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FTC Looking Bear at Stearns Mortgage Unit

Apr 2, 2008 | Parker Waichman Alonso LLP

The Federal Trade Commission (FTC) is the latest federal agency investigating doomed investment bank Bear Stearns.  According to a recent filing with the Securities and Exchange Commission (SEC), Bear Stearns Cos' EMC Mortgage Corp unit has received a notice from the FTC that it may have violated laws regarding its servicing activities.

Bear Stearns, once the fifth-largest U.S. investment bank, faced a run on the bank in March and was forced to sell itself to JPMorgan Chase & Co.   Two of its hedge funds, heavily invested in subprime mortgages, folded in July. Bear’s investors became increasingly reluctant to do business with the company. Despite the company’s assurances that it had plenty of cash on hand to continue operations, it collapsed  last month.

The buyout of Bear Stearns by JPMorgan Chase - termed a “shotgun marriage” by some - was consummated after the Federal Reserve agreed to provide up to $30 billion in non-recourse financing to JPMorgan, with Bear Stearns’ illiquid mortgage and other securities as collateral.  

According to the SEC filing, FTC staff believes EMC and Bear Stearns violated a number of federal consumer protection statutes. The FTC delivered a draft complaint and draft consent order asking for changes in business practices and unspecified monetary payments, according to the filing. EMC expects to engage in settlement talks before a formal complaint is filed, the filing shows.

Last week, the SEC indicated it was considering the its own investigation of the Bear Stearns collapse.  In the days leading up to the Bear Stearns failure, several of the investment bank’s executives made reassuring statements about its prospects.  On the  Monday before the buyout, when rumors started to circulate that Bear Stearns might not have enough cash to do business, the firm’s executives sent out a press release to calm fears. It said Bear Stearns’ “balance sheet, liquidity and capital remain strong. … There is absolutely no truth to the rumors of liquidity problems that circulated today in the market.”  That Wednesday, Bear Stearns CEO Alan Schwartz appeared on CNBC to reassure investors that the firm had ample liquidity and said he was “comfortable” that it would turn a profit in its fiscal first quarter. But by Thursday, Bear Stearns’ solvency was being called into question and by Friday it told regulators it was ready to file for bankruptcy.

The SEC enforcement division has written a letter to JPMorgan that discussed “investigations and potential future inquiries into conduct and statements by Bear Stearns” before the announcement of the takeover, the agency said.  In the letter, the SEC enforcement attorneys “declined to provide assurances about possible future enforcement actions” and said it would be premature to reach conclusions about their inquiry. However, they added that the staff “would favorably take into account” the circumstances surrounding the takeover when considering whether to recommend enforcement action against JPMorgan for public statements made by Bear Stearns.