By Pam Martens: November 19, 2012

Is JPMorgan actually a cartel of lawyers in drag as a bank? You’d think so reading the fine print buried in the firm’s 2011 annual report and the legal disclosures in its hair-raising third quarter report filed with the Securities and Exchange Commission (SEC) on November 5. According to its own figures, JPMorgan has paid the following sums for litigation expense: $3.8 billion for the nine months of 2012 ending September 30; $4.9 billion in 2011; and $7.4 billion in 2010 for the whopping total of $16.1 billion in 33 months. There are more than a dozen small countries that have less than that in annual GDP.

How many times have we heard the now enshrined gospel that JPMorgan escaped the 2008 crisis unscathed. Reading the mountain of lawsuits now filed against the firm, it’s clear why: JPMorgan’s role in the housing collapse has been significantly shielded from public view – until recently.

The SEC, continuing a long standing practice of dumping news of toothless settlements against Wall Street firms on Friday afternoons when, hopefully, no one is paying close attention, announced the settlement of charges against JPMorgan Chase & Co. and Credit Suisse Group AG this past Friday. The settlement related to charges that the firms misled investors in the sale of securitized residential home loans. JPMorgan agreed to pay $296.9 million, while Credit Suisse will pony up $120 million. (Included in the JPMorgan payment were separate claims against a Bear Stearns unit, which JPMorgan acquired during the financial crisis of 2008.)

Because of the muddled press release from the SEC and the late Friday afternoon announcement, it is easy for the public to dismiss this as an isolated incident relating to one JPMorgan securitization or to confuse it as a misdeed by Bear Stearns, without any underlying intent to defraud on the part of JPMorgan. Both assumptions would be wrong.

For those few taking the time to read the full SEC complaint, it is clear that the SEC is alleging that JPMorgan, itself, filed a registration for a $1.8 billion offering of securities, knowing it was intentionally misleading investors about the number of delinquent mortgages in the offering. The SEC complaint produces an email showing an investment banker at the firm was aware of the misreporting in advance of the filing of the registration, as were the lawyers writing the prospectus. Neither the investment banker’s name nor the name of the law firm were disclosed by the SEC in their complaint.

According to the SEC charges: “The prospectus supplement that JP Morgan and JPMAC filed on December 20, 2006, was for the offer of approximately $1,834,557,000 of securities collateralized by 9,637 sub-prime mortgage loans with a total principal balance of approximately $1,911,922,433…the loans included as collateral for the WMC4 transaction as to which payments due on November 1, 2006, had not been made by the cut-off date for the transaction should have been treated and disclosed as loans that were 30- 59 days delinquent. Rather than the .04% of loans in the aggregate loan pool, representing 4 loans, that JP Morgan and JPMAC disclosed, there were approximately 623 loans that, as of the cut-off date, were 30 – 59 days delinquent.”

The SEC complaint deals with just one JPMorgan securitization. But JPMorgan’s lawyers are racking up huge amounts of billable hours from a lawsuit brought in Federal Court by the Federal Housing Finance Agency (FHFA) where JPMorgan – prior to any acquisition of Bear Stearns or Washington Mutual, is charged with fraud and aiding and abetting fraud under the common law of New York State in the sale of pools of mortgages to Fannie Mae and Freddie Mac. (Fannie Mae and Freddie Mac were placed into government conservatorship due to billions in losses from defaulting mortgages.) In that case, JPMorgan served as the lead underwriter for 30 out of the 103 securitizations at issue, and for 27 of those it also served as sponsor and depositor. In other words, it had asymmetric knowledge of every phase of the securitizations in which it is has tried to convince a Federal court of its ignorance.

On November 5, 2012, Judge Denise Cote rejected the request by JPMorgan and other Wall Street firms to dismiss the case. (A few issues were removed from the case but the core charges remain.)

In refusing to dismiss the case against JPMorgan, Judge Cote noted the following:

“FHFA finds further support for its scienter allegations in a report prepared by the third-party due diligence firm Clayton Holdings and recently made public by the Government in connection with an investigation by the Financial Crisis Inquiry Commission. The report indicates that between the first quarter of 2006 and the second quarter of 2007, JPMorgan was informed that up to 27% of the loans that it proposed for securitization were not originated in accordance with represented underwriting standards. Although the Offering Documents allowed for the inclusion of non-conforming loans, where sufficient compensating factors existed, FHFA asserts that the 27% of loans identified by Clayton as non-conforming ‘did not have any compensating factors’ and therefore fell outside of this exception.

“Faced with such a defect rate in Clayton’s sample, JPMorgan might have investigated its own underwriting practices and those of the third-party originators from which it purchased loans to determine whether its public statements regarding underwriting practices were accurate. Instead, FHFA alleges, JPMorgan waived into its securitization pools 51% of the loans identified by Clayton as defective. The Agency suggests that this response is a strong indicator that JPMorgan consciously disregarded facts that would reveal that the underwriting guidelines information it included in its Offering Documents was false.

“FHFA also relies on JPMorgan’s role as an originator of many of the very loans that made their way into the Supporting Groups as evidence that JPMorgan ‘had knowledge of the true characteristics and credit quality of the mortgage loans.’ As alleged in the Amended Complaint, CHF, JPMorgan’s subprime lending arm, originated all or the majority of loans underlying six of the securitizations at issue here, and contributed a significant number of loans to a seventh. FHFA cites evidence of CHF’s questionable origination practices in an effort to show that JPMorgan disregarded evidence that loans originated by CHF and selected for inclusion in JPMorgan-sponsored securitizations did not conform to the stated guidelines.

“For instance, according to the Amended Complaint, CHF supervisors in Oregon distributed a memorandum to their employees containing ‘cheats & tricks’ that would allow borrowers who did not otherwise qualify to obtain low-documentation loans. Among other things, loan officers were instructed that if the bank’s automated underwriting software rejected a Stated Income/Stated Asset loan application, they should ‘try resubmitting with slightly higher income. Inch it up $500 to see if you can get the findings you want.’ FHFA also cites an interview that James Theckston, a former vice president at CHF, gave to the New York Times, in which Theckston disclosed that 60% of his 2006 performance review depended on his success in increasing high-risk loans. Speaking specifically about the potential to securitize and sell off questionable loans, Theckston said, ‘The bigwigs of the corporation knew [about declining lending standards], but they figured we’re going to make billions out of it, so who cares? The government is going to bail us out. And the problem loans will be out of here, maybe even overseas.’

“The Amended Complaint alleges fraud with respect to each of the three categories of false statements upon which FHFA’s Securities Act and Blue Sky claims are premised — statements regarding the owner-occupancy rates, LTV ratios and underwriting standards that characterized the Supporting Loans. It can hardly be disputed that, taken together, the allegations above adequately plead that JPMorgan acted with fraudulent intent in misrepresenting the underwriting standards that governed the Supporting Loans.”

Judge Denise Cote Decision Against Dismissal of Federal Housing Finance Agency v. JPMorgan Chase & Co., et al Dated November 5, 2012 11 Civ 6188 in the U.S. District Court for the Southern District of New York