Author: George Mentz

The Securities and Exchange Commission (SEC) recently announced that J.P. Morgan Securities LLC will pay $153.6 million to settle SEC charges that it misled investors in a complex mortgage securities transaction just as the housing market was starting to plummet. Under the settlement, harmed investors will receive their money back and J.P. Morgan also agreed to improve the way it reviews and approves mortgage securities transactions.

The SEC alleges that J.P. Morgan structured and marketed a synthetic collateralized debt obligation (CDO) without informing investors that a hedge fund helped select the assets in the CDO portfolio and had a short position in more than half of those assets. As a result, the hedge fund was poised to benefit if the CDO assets it was selecting for the portfolio defaulted.

The SEC claims that 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. That’s because the SEC states that the bank failed to tell investors that a prominent hedge fund that would financially profit from the failure of CDO portfolio assets heavily influenced the CDO portfolio selection.

According to the SEC’s complaint against J.P. Morgan filed in U.S. District Court for the Southern District of New York, the CDO known as Squared CDO 2007-1 was structured primarily with credit default swaps referencing other CDO securities whose value was tied to the U.S. residential housing market.

The SEC brought the securities fraud action relating to portfolios consisting primarily of credit default swaps (“CDS”) referencing other CDO securities whose value was tied to the United States residential housing market. The SEC claims J.P. Morgan Securities structured and marketed this $1.1 billion “CDO squared” in early 2007 when the housing market and the securities referencing it were beginning to show signs of distress.  The SEC further alleges synthetic CDO squareds were designed to, and did, result in leveraged exposure to the housing market and therefore magnified losses when the United States housing market experienced a downturn. [1]

The SEC alleges that in March and April 2007, J.P. Morgan knew it faced growing financial losses from the Squared deal as the housing market was showing signs of distress. The firm then launched a frantic global sales effort in March and April 2007 that went beyond its traditional customer base for mortgage securities. By 10 months later, the securities had lost most or all of their value.

According to the SEC’s complaint, J.P. Morgan sold approximately $150 million of so-called “mezzanine” notes of the Squared CDO’s liabilities to more than a dozen institutional investors who lost nearly their entire investment.

Without admitting or denying the allegations, J.P. Morgan consented to a final judgment that provides for a permanent injunction from violating Section 17(a)(2) and (3) of the Securities Act of 1933, and payment of $18.6 million in disgorgement, $2 million in prejudgment interest and a $133 million penalty. The settlement also requires J.P. Morgan to change how it reviews and approves offerings of certain mortgage securities. In addition, J.P. Morgan’s consent notes that it voluntarily paid $56,761,214 to certain investors in a transaction known as Tahoma CDO I. The settlement is pending court approval.

Personally I have been a long-term satisfied customer of JP Morgan Chase.  It is a great company and their stock has held up well in light of the most challenging economy in over 70 years in contrast to Bank of America and Citigroup.   The author is also enjoys personal and business banking services from several other banks and brokerage firms.   As an outsider, it may appear that JP Morgan should have received stiffer penalties, but as a lawyer, it is good to see a Bank fight for its shareholders, customers and stakeholders. In the end, it is not against the law to utilize prudence, strategy, or wisdom.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

George Mentz, JD, MBA, CWM  -  is an international lawyer, editor, author and contributor in the areas of personal finance, securities law, and wealth management.  Prof. Mentz continues to consult  with the US Government and United Nations on issues related to careers and education. Dr. Mentz is the first person in the US to obtain quad credentialing as a lawyer, Double Accredited MBA, Juris Doctorate Degree, financial consultant certification, and qualified financial planner.  Mentz and his educational & professional development firms have worked with thousands of executives and industry workers  in over 150 countries. Dr. Mentz has personally taught over 200 business, ethics, wealth management,  and law courses at various accredited institutions, and he is the founder of the Mentz Consumer Protection, Class Action,  and Securities Law Firm http://securitieslawyers.us Mentz has served on the advisory boards of the: The African Economists Association, The Royal Society of Fellows, The Arab Academy of Banking & Finance, The China Wealth Council, The GFF Global Finance Forum in Switzerland, and the Indian Academy of Financial Management.    Mentz is the winner of several faculty awards and a meritorious award for charitable service.   Mentz has been a pioneer in promoting accredited program courses, exams and standards as a government recognized path to professional certification. www.georgementz.com

[1] See SEC v. J.P. Morgan Securities Complaint. http://sec.gov/litigation/complaints/2011/comp-pr2011-131-jpmorgan.pdf.