1. J.P. Morgan to Pay $153.6 Million to Settle SEC Charges of Misleading Investors in CDO Tied to U.S. Housing Market
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J.P. Morgan to Pay $153.6 Million to Settle SEC Charges
of Misleading Investors in CDO Tied to U.S. Housing
Market
Harmed Investors Getting Their Money Back, Firm to Pay Penalty and
Change Practices
FOR IMMEDIATE RELEASE
2011-131
Washington, D.C., June 21, 2011 – The
Securities and Exchange Commission today Tracking the
announced that J.P. Morgan Securities LLC Transaction
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.
In settling the SEC’s fraud charges against
the firm, J.P. Morgan also agreed to improve Full-size (PDF)
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 separately charged Edward S. Steffelin, who headed the team at
an investment advisory firm that the deal’s marketing materials
misleadingly represented had selected the CDO’s portfolio.
Additional Materials
SEC Complaint v. J.P. Morgan Securities LLC
SEC Complaint v. Edward S. Steffelin
“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,” said Robert
Khuzami, Director of the Division of Enforcement. “What J.P. Morgan 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 today’s settlement, harmed investors receive a full
return of the losses they suffered.”
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
http://www.sec.gov/news/press/2011/2011-131.htm[28-12-2011 20:01:19]

2. J.P. Morgan to Pay $153.6 Million to Settle SEC Charges of Misleading Investors in CDO Tied to U.S. Housing Market
market. Marketing materials stated that the Squared CDO’s investment
portfolio was selected by GSCP (NJ) L.P. – the investment advisory arm of
GSC Capital Corp. (GSC) – which had experience analyzing CDO credit risk.
Omitted from the marketing materials and unknown to investors was the
fact that the Magnetar Capital LLC hedge fund played a significant role in
selecting CDOs for the portfolio and stood to benefit if the CDOs defaulted.
The SEC alleges that by the time the deal closed in May 2007, Magnetar
held a $600 million short position that dwarfed its $8.9 million long
position. In an internal e-mail, a J.P. Morgan employee noted, “We all know
[Magnetar] wants to print as many deals as possible before everything
completely falls apart.”
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. The J.P. Morgan employee in charge of
Squared’s global distribution said in a March 22, 2007, e-mail that “we are
soooo pregnant with this deal, we need a wheel-barrel to move around. …
Let's schedule the cesarian (sic), please!” 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. These investors included:
Thrivent Financial for Lutherans, a faith-based non-profit membership
organization in Minneapolis.
Security Benefit Corporation, a Topeka, Kan.-based company that
provides insurance and retirement products.
General Motors Asset Management, a New York-based asset manager
for General Motors pension plans.
Financial institutions in East Asia including Tokyo Star Bank, Far Glory
Life Insurance Company Ltd., Taiwan Life Insurance Company Ltd.,
and East Asia Asset Management Ltd.
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. Of the $153.6 million total, $125.87 million will be
returned to the mezzanine investors through a Fair Fund distribution, and
$27.73 million will be paid to the U.S. Treasury. 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 subject to court approval.
In a separate complaint filed against Steffelin, who headed the team at GSC
responsible for the Squared CDO, the SEC alleges that Steffelin allowed
Magnetar to select and short portfolio assets. The complaint alleges that
Steffelin drafted and approved marketing materials promoting GSC’s
selection of the portfolio without disclosing Magnetar’s role in the selection
process. In addition, unknown to investors, Steffelin was seeking
employment with Magnetar while working on the transaction.
The SEC’s complaint charges Steffelin with violations of Sections 17(a)(2)
http://www.sec.gov/news/press/2011/2011-131.htm[28-12-2011 20:01:19]

3. J.P. Morgan to Pay $153.6 Million to Settle SEC Charges of Misleading Investors in CDO Tied to U.S. Housing Market
and (3) of the Securities Act and Section 206(2) of the Investment Advisers
Act of 1940. The SEC seeks injunctive relief, disgorgement of profits,
prejudgment interest, and penalties against Steffelin.
Separately, GSC’s bankruptcy trustee has consented to the entry of an
administrative order requiring the firm to cease and desist from committing
or causing violations or future violations of Sections 17(a)(2) and (3) of the
Securities Act and Section 204 and 206(2) of the Advisers Act and Rule
204-2 thereunder. GSC is in bankruptcy, and its settlement is subject to
approval by the bankruptcy court.
The SEC’s investigation was conducted by the Enforcement Division’s
Structured and New Products Unit led by Kenneth Lench and Reid Muoio.
The SEC investigative attorneys were Carolyn Kurr, Jason Anthony, Jeffrey
Leasure, and Brent Mitchell. The SEC trial attorneys that will handle the
litigation against Steffelin are Matt Martens, Jan Folena, and Robert Dodge.
For more information about dozens of other SEC enforcement actions
against misconduct related to the financial crisis, visit the SEC website at:
http://www.sec.gov/spotlight/enf-actions-fc.shtml
# # #
For more information about this enforcement action, contact:
Robert S. Khuzami
Director, SEC Division of Enforcement
(202) 551-4500
Lorin L. Reisner
Deputy Director, SEC Division of Enforcement
(202) 551-4787
Kenneth R. Lench
Chief of Structured and New Products Unit, SEC Division of Enforcement
(202) 551-4938
http://www.sec.gov/news/press/2011/2011-131.htm
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http://www.sec.gov/news/press/2011/2011-131.htm[28-12-2011 20:01:19]