More On Legal & Compliancefrom The Advisor's Professional Library
- Updating Form ADV and Form U4 When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.
- Agency and Principal Transactions In passing Section 206(3) of the Investment Advisers Act, Congress recognized that principal and agency transactions can be harmful to clients. Such transactions create the opportunity for RIAs to engage in self-dealing.
On Tuesday, the Securities and Exchange Commission charged Bank of America (BAC) and two subsidiaries with defrauding investors who bought residential mortgage-backed securities (RMBS) by failing to disclose key risks and misrepresenting facts about the underlying mortgages.
The SEC alleges that BofA did not tell investors that more than 70% of the mortgages backing the offering – called BOAMS 2008-A – came from the bank’s “wholesale” channel of mortgage brokers unaffiliated with Bank of America entities.
Furthermore, the SEC says, BofA knew the wholesale-channel loans – described by its then-CEO as “toxic waste” – presented greater risks of delinquencies, early defaults, underwriting defects and prepayment, yet it “only selectively disclosed the percentage of wholesale channel loans to a limited group of institutional investors,” regulators say, rather than disclose this material information to all investors or file the information publicly as required.
“In its own words, Bank of America ‘shifted the risk’ of loss from its own books to unsuspecting investors and then ignored its responsibility to make a full and accurate disclosure to all investors equally,” said George S. Canellos, co-director of the SEC’s Division of Enforcement, in a press release. “This is one in a long line of RMBS-related enforcement actions brought by the SEC to hold entities accountable for wrongdoing connected to the financial crisis.”
Also on Tuesday, the Department of Justice says it will take parallel civil action against BofA for violations of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 involving $850 million of RMBS sales in 2008, which have resulted in estimated losses of roughly $120 million.
The SEC and DOJ charges do not affect BofA’s wealth-management operations, which include Merrill Lynch, according to Bank of America and concern institutional investors.
“This is the RMBS Working Group’s most recent legal enforcement targeting misconduct in the RMBS market, but it will not be our last,” said Associate Attorney General Tony West, in a press release. “Combating financial fraud is a top priority for the Department of Justice. By filing this lawsuit today, we reaffirm an important principle – that everyone must play by the same set of rules, and no institution is too big or too powerful to escape appropriate enforcement.”
On its behalf, BofA explained in a statement that the prime mortgages were sold to “sophisticated investors who had ample access to the underlying data, and we will demonstrate that. The loans in this pool performed better than loans with similar characteristics originated and securitized at the same time by other financial institutions.”
In addition, the bank says it is “not responsible for the housing market collapse,” which led to unprecedented rates of mortgage-loans defaults and sharp declines in the value of the underlying securities.
According to the SEC’s complaint, a disproportionate concentration of high-risk wholesale loans and the inclusion of a material number of loans that did not comply with internal underwriting guidelines led to a 8.05% cumulative net loss rate for the RMBS through June 2013 – “the greatest loss rate of any comparable … securitization.” This led to losses of nearly $70 million with anticipated future losses of some $50 million, the regulators note.