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02/07/2008
'Ultimate' Prosecution Weapon Deployed in Mortgage Probes
By Beth Bar -
New York Law Journal
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As
Attorney General Andrew Cuomo has turned his attention to the subprime
mortgage scandal, he increasingly has deployed one of the most powerful
legal weapons in his office's arsenal: the Martin Act.
According to news reports last week, Mr. Cuomo has issued
Martin Act subpoenas to several Wall Street investment banks seeking
information about the packaging and selling of mortgage securities.
In November, he filed a lawsuit against First American, the
nation's largest title issuer, accusing the company of inflating home
values in reports to banks.
He also has issued subpoenas to Fannie Mae and Freddie Mac.
The
86-year-old act, General Business Law Article 23-A, grants the attorney
general the power to investigate any "fraudulent practice" in
connection with the "issuance, exchange, purchase, sale, promotion,
negotiation, advertisement, investment advice or distribution within or
from [New York] state." (See sidebar.)
The attorney general does not have to specify whether he is
investigating criminal or civil charges, and does not have to prove
fraudulent intent on the part of the defendants.
The law is unusual in its scope among state "Blue Sky"
securities laws. Robert J. Giuffra Jr., a partner at Sullivan &
Cromwell, called the act the "ultimate" prosecutorial weapon. Mr.
Cuomo's use of the law duplicates the aggressive tactics of his
predecessor, now-Governor Eliot Spitzer, who used the law to pry large
settlements from investment banks and mutual funds.
"The Martin Act is an effective tool for the attorney general
[because] its scope and limitations have not been clearly defined,"
said Mark Zauderer, a partner at Fleming Zulak Williamson Zauderer.
Mr. Giuffra said the Martin Act is so potent because the
attorney general can "cite to it, say it is really old, say [he does
not] need to prove fraudulent intent, and then can use it to reach a
settlement."
The statute was originally used in New York to go after
boiler room securities operations in which penny stocks were being sold
to unsophisticated investors. Mr. Spitzer's use of the statute, which
had been moribund for years, marked "the broadest and most successful
utilization" of the law, said Barry Kamins, a partner at Flamhaft Levy
Kamins & Rendeiro and criminal procedure expert.
"Mr. Spitzer's office investigated and brought actions
against Wall Street brokerage firms for providing investment advice to
investors they knew to be false in order to obtain more business," he
said in a Dec. 13, 2007 Law Journal column.
Beginning in 2002, Mr. Spitzer's office used the Martin Act to
"force" 10 of New York's biggest investment firms, including Merrill
Lynch and Goldman Sachs, to pay a total of $1.4 billion in fines and
settlements, Mr. Kamins said. Mr. Spitzer followed that success with
investigations of mutual funds that resulted in criminal convictions
and a total of $3 billion in fines, penalties and restitution.
Mr. Cuomo has used the law in an "even more far-reaching"
way, Mr. Kamins said in an interview. "Mr. Cuomo has built on what Mr.
Spitzer did with [the Martin Act] and has used the law to branch into
other areas."
New Uses of Law
As an example, Mr. Kamins cited Mr. Cuomo's investigation of
whether former state comptroller Alan Hevesi misused his position by
helping campaign contributors gain access to business from New York's
$154 billion pension fund, which he oversaw.
The investigation apparently is the first use of the act in connection with the investigation of possible government corruption.
Mr. Hevesi resigned and pleaded guilty in December 2006 to
defrauding the government after it was discovered that state workers
were acting as drivers for his ill wife. He was fined $5,000.
Bradley D. Simon, a partner at Simon & Partners in
Manhattan who represents Mr. Hevesi, said in an interview that the
Martin Act should not be applied against his client.
"The allegations do not have anything to do with securities violations," Mr. Simon said.
He added that the statute is not "to be used in all seasons and
for all reasons," and stressed that the allegations must involve
securities violations.
Mr. Cuomo has not taken any action against Mr. Hevesi or anyone else in connection with the probe.
Mr. Cuomo also has used the statute to investigate whether
plans by five energy companies (AES Corporation, Dominion, Dynegy,
Peabody Energy and Xcel Energy) to build coal-fired power plants
concealed financial risks to their investors.
The attorney general asked the companies in letters sent in
September whether investors had been sent enough information about the
potential financial liabilities of carbon dioxide emissions that could
contribute to global warming.
"Any one of the several new or likely regulatory initiatives
for CO2 emissions from power plants - including state carbon controls,
E.P.A.'s regulations under the Clean Air Act, or the enactment of
federal global warming legislation - would add a significant cost to
carbon-intensive coal generation," the letters said.
