JPMorgan pays $153 million to settle mortgage case

@CNNMoney June 21, 2011: 7:01 PM ET
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NEW YORK (CNNMoney) -- JPMorgan has agreed to pay $153.6 million to settle charges it misled investors in the sale of a complex mortgage-backed security, the Securities and Exchange Commission announced Tuesday.

The charges stem from the 2007 sale of a collateralized debt obligation, or CDO, that JPMorgan Securities marketed to investors without disclosing that a hedge fund involved in the creation of the CDO was betting it would decline in value, according to the SEC.

"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," said Robert Khuzami, the SEC's top enforcement officer. (Read: Time to stick a fork in the big banks)

The $1.1 billion CDO in question -- called "Squared CDO 2007-1" -- was designed to allow investors to make bets on the housing market.

According to the SEC, JPMorgan allowed Magnetar Capital, a Chicago based hedge fund, to help select the underlying assets in the Squared CDO.

By the time the deal closed, Magnetar had a $600 million "short" position in the CDO betting it would decline, compared with a $8.9 million long position, according to the SEC.

The sale occurred just as the housing market began to collapse and more homeowners started to default.

Bankers skate again in SEC-JPMorgan deal

Investors will be paid: Among the investors in the Squared CDO were a faith-based nonprofit in Minneapolis and a New York asset manager for General Motors pension plans.

The $153 million settlement will make the investors whole, according to the SEC. But the agency did not say how much money would go to each investor.

JPMorgan -- the most profitable U.S. bank -- made a $5.6 billion profit in the first quarter of this year.

As part of the settlement, JPMorgan (JPM, Fortune 500) agreed to improve how it reviews and approves mortgage-backed securities, the SEC said.

The agreement has many similarities to a settlement the SEC achieved last year with Goldman Sachs (GS, Fortune 500), which paid a record $550 million to settle charges it misled investors in the sale of a CDO that was being shorted by Paulson & Co.

Hedge fund regulation? What hedge fund regulation?

Bank ready to move on: JPMorgan did not admit or deny the charges, as is customary with such settlements. The agreement is subject to approval by the courts.

In a statement, JPMorgan said it was pleased "to put this matter concerning certain 2007 disclosures behind us," adding that the SEC had not charged the bank with "intentional or reckless misconduct."

JPMorgan said it ultimately lost $900 million in connection with the securities in the CDO, and that it assumed almost all of the risk involved in the transaction.

In an internal e-mail cited by the SEC, a JPMorgan employee noted: "We are so pregnant with this deal ... Let's schedule the cesarian (sic), please!" Within 10 months, the securities in the CDO had lost most or all of their value.

In a statement, Magnetar said that it "is not a party to the settlement nor a defendant in this case, and was not involved in the marketing of the securities."

The hedge fund also noted that the SEC issued a letter to Magnetar stating that the agency "does 'not intend to recommend any enforcement action' against Magnetar, any of its funds or any current or former Magnetar personnel in connection with that investigation."

JPMorgan: Lending more, but not much to brag about

Khuzami, the SEC official, declined to comment on any potential action against Magnetar. But he said the case announced Tuesday was based on disclosures that JPMorgan was obligated to make, not Magnetar.

The SEC also charged Edward Steffelin, an employee of a now bankrupt investment advisory firm called GSC, which was supposed to have selected the assets in the Squared CDO.

Steffelin is charged with drafting marketing materials that misled investors about Magnetar's role in the CDO, while at the same time seeking employment with the hedge fund.

Alex Lipman, the attorney representing Steffelin, said there is no proof Steffelin committed fraud.

"None of the relevant disclosure statements were his," Lipman said in a statement. "However, it looks like the SEC now believes that it has to attach a name and a face to the cases it brings against big banks."

Lipman added that the SEC's assertion that Steffelin's attempt to get hired by Magnetar constitutes a conflict of interest is a "misstatement of the record" because the discussions occurred two months before the CDO was created.

What's next: While the SEC's case against Steffelin is ongoing, the agency did not name any specific employees of JPMorgan in its civil complaint.

The SEC has come under fire from Congress and the public for failing to punish the top executives at Wall Street firms involved in the financial crisis.

In a call with reporters, Khuzami defended the agency saying "we look long and hard at the conduct of individuals and make our decisions based on the evidence. That's where we start."

He added later that "cases arising out of the credit crises remain a high priority for the SEC."  To top of page

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