Can the Lawsuit Against DoJ Over JPM Settlement Succeed?

Updated from 12:49 p.m. Feb. 11, with comment from Frank Mayer, a partner in the Financial Services Practice Group of Pepper Hamilton in Philadelphia.

NEW YORK (TheStreet) -- Better Markets is making some excellent points through its lawsuit against the Department of Justice against the unprecedented $13 billion residential mortgage-backed securities settlement JPMorgan Chase (JPM) agreed to in November, but the lawsuit is likely to be thrown out.

The settlement was announced by New York State Attorney General Eric Schneiderman, who heads President Obama's Residential Mortgage-Backed Securities Working Group, which includes representatives from the Justice Department, federal regulators and other states' attorneys general.

The settlement covers all civil claims by government authorities related to residential mortgage-backed securities (RMBS) sales by JPMorgan, Bear Stearns and Washington Mutual before 2009.

JPMorgan acquired Bear Stearns when the investment bank was faced with bankruptcy after its liquidity dried up in March 2008. Washington Mutual failed in September 2008, after which it was sold to JPMorgan by the Federal Deposit Insurance Corp.

As has been the case in most settlements between U.S. authorities and large banks, shareholders wound up taking the losses, while company executives escaped blame.

Better Markets, a nonprofit market watchdog, on Tuesday announced it had sued the Justice Department in federal court in Washington challenging the JPMorgan settlement, saying the agreement was "a mere contract and was not reviewed or approved by any court. And, it gave JP Morgan Chase complete civil immunity for years of alleged pervasive, egregious and knowing fraudulent and illegal conduct, which contributed to the worst financial crash since 1929 and the worst economy since the 1930s."  Better Markets didn't mention any law firm filing the suit on its behalf.

Here's more from the press release, holding the Department of Justice to the fire:

Adding insult to injury, this deal was cut in secret by the DOJ and JP Morgan Chase with the DOJ acting as investigator, prosecutor, judge, jury, sentence and collector without any independent review by a judge. This violates the constitutional separation of powers because there are no checks and balances on the back room deals that DOJ cuts with Wall Street.

Making matters worse, the agreement fails to disclose any meaningful information about JP Morgan Chase's alleged widespread illegal conduct. In fact, the deal was clearly carefully crafted more to conceal than reveal. As a result, there is no publicly available information that would enable anyone to determine if the agreement is, as the DOJ claims, tough, or just another sweetheart settlement for a Wall Street bank. Given the DOJ's motive and self-interest in burnishing its record of failure to go after Wall Street, its claims about the settlement must be reviewed by an independent court.

And, don't be fooled by the big dollar amount. Sure, $13 billion is a lot of money, but not to Wall Street, not to JP Morgan Chase, not relative to the amount of damage the financial crash has cost this country, and not if JP Morgan Chase's liability was $200 billion or more, or if its profits from its illegal actions were more than $13 billion or if the losses and damages it caused exceeded $13 billion. But, none of this is known because DOJ settled with JP Morgan Chase without disclosing a single one of those facts.

The American people have a right to know these basic facts and judge for themselves whether the DOJ was really tough and punished the biggest Wall Street bank as it claims or if this is just more of the same from a DOJ that has failed so miserably to enforce the law on Wall Street. That's why we sued DOJ and that's why any settlement must be submitted to a judge for an independent, public review.

OK, there's a lot of great stuff there. JPMorgan shareholders can't be entirely pleased, taking it on the chin to the order of $13 billion through a "secret agreement," and may be wondering if the tab could have been much lower if the Justice Department had followed through with a lawsuit against the bank.

It's also easy to question the motives of any prosecutor, since the job is, by its nature, political and prosecutors are naturally looking to build a record of success as they look further down their career paths.

Better Markets also gets a little cute when saying "not if JP Morgan Chase's liability was $200 billion or more," because they can just throw out the figure without proving anything.

But there's no question that Better Markets has raised some excellent points.

Better Markets -- founded by and funded by Michael Masters, who also founded Masters Capital Management, LLC. -- made quite a splash in September 2009, when the organization said the financial crisis had cost the U.S. economy nearly $13 trillion.

Rafferty Capital Markets analyst Richard Bove -- who has previously said that JPMorgan's executives and board of directors weren't fulfilling their responsibilities to protect shareholders when entering into such a large settlement -- wrote in a note to clients Tuesday, "have no idea how the District Court in Washington will respond to this request but I do know that the plaintiffs are in the right and the Justice Department has violated every tenet of fairness and equity in its actions."

"The Justice Department and State Attorney Generals have argued their cases through press leaks to a media that has abdicated its requirement to act objectively," Bove wrote. We made that same point at TheStreet last August.

Bove in his usual succinct manner, also wrote, "The shareholders of JPMorgan Chase were being fined for actions that they did not commit," adding, "The supposed miscreants in these actions were not being fined or subjected to legal scrutiny."

The analyst went further by saying large banks were being "extorted" by "a McCarthyite Justice Department."

The pattern of leaks, meant to maximize headlines before, during and after settlements has indeed been disturbing.

So Better Markets and Bove together are making a good case against the Justice Department and other government authorities that their actions against the banks have been a bit over the top, with bank executives not suffering as their shareholders suffer.

Too Bad It Won't Fly

But the lawsuit against the Justice Department is likely to be tossed, for the simple reason that the agreement with JPMorgan was made before the DoJ or other government authorities represented on the Residential Mortgage-Backed Securities Working Group sued the bank.

Judge Jed Rakoff of the Federal District Court in Manhattan famously objected to a settlement between Bank of America (BAC) and the Securities and Exchange Commission in 2009, however, he had authority over the settlement, since the SEC had sued the bank. The same thing happened with a settlement between Citigroup (C) and the SEC in 2011.

But the JPMorgan Chase situation is different, because there was no lawsuit.

Bove commended Better Markets: "Amen, brother; well said. Shareholders have rights which no one in this settlement cared to consider."

It's too bad that in this case, no judge will be able to do anything for JPMorgan's shareholders. Then again, the shareholders could try and do something themselves.

Additional Comment from Frank Mayer

Frank Mayer, a partner in the Financial Services Practice Group of Pepper Hamilton in Philadelphia, said the following about the Better Markets lawsuit during a phone conversation Wednesday:

Better Markets should realize that this is a policy issue, which would be best addressed in Congress, which could potentially provide Better Markets with a Forum.  The judicial branch lacks jurisdiction over an executive branch, absent the U.S. government, via Congress, expressly waiving sovereign immunity.

In addition, it's unlikely that Better Markets would prevail, because it is unlikely they can prove that their organization, as plaintiff, has been directly harmed by the settlement, and the courts are very reluctant to interfere with prosecutorial discretion.  The Department of Justice has the authority to enforce the law under their jurisdiction, and therefore has the authority to settle and resolve.

There are other important powerful defenses that the government would have, as well.

Mayer added that the lawsuit "has certainly added to the publicity of the settlement."

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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