It also said that "selective disclosure of favorable
information or omission of unfavorable information concerning climate
change" would be considered misleading.
Mr. Cuomo told The New York Times that "this is a very
straightforward, consistent use of the act because it's about
disclosure to investors."
Mary Sandok, a spokewoman for Xcel, said in a statement that
"the plant under construction in Colorado is being built under an
agreement we reached with national, state and local environmental
groups, including the Sierra Club and Environmental Defense. Our
financial disclosures are adequate. We look forward to discussing this
matter further with the New York attorney general."
Subprime Probes
Attorneys familiar with the act say Mr. Cuomo is on more
familiar ground in using it to investigate the sale of mortgage-backed
securities that have resulted in significant losses to investors.
"The act deals with the sale and offering of securities,"
said
Stuart D. Meissner, a Manhattan solo practitioner who was an
assistant attorney general under Mr. Spitzer. "In this case, the sales
[of] these mortgage investments opens the door for the Martin Act to be
used."
( ***
This
article mistakenly refers to Mr Meissner as a Solo
Practioner.*** )
Benjamin Lawsky, deputy counselor and special assistant under
Mr. Cuomo, and Eric O. Corngold, executive deputy attorney general for
economic justice, are leading Mr. Cuomo's subprime probes. Messrs.
Lawsky and Corngold declined to comment.
Mr. Lawsky previously served as an assistant U.S. attorney in
the Southern District of New York, where he prosecuted securities
fraud, organized crime and terrorism cases.
He also has served as chief counsel to Senator Charles E.
Schumer, D-New York, and as a trial attorney in the Department of
Justice's civil division in Washington, D.C.
Mr. Corngold is a former chief assistant U.S. attorney in the
Eastern District of New York. There he was the chief of the business
and securities fraud unit.
The Wall Street Journal and The New York Times have reported
that Mr. Cuomo is investigating whether investment banks violated the
Martin Act in connection with their packaging and selling of
mortgage-related securities.
Investment banks that purchase loans from originators hire
due diligence companies to review the loans before they are transformed
into securities and sold to investors.
Mr. Cuomo is reportedly looking into whether after the
investment banks received information about loan problems, they used
this information to negotiate a low prices but then withheld this
information from rating agencies and investors when the banks were
packaging and reselling the loans.
The Wall Street Journal reported last week that Mr. Cuomo has
sent Martin Act subpoenas to Bear Stearns, Deutsche Bank, Morgan
Stanley, Merrill Lynch, Lehman Brothers, and possibly others. Bear
Stearns, Deutsche, Morgan and Lehman declined to comment on the
investigation. A Merrill Lynch spokesman said his company "cooperates
with regulators when they ask us to" but declined to say anything more.
Representatives from the attorney general's office have also declined to comment on the investigation.
Jerry D. Bernstein, a partner at Blank Rome, is outside counsel
to Clayton Holdings, a large due diligence company. Mr. Bernstein said
in an interview that Clayton was subpoenaed under the Martin Act
several months ago and that the company "has provided documents and
other information as would any other company that is directed to
cooperate with the attorney general's office."
Meanwhile, in November Mr. Cuomo sued the real estate appraisal unit of First American, the nation's largest title issuer.
The lawsuit, which was filed in state court but has been
removed to the Southern District of New York, alleges that First
American and its subsidiary eAppraiseIT caved to pressure from
Washington Mutual to use appraisers who provided inflated appraisals
from homes. State of New York v. First American, 07 Civ. 10397. Such appraisals can make mortgage securities look more attractive than is justified by the facts.
Mr. Cuomo claimed that e-mails also show that executives at
First American and eAppraiseIT knew their behavior was illegal, but
intentionally broke the law to secure future business with Washington
Mutual.
First American said in a Nov. 2, 2007 statement that the
attorney general's allegations, "largely based on a handful of e-mails
that have been taken out of context, or mischaracterized . . . belie
our record of compliance with applicable law."
First American has asked the court to dismiss the suit,
arguing that the federal government, not the state, has the authority
to regulate its mortgage appraisal business. Washington Mutual did not
immediately return a call for comment.
In connection with the First American case, Mr. Cuomo also
issued Martin Act subpoenas to Fannie Mae and Freddie Mac, two of the
nation's largest home mortgage financers.
Fannie Mae and Freddie Mac both responded that they were
committed to fighting mortgage fraud and pledged to cooperate with Mr.
Cuomo. Freddie Mac also said it would appoint an independent examiner
to review appraisal practices.
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