A U.S. lawsuit against ICP Asset Management LLC opens a new front in the government’s probe of collateralized debt obligations, focusing on managers of instruments that in some cases wiped out investors in less than a year.
ICP and Chief Executive Officer Thomas Priore, 41, arranged more than $1 billion in trades that defrauded clients or broke rules limiting risks in CDOs whose insurers included American International Group Inc., the Securities and Exchange Commission said in a complaint yesterday. The case stems from scrutiny of more than 50 structured-product managers, and it continues, said George Canellos, head of the SEC’s New York office.
“This was by no means isolated,” said Janet Tavakoli, founder of Chicago-based Tavakoli Structured Finance Inc., referring to the broader collateral-management industry. Some investment advisers “were just raping their CDOs for the benefit of their hedge funds.”
The lawsuit is the SEC’s first from the global credit crisis to target a manager of CDOs, which pool assets such as mortgage bonds, bank capital notes and buyout loans into new securities with varying risks. Collateral managers often pick the initial assets and sometimes select replacements as the original underlying debt pays down.
Starting in late 2007, some mortgage-bond CDOs overseen by other managers were liquidated at complete losses to all but the senior-most investors, Standard & Poor’s said at the time.
ICP favored itself and certain clients in its trading, for example, by having CDOs purchase assets at inflated prices from other CDOs or accounts, the SEC said. The dealings helped the firm generate tens of millions of dollars in fees and undisclosed profits, according to the lawsuit. The agency is seeking fines and disgorgement of gains.
The case underscores “the dangers of opaque markets,” Enforcement Director Robert Khuzami said today in an interview on CNBC. “All the safeguards that you rely upon to make sure that investors are protected are often not there in those markets, and so that’s why a strong enforcement presence is critical,” he said.
Priore, who the SEC says has a majority stake in the New York-based firm, denied wrongdoing.
‘Best Interests’ of Clients
“We at all times acted in the best interest of our clients and intend to vigorously defend ourselves against these allegations,” he said in an e-mailed statement.
ICP oversaw $8.8 billion of CDOs filled with asset-backed securities as of Sept. 30, 2007, according to S&P data. It was the second-largest manager of CDOs taken over by the Federal Reserve Bank of New York after the government in 2008 initiated a bailout of AIG that swelled to $182.3 billion, according to data compiled by Bloomberg.
In a November 2007 conference call, AIG executives including Joseph Cassano, then head of its derivatives unit, and Andrew Forster, an executive vice president, tried to reassure investors about AIG’s insurance of mortgage-linked instruments that could be reshaped over time by collateral managers.
“We are aligning ourselves with the very best managers,” Forster said at the time. “There is a huge amount of due diligence that goes on.”
New York-based AIG and its former executives weren’t accused of wrongdoing. Company spokesman Mark Herr declined to comment. The SEC didn’t specify what losses, if any, AIG incurred from CDOs managed by ICP.
The CDOs managed by ICP, known as Triaxx, invested primarily in mortgage-backed securities, and unlike most of the vehicles insured by AIG, eschewed subprime debt.
In August 2008, an ICP portfolio manager caused a Triaxx CDO to purchase about $22 million of mortgage-backed bonds in the open market at a price of 63.5 cents on the dollar. The CDO’s trustee rejected the trade because the vehicle was prohibited from purchasing bonds priced below 75 cents, a rule aimed at limiting risk and ensuring that ICP didn’t add highly distressed bonds.
After conferring with Priore, a portfolio manager bought the bonds through an account jointly owned by Priore and “an important client of ICP,” and sold them to the Triaxx CDO at 75 cents, the SEC said, without identifying the client. The transaction resulted in an immediate, risk-free profit of about $2.5 million for the account.
“When you look at a trade like that, nothing could be clearer,” the SEC’s Canellos told reporters on a conference call yesterday. “You don’t need to be too scientific in studying the market to know that was an off-market trade.”
