF%7D&dist= SecMostRead (last visited Mar. 20,2009).
196. See generally GRUNER, supra note 103, ch. 6 (discussing possibility of due diligence defense to corporate criminal liability).
197. See generally Lisa Kern Griffin, Compelled Cooperation and the New Corporate Criminal Procedure, 82 N.Y.U. L. REV. 311,313-28 (2007).
198. See Matthew L. Siegel, Corporate America Fights Back: The Battle over Waiver of the Attorney-Client Privilege, 49 B.C. L. Rev. 1,4 (2008).
199. See id.
200. See id. at 13-17 (describing difficulties prosecutors face without corporate cooperation).
201. Indictment at & para; 17, United States v. Cioffi, No. CR-08-415 (E.D.N.Y. Jun. 18,2008).
202. Id. at & para; 7-8.
203. Id .atI17.
204. Id. at & para; 17-18.
205. Id. at & para; 24.
206. Id.
207. Id. at & para; 41 (emphasis in original).
208. Id. at & para; 43.
209. Id. at & para; 45.
210. W. atH 57-68.
211. Cf. Zomow, supra note 133, at S10 (arguing that valuation issues will make prosecutions difficult unless other factors are present, such as clear evidence of manipulated valuations). Jury selection in the trial is scheduled to begin in September 2009, but delays may arise due to two lead prosecutors leaving the U.S. Attorney's Office and defense counsel complaints that they are being buried in documents by the prosecution. See Kate Kelly & Dionne Searcey, For J.P. Morgan, Legal Headaches, WALL ST. J., Mar. 15, 2009, at B2 (noting prosecutors' leaving Attorney's Office); Tom Hays, Defense Digs out of Documents in Bear Stearns Case, YAHOOIFINANCE, Mar. 16, 2009, http://finance.yahoo. com/news/Defense-digs-out-of-documents-apf-14658479.html (last visited Mar. 20,2009).
212. See Richard Hill, Economic Conditions Have SEC Staff Bracing for Fraud, Whistle-Blower Cases, 40 BNA SEC. REG. & L. REP. 1990 (2008) (quoting Scott Friestad, Deputy Director, SEC Division of Enforcement).
213. Wilczek, supra note 116, at 1603 (quoting SEC's New York Associate Regional Director).
214. Id. Similarly, the DOJ likely will steer clear of valuation cases and focus on straightforward fraud and misrepresentations. See id. (quoting unnamed DOJ official that "misrepresentations will be the focus of the DOJ's prosecutions" and not the rather than the "'tricky' issue of trying to prove which valuation method is more appropriate," because misrepresentations are "where the rubber really hits the road, that's where you make a clear case for fraud").
215. The SEC defines a short sale as "any sale of a security which the seller does not own or any sale which is consummated by the delivery of a security borrowed by, or for the account of, the seller." SEC Rule 3b-3, 17 C.F.R. § 242.200(a) (2008).
216. See 5 HAZEN, supra note 124, § 14.22[3].
217. See id. § 14.22.
218. See id.
219. ATSI Commc'ns, Inc. v. Shaar Fund, Ltd., 493 F.3d 87,101 (2d Cir. 2007) (internal citations omitted);
220. see also GFL Advantage Fund, Ltd. v. Colkitt, 272 F.3d 189,209 (3d Cir. 2001) ("[S]hort selling can help move an overvalued stock's market price toward its true value, thus creating a more efficient marketplace in which stock prices reflect all available relevant information about the stock's economic value."); Press Release, Sec. and Exch. Comm'n, Statement of Securities and Exchange Commission Concerning Short Selling and Issuer Stock Repurchases (Oct. 1, 2008), available at http://www.sec.gov/news/press/ 2008/2008-235.htm (noting that "short selling plays an important role in the market for a variety of reasons, including contributing to efficient price discovery, mitigating market bubbles, increasing market liquidity, promoting capital formation, facilitating hedging and other risk management activities, and importantly, limiting upward market manipulations").
221. 15 U.S.C. § 78j(b) (2006). Similarly, Section 9(a), Manipulation of Security Prices, makes it illegal "to induce the purchase or sale" of securities registered on a national securities exchange "by the circulation or dissemination ⋯ of information to the effect that the price of any such security will or is likely to rise or fall" that is "conducted for the purpose of raising or depressing the price of such security" when the statement was "at the time and in the light of the circumstances under which it was made, false or misleading with respect to any material fact," and which the defendant "knew or had reasonable grounds to believe" was false or misleading. 15 U.S.C. § 78i(a)(4) (2006). More generally, Section 17(a) makes it unlawful for any person "to employ any device, scheme, or artifice to defraud," or "to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact" in the offer or sale of any securities. 15 U.S.C. § 77q(a) (2006).
