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Subprime Criminal Probes Yet to Catch Big Fish

More than a year into a U.S. housing market meltdown, prosecutors have yet to bring major cases against mortgage industry leaders — and the slump's worst may pass before any charges are filed.

After the FBI revealed in January that it was looking into possible mortgage-related corporate crime such as accounting wrongdoing or insider trading at 14 major companies, the number of firms under scrutiny has grown to 19 but developments have slowed to a trickle. Separately, federal authorities are probing about 1,200 cases of individual mortgage scams.

AP

Just because authorities have proceeded quietly does not mean the probes have stalled. Legal experts say complex financial frauds can take years to investigate before prosecutors make a decision on whether they have a case.

And outlines of the government's strategy are taking shape. The FBI and U.S. Department of Justice say they are examining some major industry executives in their investigations, with FBI Director Robert Mueller saying the bureau is working to identify "large-scale industry insiders" in its probes.

But the prospect is unlikely of a major federal task force zeroing in on a large company, as with the special group created several years ago to investigate the collapse of Houston-based energy trader Enron. However, the Justice Department has created a mortgage fraud working group to oversee issues such as standards for measuring losses and establishing a central storehouse for mortgage documents.

Authorities also are unlikely to look to force companies out of business through criminal charges, well aware of the many job losses spurred by the demise of accounting firm Arthur Andersen after it was indicted over its dealings with Enron.

The subprime meltdown began more than a year ago, gaining momentum with the April 2007 bankruptcy of New Century Financial, which once epitomized the boom in extending home loans to borrowers with weak credit histories.

The criminal probes involving financial firms are examining whether shareholders were properly informed of companies' exposure to risky mortgage loans, and whether portfolios of mortgage-backed loan products were properly accounted for.

Investigators must first develop expertise in these areas, and then try to unravel whether anyone intentionally misled investors, experts say.

"In a case of this size and complexity, a year is nothing," said Samuel Buell, a former prosecutor on the Enron Task Force who now is a law professor at Washington University in St. Louis. "In fact, if there were a case brought within mere months of something of this scale that would be troubling."

Prosecutions Won't Be Easy

Prosecutions may be difficult to bring, said white-collar crime expert Peter Henning, a law professor at Wayne State University. He said it is much more likely to see action by the Securities and Exchange Commission, which can bring civil cases, rather than criminal prosecutions.

"I don't think we'll see high-level people involved because it's hard to identify exactly what went wrong," he said. "They are going to have to find the fraud. Losing billions of dollars is assumed to be bad, but that doesn't make it a crime."

Among the companies cited in press reports, court documents or company statements as subjects of federal investigations are: Doral Financial, Beazer Homes USA and Countrywide Financial .

In one criminal case, Manhattan federal prosecutors in March announced charges against a former treasurer at Doral, Mario Levis, who is accused of scheming to defraud investors at the mortgage lender. He denies the allegations.

Last week, American International Group disclosed that the Justice Department and the the SEC were investigating whether it overstated the value of contracts linked to subprime mortgages.

Authorities have been criticized in the past for moving too slowly in major financial fraud cases. With Enron, it took more than two years after the company's late 2001 collapse for prosecutors to secure criminal indictments against former top executives Jeffrey Skilling and Kenneth Lay.

There was "severe public criticism and bewilderment regarding why it was taking so long for indictments to be issued," said another former prosecutor in the Enron case, John Hueston. He is now a lawyer at law firm Irell & Manella in Los Angeles, and represents companies and individuals in subprime mortgage investigations.

U.S. Attorney General Michael Mukasey last week ruled out an Enron-style task force — which involved a large team of prosecutors working in Houston and Washington.

"This isn't that type of phenomena," he told reporters. He said the mortgage problems appeared to be in specific geographic markets and cited the FBI's current policy of pursuing fraud cases through regional task forces.

In New York, home of the U.S. financial industry, the U.S. attorney in Brooklyn last month launched a mortgage task force. His office recently brought a case in which lenders were said to be the victims. Eleven people, including mortgage brokers and attorneys, were charged with scheming to defraud mortgage companies and banks of more than $14 million.

So far, most federal mortgage prosecutions have involved relatively low-level frauds. These types of small, localized frauds are similar to the kinds of cases that emerged from the savings-and-loan crisis of the late 1980s, Henning said.

One big prosecution came from that crisis — the criminal case against former S&L boss Charles Keating. His convictions on charges of defrauding investors were later overturned.

Mueller, asked last month whether one company would emerge as the criminal emblem of the mortgage fraud crisis, said it was too early to say.

"We would have to look at those cases, if and when charges are brought down the road, to get a better handle on an answer to that question," he said.

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  • Diana Olick serves as CNBC's real estate correspondent as well as the editor of the Realty Check section on CNBC.com.