JPMorgan (JPM) has agreed to pay $153.6 million to settle charges it misled investors in connection with complex mortgage-backed securities created and sold by the bank just ahead of the collapse of the U.S. housing market.
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The Securities and Exchange Commission said in a statement that JPMorgan structured and marketed whats known as a synthetic collateralized debt obligation [CDO] but failed to tell investors that a hedge fund had helped select the assets included in the CDO and that the hedge fund had a short position in more than half those assets.
In other words, the hedge fund was betting that the securities would sour even as it was helping JPMorgan pick the assets for a product JPMorgans clients believed would prosper.
JPMorgan 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 SECs director of the Division of Enforcement, said in the statement.
What JPMorgan 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 todays settlement, harmed investors receive a full return of the losses they suffered.
Goldman Sachs (GS) settled similar charges last year for $550 million.
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Under the settlement with JPMorgan, harmed investors will receive all of their money back, the SEC said. The SEC said the settlement also requires that JPMorgan improve the way it reviews and approves mortgage securities transactions.
According to the SECs complaint, the CDO was structured primarily with credit default swaps referencing other CDO securities whose value was tied to the U.S. residential housing market. Marketing materials stated that the CDOs investment portfolio was selected an investment advisory arm of GSC Capital Corp.
But JPMorgan didnt tell investors that hedge fund Magnetar Capital LLC had also played a significant role in selecting CDOs for the portfolio and stood to benefit if the CDOs defaulted, the SEC said. The SEC said Magnetar held a $600 million short position that dwarfed its $8.9 million long position in the security.
According to the SEC, a JPMorgan employee wrote in an e-mail, We all know [Magnetar] wants to print as many deals as possible before everything completely falls apart.
The SEC claimed JPMorgan launched a frantic global sales effort to unload the security to investors in the spring of 2007 as it became clear the housing bubble was about to burst. One JPMorgan employee wrote in an e-mail, we are so pregnant with this deal&Lets schedule the cesarian (sic), please!
Within a year the securities had lost most or all of their value, according to the SEC.
Among the investors in the deal was Thrivent Financial for Lutherans, a faith-based non-profit membership organization in Minneapolis, the SEC said.
JPMorgan neither admitted nor denied the charges and did not immediately respond to a request for comment.
Of the $153.6 million total settlement, $125.9 million will be returned to investors through a Fair Fund distribution, and $27.7 million will be paid to the U.S. Treasury, the SEC said.