JPMorgan Chase & Co. agreed to pay $153.6-million (U.S.) to settle U.S. Securities and Exchange Commission charges that it defrauded investors who bought mortgage securities it helped sell just before the nation's housing market collapsed.
The SEC also filed civil charges accusing Edward Steffelin, a former managing director at GSC Capital Corp, of failing to reveal in marketing materials for the transaction, Squared CDO 2007-1, that the Magnetar Capital LLC hedge fund helped choose the underlying securities – and bet that they would lose value.
Tuesday's announcement marks one of the most significant legal settlements arising out of allegations of Wall Street's role in fuelling the 2008 global financial crisis.
It comes less than a year after Goldman Sachs Group Inc. agreed to pay $550-million to settle SEC charges over another collateralized debt obligation, Abacus. The SEC said Goldman had failed to reveal that hedge fund investor John Paulson had helped choose and bet against the underlying securities.
SEC enforcement chief Robert Khuzami told reporters that the cases are "generally similar" because "there was an undisclosed party who was involved in selecting assets for a CDO that the investors were unaware of."
No JPMorgan executives were charged, and Mr. Khuzami said he did not expect any such charges.
"Cases arising out of the credit crisis remain a high priority for the SEC," he added.
Fabrice Tourre, a Goldman vice-president, was the only individual charged by the SEC over Abacus and has not settled.
Critics say CDOs such as Squared and Abacus worsened the housing bubble by fuelling investors' insatiable demand for debt bearing risks they did not understand, and by causing pain as defaults mounted and the debt lost value or became illiquid.
The JPMorgan settlement calls for the second-largest U.S. bank to pay a $133-million fine and $20.6-million reflecting improper profits plus interest.
Of the total, $125.9-million will go to Squared CDO investors, covering all their losses, and $27.7-million will go to the U.S. Treasury.
JPMorgan also voluntarily agreed to pay $56.8-million to investors in a separate CDO, Tahoma CDO I.
The bank did not admit wrongdoing, and in a statement said it lost nearly $900-million on Squared notes. It said the SEC took the Tahoma payment into account in assessing a penalty.
Alex Lipman, a partner at Nixon Peabody who represents Mr. Steffelin, criticized the SEC's actions against his client.
"We are baffled by the SEC's decision to proceed against an individual in a contested proceeding on a negligence theory, especially in a case where Mr. Steffelin did not work for the underwriter and had no responsibility for the contents of the offering memorandum," Mr. Lipman said in an interview.
In January, the SEC had sent a so-called Wells notice indicating possible civil charges against Mr. Steffelin over the Squared CDO. It also sent a similar notice to Michael Llodra, once global head of structured product collateralized debt obligations at JPMorgan, over the 2007 sale of such a product.
According to the SEC, JPMorgan in 2007 structured the Squared CDO mainly with credit default swaps tied to other CDO securities whose value reflected the health of the nation's housing market.
Squared CDO sales materials indicated that the underlying investments were chosen by a GSC affiliate, but in fact Magnetar played a significant role and held a nearly $600-million short position, the SEC said.
The complaint quoted excerpts from internal JPMorgan communications indicating that the bank knew of distress in the housing market but still pushed for the CDO to be sold.
"We are soooo pregnant with this deal, we need a wheel-barrel [sic]to move around.... Let's schedule the cesarian [sic] please!" wrote the person heading the CDO's distribution to sales staff in a March 22, 2007 e-mail quoted in the complaint.
The SEC also suggested Mr. Steffelin, a 41-year-old Manhattan resident, had an undisclosed potential conflict of interest when the CDO was being created because he was looking for employment at Magnetar at the time.
"At no time did Mr. Steffelin seek employment with Magnetar," his lawyer Mr. Lipman said. "At all times, Mr. Steffelin's interests were aligned with the interests of investors in the deal."