Whistleblower suit targets accounting, controls in Wachovia’s investment bank

A newly unsealed federal lawsuit alleges Wachovia’s investment bank violated accounting rules and skirted internal controls to pursue short-term profits, benefiting senior management at the expense of the former Charlotte-based bank’s financial health.

Two whistleblowers, including a former Wachovia controller who lives in Union County, filed their lawsuit on behalf of the federal government, alleging the bank defrauded U.S. agencies that loaned money and provided other assistance to the bank in the financial crisis.

The lawsuit was first filed in 2011 but kept under seal until this week. Under the U.S. False Claims Act, the whistleblowers could be eligible to receive up to 30 percent of any damages or penalties awarded under the action.

The suit – filed against Wells Fargo, which bought Wachovia in 2008 – is the latest legal action to take on banks for their role in the global financial meltdown.

The complaint mostly targets alleged fraud that occurred in Wachovia’s Charlotte-based corporate and investment bank, which was a major player in packaging commercial real estate loans into securities. The complaint also alleges that Golden West Financial, the mortgage company Wachovia bought in 2006, had poor internal controls and inadequate underwriting practices.

Like other big banks, Wachovia began reporting billions of dollars in losses in its investment bank in 2007 after a global credit crunch spurred by a meltdown in subprime mortgages made to borrowers with spotty credit. By the fall of 2008, with losses also ballooning in its Golden West portfolio, the stalwart North Carolina institution was on the verge of failure and in need of an emergency sale to San Francisco-based Wells Fargo.

The suit says Wachovia defrauded the government of billions of dollars when it accepted payment from various federal programs while engaging in unsound banking practices, making false certifications about its financial statements and concealing “mismanagement and fraudulent practices.” Later, Wells Fargo did not “come clean” about the fraud it inherited, the suit claims.

The government “should do right by the U.S. taxpayer and recover monies from Wachovia and Wells Fargo under the U.S. False Claims Act for having bailed them out under outrageously false and fraudulent pretenses,” the complaint states.

Wells Fargo in a statement said the bank “continues to believe these claims are without merit.”

Whistleblowers bring case

The case was filed in U.S. District Court for the Eastern District of New York by Robert Kraus, a former Wachovia controller who lives in Marvin, and Paul Bishop, a former Golden West mortgage loan officer who lives in California’s Bay Area.

In 2010, the Observer wrote about an earlier lawsuit Kraus filed against Wachovia, as well as his struggles finding work in the financial industry after he said he was forced out of the bank.

Kraus had been recruited to Wachovia’s Charlotte headquarters in 2005, when he was working as a commercial real estate consultant in New York. As a controller, his job was to flag problems in commercial mortgage-backed securities at the investment bank.

According to his 2010 suit, Kraus identified problems almost immediately, including the inappropriate valuation of trading positions, but his superiors took no action. He filed suit after he lost his job, but a judge in 2011 dismissed the complaint because Kraus had signed a severance agreement with the bank.

The bank has previously said Kraus’ allegations of improper business conduct were “simply unfounded.”

Bishop gained national attention in 2009 when CBS’ “60 Minutes” aired a program on his allegations of improper lending practices at Oakland, Calif.-based Golden West. In a 2008 lawsuit, Bishop said he threatened to warn Wachovia about Golden West’s practices before the merger closed but instead lost his job.

Former Golden West CEO Herb Sandler responded to the “60 Minutes” piece by firing off letters to the program standing up for Golden West’s practices.

The pair initially filed their suit under seal, which is normal for a false claims case. The United States in July declined to officially join the suit but said the whistleblowers could continue the case on their own. The plaintiffs filed a motion this week saying they had no objection to it being unsealed.

‘Black Box’ allegations

The complaint builds on allegations made in Kraus’ earlier lawsuit but also makes new accusations about practices inside Wachovia’s corporate and investment bank, including the use of a “Black Box” to shield loans from proper supervision.

The suit says Wachovia, in violation of federal law and proper accounting practices, routinely placed loans in an off-the-balance-sheet entity called the College Street Funding Master Trust, known internally as the Black Box. Wachovia’s former headquarters was on College Street in Charlotte.

The goal was to skirt regulatory constraints on the amount of loans the bank could keep on its balance sheet.

If the bank reached loan funding limits or wanted to hide certain loans from internal or regulatory review, Wachovia sold the loans to the Black Box or other vehicles until they could be packaged into bonds for investors, the suit says.

As of Aug. 1, 2005, the Black Box held some $6 billion in loans, the suit says, attributing the figure to an email written by Ira Malter, the bank’s former controller for structured products. The loans were equal to about 12.75 percent of the total equity of Wachovia’s banking subsidiary.

In an email in December 2005, Malter wrote, according to the suit, that the accounting process was “held together with band-aids, spit and gum.” That month, the bank shut the Black Box down, according to the complaint.

Kraus, according to the suit, was told by Malter and two other Wachovia executives – Bill Green and Stephen Nelson – not to discuss the existence of the Black Box with federal regulators or other bank employees.

Nelson and Malter have previously said Kraus’ claims were false and denied any wrongdoing. Nelson declined comment Tuesday. Green and Malter, who are no longer working for the bank, could not be reached.

Loan-to-value limits

The suit also says the bank flouted laws and regulations that required it to assign credit grades to the commercial real estate loans it kept on its balance sheet. Had it done so, the suit states, internal risk management executives would have exposed the bank’s “flawed loan and valuation practices.”

In order to keep pumping out commercial real estate loans, Wachovia also violated supervisory limits on loan-to-value ratios.

Commercial real estate loans made by the bank weren’t supposed to exceed 80 percent of the value of the property, according to the suit. But to get around this requirement, Wachovia would extend senior loans backed by the property, plus additional unsecured loans to the borrower, the suit states.

In one example, Wachovia extended credit to an entity called One Oliver Associates Limited Partnership in connection with the purchase of an office complex, according to the suit.

The partnership received a $40 million senior loan from Wachovia, $12 million in unsecured loans from the bank and $8 million from a Lehman Brothers entity, according to the suit. Less than the two months after the deal’s closing, Robert Verrone, head of Wachovia’s large loan group, acknowledged in an email there were too few leases on the property to substantiate Wachovia’s valuation and that the “true” value was only $40 million, the suit states.

Verrone, once known by the nickname “Large Loan,” declined to comment. One Oliver Associates did not immediately respond to a request for comment.

The suit alleges senior management violated laws and regulations in pursuit of short-term profits, which produced higher bonuses for executives and top bankers “at the expense of the bank’s long-term financial health, shareholders and the financial well-being of the vast majority of its shareholders and its employees.”

According to the suit, Kraus in April 2006 brought his concerns to the head of Wachovia’s corporate and investment bank, Steve Cummings. Months later, he was told he was being terminated, the suit states.

Cummings, now the chairman of UBS’ investment bank in the Americas, has previously told the Observer that he met with Kraus and then asked the “appropriate members of (the bank’s) legal, compliance and finance staff to independently look into the issues” he raised. Cummings did not immediately respond to a request for comment.

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