Most managers of mortgage-bond CDOs also oversaw other types of investment funds, had affiliates that did or started doing so once the housing market soured. Those firms include the largest money managers, such as BlackRock Inc. and TCW Group Inc., as well as specialists such as Ellington Management Group LLC and Tricadia Capital Management LLC.
ICP differed from most managers in that it also had a brokerage business. The SEC’s complaint described instances when that unit handled allegedly fraudulent trades between its funds and CDOs.
The practices described by the SEC may be “the tip of the iceberg” in the industry, said Thomas Adams, a partner with the law firm Paykin Krieg & Adams LLP in New York and a former executive with bond insurer FGIC Corp., which also sold protection against the default of a Triaxx CDO.
Most of the largest debt brokers also managed some types of investment funds or CDOs. Bear Stearns Cos., which was among the largest managers of mortgage-bond CDOs and traders of home-loan securities, almost collapsed in 2008, before being bought by JPMorgan Chase & Co. Credit Suisse Group and Merrill Lynch & Co., which was later bought by Bank of America Corp., were also among investment banks that managed CDOs.
Spokespeople for the companies either didn’t return messages or declined to comment.
“Our examination of collateral managers in this industry has been going on for a number of months,” the SEC’s Canellos said, without identifying any firms. The inquiry, disclosed by SEC Chairman Mary Schapiro in January, focuses on possible conflicts of interest and whether managers appropriately priced assets at times of “market stress,” he said.
Goldman Sachs Case
The question is whether regulators will accuse additional firms of moving assets among entities they influence or having one enter the opposite side of another’s bets, said Tavakoli.
“This is something I call CDO hawala,” she said, referring to informal, unregulated cash-transfer networks used mainly in the Middle East, Africa and Asia. “The abuse was widespread and massive.”
The SEC has already sued other companies and executives for misconduct associated with the housing crisis. The agency sued Goldman Sachs Group Inc. in April, claiming it didn’t disclose to investors the role played by hedge fund Paulson & Co. in devising a CDO, along with manager ACA Management LLC, that the fund then bet against. Goldman Sachs has denied the allegations.
AIG, which partly insured two Triaxx CDOs, was supposed to sign off on purchases by the vehicles, providing comfort to investors, the SEC said. The insurer wasn’t given a chance in many cases, according to the agency’s complaint.
In an attempt to get around those rules by selling the CDOs bonds similar to ones they had purchased in the past, ICP in some cases sold securities from a client account into the market, bought new debt in that account and then sold it to the CDOs at inflated values under a so-called forward-sale agreement that didn’t reference the new debt, the SEC said.
Priore bought about $1.3 billion in bonds from Bear Stearns in June 2007 after two of its hedge funds collapsed, according to the lawsuit. He used a forward agreement -- a contract forbidden in the Triaxx investment guidelines because it could increase risk by setting prices before actual purchases -- to buy most of the bonds because ICP didn’t have enough funds available for the deal, the SEC said. He didn’t get AIG’s approval, nor did he inform the CDOs directors, the SEC said.
Priore later arranged to have that sale amended, acquiring the bonds for ICP and its affiliates, the SEC said. He then resold the bonds at higher prices to a client’s account, misappropriating a $14 million profit, the agency said.
ICP kept some bonds in one of AIG’s CDOs after the insurer rejected them in October 2007, the SEC said. “In late 2008, after AIG complained about unauthorized trades, ICP was compelled to stop nearly all reinvestments by the Triaxx CDOs,” the complaint said.
The value of the $5.5 billion of ICP’s CDO slices insured by AIG fell to $3.2 billion by the time the Fed bought them from the insurer in 2008 as part of its bailout, according to the insurer’s disclosures.
TCW was the largest manager of AIG-insured CDOs, which were placed in the New York Fed’s Maiden Lane III, overseeing $10.2 billion, according to the data. After ICP, the next managers were Vanderbilt Capital Advisors, Ellington’s Duke Funding unit and Aladdin Asset Management, the data show.
Adams, the former bond-insurance executive who met with Priore and others from ICP when they sought insurance on one of the Triaxx CDOs, said that “they seemed like smart guys who wouldn’t do this type of thing.”