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Credit Suisse Waits for $11 Billion Answer in N.Y. Fraud Suit

businessweek.com | February 19, 2014

By Christie Smythe and Chris Dolmetsch

As Credit Suisse Group AG (CSGN) sees it, time has run out on New York Attorney General Eric Schneiderman’s pursuit of Wall Street banks for mortgage fraud that helped trigger the financial crisis.

Schneiderman sued Credit Suisse in 2012 as part of a wide-ranging probe into mortgage bonds. He claimed Switzerland’s second-largest bank misrepresented the risks associated with $93.8 billion in mortgage-backed securities issued in 2006 and 2007.

Credit Suisse asked a Manhattan judge in December to dismiss Schneiderman’s case, as well as his demand for as much as $11.2 billion in damages. The bank argued that New York, by waiting so long to file the lawsuit, missed a three-year legal deadline for suing. The state countered that it had six years to file its complaint.

If the bank wins, Schneiderman will face a new roadblock as he considers similar multibillion-dollar claims against a dozen other Wall Street firms. The judge in New York State Supreme Court could rule at any time.

“It would obviously tilt everything in the favor of Credit Suisse and similarly situated financial institutions,” said David Reiss, a professor at Brooklyn Law School, hindering New York’s remaining efforts to hold banks accountable for mistakes that spurred a recession.
Obstacles Posed

The obstacle posed by such statutes of limitation in pursuing mortgage-bond cases may be traced back to Andrew Cuomo, Schneiderman’s predecessor. Although now-Governor Cuomo didn’t file any such cases against the banks, he announced a probe into all aspects of the mortgage business in 2008.

In doing so, he may have started the clock ticking on how long a state suit could be filed, making it impossible for fellow Democrat Schneiderman to argue his office didn’t learn of the bank’s conduct until he took office in 2011.

On Feb. 6, Credit Suisse said it was setting aside 514 million Swiss francs ($568 million) for legal issues, including 339 million francs for mortgage litigation. The bank may be preparing to resolve a related bond insurer lawsuit, Mark Palmer, an analyst with BTIG LLC in New York, said in a Feb. 10 note.

Matt Mittenthal, a spokesman for Schneiderman, and Dani Lever, a spokeswoman for Cuomo, declined to comment on the Credit Suisse case.
Filing Deadline

Schneiderman, 59, avoided a filing deadline dispute by settling a mortgage-bond case with JPMorgan Chase & Co. (JPM:US) last year. The state got $613 million in that pact, New York’s share of the landmark $13 billion federal-state accord with the largest U.S. lender.

Armed with the Martin Act, New York’s powerful anti-fraud tool, Schneiderman has said he is seeking settlements with the other, unidentified banks.

In the lawsuit against Zurich-based Credit Suisse, filed in November 2012, he claims the bank ignored warning signs about the quality of loans it was packaging and selling. One example cited was its use of New Century Financial Corp. mortgages after that firm’s 2007 bankruptcy.

The attorney general’s lawsuit involves 64 Credit Suisse bond offerings in 2006 and 2007. Credit Suisse has said the losses on those offerings were only about half of the $11.2 billion claimed by Schneiderman.

One Credit Suisse executive described some of the mortgages the bank sold as “complete and utter garbage,” according to the complaint. The bank relied on mortgage originators that “systematically abandoned underwriting standards in the years leading up to the collapse of the housing market,” Schneiderman said.
Thrown Out

Credit Suisse, which denies any wrongdoing, told Justice Marcy S. Friedman Dec. 11 that the suit should be thrown out because it was filed more than three years after the alleged wrongdoing was discovered.

Consumer fraud and personal injury claims are generally subject to a three-year statute of limitations under New York law, while financial frauds can be granted six years.

The Martin Act has been previously held to have a six-year limitation, lawyers for the attorney general argued. Credit Suisse contends New York’s highest court held that the attorney general must be able to show that investors relied on misstatements by the bank and that it knowingly committed fraud to get the longer time limit.

No such allegations of intentional fraud by the bank are made in the lawsuit, according to Credit Suisse.
Latest Bonds

Since the latest bonds cited in Schneiderman’s suit originated in 2006 and 2007, if the judge chooses the bank’s argument, the lawsuit may be dismissed. If the judge takes Schneiderman’s more expansive view, most or all of the suspect bonds may still be covered by the litigation.

“The entire case is time-barred,” Richard Clary, a lawyer for the bank, told Friedman at the December hearing. Lawyers for the state argued that such limits weren’t intended to apply to the attorney general.

“We’ve successfully resolved cases filed within six years,” Deputy Attorney General Virginia Chavez Romano said, citing last year’s JPMorgan accord. “It has been our decades-long practice.”

So far, New York’s courts have broadly interpreted the statute in finding a six-year period, Brooklyn Law School’s Reiss said. That may be changing as legal scholars and financial industry lawyers question its propriety.

“Having these incredibly long and ambiguous statutes of limitations is not particularly fair,” he said.
Other Banks

Friedman’s ruling in the Credit Suisse case may be crucial to Schneiderman’s probe of close to a dozen other banks, and whether he can sue them successfully.

New York agreed with the firms in October 2012 that any legal deadline for bringing fraud claims against them would be suspended while he continues his investigation, a person familiar with the matter said.

Such tolling agreements stopped the clock on any statute of limitations and ensured Schneiderman can bring fraud claims against banks for conduct going as far back as 2006, said the person.

Brooklyn Law School’s Reiss said the banks may have agreed to the delay to avoid forcing Schneiderman to file a “kitchen sink complaint with every possible allegation in it” just to beat the clock. Doing so also builds good will with regulators and may also facilitate a favorable settlement.

The agreements don’t necessarily mean that suits will be filed, the person said. If Schneiderman sues any of the banks, they may then assert the statute of limitations is three years, and not six, just as Credit Suisse has done.
Potent Argument

This may be a more potent argument if Friedman rules for the Swiss bank in the pending case.

A three-year statute-of-limitations would mean they can’t be held responsible for transactions before 2009, while a six-year deadline would allow Schneiderman to reach back to 2006.

There’s “great uncertainty” about whether Schneiderman can move forward with the Credit Suisse case in light of the statute of limitations arguments, said James Cox, a corporate law professor at Duke University in Durham, North Carolina.

Reiss said that any ruling would probably be challenged all the way to the Court of Appeals in Albany, the state’s highest court.

By 2006, about 40 percent of all mortgage loans issued in the U.S. were either subprime or alt-A, meaning lenders required no proof of income from borrowers, according to a report from the Center for Responsible Lending. Most were packaged into securities, according to the center.
Legal Expenses

U.S. banks have yet to see an end to their expenses tied to home loans that soured when the housing market slumped and prompted 2008’s market turmoil. The six largest U.S. lenders have allocated more than $114 billion since the crisis to cover legal expenses, government probes and investor claims, much of which stemmed from mortgage-related liabilities.

JPMorgan snapped three straight years of record profits in 2013 after reaching the $13 billion deal to resolve inquiries into mortgage-bond sales.

Regardless of how Friedman rules, Credit Suisse’s argument may have already borne fruit for bank defenders.

New York’s lawyers have acknowledged in court filings that transactions before early March 2006 are too old and should be excluded from the case, wiping out about $1 billion in potential damages.

The case is People of the State of New York v. Credit Suisse Securities (USA) LLC, 451802-2012, New York State Supreme Court, New York County (Manhattan).

 

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