222. Ernst & Ernst v. Hochfelder, 425 U.S. 185,199 (1976).
223. See 3 HAZEN, supra note 124, § 12.1[2][A]. Whether aggressive short-selling conducted with the purpose of affecting the price of securities, but not accompanied by other deceptive conduct (so-called "open-market manipulation"), counts as market manipulation is an open question. See generally Brian A. Ochs, When Does Short Selling Become Manipulation?, 40BNASEC. REG.& L. REP. 1951 (2008). -
224. See 5 HAZEN, supra note 124, § 14.22[3][D].
225. See id.
226. See id. § 14.22[3][D] & n.107 (citing Jag Media Holdings Inc. v. A.G. Edwards & Sons Inc., 387 F. Supp. 2d 691, 695 (S.D. Tex. 2004));
227. see also In re Eagletech Commc'ns, Inc., Exchange Act Release No. 34-54095 (June 5,2006).
228. See Christopher Twarowski, SEC Order On Naked Short Selling Takes Effect, WASH. POST, July 22,2008, atDl.
229. 17 C.F.R. § 242.203(b) (2008). The SEC has explained that "locate" means that a broker-dealer is prohibited from accepting a short sale order for its own account unless it has (1) borrowed, or entered into an arrangement to borrow, the security, or (2) has reasonable grounds to believe that the security can be borrowed so that it can be delivered on the due date. See 5 HAZEN, supra note 124, § 14.22[3][B] & n.51 (citing Short Sales, Exchange Act Release No. 34-50103 (July 28,2004)).
230. See Emergency Order Pursuant to Section 12(k)(2) of the Securities Exchange Act of 1934 Taking Temporary Action to Respond to Market Developments, Exchange Act Release No. 58166 (July 15, 2008) ("During the week of March 10, 2008, rumors spread about liquidity problems at Bear Stearns, which eroded confidence in the firm. As Bear Steams' stock price fell, its counterparties became concerned, and a crisis of confidence occurred late in the week."). These counterparties became unwilling to make secured funding available to Bear Steams on customary terms. See id.
231. See Brian Wingfield, What Killed Bear?, FORBES.COM, Apr. 3,2008, http://www.forbes.com/2008/04/03/banking-bear- bemanke-biz-wall-cx-bw-0403bear2.html (last visited Mar. 20,2009); David Scheer, SEC Opens Bear Steams Stock Manipulation Inquiry, BLOOMBERG.COM, Mar. 18, 2008, http://www.bloomberg.com/apps/news?pid=20601087&sid= a3K784kZkBlQ&refer=home (last visited Mar. 20,2009). Following Bear's resulting collapse and sale to JPMorgan Chase, several self-regulatory organizations announced a coordinated effort to heighten the monitoring and investigation of trading activity in "issuers that may be subject to credit market-related volatility." See Press Release, Fin. Indus. Regulatory Auth., Self-Regulators Warn Against Spreading False Rumors and Other Abusive Market Activity (Mar. 31,2008), available at http://www.finra. org/Newsroom/NewsReleases/2008/P038211. To emphasize the gravity of the concern over rumors and short selling, the SROs admonished market participants to be "especially aware that intentionally spreading false rumors or engaging in collusive activity to impact the financial condition of an issuer will not be tolerated and will be vigorously and aggressively investigated," and added that, "[fjhis type of activity is highly detrimental both to the investing public and to companies constituting important components of the U.S. financial system." Id.
232. See Press Release, Sec. and Exch. Comm'n, Securities Regulators to Examine Industry Controls Against Manipulation of Securities Prices Through Intentionally Spreading False Information (July 13, 2008), available at http://www.sec.gov/news/press/2008/2008-140.htm;
233. see also Jenny Anderson, S.E.C. Unveils Measures to Limit Short-Selling, N.Y. TIMES, July 16,2008, at CI.
234. See David Scheer and Edgar Ortega, SEC Extends Limit on Short Sale of Fannie, Freddie, BLOOMBERG, COM, July 30, 2008, http://www.bloomberg.com/apps/news?pid=20601103&refer=news&sid= a2TrS9f34oao (last visited Mar. 20,2009).
235. Emergency Order Pursuant to Section 12(k)(2) of the Securities Exchange Act of 1934 Taking Temporary Action to Respond to Market Developments, Exchange Act Release No. 58166 (July 15,2008) (imposing ban on naked short selling). The order thereby went beyond Rule SHO, which requires traders only to locate or identify available shares before effecting a short sale. Id. Among the 19 companies were Goldman Sachs, Merrill Lynch, Lehman Brothers, Fannie Mae, and Freddie Mac. Id. at App. A.
236. Emergency Order Pursuant to Section 12(k)(2) of the Securities Exchange Act of 1934 Taking Temporary Action to Respond to Market Developments, Exchange Act Release No. 34-58592 (Sept. 18,2008).
237. Id.
238. See Press Release, Sec. and Exch. Comm'n, SEC Expands Sweeping Investigation of Market Manipulation (Sept. 19,2008), available at http://sec.gov/news/press/2008/2008-214.htm ("Abusive short selling, market manipulation and false rumor mongering for profit by any entity cuts to the heart of investor confidence in our markets. Such behavior will not be tolerated. We will root it out, expose it, and subject the guilty parties to the full force of the law.") (quoting Linda Thomsen, Director of SEC Enforcement Division). At the same time, the New York Attorney General's Office announced a "wide-ranging investigation into short selling" following from complaints about false rumors being spread by short sellers. See Aaron Lucchetti et al., Cuomo Plans Short-Selling Probe, WSJ.COM, Sept. 18, 2008, http://online.wsj.com/article/ SB122176389889653245.html (last visited Mar. 20,2009).
