Though the potential for the anti-predatory lending campaign to target the securitization industry has been on the market's radar screen for some time, the charges brought against Lehman Brothers as co-defendant in a class action suit last week mark the first time the movement has significantly penetrated ABS.
What is more, the allegations - which try to associate Lehman Brothers, as an underwriter, with the lending practices of First Alliance Mortgage Co. - could set a precedent for an investment bank's exposure to the ethical practices of its clients.
"It really opens up the floodgates," one ABS analyst said.
First Alliance, which filed for chapter 11 in March, was one of the featured predatory lenders in a recent episode of the ABC News program "20/20."
However, as reflected in charges detailed by San Francisco-based law firm Jenkins & Mulligan, which filed the suit in federal bankruptcy court in Santa Ana, Calif., Lehman Brothers was allegedly more heavily involved with First Alliance than is typical. Lehman was running a fairly large conduit operation with First Alliance, resembling the structures set up by subprime players ContiFinancial or Amresco Inc., according to the ABS analyst.
"Most Wall Street firms do not do that," the analyst said. "Functioning purely as an underwriting firm, I think you're probably insulated from those problems. You're not really in the chain of title on those loans, but if you're functioning in a capacity to close the loans, where a broker brings you a loan and says, Do you like the package?' I think you're right in the line of fire."
One likely outcome is increased due diligence on the underwriter's part when dealing with lenders in potentially controversial sectors.
"I'm not sure if anybody really thought about these issues before," the analyst said. "I have a feeling none of this was deliberate in the sense of the people who bought the loans."
Significantly, other than an incident in March when protestors stormed the Washington office of Salomon Smith Barney, the anti-predatory lending movement has had little penetration into the asset-backed market. Delta Funding Corp., accused of questionable lending practices, settled with regulators last fall and again this year. Similar charges were brought against other issuers.
However, the fact that Lehman faces charges as an underwriter indicates that the bridge between the lending practices and the funding mechanism has been crossed.
Sources familiar with the situation speculate that Lehman will likely settle outside of court to avoid a bombardment of similar lawsuits.
"If Lehman were to lose on this one, there'd be a line of people claiming compensation," said one source. "From every deal that Lehman has underwritten over the past couple of years, somebody would come out."
The charges allege that, for one, Lehman had a significant, monetary stake in First Alliance.
The charges allege that in 1998, as part of a $150 million warehouse credit facility First Alliance granted Lehman stock warrants equaling one percent of the total number of diluted First Alliance shares outstanding.
Because Lehman Brothers was allegedly part owner and financier, it is being accused of having knowledge of First Alliance's fraudulent practices, and thereby tacitly or expressly approving those practices in its financing of the lending operations.
Though Lehman Brothers would not comment on the specifics of the lawsuit, spokesman William Ahearn did say, "The lawsuit says we were an equity holder in First Alliance, which is not true. We had warrants that we received from First Alliance as partial payment for credit services, but we never exercised them. Calling us an equity holder isn't exactly true."
Perhaps the most detrimental allegation links a former officer of a Lehman Brothers affiliate to First Alliance's management team.
Francisco Nebot, formerly the chief financial officer of Shearson Lehman Mortgage Corp., was named president of First Alliance in February of this year.
"If the plaintiffs can prove that Nebot was hired by First Alliance in response to Lehman's demands, I think they can argue Lehman was in control prior to bankruptcy and then would have a good chance of being able to reach into Lehman's pocket," the source said.