Wall Street banks, investors, credit-rating agencies and others are under scrutiny following the subprime mortgage crisis.
"We look at all the players" to determine whether there were missteps in accounting and disclosure and possible insider trading, says Walter Ricciardi, deputy enforcement director at the Securities and Exchange Commission.
In a telephone interview Wednesday, Ricciardi said the SEC is asking mutual fund managers, lawyers, company executives and credit-rating analysts for details of their involvement in trading of securities that came from bundled mortgages.
Amid financial market turmoil that has raised the specter of stalling economic growth, federal securities regulators and Congress are probing the $6 trillion (4.28 trillion EUR) market of globally traded securities made from home loans.
As housing market conditions worsen, regulators are realizing how hard it is to track the trail of transactions from home borrower to lender to investor, and that it may be even harder to determine blame and liability on some of the players.
"They've thrown this dragnet out, trying to find out what these relationships are," said James Cox, a professor at Duke University who specializes in securities law. He called the undertaking "staggering."
Here are some of the areas the SEC is focusing on:
- collateralized debt obligations, which are complicated pools of mortgages purchased by investors around the world in recent years. In June, two hedge funds at Bear Stearns Cos. nearly collapsed after making bad bets in CBOs, especially those that include subprime loans made to borrowers with tarnished credit.
- major Wall Street investment banks and their vulnerability to mortgage defaults, an inquiry that is described as a routine part of the SEC's oversight.
- the securities and operations divisions of Bear Stearns, Goldman Sachs Group, Lehman Brothers, Merrill Lynch and Morgan Stanley. "Given the recent events in the mortgage and credit markets, and their potential impact on financial institutions," the SEC staff is monitoring the five firms' cash positions and balance sheets "with greater frequency than during periods of normal market stress," Erik Sirri, director of the SEC's market regulation division, told Congress recently.
- evaluating regularly whether large securities firms are adhering to policies on the pricing of subprime mortgage debt. In August, SEC staff queried by telephone managers at 25 of the biggest mutual fund companies about their holdings of mortgage-backed securities.
The regulators are concerned that fund companies invested in the securities before the collapse in subprime mortgages in the spring may overvalue them when they sell fund shares as investors press to cash out, Douglas Scheidt, an associate director of the SEC's investment management division, said Wednesday.
The SEC, as well as Congress and European market regulators, also are reviewing the role that Standard & Poor's, Moody's Investors Service and Fitch Ratings - the three credit-rating agencies - played in the subprime mortgage debacle. Critics say the agencies failed to give investors adequate warning of the risk of mortgage securities featuring subprime loans.
The SEC, which oversees public companies, securities firms and investment companies, has been dragged into the mortgage post-mortem because of sharp declines in the value of mortgage-backed securities.
Although the conclusions of the SEC's inquiries is not complete, some on Capitol Hill say they know enough to look at possible fixes for failures of the market.
Sen. Robert Menendez, a member of the Senate Banking Committee, said Wednesday he is considering legislation to tighten oversight of financial sectors and market participants "that may have contributed to the nationwide mortgage crisis."
"It is time those responsible are held accountable - and until now, Wall Street has been getting a free ride," he said. "We need to question what it will take to make sure we do not end up here again."