239. Jonathan D. Glater, Whispering With Intent, N.Y. TIMES, July 20,2008, at A4 (quoting Arthur Levitt);
240. cf. Richard D. Marshall, Rumor-Mongering in the Crosshairs, N.Y. L.J., Feb. 9, 2009, at S8, Sll (arguing that efficient markets require free dissemination of information and that SEC drive to prevent gossip may implicate First Amendment considerations).
241. See In re Salomon Analyst AT&T Litig., 350 F. Supp. 2d 455, 465-66 (S.D.N.Y. 2004) (citing Va. Bankshares, Inc. v. Sandberg, 501 U.S. 1083,1095-96 (1991)).
242. Hill, supra note 170, at 1990.
243. See Peter Behr & David A. Vise, Wall Street Rumors: Experts See Rise of Stock-Price Manipulation Through Planted Tips, WASH. POST, Feb. 16, 1986, at Gl (describing a "growing trend of rumors that have triggered sharp, speculative swings in stock prices in the past year, particularly among companies that are targets, or likely targets, of mergers and takeovers").
244. David A. Vise, SEC Forum Fails to Find Solutions to Rumors, WASH. POST, Feb. 20,1986, at El (quoting Gary Lynch).
245. See id. ("Furthermore, once a rumor starts circulating, the SEC may not be able to trace the initial source of the rumor.") (quoting Gary Lynch).
246. As then SEC Chairman Christopher Cox testified at a Congressional hearing in the summer of 2008: "For the entirety of its 74-year-history until 2008, the Commission had never brought an enforcement action of this kind." Glater, supra note 194 (quoting Christopher Cox).
247. See Press Release, Sec. and Exch. Comm'n, SEC Charges Wall Street Short-Seller with Spreading False Rumors (Apr. 24, 2008), available at http://www.sec.gov/news/press/2008/2008-64.htm. The SEC cited violations of Section 17(a) of the Securities Act of 1933, Sections 9(a)(4) and 10(b) of the Securities Exchange Act of 1934, and SEC Rule 10b-5, promulgated under Section 10(b).
248. See Complaint at 4, Sec. and Exch. Comm'n v. Berliner, No. 08-CV-3859 (S.D.N.Y. Apr. 24,2008).
249. See id.
250. See id. at 5-6.
251. See supra notes 159-169 and accompanying text (discussing Cioffi and Tannin case).
252. See Press Release, Sec. and Exch. Comm'n, supra note 201.
253. See, e.g., In Re Sandell Asset Mgmt. Corp., Exchange Act Release No. 33-8857 (Oct. 10,2007) (settled enforcement action against Sandell Asset Management for, inter alia, allegedly shorting stocks in 2005 while misrepresenting to counterparties that it had located stocks to borrow); In Re Goldman Sachs Execution & Clearing, Exchange Act Release No. 34-55465 (Mar. 14, 2007) (censuring Goldman for facilitating illegal short sales from 2000 to 2002 by unreasonably relying on customer representations that sales were "long" orders). According to the SEC Inspector General, of 5000 complaints of naked short-selling the SEC received between January 1, 2007 and June 30, 2008, only 123 were forwarded for investigation, and none resulted in an enforcement action. See Zachary Goldfarb, SEC Faults its Handling of Tips on Short Sales, WASH. POST, Mar. 19, 2009, at Dl.
254. See Rachelle Younglai, SEC Chief Has Regrets Over Short-Selling Ban, REUTERS.COM, Dec. 31, 2008, http.//www.reuters.com/article/ ousivMolt/idUS%5e (last visited Mar. 20,2009).
255. See id.
256. Id.
257. In 1911, Kansas was the first state to promulgate a securities statutory regulatory regime. A number of states quickly followed Kansas's lead, and today all states have blue sky laws. See 2 HAZEN, supra note 124, § 8.1[1][A] & n.4. See generally ROBERT N. RAPP, BLUE SKY LEGISLATION (2d ed. 2008).
258. The "blue sky" appellation may have originated from the Kansas statute, which was intended to protect Kansas farmers from industrialists' selling "a piece of the blue sky." See 2 HAZEN, supra note 124, § 8.1[1][A].
259. See Christopher R. Lane, Halting the March Toward Preemption: Resolving Conflicts Between State and Federal Securities Regulators, 39 NEW ENG. L. REV. 317,321 (2005).
