Who Is On the Market Police's Radar?

The Federal Bureau of Investigation's probe of the subprime mortgage industry could uncover fraud involving Wall Street investment banks, private equity firms or hedge funds, the head of the bureau said.

The FBI probe comes as losses and write-downs from the housing and credit could eventually hit the $1 tn mark, the International Monetary Fund reports. More than 100 U.S. mortgage lenders have gone bankrupt, been sold, or exited the mortgage business since the end of 2006.

But who is on the regulatory radar screen? So far, the FBI has publicly acknowledged the name of only one company caught up in the dragnet, Doral Financial Corp.--its former treasurer was recently indicted for investment fraud. The former treasurer has denied the allegations.

As I've reported to you earlier, a senior law enforcement official told me that hedge funds now sit at the top of the hit list of federal investigations into the subprime crisis, including at the Department of Justice and the Federal Bureau of Investigation. Expect more announcements of hedge fund indictments in coming days, sources say ("Hedge Funds in the Crosshairs").

Hedge funds made hundreds of billions of dollars in trades of hard-to-value subprime and credit assets that do not always carry market prices. Because hedge funds annually pay their managers as much as 20% of investment gains each year, the fear is that they helped overestimate the values of these securities to line their own pockets at the expense of investors.

At bottom you'll see a list of companies involved in a range of regulatory probes; again, please note, it's unclear which companies the FBI is looking into, and this list comes from a perusal of company regulatory filings as well as news reports. Word of caution: if you want to know who is really on the radar screen, use this list only as a potential lead. The regulatory probes come from a wide range of places, including the Securities and Exchange Commission and various attorneys general across the country. Do not stop your research here.

The FBI's investigation of potential fraud in the U.S. home mortgage industry now encompasses 19 companies in "cases that may have a substantial impact on the marketplace," FBI director Robert Mueller said. "We are targeting accounting fraud, insider trading and deceptive sales practices. These investigations may well lead to other instances of fraud, from investment banks and private equity firms to hedge funds." The bureau is examining whether portfolios of mortgage-backed securities were properly valued, accounted for, and disclosed to investors, among other things.

FBI director Mueller recently told an American Bar Association conference he expected to see more corporate fraud cases in the future "because of the ripple effect" of the subprime mortgage crisis. Mueller has said the bureau is working to identify "large-scale industry insiders" in its probes.

Major investment banks Goldman Sachs Group (GS), Morgan Stanley (MS) and Bear Stearns (since bought for $10 a share by JPMorgan Chase (JPM) each indicated the government had asked them for information, but please be careful here. Reportedly none confirmed any FBI role, and financial disclosures make no statements about any FBI probe whatsoever.

To date, prosecutors have not brought any major cases against mortgage industry leaders. Last week, two former hedge fund managers at Bear Stearns were arrested in the connection with two funds that went belly-up, costing investors $1.6 bn, a bellwether event in the subprime meltdown. The subprime collapse was kicked off by the April 2007 bankruptcy of New Century Financial Corp., a lender which gave numerous home loans to dodgy borrowers with weak credit histories.

Separately, the Dept. of Justice and the FBI announced its "Operation Malicious Mortgage"  involving more than 300 arrests and charges brought against more than 400 real estate industry insiders, midlevel players alleged to have committed mortgage fraud, which US Attorney General Michael Mukasey has deftly called "white collar street crime."

Reported cases of fraudulent mortgages stretch from New York to Rhode Island to Illinois to Texas, and from California to Florida. Fraudulent loans amounted to more than $4 bn in 2007, up from $1.6 bn in 2006, says the website MortgageDaily.com. The FBI reports fraud has already cost $4 bn to $6 bn.

A roundup of reports flushes out who is on a regulator's radar screen:

Countrywide Financial Corp. (CFC): The largest U.S. mortgage lender is reportedly under FBI investigation for suspected securities fraud as part of investigations into the mortgage crisis, although the FBI has declined to comment and Countrywide said it was unaware of any investigation.

Separately, the Securities and Exchange Commission is reportedly conducting an informal probe of suspicious stock sales by Countrywide chief executive Angelo Mozilo. At issue is Mozilo's use of an SEC rule known as 10b5-1 that lets corporate executives file a trading plan for future sales of their stock. The plans are intended to prevent suspicions that executives illicitly traded on insider information. The question however is, "did Countrywide repeatedly adjust Mozilo's prearranged selling plans at his request, such that the intent and purpose of these plans -- the prevention of insider trading -- was undermined?" Sen. Charles Schumer (D-NY) has asked. And separately, the Office of the U.S. Trustee, an arm of the Justice Department responsible for policing federal bankruptcy courts, will be able to interview Countrywide execs under oath and subpoena key documents from the lender after federal bankruptcy trustees in Florida, Georgia and Ohio have filed legal actions against the Calabasas, Calif.-based lender, saying the lender was abusing the bankruptcy process.

*Footnote: Since this story ran, the attorneys general of Illinois and California have filed suit against Countrywide and its officers, alleging unfair and deceptive business practices. The Washington State Dept. of Financial Institutions has also filed suit as well, alleging Countrywide engaged in discriminatory lending practices.

UBS (UBS): The U.S. attorney in New York's Eastern District in Brooklyn is reportedly probing whether the Swiss financial giant booked inflated prices for mortgage bonds despite knowing their valuations had fallen.  Prosecutors, who frequently work closely with the Securities and Exchange Commission, had yet to issue subpoenas. Separately, the FBI is reportedly planning to travel to Switzerland to probe a multi-million-dollar tax evasion case involving the Swiss bank. 

