JPMorgan Chase & Co. (JPM)’s deal to settle a U.S. regulator’s claims that the bank misled buyers of mortgage-linked securities before the housing market collapsed echoed a case brought last year against Goldman Sachs Group Inc. (GS)
JPMorgan agreed to pay $153.6 million to end a Securities and Exchange Commission suit. The SEC alleged that the New York- based bank failed to tell investors in 2007 that a hedge fund helped pick, and bet against, underlying securities in the collateralized debt obligation they purchased. In July, Goldman Sachs paid a record $550 million for failing to inform clients in 2007 that it allowed a hedge fund that also bet against housing to help formulate the CDOs.
“It’s the same general allegation of wrongdoing,” Robert Khuzami, enforcement chief of the SEC, said yesterday in a Bloomberg Television interview. “The message in both cases is if you engage in this kind of wrongdoing, if you mislead investors, you’re going to pay a fine.”
The SEC is targeting mortgage-industry firms from loan originators including Countrywide Financial Corp. to Wall Street CDO underwriters. The regulator has looked at Citigroup Inc. (C), Deutsche Bank AG, UBS AG and Morgan Stanley, a person with knowledge of the matter has said.
Like Goldman, JPMorgan’s brokerage unit, JPMorgan Securities LLC, didn’t admit or deny wrongdoing in settling. Unlike Goldman, the claims against the firm relied solely on a section of the Securities Act of 1933 that connotes a “lesser violation,” said Ed B. Horahan, a Washington-based securities lawyer.
Goldman Sachs settled under a section of the Securities Exchange Act of 1934 that says the accused firm knew what it was doing, while JPMorgan’s case is closer to negligence, Horahan said. Michael DuVally, a spokesman for Goldman Sachs, declined to comment yesterday.
“JPMorgan simply admitted that it ‘messed up’ the documentation,” said Brad Hintz, an analyst with Sanford C. Bernstein & Co. The bank “pays a fine, announces a public mea culpa and has no more liability. This looks like a win for JPMorgan.” JPMorgan rose 1.1 percent to close at $40.91 yesterday in New York Stock Exchange composite trading.
The customers misled by the two banks also differed, according to the SEC suits. JPMorgan sold about $150 million of notes in the CDO, known as Squared, to about 15 firms including a not-for-profit Lutheran insurer, Thrivent Financial, and a New York City-based manager of General Motors Co. pensions.
Meanwhile, one of the biggest investors in Goldman Sachs’ Abacus CDO was Dusseldorf, Germany-based IKB Deutsche Industriebank AG. The German bank was aware of the risk associated with the securities and was “among the most sophisticated mortgage investors in the world,” Goldman Sachs said in April 2010.
The facts of JPMorgan’s case, which involve hedge fund Magnetar Capital LLC, look worse than Goldman Sachs’s, said Charles Whitehead, an associate professor at Cornell Law School in New York. Magnetar, betting housing prices would fall, stood to profit if assets defaulted.
“Goldman was able to point to a number of cases where the Abacus collateral manager refused to take suggestions made by the hedge fund,” Whitehead said. “In this case, the SEC’s complaint goes out of its way to highlight the fact that the collateral manager was taking direction very much from Magnetar.”
Magnetar had a “significant role” in picking the assets linked to the CDO, known as Squared, during February 2007, according to e-mails between the hedge fund, JPMorgan and the collateral manager, a unit of GSC Capital Corp., the SEC said. That month, the hedge fund bet against 18 of 19 securities inserted into the investment, according to the complaint.
Magnetar didn’t control the asset-selection process and its bets were part of a “market-neutral” portfolio, Steve Lipin, a spokesman for the hedge fund, said yesterday in an e-mail.
“Magnetar is not a party to the settlement nor a defendant in this case, and was not involved in the marketing of the securities,” Lipin said. “The SEC staff issued a closing letter to Magnetar stating that it does ‘not intend to recommend any enforcement action’ against Magnetar, any of its funds or any current or former Magnetar personnel.”
JPMorgan said in a statement that the bank booked $900 million in losses on the CDO and, after an internal review, voluntarily made $56 million in payments to investors of a separate CDO called Tahoma I.
“The SEC has not charged the firm with intentional or reckless misconduct,” JPMorgan said in the statement.
Losses on CDOs
CDOs package assets such as mortgage bonds into new securities with varying risks. A surge in U.S. home loan defaults undermined the instruments, helping lead financial companies to record $1.82 trillion in losses and writedowns during the housing crisis, data compiled by Bloomberg show.
The SEC’s claim focuses on JPMorgan’s disclosures about Squared CDO 2007-1. Marketing materials said the instrument’s portfolio was selected by GSC, which had experience analyzing CDO credit risk. Magnetar also played a role in the selection and stood to benefit if CDOs tied to the instrument defaulted, according to the agency’s complaint.
In the months before the deal closed in May 2007, the bank made a “frantic global sales effort” to sell the Squared securities amid signs of distress in the housing market, the SEC said in a statement.
“We are soooo pregnant with this deal, we need a wheel- barrel to move around,” wrote a JPMorgan employee in charge of distributing the CDO in a March 2007 e-mail meant to encourage the sales staff, according to the SEC complaint. “Let’s schedule the cesarian, please!”