260. See Lane, supra note 213, at 325 (concluding that Congress envisioned "a dual system of regulation"). Section 18 of the Securities Act of 1933 originally provided in pertinent part: "[n]othing in this title shall affect the jurisdiction of the securities commission (or any agency or office performing like functions) of any State or Territory of the United States, or the District of Columbia, over any security or any person." Securities Act of 1933, ch. 38, 48 Stat. 85 (codified as amended at 15 U.S.C. § 77r (2006)). The National Securities Markets Improvement Act of 1996, Pub. L. 104-290,110 Stat. 3416, substituted and amended this provision, which now reads: "Fraud authority. Consistent with this section, the securities commission (or any agency or office performing like functions) of any State shall retain jurisdiction under the laws of such State to investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by a broker or dealer, in connection with securities or securities transactions." 15 U.S.C. § 77r(c)(l) (2006).Section 28(a) of the Securities Exchange Act of 1934 originally provided in pertinent part: "Except as otherwise specifically provided in this chapter, nothing in this chapter shall affect the jurisdiction of the securities commission (or any agency or officer performing like functions) of any State over any security or any person insofar as it does not conflict with the provisions of this chapter or the rules and regulations thereunder." Securities Act of 1934, ch. 404,48 Stat. 903 (codified as amended at 15 U.S.C. § 78bb (2006)).
261. Jonathan Mathiesen, Dr. Spitzlove Or: How I Learned To Stop Worrying and Love "Balkanization", 2006 COLUM. Bus. L. REV. 311, 313 ("Recently, the term "balkanization" has arisen in the context of securities regulation, in reference to the wave of activism by select state attorneys general in prosecuting cases of securities fraud.").
262. States' actions have been facilitated by the fact that blue sky laws may have less stringent scienter requirements than their federal counterparts. See RAPP, supra note 211, §§ 14.08[2]-[3] (discussing various scienter requirements);
263. see also 25A STEINBERG & FERRARA, supra note 125, §§ 13:22-13:23 (2001) (same). For example, New York's blue sky statute, the Martin Act, does not require scienter for criminal misdemeanor convictions or for civil enforcement actions. See Barry Kamins, 77ie Martin Act: A Sleeping Giant, N.Y.L.J., Dec. 13,2007, at 3. The Martin Act's robust enforcement authority has contributed to New York becoming a leader in prosecuting securities fraud.
264. See DEP'T OF HOUS. AND URBAN DEV. AND DEP'T OF THE TREASURY, REPORT OF THE JOINT TASK FORCE ON PREDATORY LENDING 1-2,17-18 (2001).
265. See MORRIS, supra note 69, at 69-71 (describing "viciously predatory" underbelly of mortgage industry);
266. Gretchen Morgenson, Cruel Jokes, and No One Is Laughing, N.Y. TIMES.COM, Jan 13. 2008, http://www.nytimes.com/2008/01/13/business/ 13gret.html?pagewanted=2&emc=etal (last visited Mar. 20, 2009) (describing functioning of ARMs).
267. See Christina Crapanzano, Countrywide Is Assailed in Protest of Policies, N.Y. TIMES.COM, Oct. 12,2007, http://www.nytimes.coni/ 2007/10/12/business/12mortgage.html?emc=etal (last visited Mar. 20,2009);
268. see also Gretchen Morgenson, Illinois to Sue Countrywide, N.Y. TIMES.COM, June 25,2008, http://www.nytimes.com/2008/ 06/25/business/25mortgage.html (last visited Mar. 20, 2009) ("People were put into loans they did not understand, could not afford and could not get out of.") (quoting Lisa Madigan, Illinois Attorney General).
269. See, e.g., DEP'T OF HOUS. AND URBAN DEV. AND DEP'T OF THE TREASURY, supra note 217.
270. Gretchen Morgenson, Countrywide Subpoenaed by Illinois, N.Y. TIMES, Dec. 13,2007, at CI.
271. Press Release, Office of the Att'y Gen. of Cal., Brown Sues Countrywide for Mortgage Deception (June 25,2008), available at http://ag.ca.gov/newsalerts/print-release.php?id=1582;
272. see also Reuters, California Sues Countrywide over Lending, N.Y. TTMES.COM, June 26, 2008, http://www.nytimes.com/2008/06/26/business/ 261end.html (last visited Mar. 20,2009);
273. Gretchen Morgenson, supra note 219.
274. .See Andrew Harris, Countrywide Settles Fraud Cases for $8.4 Billion, BLOOMBERG.COM, Oct. 6, 2008, http://www.bloomberg.com/apps/news?pid=20601087&sid=aWdK8sUC0Lf0&refer= home (last visited Mar. 20, 2009) (listing California, Illinois, Connecticut, Florida, Texas, Arizona, Washington, Iowa, Ohio, Michigan, and North Carolina as participating in settlement).
275. Press Release, Office of the Attorney General of California, Attorney General Brown Announces Landmark $8.68 Billion Settlement with Countrywide (Oct. 6, 2008), available at http://ag.ca.gov/newsalerts/ release.php?id= 1618 (last visited Feb. 26,2009).
276. See, e.g., Morgenson, supra note 221 (describing home owner's problems with Countrywide pay option loan);
277. see also MORRIS, supra note 69, at 70-71 (describing similar situation involving Countrywide).
278. Accordingly, Bank of America had accounted for the cost of a potential settlement when acquiring Countrywide. According to a statement of the bank's CFO, the cost of restructuring the loans and the other provisions of the settlement were within the bank's pre-acquisition estimate. Dina ElBoghdady, Bank of America to Modify Mortgages from Countrywide, WASH. POST, Oct. 7,2008, at D03.
