The SEC announced on Tuesday 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 all of their money back.”
This settlement is a significant win for JPMorgan and its CEO Jamie Dimon, who once again has managed to avoid the reputational and financial damage done to other banks with very similar problems. My sources say that other large Wall Street banks with similar problems related to complex mortgage deals are likely to settle SEC claims shortly. But this is only one battle won in a longer war for survival for JPMorgan and other top banks.
Why is the icky SEC settlement a win for JPMorgan? For one thing, Goldman Sachs got tagged with a $550 million fine for the “ABACUS 2007-1″ transaction, a deal that looks a lot like the “Squared CDO 2007-1″ deal that earned JPMorgan one third of the fine. Of course in the case of the former, Goldman was the sponsor and John Paulson was the beneficial party shorting the deal as it was sold to investors.
With JPM, the bank was the sponsor of “Squared CDO 2007-1″ and Magnetar Capital was the winning, hidden short seller against the deal. Edward Steffelin seems the designated fall guy for JPM, while Fabrice Tourre seemed to play this role in the Goldman transaction. ACA Management was the collateral manager for the Goldman deal, while the now bankrupt GSC Capital played that role in the JPM deal, in effect picking the assets that went into the transaction.
In these deals, investors bought what they thought was AAA-rated security. The investors were told that a neutral collateral manager had picked the assets. But as with Paulson and Goldman in the ABACUS 2007-1 deal, the SEC says that Magnetar had undisclosed influence in picking what assets went into Squared CDO 2007-1. Apparently they really wanted to put inferior assets into the pool in order to profit.
Magnetar was reported to be involved in many of the worst collateralized debt obligations or CDOs. They often helped sponsor these deals by buying the riskiest equity piece. But they didn’t disclose that they were making a much bigger — and undisclosed — bet by using credit default swaps to bet against the rest of the deal.
The sad part is that any duty of care or disclosure was up to the banks, Goldman Sachs and JPMorgan respectively, so Magnetar is likely to avoid liability in any civil claims. The big story on this litigation involving CDOs is that we may or may not ever see proof put forward in public as to how the collateral managers got corrupted in the creation and sale of a security.
The US Attorney for the Southern District of New York, Preet Bharara, is said to be on the trail. In theory, he can make people flip and squeal in a way that the SEC can’t, but so far there is little evidence of progress. In a recent feature piece in The New Yorker by George Packer, “A Dirty Business,” Bharara is criticized for not going after the real crooks of the financial crisis — the large banks and deal sponsors. Instead Bharara has only pursued the side show of insider trading by the likes of Raj Rajaratnam and Galleon.
Now, don’t start popping the champagne corks for JPMorgan just yet. In a research note published by my firm on Tuesday, we summarize some of the civil liabilities facing the top banks and loan servicers in just one narrow area, namely claims made under the Securities Act of 1933.
At the start of the financial crisis, there was over $1 trillion in 1933 Act securities fraud claims filed against the major servicer banks. After appeals, motions to dismiss and procedural delays, there are today about $200 billion in remaining claims which are now headed toward trials later this year or in 2012.
These claims total into the tens of billions of dollars and are approaching the point where the bank defendants will need to start setting aside significant reserves for settlements. The benchmark for the settlement of ’33 Act claims is the Worldcom litigation, where payments were generally 50% of losses.
In the case of Bear Stearns, for example, some $17 billion in claims are headed for trial. As and when a settlement occurs, this tab will be presented to Jaime Dimon, who forgot to stuff the Fed with the unliquidated claims against Bear Stearns when he paid $10 per share for the crippled investment bank. But that is hardly the totality of the exposure facing JPMorgan. Add the legacy claims from Washington Mutual and the bank’s own production, and the total claims facing JPMorgan total nearly $50 billion.
And keep in mind that JPMorgan is not at the top of the list in terms of total securities fraud claims pending in the New York Courts. Names such as Bank of America and Wells Fargo also have double digit billions in claims pending against them that are now set to go to trial in the near future.
So when you hear people talking about settlements by the large banks with the SEC or various state attorneys general, remember that the real action in terms of legal risk remains the various types of investor claims against these banks, only one of which we have discussed today.