Happy Tax Month! This month's newsletter addresses a fascinating veil piercing story related to the near-collapse of one of Wall Street's biggest investment banks.

Bear Stearns & Co. is at the center of a major Wall Street drama. The subprime mortgage crisis and the collapse of the US housing market have caused financial firms such as Bear to suffer multi-billion dollar losses in failed mortgage investments. Last month, liquidity problems at Bear Stearns helped end 85 years of independence for Wall Street's fifth-largest securities firm.

The United States Federal Reserve (the "Fed") has recently taken extraordinary moves to shore up US financial markets, including allowing big investment houses to get emergency loans directly from the central bank. The Fed is also helping JP Morgan Chase & Co. acquire Bear Stearns by providing up to $30 billion in financing. This controversial deal prevents a "fire sale" of Bear's mortgage-backed securities, which could have created recession havoc in the US economy.

You may wonder how the subprime loan practices of big Wall Street firms like Bear Stearns can imperil your personal wealth. The answer is veil piercing, as illustrated in the case of Coppola v. Bear Stearns & Co, Inc. Enroll today in Bulletproof Veil and contact your Bulletproof Veil representative to resolve any questions about the viability of your business entity.

Bear Stearns, Subprime Mortgage Loans, and Veil Piercing

Mortgage-Backed Securities

A mortgage-backed security is an investment whose cash flows are backed by payments from a pool of mortgage loans. The strong US housing market has made mortgaged-backed securities popular for years.

The safety of mortgage-backed securities depends on their underlying mortgage loans. If mortgage foreclosures increase, mortgage-backed securities are hurt.

In March 2007, the United States' subprime mortgage industry collapsed due to high home foreclosure rates, with more than 25 subprime lenders falling into crisis.

Bear Stearns and National Finance Corp.

National Finance Corporation (NFC) was a privately held company providing subprime mortgages and home equity loans to homeowners. To finance its loan business, NFC relied on a line of credit from Bear Stearns & Co (Bear).

NFC earned revenue from loan origination fees. NFC also made money by selling its loans on the secondary market. These loans would become part of pools of loans used to create mortgage-backed securities.

When NFC sold a loan on the secondary market, it would pay Bear an agreed-on price and retain any profit earned from the sale. For a time, this arrangement worked well - the two companies earned money both when NFC created mortgage loans and later when they were sold at a premium.

Money Problems for NFC

NFC's subprime mortgage business began to suffer and could not fund its continued operations. In response, David Silipigno, NFC's CEO, began to keep money from sales of loans that should have been paid to Bear.

Bear ultimately discovered NFC's deception. In response, Bear found NFC in default and took control of Silipigno's NFC stock (96% of all NFC stock). Bear attempted a workout strategy that would allow NFC to remain in business for a time in the hope of selling NFC and using the proceeds to repay Bear.

But the knowledge of NFC's fraud spread quickly, and the market would have nothing to do with NFC. NFC could no longer obtain funding or relationships that would allow it to stay in business. As a result, Bear closed up the NFC shop.

Coppola v. Bear Stearns, & Co., Inc.

In an "only in America" legal twist, Bear shortly found itself being sued by former NFC employees. The employees brought a class action under the Worker Adjustment and Retraining Notification Act (WARN). This federal law requires employers to give 60 days' advance written notice before a plant closing or mass layoff. NFC employees argued that since Bear had essentially taken over NFC, Bear was liable as an employer for violating WARN.

The key question in the case was whether Bear, as a creditor of NFC, was also an "employer" within the meaning of the WARN statute. This should have been an open-and-shut case for Bear- given the language in the statute; the lawsuit should have been dead in the water. But Bear's failure to pay attention to corporate veil piercing issues cost it dearly.

Because Bear had not properly documented its takeover of Silipigno's NFC stock, it suffered millions in legal fees and a lengthy litigation process ending in the U.S. Second Circuit Court of Appeals. The combination of all these losses couldn't have helped Bear as it suffered its recent liquidity crisis.

Veil Piercing Implications of Coppola v. Bear Stearns & Co., Inc

Why is this case relevant to you? Because in defining the term “employer” for purposes of assigning liability, the Court chose a legal test that broadens the corporate veil piercing threat for business owners.

The Circuit Court stated "[A] creditor that has not assumed the formal indicia of ownership [of its borrower] may become liable for the debts of its borrower if the lender's conduct is such as to cause it to become the debtor's agent, partner, or alter ego."

Note the court's use of the terms "agent", "partner", and "alter ego". These are all common law theories used by courts to pierce a corporate veil. Previously, courts would have used the narrower statutory law definition of "employer", making it highly unlikely that a creditor like Bear could be found liable.

But by using broader common law veil piercing arguments, the court essentially said, "even if you don't fall under the statutory definition of an employer for liability purposes, you could still be liable if you have broken veil piercing rules". Fortunately for Bear, the Court ultimately ruled in its favor, so Bear was not held liable.

Summary & Conclusion

The key point is this: if you own one or more business entities, and you or one of those businesses (the lender) has loaned money to your other business entity (the borrower), you or your "lending" company may be liable for the borrower's debts-even if you or your lending company don't own the borrowing company.

The key to protection is to work with Bulletproof Veil to make sure all of your documentation and behaviors regarding any loans or entity ownership are complete, correct, and up to date. Enroll today and contact your Bulletproof Veil Representative for more information.

Material discussed is meant for illustration and/or informational purposes only and it is not to be construed as tax or legal advice. Although the information has been gathered from sources believed to be reliable, note that individual situations can vary.