This week, the Ninth Circuit Court of Appeals affirmed a jury finding that Wall Street-wizard Lehman Brothers aided and abetted consumer fraud. (See the opinion here.) Lehman Brothers does not, of course, have a consumer finance division. Rather, it got into trouble by financing another firm’s dirty business of predatory lending. Here’s the story, as presented by the court, followed by my own commentary ...

According to the court:

First Alliance originated, sold and serviced residential mortgage loans in the subprime market through a network of retail branches located throughout the country, utilizing a marketing methodology designed to target individuals who had built up substantial equity in their homes, many of whom were senior citizens. Through telemarketing efforts, First Alliance employees would set up appointments for what they described as in-house appraisals with targeted prospective borrowers. Following the appraisals, loan officers would employ a standardized sales presentation to persuade borrowers to take out loans with high interest rates and hidden high origination fees or “points” and other “junk” fees, of which the borrowers were largely unaware. The key to the fraud was that loan officers would point to the “amount financed” and represent it as the “loan amount,” disregarding other charges that increased the total amount borne by the borrowers. First Alliance trained its loan officers to follow a manual and script known as the “Track,” which was to be memorized verbatim by sales personnel and executed as taught. The Track manual did not instruct loan officers to offer a specific lie to borrowers, but the elaborate and detailed sales presentation prescribed by the manual was unquestionably designed to obfuscate points, fees, interest rate, and the true principal amount of the loan. First Alliance’s loan officers were taught to present the state and federal disclosure documents in a misleading manner, and the presentation was so well performed that at least some borrowers had no idea they were being charged points and other fees and costs averaging 11 percent above the amount they thought they had agreed to. Loan officers were taught to deflect attention away from things that consumers might normally look at, and the loan sales presentation was conducted in such a way as to lead a consumer to disregard the high annual percentage rate (“APR”) when it was ultimately disclosed on the federally-required Truth in Lending Statement.

First Alliance needed big money in order ramp up this game, and Lehman Brothers saw an opportunity to be the “secondary lender” who could “profit from interest and fees as the credit line was repaid as well as from fees earned for underwriting the securitizations.” So Lehman Brothers did its own investigation before diving in, and sure enough, learned that First Alliance was dirty. This didn’t stop Lehman Brothers, however, and they dove in to the tune of $500 million dollars. According to the courts, this knowledge of First Alliance’s fraudulent methods that satisfied the essential elements of aiding and abetting fraud. (See this activist site’s account of other Lehman Brothers involvement in this area.)

From an analytical perspective, one might wonder why we need to hold Lehman Brothers accountable for the sins of its brother, First Alliance? The answer is in the theory of deterrence. You may recall my post from last week discussing judgment proofing. The tort system can’t deter fly-by-night firms like First Alliance, since when the going gets tough, they will just run to bankruptcy court and abslove themselves of their liabilities (as they did in this case). But a deep-pockets firm like Lehman Brothers can be held accountable for knowingly supporting the fraud. Facing this threat, hopefully Lehman Brothers and their Wall Street buddies will take a pass next time a corporate huckster offers them a piece of the action. And when there is no money to support these sorts of fraud, that ultimately means that fewer consumers will get stuck in this kind of financial trouble.

Full disclosure: I am affiliated with one of the plaintiffs firms in this matter, the Scruggs Law Firm.