JP Morgan Settles SEC Charges of Misleading Investors Over Housing Market

(June 22, 2011) — The Securities and Exchange Commission has announced that JP Morgan will pay $153 million to settle charges of allegedly selling $1.1 billion in mortgage-backed securities that were designed to fail.

Following the financial crisis and housing collapse, countless other cases of alleged fraud and acts of misleading investors among the nation’s largest banks have been brought to light. Similar to suits against Goldman Sachs, Citigroup, and other US financial institutions, the case against JP Morgan encompasses an accusation that a hedge fund was seminally involved in the selection of the underlying collateral in the portfolio while simultaneously betting against it with a short position.

The US regulator asserted that as the housing market crumbled in March and April 2007, JP Morgan executives urged the marketing of Squared CDO 2007-1, a synthetic collateralized debt obligation (CDO) linked to a collection of residential mortgages, without informing investors that a hedge fund — Magnetar Capital — helped select the assets in the CDO portfolio and had a short position in more than half of those assets. Consequently, the hedge fund was positioned to benefit if the CDO assets it was selecting for the portfolio defaulted.

“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, the SEC’s director of the division of enforcement, said in a statement. “What JP 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 release states: “The SEC alleges that by the time the deal closed in May 2007, Magnetar held a $600 million short position that dwarfed its $8.9 million long position. In an internal e-mail, a J.P. Morgan employee noted, ‘We all know [Magnetar] wants to print as many deals as possible before everything completely falls apart.'”

Instead of closing the deal, the SEC said the bank continued to pitch the failed product to institutional clients to avoid additional losses over its already $40 million mark-to-market loss.

J.P. Morgan sold the approximately $150 million of “mezzanine” notes of the Squared CDO’s liabilities to more than a dozen institutional investors. These investors, who lost nearly their entire investment, included:

• Thrivent Financial for Lutherans, a faith-based non-profit membership organization in Minneapolis.
• Security Benefit Corporation, a Topeka, Kan.-based company that provides insurance and retirement products.
• General Motors Asset Management, a New York-based asset manager for General Motors pension plans.
• Financial institutions in East Asia including Tokyo Star Bank, Far Glory Life Insurance Company Ltd., Taiwan Life Insurance Company Ltd., and East Asia Asset Management Ltd.

In a statement, JPMorgan said it was “pleased to have reached agreement with the SEC to put this matter concerning certain 2007 disclosures behind us.” In settling the US regulator’s fraud charges against the firm, JP Morgan agreed to improve the way it reviews and approves mortgage securities transactions, the SEC said.