The New York attorney general's office has hit JPMorgan Chase & Co. with a civil lawsuit, alleging that investment bank Bear Stearns - prior to its collapse and subsequent sale to JPMorgan in 2008 - perpetrated massive fraud in deals involving billions in residential mortgage-backed securities.
The lawsuit is the first to be filed under the auspices of the RMBS Working Group, which was set up by President Barack Obama to investigate and prosecute alleged misconduct that contributed to the financial crisis.
New York-based JPMorgan said it intends to contest the allegations. Spokesman Joseph Evangelisti noted that the lawsuit relates solely to alleged actions by Bear Stearns prior to its takeover by JPMorgan in May 2008.
In the lead-up to the financial crisis, subprime mortgages were sold to people with less-than-ideal credit. Many of them defaulted on their loans when the housing bubble burst and their introductory "teaser" interest rates skyrocketed.
Because many of those mortgages had been sliced and repackaged as securities that could be bought and sold - known as RMBS - the mass defaults led to huge losses at large U.S. banks and other financial firms, helping fuel the global economic meltdown.
New York Attorney General Eric T. Schneiderman is alleging that Bear Stearns led its investors to believe that the loans in its RMBS portfolio had been carefully evaluated and would be continuously monitored. Bear Stearns failed to do either, resulting in investors buying securities backed by mortgages that borrowers couldn't repay and defaulted on in huge numbers, Schneiderman alleges.
The complaint further alleges that even when Bear Stearns executives were made aware of the problems, the firm failed to correct its practices or disclose material information to investors. The executives routinely overlooked negative findings and continued to package the loans into securities for sale to investors, it says.
Investors have so far lost $22.5 billion on more than 100 subprime securities that Bear Stearns issued in 2006 and 2007, according to the complaint. That's over one-quarter of the original principal balance of $87 billion. The lawsuit seeks injunctive relief, damages and payment of restitution to investors for "fraudulent and deceptive acts."
"We're disappointed that the NYAG decided to pursue its civil action without ever offering us an opportunity to rebut the claims and without developing a full record - instead relying on recycled claims already made by private plaintiffs," JPMorgan's Evangelisti said in a statement.
"We will nonetheless continue to work with members of the president's RMBS Working Group and are fully cooperating with their inquiries," he added.
Bear Stearns teetered on the verge of bankruptcy in early 2008 after its two hedge funds imploded, costing investors $1.8 billion and kicking off the domino effect that led to the 85-year-old bank's demise. With the backing of the New York Federal Reserve, JPMorgan bought the ailing investment bank for about $2.3 billion.