DEFINITION of 'Caveat'

Caveat is a Latin term that means "let him beware." There are many types of caveats in law and finance, with the most common being "caveat emptor," meaning "let the buyer beware," and "caveat venditor," meaning "let the seller beware." The legal applicability of these concepts can determine civil and criminal liability.

BREAKING DOWN 'Caveat'

Caveat is a warning or caution to an individual or entity to use care before proceeding. The term has a range of usages.

Examples

The most common usage is "caveat emptor," which means that the buyer of goods or services is expected to exert caution and cannot recover damages for an inferior product. In some jurisdictions, consumer protection laws provide for refunds or exchanges for consumers that purchase goods that do not do what they're supposed to do. Many transactions between businesses treat the two as equals with no protection to the buyer unless fraud can be demonstrated.

"Caveat venditor" puts the burden on the seller to investigate potential flaws in the goods or services to be sold and to meet all legal requirements related to the transaction. Failure to do so can make a contract unenforceable.

"Caveat lector" warns the reader to beware of what may be written, while "caveat auditor" warns the listener to beware of what he may hear.

Mortgage-Backed Securities

Among the factors that fueled the 2008 market crisis was the widespread sale of securities that were backed by pools of mortgages that were bundled and sold by investment banks. The securities were backed by multiple tranches of residential mortgages of differing credit quality, and the securities were known to include sub-prime mortgages. Many of the securities quickly became worthless as the housing market collapsed.

The U.S. Securities and Exchange Commission and the Department of Justice have charged many of the country's largest financial institutions with defrauding investors because they lied about the quality of the underlying mortgages. They have had only limited success in criminal prosecutions but have reached civil settlements in the billions of dollars with Goldman Sachs, Citigroup, Bank of America and JPMorgan Chase.

The packaging of the securities, which were given investment-grade ratings by the credit rating agencies, was done under the caveat emptor concept. The concept was central to the business model as the purchasers of the securities were considered sophisticated investors who should be able to evaluate their worth. While that has made successful criminal prosecutions difficult, it has not been a protection against civil charges.

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