J.P. Morgan Securities LLC has agreed to pay $153.6 million to settle SEC charges that it misled investors in a complex “built to fail” mortgage securities transaction just as the housing market was starting to plummet.
The mortgage security was a synthetic collateralized debt obligation (i.e., a CDO that held credit derivatives called default swaps on mortgage bonds or CDOs rather than the mortgage bonds or CDOs themselves). Synthetic CDOs enabled parties to make large, leveraged bets on mortgage-backed securities, which contributed to lower lending standards and fraud, and set the stage for the financial crisis of 2008.
The synthetic CDO in question, Squared CDO 2007-1, was composed of credit default swaps linked to other CDO securities, which were in turn linked to the U.S. residential housing market.
According to the SEC, marketing materials stated that an investment advisor with experience in analyzing CDO credit risk selected the CDO’s portfolio. That was misleading because J.P. Morgan failed to inform investors that a hedge fund, Magnetar Capital LLC, helped select the assets in the CDO portfolio, and that the hedge fund stood to make a profit if those assets defaulted.
In fact, when the deal closed in May 2007, Magnetar held a $600 million short position that dwarfed its $8.9 million long position, according to the SEC.
“J.P Morgan marketed highly-complex CDO investments to investors with promises that the mortgage assets underlying the CDO would be selected by an independent manager looking out for investor interests,” Robert Khuzami, Director of the Division of Enforcement, was quoted as saying, adding: “What J.P. Morgan failed to tell investors was that a prominent hedge fund that would financially profit from the failure of CDO portfolio assets heavily influenced the CDO portfolio selection. With today’s settlement, harmed investors receive a full return of the losses they suffered.”
The SEC is also scrutinizing another $1.5 billion CDO deal marketed by Merrill Lynch known as Norma, in which Magnetar helped select the assets. The news is apparently “sending chills” through other banks that put together deals with Magnetar, such as Citigroup, UBS, Wachovia (now Wells Fargo) and Deutsche Bank, according to John Carney of CNBC (“Who Else Did Magnetar Deals?”).
Last year, Goldman Sachs agreed to pay a record $550 million and admitted to making a “mistake” in its disclosures about a subprime-linked CDO.
Page Perry is an Atlanta-based law firm represents investors in subprime-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 45 occasions. Page Perry’s attorneys have extensive experience in representing investors in CDO matters. For further information, please contact us.