Holders of $1 billion of securities issued by a Washington Mutual Inc entity have sued to void an eve-of-bankruptcy exchange of their investment, according to a complaint filled with claims of fraud and secret agreements.
The dispute centers around an exchange of securities that were swapped into preferred stock just as regulators seized Washington Mutual Bank in September 2008, in the biggest bank failure in U.S. history.
Along with the bank seizure, regulators ordered that the $4 billion of outstanding trust preferred securities that had been issued by a special purpose entity of Washington Mutual be exchanged for preferred stock of Washington Mutual Inc. The suit was filed by holders of $1 billion of the total.
The trust securities were transferred to Washington Mutual Bank, which was then sold to JPMorgan Chase & Co. Washington Mutual Inc declared bankruptcy the next day.
The lawsuit filed in Delaware's Bankruptcy Court seeks to undo that exchange of securities, and the investment funds that brought the lawsuit list a series of misdeeds.
The suit also seeks a determination by the judge that JPMorgan knew of the misrepresentations by Washington Mutual about the soundness of its bank and that it cannot be a bona fide purchaser of the securities. The plaintiffs further want JPMorgan's claims to the securities to be subject to fraud claims by investors, according to the complaint.
The complaint seeks damages to be determined at trial.
Washington Mutual touted the strength of its risk management and quality of its mortgages to buyers of the securities, when in fact it was pushing low-quality loans and corrupting appraisals, according to the complaint.
Washington Mutual also had a "secret side letter" agreement with the U.S. Office of Thrift Supervision, the main regulator of its bank, to transfer the securities in such an exchange to the lender, according to the complaint.
In contrast, the offering documents said the securities could be exchanged under "extraordinary" circumstances, but would remain with the holding company, Washington Mutual Inc, according to the complaint.
Since Washington Mutual Inc was also issuing the preferred stock, the exchange as described in the offering documents might be considered a "wash" by investors who would continue to indirectly benefit from the securities.
Washington Mutual said it is reviewing the complaint. It said: "The debtor and its affiliates intend to vigorously defend against these allegations." JPMorgan and the Office of Thrift Supervision declined to comment.
Most of the company's stay in bankruptcy has been spent suing JPMorgan and the U.S. Federal Deposit Insurance Corp, which sold the banking business.
Washington Mutual reached an agreement earlier this year with JPMorgan and the FDIC to settle outstanding lawsuits, including an agreement to recognize JPMorgan as the owner of the trust securities. As part of that settlement, JPMorgan would provide $50 million for those who were forced to exchange their securities.
On Thursday, Washington Mutual will ask the judge overseeing the case, Mary Walrath, to approve its disclosure statement. Approval would clear the way for the company to ask creditors to vote on its plan of reorganization.
The complaint by the holders of the trust securities could again delay a hearing on the disclosure statement, or the statement could be approved with amendments mentioning the lawsuit.
The case is In re Washington Mutual Inc, U.S. Bankruptcy Court, District of Delaware (Wilmington), No. 08-12229.
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