According to reports, AIG invested in billions of dollars of mortgage-backed securities sold by Bank of America prior to the housing collapse. In January 2011, after analyzing data from hundreds of thousands of loans, AIG reportedly informed the bank that it felt the risk of the securities had been misrepresented and was prepared to sue the banking giant for more than $10 billion.
Bank of America shares fell more than 20 percent on August 8, the day the lawsuit was filed, adding to worries about the stability of the largest U.S. bank. It wasn’t until Warren Buffett stepped up with a $5 billion investment that those fears were eased, though hardly eliminated.
Hagens Berman is investigating whether Bank of America failed to disclose fully the risks of its dispute with AIG. According to media reports, the bank did not mention the threat of the lawsuit in its quarterly regulatory filing, which was issued four days before AIG’s lawsuit was filed.
“We believe that Bank of America knew, or should have known, that its dispute with AIG represented a significant risk for investors,” said Partner Reed R. Kathrein, who is leading the firm’s investigation from its San Francisco office. “If the company did indeed fail to disclose such a risk, it could represent a major breach of the securities laws.”
The bank made no mention of the lawsuit threat in a quarterly regulatory filing with the U.S. Securities and Exchange Commission just four days earlier. Nor did management discuss it on conference calls about quarterly results and other pending legal claims.
Bank of America bought Countrywide Financial Corp. in 2008. The lawsuit, which was filed in New York on Monday, claims Countrywide sold U.S. Bancorp a pool of over 4,000 loans originally valued at $1.75 billion. U.S. Bancorp claims Countrywide ignored its own mortgage underwriting guidelines when issuing those loans.
According to the complaint, Countrywide agreed to repurchase loans within 90 days if any of the statements made in the loan contract wound up being untrue. Those statements included an assertion that the loans complied with the bank’s underwriting guidelines.
The SEC’s rules for litigation disclosure are murky, and some lawyers said Bank of America may have been justified in not revealing AIG’s lawsuit before it was filed. The bank’s litigation disclosures are in line with those of many rivals.
But other lawyers said banks have an obligation to disclose legal threats that could have major consequences. “Publicly owned companies are supposed to disclose material threatened litigation under generally accepted accounting principles,” said Richard Rowe, a former director of the SEC’s Division of Corporation Finance, who was commenting generally and not specifically about Bank of America.
AIG’s lawsuit shows why investors are so fearful: they have no idea how much litigation lurks behind closed doors. “Management surely has a credibility problem with investors,” said Jonathan Finger, whose Finger Interests Number One Ltd in Houston owns Bank of America shares. “They continue to under-address or under-disclose on the mortgage issue.”
Finger in 2009 sued the bank over its disclosures related to the takeover of Merrill Lynch & Co. Bank of America and AIG refused to comment for this article.
SEC staff have this year advised banks including Bank of America, JPMorgan Chase & Co, Citigroup Inc, Wells Fargo & Co, Goldman Sachs Group Inc, and Morgan Stanley to disclose more information about lawsuits that have been filed, as well as legal proceedings that they know the government is considering.
Banks have responded by providing additional information, including legal loss estimates in some cases. There are two standards for disclosing legal liabilities. One under banks’ legal proceedings relies on whether losses are “reasonably probable” and “reasonably estimable.”
Another, under management’s discussion and analysis, is based on whether losses are “reasonably possible.” Disclosure relies heavily on management’s assessment of the merits of a case.
Companies might need to disclose large potential lawsuits, even if they believe a loss is improbable, as well as less consequential cases if a loss appears certain, said Meredith Cross, director of the agency’s Division of Corporation Finance, in an interview with Reuters about the SEC’s disclosure requirements.
“The goal has been to have better disclosures, which should result in fewer surprises,” said Cross, who was speaking generally and not commenting on any specific institution.
Legal experts say it is difficult for top bank executives to decide exactly what they have to disclose in relation to pending and potential legal matters. That is particularly true in the current environment, they said, in which confidence in large banks is so easily shaken by legal threats that may or may not have merit.
“This is a classic problem in the disclosure regime with litigation,” said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “You’re required to disclose anything material. The question is, ‘is it material?’ You have to gauge the size and the probability of success, which is very hard to evaluate.” [via Reuters, Market Watch and Shreveport Times]