279. See id (noting that settlement made financial sense for Bank of America because if 20% of troubled loans went into foreclosure-the industry rate at the time-the bank would be hit with $22 billion in losses).
280. See Complaint at 72-81, People v. Countrywide Fin. Corp., (111. Cir. Ct. June 25, 2008); Complaint at 42-46, People v. Countrywide Fin. Corp. (Cal. Super. Ct. June 24,2008).
281. See ElBoghdady, supra note 226.
282. See Ruth Rudden, EVOLUTION OF CREDIT RATINGS - PART I, CARICRIS (2005), http://www.caricris.com/pdfs/article/evolutionpartl.pdf (last visited Mar. 20,2009).
283. See id.
284. See id.
285. See id.;
286. see also SEC. AND EXCH. COMM'N, REPORT ON THE ROLE AND FUNCTION OF CREDIT RATING AGENCIES IN THE OPERATION OF THE SECURITIES MARKETS, AS REQUIRED BY SECTION 702(b) of the Sarbanes- Oxley Act of 2002, at 41 & n. 110 (2003) (noting that 90% of Moody's and Fitch's revenues come from issuers who pay fees for ratings).
287. See id. at 3-4,16-17.
288. See Rating the Rating Agencies: The State of Transparency and Competition: Hearing Before the Subcomm. on Capital Markets of the H. Comm. on Financial Services, 108th Cong. (2003) (opening statement of Chairman Michael G. Oxley), available at http://financialservices.house.gov/media/ pdf/040203ox.pdf (noting that Sarbanes-Oxley required SEC to submit report on rating agencies).
289. SEC. AND EXCH. COMM'N, supra note 233.
290. Pub. L. No. 109-291,120 Stat. 1327 (2006).
291. The Act also abolished the SEC's authority to create Nationally Recognized Statistical Rating Organizations ("NRSROs"). See Marie Leone, Senate Passes Credit Agency Reform Act, CFO.com;
292. Sept. 22, 2006, http://www.cfo.com/article.cfm/7959117?f=related (last visited Mar. 20, 2009). In thirty years of using the appellation, the SEC had granted NRSRO status to only five firms: A.M. Best, Dominion Bond Rating Service, Fitch Ratings, Moody's Investors Service, and Standard & Poor's. See id. This led to concerns that the SEC had fostered an oligopoly in the rating agency market. See Rating the Rating Agencies: The State of Transparency and Competition: Hearing Before the Subcomm. on Capital Markets of the H. Comm. on Financial Services, 108th Cong. (2003) (opening statement of Michael G. Oxley, Chairman, Committee on Financial Services);
293. see also Leone, supra (noting that Moody's and S & P controlled 80% of the market). While the act was intended to open up the market, the dominance of the top agencies continued throughout the credit crisis. See Credit Rating Agencies and the Financial Crisis: Hearing Before the H. Comm. on Oversight and Government Reform, 111th Cong. (2008) (testimony of Sean J. Egan, Managing Director, Egan-Jones Rating Co.) (listing same market share for Moody's and S & P).
294. See Serena Ng & Ruth Simon, Rating Cuts By S & P, Moody's Rattle Investors, WALL ST. J., July 11,2007, atAl.
295. See id.
296. See Bloomberg News, Fitch May Downgrade Bonds Tied to Subprime Mortgages, N.Y. TIMES, July 13, 2007, at C7.
297. See id.
298. See Ng & Simon, supra note 239.
299. See id.
300. See id.
301. See id.
302. See Robert Schroeder, SEC Probing Rating Agencies' Subprime Role, MARKETWATCH, Sept. 26, 2007, http://www.marketwatch. com/news/story/sec-probing-ratings-agencies-subprime/story.asp (last visited Mar. 20, 2009).
303. See Press Release, Sec. and Exch. Comm'n, SEC Proposes Comprehensive Reforms to Bring Increased Transparency to Credit Rating Process (June 11, 2008), available at http://www.sec.gov/news/press/2008/2O08- 110.htm.
304. Press Release, Office of the Att'y Gen. of N.Y., Attorney General Cuomo Announces Landmark Reform Agreements With The Nation's Three Principal Credit Rating Agencies (June 5, 2008), available at http://www.oag.state.ny.us/ media-center/2008/jun/june5a-08.html.
305. Id.
306. See id.
307. See id.
308. See id.
309. Press Release, Sec. and Exch. Comm'n, Statement from SEC Chairman Cox Regarding New York Attorney General Agreement with Credit Rating Agencies (June 5,2008), available at http://www.sec.gov/news/press/2008/2008-109.htm.
310. See Press Release, Sec. and Exch. Comm'n, SEC Approves Measures to Strengthen Oversight of Credit Rating Agencies (Dec. 3, 2008), available at http://www.sec.gov/news/press/2008/2008-284.htm;
311. see also Kara Scannell & Aaron Lucchetti, SEC Tightens Rules for Ratings Firms, WALL ST. J., Dec. 4,2008, at C3.
