The U.S. Justice Department took the unusual step of suing Barclays PLC, alleging the bank fraudulently sold more than $ 30 billion of mortgage securities that helped fuel the financial crisis, after long-running settlement negotiations broke down.
The complaint filed Thursday against the U.K.'s second-largest bank shows the urgency among senior Obama appointees in the Justice Department to resolve the outstanding probes of precrisis conduct at major banks before those officials leave office in mid-January. Part of the urgency stems from a great deal of uncertainty about how a Trump administration might pursue, settle or drop the remaining probes, according to people familiar with the discussions.
Many of the banks caught up in the multibillion-dollar inquiries have reached settlements over the past three years without going to court. The Justice Department did file two lawsuits against Bank of America Corp. related to precrisis sales of mortgage-backed securities in 2012 and 2013, one of which was thrown out earlier this year on appeal.
The government complaint didn't quantify the damages it is seeking from Barclays.
Barclays said in a statement that it would seek the suit's "dismissal at the earliest opportunity," and that it considers the claims "disconnected from the facts." Bank officials declined to elaborate on why the talks broke down, but one person familiar with the matter said that continuing the talks under "a fresh pair of eyes"—in a new presidential administration—might be more beneficial.
A prolonged legal battle would be handled by Justice Department officials appointed by President-elect Donald Trump. Neither Mr. Trump nor his aides have indicated how they might handle legacy financial-crisis fallout inherited from Mr. Obama. But Mr. Trump in 2013 criticized J.P. Morgan CEO James Dimon that year as "the worst banker in the United States" for reaching a $ 13 billion settlement in a similar case. "What happened to the days when you actually go to trial?" Mr. Trump said at the time.
The Barclays suit comes as the Justice Department is deep in negotiations over mortgage securities with two other big European banks— Deutsche Bank AG and Credit Suisse Group AG—it aims to wrap up by next month. While those talks are progressing, they have yet to reach a point that suggests a settlement is certain, according to people familiar with the discussions.
The Justice negotiations this year have been a big cloud hanging over an already-fragile European banking industry, weighing on several major lenders' stock prices. Investors have worried about whether those institutions' capital is sufficient to cover any possible U.S. fines. As of this summer, Barclays had set aside about $ 3.1 billion to cover fines and litigation, and has been selling assets in Europe and Africa to bolster its balance sheet.
The 198-page lawsuit by the U.S. government says the bank "engaged in a fraudulent scheme to sell tens of billions of dollars of residential mortgage-backed securities (RMBS), in which it repeatedly deceived investors about the characteristics of the loans backing those trusts."
Barclays sold the securities to a wide range of investors, including financial institutions, Fannie Mae and Freddie Mac, federal home-loan banks, credit unions, pension plans, charitable and religious organizations, and university endowments.
"Many of these investors suffered devastating losses,'' according to the suit, which was filed in a U.S. District Court in New York. The suit singles out two former New York-based Barclays executives, Paul Menefee and John Carroll, who had been hired in 2003 to help run the bank's asset-securitization team, according to an announcement at the time. Both were previously at Morgan Stanley and left Barclays in 2008.
The complaint is filled with expletive-laced conversations involving those men and others familiar with the loans, taken from transcripts of recorded phone calls and emails. In one, the complaint says that Mr. Menefee, who was charge of due diligence on the subprime deals at issue, allegedly said that one loan pool "scares the shit out of me.'' At another point, that same executive said about a Wells Fargo & Co. pool, according to the complaint: "We have to eat their shit loans."
Mr. Menefee's lawyer called the complaint "a misguided attempt'' to blame his client and others for losses incurred by sophisticated institutional investors after an industrywide housing market collapse.
Mr. Menefee, the lawyer said, plans to refute the accusations in court "where it will be shown why the government's own witness described Mr. Menefee as 'honest', 'careful', and 'the fairest person he ever dealt with.'''
Mr. Carroll's lawyer didn't immediately respond to requests for comment.
The suit also alleges that companies hired to conduct due-diligence checks on the mortgages warned the bank, and those warnings were essentially ignored. "These vendors described some of these securitized loans as 'craptacular,' others as 'scariest collateral,' and others as having the 'distinct aroma of default,'" the suit says.
The allegations relate to activities and employees at Barclays, before the bank's 2008 buy of the collapsed investment bank Lehman Brothers.
The breakdown in the talks between the government and the bank came as Barclays executives made clear they were wary of being pressured to make a big payout.
Barclays Chief Executive Jes Staley had told people in recent months that the bank wouldn't give U.S. authorities a blank check, and wouldn't settle if he felt the price was too high, according to people familiar with the discussions.
Government officials had discussed with Barclays lawyers numerous times the possibility of suing, but the bank only learned Thursday that a lawsuit was arriving the same day, according to a person familiar with the matter.
The impasse between the two sides was still big: They remained multiple billions of dollars apart, with Barclays unwilling to pay $ 5 billion—an amount the government had said was in the range of possibilities, according to a person familiar with the matter.
Lawyers for the bank could respond to the lawsuit as early as next month, people close the matter said.
One of the key arguments Barclays made to Justice Department lawyers during the negotiations was that Barclays was the most-exposed investor in the securities in question, and had already taken a big write-down during the financial crisis as a result of losses.
Barclays also insisted that losses from the securities were related to broad market events, not its own practices, and argued that its due diligence on the deals was deemed at or above industry standards, including by government-backed entities that approved of Barclays's methodology at the time.
In recent days, government lawyers were scheduling calls with Barclays lawyers, pushing for progress in the talks, a person familiar with the matter said.
On Thursday, the government gave the bank a brief heads-up before filing the complaint about 3 p.m. ET.
Write to Max Colchester at max.colchester@wsj.com, Devlin Barrett at devlin.barrett@wsj.com and Jenny Strasburg at jenny.strasburg@wsj.com
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