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Probe of WaMu's Demise Approved

By PEG BRICKLEY
AUGUST 10, 2010, 6:24 P.M. ET

A bankruptcy judge signed off on the work plan that sets out how former Justice Department fraud chief Joshua Hochberg will tackle the legal trouble spawned by the largest banking collapse in U.S. history, that of Washington Mutual, or WaMu.

"I appreciate your efforts jumping into this with both feet," Judge Mary Walrath told Hochberg attorney Henry Sewell at a hearing in the U.S. Bankruptcy Court in Wilmington, Del.

Mr. Sewell and Mr. Hochberg are with law firm McKenna Long & Aldridge. The firm is putting teams of attorneys to work on the probe of WaMu's demise, the latest in a series of investigations of what went wrong at the mortgage-stuffed thrift, which was seized by regulators in September 2008.

A Senate panel turned up evidence WaMu helped fuel the boom in risky mortgages and engaged in questionable lending practices, as well as signs regulators were at odds over what should become of the troubled thrift.

Lawyers for multiple groups of investors and lawyers for WaMu's former parent company, Washington Mutual Inc., have also conducted investigations and found enough to file lawsuits claiming everything from market manipulation to mismanagement.

Mr. Hochberg's probe, however, will be the decisive one because his results will determine whether a proposed $7 billion settlement is worthy of bankruptcy court approval. He has only a few months to test the validity of the claims WaMu's former parent could press against the other parties to the settlement, the Federal Deposit Insurance Corp. and J.P. Morgan Chase & Co.

J.P. Morgan bought WaMu from the FDIC shortly after it was seized in a $1.9 billion deal that sparked outrage among bondholders and shareholders. If the settlement goes through, J.P. Morgan will get more than it paid for WaMu, from tax refunds, securities and other assets, and it will be immunized from liability to those burned in WaMu's takeover.

At the start of Tuesday's hearing, Judge Walrath heard directly from shareholders, including a man who said he lost his life savings when Washington Mutual's stock plummeted, and a former top loan producer who watched the value of the restricted stock she had taken as pay shrink.

Bankruptcy rules put shareholders on the bottom rung of the payment priority ladder, beneath at least $8 billion in debts, perhaps more, according to WaMu's former parent.

Shareholders say the legal claims Washington Mutual has filed should bring $20 billion in damages, but the company says the risks and uncertainty of litigation make the settlement worthy of approval.

Allegations that J.P. Morgan engineered WaMu's collapse, for example, could turn out to be worthless to the former parent company if a court finds that the damage was done to the thrift, rather than to its parent, attorneys for Washington Mutual have suggested.

WaMu, the thrift, has some $13 billion worth of unpaid bond debt to cover. The Chapter 11 plan proposed by former parent Washington Mutual pays only the parent company's bond debt.

There are also questions about the marketing of WaMu in the period when regulators were pondering a seizure of the thrift, according to documents that have surfaced. According to Mr. Hochberg's work plan, the probe will examine whether Washington Mutual is walking away from valid claims connected to that period in WaMu's history.

As the U.S. financial system teetered on the brink of ruin in 2008, WaMu went from a thrift perceived as relatively stable to a dangerously shaky bank that needed to be seized from its parent and put into safe hands.

The speed of the disintegration has investors, bondholders and shareholders questioning whether the seizure was justified.

Washington Mutual attorney David Hird of Weil, Gotshal & Manges referred to the thrift's disillusioned backers as "people who thought that WaMu was run a certain way and found out, or believe, that it was not."

Shareholder complaints prompted Judge Walrath to summon an independent outsider to review the proposed settlement, which is the foundation for the Chapter 11 plan Washington Mutual is attempting to push through the courts.

Besides shareholders, holders of trust preferred securities are protesting the settlement on the grounds their securities were mishandled at the time of WaMu's seizure. Their attorneys say the trust preferred securities don't belong in the package of assets headed into J.P. Morgan's hands if the proposed settlement goes through.

Their attorneys complained Tuesday that Washington Mutual's document depository, the central resource of information for those attacking the settlement and those defending it, is an unworkable pile of information, including multiple copies of documents pertaining to golf outings, whale-watching expeditions and salmonella.

"Putting aside migratory patterns of killer whales and food-borne pathogens," attorney Jeremy Coffey of Brown Rudnick said the trust preferred security holders want the information they need to reclaim what they contend is their property from the bankruptcy case of WaMu's former parent.

Confirmation hearings are set to start in November on Washington Mutual's Chapter 11 plan.

Write to Peg Brickley at [e-mail]

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