312. .See STEPHANIE LEE, NERA ECONOMIC CONSULTING, AUCTION-RATE SECURITIES: BIDDER'S REMORSE? A PRIMER 1-2 (2008), available at http://www.nera.com/image/PUB-Auction-Rate-Securities-0708.pdf [hereinafter ARS Primer]. Closed-end mutual funds also issued ARS in the form of auction preferred stock. See id. at 3 (explaining closed-end mutual funds are investment companies that issue fixed number of shares, typically preferred stock to take advantage of leverage requirements under the Investment Company Act of 1940).
313. See id. at 5.
314. See id. at 5-9;
315. see also Adrian D'Silva et al., Fed. Reserve Bank of Chi., Explaining the Decline in the Auction Rate Securities Market, ESSAY ON ISSUES No. 256, at 1-2 (Nov. 2008), available at http://www.chicagofed.org/publications/fedletter/cflnovember2008-256.pdf (describing auction process).
316. See ARS Primer, supra note 256,5-9.
317. See D'Silva et al., supra note 258, at 1-2.
318. See ARS Primer, supra note 256, at 5;
319. D'Silva et al., supra note 258, at 1.
320. See ARS Primer, supra note 256, at 1.
321. See Liz Rappaport, Auction-Rate Crackdown Widens-UBS Faces New Charges in New York, As Scrutiny of Wall Street's Role Intensifies, WALL ST. J., July 25,2008, at Al.
322. See Thomsen Testimony, supra note 50, at 11 (describing broker-dealers functioning in both capacities);
323. Jacqueline Doherty, The Sad Story of Auction-Rate Securities, BARRONS.COM, May 26, 2008, http://online.barrons.com/article/ SB121159302439419325.html?mod=b-hpp-9-0002-b-this-weeks-magazine-home-right (last visited Mar. 20,2009).
324. This is not to say that the ARS market was entirely without hiccups prior to the credit crisis. In 2004, the SEC initiated an investigation, reaching a settlement with 15 broker dealer firms for $13 million. See Press Release, Sec. and Exch. Comm'n, 15 Broker-Dealer Firms Settle SEC Charges Involving Violative Practices in the Auction Rate Securities Market (May 31,2006), available at http://www.sec.gov/news/press/2006/2006-83.htm. The SEC found that the settling firms had not adequately disclosed to investors certain auction practices, some of which had the effect of favoring certain customers over others or the issuer of the securities over the customer (or vice versa). The investigation concluded that, because "firms were under no obligation to guarantee against a failed auction, investors may not have been aware of the liquidity and credit risks associated with certain securities." Id. A central condition of the settlement was that broker-dealers would disclose ARS liquidity risk, their input to the auctions, and their potential conflicts with current clients. See id.
325. See Dakin Campbell et. al, Auction Rate Market Turmoil Continues, BOND BUYER, Feb. 15,2008, at 1; Liz Rappaport, New Hitches in Markets May Widen Credit Woes, WALL ST. J., Feb. 11,2008, at Al (describing decline in investor interest in ARS market in early 2008);
326. see also Thomsen Testimony, supra note 50, at 37 (describing role of monoline insurance companies).
327. See supra note 263 and accompanying text.
328. See John Carney, What Happened to the ARS Market Anyway?, DEALBREAKER, Feb. 21, 2008, http://www.dealbreaker.com/2008/ 02/what-happened-to-the-ars-rnarke.php (last visited May. 20, 2009);
329. see also Thomsen Testimony, supra note 50, at 37 (describing actions of broker-dealers); Doherty, supra note 264 (same).
330. See Thomsen Testimony, supra note 50, at 33-34 (describing mechanics of auction failure); Fin. Indus. Regulatory Auth., Auction Rate Securities: What Happens When Auctions Fail, http://www.finra.org/Investors/ ProtectYourself/InvestorAlerts/Bonds/P038207 (last visited Mar. 20, 2009). In the event of a failed auction, in order to provide an incentive for issuers to restructure the ARS and improve the potential for a later successful auction, the interest rate reverts to a fail rate that is often set higher than the market rate. See Anna Pinedo, US Auction-Rate Securities: A Market Being Replaced, INT'L FIN. L. REV., Nov. 2008, at 1, available at http://www.mofo.com/docs/pdf/081106MarketReplaced.pdf. In early 2008, however, this mechanism did not succeed in kickstarting the ARS market.
331. See Joan Gralla, Failed U.S. Muni Auctions Attract Investors, REUTERS.COM, Feb. 14, 2008, http://www.reuters.com/ article/companyNews/idUSN1446747120080214 (last visited Mar. 20, 2009);
332. see also Jenny Anderson & Vikas Bajaj, New Trouble in Auction-Rate Securities, N.Y. TIMES, February 15,2008, at C6.
