A spate of threats over the indirect financing of so-called predatory mortgage loans is the latest volley in a two-decade-long legal war that has put the financial community increasingly on the defensive.
By brandishing Truth-in-Lending, fair-housing and anti-racketeering laws as hammers against large financial companies that buy, securitize, or help finance abusive loans, trial lawyers are applying a strategy many experts trace back to a 1980 law that made banks potentially liable for clients' environmental cleanup costs.
"Plaintiffs' lawyers are following the money," said Alan White, a lawyer at Community Legal Services in Philadelphia.
The Comprehensive Environmental Response, Compensation, and Liability Act, better known as the Superfund law, forced the financial community to heed environmental issues in much the same way it is now being forced to look out for abusive loan practices by clients and subsidiaries.
With a pair of potentially precedent-setting claims still on the horizon for Wall Street companies that financed subprime lenders, it remains to be seen how far up the financial food chain predatory-lending claims will go. But the financial industry faces a host of similar pressures to take responsibility for clients' actions - possibly including anti-money-laundering law. (See lead article on page one.)
Big mortgage buyers are taking the legal and public relations threats seriously.
Indeed, Fannie Mae on Tuesday unveiled a set of guidelines for subprime loans it will buy as it tries to broaden its activity in the subprime mortgage market - emphasizing that it will not finance many activities that trial lawyers and activists have targeted.
"We have an obligation to define the loans we will not buy, and practices we will not support - practices that can have the effect of encouraging predatory lending," said Fannie Mae chairman and chief executive officer Franklin D. Raines. "Many of these practices such as steering, equity stripping, excessive fees, and prepayment penalties take away affordable mortgage opportunities from those borrowers who need them the most."
As with environmental claims, the accusations of predatory lending put financial firms on the wrong side of a good-versus-evil issue.
Under the Superfund law, the universe of liable parties for environmental cleanup included current and former owners and operators, as well as those who arranged the disposal of waste and those who transported it. That meant lenders that had foreclosed on properties were potentially at risk for actions they did not commit.
United States v. Fleet Factors Corp. in 1990 sent shock waves through the banking community, because it spread responsibility far further than many had imagined was possible. The decision by the 11th Circuit Court of Appeals said that a lender with the capacity to influence a borrower's waste-handling practices can be held responsible as an owner or operator if it does not use that influence constructively.
Subsequent decisions have set limits on how far up the food chain such claims can go. These include a 1998 ruling, in a case involving Best Foods, that the corporate parent of an entity that is a liable party under Superfund is not necessarily liable.
Adeeb Fadil, counsel at Simpson Thacher & Bartlett of New York, said that "it's still quite important [for companies] to evaluate transactions with care, because there's a number of bases for substantial liability in ways that may seem counterintuitive to businesspeople."
For example, Mr. Fadil said, a leveraged buyout shop or strategic buyer may purchase a company in an innocuous business, "but if it is a successor to a business that has an environmental-contamination history, the buyer could be liable or find that it doesn't have the value it thought it had."
In recent years, legal claims against financial firms have started popping up outside the realm of lending.
Last August Bear Stearns & Co. paid $38.5 million to settle criminal and civil charges that it helped facilitate improper trading in customer accounts managed by a client of its clearing operations, A.R. Baron & Co.
And in December, a group of investors in California sued Bank One Corp. and SunTrust Banks Inc. over their role as trustees for securities issued by First Lenders Indemnity Corp. The investors are claiming the banks should be held responsible for losses on what they said was a Ponzi scheme orchestrated by a man who had been convicted of bank fraud.
By aiming higher in the financial industry hierarchy, activists are seeking not only to win judgments, but to snuff out practices they object to by intimidating loan buyers and other indirect participants.
"I think the theory is that plaintiffs and their attorneys want to ratchet up reputation risk," said Laurence E. Platt, a partner with Kirkpatrick & Lockhart in Washington. "There may be no legal liability, but the secondary players don't want their names in the papers or offices picketed." He said the strategy tries to force companies to do what is right. But, he asked, "When do you know when something is bad or good? It's purely subjective."
Much attention has been paid to Lehman Brothers' role in funding First Alliance Corp., an Irvine, Calif., subprime lender that filed for bankruptcy last month.
