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Fraud Trial Is Key to Mortgage Probe

online.wsj.com| January 9, 2014

By Jean Eaglesham

A criminal fraud trial next month may have a big impact on a wide-ranging probe into whether banks cheated mortgage-bond clients in the years after the financial crisis.

The line between savvy sales tactics and securities fraud isn’t always easy to find, at least in the murky world of mortgage-bond deals.

The criminal trial of Jesse C. Litvak in federal court in New Haven, Conn., next month will shine a light on this issue. It could also have a big impact on a wide-ranging probe into whether banks cheated mortgage-bond clients in the years after the financial crisis, legal experts said.

Prosecutors allege Mr. Litvak, a former Jefferies LLC trader, cheated his clients out of a total of more than $2 million. Mr. Litvak is accused of using dishonest sales tactics to inflate the prices the clients were willing to pay for the bonds, including inventing imaginary sellers, and lying about how much Jefferies had paid for the bonds.

Lawyers representing Mr. Litvak, who has pleaded not guilty to the charges, have said he has done nothing wrong and that the hedge funds and other Wall Street firms that bought the bonds were capable of deciding fair prices, based on the yield and other characteristics. The alleged secret extra markups on the bond were too small to have mattered to the investors, a court filing by the defense lawyers said last year.

A markup on an asset, generally speaking, is the difference between what it cost and the price paid by the seller. The bigger the markup, the greater the profit for traders.

In the residential mortgage-backed securities market, pricing information isn’t publicly available, and investors often use traders, as well as their own judgment, to help gauge a product’s fair value.

In Mr. Litvak’s case, prosecutors haven’t said the trader had to tell investors how big his markups were. But they said that once Mr. Litvak decided to tell investors about the markups “he was required by law to speak truthfully.”

A spokesman for Jefferies, now part of Leucadia National Corp., declined to comment this week. Jefferies hasn’t been accused of any wrongdoing.

The outcome of the case matters to Wall Street. The precedent set could directly affect the probe that began after Mr. Litvak’s arrest last year, looking at whether traders at other banks acted similarly.

“If they find [Mr. Litvak] guilty, it’s got to be easier for the investigators,” said John Alan James, executive director of the Center for Global Governance, Reporting and Regulation at Pace University in New York.

The wider probe, revealed by The Wall Street Journal in a page-one article Wednesday, is being conducted by the Justice Department, Securities and Exchange Commission and the special inspector general for the Troubled Asset Relief Program, or Sigtarp, according to people close to the investigation. Spokesmen for the SEC, U.S. attorney’s office in Connecticut and Sigtarp declined to comment.

J.P. Morgan Chase & Co., one of at least eight banks under scrutiny, said in a securities filing last year that it had received requests for information from the U.S. attorney’s office in Connecticut as well as subpoenas from the SEC and a request from Sigtarp to review “certain activities” related to mortgage-backed securities transactions. The disclosure refers to the government probe reported by the Journal, according to a person familiar with the matter.

The investigation, which is still at an early stage and may not lead to enforcement action, is the latest to focus on the issue of markups and markdowns. In the past, regulators have often found it difficult to bring cases when there is no hard evidence indicating that traders intended to deceive their counterparties.

The difficulty of deciding reasonable prices for mortgage bonds became particularly acute when markets seized up in the financial crisis and continued even as buyers started to return from 2009 through 2011—the period covered by the probe.

In a court filing, Mr. Litvak’s lawyers said the investors he is alleged to have deceived were all “sophisticated market participants” capable of analyzing bonds to determine reasonable prices to pay.

The list of what prosecutors call Mr. Litvak’s “victim-customers” in the indictment includes hedge funds such as Third Point LLC and Magnetar Capital LLC, as well as the Soros Fund Management LLC family office.

Representatives of Third Point, Magnetar and Soros declined to comment.

Magnetar was itself investigated by the SEC for its role in helping Wall Street firms create mortgage-bond deals in the run-up to the financial crisis. The Chicago based firm said last month SEC enforcement officials had told it they had closed the investigation and didn’t plan to recommend enforcement action.

“If you’re a defense lawyer, it’s a tough sell when you’ve got widows and orphans on the other side,” said Adam Pritchard, a law professor at the University of Michigan. “If it’s Magnetar, [you can portray the case to the jury as] ‘a pox on all their houses.’”

But James Cox, a law professor at Duke University in Durham, N.C., said “it’s just as easy to say with sophisticated investors that they’re assuming that people are playing by the rules of the game” and not misrepresenting the circumstances of the deal, as alleged in Mr. Litvak’s case.

–Dan Fitzpatrick contributed to this article.


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CFLA was founded by the Nation's Leading Foreclosure Defense Attorneys back in 2007 to serve the Foreclosure Defense Industry and fight pervasive Bank Fraud. Since opening our virtual doors, CFLA has rapidly expanded to become the premier online legal destination for small businesses and consumers. But as the company continues to grow, we're careful to hold true to our original vision. For us, putting the law within reach of millions of people is more than just a novel idea—it's the founding principle, just ask Andrew P. Lehman, J.D.. With convenient locations in Houston and Los Angeles, you can contact Our National Account Specialist and General Manager / Member Damion W. Emholtz at 888-758-2352 for a free Mortgage Fraud Analysis or to obtain samples of work product, including cutting edge Bloomberg Securitization Audits, Litigation Support, Quiet Title Packages, and for more information about our Nationally Accredited and U.S. Department of Education Approved "Mortgage Securitization Analyst Training Certification" Classes (3 days) 24 hours for approved CLE & MCLE Credit (Now Available Online).

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