SEC eyes disclosure in subprime probes

By Rachelle Younglai

WASHINGTON (Reuters) - The Securities and Exchange Commission is investigating how banks, credit rating firms and lenders valued and disclosed complex mortgage-backed securities that ultimately led to the subprime crisis, a top agency enforcer said on Saturday.

"The big question is, who knew what when, and what did they disclose to the marketplace?" said Cheryl Scarboro, an associate director in the SEC's enforcement division in charge of the subprime working group.

The SEC has opened about three dozen investigations into firms and individuals involved in the subprime mortgage market. The investor protection agency has not named any names. But Morgan Stanley and Merrill Lynch are some of the firms in the financial services industry that have disclosed that government investigators are seeking information about their subprime activities.

Scarboro said the cases can be broken down into three main areas: the securitization process, the origination process and the retail area. Insider trading, which is one of the SEC's highest priorities, is also a key area.

"Our investigations into potential misconduct is clearly a priority at the division," Scarboro said at a Practising Law Institute conference in Washington.

Banks, due diligence firms and credit rating agencies are being examined for their role in the securitization process, or how mortgages were sold, repackaged and bundled into special financial products.

The SEC is looking at the valuations and accounting treatments of mortgage-backed securities. It is looking at whether the securities were valued correctly in the first place, what was the level of risk and if that was adequately disclosed to shareholders.

METHODOLOGY, MODELS SCRUTINIZED

The methodology and models that companies used to value the complex financial products are being examined as well.

The agency also is looking at write-downs that financial firms have been forced to take and whether the assets should have been taken down and disclosed earlier.

In terms of the retail area, the agency is looking at whether brokers followed "suitability" requirements when they sold the mortgage-backed securities that then quickly soured.

Doria Bachenheimer, who is part of the SEC's subprime working group, said issues that could come up with lenders and investment banks are similar to those in many accounting fraud investigations.

The agency will look into whether people were motivated to mask the bad numbers because of some upcoming corporate event, Bachenheimer, an assistant regional director of enforcement in New York, said at the conference.

The subprime working group, which involves more than 100 lawyers, is coordinating with other divisions within the SEC. It is also talking regularly with other regulators including the Federal Reserve, Federal Deposit Insurance Corp, Office of the Comptroller of the Currency and Office of Thrift Supervision.

When asked if the SEC had enough resources to dig out any subprime abuse while policing other areas, the SEC's head of enforcement said she was always amazed by the work people do with what they have got.

"We do have to work very hard at bringing the right cases," SEC enforcement division chief Linda Chatman Thomsen said at the conference. "We work on the most 'impactful' cases ... . At the end of the day we have to be about deterrence."

(Reporting by Rachelle Younglai; Editing by Xavier Briand)

(c) Reuters 2008. All rights reserved. Republication or redistribution of Reuters content, including by caching, framing or similar means, is expressly prohibited without the prior written consent of Reuters. Reuters and the Reuters sphere logo are registered trademarks and trademarks of the Reuters group of companies around the world.

More US (Business) News click here