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LOUISVILLE, Ky. (AP) — A Kentucky-based bank that lost at least $14 million on mortgage-backed securities failed to read documents associated with the investment and didn't give enough specifics to sustain claims of fraud against now-defunct investment bank Bear Stearns, a federal appeals court ruled Wednesday.
While Republic Bank showed some elements of fraud on behalf of the salesman for the investment bank, it failed to lay out specific incidents in which Bear Stearns knowingly lied about the securities and failed to do its due diligence before investing a total of $52 million from 2003 through 2006, Judge Danny Boggs wrote for the U.S. 6th Circuit Court of Appeals.
"Republic would have understood that the loans underlying the certificates carried a high risk of default, had it read the prospectus supplements," Boggs wrote in a 30-page opinion joined by judges Eric L. Clay and Gilbert S. Merritt.
The ruling stems from a lawsuit brought by Republic Bank against Bear Stearns and its current owner JPMorgan Chase & Co. Republic sued the group in federal court in Louisville in 2009, saying Bear Stearns lied about the profitability of the securities and didn't disclose the risks in investing in a security backed by risky home loans.
At its peak, Bear Stearns was among the largest sellers of the mortgage-backed securities.
Republic Bank initially bought in March 2003 about $20 million in mortgage-backed securities, investments created by combining thousands of mortgages of different types from around the country, particularly subprime loans which are generally made to people who have difficulties maintaining a regular payment schedule or have little collateral for the loan.
"These loans frequently do not conform to established underwriting standards, which require good faith evaluation of both the borrower's ability to repay the loan and the value of the property offered as collateral," Boggs wrote.
At the time of that purchase, the prospectus, which gives details about the security to investors, was unavailable and Bear Stearns did not give the bank an advance copy.
The bank returned to Bear Stearns on Oct. 2, 2006 and purchased more than $32 million in mortgage-backed security certificates from Bear Stearns and this time had access to the prospectus. Boggs found that Republic Bank officials did not read the document before making the investment.
Boggs found that Bear Stearns, in the October 2006 offering, disclosed that the mortgages used in the security were "non-conforming loans," meaning either the person taking out the loan had credit issues or there were potential problems with the documentation standards in making the loans.
Boggs found that those disclosures, unread by Republic Bank officials, mean the bank is unable to sustain a fraud-by-omission claim.
"Had it read the disclosures, it would have known that the trusts contained loans issued to borrowers with questionable credit histories," Boggs wrote. "Finally, the offering documents amply warned that the loans underlying the certificates carried a high risk of default."
Bear Stearns into trouble in 2006 and 2007 as subprime mortgages and other risky home loans began to collapse. In March 2008, the Federal Reserve Bank of New York floated a $25 billion loan to Bear Stearns in an effort to keep the company afloat. Bear Stearns collapsed two days later, being bought by JPMorgan Chase & Co., for $1.2 billion, a fraction of its peak value, as the country spun into a housing market collapse.
Boggs found that Republic Bank failed to clearly state any action by Bear Stearns that showed the company knew the loans backing the securities would fail.
"It made no effort to explain why the loans issued were fraudulent, how they differed from established lending standards or what abusive acts originators performed," Boggs wrote.
Michael Sadofsky, a spokesman for Republic Bank, declined comment Wednesday.
Follow Associated Press reporter Brett Barrouquere on Twitter: http://Twitter.com/BBarrouquereAP