333. See Thomsen Testimony, supra note 50, at 11.
334. See Press Release, Ala. Sec. Comm'n, Alabama Investors to Participate in Settlements over the Sale of Auction Rate Securities (Sept. 26,2008), available at http://www.asc.state.al.us/ Auction%20Rate%20Securities%20Settlements/ Investors%20to%20Participate%20in%20Settlements.pdf (describing Alabama's involvement in ARS investigation); Press Release, Office of 111. Sec'y of State Jesse White, Secretary of State Jesse White Investigates Auction Rate Securities Complaints (Apr. 18, 2008), available at http://www.cyberdriveillinois. com/press/2008/april/080418d2.html (describing involvement of Illinois, Massachusetts, Florida, Georgia, Missouri, New Hampshire, New Jersey, Texas and Washington).
335. See Press Release, Ala. Sec. Comm'n, supra note 271 (describing investors);
336. Press Release, Office of 111. Sec'y of State Jesse White, supra note 271 (same);
337. Press Release, Office of Mo. Sec'y of State Robin Carnahan, Camahan Launches Investigation into Auction Rate Securities Sales (Apr. 10, 2008), available at http://www.sos.mo.gov/news.asp?id=695 (same).
338. See Thomsen Testimony, supra note 50, at 35 (describing potentially conflicting incentives for broker- dealers functioning in both capacities).
339. See, e.g., Press Release, Office of the Att'y Gen. of Mass., Citigroup Agrees to Purchase Auction Rate Securities from Massachusetts Water Pollution Abatement Trust (Sept. 12,2008), available at http://www.mass.gov/?pageID=cagopressrelease& L=l&L0=Home&sid= Cago&b=pressrelease&f=2008-09-12-citigroup-mwpat& csid=Cago;
340. Press Release, Office of the Att'y Gen. of Mass., Morgan Stanley & Company Agrees to Repay Massachusetts Municipalities for Auction Rate Securities Investments (Aug. 7, 2008), available at http://www.mass.gov/?pageID= cagopressrelease&L=l&L0=Home&sid=Cago&b=pressrelease&f= 2008-08-07-morgan-stanley-agreement&csid=Cago;
341. Press Release, Office of the Att'y Gen. of Mass., UBS Financial Services Agrees to Return Over $35 Million from Impermissible Municipal Investments to Massachusetts Towns and Cities (May 7, 2008), available at http://www.mass.gov/?pageID=cagopressrelease&L=l&LO= Home&sid=Cago&b=pressrelease&f=2008-05-07-ubs-agreement&csid= Cago;
342. see also Auction Rate Securities Market: A Review of Problems and Potential Resolutions: Hearing Before the H. Comm. On Financial Servs., 110th Cong. (2008) (statement of Martha Coakley, Att'y Gen. of Mass.), available at http://www.mass.gov/Cago/docs/press/testimony-ag-septl9- auction-rate-securities-hearing.pdf (describing Massachusetts actions regarding ARS market).
343. See, e.g., Press Release, Office of the Att'y Gen. of N.Y., Attorney General Cuomo Announces Settlement with Wachovia to Recover Billions for Investors in Auction Rate Securities (Aug. 15, 2008), available at http://www.oag.state.ny.us/media-center/2008/aug/augl5a-08.html (describing Wachovia settlement);
344. Press Release, Office of the Att'y Gen. of N.Y., Attorney General Cuomo Announces Settlements with JP Morgan and Morgan Stanley to Recover Billions for Investors in Auction Rate Securities (Aug. 14, 2008), available at http://www.oag.state.ny.us/media-center/2008/aug/augl4a-08.html (describing JPMorgan and Morgan Stanley settlements);
345. Press Release, Office of the Att'y Gen. of N.Y, Attorney General Cuomo Announces Settlement with UBS to Recover Billions for Investors in Auction Rate Securities (Aug. 8, 2008), available at http//www.oag.state.ny.us/media- center/2008/aug/aug8a-08.html (describing UBS Settlement);
346. Press Release, Office of the Att'y Gen. of N.Y., Attorney General Cuomo Announces Landmark Settlement with Citigroup To Recover Billions in Auction Rate Securities for Investors Nationwide (Aug. 7,2008), available at http://www.oag.state.ny.us/media-center/2008/aug/aug7a-08.html (describing Citigroup settlement);
347. see also Eric Dash, Three Banks Settle Cases over Bonds, N.Y. TIMES, Aug. 22, 2008, at C3 (describing ARS settlements with Merrill Lynch, Goldman Sachs, Deutsche Bank, Citigroup, JPMorgan Chase, Morgan Stanley, UBS, and Wachovia).
348. See sources cited supra note 275;
349. see also Liz Rappaport & Randall Smith, UBS to Pay $19 Billion as Auction Mess Hits Wall Street, WALL ST. J., Aug. 9, 2008, at Al (describing regulators allegations that firms, among other things, "secretly propped up failed auctions" and "misled investors on the safety of the securities"). Some firms also were alleged to have allowed executives to trade in ARS for their own benefit. See, e.g., Evan Weinberger, Ex-UBS Counsel Settles Cuomo's ARS Claims, LAW360, Oct. 7, 2008 (describing New York settlement with former general counsel of UBS) (on file with authors). One firm was alleged to have improperly influenced one of its research analysts to write a favorable piece on ARS to prop up the market price. See infra note 288 (discussing Massachusetts complaint against Merrill Lynch.
