Reported by Sam Goldfarb

(Summary shares below. To read full report, go to: https://www.wsj.com/finance/investing/wall-street-intensifies-scrutiny-of-fraud-after-spate-of-loan-losses-0397bc55?mod=mhp)

A surge of alleged corporate frauds has rattled Wall Street, pushing banks and investors to tighten their lending practices and enhance due diligence. In response to recent loan losses, lenders are demanding longer financial histories from borrowers and incorporating stricter oversight clauses in loan agreements. The wave of fraud cases—mostly among small and midsize firms in industries like automotive and telecommunications—has prompted the formation of a new task force made up of major banks, investment managers, and accounting firms. This initiative aims to assess the nature of recent frauds and develop new safeguards to protect investors from similar risks.

The alarm was triggered by a series of bankruptcies that revealed troubling lending practices. First Brands, an auto-parts supplier, collapsed amid accusations of double-pledging receivables to multiple lenders. Around the same time, Tricolor Holding, an auto dealer and subprime lender, also filed for bankruptcy over similar allegations of fabricated loans. Other notable cases include alleged fraud involving California real-estate investors tied to Zions Bancorp and a borrower accused by BlackRock’s private-credit division. The accumulation of such cases has made it harder to dismiss these incidents as isolated and has raised deeper concerns about systemic weaknesses in credit-market oversight.

In response, the Structured Finance Association (SFA) has established a “Fraud Mitigation Task Force” to identify the most common forms of fraud and recommend detection best practices. This group, which includes representatives from Wall Street’s largest banks, asset managers, and the Big Four accounting firms, will present its findings early next year. The initiative holds symbolic importance for the structured-finance sector, which has worked hard to restore credibility after its role in the 2008 financial crisis. According to SFA CEO Michael Bright, the urgency reflects a desire to determine whether these frauds are isolated events or signs of a broader, systemic issue emerging across credit markets.

The collapse of First Brands also highlights growing risks tied to asset-based lending, where short-term loans are backed by receivables or other collateral. While such financing remains popular among investors seeking higher yields, many lenders are now requiring multi-year payment histories and conducting more frequent collateral reviews to avoid being blindsided by false claims. Experts such as Colin Adams of Uzzi & Lall note that lenders are rethinking how much trust they place in borrower-reported data, realizing that enhanced verification—akin to rigorous Know Your Customer (KYC) standards—must extend deeper into corporate financial disclosures.

Despite the increased scrutiny, the broader credit market remains stable. Economic indicators show steady performance, and corporate default rates have not spiked, suggesting resilience even amid these revelations. However, specific segments—such as bonds tied to subprime auto loans—have come under strain as Tricolor’s bankruptcy amplified investor concerns about low-income borrowers. While portfolio managers like George Goudelias of Seix Investment Advisors view the recent frauds as concerning, they continue to prioritize core credit metrics like earnings growth and debt coverage. For now, the focus on stricter due diligence, enhanced data transparency, and collective industry oversight reflects Wall Street’s determination to prevent another confidence crisis.