Lehman Brothers has not been sued in connection with First Alliance, and a spokesman dismissed the idea. "Financial companies have always been sued in situations where they are tangentially involved," he said. "Simply because people want to include you in a lawsuit does not mean there is any liability there."
But consumer advocates believe Lehman should be held responsible for any First Alliance's actions proved unlawful. Josh Zinner, coordinator of the Foreclosure Prevention Project for Seniors of South Brooklyn Legal Services, said Lehman Brothers "underwrote the loans and should be held liable" under the
William Brennan, director of Atlanta Legal Aid's home defense unit, agreed. "You have to assume that having done the due diligence," Lehman had a lot of knowledge" of how First Alliance worked.
In another case, Bankers Trust Corp., which has since been bought by Deutsche Bank AG, has been named as a defendant in a class action against Delta Financial Corp. for its role as an underwriter for the subprime lender.
Mr. Zinner said the two cases are a key to establishing a precedent that discourages predatory lending. "Without the securitization system, predatory lenders wouldn't be able to make loans," he said.
The lawyers are shifting their sights to bigger game as control of the subprime market shifts away from fly-by-night finance companies. Indeed, eight of the top 10 subprime lenders are subsidiaries of large banks, including Bank of America Corp., Wells Fargo & Co., First Union Corp., and Citigroup. The trial lawyers say they are looking to establish a firmer precedent to attack both lenders and their backers.
"It's the institutions on Wall Street that are supporting predatory lending through funding," Mr. Zinner said. "And if they don't voluntary stop enabling the predatory lenders by providing an unlimited source of funds, advocates will start going after them legally."
Fair-housing advocates have also zeroed in on Freddie Mac, which inadvertently purchased about 70 high-rate or loans that triggered disclosure requirements under the Home Owner Equity Protection Act loans. Such loans carry rates of at least 10 percentage points over Treasury rates of the same maturity or charge closing costs that exceed 8% of the loan amount. Freddie Mac, which bought the loans when its subprime mortgage initiatives were in the pilot stage, says it has safeguards in place to prevent a similar incident.
But the situation underscored how treacherous the subprime market could become.
The Truth-in-Lending Act states that under the Home Owner Equity Protection Act, "Purchasers or assignees & could be liable for all claims and defenses with respect to the mortgage that the borrower could assert against the creditor."
On Feb. 16, a plaintiff won a decision in a Pennsylvania bankruptcy court against the trustee for the securitization and the holder of a loan after the originator went out of business. The plaintiff, Pauline M. Jackson, sought to rescind the loan, which was originated by Money-Line Mortgage and assigned to CityScape Corp.
CityScape filed for Chapter 11 late last year. But bankruptcy judge David A. Scholl in U.S. Bankruptcy Court for the Eastern District of Pennsylvania found that US Bank National Association, "as the assignee of the loan, can and will be held liable for all of the damages that flow from the statute and for the ignored valid rescission of this HOEPA loan." Ms. Jackson's liability on the loan was eliminated and she was awarded damages of $3,800.
Lawyers surveyed by American Banker said that in the broader mortgage market, the pass-through strategy is uncharted but will be used in more lawsuits using that will shape this issue over the next two years. Though section 32 liability applies only to HOEPA loans, it is not a stretch to imagine a plaintiff and his attorney arguing liability should expand beyond the original lender in other cases as well.
In addition, legal experts said the Truth-in-Lending Act, fair-Housing laws, and state statutes could be used to litigate pass-through liability. Some also mentioned the law created to battle the Mafia, the Racketeer Influenced and Corrupt Organizations Act, as a means to go after secondary marketing companies.
RICO provides for treble damages against defendants.
In fact, a 1993 lawsuit against Fleet Finance Inc. and a host of other companies over terms of home-improvement loan used federal and state RICO statutes with some success. The lawsuit also named Tower Financial Services; Home Equity Centers Inc.; Better Homes Co.; and Modern Homes Company. It ended with a confidential settlement, but the plaintiffs' attorneys successfully argued against a dismissal motion and "showed that the evidence supported the legal theory," an attorney involved in the case said.
"There's no question that this type of case could be successful. And that case is coming," said F. Willis Caruso, co-director of the John Marshall Law School Fair Housing Support Center.
"I think everyone should be liable up the ladder," Mr. Zinner said. "Whether that will hold up in court remains to be seen." 
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