The SEC is expanding its investigation into Wall Street’s sales practices involving toxic collateralized debt obligations that were linked to subprime mortgages as more and more evidence comes out that the Wall Street banks deliberately defrauded some of their customers.
According to Jan Eaglesham’s and Jeannette Neumann’s Wall Street Journal article entitled “SEC Widens CDO Probe”, the SEC is reportedly close to a $200 million settlement of its civil action filed against Citigroup relating to that firm’s 2007 billion dollar deal known as Class V Funding III. Citigroup may have held undisclosed short positions that would gain if the housing market fell, according to the article. The SEC is also said to be negotiating a settlement with Credit Suisse over its role as collateral manager of the Class V Funding deal.
One of the SEC’s priorities is investigating cases in which CDO investors were not told that firms betting against the deal had a role in selecting the underlying assets. The SEC has said that such CDOs were built to fail so as to benefit favored business partners of Wall Street firms that sold the CDOs at the expense of their investor clients. In such cases, the conflicts of interest and related breaches of trust associated with the sales of the CDOs were patently offensive.
Accordingly, the SEC is investigating a Japanese bank named Mizuho Financial Group, Inc. for its role in another CDO called Tigris, which hedge fund firm Magnetar helped to design. Magnetar was involved in selecting the assets in another CDO named Squared that was sold by J.P. Morgan Chase, which paid $153.6 million to the SEC to settle charges that it misled investors.
The SEC is also moving ahead with its investigation into Stifel Financial Corp. for its role in misleading five Wisconsin school districts about CDOs it sold to them in 2006 and is apparently considering filing civil charges against Royal Bank of Canada, which created the CDOs that were sold to the school districts.
All these actions are consistent with previous actions filed by the Commission. For example, Paulson & Co. Inc. allegedly helped build a CDO named Abacus to fail so that Paulson’s hedge fund could profit from the failure, which it did. Goldman Sachs, which sold the CDO to investors, paid $550 million to settle SEC charges that it misled its clients about Paulson’s role in the Abacus deal.
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