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Credit Suisse Group (CS - Snapshot Report) has been pressed with charges of a civil fraud by the New York Attorney General (AG), Eric Schneiderman. This is the second lawsuit of its kind to be filed by the AG, the first being against JPMorgan Chase & Co. (JPM - Analyst Report) in October.

The litigation has been filed with the backing of the Residential Mortgage Backed Securities Working Group, which was formed by President Barack Obama in January to investigate and impeach the accused organizations for misconducts that eventually led to the financial crisis. The group consists of officials from the U.S. Justice Department, the Securities and Exchange Commission (SEC), the FBI and other federal and state officials.

Allegations

The AG alleged that Credit Suisse defrauded a large number of mortgage bond investors by misrepresenting the quality of loans underlying residential mortgage backed securities (RMBS) it sponsored and underwrote in the 2006-2007 period. Consequently, this led to a loss of $11.2 billion to the investors.

Similar to the JPMorgan case, this lawsuit has also been filed under New York’s Martin Act (that does not require proof of intent to mislead). Apart from seeking damages, the litigation demands proper compensation for the investors who were defrauded by deceptive practices as well as stoppage of such fraudulent practices.

The lawsuit alleges that Credit Suisse, while selling the RMBS, convinced the investors that the underlying loans had been evaluated properly and were under constant vigilance. However, the company failed to do either. Further, the executives ignored various negative signals that showed that the underlying loans were most likely to fail and yet continued to bundle them as RMBS and sold them to investors.

Credit Suisse also failed to take corrective measures once the flaws were detected. The company was more focused on maintaining high volume of loans from the mortgage originators rather than concentrating on removing defective loans from the underlying portfolio.

Credit Suisse’s spokesperson, while commenting on the litigation, stated the company will challenge the allegations.

Similar Cases and Other Settlements

This is the second time in the past week that Credit Suisse’s name has cropped up in relation with the sale of faulty RMBS. Last week, Credit Suisse and JPMorgan agreed to resolve the allegations leveled by the SEC by paying a total compensation of nearly $416.9 million. The allegations were related to the sale of faulty RMBS by these banks prior to the financial crisis of 2008.

Further, as mentioned above, JPMorgan was also dragged to court by the New York AG. The AG alleged that Bear Stearns – acquired by JPMorgan in 2008 – defrauded a large number of mortgage bond investors. As per the complaint, the investors suffered losses aggregating to about $23 billion – nearly 26% of the original value – as a result of flawed documents used by Bears Stearns while selling RMBS in the 2006-2007 period.

Our Viewpoint

Legal troubles such as this are likely to result in mounted expenses and affect the top line of many financial institutions. However, the measures being undertaken by the regulatory and legal authorities to come down hard on such unwarranted activities of these institutions will deliver huge relief to the investors.

Credit Suisse currently retains a Zacks #3 Rank, which translates into short-term Hold rating. We believe that the legal hassles encountered by the company can generate downward estimate revisions leading to deterioration in the Zacks Rank.
 

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