350. See sources cited supra note 275.
351. See Press Release, Office of theAtt'y Gen. of N.Y., Attorney General Cuomo Announces Settlement with Wachovia to Recover Billions for Investors in Auction Rate Securities, supra note 275; Press Release, Office of the Att'y Gen. of N.Y., Attorney General Cuomo Announces Settlement with UBS to Recover Billions for Investors in Auction Rate Securities, supra note 275-.
352. See sources cited supra note 275.
353. Press Release, Office of the Att'y Gen. of N.Y, Attorney General Cuomo Announces the Release of Assurances of Discontinuance in Auction Rate Securities Settlements with Citigroup and UBS (Dec. 11, 2008), available at http://www.oag.state.ny.us/media-center/2008/dec/declla-08.html (calling the settlement the "largest consumer recovery in history").
354. Cf. Daisy Maxey, Lingering Scars: Advisers' Job Records and Client Relationships May Long Be Tarred by the Auction-Rate Blowup, WALL ST. J., Dec. 1, 2008, at R4 (discussing positive effect of settlements on financial advisers' client relations and retention).
355. See David Mildenberg, Merrill, Goldman Pressured by Cuomo on Auction-Rate Debt, BLOOMBERG.COM, Aug. 16,2008, http://www.bloomberg.corr-apps/news?pid=20601087&sid=a4XnkdnnlMJQ&refer= home (last visited Mar. 20,2009).
356. See Dan Jamieson, Reps Angry Over ARS Payback Delay, INVESTMENT NEWS, Aug. 18, 2008, http://www.investmentaews.com/ apps/pbcs.dll/article?AID=/20080818/REG/518129496/1009/rOC (quoting Morgan Stanley employee that repurchases posed "no risk" because of high quality of ARS) (last visited Mar. 20,2009).
357. Cf. Mildenberg, supra note 282 ("All the banks want to put these things behind them quickly so they can move on.") (quoting Duke University Law School professor).
358. See, e.g., Rappaport, supra note 263 ("It is frustrating that the New York Attorney General has filed this complaint while we have been fully engaged in good-faith negotiations with his office") (quoting UBS spokesperson). This tactic is not one normally employed by federal prosecutors, who are typically bound by grand jury secrecy rules during the course of an investigation, generally wait until an investigation is completed to release information and file complaints, and often provide formal processes for contesting allegations prior to the commencement of an enforcement action. In addition, under the Martin Act, the New York Attorney General did not have to prove any intent to defraud for a criminal misdemeanor. See supra note 216.
359. See 25A STEINBERG & FERRARA, supra note 125, § 13:14.
360. See, e.g., Press Release, Office of the Att'y Gen. of N.Y, Attorney General Cuomo Announces Settlement with Wachovia to Recover Billions for Investors in Auction Rate Securities, supra note 275 ("From the beginning of his investigation into the auction rate market, the Attorney General's objective has been to bring relief to investors stuck with illiquid auction rate securities The settlements with Citigroup, UBS, JP Morgan, Morgan Stanley, and Wachovia accomplish precisely the kind of relief investors have demanded.").
361. For some firms, the facts underlying the allegations also were not auspicious. The Massachusetts complaint against Merrill Lynch provides a good illustration. The bank allegedly had permitted its sales and trading managers, including the auction desk managers, to inappropriately influence and pressure the bank's research department. These managers allegedly were allowed to push the research department to publish pieces endorsing the stability and quality of all types of ARS. For example, a research department piece comparing Variable Rate Demand Obligations ("VRDOs") and ARS noted that VRDOs have a protective put option feature that ARS lack. The complaint alleges that the ARS manager demanded a retraction; when the research analyst refused, the ARS manager escalated the complaint. The research department ultimately retracted and rewrote the piece with a markedly different focus and scope, concluding with a glowing endorsement of ARS "as a buying opportunity for investors who are looking for short-term instruments." See Office of the Sec'y of the Comm. Of Mass. Sec. Div., Administrative Complaint, In Re Merrill Lynch, Pierce, Fenner, & Smith, Inc., No. 2008-0058 (July 31,2008).
362. Evan Weinberger, Heads May Roll in Wake of Financial Collapse, LAW360, Oct. 3, 2008 (on file with authors).
363. Sudeep Reddy et al., Job Losses Worst Since '74: 533,000 Shed in November, WSJ.COM, Dec. 6, 2008, http://online.wsj.com/article/ SB122848262764182657.html (last visited Mar. 20,2009).
364. See, e.g., Andrew Ross Sorkin, Outcry Builds for Recovery ofA.I.G. Bonuses, DEALBOOK, Mar. 17,2009, http://dealbook.blogs.nyumes.com/2009/03/17/outcry-buast=cse (last visited Mar. 20,2009) (noting congressional reaction to announcement that A.I.G. had paid out $165 million in bonuses after receiving more than $ 170 billion in federal bailout money).
365. Cf. David Segal, Financial Fraud Is Focus of Attack by Prosecutors, N.Y. TIMES, Mar. 11, 2009, at Al (describing state and federal plans for "a surge of prosecutions of financial fraud").