As the housing market began to tank in 2007, J.P. Morgan Securities sold investors a complex instrument that was secretly designed to help a hedge fund profit at their expense, the government alleged Tuesday.
The investors who lost money on the deal included General Motors pension plans and a Lutheran nonprofit life insurer, the government said.
The unit of J.P. Morgan Chase agreed Tuesday to pay $153.6 million to settle civil fraud charges filed by the Securities and Exchange Commission, the agency said. The settlement will assure that investors on the losing side of the deal get their money back, the SEC said.
The case against J.P. Morgan is one of the most prominent enforcement actions yet in which regulators have accused Wall Street firms of exploiting investors in the run-up to the financial crisis.
The allegations against J.P. Morgan generally parallel those the SEC leveled last year against Goldman Sachs, which agreed to a $550 million settlement.
J.P. Morgan neither admitted nor denied any wrongdoing, and none of its employees or executives were charged. However, an outside adviser who helped structure the deal, Edward S. Steffelin, was charged with civil securities fraud in the case.
Steffelin allowed the hedge fund, Magnetar Capital, to select and bet against the housing assets on which the J.P. Morgan instrument was built, the SEC said. Steffelin was a managing director at GSC, an advisory firm, but was seeking a job at the hedge fund at the time, according to the SEC.
In a statement, J.P. Morgan said it was pleased to put the matter behind it. “The SEC has not charged the firm with intentional or reckless misconduct,” the firm said.
J.P. Morgan said it lost almost $900 million on the 2007 deal. Bank spokesman Joe Evangelisti said the SEC settlement would have no “material impact” on earnings. During the first quarter of this year, J.P. Morgan reported a profit of $5.6 billion.
“We do not understand why the SEC lays any failure to make additional disclosure at Mr. Steffelin’s feet; none of the relevant disclosure statements were his,” Alex Lipman, an attorney for Steffelin, said in a statement.
The complex investment at the heart of the case is known as a “synthetic collateralized debt obligation,” or CDO.
Steffelin was told by lawyers that the disclosures were complete and accurate, Lipman said. It was a “misstatement of the record,” Lipman added, to say Steffelin had a conflict of interest because his “so-called” employment discussions ended before the CDO was created.
According to the SEC, a J.P. Morgan sales representative described the hedge fund’s intentions in an internal e-mail, saying, “We all know [Magnetar] wants to print as many deals as possible before everything completely falls apart.”
In early 2007, with the subprime mortgage market imploding, J.P. Morgan’s sales force was having a hard time selling the CDO and extended its efforts far afield of its “historic go-to guys,” the SEC said in a court filing.
“This is a top priority from the top of the bank all the way down,” an unnamed J.P. Morgan employee told her sales force, according to the SEC filing.
Some of the investors lost “most, if not all” of the money they put in when their piece of the CDO “became nearly worthless,” the SEC said.
J.P. Morgan told investors that GSC selected the assets that went into the CDO but failed to disclose that Magnetar, whose interests were at odds with buyers of the CDO, played a significant role in the selection of the components, the SEC said.
J.P. Morgan’s settlement forces it to give up about $19 million it earned for putting the deal together, SEC Enforcement Director Robert Khuzami said.
Separately, J.P. Morgan agreed to repay investors $56.8 million in a second CDO deal, though it was not charged with wrongdoing in that transaction, the SEC said .
Khuzami said he does not anticipate any additional charges against J.P. Morgan in the case. Asked why no individuals at the firm were charged, he answered generically, saying, “We look hard and long at the conduct of individuals and make our decisions based on the evidence. . . . For particular individuals, there may be mitigating factors, defenses, litigation risk.”
The settlement is subject to court approval. A spokesman for GSC did not return calls.
Magnetar Capital was not charged. Magnetar said it “did not control” the selection of assets for the CDO. The SEC staff has notified Magnetar it does not plan to seek enforcement action against it “in connection with that investigation,” the hedge fund said.
In a news briefing, Khuzami said it was the responsibility of J.P. Morgan and GSC, not Magnetar, to disclose the conflicts of interest built into the investment.