American International Group (AIG): The Justice Department and the SEC are reportedly investigating whether the world's biggest insurer overstated the value of derivative contracts linked to subprime mortgages, specifically, the way AIG valued credit default swaps. Prosecutors from the Department of Justice and the U.S. attorney's office in Brooklyn, New York have reportedly asked for information the SEC is gathering, which reportedly could signal a criminal investigation. AIG spokesman said the company would co-operate in regulatory and governmental reviews on all matters. AIG has been hit with record writedowns from the credit crisis, and in 2006 AIG settled an accounting case for $1.6 bn. The accounting probe had led to the ouster of AIG's longtime chief executive, Maurice "Hank" Greenberg.

Merrill Lynch (MER): The Securities and Exchange Commission has launched an investigation into Merrill Lynch's subprime mortgage portfolio. The investment banker said in its quarterly SEC filing the probe was initiated on October 24. That was the day Merrill announced a net loss of $2.3 bn from continuing operations for the third quarter. Meanwhile, Merrill is facing a lawsuit from Massachusetts alleging the company committed fraud by selling esoteric debt products containing mortgage-backed paper to the Massachusetts city of Springfield. The New York attorney general's office has also been conducting an investigation of the mortgage industry, which is focused on appraisals and the packaging of loans into mortgage-backed securities for sale to investors. New York attorney general Andrew Cuomo's office has reportedly issued subpoenas to Merrill Lynch.

DB Zwirin: The SEC has been investigating the $5 bn hedge fund DB Zwirn, which ran a high-yield bond portfolio. The commission is requesting information about how the hedge fund valued its assets, sources say. DB Zwirn is winding down its fund after colossal redemptions. The fund had specialized in purchasing corporate loans and other illiquid credits. The fund had raised the valuation issue itself in a letter to investors last year that said a fund manager who left in 2005 had failed to "follow a systematic pricing methodology" for a portfolio of high-yield bonds, according to reports.

Beazer Homes USA (BZH): Said last year it received a federal grand jury subpoena related to its mortgage business.

Thornburg Mortgage (TMA): This provider of jumbo mortgages said it had received subpoenas from the Securities and Exchange Commission amid doubts about its long term survival. Nearly went bankrupt in March. Posted recently a $3.3 bn first quarter loss as the value of mortgages and other securities it owns plummeted. In a filing it said it was complying with the subpoenas for documents related to an ongoing regulatory probe and that it is cooperating with the SEC inquiry. Also notified in April by the SEC that the agency investigating its restatement of 2007 financial results and its accounting treatment of mortgage backed securities. Lender said it was defending itself against securities class action lawsuits alleging made false and misleading statements about its financial health, which results in inflated stock prices. It has said these allegations were without merit.

Wachovia (WB): Recently agreed to pay $144 mn to settle charges of turning a blind eye when telemarketers used the bank's accounts to steal from customers. Telemarketers reportedly had obtained account information from consumers through a variety of ruses, and then used the information to write themselves fraudulent checks, which they deposited at Wachovia. Wachovia is also reportedly under scrutiny for money laundering by Mexican and Colombian money transfer companies move proceeds of US drug sales to Latin America. Wachovia had reportedly cultivated ties with the money transfer outfits.

Impac Mortgage Holdings (IMH): This struggling lender recently said its survival could be threatened following a $2.05 bn loss in 2007, and that the SEC was inquiring into its operations. Impac is a real estate investment trust that once specialized in "Alt-A" mortgages, which often go to people who cannot document income or assets. The Irvine, California-based company has reportedly struggled with falling housing prices, mounting delinquencies on mortgages once, and investors' refusal to buy all but the safest home loans. Impac said its liabilities exceeded its assets at year-end, giving it negative shareholder equity of $1.08 bn. The company said it has provided information to the SEC this year in response to the agency's informal inquiries into its business operations, related accounting policies and methodology. Last September, Impac quit substantially all mortgage lending operations. 

Franklin Bank (FBTX): This Houston, Texas bank, overseen by mortgage bond pioneer Lewis Ranieri, said it faces an SEC probe related to its lending practices. Recently it has replaced its chief executive. Ranieri, the bank's chairman and a former Salomon Brothers vice chairman, will become interim chief executive. The SEC inquiry came after a 10-week internal investigation that the bank said uncovered a variety of accounting errors, largely related to residential mortgage loans. Franklin said it has also been in communication with the Federal Deposit Insurance Corp. and the Texas Department of Savings and Mortgage Lending, and plans to cooperate with those agencies and the SEC. The company has been unable to file its first-quarter report because of the internal probe, and this month said investors should not rely on its reported fourth-quarter results, which included a $66.1 mn loss. It also said it working to restate its third-quarter report and complete its 2007 annual report, but does not know when it will complete either.

Olympia Mortgage: Two former principals of this now defunct Brooklyn mortgage lender surrendered to the FBI recently after being indicted on charges of conspiracy and fraud involving Fannie Mae and Credit Suisse First Boston, a federal prosecutor said. Lieb Pinter, 64, is charged with fraud in connection with the theft of $44 mn of payoff proceeds for refinanced mortgage loans financed by Fannie Mae and serviced by Olympia. Barry Goldstein, 59, is charged with fraud in connection with Olympia's sale of a portfolio of non-performing mortgage loans to Credit Suisse using falsified loan histories.