Lehman Bros. Potentially Liable in Lending Case

A federal judge in Santa Ana has made Lehman Brothers Holdings Inc. potentially liable in the “predatory” mortgage lending case involving bankrupt First Alliance Corp. The ruling could have far-reaching consequences for Wall Street firms that increasingly have bankrolled companies like First Alliance.

In an order released Monday, U.S. District Judge David O. Carter said Lehman, one of Wall Street’s oldest firms, will be a defendant in the consolidated case against First Alliance because Lehman’s funds and services provided “substantial assistance” to the Irvine lender.

“Lehman’s credit facility made First Alliance’s fraudulent practices possible,” Carter wrote, denying Lehman’s motion to be dismissed as a defendant on grounds that the New York firm provided only routine commercial lending to First Alliance.

Lawsuits by the Federal Trade Commission, six states and groups representing numerous borrowers have been consolidated in a civil case before Carter. Trial is set to begin April 9, although settlement talks are continuing.

In the late 1990s, First Alliance was making about $500 million a year in mortgage loans, marketing them heavily to people who had considerable home equity as well as high levels of credit card debt.

Lawsuits accuse Brian Chisick, First Alliance’s founder and majority shareholder, of crafting an intricate spiel to hide the fact that origination fees of up to 24% were wrapped into the loan amount. The suits contend that salespeople also failed to disclose that the initial rates on adjustable loans would soon rise far higher.

The company filed for bankruptcy in March 2000.

Groups representing borrowers who are poor, minority or elderly, like many of First Alliance’s customers, hailed Carter’s ruling. The American Assn. of Retired Persons’ suit against First Alliance alone is seeking $305 million in damages.

By its own estimate, First Alliance has just $47 million in assets that can be liquidated, so the addition of a defendant with deep pockets such as Lehman could prove to be important to thousands of former First Alliance borrowers who may have claims.

William J. Ahearn, a Lehman spokesman, said Monday that the firm will defend the suit vigorously and believes it’s no more liable for fraud than “the phone companies that provided phones so they [First Alliance] could call up their customers and solicit them.”

Lehman has said it knew of allegations that First Alliance concealed huge fees and other onerous loan terms from customers, but believed the company cleaned up its act by the time Lehman became its chief backer in 1999. It also maintains it can’t be held responsible for policing actions by loan originators like First Alliance.

Lehman executives conducted a thorough investigation into First Alliance practices in the mid-1990s and found them disturbing, according to internal company memos made public in pre-trial proceedings.

First Alliance is “the used car salesperson of B/C lending,” Lehman executive Eric Hibbert wrote in July 1995, using an industry term for loans to people with blemished credit ratings. “It is a requirement to leave your ethics at the door.”

Ahearn said that because of that finding, Lehman limited its business with First Alliance to minor roles from 1995 through 1997, when Prudential Securities was its main lender and bond underwriter. Prudential bowed out in late 1998.

From early 1999 until First Alliance’s bankruptcy in March 2000, Lehman was its chief backer. It provided a $150-million credit line and bundled its mortgages for sale as securities every quarter, although Hibbert was still expressing reservations. In January 1999, Hibbert wrote that First Alliance at the very least was violating the spirit of the Truth in Lending Act.

First Alliance settled one class-action suit over its lending practices in 1994. Additional suits piled up, including one by the California attorney general.

The company filed for Chapter 11 bankruptcy, stopped making loans and began liquidating after negative publicity, including questions of Lehman’s role, arose in March 2000.

It is currently servicing about 350 loans it still owes and has about a dozen full-time employees, among them Chisick, who no longer earns a salary.

Analysts said that if Lehman is ultimately made liable in the First Alliance case, it could force every Wall Street firm and commercial bank that backs such firms to investigate clients more carefully and proceed with greater caution in funding them. And that in turn could cut into the amount of loans that are made.

In recent years, Wall Street firms have played a big part in the booming market in asset-backed securities, which are bonds backed by payments on mortgages, credit cards, car loans and other revenue streams. The total amount of such loans trading has grown from $316 billion in 1995 to $1.24 trillion as of Sept. 30, according to the Bond Market Assn.

Lehman profited by lending funds so First Alliance could make its loans and by earning fees bundling these mortgages as securities and selling them. Home-equity lenders such as First Alliance had $178billion in such bonds out on Sept. 30.

Steve Grundleger, the top specialist in mortgage bonds for the Fitch ratings agency, said the First Alliance case could cause a ripple or “domino effect because everybody needs these [credit] lines to get business done....It could cost more to operate, so there’s less profit to be had. And if there’s less profit, there will be less business done.”

Carter previously ruled that the Federal Trade Commission, the lead plaintiff in the consolidated case, can include as defendants Chisick and his wife, who made about $140 million when First Alliance sold its shares to the public in 1996.

It was the first time the FTC had targeted an officer or director of a public company as large as First Alliance.

Lehman Bros. stock closed down $1 a share at $65.32 on the New York Stock Exchange.