JPMorgan Chase & Co. (JPM), the only Wall Street bank to remain profitable throughout the financial crisis, is in “advanced” negotiations to resolve its piece of a broader U.S. Securities and Exchange Commission investigation into how mortgage-linked securities were packaged and sold as the housing market unraveled.
JPMorgan’s securities unit has been cooperating with agency officials and “is currently in advanced discussions with the staff concerning a potential resolution of that investigation,” the New York-based bank said in a quarterly financial report filed with the SEC today.
The SEC is working to wrap up investigations into how banks bundled and sold investments tied to risky mortgages, after years of being faulted by lawmakers and investors for failing to hold Wall Street accountable for misconduct that may have fueled the financial crisis. JPMorgan has been probed by the SEC for its role in designing and selling a $1.1 billion collateralized debt obligation known as “Squared” in 2007, according to a person briefed on the matter.
“There can be no assurance that any such resolution will be finalized or approved,” JPMorgan said in today’s filing. The bank didn’t specify which CDOs were the subject of the SEC talks.
JPMorgan, the second-largest U.S. bank by assets, also received a subpoena from the SEC over failed mortgages as part of a separate investigation into whether some banks, including Credit Suisse Group AG, failed to share refunds from sellers of faulty debt, a person familiar with the investigation said.
The agency has targeted firms at various stages of the loan-packaging process, ranging from originators such as Countrywide Financial Corp. to underwriters including Wells Fargo & Co. (WFC), which agreed last month to pay $11 million to settle SEC claims that it sold risky CDOs at unfair prices.
The CDO investigation gathered momentum last year when Goldman Sachs Group Inc. (GS) agreed to pay a record $550 million and admitted to making a “mistake” in its disclosures about a subprime-linked CDO. The probe has included Wall Street CDO underwriters including Citigroup Inc., Deutsche Bank AG, UBS AG, and Morgan Stanley, a person familiar with the matter said.
As part of the SEC’s investigation of JPMorgan, the SEC is looking into whether the bank misled investors about hedge-fund Magnetar Capital LLC’s possible role in selecting underlying assets in the Squared deal, the person said, speaking last month on condition of anonymity because the matter isn’t public.
Michael Llodra, formerly JPMorgan’s global head of structured product collateralized debt obligations, received a Wells notice from the SEC on Jan. 4 saying investigators planned to pursue civil claims against him related to the sale of a 2007 product, according to Llodra’s broker registration filings. The SEC also gave a Wells notice on Jan. 14 to Edward Steffelin, a former executive at a firm that helped manage Squared, his brokerage records show.
Squared was sold in April 2007, with GSC Group serving as the CDO’s manager and JPMorgan underwriting the deal, according to data compiled by Bloomberg. Its collateral consisted partly of other CDOs tied to bonds backed by assets such as mortgages, with the initial holdings including credit-default swaps referencing $968 million of those CDOs, according to an offering document. CDOs backed by other CDOs were referred to as “CDOs squared.” Squared went into default the following January.
JPMorgan spokesman Joe Evangelisti declined to comment about that probe last month, as did Llodra and Steffelin.
Magnetar said it bought the junior slice of the Squared CDO as part of a strategy of investing in mortgage-linked securities while betting against other housing debt, sometimes including bonds from the same deals. CDOs package assets such as mortgage bonds and buyout loans into new securities with varying risks.
The hedge-fund firm told investors in an April 2010 letter that it didn’t help banks create CDOs that were “built to fail” on a bet that homeowners with bad credit would default on their loans. The firm offered limited input on the creation of CDOs, and its bets were part of a “market neutral” portfolio designed to profit no matter what happened, Magnetar said.
Magnetar was started in late 2005 by Alec Litowitz, who previously worked at Ken Griffin’s Citadel Investment Group LLC. He specialized in trading the stocks of merging companies.
GSC, based in Florham Park, New Jersey, filed for bankruptcy last year, blaming losses caused by the credit crisis and an “extremely unfavorable global business environment.” The investment firm, founded by former Goldman Sachs partner Alfred Eckert III, managed $28 billion at its peak, according to court papers.
GSC, which entered into the business of managing CDOs tied to asset-backed securities in 2006, ran $8.1 billion of them by the time the market collapsed the next year, according to a Standard & Poor’s report at the time. The company ranked as the No. 17 manager of such CDOs, S&P said.
Black Diamond Capital Management LLC won a bankruptcy auction for GSC’s assets.
A U.S. Senate panel said last month that Deutsche Bank, Germany’s biggest bank, pressed to sell a $1.1 billion collateralized debt obligation to clients in 2007 as the co-head of its CDO team foresaw a market slump. The Frankfurt-based firm sold $700 million of the instruments, which lost most of their value within 17 months.
“There were divergent views within the bank about the U.S. housing market,” Michele Allison, a spokeswoman for Deutsche Bank, said in an e-mailed statement last month. “Moreover, the bank’s views were fully communicated to the market through research reports, industry events, trading-desk commentary and press coverage.”
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